Full text of Review (Federal Reserve Bank of St. Louis) : March 1969

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FEDERAL RESERVE BAN K
MARCH 1969
OF ST. LO UIS

Restraining Inflation .......................................... 3
Relations Among Monetary Aggregates........ 8
A Program of Budget Restraint.......................TO
L IT T L E R O C K




The Relation Between Prices and
Employment: Two V ie w s .............................. 15
Farm Income Prospects ..................................... 22

Reprint Series
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NUMBER

TITLE OF ARTICLE

ISSUE

1. Price Movements in Perspective

July 1961

2. Changes in Selected Liquid Assets, 1951-1961
3. M em ber Bank Reserves and the M oney Supply

O cto b e r 1961
M arch 1962

4. Changes in the V e lo city o f M oney, 1 9 5 1 -1 9 6 2

June 1962

5. Movem ents in Time & Savings Deposits, 1 9 5 1 -1 9 6 2
6. Excess Reserves

M arch

7. Bank Loans and Investments, 1 9 5 1 -1963

O cto b e r 1963

8. Recent Trends in Time Deposits

July 1964
September 1964

9. M oney S upply and Time Deposits, 1 9 1 4 -1 9 6 4
10. Bank Loans, 1 9 6 1 -1 9 6 4

1963

A p ril 1963

11. Currency and Demand Deposits

O cto b e r 1964
March 1965

12. Federal Reserve Open M a rke t Transactions and the
M oney Supply

A p ril 1965

13. Im plem entation o f Federal Reserve Open M a rke t Policy
in 1964

June 1965

14. Trends in Commercial Banking 1 9 4 5 -1 9 6 5

A ugust 1965

15. Interest Rates, 1 9 1 4 -1 9 6 5
16. Budget Policy in a H igh-E m ploym ent Economy

O cto b e r 1965
A p ril 1966

17. Federal Reserve Open M a rke t O pera tio n s in 1965:
Objectives, A ctions, & Accomplishments
18. The Effect o f Total Demand on Real O u tp u t
19. Banking M arkets fo r Business Firms in the St. Louis A rea

June 1966
July 1966
September 1966

20. The Federal Budget and Economic S ta b iliza tio n
21. Economic Theory and Forecasting

February 1967
M arch 1967

22.
23.
24.
25.

1966 — A Year o f C hallenge fo r M o n e ta ry M anagem ent
Estimates o f the H igh-E m ploym ent Budget: 1 9 4 7 -1 9 6 7
Three A pproaches to M oney Stock D eterm ination
M o n e ta ry Policy, Balance o f Payments, and Business
Cycles — The Foreign Experience
26. M oney, Interest Rates, Prices and O u tp u t
27. The Federal Budget and S ta b iliza tio n Policy in 1968

A p ril 1967
June 1967
O cto b e r 1967

28. 1967 —

M a y 1968

a Year o f C onstraints on M o n e ta ry M anagem ent

N ovem ber 1967
N ovem ber 1967
M arch 1968

29. Does S low er M o n e ta ry Expansion Discriminate
A g a in st Housing?

June 1968

30. The Role o f M oney and M o n e ta ry Policy

July 1968

31. The M o n e ta ry Base —

August 1968

32. Interest Rate C ontrols —
and Problems

E xpla n a tio n and A n a ly tic a l Use
Perspective, Purpose,

33. An A pproach to M onetary and Fiscal M anagem ent

September 1968
N ovem ber 1968

34. M onetary and Fiscal Actions: A Test o f Their Relative
Im portance in Economic S tabilization

Novem ber 1968

35. A Program o f Budget Restraint

M arch

1969

36. The Relation Between Prices and Employm ent:
Two Views

March

1969




Restraining Inflation
I n FLATION continues to be a major concern of
consumers, producers and stabilization policymakers.
The strong desire to reduce the rate of inflation is
apparently tempered by an equally strong desire to
avoid a sharp reduction in the growth of real product
and employment. Economic analysts are looking for
signs that restraint is being effectively pursued by
monetary and fiscal means and that the growth of
total demand is moderating. At the same time we
are cautioned that too rapid a slowdown in the growth
of total spending could have serious repercussions on
the rate of growth of production and employment.

D e m a n d a n d P roduction
Rati Scale
Billie ns of Dc liars

RatioS cole
Billions of Do liars

Q uarterly Totals at A nual Rotes
Seasonally Adj jsted

............
95 0
900

900

87.4

+
9

85 0

850

800

800

75 0

otal Spei ding
70 0

'
1
/y

75 0
18.4

70 0
+437.

65 0
600

/

+8.1%

Real Prt duct £
550

550

Total Spending

5.4%

500

Total demand for goods and services has continued
to rise at a pace exceeding the growth of the produc­
tive capability of the economy, despite some slowing
in the growth of total spending since mid-1968. From
the third to the fourth quarter last year total spend­
ing, as measured by Gross National Product, increased
at a 7.8 per cent annual rate, less than the 9.5 per
cent growth in the previous four quarters, but the
same as the average rate for the previous three in­
flationary years.
The rapid 9 per cent rate of advance of total
spending in 1968 characterized all major spending
groups in the economy, although the relative impor­
tance of spending groups shifted from quarter to
quarter. Quarterly changes in the components of total
spending are summarized in Table I.
The course of consumer spending and of business
spending for inventories shifted in an alternating pat­
tern during 1968. In the first and third quarters con­
sumer expenditures accounted for the largest portion
of increases in spending, while spending for business
inventories declined. In the second and fourth quar­

500

£
stqtr.

4th c r.

Is qtr.

4th q

♦

45 0 ♦
1961

1962

1963

1964

1965

t
1966

a GNP in current dollars.
1 GNP in 1958 dollar*.
2

4th q

♦
1967

45 0
1968

1969

Source: U.S. Department of Commerce

Percentages are annual rates of change between periods indicated. They are presented to aid in
comparing most recent developments with past "trends."
atest data plotted: 4th quarter

ters, when consumption spending was rising at a
reduced rate, spending for business inventories in­
creased markedly. The fourth quarter slowing in
consumer spending has been attributed partly to the
flu epidemic and to fewer shopping days between
Thanksgiving and Christmas than usual.
The level of retail sales increased only slightly
on balance from September to February, after in­
creasing $1.9 billion from January 1968 to Septem­
ber, or at a 10.5 per cent annual rate. A slowing in
the rate of increase of income may have been a factor
in the leveling of consumer spending in the past six
months. From last September to January, personal
income rose at a 6.8 per cent annual rate, compared
with a 9.8 per cent rate in the previous year. From
December to January, personal income increased at
less than a 3 per cent annual rate because of the in­

Table 1

CHANGES IN COMPONENTS OF TOTAL SPENDING, 196 81
(an n ua! rates of change in parentheses)
1st Q uarter
Consumption
Fixed Investment
Changes in Business Inventories
G o v ’t. Spending
Net Exports
Total Spending2

1 7.2
4.1
“ 6.2
7 .0
- 1 .9
2 0.2

(1 4 .4 )
(1 5 .3 )
(1 6 .2 )
(1 0 .4 )

2nd Q uarter
8 .5
- 1 .1
8.7
5 .2
.5

( 6 .7 )
( - 3 .7 )

2 1 .7

( 1 0 .9 )

( 1 1 .4 )

3rd Q uarter
1 3.2
3.1
- 3 .3
3 .9
1.3
18.1

(1 0 .4 )
(1 1 .1 )
( 8 .2 )
( 8 .8 )

4th Q uarter
5 .7
6 .4
3.1
3 .4
- 2 .3
1 6 .4

( 4 .3 )
( 2 3 .2 )
( 7 .0 )
( 7 .8 )

‘In billions of dollars
Components may not sum to totals because of rounding.




Page 3

MARCH.

F E D E R A L R E S E R V E BANK O F ST. LO UI S

crease in social security taxes and other special factors
such as strikes in the shipping and petroleum indus­
tries. However, in February personal income probably
increased at about the same rate as the average rates
of increase since last July. From the third to the
fourth quarter 1968, disposable income increased at
a 6.7 per cent rate, compared with a 7.8 per cent
average increase in the previous four quarters.
The rate of increase of fixed investment, including
spending for plant and equipment and residential
construction, rose sharply from the third to the fourth
quarter of 1968, and the economy continues to op­
erate at a high level of labor and other resource
utilization. Even so, production has continued to ad­
vance rapidly. From September 1968 to January 1969,
industrial production increased at an 8 per cent rate,
compared with a 5.3 per cent rate in the previous
twelve months.

1969

per year for very long, because of limitations on re­
sources such as labor, productive facilities, and tech­
nology. The very large increases in real product in
the first two quarters of last year were possible be­
cause the economy was able to bring additional
resources into production at higher costs.
Prices
Ratio Scale
1957-59=100
135

Ratio Scale
1957-59=100
135

Real Product, Prices and Employment
The increase in total spending from late 1967 to
late 1968 was manifested in a 5.4 per cent increase
in real output and a 3.9 per cent increase in the
average level of prices. In the fourth quarter, growth
Table II

Source: U.S. Department of Labor
Percentages ore annual rate* of change between periods indicated. They ore presented to aid in
comparing most recent developments with past "trends."
Latest data plotted: January

QUARTERLY CHANGES IN GNP, PRODUCTION
A N D PRICES— 1968
(B illio n s of D ollars)
Q uarter

1
II
III
IV

Nom inal
GNP

Real Product

Prices’

2 0 .2
2 1 .7
18.1
16 .4

10.9
1 0 .7
8 .9
6.1

9 .3
11.0
9 .2
10.3

(Percentage Changes From Preceding Q uarter)
Q u arter

1
II
III
IV

Nominal
GN P

Real Product

Prices

1 0 .0 %
10.5
8.5
7 .5

6 .4 %
6 .2
5 .0
3 .4

3 .6 %
4 .3
3 .5
4.1

♦Change in nominal (total)
(GN P in constant dollars)

GNP minus the change in real product

of real product slowed to a 3.5 per cent annual rate,
while prices continued to rise at a 4 per cent rate.
The distribution of changes in total spending between
prices and real product in each of the four quarterr
of 1968 is shown in Table II. Most of the slower
growth of total spending in the second half of 1968
was manifested in reductions in the growth of real
product. It is unlikely that the growth of real product
could be maintained at rates much above 4 per cent
Page 4



The rapid rate of price increases has continued
into 1969. The consumer price index has continued
to rise rapidly early this year, after accelerating from
about a 4 per cent average rate in the second half of
1967 to nearly a 5 per cent average rate in the second
half of 1968. Wholesale prices of industrial commodi­
ties went up at an 8 per cent rate in January after
rising about 2.6 per cent in the previous year. Whole­
sale prices of farm products also increased at a very
rapid rate in January and, as a result, wholesale
prices of all commodities increased at a 10.3 per
cent annual rate from December to January.
Total civilian employment increased at a rapid 7
per cent annual rate from October 1968 to February,
representing an increase of almost 1% million persons.
The unemployment rate remained at 3.3 per cent of
the labor force in January and February, matching
December’s 15-year low. Unemployment among mar­
ried men was 1.4 per cent in the first two months
of this quarter, compared with 2.4 per cent in 1965.
Employment as a percentage of population of work­
ing age also indicated an increase in the intensity of
manpower usage last year. In 1968, 73 per cent of
those between the ages of 20 and 64 were employed.

