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CURRENT ECONOMIC SITUATION
Speech by
Darryl R. Francis, President
Federal Reserve Bank of St. Louis
Before
The Oklahoma Mortgage Bankers Association
Tulsa Club, Tulsa, Oklahoma
Friday evening, November 19, 1971
I am pleased to have this opportunity to present
to you some of my views regarding attempts since 1968 to
restore stability in the American economy. We presently
find our economy, as well as the world economy, in a
serious state of disarray. First, let us examine briefly
cur major economic problems.
Economic Problems
In the last six years, the American economy
has suffered a high and accelerating inflation. This
inflation has proven very difficult to bring under
control. The rest of the world has also faced serious
inflation, with leading industrial countries experiencing
very rapid price rises.
interest rates in the United States have been
at historically high levels for much of the last six
years.
However, it was not until the late 1960's
that interest rates surpassed those of the early 1920's.
-2 Accompanying the nigh and rising interest
rates and the inflation, there have been many serious
problems in the financial markets.
wrocmms nave
included financial "crunches" and disintermediation
of funds from cur savings institutions into money market
instruments. The housing industry and small businesses
have been particularly hard-hit by these deveicpments.
The stock market also underwent a major downward adjustmen
in the late 19u3's and in early 1973.
Unemployment has been relatively high for
two years, but this unemployment has net been as large
as in other recessions in the posa-Tfcria War i 1 era.
The nation's bslanos-ef-payments position
has been deteriorating for the past ter. years with
respect to other major industrial countries. The
first
nine-month figures indicate that the year 1971
may show the first trade deficit that our country has
experienced since 1893.
Repeated crises have occurred
in foreign exchange markets, which in turn, have led to
increased restrictions to the free flow of international
trade and finance.
This sad state of economic affairs has developed
«
despite
a supoosed
better understanding
A
AA
w* of economic
processes and well meaning attempts to fine-tune the
" j "
American economy.
In the decade of the 1960’s, econo
mists had high hopes for the use of traditional monetary
and fiscal tools for promoting high employment, price
stability, and a viable balance-cf-payments.
It became
very fashionable to claim that we could turn the American
economy around on a dime.
In the early and middle 1960's
most confidence was placed on the use of fiscal actions,
that is, changes in Federal tax rates and spending.
Later in the decade, as.the power of fiscal actions
began to be questioned, more stress was placed on the
use of monetary actions, that is, managing the nation's
money stock.
The New Economic Program
Our recent experience with the prolonged
simultaneous occurrence cf high inflation and high
unemployment, has led to a widespread disillusionment
with traditional tools of economic stabilization.
As a result, a drastic new program has been developed
for the American economy. This program includes re
strictions of price and wage movements for the control
of inflation. First, there was a complete price-wage
freeze, and more recently we have had the announcement that
in Phase 11 there will be price and wage restrictions. Fiscal
-b-
actions have been proposed to stimulate the domestic
economy, end major actions have been taken to improve
our baiance-of-payments position, pending a basic
reappraisal of the international payments mechanism.
Background
in attempting to analyze cur present economic
situation, I find it useful to examine the history of
our current state of economic disarray.
Such a review
should provide us with insights into the causal forces
and likely cures, and aid us in preventing the same
events from happening again.
First, ! will examine the main cause of our
economic dislocations, as we at the St. Louis Federal
Reserve Bank see it. This will be followed by a dis
cussion of the forces which allowed this basic cause
to come into existence. And, finally, there is an
analysis of what 1 believe to be the basic requirement
ror success in restoring economic staoiiity.
Basic Causal Force
Let us now turn to the first topic, the basic
cause of our serious economic problems. At the Federal
Reserve Bank of St. Louis, we have been conducting
many studies into economic fluctuations.
Considerable
evidence has been developed indicating that the economy
-5 -
is basically stable and resilient and net naturally
subject to great inflation or recession. Our studies
indicate that the course of monetary expansion has been
the major destabilizing factor underlying the problems
which I have just outlined. According to these studies,
the trend growth of money-stock, over several years,
determines the rate of inflation,
phenomena.
inflation is a monetary
in addition, variations of a few quarters
in the rate of money growth around the trend, as
well as a shift In the trend rate of monetary expansion,
have an important bearing on movements in output and
employment.
Chart I, which was passed out, demonstrates
these two propositions and helps to illustrate why we
have experienced a high rate cf inflation and a high unemploy
ment rate at the same time. This paradox has led many
commentators and economists to conclude that the character
cf cur economy has been so changed in recent years as
to render traditional economic stabilization tools
useless, and has caused these individuals to look for
additional tools to curb inflation.
As you can see, Chart i covers the period
since early 1952 and contains four panels. The top
pane! presents the money stock, which consists of
-odemand deposits and currency he'd by the nonbank
public. The second panel Is labeled "The General
Price Index," the broadest measure of price mcvements
available. The third pane! is labeled "Real Output."
