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For release on delivery
P.M. Eastern Daylight Time
, May 18, 1970


The Fundamental Challenge to Stabilization Policies

Remarks of Arthur F. Burns,
Chairman, Board of Governors of the Federal Reserve System
before the
Seventeenth Annual Monetary Conference
of the American Bankers Association

Hot Springs, Virginia

May 13, 1970

We have gathered together as representatives of government
and the banking industry to discuss our problems, experiences, and
concerns about financial affairs*

Each of our countries has specific

problems that are peculiar to the character of its own economy.


nearly all of our countries, however, the fundamental challenge to
current stabilization policies is the persistence of inflationary
What I should like to convey to you today is the following
simple message: Although the forces making for inflation in modern
society are strong and pervasive, these forces need not prevail.
Stabilization policies can be formulated and executed in a way that
will permit our economies to enjoy the benefits of prosperity without

I do not minimize the difficulties of meeting this

challenge, but I am convinced that success is possible.
We are living now in an inflationary climate.

In the United

States periods of strong upward price pressures over the past quarter
century have been episodic.

Interspersed between them have been years

of relative price stability.

But the period since 1964 has witnessed

stronger and more widespread cost and price pressures than in the
previous inflationary outbreak of the mid-19501s. And the current
episode of inflation has lasted longer than any other since the end
of World War II.

-2In most other industrial countries, price performance over the
past two decades has been poorer than in the United States.

However, after

1964 the American price level began to move up briskly and our inflation
from 1966 to 1969 tended to outpace that in Europe. More recently, we see
an acceleration of cost and price pressures in Europe and Japan.
In these circumstances, it should not be surprising that so many
businessmen and consumers believe that inflation is inevitable.

This has

happened before. During the 195Ofs, the notion that creeping inflation was
endemic to a modern economy was widely held in the United States. Yet
the period from 1958 through 1964 was marked by reasonable price stability.
We in government therefore have a responsibility, I feel, to make it convincingly clear to everyone that inflation is not an economic necessity and
that it will not be accepted as an inevitable course of events,
I believe there are grounds for optimism about our ability to
achieve and maintain reasonable price stability, and to do so without
incurring excessive costs in terms of unemployment and lost output.


reach that conclusion from long exposure to the inflationary problem in the
United States.

The basic sources of inflation in all of our economies are

similar, however, and what we can learn from American experience may also
be applicable elsewhere.
What are the sources of the inflationary bias that is presently
troubling us?

On a first view, the root of the difficulty seems to be the

broadening of the social aspirations that have been shaping our national
economic policies, and especially the commitment to maintain high levels

-3of employment and rapid economic growth.

For several decades, the primary

concern of economic stabilization policies was to avoid substantial or
prolonged declines in the level of economic activity «

declines of the

sort that had plagued industrialized economies for a century or more.


we gained experience in moderating business downturns, our standards of
economic performance became more exacting.

Now, we are not prepared to

accept more than brief departures of our economic growth rate from its full
employment path.
Improvements in our ability to control cyclical fluctuations in
business activity have also emboldened us to search for ways to increase the
potential growth rate of our economies -- through better education and training of the labor force, through larger investment in public facilities, and
through stimuli to private investment in fixed capital.
we have achieved some measure of success,

In this effort, too,

In the short run, however, I

suspect that these policies have added more to aggregate demand than to
aggregate supply.
Another source of inflationary pressure in recent years has been
the rise of governmental expenditures for social welfare.

The consequences

for the Federal Budget in the United States have been dramatic.

Since fiscal

year 1965, Federal expenditures for health, income security, veterans1 benefits,
education and manpower, and community development and housing have more than

And as we look to the future, we must expect substantial further

increases in the level of government expenditures to help halt the decay of

-4our central cities, to bring air and water pollution under control, to

added financial assistance to beleaguered state and local govern-

ments, to finance basic research in areas where private incentives are
insufficient, to provide better housing for the less privileged, better
medical services to the indigent and the aged, improved job training-in short, for the host of things our people have come to expect their
government to provide.
The present world-wide inflationary trend may thus be ascribed
to the humanitarian impulses that have reached such full expression in
our times.

