Full text of The Unemployment Crisis and Policies for Economic Recovery : Hearings Before the Joint Economic Committee, Congress of the United States, Ninety-Seventh Congress, Second Session, October 15, 20, and November 24, 1982

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THE UNEMPLOYMENT CRISIS AND
POLICIES FOR ECONOMIC RECOVERY

HEARINGS
BEFORE THE

JOINT ECONOMIC COMMITTEE
CONGRESS OF THE UNITED STATES
NINETY-SEVENTH CONGRESS
SECOND SESSION

OCTOBER 15, 20, AND NOVEMBER 24, 1982

Printed for the use of the Joint Economic Committee

U.S. GOVERNMENT PRINTING OFFICE
17-871 O




WASHINGTON

19S3

JOINT ECONOMIC COMMITTEE
(Created pursuant to sec. 5(a)
HOUSE OF REPRESENTATIVES
HENRY S. REUSS, Wisconsin, Chairman
RICHARD BOLLING, Missouri
LEE H. HAMILTON, Indiana
GILLIS W. LONG, Louisiana
PARREN J. MITCHELL, Maryland
AUGUSTUS F. HAWKINS, California
CLARENCE J. BROWN, Ohio
MARGARET M. HECKLER, Massachusetts
JOHN H. ROUSSELOT, California
CHALMERS P. WYLIE, Ohio




Jam es
B ruce

K.
R.

of Public Law 304, 79th Cong.)
SENATE
ROGER W. JEPSEN, Iowa, Vice Chairman
WILLIAM V. ROTH, Jr., Delaware
JAMES ABDNOR, South Dakota
STEVEN D. SYMMS, Idaho
PAULA HAWKINS, Florida
MACK MATTINGLY, Georgia
LLOYD BENTSEN, Texas
WILLIAM PROXMIRE, Wisconsin
EDWARD M. KENNEDY, Massachusetts
PAUL S. SARBANES, Maryland

G a lb r a ith ,
B a r tle tt,

(II)

E xecutive Director
D eputy Director

CONTENTS

WITNESSES AND STATEMENTS
Friday,

October

15, 1982

Reuss, Hon. Henry S., chairman of the Joint Economic Committee: Open­
ing statement___________ ____________________________________________
Wylie, Hon. Chalmers P., member of the Joint Economic Committee: Open­
ing statement________________________________________________________
Eisner, Robert, William R. Kenan Professor of Economics, Northwestern
University, Evanston, 111____________ _______________________________
Galbraith, John Kenneth, professor of economics emeritus, Harvard Uni­
versity, Cambridge, Mass__________________ __ _______________________
Heller, Walter W., regents’ professor of economics, University of Min­
nesota, Minneapolis-_____ _______
__ ___________ ____ ________
Marshall, Ray, professor of economics and public affairs, University of
Texas, Austin____
________
_______ __________________________
Wirtz, Willard, chairman of the board, National Institute for Work and
Learning, Washington, D.C
...............................
.....
Wednesday,

October

November

1
3
4
21
24
32
62

20, 1982

Reuss, Hon. Henry S., chairman of the Joint Economic Committee: Open­
ing statement_
_ ---------------------- ----------------------------Bator, Francis M., professor of political economy, John F. Kennedy School
of Government, Harvard University, Cambridge, Mass---- --------—
Dalio, Raymond T.. president, Bridgewater Associates, Wilton, Conn----Evans, Michael K., president, Evans Economics, Washington, D.C-----------Ratajczak, Donald, director, ecomonic forecasting project, Georgia State
University, Atlanta------------- ------------------------ --------------- --------------- Sinai, Allen, senior vice president, Data Resources, Inc., Lexington, Mass_.
Wednesday,

Page

89
92
111
166
202
219

24, 1982

Reuss, Hon. Henry S., chairman of the Joint Economic Committee: Open­
ing statement------------- r_ ----------------------------------------------------------- -----Wrylie, Hon. Chalmers P., member of the Joint Economic Committee:
Opening statement________ ______ _______
____ ____________
Volcker, Hon. Paul A.; Chairman, Board of Governors of the Federal Re­
serve System—------------------- - — --- -------------------

285
288
289

SUBMISSIONS FOR THE RECORD
Friday,

October

15, 1982

Eisner, Robert. Prepared statement--------------------- ------ ------------ --------------Heller, Walter W. ; Bank letter entitled “U.S. Economic Policy and Out­
look” --------------------------- -----------------------------------------------------------Jepsen, Hon. Roger W. : Opening statement--------------------------------------------Marshall, Ray . Prepared statement-----------------------------------------------Wirtz, Willard : Prepared statement-------------- -------------------------------------




(HI)

8
28
4
40
67

IV
Wednesday,

October

20, 1982

Barlow, Wallace D., executive director, Share the Work Coalition, Wash­
ington, D.C.: Prepared statement, together with an enclosure. ________
Bator, Francis M .. Prepared statement________ _______________ _______
Dalio, Raymond T .. Prepared statement, together with an attachment___
Evans, Michael K. Prepared statement-......................
____ ___171
Jepsen, Hon. Roger W Opening statement______
__ ____ .
____
_
...
Ratajczak, Donald: Prepared statementSinai, Allen : Prepared statement_____
________________ ______ _____
Wednesday,

November

274
97
115
91
206
225

24, 1982

Reuss, Hon. Henry S .. Letter to Chairman Volcker, from Representative
Reuss, dated November 17, 1982, making a number of suggestions for
strengthening the working relationship between Congress and the Fed­
eral Reserve Board and the Federal Open Market Committee__________
Volcker, Hon. Paul A .: Response to Senator Proxmire’s request to explain
in detail how, international banks could continue to provide new credits
to developing countries in the context of effective adjustment programs
while at the same time reducing their exposure to those countries rela­
------ -----------------------------tive to their capital assets____________




Page

287

316

THE UNEMPLOYMENT CRISIS AND POLICIES FOR
ECONOMIC RECOVERY

F R ID A Y , OCTOBER 15, 1982
C on gress

of

the

J o in t E

U

n it e d

c o n o m ic

S tates,
C o m m it t e e ,

Washington, D.C.
The committee met, pursuant to notice, at 10 a.m., in room 2128,
Rayburn House Office Building, Hon. Henry S. Reuss (chairman of
the committee) presiding.
Present: Representatives Reuss, Hawkins, and Wylie.
Also present: James K. Galbraith, executive director; Louis C.
Krauthoff II, assistant director; Charles H. Bradford, assistant direc­
tor; Betty Maddox, assistant director for administration; and Mary
E. Eccles, professional staff member.

OPENING STATEMENT OF REPRESENTATIVE REUSS, CHAIRMAN
Representative R e u s s . Good morning.
The Joint Economic Committee will be in order for further hearings
on its investigation in the Nation’s unemployment crisis.
Recovery hasn’t been sighted. We now have double-digit unemploy­
ment, which is producing new misery in sector after sector. Nothing
resembling a recovery program is even in place. And the present Presi­
dent doesn’t have a single constructive suggestion to offer.
A valid recovery program can be developed. It can be put in place
in time to avert economic collapse. But we have got to act soon.
At the request of the Democratic leadership of the House and Sen­
ate, the Joint Economic Committee will be preparing policy recom­
mendations for the lameduck session of Congress in November, with
the hope that it can be a lameduck session that roars.
I would offer the following as the basis, in a preliminary way, for
such a package:
in v e s t m e n t

in

in f r a s t r u t u r e

The Nation’s streets, bridges, water systems, ports, railroads, and
other public facilities are in ruins. Jobs for some of our 11 million
unemployed must be found building and maintaining these vital sup­
port systems.
HOUSING

Subsidies of moderately priced housing are essential as long as skyliigh mortgage rates make home ownership for the great body of
Americans unaffordable. In the process of meeting our housing needs,
hundreds of thousands of idle workers in the construction industry
would be brought back to jobs.




(l)

2
JOBS PROGRAMS

A well-run public employment program can quickly put people to
work restoring public services at the State and local levels, and thus
provide for a variety of unmet social needs.
MONETARY POLICY

Last week, the Federal Reserve happily abandoned its rigid ad­
herence to monetary targets, in recognition of the critical need to
take into account interest rates. This must not be a temporary cor­
rection, to be forgotten once the election is over. Monetary policy
must be geared to the demands of a growing economy if recovery is
to endure after the election.
In each of these areas, the committee will present concrete rec­
ommendations to a lameduck session.
We are happy to have this morning a most distinguished panel to
assess the economy’s prospects and alternative course of action. In a
sense, they will provide the media— whom I am glad to see are here in
force— with a Democratic answer to the President’s television address
the other evening.
Unfortunately, the television media were only able to cover the
President’s speech, which preempted the Brewers-St. Louis Cardinals
World Series. The Milwaukee Brewers were so depressed by it that
they proceeded to lose the game in St. Louis.
I am hopeful that today’s testimony will so inspirit the Brewers that
they will go out and take it from the Cardinals in Milwaukee tonight.
The group of statesmen— some elder, some younger— who are with
us today include :
Robert Eisner, professor of economics at Northwestern University,
adviser to Democrats for many years.
John Kenneth Galbraith, professor of economics emeritus at Har­
vard and also a counselor of Democrats for many years, starting in
his successful efforts to grapple with the unemployment-inflation
problem in F.D.R.’s administration.
This, I understand it, Ken, is your 74th birthday, and I join in wish­
ing you all the best. May you have many more and continue to help
this committee.
Walter Heller, professor of economics, University of Minnesota,
who was Chairman of the Council of Economic Advisers under John
Kennedy, the true founder of honest supply-side economics, which has
fallen among thieves nowadays.
Ray Marshall, professor of economics and public affairs, University
of Texas, and Labor Secretary of the Carter administration. He has
been listened to some. Had he been listened to more, things might
have been even better.
Willard Wirtz, chairman of the board of the National Institute for
Work and Learning in Washington, Labor Secretary for President
Kennedy and President Johnson, who has continued his expertness on
the question of jobs and work in the years since.
We are honored and delighted to have all of you with us. And we
look forward to the united learning that you will give us.
Representative Wylie.




