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Statement by

Arthur F. Burns

Chairman, Board of Governors of the Federal Reserve System

before the

Joint Economic Committee

February 20, 1973

It is a pleasure to meet once again with the Joint Economic
Committee to present the views of the Board of Governors on the
condition of the national economy.
The past year has witnessed a remarkable expansion of
economic activity.

The physical output of goods and services

rose 7. 6 per cent over the past four quarters, and production in
the industrial sector advanced even faster.

The number of persons

employed in civilian jobs has of late averaged about 2-1/2 million
above year-earlier levels.

Last month, the rate of unemployment

fell to 5 per cent, or nearly a full percentage point below the level
of a year ago.
Economic expansion during the past year was also well
balanced, and employment therefore recovered in practically
all major sectors of the economy.

Consumers have been spending

freely on a wide array of goods and services.

The housing industry

has defied earlier predictions of an impending decline.


expenditures for capital equipment have risen substantially.


inventory investment, a laggard in this recovery, has also joined
the economic advance of late.
As we see the state of business, the current expansion has
considerable momentum.

Consumer buying and business investment

in fixed capital are both likely to continue their upward course.
Business firms, moreover, will need to add substantially to their
inventories in coming months to accommodate a rising pace of

A good increase in physical output during 1973 thus appears

in prospect.

As production increases, the demand for labor will

grow, and we may look forward with some confidence to further
declines in unemployment during 1973.
While we have been experiencing robust expansion in the
domestic economy, our foreign trade has proved singularly

True, exports rose substantially last year, but

the dollar value of our imports increased even more.

The vigor

of our economic expansion was a major cause of the rise in

Other factors were also at work, including the explosive

increase in energy requirements which caused our oil imports;/to
Our over-all international economic accounts have continued
to be seriously out of balance.

The Smithsonian agreement of

December 1971 was recognized by all concerned as a temporary
arrangement, but it was also felt that it would give the nations
of the world sufficient time to rebuild the monetary system on a
permanent basis.

As events have turned out, less was achieved

through the Smithsonian agreement than we or other nations
expected from it.

Serious conversations on international monetary

reform have been under way for several months, but they have
gone forward much too slowly.

Meanwhile, another monetary

crisis developed in recent weeks.

The reasons for its precise

timing may be debated, but there can be no doubt about the underlying cause—namely, the huge continuing deficit in the balance of
payments of the United States, which has had its counterpart in
the persistent surpluses of other countries.
The progress we need in our international accounts is
enormous, and the way to a lasting solution does not depend on us

The devaluation of the dollar announced last week, together

with the realignment of exchange rates accepted by other countries,
should prove helpful over the longer run.

Prompt action is now

needed to revise the par value of the dollar and to adopt new
legislation to promote expansion of international trade and to help
restore equilibrium in our international transactions.
In the months immediately ahead, opposite influences will
play on our foreign trade.

The currency realignment will have a

perverse influence until demand patterns become readjusted to the
new structure of exchange rates.

On the other hand, the expansion

of economic activity abroad will tend to bolster our exports in
corning months.

Also, our underlying competitive position in

world markets should improve as a result of recent trends in
costs and prices in the United States and abroad.
In most industrialized nations, inflation last year was
proceeding at a pace substantially faster than in the United

Our own inflationary problem, though worrisome, has

thus far been under better control.

In the first half of 1971, prior

to the imposition of wage and price controls, the rate of inflation
was about 5 per cent, judging by comprehensive price measures for
goods and services produced in the private sector.

The inflation

rate slowed to 3-1/2 per cent in the first half of 1972, and to about
3 per cent in the latter half of last year.
This moderation in the pace of inflation has resulted from
reduced pressure of rising costs on prices.

Unit labor costs in

the private nonfarm sector rose last year by only 1. 6 per cent,
compared with 3. 4 per cent in 1971 and 6. 6 per cent in 1970.
The improvement stemmed mainly from larger increments to
productivity, but a somewhat slower advance in wages was also
a factor.

The progress we have thus far made in moderating inflation
is, however, insufficient.

There is no room for complacency when

the average level of prices is still rising quite1 rapidly, when it
appears likely that productivity improvements will fall short of
last year's fast pace, when wage rate increases - -if we may judge
from the closing months of last year--are becoming larger again.,
when imported goods are going to cost more as a result of the
recent devaluation of the dollar, and when American families are
facing sharply higher grocery bills.
The unhappy recent rise in food prices is especially

This should not, however, blind us to the remarkable

accomplishment of the past year and a half--a period when price
advances became smaller while real output and employment were
growing very briskly.

This is an unusual pattern of behavior in

an advanced phase of a business-cycle expansion.
Let me turn next to the role that monetary policy has played
in recent developments.
A year ago, as the Committee will remember, unemployment
was still nearly 6 per cent of the labor force, and industrial
production had not yet regained pre- recession levels, /With an
effective wage and price policy in place, the central task of

monetary policy was to promote expansion in economic activity
on a sufficient scale to reduce the gap between actual rates of
production and our full employment potential. }
.... (
There can be no doubt that ample availability of credit
contributed materially to the expansion of economic activity over
the past year.

