View original document

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

ftor release on delivery

Statement by-

Arthur F. Burns

Chairman, Board of Governors of the Federal Reserve System

before the

Committee on Appropriations

House of Representatives

February 21, 1974

I appreciate this opportunity to assist the Committee in
its over-all examination of the budget for fiscal 1975. My comments
will be brief.

They are directed, first, to the general outlook for

the economy in the near-term future, second, to the implications
of prospective developments for stabilization policy in the year
ahead, third, to needed reforms in our fiscal policies and procedures.

Outlook for the Economy
The nation faces at the present time a severe shortage of
petroleum products that is slowing business activity and aggravating
our inflationary problem*

Some firms have been unable to obtain

the raw materials or other supplies needed to maintain production
schedules; others have experienced a weakening in the demand for
their products*

The oil shortage has had particularly adverse effects

on the purchase of new autos, of homes in outlying suburban areas,
of recreational vehicles and other travel-related goods and services*
A downward adjustment of production and employment is
therefore underway.

Industrial output declined in December and

again in January, and unemployment last month rose rather sharply,
to 5o 2 per cent of the labor force,

I would expect some further

weakening of economic activity, with industrial production probably
declining and unemployment rising in the months immediately ahead.

- 2-

The current economic slowdown, however, does not appear
to have the characteristics of a typical business recession.


in employment and production have been concentrated in specific
industries and regions of the country, rather than spread broadly
over the economy,

In some major sectors, the demand for goods

and services is still rising.

Capital spending plans of business

firms remain strong, and so do inventory demands for the many
materials and components in short supply.

In fact, new orders

for business capital equipment continued to increase in the fourth
quarter of last year* and the backlog of unfilled orders rose further,
to a level 17 per cent above a year earlier.
Expenditures by businesses for fixed capital will probably
continue to strengthen in view of the urgent need for added capacity
in a number of our basic industries.

Residential construction may

pick up later in the year, in response to the improvement that has
been occurring in mortgage credit supplies,

With government

expenditures at all levels also moving higher, as seems virtually
certain* it seems unlikely at present that the current economic
slowdown will become pervasive or be of extended duration.

- 3-

The oil shortage is causing hardships for some of our
people and inconveniences for many,

In some other countries,

the adjustments to the energy problem will be more severe than
for us.
However, our nation's business firms and consumers
already have found ways to economize on their uses of oil and
other forms of energy.

For example, there have been significant

declines during recent months in the use of fuel oil and electricity
across the nation.

As 1974 moves on, I would expect these

adjustments to continue.

Domestic output of crude oil will

increase gradually; electric utilities will shift to greater use of
coal; auto manufacturers will expand their capacity to produce the
smaller cars demanded by consumers; and myriad other adjustments
will be made to the energy problem.

We are living in a difficult

time, but our principal asset - - the resourcefulness of the American
people - - remains intact*

In numerous ways we are, even now,

laying the basis for recovery in business activity.
The durability of that recovery will depend heavily on
our ability to gain control of the inflation that has been ravaging
our economy for the past 8 or 9 years.

Last year, fresh

inflationary forces - - reinforcing those already plaguing us —
culminated in the sharpest upsurge of the price level since the

- 4-

Korean War.

Even before the disruptive manipulation of oil

shipments and prices by some oil-exporting countries got under
way, the erosion of workers' real earnings and the soaring of
interest rates - - both of which were a consequence of the
inflation - - had begun to restrict consumer demand, particularly
the purchase of new homes.
A major source of the inflationary problem last year
was the coincidence of booming economic activity in the United
States and other countries in the latter part of 1972 and much
of 1973. Production of strategic commodities approached
capacity limits throughout the industrial world, and inflation
accelerated everywhere.

In our country, the effects of world-

wide inflation were magnified by the depreciation of the dollar
relative to other currencies in foreign exchange markets.


make matters worse, disappointing harvests in 1972 -« both
here and abroad - - caused a sharp run-up in the prices of food
products last year, and the spectacular advance in the prices
of crude oil and petroleum products since last fall has greatly
worsened the inflationary problem.

In addressing this Committee, I cannot stress strongly
enough the urgency of making some headway this year in reducing
the rate of increase in prices.

Failure to do so will further injure

tens of millions of our families, and it may destroy confidence in
the capacity of government to deal with an inflationary problem that
has been retarding economic progress and sapping the energies of
our people.
Improvement in the price performance of our economy during
1974 is? I believe, within our means.

The rise in consumer prices

should moderate later this year as petroleum prices level off in
response to the drastic adjustments now under way in oil markets
around the world, and as our own food supplies expand in response
to incentives for farmers to increase production.
favorable price developments on the horizon.

There are other

A slower pace of

economic activity, both here and abroad, may well cause a decline
in the prices of industrial raw materials and internationally traded

Also, the appreciation of the dollar over recent

months in foreign exchange markets should make imported goods
less expensive and moderate the demand for our exports, thereby
increasing the supply of goods available in domestic markets.

Realistically, however, we can hardly expect a return to
general price stability in the near future.

