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For release on delivery
Friday, September 23, 1977
12:30 pm, EDT

The Threat of Inflation
Remarks by
David M. Lilly
Member, Board of Governors of the Federal Reserve System

before the
Virginia Council on Economic Education
Richmond, Virginia
September 23, 1977

It is a pleasure to appear before you today, especially
since the Virginia Council on Economic Education has long
been a leader in promoting improvement in economic education
and understanding, an improvement that is sorely needed in
our society.
I would like to discuss with you an issue that is perhaps
the greatest threat to our economic society as we know it

That threat is inflation.

It's a disease that could

change the entire fabric of our life unless it is brought
under control.

And I must say to you in all frankness that

we at the Federal Reserve feel very lonely when the Government
institutions that worry about inflation are asked to stand up
and be counted.

We live in almost virtual isolation, a condi­

tion that I hope will change, and change dramatically, as time
goes o n .
The seriousness of inflation cannot be overestimated.
Except for a brief period after World War II, prices in this
country in recent years have been rising faster than in any
other peacetime period in our history.

Most recently, there

has been some respite from double-digit inflation, but a
resurgence of inflation could jeopardize the future of our

- 2 country, if past experience is any guide.

No country in

history has been able to maintain widespread economic
prosperity once inflation got out of hand.

A n d the unhappy

consequences are not just of an economic nature.


inevitably causes disillusionment and discontent.

It robs

millions of people who have set aside funds for education
or retirement, and it hits the poor and the elderly
especially hard.
Inflation has also been a contributing factor to the
fall of governments.

Even in this country, the distortions

and injustices created by inflation have contributed to a
distrust of government officials and governmental policies.
History teaches us that the discontent bred by inflation
can provoke disturbing social and political change.


ultimate consequences of inflation could well be a signi­
ficant decline of economic and political freedom.
To appreciate the threat of inflation fully, one must
understand how it has infected our economy.

There is in

our society a built-in inflationary bias that has grown
more intense over the last decade.

Our long-range problem

- 3 of inflation has its roots in the structure of our economic
institutions and in the financial policies of our Government.
This basic fact is all too frequently obscured by outside
events that increase the rate of inflation noticeably, such
as a crop failure or action to raise oil prices.

The plain

truth is, however, that the United States -- and many other
countries throughout the world -- has developed an underly­
ing bias toward inflation that has only been magnified by
these special influences.
Where does this leave our traditional tools of policy?
Fiscal and monetary policy still have important roles to
play in our fight against inflation, but they can no longer
do the entire job.

Removal -- or even a reduction -- of

structural barriers will help us squeeze the inflation­
ary bias from the economy and remove the distortions that we,
ourselves, have made a part of our system.
One indication of these distortions is the constant
penchant of our society to run budget deficits.

There are

times when a Federal budget deficit can be helpful.
must we run deficits all the time?


Since 1950, deficits

- 4 have outrun surplus by 23 to 5.

That is a runaway score

in anybody's language.
Throughout the postwar period, there has been heavy
emphasis by governments on rapid economic growth.
of course, is commendable.


But while we have tended to

move promptly to check recessions, we have been hesitant
to move just as promptly to check inflation.

Many govern­

ments, including our own, have attempted to relieve the
adversity facing their citizens and in the process they
have moved in varying degrees toward an economy that places
more and more emphasis on welfare.
Welfare programs have been established for a large
portion of our population and they now include food stamps,
school lunches, medicare and medicaid, public housing, and
many other forms of assistance.

Many of these programs are

commendable, and they help segments of our population face
an otherwise burdensome life.

But they also add to the

inflationary bias in our economy when they produce budget
d efi c i t s .
Let me give you some additional examples of what I mean
by the inflationary bias in our economy.

- 5 For many years, the Federal Government has regulated
various forms of transportation -- trucks, railroads, air­
lines, water.

A certain amount of regulation is undoubtedly

good, but analysts estimate that regulation of transportation
in this country has raised costs anywhere from 10 to 30 per
Tariffs, together with import barriers, are another
factor in this bias.

Granted, tariffs and import barriers

have benefited certain industries and groups of Americans.
But they have also served to increase prices in some commodi­
ties, or to prevent a drop in others.
The list of examples is legion -- restrictive building
codes, agricultural price supports, the market power of
business and unions, pollution controls, safety regulations,
pension costs, mandatory retirement, the minimum wage laws.
Taken together or individually, they increase the economy's
bias for inflation.
Let me take a moment to explain one bias that is
particularly troublesome to me.

