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rSr release on delivery
fhursday, July 19, 1979


Remarks by
G. William Miller
Chairman, Board of Governors of the Federal Reserve System
before the
Commonwealth Club of California
San Francisco, California

July 19, 1979


It is a special pleasure for me to be here today. It was
just over a year ago that I made my first appearance on the West
Coast as Chairman of the Federal Reserve. At that time, I detailed
several new directions that could form the blueprint for achievement
of our fundamental economic goals. Today, in a sense, I'm here to
give a progress report. I want to discuss with you the steps that
have been taken over the past year to redirect economic policy and
the challenges that persist in perfecting an effective economic
strategy in these difficult times.
Indeed, this past year has produced constructive and measurable
acceleration in our responses to the present danger: major shifts
in economic direction; heightened awareness of the perils of inflation
to our Nation's well-being; and individual and collective actions that
attest to America's mobilization to meet the crisis. Most important,
we have witnessed the essential emergence of a long-range economic
strategy for winning the inflation war.
We now face a crucial period in this struggle. The war against
inflation has been set back temporarily by another oil price shock.
America is being sorely tested. We now need to demonstrate forcefully
our will and determination to stay on course despite the prospect of
a delay in our timetable -- perhaps by a year or more -- for wringing
out inflation.
We will have to adjust our timetable. But we must not succumb
to the nebulous peril posed by our frustration at encountering any
delay. We must be particularly wary, over the coming months, not


to mold our policies around hasty predictions and reactions.
Sudden swings and switches could be our undoing.
On the contrary, as we assess the impact of recent developments, and as we wOTk toward greater energy independence3 we must
recommit ourselves to the basic long-term strategy* Even as we
continue to struggle in coping with day-to-day difficulties, the
policies put in place during the past year offer a more promising
economic future. And if we persist in these policies, we have the
opportunity to make up for lost time and still attain our ultimate
goals within the next 5, 6 or 7 years.
Inflation --The Problem
You are all familiar with the causes of the present virulent
inflation, but let me just recap briefly the events that led to
our current malaise.
We have now experienced a decade and a half of repetitive
and unprecedented shocks. The war in Vietnam divided the country,
and failure to pay for that war planted the seeds of inflation.
Inflation was nourished by inadequate policies -- policies
that, in retrospect, did not arrest the underlying inflationary
pressures. As a result, our present inflation involves not only
cyclical forces, but also structural anomalies. Large Federal
deficits, excessive government regulation, declines in productivity,
legislated cost increases — these and other structural factors have
been contributors to the growing inflation bias. They have weakened



our economic vitality, leaving us even more vulnerable to impacts
from external forces, such as the series of stiff increases in
foreign petroleum prices.
Moreover, inflation has become resistant to the old-fashioned
remedy of recession. During the 1973-75 recession, prices continued
to rise nearly 11 per cent. The effects of recession operate to
divert us from our basic course: recession entails automatic increases
in Federal deficits; increases pressure for additional Federal spending;
produces strains from increased unemployment. Recession cannot solve
the inflation problem; it only makes it more intractable. Consequently,
we need to be steadfast in our efforts to ensure that the present
recession remains moderate and does not develop into a more serious
Because the roots of inflation run deep, the problem was never
amenable to a "quick fix.11 We must reconcile ourselves not to the
presence of inflation, but to the fact that we will b e - — must he —
waging a long and sustained war. There will be no single cure, no
swift victory.
Inflation — The Response
As the shadow of inflation lengthened last year, a series of
significant shifts in attitude took place. Let me briefly enumerate
a series of major policy changes which recognize that we cannot
treat a single cell to cure the cancer of inflation; we need to
work on the whole economic body. Recent events, as I've indicated,