MARCH.

F E D E R A L R E S E R V E BANK O F ST. L OUI S

E m ploym ent
R atio S c a le
M illio n s of Persons
901

R atio S c a le
M illio n s of Persons
90

S e a so n a lly Adjusted

1969

per cent in late February, compared with 6.25 per
cent in late December and 5.8 per cent in October.
Yields on three-month Treasury bills declined sea­
sonally to an average of 6.1 per cent in late Feb­
ruary, compared with 6.2 per cent in late December
and 5.35 per cent in October.
Interest rates on long-term securities have moved
in a similar pattern. Yields on long-term Government
bonds rose from 5.24 per cent during October to 5.82
per cent in late December. The average yield on
corporate Aaa bonds rose from 6.09 per cent in OcM oney M a rke t Rates

(v o t

w oi

ly o j

1964

1965

1966

1967

1968

1969

R a tio S c a le

R a tio S c a le

So urce. U .S. D epartm ent of La b o r
Percentages are annual rates of change between periods indicated. They are presented to aid in comparing
most recent developments with past "trends."
Latest d ata p lotted: Febru ary prelim inary

P
rine C m rcial P er
om e
ap
4- to 6 lonth
-1

At the peak of the Korean War (1953) this ratio was
68 per cent, and when economic activity was at a high
level in 1957, 1959, and 1965, the figures were 69
per cent, 69 per cent and 71.4 per cent, respectively.

\r— /
R ulation Q M
e
axim Rale n j
um
,'W
i
i

\u

^6.63
r6.12
6.00
m /\ J
/ \/

/

J

Real product growth would be expected to slow
to its full-employment potential rate (probably about
4 per cent) when the economy moves beyond an
efficient level of resource use. This full-employment
growth rate of real product can be exceeded only tem­
porarily due to stimulative actions which attract
larger amounts of resources into production, but at
the cost of acceleration of inflation. Since the slowing
of total spending in the third and fourth quarters of
last year was matched by an unavoidable slowing of
real product growth to its full employment potential,
it may be inferred that the economy was subjected
to a similar amount of excessive inflationary stimulus
throughout last year.

Credit Demand and Interest Rates
The demand for loans has been very strong during
early 1969. Business loans at large commercial banks
have increased at an 18 per cent annual rate in the
past three months, almost twice the 9.6 per cent
trend rate from 1960 to 1968. Banks have liquidated
some securities in meeting the rising demand for loans.
In recent months the loan portion of bank credit has
risen sharply, while the investment portion of bank
credit has declined.
Most market interest rates rose slightly in January
and February after rising sharply from October to
record high levels in late December. Interest rates on
four- to six-month commercial paper averaged 6.75



T
W

D's

j
reasu 1B
r ills
3-Moi Ih T

if

V
A .

J

1961

1962

1963

1964

1965

1966

1967

1968

1969

[]_Rate on deposits in amounts of $100,000 or m ore maturing in 90 -179 d ays.
12 A v erag e new issue rates on six month certificates of d eposit of $100,000 or more. Data a re estimated
by the F e d e ra l R eserve Bank of St. Louis from g uide rates p ublished in the Bond Buyer a nd are
monthly a ve ra g e s of W e dn esd ay figures.
Latest d ata plotted: Feb ru ary

tober to 6.53 per cent in late December. During Feb­
ruary the yields on these securities averaged 5.86
and 6.66 per cent, respectively.
The high levels of interest rates suggest to many
analysts that “money has been very tight.” However,
if nominal interest rates are adjusted for inflationary
expectations, interest rates do not indicate such a
degree of tightness. Recent and anticipated inflation
have altered the portfolio preferences of asset holders
away from financial assets with fixed nominal yields,
while encouraging spending financed through bor­
rowing.

The Money Stock and the Monetary Base
In the past three months expansion of some mone­
tary aggregates has slowed from the very rapid pace
of the previous two years. However, part of the slowPage 5

MARCH,

F E D E R A L R E S E R V E BAN K O F ST. L O U IS

B a n k Credit*
A ll Com m ercial Banks

Ratio S c a le
B illio n s of D ollars
500

Ratio Sca le
B illio n s of D ollars
50 0

1969

lations Among Monetary Aggregates" in this
Review. From December to February there was an
unusual buildup in Government deposits (not in­
cluded in money) causing private deposits to be
correspondingly less than they would otherwise have
been for the same amounts of the monetary base. As
Government deposits at commercial banks decline,
private demand deposits and the money stock prob­
ably will rise rapidly if the monetary base continues
to increase at the recent rapid rate.
Monetary Indicators
Ratio Scale
Billions of D ollars
85

M o nth ly A v e r a g e s o f D a ily Fig u re s
S e a s o n a lly A d ju ste d

Ratio Scale
Billions of D ollars
85

80
June‘6?

h i / 66 Dee <
50 N ov.6 7

Fe b '69

6 0 ----^
_________________________________________________ L J ________ U_________ \1________
1961
19 62
19 63
19 6 4
1965
1966
19 6 7 19 68
1969

80

70

60

•D a ta o re estim ated b y the F e d e ral R eserve Bank o fS t .lo u is .
Percentages are annual rates of change between p eriods indicated. They are presented to aid in
comparing most recent developments with past "trends."

2 767

75

75

+t

70

+277.

L ate s t d a ta p lo tted : F e b ru a ry prelim inary

70

Monetary Base U
-

65

ing can be explained by special circumstances, re­
quiring more careful interpretation of the apparent
signs of restraint in some indicators, as discussed
below.
The money stock, consisting of private demand
deposits and currency in the hands of the public, in­
creased at only a 4 per cent annual rate in the past
three months, slower than the 6.4 per cent rate of the
past two years. Analysis of the growth of money for
very short periods of a few months must consider
the influence of fluctuations of U. S. Government de­
posits at commercial banks, as pointed out in “Re-

65
J 6 0 .5

60

60

+

55

55
+3.4%

(

S

Federal Reserve Credit £

50

50

45

45

Apr."66

40

Dec 66

eb.69

i i !ti 1 1 11 1 1 it _L l l l l l l .

1966

.1J. 1 1 I. 1, 1.I l l l l i

1967

1968

1 ill 1 1 1 1 1 1 1 1 1

1969

40

l]_U se s of the m on eta ry b a s e a r e m em b er b a n k re s e rv e s a n d cu rren cy held b y the p u b lic
a n d n o n m em b er b a n k s . A d ju stm en ts a re m a d e fo r re s e rv e re q u ire m e n t ch a n g e s an d

Money Stock
Ratio Scale
Billions o f Dollars
210

shifts in d e p o sits a m o n g c la s s e s o f b a n k s . D a ta a re com puted b y th is b a n k .

Ratio Scale
Billions of Dollars
210

M onthly A v e ra g e s of D a ily Fig u res
Cu— i u n a n f n u |u. s-ii« u
l J. J
j a

205

205

200

[^ T o ta l F e d e ra l R e se rv e c re d it o u tsta n d ing a s d e fin e d in the F e d e r a l R e se rv e B u lletin
an d se a s o n a lly a d ju ste d b y th is b a n k . A d justm ents a re m a d e fo r re s e rv e re q u ire m e n t
c h an g e s a n d shifts in d e p o s its a m o n g c la s s e s o f b a n k s . D a ta a r e com puted b y th is b a n k .
P ercen ta g es a re an n u al rates o f c h a n g e b etw een p e rio d s in d ica te d . Th ey a re p resented
to a id in c o m p a rin g m ost recent developm ents w ith p a s t "tre n d s ."

200
-1

195

_______
193.8

190

195
190

+ 4 % / y
<»

185

185

180

180

175

175

170

170

165

165

160

La te st d a ta p lo tte d : F e b ru a ry p re lim in a ry

The monetary base, the total credit supplied by
the Treasury and Federal Reserve to the private sec­
tor of the economy,1 has risen at a 5.4 per cent annual
rate in the last three months, compared with the
rapid 6.2 per cent rate of the past two years, and
above the 3.6 per cent trend rate from 1957 to
1968. The growth of the monetary base dominates
the trend growth of the money stock over time.

160

155
150

Apr.'66

i i Iti i 1i i 1i i
1966

155

eb.69

Ja .67
,11 ,I n

1967

.l l l l l l , ill 11 1i 11 Ll l
1968

1969

Percentag es a re an n u a l rates o f ch an g e betw een perio ds ind icated . They a re p resented
to a id in com paring most recent developm ents with p a st "tre n d s."
Latest d a ta plotted : F e b ru a ry p relim in a ry

Page 6



150

Disintermediation
Growth rates of the money stock plus time deposits
and of total credit at commercial banks have slowed
1See “The Monetary Base —Explanation and Analytical Use,”
in the August 1968 issue of this Review.

MARCH,

F E D E R A L R E S E R V E BANK O F ST. L OUI S

markedly since December. The broad measure of
money decreased at a 3.9 per cent annual rate from
December to February, compared with an 8.5 per
cent rate of increase during the past two years. Bank
credit has increased at a 2.4 per cent rate since
December, compared with a 10 per cent rate of in­
crease since late 1966.
The slowing in the growth of these two measures,
money plus time deposits and bank credit, is largely
the result of the disintermediation of bank time de­
posits caused by market interest rates rising relative
to rates banks are permitted to pay on time deposits.
New issue interest rates on large negotiable certificates
of deposit ($100,000 or more) at commercial banks
reached the maximums permitted under Regulation
Q in late November 1968, while rates on commercial
paper and other market instruments continued to
rise. Large certificates of deposit at large commercial
banks declined from $24.3 billion in early December
to $19.6 billion on March 5. Total time deposits at
commercial banks have declined at a 9 per cent
annual rate since December.
The contraction of CD’s and resulting slowing in
the growth of total bank deposits and bank credit
have been cited by some observers as signs of signifi­
cant tightening of monetary actions. Although the de­
cline of time deposits does restrict the growth of total
bank deposits and bank credit, it does not necessarily
limit growth of total liquid assets or total credit in
the economy. As time deposits at commercial banks
decline, funds are made available in the market
through other credit instruments. Total deposits and,
therefore, total assets of commercial banks decline,
but the restriction of bank credit growth caused by
the interest rate ceilings on time deposits is probably
not any greater than the offsetting increased growth
of credit in nonregulated markets.
As discussed in “Relations Among Monetary
Aggregates” in this Review, the falling demand for
time deposits, caused by high market interest rates
relative to Regulation Q ceilings, is the cause of the
decline in the growth of money plus time deposits
and bank credit. Therefore, the observed slower
growth of these two aggregates is not sufficient infor­
mation to indicate that monetary actions have become
less stimulative since November.
The rise in the volume of net borrowed reserves
has also been cited as an indication of monetary re­
straint. Borrowings from Federal Reserve Banks aver­
aged $820 million during February, up from $570
million in November. Other sources of funds to banks



1969

have been relatively expensive, as interest rates on
Federal Funds and short-term assets remain high
compared to the discount rate, and banks continue
to lose large CD’s. During February, the three-month
Treasury bill rate averaged 60 basis points above the
discount rate. On average since 1961, the bill rate has
been slightly below the discount rate. The increased
borrowing probably reflects a decline in banks’
liquidity, and has contributed to bank reserves and
continued money creation.

