Full text of Review (Federal Reserve Bank of St. Louis) : January 1982

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

The R e v ie w i.s published 10 times per year by the Research Department o f the Federal Reserve
Bank o f St. Louis. Single-copy subscriptions are available to the public free o f charge. Mail
requests fo r subscriptions, back issues, or address changes to: Research Department, Federal
Reserve Bank o f St. Louis, P.O. Box 442, St. Louis, Missouri 63166.
Articles herein may be reprinted provided the source is credited. Please provide the Bank’s
Research Department with a copy o f reprinted material.




Potential Output and the Recent
Productivity Decline
JOHN A. TATOM

X ^ ) T E N T I A L o u tp u t re fe r s to th e rea l g ro ss
n ation al p r o d u c t (G N P ) that is p r o d u c e d i f the
e c o n o m y operates u n der h ig h -e m p lo y m e n t c o n d i­
tio n s. M ea su res o f p o te n tia l ou tp u t d e p e n d on
m easures o f available resou rces, such as capital and
labor, and re lia b le estim ates o f the rela tion sh ip
b e tw e e n national output and the e m p lo y m e n t o f
resou rces.
S in ce 1973, the grow th o f p rod u ctivity (m easured
as ou tput p er unit o f labor) has s lo w e d substantially
(see chart 1), raising d o u b t a bou t the relation sh ip o f
inpu t to ou tput and, th erefore, the m easu rem en t of
the n ation ’ s poten tial G N P . T h is issu e is o f co n s id e r­
a ble im portan ce as it bears on the traditional con cern
o v e r the d e g re e of resou rce u n deru tilization and the
a ssociated ou tput losses in the e co n o m y . An accurate
assessm ent o f poten tial output is essential to d ete r­
m in e the e x p e cte d gain in ou tput from a p o lic y in­
te n d e d to a ch ie v e full em p loy m en t. T h e relation sh ip
b e tw e e n resou rce su p p lies and poten tial output also
is im portant in analyzin g the ou tp ut gain from su p ­
p ly -sid e p o licie s to increase the su pp ly o f resou rces
through in crea sed w ork, saving and investm en t.

dram atically sin ce 1978, it is im portant to verify that
the ea rlie r e m p irica l results are co n s iste n t w ith
recen t p rod u ctivity e x p e rie n ce , as w e ll as to assess
the im pa ct o f this sh ock on poten tial G N P . A lso,
recen t revision s o f the G N P a ccou n ts incorporate
n e w inform ation on ou tp ut and in v o lv e som e c o n ­
ceptu al chan ges that req u ire revision s in potential
G N P m easures. In ad d ition , sin ce 1977 som e m o d i­
fications have o cc u rr e d in the m eth od s u sed b y this
Bank to m easure poten tial output. T h e revision s and
m od ification s are d e s c rib e d b e lo w .

ENERGY PRICE SHOCKS AND
PRODUCTIVITY

T h is B ank’ s m easure o f p oten tial ou tp ut differs
from others in that it p rovid es d irect estim ates o f the
effects o f lab or force grow th, capital accum ulation
and ch an ges in the relative cost o f en erg y resou rces
on p rod u ctivity and e c o n o m ic ca p a city .1 T h e stabil­
ity of the in p u t-ou tpu t relation sh ip on w h ich this
m easure is b ased, and its ability to fully a ccou n t for
the unusual p rod u ctiv ity d ev elop m en ts d urin g the
last d e ca d e , p r o v id e d su p p ort for the cr e d ib ility
o f past estim ates. S in ce en erg y costs have in crea sed

A sharp in crease in the relative p rice o f en erg y
causes a red u ction in the ou tput (p rod u ctiv ity ) of
existin g labor and capital resou rces, or e c o n o m ic
capacity. T h e particular ch a n n els through w h ich this
ch a n ge occu rs vary from firm to firm, but in clu d e
ch a n gin g p ro d u ctio n m eth od s to re d u ce the use o f
h ig h er-cost en erg y, the clo s in g o f plants re n d e re d
u n p ro fita b le , r e d u c e d op tim a l and actual u se of
existin g facilities, and the d iv e rsio n o f labor and
capital resou rces to uses that e c o n o m iz e on h igh erco st en ergy. T h e s e ch an ges result in less output
b e in g p ro d u ce d d e sp ite an in itially u n ch a n g ed avail­
ability of d o m e stic capital and lab or resou rces. As a
result, m easures o f p rod u ctivity such as ou tput p er
w orker, p er hour, or p er unit o f capital, d e clin e . T h e
rise in e n erg y p rice s also in d u ce s a p ercen ta ge in ­
crease in the nom inal p rices o f ou tput eq u a l to the
p ercen ta ge d e clin e in p ro d u ctiv ity or poten tial out-

'T he original measures used by this Bank and the methods oi their
construction are explained in Robert H. Rasche and John A.
Tatom, “ Energy Resources and Potential GNP,” this Review
(June 1977), pp. 10-24. The theoretical basis for the energy price
effect is developed in Robert H. Rasche and John A. Tatom, “ The
Effects of the New Energy Regime on Econom ic Capacity Pro­
duction and Prices,” this Review (May 1977), pp. 2-12. These

hypotheses are further elaborated, and international evidence
supporting them are presented in Rasche and Tatom, “ Energy
Price Shocks, Aggregate Supply and Monetary Policy: The
Theory and International Evidence,” in Karl Brunner and Allan
H. M eltzer, eds., Supply Shocks, Incentives and National
W ealth, C arnegie-R ochester C on feren ce Series on Public
Policy, Vol. 14 (1981), pp. 9-93.




3

FEDERAL RESERVE BANK OF ST. LOUIS

JANUARY 1982

C h a rt 1

Output per Hour (Private Business Sector)
1972 d o l l a r s

L a te s t d a t a p lo tte d : 3 rd q u a rte r

put, s in c e less ou tp u t is p r o d u c ib le tor a g iv e n
s u p p ly of m on ey.
In a dd ition , the d e c lin e in p rod u ctivity shifts the
d em an d for labor and capital resou rces d ow n . In the
short run, th ese shifts are reflected in a fall in the real
w ages o f w orkers and a d e c lin e in th e va lu e o f exist­
in g plan t and e q u ip m e n t relative to its rep la cem en t
cost. O v er a lon g er p e rio d , the capital stock available
p er w orker w ill d e clin e from the le v e l that w o u ld
oth erw ise have o ccu rred , so that the long-run d e ­
c lin e in p oten tia l output, labor p rod u ctiv ity and real
w ages is larger than the initial d e clin e .
T h e effe ct o f a rise in the relative p rice o f en erg y
on p rod u ction is m a n ifested in a p rod u ction fu n ction
approach through red u ction s in inputs (esp ecia lly



1972 d o l l a r s

S o u rc e : U.S. D e p a rtm e n t o f L a b o r

r e d u c e d e n e r g y u s a g e ), o r th ro u g h c h a n g e s in
p ro d u ctiv e e ffic ie n c y or ca p acity that are “ d is e m ­
b o d ie d ,” that is, n ot a sso cia te d w ith ch a n g e s in
the use o f p h y sica l inputs such as labor, capital or
en ergy. E arlier studies have p r o v id e d an u n b ia sed
estim ate o f the e ffe c t o f a rise in the relative p rice o f
en e rg y on ou tput that supports the e n e rg y p rice /
e c o n o m ic cap acity h y p o th e sis.2 B efore re-exam in in g
2An elaborate review o f other analyses o f energy price effects on
the econom y is presented in Rasche and Tatom, “ Energy Price
Shocks, Aggregate Supply,” pp. 16-33. A more recent critique
o f the analysis here is Ernst R. Berndt, “ Energy Price Increases
and the Productivity Slowdown in United States Manufactur­
ing,” Federal Reserve Bank o f Boston, The Decline in Produc­
tivity Growth, Conference Series No. 22 (June 1980), pp. 60-89.
Berndt finds no effect o f higher energy prices on manufactur­
ing productivity, in contrast to the evidence in John A. Tatom,

JANUARY 1982

FEDERAL RESERVE BANK OF ST. LOUIS

the p rod u ction fu n ction estim ates, h ow ev er, it is
u sefu l to re v ie w recen t revision s in the data series
u sed to estim ate potential G N P.

THE RECENT GNP AN D CAPITAL
STOCK REVISIONS
From tim e to tim e, the U.S. D ep artm en t o f C o m ­
m e r c e a n n o u n c e s m a jor r e v is io n s in th e G N P
accou n ts b a sed on n ew sou rce data, n e w estim ating
p ro ce d u res and d efin ition al or con cep tu a l ch anges.
T h e latest rev ision w as p u b lis h e d in D e c e m b e r
1980.3
T h e basis o f the recen t rev ision was n ew inform a­
tion from the 1972 inp u t-ou tpu t tables, the 1977
e c o n o m ic cen su ses o f various industries, and in for­
m ation from the 1973 and 1976 T axpayer C o m p li­
a n ce M ea su rem en t Program . In a ddition , G N P was
r e d e fin e d to in c lu d e th e re in v e s te d ea rn in gs o f
in corp ora ted foreig n affiliates o f U.S. d irect in v e s­
tors and to e x clu d e th ose o f in corp ora ted U.S. affil­
iates of foreign d irect investors. T h e red efin ition
o f G N P prim arily affects th e m easu re o f in c o m e
origin ating in the rest o f the w orld , w ith little effe ct
o f the m ea su rem en t o f ou tp u t from the n ation ’ s
private sector.
A n oth er im portant part o f the revision was in gross
private d o m e stic investm ent. T h e rev ision o f this
m easu re was largely d u e to re v is e d estim ates o f
p r o d u ce r d u rab le e q u ip m e n t in vestm en t. At the
sam e tim e, a con cep tu a l ch an ge occu rred , shifting
the ou tput and investm en t in h otels and m otels from
the residen tial to the n on resid en tial sector. E x ce p t
for the treatm ent o f re in v e s te d earn in gs abroad,
h o w e v e r, the revision s of G N P prim arily affect data
b e g in n in g in 1968.
“ The Productivity Problem,” this Review (September 1979), pp.
13-14. Unfortunately, as Berndt notes, a major share of energy
resources is classified as raw materials in his data set, and his
analysis can be easily extended to show that most of the
productivity decline he analyzes is due to an increase in the
relative price of these “ raw materials.” Berndt also claims to
show that an observed decline in the value of claims on existing
physical capital relative to the replacement cost, as hypothesized
above, is also not explained by energy price increases. His
theoretical analysis is flawed by the omission o f a significant
output effect that substantially raises the magnitude o f his esti­
mate o f the effect of higher energy prices on the value o f existing
capital.
3For a discussion o f these revisions, see Keith M. Carlson, “ Re­
cent Revisions o f GNP,” this Review (March 1981), pp. 27-32; and
“ The National Income and Product Accounts of the United
States: An Introduction to the Revised Estimates for 1929-80,”
Survey o f Current Business (D ecem ber 1980), pp. 1-26.




Table 1

Revisions in Real Net Capital Stock and
Private Business Sector Output
(selected years)1

Year

Upward revision
of capital stock at
beginning of year

Upward revision
of private
business sector output

1950

2.1%

0.3%

1955

2.0

0.6

1960

1.8

0.5

1965

2.9

0.2

1970

2.9

0.2

1975

4.9

2.8

1Figu res are the percentage increase of 1980 revised data over
data available in 1977.

T h e n e w sou rce inform ation a ffected m easures o f
the n ation ’ s capital stock as w e ll, e sp e cia lly after
1967. T h e reclassification o f h otel and m otel capital
stocks is the prim ary sou rce o f ch an ges in the m ea­
sures p rior to 1967. W h ile the le v e l o f the n ation’ s
n et n o n resid en tia l private capital stock (constant
p rices) was raised b e ca u se o f these ch a n ges, the
grow th rate was ch a n g e d very little p rior to 1973. F or
e xa m p le, the re v ise d data sh ow a 4.2 p e rce n t annual
rate o f grow th from 1948 to 1968, the same as earlier
data. F rom 1968 to 1973, the re v is e d data indicate
grow th o f the n et capital stock at a 4.4 p ercen t rate,
up from 4.0 p e rce n t in the earlier data. From 1973 to
1978, the rev ised capital stock sh ow s that capital
form ation s lo w e d to a 3.1 p ercen t rate. E arlier data
sh ow the sam e exten t o f s lo w in g in capital form ation
to a 2.7 p e rce n t rate from 1973 to 1978. As a result,
the co n c lu s io n o f earlier research that capital form a­
tion slo w e d s u b se q u e n t to 1973, e sp e c ia lly w h e n
m easu red relative to labor fo rce grow th, has b e e n
u n affected b y the revisions. T h e rate o fg r o w th o fth e
capital stock, h o w e v e r, has b e e n som ew h at faster
sin ce 1968 than earlier estim ates s h o w e d ; this co u ld
affect earlier estim ates o f inpu t-outpu t relationships.
T a b le 1 sh ow s the exten t of b o th the u pw ard rev i­
sion o f the con stan t-dollar net stock o f fixed n o n re si­
dential private capital at the b e g in n in g o f the year
and the private b u sin ess sector ou tput for data u sed
in 1977 as co m p a re d w ith the recen t revision s. T h e
capital stock has b e e n re v ise d upw ard relatively
m ore than output.

