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THE ECONOMY
AND ECONOMIC
POLICY

H tM AH Kb bY

John J. Balles
PRESIDENT
FEDERAL RESERVE BANK
OF SAN FRANCISCO

Chamber of Commerce
Anchorage, Alaska
August 16, 1976







Su m m a ry
There's no reason why a boom and-bust sequence should take
place either in Alaska or in the larg­
er national econom y, according to
Mr. Balles. The base of the Alaskan
econom y has broadened over the
past decade, so that it has the
strength to continue m oving for­
ward after the com pletion of the
oil-pipeline project. The national
econom y meanwhile is on a strong
expansion path, follow ing the re­
covery which was brought about by
the adoption o f stimulative m one­
tary and fiscal policies in early 1975.
But the econom y must avoid over­
stimulus in this expansion period,
such as may be generated by the
massive 1976-77 Federal deficits.
Given this inflationary potential of
fiscal policy, an independent Feder­
al Reserve policy stance must be
maintained.







John J. Balles

I’m glad to have the chance of meeting all
you blue-eyed Arabs, as you decide how
you're going to spend the money raised by
the next O PEC price increase. Perhaps I can
interest you in some choice California real
estate. Seriously, it's great to visit an area
that’s wrestling with problems of abun­
dance rather than problems of scarcity. It’s
a healthier atmosphere, and I’m sure the
country could benefit from more cities like
Anchorage.
I want to spend some time today telling you
how business conditions in the Lower
Forty-eight appear to me. In this connec­
tion, I'll describe what econom ic policy­
makers have been doing to battle the evils
of recession and inflation, and what we
should do to keep the economy on its pres­
ent favorable growth path. But first, let me
say a few things about the way this visitor
from Outside views the boom ing Alaska
economy.



Alaska— Boom But No Bust
Alaska of course is affected by broad na­
tional trends, but the pipeline has been by
far the most important influence on the
state's economy in the last several years.
Thanks to the pipeline, Alaska in 1975
showed far greater gains in income and em­
ployment than any other state, and it
should continue to register impressive gains
in 1976. Then, in addition to the stimulus
from the pipeline and from Federallyfunded construction projects, we should
see some improvement in those industries
that had been affected by the worldwide
recession (such as forest products) and by
local problems (such as fisheries).
Even so, there are some clouds behind that
silver lining. The labor force has grown
even faster than the number of jobs, be­
cause of the large influx of jobseekers
(many untrained) who have been enticed
here by the Prudhoe Bay bonanza. As a re­
sult, the state's perennially high unem ploy­
ment rate may remain burdensome. Then
there is the basic question—what can you
do for an encore after Prudhoe Bay? An
estimated 21,000 people are employed on
pipeline-related activities this summer, but
what will happen later on when the basic
construction work is completed?
Past history would suggest that a bust will
follow the boom, but there are enough off­
setting factors this time to indicate that the
state can continue to maintain a relatively
high level of econom ic activity. O ne im­
portant follow-on project will increase the
capacity of the pipeline from its initial flow
of 1.2 million barrels a day to its upper level
of 2.0 million barrels. The next likely project
would involve tapping the natural-gas re­
serves of the Prudhoe Bay area and the oil
and gas reserves of the O uter Continental
Shelf. As you’ve probably noticed, this




spring's sale of oil and gas leases in the Gulf
of Alaska brought bids of $572 m illion, sur­
passing last December's sale of Federal
leases off the California coast. The Prudhoe
Bay pipeline should supply 12 percent of to­
tal U.S. oil requirements by 1978, and the
proposed natural-gas pipeline— probably
only the first of several— by itself could
meet 5 percent of the nation's needs.
The oil boom will not be the last one in
Alaska, considering the strong long-term
demand for natural resources by the
world's industrial powers, and considering
Alaska's enormous supplies of such re­
sources as coal, copper, gold, tin and iron
ore. Moreover, Alaskans as well as O utsid­
ers participated in the planning of oil ex­
ploration, extraction and export, and the
outcome thus has been far more satisfacto­
ry than with earlier booms. The $900 million
received from the 1969 lease sale went to fi­
nance the construction and maintenance of
public facilities; the $962 million in cash and
40 million acres of land involved in the set­
tlement of the native-claims question
helped improve a badly depressed sector of
the econom y; and the industry's actions in
subcontracting and setting up administra­
tive facilities within the state helped guar­
antee an Alaskan flavor to the oil boom.
With the base of the state's econom y
broadened in this fashion, there's no reason
why boom should inevitably lead to bust, as
it did so often in Alaska's earlier history.
Strength in the U.S. Economy
Turning now to the business situation in the
Lower Forty-eight, let me say that there's no
reason why another boom -and-bust se­
quence should take place there either.
We've seen the damage that was done by
the worldwide inflationary boom of the
early 1970's, with the damage being com ­
pounded by wage and price controls which