This is total output of goods and services in our
economy, measured by Gross National Product in con
stant cellars. And the bottom panel contains the
unemployment rate, that Is, unemployment as per cent
of the labor force. Also cn the charts, you will
observe four shaded vertical bars.
Each cf these
shaded bars indicates a period of economic recession,
as determined by the National Bureau cf Economic Research.
It is the period from the ceak to the trough of the business
cycle.
First, let us fccus our attention on the top
panel,
i have divided the period since early 1952 into
three subperiods and have shown the trends of money stock
for each. The money stock grew at a 1.7 per cent annua! rate
from the first quarter of 1952 to the third quarter
cf 1962. Then, the trend rate c? growth was accelerated
to a 3.7 per cent annua! rate to the fourth quarter of
1966. Then, it was further accelerated to a 5.7 per
cent annual rate to the first quarter of 1971.
- 7 New, observe that on the Genera! Price Index
pane! i have also pla cGG tfl ree trend rates. We had
a period cf relative price stability from the first
quarter of 1952 to the fourth quarter of 1965.
During
this period, prices rose at a very moderate 1.8 per cent
trend rate, with only one outburst of a rapid price
rise, in '955 and S956.
Following the acceleration cf the trend
growth rate cf money, prices rose at a 3.9 per cent
annua! rate from the fourth quarter of 1965 to m id-1969.
Since m id-1969 the prices have risen at a5.1 per cent
annual rate. While this Is not conclusive evidence
that a change in the trend growth rate of money causes
a change in the trend growth rate of inflation, it is
quite consistent with that view.
This chart also illustrates my second point,
that short-run variations in the growth rate of money
have an important bearing on output and employment.
On the third pane! labeled "Real Output", i have placed
the trend growth rates of potential real Gross National Pro
duct. This shows the practical maximum growth of
output given the growth in the labor force, technology,
capital resources, and natural resources. The President's
Council cf Economic Advisers has estimated that tine
potential GNP rose at a 3.5 per cent rate from the
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but this
years
apart.
Also, the economy received a .minor additional shock two
years later, in 1962, when money declined relative to
the trend.
On the unemployment rats panel, you will find
that despite slow money growth in the 1950's and early 1960‘s
and very rapid, accelerating, money growth throughout much
of the 196j's that the unemployment rate averaged
about the same, 4.9 per cent in the first period
and 4.6 per cent In the last period. Despite all
the fine-tuning we had in the 1960’s plus the stimulation
received from an accelerating inflation, the average level
of the unemployment rate was little affected.
What caused this pattern of monetary expansion
ever the last two decades, which has had an important
bearing cn inflation and cn output and’employment?
There are three chief causes, and I will discuss each.
First, is the method of financing the rising Government
debt, second is concern over interest rates, and third
is concern ever unemployment.
Let us now look at Chart II, which has five
panels. T’ne top panel labeled "Public Debt" is the
Federal Government debt outstanding, net o? the debt
held by U. S. Government agencies and trust funds.
- 10 The second panel is the "Public Debt Held by Federal
Reserve Banks." This is the debt which the System
acquires in the course cf our Open Market operations.
The third panel Is the portion cf Public Debt Held by
Federal Reserve Banks. The fourth, panel contains the
"Monetary Sass" which Is the major determinant of
movements In the money stock, and the bottom panel
replicates the movements of the money stock that you
have seen In the first chart.
Let us look now at the role of the method
of financing Federal Government debt and the course
of monetary expansion.
In the early 1950’s we find
that the public debt outstanding changed little, varying
between $215 and $250 billion.
it Lagan to rise
?~ I n - j
• to rise
A Aand continued
rapidly in the lace isob's
throughout the 15'cO’s and early 1970's. At the time of
relative stability in the national debt, the Federal
Reserve did not change aooreclsb’v its holdings cf U. S.
Government securities.
In the late 1950's the Federal
Reserve began to add an ever increasing amount of
Federal debt to its portfolio,
in fact, the rate of
acquisition cf debt by the Federal Reserve System was
more rapid than the expansion of the national debt
itself. This is illustrated in the third panel, which
!<
11
shows the share of public debt he'd by the Federal
Reserve Banks. This ratio held nearly constant,
up to the late 1950's.
at around ii pet
Since
then it has been constantly rising, reaching about
22 per cent at the present.
Movements in the monetary base parallel this
o
UZ
acquisition ot reoera; Reserve ceot.
nc.n iie reus
r^ra!
Reserve buys Government securities, it adds to the
monetary base.
as i
mentioned earlier, the monetary
base is the major determinant of the money stock. ,
With these greater purchases of Government securities,
there has-been an acceleration in the trend growth of
the monetary base ever the last two decades, from at
a 1.6 per cent annual rate from early 1952 to the fall
of 1951, then to a 4.4 per cent rate to the end of 1956,
and since then to a 5.4 per cent rate. You will also
observe that a trend growth in money changed in a
roughly parallel fashion as the trend growth for the
monetary base.