Summary
Total demand for goods and services remains ex­
cessive; therefore, upward pressures on prices con­
tinue to be intense. The major short-run domestic
economic objective is to reduce the excessive total
spending, and hence inflationary pressures, without
causing an undue interruption in the growth of pro­
duction. While the slight reduction in the growth rate
of total spending from the second to fourth quarters
in 1968 was manifested in a deceleration of the
growth in real product, employment and production
in early 1969 continue to show exceptional strength.
The general level of prices rose at a 4 per cent rate
throughout last year, and the increases in consumer
and wholesale prices have continued into early 1969.
Monetary authorities recently have announced in­
tentions to impose monetary restraints on economic
activity in order to reduce the intensity of the inflation.
Since monetary actions affect spending with a delayed
effect over time, monetary actions must be judged
by proximate measures. The measures commonly
used, if not properly interpreted, currently give contra­
dictory signals. Recent slower growth rates of money,
money plus time deposits, and bank credit, or high
market rates of interest and a large volume of net
borrowed reserves, have led some observers to con­
clude that monetary actions in recent months have
been highly restrictive. However, others note that
the monetary base has continued to increase rapidly,
that the slower growth of money was chiefly the
result of a large and temporary buildup of U.S.
Government deposits at commercial banks, and that
the slower growth of both money plus time deposits
and bank credit was the result of Regulation Q in­
terest rate ceilings and does not indicate any reduc­
tion in total credit flows. Thus interpreted, available
data seem to indicate that lasting monetary restraint
may not yet have been exercised. The observed
slower rates of monetary expansion will only be effec­
tive if they are maintained over the next few months.
Page 7

Relations Among Monetary Aggregates
I n RECENT YEARS greater attention has been
given to the growth rates of various monetary ag­
gregates as measures of the influence of stabilization
actions on economic activity. Four of the most fre­
quently discussed aggregates are the money stock
(private demand deposits plus currency held by the
public), money plus time deposits, bank credit (total
loans and investments of commercial banks), and the
monetary base1. This note discusses briefly the prin­
cipal factors influencing the growth of these aggre­
gates over time and cites special considerations ana­
lysts must keep in mind in deriving conclusions from
observed changes in the growth of these aggregates.
Expansion of the monetary base over periods of
several months is dominated by the growth of Fed­
eral Reserve Credit and, therefore, is determined
principally by changes in the Federal Reserve’s hold­
ings of U.S. Government Securities. It is generally
agreed that, among the four major monetary aggre­
gates, the Federal Reserve, through its open market
operations, can exercise closest control over the mone­
tary base.
The money stock, money plus time deposits, and
bank credit can all be related to the monetary base
through “monetary multipliers.”2 These multipliers
summarize all of the economic and institutional fac­
tors which link changes in the monetary base to
changes in the other three aggregates. For the past
two years the monetary base has grown at a rather
steady 6 per cent annual rate. During the same pe­
riod, money, money plus time deposits, and bank
credit each have grown, for short periods of a few
months, slower than the monetary base, while in
other periods they have grown much faster than the
base.
In recent years, changes in the growth rate of bank
credit have been more highly correlated with changes

1See “The Monetary Base —Explanation and Analytical Use,”
in the August 1968 issue of the Review.
2For a thorough presentation of one theoretical model relating
money, money plus time deposits, and bank credit to the
monetary base, see A. E. Burger, “A Summary of the
Brunner-Meltzer Non-Linear Money Supply Hypothesis,”
Working Paper No. 7, Federal Reserve Bank of St. Louis,
January 1969.

Page 8




in the growth of money plus time deposits than with
changes in the growth of the money stock, because of
the effects of Regulation Q ceilings on the interest
rates banks are permitted to pay on time deposits.
The following discussion will illustrate how changes
in the money stock, in money plus time deposits, and
in bank credit are influenced by factors other than the
monetary base.
In recent years, there have been two principal
factors influencing the growth rates of money, money
plus time deposits, and bank credit relative to each
other and relative to the base. These are fluctuations
in U.S. Government deposits at commercial banks
and the growth of time deposits relative to demand
deposits.

U.S. Government Deposits
U.S. Government deposits are a direct substitute
(in an accounting sense as a liability of commercial
banks) for private demand deposits. Banks which
are members of the Federal Reserve System are re­
quired to hold the same minimum reserve balances
against U.S. Government deposits as against private
demand deposits.
As individuals and corporations pay taxes (includ­
ing withheld taxes) or purchase newly issued Treas­
ury securities, their demand deposit (checking ac­
count) balances decrease and U.S. Government
deposits increase. Then as the Government spends,
its balances decrease and private balances increase.
Since U.S. Government deposits are not defined as
part of the money stock, private money decreases as
Government balances are built up, and increases as
Government balances are run down, other things
equal. In recent years, the Government’s balances at
commercial banks have ranged from as low as $3
billion to as high as $9 billion within a few months
time.
On average over the past twenty years, the money
stock has increased a little more than $2.5 billion
for every $1 billion increase in the monetary base.
In the last two years the base has been increasing
about $1 billion every three months, or at about a
6 per cent annual rate. However, there have been
several instances in recent years when money in­
creased very little for a few months while Govern­

ment balances were being built up, even though the
monetary base was continuing to grow rapidly. In
subsequent months, as Government balances were
reduced, the growth of money accelerated to rates
much faster than the growth rate of the base. Over
the period as a whole, the growth rate of money
averaged very close to the growth rate of the base.

Time Deposits
Changes in time deposits at commercial banks also
cause an offsetting change in private demand deposits,
but not on a one to one basis. Banks are required to
hold reserve balances against both time and demand
deposits, but the reserve requirement percentages are
much lower for time deposits than for demand de­
posits. A dollar of reserves can “support” a much larg­
er volume of time deposits than demand deposits. If
the growth of time deposits accelerates relative to the
growth of total reserves, the growth of total demand
deposits will decrease (assuming excess reserves are
constant). That is, a larger proportion of total re­
serves becomes “required” behind the increased time
deposits, so there are less “reserves available” to sup­
port demand deposits.
In the 1960’s time deposits at commercial banks
have grown much faster on average than demand
deposits. Therefore, an increasing proportion of total
reserves have been required behind time deposits,
leaving a diminishing proportion of total reserves
available for demand deposits. This upward trend of
time deposits has altered the multiplier relationship
between the monetary base and money, and between
the base and money plus time deposits. Since 1960 the
multiplier relation between the base and money has
trended downward, resulting in a somewhat slower
average growth rate for money than for the base. At
the same time, the multiplier between the base and
money plus time deposits has trended upwards, re­
sulting in a faster average growth rate for money plus
time deposits than for the base.
There have been at least three distinct instances
in the past three years in which the growth rate of
time deposits has declined sharply relative to the
growth rate of demand deposits.3 As the growth of
time deposits declined, reserves which otherwise
would have been held as required reserves behind
time deposits were “released” and became “available”
3Specifically, in the fall of 1966, spring of 1968, and from
December 1968 to the present, the growth of time deposits
slowed significantly relative to the growth of demand de­
posits.




for demand deposits. Consequently, the sum of pri­
vate and Government demand deposits was able to
increase at rates faster than the growth rates of re­
serves and base money. (However, total deposits de­
clined in these instances). In each of these cases the
declining growth rate of time deposits (an absolute
decline of time deposits in two of the instances) was
directly attributable to rapid increases in market in­
terest rates relative to the Regulation Q ceiling interest
rates banks are permitted to pay on time deposits.
The demand for time deposits by individuals and
businesses is positively related to the yield on time
deposits and negatively related to the yield on sub­
stitute earning assets, such as savings and loan shares,
mutual savings bank deposits, Treasury bills, and
commercial paper. When banks are offering to pay
the ceiling rates permitted by Regulation Q and are
prevented from offering higher yields even though
the yields on substitute assets are continuing to rise,
the demand for time deposits declines as does the
outstanding volume (or growth rate) of time depos­
its. In such circumstances, the growth of time deposits
is determined by changes in the demand for them,
since banks are willing to accept all deposits at the
ceiling rates. Consequently, the decreasing growth
rates of money plus time deposits, which occurred
in the three above-mentioned instances when banks’
offering rates on time deposits were constrained by
the ceiling rates, were paralleled by falling demand
for money plus time deposits.

Summary
Prediction of the effects of changes in the growth
rate of a monetary aggregate on economic activity
requires knowledge regarding the relative movements
in the supply of and demand for the asset. Thus,
when an analyst concludes that an acceleration in
the growth rate of money will have expansionary
effects on total spending in the economy, he is indicat­
ing that the supply of money is increasing relative
to the demand for money to hold.
In the above-mentioned cases, the behavior of in­
terest rates is evidence that a decline in the demand
for money plus time deposits accompanied the ob­
served reduction in the growth of the quantity of
money plus time deposits. Under such circumstances,
it should not be concluded that the observed slower
growth rate of money plus time deposits will have a
contractionary effect on total spending, since there is
no evidence indicating that the supply of money plus
time deposits is decreasing relative to the demand.
J e r r y L. J o r d a n

Page 9

A Program of Budget Restraint

X HE FEDERAL BUDGET and the Economic
Report of the President were presented to Congress
in mid-January. These two documents represent the
former Administration’s evaluation of current eco­
nomic conditions and the 1969 national economic
plan, and have been adopted without substantial
change by the present Administration.1 The Federal
budget calls for a spending increase of 5.5 per cent
from fourth quarter 1968 to fourth quarter 1969, and
Congress was asked to extend the 10 per cent sur­
charge to mid-1970. In the context of these proposals,
GNP is projected to increase about 6 per cent in the
year ending fourth quarter 1969.
The 1969 Economic Report and the appended An­
nual Report of the Council of Economic Advisers
(CEA) focus on the problem of inflation. According
to the CEA Report, “With inflationary pressures still
strong, economic policy should continue to exert re­
straint in 1969. Total demand must be brought into
better balance with the nation’s productive capacity to
permit a slowing of price and cost increases.” To
achieve these objectives, the outgoing Administration
outlined a fiscal program which would shift the Fed­
eral budget, on a national income accounts (NIA)
basis, from near balance in late 1968 to a surplus of
$3 billion in late 1969. With respect to monetary pol­
icy, the CEA Report suggests that such policy should
generally reinforce the intent of fiscal restraint in 1969.
Appraising the 1969 economic plan is complicated
by the change of administrations. Apparently the new
Administration has adopted the plan of the outgoing
Administration with regard to the selection of targets,
but there may be some differences as to the means
of achieving them. The objective of this article is to
determine what insights can be gained from recent
experience that may be of help in the formulation
of current and future stabilization policy.
JSee the statement of the Council of Economic Advisers
prepared for the Joint Economic Committee, February 17,
1969.
Page 10




Stabilization Actions and Economic
Activity in 1968
The nation’s major economic problem in 1968 was
inflation, generated by an excessive demand for goods
and services.2 Prices rose about 4 per cent during
the year, compared with a 3 per cent annual rate of
increase from 1965 to 1967, and a 1.5 per cent average
rate from 1961 to 1965. Excessive total demand was
fostered by expansionary fiscal conditions to mid-year
and rapid monetary expansion through the year.
G e n e r a l Price I n d e x *

Ratio S e a l*
1958=100
130

4tb qtr

1961

1962

1963

1st qtr.