5

FEDERAL RESERVE BANK OF ST. LOUIS

JANUARY 1982

THE PRODUCTION FUNCTION
T h e basis of this Bank’ s poten tial ou tput estim ates
is a p rod u ction fu n ction for private b usin ess sector
(PBS) output that relates output to hours o f e m p lo y ­
m ent, the utilization o f capital, and en ergy. A va il­
able m easures o f en erg y ten d to b e b rok en d o w n b y
types o f users, such as residen tial, com m ercia l and
industrial. N o en erg y m easures exist that are d e ­
tailed b y p rod u ction vs. con su m p tion use b y h o u se ­
h old s, or b y p ro d u cin g sectors lik e the m an ufac­
turing and private b u sin ess sector. S in ce en e rg y
m easures co m p a tib le w ith existin g data on sectoral
ou tput and em p loy m en t o f lab or and capital d o not
exist, a “ first-order c o n d itio n ” for en erg y e m p lo y ­
m en t is u s e d to elim in ate the quantity o f en erg y from
th e p r o d u c t io n fu n c t io n , r e p la c in g it w ith th e
relative p rice o f en ergy. Form ally, th e estim ated
eq u a tion is o f the form ,

Table 2

Indirect Least Squares Estimation of a
Cobb-Douglas Production Function
Production Function: Xt = A h“ kf Et
where X
h
k
E
A
a, f3, y

ert,

=
=
=
=
=
=

output
hours of all persons
utilized capital stock
energy input
scale factor
output elasticity of hours,
capital, and energy, respectively
= trend growth rate per year or
per quarter
= time period

r
t

First-Order Condition for Energy: Pe/P = yX/E,

( 1 ) In X t = /8o + /8iln ht + y8oln kt + /J3I11 (Pe/P)t + /3-tln t,

w h e re X t is PBS ou tput in p e rio d t, ht is hours o f all
person s, kt is the u tilized n et n on resid en tial capital
stock (constant p rices), the p rod u ct o f the F ed eral
R eserve Board m anufacturing ca p acity utilization
rate and the capital stock in p la ce at the e n d o f p e rio d
t-1, and P e/P is the relative p rice o f en erg y, fou n d b y
d eflatin g the p ro d u ce r p rice ind ex for fuel, p o w e r and
related p rodu cts b y the im p licit p rice deflator for
private b usin ess sector output. T h e t term is a tim e
trend in ten d ed to capture the rate o f te ch n o lo g y
ch a n ge. W h en eq u a tion 1 is d e riv e d from a C o b b D ou glas p rod u ction fu n ction , the /3s in eq u a tion 1
are related to the ou tput elasticities o f the inputs, as
sh ow n in table 2.

where Pe/P = the price of energy relative to the
price of output

Linear model: In Xt

=

In A
-

CL
+ t—

1-7

l-y

In ht

+

B
-r—

l-y

In kt

+

rt

In (Pe/P),

Estim ates o f the annual p ro d u ctio n fu n ction u sing
the rev ised data for the p eriod s 1949-73, 1949-75 and
1949-80 are sh ow n in table 3.4 T h ere are three n o te ­
w orth y revisions in the estim ates. First, the co e ffi­
cie n t on the relative p rice o f en erg y and estim ate
o f the ou tp u t ela sticity o f e n e rg y are sm aller in
a bsolu te value, th ou gh not in a statistically signifi­
cant sen se, w ith the n e w m easures o f ou tput and

capital. In the earlier estim ation for 1949-73 and
1949-75, y is 11.7 p e rce n t (t = 1.92) and 12.0 p ercen t
(t = 5.66), re sp e ctiv e ly . S e co n d , the autocorrelation
adjustm ent, p, is sm aller than b e fo r e (0.63 for the
1949-75 p eriod ). F inally, the estim ates for the p e rio d
1949-73 are e v e n c lo s e r to th ose for the lo n g e r
sam ple p e rio d s than they are w ith the earlier esti­
m ates. In the e a rlie r e s tim a tio n s, th ere are n o
significant d iffe re n ce s in the co e ffic ie n t estim ates
across p e rio d s, b u t r is 1.2 p e rce n t p er year and a is
58.9 p e rce n t in the 1949-73 sam p le p e rio d ; th ese are
1.6 p e rce n t and 64.9 p ercen t, re sp e ctiv e ly , in the
earlier estim ation for the 1949-75 sam p le p e rio d .

4The ordinary least squares (OLS) estimates of the coefficients in
table 3 are virtually identical but the Durbin-Watson statistics
are 1.28, 1.35, and 1.37 for the 1949-73, 1949-75, and 1949-80
periods, respectively. To check whether this autocorrelated
error pattern results from the omission of significant lagged input
effects on output, one and two period lags on the input variables
are added to the equations in table 3 and their OLS counterparts.
When this is done, the coefficients are not significant, the
Durbin-Watson statistic does not change and the estimate of p
shown in table 3 is not reduced.

An im portant h yp oth esis that was su p p orted in
earlier w ork is re je cte d u sin g th e re v ise d data. A
slo w in g in the tim e trend for te ch n o lo g ica l ch a n ge
b e g in n in g in 1967 c o u ld not b e re je cte d earlier. F or
all three sam ple p e rio d s in table 3, this h yp oth esis
is rejected . A tim e-tren d variable w ith a va lu e o f zero
to 1966, then in crea sed b y on e each year from 1966
on, was a d d ed to each eq u a tion estim ated in table 3.
T h e t-statistics for the s lo w e r trend variable are




FEDERAL RESERVE BANK OF ST. LOUIS

JANUARY 1982

Table 3

Production Function Estimate for the
U.S. Private Business Sector
1949-73

1949-75

1949-80

0o

1.3440
(3.78)

1.4663
(10.70)

1.4971
(13.25)

01

0.6885
(12.53)

0.7302
(13.25)

0.7201
(13.07)

02

0.3115
(5.67)

0.2698
(4.90)

0.2799
(5.08)

03

-0.07 04
(-1.00 )

-0.08 75
(-3 .9 6 )

-0.09 53
(-6 .2 2 )

04

0.0168
(7.84)

0.0182
(9.69)

0.0177
(9.48)

a

0.6432
(9.57)

0.6715
(14.30)

0.6574
(14.58)

0

0.2910
(5.27)

0.2481
(4.64)

0.2555
(5.31)

y

0.0658
(1.07)

0.0805
(3.96)

0.0870
(6.81)

t

0.0157
(6.11)

0.0167
(10.24)

0.0162
(10.36)

R2

0.97

0.97

0.97

SE

0.0091

0.0099

0.0102

DW

2.03

1.93

1.93

P

0.44

0.39

0.39

- 1 .6 7 , - 1 .5 0 , and - 1 .4 1 , for the 1949-73, 1949-75,
and 1949-80 p eriod s, resp ectiv ely . T h e slow in g is
n ot statistically significant at a 5 p ercen t le v e l in any
o f these p e rio d s .5 In ad d ition , a test for an optim al
p o in t for a trend break u sin g a m in im u m standard
error criterion fails to reveal a p oin t su perior to 1967.
T h ere is n o e v id e n c e then for a s lo w d o w n in p r o d u c ­
tivity grow th d u e to d is e m b o d ie d factors in flu en cin g
the trend.
T h e n ew estim ates d o n ot alter any o f the other
earlier co n clu s io n s . In particular, the status o f a n u m ­
b e r o f h yp oth eses tested earlier has b e e n u n ch a n g ed
b e ca u se o f the ch anges in the private b u siness sector
co n ce p ts and the n e w m easures. F or exa m p le, tests
o f the C o b b -D o u g la s restriction y ie ld the rejection
o f a translog sp ecifica tion o f the p rod u ction fun ction .

’ This result held before the recent revisions as well. See Rasche
and Tatom, “ Energy Price Shocks, Aggregate Supply,” p. 25.




T h e ou tput elasticity o f hours d u rin g the three
p eriod s is n ot significan tly d ifferen t from the share
o f la b o r in total co sts d u rin g e a ch o f th e th re e
p eriod s. T h is is extrem ely im portant as the C o b b D ou glas p ro d u ctio n fu n ction im p lies a p rice elastic­
ity for e n e rg y d em a n d that m ay b e b ia se d upw ard.
W h ile this w o u ld n ot y ie ld a bias in the estim ated
effe ct o f e n erg y p rices on output, it w o u ld y ie ld an
u p w a rd -b ia sed estim ate o f yand a d o w n w a rd -b ia se d
estim ate of a. T h ere is no e v id e n c e o f such a bias.
T h e t-statistics for the e q u a lity o f the a estim ate and
the actual share o f labor in ea ch p e rio d are —0.22,
0.27, and —0.08, re sp e ctiv e ly , so that the h yp oth esis
that a is equal to the actual share o f lab or can n ot
b e rejected .
O th er factors that failed to add significan tly to
th e p r o d u c tiv ity re la tio n s h ip s e stim a te d e a rlie r
c o n t i n u e to b e i n s i g n i f i c a n t . T h e s e i n c l u d e
adjustm ents for p o llu tio n abatem en t capital and the
ch a n gin g p rop ortion s o f y o u n g p e o p le (age 16-19) or
w o m e n in the labor force.
F in ally, it rem ains the case that p re-19 74 p ro d u c­
tion fu n ction estim ates that om it e n erg y d e v e lo p ­
m ents break d o w n after 1973. W h en the 1949-73
m o d e l is estim ated w ith ou t the relative p rice o f
en erg y, the standard error o f the equ ation is iden tical
to that sh ow n in table 3. W h en the sam ple p e rio d is
ex te n d e d to 1975 and 1980, the standard error o f the
equation w ith ou t e n erg y rises to 1.24 p e rce n t and
1.37 p ercent, re sp e ctiv e ly . T h e C h o w test indicates
that a significant ch a n ge in the structure o f th e p ro­
d u ction fu n ction occu rs in each case w h e n e n erg y is
om itted and the sam ple p e r io d is len g th en ed . As the
stability o f the standard errors in table 3 indicates,
such structural ch a n ges can b e rejected u sing the
C h o w test w h e n e n e rg y p rice s are in clu d e d .
An estim ate o f the p ro d u ctio n fu n c tio n u sin g
quarterly data from 11/1948 to III/19 8 1 is:
(2) hi X, = 1.4688 + 0.7.351 In h, + 0.2649 hi kt
(21.03) (23.81)
(8.58)
- 0.0893 ln (P e /P )t + 0.0045 t

(-8 .3 1 )

(16.94)

R2 = 0.99

SE = 0.0074

DW = 1.96

p = 0.76

a =0.6748

= 0.2432
(10.22)

y = 0.0820

f = 0.0041
(18.41)

(26.09)

(9.05)

T h e estim ated co e fficie n ts are essen tially the sam e
as th ose in table 3. T h is quarterly p ro d u ctio n fu n c-

7

FEDERAL RESERVE BANK OF ST. LOUIS

tion is u sed b e lo w to d erive the rev ised poten tial
ou tp ut series. T h e stability and all oth er p rop erties
d iscu s s e d a b ov e for the annual eq u a tion s in table 3
a p p ly to the quarterly estim ates as w ell.
T h e im pact o f a ch a n ge in the relative p rice o f
e n e rg y on output, p rod u ctivity, real w a ges, and the
capital stock can b e a ssessed u sin g the p rod u ctio n
fu n ction estim ate in eq u a tion 2. F o r a giv en e m p lo y ­
m en t o f la b or hours and capital services (the shortrun e ffect), a 10 p e rc e n t rise in the relative p rice o f
e n e rg y re d u ce s PBS ou tp u t (X t) and p rod u ctivity b y
0 .8 9 p e rc e n t. T h e lo n g -r u n e la s tic ity o f ou tp u t,
labor p rod u ctivity, real w a ges, and the capital stock
is ( ~ y lot), or 0.122 in this ca se.6 T h u s, a 10 p ercen t
rise in the relative p rice o f e n erg y leads to a long-run
d e clin e in output that is 36 p e rce n t larger than in the
sh ort ru n . In p a rticu la r, a 10 p e r c e n t in c r e a s e
re d u ces output, p rod u ctivity and the capital-labor
ratio b y 1.22 p ercen t. From the third quarter o f 1973
to th e third quarter o f 1974, and, again from the
first quarter o f 1979 to the s e co n d quarter o f 1980,
the relative p rice o f en erg y rose 40 p e rce n t.7 G iv e n
the estim ates a b ov e, ea ch sh ock re d u ce d p ro d u c­
tivity and poten tial ou tput b y 3.6 p e rce n t in the short
run and 4.9 p e rce n t after adju stm en t o f the m arket
for capital good s.

REVISED MEASURES OF POTENTIAL
OUTPUT
T o d eterm in e p oten tia l real G N P , m easures o f
p oten tial em p lo y m e n t o f lab or and capital are u sed
to con stru ct potential private b u sin ess sector output.
O th er com p on en ts o f real G N P that are n ot sensitive
to c y c lic a l m o v e m e n ts in o u tp u t a n d are in d e ­
p e n d e n t o f the em p loy m en t o f labor are then a d d ed
to obtain potential G N P . T h e latter co m p on en ts are
the ou tp u t o rig in a tin g in th e rest o f the w o r ld ,
g e n e ra l g o v e rn m e n t, h o u s e h o ld s and n o n -p ro fit
institutions.

6See John A. Tatom, “ Energy Prices and Capital Formation: 197277,” this Review (May 1979), pp. 2-11, for an explanation and
derivation of this result.
’ Note that percentage changes are measured by the change in the
logarithm of the relative price of energy. The exact magnitudes
over the two periods are 40.7 percent and 40.3 percent, which
measured as actual percentage increases are 50.2 and 49.6 per­
cent, respectively. The relative price of energy rose another
12 percent in the first half of 1981 due to the immediate effects
o f domestic crude oil decontrol, but subsequent adjustments
in the world market due to decontrol took 2.8 percentage points
off this in the third quarter o f 1981 alone.

Digitized for8 FRASER


JANUARY 1982

T h e d evia tion o f actual from p oten tial e m p lo y ­
m e n t o f th e n a t io n ’ s ca p ita l s to ck is b a s e d on
an ob se rv a tio n that at peak p e rio d s in th e past,
the F ed era l R ese rv e B oard ca p acity u tilization rate
m easure has b e e n abou t 87.5 p ercen t. T h is b e n c h ­
mark is u sed in th e private b u sin ess sector p r o d u c ­
tion fu n ction for full e m p lo y m e n t.8
T h e p oten tia l inpu t o f hours o f all p erson s e m ­
p lo y e d in the private b u sin ess sector is fo u n d b y
d eterm in in g p oten tial hours p e r w ork er and p o te n ­
tial e m p lo y m e n t. In ea ch case, actual m easures are
related to a m easure o f slack in the lab or market. This
slack m easure (U N ) is the u n e m p lo y m e n t rate o f the
civ ilia n lab or fo rce (U), m inus the fu ll-e m p lo y m e n t
u n e m p lo y m e n t rate o f the civ ilia n labor force (U F ),
w h ich was p rep ared in 1977 for the C o u n c il o f E c o ­
n o m ic A dvisers (U N = U — U F ).9 H ours p er w ork er
in the private b u sin ess sector are fou n d from the
regression o f hours p er w ork er on excess u n e m p lo y ­
m en t in the current and past quarter, a shift variable
(D ) to a ccou n t for the un u su ally h igh le v e ls o f hours
p e r w ork er from III/1961 to 11/1967, and a tim e
trend (t) to a ccou n t for a secu lar d e c lin e in hours p er
w ork er. F o r the p e r io d 11/1948 to III/1 9 8 1 , this
eq u a tion is:
(3) In HPW = 0.797 - 0.496 UN, + 0.177 UN,.i
(546.1) (-6.06)
(2.16)
- 0.0011 + 0.014 D
(-57.06)
(7.29)
R2 =0.99

Si: = 0.0032

DW = 1.89

p = 0.62

T h is eq u a tion has not b e e n ch a n g e d sin ce 1977,
e x c e p t for the a d d ition o f the significan t la g g e d slack
8It can be argued that, at these peaks, “ normal” operating con­
ditions for the nation’ s plant and equipment are not observed and
that, if demand were sustained, firms would increase investment
to lower operating rates to optima] levels. In this case an 87.5 per­
cent rate for the FRB capacity utilization rate overstates the
“ natural rate” o f capacity utilization. This argument has been
made in John A. Tatom, “ The Meaning and Measurement of
Potential Output: A Com ment on the P erloff and Wachter
Results,” in Karl Brunner and Allan H. Meltzer, eds., Three
Aspects o f Policymaking: Knowledge, Data and Institutions,
Camegie-Rochester Conference on Public Policy, volume 10
(1979), pp. 165-78. The benchmark is supported by comparative
movements in “ excess” unemployment o f the civilian labor
force and the capacity utilization rate. When the capacity utiliza­
tion is regressed on the excess unemployment rate described in
the text below over the period I/1955-II/1981, the constant is
86.2 percent with a standard error o f 0.78 percentage points
when a significant lagged unem ployment rate is included.
9This data series and its developm ent is described by Peter K.
Clark, “ Potential Output in the United States 1948-80,” U.S.
Productive Capacity: Estimating the Utilization Gap (Washing­
ton University: Center for the Study o f American Business,
Decem ber 1977), pp. 21-66.

