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For release on delivery

Statement by-

Arthur F« Burns

Chairman, Board of Governors of the Federal Reserve System

Committee on the Budget

House of Representatives

October 2, 1975

I am pleased to meet with this Committee today to
discuss the condition of the national economy and the course
of monetary and fiscal policy.
The American economy is now in process of emerging
from the deepest decline of business activity in the postwar
period.

Total industrial production has risen in each month

since April, and the scope of the recovery is broadening.
At the same time, the demand for labor has been improving.
This August, 1-1/2 million more workers were employed
than in March.

The unemployment rate has declined from a

peak of about 9 per cent in May to about 8 per cent currently*
And the lengthening of the average workweek in our factories
is indicative of a return to more normal production schedules.
As we look back, it is clear that the consumer has led
the way out of recession and into recovery.

Early this yearf

when price concessions became common, consumer purchases
began to pick up«

Retail sales of nondurable goods have risen

briskly, and by this summer exceeded their level in the final
quarter of 1974 by 8 per cent in dollar terms, and 3 per cent
in real terms.

As confidence improved, consumers also became

-2-

more willing to dip into their savings or to incur new indebtedness in order to purchase big ticket items.
for consumer durables have also strengthened.

Thus, outlays
This is

clearly evident in the automobile sector where sales of new
cars have been running recently at around a 10 million annual
rate - - a considerable advance from the 7 million rate recorded
last November.
The spending of consumers has not been the only element
of strength in the economy this year*

A sharp turnaround in

foreign trade has also helped to pave the way for recovery*
Our merchandise trade balance was unfavorable throughout
1974 and reached an unprecedented $9 billion annual rate of
deficit in the third quarter.

But a deep cutback of imports,

especially of fuel and of industrial supplies, occurred during
the recession, while the demand for our exports held up well.
The result was a swing in our trade position to a surplus at an
annual rate of over $13 billion in the second quarter of this
year.

The rise in the value of the dollar in foreign exchange

markets reflects this basic improvement of our international
competitive position.
The sustained buying by foreigners and American consumers at a time of declining industrial production has enabled
business firms to make remarkable progress in clearing their
shelves of excess inventories.

Liquidation of inventories got

-3-

underway around the turn of the year, and by the second quarter
the rate of decline was larger in relation to the gross national
product than in any quarter of the entire postwar period*

The

ratio of stocks to sales began to decline at retail stores in
January; reductions soon followed in factories producing nondurable goods and more recently in durable goods manufacturing*
The improvement in industrial production over recent months
reflects the better balance between inventories and sales that
developed as this inventory adjustment took place.
The basis for recovery was laid in large measure by
adjustments of the private economy that served to correct
the imbalances which had precipitated the recession*

Most

notably, the slowing of inflation helped to rebuild confidence
and led to larger consumer spending early this year.

By the

second quarter, the annual rate of increase in the general price
level had receded to 5-1/2 per cent - - half that of a year earlier•
In the highly competitive environment created by the recession,
business managers found it necessary to devote more attention
to cost controls and improvements in efficiency.

Their efforts

have begun to bear fruit, as is evidenced by the increase in output per manhour during the second quarter - - the first increase
in over two years.

-4-

The self-corrective forces of the recession have been
aided materially by fiscal and monetary policies that sought
to cushion the effects of economic adversity and to provide
some stimulus to economic recovery.

On the fiscal side,

public employment programs were expanded, unemployment
insurance was liberalized, and income taxes were reduced.
The Tax Reduction Act of 1975, besides bolstering consumer
purchasing power, strengthened incentives for business investment in fixed capital.
On the monetary sidef Federal Reserve policies sought
to bring about substantial improvement in financial conditions.
Interest rates - - particularly on short-term loan's and securities moved to. lower levels as a result of declining credit demands
and the efforts of the Federal Reserve to increase the availability of money and credit.

Business corporations made

effective use of the easier credit conditions that have prevailed
this year.

They have issued exceptionally large amounts of long-

term securities, and they have used much of the proceeds to
repay short-term debt or to acquire liquid assets.

Banks and

other financial institutions also have strengthened their liquidity
position.

Consumers too have paid down some of their indebtedness,

while adding substantially to their savings deposits and other
financial assets.