4tb qtr. 2nd qtr

JJ____ L
i___ILL

1964

1965

Ratio S c a le
1958=100
130

1966

1967

1968

1969

* As used in N a tio n o l Income A cco u nts
S o u rce : U .S . D epartm en t of C o n m t r c i
Percentages are annual rates of ch ange between p eriod* indicated. They are presented to aid in
comparing most recent developments with past "trends."
Latest d ata plottedi 4th quarter

Total spending rose 9.5 per cent from late 1967 to
late 1968, compared with a trend rate of 7.2 per cent
from 1961 to 1967. The 1968 rise in spending was
manifested in a 5.5 per cent increase in real output
and a 3.9 per cent advance in prices.

Fiscal and Monetary Actions
The Government’s fiscal condition was stimula­
tive in the first half of 1968, but became much
less expansionary after mid-year, following passage
2See “1968 —Year of Inflation,” in the December 1968 issue of
this Review.

MARCH,

F E D E R A L R E S E R V E BAN K O F ST. LO UI S

to 1967 and at a 5 per cent rate from
1961 to 1965. Defense spending rose
at a 2.5 per cent annual rate during the
second half of 1968, compared with a
12.1 per cent rate of advance in the
first half and a 20.2 per cent average
rate from 1965 to 1967. Nondefense
spending rose in the second half of 1968
at a 7.7 per cent rate, compared with
a 19.8 per cent rate in the first half
and an 11.5 per cent rate in the 1965
to 1967 period.

Fed eral G o vern m en t Exp en d itu res
N a t i o n a l Incom e A c c o u n t s B u d g e t

So urce: U .S . D ep artm ent o f Com m erce
Percentages are annual rate so fch ang e between periods indicated.They are presented to aid in
comparing most recentdevelopm ents with p a sf'tre n d s ."
L a te s td a ta p lo tte d :4 th quarter 1968 prelim inary;
1969 estim ated by this bank

in late June of the Revenue and Expenditure Control
Act of 1968. The high-employment budget shifted
from a very high rate of deficit in the first half to
a small surplus in the fourth quarter.
Federal spending (NIA basis) rose at a 16.4 per
cent annual rate during the first half and a 5.5 per
cent rate in the second half. In comparison, Federal
spending rose at a 15 per cent average rate from 1965
F e dera l B u d g e t In flu e n c e *
S t im u lu s o r R e s t r a i n t

1969

Enactment of the 10 per cent sur­
charge and continued rapid advances
of nominal incomes boosted the Gov­
ernment’s tax revenues sharply during
the year. Receipts (NIA basis) rose by
$31 billion from late 1967 to late 1968,
$18 billion of which resulted from in­
creased tax rates. The remaining $13
billion reflected the rapid advance of
incomes and profits.

As Federal spending growth slowed
during the year and receipts rose very
rapidly, the high-employment budget
moved from a very large deficit ($16.1 billion
annual rate) in the second quarter 1968 to a small
surplus ($0.6 billion annual rate) in late 1968. The
delay in the passage of the Revenue and Expenditure
Control Act contributed to the over-all growth of
revenue to the extent that inflation was allowed to
intensify before action was taken, thereby adding to
Government tax receipts.

Monetary expansion was very rapid in 1968. The
nation’s money stock rose 6.5 per cent from December
1967 to December 1968, about the same as the pre­
vious year, compared with a trend rate of 3.5 per
cent from 1961 to 1967. The monetary base increased
6.4 per cent in 1968, about the same as the previous
year but greater than the 4.5 per cent average
annual rate from 1961 co 1967.

Evaluation of the 1968 Economic Plan

1957 1958 19 5919 60 1961 1962 1963 1964 1965 19661967 1968 1969
•The H igh-Em ploym ent Budget, first p u b lis h e d by the C o u n cil o f Econom ic A d viso rs.
Source-. F e d e r a l R e se rv e B ank o f Sf. Louis
L a te s td a ta plotted: 4th q u arter 1968 p relim inary ; 1969 estim ated by this bank




The 1968 CEA Report projected a 7.8 per cent
advance of total spending for calendar 1968; the ac­
tual increase was 9 per cent. The CEA anticipated
a rapid advance in the first half followed by a more
moderate expansion in the second half. In fact, spend­
ing grew faster than anticipated in both halves of the
year.
Page 11

MARCH,

F E D E R A L R E S E R V E BANK O F ST. L OUI S

Table I

PROJECTED A N D ACTUAL CHANGES IN GNP
A N D C O M PO N ENTS— 1967 TO 1968
m
>

(B illio n s of D ollars)
Projection

Actual

Error

GNP

3 3 .8
4 .7
3.3
5 .4
6.2
8.5
- 0 .4

4 1 .6
6.4
1.6
5.3
9 .4
9 .4
— 2.8

6 1 .4

Personal consumption
Business fixed investment
Business inventories
Residential construction
Federal purchases
State and local purchases
Net exports

- 7 .8
— 1 .7
1.7
0.1
- 3 .2
- 0 .9
2 .4

7 0 .9

- 9 .5

The CEA error of $9.5 billion for the year con­
sisted primarily of underestimates of consumption and
Federal purchases. With final spending on domestic
goods and services much greater than projected, in­
ventory accumulation and net exports (exports minus
imports) were overestimated.
Table II

PROJECTED A N D ACTUAL CHANGES IN SPENDING,
OUTPUT A N D PRICES — 1967 TO 1968
(P e r Cent)
C EA Projection
Total spending ( G N P ) 1
Real product2
Prices3

7.8
4.3
3.4

A ctual
9 .0
5 .0
3.8

Error
—1.2
- 0 .7
- 0 .4

The second possible source of error was in estimat­
ing the effect of monetary actions. An explicit assump­
tion about monetary actions was not specified in the
1968 Economic Report. If it were asumed, however,
that the CEA anticipated about a 4 per cent growth in
the money stock, their forecast went awry because
the realized growth in money stock was 6.5 per cent.
The empirical importance of the growth of money
stock in the determination of the growth of total
spending has been suggested in a previous issue of
this Review.3 The policy-oriented model presented

PROJECTED CHANGES IN G N P —

The GNP projected for 1968 can also be evaluated
in terms of anticipated growth of real product and
advance of prices. Real product was forecast to in­
crease 4.3 per cent and actually rose 5 per cent. Price
advances were similarly underestimated. Prices were
projected to rise 3.4 per cent and actually increased
3.8 per cent.
To determine the underlying source of error, fiscal
and monetary plans are compared with actions. The
CEA has indicated that its error in projecting eco­
nomic activity was traceable in large part to delayed
passage of the tax surcharge. However, an examina­
tion of the national income accounts budget re­
Table III

(B illio n s of D ollars)
Budget Plan
2 2 .6
14.9
7 .7

1967 TO 1968

B illions of
Dollars

Per cent
Increase

C EA projection (2 -1 -6 8 )

6 1 .4

7 .8 %

Actual

7 0 .9

9 .0

Policy-oriented model1
1)

with changes in money and
government spending based
on CEA assumptions

6 8 .6

8 .7

2)

with changes in government
spending perfectly anticipated
but not changes in money

6 9 .9

8 .9

3)

with changes in money per­
fectly anticipated but not
changes in government spending

7 5 .5

9 .6

4)

with changes in money and
government spending perfectly
anticipated

7 6 .9

9 .8

JThis policy-oriented model was described in the November issue of
this Review.

there, given the information available at the time of
the preparation of the 1968 Economic Report and
assuming a 4 per cent growth in money, would have
predicted an 8.7 per cent increase in GNP for 1968.

PLANNED A N D ACTUAL CHANGES IN
N IA BUDGET — 1967 TO 1968

Page 12



veals that the actual deficit was little different from
the anticipated deficit. Federal expenditure growth
was more rapid than anticipated, but so was the
growth of receipts. Such a comparison is misleading,
however, because receipts reflected the rapid advance
of incomes, which is a reflection of inflation rather
than fiscal restraint. This underestimation of income
growth may account for the bulk of the $3.1 billion
error in the receipts estimation. Taking into account
this effect, the error in the estimate of the NIA deficit
may have been, more accurately, $3 to $4 billion. It
seems unlikely, however, that this error would be
sufficient to explain the $9.5 billion error in the CEA’s
estimate of GNP for 1968.

Table IV

*GNP in current dollars.
’GNP in 1958 dollars.
3GNP deflator.

Receipts
Expenditures
Surplus or deficit

1969

Actual

Error

2 5 .7
18.6
7.1

- 3 .1
- 3 .7
0 .6

3See “Monetary and Fiscal Actions: A Test of Their Relative
Importance in Economic Stabilization” in the November 1968
issue of this Review.

MARCH,

F E D E R A L R E S E R V E B A N K O F ST. L O U I S

As it turned out, that model, too, would have under­
estimated growth in total spending because it under­
estimated growth in money. It’s error would have
been $2.3 billion, compared with the CEA error
of $9.5 billion. When the actual growth of money
is inserted in the forecasting equation, the predicted
increase would have been $75.5 billion, or $4.6 billion
more than realized. In other words, the policyoriented model would have predicted a 9.6 per cent
increase in GNP, compared with an actual increase
of 9 per cent.
In short, the CEA’s forecast for 1968 was too low,
an error which is particularly costly in an inflationary
situation. There are two key reasons for this error.
First, the growth of Federal expenditures was under­
estimated and the surtax was passed later than plan­
ned. Second, the effect of monetary actions was evi­
dently underestimated. The effect of a given change
in money apparently was not properly taken into
account, and the rate of growth of money was under­
estimated. Based on the 1968 experience, however,
the policy-oriented model which was used for com­
parative purposes slightly overestimated the effect of
monetary actions.

Policy and the Economic Outlook for 1969
Budget plans for the 18-month period ending June
30, 1970 are formulated with the view that fiscal
restraint is necessary to reduce inflationary pressures,
and that there is merit in stabilizing the high-employment budget in balance or slight surplus. Given this
budget program, the CEA expects total spending to
slow in 1969. Whether such a slowing will occur
depends largely on the fiscal program ultimately
adopted by Congress and the new Administration,
and the forthcoming rate of monetary expansion.

