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Statement by

Arthur F. Burns

Chairman, Board of Governors of the Federal Reserve System

before the

Joint Economic Committee

August 3, 1973

I am pleased to meet once again with the Joint Economic
Committee to present the views of the Federal Reserve Board on
the state of our national economy.
In my testimony before this Committee in July 1972, I
presented evidence of a significant strengthening in the pace
of economic expansion.

Recovery was finally underway in

business capital formation, residential construction was moving
up briskly, and consumer buying was continuing its marked
The rate of expansion in aggregate economic activity
rose further in the closing months of 1972, and rapid expansion
continued on into 1973,

The physical volume of production of

goods and services advanced by more than 6 per cent during
the year ending this June, while the output of the nation's
factories and mines rose 9 per cent.
These large increases in production were accompanied
by a growing demand for labor as well as by sizable increases
in average output per manhour.

Civilian employment rose by

nearly 3 million persons during the past 12 months, and the

rate of unemployment dropped from 5.6 per cent to 4.7 per
cent of the labor force.
The pattern of growth in economic activity has been
similar in many respects to that of earlier cyclical expansions.
Thus consumers, besides spending rather freely out of their
increased incomes, borrowed heavily to finance purchases of
autos, furniture, and other durable goods.

Business firms,

meanwhile, enlarged their plant facilities and stepped up their
acquisition of new and more modern equipment.

They also

increased their inventories; but as their sales often rati ahead
of expectations, the over-all ratio of stocks to business sales
actually declined.
These domestic forces of economic expansion were r e inforced by a strong upsurge in export orders.

This June, the

annual rate of our merchandise exports was $21 billion larger
than a year ago - - a rise of 44 per cent.

After allowance for

price increases, the rise was still close to 30 per cent.


extraordinary increase in foreign demand for our products has
had substantial consequences both for production and prices.
The dollar value of our imports also rose rapidly during the
past twelve months; but the increase of about $16 billion in the

annual rate reflected in large part the rise in import prices, and
this rise too left its mark on our general price level.
As this Committee is well aware, prices in the United
States have risen very sharply since the beginning of this year.
In fact, inflationary pressures over the past 6 or 7 months have
been stronger than at any time since the Korean War.
In view of the strong cyclical expansion in production
and employment, it would have been difficult to avoid an appreciable upward tilt of the price level in the best of circumstances.
But as the tides of fortune would have it, several factors of an
unusual character combined to impart to our inflationary problem
a new and more ominous dimension.
First, the wage and price policy of Phase III made it
easier to pass on rising costs to product prices and also, here
and there, to widen profit margins which had been suppressed
Another and far more important development was the coincidence of strong business expansions in the United States and
other countries.

To a degree without parallel since World War

II, economic activity has recently been booming in virtually all
industrial countries.

For example, industrial production during


the past twelve months increased about 7 per cent in Belgium
and the Netherlands, 8 per cent in West Germany, 9 per cent
in France, Canada, and the United Kingdom, and 19 per cent
in Japan.
With production increasing rapidly in the industrial
world, there has been a swelling demand for industrial materials,
machine tools, component parts, and capital equipment - - goods
for which this country is a major source of supply.

The boom

in other countries has thus had a considerable impact on our
domestic markets.
The inflationary dimension of this world-wide boom
became visible after mid-1972, when wholesale prices began
to increase sharply in many countries.

During the past year,

prices at wholesale rose on the average about 6 per cent in
West Germany, 9 per cent in France, 11 per cent in Japan,
and 13 per cent in Canada - - t o mention a few examples.


the end of 1972, the rise in wholesale prices generally accelerated,
and rates of inflation are now even higher than these year-to-year
changes indicate.
The advance of prices has been particularly large for
internationally-traded commodities, such as agricultural products and industrial materials.

The rise in dollar prices of

Sharply higher prices of industrial materials have
also been a prominent feature of the recent accelerated
pace of world-wide inflation.

In the past 12 months, whole-

sale prices of crude industrial materials rose on the average
by 18 per cent in our country, and prices of intermediate
materials increased 8 per cent.