will impact on this strategy and perhaps postpone temporarily the
realization of its benefits. But we must resist any pressure to
The first major change last year was a courageous action to
shift fiscal policy from a mode of stimulus to restraint. The
original financial plan for 1979 called for a budget deficit of
$61 billion. In an unprecedented redirection of policy, this
large deficit was reduced substantially — now expected to be
around $30 billion — changing ttae-fiscal.-atanee frcmtft^iiuliifetQward
restraint. The fiscal year 1980 budget resolution now calls for
a further substantial reduction. The President and the Congress
should be commended for the degree and the speed with which they
reversed the fiscal direction and steered us toward a more appropriate course. We must stay on this path and achieve a balanced
budget. And we must reduce the relative role of Federal expenditures
as a percent of our gross national product.
The second major new direction was the introduction of an
incomes policy calling for voluntary compliance with a program to
moderate wage and price increases. Let me dispel, at the outset,
a misconception that this is the sole anti-inflation program: it
is not. It is only one weapon in the government's arsenal. It is
designed to buy the time needed for the more fundamental monetary
and fiscal policies to have their effect. And I must say that in



my opinion, the voluntary standards have contributed to smaller
increases in price and wages than otherwise would have been
experienced. Most major corporations are in compliance with the
program, and all but 10 of 130-plus major labor contracts signed
since last October are in compliance. Labor, management, and
government should continue to work together in striving for a
new accord to break the cycle of prices chasing wages and wages
chasing prices, an accord that will be in the best interests of
every American.
A third important new direction was the forceful action of
last November 1 to halt the slide of the dollar. The decline of
the dollar in the year prior to November 1978 added 1 percent
to the inflation rate last year by increasing the cost of imports
and reducing competitive constraints on domestic producers. As
these higher costs ripple through the econoirjy, they will add
another 1 percent to the inflation rate in 1979.

This additional

2 percent inflation over two years constitutes a $30 billion tax
on the American consumer. We must and will continue our commitment
to a strong and stable dollar. We cannot afford to unleash another
injection of inflation from international monetary pressures.
Energy Policy
Fourth, new directions in energy policies — looking toward
greater energy independence — have been commenced and President
Carter has initiated an urgent and comprehensive program kicked-off
by his address to the Nation last Sunday evening.


America is at the end of the era when pools of oil can be
sucked up with straws, when we can depend upon abundant and
inexpensive oil to light the lamps of the Nation's progress.
A nation that has 6 per cent of the world's population but is
consuming 30 per cent of its energy -- with an import oil bill
that will climb from about $8-1/2 billion in 1973 to an annual
rate of about $70 billion by the end of 1979 -- needs desperately
to change its habits.
Several new energy policies are already in place- The natural
gas bill, which establishes a national market for natural gas, has
contributed to increased supplies. The President has taken the very
important step in the phased deregulation of domestic crude oil
prices to create incentives for greater conservation and production.
He has just added an additional major step in setting quotas on oil
imports, and in committing America to a steady reduction in quantities
of imported petroleum.
We must reduce our dependence on oil as an energy source;
and we must reduce our dependence on imported oil. All of us need
to lend our support to the President in achieving a strong and
effective energy program.
Monetary Policy
Finally, in the arsenal of weapons, we have pursued a monetary
policy, acting in confluence with other policies, to counter the
fundamental inflation problem. Monetary policy has been directed



to reduce progressively the rate of increase in money and credit,
and to slow, deliberately, the rate of growth of the economy to
a more sustainable level. We have endeavored to accomplish this
on a consistent and continuous course to avoid shocks to the
economy and to allow time for businesses and individuals to adjust.
At the same time, we have sought to maintain balance in the economy
so that no one sector would carry too heavy a burden. Clearly, our
task has now been made more difficult; the course between greater
inflation on the one hand, or a deepening of the pressure entailed
in downward adjustment in growth, on the other, is now more treacherous
to steer.
Nevertheless, because of the cumulative effect of all the new
directions — reduction in the Federal deficit, compliance with the
wage-price program, a stronger dollar, initiation of a more effective
energy program, a restraining monetary policy ~ the Nation is now
in much better shape to weather the storm than it would otherwise
have been. There are no major imbalances in the economy: there is
no serious overhang in business inventories; consumers have become
more cautious in spending as their budgets have been squeezed by
rising prices of basic necessities, but they have not been driven
from the marketplace; housing has been slowed, but, because of the
introduction of money market certificates and other changes that
allowed the industry to compete for funds, it has not been shut
down as in some past business cycles. We are headed in the right
basic direction to wring out inflation over the long haul.