This explanatinn, however, encompasses only part of the truth.

As every economist knows, the growth of aggregate demand that has been
generated by our social aspirations could, in principle, have always
been offset by monetary and tax policies, supplemented by more selectivity in public expenditures.
The present world-wide inflationary trend must, therefore, also
be recognized as evidence of the shortcomings of economic stabilization

Serious inflationary problems are always traceable to excessively

expansionist monetary and fiscal policies or to the failure of such policies
to offset the effects of excessively exuberant demand in the private sector.
This, however, is something that admits of correction.
The reason for my optimism about the prospects for long-run improvement of our price performance is a deep faith in the learning process.
we have ma<Je many mistakes in* the formulation and administration of our


-5national economic policies, and we will doubtless make some mistakes in
the future.

But we can also learn from past experience how to distinguish

the paths that need to be taken from those that must be shunned
if we are to win the ever-recurring bouts with the threat of inflation,,
Let us consider briefly the experience with stabilization policy
in the United States, drawing on the record of the past few years by way of

These years offer, I believe, lessons that we cannot afford

t© ignore,
One of the serious economic blunders of recent years was the
failure to alter the course of fiscal and monetary policies when early warnings of inflation began to flash.
on our nation's

Late in 1964, signs of growing pressure

resources were already multiplying and these signs became

stronger and more widespread in the first half of 1965, With the economy
moving rapidly toward full employment, the time had come for backing away
from the stimulative policies pursued in the earlier years of the 1960fs«
But precisely the opposite course was taken — both fiscal and monetary
policies became substantially more stimulative during 1965.
In my judgment, the fateful policies of 1965 stemmed only in part
from the inadequacies of economic forecasting.

It is true that attention

had been diverted from the problems of inflation by the experience of the
previous 5 or 6 years, when much slack existed both in industrial plants
and the labor market and the price level moved within a narrow range.

By the late summer of 1965s however, it was entirely clear that storm
clouds were gathering on the economic horizon.

The unemployment rate had

moved close to the 4 per cent target, while the rate of utilization of
industrial capacity — which was already high -- still kept rising, Yet5
despite the strains under which industry was already operating, the economy was called upon to shoulder a much enlarged military burden in Vietnam
without any change in monetary or fiscal policy.

Monetary policy continued

on its expansionist track during the latter half of 1965 and fiscal restraints of material consequence were postponed much longer.
The mistakes of stabilization policy in 1965 reflected an unwillingness to face up promptly to the urgent need for restrictive actions
on the fiscal and monetary front.

It was soon found, however, that by

eschewing an ounce of prevention, a pound of cure had become necessary.
Inflationary forces gathered such momentum that it took stern measures in
subsequent years to eliminate excess demand.
Another deficiency in the formulation of stabilization policies
in the United States has been our tendency to rely too heavily on monetary
restriction as a device to curb inflation, rather than on a balanced program of fiscal and monetary restraints.

There are several reasons why

excessive reliance on monetary restraint is unsound,


First, severely restrictive monetary policies distort the
structure of production. General monetary controls, despite their
seeming impartiality, have highly uneven effects on different sectors
of the economy*

On the one hand, monetary restraint has relatively

slight impact on consumer spending or on the investments of large
businesses. On the other hand, the homebuilding industry, State and
local construction, real estate firms, and other small businesses
are likely to be seriously hatidicapped in their operations. When
restrictive monetary policies are pursued vigorously over a prolonged
period, these sectors may be so adversely affected that the consequences
become socially and economically intolerable, and political pressures
mount to ease up on the monetary brakes,
Second, the effects of monetary restraint on spending often
occur with relatively long lags.