By contrast, wholesale

prices of finished goods other than foods rose about 6 per cent.
Prices of industrial materials typically rise faster
than those of finished goods during a period of cyclical
expansion - - and the more so when rapid economic growth
occurs simultaneously in many countries.

Recent price

developments, however, have also been aggravated by severe
capacity constraints on the production of major industrial

Calculations by the research staff of the Federal

Reserve Board indicate that in the first half of this year the
rate of capacity utilization in major materials-producing
industries - - including petroleum refining, production of
aluminum, steel, cement, synthetic fibers, paper, paperboard, and the like - - was at the highest level since the
second quarter of 1951.
In many of these industries, there has been very little
growth of productive capacity in recent years.


these goods has been much larger than in German marks, Swiss
francs, or Japanese yen, because of the huge decline in the purchasing power of the dollar over these and many other foreign

The depreciation of the dollar thus immediately

affected our price level; but its indirect effects were probably
much larger, first, because rising import prices led to some
substitution of domestic products and thereby served to raise
their prices, second, because a cheaper dollar also gave a
sharp impetus to exports and thereby further reinforced the
pressures of demand on our resources.
The most troublesome aspect of the recent worsening
of inflation in the United States and other countries has been
the rapid run-up in food prices.

At the very time when the

demand for foodstuffs was rising in response to the world-wide
expansion in incomes and employment, world agricultural production was restricted by unusually bad weather conditions in
a number of countries.

In the United States, moreover, the

restrictive effects on output of earlier agricultural policies
were reinforced by disappointing crop harvests and some decline
in production of beef and pork.

The resulting rise in our food

prices was compounded by swelling export demands for agricultural commodities.

controls have held up construction of new plants, have led to
shut-downs of some existing plants, and have prevented the
activation of some older standby capacity.

Moreover, invest-

ment in new capacity was discouraged by the relatively low profits
of our domestic non-financial corporations between 1966 and 1971.
Productive capacity in the paper industry, and also in petroleum
refining, appears to have grown less than 2 per cent per year
during the past several years.

In the cement industry, productive

capacity has shown little or no growth over the past 5 years.
Not a single new cement plant has come into production during
the past year and a half, and only one new petroleum refinery
has been opened since 1969These are sobering facts.

Lack of sufficient attention

to investment incentives in these industries, and to the special
problems they face as a consequence of environmental control
programs, has resulted in shortages of many basic materials
needed by American industry to expand production.

For want

of steel, or aluminum, or industrial chemicals, or adequate
fuel supplies, business firms in various lines of activity have
been unable to increase production rapidly enough to meet the
demands of their customers; unfilled orders have mounted, and
delivery delays have lengthened.

Price pressures originating


in short supplies of major materials have thus been generalized
to semi-finished and finished goods.
In short, our inflationary problem this year has arisen
in substantial measure from sources well beyond the influence
of domestic monetary and fiscal policies.

A world-wide boom

has been underway, the dollar has been devalued, and both agricultural products and basic industrial materials have been in
short supply.

Violent price increases that stem from such

sources cannot readily be handled with customary weapons of
economic stabilization policy.
It now appears, nevertheless, that a somewhat slower
rate of growth in aggregate demand late last year and in the
first quarter of 1973 would have been desirable.


spending rose faster than we at the Federal Reserve Board
had foreseen, and I believe much more than most business
firms had expected.

In the fourth quarter, the growth of real

GNP reached an annual rate of about 8 per cent, and this rapid
pace continued in the first three months of 1973. So high a
rate of expansion is welcome when most lines of activity have
sizable unutilized resources at hand, but it raises problems
when basic industrial materials are in short supply and when
skilled labor is becommg h&fcder to obtain.

Both monetary and fiscal policies moved in the right
direction last year.

In retrospect it appears, however, that

restraint should have been somewhat greater*

True, efforts

to hold the line on Federal budgetary expenditures were successful.

Contrary to widespread expectations, the Presidents

objective of holding Federal expenditures down to $250 billion
was not only reached but in fact exceeded.

