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Our Turbulent Economy
Remarks of Mr. Robert P. Mayo
President of the Federal Reserve Bank of Chicago
before the Rotary Club of Chicago
May 7, 1974
The current state of the U.S. economy presents a picture
of cross currents, variety--and indeed tumult unknown in our recent
history.

Anyone glancing only at the overall Gross National Product

data for the first quarter would have to conclude that it had all
the earmarks of a recession period.
it just that way.

Indeed, some economists view

Yet during the same time that total real output

dropped at an annual rate of almost six percent, more sharply than any
time since 1958, many of our major industries were operating at or
near capacity.

While the overall number of unemployed was rising

nearly ten percent we had major industries operating below capacity
because they could not hire the skilled labor they needed.

And despite

this overall decline in output, materials and intermediate products
of every sort were in short supply, with producers alloc~ting their
output to customers.
Not only did the most recent quarterly period show a decline
in real output, but the growth during the three previous quarters was
significantly below the long tern growth trend.

Yet the upward move-

ment of prices at an annual rate of over 10 percent--was the greate~t
since 1951.

The amount of slowdown which occurred would normally be

expected to be accompanied by declining growth in borrowing and lower
interest rates.
rates.

Instead we are seeing new records set in short-term

We see long-term rates pressin~against record levels.

If this

is a recession it is indeed t~e strangest one the economy has ever
undergone.

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As early as a year ago, when data relating to the first quarter
of 1973 became ~vailable, it was clear that the economy could not
continue the extremely high rate of growth that was then in progress.
A gradual slowing through the balance of 1973 and, possibly early 1974,
was generally expected, with a return to about a so-called "normal"
rate of four percent in the latter half of 1974.

Accompanying this

slowdown, a slowing of the inflation rate was also logically expected.
Given conditions at the time, these were reasonable expectations.

And,

indeed, second and third quarter output did show the expected slowdown.
But there was little evidence of any slowing of the inflation rate,
primarily because of the intense world-wide demand for food, but also
because of high levels of demand for a wide range of other cor.unodities.
Then crune the October War and the Arab oil erl>argo.

No one needed to

be an econorais t or even to read the newspapers to discover the impact
of that action on his daily life.

Each of you, I'm sure, has his own

private horror story to tell about the new sport that suddenly became the
new national pasttime--filling the gas tank.
us, even though the energy problem is not.
live with the increased price of energy.
gasoline is not the only consequence.

The embargo is now behind
And we have to learn to

The new price level for

Higher petroletnn prices are.

seeping pervasively through the economy to raise the cost of producing
virtually everything we use from toothpicks to computers.

The increase

in energy costs was, in large measure, responsible for the unpredicted
acceleration of the general price level both in late 1973 and early 1974.
But the impact of the oil embargo was not limited to prices.
It had a serious impact on industrial output as well, not the least


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of which was the direct production cut in petroleum products themselves--plus the. cutbacks in growth pf electric power production
and natural gas consumption which carae for conservation measures.
Automobile sales~ which had been declining gently from the unprecedented levels of the first quarter of 1973, ttnnbled drastically, and
production was cut even more severely to prevent enormous inventory
gluts from developing.
closed down.

The recreational vehicle industry virtually

Hotels, resorts, and other businesses dependent on the

auto vacation traveler felt the pinch, and airlines were forced by
fuel shortages and fuel costs to curtail service.

In short, a signi-

ficant portion of the decline in output during the past two quarters
can be ascribed to the oil embargo and to the ir:ipact of higher oil
prices that prevail now that it has ended.
At the same time that the embargo was making us all aware
that we were rapidly outgrowing all our sources of energy and causing

.

a slowdown in several industries, it was also acting in an expansionary
direction, providing incentives for the coal industry, accelerated work
on nuclear power plants, and for rail transportation, to mention a
few.

Domestic oil exploration activity is at a level not seen since

the early 19SO's.

These expansion needs added strongly to a demand

for capital goods that was already underway as a result. of the strong
pressures on capacity, the need for modernization, and the requirements
to meet environmental and safety regulations which had been underway
for several quarters.

Even the depressed auto industry began making

major capital investments to meet what is generally viewed as a permanent shift in consumer demand toward smaller and more efficient cars
and to meet the pollution control requirements which becor:ie much more
stringent beginning with the 1975 model year.

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Thus we find ourselves in a very strange economic environment
in the spring of 1974.

While all recent surveys of consumer attitudes

have been very pessimistic in tone, the consumer is spending his money.
Consumer spending has been growing nearly twice as fast as the growth
in disposable income.

But tl1e conslllller has been enjoying it less.

While spending is up, the real level of goods and services that this
spending purchased is down slightly, and one place the consumer is
not spending his money is for new housing.

There has been no decline

in the basic demand for new housing, but high interest rates, the decline
in personal savings, and the shifting of savings from normal channels into
areas yielding markedly higher returns have sharply curtailed the availability of mortgages.

If we were in the midst of a typical recession,

this decline in real constnner spending would be accompanied by a slowdown in capital spending, but instead we are currently witnessing
accelerated capital spending and appropriations, combined with fairly
rapid returns to more normal conditions in many areas affected by the
petroleum embargo and a slight decline in the tmemployment rate.

