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For release on
Wednesday, August 12, 1970
at 2:00 p.m. EDT

Forecasting Economic Activity in 1970

Remarks of George W. Mitchell
Member, Board of Governors of the Federal Reserve System
at the
Denver Economics Club
Denver, Colorado
August 12, 1970

Forecasting Economic Activity in 1970
Economic prospects today are more shrouded than usual
in uncertainty and apprehensiveness.

Uncertainties are manifest

in the violently fluctuating expectations of investors; they are
also evident in the relatively low rates of spending by consumers.
Apprehensiveness is apparent in the widespread doubts within
business, political and financial circles as to the efficacy of
monetiary and fiscal restraints in bringing prices and costs
under control without inducing a serious recession.
The present environment, in contrast with that prevailing
in the Sixties, has some unfamiliar patterns— while the "go-go" is
no longer with us, the aura of a Fifties-type recession has not
returned either.

We are living in a kind of surrealist stillness,

in which the economy respires but does not otherwise move— a
dangerous state in which to linger too long.
What has happened to cause consumers to break their
long-established peacetime consumption patterns?

Vietnam did

not divert much, if any, production from consumer output but
Vietnam did alter consumer attitudes toward spending and saving.
The extreme posture of anti-consumerism?— so much in the news
lately— is held by only a very small part of the population,
but the environment which produced it has, in a less spectacular
way, weakened consumer demands on a much broader front.


concern about inflation seems to have had an adverse effect on
spending over and beyond necessitous retrenchment by those living

-2on fixed incomes.

Recently, concern about income prospects

also appears to have brought about more conservative spending

Our youth have' shown no more inclination to spend

freely than their elders.

Disenchantment with the ultimate

goals and the structure of society has not stimulated their
consumption, either; neither their concern nor their protest
appears in our calculation of the gross national product.
Attitudes generally have been buffeted by non-economic
forces— the ups and downs in our progress toward disengagement
in Vietnam, the tensions introduced by social and student unrest,
and the uneasiness of so much questioning of our society's goals
and the establishment's institutional arrangements for meeting

One might epitomize the worrisome mix of economic and

non-economic trends in the past few months by observing it's
been a tough time for both ticker tape and girl watchers with
plunging stock prices and hemlines.
Uncertainties of the type I have been mentioning, by
altering the psychology and attitudes of consumers and investors,
influence their spending and investment decisions.

But since

the underlying forces are essentially non-quantifiable, directly
or through proxies, the timing, duration and magnitude of these
influences are not readily incorporated into econometric models
on which we have become dependent.
Dependence on the models is not misplaced.


capacity for internal consistency, for bracketing the forecast

-3range, for policy simulations, and for objectivity are invaluable
aids to economic forecasters.

Edward Gramlich, an econometrician

on the Board's staff, put it well recently:

"Judgmental forecasts may be consistent in the sense that
all identities add up correctly, but they are not always
consistent in the economic sense that consumption patterns
may not be consistent with inventory patterns, or that
flow-of-funds projections imply interest rate patterns
which are consistent with the patterns of final demand.
Model forecasts, whatever their defects, insure this
consistency automatically."

Within, I would add, the

range of past experience.
"Secondly, model forecasts can increase the mechanical
advantage of judgmental forecasters.

Rather than having

to appraise major economic relationships and specific
factors simultaneously, models can take care of the major
economic relationships and allow judgmental forecasters to
worry exclusively about specific developments.

Thirdly, a

close study of the residuals might itself be instructive
because it acts as an early warning device in noting
instances of structural change in economic relationships.
Fourthly, models provide a technological advance in that
once a forecaster has adjusted residuals to give reasonable
predictions, he can at zero cost extend his forecast further
into the future and alter policy variables to examine the

-4effects of policy changes.

And, finally, the model

gives the forecaster an independent and completely
honest check on his judgment."
Mr. Gramlich stresses the strengths of the econometric
approach but the prestige of this technique can be misused.


example, there is some tendency for sorcerers' apprentices to use
simplistic models to simulate nightmares for policy makers, by
projecting intolerable levels of inflation or unemployment, or
even both!