That is the innovation

that has crept into our economic thinking in recent years
of indexing price increases.

Since the economy experienced

- 6 double-digit inflation several years ago, there has been
more and more emphasis on indexing.

The "cost-of-living

adjustment" was once called an engine of inflation by
government economists.

Recently it has lost that title.

More and more labor contracts now include a cost-of-living
escalator and business contracts frequently include the
same type of provisions.
There are some economists who believe a cost-of-living
escalator -- or indexing -- is a perfectly rationale approach
to the nagging problem of inflation.

As costs go up, incomes

also go up by the same amount and the effects of inflation
are nullified, or so the argument goes.

But indexing also

has one destructive feature that makes it an unacceptable
approach to inflation.

It serves to take away the incentive

of people to fight the inflation itself.
of defeat.

It is an admission

It is, literally, throwing in the towel, and that

is one thing I and my colleagues at the Federal Reserve will
never do.
What we as a people have done, therefore, has been to
subject our available resources to increasingly intense

- 7 demands.

At the same time, we have sought to insure that

incomes do not get eroded when excessive pressures generate

This amounts to creating upward pressures on

costs and prices, and then arranging to perpetuate them.
It is an awesome combination and one which we at the Federal
Reserve must cope with.
I become very disappointed when I see the Federal Reserve
alone in its struggle against inflation.

Inflation, or rather

the control of inflation, is a primary objective of the
Federal Reserve.

But we Americans cannot afford to assign

that job only to the "Fed."

Inflation is everybody's business,

and it is up to everybody to lend a helping hand to control it.
But you ask:

Won't the unemployment picture worsen if we

try to reduce inflation?

The answer to that is an emphatic NO.

There is no longer a meaningful trade-off between unemployment
and inflation.

Inflation is one of the major causes of unem­

ployment in the current environment.
and sluggish buying.

It leads to hesitation

Today's high unemployment rate is,

fundamentally, the legacy of an inflation that surely could
have been avoided if proper steps had been taken in time.

- 8 It is true that stimulative policies have merit when
unemployment is extensive and inflation weak or nonexistent.
But such policies do not work well once inflation has come
to dominate the thinking of the nation's consumers and
businessmen as it does today.

Expansionary monetary and

fiscal policies might provide some additional thrust to the
economy for a short time.

But inflation would inevitably

accelerate and even more difficult economic problems would
be encountered.
I hope you have not become discouraged by my remarks
thus far.

Now that I have painted a rather gloomy picture

of inflation, let me offer some measures designed to bring
it under control.

And I must emphasize that inflation can

be brought under control if we work together.
years ago, we had double-digit inflation.

Only a few

The present rate

of inflation is half what it once was but we must do better
and we can.
Conventional thinking about the economy, however, is
out of date.

Ways must be found to reduce unemployment while

at the same time avoiding a new wave of inflation.

The areas

- 9 that must be explored are many and difficult, but we must
open our minds if we are to have any chance of ridding our
economy of its inflationary bias.
The first step in an anti-inflationary program is p r u ­
dent monetary and fiscal policy.

That is essential.


heightening of inflationary expectations will erode business
and consumer confidence and impair the economic expansion
now underway.

Thus, any attempt to make a "quick fix" of

our major economic problems by a heavy dose of economic sti­
mulation may be counter-productive.

Only a steady, moderate

policy will provide the foundation for both a lessening of
inflation and a return to full use of our labor force and
productive capacity.
A prudent policy requires a balance between monetary and
fiscal m e a s u r e s .

Huge increases in government spending place

a heavy burden on monetary policy.

Large deficits can create

strains on our financial markets, raise interest rates, and
make the financing of business capital and housing outlays
more costly.

As a result, monetary and fiscal policy must

complement each other and work in tandem.

- 10 But that is not all that must be done.
more than an evil of the business cycle.
phenomenon as well.

Inflation is

It is a structural

We must improve the efficiency and

flexibility of our markets.

Structural changes in our

economy will be hard to come by.

But we must make the

effort if we are to have any success in our struggle.
For example, steps must be taken to improve competition
among businesses through increased emphasis on anti-trust
policy, changes in regulatory procedures, and an easing of
barriers to international trade.

Job training programs

should be strengthened to increase productiveness of workers,
particularly minorities and teenagers.

Minimum wage laws

need to be altered to encourage the employment of the less
skilled and disadvantaged w o r k e r s .

