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Statement of
William McChesney Martin, Jr.,
Chairman, Board of Governors of the Federal Reserve System,
before the
Ways and Means Committee
of the
House of Representatives

November 29, 1967

Last September I was privileged to appear before this
Committee in support of the President's proposals for reducing
Federal expenditures and raising Federal income taxes.
for such fiscal restraint was clearly evident then.

The need

It has become

compelling now.
Inflation is no longer just a threat--it is a reality.
Its pervasive effects are now spreading through many aspects of our
economic life.

The advance in prices has been rapid and widespread.

Wage increases continue to be far in excess of productivity gains.
Financial markets have become heavily congested and long-term
interest rates have risen to the highest levels in decades, despite
continued generous provision of reserves to the banking system.
And our balance of international payments has continued in substantial deficit.

Inflation is jeopardizing attainment of both our

domestic and our international objectives.
The entire world is looking to the United States to see if
it has the capability, the will, and the determination to preserve
and maintain this period of prosperity which is now the longest in
our history.

In my judgment, the strategic element in demonstrating

that determination will be our success in reducing the prospective
deficit for fiscal 1968 and thereafter to more manageable levels.
I don't think any one here or abroad questions the ability
of our country to pay whatever it costs to fight the war in Vietnam




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and to provide the essential public services the American public
demands.

But I think there are a great many persons—probably an

increasing number, infact—

who

question whether we have the will

to pay these costs.
I am not opposed to government deficits, per se, in any
sense, for there are occasions when they may be fully justified.
At the same time, I am concerned lest there be acceptance of the
idea that deficit financing is a way of life; and I am especially
concerned when our government debt climbs at a faster rate than our
economy as awhole—

and

this is the prospect we face unless our

present fiscal course is altered.
The events of the past two weeks are sobering.

Britain's

international payments problems proved too large and too intractable
to be resolved by partial solutions and emergency loans; drastic
corrective measures were required.

Along with the devaluation of

the pound, the British public is bearing the burden of an 8 per cent
Bank rate, severe restrictions on credit availability, an increase in
taxes and higher costs of imports.
In our case the need for restraint does not rest primarily
on balance of payments considerations, important though they are.
Our economic discipline has slipped somewhat over the past two years,
and this has cost us significantly in terms of domestic economic
progress.

The consequence of allowing inflationary pressures to get

ahead of us in the latter half of 1965 and during 1966 was a near




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cessation of economic growth earlier this year, as the distortions
and inventory excesses of last year were unwound.

With the re-

sumption of more rapid growth this summer, we have allowed price
pressures to get ahead of us again.

Nearly half of the increase

in our Gross National Product in the third quarter of the year reflected rising prices, rather than growth in real output.
Increased prices are being reflected and embedded in
higher wage contracts of long-term duration, and establishing precedents for the many important wage negotiations scheduled to come
up in 1968.

These price and wage developments fit closely the

classic interaction of cost-push and demand-pull inflation.

American

businesses have experienced sharp increases in production costs over
the past year and a half, increases which they began to pass on in
the form of higher prices as soon as overall demands picked up during
the summer.

With experienced labor still in short supply, reduced

rates of utilization of manufacturing capacity did not prove to be
much of a deterrent to price advances, which accelerated sharply at
both wholesale and retail.
This fall, the underlying strength of expansionary forces
has been obscured by the effect of strikes in several major industries,
Largely reflecting these strikes, industrial production dipped and
business orders for durable goods declined.
also increased.

Some of the edge has been taken off the economic

exuberance evident earlier.




The unemployment rate

The reduction in demands resulting from

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these factors has been confined to a few industries, however, and
the pace of expansion in other sectors of the economy has continued
rapid and prices have continued to rise.
Moreover, with the termination of some major strikes this
month, industrial production is resuming its upward trend.

In

coming months, further acceleration in activity appears likely, as
the automobile industry tries to catch up for output lost during the
strikes, and as the steel industry tries to meet orders placed by
customers beginning to stockpile in anticipation of wage negotiations
next year.
Consumer incomes, augmented by the spurt in auto and steel
production, are scheduled to receive additional boosts from proposed
increases in social security benefits, higher Federal pay, and from
the rise in minimum wages.

The likely increase in consumer spending

resulting from such a surge in income would add an extra fillip to
business demands for inventories, and possibly to business spending
for new plants and new processes.

But even without resumption of an

investment boom, the prospective rise in public and private demands
for goods and services appears large enough to reinforce and amplify
the upward pressure on prices generated by rising wage and material
costs.
The prospect of continuing price pressures, together with
heavy credit demands resulting from the large Federal deficit, have
been reflected in congested financial markets and rising interest




-5-

rates.