Actual budgetary

outlays in the fiscal year just ended fell short of $247 billion.
Nevertheless, a deficit of over $14 billion is still huge; it was
particularly inappropriate at a time of rapidly advancing prosperity; and it played its part in stimulating private spending
and aggravating price pressures.
Monetary policy began to move in the direction of
restraint in the spring of 1972, when mounting pressures in
financial markets were allowed to express themselves in higher
short-term interest rates.

As the year progressed, it became

evident that the rise in short-term interest rates was not
accompanied by moderation in growth of the major money and
credit aggregates to the extent desired.

The Federal Reserve,

therefore, began to move more aggressively toward monetary
restraint last fall.

Margin requirements on common stocks


were raised, and what is far more important, open market
operations were directed toward reducing sharply the rate of
expansion in non-borrowed reserves of commercial banks.
Since the need for bank reserves was growing rapidly at that
time, the rise in the Federal funds rate accelerated, and
member banks turned increasingly to the discount window
as a source of additional reserves.
By the end of last year, member bank borrowings
reached an unusually high level.

In January, therefore, the

Board approved the first in a series of higher discount rates
with a view to discouraging reserve expansion through the
discount window and inducing the commercial banks to restrain
loan expansion.

Altogether, the discount rate has been raised

six times this year to its present level of 7 per cent - - a rate
that our financial markets had not experienced in over fifty

In May, the Board also raised the reserve requirements

applicable to any further increase in the amount of largedenomination certificates of deposit (CDs) outstanding at member

And the Board took the further and, I believe, unprece-

dented step of addressing a request to non-member banks and
agencies or branches of foreign banks to accept voluntarily the

higher reserve requirements imposed on member banks. In
late June reserve requirements were again increased - - this
time on demand deposits of member banks.
Since these restraining moves were taken during a
period when credit demands were unusually heavy, interest
rates on short-term securities increased sharply, and longterm rates followed suit - - although with a lag and to a much
smaller degree.

The yield on 3-month Treasury bills has been

above 8 per cent of late, in contrast to a level of 5 per cent at
the end of last year and 4 per cent at this time a year ago.
And the prime rate of interest on bank loans to large businesses
has increased since the first of January from 5-3/4 to 8-3/4
per cent.
Some classes of loans and securities have remained
sheltered thus far from the strong upward pressures in markets
for short-term securities.

For example, rates on consumer

instalment loans are on the average no higher now than they
were six months or a year ago.

Rates on loans to small busi-

ness firms appear to have increased over the past six months
by little more than 1/2 percentage point - - i n contrast to a ri^e
of 3 percentage points in the prime rate on large business loans.


Mortgage loan rates, however, are up sharply in recent weeks,
although they are still below their earlier peaks in 1970.
All in all, existing interest rates in this country are
clearly much higher than any of us would like.

Some advance

of interest rates is unavoidable during a business-cycle
expansion, particularly when the economy is booming - - a s
it has of late.

But the underlying reason for the high level of

interest rates is the persistence of inflation since 1965.


flationary expectations have by now become fairly well entrenched in the calculations of both lenders and borrowers.
Lenders commonly reckon that loans may be repaid in dollars
whose real value will deteriorate because of inflation, and they
therefore tend to hold out for nominal rates of interest high
enough to ensure them a reasonable real rate of return.
Borrowers, on their part, anticipating repayment in cheaper
currency, are less apt to resist rising costs of credit.
The marking up of nominal rates of interest during
periods of inflation is a process that is much too familiar to
economic historians.

Businessmen and laymen have also seen

its recent manifestation in other countries.

If I accomplish

nothing else this morning, I want to emphasize the simple truth


th at inflation and high interest rates go together and that both
the one and the other pose perils for economic and social
stability in our country.
I wish I could offer hope that the general level of interest
rates will soon decline.
that thought.

I cannot in good conscience encourage

A lasting downward movement of interest rates

cannot be reasonably expected until better control is gained
over the forces of inflation.

Some downward movement of

short-term rates may occur, however, once we achieve a
larger measure of success in moderating growth of the monetary
and credit aggregates.

