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INFLATION AND CONSUMER AND BUSINESS ATTITUDES An Address to the Columbus Rotary Club Columbus, Georgia November 17, 1976 by Monroe Kimbrel, President Federal Reserve Bank of Atlanta INFLATION AND CONSUMER AND BUSINESS ATTITUDES It is always a privilege to meet with fellow Rotarians and a special privilege to address this sophisticated group of Rotarians in Columbus today. Listening to the speeches of candidates for various political offices, you are doubtless tired of debates about economic policy. And with analysts studying every fresh statistic for signs of possible improvement in current business conditions, you must also be tired hearing about the economic pause, or lull. Therefore, I think it appropriate to focus on more basic economic matters, essentially on inflation and on consumer and business attitudes. At the Federal Reserve, we spend much of our time thinking about and acting on ways designed to influence credit and inflation. And information about consumer and business attitudes is immensely helpful in explaining the ups and downs of the economy. These subjects are constantly on our minds and sometimes other subjects of undisputed importance may be temporarily pushed to the back burner. Inflation and consumer and business attitudes are surely important to you, too. Inflation is a serious problem for all Americans, and it is a serious problem for foreigners. It’s the No. 1 problem all over the globe. Individually, inflation determines how much income we really have available to spend and determines how much our home, stocks, and whatever assets we have are really worth. Collectively, how our nation fares -2- in terms of inflation could be crucial to the life of this current economic recovery. Many believe double-digit inflation was an important factor in the last recession, since it cut into purchasing power and then into spending. Price prospects, therefore, are a key to future consumer spending and the ultimate staying power of this recovery. I can think of no other factor than stable prices to assure long life to this expansion. If control of inflation is vital, confidence is no less important. There have been many shocks to confidence in recent years— Vietnam, Watergate, the oil crisis, drought, and other factors. been some drift in confidence in the last six months. And there has Confidence is crucial to investment decisions, and it is mainly business reluctance about investing in new plants that has economists worrying about the current economic lull. Confidence is also crucial in consumer decisions, and it is consumer reluctance about buying that has been heavily responsible for this lull. Your decisions, collectively and individually, contribute substantially to the question o.f whether our economy moves forward. The spending you will make as consumers, the commitments you will make as businessmen or investors-— these actions will play a part in Federal Reserve monetary policy decisions. If you will consider the problems of inflation and the questions about the supply and cost of credit and then tangle them up with the mystery of investor attitudes, you will have some idea of the complexities -3- faced by economic forecasters. At the Federal Reserve, we know what is happening in the economy right now. It is what we don’t know that will reflect in the clarity of our predictions for the future. Do consumers and businessmen have the confidence to commit their spending? The U. S. economy would benefit if they did. So far, you have the general theme of my remarks today; now, to some specifics. Inflation is a less serious problem today than it was two years ago. Now, inflation is around 6 percent; then, 12 percent. This improvement represents a major accomplishment, much of which reflects reduced price increases for fuels and stable-to-lower food prices. The United States, in fact, is now a comparatively cheap place to live, as has been so quickly discovered by recent travelers to Europe. Aside from Germany and Switzerland, Western Europe’s inflation rate remains well above ours, though there, too, it has come down. -From a different perspective, our price performance represents progress, but not unqualified success. Inflation is usually mild after a recession, and we are now only twenty months into economic recovery. periods. Prices this time rose faster than in comparable recovery We still have a troublesome task to even match the 2-percent inflation rate achieved in the early 1960’s. We cannot afford the luxury of being complacent about the problem of inflation. Suppose the 6-percent inflation rate continues. Our price level would double, and the purchasing power of savings and assets -4- would shrink by 50 percent in twelve years. to happen. None of us want this And yet, looking toward 1977, the evidence is less than convincing that the inflation rate is likely to come down significantly. Food is the only major item for which the near-term price outlook is favorable for the consumer. for the next few months. There, we are reasonably optimistic Crops are breaking or approaching records. Even in the food sector, however, we must not be too confident. Drought in Western Europe and a history of having the unexpected happen are good reasons to suggest caution. the cattle supply. There has been a sharp reduction in This factor eventually could exert upward pressure on beef prices. More predictable, but less optimistic, is the price outlook for industrial products. On the horizon is a widely expected oil price hike by the OPEC countries on which we have been relying more and more for our oil. Moreover, this past month alone, higher prices were announced for lumber, rubber, leather, and fuels. covers mainly products in ample supply. This incomplete list If many such price increases remain Firm, imagine what could happen if shortages should develop. Keep in mind that the shortages experienced in 1973-74 were an evil gremlin contributing to the double-digit inflation in 1974. Serious shortages are not likely to develop soon because of slack in product markets generally. its expansion. But we look for the economy to continue That means the productive capacity for many materials and commodities will eventually fail to match demand. As a consequence, precautionary buying, shortages, and bottlenecks can be expected in -5- the long run, thus intensifying price pressures. The chance that these and other problems will reappear makes me pessimistic about a sharp reduction in the inflation rate. For example, significant reductions in inflation appear impossible without a substantial drop in labor cost increases. is this prospect? How realistic Can we anticipate smaller wage increases or larger productivity gains, or both? So far this year, wage and Fringe increases have moderated to about 8 percent; productivity rose about 5 percent; labor cost increases went down to about 3 percent. Nevertheless, recent wage contracts and the upward wage pressures usually accompanying later stages of economic expansion make it doubtFul that these wage trends will continue indefinitely. In addition, productivity, though increasing, is still well below postwar rates, and its growth has come down. For these reasons, I