FEDERAL RESERVE BANK OF ST. LOUIS

JANUARY 1982

term .10 T h e sum o fth e slack term s, - 0 .3 2 , is virtually
iden tical to the sin gle con tem p ora n eou s term in the
earlier estim ates, so that o n ly the tim in g o ft h e c y c li­
cal e ffe c t has b e e n ch a n ged . Potential hours per
w orker is fou n d from the p re d ic te d valu es of eq u a ­
tion 3 w ith the slack variable set at zero in the current
and past quarter.
P oten tia l e m p lo y m e n t in th e private b u sin e ss
sector is fou n d in a sim ilar m anner. In particular, the
logarithm o f private b u sin ess sector e m p lo y m e n t (In
E M t) is regressed on a constant, a tim e trend (T), e x ­
cess u n e m p lo y m e n t in the current and past quarter,
and a trend shift variable (T 2) to a ccou n t for a shift
in the trend rate o f grow th o f the lab or force after
1964. T h is particular break in trend was ch ose n
on the basis o ft h e lo w e st standard error o ft h e eq u a ­
tion. A break in trend is in c lu d e d to im prove the
e fficie n cy o ft h e estim ation o ft h e coefficien ts for the
sla ck v a r ia b le s . T h e e q u a tio n fo r th e 11/1948III/1981 p e rio d is:
(4) In EM = 3.94 + 0.002 T + 0.004 T2
(371.63) (7.21)
(9.59)
- 0.013 UN, - 0.003 UNu
(-1 1.03 )
(-2 .6 3 )
“R- = 0.91

SE = 0.0046

DW = 1.87

p = 0.92

W h en this equation is d ifferen ced , the autoregressive
distu rban ces d isap p ear (the D u rbin -W atson statistic
w ith o u t first-order a u tocorrela tion adju stm en t is
1.89), and the coefficien ts for the trend, break in
trend, and slack variables are virtually iden tical. T o
find potential e m p lo y m e n t in the private b u siness
sector, the actual le v e l o f em p lo y m e n t is cy clic a lly
adju sted b y (0.13 U N t + 0.003 UN,.]) p ercen t, a cco r d ­
in g to the lev el and first-d ifferen ce eq u a tion s.11

10This equation was explained in Robert H. Rasche and lohn A.
Tatom, “ Potential Output and Rs Growth Rate — the D om i­
nance o f Higher Energy Cost in the 1970’s,” U.S. Productive
Capacity: Estimating the Utilization Gap (Washington Uni­
versity: Center for the Study o f American Business, Decem ber
1977), pp. 76-77. The unusual shift in hours per worker in the
'60s has also been noted by George L. Perry, “ Potential Output
and Productivity,” Brookings Papers on Econom ic Activity
(1:1977), pp. 11-47. Tests o f additional lagged values ofthe excess
unemployment rate found them to be insignificant.
“ The effect of a one percent rise in the excess unemployment rate
on PBS employment should be roughly a percent decline equal
to the ratio o fth e civilian labor force to PBS unemployment.
This may be derived from the relation that PBS employment is
(1 — U) LF — NE, where U is the unemployment rate ofth e
civilian labor force (LF), and NE is non-PBS employment,
measured by the difference in civilian employment and PBS
employment. The actual ratio ofth e labor force to PBS employ-




T his m e th o d o f d e te rm in in g p oten tial e m p lo y ­
m en t differs from the o n e this Bank u sed earlier.
U ntil re c e n tly , p o te n tia l PBS e m p lo y m e n t was
fou n d b y subtracting the le v e l o f current e m p lo y ­
m en t ou tsid e the private b u sin ess sector from p o te n ­
tial civ ilia n e m p lo y m e n t [(1 — U f ) tim es the civilian
labor force]. T h e form er was equated to the d ifferen ce
in actual civ ilia n e m p lo y m e n t and PBS e m p lo y m e n t.
T h is m eth od had tw o m in or sh ortcom in gs. First,
p e r io d ic cen su s revision s and ch a n ges in sam plin g
and estim ation m eth od s alter the civilia n lab or force
and e m p lo y m e n t data, sligh tly a ffectin g a m easure
such as the a b o v e and an a cco m p a n y in g m easure of
poten tial output. S e co n d , this e m p lo y m e n t m easure
was som ew h at cy clic a l, d e sp ite the a b se n ce o f any
perm an ent cy clic a l effects on the civilian labor force
m easure. T h e reason for this appears to b e that PBS
e m p lo y m e n t and civ ilia n e m p lo y m e n t data are esti­
m ated b y d ifferen t m eth od s, and their d iffe re n ce
is c y c lic a l.12
B e v ise d quarterly estim ates of poten tial real G N P
are p resen ted in the a p p en d ix to this article. T h e se
data as w e ll as actual real G N P are sh ow n in chart 2.
T h e grow th rate o f this re v is e d p oten tia l ou tput
series has b e e n u n ch a n g e d for past p eriod s. T h e
average grow th rate o f poten tial ou tp u t was 3.7 p e r­
ce n t from 1949 to 1973, the same as in the original
estim ates. T his rate has varied som ew h at in the past,
h o w e v e r, largely re fle ctin g d iffe re n ce s in the grow th
rate o f the labor force. F or exam p le, from 1951 to
1963, p oten tial ou tput grew at a 3.3 p e rce n t rate
w h ile the civ ilia n labor fo rce grew at on ly a 1.2 p e r­
ce n t rate. Potential ou tp ut grow th a ccele ra te d to a
4.0 p e rce n t rate from 1963 to 1973, as labor force
grow th a ccele ra te d to a 2.1 p e rce n t rate.
S in ce 1973, the p oten tial grow th rate has averaged
3.1 p e r c e n t d e s p ite a la b o r fo r c e gro w th o f 2.4
p ercen t. T h e potential ou tput grow th rate has b e e n
as high as 5.0 p e rce n t in 1977-78. T h e annual grow th
rate o f poten tial ou tput in 1974 and 1980 was o n ly
2.0 p ercen t; in 1975, this grow th rate w as o n ly 2.6
p ercen t. T h e se rela tively s lo w rates reflect the im pact

ment in the sample period has a mean ol 1.26. The remainder is
due to cyclical variation in non-PBS employment that does not
affect non-PBS output.
12The difference between establisment-based payroll measures
o f employment and households-sampling-based civilian employ­
ment measures is procyclical so that the old method resulted in a
measure o f potential PBS em ploym ent that was inversely
related to excess unemployment. This cyclical difference is
discussed by Alexander Korns, “ Cyclical Fluctuations in the
D ifference Between Payroll and Household Measures of Em­
ployment,” Survey o f Current Business (May 1979), pp. 14-44.

9

FEDERAL RESERVE BANK OF ST. LOUIS

JANUARY 1982

C h a rt 2

Real GNP
B il li o n s of 1972 d o l l a r s

Latest d a ta p lo tte d : 3 rd q u a rte r

o f sharp in creases in the relative p rice o f en e rg y
resou rces.
T a b le 4 sh ow s the annual averages o f recen t le v e ls
o f p oten tial G N P togeth er w ith recen t estim ates b y
th e C o u n c il o f E c o n o m ic A d v isers (C E A ).13 T h e
C E A estim ates range from 1.4 p e rce n t b e lo w to 1.0
p e rce n t a b ov e those p resen ted here. T h e p ercen tage
d iffe r e n ce b e tw e e n the tw o m easures is virtually
the same in 1973 as rep orted earlier, but the 1977
C E A estim ates for the p e rio d 1974-76 rose from
1.1 p ercen t larger to alm ost 3 p ercen t larger than this
Bank’ s estim ates. T h e tw o estim ates are now extrem e­
ly clo s e , largely d u e to m ajor revision s in the C E A
13See Council of Econom ic Advisers, Economic Report o f the
President, 1981.

10FRASER
Digitized for


B il li o n s of 1972 d o l l a r s

Source: U.S. D e partm ent o f C om m erce

estim ates re p o rte d in the Economic Report o f the
President in 1977 and 1978. T h e se revision s p u s h e d
the 1973 level b e lo w that estim ated b y this Bank, but
then assu m ed a rou g h ly con stan t grow th rate that
w as faster in 1974-76, then slo w e r in 1976-79, than
that estim ated h ere. T h e C E A re p o rte d in 1981 that
p oten tial ou tp ut was e x p e cte d to grow at a 2.9 p e r­
ce n t rate in 1979 and 1980, then return to a 3.0 p e r­
ce n t rate.14
14The CEA estimate is apparently based upon the expectation that
the labor force will grow at a 1.75 percent rate, hours per
worker w ill decline at a secular rate o f 0.5 percent and that
potential productivity (output per hour) will rise at about a
1.75 percent rate. See Economic Report, 1980, pp. 89-90 and
Economic Report, 1981, pp. 180-81. Such a rate o f productivity
advance may appear optimistic in light o f the experience since
1978 or in 197.3-75. It should be noted, however, that potential

FEDERAL RESERVE BANK OF ST. LOUIS

JANUARY 1982

Table 4

Table 5

Recent Measures of Potential GNP
(billions of 1972 dollars)

Recent Productivity Developments
(compound annual rates)

1973

Potential GNP

CEA estimate

Ratio

$1,254.8

$1,234.9

98.3%

1974

1,279.7

1,277.5

99.8

1975

1,313.0

1,320.6

100.6

1976

1,351.8

1,365.1

101.0

1977

1,400.6

1,411.4

100.8

1978

1,470.0

1,459.3

99.3

1979

1,526.2

1,504.6

98.6

1980

1,556.2

1,548.5

99.5

T h e prim ary d iffe r e n ce sh ow n in table 4 is that the
C E A grow th rate o f poten tial ou tput o f 3.4 p erce n t
in 1973-76 e x ce e d s the 2.5 p e rce n t rate estim ated
h ere, w h ile its grow th rate for 1976-79 o f 3.3 p erce n t
is less than the 4.1 p e rce n t rate estim ated here. It
appears that, in recen t years, the C E A has sm ooth ed
its p oten tial ou tp ut series to capture the sharp su p p ly
shock effects on poten tial output b y lo w e rin g the
grow th rate o f potential ou tput over several years. As
a resu lt, the le v e ls o f p oten tia l ou tp u t h ave not
d iffe re d substantially. This d iffe re n ce is to an extent
intentional, as the C E A has always e m p lo y e d a given
grow th rate for lo n g p eriod s. T h is te n d e n c y has b e e n
te m p e red in recen t years, as can b e seen b y the slight
variability in the C E A annual grow th rate sh ow n in
table 4. It m ay b e that the 1980-81 p rod u ctiv ity losses
that re s u lt from e n e r g y s h o ck s w ill b e la r g e ly
re flected in the C E A ’ s use o f too slow a rate o f p o te n ­
tial grow th for the early 1980s.

RECENT ACTUAL AN D POTENTIAL
PRODUCTIVITY DEVELOPM EN TS
T h e sharp drops in poten tial output grow th in
1974-75 and 1980 reflect the e ffe c t o f m ajor en e rg y
p rice ch an ges on actual and p oten tial prod u ctivity.
output per hour, discussed in the next section, rose over fiveyear periods at no less than a 2.5 percent rate from 1948-73.
Following the implementation o f accelerated depreciation and
corporate tax cuts, the pace o f capital formation rose sharply so
that it surged to the post-World War II peak rate of 3.2 percent
from 196.3 to mid-1970. Even during 1978 potential productivity
growth had risen to over a 2 percent rate as the adjustment to
the prior energy shock was apparently approaching completion.
A repeat of that pattern and recent supply-side policies suggest
a more rapid pace o f productivity growth from 1982-85 than that
projected by the CEA.




IV/1948IV/1973

IV/1973IV/1980

Difference

Growth of output/hour

2.87%

0.67%

2.20

Potential growth rate

2.82

0.94

1.88

Cyclical factors

0.09

-0 .2 0

0.29

-0 .0 4

-0 .0 7

0.03

Residual factors
Contribution to potential
growth rate of:
Capital accumulation
(Growth in high-employment
capital-labor ratio)

0.92
(3.52)

Energy price changes

0.07

0.28
(1.04)
-1 .1 3

0.64
(2.48)
1.20

S in ce 1973, p ro d u ctiv ity ’ s abysm al p erform a n ce has
b e e n a m ajor co n ce rn for p olicym ak ers. Th u s, it is
u sefu l to detail the factors in flu e n cin g such grow th
o v e r the last seven years.15
A n analysis o f th e actual and p oten tial p rod u ctivity
d e c lin e for the private b u sin ess sector appears in
table 5, w h ere grow th rates and the con trib u tion o f
various factors are co m p a re d for tw o p eriod s: 1948 to
the en d of 1973, and 1973 to the e n d o f 1980. O utput
p er h ou r grew at a 2 .87 p e rce n t rate from IV /1948 to
IV /1973, th en s lo w e d to a 0 .67 p e rce n t rate o v e r the
next seven years. This grow th can b e an a ly zed in tw o
w ays. T h e first is to lo o k at the con trib u tion o f the
factors en terin g eq u a tion 2: the actual ch a n ges in the
grow th o f e m p lo y e d capital relative to labor, the
relative p rice o f en erg y, the p a ce o f te ch n o lo g ica l
ch a n ge, and residuals d u e to random errors o f fitting
the equ ation at the e n d points o f the p e rio d . T h e
se co n d , sh ow n in the top p an el o f table 5, is to break
d o w n actual p rod u ctivity grow th in ea ch p e rio d into
ch an ges d u e to the grow th o f p oten tia l p rod u ctivity,
ch a n ges d u e to cy clic a l variations in the e m p lo y ­
m en t o f capital and lab or at the b e g in n in g and e n d
p e rio d s, and d iffe re n ce s in the residu al or random
error co m p o n e n t o f equation 2.
15In contrast to Edward F. Denison, “ Explanations o f Declining
Productivity Growth,” Survey o f Current Business, (August
1979, part 2), pp. 1-24, the analysis here o f post-1973 productiv­
ity developments fully explains the productivity “ puzzle,”
while other explanations do not. See Tatom, “ The Productivity
Problem” or especially D enison’s paper for a discussion o f
these other factors. The puzzle is presumably all the more
challenging to other analysts due to the post-1978 cessation o f
productivity growth.

11

FEDERAL RESERVE BANK OF ST. LOUIS

JANUARY 1982

C h a rt 3

C ap ital Labor Ratio (Private Business Sector)
1972 d o l l a r s per w o r k e r

1972 d o l l a r s per w o r k e r

Sources: U.S. D epartm ent o f Lab or, a n d B o ard o f G overnors o f the Federal Reserve System
The p o te n tia l r a tio is th e c a p ita l sto c k a d ju s te d fo r an 8 7 .5 % c a p a c ity u t iliz a t io n r a te d iv id e d b y p o te n tia l h o u rs o f e m p lo y m e n t in th e p r iv a te
b u sin e ss s e cto r. The a c tu a l r a tio uses th e a c tu a l c a p a c ity u t iliz a t io n ra te a n d h o u rs o f e m p lo y m e n t in th e p r iv a te bu s in e s s s e c to r.
L a te s t d a t a p lo tte d : 3 rd q u a rte r

T h e con trib u tion o f cy clic a l factors accou n ts for
the d iffe re n ce b e tw e e n the p rod u ctiv ity effe ct o f the
grow th o f the p oten tial PBS ca p ita l-lab or ratio (the
con trib u tion o f the cap ital-labor ratio to poten tial
grow th) and the e ffe c t o f the actual grow th in the
utilization o f capital p er hour. T h e d iscrep a n cy b e ­
tw e e n the tw o arises from the cy clic a l variability o f
the ca p ital-labor ratio sh ow n in chart 3. T h e sum o f
the “ cy clic a l factor” and the con trib u tion o f “ capital
a ccu m u la tion ” to poten tial p rod u ctiv ity grow th in d i­
cates the estim ate o f the actual im pact o f m ovem en ts
in the o b se r v e d ratio o f u tilized capital to la b or hours
on the o b s e r v e d p rod u ctivity grow th.

