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Statement by

Arthur F. Burns

Chairman, Board of Governors of the Federal Reserve System

before the

Joint Economic Committee

July 26, 1972

I am pleased to report to this Committee once again the
views of the Federal Reserve Board on the state of the economy.
Since my appearance before this Committee in February,
evidence has accumulated of a significant strengthening in the pace
of economic expansion.

The output of our Nation's factories and

mines has increased rapidly since last fall and now exceeds the
previous peak rate in September 1969.
Advancing levels of production and sales have resulted
in a larger demand for labor by manufacturing plants, distributive
firms, service establishments, and other places of business.

Total

employment since June of last year has risen by 3 million and the
length of the workweek has generally increased.
The improvement of labor markets has encouraged substantial
numbers of women and younger workers to enter the labor force.

The

ranks of job seekers have also been swelled by a sizable reduction
in the Armed Forces.

As a consequence, unemployment has remained

high despite better job opportunities.

Last month, however, unemploy-

ment did show a heartening decline.
A major source of the quickening tempo of economic activity
has been the recovery in business capital formation.

Confidence of

the business community was bolstered by the governmental measures
adopted last year to moderate inflation and to stimulate employment
and output.

With incentives to invest strengthened, contracts for

business construction and orders for machinery and equipment have
been rising vigorously.

-2Higher residential construction has also been a stimulating
factor.

New housing starts have declined somewhat from the level

reached early in 1972, but the effects of the pronounced rise I D new
housing starts last year are still ramifying.

Sales of furniture and

appliances, for example, have been soaring this year.
Consumer buying generally has been on a marked uptrend
since the late summer of 1971.

Spendable incomes of consumers have

risen steadily and substantially, as employment has increased and
the workweek has lengthened.

After more than 5 years of stagnation,

average weekly earnings of production workers have increased significantly in real terms since last summer.

Confidence in the economic

outlook has improved, and consumers are now borrowing at record rates
to buy new autos and other durable goods.
In short, as we see the economic scene, the current
expansion is now exhibiting the characteristics typical of cyclical
recoveries.

A strong revival of output in the durable goods trades

is under way, employment is rising rapidly, and more and more branches
of production are being caught up in the rising trend of activity.
There is good reason to expect this cumulative process of
business expansion to continue on into 1973.

Inventory accumulation

should provide an upward thrust in the months immediately ahead.
Stocks have fallen to low levels in relation to sales, and it appears
that a pick-up in inventory building is already in process#

Business

investment in fixed capital should continue to be a major expansive
factor, since new orders and contracts for plant and equipment have

-3been moving strongly upward for some time.

If these categories of

business spending rise briskly, as now seems likely, growth rates of
employment and earnings will remain high.

Disposable income will also

gain from a rise in social security benefits this fall and sizable tax
refunds next spring.

With consumers in a more optimistic mood, these

additions to purchasing power should stimulate demand further.
Thus, when I consider the recent course of economic activity
and the prospects for the near-term future, I find reason for optimism.
The expansion in real output and employment has remained orderly and
well balanced.

Most major sectors appear to be poised for a further

rise in activity.

And it seems likely that unemployment will

diminish as real output continues to rise.
Progress has also been made in moderating the rate of
increase in wages and prices. Over the first half of this year,
average hourly earnings in the private nonfarm economy rose at an
annual rate of about 5-1/4 per cent, compared with 6-3/4 per cent
during the first 7 months of 1971. The control program has evidently
had a salutary effect, although competitive forces may also have
served to dampen the rise in wage rates.
Price indexes too indicate some reduction in the rate of
inflation. A comprehensive measure of price performance--the fixedweight index of prices of all private goods and services in the gross
national product—rose over the first three quarters of last year at
an annual rate of about 4.5 per cent.

In the three most recent

quarters, the rate of increase has receded to about 3 per cent.

-4Other price indexes also show improvement.

Thus, consumer

prices since last August have increased at an annual rate of 2.7 per
cent, compared with 3.8 per cent in the first 7 months of 1971. lit
the last 4 months, the annual rate of increase averaged about 2 per cent.
The need for further progress in curbing inflationary pressures
remains great, however, particularly in view of potential developments
in 1973. Next year, collective bargaining agreements covering large
numbers of workers will be reopened in major industries. The negotiations will take place in a climate of improving labor markets and
against the backdrop of a substantial increase in consumer prices over
the past several years.

If wage rate increases should accelerate,

pressures on unit costs of production would intensify. And business
firms would probably take advantage of receptive product markets to
pass on cost increases to customers.
Greater success in our efforts to moderate inflation is
therefore vital.