In

addition, we are on the threshhold of what promises, weather permitting,
to be a record year in agricultural output.

It seems to me that two

things are holding back the resumption of rapid economic growth--inflation and capacity limitations.
The outlook for reduction in the rapid rate of inflation
which is currently occurring is din in the immediate future.

The

full impact of increased energy costs has yet to work its way through
the price system to the final sales level.

We are just at the begin-

ning of a long period of labor negotia~~ons in which settlements are
bound to include "catch-up" provisions that will add further to costs.
Despite the promise of a bumper U. S. harvest, world food stocks are
 low, so
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that demand will put a floor under agricultural prices.

At

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the same time energy and fertilizer costs-will increase the costs of
producing our food.

Under the best of circumstances it seems likely

that several quarters will elapse before the rate of inflation recedes
to a level on the high side of what were our goals only two years ago.
Just as it is going to take substantial time to subdue inflation, so an extended period of capital expansion is needed to add
production capacity in those industries that are most short of capacity.
Production of almost every important raw material used to feed our
industrial machine, from paper to steel, must be expanded if substantial economic growth is to resume.

Massive additions have to be r.iade

to our coal, petroleum, and electric industries, particularly if we
are to move toward energy self-sufficiency.

Even in industries where

capacity is a~equate to permit growth, capital investment is required
to meet environmental problems, to comply with the occupational health
and ·safety regulations, and to increase productivity as an antidote
to rising costs of energy, materials and labor.
The outlook, then, for the next few quarters, has got to be
one of slower growth of the economy than the four percent or so annual
growth we have come to consider nonnal, with the capital investment
sector (except housing) significantly stronger than the constmter area.
This sluggishness is likely to be accompanied by levels of unemployment somewhat above those we have customarily set as our nati·onal
objective in the post war period than we would like to see.

The reward

for going through this pain, a slowdown in the general rise in the price
level, is going to be slow in coming.

This means that considerable politi-

cal pressure is going to build up for stimulative fiscal and monetary policy.
Already we have heard several calls· from leading political figures for


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a major tax cut to stimulate consumer spe~ding and employment.

Yet,

it is easy to make the case that virtually all the ·first quarter
drop in output and increase in unemploy~ent resulted from the cutback
in the auto and petroleum related industries.

We will probably not know

where the economy is heading over the longer term until the second
quarter's data are available.

Given the special circumstances of the last

six months it seens very tmlikely that we are in a recession in any nonnal
sense of that word.

Policies appropriate to bringing about rapid

recovery in a more typical business slowdown could easily bring on
substantially worse inflation that we are now experiencing without
significantly increasing real growth.

This brings me, then, to the

question of appropriate economic policy for the next several months.
The current situation presents a formidable challenge to
economic policy.

With the economy exhibiting sharply rising prices

and, at the same time, declining real output, there is more than the
usual amount of uncertainty concerning the underlying state of total demand relative to total capacity.
For purposes of framing economic policy, we must start with
the critical factors involved in the current situation and the possible
remedial steps that might be taken to inprove that situation.

But,

it is also iraportant to review how we got to this unenviable position
in order to avoid repeating past errors.
Following the economic downturn of 1969-70, monetary policy
in my opinion was not excessively expansive.

But, the growth in

monetary aggregates during 1972 and the first part of 1973 was higher
than warranted by subsequent economic developments, and higher


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than desired by the Federal Reserve.

Given the laggec effects of monetary

expansion on aggregate econonic activity, and the fact that the economy
was fast approaching capacity output in th~ latter part of 1972, this
unintentional e~ansion of the aggregates most likely added to inflationary
pressures.
Nevertheless, ·other factors share even more inportantly the
responsibility for the current inflation problem.

Fiscal policy, in

terms of budget deficits, has been excessively expansionary in recent
years.

Providing for the financing of the deficits is one reason for

the monetary expansion we have witnessed.

The revision of the in-

ternational monetary system--a revision which entailed successive devaluations of the dollar--is another factor.

This factor, coupled

with simultaneous strong economic expansion of industrialized nations
abroad led to sharper export derr~nd for United States goods than envisioned.

ln addition crop failures abroad led to larger demands for

United States agricultural output than foreseen, resulting in sharp
increases in domestic food costs.

Finally, of course, the oil enbargo,

coming at a time when United States import demands for petroleum products were rising sharply, resulted in absolute shortages of petroleum
based products and sharp increases in prices for such products in a
very short period.
I would also add my personal opinion that the wage-price control
program which was just buried was kept alive too long, given monetary
and fiscal policy actions over the period.

This had the nnfortunate

damaging effect of masking inflationary pressures.

It caused distor-

tions in relative wages, prices and output, and it made accurate
economic intelligence increasingly difficult to acquire.


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Taking a slightly longer term view, the quickening in the pace of
inflation following 1967 has brought into sharp relief a serious problem
associated wi.th the Ernployoent Act of 1946 goal of fostering full employment of resources.