12FRASER
Digitized for


M ost o f the 2.2 p e rce n ta g e -p o in t d e c lin e in p ro ­
d u ctivity grow th o v e r the last se v e n years has b e e n
d u e to factors that s lo w e d p oten tia l p ro d u ctiv ity
grow th. F or the particular com p a rison sh ow n , c y c li­
cal d iffe re n ce s b e tw e e n p ro d u ctiv ity m ovem en ts in
the tw o p e rio d s o r residu al errors a cco u n t for o n ly
0.3 p ercen tage points o f the o b s e r v e d slow in g.
In the lo w e r part o f the table, the factors co n trib ­
u tin g to the p oten tial p ro d u ctiv ity grow th s lo w d o w n
are sh ow n . W hat is om itted in the lo w e r part o f the
table is th e trend grow th o f total factor p rod u ctivity
w h ich con trib u ted 1.82 p ercen ta ge poin ts to the rate

FEDERAL RESERVE BANK OF ST. LOUIS

JANUARY 1982

C h a rt 4

Potential and A ctual Output per Hour (Private Business Sector)
1972 d o l l a r s

L a te st d a t a p lo tte d : 3 rd q u a rte r

of p rod u ctivity grow th in both p eriod s. T h e d irect
e ffe c t o f en erg y p rice shocks o v e r the last seven
years has b e e n to reverse the slight p ositive con tri­
b u tion o f en e rg y p rice d e clin e s o v e r the p rior 25
years, so that 1.20 p ercen ta g e p oin ts o f th e 1.88
p e rcen ta g e-p oin t-p er-y ea r d e clin e in p oten tial p ro­
d u ctivity grow th has b e e n d u e to this factor. T h e
re m a in d er has b e e n d u e to a s lo w in g in capital
form ation.
As n oted in parentheses, the grow th rate o f the
capital stock relative to p oten tia l hours o f e m p lo y ­
m en t was 3.52 p e rce n t o v e r the 25 years e n d in g in
1973; su b seq u en tly , this grow th slo w e d to about
o n e p ercen t. This s lo w in g re d u ce d the con trib u tion
o f capital form ation from a 0.92 p erce n t rate to a 0.28
p e rce n t rate o v e r the last seven years. W h en this



1972 d o l l a r s

S o u rc e : U .S . D e p a rtm e n t o f L a b o r

result is c o m b in e d w ith the e ffe ct on p rod u ctivity
grow th o f cy clic a l m ov em en ts in the capital-labor
ratio, th e resu lt is that cap ital form a tion , w h ich
a d d e d 1.01 p ercen tage p oin ts (0.92 + 0.09) to the
actual p a ce o f p rod u ctivity grow th from the e n d o f
1948 to the e n d of 1973, o n ly co n trib u te d 0.08 p e r­
ce n ta g e p oin ts to the actual rate o f p ro d u ctiv ity
grow th from the e n d o f 1973 to the e n d o f 1980.
Im p lic itly , c y c lic a l d iffe r e n ce s b e tw e e n th e e n d
o f 1973 and 1980 o ffs e t the e ffe c t o f grow th in
capital p er h our, so there was virtually n o ch a n ge in
the actual e m p lo y m e n t ratio.
T h e sm all ch an ges in table 4 b e c o m e quite large
w h e n c o m p o u n d e d o v e r the seven -y ear p e rio d . F or
exam p le, the slo w in g in the p oten tial grow th rate
o v e r the seven -y ea r p e rio d re d u ce s private sector

13

FEDERAL RESERVE BANK OF ST. LOUIS

JANUARY 1982

C h a rt 5

Real GN P per C ivilia n W orker

1 948 49

50

51

52

53

54

55

56

57

58

59

60

61

62 63

64

L a te st d a ta p lo tte d : 3 rd q u a rte r

ou tp ut b y 13.8 p erce n t b y the en d o f 1980. T h e d irect
im pact o f en erg y p rice increases alon e o v e r these
seven years red u ces ou tp ut b y 8.3 p ercent.
M o reov er, a large share o f the red u ction in capital
form ation sin ce 1973 has b e e n d u e to en erg y p rice
d e v e lo p m e n ts . T h e in clu sion o f the en erg y p ricein d u ce d s lo w in g in the d e sire d ca p ita l-lab or ratio
leads to an 11.5 p e rc e n t loss in output. T h e rem ain­
in g loss in p oten tial p rod u ctiv ity is a ssociated w ith a
n on -en ergy-rela ted s lo w in g in capital form ation .16

16Factors responsible for the cessation o f growth in the utilized
capital-labor ratio besides the decline in the productivity o f
capital due to energy price changes and minor cyclical influ­
ences, include such factors as higher expected inflation, inflation
uncertainty, and riskier returns due to an increased probability
o f governmental intervention through regulatory initiatives.
See Tatom, “ The Productivity Problem.” Patric H. Hender-

Digitized for
14FRASER


65

66

67

68

69

70

71

72

73

74

75

76

77

78

79

8 0 1981

Sources-. U.S. D e p a rtm e n t o f L a b o r a n d U.S. D e p a rtm e n t o f C o m m e rc e

Fin ally, it sh ou ld b e n oted that table 5 presents a
sum m ary v ie w o f the e ffe c t o f e n e rg y p rice ch an ges
on actual and p oten tia l p ro d u ctiv ity that d oes not
reflect the actual pattern o f even ts. In particular, the
“ s lo w d o w n ” d e s c r ib e d in table 5 is n ot con tin u ou s.
A ssocia ted w ith each e n erg y sh ock is a on ce -a n d -fo rall d e c lin e in b o th m easures o f p rod u ctivity, w ith
shott, “ The D ecline in Aggregate Share Values, Taxation,
Valuation Errors, Risk, and Profitability,” American Economic
Review (D ecem ber f9 8 f), pp. 909-22, discusses these and other
factors that contribute to the slowdown in capital formation and
argues that inflation alone has had little impact on the decline
in share values and, implicitly, capital formation. Instead he
claims that a change in risk premiums (attributed to increased
uncertainty about price and regulatory changes) in equity and
bond yields and reduced pretax profitability have been the
reason for about half the decline in share values. Hendershott
does not assess the role o f a higher relative price o f energy in
reducing the pretax real profitability o f the corporate capital
stock.

FEDERAL RESERVE BANK OF ST. LOUIS

JANUARY 1982

tem porarily slo w e r grow th as the cap ital-labor ratio
is adju sted tow ard a lo w e r d esired lev el. T h is pattern
is m ore clea rly apparent in chart 4, w h ich show s
poten tial and actual m easures o f private b u siness
sector ou tput p er hour. D ev ia tion s in the tw o are
p red om in a n tly d u e to the b u sin ess c y c le . T h e pat­
tern o f poten tial p rod u ctivity d ev e lo p m e n ts in chart
4 show s virtually n o grow th from m id-19 7 3 to m id1975 and relatively slow exp an sion from m id -19 7 5
to m id-1977. F o llo w in g the s e co n d e n e rg y shock,
potential p rod u ctivity fell, then was virtually un­
ch a n g ed until the e n d o f 1980. T h e s e co n d phase
o f a r e la t iv e ly s lo w p a c e o f p o te n tia l p r o d u c ­
tivity expan sion is apparent in the first three quarters
o f 1981.
Chart 5 sh ow s an alternative m easure of p ro d u ctiv ­
ity, real G N P p er civ ilia n w orker, again m easu red
on b oth an actual and a h ig h -em p loy m en t b asis.17
T h e prim ary d iffe re n ce from chart 4 is the secular
rate o f d e c lin e in hours p er w orker. Both actual and
poten tial real G N P p er w ork er have flattened out
tw ice relative to the p rior trend grow th , w ith a
resu m p tion of grow th from early 1977 until early
1979. At the en d o f 1980, poten tial real G N P per

17The high-employment measure of civilian employment is found
by regressing changes in the logarithm o f the civilian labor force
on a constant, a shift for faster labor force growth after 1964 and
current and one-lagged changes in the excess unemployment
rate. Additional lags are not statistically significant. Moreover,
the constraint that the effect of slack is zero after two quarters
could not be rejected. The effect o f a one percentage-point in­
crease in slack is to increase the labor force by 0.2 percent (t =
2.34) in the current quarter and this is offset in the subsequent
quarter. To find the high-employment civilian employment,
these cyclical effects are added back to the observed civilian
labor force and high-employment unemployment (UF) (LF) is
removed.




w orker stood o n ly 5.7 p e rce n t h igh er than at the
e n d o f l9 7 3 , so that five years w orth o ft h e prior trend
grow th (2.2 p e rce n t rate) has b e e n lost du rin g the
past seven -y ear p eriod .

SUMMARY
R e ce n t revision s in the m easures o f the nation’ s
ou tput and capital stock, as w e ll as m in or ch an ges in
p ro ce d u re s, have altered this Bank’ s m easures of
p oten tial output. T h e m ajor co n clu s io n s o f earlier
Bank studies, h o w e v e r, have b e e n u n affected b y
th ese ch anges. In particular, the grow th o f potential
ou tput has b e e n sharply re d u ce d b y the 1973-74 and
1979-80 e n erg y shocks and s u b se q u e n t adjustm ents
in the d e sire d capital intensity o f p rod u ction . T h e se
effects have b e e n con firm ed b y the re-estim ation of
ea rlier p ro d u ctio n fu n ction co e fficie n ts, and, m ore
im portant, the confirm ation o f the p rior em p irical
e s tim a te s in th e la te s t r o u n d o f e n e r g y p r ic e
increases.
T h e d e c lin e in the grow th o f potential ou tput sin ce
1973 has, in recen t years, b e e n a ck n o w le d g e d b y the
C o u n c il o f E c o n o m ic A dvisers, b u t through a trend
r e d u c t io n rather than th rou g h sharp te m p o ra ry
d e clin e s in 1974-75 and 1979-80 as im p lie d here.
N on eth eless, the lev e l o f poten tial ou tp ut estim ated
b y the C E A in recen t years is little d ifferen t from this
Bank’ s estim ate. T h e slo w in g in p oten tia l ou tput
masks a sharper red u ction in the grow th o f p ro d u c­
tivity in re ce n t years. A d eta iled analysis o f p ro d u c­
tivity d e v e lo p m e n ts show s a m arked deterioration
in grow th relative to past trends. In the m easu rem en t
o f potential output, this d eterioration has b e e n par­
tially o ffse t b y a m ore rapid grow th o f b oth poten tial
and actual em p loy m en t.

(See appendix on next page)

15

FEDERAL RESERVE BANK OF ST. LOUIS

JANUARY 1982

Appendix

Potential GNP (in billions of dollars)1
I

II

IV

1948

NA

$ 489.1

$ 502.9

$ 506.1

1949

$ 515.0

523.6

530.1

532.0

1950

536.1

540.7

546.9

555.7

1951

566.3

576.6

582.9

586.7
609.3

1952

592.3

591.4

599.3

1953

612.8

615.6

617.5

621.6

1954

630.1

634.3

641.0

643.7

1955

648.6

653.5

662.9

672.4

1956

672.3

679.7

683.5

687.8

1957

691.2

698.0

707.7

708.5

1958

710.1

720.8

730.4

731.3

1959

732.0

739.8

746.3

756.0

1960

757.7

763.6

768.4

774.5

1961

782.8

789.2

797.7

806.1

1962

813.7

824.7

828.8

828.9

1963

836.9

843.5

853.7

862.7

1964

870.9

877.1

881.2

884.7

1965

895.9

908.5

918.6

930.7

1966

942.8

955.6

963.2

973.1

1967

981.4

985.3

997.9

1,010.2

1968

1,017.1

1,033.1

1,041.4

1,051.3

1969

1,069.3

1,081.3

1,092.0

1,097.3

1970

1,109.9

1,117.8

1,128.6

1,136.6

1971

1,150.2

1,160.8

1,166.4

1,176.3

1972

1,188.9

1,203.1

1,216.8

1,226.2

1973

1,236.9

1,247.6

1,262.3

1,272.4

1974

1,273.5

1,275.0

1,280.1

1,290.3

1975

1,300.3

1,307.3

1,316.8

1,327.5

1976

1,335.3

1,345.7

1,355.6

1,370.5

1977

1,384.8

1,394.5

1,405.5

1,417.7

1978

1,437.8

1,460.7

1,479.5

1,502.2

1979

1,521.7

1,520.9

1,529.3

1,533.1

1980

1,545.6

1,544.4

1,560.9

1,573.9

1981

1,584.0

1,580.4

1,595.0

'Prepared using data available through November 30, 1981.

16FRASER
Digitized for


III

JANUARY 1982

FEDERAL RESERVE BANK OF ST. LOUIS

The Role of Fiscal Policy in the
St. Louis Equation
R. W. HAFER

T H E “ St. L ou is eq u a tio n ” relates the grow th of
n om inal in com e (G N P ) to b oth the grow th o f m o n e y
and h ig h -em p loy m e n t gov ern m en t exp en ditu res. In
o th e r w o r d s , it attem p ts to e x p la in ch a n g e s in
G N P b y ch a n ges in m on etary and fiscal actions.
O n e con sisten t result o f estim ating the St. L ou is
eq u a tion for the U.S. e c o n o m y is that m on eta ry
action s have a stron g and lastin g im p a ct o n the
grow th of G N P , w h ile fiscal actions have on ly a w eak
and transitory im pact; fiscal effects essen tially wash
out o v e r four or five quarters.
T h e p u rp ose o f this article is to reassess the role
o f fiscal actions within the framework o f the St.
L ou is e q u a tion .1 As a result o f u pd a ted estim ates
and tests, strong e v id e n c e is p resen ted reaffirm ing
that fiscal actions are in con seq u en tia l in d eterm in ­
ing G N P grow th, o n ce the effects o f m o n e y grow th
are taken into a ccou n t.

