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Ebr release on delivery Sunday, May 26, 1974 4:00 PM CDT (5:00 PM EDT) The Menace of Inflation Address by Arthur F. Burns Chairman, Board of Governors of the Federal Reserve Syster at the 141st Commencement Exercises Illinois College Jacksonville, Illinois May 26, 1974 It is a pleasure to be with you today here in the heartland of America. As graduates of this College, you are launching your careers at a challenging but troubled time. Confidence in established institutions, particularly in our government, is at a low ebb. And hopes for the future of our economy have been shaken by the debilitating effects of inflation on the nation's businesses, workers, and consumers. Inflation is not a new problem for the United States, nor is it confined to our country. Inflationary forces are now rampant in every major industrial nation of the world. Inflation is raging also in the less developed countries, and apparently in socialist countries as well as in those that practice free enterprise. The gravity of our current inflationary problem can hardly be overestimated. Except for a brief period at the end of World War II, prices in the United States have of late been rising faster than in any other peacetime period of our history. If past expe- rience is any guide, the future of our country is in jeopardy. No country that I know of has been able to maintain widespread economic prosperity once inflation got out of hand. And the unhappy consequences are by no means solely of an economic -2- character. If long continued, inflation at anything like the present rate would threaten the very foundations of our society. I want to discuss briefly with you today the sources of our inflationary problem, the havoc being wrought in the economy, and the steps that must be taken to regain general price stability and thus strengthen confidence in our nation's future. A large part of the recent upsurge in prices has been due to special factors. In most years, economic trends of in- dividual nations tend to diverge. But during 1973 a business- cycle boom occurred simultaneously in the United States and in every other major industrial country. With production rising rapidly across the world, prices of labor, materials, and finished products were bid up everywhere. To make matters worse, disappointing crop harvests in a number of countries in 1972 forced a sharp run-up in the prices of food last year. The manipulation of petroleum supplies and prices by oil-exporting countries gave another dramatic push to the general price level last autumn and early this year. The influence of these factors is still being felt in consumer markets. Recently, our price level has also reacted strongly to the removal of wage and price controls - - a painful, but essential adjustment in the return to free markets. -3- These special factors, however, do not account for all of our inflation. For many years, our economy and that of other nations has had a s eric as underlying bias toward inflation which has simply been magnified by the special infxuences that 1 have mentioned. Ironically, the roots of that bias lie chiefly in the rising aspirations of people everywhere. We are a nation in a hurry for more and more of what we consider the good things of life. I do not question that yearning. Properly directed, it can be a powerful force for human betterment. Difficulties arise, however, when people in general seek to reach their goals by means of short cuts; and that is what has happened. Of late, individuals have come to depend less and less on their own initiative, and more on government, to achieve their economic objectives. The public nowadays expects the government to maintain prosperous economic conditions, to limit such declines in employment as may occasionally occur, to ease the burden of job loss or illness or retirement, to sustain the incomes of farmers, homebuilders, and so on. These are laudable objectives, and we and other nations have moved a considerable distance toward their realization. Unfortunately, in the process of doing so, governmental budgets have gotten out of control, wages and prices have become less responsive to the discipline of market forces, and inflation has emerged as the most dangerous economic ailment of our time. The awesome imbalance of the Federal budget is probably the contributory factor to inflation that you have heard the most about. In the past five years, total Federal expenditures have increased about 50 per cent. In that time span, the cumu- lative budget deficit of the Federal government, including government-sponsored enterprises, has totaled more than $100 billion. In financing this deficit, and also in meeting huge demands for credit by businesses and consumers, tremendous pressures have been placed on our credit mechanisms and the supply of money has grown at a rate inconsistent with price stability. I am sure that each of you in this graduating class is aware of some of the troublesome consequences of inflation. The prices of virtually everything you buy have been rising and are still going up. For the typical American worker, the increase in weekly earnings during the past year, while sizable in dollars, has been wiped out by inflation. In fact, the real weekly take-home pay of the average worker is now below what it was a year ago. Moreover, the real value of accumulated savings deposits has also declined, and the pressure of rising prices on family budgets has led to a worrisome increase in delinquency rates on home mortgages and consumer loans. Many consumers have responded to these developments by postponing or cancelling plans for buying homes, autos, and other big-ticket items. Sales of new autos began to decline in the spring of 1973, and so too did sales of furniture and appliances, mobile homes, and newly built dwellings. The weakness in consumer markets, largely engendered by inflation, slowed our economic growth rate