only disguised the distortions created by in­
flation. Those distortions led inevitably to
the worst recession of the past generation,
and in the process created a real dilemma
for fiscal and monetary policymakers. O ur
task was two-fold: first, to stimulate the
economy sufficiently in the short-run to
push it out of recession, and second, to
keep the subsequent recovery from gen­
erating further inflation in the longer-run.
Some naive observers, at the first onset of
recession, announced that it was either a) a
replay of the Great Depression or b) the
end of the world— and their policy pre­
scriptions ranged from restructuring our fi­
nancial regulatory system to overturning
the entire econom ic system. Now, I like
Hollywood disaster movies as much as any­
one else, but I watch them for entertain­
ment and not for instruction. Thus, when
we policymakers saw the recession devel­
oping, we avoided extreme solutions and
instead applied the standard textbook m ed­
icine. Indeed, the recovery unfolded on
classic textbook lines, just as we expected.
Between late 1973 and early 1975, the real
output of the U.S. economy dropped about
6V2 percent. Half of the decline was due to
cutbacks in spending for autos, hom ebuilding and business plant and equipment, and
the other half was due to cutbacks which
businessmen made to bring their invento­
ries back into line with sales. The situation
called for a rebuilding of consumer and busi­
ness spending power, and this was accom ­
plished through a combination of tax cuts
and Federal spending programs, accom ­
panied by a moderately stimulative m one­
tary policy. The result, as I said, was a classic
textbook recovery, led by a consumer
spending upsurge and a restocking of in­
ventories. The econom y already has
reached new heights in employment and



output, and it is making at least some head­
way against the continuing evils of unem ­
ployment and inflation.
The recession and the recovery periods
have witnessed an almost unprecedented
restructuring of household, corporate and
bank balance sheets— and this in turn has
built a solid financial base beneath the
economy. Consum ers, businessmen and
bankers have been paying off their debts
and rebuilding their cash resources at a fast­
er rate than in any upswing since W orld
War II. This development has reduced the
pressure on financial markets to finance the
rebound, and the increased liquidity thus
offers support for a durable recovery well
into 1977 and perhaps beyond. A sustained
and durable recovery also seems assured on
the basis of other important ongoing
developments— such as the general ab­
sence of bottlenecks and imbalances in the
econom y, the success in reducing inflation
and inflationary expectations, the substan­
tial gains in income and employment, and
the signs of an upturn in business capital
spending.
Progress and Policy in ’77
Looking towards 1977, most observers pro­
ject a gain of more than 6 percent in real
G N P—the second straight increase of that
magnitude following the drop of the 197475 period. With the econom y growing
above its long-term trend in this fashion,
unutilized resources should be brought
into play and the unemployment rate
should decrease— perhaps from today's lev­
el of over 7Vi percent to about 6 V2 percent a
year from now. Unem ployment thus will re­
main a problem , although the labor market
has responded well to expansive monetary
and fiscal policies. The anti-recession ac­
tions taken a year ago have added almost 4
million people to the job rolls, and have re­



duced by a million the number of long­
term unemployed, the most serious victims
of recession. But stimulative policies do not
cure the problems of the millions of rela­
tively untrained women and teenagers who
have poured into the labor force in recent
years. The solution for them is better train­
ing programs, a more realistic minimum
wage, and the end of restrictive em ploy­
ment practices.
The projected increase in prices next year
may be in line with the 5-to-6 percent infla­
tion rate expected this year— far better than
the double-digit inflation rate of several
years ago, but still not good enough if we
hope to achieve our policy goal of sustain­
able long-term growth. Here, indeed, is the
big question mark of 1977. As the economy
expands, inflationary expectations could al­
ways be rekindled, especially on the part of
those who were burned by the price up­
surge of several years ago.
In order to keep the econom y on the re­
covery path, the Federal Reserve has fos­
tered a moderate rate of monetary expan­
sion over the past twelve months. During
this period, the narrowly defined money
supply, M i, grew about 514 percent, while
the broader measure, M 2, rose by 10 per­
cent. (Mt equals currency plus demand de­
posits, and M 2 equals Mi plus savings and
time deposits other than large time certifi­
cates.) But over jthe longer run, this rate of
monetary expansion is too high to be con­
sistent with general price stability. Thus, as
Chairman Arthur Burns has noted in several
appearances before Congress, money
growth targets are being lowered gradually
over time.
Fight Against Inflation
O ur basic task, then, is to keep from repeat­
ing the scenario that led to the destructive