In the hands of the master economist, models greatly

extend insight and usefulness.

A master does not hesitate to

adjust judgmentally the model's workings and findings in light of
known weaknesses or those that come to light, and he does not
needlessly stir up policy makers.
In the current environment the greatest difficulty of
the model user seems to me to be found in evaluating consumer
demand, appraising the effect of the recent large decline in
equity values .on consumer demand, housing, and business investment.
Models in use are not adequately equipped to deal with the abnormally
large changes that have occurred in financial asset values or with the
historically unprecedented level of interest rates at which funds
must be obtained.

Under the circumstances, I find it difficult to achieve
a high degree of confidence of forecasts within the range of pro­
jections that are offered for GNP, real GNP, the unemployment
ratio, the GNP deflator and other stripped down indicators of the
economy's performance.

No do I sleep much better at night knowing

that the money supply in the first half of the year grew at the


-5magic rate of 4.0 per cent, since it may well be that demands
for cash balances in a time of uncertainty changed by much
more than this.

But some people do.

Money supply watchers these days are almost as
numerous as ticker tape and girl watchers.

As a technique

of business forecasting it supports a broad range of applica­
tions and devotees.

It is simple enough for dilettantes and

can be made complex enough for erudition or darkly obscure

And it can also be adapted to policy making or to

second guessing the decisions of policy makers.
The basic difference between the econometrician and
the money supply watcher is that the former seeks an explanation
of the process by which changes in the various sectors of the
economy occur.

The money supply watcher, on the other hand,

professes little or no interest in that process— it may be too
complicated to unravel or it may simply be irrelevant to the

The relationship of changes in money and changes in

economic activity in the past demonstrates— the dogma goes-that with a lag, the changes in business activity will respond
to changes in the rate of growth of money.

But in this simplistic

approach lies the danger that the past relationships may not hold,
or that the sub-structure of the relationship will hide economically
meaningful differences.

Even if a change in current dollar GNP lags

predictably behind money supply developments, for example, the share
of the GNP that is real and the share that reflects price increases
may well shift with economic attitudes.

-6While my preference is for econometric analysis of
the more substantive variety, I fully agree that the relevance
of monetary and credit aggregates as proxies, responders or
generators must not be ignored.

Monetary policy making is

better for giving more attention to the monetary and credit

But without some theory of relationship between

money, however defined, and the economy, confidence in a particular
regression result tends to become an act of faith in light of the
unlimited possibilities of alternative regression findings de­
rived from alternate definitions of money, varying time periods
of lag, and different paths through which the monetary influences
may work themselves out in different economic circumstances.
Another limitation money supply watchers should bear
in mind is that no single aggregate merits consistent allegiance
as the economy's financial needs and practices change, or as
bankings' share of credit flows change.

This fact is well

illustrated by the 1969-70 experience with the use of Regulation Q
ceilings, constraints on repurchase agreements and other devices
adopted by the Federal Reserve to limit if not sever bankings'
connection with money and capital markets.


These measures made

M 2 and the credit proxy, in my opinion, inappropriate measures
of monetary conditions.

Their relevance, even with the adjust­

ment of the proxy for Euro-dollar use, loan sales and the like,

requires the assumption that limiting the impact of monetary
restraint to the banking system while leaving funds to flow more


-7freely in dircct credit market channels, somehow administers
the monetary coup de grace.

Bankings' share of the market

declined dramatically during this period but because of
extensive disintermediation comparable restraint was not
applied to the. economy as a whole.

Most of the proponents of

M¿ as a significant monetary variable discontinued reliance
on it during the period in which banks were forced to limit
their access to U. S. money markets.
Under those circumstances, M¿ has recently been the
focus of most money supply watchers.

And it has put on quite

a pyrotechnic display for them— particularly those who believe
that a week or month of rapid rise or decline, measured


terms of annual rates of change, presages more of the same.
To a significant degree these explosive changes have been due
to imperfections in the basic statistics obtained in the course
of estimating net 1PC demand deposits.