Progress has been made in this effort,

but less than we had hoped for.
In the first quarter of this year, growth of the narrowlydefined money supply - - that is, currency in circulation plus
demand deposits - - slowed abruptly.

At the time, it appeared

that transitory factors were reducing the public's demand for
money, but that a substantial bulge in the money stock would
probably soon develop.

We therefore persisted in moving

further toward monetary restraint.
As events turned out, the growth of currency and demand
deposits during the second quarter exceeded our expectations.
Taking the two quarters together, the annual rate of growth


averaged 6 per cent.

This was well below the growth rate

during 1972, but greater moderation was needed.
Strenuous efforts were made by the Federal Reserve
to resist the resurgence of monetary expansion during the
second quarter, and these efforts are continuing.

We could,

to be sure, have exerted still stronger resistance to that upsurge in money demand.

Had we done so, we would have run

the risk of stimulating far larger increases in interest rates - increases of a magnitude that might well have created serious
turbulence in financial markets.
In any event, indicators of monetary and credit expansion
other than the narrowly-defined money supply indicate that our
restrictive policy was beginning to bear fruit in the second quarter«
For example, the annual growth rate of total bank credit declined
to about 10 per cent, compared with rates of increase of over 15
per cent in the previous two quarters.

Bank loan expansion,

particularly loans to business, slowed materially, as lending
policies at banks across the country tightened.
These are characteristic signs of developing restraint
in the money and credit markets, and I therefore expect growth
in the narrowly-defined money supply to slow in the very near

Let me make clear, however, that if the restrictive

actions already taken by the Federal Reserve do not reduce
growth of money and credit to an acceptable rate, further
measures will be adopted as needed.
We have thus far avoided a severe stringency in credit

There has, however, been some loose talk of an im-

pending credit crunch, which I believe is traceable to failure
to appreciate the significance of what has been done to minimize
the likelihood of any such event.

Let me therefore try to clarify

this vital dimension of the credit market.
Some weeks ago, the Board suspended the remaining
ceiling rates on large denomination CDs, As a consequence, the
situation that banks now face is very different from that of 1966
or 1969* when inability to bid for CD funds forced banks to act
abruptly and deny access to credit to a, wide range of borrowers.
Under present circumstances, individual banks can obtain funds
in the CD market if they --and ultimately the business firms that
borrow from them— are willing to pay the price.

Of late, as

the cost of CD funds has risen, expansion in the volume of outstanding CDs appears to have moderated.

But let me add that

if further steps are needed to discourage banks from financing
excessive expansion of business loans with CD funds, the Board
could raise once again the reserve requirement on these deposits.


The Board, acting in concert with the Federal Deposit
Insurance Corporation and the Federal Home Loan Bank Board,
has also taken steps to protect the time and savings accounts
of depository institutions, which are the preponderant source
of mortgage funds for homebuilding.

In recent months, as

market rates of interest have become increasingly attractive
to depositors, the inflow of savings funds to banks and other
thrift institutions has dropped substantially.

By lifting the

ceiling on interest rates payable on time and savings accounts,
the regulatory agencies have reduced the danger of severe
stringency in the mortgage market.
Let me now turn briefly to the questions that are
undoubtedly uppermost in the minds of the members of this

What are the prospects for cooling off the economy?

What are the prospects for reducing the rate of inflation?
What are the prospects of an early end to direct controls on
prices and wages?

What are the prospects for regaining

stability in foreign exchange markets?

These are interrelated

and difficult questions; and while neither I nor my colleagues
on the Board have the gift of prophecy, we do have the duty of
advising the Congress to the best of our ability.


There are, we believe, some convincing signs that
economic expansion is slowing to a more sustainable pace.
To give one example, industrial production increased at an
annual rate of around 9-1/2 per cent during the first three
months of this year.

From March to June, the increase

receded to an annual rate of about 6 per cent.
In part, this slowdown has reflected the impact of
capacity constraints on the physical volume of production.
But we also know that the advance of retail sales moderated
and that an actual decline occurred in new housing starts
during the quarter.

