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For release on delivery
10:00 a.m. E.S.T.

Statement by

G. William Miller

Chairman, Board of Governors of the Federal Reserve System

before the

Joint Economic Committee

December 15, 1978


Mr. Chairman, members of this Committee, thank you for the

to participate in this important dialogue.

At present,

the economy is at a critical juncture. Economic growth has continued
at a moderate pace, but the rate of inflation is unacceptably high
and poses an ever-growing

threat to our social and economic struc-

While the challenge for public policy is clearly formidable,

these problems are not insurmountable.

The Federal Reserve, for its

part, is continuing to pursue a monetary policy that aims at a reduction
of inflationary pressures while encouraging continued economic growth
and high levels of employment.
The rise in economic activity has been both vigorous and
generally well balanced

The sharp

since the present expansion began in early



in inventories and production that have


been avoided.

Growth in

the latter part of this year—-well into the fourth year of expansion—
has moderated, but this represents a desirable adjustment in the pace
of activity, given the intensification of inflationary pressures,
the rise in capacity use, and the decline in unemployment that has
occurred over the expansion period.
The persistence and recent intensification of high inflation
has been the most serious problem in the present expansion.


price increases generally remained in the 6-1/2 per cent range over
the 1975-77 period, but these prices have risen at a 9-1/2 per cent

-2pace thus far this year.
to weather-related
the farm sector.

Some of this acceleration can be attributed


and to unexpected developments

Labor cost pressures also have played an important

role as wage gains have moved up to about 8-1/2

per cent during a

period when productivity growth has slowed to a virtual
At the same


time. Government-mandated increases in the minimum wage

and in payments

for social security and unemployment insurance have

added a further premium to labor compensation.
tive depreciation of the dollar's


impact on domestic prices

Finally, the cumula-

foreign exchange value has had an
that has yet to run its course.

Looking ahead, there is a threat that wage demands could
be further escalated, especially with a heavy collective


for 1979 in an environment where inflationary expectations

are intense. Cost pressures are also likely to be further exacerbated
by another

round of legislated


in payroll taxes and the

minimum wage. However, the Government's over-all anti-inflation program holds out the real hope that inflationary pressures can be contained, and that the groundwork can be laid for gradual attainment of
price stability.

The success of the program requires


perseverance, and patience from all. groups of our society. An important
new ingredient of the program is the quantitative standards. If adhered
to, these standards could very well help unwind the intractable spiral
of wages and prices. But it is particularly important that the program

that Government actions can, in themselves, be important

sources of inflation; consequently, fiscal restraint and regulatory
reform are essential components of this comprehensive set of proposals.

-3Inflation in the United States not only has eroded the
value of the dollar domestically, but has also been associated with
a decline in its international value.

As the exchange value of the

dollar dropped, this in turn adversely affected the domestic price

It raised the cost of imported goods, and also resulted in

a further ratcheting up of domestic prices for those goods competing
with imports. While the dramatic drop of late October underscored the
problem of deteriorating



in the value of

the dollar, the period of decline in this current episode dates back
to late September of 1977.
From that date to its

low in late October of this year,

the dollar's exchange value declined by 21 per cent on a weighted

basis against



the currencies
some individual


the G-10 countries and

currencies, of course, the

decline was even greater, amounting to 26 per cent against the German
mark, 34 per cent against the Japanese yen, and 38 per cent against
the Swiss franc. Since important external imbalances between the United
States and major foreign countries have existed for several years—most
notably differential growth and, more recently, disparate inflation
trends—some depreciation of the dollar could be viewed as a necessary

However, by mid-summer it was clear that the dollar's

decline was continuing in trading that was increasingly disorderly.
Consequently, in August the Federal Reserve announced a half point
increase in the discount rate and an elimination of reserve requirements on Euro-dollar borrowings.

At the same time, the Treasury

indicated that it would increase and extend its regular monthly gold

-4These measures, which produced a brief rally

and then a

few weeks of stability for the dollar, were followed by another threequarter percentage point rise in the discount rate between mid-September
and mid-October, But the dollar's slide soon resumed, and it dropped

to a level well below that warranted by basic economic


As a result, the severity of this latest decline

threatened to undercut the anti-inflation program at home and lead
to an even greater erosion of confidence abroad.
Under these circumstances, more forceful action was clearly
necessary. Accordingly, on November 1 the Federal Reserve increased
the discount

rate by 1 percentage point and


a 2 per cent

supplementary reserve requirement on large time deposits. In addition,
the Federal Open Market Committee voted to take further actions to
tighten conditions in the money market
expansion of money and credit.

and thereby resist excessive

Furthermore, in order to provide a

substantial increase in foreign exchange available to finance exchange
market intervention* swap lines were increased with the central banks
of Germany, Japan, and Switzerland by a total of $7.6 billion.


U,S 9 Treasury simultaneously announced its intention to draw a portion
of the U.S. reserve position in the IMF, to sell SDR's, and to issue
foreign currency denominated securities.

