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For release upon delivery Wednesday , June 1 2 , 1974 8:30 p.m., EDT INFLATION, MO N E T A R Y POLICY A N D BUSINESS INVESTMENT Summary of Remarks by Robert C. Holland, Member Board of Governors of the Federal Reserve Sy s t e m before Directors, Officers and Guests of the Federal Reserve Bank of Cleveland Pittsburgh, Pennsylvania June 12, 1974 I a m pleased to be w i t h you this evening, and to join in an exchange of views covering business conditions and their prospects. W h e n a group like this gathers at a time like this, one theme must dominate all others in our discussion. I refer, of course, to inflation. Ea c h of us, in our own way, is w r estling w i t h this fearsome antagonist. The contest is a fierce one, for we are caught in the grasp of one of the most powerful and persistent inflations in our history. It is tearing at the vitals of our economic s ystem--distorting income flows, eroding real standards of living, sapping the value of savings, creating the illusion of progress and profit where none r e ally exists. T he blunt fact is that we cannot long tolerate so rapid a pace of price advance without substantial and irreparable damage to our present w a y of life. We have tried, of course, in a number of often ingenious ways over the past decade to force this i nflationary genie back into its bottle. We have tried t alking it into submission; we have tried enmeshing it in an apparatus of direct price and wage controls; we - 2 - have tired generous doses of wishful thinking; and-intermittently and sometimes only partially--we have turned to the application of the fundamental remedies of fiscal and m o n etary restraint. None of these remedial efforts deserves to be judged a real success to date. Fiscal policy clearly has a powerful anti-inflationary potential, but our i n e f f e c tuality on this front is indexed by the cumulative mass of our Federal budget deficits--over 100 billion dollars in the last 10 years. There is, I believe, some hope appearing on the fiscal side. The Adm i n i s t r a t i o n is attacking the goal of a balanced budget w i t h new vigor, and Congress seems about to impose upo n itself the most comprehensive procedure for budgetary control in its history. But real fiscal restraint results from actions, not intentions; I devoutly hope these admirable intentions are fulfilled. Meanwhile, m o n etary policy is having to bear a v e r y heavy share of the burden of the current inflationary fight. W e at the Federal Reserve are determined that m o n e t a r y restraint will make its responsible contribution - 3 to slowing the rate of increase in prices. For that to happen takes time, however, and in the interim we cannot o verlook some of its u n h a p p y side effects. Interest rates are very high, and the fact that other prices are going up does not always make such money rates mu c h easier for the borrower to bear. Housing starts have been reduced, a nd they may be pared even further as the availability of mortgage mon e y is curtailed. Financial intermediaries w ho have specialized in borrowing short and lending long are finding themselves increasingly har d pressed to earn enough to keep pace wi t h their high cost of money. Here and there liquidity squeezes are imparting some sobering e xperience to those who had built up business commitments on the blithe assumption that they could always "buy the m o n e y someplace." For a long time it has been accepted as a fact that business corporations--particularly the larger o n e s — had no place on the list of victims of monetary restraint. Indeed, the more common impression was that larger businesses did not alter their spending decisions at all because of the changing cost and availability of credit-their business was too attractive for any lender to deny, - 4 a nd rising interest costs were but a trivial increment in their overall income and expense f i g u r e s . However true that model once might have been, there are signs that it is out of step w i t h current realities for at least a substantial proportion of Amer i c a n business enterprise. In a w o rld of rapidly rising selling prices and replacement costs, some corporations are p e r ceiving that part of their v a u n t e d imperviousness to tight money grows out of the "inflation-blindness" of c o n ven t i o n a l double-entry bookkeeping. In a w o r l d of high and rapidly fluctuating interest rates, even s ophisticated corporate executives may be given pause by the thought that if their borrowing is delayed for a few months the cost of the funds might change by two or three percentage points. In a business environment where leveraging (often by borrowing at short term) has become a more and more common stepping stone to higher per-share e a r n i n g s , the resultant enhancement of the weight of m o n e y cost and availability in corporate calculations is not always appreciated by outsiders. In a corporate inve s t ment community where issuance of common stock is not only a - 5 source of ne w equity capital but also a base for further leveraging an d a special currency for corporate a c q u i s i tions, the extent of the drop in stock prices induced by tight money is an indirect but appreciable dampener of e n t repre neuri al spirit. Some of the effects of these influences on corporate spending are too subtle to pin down concretely. Reports reach my ears, however, of a number of inventory decisions tilted toward the conservative side by credit considerations. Occasionally, there are hints of s l o w down or restudy of some planned capital e x pansion programs. In general, such curtailments are in an antiinflationary direction, and should be welcomed. Sometimes advocates of economic stabilization go further, and favor direct or indirect measures to curtail business investment to a greater degree, in the interest of balancing the bite of all anti-inflationary measures among the various sectors of the economy. That approach makes the most sense w h e n timed to coincide w i t h one of the short but intense periods of inflationary pressure that have been so characteristic - 6 of A m e r i c a n business history. - In such periods in the past, b u i l d i n g a plant meant taking some r e l atively scarce supplies of steel, concrete, and the like off the current market, but w i t h little or no hope of bringing the n e w plant into p r o d u c t i o n before the inflation rate subsided. It is important for business a n d public p o l i c y makers to recognize h o w different the current situation is fro m that illustration. Ma n y economic forecasts presently look forward to an inflation that will at best recede only gradually over the next several y e a r s . Given that k i n d of schedule, there would be time for quite a number of plant and equipment investments to be completed and to b e g i n producing. Such developments wou l d add to available supplies, thereby putting downward pressure on the price of such products. That downward pressure w o uld be greater in the numerous instances in w h i c h new plants were more efficient, turning out products at lower unit costs. It w o u l d be most welcome in those several sectors currently p l a g u e d by out-and-out supply shortages. Continuation of this k i n d of business capital investment today could - 7 produce useful anti-inflationary results in the more distant stages of this tough-to-control inflation. Public policies need to be shaped wi t h some awareness of this potential. One p r o b l e m attaching to such business in v e s t ment prospects deserves special mention tonight. In a number of lines of business, both the inflation of costs and the complexities of the latest technology have combined to make the most efficient plant additions ve r y expensive indeed. As a result, the blocks of long-term funds needed to finance such capital investments appear so large as to place strains both on some borrowing businesses and on the credit and capital markets t h e m s e l v e s . As extreme examples of this phenomenon, we need only to look to the public utilities, where the bite of these two facts of economic life is being compounded by bureaucratic delays in approving needed increases in selling p r i c e s . In this environment, a special need exists for imaginative thinking as to the design of financial instruments w h i c h could best raise these funds. Ideally, such instruments should rest heavily upo n the strong final market demands - 8 for the products or services in question. Given the size of the needs in question, multi-c o m p a n y guarantees ma y be advisable in some cases to disperse the burden of risk. Other ideas are undoubtedly occurring to fertile minds in the corporate financing field. Those ideas n e e d to be brought forward promptly and tested against one another in the crucible of the market place, to w i n n o w out those most viable additions to our corporate finance arsenal. A goodly number of our most important industries are going to need all of this kind of help they can get if they are to be of major help in ultimately bringing this current inflation under control.
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