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L IV IN G W ITH IN F L A T IO N An A d d r e s s P r e s e n te d by- M on roe K im b re l P re s id e n t F e d e r a l R e s e r v e Bank of Atlanta A tlanta, G e o rg ia b e fo r e the R o ta ry Club of Chattanooga C hattanooga, T e n n e sse e M ay 23, 1974 LIVING WITH INFLATION You have already been to ld that my ta lk is e n t it le d "L iving With I n f la t i o n ." But b e fo re g ettin g to th is to p ic I should lik e to say a few words about some o f our broader economic problems. Some persons would have us b e lie v e we are in the midst o f an economic re ce s s io n . Now i f th is were a Midwestern auto assembly cen ter, you might think th is was s o , no matter what I to ld you. But, o f cou rse, Chattanooga is not D e tr o it. In any ca se, i t seems to me that to attach the tag o f re ce ssio n to current economic con d ition s is a s lig h t exaggeration. Many business analysts d efin e a re ce ssio n as a p eriod during which the Gross National Product, when adjusted fo r r is in g p r ic e s , f a l l s f o r two quarters in a row. So d efin ed , i t is s t i l l too ea rly to t e l l whether we are in a re ce s s io n . The f i r s t drop in constant d o lla r GNP ju s t occurred in the f i r s t quarter o f 1974. T h erefore, i t w i l l take a d e clin e in the second quarter b e fo re those who so d efin e re ce ssio n s can be sure we are in one; and they w i l l not be sure u n til the second quarter GNP fig u re s come out th is summer. P erson a lly , I think the times we liv e in , rig h t now at le a s t , are not re ce ssio n a ry . They seem more lik e a p eriod o f stagn ation , where some se cto rs are going up w hile others are going down. is r e a lly happening is that the economy has been more or le s s holding i t s own. What 2 R ecession or n o t, nobody w i l l dispute that we are b eset with seriou s in f la t io n . I t was not too many years ago when some o f us shuddered about ta lk that a 1- or 2-percent annual r is e in p rice s was in e v ita b le and harmless to b o o t. Last yea r, consumer p r ic e s in th is country rose 9 percent in the worst in fla t io n sin ce 1951. This problem, furtherm ore, is becoming, i f anything, more d istu rbin g rather than le s s . I n fla tio n has a ccelera ted to a 1 3 .6 -p ercen t annual ra te in the f i r s t quarter o f 1974. Thus, i t has become abundantly cle a r that the problem is not going away. There are sev era l aspects about th is s itu a tio n that I fin d p a r tic u la r ly d istu rb in g . p rice s r is e ra p id ly . I t used to be that only a ft e r wars did Only then was in fla t io n at i t s f i e r c e s t . But with the Vietnam c o n f l i c t ending 15 months ago, we cannot use h is t o r ic a l analogy as an excuse. For the f i r s t in a long tim e, in fla t io n is rampant, not during or a fte r a war, but in a p eriod o f comparative peace. Another astonishing thing is that in fla t io n in th is country is no longer mild compared with the re s t o f the w orld. we r a t io n a liz e d , saying: we. For y ea rs, Most other cou n tries have worse luck than A change has taken p la ce in th is re sp e ct, however. Our in fla t io n ra te is now g reater than that o f some fo re ig n co u n trie s. Consequently, we no longer can comfort ourselves with the thought 3 that we are not as bad o f f as everyone e ls e . This change is im portant, not ju s t fo r i t s own sake, but because a contin uation o f th is trend would make our goods le s s a ttr a c tiv e to fo r e ig n e r s , thus hurting our economy and our balance o f payments. The g a llo p in g p r ic e trend in which we now fin d ourselves has i t s seeds in the Vietnam War, when we tr ie d to have guns without givin g up b u tte r. Before Vietnam, th is country enjoyed a period o f p r ic e s t a b ilit y that many o f us have long fo rg o tte n . A ctu a lly , fo r s ix years (1958 to 1964) the consumer p r ic e index rose only 1 percent per year. Vietnam. Then came our involvement in We stepped up our defense spending w hile consumers and businessmen, at the same tim e, increased th e ir spending at rates fa s t e r than the economy could su sta in . The re s u lt was the s ta rt o f an in fla tio n a r y clim ate that except fo r temporary successes has never been broken. Instead o f dealing d ir e c t ly and fo r t h r ig h tly with th is problem, the Federal Government fa ile d to enact permanent tax in c r e a s e s . And i t f a ile d to hold down spending. A ll o f th is produced horrendous Federal d e f i c i t s that added to the in f la t io n . In f a c t , only once sin ce 1964 has the Federal budget been in surplu s; and fo r the la s t three y ea rs, we have had a d e f i c i t o f $24 b i l l i o n in f i s c a l 1971, $23 b i l l i o n in 1972, and $14 b i l l i o n in 1973. To be sure, unw illingness to reduce p riv a te spending during the Vietnam War and in s u ffic ie n t f i s c a l r e s tr a in t during and a fte r bear some o f the r e s p o n s ib ilit y fo r our in f la t io n . other aspects that a lso deserve mentioning. But there are For example, some people might say that p rice s would have increased le s s had the Federal Reserve follow ed greater r e s t r a in t. Who e ls e