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For Release on Delivery
Statement by
G. William Miller
Chairman, Board of Governors of the Federal Reserve System
before the
Joint Economic Committee
June 29, 1978
Mr. Chairman, 1 appreciate this opportunity to participate
on behalf of the Federal Reserve Board in the Joint Economic Committee's
mid-year review of the economy*
These sessions provide an excellent
opportunity to assess economic conditions and policies.
• ECONOMIC ACTIVITY EXHIBITS HEALTHYGROWTH
The economy has continued to expand at a satisfactory though
uneven rate over the first half of this year*
industrial production,
construction, and retail sales were temporarily depressed early in the
year by unusually severe weather and the long coal strike, as shown in
Chart 1.
But these were transitory effects—and business activity
recovered vigorously in the spring.
For the first six months of the
year, real annual growth in the gross national product appears likely
to average around 4 per cent—close to the pace during the latter half
of 1977•
Thus, despite the considerable volatility in key areas of
the economy, the underlying momentum of the expansion appears to have
been well maintained*
The strength of aggregate demand has stimulated a substantial
further improvement in the job market•
As is indicated in the bottom
panels of the Chart, employment gains have been exceptionally strong.
More than 2 million nonfarm jobs were created over the last six months,
which lowered the unemployment rate by more than one-half of a percentage point to just over 6 per cent of the labor force.
The jobless
rate for heads of households fell one-half percentage point to
3.7 per cent.
The proportion of the working-age population with
jobs has moved up to 58 ,.6 per cent. ^ a new record high. The sustained
strength of demand for workers suggests that businessmen remain
optimistic, and are prepared to increase production and other activities further.
Growth of economic activity recently has slowed, as was
expected, from the unusually rapid pace of the spring*
A moderate
rate of economic growth appears to be a reasonable prospect for the
balance of the year*
Both consumer outlays and business spending
should provide support for further expansion of activity* Consumers9
demand for new cars has been particularly strong, and the current
rate of sales is the highest in this expansion*
The advanced sales
pace may, in part, represent: purchasing in anticipation of further
price rises•
But surveys indicate that consumer confidence remains
generally high, although there has been some recent moderation, and
if growth of income is sustained, the prospects for further gains
in consumer spending appear good*
Business outlays for both inventories and fixed capital goods
have contributed significantly to the recent pace of activityo
A larger
rate of inventory accumulation was to be expected, in light of the burst
of final sales late last year, and the damping effect of adverse weather
on production during the winter*
Inventories in most sectors appear
quite low relative to sales, and continued growth of Inventory investment—albeit at a more moderate rate---should be evident over the next
few quarters*
Business investment in plant and equipment, after
—3~»
lagging early in the economic upswing, has increased at a reasonably
good pace over the past two years*
While recent surveys have shown
little propensity for business to scale up capital spending plans,
these and other indicators of prospective capital outlays suggest further moderate growth in the year ahead•
Our foreign trade position should also lend moderate support
to the economic expansion*
Some pick-up in growth abroad and our
improved competitive position should help to boost exports*
However,
U*S» demand for imports—both oil and other products—is likely to
remain quite high.
Among other sectors of demand, State and local governments
have maintained conservative spending policies for some time, and it
is likely that the reverberations of the passage of Proposition 13 in
California may be evident in an even more cautious pattern of outlays
in the period ahead.
Residential construction activity is expected to begin to
taper off later this year in response to tighter mortgage market conditions o However, housing starts were still above a 2 million annual
rate in May, virtually assuring brisk construction activity over the
next few months.
• BUT
THE
PRICE
SITUATION
WORSENED
Thus in most respects the immediate outlook appears generally
favorable.
riorated.
But in one critical regard the economic situation has deteThe recent intensification of inflation, illustrated in
Chart 2, raises profound questions in regard to the longer run,
As can
be seen in the Chart* the rate of price increase has accelerated
sharply both at the consumer and producer level* A major factor
was the effect on food prices of a decline in meat production.
But other prices rose, at an accelerated rate as well*
Excluding food
and energy, retail prices have risen at an annual rate of over 8 per
cent so far this year, up from a 6-1/2 per cent rate of increase in 1977,
Actions of the Government have also played a significant role in the
recent worsening of inflation.
Service prices have risen strongly, influ-
enced importantly by the rise in the minimum wage on January 1«, Moreover,
increases in social security and unemployment insurance taxes have added
to labor costs on a broad scale, while costly regulatory actions continue
to put upward pressures on costs.
There is some hope that the exceptional rate of increase in food
prices will moderate as the year progresses, but there is much less likelihood of any easing of underlying inflationary forces.
The recent accelera-
tion in consumer prices will add to the pressure for substantial wage
boosts, and resulting higher labor costs will largely be transmitted
through to prices.