But if this limitation

had been overcome there still would have been an irregular
growth in the money stock on a month-to-month basis and some
money supply watchers would have been able to view developments
with great alarm by peak-to-trough or trough-to-peak measurements.
Considering the data problems and the System operational
techniques money supply watchers would dc better to take another
look before reaching a judgment they must shortly reverse.



In the record of the past 12 months the monetarist
would--in my judgment--have hadI little to disturb him had he
taken a longer look and a more discriminating one at the
actual data:
Annual rates of change
1969--- July


1970--- January

4. Ip



My judgment over the year as manifested in my voting
record was that, with one exception, the money supply aggregates
have been appropriate to actual conditions.

In the late summer

of 1969, however, monetary conditions were getting too tight as
evidenced by the behavior of Mi, as well as by the further rise
in long-term interest rates at a stage that was obviously very
late in the cycle.

A majority of the FOMC did not agree that

these trends indicated further tightening and stated in the
directive the intent to maintain "prevailing firm conditions in
money and short-term credit markets."

Governor Maisel and I were

the only members of the Committee at the meetings of August 12
and September 9 to confcoa^uA a t a "no change" directive in terms


-9of money market conditions would, in fact, be a tightening
Short-run money supply trends in January, March and
April of 1970 were not indicative of longer run Mi trends, as
subsequent developments have indicated.
In recent weeks, liquidity stresses in the economy
have been eased without any great change in Mi or its components.
But there has been a great increase in intermediation at
commercial banks and savings and loan associations.


denomination CD's, freed of ceiling restraints in the important
maturity ranges, rose about $1 billion per week for five successive

Total time and savings deposits at commercial banks rose

at an estimated annual rate of 35 per cent in July and re­
intermediation, along with discount window accommodation, made
funds available to banks who, in turn, accommodated those sectors
of the economy under liquidity stresses.
In June-July some observers thought that liquidity
demands of the economy would require large changes in Mi which,
on the basis of some model projections, would lead to resurgence
of inflation.

It now appears that the liquidity crisis was not

a problem of the economy as a whole but only of limited sectors.
Nor do data available up to this time indicate much net
effect on Mi.

The most recent evidence of behavior of money

holders shows them exhibiting a strong preference for the
convenience, safety and liquidity of near monies— high quality,
short-term securities or interest-bearing time deposits.

-10These shifts seem to be at the expense of equity holdings,
riskier investments and consumer expenditures.
The cooling-off process initiated by a combination
of monetary policies nearly two years ago was described at the
time as "gradualism."

The gradualist approach was derided by

some as ineffectual but, with some fortuitous assists, it has
turned out to look pretty good.

It has slowly but spectacularly

altered economic expectations and business prospects.

It has

set in train a sequence of events which will, given still more
time, bring inflation under control.

It has uncovered weaknesses

and abuses in credit practices and financial structures that are
characteristic of an inflationary environment.

These are now

undergoing correction and modification, but in an orderly way
and without aspects of cumulative over-reaction by lenders and
The processes set in motion have yet to run their
course in the effects on prices and costs.

But the policy issues

of the moment are not those of sustaining restraint until the
last ripples of earlier inflationary programs and policies have
died away.

Rather, the issue is one of timing action to

stimulate those sectors of the economy on whose activity we will
be dependent for jobs and opportunities six to nine months hence.
Since we have limited experience with the conjunction of a
dramatic decline in wealth, a widening recognition of the continuing
burden of high interest rates and an economy greatly concerned with



non-economic issues, we can easily underestimate the economic
contraction that has been set in process, and will need to be

The dimensions of the problem are difficult to

bracket and the forecasting complexities in an environment
with so many cross currents present are formidable.


experience of the past year or more convinces me, however,
that above all we will need a greater awareness of the
limitations in our projection techniques if we are to avoid
being impaled by doctrinaire monetarist or non-monetarist
models of sorcerers' apprentices.