IN-SAMPLE ESTIMATES
T h e St. L ou is eq u a tion is the fou n d ation for the
sm all-scale m onetarist m o d e l associated with the
F ed era l R eserve Bank o f St. L ou is. T h e nature o f the
eq u a tion (as w e ll as the m o d e l) is m onetarist b eca u se
G N P grow th is d e term in ed prim arily b y the grow th
o f the n om inal m o n e y stock. A lth ou gh the eq u a tion
re co g n izes and e m p irica lly captures the short-run
e ffe cts o f stim ulative fiscal a ction s, p re v io u s re1Alternative specifications of the St. Louis equation provide other
frameworks in which the role o f fiscal actions could be tested. Our
purpose, however, is not to test for the impact of fiscal actions
across a broad class o f models, but to focus attention on the
widely recognized St. Louis specification. An alternative specifi­
cation may be found in John A. Tatom, “ Energy Prices and ShortRun Econom ic Performance,” this Review (January 1981), pp.
3-17.




search has dem on strated that fiscal actions have no
lastin'' e ffe c t o n G N P g ro w th in th e St. L o u is
s p e c ific a tio n .2 N ot su rp risin g ly , this fin d in g has
b e e n the so u rce o f a co n tin u in g d e b a te .3
T h e St. L ou is e q u a tio n ty p ica lly is w ritten as
4
(1) Y(t) = a« +

1 in, M (t-i) +
i= 0

4
i
e, E (t-i) + e(t),
i= 0

w h e re Y is n om inal G N P , M is the m o n e y su p p ly and
E is the m easure o f fiscal p o licy . T h e dots a bove the

2See, for example, Leonall C. Andersen and Jerry L. Jordan,
“ Monetary and Fiscal Actions: A Test o f Their Relative Impor­
tance in Econom ic Stabilization,” thisReview (November 1968),
pp. 11-24; Leonall C. Andersen and Keith M. Carlson, “ A Mone­
tarist M odel for Econom ic Stabilization,” this Review (April
1970), pp. 7-25; Keith M. Carlson, “ Does the St. Louis Equation
Now Believe in Fiscal Policy?” this Review (February 1978), pp.
13-19; Keith M. Carlson, “ Money, Inflation, and Econom ic
Growth: Some Updated Reduced Form Results and Their Impli­
cations,” this Review (April 1980), pp. 13-19; and Keith M.
Carlson and Scott E. Hein, “ Monetary Aggregates as Monetary
Indicators,” this Review (November 1980), pp. 12-21.
3Earlier works include Richard G. Davis, “ How Much Does Money
Matter? A Look at Some Recent Evidence,” Federal Reserve Bank
o f New York Monthly Review (June 1969), pp. 119-31; E. Gerald
Corrigan, “ The Measurement and Importance o f Fiscal Policy
Changes,” Federal Reserve Bank o f New York Monthly Review
(June 1970), pp. 133-45; and Edward M. Gramlich, “ The Useful­
ness of Monetary and Fiscal Policy as Discretionary Stabilization
Tools,” Journal o f M oney, Credit and Ranking (May 1971), pp.
506-32. More recent analyses include Alan S. Blinder and
Stephen M. Goldfeld, “ New Measures o f Fiscal and Monetary
Policy, 1958-73,” American Economic Review (D ecem ber 1976),
pp. 780-96; Benjamin M. Friedman, “ Even the St. Louis M odel
Now Believes in Fiscal Policy,” journal o f M oney, Credit and
Ranking (May 1977), pp. 365-67; Yash P. Mehra, “ An Empirical
Note on Some Monetarist Propositions,” Southern Economic
Journal (July 1978), pp. 154-67; and Yash P. Mehra and David E.
Spencer, “ The St. Louis Equation and Reverse Causation,”
Southern Economic Journal (April 1979), pp. 1,104-20.

17

FEDERAL RESERVE BANK OF ST. LOUIS

variable s y m b o liz e ra tes-of-ch ange, ao, nii and e; are
param eters to b e estim ated, a nd e(t) is a random error
term .4
T h rou gh the years, various em p irical m easures o f
m on etary and fiscal actions have b e e n u sed to esti­
mate the St. L ou is equ ation. R e cen t red efin ition s o f
the m on eta ry aggregates rek in d led the d eba te abou t
w h ich aggregate b est explains G N P grow th . Since
recen t e v id e n c e suggests that M 1B is the p referred
aggregate, it is u sed in this article.5
T h e con sen su s c h o ic e o f the fiscal m easure has
n ot yet b e e n resolved . T h e h ig h -em p loy m en t fe d ­
eral exp en ditu re m easure o f fiscal p o lic y is clo s e ly
associated w ith the textbook in com e-ex p en d itu re
m o d e l o f the e c o n o m y .6 In that m o d e l, gov ern m en t
purch ases of g ood s and services plus transfers are
c o n s id e r e d a d irect stim ulus to nom inal aggregate
d em an d . C on seq u en tly , an increase in this m easure
represents an increase in the g ov ern m en t’ s in flu en ce
o n n om inal d em a n d and, therefore, nom inal in co m e .
A n alternative, the h ig h -em p loy m en t federal surplus
variable, captures the net in flu en ce o f exp en ditu res
and receip ts d u e to the ch a n gin g patterns in federal
g ov ern m en t p urch ases and transfers, and in tax rates.
A lth ou gh oth er less co m m o n ly u sed m easures exist,
th ese tw o are u sed in this article to assess the in­
flu en ce o f fiscal actions on the grow th of G N P.
E q u a tion 1 was estim ated u sing ordinary least
squares for th e p e r io d I/1 960-IV /1980; the regres­
sion results are rep orted in table 1. E qu ation s A and
B sh ow the results ob tain ed u sin g the grow th o f t h e
h ig h -e m p lo y m e n t fe d e r a l e x p e n d itu r e s and the
ch a n g e in le v e l o f the h ig h -e m p lo y m e n t fed era l
su rplus, r e s p e c tiv e ly .7 T h e results co n fo rm w ith

4The rate-of-change specification was introduced by Carlson, who
demonstrated that the original first-difference specification ot
Andersen and Jordan introduced econometric difficulties when
estimated into the mid-1970s. See Carlson, “ Does the St. Louis
Equation Now Believe in Fiscal Policy?”
5For evidence o fth e superiority o f M1B, see Carlson and Hein,
“ Monetary Aggregates as Monetary Indicators;” R. W. Hafer,
“ Selecting a Monetary Indicator: A Test o fth e New Monetary
Aggregates,” this Review (February 1981), pp. 12-18; and R. W.
Hafer, “ Much Ado About M2,” this Review (October 1981), pp.
1.3-18.
G“ High-employment” measures are used to reduce the distortion
introduced from the impact of the level o f econom ic activity on
actual government receipts and expenditures. See Keith M.
Carlson, “ Estimates o f the H igh-E m ploym ent Budget and
Changes in Potential Output,” this Review (August 1977),
pp. 16-22.
7The changes in the high-employment federal surplus variable
scaled by income also was used as an alternative measure of

Digitized for
18FRASER


JANUARY 1982

p re v io u sly rep orted findings: T h e su m m ed im pact
o f m o n e y grow th is not statistically d iffe re n t from
unity at the 1 p e rce n t le v e l, and the cu m u lative
im pact o f fiscal actions is n ot statistically d ifferen t
from zero. T h e grow th o f M 1B has a significant, sus­
tain ed in flu en ce on the grow th o f G N P ; fiscal actions,
m ea su red eith er as the grow th o f h ig h -e m p lo y m e n t
fe d e ra l ex p e n d itu re s or th e ch a n g e in the h ig h e m p lo y m e n t federal surplus, d o not.
T h e cu m u lative im pa ct o f the m onetary and fiscal
variables is statistically co m p a ra b le w ith p reviou s
results. In d e e d , th e lag pattern for the m o n e y grow th
variable is essen tially the sam e as C arlson rep orted
for a variety o f sam p le p e r io d s .8 As in p re v io u s
studies, the im pact of m o n e y grow th on G N P grow th
is quite rapid: T h e rep ercu ssion s o f a ch a n ge in the
grow th o f m o n e y o c c u r w ith in tw o quarters and fade
away b y the third and fourth la g g e d quarters.
T h e lag patterns for the fiscal variables, in contrast,
d o not com p a re as w e ll to p re v io u sly rep orted fin d ­
ings. W h e n c o m p a re d w ith th e results for oth er
sam ple p e rio d s, the m a gn itu d e o f t h e in d ivid u al lag
co e fficie n ts and their sign ifican ce ch an ge dramati­
ca lly for the fiscal variables. In d e e d , it appears that,
in a d d ition to h avin g no lasting im pact on G N P
g ro w th , th e fisca l v a ria b les exert n o sig n ifica n t
e ffe c t in any quarter. A lthough e co n o m e tric d ifficu l­
ties p re c lu d e a firm co n c lu s io n b a se d o n the signifi­
ca n ce o f in d ivid u al lag estim ates, the sen sitivity o f
e stim a te s o f th e fisca l m e a su re s o v e r d iffe r e n t
sam ple p e rio d s suggests that a G N P -fiscal actions
link is d u b io u s. T o further exam ine this issu e, three
alternative eq u a tion s w e re estim ated. T h e s e e q u a ­
tions isolate the relative explanatory p ow ers o f t h e
m o n e y and fiscal variables on G N P grow th. E sti­
m ates from th ese specification s also are rep orted
in table 1.
E qu a tion C reports the estim ation o f eq u a tion 1
u sin g o n ly the m o n e y grow th variable to explain
G N P grow th. N ot surprisingly, the overall explan a­
tory p o w e r o f the eq u a tion is not d im in ish e d su b ­
stantially b y the e x clu s io n o f eith er fiscal p o licy
m easure. M o re o v e r, the cu m u lative im pact o f m o n e y
grow th on G N P grow th is n ot statistically differen t
from unity o v e r the cou rse o f o n e year. T h is suggests
that the m o n e y -G N P link in the St. L ou is equ ation is
q uite robust. T h e sam e can n ot b e said, h o w e v e r , o f
fiscal actions. The conclusions reached in the article were not
altered by this change.
8See Carlson, “ Does the St. Louis Equation Now Believe in Fiscal
Policy?” and Carlson, “ Money, Inflation, and Economic Growth.”

JANUARY 1982

FEDERAL RESERVE BANK OF ST. LOUIS

Table 1

Regression Results for Alternative St. Louis Equations,
1/1960-1V/1980
Equations Tested1
Coefficients

A

B

Constant
mo
mi
m2
m3
rri4
2mj

2.46 (2.17)
0.401 (3.40)
0.393 (5.07)
0.225 (2.21)
0.062 (0.85)
-0.013(0.11)
1.067 (5.53)

2.69
0.359
0.349
0.200
0.061
-0.001
0.969

eo
ei
e2
e3
e4
-e.

0.062 (1.46)
0.020 (0.62)
-0.021 (0.58)
-0.018(0.54)
0.014 (0.33)
0.056 (0.59)

-0.006(0.13)
-0.031 (0.84)
-0.05 8(1 .4 7)
-0.072(1.94)
0.057 (1.33)
-0.22 5(1 .6 3)

R2
SE
DW

0.349
3.493
2.02

(2.69)
(2.82)
(3.92)
(1.87)
(0.74)
(0.00)
(3.50)

0.361
3.460
2.07

C

D

2.80 (2.84)
0.422 (3.73)
0.397 (5.28)
0.218(2.16)
0.065 (0.90)
0.007(0.06)
1.109(6.30)

6.02 (5.42)

0.086(1.70)
0.047(1.22)
0.016(0.38)
0.039(1.02)
0.076(1.54)
0.265 (2.50)
0.355
3.477
2.02

0.055
4.209
1.52

E
8.52 (18.13)

-0.031
-0 .0 0 6
-0 .0 5 9
-0.09 0
-0 .0 7 3
-0 .1 9 6

(0.61)
(0.13)
(1.23)
(2.00)
(1.39)
(1.18)

0.017
4.291
1.47

1All equations estimated using a fourth-degree Almon polynominal lag with both end points
constrained to zero. Equations A and D use high-employment federal expenditures; equations
B and E use high-employment federal surplus. M1B is the money measure used throughout.
Absolute values of t-statistics appear in parentheses; R2 is the coefficient of determination
corrected for degrees of freedom, SE is the regression standard error and DW is the DurbinWatson statistic.

the em p irical relation sh ip b e tw e e n the fiscal actions
and G N P.
E qu ation s D and E in table 1 report the results of
re g re s s in g G N P g row th on th e grow th o f h ig h em p lo y m e n t exp en ditu res and changes in the lev el
o f h ig h -em p loy m en t surplus, resp ectiv ely . In e q u a ­
tion D , the estim ated co e fficie n ts are n o tice a b ly
d ifferen t from th ose in eq u a tion A. T h e first lag
co e ffic ie n t is m ore than d o u b le the estim ate from
eq u a tion A, and th e s e co n d and third lag terms
are p o s i t i v e . M o r e im p o r ta n t, th e c u m u la t iv e
im pact for the exp en d itu res variable is positive and
statistically significan t at the 5 p ercen t lev el. U nfor­
tunately, th ese results are m arred b y the existen ce
o f significant first-order serial correlation a m on g the
residu als, e v id e n c e d b y the lo w D u rb in -W a tson
(D W ) statistic.
T h e p re s e n ce o f significant serial correlation in
eq u a tion D p rov id es im portant inform ation . O n e
potential cau se o f serial correlation is the om ission
o f an im portant explanatory variable w h ich is c y c li­
cal. T h e c o n s e q u e n c e o f such an om ission is that the



error term w ill absorb the cy clic a l pattern o f the
variable, and the su cce ssiv e error terms w ill n ot b e
random . It is clea r from a com pa rison o f equ ation s A
and D that the e x c lu d e d variable is the grow th o f
M 1B : A d d in g m o n e y grow th to eq u a tion D e lim i­
nates first-order serial correlation . I f o n e assum es
that equ ation A is the “ co rre ct” sp ecifica tion , the
m o d e l re p re se n te d b y eq u a tio n D (b e ca u se it is
m issp eeified ) yie ld s co e ffic ie n t estim ates that may
b e seriou sly b ia se d and sig n ifica n ce tests o f q u e s ­
tion ab le efficacy. Th u s, the e v id e n c e p ro v id e d b y
e q u a tion D d o e s n ot su p p ort the e x is te n ce o f a
significant, lasting affect on G N P grow th o f fiscal
actions cap tu red b y the grow th of h ig h -e m p lo y m e n t
exp en ditu res.
E q u a tio n E in ta ble 1 p resen ts th e results o f
re g ressin g G N P grow th on ch a n ges in the high e m p lo y m e n t federal surplus. In lin e w ith a priori
reason in g, the results suggest that an in crease in the
size o f the h ig h -e m p lo y m e n t surplus retards G N P
grow th. A lth ou gh the su m m ed im pact o f the surplus
variable is o f the appropriate sign, it is not statis­

19

JANUARY 1982

FEDERAL RESERVE BANK OF ST. LOUIS

tica lly d ifferen t from zero. T h is variable d oes not
exert a significant, lasting effe ct on G N P grow th, a
fin d in g con sisten t w ith eq u a tion B. T h e p re s e n ce o f
serial correlation , h o w e v e r, again suggests the p o s ­
sib ility o f a m issp ecifica tion . This is e v id e n c e d by
com p a rin g equation s D and B: T h e add ition o f the
m o n e y grow th variables rem oves the serial correla ­
tion p rob lem . T his result indicates that eq u a tion E,
like eq ua tion D , is m iss p e cifie d w ith ou t the m o n e y
va riab le.9
A n y u n ce rta in ty a b o u t th e re la tiv e im p a ct o f
m onetary and fiscal actions on G N P grow th can b e
d is p e lle d further b y a com p a rison o f equ ation s A, B
and C in ta ble 1. T h is co m p a riso n a llow s us to
address the q u estion “ G iv en the in flu en ce o f m o n e ­
tary actions on G N P grow th, d oes the inform ation
con ta in ed in the fiscal variables significantly im ­
p ro v e u p on m o n e y ’ s explanatory p o w e r ? ”
T o answ er this qu estion , o n e n e e d o n ly exam ine
th e re p o r te d t-statistic for th e re le v a n t su m m ed
variables. F or exa m p le, eq u a tions A and B in d ica te
that adding the fiscal variables to the G N P m o n e y
regression d oes not significantly im p rov e the e x ­
planatory p o w e r: T h e t-statistics for the re sp ectiv e
Seis are n ot greater than n orm ally a ccep ta b le critical
values. T h e s e results in d icate that, o n c e the influ en ce
o f m o n e y grow th is a ccou n ted for, the a dd ition o f
the fiscal variables d oes not statistically im p rove
th e e x p la n a tio n o f G N P g r o w th . T h e s e resu lts
further p o in t to the statistical d om in a n ce o f m o n e y
g ro w th o v e r eith e r fiscal m ea su re in e x p la in in g
ch an ges in G N P grow th.

