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For Release on Delivery
Wednesday, August 23, 1967
6:00 P.M., P.D.T.
9:00 P.M., E.D.T.

Implications of Price and Wage Trends for National
Stabilization Policies

Remarks By
Andrew F. Brimmer
Board of Governors of the
Federal Reserve System
at the
1967 Session of the
Pacific Coast Banking School
at The University of Washington, Seattle
Seattle, Washington

August 23, 1967

Implications of Price and Wage Trends for National
Stabilization Policies

The central question confronting monetary policy today is the future
course of fiscal policy.

If the revenue and expenditure program which

the President recently recommended to Congress is enacted in a timely
fashion, it would undoubtedly result in a better mix of public policies
conducive to achieving and maintaining stable economic growth without

Through reducing the size of the Federal deficit, it would

lessen the Government's need to borrow.

It would thus simultaneously

ease pressures on the capital market and interest rates, some of which
are essentially back to the historic levels reached in 1966 -- despite
the liberal provision of bank reserves this year.
In recommending the enactment of a 10 per cent surtax on personal
and corporate incomes, the President stressed fotar urgent objectives:

The reduction in the deficit in the Federal Government's
budget, which under the impact of Vietnam spending may
exceed $25 billion in fiscal 1968 without the tax increase.
The lessening of capital market congestion and pressure on
interest rates.
The avoidance of renewed inflation and the maintenance of
balanced economic growth, and
Improvement in our balance of international payments.


These objectives are obviously of vital concern to the Federal
Reserve System -- and particularly the last three which fall directly in
the area of the central banks1 traditional responsibility.

In fact, all

seven members of the Federal Reserve Board joined in a public statement
endorsing the proposed surtax when it was announced on August 3. As the
Congress proceeds with its examination of the President's proposal, I am
certain the Board will have an opportunity to present its views both
officially and comprehensively.
In the meantime, I would like to explore two aspects of the case
for enactment of the surtax:

the need to avoid renewed domestic inflation

and the need to make further progress in our balance of payments. My
theme can be summarized quite briefly:

The slowdown in economic growth associated with the inventory
adjustment earlier this year is about over. The pace of
activity is again quickening, and left unrestrained private
spending would combine with Government expenditures (especially
for the Vietnam war) to generate another round of excess demand
for goods and services.
Inflationary pressures, which lessened appreciably in the first
half of this year, are again stirring as expanding demand
provides an environment hospitable to price increases.
Because of the sharp increase in labor cost in relation to
output in the last year, some price rises probably cannot be
avoided during the rest of 1967.
However, this is by no means true for 1968. While profit
margins have shrunk this year, they still remain high by
historical standards. Consequently, we as a nation should not
tolerate a spiral of price increases on into next year aimed at
restoring profit margins to the record level established in
early 1966.



We also need a viable means of moderating the rise in
wages and other forms of labor compensation. While we
can understand the frustrations of wage earners whose
real incomes have been shaved by the substantial increases
in the cost of living in the last few years, we should not
permit such sympathy to divert our attention from the
fact that excessive wage increases are also inflationary.

Domestic price stability is a crucial ingredient in our
long-run efforts to expand our trade surplus as the
principal means of erasing the deficit in our balance of
payments. However, in the last two years, prices in the
United States seem to have advanced more than prices in
most other industrial countries. Renewed inflation in the
U.S. would further worsen our international competitive
position and would make it even more difficult to improve
our balance of payments.

While the dampening effect of the proposed surtax on
inflationary pressures cannot be estimated with any
precision, a rough calculation suggests that it would have
a significant impact on the general price level.

Quickening of Economic Activity
Almost daily, another set of statistical indicators brings
additional confirmation of the quickening pace of economic activity.


naturally must refrain from attempting to forecast the future course
of the economy.

On the other hand, I cannot avoid concluding from the

unfolding evidence that the forces which retarded the economy earlier
this year are now giving way to the forces of renewed expansion.


the earliest stage of production to the counters of final demand, moreand-more indicators point toward a vigorous advance -- while virtually
none suggest continued sluggishness.
Manufacturers1 new orders for durable goods, a fairly reliable
indicator of future production activity, rose further in June, with the
gain centering in the durable goods sector.
goods have recovered

over half

In fact, orders for hard

of the earlier decline (which was

about 13 per cent) from the peak set last September.
Unfilled orders registered a further modest gain in June
and July.

Industrial production advanced by 1 percentage point in July,

after declining during five of the preceding six months.

