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Testimony before House A p p r o p r i a t i o n s C o m m . January 28, 1976 M r . Burns: Thank you v e r y m u c h , M r . C h a i r m a n . I am not going to try to tell you how to i n f o r m your constituents, and I a m not going to try to p r e a c h a s e r m o n to m y f e l l o w economists. I w i l l s i m p l y tell you what I think. I can s u m m a r i z e b r i e f l y what I have on m y mind and what I would like to convey to this c o m m i t t e e in t h r e e b r o a d propositions. F i r s t , a good r e c o v e r y of e c o n o m i c activity is now under w a y . S e c o d , inflation m o d e r a t e d a p p r e c i a b l y during the past y e a r , but t h e r e is a g r a v e danger that it m a y a c c e l e r a t e again. T h i r d , the c o u r s e of f i s c a l p o l i c y during this year and next will play a d e c i s i v e r o l e in determining whether or not our country can win the battle against inflation. Let m e turn to the f i r s t of t h e s e p r o p o s i t i o n s . A good e c o n o m i c r e c o v e r y has been under way s i n c e A p r i l o r May of last y e a r . The r e c o v e r y has gathered s o m e m o m e n t u m ; in the s e c o n d half of 1975 the physical volume of our nation's total production r o s e at an annual rate of a p p r o x i m a t e l y nine per cent, which is a rather r a p i d rate of i n c r e a s e . -2- Industrial production - - that i s , the output of our f a c t o r i e s , m i n e s and utilities - - g r e w even f a s t e r . Between A p r i l and D e c e m b e r of 1975, industrial production r o s e at an annual rate of 12 per cent. T h e s e gains in production have been w i d e s p r e a d . They started in the nondurable goods fields - - i n the production of t e x t i l e s , leather p r o d u c t s , paper p r o d u c t s , c h e m i c a l s . After m i d - y e a r , the s c o p e of the expansion in production broadened out and m o s t durable goods lines - - such as the m a c h i n e r y and equipment t r a d e s , the m e t a l s industry, and the furniture industry - showed a p p r e c i a b l e gains. The i n c r e a s e s in production led to a m a t e r i a l strengthening in the demand f o r l a b o r . Since M a r c h of last y e a r , total e m p l o y - ment has i n c r e a s e d by 1. 7 m i l l i o n . The f a c t o r y w o r k week has lengthened'. It i s , as of the latest count,one and a half hours l o n g e r on the a v e r a g e than it was last M a r c h . And'the unemployment r a t e has declined f r o m a p p r o x i m a t e l y nine per cent last spring to about eight per cent p r e s e n t l y . A s 1975 ended, the e c o n o m y was moving up at a fast clip. In the month of D e c e m b e r , industrial production r o s e one per cent; e m p l o y m e n t r o s e by a quarter of a m i l l i o n ; r e t a i l s a l e s r o s e by a r e m a r k a b l e t h r e e and a half per cent. In f a c t , the r i s e in retail -3- s a l e s toward the end of last year was so rapid that i n v e n t o r i e s of trade f i r m s actually f e l l . Let m e try now to speculate a little about the future with you. A s I s e e the e c o n o m y , t h e r e is good r e a s o n to e x p e c t that the expansion in production and e m p l o y m e n t w i l l continue in the months i m m e d i a t e l y ahead. Certainly, inventory r e s t o c k i n g w i l l be needed to fill h a l f - e m p t y shelves in many of our f i r m s . The c o n f i d e n c e of c o n s u m e r s is r e t u r n i n g . P e o p l e around the country a r e in a better m o o d now; they a r e spending m o r e f r e e l y and the rate of saving, which w a s r e m a r k a b l y high last y e a r , is diminishing. Our export m a r k e t s a r e s t r o n g . A s you m a y have read in this m o r n i n g ' s paper, w e had a trade surplus in 1975 of $11 billion, Our exports w i l l continue expanding this y e a r , partly b e c a u s e other industrial countries a r e beginning to r e c o v c r . A l s