In the spring, long-term interest rates began to rise under

the impetus of corporate efforts to rebuild liquidity by borrowing
in the capital markets.

In short-term credit markets, however,

interest rates continued to decline until about mid-year, as monetary ease permitted the banking system to acquire a large volume of
liquid assets and as the Federal Government was able to retire a
large volume of short-term debt.

By mid-year, the cost of short-term

financing to the Treasury was about 2 full percentage points below
the peak of such costs in 1966.
But after mid-year, the Treasury had to return to financial
markets as a large net borrower of funds.

The volume of Federal cash

borrowing in this half year has been substantially larger than in any
comparable period since World War II, and has been reflected in a
sharp rebound in short- and intermediate-term interest rates.
Along with the change in the Treasury's financial position,
from that of a major supplier of funds in the first half of the year
to a major borrower in the second half, came a further increase in
business demands for long-term credit.

With business activity

picking up, and with mounting concern for the possibility of even
greater stringency in credit markets, corporations have been willing
to pay record prices to borrow longer-term funds.

The volume of new

corporate security issues this fall has been about two-thirds larger
than last year, and interest rates on new corporate issues have risen
substantially above the peaks of 1966.




-6-

The pressures that have developed in financial markets
threaten to give rise, once again, to distortions in financial flows
and in the structure of production such as marred our economic performance last year.

For example, local governmental units are finding

it harder to compete in credit markets with heavy business and Federal
financing demands.

In the past 6 months, over one hundred scheduled

municipal bond issues, representing over three-quarters of a billion
dollars, have been postponed or cut back in size.
And, once again, competing financing demands are beginning
to curtail the availability of funds for home mortgage financing.
Inflows to savings and loan associations and mutual savings banks,
which had recovered to peak levels earlier in the year, have
moderated in recent months as returns on Treasury securities and
other market investments have risen.

Upward pressure on home mort-

gage rates has intensified, with discounts on insured mortgages
widening.
In the present situation financial market tensions cannot
be tranquilized merely by increasing the supply of money.

Indeed,

the congestion in financial markets and the rise in interest rates
since mid-year have occurred even though the reserves available to
the banking system have been expanding rapidly.

In the absence of

fiscal restraint, continued provision of reserves at such a rapid
pace would only reinforce market expectations and induce even more
urgent demands for credit.




Vigorous fiscal action to reduce the

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prospects of further inflation and of further large Federal demands
on financial markets offers the best hope for alleviating the intense upward pressure on interest rates.
Fiscal action to reduce tensions in our financial markets
and to cool off demand pressures would also be beneficial for our
balance of payments problem.

Our basic need, in this respect, is

to sustain and improve our favorable trade balance in order to move
towards equilibrium in our overall payments

position.

This entails

both the avoidance of excessively rapid growth in our imports and
the maintenance of competitive prices for our exports.

And this,

in turn, depends on our success in keeping the growth of our economy
within the limits of our capacity to produce at reasonably stable
prices.
It is clear, then, that our domestic economic needs and our
international financial responsibilities call for the same policy
prescriptions.

Restraint on spending--both private and public--is

essential to relieve financial market pressures, to restore sound
economic growth, to pay for the war, and to protect the strength
of the dollar at home and abroad.

This restraint can be achieved

most effectively and most equitably by a fiscal program which
moderates both the rise in Governmentspending—
cuts —

and

the rise in privatespending—

through
through

budget
a tax increase.

Ours is the richest country that the world has ever known,
and it is only fitting and right that we devote large sums to public




-8-

endeavors.

But in our governmental activities, as elsewhere, we

must recognize—especially at a time when we are engaged in a major
wareffort—

that

our resources are not

unlimited.

And we must

recognize also that we cannot keep on calling upon our governments-federal, state orlocal—

to

do things we are unwilling to pay for.

If we are to achieve in fact the public goals we feel most useful
and desirable, then we must, as a self-governing people, be willing
to accept and adhere to some sensible order of priorities among them
in accord with the national preferences.
It is neither my prerogative nor my competence to suggest
where and by how much budget expenditures should be cut, nor what
types or amounts of tax increase should be enacted.

But it is my

duty and responsibility to say that some combination of lower spending
and higher taxes is urgently needed to maintain the value of the
dollar and the social and economic progress that depend on a sound
dollar.

We simply cannot afford the risks inherent in a failure to

bring our fiscal affairs into order.





Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102