results are rep orted in table 2 .10
T h e C h o w test results in d ica te that the stability
h yp oth esis is re je cte d only for the reg ression s o f
G N P grow th on the tw o fiscal variables, that is, e q u a ­
tions D and E : T h e ca lcu la te d F-statistics e x c e e d the
releva n t 5 p e rce n t critical valu e. T h e ca lcu la ted
F-statistics for the equations that in clu d e m on ey
grow th or use m o n e y grow th alon e to exp la in G N P
grow th in d ica te that th ey p r o v id e structurally stable
p a r a m e te r e s tim a te s a cro s s th e I /1 9 6 0 -I V /1 9 8 0
p e rio d . T h e s e findings im p ly that the rela tion sh ip
b e t w e e n G N P g r o w th a n d m o n e y g r o w th has
r e m a in e d r e la t iv e ly s t a b le a cro s s th e 2 0 -y e a r
sam ple p e rio d . O n the oth er hand, th ey su ggest that
th e e ffe c ts o f fisca l a ctio n s o n G N P g ro w th are
uncertain and may b e q u ite d ifferen t across e c o ­
n o m ic en viron m en ts.
T h e s e co n d test exam ines the statistical causal
o rd e rin g b e tw e e n the m on etary and fiscal variables
and G N P grow th. T h is test p ro ce d u re , d e v e lo p e d b y
G ranger, in v o lv e s estim ating a set o f eq u a tion s for
ea ch p air-w ise test.11 T o test for G ran ger causality,
it is assum ed that the inform ation releva n t to the
p re d ictio n o f the re s p e ctiv e variables is co n ta in e d
s o le ly in the data series Y and X (e.g., G N P and
m o n e y or fiscal variables). T h e test p ro ce d u re c o n ­
sists o f estim ating the equ ation s
n
n
(2) Y(t) =

1

T h e results o f tw o additional statistical tests are
rep orted in this section . T h e first test exam ines the
stability properties o f the alternative specification s
rep orted in table 1. T h e s e con d test p rovid es som e
e v id e n c e about the causal ord erin g o f the m onetary
and fiscal variables w ith resp ect to G N P grow th.

1

ftY(t-j) + € (t)

j= l

and
(3) X (t) =

in
i
i= l

STABILITY AN D CAUSALITY TESTS

« , X(t-i) +

i= l

K, X (t-i) +

m
1

Sj Y(t-j) +

7 ,(t).

j= l

It is assu m ed that e(t) and r)(t) are u n correla ted error
se rie s. U n id ir e c tio n a l ca u s a tio n from X to Y is

p re s e n te d in ta ble 1, the I/1 9 6 0 -IV /1 9 8 0 sam p le
p e rio d was split at 11/1970 (the m id -p oin t o f the
sam ple) and the C h o w test was a p p lied . T h e test

10The mid-point was chosen to maximize the pow er o f the test. On
this point, see John U. Farley, Melvin Hinich and Timothy W.
McGuire, “ Some Comparisons o f Tests for a Shift in the Slopes o f
a Multivariate Linear Time Series M odel,” Journal o f Econo­
metrics (August 1975), pp. 297-318. The Chow test may be
inappropriate given the existence o f serially correlated errors,
as evidenced in equations D and E. Even so, the stability
test results in table 2 are based on the ordinary least squares
estimation found in table 1 as a matter o f consistency. Using GLS
estimates o f equations D and E in table 1 indicates that the
stability hypothesis still is rejected at the 5 percent level: The
F-statistics are 3.02 and 3.44 for the GLS estimates o f equations
D and E, respectively.

9The reader may note that equation C, the specification em ploy­
ing only the m oney growth variable, is not beset by the
problems o f serial correlation. This, along with the textual evi­
dence, strongly suggests that the misspecification problems affect
only the regressions o f GNP growth on fiscal variables.

11C. W. J. Granger, “ Investigating Causal Relations by E cono­
metric M odels and Cross-Spectral Methods,” Econometrica
(July 1969), pp. 424-38. For a useful comparison o f various
causal tests, see Edgar L. Feige and Douglas K. Pearce, “ The
Casual Causal Relationships Between M oney and Income: Some
Caveats for Time Series Analysis,” Review o f Economics and
Statistics (November 1979), pp. 521-33.

T o test the tem p ora l stability o f the eq u a tion s

Digitized for
20FRASER


JANUARY 1982

FEDERAL RESERVE BANK OF ST. LOUIS

Table 2

Table 3

Stability Test Results for GNP
Equations, 11/1970 Break Point

Granger Test Results

Equation1

Calculated F-statistic

Reject Stability2

A

1.63

No

B

1.62

No

C

1.53

No

D

2.83

Yes

E

3.62

Yes

'See table 1 for description of alternative equations.

Exogeneity test1

Calculated F-statistic

M —» Y

2.682

Y -» M

0.56

Reject exogeneity
of policy variable
No

Y

1.10

Y -» HEGE

0.24

AHEGS - * Y

0.66

Y - » A HEGS

2.922

HEGE

Yes

2Based on 5 percent critical value (F(7,70) = 2.14).
Yes

im p lie d if the estim ated coefficie n ts on the la gg ed X
variable in eq u a tion 2 are statistically d ifferen t from
zero as a grou p and th e set o f estim ated coefficien ts
on the la g g ed Y variable in equation 3 is n ot statisti­
ca lly d ifferen t from zero. C on v ersely , u n id irection al
causation from Y to X exists i f the set o f lagg ed X
co e fficien ts in equ ation 2 is not statistically d ifferen t
from zero and the set o f lagg ed Ys in eq u a tion 3 is
statistically n on -zero as a group. F e e d b a ck is su g ­
gested w h en the sets o f X and Y coefficie n ts are
statistically significan t from zero in b oth equations
2 and 3. In d e p e n d e n c e occu rs w h en the sets o f X and
Y co e fficie n ts are not significant in eq ua tion s 2 and 3.
T h e G ranger test results, b a s e d on the 1/1960IV /1980 sam ple, are rep orted in table 3 .12 T h e first
pair-w ise test is d o n e w ith m o n e y grow th and G N P
grow th (M ,Y ). T h e ca lcu la ted F-statistics suggest
that there is u n id irection a l causation from m on e y
to G N P .13 In the s e c o n d bivariate test, w ith the
grow th o f h ig h -e m p lo y m e n t g ov ern m en t e x p e n d i­
tures (H E G E ), n eith er F -valu e surpasses the 5 p e r­
cen t critical value. T h e s e results su ggest that the
grow th o f h ig h -e m p lo y m e n t exp en ditu res and G N P
grow th are in d e p e n d e n t. T h e last test, w h ich uses
the ch a n g e in the h ig h -e m p lo y m e n t gov ern m e n t
12The estimated equations consist of four lagged dependent vari­
ables and four lagged “ causal” variables. Because the Granger
test requires the data to exhibit stationary characteristics, a
linear time trend and seasonal dummies were entered into the
estim ated regressions. M oreover, the fu ll-p eriod results
are based on the finding o f no structural break in the estimated
test equations. For a further discussion and application o f the
Granger test, see Hafer, “ Selecting a Monetary Indicator.”
13This finding is supported by previous empirical research. See
Christopher A. Sims, “ Money, Income, and Causality,” Ameri­
can Economic Review (September 1972), pp. 540-52; Mehra and
Spencer, “ The St. Louis Equation and Reverse Causation;” and
Hafer, “ Selecting a Monetary Indicator.” Contrary findings are
presented in Feige and Pearce, “ Casual Causal Relationships.”




1The arrow indicates hypothesized direction of causality.
Significant at 5 percent critical value (F(4,71) = 2.50).

surplus variable (A H E G S ), indicates that u n id ire c­
tional causation from G N P grow th to ch an ges in the
surplus m easure ca n n ot b e rejected.
T o sum m arize, the statistical e v id e n c e suggests
th at m o n e y g r o w th c a u s e s G N P g r o w th . T h e
fin d in g s p r e s e n t e d h e re p r o v id e n o e m p ir ic a l
su pp ort for the “ reverse cau sation ” argum ent. T h e
e v id e n c e a b o u t th e r e la tio n s h ip b e t w e e n fiscal
m e a su re s and G N P g ro w th , h o w e v e r , su g g e sts
that G N P causes fiscal actions. T h is is true sp e cifi­
ca lly for the surplus m easu re; the o u tco m e for the
exp en ditu res variable indicates n o causal relation ­
ship in eith er d ire ctio n (in d e p e n d e n ce ). T h e s e find­
ings indicate that there is no reliable relation sh ip
b e tw e e n G N P grow th and the fiscal m easures u sed
in this article. T h e p r e c e d in g C h o w test results
su pp ort this co n c lu s io n b y sh o w in g that o n ly the
relation sh ip b e tw e e n m o n e y and G N P is statistically
stable across the entire sam ple p eriod .

POST-SAMPLE ESTIMATES
T h e final p ie c e o f e v id e n c e u sed to assess the
relation sh ip b e tw e e n G N P grow th and m onetary/
fis ca l a c t io n s is a c o m p a r i s o n o f th e r e la t iv e
p o s t-s a m p le p r e d ic t iv e a b ilit ie s o f s e le c t e d
equations fou n d in table 1. T o this en d, each equation
in itia lly w as e stim a te d from 1/1960 th rou gh IV /
1970. Four-quarter-ahead estim ates o f G N P grow th
w e r e th en g e n e r a te d u sin g actual v a lu es o f the
m o n e y and fiscal m easures o v e r this p e rio d . T h e

21

FEDERAL RESERVE BANK OF ST. LOUIS

JANUARY 1982

Table 4

Post-Sample Prediction Errors of GNP Growth1
Sample period
from 1/1960 to
fourth quarter:

Equation
Money only

Money growth and highemployment expenditures

Money growth and highemployment surplus

1970

0.22%

0.20%

1971

2.06

1.58

1972

1.35

2.07

1.10

1973

—1.18

-1 .8 3

-0 .1 8

1974

2.28

2.01

0.69

1975

0.41

0.65

1.70

1976

1.23

1.14

1.36

1977

2.58

2.80

2.94

1978

-1 .8 3

-1 .9 4

-0 .4 8

1979

-0.11

-0 .6 0

-1 .4 8

Average Error

0.70%

0.61%

-0.31 %
1.98

0.73%

’ Errors are actual less predicted and are calculated for the four quarters following the sample
period.

estim ation p e rio d was then ex te n d e d to in clu d e the
fo u r quarters o f 1971, and four-quarter-ahead fo re ­
casts for 1972 w e re con structed . T his p ro ce d u re was
co n tin u e d ea ch yea r th rou gh 1980. T h e average
errors in p re d ictin g G N P grow th are p resen te d in
table 4. S in ce the p u rp ose of these com parison s is to
determ in e if the alternative fiscal p o lic y m easures
add anything to the estim ates o f G N P grow th once
money growth is known, results for three equations
are p r e s e n t e d : m o n e y o n ly , m o n e y a n d h ig h e m p lo y m e n t exp en d itu res, and m o n e y and h igh e m p lo y m e n t surplus.
T h e results in table 4 in d icate that, on average,
m o n e y alon e (equ a tion C ) results in G N P grow th
p re d ictio n errors that are less than 1 p ercen tage
point. T h e addition o f the exp en d itu res m easu re o f
fiscal p o lic y (equ ation A) leads to on ly a m arginal
red u ction in the average error, w h ile the addition o f
the surplus m easure (equ ation B) leads to a m arginal
increase in th e average foreca st error. A lth o u g h
th ese ch a n ges m ay appear rather substantial, tests
rev ea l that the average errors for the alternative
specification s are not statistically differen t. In fact,
the ca lcu la ted t-statistics com p a rin g the averages are
all less than u n ity.14 B ased on the eq u a tion s’ relative
p re d ictiv e abilities, th erefore, on e w o u ld d o ju st as
14For instance, the t-statistic comparing the average error term
from the “ money only” regression to that using money and the
expenditures variable is 0.14. The statistic comparing money
only and the regression using the surplus measure is -0 .5 0 .

Digitized for22
FRASER


w e ll, on average, to use o n ly m o n e y grow th to p re ­
d ict future G N P grow th as u sin g m o n e y grow th and
eith er o f the tw o fiscal p o lic y m easures exa m in ed
in this article.

CONCLUSION
T h is paper has re -exa m in ed the role o f fiscal p o lic y
in the con tex t o f the St. L ou is equ ation . T h e results
are b roa d ly con sisten t w ith p reviou s findings. S p e ­
cifically , fiscal actions exert n eith er a significan t n or
lasting im pa ct on the grow th o f G N P .
A u g m e n tin g p re v io u s w ork, h o w e v e r, the results
h ere p ro v id e further e v id e n c e against the relian ce on
fiscal p o lic y m easures to explain m ovem en ts in G N P .
T h ree co n clu s io n s can b e draw n from th ese test
results: T h e fiscal p o lic y m easures 1) d o n ot signifi­
cantly increase the explanatory p o w e r or forecastin g
a b ility o f an e q u a tio n that a lrea d y in co rp o ra te s
m o n e y grow th ; 2) d o n ot e xh ib it stable statistical
re la tio n s h ip s w ith G N P g ro w th ; a n d 3) are n o t
e x o g e n o u s w ith re sp e ct to G N P grow th. T h e e v i­
d e n c e suggests that fiscal actions are in e ffe ctiv e
for stabilization p u rp oses. M o re o v e r, the results add
in creasin g stature to the u se o f m onetary p o lic y as a
tool in stab ilizin g fluctuations in e c o n o m ic activity.
Comparing the mean forecasts generated by the two fiscal equa­
tions yielded a t-statistic o f -0 .1 9 .

