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For release on delivery

Statement by

Arthur F. Barns

Chairman, Board of Governors of the Federal Reserve System

before the

Committee on Banking, Housing and Urban Affairs

United States Senate

February 7, 1973

I appreciate the opportunity to appear before this Committee.
In my capacity as Chairman of the Committee on Interest and
Dividends, I have certain responsibilities under the Economic
Stabilization Act.

Let me therefore say at once that I endorse

extension of the Act for another year.
The performance of the American economy in recent
years, as well as that of other industrialized nations, has persuaded
me that there is a need for legislation, permitting some direct controls
over wages and prices,

I do not think that resort to such controls

will be required all, or even much, of the time.

However, the

structure of our economy--in particular, the power of many
corporations and trade unions to exact rewards that exceed what
could be achieved under conditions of active competition--does
expose us to upward pressure

on costs and prices that may be

cumulative and self-reinforcing.

In dealing with the immediate

inflationary problem, it would not be safe to rely exclusively on
the Government's management of aggregate demand policies.
This nation has already incurred heavy sacrifices, besides
investing a great deal of time and energy, in the effort to bring
inflation under control.

Of late, a substantial measure of success

has actually been achieved.

Judging by comprehensive measures,


the rate of inflation declined from about 5 per cent in the first half
of 1971 to about 3 per cent in the latter half of 1972.

As a result,

private decisions concerning wages, prices, and investments are
now being made in a more tranquil atmosphere.
Yet, a vestige of the old inflationary psychology remains,
and public apprehension appears to be spreading that the inflation
rate may once again accelerate.

That concern is understandable

in view of soaring food prices and the quickening tempo of economic

Over the past year and a half, economic recovery has been

vigorous, and the prospects appear good for strong continuing
expansion in the year ahead.

In these circumstances, monetary

and fiscal policies must necessarily play the basic role in keeping
economic exuberance within bounds.

But direct concern with the

wage-price area cannot be neglected by the Government in the
months immediately ahead if the economy is to be protected against
the risk of renewed inflationary pressure.
The precise form that a controls program should take is
more a matter of judgment.

As I see the problem, good logic

underlies the phase-by-phase evolution of the program that the
Administration has followed.
a freeze of prices and wages.

First came shock therapy through
This was followed by a program that

subjected most of the nonfarm economy to mandatory controls,
implemented with extensive rules of prenotification,
and policing.


Now we have moved to a phase in which more

reliance is placed on self-discipline in abiding by rules of
appropriate behavior.

The Economic Stabilization Act has thus

permitted an orderly evolution of the controls program.
The move towards greater freedom was, I believe, both
necessary and desirable.

With the passage of time, any rigid

program of controls leads to some economic inefficiency and
distortion, to some misallocation of resources, to increasing
administrative burdens, and to growing inequities among various
classes of employees, employers, and industries.

In the end,

incentives to constructive innovation and enterprise are damaged,
and the basis for economic prosperity may be seriously weakened.
It was virtually inevitable, therefore, that the comprehensive
controls of Phase II would in time give way to procedures that allow
greater freedom in private decision-making.

Some observers

believe that effective control over wages and prices has been
weakened materially by Phase III.
as premature.

Such a judgment strikes me

In the first place, a major step forward has been

taken by bringing trade union leaders back into the policy-making



This was probably essential to continuation of an

effective control program.

Furthermore, several of the major

areas of the economy that have been especially troublesome remain
under strict mandatory control; and the rest of the economy previously
covered by Phase II remains fully subject to established rules of

I am inclined to think that self-administration will be

respected by a large majority of economic participants.

In any

event, enforcement remedies remain available to compel adherence
to the program in obdurate cases.

The broad approach of Phase III

thus appears to me to be quite reasonable, and it should be given a
fair chance to show what it can accomplish.
As I have already suggested, Phase III is hardly a voluntary

A mandatory dimension is, in fact, built into it.

But I

also want to remind the Committee that even entirely voluntary
programs can at times prove as effective as their mandatory

This is most likely to happen when the objectives

sought are widely accepted, the rules of the program are clearly
understood, and ongoing performance is adequately monitored.
The program of voluntary foreign credit restraint by banks and
other financial institutions, which the Federal Reserve has
administered during the past several years, is an example of
excellent cooperation.


The experience of the Committee on Interest and Dividends,
which was established under the aegis of the Economic Stabilization
Act, is another example of a voluntary program which has thus far
achieved practical results.
issued a guideline

On November 2, 1971, the Committee

that allowed for no more than a 4 per cent

increase in dividends per share in 1972.