All this may portend a more orderly

growth of consumer expenditures, and therefore a lower
rate of expansion in aggregate demand, over the remainder
of 1973. However, the momentum of rising business expenditures for fixed capita and inventories, together with surging
demands for our exports, seem likely to sustain a good rate
of growth in industrial activity for some months yet.
It is against this backdrop of economic conditions that
the prospects for price developments during Phase IV and
beyond must be considered.
The President's decision to terminate the freeze on prices
that went into effect about mid-June came none too soon.


Seriously adverse effects on agricultural supplies had begun
to develop, because in some cases domestic prices were
frozen at levels below production costs or below prices in
foreign markets.

Food prices, therefore, moved up sharply

as soon as the freeze was lifted.
Food prices will probably continue to rise until the supply
of agricultural products increases appreciably once again.
Evidence on that score is discernible, but as yet inconclusive.
The mid-year crop report by the Department of Agriculture
suggests larger harvests of wheat, soybeans, and corn in the
United States.

Our acreage restrictions on agricultural

production, moreover, have now been largely eliminated.
Also encouraging is the fact that more attention is being
given to production of soybeans in the developing nations -notably in Brazil, Mexico, and Argentina.
trends for the longer term.

These are favorable

In the near term, however, we

must be prepared for a continuation of upward pressures on
food prices.
The same is true of many industrial products.


controls imposed on prices of nonfood commodities under
Phase IV are stringent.

Costs can be passed through only


on a dollar-for-dollar basis, and many nonfood commodity
prices will be effectively frozen until about mid-September
because of the 30-day prenotification period.

We cannot,

however, realistically expect results in Phase IV comparable
to those of Phase II.

Economic conditions are very different

now than in the summer and fall of 1971. At that time, we had
substantial slack in labor markets, and a significant part of our
industrial capacity was idle.

Market forces therefore worked

hand in hand with the control program in holding down wage
and price increases.

At that time, also, a more or less

uniform rate of inflation had been underway throughout the
economy for some time.

The control program, consequently,

did not need to allow many significant price increases in order
to prevent disruptions in production or severe inequities.
Under present conditions, the repressing effects of the
control program on prices will not have the support of market

Wage rate increases are creeping up; goods in many

markets are in short supply relative to demand; foreign
orders are there to take up slack that might be created by
faltering domestic demand; import prices are still increasing


as a result of the devaluation of the dollar.
moreover, are badly out of equilibrium.

Relative prices,
Producers have

experienced sharp increases in costs of materials and
supplies over the past six to nine months, and many of
these cost increases have not yet been passed through to
end products.

In the present environment, the controls on

prices and wage rates must therefore be administered with
flexibility and practical wisdom if adverse effects on production and employment are to be avoided.
We have been operating under a system of direct
controls over wages and prices for nearly two years now,
and we can no longer count on benefits to the economy such
as were experienced in Phases I and II.

In view of existing

circumstances, markets should soon be allowed to function
more freely, so that they can perform their accustomed
role in promoting economic efficiency, in encouraging
investment, and in allocating resources to areas of greatest


There is a continuing role for income policies in a
modern economy.

We need to move, however, toward the

elimination of mandatory controls in areas where competition
is reasonably effective in regulating prices and allocating resources.

Over the long run, we will probably need to have

thorough surveillance over wage rates and prices in key industries where competition is inadequate, but the large majority
of wage and price decisions are best left to market forces.


economy has grown and prospered under free enterprise in the

We should not overlook this teaching of our history or its

confirmation in other nations.
If this judgment is accepted, greater reliance in dealing
with inflation - - both in the near future and over the longer term •
will have to be placed on fiscal and monetary policies.
rise of prices in the months ahead is unavoidable.

A further

But the re-

sulting damage can be minimized if excess demand is avoided.
The inflationary forces that now plague us will then have a better
chance to burn themselves out.
The Federal Reserve is prepared to cooperate fully in
this endeavor.

It cannot, however, do the job alone.

fiscal restraint is also needed at this time.


I for one would

support stronger efforts to cut governmental expenditures or


actions to increase taxes.

