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FEDERAL RESERVE BANK
OF ST. LOUIS
MARCH 1974

The 1974 National Economic Plan:
Riding Out the Storm
The 1974 Outlook for Food
and Agriculture ................................. 11
LITTLE R O C K

Letter on Monetary Policy......... .............. 20

The 1974 National Economic Plan:
Riding Out the Storm
KEITH M. CARLSON

T H E Administration recently presented to Con
gress and the public its national economic plan for
the eighteen-month period ending June 30, 1975. The
Administration’s plan is contained in three documents
—the Federal Budget, the Economic Report of the
President, and the Annual Report of the Council of
Economic Advisers. Included in the economic plan
are: (1 ) a proposed program for the Federal budget;
(2) goals for gross national product (GNP), output,
prices, and employment; and (3) recommendations
for monetary actions by the Federal Reserve System.
Goals for the U.S. economy in the months ahead
are outlined in the Council of Economic Advisers’
(CEA) Report and are conditioned by economic
forces already in motion, as well as the expected im
pact of planned policy actions. Because of conditions
existing at the beginning of the year, the CEA indi
cates that the idea of a “goal” is more relevant to the
latter part of the year than to the months immediately
ahead. The Administration’s goals include; an 8 per
cent advance in GNP from calendar 1973 to 1974 (or
about 7.5 percent from fourth quarter 1973 to fourth
quarter 1974); an increase in output of 1 percent
from 1973 to 1974; a rise in prices, as measured by
the GNP deflator, of 7 percent; and a rise in unem
ployment to an average slightly above 5.5 percent of
the labor force in 1974.
Proposed as consistent with these economic projec
tions for 1974 is a Federal budget program containing
expenditure increases ( on a national income accounts
basis) of 15 percent from calendar 1973 to 1974.1 Tax
changes consist of an increase in the tax base for so
cial security contributions and a proposed emergency
windfall profits tax. The Administration indicates that
■The Administration does not provide estimates for calendar
1974. Such estimates have been prepared by this Bank on
the basis of fiscal year projections in the budget and actual
data through fourth quarter 1973.

Page 2

stock would be consistent with their economic projec
tions for 1974.
This article summarizes and evaluates the Adminis
tration’s 1974 economic plan. First, as background, the
economic experience of 1973 is summarized in light of
plans and projections made in January 1973. Second,
the proposed Federal budget program is discussed in
some detail, along with the CEA recommendation for
monetary policy. Third, the economic plan for 1974 is
evaluated in terms of its feasibility and internal
consistency.

REVIEW OF THE 1973 ECONOMIC PLAN
In late 1972 and early 1973 the U.S. economy was
in the midst of a strong economic expansion. For the

FEDERAL RESERVE BANK OF ST. LOUIS

MARCH

year ending fourth quarter 1972, output grew 7 per
cent and reported prices rose 3.3 percent. In early
1973 wage and price controls were in the process of
being relaxed by the Administration. In general, the
objective of Administration policy at that time was to
slow the economy to a maximum sustainable growth
of output. Furthermore, with proposed policies of
moderate restraint, inflationary pressures were ex
pected to subside by late in the year. However, the
record of developments in 1973 is all too familiar;
problems evolved which were not accurately foreseen
by the Administration, or by anyone else for that
matter.
Economic Goals vs. the Record
The CEA Report of a year ago projected an in
crease in GNP of 10 percent from 1972 to 1973. The
realized increase was 11.6 percent. In only one other
year out of the last twelve has the CEA underesti
mated the rise in GNP by such an extent —in 1966
(see Table I). And, interestingly, 1966 was also a year
racked by excess demand and inflation, though in retro
spect, the severity of the problem at that time appears
mild by comparison.

T a b le II

Projected and Actual C h ange s in
Economic Activity: 1973
CEA
Projection
GNP
O u tp u t

6 .8

5 .9

Prices

3 .0

5 .4

2.4

U n e m p lo ym e n t Rate

4 .7

4 .9

0 .2

2 .7 %

1962

9 .4 %

6 .7 %

1963

4 .4

5 .4

— 1.0

1964

6 .5

6 .6

0.1

1965

6.1

7 .5

1.4

1966

6 .9

8.6

1967

6 .4

5 .6

1968

7.8

9 .0

—

1969

7 .0

7 .7

— 0 .7

1970

5 .7

4 .9

0 .8

1971

9 .0

7 .5

1.5

1972

9 .4

9 .7

— 0 .3

1973

1 0 .0

1 1 .6

A v e r a g e a b so lu te error

1 .7
0 .8

1.2

1.6
1 .2 %

•Based on data given in the CEA Report for the year following
the forecast year.
**No adjustment is made for deviation o f policy realizations from
plans, or for major strikes.

An examination of the 1973 projection of GNP ac
cording to its distribution between output and prices
indicates that the error in projecting GNP was asso
ciated with an underestimate of the extent of price
inflation (Table II). The CEA projected a 6.8 per
cent increase in output, compared to actual growth of
5.9 percent. Prices were projected to increase 3 per
cent, but actually rose 5.4 percent. The projection of

1 .6 %
0 .9

The error in the 1973 GNP forecast is shown in
greater detail in Table III. A large portion of the
error in projecting total GNP took the form of an
underestimate of the increase in personal consump
tion and a turnaround in the nation’s net export posi
tion. These underestimates were offset partially by an
overestimate of inventory accumulation.
T a b le III

Projected and Actual C h anges in G N P
and Components: 1973
(B illio n s of D o lla rs )

B u sin e ss fixed investm ent

E rro r* *

—

unemployment to average 4.7 percent of the labor
force was close to the actual average of 4.9 percent.

P e rso n a l consu m p tion

A ctual
Change*

Error

1 1 .6 %

CEA
Projection *

CEA
Projected
Change

A ctu a l

1 0 .0 %

T a b le 1

C EA Projection Accuracy for G N P

1974

A ctu a l

Error

$ 6 8 .9

$ 7 7 .5

$ — 8 .6
— 1.4

1 6 .6

1 8 .0

C h a n g e in in ven to rie s

6 .7

2 .0

R esid en tia l construction

1.6

4 .0

0 .6

2.2

—

1.6

18.1

2 0 .0

1.9

Fed eral p urch a ses
State a n d local p urch a ses
N e t exports
GNP

2.6

1 0 .4

$1 1 4 .9

$ 1 3 3 .9

4 .7
2 .4

— 7.8
* -

1 9 .0

♦Estimated by this Bank and based on 1973 CEA Report.

There were, of course, special factors which came
into play during the year that contributed to the
deviation of economic performance from the CEA’s
goals. Reference is made to the circumstances relating
to agricultural prices, the energy situation, distortions
built into the economic system by price and wage con
trols, and foreign exchange rates.
Policy Plans vs. Realizations
Normally, ex-post assessment of any economic plan
depends on more than just a comparison of realized
and projected values of GNP, prices, and output. A
more complete evaluation also takes into account a
comparison of policy plans with policy realizations.
This section indicates that the error in projecting the
major economic aggregates cannot be traced to sharp
deviations of monetary and fiscal actions from original
plans and recommendations. Significant projection er
Page 3

FEDERAL RESERVE BANK OF ST. LOUIS

MARCH

rors do raise the possibility that the economic impact
of prior and current monetary and fiscal actions was
miscalculated. It is difficult, however, to gauge the
extent of this miscalculation, given special factors like
reduced supplies of farm products and petroleum.
Federal budget plans are compared with the actual
results in Table IV. Indications are that Federal ex
penditures were almost exactly on target in calendar
1973, while receipts were substantially underes
timated. As a result, the NIA budget recorded a slight
surplus during the year, or a decline in the deficit of
$17 billion, compared to a projected increase in the
deficit of $4 billion. The faster-than-expected rise in
receipts is, of course, related to the underestimation of
GNP and the pace of inflation. In particular, the un
expectedly rapid increase of corporate tax accruals
contributed to a large underestimate of total Federal
receipts.
T a b le IV

Planned and Actual Changes in the Federal Budget:
1973

1974

M o n e y Stock
R a tio S e a l*
B illio a s o f D o lla rs

1966

1967

Q u arterly A v e ra g e s o l M onthly Figures

1968

1969

1970

1971

Percentages are annual rates of chan ge (or periods indicated.
Latest d ata plotted: 4th quarter

mine, in retrospect, whether monetary expansion dur
ing the year was consistent with the CEA recom
mendations in January 1973. In their 1973 Report, the
CEA specified the role for monetary policy as follows:

( B illio n s o f D o lla rs)
Budget
Plan
N IA

Receipts

N IA

E xp e nd iture s

N I A S u rp lu s o r Deficit
H ig h -E m p lo y m e n t Receipts

2 3 .0

3 6 .5

Error
$ -

1 7 .4

21.1

1 9 .4

3 .6

$ - 4 .0

17.1

$ -

2 3 .6

$ 3 0 .9

$ -

2 4 .7

2 0 .8

H ig h -E m p lo y m e n t E xp e nd iture s
H ig h -E m p lo y m e n t
S u rp lu s or Deficit

19.1

A ctu al

$ -

1.1

10.1

7.3
3 .9

* -

1 1.2

Planned and realized increases in receipts and ex
penditures, on a high-employment basis, are also
shown in Table IV. Normally, an examination of highemployment budget plans provides a more meaning
ful basis of comparison of policy plans and realiza
tions than does the NIA budget. However, during
times of rapid inflation, the high-employment budget
gives a distorted picture of the extent of fiscal stimulus
or restraint. That is, according to Table IV, it would
appear that there was more restraint than planned as
evidenced by a surplus $11 billion greater than
planned in January 1973. High-employment receipts,
and thus the net surplus or deficit, reflect inflation, and
thereby suggest that the budget is showing more re
straint than is actually the case. Some rough guesses
can be made of the magnitude of the inflation bias, but
there is no generally accepted method of making an
inflation adjustment in the high-employment budget.
With regard to monetary actions as a part of the
economic plan for 1973, it is very difficult to deter
Page 4

A gradual slowing of the expansion of money
GNP to a steady rate consistent with the long-run
potential growth rate o f the econom y and reason
able price stability is also an appropriate goal for
monetary policy. This is likely to require a slower
increase of the supply of money and credit than was
proper when the main objective was to encourage a
quickened econom ic expansion in an environment of
substantial unused resources.2

On the basis of recently revised figures for the
money stock, it appears that, on average, the course
of monetary expansion in 1973 was consistent with the
CEA’s general recommendation. Money grew 6.1 per
cent in the year ending fourth quarter 1973, compared
to a 7.8 percent increase in the previous year. It
should be pointed out, however, that this slowing in
monetary growth occurred in the second half of the
year. Given the lag with which monetary actions af
fect economic activity, the deceleration in money
growth probably had little effect in slowing the growth
of nominal GNP during the year. Money grew at a 7.4
percent annual rate in the first half of 1973, only
slightly less than the 7.8 percent increase in the previ
ous year.
Analysis Based on St. Louis Model
Substantial error in the CEA’s GNP forecast, in the
absence of any significant deviation of monetary-fiscal
21973 CEA Report, p. 75.