This guideline applied to

approximately 7, 000 of the larger business corporations, which
were to be monitored by the Department of Commerce, and to
14, 000 banks, to be monitored by Federal bank supervisory

I can now report to you that adherence to the 4 per

cent limitation by both financial and nonfinancial corporations has
been nearly perfect.
As of the end of 1972, only 43 of the covered corporations
had declared dividends in excess of the Committee's prescription-some, apparently, due to misunderstandings.


practically all of the corporations in violation have now agreed
to take the necessary steps to move into compliance.

I might

add that very few exceptions to the guideline and related interpretations have been granted by the Committee.

As of the end

of the year, only 67 requests for exceptions had been received,
and 46 of these were denied.

This record of voluntary compliance contributed very
materially to holding the increase in total dividend payments by
domestic corporations to 3. 6 per cent during 1972.

This figure

is far below the increase in most other categories of income
Without the Committee's program, a much larger rise in
dividend payments would undoubtedly have taken place.

Our best

estimate is that dividend payments in 1972 might well have been
some $2 billion higher if it had not been for the Committee's

One of the important results of this smaller dividend

payout has been a reduction in business needs for external financing.
Thus the dividend program, by moderating the demand for credit,
has reduced upward pressure on interest rates.

This, of course,

redounds to the benefit of all borrowers--individuals and governments, as well as business corporations.
In view of the fact that the intent of Phase III is to continue
a strong incomes policy, the Committee reaffirmed its 4 per cent
dividend guideline on January 26.

At the same time the Committee

indicated that it was continuing surveillance of interest rates and
earnings of financial institutions, and that it expected these
institutions to continue cooperating with the program.

Since its inception, the efforts of the Committee to hold
down interest rates have focused on institutional lending rates,
often termed "administered" rates.

These interest rates are

administered in the sense that they change on the basis of
institutional decisions.

Traditionally, they have been less

volatile than market interest rates.

One reason for the smaller

fluctuation of institutional rates is that to some degree they reflect
relatively inflexible costs—items such as overhead, advertising,
and rates of return paid on some types of funds.

Another reason

is that the policies of institutional lenders commonly reflect
longer-run considerations, such as the maintenance of favorable
relationships with their borrowing customers.
Institutional lending rates need to be distinguished sharply
from the interest rates that are set in the open and highly competitive
market for securities of both short and long maturity.

In this market,

interest rates change continuously in response to the shifting needs,
preferences, and attitudes of large numbers of individual lenders
and borrowers.

In the upward phase of the business cycle, market

interest rates usually tend to rise as credit demands grow,
particularly when inflationary expectations are being generated
by advances in costs and prices.

In a weakening economy, on the


other hand, market interest rates tend to fall.

That is the way

in which market forces normally express themselves, and it is
important that they be permitted to do so.

For any effort to keep

market interest rates artificially low in a strong economy could
have disastrous inflationary consequences and would, in the end,
be self-defeating.

And just as clearly, any effort to keep interest

rates artificially high in a weak economy would run the risk of
depressing economic conditions further.
During the past year, with the economy expanding vigorously
and loan demands rising steadily, short-term market interest rates
increased two to three percentage points from their early 1972 lows.
But in large part because of the progress recently made in curbing
inflation, longer-term market rates--those on corporate, State,
municipal, and Treasury securities--remained rather steady, and
on balance are only a little above their lows reached early last year.
Moreover, interest rates of all types--short as well as long, market
as well as institutional--are substantially below the peaks reached
in 1969 and early 1970. And I might note, in passing, that interest
rates in our country remain a good deal lower than in most
industrialized nations.

The Committee on Interest and Dividends recognized from
the start that it would be unwise as well as impractical to attempt
to interfere with market interest rates.

Hence, the main concern

of the Committee over these past 15 months has been to see to it
that the interest rates set administratively by our lending institutions
are kept at the lowest practicable levels.

Our initial objective was

to see institutional rates reduced more promptly than in the past
as the cost of funds to the lending institutions declined.


recently, as short-term market rates moved to a higher level, the
situation of institutional lenders has changed.

The main principle

that needs to be observed now by financial institutions is that
increases in lending rates should be made only when they can be
fully justified on the basis of the cost of acquiring lendable funds.
The Committee has recently re-emphasized its concern
about advances in interest rates charged by financial institutions.
In particular, we wish to see moderation in institutional policies
with respect to rates--such as those charged on various types of
consumer credit and on home mortgage loans--that matter most
directly to American families.

We have urged financial institutions

to hold these rates down as far as they reasonably can, and the
record appears to indicate that they have generally done so. We


have also urged banks to exercise restraint in adjusting such key
institutional rates as the prime rate on business loans.