Federal Budget Program for 1969
The proposed budget of the Federal Government
for calendar 1969 results in a budget surplus of $3.8
billion on a NIA basis. Budget plans include provi­
sions to increase expenditures 5.5 per cent during
1969 and to extend the 10 per cent tax surcharge
through June 1970.
Expenditures —The budget plan of a 5.5 per cent
rise in spending during 1969 is down sharply from
the 10.8 per cent increase during the previous year.
Federal spending rose at a 15.1 per cent average an­
nual rate from 1965 to 1967 and a 4.9 per cent average
rate from 1961 to 1965.



1969

Defense spending is projected to change little in
1969, following a 7.2 per cent increase in 1968. The
average rate of advance from 1965 to 1967 was 20.2
per cent. Estimates of defense spending for 1969 re­
flect a planned decline in expenditures for support
of Vietnam operations.
Federal spending on civilian programs, i.e., non­
defense spending, is budgeted to rise 8.1 per cent dur­
ing 1969. This rate of increase is less than the 13.6
per cent rate of advance during 1968 and the 11.5 per
cent rate from 1965 to 1967. Nondefense spending rose
at a 7.8 per cent rate from 1961 to 1965. The increase
in domestic spending in 1969 reflects a pay increase
for government employees effective July 1.
Receipts —Federal receipts are expected to rise
commensurate with the increase in spending. Ex­
tension of the 10 per cent tax surcharge is required
to keep the budget in surplus in 1969. The increase
in receipts during 1969 consists of $3 billion from
changes in tax rates and $10 billion expected to be
produced by growth in the economy.

CEA Projection for 1969
The fiscal program proposed by the outgoing Ad­
ministration, and apparently adopted by the present
Administration, is supposedly consistent with a 7 per
cent growth of total spending in 1969. The former
CEA projected a slowing of total spending in the
first half of 1969, followed by acceleration in the sec­
ond half. The present CEA indicated in their state­
ment to the Joint Economic Committee that the
slowing in the first half may not be so pronounced,
and that the anticipated acceleration in the second
half should be checked by monetary actions.
The present Council has further judged that the 7
per cent growth in total spending would be mani­
fested in a 3.4 per cent growth in real product and a
3.5 per cent advance in prices. This evaluation, how­
ever, runs contrary to recent experience in the United
States. In the period from 1954 to present, all major
slowdowns in the growth of total demand have been
accompanied by simultaneous deceleration of real out­
put growth, followed three or four quarters later by a
slowing in the rate of price increase.4
In view of the former CEA’s forecasting errors in
1968, the estimates for 1969 should be subjected to
careful review. No specific recommendations are made
4See “Stabilization Policy and Inflation” in the February 1969
issue of this Review.
Page 13

F E D E R A L R E S E R V E BAN K O F ST. L OUI S

M o n e y Stock

,
-

Ratio Sc a le
Billions of D o llars

210

MARCH,

Ratio Sca le
B illio n s o f D o llars
------ .2 1 0

Monthly Averages of Doily Figures
Seasonally Adjusted

Moy'65

Apr.'66

Jan.'67

- 1 ____L i ____ It—
1961

1962

1963

1964

1965

1966

1967

1968

1969

1969

cil’s statement before the Joint Economic Committee,
it might be assumed that a 4 per cent growth in money
in 1969 would represent a policy of moderate mone­
tary restraint without being so restrictive as to drive
the economy into recession.
To gain some understanding of the alternatives
that seem to be forthcoming, the policy-oriented fore­
casting model of this bank may be examined. This
model would yield an increase in total spending
similar to the CEA’s projection if money grew at
about a 3 per cent rate. A steady 4 per cent growth
in money would yield a 7.4 per cent growth in total
spending. These estimates are quite close to the CEA
forecast, and indicate that the CEA forecast may be
achievable if money is slowed to about a 3 or 4 per
cent rate of advance. Even if a slowing in the rate
of monetary expansion were apparent by spring 1969,
little should be expected in the way of reduction in
the rate of price advance before late 1969.

Percentages are annual rates of change between periods indicated. They are presented to aid in comparing
most recent developments with past "trends."
Latestdata plotted: February preliminary

Summary

in either the CEA Report or in the CEA statement be­
fore the Joint Committee about monetary actions other
than that they should be appropriate. In view of the
tone of restraint in the Report and the present CounTable V

PROJECTED CHANGES IN G N P —

1968 TO 1969

Billio ns of
Dollars
CEA projection

(1 -1 6 -6 9 )

Per Cent
Increase

6 0 .3

7 .0

Policy-oriented model*
1)

with 0 per cent change in
money and government spending
based on CEA assumptions

4 9 .5

5 .8

2)

with 2 per cent change in
money and government spending
based on CEA assumptions

5 6 .5

6 .6

3)

with 4 per cent change in
money and government spending
based on CEA assumptions

6 3 .6

7 .4

4)

with 6 per cent change in
money and government spending
based on CEA assumptions

7 0 .7

8.2

JThis policy-oriented model was described in the November issue of
this Review.

This article is available as Reprint No. 35

Page 14



The former and present Councils have appropriately
outiined a program of fiscal restraint for 1969. As in
the past, however, little emphasis has been placed on
the crucial role of monetary actions in the determina­
tion of the growth of total demand. There is some in­
dication, however, that the present CEA is aware of
the influence of monetary actions, though the case was
not strongly presented in the Joint Committee
statement.
The economic program for 1969, which calls for
some moderation in demand growth, presents objec­
tives which may be achievable if accompanied by a
reduction in the growth of monetary aggregates from
the rapid rates of increase in 1968. If the rate of
monetary expansion is not reduced to these slower
rates, given the proposed budget plan, the projection
would probably prove low, as in 1968. On the other
hand, if monetary expansion should be replaced by no
growth or contraction, and the fiscal program is im­
plemented as planned, the projection of spending
growth is likely to be high.
K e it h

M.

C arlson

The Relation Between Prices and Employment
Two Views
ONETARY and fiscal authorities are currently
confronted with the task of simultaneously slowing
price increases and maintaining employment growth.
Policies directed toward the achievement of both
objectives are affected by the policymakers’ under­
standing of the underlying factors influencing prices
and employment (or unemployment). Two principal
views on this issue have emerged in the past decade.
One stresses the short-run “trade-off” between prices
and unemployment, and the other emphasizes the ab­
sence of a stable long-run relationship between vary­
ing rates of anticipated price changes and the level of
unemployment. The short-run, for purposes of this
analysis, is a period in which the relevant economic
factors do not fully adjust to expectations, while the
long-run is a period in which the values of actual and
anticipated variables coincide.
This article discusses these two views of the relation
between prices and employment without delving ex­
cessively into the theoretical complexities of the rela­
tion. For expositional purposes, the two views are dis­
cussed separately, because the literature tends to be
divided into these two groups. The purpose of the
article, however, is to demonstrate that the differences
between the two views stem primarily from the em­
phasis on short-run vs. long-run considerations rather
than from diametrically opposing theories or models.
Whether the short run or the long run is empha­
sized has substantially different implications for
stabilization policy. These different implications are
discussed in the concluding section of the article.

The Short-Run Trade-Off View
High levels of unemployment in this country have
generally been associated with slowly changing price
levels, while low levels of unemployment have usually
been accompanied by rapidly rising prices. These
observed relationships have prompted attempts to
explain price variations through changes in unemploy­
ment relative to the labor force. The Trade-Off View
does not focus on unemployment as a determinant of
prices directly, however. It holds that unemployment



and the rate of change of unemployment influence
money wages, and wage changes, in turn, bring about
changes in the level of prices.
A. W. Phillips’ study of the relation between wages
and unemployment in England is generally con­
sidered the point of departure for most recent investi­
gations into the trade-off controversy.1 Phillips
constructed a “trade-off curve” between the unem­
ployment rate and wage changes, which indicated
that wages in Great Britain rose rapidly when unem­
ployment was declining and slowly when unemploy­
ment was rising. The “Phillips curve” was drawn to
reflect a relationship between wages and unemploy­
ment, but other analysts have maintained that a sim­
ilar relationship holds between prices and unemploy­
ment.2 They have assumed or observed that the factors
which influence wages similarly influence other prices,
or that wages are a principal independent determi­
nant of prices.
Those analysts who follow Phillips in stressing a
trade-off between wages or other prices and unem­
ployment have found several factors besides employ­
ment pressures which apparently determine wage
changes. Factors most often included in this group
are profits, productivity, and the cost-of-living. Em­
ployment pressures, however, remain the primary
explanatory variable.

Factors Influencing Wage-Price Changes
The unemployment rate reflects the state of the
demand for labor, a demand which is derived from
the demand for goods and services. In a period of
rising labor demand, employers attempt to attract
workers from one another, thus bidding up wage
rates. Additional labor may be obtained by attracting,
1A. W. Phillips, “The Relationship Between Unemployment
and the Rate of Change of Money Wage Rates in the
United Kingdom, 1861-1957,” Economica, Vol. XXV (No­
vember 1958), pp. 283-299.
2See, for example, George L. Perry, Unemployment, Money
Wage Rates, and Inflation (Cambridge: The M.I.T. Press,
1966), p. 107. Perry states that “the factors affecting
wage changes have been analyzed on the assumption that
the wage relation is central to an understanding of the
inflation problem.”
Page 15

F E D E R A L R E S E R V E B A N K O F ST. L O U I S

through higher pay, such “secondary” or “reserve”
workers as housewives, students, retired persons, or
those already holding one job. The ability of workers
to obtain large wage gains may be increased in pe­
riods of rising demand for goods and services when
employers are especially anxious to avoid strikes.
Profits are usually higher and inventories are often
at lower levels when demand is high; consequently,
employers probably exhibit less resistance to wage
demands at such times.
A state of falling demand for goods and services
and labor is reflected in a higher unemployment rate.
According to Phillips,
. . it appears that workers
are reluctant to offer their services at less than the
prevailing rates when the demand for labour is low
and unemployment is high so that wage rates fall
only very slowly.”3
Changes in both profits and consumer prices are
positively associated with changes in wages in the
Trade-Off View. Workers often use high earnings re­
ports and cost-of-living advances to improve their
bargaining position. Some labor groups have cost-ofliving escalator clauses written into their wage
contracts.
No general agreement relating productivity and
wage changes can be found among those who favor
the Trade-Off View. Statistical studies have produced
conflicting results.4 Analysts have found insignificant,
significantly positive, and significantly negative rela­
tionships between productivity and wage changes.
Consequently, for purposes of analysis, productivity
is generally assumed to increase at some constant
rate. Analysts then can focus on the effects of changes
in other variables, particularly unemployment, on
wage rates.
Most observers who emphasize the Trade-Off View
relate money (nominal) wage changes to the above
explanatory variables through regression analysis. If
all but one of the explanatory factors are held con­
stant, a relationship between one variable —usually
the unemployment rate — and wages can be depicted
graphically. The resulting curve slopes downward from
left to right, and is usually shaped similar to the
rounded “L” determined by Phillips. (See Figures 1
and 2). The non-linear shape suggests the existence of
a critical high-employment range. According to Levy,
^Phillips, p. 283.
4See Ronald G. Bodkin, The-Wage-Price-Productivity Nexus,
(Philadelphia: University of Pennsylvania Press, 1966), pp.
143-151, for a discussion of such studies as well as Bod­
kin’s own regression results.
Page 16