FEDERAL RESERVE BANK OF ST. LOUIS

policy realizations from plans, raises
the possibility that there was a miscal
culation of the impact of current and
past policy actions on economic ac
tivity. To aid in the assessment of the
CEA’s 1973 economic plan, some simu
lation results with the St. Louis model
are presented.

MARCH

1974

T a b le VI

Changes in G N P and Components:
1973 and 1974
( D o lla r A m o u n ts in B illio n s)
1973
Person al co nsu m p tion
B u sin e ss fixed investm ent
C h a n g e in in ven to rie s

$ 7 7 .5
1 8 .0
2 .0

1974*
1 0 .7 %
1 2 .7
—

$ 6 5 .0
1 6 .0
2.1

8 .1 %
1 1 .7
—

Two after-the-fact projections of the R esid en tia l construction
4 .0
7 .4
-8 .5
- 1 4 .7
St. Louis model are presented in Table Federal p urch a ses
2.2
2.1
11.1
1 0 .4
2 0 .0
1 3 .3
2 0 .7
12.1
V. The first projection uses money and State a n d local p urch a ses
N e t e xpo rts
1 0 .4
—
—
— 4.6
high-employment expenditures as they
GNP
$ 1 3 3 .9
1 1 .6 %
$ 1 0 1 .8
7 .9 %
were recorded in 1973. The second pro
jection is the result of using money and ♦Estimated by this Bank and based on 1974 CEA Report.
high-employment expenditures consis
tent with the recommendations of the Administra
the energy problem and the scheduled dismantling of
the system of price and wage controls. Monetary and
tion in January 1973. The first projection, using
fiscal actions seem to be assigned a secondary role in
actual movement in the policy variables, indicates
the assessment of the 1974 economic outlook.
that the St. Louis model projected the increase in
GNP at $118 billion, or $16 billion less than actually
occurred. The second projection indicates that move

The 1974 projections of the broad economic aggre
gates differ substantially from the actual experience
in 1973. Furthermore, substantial dif
T a b le V
ferences are projected in the composi
Projected Changes in Spending, Output, Prices,
tion of GNP (Table VI). The most
and Unemployment: 1973
notable differences are with reference
( D o lla r A m o u n ts in B illio n s)
to personal consumption, residential con
U n e m p lo y
struction, Federal purchases, and net ex
GNP
O u tp u t
Prices
ment Rate
ports. Personal consumption is projected
C E A Projection
(1 / 3 1 / 7 3 )
$ 1 1 4 .9
1 0 .0 %
6 .8 %
3 .0 %
4 .7 %
to slow to an 8 percent increase, in con
A ctua l
5 .4
1 3 3 .9
1 1 .6
5 .9
4.8
trast to a 10.7 percent rise in 1973.
St. Louis M o d e l Projections:
Residential construction is expected to
C h a n g e s in m on ey a n d Federal
decline by about 15 percent, after in
s p e n d in g a s actu a lly occurred
1 1 8 .2
1 0 .2
6.1
3 .9
4.5
creasing 7.4 percent in 1973. Federal
C h a n g e s in m on ey a n d Federal
s p e n d in g consistent with C E A
purchases
are projected to rise over 10
a ssu m p tio n s of 1 / 3 1 / 7 3
1 1 6 .7
10.1
6 .0
3 .9
4 .5
percent, compared to a 2.1 percent
ments of the policy variables in line with Administra
increase in 1973. The net export position is expected
tion recommendations would have increased GNP by
to decline from the substantial surplus registered in
$117 billion. Thus, to the extent that the impact of
1973.
monetary and fiscal actions is accurately captured by
the St. Louis model, the effect of policy error on GNP
Federal Budget Program for Calendar 1974
can be assessed as negligible. Within the framework
of the St. Louis model, $16 billion of the $19 billion
The budget plan for 1974 is to restrain the decline
error in the CEA forecast reflects the operation of
of the economy during 1974 but to inject no fiscal
special factors on the income velocity of money.
stimulus to push the economy above its average rate

POLICY PLANS AND
RECOMMENDATIONS FOR 1974
The Administration’s projections of a 1 percent rise
in output and a 7 percent rate of inflation in 1974 re
flect the expected adjustment of the economy to some
special factors relating to uncertainties surrounding

of expansion. Consequently, the budget plan is de
signed as a middle-of-the-road policy, supposedly
geared so as not to contribute further to either unem
ployment or inflation.
The purpose of this section is to present the quanti
tative details of the Federal budget program on an
Page 5

FEDERAL RESERVE BANK OF ST. LOUIS

NIA basis for calendar 1974.3 The budget on an NIA
basis is considered by many analysts to be more ac
curate than the unified budget for evaluating the eco
nomic impact of fiscal actions. On a unified basis some
misleading information can be emitted because of
matters of timing in expenditures and receipts, as well
as transactions in existing assets. A judgment is offered
as to the possible accuracy of the Administration’s
assessment of the economic impact of its budget.
Expenditures — The budget program indicates a $41
billion increase, or 15 percent, in Federal expendi
tures on an NIA basis for calendar 1974 (Table VII).
This compares with an 8.2 percent advance in 1973
and a 7.7 percent average rate of increase from 1968
to 1972. If realized, the 1974 increase in expenditures
would be greater than 82 percent of all year-to-year
changes since 1947.
Defense spending is projected to increase in 1974
by 5.5 percent, compared to no change in 1973 and a
1.3 percent average annual rate of decline from 1968
to 1972. This planned increase in defense spending
reflects an attempt to meet the higher costs of main
taining forces and stocks of equipment and supplies,
as well as an effort to produce new weapons systems.

MARCH

1974

T a b le V II

Planned C h anges in Federal ( N IA ) Budget: 1974*
( B illio n s o f D o lla rs )
N I A Receipts
C h a n g e d u e to grow th
C h a n g e d u e to cycle
C h a n g e d u e to tax rate adjustm ents

$ 2 9 .7
3 2 .8
8 .7
5 .6

N I A E xp e nd iture s
C h a n g e in d efen se
C h a n g e in n o n d e fe n se
N IA

S u rp lu s o r Deficit

4 0 .7 **
4.1
3 6 .6 **
-

1 1 .0 **

H ig h -E m p lo y m e n t Receipts

3 8 .4

H ig h -E m p lo y m e n t E xp e nd iture s

3 8 .0 **

H ig h -E m p lo y m e n t S u rp lu s o r Deficit

0 .3 **

‘ Estimated by this Bank from the Federal Budget for fiscal 1975.
♦•Includes rupee transfer to India of $2.2 billion.

Nondefense spending, according to the Administra
tion’s budget, is projected to advance 19 percent in
1974, compared with 12 percent in the previous year
and a 13 percent average rate of increase from 1965
to 1972. Within recent years there has been a drama
tic shift in the size of nondefense spending relative to
the total. The estimated proportion of Federal expend
itures going toward nondefense purposes in 1974 is
74.3 percent, compared to 56.9 percent in 1968.
Receipts — Federal receipts on an NIA basis are
projected to rise by $30 billion, or by 11 percent, in
calendar 1974. By comparison, receipts rose by 16 per
cent in 1973 and 15 percent in 1972. These year-toyear comparisons require interpretation in light of
changes in tax rates, as well as the advance of eco
nomic activity.
To aid in the interpretation of receipts projections,
estimates of the sources of changes are given in Table
VII. The receipts projection for 1974 reflects two ma
jor tax changes. Existing law calls for an increase in
the tax base for social security contributions from
$10,800 to $13,200, effective January 1, 1974. The only
other major change is a proposed emergency wind
fall profits tax, although there is no indication in the
budget as to when this new tax is expected to be
effective.4 In addition, there are other minor proposed
changes in tax laws which would have a negative
effect on receipts —namely, liberalized deductions and
tax structure simplifications.

3As indicated above, all calendar year estimates for 1974 are
prepared by this Bank. The chief basis for these estimates is
Table C-68 in the 1974 CEA Report, though fourth quarter
1973 figures have been revised since the Report was
published.

Page 6

Thus, given the estimated effect of changes in the
tax structure, the estimate of the rise in receipts at
tributable to the advance of economic activity (in
cluding both growth and cyclical factors) is estimated
4The calculations in Table VII were based on the assumption
that the new tax would be fully effective by second quarter.

