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gor release on delivery 8:30 a . m . C . D . T . , May 7 , J 9 7 4 Xgj3Q a . m . E.D.T.) BANKING A N D INFLATION Summary of Remarks by Robert C . Holland M e m b e r , Board of Governors of the Federal Reserve System before the Seventy-Seventh A n n u a l Convention Nebraska Bankers A s s o c i a t i o n L i n c o l n , Nebraska May 7 , 1974 I am happy to join you here this m o r n i n g , but it is a v e r y unhappy subject which I am a d d r e s s i n g . Inflation has come to be the dominant economic problem of today. This statement applies not only to the United S t a t e s , but to virtually all the industrialized nations of the w o r l d . In greater or lesser d e g r e e , this problem has been building here in America for a decade or longer. Its causes--and our attempted cures--have v a r i e d over those y e a r s , but never did we master it. In much of the latter half of the 1960's, the root cause of our inflation was excess demand, spurred by large deficits in our "guns and butter" Federal budgets. Occasionally during those years, and for a longer interval in the early 1970's, demand for goods and services was brought under c o n t r o l , but strong cost-push pressures kept prices climbing nonetheless. T h e n , in 1973 and 1974, shortages on the supply side — first of food, then of industrial raw m a t e r i a l s , and finally of energy—triggered the sharpest new price advances of the d e c a d e , and the end is not yet in s i g h t . - 2 We have been fairly imaginative in the v a r i e t y of tools we have tried to use to slow the inflation, but not altogether successful in their a p p l i c a t i o n . The Federal budget was finally pulled into surplus late last year, but already it is starting to slip back toward deficit and there is talk in Congress of actions that would deepen that deficit still m o r e . fiscal policy cannot halt inflation. That kind of W e tried wage and price c o n t r o l s , but after some initial successes their distortions chafed and they were battered by the latest inflationary outbursts; they died one week ago at their low point in c r e d i b i l i t y , and few bothered to mourn their passing. We have tried to encourage expanded s u p p l i e s , but in most areas they are a long time coming. Thus far the only major result is sharply increased farm p l a n t i n g s . If this year's harvest measures up to its indicated abundant proportions, it w i l l indeed exert a major force holding down food and related prices and be a significant brake on the inflationary spiral. But the thanks that the Midwestern farmer is due for his invaluable contribution - 3 may be accompanied by another cost-price squeeze on h i m , a poignant reminder that few counter-inflationary forces are p a i n l e s s . The chief remaining instrument in our antiinflationary arsenal is monetary policy. We have used it hard and often during the past decade to try to slow the inflationary spiral. I think it has helped from time to time, but not without som? unpleasant side effects in the form of credit market distortions, disproportionate downward pressures on housing and several other a r e a s , and historically high levels of interest r a t e s . Yet now it once again bears a very heavy share of the burden of fighting inflation, for the very practical reason that no other public policy tool seems presently capable of doing more of the j o b . In these circumstances, some people can be tempted to throw up their hands in despair. Floating along on the inflationary tide can be a beguiling p r o s p e c t , with more and more contracts tied to rising price indexes, and public welfare programs primed to help out the laggards. - 4 That course arguments I hope we firmly r e j e c t . against i t . against it. There are theoretical There are practical arguments But the most compelling argument I know against it is that the average American citizen is against it. He doesn't like the idea of bobbing along on a swelling inflationary tide--he detests it. In the e n d , I believe that kind of broad national conviction w i l l strengthen the w i l l of both public and private policy makers to do what has to be done to bring inflation back to e a r t h . If that is to be d o n e , and if monetary policy is to be a workhorse in that anti-inflationary e n d e a v o r , then I must say to you that banks are in for an uncomfortable time. The basic design of our financial system has banks at its c o r e , and it makes banks the chief channel through which the bite of monetary restraint is spread through the economy. Your liabilities become costly and hard to support, your bond portfolios drop in market v a l u e , and you are pressed to speak in discouraging terms to your good loan c u s t o m e r s , either in terms of higher interest rates or constrained loan totals or b o t h . The Federal - 5 Reserve talks of such unpleasantries to you as high reserve requirements and possibly increased interest rate ceilings on time d e p o s i t s . Plenty of causes of irritations w i l l arise between u s . There w i l l be human mistakes in actions-- misunderstandings w i l l occur --and imperfections in institutions and markets may produce some jarring m o m e n t s . Your role and ours w i l l be in some respects an u n h a p p y one--but it w i l l be absolutely essential to success in this b a t t l e . Whatever the irritations and secondary difficulties we f a c e , we both must put first things first. W e need to give top priority to those things that further the efforts to slow down inflation. the nation's number one economic e n e m y . community's biggest economic e n e m y . greatest economic e n e m y . It is It is your It is your own bank's The essence of banking is taking custody of people's dollars and promising to give them back in good shape. stock in If the dollar which is your trade continues to be a rapidly depreciating a s s e t , then you are in a losing business. So I appeal to you--in your own interest and the nation*s--to be the leaders in the fight against inflation. to Give your support, and your wisest counsel, the makers of monetary and fiscal policy as they pursue this s t r u g g l e . That struggle is so fierce and closely contested that you could help to make the difference.