The civilian

labor force (which increased rather slowly for several months) has
regained its momentum, rising by 250,000 in July. Nevertheless, nonfarm
employment climbed by 200,000 in July, lifting the employment level by
almost a half million workers above its recent low point in May. Also in


July, the unemployment rate drifted downward to 3.9 per cent. While
employers still seem interested in restricting over-time, the average
number of hours worked at straight-time in manufacturing did rise
moderately in July.
With quickening activity, personal income rose by $4.5 billion in
July, following a rise of $4.4 billion in June.

At a seasonally adjusted

annual rate of $627 billion, personal income is running 7 per cent above
its year-ago level.

Through the second quarter of this year, after-tax

personal income had gained almost 7% per cent compared with the level in
the same quarter of 1966.

Sustained by the strong advances in disposable

income, consumer expenditures have also been expanding briskly, registering
a gain of 2 per cent in June.

In the durable goods sector, sales of

domestically-produced automobiles in July were maintained at the annual
rate of 8.4 million units to which they had risen in June.

Sales of soft

goods also accelerated in June to reach a new peak and were maintained

in July.

With the steady growth of employment, additional wage

increases in the private sector and a projected pay raise for Federal
employees and military personnel, expanding consumer expenditures seem
almost certain to provide a strong underpinning for further growth in
economic activity during the balance of this year.

Such outlays may well

receive an additional boost if the exceptionally high savings rate

continues to decline (from 7.3 per cent in the first quarter and 6.7
per cent in the second) toward the more normal level of just under
6 per cent which it averaged in 1965-66.
While the foregoing indications are clear signs of revival in
economic activity, the most striking evidence is found in the pace of
the inventory adjustment.

In the fourth quarter of last year, nonfarm

business inventories were being accumulated at an annual rate of $18.5

By the first quarter, the rate had declined to $7.1 billion,

and it dropped further to only $0.5 billion in the second quarter.


from adding $18 billion at an annual rate to the demand for output in the
closing months of last year -- as inflationary expectations induced
businessmen to rush to add to their stocks — nonfarm inventories swung
around drastically to the position of subtracting roughly the same amount
from output six months later.

Because of this serious drag on activity,

GNP rose by only $13 billion, or 1.7 per cent, during the first half of
this year.

Sales to final users, however, climbed by $31 billion, or

4 per cent, in the same period.

Because of this rapid pace of inventory

adjustment, many businessmen may have brought their stocks fairly well
into line with sales -- although some further reduction in the rate of
inventory investment may occur over the next few months.


even if the growth of final sales were simply to hold to the average increase

of $15 billion per quarter registered so far this year, it seems
obvious that the economy has passed successfully through the period
of inventory adjustment and is now headed into a period of strong
Construction activity also appears to be adding strength to the
quickening pace of business.

In the second quarter, residential

construction expenditures were $2.2 billion(or 10.5 per cent) higher
than in the fourth quarter of last year when the recent low was reached.

A further
advance in spending for private dwellings accounted for part of the
estimated increase in total construction expenditures.

While housing

starts edged down somewhat in June, they rose sharply in July to an annual rate
close to
/1.4 million units. The present quarter still seems likely to register
further increases —

reflecting the continued moderate uptrend in building

permits, the unusually low current level of vacancies, and the build-up
in mortgage commitments outstanding.
With the turnaround in industrial production last month and prospects
for additional gains in the months ahead, the downtrend in the rate of
capacity utilization in manufacturing/ to have ceased.
from 91 per cent last August to 84 per cent in July.

This rate fell

Only in a few

industries (particularly aircraft and electrical generating equipment)
does pressure on capacity continue to be felt.

In most industries

capacity is continuing to grow at a rapid pace, despite
low rate of utilization.

the relatively

Furthermore, partly reflecting the restoration

of the investment tax credit, the outlook for business fixed investment
appears to be brightening.

In recent months, new orders for machinery

have advanced steadily, and order backlogs have risen. Moreover in
July both output and employment in machinery industries turned up.
To me, all of the above indicators suggest strongly that the most
likely course of economic activity in the months ahead is one of growing
strength — and not accumulating weakness.

The Mosiac of Price Developments
In this environment of improving economic conditions, price increases
are becoming more-and-more wide-spread. While these increases do not by
any means add up to a new outbreak of inflation, the current stirrings
on the price front are unmistakable harbingers of the pressures that can
develop as aggregate demand expands more vigorously.
cumulative impact of particular —

Moreover, the

though increasingly numerous — price

advances may be the stimulation of an inflationary psychology which would
feed on itself and help to trigger a genuine bout of inflation.