MARCH

FEDERAL RESERVE BANK OF ST. LOUIS

Fiscal M e a su re s
(+ ) S « r p l« s ; (-)D e fiiit

1974

tends to be dictated by the nature of the mandate of
the Employment Act of 1946 and the way the CEA
interprets its role in fulfilling the conditions of that
legislation. For 1974, the CEA Report states its rec
ommendation for monetary policy as follows:
The monetary expansion in the second half of 1973
can be described b y an increase in the narrowly
defined money stock ( M j ) of somewhat under 5 per
cent and an increase in the broadly defined money
stock ( M 2) o f about 8 percent, at annual rates. Con
tinued growth in M 2 at approximately this rate
would be consistent with our expectations concern
ing the increase in GNP during 1974.5

Sources: U S- Department of Commerce
ond Federal Reserve Bonk of St. louis
lotest data plotted: 4th quarter 1973; dashed line indicates half-yeor estimates b y this Bonk based
on the fiscal I9 7 S Federal Budget ond the 1974 Annuol Report of the Council of
Economic Advisers

at $24 billion. However, when allowance is made for
the rise in receipts that could be expected from normal
growth of the economy, it is apparent that cyclical
forces are contributing to a decline in receipts in 1974.
Surplus/Deficit Position - T h e combined effect of
expenditures rising more rapidly than receipts results
in a substantial shift in the net position of the NIA
budget from a $1.2 billion surplus in 1973 to a $9.8
billion deficit in 1974. As indicated above, this shift
toward deficit reflects a projected slowdown in eco
nomic activity, as well as changes in expenditure
plans and tax laws.
The results of these calculations for the budget pro
gram for 1974 on a high-employment basis are given
in Table VII. The high-employment budget is pro
jected to show a surplus of about $5 billion in 1974,
about the same as the estimated surplus in 1973.
Superficially, these figures indicate that the budget
program is one of continuing restraint, but it should
be recalled that these calculations are influenced in
substantial measure by inflation. Thus the Administra
tion’s budget plan for calendar 1974 is more stimula
tive than indicated by the movement of the high-em
ployment surplus.
Monetary Policy Recommendations for 1973
The Administration’s discussion of stabilization
policy focuses on the Federal budget, with monetary
policy receiving secondary emphasis. This emphasis

Though the discussion relating to this recommenda
tion is limited, the precision of this recommendation
represents a break with past tradition. Never before
has the CEA given such a precise indication of its
monetary policy recommendation. Usually such recom
mendations take the form of statements like “The role
of monetary policy in the expansion ahead will be to
provide for the increase of liquidity required to sup
port increases in activity and income.”6

EVALUATION OF 1974 ECONOMIC PLAN
According to the CEA, “the main functions of policy
[in 1974] will be to keep the dip in the early part of
the year from going too far and to assist the revival
later in the year, but to avoid stimulating too rapid a
surge.” Clearly, the Council is fully aware of the un
certainties relating to the economic outlook, and
wishes to keep its options open so that policy can be
flexed in either direction, depending on the actual
course of developments during the year.
In general, the special circumstances which are
present in shaping the course of the economy in 1974
are quite unique. As a result, econometric models are
less useful than otherwise in providing information
about the probable course of economic events. Eco
nometric models, by necessity, are structured on the
basis of experience. However, despite their limitations,
model results, particularly as they relate to the re
sponse of the economy to monetary and fiscal actions,
should not be overlooked just because certain special
circumstances seem to be so overwhelming in their
implications. For this reason, it is still useful to con
duct simulations for purposes of gaining insights into
the expected effects of planned monetary and fiscal
actions in 1974. These simulations have to be given a
liberal interpretation but can still serve as a general
51974 CEA Report, pp. 31-32.
81972 CEA Report, p. 26.

Page 7

MARCH

FEDERAL RESERVE BANK OF ST. LOUIS

guide in the assessment of the Adminis
tration’s economic plan.

1974

T a b le V III

Projected C h anges in G N P :

1974 and 1975
This section evaluates the 1974 eco
( D o lla r A m o u n ts in B illio n s)
nomic plan with the use of the St. Louis
model. This is a policy-oriented model
1974
1975
—
—
and is based solely on past experience. C E A Projection ( 2 / 1 / 7 4 )
$ 1 0 1 .8
7 .9 %
As a result, the St. Louis model does not St. Lou is M o d e l Projections
1) W it h 8 percent grow th
lend itself to manipulation for purposes
in M 2 a n d Federal
s p e n d in g b a se d on
of analyzing energy problems or pro
1 9 7 5 budget
1 2 3 .6
9 .6
7 .9 %
$ 1 1 1 .3
grams of price and wage control or de
2 ) W ith 5 percent grow th
in M i a n d Federal
control. Given these qualifications, simu
s p e n d in g b a se d on
lations of the St. Louis model are pre
1 9 7 5 budget
1 1 4 .5
8 .9
7 .0
9 7 .7
sented for purposes of determining ( 1 )
if the projected increase in total spending (GNP) by
estimated impact of past monetary and fiscal actions,
the Administration is consistent with the proposed set
when combined with policy plans for 1974, appear to
of monetary and fiscal actions, and ( 2 ) if the price
be greater than foreseen by the Council. An interpre
and output projections are consistent with the fore
tation is that the Council envisions a slower growth
cast of total spending.
in velocity as a result of special factors relating to
the energy problem and the program of price and
wage decontrol. With little past experience to draw
Feasibility of Total Spending Projection
on, it is not possible to assess the validity of this inter
The Administration’s projection of an increase in
pretation. Nevertheless, the CEA projection appears
GNP of $102 billion, or 8 percent, is examined by
to be within the range of error of the St. Louis model’s
considering two simulations of the St. Louis model.
GNP equation (though this judgment is questionable
One simulation uses an 8 percent rate of steady growth
with regard to the results based on the M2 equation),
in M2, and the other uses a 5 percent rate of growth
so there is no firm basis for considering the GNP
in M j.7
projection to be inconsistent with the policies they
recommend.
Both simulations use a path of high-employment

Federal expenditures which is somewhat different
than implied in the budget. Budget estimates imply
an intra-year pattern for 1974 which consists of a sub
stantial acceleration in spending in the first half of
calendar 1974 followed by a sharp deceleration carry
ing through the first half of calendar 1975. A more
likely path is used for simulation purposes which in
volves a gradual approach to a 10.7 percent annual
rate of increase of expenditures by second quarter
1974. This path still implies a substantial pick-up in
expenditure growth in the first half of 1974, but the
subsequent deceleration is much less marked than
strictly implied by the budget plan. This deviation
from the budget plan is premised on the recent budget
experience of overestimating current (fiscal) year
expenditures.
The results for these combinations of policies are
shown in Table VIII. The two combinations of mone
tary and fiscal actions yield GNP results which are
higher than the CEA projection. In other words, the
7Since the Administration is not specific in recommending a
growth rate for Mi, the 3 percentage point spread between
Mi and M2 growth experienced over the last two years is
used to provide an estimate of Mi growth.

Page 8

An implication of these results with the St. Louis
model is that, at a minimum, monetary growth should
be kept from exceeding the recommended rates in

FEDERAL RESERVE BANK OF ST. LOUIS

MARCH

1974

G e n e ra l Price Ind e x*
R a tio S e a l*

1958=100

R a tio S c a lt

1958=100

• A s used in National Income Accounts.
Percentages are annual rates of change (or periods indicated.
Latest data plotted: 4th quarter 1973; dashed line indicates half-year estimates by this Bank based
on the fiscal 1975 Federal Budget and the 1974 Annual Report of the Council of
Economic Advisers

order to avoid a faster-than-desired increase in GNP.
Given existing capacity constraints, a rise in GNP
faster than projected would be reflected primarily in
prices rather than in output.
Implications of Total Spending Projections
Given the feasibility of attaining the CEA’s projec
tion for GNP, the question remains whether the dis
tribution of GNP growth between prices and output is
consistent with the CEA projection. Examination of
this question depends critically on what assumptions
are made about the aggregate price effects of the
energy problem, as well as the program of price and
wage decontrol.
There have been some studies that have purported
to measure the success of the price-wage control pro
gram, and thus carry implications about what the eco
nomic response might be to a program of decontrol.8
Closer examination indicates that such studies shed
little, if any, light on the problem. For example, pre
dicting what a price index would have done in the
absence of controls and comparing that hypothetical
result with what actually happened provides little in
sight because it is assumed that all of the effects of
controls are reflected in a chosen price index. Since
controls distort the operation of relative prices as an
allocative mechanism in a market economy, the effect
of controls on an aggregate index is simply impossible
to measure. Furthermore, there are output effects re8For a general discussion of price-wage controls in this con
text, see Robert J. Gordon, “The Response of Wages and
Prices to the First Two Years,” Brookings Papers on Eco
nomic Activity, 3 (1973), pp. 765-78.

lated to a control program which affect the interpre
tation of a particular price index. In other words, the
market basket is changing because of the control pro
gram which invalidates the price index as a measure
of intertemporal price changes.
It appears that the most important aspect of the
CEA’s 1974 price and output projections is not so
much whether or not they are likely to be realized, but
rather the lessons they carry for the formulation of
future monetary and fiscal policy. The relatively bleak
1974 outlook for prices and output shows the inter
dependence over time of economic policy decisions.
The Administration, by becoming impatient in mid1971 with the pace of economic expansion and the
rate of deceleration of inflation, adopted policies
which formed the basis for an adjustment which ap
pears to be developing in 1974. Interference with the
operation of free markets beginning in August 1971,
followed shortly by stimulative monetary and fiscal
actions, set the stage for the economic problems which
began to surface in 1973.
Special circumstances undoubtedly play an impor
tant role in the analysis of current problems of infla
tion and capacity constraints. However, pointing to
special circumstances as the chief cause of the current
inflation demonstrates a lack of perspective. Instru
mental in the development of some of these special
circumstances were the policies adopted in late 1971
Page 9

FEDERAL RESERVE BANK OF ST. LOUIS

and the subsequent inordinate monetary and fiscal ex
pansion. The demand for energy is not unrelated to
the rapid pace of economic expansion and the 1971
policy emphasis on stimulating the automobile indus
try. Furthermore, the supply of energy is not unrelated
to the administration of the program of price controls.
Worldwide inflation would probably have been less
rapid if the U.S. expansion and the associated demand
for imports had been restrained. It is true that these
policy actions cannot be undone, but such mistakes
can be avoided in the future.

SUMMARY
The Administration has projected a year of rapid
inflation and little growth in output, on balance. How
ever, by focusing on the second half of calendar 1974,
the CEA projection turns more optimistic — a pick-up
in output growth and a slower rate of inflation.
Offered as consistent with these projections is a
Federal budget program which is allegedly neutral in
its impact, but on closer inspection is more stimulative
than in 1973. The Administration’s monetary recom
mendations are couched in terms of an 8 percent
growth rate in M2, or slightly less than the growth
in the previous year.

Page 10

MARCH

1974

Using the St. Louis model as an aid in evaluating
the 1974 economic plan, it was found that the CEA
projection of GNP appears to be less than implied by
the recommended 8 percent growth in M2. Given the
capacity constraints operating in the economy, under
estimating the growth of GNP raises the specter of
inflation in excess of the CEA’s projection of 7 percent.
An accurate assessment of the Administration’s pro
jections for prices and output, given their GNP projec
tion, is simply not possible given short-run considera
tions such as the energy situation and the scheduled
program of price and wage decontrol. Aside from the
question of whether the price and output projections
are consistent with the projected GNP path is the
more important consideration that the developing eco
nomic situation be viewed in perspective so that
similar situations can be avoided in the future. The
interplay of “special circumstances” does inject some
element of doubt over the future course of the econ
omy. It should be noted, however, that the 1974
economic situation is not evolving independently of
the inordinate monetary expansion of the previous
two years and a price-wage control system that dis
torted the operation of a free market economy.