For example, the impressive rise in consumer

purchases of new autos and other durable goods could hardly have
occurred without a pronounced increase in consumer instalment

Again, the exceptional growth of residential mortgage

loans contributed powerfully to sustaining new housing construction
at record levels.

I am also convinced that the stability of long-

term interest rates strengthened investor confidence and facilitated
the expansion of business capital investment; the weakness of this
sector, it may be recalled, had seriously restricted economic
recovery during 1971.
Early in 1972, monetary policy sought to make up for the
shortfall in the growth of money balances in late 1971.

The rate

of monetary expansion was, therefore, high in the first quarter
of 1972.

As the year progressed, evidence accumulated that

economic expansion was quickening and that increasing demands
for credit were putting upward pressure on short-term market

interest rates.

This gave rise to some concern about the market

for longer-term securities.

It nevertheless was clear that efforts

to prevent a rise of short-term market rates would result in
excessively rapid expansion of the monetary aggregates.
Federal Reserve policy therefore tolerated the rise in
short-term market interest rates that began last March and has
continued since then.

By the end of 1972, yields on Treasury

bills, commercial paper, Federal funds, and on other short-term
market instruments had increased about two percentage points from
their lows, and some further upward adjustment has occurred since
the beginning of this year.
Past experience indicates that a rise in short-term market
interest rates is usually followed by slower growth of the monetary

This was an objective of monetary policy during 1972,

and the rate of increase in the narrowly-defined money supply-that is, demand deposits plus currency in public circulation--did
in fact moderate during the late summer and early fall of 1972.
Late in the year, however, additions to money balances spurted to
a pace well above what the Federal Open Market Committee desired.
The precise causes of the unusual increase in money supply
last December are still somewhat elusive.

One known factor is


that the revenue-sharing checks received by States and localities
temporarily raised the cash balances of these governmental units.
It may also be that a change during November in Federal Reserve
regulations governing bank remittances for cash letters contributed
to the spurt.

In any event, the December bulge in money growth

proved to be short-lived.

This January, the narrowly-defined

money supply showed no further increase.
Increases in the money stock are very uneven over time,
and rates of increase must be measured over more than a few
months to determine the thrust of monetary policy.

Thus, the

narrowly-defined money supply grew by 7. 4 per cent from the
fourth quarter of 1971 to the fourth quarter of 1972.

This was

actually a little less than the increase in real output of goods and
services, and far less than the 11 per cent rise in the dollar value
of output.

If the money supply had grown at a significantly lower

rate, we would probably have experienced smaller gains in real
output and employment last year, and unemployment would be at
a higher level now.
In view of the lag in the workings of monetary policy, the
Federal Reserve did, however, deem it desirable to move gradually
toward a less expansive monetary policy during 1972.

In the first

quarter, the reserves for supporting bank-deposit expansion came
entirely from open market operations.

But as the year moved on,

a sharp reduction occurred in the additions to nonborrowed reservesfrom a 12 per cent annual rate in the first half of the year to 2 per
cent in the second.

Member banks reacted to this more reluctant

provision of reserves as they customarily do--that is, by borrowing
more at the discount window.
a process.

There are, however, limits to such

Bankers know that they cannot rely on these borrowings

in more than limited amounts or for more than limited time periods.
Developments have thus been underway for some time that
should result in somewhat slower growth of the monetary aggregates.
The Federal Reserve has also taken other restraining actions.


in November, the Board raised margin requirements to forestall
excessive use of credit in the stock market, and we thereby also
indicated our concern about potential inflationary developments.
And in January, the discount rate was raised to bring it into better
alignment with market rates of interest.

This move served notice

to the banking system and to the public at large that supplies of
money and credit were being brought under a tauter rein.
The current economic expansion has entered a more
sensitive phase, in which new problems may be encountered.


A substaatial further increase of real output is needed to provide
employment opportunities for a growing labor force, and to make
possible further progress in reducing unemployment.


with labor and capital resources being utilized more fully, the
expanding demand for goods and services could begin to pull
prices upward and thereby reinforce prevailing cost-push pressures.
In the absence of monetary and fiscal restraint, excess aggregate
demand might easily reemerge and touch off a new round of
This must not be permitted to happen.

The hard-won

gains our nation has made in the struggle against inflation must
not be frittered away.

To do so would sap the confidence of our

people in the integrity of government.

We must also be mindful

of the fact that inflation is now being resisted abroad by more
stringent monetary policies, and also by incomes policies in
some countries.

If the potential benefits of the new exchange

rate realignment are to be realized, the rate of inflation in the
U. S, must be reduced further.

For monetary policy, these

considerations indicate a need to practice greater moderation
during 19 73 in the provision of new supplies of money and credit.


The Federal Reserve will remain mindful, nevertheless,
of its responsibility to support further gains in real output and

Success in that endeavor will mean continued

expansion in business activity, and thus rising credit demands.
Market interest rates may, therefore, rise further, as they
typically do in the expanding phase of the business cycle.


it is my hope and expectation that sharp increases in long-term
rates can be avoided.
I can assure this Committee of two things.