If costs are to be stabilized, the wage guidelines—

which now permit increases in wage rates well above long-term productivity gains—will need to be lowered.

But any such wage development

will necessitate measures to assure workers that their real earnings
will not be eroded by continuing increases in consumer prices.
A tighter rein on inflation is needed not only to protect
the incomes and savings of our people; it is needed also to restore
equilibrium in our international accounts.

Indeed, I seriously doubt

whether this external objective can be achieved without a stable price
level. The Smithsonian realignment of exchange rates last December

-5laid the basis for a substantial improvement in our competitive
position. But that potential will be dissipated if appreciable
increases in domestic costs and prices continue.
Our international accounts are still seriously out of
balance.

Imports this year have increased substantially further, add

while exports have also risen, our trade deficit has deepened.

Such

a development is not unusual in the months immediately following a
currency depreciation, and the more advanced stage of our economic
recovery relative to that of our major trading partners has undoubtedly
been an aggravating factor. With economic conditions abroad again
improving, the demand for our exports should rise more vigorously over
the near term.

Past experience suggests, however, that 2 or 3 years

may need to elapse before the full benefit of last December's
exchange rate realignment is realized.
The over-all balance of payments was in substantial deficit
during the first quarter. But beginning in mid-March, the over-all
balance became more favorable, due principally to short-term capital
inflows.

Indeed, we actually experienced a balance of payments surplus

between mid-"March and June 23, when the British pound was floated.
In the weeks inm3distely following the Prizish decision,
exchange markets around the world experienced rsnsw^I -curr.w-il, and
a sizable shift of dollars into European central banks occurred.
Most recently, however, order has been re-established on the foreign
exchanges.

The renex^al of market confidence is due in no small measure

to the intervention in the exchange markets by the Federal Reserve in
collaboration with the Treasury.

-^6The recent disturbances of exchange markets provide a clear
warning*

If repetitive monetary crises are to be avoided and an

environment conducive to healthy expansion of foreign trade and
investment is to be preserved, international negotiations on
monetary reform must begin promptly.

The recent disturbances are

also a warning that turmoil in international financial markets may
continue until the United States and its major trading partners find
ways to rid their economies of the inflationary sickness that is
plaguing us all.
Let me turn next to the course that our Nation's monetary
and fiscal policies must pursue to offer hope of solving our inflation
problem, and at the same time facilitate growth in production and
employment.
Typically, expansions in economic activity are accompanied
by pronounced pressures in credit markets, reflecting larger credit
demands as x^ell as more stringent monetary policies.
expansion has been rather free from such pressures.

Thus far, this
Inflows of

savings deposits to nonbank thrift institutions--though below earlier
peaks—remain abundant, and these funds are being used actively in
mortgage lending.

Commercial banks, besides extending substantial

amounts of credit to businesses and consumers this year, have been
able to acquire a record volume of mortgages and to supply a major
part of the funds raised in credit markets by state and local governments.

And although interest rates on short-term securities have

risen from their lows early this year, long-term rates of interest

-7have changed very little.

Actually, interest rates on practically

all classes of loans and securities--including mortgages—are distinctly
below their July 1971 levels.
A major reason for the relative stability of interest rates
was the substantial reduction in the size of the Federal deficit for
fiscal 1972 from earlier expectations.

Moderation in business credit

demands was also a contributing factor.

Retained earnings of corpora-

tions were augmented by the rise in business profits, the release of
funds by the investment tax credit and accelerated depreciation, and
the 4 per cent ceiling on dividends imposed by the Committee on
Interest and Dividends.

Businesses were thus in a good position to

finance their needs for increased investment spending and working
capital from internal sources.
Monetary policy over this past year also contributed to
stability in credit markets.

The Federal Reserve pursued a

course of monetary expansion, so that fears of a
tionary pressures would not be generated.

moderate

new wave of infla-

But the Federal Reserve

also saw to it that the economic recovery Xi/ould not suffer for x^ant
of money or credit.
The moderate course of monetary policy is evidenced by the
major monetary aggregates.

During the 12 months ending in June, the

narrowly defined money supply (currency plus demand deposits) increased
by 5 per cent, or less than the increase in the Nation's real output..
The money supply defined more broadly, so as to include time deposits
other than large-denomination certificates of deposit, rose faster as
consumers built up liquid assets by adding to their time and savings
accounts.

-8*
As this Committee knows, rates of monetary expansion have
recently varied considerably from one quarter to the next. The effects
of such variations on economic activity can easily be exaggerated.
Last fall, for example, growth in money balances slotted sharply, and
concern was voiced in some quarters that the economic expansion would
falter. Actually, there was no shortage of money or credit at that
time.