Food and Agriculture — Current Situation
and Prospects for 1982
CLIFTON B. LUTTRELL

T

A H IS article is largely a sum m ary o f the U nited
States fo o d and agricultural ou tlook for 1982 as d is­
cu ssed at the A nnual N ational A gricultural O u tlook
C o n fe r e n ce in N o v e m b e r 1981. T h e overall ou tlook
for this year is for in crea sed p rod u ction and lo w e r
p rices for m ost farm products. Retail fo o d p rices,
w h ich rose abou t 8 p ercen t last year, are lik ely to rise
at an e v e n slo w e r rate in 1982.
In a dd ition to the p rosp ectiv e im pact o f larger
farm com m od ity su p p lies, agricultural p rices w ill
also b e a ffe c te d b y a s lo w in g in the grow th of
overall fo o d d em an d this year. R estrictive d om e stic
m onetary p o licie s d e s ig n e d to re d u ce inflation w ill
ten d to re d u ce the grow th in d o m e stic dem an d .
Sim ilar restrictive m on etary p o lic ie s in a n u m ber of
foreign coun tries p oin t to a slu ggish foreign d em an d
for U.S. farm prod u cts.
D e s p ite the e x p e c te d relatively lo w prices o f farm
p rod u cts and the rising farm p rod u ction costs, the
quantities o f m ost co m m od ities available, such as
cereals and bakery p rod u cts, b e e f and vea l, and fresh
fruits and veg eta b les, are lik ely to rise further in
1982. A record 1981 fe e d grain cro p b o o s te d 1981-82
fe e d grain su pp lies to 280.1 b illio n tons, 11 p ercen t
a b o v e last year. L arge fe e d grain su p p lies and low e r
fe e d p rices w ill in d u ce farmers to m aintain livestock
p ro d u ction at a rela tively h igh le v e l. W h eat and rice



su pp lies are at re co rd levels and a large potato crop
was h arvested. O f th e m ajor crop s, o n ly the 1981 fruit
cro p was som ew h at sm aller than a year ago. Th u s,
the overall farm and fo o d o u tlo o k for this year is for
in crea sed ou tp ut o f farm prod u cts, e s p e c ia lly liv e ­
stock p rodu cts, and relatively large fo o d su pp lies.
N et farm in co m e after in ven tory adjustm ents rose
in 1981 to about $22 b illio n or a bou t $2 b illio n a bove
the 1980 total. N et in co m e in 1982 w ill b e d e te r­
m in ed ch iefly b y returns on crop s to b e p la n ted later
this year. H o w e v e r , it m ay d e c lin e from last yea r’ s
le v e l, e sp e c ia lly i f th ere are further increases in crop
in ven tories in the 1982-83 cr o p year.

OU TLO O K FOR AGRICULTURE
E c o n o m ic co n d itio n s in the farm sector in 1982 are
lik ely to ch a n ge v e ry little from 1981, e sp e c ia lly for
the next several m onths. T h e su p p ly o f farm prod u cts
relative to d em a n d is e x p e cte d to rem ain relatively
high and, d esp ite further overall inflation, farm c o m ­
m od ity p rices w ill p ro b a b ly increase little, if any.
P rodu ction ex p e n se s, w h ile risin g at a s lo w e r rate
than a year ago, are e x p e cte d to con tin u e to increase,
resu ltin g in little ch a n ge in n et cash receip ts through
m id-vear.

23

FEDERAL RESERVE BANK OF ST. LOUIS

T h e su ccess o f 1982 crop s, h o w e v e r, w ill b e a
m ajor factor in d eterm in in g con d ition s in the last h a lf
o f the year. B eca u se the d em an d for crop s is relative­
ly in elastic in the short run, another large crop w ill
result in a further d e c lin e in relative p rices o f farm
p rod u cts and lo w e r real farm in co m e . A sm all crop ,
h o w e v e r, co u ld lead to an in crea se in farm p rices
and in com es.

Recent Production and Price Movements
T o som e extent, the overall ou tlook for fo o d and
agriculture this year is related to the relative p rices
o f th ese co m m o d itie s vs. oth er com m od ities. This
rela tion sh ip is cle a rly o b s e r v a b le in the grow th
rates o f cro p and livestock p rod u ction d urin g recen t
d e c a d e s . P ro d u c tio n o f all farm p rod u cts in the
U n ited States rose at abou t 2.5 p ercen t p er year
th ro u g h th e 1 970s, f o ll o w in g a r e la tiv e ly s lo w
grow th rate o f abou t 0.6 p ercen t p er year in the
last h a lf o f the 1960s (table 1). T h e h igh er grow th
rate for farm prod u cts in the 1970s fo llo w e d rela tiv e­
ly h ig h er farm p rod u ct p rices, e sp e c ia lly in the first
h a lf o f the d eca d e.
D u rin g the 1965-70 p eriod , the p rice o f all farm
prod u cts rose on average o n ly 2.4 p ercen t p er year,
co m p a red w ith an average in crease o f 4.2 p ercen t
p e r year for the con su m er p rice index. T h is d e clin e
in relative p rice o f farm p rod u cts, e s p e c ia lly for
crop s, re d u ce d the in cen tiv es for p rod u ction .
T h e increase in exp ort d em an d for farm p rodu cts
in the early 1970s, c o u p le d w ith the re d u ce d stocks
o f crop s h e ld b y the g ov ern m en t in p rice support
operation s, le d to a sharp turnaround in the p rices
o f farm p rod u cts com p a red w ith gen eral p rices. D u r­
ing th e 1970-75 p eriod , the average p rices o f all farm
p ro d u cts rose sharply (11 p e rc e n t p e r year) and
p ro d u ction q u ick ly in crea sed in resp on se. O verall
farm output, as sh ow n in table 1, rose at a 2 .45 p er­
cen t rate in the first h a lf o f the 1970s, co m p a re d w ith
a 0.6 p ercen t rate du rin g the p reviou s five years.
C ro p p rod u ction grow th was greater than liv e ­
stock p rod u ction d u rin g th e 1970s, reflectin g the
relatively larger rise in cro p p rices, e sp e c ia lly dur­
in g th e first h a lf o f th e d e ca d e . D u rin g the 1970-75
p e rio d , crop p rod u ction rose at a 3.89 p e rce n t rate
co m p a red w ith - 0 . 7 7 p e rce n t for livestock p ro d u c­
tion. In contrast, d u rin g the last half of the 1960s,
livestock ou tp ut in crea sed at a 2.02 p erce n t rate c o m ­
pared w ith a 0.20 p ercen t rate o f in crease for crops.
T h e g ov ern m en t h e ld large in ven tories of crops
a cq u ire d in p rice su p p ort op era tion s d u rin g the

24FRASER
Digitized for


JANUARY 1982

Table 1

Rates of Change of Production and
Prices of Farm Products
Percent changes,
annual rates1
1965-70

1970-75

1975-81

Prices
All farm products
Livestock
Crops
Consumer prices

2.4%
4.7
-0 .6
4.2

11.0%
7.8
15.0
8.0

5.5%
6.7
4.5
8.0

Production
All farm products
Livestock
Crops

0.60
2.02
0.20

2.45
-0 .7 7
3.89

2.47
2.04
3.41

1Beginning year average to ending year average.
SOURCE: U.S. Department of Agriculture, A g ricu ltu ra l
Statistics (1980), and A g ricu ltu ra l O utlook (1981).

1960s. As inflation a cce le ra te d in the late 1960s, h o w ­
ever, gov e rn m e n t p rice supports for th ese p rod u cts
fa ile d to k e e p p a ce w ith gen eral inflation, and g o v ­
e rn m en t-h eld stocks w e re re d u ce d . T h e valu e o f
farm com m o d itie s o w n e d b y the g o v e rn m e n t (large­
ly crop s) d e c lin e d from $4.1 b illio n at the e n d o f 1965
to $1.6 b illio n at the e n d o f 1970.1 Partly as a result
o f this red u ction in gov e rn m e n t stocks, cro p p rices
d e c lin e d both in n om inal term s ( —0.6 p e rce n t p er
year) and relative to oth er p rices.
F o llo w in g the sharp increase in exports (largely
crop s) and the d e clin e o f stocks in the early 1970s,
cro p p rices rose at a 15 p e rce n t rate and livestock
p ro d u ct p rices at a 7.8 p e rce n t rate.2 D u rin g this
p e rio d , the annual rate o f inflation as m ea su red b y
the co n su m e r p rice ind ex was 8.0 p ercen t. A siza ble
ch a n ge in the relative p ro d u ctio n o f crop s and liv e ­
stock fo llo w e d : C rop ou tp ut rose at a 3.89 p e rce n t
rate w h ile livestock ou tp ut d e c lin e d at a 0 .7 7 p e r­
cen t rate. This d e clin e re fle cte d th e h ig h e r-p rice d
fe e d and the slo w e r grow th in d e m a n d for livestock
produ cts.
D u rin g m ore re ce n t years, 1975-81, the grow th
rate o f exp ort d em a n d for crop s has d e c lin e d , and
agricultural p rices, w h ich rem ain ed rela tively h igh

'U.S. Department o f Agriculture, Agricultural Statistics (1980).
2For an analysis o f the rise in export demand, see Clifton B.
Luttrell, “ Rising Farm Exports and International Trade Poli­
cies,” this Review (July 1979), pp. 3-10.

FEDERAL RESERVE BANK OF ST. LOUIS

into the last h a lf o f the d e ca d e , n ow have d e c lin e d
relative to oth er p rices. G row th in the average p rice
o f all farm p rodu cts d e ce le ra te d d urin g the 1975-81
p e rio d to a 5.5 p ercen t rate com p a red w ith the g e n ­
eral inflation rate o f 8 p ercen t as m ea su red b y the c o n ­
sum er p rice index. T h e p rice o f liv estock produ cts,
h o w e v er, rose at a faster rate than crop s, and liv e ­
stock p rod u ction a ccelera ted som ew h at from the
1970-75 rate. N everth eless, partly as a c o n s e q u e n c e
of the favorable 1981 w eather, crop ou tput rose at a
faster rate than liv estock output.

Incentive f o r Farm Production
A gricultural p rices in late 1981 w ere relatively
low w h e n com p a red w ith the gen eral p rice level.
F or exa m p le, late in the fourth quarter, farm p rod u ct
p rices w e re 8 p erce n t b e lo w levels o f a year earlier
and o n ly 26 p ercen t a b ov e their 1977 average. In
contrast, the con su m er p rice in d ex was abou t 10
p ercen t a b ov e a year earlier and 54 p ercen t a b o v e
its 1977 average. M oreov er, p rices p aid b y farmers
for p ro d u ction item s w e re abou t the same as a year
earlier and 46 p e rce n t a b ov e the 1977 average.
W h ile there is less in cen tiv e for in crea sed overall
farm p rod u ction this year than last, su p p ly and
d em an d factors are m ore en cou ra g in g for livestock
p rod u cers than for cro p p rod u cers. Large fe e d su p­
p lies and a ccom p a n y in g rela tively lo w fe e d p rices
m ean lo w e r fe e d cost for livestock p rod u cers and,
co n se q u en tly , som e im p rov em en t in livestock re ­
turns relative to those for crop s. A verage crop prices
in the fourth quarter o f 1981 w e re d ow n 15 p ercen t
from a year earlier, w h ile liv estock prices w ere d ow n
o n ly 10 p ercen t.3 Sim ilarly, a com p a rison o f recen t
p rices w ith the average for 1977 sh ow s that, d urin g
this p e riod , the average p rice o f liv estock p rodu cts
rose 33 p ercen t w h ile that o f crop s in crea sed on ly
19 percent.

Meat Animals and Poultry
A relatively high le v e l o f m eat and p ou ltry p ro­
d u c tio n is e x p e c t e d later this y e a r f o llo w in g a
slight red u ction in ou tp ut d u rin g the first quarter.

JANUARY 1982

p e cte d to rem ain large, and p lacem en ts of cattle
in fe e d lo ts are lik ely to exp an d from the relatively
lo w n u m b er cu rren tly o n feed .
A lth ou gh ))ork p ro d u ctio n in early 1982 w ill lik ely
b e greater than was p ro je cte d last autum n, slaughter
for the year is e x p e cte d to b e 4 p e rce n t to 6 p ercen t
less than a year ago. B ased on in ten d ed farrow ings,
h o w e v e r, the slaughter le v e l in late 1982 m ay equal
that o f late 1981.
D e sp ite the m ore favorable fe e d p rice s this year,
broiler p rod u cers are p la n n in g o n ly a sm all exp an ­
sion for 1982. T h is fo llo w s an 11 p e rce n t increase
last year, w h e n sizable losses w e r e in cu rred o n m uch
o f the ou tput as the larger than e x p e cte d pork su p ­
p lie s d e p r e ss e d poultry p rice s.4 B roiler ou tp u t w ill
lik ely con tin u e a b o v e 1981 le v e ls in the first part
o f this year but m ay d e c lin e to 1981 levels in the
fourth quarter. T u rk ey p rod u ction in 1982 is lik ely
to b e lo w e r than 1981 p ro d u ctio n as a result o f re­
d u c e d p rices and rela tively lo w net returns last year.
G iv e n the p ro sp e ctiv e su p p ly of and d em an d for
m eat and poultry, 1982 average p rices o f th ese p ro d ­
ucts are not e x p e cte d to greatly e x c e e d the average
o f 1981. C h o ic e b e e f p rices are e x p e cte d to increase
on ly m od era tely through the first half of the year and
m ay average o n ly 1 p e rce n t to 2 p ercen t a b o v e the
range o f the past tw o years. H o g p rices in the first half
o f the year are e x p e c te d to average about 10 p ercen t
a b o v e the 1981 le v e l b u t are lik ely to b e o n ly m o d ­
erately h ig h er in the s e co n d half of the year. B roiler
p rice s are e x p e cte d to average slightly h igh er than
last year, lo w e r in the first h a lf and h ig h er in the
s e co n d . T u rk ey p rice s are e x p e cte d to rise to about
70 cents p er p o u n d in the s e co n d h a lf o f the year, up
from 55-56 cen ts p er p o u n d in late 1981.

Dairy Products and Eggs
R eflectin g the relatively h igh g ov ern m en t p rice
supports ($13.10 p er h u n d re d w e ig h t (cw t.) for 3.67
p e rce n t m ilk) and lo w e r fe e d p rices, m ilk p ro d u ctio n
is e x p ected to increase, at least in the first h a lf o fl9 8 2 .
T h e U.S. D epartm en t o f A gricultu re projects that
dairy output m ay d e c lin e from year-earlier le v e ls in
the s e co n d h a lf o f the year, but eq u a l last year’ s ou t­
put for the year as a w h o le . A n industry report given

B eef p rod u ction is lik e ly to increase 2 p ercen t to
4 p ercen t. T h e sla u gh ter o f n o n fe d cattle is ex3U.S. Department o f Agriculture, Agricultural Outlook (D ecem ­
ber 1981).




4Pork is a good substitute for poultry. Hence, with large pork
supplies and relatively low pork prices, consumers tend to
substitute pork for poultry in their diets. This results in reductions
in the demand for and price o f poultry as well.