New Directions — How Far Have We Come?
It was precisely with the long-term view in mind that I
suggested a year ago several new economic directions as a blueprint against which we could measure and evaluate our progress.
I suggested that we quantify our goals, to give us a clearer
picture of where we wanted to be over the next five to seven years.
Let me now "revisit" some of these directions to assess how
far we have travelled. Although the timetable may have to be
extended, I believe these are still the valid directions to pursue
for success in our inflation fight. In fact, if progress continues
to be made toward the solution of structural problems in our economy,
we could ease considerably the dilemma of choosing between inflation
and slow growth.
All of the policy shifts I have described work toward the first
new direction I suggested a year ago -- a commitment to fiscal prudence,
and, in particular, to reducing the role of the Federal Government
in the economy.

It is vital that we return more of the spending

and investment decisions to the private sector, where their cumulative
effect will be to increase the efficiency and effectiveness of the
economy's operation. The share of the Federal Government in GNP,
at a peak of 22.6 per cent in 1976, has come down slightly to 22
per cent currently. This progress needs to be continued so that
over the next three to five years we achieve further reduction of
Federal expenditures to about 20 per cent of GNP, thereby freeing
about $50 billion for the private sector.



Reducing the government's share of GNP, in turn, moves us
toward the second new direction — a balanced budget with high
employment. Present plans head us down to a deficit of around
$30 billion this fiscal year. The President, the Congresss, and
the American public are united in support of the goal of a balanced
budget. Even in the face of higher unemployment, we must stick to
this disciplined fiscal policy.
But when we think about the unemployment figures we should
take credit for the present historically high percentage of the
adult civilian population that is employed. The capacity of our
economy to absorb substantial one-time labor force increases over
the past several years has been tremendous. And let us not forget
that the best hope for high employment on a continuing basis still
lies in wiping out the disease of inflation; inflation is still the
primary obstacle to our employment goal.
Last year I also suggested a vigorous program to expand exports.
Some progress has been made in the past half-year as export growth
accelerated. We must continue this progress, increasing our exports
over the coming years from 7 per cent of GNP to 10 per cent. This
will help to correct the balance of payments problem and to maintain
a strong dollar. But I would stress that further impetus to export
growth must come from improved price, product and market performance,
not from changes in the dollar exchange rate.


Intertwined with the other points in this blueprint is the
commitment to reduce inflation. Over the coming months, we will
see only little progress on this front, as increases in the energy
and food sectors continue to push up the Consumer Price Index.
But this past year has been characterized by a heightened recognition
of the inflation peril by the American people, and a deep commitment
to give first priority to the war against inflation.
As to the Federal Reserve, we are firmly enlisted in this
commitment. We are determined to pursue a monetary policy that
will contribute to wringing inflation out of our economic system.
The Investment Challenge
Let me turn now to another new direction that is beginning to
take shape. A reduction in Federal expenditures, in combination
with our progressive tax structure, should yield sizeable surpluses
in the Federal sector during the 1980's. We should use the opportunity,
at the appropriate time, to return the fiscal dividend to individuals
and businesses through tax reductions. Again, the goal should be to
give more spending decisions back to the people.
My personal preference, when the time is right, is for reductions
in payroll taxes to aid individuals while at the same time reducing
costs that go into prices, and for reductions for businesses which
are tied directly to expenditures for new plant and equipment.
This brings me to another important new direction — the investment challenge. The economic strategy, as I've outlined it, has



contemplated slower growth in the economy to reduce excess demands
on resources. This was intended to relieve pressure on capacity —
giving us time to catch our breath and to adjust to a more moderate
and sustainable growth rate.