Industrial wholesale prices; One of the striking developments
over the last year has been the marked slowing of the rise in the BLS
wholesale price index for industrial commodities, which is generally
more sensitive to business conditions than other price indexes. In
June, this index was 1 per cent above June, 1966, and in mid-July it
was up less than 1 per cent from a year earlier. In contrast, from
mid-1965 to mid-1966, it had increased about 2.5 per cent; and during a
nine-month period in late 1965 and early 1966, it had increased at an
annual rate of 3 per cent.
Moreover, the rise over the last year in average industrial prices
had occurred by last February. From February through early July, the BLS
index was stable.
The shift to a much smaller advance over the last year — and
stability this spring and early summer — reflected in large part the
reversal of the earlier sharp climb in prices of sensitive industrial
materials (including nonferrous metals, hides, and lumber) which
had begun in 1964 and continued to mid-1966. The sharp drop in prices
for most of these materials over the last year can be traced in some cases
to marked improvement in domestic and world supplies; slackening in demands
abroad as a result of slower economic activity in major European countries,
and slackening housing and consumer and business demands at home. Price

increases for other non-sensitive materials have also slowed since
mid-1966, and particularly since early 1967. Moreover — although
producers1 equipment prices increased more (3.2 per cent) from mid-1966
to mid-1967 than over the preceding twelve-month period (2.4 per cent),
these prices were accelerating during 1966 when they increased at the
rate of 4-5 per cent a year. Since the end of 1966, when business fixed
investment demands eased noticeably, equipment prices have increased at
an annual rate of only 2 per cent. Wholesale prices of finished consumer
goods (other than food) increased as much from mid-1966 to mid-1967 as
over the preceding year, but (as in the case of producers1 equipment) the
rate of increase has been slower in recent months.
Outlook for industrial prices:

The slowing of the rise in wholesale

prices of industrial commodities from mid-1966 to mid-1967, and particularly
during the first half of this year, has been predominantly a demand
phenomenon. Of course, as noted above, the drop in sensitive industrial
materials was partly a supply development, and lower prices of these
basic industrial materials have represented a reduction in materials cost
for fabricators. In general, however, cost pressures have remained strong,
and profit margins have been under pressure.
It appears likely that average industrial (wholesale) prices are now
starting to increase again, partly because of continuing pressures from rising
unit labor costs supplemented by the first significant boost in transportation/

/seven years. Since early July, substantial price advances have been
effected for tires and other rubber products following the large wage
settlement which ended a 3-month strike. Growing strength in housing
has been accompanied by a wide array of price increases -- for lumber,
plywood, flat glass, gypsum products, and hardware and heating equipment.
Uncertainty over the course of the current strike has brought some
recovery in secondary copper and copper products, despite a still generally
ample supply situation. The current copper strike (as the rubber strike)
is acting to work off excessive stocks and — depending on the size of the
wage settlement (which may be large) and on continuing increase in domestic
demands — an increase in the domestic producer price of refined copper
may be in the offing.
Metals demand — and prices -- generally were affected by the easing
off in business equipment and consumer durable goods production, as well
as by the slack in housing. Recovery in durable goods production, now
anticipated during the last half of this year, may well lead to metal
price advances and to some acceleration in price increases for finished
metal products.

The steel industry, noting a recent improvement in

demands, as well as higher labor and transportation costs, has recently
announced price increases for tin plate and steel plate. Moreover, major
truck producers have announced higher list prices for 1968 models.


Recent price increases in a number of cases undoubtedly reflect
a testing of markets and efforts to relieve some of the growing cost
pressures of the last year.

In general, however, most markets remain

quite competitive, with import competition an important factor. As
indicated above, rates of capacity utilization are relatively low (by
1965-1966 standards) in all but a few major manufacturing industries.
Altogether, a situation is clearly developing which promises
increases in average prices of industrial commodities over the coming

But it is not evident, yet, that the increases will be

excessive in the short-run.