is to blame? One can c i t e wages going up w e ll in excess o f p ro d u ctiv ity gains as an important fa c t o r . tio n o f the d o lla r was s t i l l another. The devalua Although th is was a necessary step , i t had the e f f e c t of making U.S. products too a ttr a c tiv e in world markets. Acting as a stimulant to U.S. e x p orts, i t cut in to domestic su p p lie s, e s p e c ia lly fo o d , and in th is way p rop elled p rice s upwards. I think the many shortages that a l l of us have been experiencing are yet another fo r c e behind the in f la t io n . For y ea rs, we could a l l f e e l that whatever we wanted we could buy as long as we could pay fo r it. But, as we a l l know, th is has not been so re c e n tly . A l o t of p rodu cts, in a dd ition to g a so lin e , e ith e r have been or are s t i l l in short supply. Booming worldwide demand fo r many commodities and the embargo, in the case o f g a so lin e , bear much o f the blame. P rice and p r o f it margin co n tro ls that discouraged investment in some b a s ic in d u stries probably a lso made these shortages even more severe. 5 Environmental co n tro ls have fu rth er com plicated the s itu a tio n . A ll o f these fa c to r s seem to have generated shortages; and, as we know, shortages lead to higher p r ic e s . The p oin t o f th is r e c it a t io n is to suggest that there has been no one v i l l a i n , but many. T h erefore, those who blame the high p rice s on a sin g le fa c t o r oversim p lify a problem that reminds one of the many-headed Hydra. Nor has the problem been m ostly one o f soaring food and fu e l p r ic e s , even la t e ly . True, higher fu e l and food p rice s were respon s ib le fo r 60 percent o f la s t y e a r 's consumer p r ic e r i s e . I t is c le a r , however, that many other products have also shown large in cre a se s. In f a c t , food and fu e l are now con tribu tin g much le s s to the general p rice trend than la s t year. Those who b e lie v e we have seen the end o f soaring food and g a solin e p rice s have, th e re fo re , s h ifte d th e ir a tten tion to the p o s s ib ilit y o f an e x p lo siv e situ a tio n in wages. While r is in g wages have long put upward pressure on co sts and, thus, on p r i c e s , i t would seem that wages have not been an important reason fo r the in fla t io n in 1973. Wage rates rose on average about 6 percent la s t year or much le s s than p rice s d id . Consequently, i t is qu ite understandable that workers should seek greater pay ra ise s th is year. They, of cou rse, have done ju s t th at. The c o lle c t i v e bargaining calendar being heavy, I am w orried about the e f f e c t of - 6 — large wage increases on p r ic e trends, ju s t when the end o f the o i l embargo and the prospects fo r greater food su pplies support the b e l i e f that p r ic e increases from these sources might moderate. I express th is concern not because I am o b liv io u s to the fa c t that taking account o f the r is e in p rice s and ta x e s , the take-home pay o f a production worker has declined by 4.7 percent th is past year. That is a dramatic drop in purchasing power and economic w ell-b e in g and underscores the tragedy o f in f la t io n . r e t ir e e , and others have a l l paid dearly fo r i t . The saver, Check with them what they have l o s t , not only in terms o f income, but in savings, fin a n c ia l a s s e ts , and not the le a s t , in peace o f mind. The consequences o f in fla t io n do not stop th ere. In the past m ajority opinion has accepted i t as a tra n sito ry m isfortune. When p rice s rose ra p id ly , most Americans would cut down on th e ir spending, trim th e ir s a i l , and try rid in g i t ou t. But when people think in fla t io n has become a permanent way o f l i f e , they begin to rea ct d iffe r e n t ly . Expecting p rice s to go ever upward, they throw caution to the wind and rush to buy products b e fo re p r ic e s go up even fu rth er Such a rush to buy can compound an in f la t io n , w hile the expectation s o f s t i l l more in fla t io n w i l l eventually discourage people from saving Home con stru ction would not fin d financing in such an environment. State and lo c a l governments, co rp o ra tio n s, and other borrowers would not be able to finance th e ir needs. Economic growth would be severely- c u r ta ile d . The impact of ra p id ly r is in g p r ic e s would f a l l in e v ita b ly on the low and middle income groups. up fa s t e r than our income. The co st o f everything we buy would go Everyone, fo r that m atter, would lo s e i f things d e te rio ra te d to what Germany, fo r example, experienced during the h y p e rin fla tio n of the m id-1920Ts. In c it in g these dangers, I do not wish to leave you with the im pression that th is country is about to experience a s u p e rin fla tio n , or even a Latin-American type where p rice s in crease in double d ig it s each year. I simply wish to r e it e r a t e the dangers. These are e s p e c ia lly relevan t to us today, not only because p r ic e s in th is country have re ce n tly been increasing at a fa s t e r than 10-percent ra te , but because the longer an in fla t io n is allowed to e x is t , the more i t becomes entrenched. harder i t is to e ra d ica te . And