MARCH,

1969

“That price inflation, rather than reduced unemploy­
ment, is the main result of any expansionary policy
after the economy has reached a critical high employ­
ment range, is a basic inference from traditional
economics which is rarely questioned.”5
The critical high-employment range may be defined
as that range in which the number of employment
vacancies are approximately equal to the number of
workers seeking employment.6 By this definition,
excess demand in the labor market exists when
the number of vacancies exceeds the number of job
seekers, and there is an excess supply of labor
when the number of workers seeking employment
exceeds the number of vacancies. Excess demand
causes wage rates to rise rapidly in the former case,
and excess supply in the latter case tends to slow
the rate of wage increase. Labor demand and supply
factors may vary from sector to sector, but there is
some evidence that a close tie exists between the
“. . . aggregate unemployment rate and unemploy­
ment among various subgroups in the population.”7

The Stability of the Phillips Curve
An issue of particular importance to policymakers
is the stability of the prices (wages)-employment
relationship. Most Trade-Off View studies, by hold­
ing constant those factors other than unemployment
which determine wages, do not stress fluctuations
within a Phillips curve, shifts of the curve itself, or
changes in the critical high-employment range. These
studies, which rely heavily on regression analysis,
often imply that the economy is operating on a single
curve, and stabilization actions directed toward guid­
ing the economy to some point off the curve may
prove unsuccessful. Such studies, strictly interpreted,
indicate that the Phillips curve is a stable relation­
ship.8 This implication is refuted by Michael Levy,
who found that “during the post-war years, the basic
(Phillips curve) relationship for the U.S. economy
between wage rate advances on the one hand, and
5Michael E. Levy, “Full Employment Without Inflation,”
The Conference Board Record, Vol. IV (November 1967),
p. 36.
6Edmund S. Phelps points out that labor union behavior
and the existence of “unemployables” may partially ac­
count for the fact that excess demand in the labor market
seldom appears to exist, that is, “. . . vacancies almost never
exceed unemployment.’ See “Money-Wage Dynamics and
Labor-Market Equilibrium,” The Journal of Political Econ­
omy, Vol. LXXVI (July/August 1968), p. 686.
7Perry, p. 25.
8Stability exists, technically, when the parameters computed
for various time periods appear to be drawn from the same
underlying population.

F E D E R A L R E S E R V E B A N K O F ST. L O U I S

MARCH,

1969

1953-1960 period. For the sixteen-year period, the
curve would be shifted slightly to the right.
Rates o f Change o f M a n u fa c tu rin g W ages
an d Rates o f Labor U n e m p lo ym e n t
R a te s o f C h a n g e o f A v e r a g e
H o u rly M a n u fa c t u rin g E a r n in g s

Graphical trade-off analysis usually focuses on the
wages-unemployment relationship, but it has also been
extended to the prices-unemployment relationship as
has been done in Figure 2. The overall fit for the
sixteen-year period would not be as satisfactory as in
the previous chart, but there is a close parallel for
the past eight years. In some earlier years, sharp
price increases occurred at varying rates of unem­
ployment. Unemployment averaged slightly above 4
per cent of the labor force in the 1955 to 1957 period,
more than 5 per cent from 1959 to 1960, and a little
less than 4 per cent in the 1965 to 1968 period. This
evidence suggests that the critical high-employment
range has varied, perhaps reflecting the changing
nature of the labor force in particular and the econ­
omy in general.
F ig u re 2

Rates o f C hange o f Consum er Prices
a n d Rates o f L a bor U n e m p lo ym e n t

C u r v e h o * b e e n a r b it r a r ily fitted to 1961-1968 d a ta .
D a t a sh o w n a r e in p e rc e n ta g e s.

R a te s o f C h a n g e o f C o n s u m e r P ric e s

1968

the unemployment rate, the corporate profit rate, and
cost-of-living increases on the other, has been highly
unstable.”8 [Italics omitted]
Although the relationship may be technically un­
stable, a plotting of the wage and price changes and
the unemployment rate reveals that Phillips’ hypoth­
esis —regarding the association of declining unem­
ployment with rapidly rising wages (prices), and
rising unemployment with slowly changing wages
(prices) —has been generally observable over the past
sixteen years. A simple correlation between two vari­
ables, as given here by a plotting of points on a twodimensional graph, does not demonstrate causality,
however. The relationship between the rate of change
of manufacturing wages and the unemployment rate
for the 1953-1968 period is plotted in Figure 1. The
curve, which is similar in shape to the curve de­
termined by Phillips, has been arbitrarily drawn to
fit the data from 1961 to 1968, a period of uninter­
rupted economic expansion.10 The shape of the curve
would be altered to some extent if fitted to the
9Levy, p. 37. Levy’s conclusion is based on a statistical
technique ( “the Chow test” ) designed to test the degree
of stability among relationships.
10The 1961 to 1968 curve for the United States mirrors more
closely the relationship found by Phillips than do other
ossible subsets of the sixteen observations. Moreover, the
tting of the curve to the last eight years emphasizes the



• 1957

1966
1967 \

e 1958

196
\
956 •

_

196 °
1963
196

1953*

w T :/

- •

” 61

• 1959
• 1954

•
1955
'i.

1

:

1

:

U n e m p lo y m e n t R a te
C u r v e h a s b een a r b it r a r ily fitted to 1961-1968 d a ta .
D a t a sh o w n a r e in p e rc e n ta g e s.

present position on the “low unemployment-rising wages”
portion of the curve. Annual data were used in keeping
with Phillips’ original work. The problems inherent in using
annual data in the Phillips curve relationship are well
known.
. . we regard the construction of a plausible
Phillips curve from annual data for a long period as a tour
de force somewhat comparable to writing the Lord’s Prayer
on the head of a pin, rather than as a guide to policy.
This is because it is highly probable that the relationship
has changed during the period.. .and because of the large
changes in some of the variables that take place during
the course of a calendar year and are blurred in the annual
data.” Albert Rees and Mary T. Hamilton, “The WagePrice-Productivity Perplex,” Journal of Political Economy,
Vol. LXXV (February 1967), p. 70.
Page 17

F E D E R A L R E S E R V E BAN K O F ST. L OUI S

Phillips curves derived from regression analysis are
based on rather specific assumptions, and the shape
can vary substantially when miner modifications of
the behavioral assumptions are made, as illustrated
by the two following examples, A basic curve derived
by George Perry relating consumer prices and un­
employment was constructed from an equation in
which prices were allowed to respond freely to market
pressures. By assuming instead that half of the price
increases were autonomous, Perry found that the
curve, fairly steeply sloped in the first instance, be­
came relatively flat. In fact, the slope of the curve
was less than half of that calculated originally.1
1
Ronald Bodkin12 determined a near-horizontal lin­
ear relation between wages and unemployment. Rees
and Hamilton,13 utilizing the same data and nearly
the same assumptions as Bodkin, found a much steeper
curve. Their results precipitated the remark:
Our final caution is that we have been
astounded by how many very different Phil­
lips curves can be constructed on reasonable
assumptions from the same body of data. The
nature of the relationship between wage
changes and unemployment is highly sensi­
tive to the exact choice of the other variables
that enter the regression and to the forms of
all the variables. For this reason, the authors
of Phillips curves would do well to label them
conspicuously “Unstable. Apply with extreme
care!’
This conclusion implies that the usefulness of such
statements as “. . . 4 percent unemployment is con­
sistent with a 2 percent rate of inflation if profit
rates are at 11.6 per cent . . . .”14 is limited by the
validity of the assumptions which underlie the model.

Characteristics of the Trade-Off View
The chief characteristics of the Trade-Off View
might be summarized as:
1) The relation between money wages and unemploycent is stressed, rather than the prices-unemploy­
ment relation.
2) Money wage changes are assumed to be a pri­
mary, if not the primary, determinant of changes
n Perry, p. 68.
12Bodkin, p. 279.
13Rees and Hamilton, p. 70.
14Perry, pp. 108-109.
Page 18



MARCH,

1969

in prices of final goods; consequently, changes in
prices of final goods follow wage changes.
3) The relevant variables are specified in nominal
rather than real (or price-deflated) terms.
4) The basic relationships are established by the use
of regression analysis using observed data.
5) The relation between rates of wage or price
changes and the unemployment rate may be rep­
resented by a line which curves downward on a
graph from left to right.
6) The rationale behind movements along the Phil­
lips curve, rather than shifts of the curve itself,
is stressed. The policymakers attempt to attain the
point on the curve which seems least undesirable.
7) The time units and period covered by the analysis
are specified in terms of months, quarters, or
years. Phrases such as “the length of time required
for the factors to reach their long-run values” are
not found in the Trade-Off View.

The Long-Run Equilibrium View
The Long-Run Equilibrium View considers the
trade-offs between wages or prices and unemploy­
ment as transitory phenomena, and that no such
trade-off exists after factors have completely adjusted
to the trend of spending growth. In the short-run
there can be a discrepancy between expectations and
actual price or wage changes, but not in the long-run.
A fter the discrepancies betw een expected and actual

values have worked themselves out, the only relevant
magnitudes are “real,” or price-deflated ones.
To illustrate the view, consider the following hy­
pothesized sequence of events in the upswing of a
business cycle, beginning with an initial condition of
significant unemployment. Monetary or fiscal actions
may start an upturn of business activity. Spending
occurs in anticipation of a continuation of the price
levels which had prevailed in the downswing. Em­
ployers begin actively seeking workers to accommodate
the rising demand, but wages increase only moder­
ately since a large number of unemployed are seeking
jobs. Output and employment rise more rapidly than
wages or prices. The remainder of the scenario is
outlined by Milton Friedman:
Because selling prices of products typically re­
spond to an unanticipated rise in nominal
demand faster than prices of factors of pro­
duction, real wages received have gone down
—though real wages anticipated by employees

MARCH,

F E D E R A L R E S E R V E B A N K O F ST . L O U I S

went up, since employees implicitly evaluated
the wages offered at the earlier price level.
Indeed, the simultaneous fall ex post in real
wages to employers and rise ex ante in real
wages to employees is what enabled employ­
ment to increase. [The non-technical reader
may wish to substitute “anticipated” for “ex
ante” and “actual” for “ex post.”] But the de­
cline ex post in real wages will soon come to
affect anticipations. Employees will start to
reckon on rising prices of the things they buy
and to demand higher nominal wages for the
future. “Market” unemployment is below the
“natural” level. There is an excess demand for
labor so real wages will tend to rise toward
their initial level.15
As real wages approach their original level, em­
ployers are no longer motivated to hire workers as
rapidly or bid up wages so much as in the earlier
portion of the upswing. Moreover, rising wages may
encourage employers to utilize more labor-saving
equipment and relatively fewer workers. As the
growth of demand for labor slows, the unemploy­
ment rate declines to its “natural” level. Economic
units come to anticipate the rate of inflation, and are
no longer misled by increases in money income —the
so-called “money illusion.” The unexpected price in­
creases which accompanied the original expansion
of total demand and production caused a temporary
reduction of unemployment below the long-run equi­
librium level. Only accelerating inflation —a situation
in which actual price rises continue to exceed antici­
pated rises —can keep the actual unemployment rate
below the “natural” rate.18
Inflation has not been allowed to rise uncontrolled
for sustained periods in this country, so little empirical
evidence can be amassed to support the contentions
that no permanent trade-off exists. In other countries
such as Brazil, however, it has been found that sus­
tained inflation does not generate continuous employ­
ment gains; in fact, recessions and high unemployment
rates have occurred as secular inflation continued.
Unanticipated price increases have, in those countries
as well as in the United States, generated increased
15Milton Friedman, “The Role of Monetary Policy,” The
American Economic Review, Vol. LVIII, (March 1968),
p. 10.
18Phelps, pp. 682-683, provides a comprehensive listing of
several authors and their variations of the “anticipated in­
flation” thesis. Also, see: Charles C. Holt, “Improving the
Labor Market Tradeoff Between Inflation and Unemploy­
ment” (Working Paper P-69-1, The Urban Institute, Wash­
ington, D. C., February 20, 1969).