The initial actions of a central bank

to moderate the pace of expansion in motiey and credit may come at a
time when liquidity positions are relatively ample in the commercial
banking system and elsewhere in the economy. Loan commitments to
businesses by banks and life insurance companies may be sizeable,
and other financial institutions may have committed large sums to the
mortgage market based on expected inflows of funds. For a time,
therefore, the effects on spending of the slower rate of expansion of
bank reserves will be cushioned. Moreover, the length of lags in the
response of spending will vary from one period of monetary stringency
to another, depending on the state of liquidity, the expectations of
the business and financial community, atid a variety of other factors.

Primary reliance on monetary policy to restrain inflation
thus places a high premium on accurate forecasting of both the strength
of private demand and the temporal effects of monetary restraint on

Because the lags tend to be long, there are serious risks

that a stabilization program emphasizing monetary restraint will have
its major effects on spending at a point in time when excess demand
has passed its peak.

The consequence may then be an excessive

slowdown of total spending and a need to move quickly and aggressively
toward stimulative policies to prevent a recession.

Such a stop-and-go

process may well lead to a subsequent renewal of inflationary pressures
of yet greater intensity.
Something like this happened, I believe, in 1966 and early

The monetary brakes began to be applied with considerable force

in the spring of 1966, and they began to take their greatest toll in
spending in the fall months of that year. By that time, the adverse
structural effects of excessive monetary restraint; had become
obvious to everyone, and some modest fiscal action was taken to help
slow the economy*

Just about that time, hox^ever, the rate of consumer

spending relative to income declined rather sharply. With the expansion
of total final demand for goods and services tapering off, monetary
policy then moved aggressively toward ease to ward off a threat of
recession. As things turned out, the adjustment proved to be mild
and short-lived, and by the latter half of 1967 we found ourselves
in an aggravated condition of economic overheating.



We need to recognize, of course, that there is considerable
uncertainty also about the effects of fiscal policy on the performance
of the economy.

The direct effects of changes in Federal expenditures

or tax rates on private incomes and spending are themselves often
difficult to predict.

But the overall impact of fiscal policy must

also take into account the effects of budgetary changes on interest
rates and hence on private spending. Our knowledge about these
effects is sketchy. Much will depend, of course, on the precise
nature of the actions taken and on the state of private expectations
at the time.
In recent years, we have tended to overestimate our knowledge
of economic processes, and how they are influenced by monetary and
fiscal policies. We have, for example, adopted temporary increases
in taxes

as though we knew with reasonable certainty that the

economic situation a year hence would warrant their removal. The
economic impact of such taxes has been considered without due regard
to our limited understanding of the effects of temporary taxes on
consumer and business spending decisions. Furthermore, growth rates
of the major monetary aggregates have been permitted to vary over
an extremely wide range, notwithstanding our hazy perception of the
timing and magnitude of the economic effects of such variations.
There has been much loose talk of "fine tuning,81 when the state of
knowledge permits us to predict only within a fairly broad band the
course of economic development and the results of policy actions,,

Improvement in the formulation and implementation of
stabilization policies requires full recognition of the great
uncertainties with which we must live.

This means that we need to

adopt a cautious approach to large changes in the intensity of
monetary and fiscal policies--avoiding extreme courses of action
unless the evidence clearly indicates that exceptional policy moves
are needed. Furthermore, the uncertainties inherent in the use of
any single instrument of policy

suggest that the prudent course is

to adopt a balanced program that relies on prompt adaptations of
fiscal as well as monetary policy.
Let me turn now more specifically to the current inflationary
problem in the United States, and suggest what these lessons of recent
experience seem to imply for the course of monetary and fiscal actions«
First, I want to note that we have made much more progress
than is generally realized in getting the inflationary forces of
recent years under control. The excess demand that bedeviled our
economy during the past four or five years has been eliminated.
recent months, total real output has declined somewhat.



production has dropped faster and is now about 2-1/2 per cent below
its peak last summer. Demand for labor has moderated, the unemployment rate has increased, and the degree of unused industrial capacity
has also risen.
Throughout this phase of economic sluggishness, there has
been a risk that the decline in industrial output would intensify and