. MONETARY POLICY HAS RESPONDED TO EMERGING DEVELOPMENTS
The faster pace of price increases in recent months along with
the sizable expansion of economic activity has been reflected clearly in
financial market developments.
exhibited appreciable strength.
Demands for both money and credit have
The Federal Reserve, for its part, has
moved carefully in the direction of greater restraint in order to ensure
that excessive money and credit supplies do not add to powerful inflationary forces evident in our economy.
-5The firming of monetary policy was undertaken also in response
to the clear tendency for monetary expansion to exceed the growth ranges
that had been established.
Transaction demands for cash balances have
been especially sizable and the narrow money stock (M-l) has grown at an
annual rate of nearly 8 per cent thus far this year, somewhat faster than
the upper end of the long-run range the Federal Reserve has set*
In the presence of strong credit demands, the worsening of
inflation, and the Federal Reserve's efforts to contain excessive monetary
expansion, market interest rates have risen significantly further*
Most
short-term rates have risen by three-quarters to one percentage point
since the beginning of the year and long-term bond yields have followed
much the same pattern, as illustrated in Chart 3* The rise of market
interest rates has been accompanied by slower growth of savings and
small-denomination time accounts at banks and thrift institutions*
As
a result, growth rates of broader monetary aggregates—M-2 and M - 3 —
have remained within the Federal Reserve's long-run ranges*
A good deal of the rise in interest rates this year can be
attributed to the acceleration of inflation,,
For lenders, rising
prices of goods and services result in an erosion in the purchasing
power of loan principal*
Consequently, when greater inflation is
expected, a rise in nominal interest rates is necessary to offset
such losses and maintain the incentive to extend credit*
For bor-
rowers, higher interest rates are less of an obstacle to incurring
debt under conditions of accelerating inflation. Greater cost savings
can be enjoyed by buying now rather than later, while tangible assets
purchased appreciate more rapidly in value. Borrowers,, moreover, can
expect to support greater debt service burdens via faster nominal
earnings growth due to accelerated rises in prices, wages and salaries.
The importance of such an anticipatory process is being
demonstrated very clearly right now in the mortgage market.
Evidently
mortgage borrowers, while expecting their nominal incomes to continue
to rise significantly, believe prices of homes also will escalate
rapidly*
Despite stiffer lending terms and higher interest rates on
mortgages, home sales have continued high, and the demand for mortgage
credit has remained very strong* Faced with reduced deposit inflows,
thrift institutions have drawn down their liquidity and sharply
increased their borrowing in order to accommodate these credit demands.
The Federal regulatory agencies have taken action recently to
improve the competitiveness of deposits subject to regulatory ceilings
by authorizing two new savings instruments—variable-ceiling, six-month
certificates with interest rates tied to the discount yield on newly
issued Treasury bills, and eight-year certificates carrying ceiling
rates of 7-3/4 and 8 per cent for banks and thrifts, respectively.
It
is still too early to quantify the contribution of the new accounts,
but early reports indicate considerable promotional activity on the
part of depositary institutions and interest on the part of savers,
. CONSUMER AND BUSINESS CREDIT DEMANDS STRONG
Consumer borrowing through mortgage credit has been a principal influence in the sustained high level of total credit demands*
sumers have also taken on record amounts of new instalment debt to
Con-
-7finance purchases of durable goods, especially cars (Chart 4 ) . The
rapid rise of household borrowing is a matter of concern.
High debt is
apt to constrain spending later on, and always carries the risk of
financial difficulties for those who have borrowed heavily.
Thus far,
however, households generally appear to be handling their increased
indebtedness well.
While the ratio of consumer and mortgage loan
repayments to disposable income is very high by historical standards
delinquency rates have only recently edged upward and they remain well
below recession peaks.
Business demands for credit have expanded sharply of late,
owing partly to the growth of capital spending and the pronounced
upturn in inventories (Chart 5 ) . In addition, internal cash flows
slowed early in the year as bad weather cut into sales and costs were
pushed up by hikes in Government payroll taxes and in the minimum wage.
Bank business loans rose at about a 20 per cent annual rate over the
first five months, with the largest rises in March, April and May.
With credit demands strong banks have borrowed heavily in money
markets, through the issuance of large certificates of deposit and
nondeposit liabilities.
. TOTAL GOVERNMENT BORROWING LARGE AS WELL
Government credit demands also have been large, as State and
local units recently issued a particularly heavy volume of advance
refunding obligations to take advantage of invested sinking fund provisions prior to a odd-May IRS ruling restricting securities with such
provisions.
Furthermore, Federal agencies have borrowed more to finance
-8support activities in mortgage markets.
Treasury borrowing—following
heavy demands early this year—has moderated in recent months with the
seasonal inflow of tax receipts,
INFLATION POSES THREAT TO THE ECONOMY
The recent acceleration of inflation has serious implications
for continued economic growth*
Unless inflation is brought under control,
business and consumer confidence will be undermined, distortions
and imbalances in the economy will develop, and ultimately recession
will be the result.