Whiie it is true that public policy also attempts

to achieve relatively stable general prices, the latter goal has been
subordinate to the employment goal for a number of years.
It appears to me that some labor unions and some corporations
have come to act increasingly on the assumpt_ion that increased wages
and increased costs can be passed through to final product prices
almost with impunity.

Given the commitment to full employment, un-

warranted increased in prices and wages--unwarranted in the sense of
maintaining employraent levels given deaand and productivity conditions--

have tended to be underwritten by government policy in order to avoid
tmemployrnent.

Resulting general price increases renew the cycle.

It

seems clear that this pointless circle of wage-cost-price inflation
must be brought under control without denying a role for collective
bargaining and for market pricing which allows for r-elative price
changes and possible income share changes as economic conditions change
through time.

A permanent price-wage review board with principally

a public report;ing responsibility, coupled with some adjustment in the
weights. attached to employment and inflation is one possible means
of approaching the problem short of direct controls.
However, this problem and the problem of closer and more
appropriate coordination of longer run monetary and fiscal policies
are matters that will be grappled with in future periods.

The

pressing question now is what policy actions should be taken in the


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current adverse situation.

Several factors ·must be considered here,

and they lead me to a conclusion regarding short term policy that
some may view as an unacceptable pos_ition.
I belieye we must recognize that the current sit1,.1ation differs
substantially from anything we have experienced in recent economic
history.

Aggregate supply and international considerations must be

taken into account more explicitly than they have been in the past.
And, we must recognize that rising energy costs represent a loss of
wealth or real incorr£ in favor of other nations.

The extent of these

real income losses is by no means clear at this juncture, nor is it
clear how the oil producing nations will employ the wealth transfers
they are now receiving.

Fin~ly, we have just seen the end of a

protracted period of price-wage controls, and the results of renoving
those controls are not yet certain.

As indicated earlier the first quarter econonic data indicate
that the real output decline we suffered is concentrated so far in
a few sectors most affected by the energy problems and most sensitive
to high interest rates.

Un1:il~e other periods of decline in real out-

put, the overall investment picture for the economy appears to exhibit
sustained demand strength thus far.
strong.

Financial market demands remain

And, real consumer spending, while not buoyant, does not

show pronounced weakness, and, unemploynent, after increasing sharply
has, in the short run, been declining marginally.
In the face of these conflicting signals concerning the state
of the econot1y, policy proposals and recommendations diverge more
sharply than usual.

One group advocates sharp restraint in general

monetary and fiscal policy to reduce inflationary pressures, with the
resulting unemploynent and specific industry effects to be dealt with


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by appropriate special programs.

Special programs, I might add, the

dimensions and fonn of which are not at all clear, let alone in place.
Another group· believes.the l.lllderlying demand situation is
weak or borders ,on weakness.

For that reason, expansive or at least

accommodative policies are advocated to maintain efilployment and encourage
investnent spending.

It is argued that most of the very sharp price

increases we experienced last year and this year are attributable to
non-recurring special factors.

If so, with inflation expected to

subside somewhat later in the year, a sharply restrictive nonetary
policy would only exacerbate the process of rising l.lllemployr.ient already started.

Tax relief is advocated by some to res tore some of

the lost real income in the lower and middle income brackets and as
an incentive to organized labor not to seek a restoration of real
income by means of increased nominal wages.
Under such l.lllcertain circtnnstances and conflicting proposals,
I should like to counsel caution in setting economic policy in the
short term.

If underlying aggregate demand is strong, an expansive

policy_ woul_d simply worsen the inflationary situation, given supply
constraints attributable to energy problems and deficient investment
in recent years.

If underlying demand is weakening, a sharply re-

strictive policy would result in an unacceptable unemployment rate
that would elevate pressures for a fast reversal of policy--a process
we have seen enough of in recent years.

On balance, I conclude that moderate monetary restriction
is called for under present circtnistances.

I take the position that

inflation attributable both to special factors and more generalized
pressures requires restraint even though that might entail some


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small increase in the unemployment rate for a year or so at least.
But I would be reluctant to see the t.memploy~ent rate rise ~ubstantially.

Although I am in-sympathy with the desires of those who

wish to stimulate the economy by expansive fiscal policy, as yet I
see no indication that the tax cut proposal would in fact lead to
restraint on the wage side.

Without such restraint an expansive policy

would, in my opinion, only foster a more severe inflationary situation.
My position is not doctrinaire, however.

I am willing to revise my

opinion if a viable ffieans of confronting the problem of so-called
stagflation can be demonstrated and stands a good chance of being carried
through _in all of its facets.
In the absence of such a demonstration currently, I believe
it important that we recognize that our current inflationary problem
cannot be resolved quickly at reasonable cost.
up over a long period.

The problem has built

It will take a long period to resolve it.

Precipitous attempts to solve the problen would only result in the
imposition of social costs that would, in my opinion, be disproportionate to the social benefits received.

More than anything, we lllust

now have patience in order to help establish a sound basis for sustained economi~ growth at nore reasonable rates of price increases in
1975 and the years ahead.


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