Local building codes

which do not reflect modern construction techniques, should
be re-examined and changed where necessary.
As a former business executive, I have a special interest
in our labor market policies.

As I mentioned, the Federal

minimum wage law is pricing many teenagers out of the job

When the minimum is raised, employers tend to ignore

the less skilled worker and seek the more productive employee.
Employers may also attempt to get along with fewer e m p loyees.
Some Federal laws -- such as the Davis Bacon Act which requires
the payment of "prevailing wages" on all government construc­
tion contracts -- continue to escalate costs.

There is also

a belief that the unemployment compensation laws provide such
generous benefits that incentives to work are reduced.


could go on, but I think you get the picture.
A restructuring of our economic system -- along the lines
I have outlined -- would improve the efficiency and effective­
ness of our conventional tools.

During periods of excessive

demand, for example, less restraint would be required to bring
inflation under control.

Consequently, I am convinced that

structural reforms deserve more attention from Congress and,
yes, from the general public, than they have been receiving.
Too many people have tended to concentrate on overall fiscal
and monetary policies.

These traditional tools are, of course,

useful and essential; but once inflationary expectations have
become widespread, they must, be used with great care and
our economy.

We must work to remove the inflationary bias of

- 12 On our part, we at the Federal Reserve will continue to
provide money and credit sufficient to accommodate a continua­
tion of the orderly economic expansion.

We will strive to

avoid excessive growth in money and credit that would stimulate
further inflationary pressures.

The Federal Reserve System,

moreover, is committed to a gradual reduction over the longer
run as one of the conditions that must be achieved in order
to bring about an end to the inflation.

As I have tried to

emphasize, however, other conditions are also necessary to
reach this happy end, including progress in reducing the
structural distortions that have added to our economy's
inflationary bias.
But these policies require public support and understand­

People must understand that this problem of inflation

is a serious long-term threat to our social and economic

People must understand that government programs,

no matter how worthy, are likely to have inflationary conse­
quences unless they are accompanied by an appropriate means
of financing.

Even programs that are superficially costless,

still may impede the efficient workings of markets and the

- 13 flexible adjustment of prices.

Such programs may impose very

heavy burdens of their own.
The Federal Reserve, in this struggle against inflation,
has a unique role to play.

Congress has enabled the Federal

Reserve System to operate independently of day-to-day political

Considerable scope for independent judgment has

been permitted by providing for the appointment of Members of
the Federal Reserve Board for long, staggered terms.


Congress has placed the Federal Reserve System outside of the
usual appropriations process.
This provides us with a unique environment especially
conducive to adopting a longer-run point of view.

And it is

this longer-run perspective that leads us to our great concern
about the problem of inflation.

We hope to convince others,

including people like yourselves, that this concern is warranted
and that this struggle against inflation is worthy of your
Let me offer one idea that might have appeal for Americans
who are worried about inflation.

Many people who have been

worried about the destruction of our environment succeeded in

- 14 pushing through requirements for "environmental impact
statements" for many types of development.

Although many

businesses have complained about the "red tape" produced
by these statements, they have served a purpose in helping
to protect our environment.

In some cases, projects have

been cancelled or modified because of their impact on the

We should, perhaps, borrow a page from this

book and require "inflation impact statements" to be filed
by the Government in connection with changes in such programs
as the minimum wage, import restrictions, and the other p r o ­
visions that give our economy an inflationary bias.


this would add another layer of red tape to already cumbersome
procedures, but it would awaken the public to the cost that
must be borne when new legislation is adopted and new proce­
dures are instituted.
I would hope that you on the Council would continue to
place yourselves in the forefront of economic education by
encouraging people in your community to understand inflation
and do something about it.

In this way, the Council, in

pursuing its purpose of improving economic education, can
confer even greater benefits on us all.

- 15 Somehow, inflationary pressures have to be uprooted.
But that cannot be done without changing a number of ideas
and attitudes that have been popular for a generation or

Consequently, we should have no illusions about find­

ing a quick and easy solution.

It will take years of prudent

and vigorous public policies and restraint on the part of
consumers, workers, and business firms alike.

Even so, I

am confident that with the imagination and leadership you
and other citizens across the country are displaying, we can
work to put an end to inflation and restore the conditions
essential to a stable prosperity.
Remember, control of inflation is not just the job of
the Federal Reserve, it is everybody's job.
I would be happy to answer any questions that you may