In this regard, the Administration's decision to
request a delay in—and reduction of the size of—the proposed tax
cut, as well as to hold down Federal spending, and to try to develop
voluntary price and wage restraint are encouraging.
These recent steps do not constitute, by themselves, an
adequate long-term attack on the inflationary practices and policies
which have given the economy its inflationary bias.
the Nation's most serious economic problem.
Inflation is now
Because high rates of
inflation erode economic values and raise uncertainties about the
future, they continuously undermine the incentives for saving and
investment®
Without adequate investment in new, more efficient tech-
nology, growth of productivity tends to slow—lending further momentum
to cost-based inflationary pressures.
It is for this reason—because
deep-seated inflation retards long-run growth and is a clear threat to
sustained high employment—that inflation must be characterized as our
highest priority economic problem.
~9• NEED_TO FOCUS ON MANAGEMENT OF SUPPLY
As this Committee has heard in recent weeks in its first series
of hearings on economic change, a major impetus to inflation lies in
problems on the supply side of the Nation's economy*
Among these
problems are:
—
Inadequate growth of the capital stock;
—
Inadequate training, experience, and
mobility among many of the unemployed;
—
Inadequate price competition in some
product and labor markets; and
—
Counter-productive, and frequently inefficient, Government regulation of private
enterprise*
Individually these supply-side issues have been obvious for
many years, but during the past three or four years there has begun to
be a general recognition that they must be addressed collectively and
aggressively if we hope to achieve our national economic objectives•
Reorientation of the Nation's economic policy to emphasize supply
management will take time and careful consideration of many alternatives•
However, some aspects of the necessary reorientation already command
general agreement. Perhaps the key element is to give renewed primacy
to technological advance and productivity growth* Surely, the sorry
productivity performance over the last decade has been a significant
factor in the sustained inflation of the 1970's* and it clearly has
played a role in weakening our international competitiveness.
-10• LARGER GAINS IN PRODUCTIVITY NEEDED
Improving productivity growth involves working on three key
elements;
labor, energy, and capital.
Potential labor contributions to
the restoration of faster productivity growth are many and varied.
Government has a role to play in enhancing labor productivity?
The
it
should focus its various labor market and welfare programs on skill
training to the maximum practicable extent, and should carefully reexamine the cost and price implications of various labor market regulatory
programs, and minimum wage policies.
The energy problem has two main elements:
a need for research
to find new sources of energy, and a need for appropriate incentives to
encourage use of existing energy-efficient technologies.
In this area,
agreement on a national energy policy is long overdue, and the Conference
Committee should intensify its efforts to reach a compromise on the Administration's proposals.
The capital problem is even more complex.
In recent years, the
stock of capital actually has declined relative to the labor force,
(depicted in Chart 6 ) , and this is undoubtedly one important factor
in the slower growth of productivity.
• CAPITALSTOCKNOWINADEQUATE
Capital accumulation is the chief engine of long-range growth
of labor productivity and rising living standards*
Yet, for an extended
period, the Nation's tax policies have not provided adequate incentives
to invest in new capital.
In particular, depreciation guidelines do
not approach actual replacement costs in periods of rapid inflation.
-11I believe a near-term, partial answer is to introduce a more liberal
variant of accelerated depreciation* Over time, careful reconsideration
of all taxes on business is essential.
Because we have been neglecting capital accumulation and
because the existing capital stock must also be adjusted to accommodate the reality of more expensive energy, a larger share of GNP must
be devoted to capital investment. It will not be enough simply to
reach the 10-1/2 to 11 per cent range that has been characteristic
of past periods of prosperity and low unemployment« The Nation should
set an ambitious objective for capital investment of, say, 12 per cent
of GNP for an extended period to enable us to make up for past deficiencies and to narrow the gap between our performance and that of
other strong industrialized countries.
• • RESOURCES MUST BE FREED FOR PRIVATE SECTOR USE
Fundamental to achieving this aim is an expansion in the savings
available for investment from outside the business sector*
To this end.
Government must have a smaller role in the economy and budget deficits
need to be eliminated over time, taking into account the ups and downs in
the economy. The private sector can take up the slack if, over five or
seven years, the Federal Government curtails the growth of its expenditures until their ratio to GNP, which is now above 22 per cent, is
reduced to the 20 per cent range. This interim goal for Federal expenditures clearly is attainable with a good measure of fiscal discipline
coupled with reduced public demands for government services.