3

OPENING STATEMENT OP REPRESENTATIVE WYLIE
Representative W y l ie . Thank you very much, Mr. Chairman.
I appreciate the opportunity for an opening statement and to wel­
come our distinguished witnesses to today’s hearings.
I am interested in the advice you offer.
May I say, Mr. Chairman, I was rooting for the Brewers before
this morning’s session. I may have to reassess my position since testi­
mony this morning might have some influence on the outcome of the
World Series. On balance, I think I ’ll stick to the Brewers anyhow.
[Laughter.]
I would like to begin my opening statement by suggesting a word
of caution, if I may, to this distinguished panel. That sounds a little
presumptuous on my part. But what one could do, it seems to me,
as a policymaker in the early sixties, commencing from the base of
almost no price inflation, cannot be done in the early eighties by an
administration that inherited the inflation rate of double-digit pro­
portions and the third highest level of unemployment since before
World W ar II.

I think, personally, that we have much to be thankful for as a re­
sult of President’s Reagan’s economic policy.
The prime rate is 12 percent and falling. Under the policies of
the previous administration, there was a prime of 21 y2 percent and
talk of a prime of 25 percent or more at one time. The momentum
has been broken, and the tide was decisively reversed by this admin­
istration, I submit.
In addition, inflation was eroding personal income at double-digit
rates over the last 2 years of the previous administration. This ad­
ministration has gotten inflation below 6 percent, and it’s still falling.
Furthermore, by reducing the Federal income tax rates by 25 per­
cent over 3 years, this administration has managed to restore a signif­
icant portion of the purchasing power lost to inflation during the
previous administration.
To be sure, the Federal deficits are still too large in my judgment.
Military spending is still increasing too rapidly, and unemployment is
too great. These are substantial problems yet to be successfully re­
solved.
However, with interest rates much lower, and with the inflation rate
virtually under control, it seems to me the stage is now set for an
economic recovery.
With the recent surge in the stock market, stockholders are weal­
thier and can spend more. Just as importantly, corporations are well
positioned to raise funds for inventories, for refinancing of high cost,
short-term liabilities, and for capital spending for new plants and
equipment.

In other words, I feel it is important, may I say, Mr. Chairman and
distinguished panel, to stay the course and not abandon policies which
require more than a year to produce their benefit.
Thank you very much, Mr. Chairman, for allowing me to offer that
opening statement.
Representative R euss. Thank you.

Representative W y l ie . Mr. Chairman, Senator Jepsen had an open­
ing statement which he intended to offer. He’s not here. And he’s asked
unanimous consent to have his comments in the record.




4
Representative R e u s s . Without objection, Senator Jepsen’s state­
ment will be placed in the record at this point.
[The opening statement of Hon. Roger W Jepsen follows:]
O pening

St a t e m e n t

of

Se n a t o r J e p s e n , V ice C h a i r m a n

There is not a member of this Congress who is not aware of how severe un­
employment is in this country. Too many Americans are facing the misery of
waking up in the morning and not having a job to go to. Their families suffer
along in this misery not only from a lack of money but also from the crushed
spirit of the breadwinners.
Their plight is, in no small way, the responsibility of all the Members of
Congress. Unfortunately, this autumn, the unemployed in this country are being
used as political footballs. More unfortunately, seme Members of this Congress
fail to understand, or at least fail to mention, that unemployment has been a
problem for many years.
It has been almost 14 years— 1969, the first year of the Nixon administra­
tion— since we have had full employment in this country. It has been 10 years—
1973, the first year of the Ford administration— since we have had unemploy­
ment below 5 percent. It has been three years since the yearly unemployment
rate fell. Unemployment did not just arrive, it has been with us a long time.
Of the 11 million people now unemployed, almost 8 million were unemployed in
January 1981.
I think the President was correct this week when he said we all had to shoulder
some of the blame for unemployment. Even some of the witnesses before us to­
day, who were part of administrations that oversaw rising unemployment, must
share some of the blame.
I do not think I would be far from wrong if I said that the witnesses before
us represent one point of view concerning unemployment. Unfortunately, what
we really need is a full discussion of the unemployment problem in order to
determine the best solution. In fact, I am sure that this variety of opinions is
what the esteemed speaker of the House of Representatives had in mind when he
asked this committee to determine “the best, independent estimates” of the
current unemployment problem and “the best and independent estimates” of the
prospects for employment.
I value the opinions of the witnesses, I just wish that we could have had a
fairer sampling of viewpoints to help solve our unemployment problem.
I think that the committee, the Congress, and the country would have been
better served by a more judicial adherence to the request of the speaker of the
House. In fact, such a straightforward and impartial hearing of opinions would
have mostly benefited the unemployed— the people who are supposed to be helped
by this hearing.

Representative R e u s s . All right. W e thank members of the panel
for complying meticulously with our rule— if you call it that— for
sending prepared statements in to us on time. We appreciate it.
Without objection, they will be received in full into the record.
We will now start out with Mr. Eisner.

STATEMENT OF ROBERT EISNER, WILLIAM R. KENAN PROFESSOR
OP ECONOMICS, NORTHWESTERN UNIVERSITY, EVANSTON, ILL.
Mr. E i s n e r . Thank you, Mr. Chairman. I have a prepared state­
ment which I will not read exactly.
I will start by asking how many remember the Humphrey-Hawkins Act set the target rate for unemployment for 1983 of 4 percent ?
Many— and too many economists— have had little dedication to an
all-out drive to attain the rise to the full employment we enjoyed not
much more than a decade ago.
The current economic situation is not the ordinary internally gen­
erated recession of a typical free-market business cycle. It is rather




5

simply enough made in Washington. I have to say that there is a bi­
partisan responsibility for the economic mess, as the current admin­
istration calls it. Unfortunately, in the Carter administration there
did begin an effort to try to slow inflation by causing a recession, a
minirecession. I recall chiding a leading Carter administration eco­
nomic policymaker at the time, asking “What is a nice guy like you
doing trying to create a recession?” He replied, “ Yeah, we’re not even
very good at it.”
Fortunately, that was true, and perhaps because they were not dog­
matic, that all-out, not quite willing to brook all of the disaster of
the unemployment we’ve had, we never got unemployment very large
in the previous administration. The current administration cannot
escape responsibility for the increase from the 7.4 percent in the be­
ginning of 1981 to the 10.1 percent, and rising, that we know of now.
It, indeed, was part of a very conscious policy of trying to slow in­
flation by causing slack in the economy. It related primarily to a much
too tight monetary policy, to a misguided attempt to follow dogmas
of a particular small group of economic theorists, indicating somehow
if you kept monetary reserves growing at a very slow rate and at a
steady rate, that would take care of things. Beyond that, the Govern­
ment should keep out of matters. The Government, in effect, should be
“off our backs,” as it was put.
In addition, however, we have had a strange, internally incon­
sistent fiscal policy of varied tax cuts, particularly for the rich and
upper middle income groups, and of a weird set of cuts in business
taxes, so extreme, so distortionary that the administration went along
with efforts, successfully, to water down and cancel out a good part of
those, just in the last month or so.
We are told somehow that these policies are now preparing the
way for recovery. I am reminded, painfully, as I am sure are so many
of us, of the frequent statements by Herbert Hoover in the 1930’s that
prosperity was just around the corner. I call it whistling in the dark.
In fact, I have no crystal ball, but neither do these people that claim
to know that somehow we’ve prepared the way for a recovery. The
economy can move up, it can move down.
What worries me, essentially, is that this administration has repudi­
ated policy, as they are quick to point out, not just of Democrats but
of administrations for 40 years, since we last had this record unem­
ployment above 10.1 percent. We have largely had, in place, with more
or less dedication, the notion that Government is responsible for pre­
venting an economy from going out of kilter, for preventing a mass
descent into tremendous unemployment and recession or depression.
Those policies have essentially, at least in word been abandoned,
in the notion the Government has no role and it should be left to the
free enterprise private economy. That, I think, suggests there are dan­
gers in the current situation which go beyond what they have been
before. I do not want to preach gloom and doom. I believe the Amer­
ican economy is essentially strong and resilient, but I have always had
in mind the notion that there is a safety net in the broadest sense,
a safety net for the economy as a whole, if there is a lack of pur­
chasing power, if businesses were going broke, if people were slid­
ing into unemployment at tremendous rates. I note that the latest fig­
ures for unemployment insurance claims, which are more recent than