last year some months before the effects of the oil shortage began to be felt. Actually, the sales of some of our nation's leading business firms have been on the wane for a year or more. Their costs, meanwhile, have continued to soar with increasing wage rates and sharply rising prices of materials. The effect on business profits was ignored for a time because accountants typically reckon the value of inventories - and also the value of machinery and equipment used up in production - - a t original cost, rather than at current inflated prices. These accounting practices create an illusory element -6- in profits - - a n element that is not available for distribution to stockholders in view of the need to replace inventories, plant, and equipment at appreciably higher prices. Worse still, the illusory part of profits is subject to the income tax, thus aggravating the deterioration in profits. This result is especially unfortunate because of the shortage of industrial capacity that now exists in key sectors of our economy - - particularly in the basic materials area. By early this year, a confrontation with economic reality could no longer be put off. Major business corporations found that the volume of investible funds generated internally was not increasing fast enough to finance the rising costs of new plant ,and equipment, or of the materials and supplies needed to rebuild inventories. Businesses began to scramble for borrowed funds at commercial banks and in the public markets for money and capital. Our financial markets have therefore come under severe strain. Interest rates have risen sharply; savings flows have been diverted from mortgage lending institutions; security dealers have experienced losses; prices of common stocks have declined; the liquidity of some enterprises has been called into question; and tensions of a financial nature have spilled over into international markets. Concerned as we all are about the economic consequences of inflation, there is even greater reason for concern about the impact on our social and political institutions* We must not risk the social stresses that persistent inflation breeds. Because of its capricious effects on the income and wealth of a nation's families and businesses, inflation inevitably causes disillusionment and discontent. It robs millions of citizens who in their desire to be self-reliant have set aside funds for the education of their children or their own retirement, and it hits many of the poor and elderly especially hard. In recent weeks, governments have fallen in several major countries, in part because the citizens of those countries had lost confidence in the ability of their leaders to cope with the problem of inflation* Among our own people, the distortions and injustices wrought by inflation have contributed materially to distrust of government officials and of government policies, and even to some loss of confidence in our free enterprise system. Discontent bred by inflation can provoke profoundly disturbing social and political change, as the history of other nations teaches. I do not believe I exaggerate in saying that the ultimate consequence of inflation could well be a significant decline of economic and political freedom for the American people. There are those who believe that the struggle to curb inflation will not succeed and who conclude that it would be better to adjust to inflation rather than to fight it. On this view, contractual payments of all sorts - - wages, salaries, social security benefits, interest on bank loans and deposits, and so on - - should be written with escalator clauses so as to minimize the distortions and injustices that inflation normally causes, This is a well-meaning proposal, but it is neither sound nor practical. For one thing, there are hundreds of billions of dollars of outstanding contracts - - on mortgages, public and private bonds, insurance policies, and the like - - that as a practical matter could not be renegotiated. Even with regard to new' undertakings, the obstacles to achieving satisfactory escalator arrangements in our free and complex economy, where people differ so much in financial sophistication, seem insuperable. More important still, by making it easier for many people to live with inflation, escalator arrangements would gravely weaken the discipline that is needed to conduct business and government affairs prudently and efficiently. Universal escalation, I am therefore convinced, is an illusory and dangerous quest. The responsible course is £b ftght inflation with all the energy we can muster and with j&lll the. we^P/ons at our command. One essential ingredient in this struggle is continued resistance to swift growth in money and credit. The Federal Reserve System, I assure you, is firmly committed to this task. We intend to encourage sufficient growth in supplies of money and credit to finance orderly economic expansion. But we are not going to be a willing party to the accommodation of rampant inflation, As this year's experience has again indicated, a serious effort to moderate the growth of money and credit during a period of burgeoning credit demand results in higher interest rates - particularly on short-term loans. Troublesome though this rise in interest rates may be, it must for a time be toleratedFor, if monetary policy sought to prevent a rise in interest rates when credit demands were booming, money and credit would expand explosively, with devastating effects on the price level. Any such policy would in the end be futile, even as far as interest rates are concerned, because these rates would soon reflect the rise in the price level and therefore go up all the more. We must not let that happen. But I cannot emphasize too strongly that monetary policy alone cannot solve our stubborn inflationary problem. We must -10- work simultaneously at lessening the powerful underlying bias toward inflation that stems from excessive total demands on