One important factor to note is this:


demands and industrial production should increase more rapidly than now
seems probable (while this would provide a congenial setting for
accelerating price increases), a marked rise in industrial production
would undoubtedly be accompanied by/large advances

in productivity and

a concomitant easing of upward pressure on unit labor costs. Another
factor influencing the future course of prices will be the coming on
stream of much new and more efficient capacity.
Wholesale prices of farm products and foods:

The reversal,

between September 1966, and April 1967, of the earlier sharp rise in
agricultural prices caused an actual decline in the total BLS wholesale
price index -- from 106.8 per cent of the 1957-59 average in September to
105.3 per cent in April. With agricultural prices down over the year
(and the rise in industrial commodities much slower), the total wholesale

price index in June was only 0.6 per cent above June 1966 (and in
July only 0.1 per cent above a year earlier), compared with increases
of 2.8 per cent a year from mid-1964 to mid-1966.
In May and June, however, agricultural prices moved up sharply
from the April low, and they increased moderately further in early

The resumption of rising prices from April to early July

reflected in large part a decline in animal slaughter and meat production
and unusually poor spring and early summer crops of fresh fruits and
vegetables due to bad weather.

In recent weeks, however, the upturn in

average meat prices has tapered off. With ample summer and fall crops
coming in or in prospect, prices of fresh produce have declined; and,
with the forecast of record crops, prices of wheat, corn, and soybeans
have also declined.
On the other hand, farmer dissatisfaction with the sharply declining
prices from the fall of 1966 to this spring has resulted in considerable
pressure for government action to help raise prices. Actions have been
taken to raise milk support prices, to curtail imports of dairy products,
and to reduce substantially next year's wheat acreage. Altogether -given the sustained strong consumer demands, particularly for meats, and
also at times sizable military requirements, and the present supply outlook
for meats and dairy products particularly, it appears likely that prices
of foods and foodstuffs will hold up over this half-year but may not
increase further.

Consumer prices:

From June, 1966, to June, 1967, the CPI rose

as much as (2.7 per cent) as it had from mid-1965 to mid-1966,
although the decline in food prices from last fall to April acted to
slow the rise in the CPI over that period.

This development reflected

the fact that prices of non-food commodities (at retail) rose much
more from mid-1966 to mid-1967 than they had earlier.

Service prices

also rose faster. And the slowdown in the pace of increase of food
prices was thus offset in the total.
To a large extent the stepped-up rise in consumer prices for nonfood commodities has reflected rather sharp increases for apparel and
gasoline and, since the beginning of this year, a marked climb in used
car prices.

For both apparel and gasoline, the price increases at

retail were much largef than at wholesale.

Because in general consumer

demands for non-food commodities were not particularly strong in late
1966 and early 1967 (and in view of the broad demand situation as well
as the slowing of the industrial price rise at the wholesale level), the
rather pronounced increase in retail prices was surprising.


retail stores have apparently been subject to especially large upward labor
particularly for apparel,
cost pressures, and retail margins have widened,/ In June, the earlier
rise in retail prices of non-food commodities slowed appreciably, when
summer sales -- and lower prices -- for apparel were instituted earlier
than usual and used car prices showed little further increase.


While service prices rose more from June, 1966, to June, 1967,
than in the preceding year, the rate of increase so far in 1967
(about 3.5 per cent) has been slower than during most of 1966.


rising mortgage interest rates contributed to the higher rate of increase
during 1966; thus far in 1967 they have edged off. Medical service
prices continue to be among those increasing most rapidly, but the
annual rate of increase has been 7 per cent so far this year compared
with 9 per cent over the last year.
In looking to the near future, the rise in retail food prices
apparently continued in July although at a sharply diminished rate. For
the rest of this year, while retail food prices may continue to rise, the
increase may not be as rapid as from April to early summer and
would thus not act as a major influence boosting the CPI.

The major

question is what retail prices of non-food commodities are likely to do.
The rise over the last year — and particularly in the first half of
1967 -- was large in relation to changes in other prices, and it may be
that the June slowdown is a sign of some moderation of upward price
movements in this sector. However, with consumer demands now stronger,
these prices may continue to move up at a sizable pace. Higher average
new car price tags are in prospect for 1968 models.

But (as over the

last several years) the higher prices which reflect the addition of new
large past
safety equipment this year may be treated in/ as quality improvements and


therefore may not result in an appreciable increase in new car prices
as measured in the CPI. Service prices will, of course, continue to
rise — perhaps at around the 3.5 per cent rate prevailing so far this
year and below the very high rates reached in 1966.
This review of price developments has convinced me that, while
some further price increases are in prospect, we clearly are not caught
up in a situation of general inflation. Far from it. On the other hand,
the emerging demand conditions are obviously generating strong potentials
for inflation, and now is the time to insure that such potentials are not
realized. The President's proposed revenue and expenditure program
provide the best means to achieve this goal.
The Mosaic of Wage Trends and Unit Labor Costs
From the view point of national stabilization policies, the outlook
for wage developments is no more optimistic than it is for prices. One
calculation shows that recently negotiated wage and fringe benefit
packages have involved an increase of/ 5% to 6 per cent in total labor
cost. Moreover, this range of increases seems most likely to persist in
the near future.
The consequences of negotiated wage settlements in manufacturing have
been particularly striking. Straight-time hourly earnings in the first
above a year earlier,
half of 1967 were 4% per cent / This was the largest increase in the first
half of any year in the last/ The rise in the cost of fringe benefits