6
the 10.1-percent unemployment figure, are continuing at a very high,
virtually record rate.
We have had the notion in the past, when these things occur, Gov­
ernment will step in to help. The answer we get at this point is, “No, we
must stay the course. There is nothing for the Government to do but
to follow the policies that have led us here and assume that they will
remedy matters.” I would suggest, however, a set of policies that I
think will remedy matters. They are not the traditional quick fix. They
are policies, in fact, that we have had, to a considerable part, if in­
adequately, over many years. I think there has been too quick a repudi­
ation of policies in the past, under perhaps the pressure of wellfinanced extremist propaganda.
Everything we’ve done in the last 40 years has not been wrong.
Somehow what we have done has prevented us from having 10.1 per­
cent unemployment in the last 40 years.
One thing we have to do, I think most of us have agreed, is to quickly
correct the disastrous monetary policy. I can’t take much comfort
from the recent fall in interest rates. Economists have told us for
years that if you have a recession, if you have a depression, if busi­
nesses no longer have any stomach for investment or borrowing to
expand, the demand for money will go down and interest rates will
go down.
So that is, again, like the unemployment, exactly what we have
created as part— associated with the unemployment and with the
recession. We do need a firm dedication by the Federal Reserve, with
whatever prodding is necessary from the administration and from
the Congress, to set the broad outlines. We need a policy which is
dedicated to getting the economy back to prosperity, which means
easing the money supply, getting real interest rates down.
I might point out again, that glad as we are to see lower and
nominal interest rates, people are not going to spend, they’re not going
to buy in the face of even moderately lower nominal rates, with
inflation and expected inflation way down. We have people buying
houses at 10, 12, 13 percent interest rates, as long as they expected
housing prices to continue to rise at 10, 12, and 13 percent. Even if
mortgage rates now get down to 12 percent, we will have, I would
predict, a pitifully small housing boom, as long as people are worried
about losing their jobs, and as long as that 12 percent cannot be sus­
tained by high expected inflation.
Beyond the monetary policy, the reduction in real interest rates,
as the chairman suggested, there is a need for a tremendous increase
in public investment. We frequently talk about the need for invest­
ment as a means for bringing about growth. I have been on record
criticizing the accelerated cost recovery system, now amended, as distortionary and ineffective, but there is great room for investment in
bridges, in roads, in water systems, in all that Government can provide
and must provide, which will then facilitate private investment and
general growth.
Most important, there must be Government investment in human
capital, in that wThich is the bulk of investment, the basis for both
product and growth, and that means investment in training, invest­
ment in supplementing and subsidizing, in giving incentives to pri­
vate firms to hire. I have elsewhere documented and gone into detail




7

on what I think would be a remarkably good use of either general
funds or tax money to offer businesses the incentive to hire youth, to
hire minorities, to hire women, and generally to hire from the unem­
ployment rolls. That in itself, in my opinion, would be insufficient.
There is also a great need for direct Government efforts to train those
who are untrained, to retrain those who are no longer in positions,
who no longer have jobs for which their training fits.
I might just refer briefly to the notion expressed by Treasury Sec­
retary Donald Regan that the normal rate of unemployment in this
country is now 6.5 percent. I would not accept that. I think those eco­
nomists who have trumpeted that figure are being misused, and I hope
they would recognize it. There is nothing magic about a 6.5-percent
unemployment rate, which w^e cannot even get. I don’t believe that
we can argue, because we have more blacks, more women, more youth
in the labor force, that they are somehow doomed to being unem­
ployed, and that, therefore, the base percentage rate of unemploy­
ment must be lower. There is a limit to what we can accomplish in
reducing unemployment by broad-based measures of stimulating
demand, and to go beyond that, we do need a massive program of
matching jobseekers to openings and a program of subsidization of
centers of training and retraining to get the unemployment rate down
to where it could be, where it has been. I can remind all of us that no
more than 13 years ago, in 1969, we had an unemployment rate below
3 percent. And I fail to see where the economy has changed to the
point where now we should say 6.5 percent is our target and then ac­
cept 10.1 percent.
I might close quickly by facing frontally the notion that this is
more “spend, spend, and spend.” The question of whether the Gov­
ernment should spend is a question of what it should spend for and
whether it is worth it. W e can spend trillions, literally, in accelerating
a hopeless arms race. There is much more profit to the American
economy, to the security of the American people in seeing to it that
we get our people back to work.
[The prepared statement of Mr. Eisner follows:]




8
P r e p a r e d St a t e m e n t of R o b er t E is ne r *
How many remember that under the Humphrey-Hawkins Act the target rate of
unemployment

for 1983 is 4 percent?

Our failure to refer to that goal,

let

alone implement programs to achieve it, suggests that the current economic
disaster is a national disgrace.
It is of course clear that many in our body politic —

and too many economists —

have had little dedication to an all-out drive to attain the relativelly full
employment we enjoyed not much more than a decade ago.

What is disturbing is

the hypocrisy with which some have proceeded with anti-employment policies —

in

the presumed interest of reducing inflation.
For make no mistake about it, the current economic situation is not the
ordinary, internally generated recession of a typical,
cycle.

free market business

It is rather, clearly and simply, made in Washington.

Unfortunately,

there is something of a

bipartisan responsibility for the

"economic mess" as current Administration spokesmen like to term it.

Following

upon new supply shocks from increases in petroleum prices and of other raw
materials on world markets, and certain self-inflicted

supply shocks, inflation

did rise again in the last years of the Carter Administration.

As public con­

cern grew, the Carter Administration initiated the policy of trying to "slow
down" the economy —

a thinly disguised euphemism for creating a mini-recession —

in order to reduce the rate of inflation.

^William R. Kenan Professor of Economics, Northwestern University.




9

To the minds of a number of us who knew better,
guided policy.

this was indeed a mis­

There is every evidence that only sharp and sustained recession

can do much to end inflation, particularly an inflation fueled by higher supply
prices rather than excess demand.
I recall that when I chided a leading Carter Administration economic policy­
maker at the time, asking "What is a nice guy like you doing trying to create a
recession?"

he replied,"Yean, and we're not even very good at it.'

That last was fortunately true.

The current Administration cannot escape

responsibility for the fact that it inherited an unemployment rate of 7.4 percent,
a rate that I and Humphrey-Hawkins deemed

much too high but too many others were

willing to accept in the name of combatting inflation, and by now has given us
the horrendous 10.1 percent figure reported last week.
relates to the dogmatism,

The difference, I fear,

indeed fanaticism, with which the current Administration

has pursued at best untested and at worst blatantly fallacious economic theories.
In the name of fighting inflation, the Administration has encouraged and
supported a monetary policy which has so held down on monetary reserves,
in an effort to hold down particular measures of the money supply, as to bring
about unbearably high real interest rates.

This has brought near-collapse of

the housing markets and body blows to the production of many consumer durables,
greatly compounding in particular the problems of

our hard-pressed automobile

industry,

supposedly most favored by

It has helped curb business investment,

Reaganomics,

and has contributed

mightly

to our record numbers of business

bankruptcies.
Our fiscal policy,

instead of focusing on broad-based support of aggre­

gate demand and economic growth, became the captive of so-called "supply-side
economics,'

which was soon acknowledged in very high Administration circles,

as we recall,

to be merely a new version of the old trickle-down economics

that does indeed go back, at least,




to Calvin Coolidge.

10

We thus have had a weird mixture of very large tax cuts for the rich,
net tax increases for the poor as payroll taxes and inflation continued to
take their disproportionate bites, large cuts in government programs designed
particularly to help the poor and those in need of employment, huge cuts in
business taxes, so extreme and distortionary that they have now wisely been
partially reversed, and very large increases in commitments for military expen­
ditures and future tax cuts which have helped frighten those in financial markets
worried about the huge,

contemplated budget deficits.

I need not dwell on details of the current economic situation, which members
of this Committee must know well.

The double-digit unemployment figure, unlike

our frightening double-digit inflation as measured by the Consumer Price Index
in the recent past, is in no part a statistical mirage.

If we add 1.7 million

of "discouraged workers" who have given up looking for jobs, and half of the
millions who are part-time for economic reasons, we reach a relevant figure
of some 14 percent without employment.

This figure is so high that it has

directly affected millions of middle- and upper-middle class people for whom
unemployment is generally something one hears about on television.

But unemploy­

ment remains unevenly distributed and has struck particularly cruel and bitter
blows in major industrial areas, such as in my own state of Illinois, along with
much of the Midwest, and among blacks and other minorities, youth and women.
And it has been devastating to millions of workers in our major goods-producing
industries —

construction, automobiles,

steel and other primary metals,

textiles, and lumber and wood products.
I have no crystal ball for the future.

But those whistlers in the dark,

evoking memories of Herbert Hoover and the Great Depression with their unabashed
proclamations that "prosperity is around the corner," have no crystal ball either.
Concensus forecasts have suggested that we may be "bottoming out," but with such
a slow recovery in sight that unemployment will hardly decline and may yet grow.




11

But it is important not to claim certainty or clairvoyance in any fore­
casts of the future.

We must all recognize the range of possibilities and

reasonable probabilities of future events, and hence the serious
potential current dangers.

The economy may be bottoming out and a slow and

inadequate recovery may be near.

But it is also possible that the dismal

developments we have seen already, along with

any new shocks to the

system, may generate serious further deterioration and collapse.

I have not usually been a preacher of gloom and doom.

I have long seen

the American economy as essentially strong and resilient and indeed able to
survive a remarkable amount of misdirection from Washington.

My generally

sanguine views, however, have related to a broad complex of economic
policies which have been followed in the United States and indeed virtually
all of the Western world for almost half a century.