With a recession underway, it is now

desirable to plan a recovery, led ncrt by stimulus of consumer demand,
but by stimulus for investment. We need to prepare for this direction
without further delay.
For the first twenty years after World War II, the United States
led the world in productivity gains. Each year we averaged about
3-1/3 per cent greater productivity. Those productivity gains
provided us with the basis for annual increases in the real income
of every American. For the last ten years, our productivity gains
have been only two per cent; for the last five years, only one per
There are many reasons why productivity gains have fallen to
dangerously low levels. One key reason is that our capital spending
has been lagging. The recent growth in the Nation's capital stock
has been far lower in net terms than in past cycles; we have not yet
even come back to the peak at the height of the last business cycle.
Because capital has grown more slowly than the labor force, we
are beginning to fall behind in the investments that are essential
to providing the jobs for the future. And we're falling behind other
countries: Japan spends more than 20 per cent of its gross national
product on capital investments; Germany, 15 per cent of its gross
national product; the United States 9 or 10 per cent.


These, then, are the consequences of ourunder-investment:
sluggish productivity gains; limited investment in providing jobs
for the future; reduction in export growth due to a faltering competitive position; and a reduced value of the dollar.
My own proposal has been that we endorse a simple formula:
1-5-10. 1-5-10 stands for a new policy of liberalized depreciation
under which all mandated investments for environment, safety and
health would be written off in one year; all new investments for
productive equipment would be written off in five years; and all
capital in structures and permanent facilities would be written
off in 10. This acceleration of the depreciation allowance offers
the most direct and efficient way to boost investment, for two
reasons: first, accelerated depreciation ties each dollar of
revenue loss directly to capital investment; and, second, because
this formula reduces risk and thus gives strong incentive for
investment in the cost-saving and modern production facilities.
Our estimates indicate that 1-5-10, after five years, could raise
the investment share of output close to 1 per cent higher than
what it would otherwise have been.
Recently, a bipartisan group of senators and congressmen
proposed a variation of this speedup in depreciation. This is
an encouraging recognition of the need to spur investment and of
the wide support the stepped-up depreciation approach seems to be
generating. As the details emerge and proposals become molded in



the Congress, I would encourage each of you to give attention and
support to this vital area.
The result of such stimulus to investment would be to reduce
the unit cost of production; to reduce the units of energy required
for output; to improve our technology; to improve our competitiveness
in the world; and to help break the wage-price spiral. We would
once again lead the world in research, technology, and production.
Where Are We Headed?
In closing, I will not minimize the impact of recent events
on our economic strategy; we will be set back. Nor will I minimize
the hardship imposed on individual Americans: the short-term burden
will be heavier and the shared responsibility is more urgent.
Over the next several years, we will, in fact, face somewhat
slower growth. We will have to accept some shrinkage in our real
incomes. But let me suggest to you that collectively we can absorb
this reduction in real growth and incomes without commensurate
social deprivation. We may surprise ourselves in how innovative
we can be in learning to make fewer demands on scarce.resources.
Let me give you just one quick example. This past year,
forced upon us by the energy crunch, Americans have changed their
preferences from gas-hungry automobiles to smaller, more energyefficient cars. What may have been lost in comfort or satisfaction
is minimal compared to what has been gained in energy conservation
and in lower pollution. It has not been so difficult a transition
as we would have thought.


There are many other areas in which we can explore alternatives
and, uninhibited by inertia, tradition, or peer group pressure, find
new patterns of consumption similarly free of large social costs.
We do have a strategy. We do have a way out. We can change
our habits from consumption to investment; we can save for future
growth; we can begin to put back what we have taken out. But we
must have the patience and strength to wait for our policies to
bear fruit. I believe the American people have that determination.