The abundant supply provided in the first half of last year was

still there to meet the need of consumers and businesses.
slowdown served a useful function.

In fact, the

For it assured the public that

there was no intention to open the monetary spigot in a reckless effort
to stimulate expansion, x^hile wages and prices were being held in
check with direct controls.
The Board recognizes, however, that fluctuations in growth
rates of money and bank credit have at times gone beyond our intentions.
To deal with this problem, techniques of implementing monetary policy
have recently been altered in ways that might permit us to minimize
undesired variations.
Early this year, the Federal Open Market Committee decided
that the pursuit of its monetary goals might be aided by focusing
less heavily on the Federal funds rate as an operating target and
instead giving more weight to the desired growth of the bank reserves
held against private deposits. This change in operating procedure did
not, of course, mean that money and capital market developments x^ould
be disregarded.

It merely 8 £ f t that, in the Committee's judgment,
vai

greater emphasis could be placed on the reserves needed to attain the
desired growth rates or une monetary aggregates, while still giving

-9attention to interest rates and other dimensions of financial markets.
Monetary developments since January seem to confirm that judgment,
but more time \tfill be needed to evaluate properly the new operating
techniques.
At present, the Federal Reserve is in a favorable position
to continue pursuing a path of moderate monetary growth, for economic
expansion thus far has been orderly and supplies of real resources
are still ample.

And if, as seems likely, private credit demands

advance at a temperate pace, interest rates near current levels could
continue to prevail in the months immediately ahead.
Whether or to what degree this desirable outcome is
realized will depend heavily on the state of the Federal budget.

At

the time of the midyear budget review, the deficit projected for
fiscal 1973 was $27 billion.

The recent passage of the social

security bill has raised that figure appreciably.

Supplements to

defense spending not allowed for in the midyear budget review may add
further to the deficit.

And there will be a temporary but potentially

dangerous bulge in the deficit next spring, when large refunds of overwithheld taxes will add to disposable income.

This concentrated fiscal

stimulus could have unfortunate consequences for prices.
I recognise that deficits are difficult to avoid when tax
revenues fall below the levels that would be produced by an economy
operating at full employment.

But in fiscal 1973 the deficit may be

growing at a time when the economy is expanding briskly and the
margins of unused capacity are narrowing.

Such a development would

-10add explosive fuel to the fires of inflation,

I therefore see no

escape from the conclusion that the time has come when the Congress
must put our fiscal house in order.
We stand at a crossroads in our fiscal arrangements.

Many

of our citizens are alarmed by the increasing share of their incomes
that is taken away by Federal, State, and local taxes.

Meanwhile,

Federal expenditures have been rising at a rate well above the grox^th
rate of our national income and product.

The propensity to spend more

than we are prepared to finance through taxes is becoming deep-seated
and ominous.

An early end to Federal deficits is not now in sight.

Numerous Federal programs have a huge growth of expenditures built into
them and there are proposals presently before the Congress that would
raise expenditures by vast amounts in coming years.
The fundamental problem, therefore, is how to regain control
over Federal expenditures.

I do not think this can be accomplished

without departing from our traditional methods of budgetary management.
I have long been an advocate of zero-base budgeting

—

a procedure that would require careful scrutiny by the congressional
appropriations committees of the full expenditure requested for every
Government program, rather than just the increase in expenditures.
Such a procedure would help to weed out programs whose social usefulness
has diminished or ended.

It would take considerable time, however, to

reform budgetary procedures along these lines even if the Congress
were ready to adopt it.

-11To obtain immediate results, other steps are needed.
Recently, a bipartisan group of Congressmen advanced a proposal
that would prohibit consideration of any appropriation bills in the
liouse of Representatives until the House had approved a resolution
containing a comprehensive Federal budget.

The proposal also xrould

require a two-thirds majority vote for any appropriation bill exceeding
the provisions of the over-all budget resolution.
constructive suggestion.

This is a highly

I hope the Congress will give it careful

study and at the same time consider the desirability of establishing
a Joint Committee of the Congress on Revenues and Expenditures.
Another proposal that could produce immediate beneficial
results has already been studied by many members of the Congress-namely, the Presidents recommendation for a legislative ceiling on
this year's budget expenditures.

I strongly support this recommenda-

tion in the hope that the ceiling would be a rigid one, that it would
admit of no escape hatches whatever, and that it would apply both to
the Executive and to the Congress.
Re-establishment of order in our Federal finances has
become a critical need in our Nation's struggle against inflation.
In the Board's judgment an enduring prosperity cannot be achieved
unless this need is attended to promptly and courageously by the
Congress.
* * * * * * * * *