The 1974 Outlook for Food and Agriculture
CLIFTON B. LUTTRELL and NEIL A. STEVENS

I HE U.S. Department of Agriculture has forecast a
further increase in food prices in the first half of 1974,
followed by rising farm production and relatively sta
ble food prices in the second half of the year.1 Farm
commodity and food prices rose sharply last year, re
flecting, in part, a number of short-run supply and
demand forces. In response, farmers are expected to
increase production this year. Both crop and livestock
product prices are expected to average somewhat
above the 1973 level. However, in contrast to the ris
ing prices during 1973, farm commodity prices are
forecast to decline in the second half of this year.
With rising farm production during the year, domestic
food supplies per capita should rebound from the 1973
level which was 2 percent less than a year earlier and
the lowest in four years.
This article provides both an analysis of national
food and agriculture developments over the past two
years and a general outlook for food and agriculture.
Also included is outlook information for major crops
and livestock products of the Central Mississippi
Valley.

be up. Per capita supplies of crop foods for domestic
consumption are expected to be about the same as a
year ago.
While retail food prices are up in the first quarter
of this year as a result of both declining farm output
and rising marketing margins, they are expected to
level off later in the year as increased farm output
and declining farm product prices will tend to offset
rising marketing costs.
Food Output Down Last Year
Reflecting a number of short-run factors, per capita
food supplies last year declined from the 1972 level.
The decline was led by a 7 percent reduction in meat
output which was only partially offset by a small gain
in crop-related foods. This was the largest year-to-year
decline in meat supplies in a quarter of a century.
Per capita red meat available for domestic consump
tion was down about 14 pounds from 189 pounds in
1972. Most of the decline reflected reduced beef and
pork supplies; however, veal, lamb, and mutton were
also down somewhat.

in 1974 are expected to
1973 decline. Further in
occurred this winter, but
at home is expected to

Total production of livestock products in 1973 was
down about 5 percent from the previous year. Domes
tic production, however, was augmented slightly by
increased imports which accounted for 4.6 percent of
livestock food supplies in 1973. Imports of dairy
products rose sharply, accounting for 2 percent of
domestic use.

Rising production is expected to result in per capita
consumption gains in livestock-related foods of about
1.5 percent for 1974. Per capita red meat production
is expected to rise about 3 percent from last year’s rel
atively low level and poultry supplies should also be
up following a 2 percent decline last year. Per capita
egg production may increase somewhat. Dairy pro
duction will probably be down for the second consec
utive year, but dairy imports are rising, hence the
per capita consumption of dairy products will likely

Crop production last year was up about 5 percent,
but most of the gain was in feed crops which were
harvested in the late summer and fall, and had little
impact on the 1973 domestic food supply. Crop exports
were up as a result of rising world demand and re
duced world supplies, and imports, consisting largely
of sugar and a number of tropical products, were down
slightly. Consequently, domestic use of crop foods did
not rise enough to offset the decline in livestockrelated food.

1The forecasts cited throughout this article are a summary of
the U.S. Department of Agriculture reports given at the 1974
National Agricultural Outlook Conference held in Washing
ton, D.C., in December 1973 and reports of subsequent
months.

Prices Sharply Higher in 1973

FOOD
Per capita food supplies
recover from most of their
creases in food prices have
the average price of food
stabilize about mid-year.

The decline in food output last year in the face of a
strong demand resulted in a sharp run-up in prices.
Page 11

FEDERAL RESERVE BANK OF ST. LOUIS

Led by a rapid increase in meat prices, the price in
dex of food in grocery stores rose 16 percent from
1972 to 1973 (see accompanying chart). Average food
prices rose 23 percent from August 1972 to its peak in
August 1973 —more than during the entire period
from 1967 to mid-1972. Meat, poultry, and fish prices
rose 41 percent during this 12-month period. Food
prices declined somewhat in September and October,
but turned up again later in the year.

Until the recent upsurge, food prices have increased
at a slower rate than other consumer prices since the
acceleration of the inflation in the mid-1960s. From
1965 until 1972, the price index for food at home rose
at an annual rate of 3.5 percent, while the index for
all consumer items rose at an annual rate of 4.1
percent.
Reflecting the rising demand and reduced supply
of food, all farm product prices last year averaged
37 percent higher than in 1972. Crop prices were up
43 percent and livestock prices rose 33 percent. Much
of the increase in crop prices was the result of an in
crease in derived demand for, and reduced supplies
of, livestock feed prior to harvesting last year. Feed
demand derived through demand for livestock prod
ucts continued to rise reflecting rising personal in
comes both here and abroad. World supplies, how
ever, were down as a result of relatively poor crops in
1972. Livestock feed prices rose 84 percent from Au
gust 1972 to August 1973, and for the calendar year
1973 they averaged 52 percent higher than a year
earlier. Hence, the short-run supply of livestock prod
ucts was reduced as feeding became more expensive;
Page 12

MARCH

1974

that is, a smaller quantity would be offered by pro
ducers at any given price level.
Reduced Output and Higher Prices Caused by
Short - Run Forces
While some of the increase in food prices last year
reflected the expansion of aggregate demand for all
goods and services, much of the rise can be traced to
a series of short-run supply and demand factors in the
food industry. Price-wage controls in some cases,
particularly the freeze on meat prices last summer,
prevented part of the rising demand signals from reach
ing the producers, thus delaying increases in produc
tion. Sales of wheat and feed grain to the Russians in
mid-1972 served to reduce domestic stocks and in
crease prices. The sharp decline in production of
Peruvian fish meal led to a shortfall in world protein
supplies and an unanticipated increase in export de
mand for soybean meal. Unfavorable crop harvesting
weather in the United States in the fall of 1972 re
duced crop output from expected levels. A decline in
world crop production in 1972 and a realignment of
world currencies led to an unexpected increase in ex
port demand for U.S. crops. In addition, the sharp
price increases for livestock tended to increase the
numbers of animals going into domestic breeding herds
and reduce the number placed in feedlots for slaughter.
Food Output and Prices Adjusting to Longer
Run Forces

These short-run fluctuations in food prices and out
put are self-correcting in a free market economy.
Given sufficient time farmers can adjust their capital,
labor, land, and other inputs so as to increase pro
duction. Hence, in the long run farm production is
more responsive to price changes than in the short run.
The higher prices for livestock feed and other crops
in early 1973 provided incentive for an upswing in
crop production last year.2 Total crop output jumped
about 5 percent from the 1972 level or well above
the average annual rate of 2 percent during the previ
ous ten years. Acres planted to feed grains, wheat,
rice, and soybeans rose 5, 8, 20, and 22 percent,
respectively.
With larger feed crops, livestock production began
to expand in the fourth quarter of last year. Red
meat production was forecast at 9 billion pounds in
the fourth quarter, up from 7.9 billion in the third
2Less restrictive Government planting controls were also a
factor in the larger feed crop output.

FEDERAL RESERVE BANK OF ST. LOUIS

MARCH

T a b le 1

Commercial M eat Production
1974'

1973

Total red m eat
(m illio n s of p o u n d s ) 2

III

8 ,7 7 3

8 ,3 4 5

7 ,9 1 2

IV*

8 ,9 7 5

8 ,4 7 4

8 ,7 0 0

Percent c h a n g e from :
Y e a r earlier

—

-1 0 %

—

P revious q uarter

—

+ 13

+ 3

n.a.

P oultry (ch icke ns & tur
keys, m illions of p o u n d s ) 2,357

2 ,5 6 0

2 ,9 0 0

n.a.

Percent c h a n g e from :
Y e a r earlier

—

P reviou s quarter

— 19

—

+ 13

1974

adjusts following a short-run dis
turbance. Producers quickly re
spond with additional output
when prices rise and major op
portunities for profit occur. In
creased production, in turn,
leads to a downward adjustment
in prices. Some of that down
ward adjustment in food prices
to more normal supply and de
mand conditions may occur this
year.

If a high rate of inflation con
tinues, most of the food price
adjustment may occur through
a decline in relative food prices
rather than an actual price de
cline. Reflecting both short-run factors in the food
industry and excessive demand, the general price level
(measured by the GNP price deflator) has risen at an
annual rate of 4.6 percent since early 1971 and the rate
has accelerated in recent quarters. From fourth quarter
1972 to fourth quarter 1973, prices rose 7.3 percent,
but most of the price acceleration during this period
reflected rising food costs. Thus the relatively stable
food prices forecast for late this year would contribute
to a slower rate of inflation, and with continuing or
accelerating inflation in prospect for other items, sta
ble food prices should result in a resumption of the
long-run downtrend in food costs relative to disposable
personal income.

1Forecast
2Beef, pork, lamb, and mutton
Source: U.S. Department o f Agriculture Livestock and Meat Situation (December 1973), and Poultry
and Egg Situation (November 1973).
n.a. — not available

quarter (Table I). Some decline is indicated for the
first quarter of this year, but following this temporary
setback, output is expected to t o n up and increase
further in succeeding quarters.
Poultry production also ton ed up in 1973, rising
from 2.4 billion pounds (ready-to-cook basis) in the
first quarter to 2.9 billion in the third quarter. Some
further increase was projected for the fourth quarter,
but total production for the year was still less than in
1972. A temporary decline may occur in the first
quarter of this year followed by rising output in the
remaining quarters.
Further gains in the production of most crops are
anticipated this year. The January 1 survey of grower
planting intentions points to major increases for most
crops in the 35 leading farm states surveyed.3 For
example, com acreage is expected to rise 10 percent
or more, durum and other spring wheat may be up 39
and 20 percent, respectively, and intended cotton
acreage is up 18 percent. Prospective plantings to all
four feed grains combined (com, sorghum, oats, and
barley) are up 4 percent from 1973 and 10 percent
from 1972. The increases in livestock feed provide the
inputs for further gains in production of meat and
other animal products.
The acreage increases last year and the planned
increases this year are in response to relaxed Govern
ment production controls and the higher feed prices.
The higher feed prices were, in turn, a response to
the rising demand for feed caused by higher livestock
and food prices. This is the way the market system
3U.S. Department of Agriculture, Crop Production (January
22, 1974).