These have been

supported by a recognition, by most Democrats and Republicans alike —
and by Laborites,

Social Democrats,

Christian Democrats, Liberals and

Conservatives alike in the rest of the world —
dedicated to "free markets,'

that however much we are

government does accept a responsibility to

prevent major recessions and to combat major unemployment.
Administration,

The Reagan

like the Thatcher Administration in Great Britain, has

repudiated this general concensus.

It denounces fifty years of Republican

and Democratic administrations for putting "big government" on our backs.
In the name of freeing us from that burden, it has proceeded to reduce
and dismantle program after program to maintain our economic well-being.
Its ideological motivation is clear.
Administration believes,

We are all better off,

this

if we operate in this mythical "free market"

without government help, except insofar as this is provided by sharp
increases in military expenditures.

It is apparently inspired by a small

number of articulate "new economists" who believe that whatever level of




12

employment or unemployment the economy attains is somehow "equilibrium,” and
that government intervention to reduce unemployment can have no long-run
benefits.
My usual optimism is hence sharply tempered.

Recession phases of

business cycles do tend to end and be followed by recoveries.

Recessions in

recent decades have come to an end particularly with the help of broadly
countercyclical government fiscal and monetary policies.

If those policies

are eschewed and we are told to "stay the course" in the hope of ultimate
salvation, my worries increase sharply.
about economic systems and economies.
sick, and usually recover.

There is nothing, after all,
Like human beings,

immutable

they occasionally get

But if we persist in policies to lay us low in

order to avoid the danger of "overheating," all bets may be. off.

Human beings,

after all, usually recover from many illnesses, but not the last.

An Administra­

tion policy that stubbornly precludes prescriptions for recovery may hasten
the final collapse.
In proposing a set of policies to move us off the current course, we may
certainly be alert to new ideas, but we must not be intimidated by wellfinanced extremist propaganda from reviving old policies that have worked
in the past.

The fact is that until this Administration,

forty years of commitment, however imperfect,

with over

to broadly countercyclical

government policies, we never did have double-digit unemployment.
some of the policies engendered by that commitment might help.

A return to

Improvements and

additions would help all the more.
First, monetary policies of the last few years must be reversed.

Attempts

at rigid adherence to monetary targets designed to restrain the economy must
be abandoned.

If the Federal Reserve does not change course on its own,

the Administration or the Congress must force it to do so.




13
Falls in interest rates that we have just witnessed, however welcome in
themselves, seem more to be the result of the recession itself and the
consequent reduction in effective demand for money than a significant easing in the
money

supply.

We might perhaps be grateful to the Fed for avoiding further

tightening of money at this time.

But accommodating only the reduced demand

of a sick economy does not in itself offer promise of a healthy recovery.
I am not suggesting that Congress take upon itself the technical details
of administration of our monetary system.

But Congress does set the broad

outlines of economic policy and must indeed accept some responsibility for
past Federal Reserve actions by encouraging it to set and present targets
for monetary aggregates.

As is all the more clear w ith our changing monetary

institutions and the necessity of successive changes in our definitions of
money,

the Federal Reserve should abandon its restrictive monetary targets.

There is already some hint that, faced with surges in checkable desposits
stemming from

monetary innovations and deregulation,

already doing that.

More fundamentally,

the Fed should return to setting

monetary policy in terms of the needs of the economy.
those

needs

the Federal Reserve is

At this time,

dictate a reduction in real interest rates.

Whatever the

conundrum of long term equilibrium theory, it is clear that increasing
monetary reserves now can bring about significant reductions in these
critical rates.
It is important to recognize that it is real interest rates that must come
down.

There is little or no advantage to the economy as a whole from reductions

in nominal interest rates that merely accompany reductions in actual and
expected inflation.

In particular, our now devastated housing industry was

previously sustained by high rates of expected inflation, despite high
nominal interest rates.

One

could

find it advantageous to pay 10 percent

and 12 percent mortgage rates to buy houses which were expected to appreciate

17-871 0




83

2

14

by 10 percent or 12 percent or 15 percent per year,

It does not pay, however,

to buy hoHses with 16 percent mortgages and 5 percent inflation.

And it must

be noted that most people will be unable or unwilling to buy houses at 12 per­
cent mortgage rates' with expected inflation of only 5 percent.
rates,

Real interest

the differences between the nominal rates and the expected r a t s of inflation,

must come down if the housing industry is to revive.
Reductions in real interest rates will also prove a major stimulus to the
automobile industry,

to purchases of consumer durables generally,

cularly as the economy recovers,
With regard to this last,

and, parti­

to business investment in plant and equipment,

I may note parenthetically but significantly that

the costly accelerated cost recovery system (ACRS) of the Economic Recovery Tax
Act of 1981 reduced the cost of capital by some two percentage points according
to calculations undertaken w i t h the Treasury's Office of Tax Analysis Tax
Depreciation Model.

Increases in real interest rates since enactment of the ACRS

business tax cuts have raised the cost of capital by considerably more than ACRS
would have reduced it,

Whatever the merits of the accelerated cost recovery

system, and I have argued that they were few indeed, the accompanying monetary
policy more than negated them.
Return to a sane monetary policy would be an important contribution to
economic recovery but there are many more measures that can and should be
undertaken.

First, w e should undertake major government programs to utilize

idle capacity of people and machines for a great program of public investment.
In housing itself, beyond the stimulus from a corrected monetary policy,
there is much room for direct government encouragement.

By the appropriate

standards of today, we may well be back in the situation of one-third of
a nation ill-housed to which Franklin D. Roosevelt
a century ago.

of thousands of construction workers are idle.




addressed himself half

There is no excuse for vast unmet housing needs while hundreds
We have indeed had disappointing

15

and miserable experiences with subsidized low-rent housing for the poor.
Might not all of us who see the advantages of private property support instead
new subsidies for home ownership for the poor?
Tax subsidies relating to the taxation and deductibility of interest, as
is well known, already offer major advantages to higher tax bracket, middle
and upper-income Americans.

Similar subsidies to low-income Americans would

make possible vast increases in owner-occupied housing, with all of the
advantages they entail for preservation of basic living standards and
neighborhood values for all of those concerned.
In addition to housing, there are vast needs in the form of public invest­
ment in basic transportation and other social overhead capital.

How many times

must we be reminded that thousands of bridges are becoming too dangerous to
travel?

How much more must we allow our road system to crumble befo-re we

undertake the massive investment necessary for its renovation and expansion?
How much further must we allow our essential resources of land, water and air
to deteriorate out of short-sighted and misguided public frugality? Failure to
act in these areas would be stupid even if we had to divert resources from
other productive activity to meet these needs.

To allow our public capital

to deteriorate further when there are millions of idle workers and thousands
of companies with under-utilized capital ready to go to work is utter folly,
Easier money and public investment will prove significant measures to
move us away from the depths of our current recession.

Much more, however,

is in order to achieve stated, if ignored Humphrey-Hawkins goals of full
employment,

as appropriately defined for 1983 at 4 percent,

Treasury

Secretary Donald T. Regan has been quoted as arguing that the norm for
"full employment" has now become about 6.5 percent.

Some of my colleagues

in the economics profession have indeed been free with arguments that
changes in the composition of the labor force in the direction of more
women, youths and blacks have raised the original full employment rate of




16

unemployment from 4 percent -- or, it might be noted, the 2.9 percent attained
as recently as 1969.

It is

of course true

that unemployment tends to be

more concentrated among "marginal" members of the labor force.

I presume

that a century ago these were largely new immigrants from abroad.

But I

see nothing unique about blacks or women or youth that should lead us to
doom them to perpetually high rates of unemployment and to assume that when
their proportions in the labor force rise it is inevitable that average
unemployment will rise.
A correct inference about the presumed 6.5 percent figure,
are currently so far, is that, with

from which we

existing labor markets and government

policies, broad and generalized macroeconomic programs for stimulating
demand bring inflationary pressures as unemployment is reduced below

it.

But

whatever

our

view

unemployment and inflation,

of

the

tradeoff

between

there is no reason to accept the figure of

6.5 percent as the immutable

"non-accelerating inflation rate

of unemployment," as it has been called.

Simply enough, there is a substantial

panoply of programs which can and should be introduced to get at significant
components of this 6.5 percent,

if indeed it is that large.

For one thing, rather obviously, labor markets should be improved.

The

vast expansion of computing facilities we are witnessing certainly has other
uses than keeping track of inventories and accounts receivable.

We should

provide a nationwide listing of job openings and qualified job seekers,
and significantly reduce, their coexistence.
But reaching further, we could insure that job workers be qualified.
We have squandered many tax dollars
in plant and equipment,

on subsidization of business investment

something that I long argued should better be left

to private decision-making in competitive markets.

But adequate investment

in human capital is something that we cannot expect from free markets.




17

If only because we are, fortunately,

not a slave economy,

business firms to invest adequately in the ability,
capital of workers
investment,

it does not pay

training and general human

because they cannot reap all of the benefits of such an

Yet similarly, because human beings cannot offer themselves as

collateral, workers cannot borrow enough, even if they could afford to take
the risk,

to invest adequately in themselves.

We are thus faced with millions

of potential workers, particularly youth, who lack jobs because they do not
appear productive to potential employers.
and experience

Yet we know that with proper training

they would appear productive and employable.