has also been substantial. Supplements per man-hour (including legally
required Social Security taxes and other employer contributions to public
as well as private programs) recently have been rising at an annual rate
of roughly 11 or 12 per cent. In contrast, during the period 1960-65,
the rate of increase averaged/per cent per year. Although the
funding of some of these added costs sometimes

can be postponed, this

rapid increase must necessarily mean a significant boost to current labor
The forces inducing workers and trade union negotiators to press for
higher wage settlements are enormous. Over the last year, increases in
consumer prices have eroded real weekly earnings in manufacturing. Sizable
wage settlements in other industries have not gone unnoticed. This is
and fringe
particularly true of wage/adjustments in the construction industry, where
recent increases have ranged between 6 and 10 per cent.

Wage negotiations are also being complicated somewhat by the desire
of skilled workers for extra wage increases to re-establish traditional
wage differentials that are often compressed in a period of tight labor
markets. Such skill differentials were provided in the recently
negotiated rubber and electrical workers contracts, and they are being
demanded in the railroad and auto negotiations.

In fact, this particular


issue is reported to be one of the most difficult features of the
current negotiations in the automobile industry. Skilled workers in
the auto plants have veto power over a contract, and at the moment
they seem unhappy about the tenor of the negotiations.

In the meantime, previous increases in labor costs and the recent
above a year ago
low productivity rates (averaging less/ 1 per cent/in the last few
quarters) have combined to produce sharply higher costs per unit of
output in manufacturing. During the second quarter of this year, the
index stood at 106 per cent of its 1957-59 base. This was the highest
point for this index in the last two decades. At this level, unit labor
costs were running about 5% per cent higher than a year ago, although the
rate of increase during the last few months remains somewhat more moderate
than earlier.
Some easing of the pressure on costs may be anticipated later this
year as productivity /

to recover. A slowdown in productivity

growth is not unusual in a period of production declines, with its
associated under-utilization of capacity, so a rebound should occur with
the expansion in output anticipated in the months ahead. However, there
seems to be little likelihood of an easing of pressure on the wage


Thus, one must also expect continued pressure on profit margins,
which have already shrunk substantially. For example, the ratio of
profits to sales in manufacturing has declined from 9.8 per cent in
early 1966 to 8.5 per cent in the first quarter of 1967 and probably declined

in the second quarter of this year. On the other hand,

despite this narrowing, profit margins in manufacturing remain close to
the average recorded over the last decade — and well above the low
points reached in earlier periods of lessened economic activity. Thus,
while the pressure on profits is unmistakable, it does not appear to
justify a general rush to restore margins through successive rounds of
price increases.

Price Stability and the Balance of Payments
Domestic price stability is obviously of critical importance to our
balance of payments and the international position of the dollar. During
the first half of this decade, we were able to effect considerable improvement in the competitive position of our exports simply by avoiding
domestic inflation — while prices rose steadily abroad. Between 1960
and 1964, U.S. prices rose much less than those in other industrial
years or so,
In the last two/

however, this cost advantage which we enjoyed

has eroded substantially. Between the end of 1964 and the second quarter
of this year, average prices of U.S. industrial goods rose by about


5 per cent, while they had remained unchanged over the previous five

In roughly the same 2% years since 1964, industrial prices

rose by only 2 per cent in Italy; by 2 per cent in France, and by
2% per cent in Germany.

Only in Japan and the United Kingdom did the

rise in industrial prices equal or exceed that which occurred in the
United States.
This faster advance in our relative price level certainly has not
aided our exports.

During the second quarter of this year, merchandise

exports were at a seasonally adjusted annual rate of $30.9 billion, about
the same as in the first three months of the year.

Imports in the

second quarter declined to an annual rate of $26.3 billion.

Thus, the

trade surplus for the second quarter was at an annual rate of about
$4% billion, compared with $4 billion in the first quarter.

But it

was still far below the $6% billion rate achieved in 1964 and too low
to meet our needs.
The failure of our exports to forge ahead at a greater rate this
year toward regaining the much larger margins over imports enjoyed in
1964 and 1965 can be attributed partly to the persistence of recessions
in some of our major foreign markets.