The easing of credit conditions has been helpful to the
severely depressed housing sector.

Lower rates of interest

on market instruments encouraged a larger flow of savings
funds to specialized mortgage lenders; the turn occurred last
fall, and a substantial rise in new mortgage loan commitments
soon followed*

Early this year* the volume of sales of both new

and old dwellings turned up* and these sales are continuing to
run well above their lows of last winter.

With better market

conditions ^ housing; starts - - especially of single-family
dwellings - - have been moving up again*
The recovery process thus appears to be broadening and
gathering momentum,

Monthly statistical reports on employ-

ment cover each of 172 nonfarm industries*

In February, only

17 per cent of these industries reported an increase of employment over the preceding month*

Since then, the percentage of

improving industries has gone up steadily j, and reached 72 per
cent in August*

Industrial production rose 1« 3 per cent in

August? far more than the gain in any of the three previous
months.

The acceleration of industrial activity reflects stronger

consumer demand for goods and services•

It also reflects the

fact that inventory liquidation has slowed, or has given way in
some branches of industry to renewed accumulation.

This is the

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beginning of a process of rebuilding stocks that should provide
considerable thrust to economic activity over the next year.
In addition, many signs now seem to be pointing to an
early turnaround in business fixed investment.

The latest gov-

ernment survey of spending on plant and equipment suggests
that business plans for capital outlays have stabilized.

New

orders for nondefense capital goods already have risen appreciably
from their March trough.

Production of business equipment

increased in August after ten consecutive months of decline.
The decline in contracts for commercial and industrial construction
appears to have ended.

The rate of formation of new firms - - a

useful early indicator of capital investment - - is moving upward
again.

Once expenditures on plant and equipment begin to contribute

to cyclical recovery - - as I believe they soon may - - the pace of
overall economic expansion is likely to become quite vigorous.
The strength of economic recovery, however, could be
undermined by a renewal of strong inflationary pressures.

We

have already witnessed an ominous upsurge in prices during
the third quarter.

Wholesale prices rose at an average

annual rate of 12 per cent in July and August.

Consumer

prices have also advanced more rapidly, though there was
some improvement in August.

To be sure, special factors - -

-7-

Russian grain purchases and the further rise in energy prices - contributed to the spurt in the price indexes, but that is only a
part of the story.

Price increases have also occurred in various

industries - - autos, steel, aluminum, industrial chemicals,
among others - - where considerable slack exists.

And the

recently announced increase in the price of imported oil is
bound to lead to price advances over a wide range of domestic
petroleum products.
These developments must be viewed with concern.

It

was uncontrolled inflation that brought on the severe economic
decline we have recently experienced, and we must recognize
the threat to a sustained recovery embodied in any new wave
of inflation.

Wider expectations and fears of inflation already

are beginning to manifest themselves.

Financial markets - -

specifically the behavior of interest rates and stock prices - have become very sensitive to any indication or suggestion of
accelerating inflation.

History suggests that at this early stage

of a business upturn, confidence in the economic future should
be strengthening steadily.

A revival of consumer and business

confidence is indeed underway, but it is being hampered by concern that a fresh burst of double-digit inflation may develop and,
before long, bring on another recession.

-8-

In setting monetary policy, the Federal Reserve has
been alert to developments in the sphere of prices.

We have

been equally alert to the need to provide the financial basis for
economic recovery.
ground.

In effect, we have sought a prudent middle

This is reflected in the monetary growth paths specified

by the Federal Open Market Committee for the twelve months
ending in the second quarter of 1976 - - that is, growth of 5 to
7-1/2 per cent in M\ (which includes currency plus demand
deposits), 8-1/2 to 10-1/2 per cent in M£ (which includes,
besides Mj, consumer-type time and savings deposits at commercial banks), and 10 to 12 per cent in M3 (which includes,
besides M2* deposits at thrift institutions)•
These growth ranges are appropriate under current
conditions, when the economy is just beginning to emerge from
recession and is still struggling with widespread unemployment
of labor and industrial capital.

However, by historical standards,

these growth ranges are on the generous side, and our economy
would have little or no chance of regaining general price stability
if they were maintained indefinitely.