The problem is

particularly acute among blacks and other minority youth who never get a chance
to acquire the human capital enjoyed by more prosperous members of society.
It is also acute among millions of experienced workers laid off in declining
industries, where retraining for other work m ay prove essential.
This is clearly a situation which calls for a combination of direct govern­
ment expenditure for education, training and employment with incentives to private
firms to provide the job training and experience which will produce not only goods
and services which are profitable for the firm but productive participants in the
economy as a whole for years to come.
I have for a number of years advocated a variety of tax incentives for private
employment,

I shall not here spell them out again in detail but may mention that

they would encompass substantial tax credits or direct subsidies for employment
of youth,

of women and veterans rejoining the labor force and for all those who

have been unemployed for more than a minimal period of. say,

13 weeks.

Such

credits or subsidies need come to no more than the amounts we pay for unemploy­
ment benefits, and would be far more beneficial.
While tax incentives and direct subsidies for employment of the unemployed
and among major groups subject to high or structural unemployment would move
us a very substantial way toward appropriately defined levels of full employment
we should allow no ideological prejudice to prevent the development and extension




18

of comparable programs by government.
whom private employers

would

There may well be many potential workers

not hire even with 100 percent subsidies.

apparent lack of suitability and the risks attached to their employment,
with the administrative costs of hiring and firing may

Their
along

be such that no

conceivable tax incentive or subsidy would work under current conditions.

It

would then be in the interest of society for government to undertake pro­
grams involving training, motivation and preparation for employment,

The armed

forces, in war and in peace,have traditionally found places for many facing
rejection by private industry.

Is it too much to ask for peace-time,civilian

programs to tap countless unutilized human resources which, once developed,
will become private and public assets?
To all of these proposals,
"Spend, spend and spend!"

I can anticipate the retort that this is more of

Will such- spending not either force increases in taxes which

will hurt the economy or increase budget deficits which will also be injurious?
I should not close# therefore, without meeting these issues head on.
course, one cannot avoid questioning the consistency,

First,

of

if not the judgment of those

who would spend trillions of dollars in the acceleration of a hopeless arms
race but cannot find the funds to invest in our own people.

Second, if increased

taxes were necessary, just as with any other cost we impose upon ourselves as
individuals or collectively,

the question to be answered is simply whether the

benefits are likely to exceed the cost.

The benefits of getting people out

of idleness and into work, now and for the future, are clearly so great that
it is hard to imagine any objective calculus would indicate that it would not
be worth the cost.
But impolitic as it may appear,

I cannot refrain, as an economist,

from chal­

lenging some of the current myths and near-hysteria about budget deficits.
bottom line, of course,

The

is not the government account, unless we have a perverse,

statist or totalitarian mind, but the account for the product of the economy
as a whole.

If budget deficits contribute to higher real national income




19

and product,

they are good.

If they somehow contribute to lower real product

by creating chaotic inflation, they are bad.
It is absurd to believe that the current,
budget deficit is creating inflation.
lack of adequate spending, output,

largely recession-created

The deficit has swelled because of

income and employment

To try to reduce

the deficit now either by reducing government spending or raising taxes will
only aggravate the recession.
Over the longer run, it is true, projected increases in government
expenditures, particularly for the military,

and already legislated cuts in

future tax rates do lead to projections of uncomfortably large deficits.
Even here, considerable confusion is engendered by conventional government
accounting.

By government accounting, with no separate capital accounts,

every major private firm would be showing huge deficits.

Conversely,

if

government were to adopt private accounting methods, particularly excluding
capital expenditures from current accounts, government budgets would prove
well in balance.
But further,
and public,

inflation has bedeviled all conventional accounting, private

Most of us are fond of pointing out some of the inconsistencies

and distortions introduced into private accounting.

We usually

fail, however,

to note that high rates of inflation similarly distort government accounting.
Most particularly, as a result of high inflation and expected rates of inflation,
the government pays huge amounts, based on high nominal rates, in interest charges
on the federal debt,

Those high nominal interest rates are, as we all know,

necessary to compensate holders of public debt,

or any debt,

for the year-by-

year depreciation in the real value of such debt brought on by inflation.
What this means, however,




is that while high government interest payments,

20

swelling the measured budget deficit,

are going largely to compensate private

holders for the inflation-related losses in the real value of their government
securities,

the government is in turn itself gaining from the year-by-year

reduction in the real value of its outstanding debt,

The real measure of

the government deficit would then be the net increase in the real value of
government debt,

or the difference between the nominal deficit,

adding to the

debt, and the reductions in the real value of debt resulting from inflation
(and, in addition,

reductions in market value of outstanding debt due to

increases in interest r a t e s ) .

An analogous way of correcting measures

of the budget deficit (or surplus)

is to count in expenditures only the pay­

ments which would correspond to the real rather than nominal interest rate.
I do not mean to insist that we get involved in these seemingly abstruse
matters of measurements of budget deficits, although I am pleased to note that
the 1982 Economic Report did use some tables which I prepared in developing
some of these issues.

It is important, however,

that we do not allow out­

dated myths and measures relating to government budgets and fiscal policy to
prevent us from doing what we have to do.

And what we have to do is to

bring our economy back to health, and along with it the economies of most
of the rest of the world, by putting our people back to work.




21

Representative
Mr. Galbraith.

R eu ss.

Thank you, Mr. Eisner.

STATEMENT OF JOHN KENNETH GALBRAITH, PROFESSOR OF
ECONOMICS EMERITUS, HARVARD UNIVERSITY, CAMBRIDGE,
MASS.
Mr. G a l b r a i t h . Mr. Chairman, the unemployment figures have re­
ceived greatly deserved attention these last few days. They, indeed,
reflect a massive despair, deprivation, and waste of manpower and
opportunity. But they are also a symbol of a much more extensive
anxiety, waste, and danger. They are the companion piece of low
levels of plant utilization, record levels of small business failures and
personal bankruptcies, the threatened insolvency of savings institu­
tions, some commercial banks and some of our larger corporations,
and of grave economic stress among farmers.
And through its effect on international trade and international
capital flows, our economic performance or nonperformance is now
a threat to the international financial system and the economic and
political stability of our more vulnerable neighbors and trading
partners.
The cause of this disaster, as it must now be called, does not lie in
some deeper past. The archeological alibi which now ascribes all blame
to earlier policies of Democratic— and Republican— Presidents is
transparent escapism: everyone knows that were things going well, all
credit wTould be taken for the policies presently in effect. Responsi­
bility must always lie firmly with those of whatever party or persua­
sion who are currently in power.
Economic performance, Mr. Chairman, does not lie suspended in
space between the errors of the distant past and the promise of the
indefinite future.
We have had a period of unprecedented experiment in economic
policy. It has failed. The present need is to accept the fact of failure—
a fact that is for all to see and for millions of our fellow citizens to
feel— and to launch on a better and wiser and, in a very real sense,
more judiciously conservative course.
EQUITABLE DISTRIBUTION OF INCOME IS SOUND ECONOMIC POLICY

The failure arises from two causes. All recent policy has had the
unifying theme of shifting income and spending power to the affluent
from people of middle income and below, That was the effect of the
tax reductions, of the accompanying cut in social expenditures and of
the increase in military spending. The rich have the agreeable alterna­
tive to not spending their income; in economic terms, their marginal
propensity to spend is low. This is also the position of those in major
line of benefit from the increased military expenditure. People of
middle income and below do not have the luxury of choice as between
spending and not spending; their marginal propensity to spend or con­
sume is high, a function of pressing need. We have shifted income
from those whose spending and demand are assured to those whose
spending and demand are discretionary.




22
In the past, the case for a more equitable distribution of income and
for public help to the disadvantaged has been made on broadly com­
passionate grounds. The lesson of current economic policy is that
such compassion and fairness have a strongly functional aspect. They
guide income to the people who can be counted on to make economi­
cally effective use of it. An equitable distribution of income is, with
all else, a sound economic policy.
With the regressive movements in social welfare expenditures and
in taxation has gone the great experiment in monetarism, an experi­
ment which, as Professor Eisner has said, antedates the present ad­
ministration. This experiment, compensating in part for the tax re­
duction, the increased military spending, and the present and pros­
pective deficit, has operated through high interest rates to restrict
spending and respending from borrowed funds. That is how mone­
tary policy works against inflation.
In a modern, highly organized economy— one of large corporations,
effective unions, substantial public employment— the first effect, as we
now know, is a cutback in business investment, in current use of plant
capacity— and notably in employment. Only as there is a substantial
Bxcess in plant capacity do producers restrain prices, only as there
is substantial unemployment do unions forego wage increases.
Monetary policy, in other words, works against inflation only as it
produces a substantial recession— or depression. This is not a matter
of introspective theory; it is the recent and present experience, avail­
able for all to see. The unemployment we presently experience is the
direct result of present policy. Monetary policy works against inflation
by way of a particularly brutal form of prices and incomes policy, one
that brings its pressure to bear by way of idle plant capacity, business
insolvencies, and mass unemployment. I am not being parochial or
partisan on these matters. As you know, that is never my tendency.
What I say is common ground for economists.
The outgoing chairman of President Reagan’s Council of Economic
Advisers, Mr. Weidenbaum, attacked the damaging commitment to
the military budget and, by inference, the greater resulting reliance
on monetary policy. His successor is even more stern on the supplyside aberration and on monetary policy. No one has put the matter
more bluntly than Mr. Feldstein:
The extremists among both the supply-siders and the rational-expectations
monetarists who predicted that inflation would be reduced without raising
unemployment have been decisively proven wrong.