-11spread across the economy, with the business slowdown taking on the
characteristics of a recession*

Thus far, the pervasive and cumulative

characteristics of a recession have not developed--largely, I believe,
because of the continuing strength of business investment in fixed

It seems highly probable, moreover, that the business

slowdown will not extend much further, and that before long we will
be enjoying a resumption of growth in industrial output and employment,,
If that proves to be the case, the success we will have had in slowing
aggregate demand without precipitating a recession will hav& been a
notable achievement.
We have been less successful than we would have liked in
moderating the advance of prices, and also less successful than we
might have expected on the basis of past experience.

But there are

some signs of progress in that area, too. After seasonal adjustmentf
the ratetof increase in consumer prices slowed in February and again
in March*

The level of wholesale prices remained unchanged in April

for the first time in a year and a half, as prices of some agricultural
products fell sharply.

The price rise for industrial commodities in

March and April was the smallest since last July.
It is clear, nonetheless, that the average rate of pricg
increase during recent months is far too high.

The question might

be raised, therefore, whether our current inflationary illness could
be cured more quickly with a shock treatment designed to rid the
patient, once and for all, of the troublesome disease.

-12Such a prescription t^ould, I believe, be unsound as well
as unacceptable*

The inflationary developments we are now experiencing

do not reflect the present state of balance between aggregate demand
and supply*

Rather, they are the aftermath of economic overheating

that existed earlier and which is still having lagged effects on wage
rates, on other costs, and hence on prices„

We are in a transitional

period of cost-push inflation, and we therefore need to adjust our
policies to the special character of the inflationary pressures that
we are now experiencing.
An effort to offsetf through monetary and fiscal restraints,
all of the upward push that rising costs are now exerting on prices
would be most unwise. Such an effort would restrict aggregate demand
so severely as to increase greatly the risks of a very serious
business recession*

If that happened, the outcries of an enraged

citizenry x^ould probably soon force the government to move rapidly
and aggressively toward fiscal and monetary ease9 and our hopes for
getting the inflationary problem under control would then be
It would be an equally serious mistake, however, for the
central bank to supply money and credit in sufficient quantities to
permit businesses simply to pass on all cost increases to their

Readiness to validate the pressures of costs on prices,

through generous provision of money and bank credit, would greatly
increase the probability of a later resurgence of excess demand*
This, too, must be avoided*


The right course for mbtietary p6licy iU, I believe, a
cautious approach that aVbidsfabfctibi these extremes. In recent
months th& major monetary aggregates have been following a path of
moderate expansion—a path that provides added insurance that the
current economic slowdown will not cumulate, but at the same time
is consistent with avoidance of excess demand later this year and on
into 1971. The adequacy of growth in supplies of money and credit
to finance increases in real output and employment will, of course,
depend heavily on the movement of costs and prices. As I noted a
moment ago, it would be inappropriate for the central bank simply
to validate the effects of all cost increases on prices. Consequently,
the longer inflationary wage settlements and pricing decisions continue,
the larger may be the shortfall of economic growth from its potential.
In the months ahead, we may be witnessing economic developments that will test patience--with costs and prices continuing to
advance despite the slack that exists in markets for goods and fot
productive services. It seems likely that we will hear an increasing
number of suggestions that additional steps need to be taken to moderate
the rise in x^rage rates and the advance of prices~-steps that could
involve the government more directly in the operations of the private
Other countries that have depended on specific wage-price
policies--or incomes policies, as they are frequently called--have
achieved relatively little success, and the same can also be said

-14of our own experiment during the sixties.

Nevertheless9 we should

not close our minds to the possibility that an incomes policy, provided it stopped well short of direct price and wage controls and was
used merely as a supplement to over-all fiscal and monetary measures,
might speed us through this transitional period of cost-push inflation
I recognize that an incomes policy may not have a lasting effect on
the structure of costs and prices if its use is restricted to a transitional period of cost-push inflation.