am pessimistic about achieving less inflation from the labor cost side. The federal budget, which has been in deficit in nine of the last ten years, gives Further encouragement For reflection. These deficits have not only been common and huge, but they have been part of the inflation problem. Federal spending in fiscal year 1976 exceeded revenues by $65 billion. Considerable red ink is again expected in fiscal 1977, although spending has fallen surprisingly short of budget projections. Deficits -may be regarded as only mildly inflationary as long as our capacity to produce remains large and the economy hums along, as in our present situation. But in a more ebullient economy, deficits -6- can cripple progress against inflation. How w e ’ll even approach price stability unless we keep more restraint on federal spending or increase taxes is difficult to foresee. Huge federal deficits, moreover, have a way of derailing monetary policy. The U. S. Treasury, of course, covers its deficits by borrowing in credit markets. If massive deficits accompany large business and consumer credit demands, private credit gets squeezed and interest rates escalate. Admittedly, the Federal Reserve is not powerless in such a situation. We can counterattack by taking actions directed toward lifting the rate of monetary expansion. But a dilemma is presented by such action. The long-range effects of a high monetary expansion rate are inconsistent with subsequent price stability. Therefore, Federal Reserve policy during the past year has been to lower gradually its long-run monetary growth targets, hoping that this will help reduce the inflation. While keeping a wary eye on prices, we are not unmindful of the need to encourage business expansion. We have sought a pace of monetary growth that was adequate to facilitate a sustainable economic recovery without aggravating inflation. During the past year, the narrowly defined money supply (M-^) grew about 5 percent. rose by about 10 percent. The broader measure (l^) In general, liquidity in the economy is ample. I feel comfortable with these .money growth rates. They fit the goal of moderate monetary stimulus, serving both short- and long-term objectives. A lesson we have learned, and in which we had a refresher course in the early Seventies, is that a sustainable recovery is far 7- better than a quick recovery. If recovery can’t be sustained, inflation is aggravated rather than eased and the next recession is pushed forward. Like a change in musical tempo, the rhythm is quickened. Unemployment remains untolerably high. About 4 million persons have been added to payrolls since the end of the recession. Never theless, the economy did not expand fast enough to absorb the extra large number of women and teenagers looking for jobs. So, the unemployment rate dropped more slowly than we would have liked and in three of the last four months even rose somewhat. At times, debates over unemployment and inflation have become so emotionally charged that the federal Reserve’s independent status has been questioned. Proposals have been made to bring monetary policy under closer control of either the Congress or the Executive Branch. There are those today who advocate reducing the protection of the federal Reserve from political pressures. The federal Reserve Act established an independent status for the country’s central bank within a governmental framework. This concept fits the basic principles of our Constitution, and it has kept the System free of the political arena with its constant pressures. It gave the System strength to fight inflation and gives us now the opportunity for lasting success. Effectively reducing inflation is a long-term process, and, at times, unpopular policies are necessary. Under persistent political pressures making the same decisions would be extremely difficult, if not impossible. It is not surprising to find countries with weak central -8- banks have the most debilitating inflation, and countries with independent central banks have the best anti-inflation records. This strikes us as convincing evidence that the independence originally granted the Federal Reserve continues to augur well for the best economic environ ment for our country. Today, credit is certainly not in short supply. is an abundance of credit. If anything, there Borrowing costs have not increased in this economic recovery phase, despite massive Treasury financing. This is remarkable— interest rates usually rise in the second year of economic recovery. There are at least three major explanations Tor the recent relative interest rate stability. Corporations have enjoyed a large cash flow, thus holding down credit demands. The cash flow of life insurance companies, pension funds, and savings intermediaries has been enormous. Large sums became available. All this together with an accommodative monetary policy, reluctance to lend, and relatively slack credit demands Cexcept Tor short-term refinancing) produced an unusual interest rate phenomenon. helped. Lower inflation rates and reduced inflationary expectations So we enjoy a bright spot in the economy; no credit squeeze and something of an interest rate plateau. Probably that statement should be qualified slightly. Borrowers can take advantage of interest rates that are not double-digited. Lenders, on the other hand, had to accept a lower nominal return than in some time and, if they wanted to extend credit, more often had to go out looking for opportunities. The adjustment has been difficult -9- because earlier losses instilled a conservative lending mood. This was a natural reaction. It follows that a look at investor attitude is appropriate. Lenders and investors have experienced a trauma, and this is easily understood. The widespread emphasis on caution, the necessity of reflect ing on our exposures, and on getting our own shop in order, including the restructuring of balance sheets, was not misplaced advice. But now that corporations have significantly rebuilt their liquidity, the time for reassessment has come. Lenders should not neglect their vital role in financing the economic recovery now in progress. To fail would hamper the recovery as well as retard the long-term growth of the country. Businessmen, too, should not neglect their vital role in making their commitments. With the Presidential election out of the way, attention once again can be centered on fundamental economic conditions. Although the policies of the new Administration have not been announced, the business of buying and selling and making long-term plans by private sector goes on. the And simply by having the election behind us, the political uncertainty of who will be the winner has been removed. What does all this mean to you? Well, decision-makers, such as yourselves, have provided commendable economic leadership and promoted practices contributing to success. International inflation, domestic unemployment, and shifting investor attitudes provide a kaleidoscope of opportunities. As fluid as these baffling circumstances may be, the approach jnust be aggressive. -10- Based on the history and common sense of the American people, I am persuaded that you and people like you will accept the risks of prudent leadership.
@FedFRASER