Particularly appropriate, in my view,

would be fiscal measures - - such as a variable investment tax
credit or a compulsory savings plan - - that could be quickly
reversed, under special legislative rules, if economic activity
began to weaken, as sometimes happens after a prolonged period
of economic expansion.
Evidence of a larger sense of fiscal responsibility in the
United States would help greatly in restoring the confidence in
the dollar that is so badly needed to stabilize foreign exchange

By May of this year, the average dollar price of 10

major currencies (those of Japan, Canada, and 8 European
nations) had risen some 20 per cent above the exchange parities
that prevailed in the spring of 1970. This degree of realignment
was generally regarded by financial authorities as necessary
and helpful.

But in the past 2 to 3 months, our nation's currency

has suffered further depreciation, with the average dollar price
of the above 10 currencies up 7 per cent, as the dollar price of
the mark rose 20 per cent, the French franc 10 per cent, and
the Swiss franc 12 per cent.
This latest depreciation in the value of the dollar cannot
be justified on any realistic evaluation of international price
levels, or underlying trends in our economy, or our balance


of trade or payments.

In 1972, we experienced a trade deficit

of nearly $7 billion - - a condition that had to be corrected and
is being corrected.

By the first quarter of this year the deficit

shrank to an annual rate of less than $4 billion, and in the second
quarter the deficit practically vanished.

Exports will probably

rise substantially further over the remainder of this year and
in 1974, as the effects of our strengthened competitive position

The improvement in our trade balance is therefore

likely to gather momentum, so that by 1974 and 1975 we should
be experiencing a sizable trade surplus for the first time since
the mid-1960 l s.
The recent excessive depreciation of the dollar in relation
to Continental European currencies occurred despite this favorable
outlook for the balance of trade and payments.
be identified with any precision.

Its causes cannot

My own impression is that con-

fidence waned with growing fears that inflation in the United States
may have gotten out of hand.

Other factors undoubtedly played

their role - - among them, the tightening of monetary policies
abroad, especially in West Germany, the sharp speculative runup in the market price of gold, the spread of some uncertainty
abroad about the ability of our government to handle economic
problems effectively, and wild rumors about another devaluation
of the dollar.


The unsettled behavior of exchange markets since midMay has been a cause of serious concern to the monetary
authorities here and abroad.

This concern heightened in early

July, when market conditions for a time became disorderly,
and normal commercial transactions were adversely affected.
In these circumstances, and after full consultation with
the Treasury and representatives of other countries, the Federal
Reserve began to intervene in the exchange market.

As reported

on July 18, in a statement issued jointly by the Board and the
Treasury, intervention will take place in the future at whatever
times and in whatever amounts are appropriate for maintaining
orderly market conditions,
A little over a month ago, I testified before your Subcommittee on International Economics that I had misgivings
about a general system of floating exchange rates.


experience of recent weeks has strongly reinforced my skepticism.
While we should not return to a system of exchange rates as
inflexible as the one that evolved under the Bretton Woods
arrangements, we also cannot afford a system that is subject to
the kind of destabilizing speculation we have seen recently.


A major objective of current negotiations on monetary
and trading relationships is to design and adopt an exchangerate regime that avoids these extremes.

But success in

arriving at monetary arrangements under which international
commerce and investment can flourish will elude us unless steps
are taken, both here and abroad, to bring an end to the nearly
chaotic inflationary conditions that now prevail throughout much
of the world.
The domestic and international tasks that lie ahead of us
are difficult but they are manageable.

They must be seen in

Our nation is experiencing great prosperity; but

it is a marred and joyless prosperity, and so it will remain
until we bring inflation under good control.
until we put our financial house in order.

We cannot do so
A massive step in

this direction would be taken if the Congress adopted this year
proposals for budgetary reform such as were recently put
forward by the Joint Study Committee on Budget Control.


unanimous report favoring early enactment each year of a
ceiling on expenditures, which would be organically related to
the state of Federal revenues and the condition of the economy,
deserves the enthusiastic support of this enlightened Committee.

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