Moreover, it seems clear to me

that an incomes policy applied over a long period would be completely

Even with these reservations, however, there may be

a useful—albeit a very modest--role for an incomes policy to play
in shortening the period between suppression of excess demand and
restoration of reasonable price stability.
Of course, primary reliance in the battle against inflation
must always be placed on policies that impinge on aggregate demand.
It is of fundamental importance that monetary and fiscal policy work
together, in this regard, in the months ahead.

If the tempo of

economic activity picks up later this year, as may now be reasonably
anticipated, the task of ensuring that this recovery does not become
too brisk--thereby threatening a re-emergence of excess demand—
should not fall on monetary policy alone.

Fiscal policy must do its

-15The Budget set forth by the Administration in January called
for a small surplus for fiscal 1971. Since January, there have been some
modifications in the projected course of Federal expenditures as a result
of actions taken by the Congress and the Administration,, Thus far, the
most significant change in projected expenditures has come from the acceleration of the Federal pay raise, which added a little over $1 billion
to expenditures in the current fiscal year, and a like amount to prospective outlays in fiscal 1971.
curing prior periods of economic slack, a small change of this
kind in the outlook for Federal expenditures would have created scarcely
a ripple in financial markets#

In recent weeks, however, reactions in

financial markets have been dramatic.

Interest rates have increased

sharply, with yields in the long-term markets rising above the peaks of
late last year. A number of factors have been responsible for this
change in market expectations, but concern about Federal expenditures
appears to have been the catalytic agent.

Participants in financial

markets greeted the news of the pay raise as if it were the first in a
series of steps that would let down the bars on Federal spending, and
recent developments in Indochina have intensified this feeling.
Perhaps these reactions are just one more evidence of the
strength of the inflationary fears and expectations still present in
our economy.

However, the public is also mindful that promises of fiscal

-16re&traint emanating from the Executive and the Congress have, time and
again, b&en unfulfilled. We must not permit that to happen in the year
At this juncture of history, the business and financial public
is deeply concerned that the Federal budgetary process may have gotten
out of hatid in recent years*

There is some basis for this concern.

Reforms of the Federal budgetary process are, I believe, essential to
long-run improvement in conducting our stabilization policies and our
battle against inflation.
For the long run, there are a number of budgetary reforms that
will be needed to keep Federal expenditures under control*


I think the concept of zero-base budgeting will have to be adopted in
order to weed out expenditures on outmoded programs whose costs have long
since exceeded their benefits. In other words, we need to have each year
a careful review by the Budget Bureau and the Congress of the total spending proposed on each program, not just the proposed increases in spending.
Progress toward this objective of zero-base budgeting might be
speeded by personnel rotation among the major divisions of the Budget
Bureau, so that a fresh point of view would be brought to bear on the
budget requests of the various departments of government.

But for the

immediate future, the single most constructive step that could be taken
would be a legislative ceiling on Federal expenditures for the coming
fiscal year. This ceiling should be tight enough to give reasonable


assurance that Federal expenditures for fiscal 1971 do not rise
appreciably above the level projected iti the Budget last January.
Alternatively, if expenditures threaten to rise significantly above
that level, taxes should be provided to cover the excess.
In conclusion, I believe that the prospects for a return
to reasonable price stability are brighter than is generally recognized.

Excess demand in our economy has been eliminated.

After a

long period of overheating, the first signs of moderation in price
behavior--though halting and slow—have begun to appear.

It seems

probable, moreover, that economic recovery, as it develops, will
proceed satisfactorily and yet not strain our physical capacities.
The sources of long-run inflationary bias in the United
States, as elsewhere in the world will, of course, continue to

But by applying sensible monetary and fiscal policies,

we can check the inflationary tendencies that emanate from the
pursuit of our social and economic goals.

The clearest lesson of

the past few years is that delay in coping with inflationary
pressures merely compounds the difficulties that need to be faced

Fortunately, this basic fact is now more widely recognized

in the United States and in other industrial countries than it was
ten or even five years ago.