our limited resources. This means, among other things, that the Federal budget has to be handled more responsibly than it has been in the past. Incredible though it may seem, the Congress has been operating over the years without any semblance of a rational budget plan. The committees that consider spending operate independently of the committees that consider taxes, and appropriations themselves are treated in more than a dozen different bills annually. All of this means that the Federal budget never really gets considered as a whole - - a fact which helps explain why it is so often in deficit. Fortunately, after many years of advocacy by concerned citizens and legislators, this glaring deficiency in the Congressional budget process is about to be remedied. Bills that would integrate spending and taxing decisions have passed both the House and the Senate. This is a most encouraging development, and we may confidently expect final action soon by the Congress on this landmark legislation. Procedural changes, however, will mean little unless the political will exists to exploit the changes fully. And this can happen only if the American people understand better the nature of the inflation we have been experiencing and demand appropriate action by their elected representatives. As you leave this hall today, I urge you to give continuing thought and study to the problem of inflation. will affect your personal lives profoundly. If it persists, it Where possible, I urge you to assume a leadership role in getting people everywhere interested in understanding inflation and in doing something about it. In the great "town hall11 tradition of America, much can be accomplished if people organize themselves - - i n their offices, tra.de unions, factories, social clubs, and churches -• to probe beneath the superficial explanations of inflation that are the gossip of everyday life. Productivity councils in local communities and enterprises, established for the purpose of improving efficiency and cutting costs, can be directly helpful in restraining inflation. While I am on the subject of what individuals can do to be helpful, let me note the need for rediscovery of the art of careful budgeting of family expenditures. In some of our busi- nesses, price competition has atrophied as a mode of economic behavior, in part because many of our families no longer exercise -12- much discipline in their spending. We have become a nation of impulse shoppers, of gadget buyers. We give less thought than we should to choosing among the thousands of commodities and services available in our markets. And many of us no longer practice comparative price shopping - - not even for big-ticket items. Careful spending habits are not only in the best interest of every family; they could contribute powerfully to a new emphasis on price competition in consumer markets. I do not expect that the path back to reasonable price stability can be traveled quickly. Indeed, our government will need to take numerous steps to reduce the inflationary bias of our economy besides those I have emphasized. The forces of competition in labor and product markets need to be strengthened perhaps by establishing wage and price review boards to minimize abuses of economic power, certainly through more vigorous enforcement of the anti-trust laws, besides elimination of barriers to entry in skilled occupations, reduction of barriers to imports from abroad, and modification of minimum wage laws to improve job opportunities for teenagers. Impediments to increased pro- duction that still remain in farming, construction work, and other -13- industries need to be removed. And greater incentives should be provided for enlarging our capacity to produce industrial materials, energy, and other products in short supply. But if inflation cannot be ended quickly, neither can it be eliminated without cost, Some industries will inevitably operate for a time at lower rates of production than they would prefer* Government cannot - - and should not - - try to compensate fully for all such occurrences. Such a policy would involve negating with one hand what was being attempted with the other. But government does have a proper ameliorative role to play in areas, such as housing, where the incidence of credit restraint has been disproportionately heavy. The special burden that has fallen on homebuilding should be lightened, as is the intent of the housing aids which the Administration recently announced* And my personal judgment is that it would be advisable, too, for government to be prepared, if need be, to expand the roster of public-service jobs. This particular means of easing especially troublesome situations of unemployment will not add permanently to governmental costs. And in any event, it would conflict much less with basic anti-inflation objectives than would the conventional alternative of general -14- monetary or fiscal stimulus. A cut in personal income taxes, for instance, would serve to perpetuate budget deficits* Not only that, it might prove of little aid to the particular industries or localities that are now experiencing economic difficulty. Much the same would be true of a monetary policy that permitted rapid growth of money and credit. There is no justification for such fateful steps at this time. In concluding, I would simply repeat my central message: there is no easy way out of the inflationary morass into which we have allowed ourselves to sink through negligence and imperfect vision. But I am confident that we will succeed if the American people become more alert to the challenge. I hope that the members of this graduating class will join with other citizens across the country in a great national crusade to put an end to inflation and restore the conditions essential to a stable prosperity - - a prosperity whose benefits can be enjoyed by all our people. This objective is within our means and is essential to our nation's future.
@FedFRASER