Share of Personal Income Spent on Food
Unchanged
Although expenditures for food increased sharply
last year, disposable personal income rose at a simi
larly high rate, resulting in little change in the portion
spent on food. Food expenditures absorbed 15.8 per
cent of the total, only a fraction of a percent more
than in 1971 and 1972 (Table II). Cost of food used
at home was 12.3 percent of disposable personal in
come, the same as a year earlier, and slightly less than
in 1971.
While the share of disposable personal income spent
on food has not declined in recent years, it may still
be lower in the United States than in any other major
industrial nation (Table III). In 1970 U.S. consumers
spent only 13.4 percent of national income on food,
beverage, and tobacco, the smallest percentage re
ported for these items by any major industrial nation
of the Organization for Economic Cooperation and
Page 13

MARCH

FEDERAL RESERVE BANK OF ST. LOUIS

T ab le II

Percent of Disposable Personal Income Spent on Food

Year

D isp o sa b le
P e rso n a l Incom e
(b illio n s o f d o lla rs)

Percent S p e n t on
Foo d at H om e

Percent S p e n t on
Total Food

1960

$ 3 5 0 .0

1 6 .2 %

2 0 .0 %

1965

4 7 3 .2

1 4 .6

18.1

1970

6 9 1 .7

1 2 .7

1 6.2

1971

7 4 6 .0

1 2 .4

1 5 .7

1972

7 9 7 .0

1 2 .3

1 5 .7

1973

8 8 2 .6

1 2 .3

15.8

1974

The decline forecast for realized farm income this
year is based largely on rising farm production ex
penses. Resources for production are being bid up
throughout the economy and farmers are facing
sharply rising prices for most farm supplies. As a re
sult of both the higher prices and a larger volume of
resources used, farm production expenses are expected
to be well above the estimated $64.4 billion last year.
Realized Gross and Net Farm Income
R a t io S c a le

R a t io S c a le
B illio n s o f D o lla r s

B i ll io n s o f D o l l a r s

200

U.S. Department o f Agriculture, National Food Situation
(February 1974).

Source:

Development (O ECD ). A number of countries,
including Canada, Japan, France, and Germany, made
rapid progress in reducing food costs during the dec
ade ending in 1970. However, it is still unlikely that
any of them, except possibly Canada, can claim equal
ity with the small share of disposable personal income
spent on food in the United States.
T a b le III

Realized Gross Income
(current dollars)

80
70

90
80

70
60

■"

Rea ized Gr >ss Inco ne H(19(5 d illars)

1960

1970

U nite d S ta t e s *

1 5 -7

1 3 .4

Canada*

1 9 .7

14.8

Japan

3 5 .6

2 7 .4

A u stria

3 0 .2

n.a.

B elgiu m

2 4 .6

20.1

D e n m ark

2 0 .8

n.a.

F in la n d *

2 8 .6

2 3 .5

France

2 9 .2

2 2 .6

G e rm a n y *

2 3 .7

1 8 .5

N e th e rla n d s

2 6 .5

n.a.

Sw eden*

2 2 .0

1 9 .0

United

2 6 .9

2 2 .6

*Percent spent on food, beverage, and tobacco.
n.a. — not available
Source: Derived from data in National Accounts o f OECD Countries,
1960-1970.

AGRICULTURE
Realized net farm income is expected to total about
$24 to $25 billion in 1974, a decline from the record
$26.1 billion estimated for 1973 (see accompanying
chart). Cash receipts from farm product sales are
likely to be higher, reflecting a larger volume of produc
tion and higher average prices; direct Government
payments to farmers, however, will probably be down
sharply from the $2.6 billion last year, and farm pro
duction expenses will rise. Nevertheless, the fore
casted net farm income is still well above the amount
realized in any year except 1973.

I!ealized Met Inc me
(curren dollars )

Selected
In d u stria l
N a tio n s

Page 14

Percent of Disposable N ational Income Spent
on Food in Selected Industrial Nations

K in g d o m *

100

Realized Nel Inco n e l ^
(19(5 dollars)
1 0 --------- --------- --------- 1---------*---------1------------------ --------- ---------

1965

1966

1967

1968

1969

19 70

1971

1972

1973

1974

N o te: D a t a a re e stim a te d fo r 1 9 7 3 a n d fo re c a st for 1974.
|J_Deflated u s in g U S D A in d e x of p ric e s o f all c o m m o d itie s b o u g h t b y fa rm e rs,
in c lu d in g interest, ta xe s, a n d w a g e rates.
|2 D e fla te d u sin g U S D A in d e x o f p ric e s o f all c o m m o d itie s b o u g h t in form fa m ily
m a in e n a n c e . A se v e n p e rc e n t p rice in c re a se is a s s u m e d from 1 9 7 3 to 1974.

Although the forecasted net farm income for 1974
is relatively high when measured in current dollars, it
is only about 18 percent more real income than the
average received during the period 1965-72 inclusive.
Deflated by the 1965 price index of commodities pur
chased for farm family living, the average realized net
income was $14.1 billion per year for the 1965-72
period, compared with the forecasted net for 1974 of
$15.8 billion (midpoint of forecast). Real income per
farm, however, has increased somewhat faster as a
result of the downtrend in the number of farms. Such
income from farming averaged $4,613 in 1965-72, an
estimated $6,329 last year, and is forecasted at $5,601
for this year.
Factors Affecting Farm Product Supply
The supply of farm products for 1974 will tend to
be reduced as a result of the sharply rising prices for
productive resources. As indicated earlier, inflation
has accelerated in recent quarters as a result of gener
ally rising demand and a number of short-run factors

FEDERAL RESERVE BANK OF ST. LOUIS

affecting the food industry; a high rate of general
inflation is forecast for 1974. This rising demand for
final product has been translated into demand for re
sources as producers bid for their use. In addition, the
problem is further exacerbated this year by the oil
embargo of the Middle-Eastern nations which will
tend to reduce the supply of farm resources. Resources
such as labor, fuel, and capital used for the production
of most goods and services are also important farm
resources. Hence, prices that farmers must pay for
many resources are determined by supply and de
mand conditions in all sectors of the economy.
The index of prices paid by farmers for all items
used in production, including interest, taxes, and
wages, was advancing sharply late last year. In De
cember the index was 17 percent above a year earlier,
and a continued uptrend in prices is anticipated this
year for a number of major items, including fuel,
labor, fertilizer, and some other chemicals.
Fertilizer, which accounts for about 5 percent of
total farm production expenses, is likely to rise in
price by about one-third from the 1972 average. The
higher price reflects both reduced supply and higher
demand. Rising production costs and price-wage con
trols have tended to reduce fertilizer production,
while rising prices for farm products plus the lifting
of Government controls on farm production have in
creased fertilizer demand.
Until 1973 fertilizer prices had been relatively
stable for several years as a result of large increases
in manufacturing capacity, especially nitrogen, in the
late 1960s. Returns on investments had been de
pressed, tending to discourage investment in new
capacity, at the time the price-wage controls were
established in 1971. As output approached capacity
levels in 1972, the controlled fertilizer price was not
sufficient to provide incentive for new investments.
The higher prices following removal of the controls
will no doubt result in plant expansion. There is a lag,
however, between the decision to invest in fertilizer
facilities and increased fertilizer output; thus, the cur
rent year’s fertilizer supply will not be enhanced
greatly even with the higher prices.
In addition to abetting the capacity problem, the
controls served to intensify the domestic fertilizer
shortage last fall by providing greater incentive for
producing firms to export their product than to sell to
domestic farmers. World fertilizer prices had risen
30-35 percent above the Government controlled do
mestic prices. Many farmers were thus unable to obtain
the desired amount of fertilizer for fall planted grain

MARCH

1974

which will mean lower wheat production than would
have otherwise occurred. Since the price controls
were removed, American farmers can bid for fertilizer
on the same basis as farmers in other countries.
Further exacerbating the fertilizer supply problem
is the rising cost of natural gas, a major raw material
for making ammonia. North America still has major
reserves of “sour” natural gas which can be used, al
though the processing of such gas is more expensive
than other gas. Also, naphtha, fuel oil, and synthetic
natural gas are higher priced substitutes for natural
gas. In addition to the rising cost of raw materials for
domestic fertilizer manufacturing, which tends to re
tard output, the Middle-Eastern countries are build
ing nitrogen fertilizer plants based on their vast
reserves of low cost “sweet” gas. Such competition
will tend to inhibit further investment in domestic
nitrogen plants, but will alleviate the world fertilizer
supply problem.
Higher energy prices will also increase the cost of
power for agricultural production. In 1972 farm fuel
costs accounted for about 4 percent of total farm
production expenses and about 3 percent of total
gasoline and diesel fuel sales. However, farm pur
chases accounted for 17 and 22 percent, respectively,
of liquid petroleum and propane gas sold. Prices paid
by farmers for motor supplies, largely fuel, were 12
percent higher in mid-February than in mid-No
vember and 26 percent higher than a year earlier.
In the allocation of energy, the Administrator of the
Federal Energy Office has given top priority to agri
culture. He reported that agriculture would be
supplied with 100 percent of its “needs” for gasoline,
propane, butane, and residual fuel oil. “Needs,” how
ever, tend to vary with price; that is, quantity
demanded tends to decline as the price rises and to
increase as the price declines. Agriculture would be
in a more favorable position than the rest of the
economy with respect to energy only if rationing or
some form of a multiple price system is maintained.
Otherwise the farm use of fuel will be determined by
supply and demand conditions in a free market, and
the fuel will be allocated according to the price that
users are willing to pay.
One factor tending to offset the impact of rising
input prices on farm product supply is reduced
Government controls. Under the Agriculture and
Consumer Protection Act of 1973, farmers have ac
quired more freedom to produce. Base acreage allot
ments have been maintained on which a guaranteed
price will be paid. The guaranteed price, however,
Page 15

FEDERAL RESERVE BANK OF ST. LOUIS

MARCH

1974

T ab le IV

Carryover Stocks of Farm Products1
A n n u a l A ve rage
1962/631971/72
Feed g r a in s, mil. short tons

43.1

Percent of
A n n u a l U se

19 7 2 -7 3 *

Percent of
A n n u a l U se

1 9 7 3 -7 4 3

Percent of
A n n u a l U se

2 6 .6

1 2 .2 %

2 4 .0 %

3 2 .4

1 5 .0 %

S o y b e a n s , mil. b u sh e ls

1 16.2

1 2 .4

5 9 .6

4 .6

2 4 0 .0

W h e a t, mil. b ush els

7 7 1 .1

5 4 .4

4 3 8 .0

2 2 .2

1 7 8 .0

9 .0

Rice, mil. cwt.