-12As spending is brought under control, government will move
from its position as a substantial net borrower of funds in credit
markets* Such a change would moderate demand pressures on credit
markets as well as relieve some of the pressures on prices that arise
from passing on high and rising taxes. Resources will be more readily
available to meet needs in the private sector. Easier credit market
conditions, less inflation, and greater availability of resources
should help ensure adequate residential construction activity to meet
the Nation's housing needs—needs that are now prey to a boom and
bust syndrome that profits no one*
• STKUCTURAL REFORMS REQUIRED AS WELL
Another essential element of a long-term strategy aimed at a
high-growth, low-inflation economy is extensive reform of Federal regulatory activities,
A critical look at price-regulating Government pro-
grams should be undertaken; a painstaking examination of all existing
and proposed regulatory activities in the environmental and health and
safety areas is also necessary9 In this connection, the President's
recent executive order to improve the regulatory process is encouraging.
The Federal Reserve is a participant in this process and has initiated
an over-all review of its own regulations9
Another important element that requires immediate attention,
and which should be an important part of a long-term strategy for
the U.S. economy, is a reduction of our foreign trade deficit, A
sound national energy policy that reduces our dependence on oil imports
is certainly one ingredient. In addition, we must raise the consciousness
-13of businessmen to the sales potential and profits that export markets
can provide. The Government can help by continuing with other governments
to resist protectionist pressures, and by simplifying, and where possible
eliminating, those regulations that hinder our export trade.
In my view,
our ultimate objective should be to expand the share of exports in our
national product to 10 per cent or so, in line with the secular rise in
the share of imports.
I am convinced that the policy reorientation outlined above,
by directly attacking inflation-causing conditions at their root, should
lessen the burden on monetary policy and result in a better balance
between fiscal and monetary policy, and thereby improve the prospects
for lower interest rates. An economic program of this type would
start the Nation on the road to becoming a model economy—-an economy
with a sound dollar, price stability, and sustained full employment.
Our Nation has met bigger challenges, and, with a sense of commitment
on the part of policy-makers and citizens, I am confident that we
will meet this challenge as well.
-0-
Chsiri 1
CURRENT ECONOMIC INDICATORS
Per cent change
S
Per cent eSiang®
Industrial Production
—2.0
Total Construction Spending
_ „
—
luo r
— 1.0
0(1 nnnn n
+
« I
1J
" li
U LJ
0
fl
—
[if
+
0
—
—
I
1.0
F M AM
1977
4
4
J F MA
1978
1978
1977
Billions of dollars
Retail Sales
Mfliions of units
Auto Sales
—
/ \
10
f00"
Domestic
62
—
8
—I 6
58
—
—Foreign
•**^«^-—- —
1_LU_L
J
1977
J
F M A M
1977
1978
86
2
I ! I i i
F M A M
1978
Per cent
^$88ions of workers
Payroll Employment
4
Unemployment Rate
——•
—
fl
—
7
84
82
80
—
6
Mill
II
J F M A M
1977
1978
J
1977
F M A M
1978
Char* 2
MEASURES OF AGGREGATE INFLATION
PERCENTAGE CHANGE FROB1 PREVIOUS PERIOD, ANNUAL RATE
GROSS DOMESTIC BUSINESS PRODUCT
Fixed-Weighted Pr Ice Index
~_Q
Ml ill
i
—
-6
i
!
1 !
!
i
1
i
11 1
—
— 3
1
1j !
1
i
I
i
i 'I
i
1
1976
1975
ll L Q1
1977
1978
'79
CONSUMER PRICES
AH items
f1
—
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1 iDecember—
April change
1975
1977
1976
'79
1978
PRODUCER PRICES
Total Finished Goods
ii ||:|j
!
!ji|i' '
;|l|i|;|
—
|li
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in
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1975
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1976
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1977
lilli Ii
flil
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DecemberMay change
1976
_J-^.
79
i
Chart 3
INTEREST RATES
Per cent
12
10
3-Month Treasury Bills
1974
1975
1976
1977
1978
Charts
HOUSEHOLD BORROWING
Annual rat®, billions of dollars
— 140
— 100
—
60
+
0
1374
1975
1976
1977
1978
HOUSEHOLD DEBT REPAYMENTS
Relative to Disposable Personal income
F@r &®n%
19
18
1977 ~ " 1975
r
1976
1977
1978
MonthSy net change in amount outstanding of Total Consumer Instalment Credit.
Chart 5
SELECTED BORROWING BY
NONFiNANCIAL BUSINESS
Billions of dollars
Total
Outstanding
260
220
Commercial
Paper
I
I
1974
1975
180
Bank Loans
1976
1977
1978
Chart 6
RATIO OF BUSINESS FIXED
INVESTMENT TO GNP
Par cant
11
10
9
1
1967
1969
1971
1973
RATIO OF CAPITAL STOCK
TO LABOR FORCE
I
I
1975
I
1977
Thousands of constant dollars
par parson
12
Trend
1948—1973 „
11
10
9
1967
I
1969
I
I
1971
I
I
1973
I
I
1975
I I
1977
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