First, the

Federal Reserve recognizes that in order to keep the monetary
and credit aggregates under good control, it will be necessary
to avoid efforts to hold open market interest rates at artificially
low levels.

Second, the Federal Reserve does not intend to permit

severe stringencies to develop in the credit markets, or to try to
correct for every error in public or private policies.
The proper role of monetary policy in the achievement of
our national economic objectives is a comparatively modest one.
Monetary policy can help to establish a financial climate in which
prosperity and stable prices are attainable.

But it cannot guarantee

the desired outcome; the task is much too large.


The course of fiscal policy certainly has a vital bearing
on reaching our national economic objectives.

It now appears

that Federal budget outlays in fiscal 1973 will be held to $250
billion--or some $6 billion below what the staff of the Joint
Committee on Reduction of Federal Expenditures estimated just
a few months ago.

This would be a welcome achievement.

Furthermore, the proposed budget for fiscal 1974 calls for a
balance between revenues and expenditures at full employment.
However, the Administration's budget for fiscal 1974 can
hardly be called austere.

After all, total outlays are scheduled

to rise an additional $19 billion or 8 per cent.

The national

interest would be well served in present circumstances if the
Congress saw fit to stay at or below the expenditure limits
proposed by the President.

It is also highly important, as the

members of this Committee well know, that Congressional
procedures be reformed so that Federal spending can be brought
under better control.
Early evidence of better control over Federal expenditures
would go a long way toward assuring the public that excess aggregate
demand will not reemerge in 1973 and later years.

But there are

times when overheating of the economy originates in the private

At such times, flexible fiscal tools can help to curb

private spending.


Some months ago, the Federal Reserve Board urged the
Congress to consider a variable investment tax credit as a means
of improving the conduct of economic stabilization policy.


essence of the proposal is that the President be given authority
to initiate changes in the investment tax credit.

At the same time,

Congress would retain its traditional control over taxes and act
as a full partner in making the needed adjustments.

For example,

the President might be permitted to change the tax credit within
a specified range--say, between zero and ten or fifteen per cent,
subject to modification or disapproval within 60 days by Congress.
This proposal, the Board believes, would facilitate making
the timely adjustments required for a more effective stabilization

Prompt action by the Congress on a flexible investment

tax credit would make it possible to use this instrument, if it
were needed, to curb the growth of business capital expenditures
later on in this expansion.
Improved policies of managing aggregate demand, important

they be, will not of themselves suffice to assure prosperity

without inflation.

Structural reforms are also needed.

Not a few

of our corporations and trade unions now have the power to exact
rewards that exceed what could be achieved under conditions of


active competition.

As a result, substantial upward pressure

on costs and prices may emerge long before excess aggregate
demand has become a problem.
There is no easy path to meaningful structural reform.
Genuine progress would require that we undertake to curb abuses
of economic power by both business firms and trade unions, besides
reappraising a host of laws and governmental regulations that
interfere with the competitive process.
Let me turn, before closing, to the role that private
policies must play to ensure that inflationary developments do
not frustrate governmental efforts to promote prosperity without
Since August 1971 our nation has been engaged in a new
effort to influence wage and price decisions through direct controls.
In its present phase, greater reliance is placed on self-discipline
in abiding by rules of appropriate behavior.
is hardly a voluntary program.

Phase III, however,

Several areas of the economy

remain under mandatory control.

Furthermore, the President

has indicated his firm intention to take whatever action may be
necessary to achieve compliance with the objectives of the

He has ample authority to do so under the Economic

Stabilization Act.


Yet, in the final analysis, the workability of any form of
controls in an economy as large and complex as ours depends on
public acceptance of the need for controls and on cooperation of
the participants in the program.

Phase II was successful in

moderating wage rates and prices because of the widespread
support it received from the American public, including business
firms and the trade unions.

Phase III will enjoy a reasonable

measure of success if that spirit of cooperation continues, and
if labor and management join together to increase productivity
and to hold down increases in wage rates and prices.
Our nation's financial institutions must also make their
contribution if the stabilization program is to succeed.

It will

be in their own interest, as well as in the national interest, to
manage their lending policies more cautiously in the months

Any rapid rise in commitments for future lending, for

example, would increase the exposure of individual financial
institutions to a liquidity squeeze, and at the same time contribute
to an inflationary round of spending by businesses and other

Wise bankers will shun the temptation that arises

during a period of business expansion to step up their lending

If excessive extensions of credit are averted through

exercise of prudence by lenders and borrowers, the need for strong
monetary restraints will not arise.


In recent weeks, I have felt a sense of concern developing
across the nation about the ability of the United States to deal with
the problems that prosperity creates.

This concern is under-

We live in troubled times, and memories are still

fresh of the damage produced by inflation during the latter years
of the 1960fs.

But there is no need to be afraid of prosperity.

Our national economic policies are now set on a course that
promises to bring us closer to the goal of a prosperous economy
with stable prices.

If we persevere, as we must, that objective

can be realized.