This is especially true of Germany,

where employment has declined about 3 per cent and industrial output by
about 10 per cent since early last year.

Reflecting the adverse effects

of the German experience, other markets in continental Europe (particularly
France) have also shown considerable weakness.

This weakness, in turn,

has lessened the demand for exports from the U.S. and the U.K.
A rough calculation by a member of the Board's staff suggests
that the combined imports of continental European countries this year may
be running about $5 to $6 billion below the level consistent with relatively
full employment — with perhaps $2% billion of the short-fall concentrated
in Germany.

On the other hand, exports of continental Europe may be only

$3 to $4 billion below what might be expected under conditions of relatively
full employment.

Thus, the trade surplus of the Continent this year may

be as much as $2 billion above the trend.

In contrast, for the U.S. imports

may not be appreciably below the level consistent with high employment,
while U.S. exports are being dampened by the recessions in Europe. The net
result may be that U.S. exports and our trade surplus are running $1 billion
or more below trend this year.
But even after allowance for this cyclical short-fall, our trade
surplus is too small, given our heavy commitments around the world, and our
persistent payments deficit.

In this situation, we certainly cannot look

forward with equanimity to a resurgence in aggregate demand next year so
rapid as to accelerate imports, hold down our ability to meet export
schedules, erode further our competitive position, and thus cause further
shrinkage in our trade surplus.
Price Effects of the Surtax
Since one objective of the 10 per cent surtax proposal is to reduce
inflationary pressures in the economy in 1968, one must naturally ask:

just how much impact is the increase in income taxes expected to have?
Unfortunately, no ready answer is available.

I am sure that the

statisticians and econometricians would wish to trace the effects of
the tax increase through their mathematical models of the economy
before offering a reply.
months of hard work.

Such an effort would undoubtedly require several

In the meantime, one can sketch the broad range

within which the price effects of the surtax may fall.

For this purpose,

one might start with the numerical projections which the Chairman of the
Council of Economic Advisers presented in testimony before the House
Ways and Means Committee on August 14.
In that statement, Mr. Ackley estimated that, if Congress were not to
accept the President's tax proposal, GNP might rise by perhaps $29 billion
to $35 billion during the last half of this year -- and by as much as
$60 billion from mid-1967 to mid-1968.

Even at the low end of this range,

GNP would be in the neighborhood of $783 billion in 1967 and $815 billion
in the second quarter of 1968. Mr. Ackley also estimated that a rise in
GNP of around $50 billion over the next year would be roughly in line
with the expansion of our productive capacity — permitting real output
to grow

at an annual rate of about 4 per cent, plus an allowance for

price increases already built into the economy.

However, because we

currently have a small amount of excess capacity, he suggested that we
could welcome a growth rate slightly above 4 per cent. With the 10 per cent
surtax in effect, CEA's projections show GNP growing by about $55 billion
through the second quarter of 1968*

On the basis of these projections, it appears that enactment of the
surtax would dampen (although not eliminate) inflationary pressures in
the year ahead. A growth of $60 billion in GNP by mid-1968 (which
Mr. Ackley estimated might occur without the surtax), would represent
a gain of 7.7 per cent. Although one cannot with any precision distribute
this gain between real output and prices, a substantial share (perhaps as
much as 3 per cent) would reflect price advances — as measured by the GNP
implicit deflator.

With the surtax enacted as proposed, the projected

growth of $55 billion in GNP next year would represent a rise of 7 per cent
in GNP. Again no hard division can be made between the growth or real
output and an increase in prices.

Yet, the advance in real output would be

almost as large -- if not equally as large -- as with the $60 billion advance
in GNP.

Thus, the surtax initially would restrain the growth of GNP through

mid-1968 by perhaps $5 billion.

However, the $5 billion of restraint would

represent mainly restraint on higher prices.

So it is clear that the

surtax would have a noticeable (if not precisely measurable) effect on the
general price level.
However, it is also worth noting that a rise of only $50 billion in GNP -a rise about in line with the 4 per cent growth rate of our productive
capacity -- would still mean a price increase of almost 2% per cent between
mid-1967 and mid-1968, reflecting the cumulation of the built-in price
advances mentioned above. While a more refined examination would yield a better
quantitative estimate of the effect of the surtax on prices, the analysis
presented here makes it unmistakably clear that the surtax is needed to moderate
inflationary forces in the coming year.