So what we had in the 1953‘s was rising
Government expenditures, both for the Vietnam War and
for expanding welfare programs. A decision was made
to not finance these outlays fully by taxes, but by
borrowing. And the borrowing was carried on in such
mnnn^r
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- 13 What can account for the variability around the trend
movements in the money stock? 1 believe this can be
attributed in considerable measure to alternating con
cern ever unemployment and inflation. Whenever the
System sought to resist inflation vigorously the growth
rate of the money stock was markedly slowed for a short
period of time. As we saw in Chart 1 whenever the growth
rate of the money stock slowed relative to the trend,
we entered into a period of economic slowdown and the
unemployment rate would rise. Then, whenever the
unemployment rate rose, the monetary authorities
shifted objectives and became much more expansive in
order to bring the unemployment rate down. This
haecened several times throughout the !950:s and
svcj's, ana eacn time we had a raacneung-uo or tne
trend growth rate of the money stock. These expansive
actions also help to explain the rising trend growth
cf money.
n n t r/rd! s r- r,
U i i S. J V S S 1 i i M
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Now, I will turn to my last topic, which
is what do I believe to be the basic requirement
for success in controlling inflation?
if we are
to have a successful program in controlling inflation,
the basic cause of inflation must be eliminated by
achieving a moderate trend rate of growth in the money stock
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holdings cf Gcvernment codt to the total outstanding remains
- 12 constant at 22 per cent, ths latest figure, such a deficit
could result in a sizeable in Cz • O V4 *2 e In the money stock.
Let us now look at the. interest rate impediment,
which could result in an increase In the ratio from its
present 22 per cent level. There Is considerable pressure
to prevent Increases In interest rates.
could be controlled in two ways.
Interest rates
One, there could be
ceilings fixed by law, as in the case of usury laws, or by
regulation of some administrative body. The second way
would be for actions of the Federal Reserve to prevent
temporarily Interest rate increases by permitting more
rapid monetary expansion.
it is likely that imposition of Interest rate con
trols would create an Impediment to the maintenance cf
moderate monetary growth. Whenever you fix a price,
problems of allocating scarce r ,2C * 5 ffC s amona com set ix we
uses arise. Assuming interest rate controls were effective,
demand for funds, in response to rising economic activity,
would outpace the supply at the celling rates.
If rate ad
justments were not permitted, the need for rationing would
arise.
Because of problems of allocating the limited funds
among competitive uses and cf enforcing interest rate con
trols, pressures would mount for the Federal Reserve System
to expand the total volume of credit.
But, if the business
■J f ~ 16
recovery is as strong as generally expected and if the
Federal Reserve supplies the funds which people demand
at the controlled interest rate levels, the System would
have to acquire an increasing orooortlon of Government
debt outstanding. As happened in the last decade, the
trend rate of money
-z crowth would increase and inflation
would be intensified.
The outlook for market forces on interest rates
curing the balance of 1971 and into 1972 is not clear. On
the one hand, there most likely will be downward pres
sures on rates as expectations of inflation are revised
downward. On the ether hand, large Government deficits
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in view of the un
certainty as to the direction and extent of net market
pressures on rates, it would seem best that rates of
interest be allowed to find their own levels in the market,
if the System contracts money to avoid a decline in interest
rates, a recession may develop.
If the System expands
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inflationary pressure will develop.
Let us now take up the unemployment impediment,
which results from the public having unrealistic aspir
ations with regard to the unemployment rats.
Much of
n
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have ied to disarray In our economy, ar.a the world
economy, disappear frem the scene.
195? 1953
1954
1955
1956
1957
1958
1959
1960 1961
1955
1956 1957
1958
1959 1960 1961
1962
1963 1964
1965
1966
1967
1968
1969
1970
1971
1972
RATIO SCALE
BILLIONS OF DOLLARS
Money Stock
1
1
1
1
—
1
1
□
1
1
u
1
1st qtr 5
1
h
i
1952 1953
1954
1962
1963
1964
1965
Shaded areas represent periods of business recessions as defined by the National Bureau of Economic Research.
Latest data plotted: 111/197'
1966
1967 1968
1969
1970
1971
1972
Prepared by Federal Reserve Bank of St. Louis
1952
1953
1954
1955
1956
1957
1958
1959
1960
1961
1962
1963
1964
1965 1966
1967
1968
1969 1970
1971
1972
1954
1955
1956
1957
1958
1959
1960
1961
1962
1963
1964
1965
1967
1968
1969
1970
1971
1972
RATIO SCA^E
BILLIONS OF DOLLARS
1952
1953
1966
Shaded areas represent periods of business recessions as defined by the National Bureau of Economic Research.
Latest data plotted: public debt 11/1971; money stock, monetary base - 111/1971
Prepared by Federal Reserve Bank of St. Loui
320
@FedFRASER