the more entrenched i t becomes, the In f a c t , even in re ce s s io n s , when one might expect reduced demand to bring about lower p r ic e s , p rice s ra rely f a l l because our economy is not highly com petitive as i t once was. The record shows that only in those se cto rs where com petition is strong are p r ic e reductions during re ce ssio n s commonplace. Have you found much evidence o f lower p rice s la t e ly , under current nearrecession a ry con d ition s? This brings me to an issu e that has received increasing d iscu ssio n . This is the view that in fla t io n is in e v ita b le and the fu rth er view , sometimes given in the same breath , that we should begin to l iv e with i t . P rofessor M ilton Friedman, fo r example, re ce n tly advanced the opinion that we ought to s ta rt a p rocess by which we reg u la rly compensate fo r in f la t io n . advocating is a broad system o f indexing. What he has been Under indexing, the value o f a ssets (wages, re n ts, and so fo rth ) are adjusted fo r p r ic e changes. You can fin d an example o f indexing in recen t aluminum, s t e e l, and can w orkers’ co n tra cts, where wages are adjusted automat i c a l l y to allow fo r in creases in the consumer p r ic e index. B ra z il uses th is d evice e x te n siv e ly . Not only are workers compensated fo r th e ir lo s s o f purchasing power, but as I understand i t , B ra zilia n banks and savings in s tit u t io n s w i l l a l l co rre ct accounts with an amount equal to the ra te o f in f la t io n . Loans, s e c u r it ie s , mortgages, personal tax exemptions and tax brackets are s im ila rly adjusted fo r higher p r ic e s . H ailing the success B ra zilia n s have had in trimming th e ir p rice in cre a se s, which in c id e n ta lly are s t i l l much greater than ours, P rofessor Friedman and others b e lie v e the United S ta te s ’ economy should copy B ra z il and have indexes fo r wages, in te r e s t r a te s , ta xes, le g a l o b lig a tio n s , and other con tra cts as a form o f coping with in fla t io n . Now, one need not b e l i t t l e the co n trib u tio n o f the d is t in guished Dr. Friedman on indexing counts. to conclude that when i t comes to h is view he is a b solu tely wrong—wrong, indeed, on several F ir s t , on a s t r i c t l y te ch n ica l l e v e l , there is nothing magical about indexing. Right now, fo r example, there is a heated dispute going on over the way the o f f i c i a l p r ic e indexes in th is country are con stru cted. Secondly, no matter how p e r fe c t p r ic e indexes a re, some groups are bound to come o f f second b est in the co r r e c tio n p ro ce ss. And, as Henry W allich (the most recent Federal Reserve Board appointee) rep orted ly remarked: Two major components o f economic a c t iv it y are im possible to index. are money and p r o f i t s . These Can you imagine anyone wanting to hold money in an economy where most everything is indexed? I cannot. Nor can I imagine that p r o f it s would not be squeezed where most everything e ls e is indexed. Indexing, to my way o f think ing, is not what i t is cracked up to be. On the contrary, i t has seriou s shortcom ings. Indexing could give momentum to a s t i l l fa s t e r p r ic e s p ir a l as people become convinced there is no longer a need to fig h t in f la t io n . To suggest that indexing is a way o f liv in g with in fla t io n means throwing in the tow el, and to some o f us o ld -fa sh ion ed people i t is almost unthinkable that our country would be part o f 10 - any such process o f solv in g our problems. I t seems to me that there should be enough statesmanship and common sense to deal with i t d ir e c t ly and fo r t h r ig h tly . How then can the in fla t io n be countered? From what I have said b e fo r e , i t should be cle a r that the economy has been on an in fla tio n a r y bent fo r too long fo r a v a rie ty o f reasons. And i t ’ s going to take many d iffe r e n t a c tio n s , ranging from more production to greater statesmanship, to do what has to be done. Such an attack must ce rta in ly include f i s c a l and monetary r e s t r a in t. In th is conn ection, I would hope that the Congress, the A dm inistration, and the Federal Reserve w i l l e x e rcis e the necessary statesmanship and w i l l have the fo r t it u d e to act in ways they know w i l l re stra in p r ic e pressu res. R estra in t—whether f i s c a l , monetary, or any other kind— u n fortu n a tely, is never p a in le ss. Can i t be achieved without some adverse e f f e c t on jo b s , on housing, or other economic programs? The answer most experts would give to th is question i s , o f cou rse, "N o." F is c a l and monetary re s tra in t i s , th e re fo re , ofte n unpopular and requires support from key business leaders and opinion molders such as you. On the other hand, what ch oice is there? in fla t io n is never easy. A fter a l l , b a ttlin g There w i l l be rough days ahead. But i f 11 - we continue to accept in fla t io n at th is past y e a r’ s r a te , we w i l l pay in the long-run a fa r greater p r ic e than i f we accept some d is lo c a tio n s tem porarily. The way to deal with in fla t io n is to fig h t i t , not to liv e with i t .
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