Substantial increases

in the prices of numerous commodities and services are practically
unavoidable this year.
out of balance.

Relative prices of many items are now badly

Prices of materials, for example, have recently

risen very swiftly, and many of these cost increases are still to
be passed through to the prices of end products,
A more fundamental factor affecting the course of inflation
in 1974, however, may well be the course of wages and unit labor

Increases in wage rates have been edging up since last


The collective bargaining calendar for this year is heavy

and includes several pattern-setting industries.

It would not be

surprising if workers sought appreciably larger wage increases to
protect their living standards against the persistent rise in prices
they have to pay for groceries and practically everything else they

But if economic activity proceeds sluggishly this year, as

now seems likely, productivity gains will probably be even smaller
than they were last year.

A rise of wages that is faster than we

have recently experienced would therefore put great upward
pressure on costs of production and ultimately on prices.

Stabilization Policies in the Year Ahead
Since strong inflationary forces are likely to continue in
1974, even in the face of declines in production and employment,
public policy is now clearly confronted with a most difficult problem.
Inflation cannot be halted this year.

But we can move

resolutely to establish this year a dependable framework for a
gradual return to reasonable price stability.

Direct controls over

prices and wages will not be of much further benefit in this effort,
New machinery for reviewing wages and prices in pace-setting
industries can, however, prove helpful; and so too may a concerted
effort to enlarge our capacity to produce industrial materials.


in the end, inflation will not be brought under control unless we have
effective management of aggregate demand through general monetary
and fiscal policies,
In the current economic slowdown, the task of monetary
policy will not be the same as in a classical business recession,
when a considerable easing in the supply of money and credit can
be expected to provide the financial basis for the subsequent recovery,
This year, our nation1 s capacity to produce may actually decline, or
at best rise at an abnormally low rate,

A great deal of caution will

therefore be needed in framing monetary policy.

An easier monetary

policy can be only a marginally constructive influence when economic
activity slows because of a shortage of oil.
Fiscal policy can be used to better advantage than monetary
policy in promoting prompt recovery in this kind of economic

Selective measures such as an expanded public

employment program, increased unemployment benefits, or some
liberalization of welfare payments in hard-hit areas
to cushion the adjustment to fuel shortages.

may be needed

Also, a selective tax

policy of accelerated amortization could stimulate investment in the
energy and other basic materials industries, thereby relieving the
more critical shortages of capacity that have recently proved so
Current economic conditions may therefore justify special
fiscal measures of the kind I have mentioned.

But I would strongly

advise against adoption of a generally stimulative fiscal policy, such
as a broad tax cut or substantially enlarged expenditures. It is not
clear that a strong dose of fiscal stimulus is needed now, and we
surely need to proceed cautiously at a time when the price level is
still soaring,

Let me remind you that last month alone the wholesale

price level rose over 3 per cent.

An overly expansive fiscal policy now would delay, perhaps
delay for many years, the progress which the Congress has been
seeking in the use of the Federal budget as a tool of economic

A moderate increase of expenditures in fiscal year

1975 seems unavoidable in view of the sharply higher social, security
benefits enacted last year, the higher governmental salaries and
procurement prices, and the recently rising claims for unemployment compensation.

All this is forcing up Federal outlays at the

same time that a decline in business activity is slowing the growth
of tax receipts.

Taken by itself, a moderate deficit in fiscal 1975

should not be particularly disturbing.

But we have had deficits far

too often over the years, and this pattern has raised serious doubts
about our government's ability to exercise rational control over its
tax and expenditure policies.

Fiscal Policy in the Years Ahead
Since 1950, we have had deficits in four years out of five,
and the size and frequency of those deficits has tended to increase
over the years.

Whether this record came about by choice or, as

I prefer to believe, largely by accident, it has contributed significantly
to the dangerous inflation we are now experiencing.

- 10 -

The economic consequences of inflation are perhaps more
apparent to American families now than at any time in recent history.
In the past year, the average worker's purchasing power diminished
in spite of rather large nominal increases in his paycheck.


rates rose sharply, reflecting anticipation of further declines in the
value of future dollar obligations.

As their real earnings fell and

interest rates rose, consumers hesitated to take on large new
commitments, and the sale of houses, mobile homes, and other
durable consumer goods suffered accordingly.

While the profits

reported by corporations rose substantially in 1973, they were in
part illusory because business accountants are still reckoning
depreciation on the basis of historical costs rather than the everrising replacement costs.

Reflecting a more sombre view of

earnings prospects, the prices of corporate stocks fell sharply.
And, even ignoring common stocks, the real value of the financial
assets held by individuals actually declined during 1973; in other
words, the nominal increase

of this basic financial aggregate was

more than nullified by the rise in the consumer price level.
Numerous measures will be needed to restore general
price stability.

Among these, none is more important in my

judgment than reform of the Federal budget.

To those who believe

- ii -

that the Congress over the years has deliberately and consistently
chosen to stimulate the economy by deficit spending, prospects for
improving matters must appear to be bleak.