In the

Committee's judgment, higher marginal costs of funds from sensitive
market sources should not be permitted to influence unduly the
spectrum of rates charged, including the rates charged to business
The Committee on Interest and Dividends recognizes, of
course., that underlying circumstances in financial markets are
always subject to change.

Higher short-term market rates have

meant higher costs of funds for some institutional lenders.
Commercial banks, for instance, have had to pay successively
higher interest rates to obtain money through such money market
instruments as negotiable time certificates of deposit.

Even so,

the banks have thus far generally practiced moderation in adjusting
upward their key lending rates.

For instance, all banks that

permitted the prime loan rate to float by use of a formula tying
it to market rates have either abandoned the formula or modified
it so as to ensure that any rise in the prime loan rate will lag
behind increases in comparable open market rates.
It is the Committee's opinion that since the costs of most
lending institutions have not been rising as rapidly as short-term

market rates, any upward adjustments in lending rates should be so
ordered that profit margins do not rise appreciably.

It is for this

reason that the Committee is now expanding its monitoring activity to
include full attention to the costs and profits of banks and other financial

When four banks announced on February 2 an increase in

their prime rate, the Committee responded at once by requesting each
of the banks to furnish complete information on costs and earnings;
together with any calculations they may have made that justified the
increase in their judgment.

Every bank in the country was informed

by letter of the Committee's action.

And as you may have noticed,

Mr. Chairman, three of the four banks that raised the prime rate have
now restored this rate to its previous level.
The moderate success that the Committee has thus far had
in its program of voluntary restraint on institutional lending rates
rests in good measure on the comprehensive system of reporting
that it has developed on interest rate developments.


institutions have cooperated fully in providing the necessary
We now have monthly reports from commercial banks on
interest rates charged small businesses, interest rates on
agricultural loans for feeder cattle operations and for other farm
production purposes, and interest rates on various types of


consumer loans— for the purchase of new autos, mobile homes, and
other consumer goods, and also on personal loans and credit cards.
These monthly reports have been collected on a consistent basis
since the beginning of 1972.

They indicate that consumer loan

rates generally declined in the early months of the year and then
edged upward.

On balance, however, interest rates charged for

loans on new autos and mobile homes dropped by about 1/4 of a
percentage point in the course of the year, while rates in other
categories showed little net change.
New data on consumer lending rates also have been
collected monthly from auto finance companies and bi-monthly
from other finance companies.

These figures, too, show either

little change or some net decline in rates, depending on the type
of loan.

Rates charged by dealers on used car loans are, however,

a clear exception.

They rose rather substantially during 1972, but

are still close to their August 1971 level.
The mortgage data collected by other government agencies
have been expanded at the Committee's request to provide more
accurate and timely information on interest rates than had previously
been available.

Putting all the existing information together, it

appears that home mortgage rates have edged up a little in recent
months, but remain about 10-15 basis points below their August 1971
levels and well below their peaks in 1969 or 1970.


In view of the exuberant pace of economic expansion which
we are now experiencing, I cannot assure you that interest rates
will not move upward in the months ahead.

As I indicated earlier,

it would be dangerous to try to prevent increases in interest rates
that are freely determined in highly competitive markets.


attempt to do so would, in present circumstances, run the serious
risk of excessive monetary expansion and an escalating pace of inflation.
I can and do assure you that the Committee will do everything
in its power to prevent premature increases in institutional lending
rates or increases that are inordinately large relative to changes
in market rates.

I must, however, draw your attention to the fact

that institutional interest rates are, by and large, also competitively
determined, so that there is less to be accomplished by governmental
intervention than in the case of various product and labor markets.
You therefore should not expect more from the Committee on
Interest and Dividends than it, or any similar group, can usefully
accomplish in practice.
Past experience of our own country and of other countries —
notably in Latin America--shows clearly that interest rate levels
are highest when and where inflation or the fear of inflation is most



There is QO way to prevent this outcome, since

investors generally become less and less willing to lend if it
appears to them that they are likely to suffer a loss in purchasing
power by the time the loan is repaid.

But these are precisely the

circumstances when businessmen are apt to be especially eager
to borrow.

It follows, as we move forward, that the behavior of

interest rates, particularly in the long-term market, will depend
very heavily on the success that we can achieve in ridding our
economy of inflation.
In closing, Mr, Chairman, I want to emphasize once again
my conviction that the very future of the American economy depends
on getting better control of our stubborn inflationary problem.


extension of the Economic Stabilization Act, and its effective
implementation by the iVdministration, are essential.
more than this is required.

But much

Frugality in government expenditures,

prudence on the part of the private sector, and appropriate restraint
in the conduct of monetary policy--all these are indispensable
ingredients of an effective stabilization policy in 1973.