o , p r i c e s , by and l a r g e , have r i s e n l e s s » r a p i d l y in our country than a b r o a d , and A m e r i c a n b u s i n e s s f i r m s a r e in a s t r o n g e r competitive position. The housing industry, as you know, is d e p r e s s e d , but t h e r e has been s o m e i m p r o v e m e n t and I think t h e r e w i l l b e gradual further i m p r o v e m e n t . The b a c k l o g of unsold h o m e s is -4- diminishing. M o n e y is certainly in ample supply at our thrift institutions. The inflow of funds to our m o r t g a g e lending institutions this January appears to be breaking all r e c o r d s f o r that month. B u s i n e s s capital spending, so f a r , has not shown any convincing signs of r e c o v e r y . This is not entirely s u r p r i s i n g b e c a u s e b u s i n e s s investment in f i x e d capital often lags in the recovery process. But I think that there a r e cogent r e a s o n s f o r expecting b u s i n e s s capital investment to j o i n the r e c o v e r y p r o c e s s b e f o r e v e r y long. A s you w e l l know, the stock m a r k e t has b e e n r i s i n g b r i s k l y , i n t e r e s t r a t e s of late have fallen rather s h a r p l y , and c o r p o r a t e p r o f i t s have m o v e d up with c o n s i d e r a b l e v i g o r — in f a c t , with unexpected v i g o r . A l s o , the utilization rate of our manufacturing industries has been r i s i n g . The F e d e r a l R e s e r v e B o a r d maintains an index of the rate of capacity utilization of m a t e r i a l s - p r o d u c i n g industries. That rate was 70 per cent in the f i r s t quarter of 1975, and by the fourth quarter it had r i s e n to 81 per cent. When the o v e r a l l a v e r a g e rate of capacity u s e is 81 per cent, t h e r e w i l l be s o m e industries that a r e w e l l a b o v e that f i g u r e and there w i l l be s o m e f i r m s within individual industries that a r e higher s t i l l . -5- In sum, with an a m p l e supply of m o n e y a v a i l a b l e , with profits i m p r o v i n g , and with the rate of utilization of our f a c t o r i e s r i s i n g , I think w e can r e a s o n a b l y e x p e c t that the capital g o o d s i n d u s t r i e s , b e f o r e v e r y long, will be showing significant expansion once again. Our financial m a r k e t s a r e now in an e x c e l l e n t p o s i t i o n to support further e c o n o m i c r e c o v e r y . Interest rates have declined o v e r the past six months in contrast to what usually happens in the e a r l y stages of a r e c o v e r y . Usually, interest rates begin r i s i n g , and they s o m e t i m e s r i s e s h a r p l y , at about the s a m e t i m e as e c o n o m i c activity starts to r e c o v e r . But interest r a t e s now a r e b e l o w their lows of last June; in f a c t , i n t e r e s t r a t e s on many s h o r t - t e r m s e c u r i t i e s a r e l o w e r now than they have been at any t i m e s i n c e the fall of 1972. The r i s e in stock p r i c e s a l s o f a v o r s the continuance of e c o n o m i c expansion. This is making it e a s i e r for b u s i n e s s f i r m s to r a i s e equity capital. It is a l s o making people f e e l r i c h e r and is thus helping to rebuild c o n f i d e n c e all around. It is a l s o important to note that the liquidity p o s i t i o n of our banks, of our thrift institutions, and of our b u s i n e s s f i r m s has i m p r o v e d v e r y m a t e r i a l l y s i n c e the spring and s u m m e r of last y e a r . -6- The c r i t i c a l question, of c o u r s e , is how far and how fast the r e c o v e r y that is now under way will p r o c e e d . In the nature of things, neither I nor anyone e l s e can speak with g r e a t c o n f i d e n c e on this question c o n c e r n i n g the future. But I can say this, with c o n s i d e r a b l e a s s u r a n c e : the strength and the duration of the r e c o v e r y that w e a r e now e x p e r i e n c i n g w i l l depend in l a r g e part on how w e l l this country does in our