Over-all, $30 billion in

foreign currencies was mobilized by the United States for forceful,


intervention to support the dollar in foreign exchange

markets,, In addition, the Treasury announced
its rate of gold sales.

a further step-up in


-5The objective of this coordinated

set of measures was to

correct the excessive depreciation of the dollar as part of the governmental effort

to reduce upward pressures on domestic prices and to

restore confidence at home and abroad.

When viewed in its entirety,

the policy initiatives of the Administration and the Federal Reserve
provide a clear message that U.S. economic policy is one that recognizes
fully the need for an integrated approach in dealing with foreign and
and domestic economic problems.
The measures taken on November 1 produced a dramatic jump in
the dollar ! s exchange value. On that day alone the dollar advanced by
5 per cent on a weighted average basis, and by about the same amount
against the mark, yen, and Swiss




central bank intervention over the following few weeks provided support
for the dollar as market participants tested the authorities1 resolve.
The strength of the dollar generally has been sustained as the market

to have adjusted to a more

favorable outlook generated by

the recent policy measures.
To date, the observable repercussions in domestic capital
markets also have been generally favorable.

In the stock market, most

composite share price measures are up from the November 1 announcement
date following relatively sharp declines in the preceding two weeks.
Short-term interest rates have moved

as much as 1 percentage point

higher since the announcement; however, over this same period interest
rates for longer-term maturities have been essentially unchanged.
comparative stability of most long-term bond


rates, as well as the

improvement in the dollar's exchange value, is most encouraging and
suggests that we may be beginning to reduce inflationary expectations.

-6A downward adjustment of price expectations is an essential
condition to slow the treadmill of inflation, and monetary policy has
an important role to play in this regard.
the Federal Reserve will

continue to encourage a moderate expansion

of over-all activity, thus also

However, at the same time,

facilitating the achievement of the

longer-run goals of growth and full employment.


as I have emphasized before, monetary policy should not be expected
to shoulder the burden alone, and to be effective, it must also be
accompanied by prudent restraint of fiscal policy.
Since April, credit conditions have become


tauter as Federal Reserve policies have allowed market rates to rise
appreciably in order to help
Yields on most

restrain expansion in money and credit.

short-term market instruments, such as Federal funds

and commercial paper, have risen more than 3 percentage points during
this period, while interest

rates at the longer end of the maturity

spectrum generally have risen by less than a percentage point.
Experience over recent years has

taught us, however, that

in an inflationary environment, expectational considerations tend to
buffer the impact of high interest rates on spending.
of rising prices of real assets may induce borrowers

to incur high

interest costs, as is illustrated by the sustained pace of activity
in the housing market thus far this year,

Indeed, real


rates—or observed rates adjusted to take account of inflation—appear
to be generally lower than in prior periods, especially if taxes are
taken into consideration.
Not only have expectations of borrowers and lenders changed
in the course of the current expansion, but also monetary institutions

have been given additional flexibility

to compete

for funds.


has helped smooth adjustments of credit markets to developing tightness
and, as a result, has helped avoid the repetition of "credit crunch"
episodes such as in 1969 and 1973-74. The new 6-month money market
certificates, introduced half a year ago, have buttressed deposit
growth at mortgage lending institutions when prevailing market interest
rates might otherwise have produced disintermediation. Consequently,
total housing

starts have remained at a very high rate—2 million

units—during the first three quarters of this year. Building activity may soon begin to decline, but the drop-off next year should be
relatively moderate, making

it unlikely

that the economy will be

thrown into a recession by a sharp housing cycle.
Furthermore, signs generally remain on the positive side
for consumer spending, as real consumption outlays currently are rising
at about the pace of over-all demands. Nonetheless, this represents a

slowdown from the rate of expansion earlier in the current

upswing. Near-term growth in consumer spending probably will be somewhat restrained by high debt repayment burdens as well as by efforts
to boost personal savings rates back to more normal levels.
In the business sector, capital spending activity continues
to be characterized by substantial momentum as equipment orders have
moved up briskly in recent months and construction contracts have been
maintained at a high level. However, the early surveys of 1979 investment plans suggest that businessmen maintain a lingering caution about
embarking on major expansion programs.

These surveys—largely


before the November 1 measures—undoubtedly reflected the uncertainty
associated with an economy plagued by high inflation.

On balance, private demands appear healthy at present, but
a further moderation of growth is likely over the year ahead. In this
environment the Federal Reserve will continue to strive for a gradual
deceleration of monetary and credit expansion in an effort to facilitate
an easing of inflationary pressures. We believe that the actions taken
in late October and early November will prove to be instrumental in the
restoration of both domestic price stability and orderly conditions in
foreign exchange markets.

At the same time, you can be assured that

recent measures in the international area were designed to reinforce
and not to sacrifice the achievement of longer-term domestic