I f Mr. Feldstein were here this morning, he would not encounter,
in this panel, any serious objection to that very straightforward
comment.
ANTIRECESSION PROGRAM PROPOSED

However, it is not enough to cite the errors of the recent past; there
must now be an affirmative program to repair the damage, get people
back to work and to insure against a serious breakup of the interna­
tional system. The agenda is not at all obscure or even dramatic; most
of it is the self-evident response to recent history. It involves the
following steps:
First, an arrest and reversal of the shift in public expenditure from
civilian to military expenditure. On this matter, we have been re­




23
spending not to need but to the military and weapons industry power
and to their captive Secretary of Defense. There is now a highly sig­
nificant shift of public, business, and political opinion against the
open military checkbook. The Congress and the administration must
now take notice. The effect of sanity on the military budget will be a
stronger fiscal policy, a reduced pressure on monetary policy, lower
interest rates, and better economic performance.
Second, we must cancel the reduction in the personal income tax
scheduled for next midyear. Its effect on individuals at lower- and
middle-income levels is either nonexistent or invisible. As I have noted,
its effect on the spending of the rich is inefficient. The revenue is
needed for job efficient programs and to relieve the pressure on mone­
tary policy.
Third, in response to the reduced military spending and the aban­
donment of the further tax cuts, we should have a continued easing of
Federal Reserve policy. It is a far, far better thing to have fair taxes
than murderous interest rates. W e have paid heavily in these last years
for a loose fiscal policy and a tight money policy when, in fact, the
reverse is required.
Like others, I have taken note of the response in these last days of
the financial markets to the relaxation of monetary policy. It is some­
thing, one hopes, that will last beyond the election and will be part of
a much more general reform. And I, here, endorse the comments of
Professor Eisner and of the chairman in this regard.
Fourth, there must be no further cuts in the social programs. In­
stead, we should restore programs on a selective basis where cuts have
caused particular hardship. I have especially in mind aid to families
with dependent children, the food stamps and— as an efficient short­
term expenditure and an important long-term investment— the sup­
port to student loans and education. The recently enacted job-train­
ing legislation is a useful step. Let it be noted, however, that job train­
ing is not a substitute for jobs.
Fifth, we must have a serious attack on structural unemployment
by direct employment programs in conjunction with the States and
cities. Within these last years, as the chairman earlier said, we have
become aware of the sorry and, in many cases, devastated conditions
of our public capital plant. It is outrageous that this deterioration
should continue when there is so much manpower available to put it
in repair. I have in mind action along the lines of House Joint Resolu­
tion 562. This was widely dismissed as a preelection political gesture.
When the election is over, the Congress should return to it as a timely
and much needed action.
Sixth, somewhat reluctantly, I have come to the conclusion that we
had better have in place a financial institution of last resort for lend­
ing and for other socially urgent investment along the lines advocated
by Felix Rohatyn. We face the possibility of insolvencies in the bank­
ing and industrial structure that could have a cumulative effect. And
we now experience a financial astringency that is inhibiting muchneeded capital investment. Thus the need.
The Reconstruction Finance Corp., the model for such action,
was not, conservatives should be reminded, a New Deal innova­
tion. It came into existence under the impeccable Republican auspices
of Herbert Hoover. The first head was Charles G. Dawes, a former




24

Republican Vice President who served in the post until the day when
his own Chicago bank, imminently threatened by insolvency, needed
a rescuing loan itself, and he had to resign and catch the train to
Illinois to become a borrower himself.
Finally, we must assume that, as and when employment recovers
and economic growth resumes, inflation wTill recur. There is now in
circulation, recently iterated by Chairman Paul Volcker, the peri­
stalsis theory of inflation. It holds, by biological analogy, that infla­
tion, once extruded from the system, will be gone for good.
This, not to put too fine an edge on things, is prime nonsense. The
basic causes of inflation, particularly the interaction of the wage and
price structure, remain as before. With recovery, wre will have infla­
tion as before— perhaps, if past trends persist, at a higher rate. We
must be prepared to deal with it by more effective and more humane
methods than in the past, specifically by measures other than an in­
comes policy enforced by idle men, idle plant, and general recession.
The Government, the unions, and the larger corporations must,
instead, seek a social consensus stabilizing prices and incomes, and
enforced as necessary by law. This is the only possible substitute for
price stability induced, as under present policies, by massive hard­
ship and despair.
Persistent in the belief of the present administration is the notion
that economic recovery and improving employment are an auton­
omous tendency of the system. Suffering is the natural prelude to
rejoicing. We have been pampering the poor and depriving the af­
fluent for a long time; once the first are sufficiently punished and the
second sufficiently rewarded, the economy is bound to respond.
Here we have the basis for the biweekly forecasts of Secretary
Regan that recovery is just ahead, just beginning, just around the
corner.
There is, Mr. Chairman, no such autonomous tendency. Recovery
is not the work of kindly gods with a special commitment to the free
enterprise system: it is, alas, the affirmative accomplishment of man—
and woman.
Representative Retiss. Thank you, Mr. Galbraith.
Mr. Heller.

STATEMENT OF WALTER W. HELLER, REGENTS’ PROFESSOR OF
ECONOMICS, UNIVERSITY OF MINNESOTA, MINNEAPOLIS
Mr. H e l l e r . Mr. Chairman, I was asked to look at the general eco­
nomic outlook, the general economic environment of the unemploy­
ment problem, but I hope I will be pardoned if I occassionally venture
into areas of policy and political economy. I have submitted earlier
to the committee the bank letter that George Perry and I got out a
couple of days ago, “U.S. Economic Policy and Outlook,” and I would
like to present a brief summary of that with some additional com­
ments.
Under Reaganomics, we have traded double-digit inflation for dou­
ble-digit unemployment. And with the current bleak prospects for
the economy, the sad prospect is that unemployment wTill hover in and
around the double-digits for months to come. The best hope for
putting and keeping the economy on the recovery track is a Federal




25

Reserve policy that decisively breaks out of the monetarist tightmoney trap coupled with a fiscal policy that puts us on the path to
balanced budgets at high employment without slamming on the
brakes just when the economy gets moving again.
The U.S. economy has been on hold for 3Y2 years. Output is no
higher today than it was in early 1979, a sputtering performance that
has added over 5 million workers to the ranks of the unemployed and
pushed factory operating rates down to their postwar low of 69 per­
cent of capacity.
Although I had expected a muted recovery to begin this quarter, a
careful sector-by-sector appraisal of prospects that George Perry of
Brooking and I have just completed simply doesn’t reveal enough
strength anywhere to get an economic revival underway this year.
Reaganomics with its combination of a fast and loose fiscal policy
and a tightly monetarist Federal Reserve policy, has kept real interest
rates sky high throughout this year’s severe recession. There is much
talk about how interest rates have come tumbling down but so has in­
flation, so that real interest rates are still extremely high. The high
cost of money has thus far overwhelmed the stimulus of tax cuts, de­
fense boosts, and lower inflation. One hopes, but has no assurance,
that last week’s turn in Federal Reserve policy is not just a 1-month
wonder but will persist until recovery is solidly underway.
By rights, we should be in a cyclical recovery. Consumers have en­
joyed a sizable tax cut, defense spending is on the move, inventories
have been cut, inflation is down, interest rates have softened, and the
upsweep in stock and bond prices has added $300 billion to people’s
assets. I note, by the way, that some economists seem to think that
the latter will substantially stimulate consumption, and I understand
that the orders for Mercedes and Gucci have increased tremendously.
But these economic pluses have been no match for the continued
sources of weakness. Consumers are cowed by double-digit unemploy­
ment and growing layoffs. Manufacturers and distributors are still
cutting inventories. State-local governments are retrenching. High
mortgage costs continue to burden housing. Auto production schedules
for the current quarter have been cut significantly. Business capital
spending is reeling under the impact of weak markets and low-capacity
utilization. And the combination of our strong dollar and weak econ­
omies abroad is sharply cutting net exports.
Barring unforeseen strength in consumer purchases or a sharp turn
in Federal Reserve policy, we now expect recovery to be delayed until
well into 1983. This will keep the official unemployment rate above
10 percent for months to come and will bring the comprehensive un­
employment rate, embracing both part-time and discouraged workers,
as well as full-time workers, to 14 percent or more. It is there now.
I retch at some of the statements that come from the White House.
“ Yes, 10 percent of the people are unemployed, but 90 percent are
employed.” Even the basic statistics totally ignore a lot of people that
have been knocked out of full-time employment into part-time employ­
ment or knocked out of the market altogether. Since this is the political
season, when President Reagan asks us to hold him harmless in the
blame game on unemployment, I note that Margaret Thatcher, in a
catch sentence that echoes Mr. Reagan’s statements, tries to take the




26

political sting out of 14 percent unemployment in Britain by saying,
“Today’s unemployed are the victims of yesterday’s mistakes/’
Well, in this country, yesterday’s biggest mistake was the coupling
of a record peacetime buildup of the military wTith a record peacetime
tax cut, thus generating alltime record deficits and a chokingly tight
Federal Reserve policy.
This grim job outlook will be paralleled by further declines in out­
put, operating rates and profits. Average operating rates in manu­
facturing wTiii drop to only two-thirds of capacity. Profits will suffer
further declines in the first part of 1983.
TRADEOFF BETWEEN UNEMPLOYMENT AND INFLATION STILL EXISTS