inflation of the early 1970’s. Everyone has
his own pet list of what went wrong at that
time, but probably the leading cause was
the decade-long string of Federal budget
deficits, which in turn consistently pulled
monetary policy off course. A look at the
numbers will show how fiscal policy gener­
ated the imbalances which led to our dou­
ble curse of inflation and recession. Be­
tween 1968 and 1975, per capita take-home
pay increased by 72 percent and corporate
after-tax profits by 43 percent—which after
adjustment for price increases, meant a
small increase in household income and an
actual decline in corporate income. But at
the same time, individual income-tax re­
ceipts rose by 78 percent and corporate in­
come taxes by 42 percent— even though
Congress reduced tax rates in both catego­
ries during that period.
Stimulative fiscal policies thus triggered in­
flationary forces that imposed a serious tax
burden upon society, and in the process
further limited the spending power of a pri­
vate sector which had already been
squeezed by the worldwide inflation. The
end result was a severe recession. M ean­
while, Federal spending programs outran
the increased revenues, creating a cum ula­
tive deficit of $130 billion over the 1968-75
period. Unfortunately, the trend has now
accelerated. Today, we find ourselves with
another $130-billion cumulative deficit in
the fiscal years 1976-77 alone (including the
present transition quarter)— a record bath
of red ink in a recovery period where no
more than a modest stimulus would nor­
mally be called for.
Against this background, let’s consider the
proposal that the Federal Reserve’s inde­
pendent status be reduced, and that m one­
tary policy be placed under the close co n ­
trol of Congress or the Executive. With all




due respect, this sounds like putting the fox
in charge of the henhouse. Now, I'm cer­
tain that every single person in Washington
is dead set against inflation. Yet the evi­
dence before us suggests that the persistent
political pressures operating against C o n ­
gress and the Executive force them in the
direction of piecemeal solutions which
don’t cost much initially, but which, in the
aggregate and over time, create the massive
budget deficits now destabilizing the econ­
omy. Subjecting the Fed to the same dayto-day political pressures would lead to a
similar destabilizing of monetary policy,
and would thus create an awesome engine
of inflation via the central-bank printing
press.
Look around the world and you can easily
pick out the countries with the best anti­
inflation records. They are the ones whose
central banks maintain an independent
stance within the governmental framework.
Am ong the major industrial countries, G er­
many and the United States alone fill the
bill. In contrast, Great Britain’s central bank
was taken over by the Governm ent several
decades ago, and now that country is expe­
riencing a chronic case of double-digit in­
flation, which not only has destabilized the
economy but has also underm ined Lon­
don’s long-standing position as a world fi­
nancial center. Then again, in some Latin
American and other countries, where the
monetary authority has never exerted an in­
dependent stance, triple-digit inflation
holds sway, bringing econom ic and political
chaos in its wake.
Concluding Remarks
I’d like to conclude on a bicentennial note.
In today’s terms, the United States was
strictly a Third W orld undeveloped type of
economy when it gained its independence.
But over time, we have com bined a large



and w illing labor force with vast infusions of
capital and creative technology, within the
framework of a far-flung transportation and
marketing network and an enterprising fi­
nancial system. As a result, we have
achieved our present $1.7-trillion economy
and the highest standard of living ever re­
corded. Surely we Americans have done
something right over the past two centuries
to create this achievement.
O ne of the things we've done right is to
learn from experience, and to maintain the
strength of those institutions that contrib­
ute to a strong and growing economy.
We've learned how to guard against the
ravages of recession, and we've recently
begun to make progress too against the rav­
ages of inflation— but I would argue that an
independent central bank is the center­
piece in the fight against both of those evils.
O ur operating techniques change over
time; for example, Chairman Burns now
makes a formal report to Congress every
quarter on the future direction of monetary
policy. That approach is effective because it
provides ample scope for the exercise of
Congressional oversight, yet keeps day-today political pressures away from the details
of Federal Reserve policy. I would say, let's
give our support to this and the other insti­
tutions that keep America strong, and our
tricentennial report will be even better.