1969

temporary employment, just as unanticipated declines
in the rate of price increase have caused temporary
rises in unemployment. But if inflation is “fully and
instantaneously discounted, the Phillips curve be­
comes a vertical line over the point of ‘equilibrium
unemployment.’ This is the rate of unemployment
where wage increases equal productivity gains plus
changes in income shares. The unemployment-price
stability trade-off is gone.”17 In other words, there is
no particular rate of price change related to a par­
ticular rate of unemployment when the price changes
are fully anticipated. Unemployment shifts to its
equilibrium value and is consistent with any rate of
change of prices. A low rate of unemployment can no
longer be “traded-off” against rapidly rising prices,
nor can a high unemployment rate be “traded-off”
against slowly changing prices.

Costs of Information
A modified version of the Long-Run Equilibrium
View is framed in terms of costs of obtaining informa­
tion about job opportunities. When the demand for
labor is low, the costs to a worker of discovering the
state of labor demand are relatively high because
employers are not actively seeking workers by pub­
licizing extensive lists of vacancies. Employers are
not as likely to absorb job training and transfer costs
as they are when aggregate demand is rising. When
labor demand rises and employers begin bidding up
wage rates to attract additional labor, the costs of
information, training and transferring are lowered to
employees. The lower costs mean that employees will
not have to search as long for acceptable employ­
ment, and the shorter the search time, the lower the
rate of unemployment. Rising wages are accompanied
by a declining unemployment rate.18
A reversal of stimulative policies will generate de­
clining demand for labor. Some workers will accept
smaller wage increases or reduced wages, but others
will prefer to leave their jobs to seek employment
at their former money wage rates. They expect prices
17Henry C. Wallich, “The American Council of Economic Ad­
visers and the German Sachverstaendigenrat: A Study in the
Economics of Advice,” The Quarterly Journal of Economics,
August 1968, pp. 356-357.
18The cost of information analysis is derived from studies
by George J. Stigler, “Information in the Labor Market,”
Journal of Political Economy, Vol. LXX (Supplement:
October 1962), pp. 94-105; and Armen A. Alcnian and
William R. Allen, University Economics, 2nd ed., Chapter
25 (Belmont, Calif.: Wadsworth Publishing Company, Inc.,
1967). Also see Armen A. Alchian, “Information Costs,
Pricing, and Resource Unemployment” in a forthcoming
issue of the Western Economic Journal.
Page 19

F E D E R A L R E S E R V E B AN K O F ST. L OUI S

and wages will remain at their earlier, higher levels.
Prices and output will have fallen, however, and the
high real wage rate will have stimulated employers
to lower the quantity of labor demanded, thereby
raising search costs to those workers who leave their
jobs to seek employment elsewhere.19 Higher search
costs and lower money wage rates will be accom­
panied by rising unemployment. When workers
realize that demand and price increases have slowed,
they will be willing to accept the lower money wage
rates and unemployment will stabilize at the “natural”
level. For the stabilization to occur, however, no
money illusion can exist. Anticipated wage (or price)
changes must equal actual wage (or price) changes.
The costs-of-information approach combines the
two factors determining the equilibrium rate of un­
employment —the structure of real wage rates as
determined by labor demand and supply, and “im­
perfections” within the labor market.20 Bottlenecks,
labor and product market monopolies, positive costs
of information, training and transfers create “imper­
fections” in the labor market. In other words, all
markets are not cleared instantaneously and without
cost. At any point in time the degree of the so-called
“imperfection” within the labor market will vary, de­
pending on transactions and information costs; cor­
respondingly, the “natural” rate of unemployment
will vary.

MARCH,

of higher prices will cause the curve to shift upward,
and expectations of lower prices move the curve in
the opposite direction. The optimal stabilization poli­
cies, therefore, would be those which would reduce
market adjustment costs and expectations of higher
prices. Enactment of such policies would at first move
the short-run Phillips curve to the left and downward,
and in time, as expectations are fully realized, cause
the curve to become a vertical line over the “natural”
rate of unemployment.
A hypothetical, long-run relationship between
prices and unemployment is presented in Figure 3.
Point D represents the “natural,” or equilibrium rate
of unemployment before market imperfections or ad­
justment costs are reduced. Curve A represents one of
many possible short-run Phillips curves that exist be­
fore price changes are fully anticipated. After the rate
of inflation becomes fully discounted, the unemploy­
ment rate will shift from some point beneath curve A
to point D, regardless of whether prices are rising at
some slow rate, X, or a rapid rate, Z. The shift may
occur along any of an infinite number of Phillips
curves. The vertical line above point D indicates that
no economic units —workers or employers, sellers or
F ig u r e 3

H y p o th e tic a l R elationships
B etw een Prices a n d U n e m p lo ym e n t
R a te s o f C h a n g e o f C o n s u m e r P ric e s

Enactment of policies oriented toward eliminating
or reducing market imperfections (adjustment costs)
will cause the short-run Phillips curve to shift to the
left and down. Policies which increase these costs
move the short-run Phillips curve upward and to the
right. Different forces are at work at different times,
causing the curve to shift frequently. Expectations
19The Committee for Economic Development points out that
“slow adjustment to unexpected price increases may in­
crease employment as prices accelerate, but this slow ad­
justment may also cause an increase in unemployment as
the rate of price inflation slows. The temporary trade-off is
a double-edged sword.” Fiscal and Monetary Policies for
Steady Economic Growth, a statement on National Policy
by the Research and Policy Committee of the Committee
for Economic Development, January 1969, p. 40.
20The Equilibrium View maintains no monopoly over discus­
sions of the relevance of labor market structure; indeed,
Lipsey’s rigorous reformulation of Phillips’ original view
was predicated to a large extent on the importance of
unemployment among different sectors of the economy.
See R. G. Lipsey, “The Relation between Unemployment
and the Rate of Change of Money Wage Rates in the
United Kingdom, 1862-1957: A Further Analysis,” Eco­
nomica, Vol. XXVII (February 1960), pp. 1-31. On the
whole, however, it seems that the Equilibrium View, which
stresses the reasons for the changing nature of the shortrun Phillips curves —varying expectations and cost-of-information —is the view in which structural considerations
should be discussed.
Page 20



1969

U n e m p lo y m e n t R a te
C u rv e " A " is a short-run p rices-u nem plo ym e nt re la tio n sh ip .
V e rt ic a l lin e "B " is the long-run re latio n sh ip b etw een p ric e s (fully a nticip ated
r e g a rd le ss o f the rate o f c h ang e) an d the "n a tu ra l" rate of u nem p loym ent, "D " ,
b e fo re reduction o f m ark et " im p e rfe c tio n s."
V e rt ic a l lin e " C " is a sim ilar long-run re la tio n sh ip b etw een p ric e s a n d u nem ploym ent
a fte r a s s u m e d red u ctio n o f l a b o r a n d p roduct m ark et im p erfe ctio n s.

F E D E R A L R E S E R V E B AN K O F ST. L OUI S

consumers, borrowers or lenders —are surprised by
price changes. If programs to reduce labor and prod­
uct market imperfections are implemented, vertical
line B will shift, after a transitory period, to the left.
Vertical line C represents the new long-run relation­
ship between prices and employment above point E.

Characteristics of the Long-Run
Equilibrium View
The principal characteristics of the Long-Run
Equilibrium View might be summarized as:
1) The relationship between all prices and unemploy­
ment is emphasized, rather than the wagesunemployment relation.
2) Changes in selling prices usually precede changes
in the prices of productive agents.
3) The relevant economic factors are specified in real
rather than nominal terms.
4) Because of the lack of data on accelerating in­
flations, expectations of price changes, and the
“natural” rate of unemployment, the analysis is
generally accomplished through abstract reasoning
rather than empirical testing.
5) The relation between the long-run rate of price
or wage changes and the unemployment rate
is a vertical line over the equilibrium rate of
unemployment.
6) The long-run relationship and reasons for observed
shifts of the Phillips curve are stressed. The
authorities do not have to choose as a target
some fixed relationship between prices and unem­
ployment on a Phillips curve, but can attempt to
move the economy off a short-run curve. In the
long-run, they can seek any trend in prices de­
sired without a sacrifice in terms of foregone em­
ployment or production.
7) The time period of the analysis is not specified.
In the long-run, the actual values of the relevant
economic variables equal the expected values,
while in the short-run, they do not.

Policy Implications of the Two Views
Unemployment declined from 5.2 per cent of the
labor force in 1964 to 3.5 per cent in 1968. The annual
rate of increase in consumer prices rose from 1.3 per
cent to 4.2 per cent for corresponding years. These



MARCH,

1969

data indicate, according to the Trade-Off View, that
stabilization authorities must decide to accept either
high rates of price increases in order to maintain low
unemployment rates, or adopt deflationary measures
and accept relatively high levels of unemployment.
Only significant reductions of imperfections within
the product and labor markets could prevent employ­
ment declines in the face of deflationary policies.
Proponents of the Long-Run Equilibrium View
point out that even in the absence of structural im­
provements, monetary and fiscal policies need not be
limited by a short-run trade-off between prices and
employment. Continuation of expansionary develop­
ments will generate either (1) a high, steady rate of
inflation which will eventually become fully antici­
pated and confer no net additional employment bene­
fits (unemployment will gradually return to its
“natural” rate), or (2) an accelerating rate of inflation
which will permit unemployment to remain below
the “natural” rate. Neither expansionary policy alter­
native appears economically or politically desirable.
Deflationary actions would produce increased unem­
ployment ( as expectations of price changes are slowly
revised) but only temporarily, according to the Equi­
librium View. As soon as a new price trend becomes
stabilized and fully anticipated, nominal and real
wages will coincide, and unemployment will fall
to its “natural” rate. An inflationary policy is neither
a necessary nor a sufficient condition for the attain­
ment of high levels of employment. Since price ex­
pectations seem to change only slowly, actions to
reduce the rate of inflation should probably be applied
gradually to minimize the transition cost in terms of
reduced output and increased unemployment.
Both views recognize the merits of structural meas­
ures in complementing monetary and fiscal actions.
Policies which reduce the costs of obtaining employ­
ment information, improve labor mobility and skills,
and eliminate product and labor market monopolies
will lower the optimal level of unemployment. Adop­
tion of such policies would improve the short-run
dilemma faced by monetary and fiscal authorities and
enable them to shift their long-run unemployment
target to a lower level.
R oger

W.