The miserable state of the economy has its counterpart in a brighter
outlook for inflation. The tradeoff between unemployment and infla­
tion still lives. Economic policies that have generated what will soon
be 4 years of no growth— nothing like it has been since the Great
Depression of the 1930’s— have also ground down the rate of inflation.
No wonder. Even if we assume that our capacity to produce, our GNP
potential, has been growing at only a bit over 2 percent per year—
and many would put it at 2 y2 percent to 3 percent— actual output is
running between $250 and $300 billion a year below our potential. This
huge overhang of excess labor and plant capacity— together with the
competitive pressure of falling import prices—has forced moderation
in both wage and price behavior.
Add to this the impact of large crops on food prices, the impact of
worldwide economic weakness on energy prices, the impact of deregu­
lation on transportation prices and wages, and the impact of Federal
Reserve policy on housing prices and now on mortgage rates— may
I note, I don’t find any of those major forces attributable to the one
who is claiming credit for them— and it is not surprising that the
overall picture is one of continued quiet on the inflation front.
What about monetary policy? The Federal Reserve’s monetarist
strategy, as has already been emphasized by our fellow members on
this panel, for the past 3 years has kept real interest rates extraor­
dinarily high at every stage of the cycle. This has not only pushed
us into the present recession but could well prolong it. What we need
now is more than just the letup in monetary stringency that comes
naturally from a listless and financially fragile economy. We need
an active pursuit of lower rates before things get worse.
True, we have had a welcome drop in rates since midyear, but the
long-term rates, and particularly the mortgage rates, have softened
very little.
The sense of relief these lower rates bring is offset by the appre­
hension that they are too little and too late to avoid a further soften­
ing of the economy. By any test of past experience, monetary policy
is still far too restrictive for this stage of the business cycle. A simple
comparison of real interest rates— market rates minus the inflation
rates— drives this home:
In the early years of previous post-war recoveries, real interest rates
averaged between iy 2 and 2 percent.
Today, with inflation running at about 5 percent and interest rates
in the private sector running from 10 to 14 percent and more, real rates




27

are three to four times as high as in the typical post-war recovery. So
in a sense, as far as easing money is concerned, we have only just begun
to fight.
With present money-supply targets and the huge Federal deficits
facing us, the prospects for sharp cuts in real rates are poor.
Both theory and experience teach that aggressive action by the Fed
in an economy with huge unemployment and excess capacity can
bring real rates down without reigniting inflation. Such a policy,
without abandoning the commitment to stem inflation, would at long
last remove the major risk of a further economic decline and a string
of financial failures.
Fiscal policy faces an uncomfortable dilemma of timing in 1983.
On one hand, further budget trimming and tax boosts are clearly
needed to put the budget on a steady course toward balance or sur­
plus at high employment, that is, to eliminate the present “structural”
deficit that would run to about $75 billion at high employment by
1985.
On the other hand, as the foregoing review of economic prospects
has shown, an economy that continues to sputter and operates nearly
$300 billion below its potential well into 1983 can ill afford a sharp
restriction in fiscal stimulus. The objective is gradually to take the
foot off the fiscal gas as the economy expands, not to slam on the
fiscal brakes at the first sign of recovery. The best policy mix would
be a decisive easing of monetary policy coupled with fiscal steps to
reduce the out-year deficits.
The balance of risks clearly favors policies to fight recession and
support expansion. Even the White House forecasts project only a
weak recovery and stubbornly high unemployment. Meanwhile, real
progress has been made in bringing inflation to bay. So the case for
shifting policy, especially Federal Reserve policy, to an expansionary
stance now seems airtight.
The big question of the day is, has the Federal Reserve made this
shift in the process of moving out from under M l toward a separa­
tion— not yet a divorce— from its 3-year marriage to monetarism? 1
read the evidence much as the stock and bond markets have: The Fed
has moved from its monetarist preoccupation with inflation toward a
concern over fragile financial markets, intolerable unemployment, de­
layed recovery, and, just possibly, some effective prodding from Con­
gress. This is good news not just for the financial community but
fo r the TT.S. economy in 1983.
[The bank letter referred to by Mr, Heller follows:]




28

FOR RELEASE WEDNESDAY A.M.’S, OCTOBER 13,1982

NATIONAL CITY
BANK
OF MINNEAPOLIS

0ctober 13 1982

U.S. EC O N O M IC POLICY A N D O U TLO O K
by
W a l t e r W . H eller a n d G eorge

L. P e r r y

For 3 xk years the A m erican e con om y has been kept under wraps. O utput to d a y is low er than in
early 1979, a perform an ce that has added 5 m illion to the ranks o f the un em ployed and brought factory
operating rates to their post-w ar low. It is hard to see the forces that will pull us out o f this dismal swamp
and push ou tp u t above the e a r ly -1979 levels before 1983. This is by all od d s our w orst econ om ic expe­
rience since W orld W ar II. W e have traded double-digit inflation for doub le-digit unem ploym ent.
W e com e to this bleak appraisal reluctantly. T he recession we projected in this letter a year ago has
already been deep and costly. B u t the second-half recovery we foresaw is sim ply n o t m aterializing. P o li­
cies that kept real interest rates at record levels in the teeth of a sustained recession have overwhelm ed
the stim ulus of tax cuts, defense boosts, and lower inflation. T h e net im pact is still u nfoldin g in econom ic
w eakness in sector after sector o f the U .S. econom y. Before turning to those sectoral prospects, we exam ­
ine the m ajor source o f that w eakness: m onetary policy.

M O N E T A R Y PO LIC Y
T h e Federal R eserve’s tight m onetarist strategy of the past 3 years has kept real interest rates extra­
ordinarily high at every stage o f the cycle. This has not only pushed us into the present recession but
cou ld well p rolong it. W h at we need now is m ore than just the letup in m on etary stringen cy that com es
naturally from a listless and financially fragile econom y. W e need an active pursuit o f lower rates before
things get worse.
T rue, we have had a w elcom e drop in rates since m id-year. T reasury bill rates are dow n 5 to 6
points, com m ercial paper rates are off by 4 to 5 points, and the prime rate has fallen 3M> points. T h e
stickier interest rates on long-term bonds have fallen 2 points and m ortgage rates abou t 1 point since
m id-year.
T h e sense of relief these low er rates bring is offset by the apprehension that they are too little and
too late to avoid a further soften ing o f the econom y. B y any test o f past experience, m onetary policy is
still far too restrictive for this stage o f the business cycle. A simple com parison o f real interest rates m arket rates m inus the inflation rate
drives this hom e:
In the early years o f previous post-w ar recoveries, real interest rates have averaged between
1 Vi% and 2%.
T o d a y , with inflation running at about 5% and interest rates in the private sector running from
10% to 14% and m ore, real rates are 3 to 4 times as high as in the typical post-w ar recovery.
G iven present m on ey-su p p ly targets and the huge federal deficits facing us, the prospects for
sharp cuts in real rates are poor.
B oth th eory and experience teach that aggressive action by the Fed in an econ om y with huge unem ­
p loym en t and excess capacity can bring real rates down w ithout reigniting inflation. Such a policy,
w ith ou t abandoning the com m itm en t to stem inflation, w ould at long last rem ove the m ajor risk o f a
further econ om ic decline and a string of financial failures.
T h e stock m arket has clearly been anticipating the further letup in Fed p olicy that w ould clear the
track for econ om ic recovery. B u t this is still in the realm o f tom orrow ’s hope. Our p rojection s are based
on to d a y ’s reality o f repressively high real interest rates.

D E LA Y E D R E C O VE R Y
B y rights, we should be in a cyclical recovery. Consum ers have e n jo y e d a sizable tax cut, defense
spending is on the m ove, inventories have been cut, inflation is down, interest rates have softened, and
the upsw eep in stock and b o n d prices has added $250 billion to p eople’s assets.
B ut these econ om ic pluses have been no m atch for the continued sources o f weakness. Consum ers
are cow ed b y d ou b le-d igit u n em ploym en t and growing layoffs. M anufacturers and distributors are still
cutting inventories. S tate-local governm ents are retrenching. High m ortgage costs con tin u e to burden
housing. A u to prod u ction schedules for the current quarter have been cut significantly. Business capital
spending is reeling under the im p act o f weak m arkets and low -capacity utilization. A n d the com bin ation
o f our strong dollar and w eak econom ies abroad is sharply cutting net exports.