8.0

9 .8

5.1

5 .7

4 .7

5 .0

U p la n d cotton, mil. 4 8 0 -lb . b a le s

9 .8

7 8 .3

4 .0

3 0 .8

3.8

2 9 .0

1 7 .3

’ Stocks at end o f marketing year. For corn and sorghum the marketing year ended September 30 ; barley and oats, June 30 ; soybeans, August 31 ;
wheat, June 30 ; rice and cotton, July 31.
Prelim inary
3Projected
Source: U.S. Department o f Agriculture, Agricultural Statistics, 1972; Feed Situation (February 1974) ; Fats and Oils Situation (February
1974) ; Wheat Situation (February 1974) ; Rice Situation (September 1973) ; Cotton Situation (February 1974) ; Statistical Handbook
Release (December 31, 1973).

generally has been set well below the current market
price, greatly reducing the taxpayer burden, and pro
gram eligibility does not generally require a reduction
in crops such as a conserving base or set-aside acreage.
With the more liberal planting provisions and the
higher price incentive last year, the number of
harvested acres rose sharply, increasing 10 percent to
312 million, and the forecast is for another increase
of 10 million acres this year.
Factors Affecting Farm Product and
Food Demand
Domestic food demand is expected to continue up
in 1974. Demand for food tends to rise with popula
tion and personal income growth. Population grew
only about 0.8 percent from third quarter 1972 to
third quarter 1973. However, personal income con
tinued sharply upward, rising 10.3 percent from 1972
to 1973; another sizable gain is forecast for 1974. Ris
ing domestic demand for farm products is thus in
prospect.
Demand for farm products for export and for in
ventory buildup may also be up this year. Exports of
farm products are forecast to total $19 billion in the
marketing year 1973-74 — almost 50 percent above the
previous record of last year. Most of the expected in
crease this year stems from higher prices as little
change in volume of exports is anticipated. Exports
jumped 60 percent to a record value of $12.9 billion
in fiscal 1973. Increased volume (mainly grain and
grain products) accounted for more than half of the
gain, and prices accounted for the remainder.
The expected increase in inventory demand is based
on the relatively low level of carryover stocks for most
major crops last year and the sharp increase in prices
Page 16

near the end of the marketing year. The carryover of
soybeans was only 4.6 percent of annual use, just
slightly more than the average quantity crushed dur
ing a two-week period. In contrast, the average carry
over of soybeans from 1963 to 1972 was 12.4 percent
of annual use (Table IV). Carryover stocks of rice,
wheat, feed grains, and cotton in 1973 were also well
below the 1963-72 average and are expected to remain
relatively low in 1974.
During the past two decades, the Government has
held sizable quantities of farm commodity inventories
at the taxpayer’s expense — a method of inventory
holding with which the private sector could not com
pete. Now that the Government has liquidated most
such inventories, there will be greater incentive for
private investors to participate in price-stabilizing op
erations through inventory holding. While private in
ventory holdings will no doubt average less than Gov
ernment holdings during the last two decades, they
will probably exceed the relatively small inventories
carried over last year since most inventory holders
realized sizable profits in 1973.

OUTLOOK FOR MAJOR FARM
PRODUCTS OF THE CENTRAL
MISSISSIPPI VALLEY
Feed Grains
Total feed grain supplies for the nation in the cur
rent marketing year4 are estimated at 237.8 million
tons, or 4 percent less than a year ago. The 1973 crop
was somewhat larger than a year earlier, but carryover
stocks last year were down. Domestic use of feed
4Year beginning luly 1, 1973 for barley and oats and Octo
ber 1, 1973 for com and sorghum.

FEDERAL RESERVE BANK OF ST. LOUIS

grain in the current marketing year is expected to be
down slightly from a year ago (171 vs. 173 million
tons), reflecting reduced feeding last fall and some
decline in the volume of exports. Stocks at the close
of the year are forecast at 27 million tons, down 18
percent from a year earlier. Production in 1974 is
projected at 235 million tons, 13 percent more than in
1973.
Feed grain prices in the first half of 1974 are ex
pected to average well above the level of a year ago.
Reduced supplies will tend to keep prices high until
about mid-year. As the larger Southern Hemisphere
crops move into world markets this spring, and as our
own crops approach maturity in the summer, prices
are likely to trend downward, and by next fall they
may average below current levels.
Wheat
Wheat supplies for the current marketing year end
ing June 30, 1974, are estimated at 2,150 million bush
els, down 11 percent from the 2,409 million bushels of
a year ago. Production of 1,711 million bushels in 1973
was up about 10 percent from a year earlier, but last
year’s carryover of 438 million bushels was only about
50 percent of the year-earlier level and 40 percent of
the 1963-72 average.
The forecast of wheat usage in the current year of
1,972 million bushels is the same as in 1972-73. Closing
inventories may be down 50 percent or more from the
relatively low carryover last year. Domestic use of
wheat may be down to about 772 million bushels this
year from 787 million a year ago, largely reflecting a
reduction in the use of wheat for livestock feed. Ex
ports are expected to total 1,200 million bushels, up
about 1 percent from a year ago and about double the
average annual commercial exports for the decade
1962-1972. Larger wheat supplies are in prospect for
1974-75. Total production may exceed 2 billion bush
els which, coupled with some decline in exports,
would result in a sizable increase in carryover stocks
next year.
Rice
Despite some increase in production last fall, rice
will remain in relatively short supply this year. Carry
over last July 31 was down to 5.1 million cwt., less
than half the 1965-71 average; carryover this year is
forecast at 4.7 million cwt., the lowest since 1952.
Rice production last year totaled 92.8 million cwt., up
9 percent from a year earlier. Exports this year are
projected at 55.4 million cwt., slightly above last
year’s level, and domestic use for food and brewing is

MARCH

1974

expected to continue upward. Total use is projected
at 93.7 million cwt., slightly in excess of production
last year.
The mid-August 1973 farm price of $10.70 per cwt.
for rice was almost double that of a year earlier. For
the marketing year ending July 31, 1974, the price is
expected to average about double the loan rate of
$6.07 per cwt. The national rice acreage allotment
was reduced for 1974, but marketing quotas were lifted
and there are no controls on the acreage that can be
planted.
Soybeans
Soybean production in 1973 rose 23 percent in re
sponse to higher prices, yet supplies remain relatively
“tight” and the average price of $5.50 per bushel dur
ing the harvest season was more than double that of a
year earlier. The total supply of 1,626 million bushels
this year is a record high, 21 percent above the supply
last year. Usage is expected to increase about 100
million bushels, but with last year’s higher production,
carryover on August 31 may rise to 240 million bush
els, up from 60 million last year. Both domestic crushings and exports are expected to rise somewhat, but
not sufficiently to prevent a sharp buildup of stocks.
In contrast to the sharp increase in the price of
soybeans to more than $10 per bushel following har
vesting in 1972, soybean prices may be at a peak this
winter. Nevertheless, prices during the 1973-74 mar
keting year are expected to average about $5.65 per
bushel. The lower soybean-corn price ratio this year
is likely to cause farmers to shift from soybeans to
com since the two crops are often competitors for the
same land. Hence, acreage p lan ted to soybeans may
be down from the 57 million acres a year ago.
Cotton
The supply of upland cotton, totaling 17 million
bales, is slightly above the 16.8 million bales of a year
ago, reflecting somewhat larger beginning stocks. As
a result of excessive rainfall and floods in the Missis
sippi delta areas, production in 1973 was down to 13
million bales from 13.6 million a year earlier. Mill
consumption is expected to decline to 7.4 million bales
from 7.7 million a year ago, but exports may rise to
5.7 million bales from 5.3 million. Total cotton usage,
domestic plus exports, is estimated at 13.1 million
bales, which would be slightly above that of 1972-73.
Carryover stocks at the close of the current year are
forecast to be down slightly from the 4 million bales
last year.
Page 17

FEDERAL RESERVE BANK OF ST. LOUIS

The guaranteed target price for the 1974 cotton crop
is 38 oents per pound, while the current market price
of 60-65 cents per pound is more than double that of a
year ago. Given this price incentive and no set-aside
or conserving base requirement, larger plantings are
anticipated. Forecasts indicate an 18 percent acreage
increase.
Tobacco
The tobacco crop was a little larger last year than
in 1972, but tobacco consumption is up and carryover
stocks at the end of the year are expected to decline.
The supply of both flue-cured and burley tobacco is
down somewhat from the 1972-73 level and usage of
both has been slowly increasing.
Sizable amounts of tobacco still remain under Gov
ernment loans, and Government price supports for
the crop are mandatory. The support price, which
usually determines the price to farmers, will go up
8 to 9 percent for the 1974 crop. Furthermore, the
national marketing quota may be increased for burley
tobacco.
B eef Cattle
The 1974 forecast for fed beef cattle is for some
what higher prices and a smaller volume of marketing
in the first quarter followed by a rising volume of
marketings and declining prices about mid-year. This
outlook is based largely on the cattle inventory which
has moved upward since 1967 and accelerated in re
cent years. On January 1, 1974, there were 127.5 mil
lion cattle and calves on farms, 5 percent more than
a year earlier. With a 5 percent larger beef calf crop,
and a 7 percent increase in steers weighing 500
pounds and over, inventory growth of feeder cattle
has increased from the relatively high rate of inven
tory growth in 1973.
Despite the rising inventory of feeder cattle, the
number on feed in 23 major feeding states on January
1 was 6 percent less than a year earlier. There was 55
percent more cattle than a year earlier in the 1,100
pound-and-over weight group and 11 percent more in
the 900 to 1,099 pound group. However, there were
fewer cattle than a year ago in the lighter weight
groups, and fed cattle marketings this winter are ex
pected to be down slightly from last winter.
Larger numbers of heavier animals are expected to
be placed on feed in early 1974. These feeders will
reach market weight more quickly than usual, result
ing in larger beef supplies by summer. Some increase
is also forecast for cow slaughter this year.
Page 18