continuing struggle with inflation. Last y e a r we m a d e significant p r o g r e s s . Consumer p r i c e s r o s e s e v e n per cent last y e a r , c o m p a r e d with an i n c r e a s e of 12 per cent during 1974. W h o l e s a l e p r i c e s r o s e four per cent last y e a r , c o m p a r e d with 21 per cent during 1974. But w e m u s t not b e c o m e c o m p l a c e n t about the i m p r o v e m e n t that has taken p l a c e on the inflation f r o n t , b e c a u s e the p r o g r e s s w e m a d e w.as pretty m u c h concentrated in the f i r s t half of 1975, when e c o n o m i c activity was weak. In the s e c o n d half of 1975, t r o u b l e s o m e signs appeared of a quickening in the pace of inflation. W h o l e s a l e p r i c e s of industrial c o m m o d i t i e s r o s e at a nine per cent annual r a t e , which was m o r e than twice the r a t e of i n c r e a s e in the f i r s t half of 1975. That was a disturbing d e v e l o p m e n t . A l s o , wage rate i n c r e a s e s r e m a i n e d rapid last y e a r . A s you w e l l know, they have been running far above the l o n g - t e r m rate of i m p r o v e m e n t in productivity. If the rate of inflation quickens this y e a r , as m a y happen, that would pose a threat to the continuance of e c o n o m i c r e c o v e r y . If the rate of inflation quickens, the r e s t o r a t i o n of c o n f i d e n c e that is now under way would probably soon c o m e to an end. If the rate of inflation quickens, interest r a t e s would r i s e and financial m a r k e t s might b e c o m e unsettled. If the rate of inflation quickens the flow of funds to our thrift insitutions - - and thus m o r t g a g e c r e d i t supplies - - would tend to dry up, and housing would s u f f e r g r i e v o u s l y o n c e again. C o n s u m e r spending would a l s o tend to weaken, b e c a u s e in our t i m e s c o n s u m e r s r e s p o n d to inflation not by spending at a f a s t e r rate but by saving at a f a s t e r r a t e . This is one of the important l e s s o n s of r e c e n t t i m e s - - a- l e s s o n that as yet is not u n d e r s t o o d w e l l enough. In view of what I have said, it s e e m s to m e that the task for public p o l i c y is eminently c l e a r : w e in g o v e r n m e n t m u s t avoid p o l i c i e s that r e l e a s e a new wave of inflation. T o the extent that we do s o , we w i l l enhance the p r o s p e c t s f o r a v i g o r o u s and durable e c o n o m i c expansion. Now let me say a w o r d or two about m o n e t a r y p o l i c y . We at the F e d e r a l R e s e r v e have been v e r y mindful, not only of the need to expand j o b s in our country, but a l s o of the need to m o d e r a t e the pace of inflation - - b e c a u s e , u n l e s s that happens we will not have good t i m e s in our land. pursued a c o u r s e of m o d e r a t i o n . We have, therefore, -8- During the past y e a r , all of the m a j o r monetarya g g r e g a t e s expanded, at a m o d e r a t e p a c e . Thus, between the fourth quarter of 1974 and the fourth quarter of 1975, the n a r r o w l y defined m o n e y supply - - n a m e l y , c u r r e n c y plus demand d e p o s i t s , frequently r e f e r r e d to as M j - - r o s e f o u r and a half per cent. A m o r e b r o a d l y defined m o n e y supply, which includes a l s o time and savings deposits of c o m m e r c i a l banks except f o r l a r g e c e r t i f i c a t e s of d e p o s i t , r o s e eight per cent during that period. T h e s e i n c r e a s e s p r o v e d to be sufficient not only to finance a v i g o r o u s r e c o v e r y in the physical v o l u m e of e c o n o m i c activity; they p r o v e d s u f f i c i e n t a l s o , I am s o r r y to say, to finance a m o d e r a t e l y high rate of inflation. M o r e o v e r , i n t e r e s t rates f e l l m a t e r i a l l y , and this indicates that the m o d e r a t e r a t e s of expansion in the m o n e t a r y a g g r e g a t e s w e r e fully s u f f i c i e n t , if not m o r e than s u f f i