Even so, the Federal Reserve

System has been frequently urged to raise its present target rates
for the money supply.

We have resisted these suggestions because,

in our judgment, such a p o l i ^ wrcild soon lead to accelerated inflation
and thereby frustrate Him 'pifrasttu. oi economic recovery.

-9-

A similar judgment was reached last spring by the
Senate Committee on Banking, Housing, and Urban Affairs
in its report on the monetary policy oversight hearings.

The

Committee expressed the belief "that pursuit of the monetary
policy plans announced by the Federal Reserve Board will be
helpful to the nation's economic recovery,

!!

and stated un-

equivocally its agreement that nif inflation is rekindled, any
recovery will be shortlived and will end in another recession,
one almost certain to be more virulent than the present one. l!
Late this spring, growth of the various money supply
measures spurted far above the longer-run target ranges as
tax rebates and special social security payments disbursed by
the Treasury were temporarily added to the public's holdings of
currency, demand deposits, and savings accounts.

Some transitory

increase in monetary expansion was viewed as necessary by the
Federal Reserve System, in view of the nature of the fiscal
actions that had been voted by the Congress.

The bulge in the

monetary aggregates was expected to be largely self-correcting
as recipients of the Treasury payments spent the proceeds or
shifted them to more permanent savings forms.

-lO-

In fact, the increase in the money supply was considerably
larger than we had anticipated, and threatened to raise the longerterm monetary growth rates to unacceptably high levels.

The

Federal Reserve therefore set forces in motion to ensure a return
to the more moderate expansion path desired.

These actions,

along with exceptionally heavy Treasury borrowing and the
early signs of economic recovery, served to raise short-term
market rates of interest somewhat.

This appeared to us to be

unavoidable if monetary expansion over the longer run was to
be held within appropriate bounds.

Our policy moves - - and

the subsequent moderation in monetary growth rates during the
summer months - - certainly helped to reassure the business
and financial community that the Federal Reserve would continue
to steer a course toward sustainable economic growth.
The Federal Reserve, however, cannot alone be expected
to assure success in the battle against inflation.

The general

public, as well as the business and financial community, is
watching to see whether Congress and the Administration will
pursue a course of fiscal prudence.

The credit markets cur-

rently face an enormous demand for funds from the Treasury.
Recently, official estimates of Treasury borrowing in the second

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half of this year were raised by $3 to $6 billion because, among
other reasons, expenditures are outrunning earlier projections.
The announcement of this larger need drove interest rates on
Treasury securities to a higher level and served to raise private
borrowing costs as well.

The massive Federal deficit may well

cause a further rise in interest rates, and this can have an
adverse effect on business capital investment and on residential
construction.
Therefore, it is of the utmost importance that this
Committee persuade the Congress to hold expenditures for
fiscal 1976 at or below the levels specified in the First Concurrent Resolution.

Not only that, but this Committee and

the Congress should be seeking ways to pull back on the growth
of Federal spending as the recovery gathers momentum.

Such

a fiscal course will enhance the prospects for regaining price
stability and a lasting prosperity.
I find it disturbing that some economists are today
proposing additional stimulative measures on the basis of
their projections that a larger gain in employment might be
achieved over the next year with minimal effects on the rate
of inflation.

Such recommendations miss the mark for two

-12-

rea^sons.

Fii-st, they fail to take account of the sensitivity to

rising rates of inflation that people in our country and elsewhere have exhibited in recent years.

In practically every

industrial nation, more rapid inflation has led to larger precautionary savings and sluggish consumer buying.

Second,

they fail to look far enough into the future, for it may not be
until two or three years down the road that the full inflationary
impact of more stimulative policies would be felt.

To overlook

these basic facts of economic life is to court disaster.
Once inflation has come to dominate the thinking of
consumers and businesses - - and this I believe to be our
present condition - - there is no longer a meaningful trade-off
between unemployment and inflation.

Even if highly expansionary

monetary and fiscal policies could, for a short time, provide
some additional thrust to economic activity, the resulting
acceleration of inflation would soon create even more difficult
economic problems than we have yet encountered.

The American

people have paid a heavy penalty for past neglect of economic
realities.

The only sound fiscal and monetary policy today is

a policy of prudence and moderation.