MARCH

1974

Hogs
Hog slaughter in the first half of 1974 is forecast to
lag year-ago levels. However, this winter, with the
high price incentive and the larger feed supplies,
farmers are expected to increase their brood sows
and their March-May farrowings. This should result
in some increased slaughter next fall.
Hog prices will be heavily influenced by beef sup
plies and prices. Consequently, the smaller winter
production forecast for beef and pork should result in
higher hog prices, but they may not rise seasonally
in the spring if beef supplies increase as anticipated.
With rising supplies of both pork and beef in the
second half of the year, pork prices will likely decline.
A recent U.S. Department of Agriculture report on
hogs and pigs indicates a higher rate of slaughter in
the first half of 1974 than was anticipated at the De
cember Outlook sessions. This report shows that for
every weight group the number of market hogs and
pigs on farms as of December 1, 1973, was greater
than a year earlier. If the higher rate of slaughter is
achieved, hog prices this winter and spring could be
lower than was anticipated in the earlier outlook
reports.
Poultry and Eggs
Poultry and egg production is expected to be up in
1974 after lagging year-earlier levels in 1973. Broiler
production is expected to expand moderately and
turkey production is projected to run well ahead of
the year-ago levels. Egg production is expected to
expand very rapidly in the early spring as a result of
a 14 percent increase in the number of pullets avail
able for flock replacement.
Weekly broiler chick placements for December 1973
marketing were up slightly from a year earlier, and
the placements for early 1974 marketing were down
about 4 percent. However, the hatchery supply flook
is growing and may exceed the 1973 flock by spring.
This larger broiler supply base, coupled with higher
red meat prices in prospect for this winter, is expected
to encourage broiler output since broilers are a sub
stitute for red meat. Turkey poults for marketing in
early 1974 were 13 percent above the year-ago level.
Turkey eggs in incubators, from which the poults will
be hatched for marketing in the second half of 1974,
were 8 percent more on November 1 than a year
earlier.
Both broiler and turkey prices are forecast to in
crease during the early months of this year, but then

FEDERAL RESERVE BANK OF ST. LOUIS

lag 1973 prices in the remaining months. Egg prices
are expected to decline seasonally this winter and
spring and to be less than year-earlier levels by
mid-year.
Dairy Products
Milk production is expected to decline slightly again
this year following a 3 percent reduction last year.
Production, estimated at 116.8 billion pounds for 1973,
was about the same as two decades ago. The number
of milk cows and heifers on farms has declined almost
50 percent since 1950, but rising production per cow
prior to last year about offset the reduction in cow
numbers. Cow numbers continued down last year, but
for the first time in almost 30 years production per
cow declined, reflecting unfavorable milk-feed price
relationships.
Most of the decline in milk production this year is
expected to occur by mid-year. The milk-feed price
ratio should improve during the year and provide
greater incentive for feeding and production in the
second half of the year. Dairy supplies have in recent
years been augmented by rising imports, which ac
counted for about 2 percent of domestic consumption
last year.
Farm milk prices last year averaged about $1 per
hundred pounds over the 1972 level of $6.07. In the
first quarter of 1974, milk prices continued to show
strong gains over year-earlier levels; however, they
may tend to stabilize after mid-year.

SUMMARY
The nation’s farmers in 1974 are expected to in
crease their output and receive somewhat higher aver
age prices for their products than a year ago. Farm
production costs will rise sharply, however, and direct
Government payments to farmers will be down.

MARCH

1974

Hence, net farm income will likely decline from the
record $26.1 billion estimated for last year.
Food output and prices are adjusting to longer-term
trends following a decline in output and sharply
higher prices last year. Food output this year is ex
pected to recover from most of the 1973 decline. How
ever, most of the gain will come in the second half of
the year.
Food prices are up again in the first quarter of the
year, but with rising farm output later in the year,
they are expected to stabilize. Declining farm com
modity prices will then tend to offset rising food
processing and marketing costs.
While food costs may appear to be high to most
consumers, such costs as a percent of disposable per
sonal income have remained relatively stable since
1972. The cost of food used at home has remained at
12.3 percent of disposable personal income for two
years and is down from 16.2 percent in 1960.
Rising prices for resources used in farm production
are tending to shift the supply schedule for farm
products to the left; that is, reduce output at any
given price level. Reflecting rising general demand
for resources, and in some cases reduced supplies,
major price increases are in prospect for a number of
critical farm inputs such as labor, fertilizer, and fuel.
Government crop production controls, however, are
being eased which tends to inorease the supply of
farm products and to offset the output effects of the
higher priced farm resources.
Demand for farm products continues to rise at a
rapid rate, reflecting a small increase in population
and large increases in personal income and export
demand. Thus, despite the supply response this year
to the sharply higher food prices, only moderate
downward adjustments in farm commodity prices are
likely after the mid-year peak.

Page 19

Letter on Monetary Policy
To SENATOR WILLIAM PROXMIRE
From PROFESSOR MILTON FRIEDMAN
Senator Proxmire, Wisconsin, is Vice Chairman of the Joint Economic Committee of
Congress. Professor Friedman is the Paul Snowden Russell Distinguished Service Professor of
Economics at the University of Chicago, and has served for a number of years as an Academic
Consultant to the Board of Governors of the Federal Reserve System. Recently, Professor
Friedman has been named by the Board of Governors as a member of a “Committee on
Monetary and Credit Statistics.”
The Honorable William Proxmire
Joint Economic Committee
United States Senate
Washington, D.C. 20510
D

ear

Se n a t o r P r o x m ir e :

On September 17, 1973, you asked the Chairman of
the Board of Governors of the Federal Reserve System
to comment on certain published criticisms of mone
tary policy. On November 6, 1973, the Chairman re
plied on behalf of the System. This Reply has been
widely publicized by the Federal Reserve System. It
was reprinted in the Federal Reserve Bulletin (N o
vember 1973) and in at least five of the separate
Federal Reserve Bank Reviews.
The Reply makes many valid points. Yet, taken as
a whole, it evades rather than answers the criticisms.
It appears to exonerate the Federal Reserve System
from any appreciable responsibility for the current
inflation, yet a close reading reveals that it does not
do so, and other evidence, to which the Reply does
not refer, establishes a strong case that the Fed has
contributed to inflation. The Reply appears to attri
bute admitted errors in monetary policy to forces out
side the Fed, yet the difficulties in controlling and
measuring the money supply are largely of the Fed’s
own making.
The essence of the System’s answer to the criticisms
is contained in three sentences, one dealing with the
Fed’s responsibility for the 1973 inflation; the other
two, with the problem of controlling and measuring
the money supply. I shall discuss each in turn.

RESPONSIBILITY FOR INFLATION
The severe rate of inflation that we have ex
perienced in 1973 cannot responsibly be attri
buted to monetary management (italics added).
As written, this sentence is unexceptionable. Delete
the word “severe,” and the sentence is indefensible.
Page 20

The Reply correctly cites a number of special fac
tors that made the inflation in 1973 more severe than
could have been expected from prior monetary growth
alone —the world-wide economic boom, ecological
impediments to investment, escalating farm prices,
energy shortages. These factors may well explain why
consumer prices rose by 8 percent in 1973 (fourth
quarter 1972 to fourth quarter 1973) instead of, say,
by 6 percent. But they do not explain why inflation in
1973 would have been as high as 6 percent in their
absence. They do not explain why consumer prices
rose more than 25 percent in the five years from 1968
to 1973.
The Reply recognizes that “the effects of stabiliza
tion policies occur gradually over time” and that “it
is never safe to rely on just one concept of money.”
Yet, the Reply presents statistical data on the growth
of money or income or prices for only 1972 and 1973,
and for only one of the three monetary concepts it
refers to, namely, Mi (currency plus demand de
posits), the one that had the lowest rate of growth.
On the basis of the evidence in the Reply, there is
no way to evaluate the longer-term policies of the
Fed, or to compare current monetary policy with
earlier policy, or one concept of money with another.
From calendar year 1970 to calendar year 1973, Mi
grew at the annual rate of 6.9 percent; in the preced
ing decade, from 1960 to 1970, at 4.2 percent. More
striking yet, the rate of growth from 1970 to 1973 was
higher than for any other three-year period since the
end of World War II.
The other monetary concepts tell the same story.
From 1970 to 1973, M2 (M x plus commercial bank
time deposits other than large CDs) grew at the an
nual rate of 10.5 percent; from 1960 to 1970, at 6.7
percent. From 1970 to 1973, M3 (M 2 plus deposits at
nonbank thrift institutions) grew at the annual rate of
12.0 percent; from 1960 to 1970, at 7.2 percent. For
both M2 and M3, the rates of growth from 1970 to

FEDERAL RESERVE BANK OF ST. LOUIS

MARCH 1974

1973 are higher than for any other three-year period
since World War II.
As the accompanying chart demonstrates, prices
show the same pattern as monetary growth except for
the Korean War inflation. In the early 1960s, consumer
prices rose at a rate of 1 to 2 percent per year; from
1970 to 1973, at an average rate of 4.6 percent; cur
rently, they are rising at a rate of not far from 10
percent. The accelerated rise in the quantity of money
has clearly been reflected, after some delay, in a simi
lar accelerated rise in prices.
M o v e m e n t s in M o n e y a n d Prices
1 *41 -

1973

States and many other countries reveal highly con
sistent patterns. A substantial change in the rate of
monetary growth which is sustained for more than a
few months tends to be followed some six or nine
months later by a change in the same direction in the
rate of growth of total dollar spending. To begin with,
most of the change in spending is reflected in output
and employment. Typically, though not always, it
takes another year to 18 months before the change in
monetary growth is reflected in prices. On the aver
age, therefore, it takes something like two years for a
higher or lower rate of monetary growth to be re
flected in a higher or lower rate of inflation.
Table I illustrates this relation between monetary
growth and prices. It shows rates of change for three
monetary aggregates and for consumer prices over
two-year spans measured from the first quarter of the
corresponding years. The average delay in the effect
of monetary change on prices is allowed for by match
ing each biennium for prices with the prior biennium
for money. Clearly, on the average, prices reflect the
behavior of money two years earlier.
T a b le I