c i e n t , to take c a r e of the nation's l e g i t i m a t e needs. We at the F e d e r a l R e s e r v e have the f i r m intention of staying with a c o u r s e of m o d e r a t i o n in m o n e t a r y p o l i c y . C l e a r l y w e need continued growth in e c o n o m i c a c t i v i t y ; c l e a r l y this growth needs to be financed. We e x p e c t to p r o v i d e -9- sufficient money and c r e d i t to finance a s a t i s f a c t o r y r a t e of expansion, but w e do not have the slightest intention of throwing caution to the winds and of taking the r i s k of rekindling inflation. The p r i n c i p l e s which a r e guiding m o n e t a r y p o l i c y at the present time should, in m y judgment, a l s o shape the c o u r s e of f i s c a l p o l i c y if our country is to r e g a i n any chance of lasting prosperity. I need hardly r e m i n d this c o m m i t t e e that s i n c e I960 w e have had a d e f i c i t in our f e d e r a l budget e v e r y y e a r but o n e . I need hardly r e m i n d this c o m m i t t e e that in the ten f i s c a l y e a r s f r o m 1968 through 1977, taking account of the P r e s i d e n t ' s r e c e n t l y announced budget, the f e d e r a l budget d e f i c i t w i l l have e x c e e d e d $20 b i l l i o n in six y e a r s . And I need h a r d l y r e m i n d this c o m m i t t e e that in the five y e a r s ending with f i s c a l y e a r 1976, the d e f i c i t in the unified budget w i l l have cumulated to about $160 b i l l i o n . And if we take o f f - b u d g e t o u t l a y s into account - - a s w e should, and as I hope M r . Lynn soon w i l l - the total r i s e s to o v e r $180 billion. The P r e s i d e n t has r e c o m m e n d e d a budget f o r the coming f i s c a l y e a r which a i m s to slow down m a t e r i a l l y the rate of i n c r e a s e in f e d e r a l spending. P a r t l y f o r that r e a s o n and partly a l s o b e c a u s e of expected i n c r e a s e s in r e v e n u e s , -10- the budget d e f i c i t is p r o j e c t e d to d e c l i n e f r o m $76 b i l l i o n in f i s c a l 1976 to $43 billion in f i s c a l 1977. I would certainly like to s e e f a s t e r p r o g r e s s in reducing the d e f i c i t , but I do r e c o g n i z e that the d e f i c i t now r e s u l t s in l a r g e part f r o m the fact that e c o n o m i c activity is w e l l b e l o w the full e m p l o y m e n t l e v e l . The P r e s i d e n t ' s r e c o m m e n d a t i o n to cut back on the growth of f e d e r a l expenditures and a l s o to cut taxes s t r i k e s m e as sound. F e d e r a l expenditures have been growing v e r y rapidly in our c o u n t r y . A c c o r d i n g to m y c a l c u l a t i o n s , y e a r total g o v e r n m e n t a l expenditures at the f e d e r a l , last state and l o c a l l e v e l s amounted to something like 38 o r 39 per cent of the dollar value of our nation's p r o d u c t i o n . i has been growing p r o g r e s s i v e l y over the y e a r s . s e c t o r in olir e c o n o m y is shrinking. That p e r c e n t a g e The private W e m u s t not o v e r l o o k the fact that the private s e c t o r has been the s o u r c e of strength and vitality of our e c o n o m y . I hope that the C o n g r e s s w i l l , in g e n e r a l , f o l l o w the r e c o m m e n d a t i o n s in the P r e s i d e n t ' s budget m e s s a g e . I am speaking of o v e r a l l t o t a l s , not of the details of the budget. This c o m m i t t e e can s e r v e a vital national function. I trust that you w i l l b e a r c a r e f u l l y in m i n d , as you have in the past, -11- the urgent need of this country to f o l l o w a c o u r s e of f i s c a l prudence and that you, M r . Chairman, and your c o l l e a g u e s on this c o m m i t t e e , w i l l bring your g r e a t influence to bear on the thinking of your c o l l e a g u e s on the Budget C o m m i t t e e and on the l e g i s l a t i v e c o m m i t t e e s . Thank you v e r y much, M r . Chairman.
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