25

FEDERAL RESERVE BANK OF ST. LOUIS

at the ou tlook co n fe re n c e , h ow ev er, p oin ts to a
further rise in m ilk p rod u ction o f 2 p erce n t from the
re co rd 1981 le v e l.5
In either case, p rod u ction of dairy prod u cts is
e x p e cte d to e x c e e d d o m e stic con su m p tion plus ex­
ports in the first h a lf o f 1982, w h ich w ill result in
further a dd ition s to g ov ern m en t stocks through p rice
support operations. G ov ern m en t purch ases in p rice
support operation s on a m ilk eq u iv a len t basis totaled
abou t 11 p erce n t o f p rod u ction in the first three
quarters o f 1981 and such purchases w ill rem ain
large. Industry estim ates o f the cost to taxpayers o f
such purchases are as h igh as $2.5 b illio n . M ilk
p rice s for all o f 1982 are e x p e c te d to average about
1 p ercen t a b ov e 1981. W ith favorable fe e d costs in
p rosp ect, dairy farmers sh ou ld realize h ig h er n et
returns.
E g g p rod u cers have b e e n red u cin g the n u m b e r o f
re p la cem en t p ullets as a result o f u n favorable p rice
relationships sin ce early 1980. E g g p rod u ction , h o w ­
ever, has b e e n m ain tain ed b y p rod u cers k eep in g
th eir hen s in p rod u ction lon ger. P rodu ction in late
1981 was d o w n sligh tly from 1980 lev els, and m ay
con tin u e b e lo w year-earlier lev els through m id1982. W ith som ew h at h ig h er e g g p rices in p rosp ect,
p ro d u ctio n is lik ely to rise in the s e co n d h a lf o f the
year and eq u a l last yea r’ s le v e l for the en tire year.
E g g p rices are e x p e cte d to average abou t 74 cents
p er d o z e n for the year, u p from 70 cen ts p er d o ze n
in 1981.

C rops
As a result o f record crop s o f w h eat, coa rse grain
and rice this m arketing year, w o r ld su p p lies o f m ost
crops are w e ll a bove their 1980/81 lev els. T h e se
larger su p p lies have le d to lo w e r average p rices and
less in ce n tiv e for p rod u ction grow th in 1982. N e v e r­
th eless, w ea th er is a m ajor factor in cro p p rod u ctio n ,
and w eather con dition s as the crop d ev elop s w ill b e a
m ajor factor in d eterm in in g both the size of the 1982
crop and the average p rices r e c e iv e d b y farmers.

Food Grains (Wheat and Rice)
T h e 1981 record wheat cro p o f 2.75 b illio n
b u sh els, u p 16 p e rce n t from 1980, c o m b in e d w ith a
rela tively large June 1981 carryover, p rov id e s a
1981/82 m arket su pp ly o f 3.74 b illio n b u sh els. This
is 14 p e rce n t a b ov e the p rev iou s record o f 1980/81.
5E. Linw ood Tipton, Dairy Outlook, Production Consumption
Estimates 1982 (Government Printing Office).

Digitized for26
FRASER


JANUARY 1982

E xport d em a n d for U.S. w h ea t is e x p e cte d to rise
as a resu lt o f rela tiv ely sm all cro p s in the S oviet
U nion and Eastern E u rop e. W h eat exports are p ro ­
je c t e d at a re co rd 1.9 b illio n b u sh e ls, u p from 1.5
b illio n last year and an average o f 1.05 b illio n fo r the
1970/79 d e ca d e . In cre a se d sh ipm ents are in p ro s­
p e ct to the S oviets, India, Brazil, Iran and M o r o cc o ,
b u t C h in a is e x p e cte d to rem ain the largest U.S.
w h ea t cu stom er. H e n c e , the average farm p rice for
1981/82 w h ea t m ay rem ain near that o f last year,
d esp ite the in crea sed short-run su pp ly.
Stocks o f w h e a t at yea r-en d are e x p e cte d to b e
d o w n to abou t 908 m illio n b u sh els from 991 m illion
b u sh els last year, reflectin g th e in crea sed exports.
N everth eless, th e Secretary o f A gricu ltu re last
S ep tem b er a n n o u n ce d plans to im p le m e n t a re ­
d u c e d a creage program for the 1982 w h ea t crop .
Rice p rod u ction in 1981 was estim ated at 178.8
m illio n c w t ., 12 p e r c e n t a b o v e th e p r io r 1980
re co rd le v e l. T h is p lu s ca rryov er stocks results in
a total rice su p p ly o f 195.4 m illio n cw t. for the 1981/
82 m arketing year, or 14 p e rce n t m ore than the
p rev iou s 1980/81 record .
R ice exports for 1981/82 are p ro je cte d at 79.0
m illio n cw t., d o w n from 91.4 m illio n last year, w ith
d o m e stic use at 56.5 m illio n cw t., u p 3.8 p e rce n t
from last year. H e n ce , yea r-en d stocks are lik e ly to
total 55 m illio n to 6 0 m illio n cw t., w e ll a b o v e last
y ea r’ s carryover.
B ecau se o f reco rd p ro d u ctio n , carryover stocks
and th e e x p e cte d d e c lin e in exp ort d em a n d , the
season -average p rice o f rice is e x p e cte d to d e c lin e
to abou t $10 p er cw t., $2 p e r cw t. b e lo w last year’ s
p rice. H e n c e , w ith a target p rice (b e lo w w h ich
d e fic ie n c y paym ents are m ade to e lig ib le farmers)
o f $10.68 p er cw t. in effect, d e fic ie n c y paym ents b y
the g o v e rn m e n t to e lig ib le p rod u cers are e x p e cte d .

Feed Grains (Corn, Oats, Barley,
Sorghum Grain)
T h e U.S. fe e d grain su p p ly o f 2 80.2 m illio n m etric
tons is abou t 10 p e rce n t m ore than a year ago. A
re co rd cr o p o f 2 45 m illio n tons, 3 p e rc e n t a b o v e the
p reviou s 1979 re co rd cro p and 24 p e rc e n t a b o v e the
1980 cro p , w as p ro d u ce d . C o rn p ro d u ctio n , a bou t
four-fifths o f total fe e d grain, was up 22 p ercent.
W ith the large cro p , the su p p ly o f fe e d grain in­
creased faster than d em an d , and the p rice d e clin e d .
C o m p rice s are e x p e c te d to average o n ly about

JANUARY 1982

FEDERAL RESERVE BANK OF ST. LOUIS

Table 2

Changes in Per Capita Consumption of Major Food Products
Percent change in

Food Group
All foods
Cereals and
bakery products
Beef and veal
Pork
Poultry
Eggs
Dairy products
Fresh fruits
Fresh vegetables
Processed fruits
and vegetables
Sugar and sweets
Fats and oils
Nonalcoholic beverages

1980 consumption
in pounds
(retail weight)

1978

1408

-0 .4 %

1979
0.8%

1980

1981
(Preliminary)

-0 .9 %

-1 .4 %

1982
(Forecast)
1%

150
78
68
61
35
308
84
207

-1 .1
-5 .7
0.2
4.7
1.8
0.4
-1 .8
-0 .7

3.8
-1 0 .9
14.1
8.4
2.0
- 0 .6
3.4
1.9

-0 .5
- 2 .3
7.1
0.2
-2 .0
-3 .0
4.0
0.9

0.7
0.4
-7 .0
2.0
- 3 .4
0.0
- 3 .0
-3 .0

1
2-3
-6
0
-2
1
1
5

142
133
55
11

0.9
0.7
3.4
7.7

1.5
1.5
2.5
3.7

-2 .8
-2 .7
0.4
-5 .0

-1 .5
- 2 .0
-0 .8
3.6

-5
1-2
1-2
1

SOURCE: U.S. Department of Agriculture, The Current Food S ituation and O utlook fo r 1981.

$2.60-$2.90 p e r b u s h e l for the year, d o w n from a bou t
$3.10 p er b u s h e l last year.
E xports are lik ely to b e u p som ew h at, 74 m illio n
m etric tons com p a red w ith 69 m illio n in 1980/81,
a nd d o m e stic use m ay in crea se from 147 m illion to
156 m illion m etric tons. N everth eless, a 50 m illio n
m etric ton carryover is estim ated for this year, w e ll
a b o v e the 35 m illio n last year.

Fats and Oils (Soybeans and Cottonseed)
Soybean p rod u ction o f 2.1 b illio n b u sh els last
year was 415 m illion b u sh els m ore than in 1980.
C o u p le d with relatively large b e g in n in g stocks, the
total quantity available for 1981/82 was b o o ste d to
2.4 b illio n b u sh els. T h is is 13 p ercen t a b ov e a year
ago and on ly 1 p ercen t b e lo w the record 1979/80
le v e l. W ith the large su p p ly available and n o m ajor
increase in d em an d , p rices to farmers have d e c lin e d
from year-ago levels and are e x p e cte d to average
from $5.50 to $7.00 p er b u sh el for 1981/82, w e ll
b e lo w the $7.61 estim ated for 1981.
Cottonseed p rod u ction m ay reach a re c o rd 6.2
m illio n short tons. W h en a d d ed to last yea r’ s very
sm all carryover o f 0.4 m illion short tons, su pp lies
this year w ill total a rela tiv ely large 6.6 m illion short
tons. P rices for co tto n se e d a veraged $105.50 a ton
d u rin g the early autum n or $10 p er ton less than a



year earlier. T h e season average p rice is forecast at
$110 a ton, 12 p e rce n t less than last year, d u e to the
rela tiv ely large su p p ly o f co tto n se e d and soybean s,
w h ich is a g o o d substitute for co tto n se e d .

Cotton
T h e rela tively large 1981 cotton cro p o f 15.5 m il­
lio n bales (480 p ou n d s p e r bale) plu s a 2.7 m illion
b a le carryover p rovid es 18.2 m illion bales for d o m e s­
tic con su m p tion and export during 1981/82. W ith
d o m e stic cotton co n su m p tio n estim ated at 6.2 m il­
lio n bales and exports at 7.0 m illio n b a les, carryover
stocks at the e n d o f 1981/82 are p ro je c te d to be
rela tively h igh at 5.0 m illio n bales.
C otton p rod u cers re c e iv e a d e ficie n cy p a y m e n tb y
the govern m en t if the 1981 calen d ar year average
p rice o f u pland cotton is less than the target p rice o f
70.87 cents p er p ou n d . S u ch d e fic ie n c y paym ents
may b e relatively large for the 1981 cro p as the
S ep tem b er p rice for u pla n d cotton was o n ly abou t
63 cents p er p o u n d .

Tobacco
T o b a c c o p ro d u ctio n in 1981 was estim ated at 2.01
b illio n p ou n d s, up 13 p e rce n t from a year earlier.
T h e large cr o p and som e in crea sed ca rryover in d i­

27

FEDERAL RESERVE BANK OF ST. LOUIS

JANUARY 1982

Table 3

Changes in the Consumer Price Index of Food
Percent change in

Component
Food
Food away from home
Food at home
Cereals and bakery
products
Beef and veal
Pork
Other meats
Poultry
Fish and seafood
Eggs
Dairy products
Fresh fruits
Fresh vegetables
Processed fruits
and vegetables
Sugar and sweets
Fats and oils
Nonalcoholic beverages
Other prepared foods

Relative
importance
in food CPI

1978

1979

100.0%
30.7
69.3

10.0%
9.0
10.5

10.9%
11.2
10.8

8.7
9.8
4.7
3.0
2.3
2.3
1.3
9.3
2.4
2.8

8.9
22.9
12.9
17.8
10.3
9.5
-5 .5
6.7
19.4
7.9

10.1
27.3
1.5
14.7
5.0
9.8
9.5
11.6
12.4
2.9

11.9
5.7
-3 .4
3.8
5.1
9.2
-1 .8
9.8
6.2
8.9

10.2
1.8
9.8
5.0
5.5
8.9
7.8
7.5
5.3
20.1

7-8
5-7
8-11
6-7
3-5
8-9
4-5
4-5
8-9
-1 - 0

4.5
2.9
1.9
7.6
5.8

10.5
12.2
9.5
5.7
8.0

8.6
7.8
8.0
5.0
10.1

7.0
22.9
6.6
10.6
10.8

12.2
8.2
11.5
4.1
10.5

9-10
2-3
5-6
2-3
9-10

1980
8.6%
9.9
8.0

1981
(Preliminary)
8.2%
9.3
7.8

1982
(Forecas
7%
8
6

SOURCE: U.S. Department of Agriculture, The Current Food Situation and O utlook fo r 1981.

cate that total su pp lies for the 1981/82 m arketing
year w ill b e abou t 5 p e rce n t larger than a year ago.
G o v e rn m en t p rice su pp ort lev els for to b a cco are 12
p e rc e n t h ig h er than a year a go so that cash receip ts
to fanners from sales o f the 1981 cr o p are u p about
25 p ercent. T h e form u la for gov ern m en t p rice su p­
ports for e lig ib le to b a c co requ ires that the support
p rice for the 1982 cro p b e in creased 11 p e rce n t from
the 1981 lev el. T h u s, w ith an average to b a cco
harvest, cash returns from to b a cco sales w ill rise
11 percent.

FOO D OU TLO O K
L e d b y sizable gains in the ou tp ut o f fresh veg eta ­
b le s, b e e f and veal, overall fo o d su p p lies this year
are forecast su fficien tly h igh to p ro v id e a 1 p ercen t
in crease in con su m p tion p er capita. In creases are
also in p rosp ect for cereals and bakery p rod u cts,
dairy p rod u cts, and fresh fruit (table 2). S om e re d u c­
tion in con su m p tion p er capita is in p ro s p e ct for
pork, egg s, and p ro c e ss e d fruit and v eg eta b les.
C ru d e fo o d s tu ff p rices are not e x p e cte d to rise
m u ch at the farm le v e l this year, on ly abou t 1 p ercen t
Digitized for28
FRASER


to 4 p ercen t. As in d ica ted earlier, b e e f, poultry, dairy
p ro d u ct and e g g p rice increases w ill b e m in im al. I f
h o g p ro d u ctio n d e clin e s relative to d e m a n d as ex­
p e cte d , pork p rice increases m ay e q u a l the inflation
rate. F resh fruit p rices m ay also rise at the inflation
rate. Farm le v e l p rice s for m ost cereals and dry
e d ib le b ean s, h o w e v e r , w ill b e lo w e r than in 1981.
C o n se q u e n tly , m ost o f the in crease in fo o d costs this
year w ill o c c u r in the p ro c e ss in g and m arketing
sector.
T h e average p rice in crease for fo o d at grocery
stores is estim ated to b e about 6 p e rce n t (table 3).
N o m ajor p rice ch a n ges are forecast for any fo o d
grou p. P rice increases for pork, p ro c e ss e d fruit and
v e g eta b les, and oth er p rep ared food s such as cereals
and bak ery p rod u cts, w h e re m ost o f the costs rep re­
sent p ro ce ss in g and m arketing services, w ill lik e ly
app roach the rate o f inflation.

SUMMARY
T h e U.S. D ep artm en t o f A gricu ltu re forecasts that
there w ill b e n o im p ro v e m e n t in n et farm in com es

FEDERAL RESERVE BANK OF ST. LOUIS

JANUARY 1982

in 1982. E xp ectation s are for risin g fo o d su p p lies and
relatively m oderate fo o d p rice increases.

receip ts to farmers c o u ld b e d o w n from $1 b illio n

A bu n d an t quantities of m ost farm p rodu cts are
available for d o m e stic use and exp ort fo llo w in g the
reco rd 1981 cr o p harvest. W h ile exports are e x ­
p e cte d to rise further, su p p lies o f m ost crop s and
livestock p rod u cts w ill b e su fficien t to lim it p rice
increases to less than the rate o f inflation. Cash

b e greater.




to $3 b illio n and the d e c lin e in n et in co m e co u ld

Larger quantities o f fo o d are in p ro sp e ct for c o n ­
sum ers, and the fo o d co m p o n e n t o f the con su m er
p rice in d ex w ill lik e ly increase at less than the rate
o f inflation.

29