Spen cer

This article is available as Reprint No. 36.
Page 21

Farm Income Prospects1

ET FARM INCOME in 1969 will be somewhat
less than the $14.9 billion of 1968, according to the
United States Department of Agriculture. Gross farm
receipts may rise, as larger supplies of farm products
and little change in average prices are in prospect.
Larger cash receipts from farm product sales, com­
bined with an increase in government payments, are
expected to push gross farm income to a record $52
billion, about $1 billion above the 1968 total. Produc­
tion expenses are expected to rise more than a billion
dollars, however, resulting in slightly less realized net
income.
With the number of farms declining, net income
per farm may remain at about the 1968 level, and
per capita disposable income of farm population from
all sources will probably continue its upward trend.

Supply and Price
The higher cash receipts in 1969 are contingent on
the estimates of somewhat larger supplies of live­
stock products and crops, and little change in average
prices from 1968 levels. A growing demand for food
products, especially meat, will probably again offset
the impact on prices of the larger livestock supplies,
resulting in producer prices about the same as in
*A summary of information presented by U.S. Department of
Agriculture representatives at the National Agricultural Out­
look Conference, Washington, D. C., February 17 to 20, 1969.
Page
22


1968. Crop supplies in the 1968-69 marketing year
are also larger than a year earlier. Little change is
expected in the government price support and crop
control programs for the current year, and crop prices
will probably remain relatively unchanged.

Livestock Products
In the livestock sector, beef production is expected
to continue its upward trend of recent years. The
growth rates of the beef cow herd may be somewhat
reduced, but cattle slaughter will likely continue
upward. The number of cattle in feedlots on January
1, 1969 was 10 per cent more than a year earlier
when fed cattle marketings of 23 million head during
the year were the largest on record. Fed cattle
slaughter should be well above 1968 levels, while lit­
tle change in cow slaughter is anticipated. Despite
the increase in beef output, prices are expected to
hold at about the 1968 levels, due to the rising de­
mand for meat.
The expansion of pig production which began in
1966 has been continuing, pointing to another in­
crease in pork output in 1969. The gain this year may
be a little larger than the 4 per cent increase last
year and is not expected to be offset by an accelerat­
ing demand. Thus hog prices may average somewhat
lower than a year earlier.
The downtrend of recent years in lamb slaughter
(7 per cent less in 1968 than a year earlier) is ex­

F E D E R A L R E S E R V E BAN K O F ST. L OUI S

pected to continue. The livestock inventory of January
1, 1969 indicated a further reduction in sheep and
lambs on farms.
Sizable gains over year-earlier levels are predicted
for both broiler and turkey production. Broiler pro­
duction was up one per cent in 1968, the smallest
year-to-year increase on record. Late in the year,
however, production was 4 to 5 per cent above levels
for the same months a year earlier, and this higher
rate is expected to continue during the spring months
in response to higher broiler prices and lower pro­
duction costs during 1968. With the higher output in
prospect, broiler prices are likely to fall below yearearlier levels and remain lower through the rest of
the year.
The favorable cost/price relationship for turkeys
in 1968 is also expected to cause an increase in
turkey production. The number of turkeys produced
in 1968 was down 16 per cent from a year earlier,
but supplies were augmented by a large carry-over.
Growers surveyed in January of this year intend to
produce 3 per cent more turkeys than a year earlier.
These indications point to a turkey output somewhat
above the 1968 level but well below the record output
of 1967. In view of this increase in production, turkey
prices are not expected to average above the 1968
level.
Lower egg and milk production prospects point to
somewhat higher prices for these commodities. Egg
production may trail the 1968 level until the end of
summer when a larger number of replacements will
be moving into the laying flock. Thus prices to pro­
ducers will probably remain well above year-earlier
levels until late in the year when the replacement
layers begin to produce. The price margin may then
disappear. The number of dairy cows is expected
to continue downward with a further increase in pro­
duction per cow. Total milk production, however,
is expected to be less, and smaller quantities will
be purchased by the government through price sup­
port operations. Milk prices are likely to be some­
what higher than in 1968, reflecting the higher aver­
age government price supports and the anticipated
decline in production.

Crops
The generally larger crop production in 1968,
coupled with sizable carry-over stocks, provides larger
crop supplies during the current marketing season
than a year earlier. Expanding demand and the gov­



MARCH,

1969

ernment support program for major crops, however,
point to little change in prices to producers.
The supply and use of feed grains are expected to
be in closer balance in the current marketing year than
in most recent years. Production was in excess of use
during most of the 1950’s, and carry-over stocks held
primarily by the government rose to excessive levels.
During most of the 1960’s, however, production has
been less than use, and carry-over stocks have de­
clined. Production of 168 million tons in 1968 may be
exceeded slightly by domestic use plus exports, which
are likely to total about 148 and 22 million tons,
respectively. Thus another slight reduction in carry­
over stocks is in prospect. Com prices have advanced
about 12 cents per bushel since the seasonal low last
October, but with the large supplies subject to re­
demption under the loan program, and carry-over
stocks of all feed grains expected to equal one-fourth
annual use, prices of com are not likely to rise much
above the loan level.
The 1969 feed grain program is essentially the
same as in 1968. The acreage diversion program was
extended to include barley. Also, some further reduc­
tion in carry-over stocks for all feed grains is planned.
The record 1968 wheat crop of 1,570 million bushels
raised the supply in the current marketing year to
2,108 million bushels, the largest supply since the
1965-66 marketing year. Domestic use plus exports
may total about 1,350 million bushels, leaving about
750 million bushels in carry-over stocks at the end of
the marketing season, the largest carry-over since
1964. Prices during the current marketing year are
not expected to average above the support rate of
$1.25 per bushel.
Rice supplies (1968 production plus carry-over) total
111 million hundredweight (cwt.), 15 million cwt.
more than in the previous season and 32 million cwt.
above the 1963-67 average. In recent years total rice
usage has increased rapidly — about 10 million cwt.
per year — and relatively small carry-over stocks have
accumulated under the government price support pro­
gram. Rice prices generally rose during the last mar­
keting season because of the large export demand.
With the larger supplies this year, prices may remain
nearer the support level of $4.65 per cwt., which was
raised $0.05 per cwt. from the 1968 level.
The record 1968 crop of soybeans plus the 167
million bushel carry-over last September provides a
supply of soybeans totaling 1,246 million bushels, well
in excess of estimated utilization during the current
market season. Soybean use is expected to rise mod­
Page 23

F E D E R A L R E S E R V E B A N K O F ST. L O U I S

erately, but carry-over stocks will
probably total more than 300 million
bushels next September. With these
excessive stocks, producer prices are
likely to average near the support
rate during the remainder of the 196869 marketing season. The price sup­
port level was $2.50 per bushel for the
1968 crop. Price supports for 1969 had
not been announced at the time of
this writing.

MARCH,

Table I

PER CAPITA MEAT CONSUM PTION1
(pounds)
Beef
1950
1955
1960
1965
1968

Veal

Lamb and
Mutton

Pork

Poultry

Total

6 3 .4
8 2 .0
8 5 .0
9 9 .3
10 9 .0

8.0
9 .4
6.1
5 .2
3 .5

4 .0
4 .6
4.8
3 .7
3 .7

6 9 .2
6 6 .8
6 4 .9
5 8 .5
6 5 .4

2 4 .7
26 .3
34.1
4 0 .8
4 4 .3

1 6 9 .3
189.1
1 9 4 .9
2 0 7 .5
2 2 5 .9

’U. S. Department of Agriculture, Livestock and Meat Situation
Situation.

The outlook for United States cotton continues to
be highlighted by competition from both synthetic
fibers and foreign-produced cotton in the export mar­
ket. Cotton’s share of the domestic fiber market fell
to 44 per cent in 1968 from 49 per cent in 1967, the
sharpest decline on record. Cotton production abroad
has been increasing faster than consumption for a
number of years, and the gap is expected to narrow
to 1.5 million bales this year. Pricing policies, which
have ignored basic economic tenets by maintaining
prices above the free market level, were a major
factor in the development and growth of this competi­
tion.
Domestic use plus exports of cotton in the 1968-69
marketing season are expected to total about 11.5
million bales, or 1.5 million bales less than last year.
Exports may decline about one million bales and
domestic use about one-half million.
The relatively small cotton crops of the past two
years (9.6 million bales in 1966 and 7.4 million bales
in 1967) permitted a reduction in stocks of about 10
million bales. The 1968 crop was larger (10.8 million
bales), but a further small reduction of 0.5 million
bales in stocks is forecast for next August, which will
bring carry-over down to 6 million bales. This will be
the smallest carry-over during the 1960 decade, but
in view of the decline in cotton use, this level is still
excessive for most types of cotton. Cotton prices are
expected to remain near the government loan level
during the remainder of the marketing season, and
the government program for 1969 is designed to en­
courage a somewhat larger crop.
Tobacco supplies in the 1968-69 marketing year
are about 5 per cent below levels of a year earlier.
The 1968 crop was 13 per cent less and carry-over
was down somewhat. Burley-type supplies are 2 per
cent below last season and 7 per cent below the
1964-65 peak.

Page
24


1969

and Poultry and Egg

Use of major tobacco types in 1967-68 continued
the slow downward trend of recent years, and little
improvement from the producers’ point of view is
anticipated this year. Burley tobacco use in 1967
totaled 594 million pounds, down from 600 million
pounds the previous year and 616 million pounds
in 1964. Flue-cured tobacco use in 1967 totaled 1.22
billion pounds, down from 1.27 billion pounds in 1966
and 1.28 billion pounds in 1955. Based on the formula
required by law, the 1969 price supports for tobacco,
which usually determine the price to farmers, will
be about 4 per cent above the 1968 level.

Food Prices
Of major significance to the nation’s welfare has
been the growth in supplies of farm products, which
has tended to meet a rising demand at relatively
stable prices. For example, prices received for meat
animals have increased only 2 per cent since 1950,
and average prices received for poultry and eggs have
declined. Output and consumption of these commodi­
ties have risen at a high rate. Meat production rose
more than 50 per cent and poultry output rose about
2.5 times during the period. This rapid growth in
output at relatively constant prices is the result of
major gains in farming efficiency. These gains from
new technology have increased the supplies of farm
products with each increase in demand. A major
beneficiary has been the consuming sector, as rising
quantities of high-quality food have moved into the
marketing channels at relatively constant prices. The
rising consumption of meat per capita is an example
of consumer gains (Table 1). Most of the food price
increases that have been experienced in recent years
have reflected rising processing and marketing costs
rather than changes in prices received by farmers.
These trends of rising efficiency in farm commodity
production, relatively stable farm commodity prices,
and rising food costs are expected to continue in 1969.