M oney and Prices
( A n n u a l Rates o f C h a n g e , First Q tr. to First Q tr.)
M o n e t a r y M e a su re s
Mi
M2
M3

LL Defined a s money stock plus savings deposits, time deposits open account, and time certificates
other than n e g o t ia b le C D s of $100,000 of large weekly reporting banks.
[3 Defined as (1) dem and deposits of commercial banks other thon domestic interbank ond U.S.
Government, less cosh items in process of collection and F.R. float; (2) foreign demand balances at
F.R. Banks,- and (3| currency outside the Treasury. F.R. Banks, and vaults of commercial banks.
[3 Consumer Price Index, All Items.
Latest data plotted: 4th quarter, 1973
___________ _______________________________________________________________________________________________________

However limited may be the Fed’s ability to con
trol monetary aggregates from quarter to quarter or
even year to year, the monetary acceleration depicted
in the chart, which extended over more than a decade,
could not have occurred without the Fed’s acquies
cence —to put it mildly. And however loose may be
the year-to-year relation between monetary growth
and inflation, the acceleration in the rate of inflation
over the past decade could not have occurred without
the prior monetary acceleration.
Whatever therefore may be the verdict on the shortrun relations to which the Reply restricts itself, the
Fed’s long-run policies have played a major role in
producing our present inflation.
There is much evidence on the shorter-term as well
as the longer-term relations. Studies for the United

C o n su m e r
Prices

1 9 5 9 -6 1

0 .8 %

2 .5 %

4 .6 %

1 .1 %

1 9 6 1 -6 3

2 .4

5 .9

7 .6

1.3

19 6 3 -6 5

1 9 6 3 -6 5

4.1

6 .9

8.3

2 .7

1 9 6 5 -6 7

3 .7

7 .2

6 .7

4.2

19 6 7 -6 9

1 9 6 7 -6 9

7 .3

9 .4

8.8

5 .5

1 9 6 9 -7 1

4 .8

6.3

3 .9

1 9 7 1 -7 3

7 .2

1 0 .4

1 2 .6

9.1 *

1973-

♦First quarter 1973 to fourth quarter 1973.

To avoid misunderstanding, let me stress that, as
the table illustrates, this is an average relationship, not
a precise relationship that can be expected to hold in
exactly the same way in every month or year or even
decade. As the Reply properly stresses, many factors
affect the course of prices other than changes in the
quantity of money. Over short periods, they may
sometimes be more important. But the Federal Re
serve, and the Federal Reserve alone, has the re
sponsibility for the quantity of money; it does not
have the responsibility, and certainly not sole respon
sibility, for the other factors that affect inflation. And
the record is unmistakably clear that, over the past
three years taken as a whole, the Federal Reserve
System has exercised that responsibility in a way that
has exacerbated inflation.
Page 21

FEDERAL RESERVE BANK OF ST. LOUIS

This conclusion holds not only for the three years
as a whole but also for each year separately, as Table
II shows. The one encouraging feature is the slightly
lower rate of growth of M2 and M3 from 1972 to 1973
than in the earlier two years. But the tapering off is
mild and it is not dear that it is continuing. More
important, even these lower rates are far too high.
Steady growth of M2 at 9 or 10 percent would lead to
an inflation of about 6 or 7 percent per year. To bring
inflation down to 3 percent, let alone to zero, the rate
of growth of M2 must be reduced to something like
5 to 7 percent.

CONTROLLING AND MEASURING
THE MONEY SUPPLY
The conduct of monetary policy could be im
proved if steps were taken to increase the preci
sion with which the money supply can be con
trolled by the Federal Reserve. Part of the
present control problem stems from statistical
inadequacies (italics added).
Again these sentences from the Reply are literally
correct, but they give not the slightest indication that
the difficulties of controlling and measuring the
money supply are predominantly of the Fed’s own
making. The only specific problems that the Reply
mentions are the “paucity of data on deposits at non
member banks” and the fact that “nonmember banks
are not subject to the same reserve requirements as
are Federal Reserve members.”
Nonmember deposits do raise problems in measur
ing and controlling the money supply, but they are
minor compared to other factors. The Reply’s em
phasis on them is understandable on other grounds.
Almost since it was established in 1914, the Fed has
been anxious to bring all commercial banks into the
System, and has been worried about the defection of
banks from member to nonmember status. It has
therefore seized every ocoasion, such as the Reply
provides, to stress the desirability of requiring all
banks to be members of the System, or at least subject
to the same reserve requirements as member banks.
Control
Nonmember banks raise a minor problem with re
spect to control. Their reserve ratios do differ from
those of member banks. But nonmember banks hold
only one-quarter of all deposits. This fraction tends to
change rather predictably, and changes in it can be
monitored and offset by open market operations.
Page 22

MARCH 1974

T a b le II

Recent M onetary Growth Rates
(Percent C h a n g e , A n n u a l D a ta )

1970-71
1971-72
1972-73

7.0%
6.4
7.4

1 1 . 8%
10.2

1 2 . 8%

9.5

12.5
1 0.7

A far more important problem with respect to con
trol is the lagged reserve requirement that was intro
duced by the Fed in 1968. This change has not
worked as it was expected to. Instead, by introducing
additional delay between Federal Reserve open mar
ket operations and the money supply, it has appreci
ably reduced “the precision with which the money
supply can be controlled by the Federal Reserve.”
Other measures taken by the Fed have had the same
effect. In an article on this subject published recently,
George Kaufman, long an economist with the Federal
Reserve System, concluded, “by increasing the com
plexity of the money multiplier, proliferating rate
ceilings on different types of deposits, and encourag
ing banks, albeit unintentionally, to search out non
deposit sources of funds, the Federal Reserve has
increased its own difficulty in controlling the stock of
money. . . . To the extent the increased difficulty
supports the long voiced contention of some Federal
Reserve officials that they are unable to control the
stock of money even if they so wished, the actions
truly represent a self-fulfilling prophecy.”
Even more basic is the procedure used by the Open
Market Desk of the New York Federal Reserve Bank
in carrying out the directives of the Open Market
Committee. These directives have increasingly been
stated in terms of desired changes in monetary aggre
gates rather than in money market conditions. How
ever, the Desk has not adapted its procedure to the
new objective. Instead, it tries to use money market
conditions (that is, interest rates) as an indirect de
vice to control monetary aggregates. Many students
of the subject believe that this technique is inefficient.
Money market conditions are affected by many forces
other than the Fed’s operations. As a result, the Desk
cannot control money market conditions very accur
ately and cannot predict accurately what changes in
money market conditions are required to produce the
desired change in monetary aggregates.
An alternative procedure would be to operate di
rectly on high-powered money, which the Fed can
control to a high degree of precision. Many of us
believe that the changes in high-powered money re
quired to produce the desired change in monetary

FEDERAL RESERVE BANK OF ST. LOUIS

aggregates can be estimated tolerably closely, even
now. They could be estimated with still greater preci
sion if the Fed were to rationalize the structure of
reserve requirements.
Measurement
Repeatedly, in the past few years, the Fed’s statisti
cians have retrospectively revised estimates of mone
tary aggregates, and sometimes, as in December 1972,
by very substantial amounts.
The one source of measurement error mentioned in
the Reply is the unavailability of data on nonmember
banks. This is a source of error because nonmember
banks report deposit data on only two, or sometimes
four, dates a year. The resulting error in estimates for
intervening or subsequent dates has sometimes been
sizable, but mostly it has accounted for a minor
part of the statistical revisions. In any event, this
source of error can be reduced drastically by samp
ling and other devices which the Fed could under
take on its own without additional legislation.
More important sources of error are seasonal ad
justment procedures and the estimation and treatment
of cash items, nondeposit liabilities, and foreign held
deposits.
It has long seemed to me little short of scandalous
that the money supply figures should require such
substantial and frequent revision. The Fed is itself the
primary source of data required to measure the money
supply; it can get additional data it may need; it has
a large and highly qualified research staff. Yet for
years it has failed to undertake the research effort
necessary to correct known defects in its money sup
ply series.1

CONCLUSION
For more than a decade, monetary growth has been
accelerating. It has been higher in the past three years
'On January 31, 1974, after this comment had been drafted,
the Board of Governors of the Federal Reserve System an
nounced “the formation of a special committee of prominent
academic experts to review concepts, procedures and metho
dology involved in estimating the money supply and other
monetary aggregates.” I have agreed to serve as a member
of this committee.

MARCH 1974

than in any other three-year period since the end of
World War II. Inflation has also accelerated over the
past decade. It too has been higher in the past three
years than in any other three-year period since 1947.
Economic theory and empirical evidence combine to
establish a strong presumption that the acceleration in
monetary growth is largely responsible for the accel
eration in inflation. Nothing in the Reply of the Chair
man of the Federal Reserve System to your letter
contradicts or even questions that conclusion. And
nothing in that Reply denies that the Federal Reserve
System had the power to prevent the sharp accelera
tion in monetary growth.
I recognize, of course, that there are now, and have
been in the past, strong political pressures on the Fed
to continue rapid monetary growth. Once inflation has
proceeded as far as it already has, it will, as the
Reply says, take some time to eliminate it. More
over, there is literally no way to end inflation that will
not involve a temporary, though perhaps fairly pro
tracted, period of low economic growth and relatively
high unemployment. Avoidance of the earlier exces
sive monetary growth would have had far less costly
consequences for the community than cutting mone
tary growth down to an appropriate level will now
have. But the damage has been done. The longer we
wait, the harder it will be. And there is no other way
to stop inflation.
The only justification for the Fed’s vaunted inde
pendence is to enable it to take measures that are
wise for the long run even if not popular in the short
run. That is why it is so discouraging to have the Re
ply consist almost entirely of a denial of responsibility
for inflation and an attempt to place the blame
elsewhere.
If the Fed does not explain to the public the nature
of our problem and the costs involved in ending infla
tion; if it does not take the lead in imposing the tem
porarily unpopular measures required, who will?
Sincerely yours,

il t o n

F r ie d m a n

Professor of Economics

Page 23

Full text of Review (Federal Reserve Bank of St. Louis) : March 1974

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