But I draw encouragement

from a conclusion that I conceive to be closer to the truth: namely,
that many, perhaps half, of the deficits in recent decades have come
about not by design, but because of a basic defect in the procedures
by which Congress acts on the budget.
Fiscal policy has not been overly stimulative by choice,
but rather because Members of Congress have been unable to vote
on the kind of fiscal policy they desire.

The decisions that determine

the ultimate shape of the budget are made in Congress each year by
acting on some 150 to 200 separate measures.

This process denies

Members a vote on much more important issues - - what total
expenditures should be, how they should be financed, and what
priorities should be assigned among competing programs.
In this process, the earnest efforts of this Committee to
control expenditures have been frustrated.

Year in and year out,

the appropriations enacted have totalled less than the executive
branch requested.

At the same time, however, the legislation

reported by other committees has inexorably pushed outlays to
higher levels, and over the years these increases have more than
offset the reductions effected in appropriation bills.

1 9

The House has now passed a budget reform bill, thanks to
the vigorous efforts of Members of this Committee, along with other
Members of the House of both political parties, liberals and conservatives alike.

This historic step reflects a growing awareness that

budget reform is essential not only for a return to stable prices,
but for restoration of confidence in government itself.

The day is

past - - i f indeed it ever existed - - when only the well-to-do need
concern themselves with economy in government.

Those who would

use government as an instrument of reform have perhaps a larger
stake in eliminating wasteful or relatively unproductive programs,
We have passed the point when new programs can be safely
added to old ones and paid for by heavier borrowing.

In principle,

taxes can always be raised to pay for more public services, but the
resistance to heavier taxation has become compelling.

If we count

outlays at all levels of government, State and local as well as Federal,
an increasingly large fraction of the wealth our citizens produce is
being devoted to the support of government.

In 1929, total government

spending came to about 10 per cent of the dollar value of our national

Since then the figure has risen to 20 per cent in 1940, 30 per

cent in 1965, and 35 per cent in 1973. My impression is that most
citizens feel that one-third of our national output is quite enough for
the tax collector.

- 13 -

Since its revenues are limited, government must choose
among many desirable objectives and concentrate its resources on
those that matter most.

That is the very purpose of budgets.

Congress, however, cannot effectively determine priorities under
its present budget procedures.
Once those procedures are modified to enable Congress to
regain control over total outlays and to determine priorities among
competing programs, there should be no occasion for broadscale
impounding of funds by the President.

Occasionally, impoundments

will continue to be called for, as a matter of good management, but
they should not be a source of friction between the Administration
and the Congress, since they will no longer be used to control total
In view of the broad consensus among Members of the House,
there are good reasons to hope that.the Senate will act soon on budget
reform legislation.

If my analysis is correct, the impoundment issue

should diminish in importance once the new budget procedures are
in place.

Enactment of this legislation would be a victory for

representative democracy - - not for conservatives or liberals - because it would give Congress the management tools it needs for
effective exercise of its power over the purse.

- 14 -

Meanwhile, it is encouraging to note the progress being made
towards better budgeting in ways that do not require legislation.
Congress needs better information about the likely costs of existing
and proposed programs, not only in the current year, but up to 3 to
5 years ahead.

The President's budget message last year broke new

ground by presenting estimates in functional detail of the outlays for
fiscal year 1975 as well as for fiscal 1973 and 1974, and this procedure
is carried forward in this yearTs budget message.

Another encouraging

development is the beginning of a consultative process between Congressional leaders and the Office of Management and Budget in connection with the formulation of the budget.
and deepen such consultations in the future.

It would be wise to expand
Involving the Congress

in budget preparation should help to eliminate the delays that have
required increasing use of continuing resolutions and frustrated
efforts to make the budget a really useful management tool.
Finally, I believe that better budget procedures must eventually
include zero-base budgeting.

If we are to get the most out of Federal

outlays, we cannot assume that last year's programs are more beneficial than this year ! s proposals.

All competitors should have equal

opportunity in the contest for Federal budget support; there should
be no grandfather rights.

Both the Executive and the Congress should,

therefore, require justification of the entire appropriation for existing

- 15 -

programs, not just for increases over last year's level.

I realize

this will be difficult to achieve, and it will probably have to take
effect gradually and by stages, but it is so clearly necessary that
we will eventually come to it.
I have offered these comments as a concerned citizen.


am deeply troubled about inflation, as I know you are, and for that
reason alone you will want to make sure that the Administration's
budget requests for fiscal 1975 are fully justified.

But I am also

greatly disturbed by what I sense to be a dangerous loss of confidence
in our government's capacity to make good on its promises.

The key

to rebuilding this confidence is improved performance by government,
and budgetary reform can move us powerfully toward this goal.
Congress must find a way to determine an overall limit on Federal
outlays that will be rationally related to expected revenues and
economic conditions, and establish spending priorities within that

I see that as essential not only to restoring general price

stability, but to regaining the confidence of our citizenry in the
integrity of their government.

>\< >\< >\< >\<.