29

Barring unforeseen strength in consum er purchases or a sharp turn in Federal Reserve p olicy, we
now expect recovery to be delayed until 1983. T h is will keep the official unem ploym ent rate above 10%
for m onths to com e and will bring the com prehensive unem ploym ent rate, em bracing both part-tim e and
discouraged w orkers, to 15% or m ore.
T h is grim jo b o u tlook will be paralleled b y further declines in ou tpu t, operating rates, and profits.
A verage operating rates in m anufacturin g will drop to only tw o-thirds o f capacity. Profits, after declin­
ing 27% this year, will suffer further declines in the first part o f 1983.
Signs of strength are hard to find as one looks across the individual sectors of the econ om y:
Consumer spending has not responded to the m id-year tax cut. One can hope that a delayed reac­
tion to the tax cut, com bin ed w ith low er consum er debt and the spectacular rally in security values,
w ould still bring a recovery in con su m er spending. B ut the worsening jo b m arket and stubbornly high
borrow ing costs have underm ined consum er confidence and discouraged spending.
Housing starts recovered to an annual rate o f a little over 1 m illion units during the summer. But
until m ortgage interest rates fall considerably further, the gains in hom e building will be very m odest.
One of the im ponderables in the housing ou tlo o k is the im pact o f new legislation perm itting savings
institutions to com pete w ith m oney m arket funds. The new law, cou pled w ith the redeploym ent o f funds
from m aturing A ll Savers’ C ertificates, is expected to increase the flow of funds into the m ortgage market.
If the m ore optim istic expectations o f participan ts in residential financing are realized, a m ore vigorous
housing revival m ay be in the cards.
M ost discouraging is the snow balling weakness in business investment. Each survey o f business
investm ent intentions has been w orse than the last. New orders for business capital equipm ent declined
nearly 20% during the past year, and orders are still declining as sales and operating rates contin ue to
fall short o f expectations. C apital g oods produ ction is still falling at a 15% annual rate. W eakness in nonresidential building will becom e progressively worse in 1983 as present projects are com pleted and
vacancies in com m ercial and office buildings discourage new construction.
T h e net export balance, after holding up rem arkably well during the first half o f this year ■partly
because recession reduced the dem and for im ports •- declined sharply in the summer. T h e strong dollar
m akes U.S. goods less com petitive and at the sam e tim e m akes im ported goods less expensive. W eakness
in foreign econom ies will further cut into U .S. export dem and. In particular, the financial crisis afflicting
the Latin A m erican econom ies will cut exports to this region. D uring the past four quarters, our m er­
chandise trade balance w ith this region declined by $6 billion. It will decline substantially further in
com ing quarters as the Latin Am erican nations are forced to lim it their im ports in order to m eet the
interest burden on their foreign debts.
T h e overdue inventory turnaround •from liqu idation to accum ulation - •is not yet in sight. W ith
orders, output, backlogs, and retail sales all falling well below ex pectations, business still finds itself
with m ore inventories than it needs. T h e rate at w hich inventories were liqu idated dropped from $36 bil­
lion in the first quarter to $16 billion in the second and still further in the third. This slow dow n has two
significant consequences:
First, when businesses rely less on draw ing dow n inventories to supply their custom ers, output
grows even in the face o f a drop in final sales. W hen businesses cut back their rate o f inventory
sell-off by $20 billion from the first to the second quarter, that translated into an autom atic plus
of $20 billion in the quarter-to-qu a rter change in G N P . T h is was the m ajor factor in the posting
o f a 2.1% real G N P gain in the second quarter. A similar slowing o f inventory liquidation also
plays a m ajor role in the C om m erce “ flash rep ort” of a 1.5% real grow th rate in the third quarter
(w hich we believe will con vert into a m inus when the final num bers are in ).
S econd, it m eans that businesses still have to w ork off unw anted inventories, thereby serving as a
drag on ou tp u t in the current quarter.
In ventory behavior is notoriou sly difficult to predict. If consum ers snap ou t o f their lethargy and
the Fed aggressively eases credit, businesses will raise their target inventory levels thus requiring added
ou tput to satisfy their custom ers.

IN F L A T IO N
T h e m iserable state o f the e co n o m y has its counterpart in a brighter ou tlook for inflation. The
tradeoff betw een u nem ploym ent and inflation still lives. E con om ic policies that have generated what
will soon be 4 years o f n o-grow th - - noth in g like it has been seen since the G reat D epression o f the 1930s
■ have also ground dow n the rate o f inflation. N o wonder. Even if we assum e that our capacity to pro­
duce, our G N P potential, has been grow ing at on ly a bit over 2% per year • ■and m any w ould put it at
2tyj% to 3% ■- actual ou tp u t is running betw een $250 and $300 billion a year below our potential. This
huge overhang of excess labor and plant capacity - - together w ith the com petitive pressure o f falling
im port prices - - has forced m oderation in b oth w age and price behavior.
A d d to this the im pact o f large crops on fo o d prices, the im pact o f w orldw ide econ om ic weakness
on energy prices, the im pact o f deregulation on transportation prices and wages, and the im pact o f Fed­

17-8 71 0




83

3

30

eral R eserve p olicy on housing prices and now on m ortgage rates, and it is not surprising that the overall
picture is one o f contin ued qu iet on the inflation front.
Th e im provem en t shows up b o th in actual and in underlying rates o f inflation. D uring the first 8
m onths o f this year, average hourly earnings have been rising at a 6 ^ % rate, the underlying rate o f infla­
tion in the C P I has dropped to 6%, and increases in the actual C P I have averaged 5.4%. C om pa red w ith
the previous 12 m onths, these represent slow dow ns o f IV2 , 2 % and 3 ^ percentage points, respectively.
A n d inflation is still heading dow nward.
T h e critical question is w hether the m oderation in price and wage behavior will survive recovery.
Rising dem and, b y definition, increases pressures for price increases. In the early stages o f recovery,
the hunger for increased p rofit m argins can be satisfied from a drop in unit costs as m ore g oods and
services are produ ced w ith the existing capital equipm ent and labor force. B u t what abou t later o n ?
M uch depends on w hether consum ers and w orkers recognize the full extent o f the redu ction in infla­
tion to date and adju st their expectations o f inflation dow nward. Survey after survey show s consum ers
still believing that inflation is significantly higher than it really is. A n d the com bin ation o f bulging fe d ­
eral deficits, painful past experience, and a certain cynicism has in du ced pessimism ab o u t the future
course o f inflation. N evertheless, a num ber o f factors suggest a sustained period o f relief from a new
round o f inflation:
W orkers no longer have to play catch -u p w ith the cost o f living.
M an y o f the industries w ith the strongest unions - - fo r exam ple, autos and steel - ■are su b je ct to
foreign com petition and other structural pressures that are likely to bring wage and price increases
in those industries to m ore m oderate levels.
E xcess cap acity and u n em ploym ent throu gh ou t the industrial w orld suggest a substantial cush­
ion against renew ed inflation as well as a m u ted rise in raw m aterials prices.
W ith an oil glut abroad and a natural gas glut at hom e, energy prices are likely to be better
behaved than had been anticipated.

T H E FIS C A L P O L IC Y D IL E M M A
Fiscal p olicy faces an uncom fortab le dilem m a of tim ing in 1983. O n one hand, further b u d get trim ­
ming and tax boosts are clearly needed to put the budget on a steady course tow ard balance or surplus
at high em ploym ent, that is, to elim inate the present “ structu ral” deficit that w ould run to a b o u t $75
billion at high em ploym ent b y 1985. (W e use 5.6% unem ploym ent as the definition o f high em ploym ent,
rather than the Congressional B u d g et Office’s 5.1%. If Secretary R e g a n ’s 6% to 6M>% range were accepted
as the definition, the 1985 high-em ploym ent deficit w ould run over $100 billion.)
On the other hand, as the foregoing review o f econ om ic prospects has shown, an e con om y th at c o n ­
tinues to sputter and operates nearly $300 billion below its potential well into 1983 can ill afford a sharp
restriction in fiscal stim ulus. T h e o b je ctiv e is gradually to take the fo o t off the fiscal gas as the e co n o m y
expands, n ot to slam on the fiscal brakes at the first sign o f recovery. T h e best policy m ix w ould be a
decisive easing o f m onetary p olicy cou pled w ith fiscal steps to reduce the out-year deficits.
U nder the leadership o f Senators D ole and D om en ici, the C ongress and W hite H ouse com prom ised
on a substantial tightening o f bud get p olicy last sum m er. T h ese changes will b o o st revenues $40 billion
b y 1985, thus offsettin g one-fifth o f the 1981 tax cut. T h e y will cu t p ro je cte d spending b y a g o o d deal
m ore. Even though the total advertised spending cuts o f $130 billion for 1985 — including such q u estion ­
able item s as $16 billion o f unspecified “ m anagem ent savings” and $56 billion o f savings from low er
interest paym ents - ■appear exaggerated, the com prom ise was significant. It will bring abou t a substan­
tial reduction in the 1984-85 deficits. E q u a lly im p ortan t, it represents a significant retreat b y P resident
R eagan from his previous adam ant o pposition to tax increases and m od est cuts in the defense buildup.
A s m odified b y Congress, real defense purchases are now scheduled to rise ju st under 6% this year, abou t
6 ^ % next year, an d 7% in 1984.
W ith these changes factored in, w hat are the near-term prospects for the budget deficit?
F or fiscal 1982, ju st ended, the bu d get d eficit will turn ou t to be slightly above the $105 billion we
p ro je cte d in this letter last February.
F or fiscal 1983, C B O p ro je cts the deficit at $155 billion, or $51 billion m ore than C on gress had
estim ated. Part o f the C B O adju stm en t com es from a m ore realistic assessm ent o f lik ely e xpen d­
iture savings from the recent bu d get com prom ise. A b o u t half o f the difference com es from less
optim istic assum ptions abou t the path o f the e co n o m y and interest rates.
G iven our even m ore pessim istic e con om ic assum ptions than those o f C B O , we e xp e ct the 1983
deficit to be over $175 billion.
T o gain m ore perspective on the fiscal p o licy dilem m a and the bud get-tightenin g m oves th at Presi­
dent R eagan w ill u n d ou bted ly recom m end in his bu d g e t m essage early next year, we should sort o u t




31

how m uch o f the deficit is a p ro d u ct o f econ om ic weakness, how m uch o f it w ould persist at high
em ploym ent, and w hat year-to-y ear changes are taking place.
T h e bulk of the fiscal 1983 deficit is a child of the recession. If the e con om y were hum m ing along
at high em ploym en t, the deficit w ould be running, not at $175 billion, but at $40 billion, or 1%
of G N P ,
If high em ploym en t were defined as 6.5% unem ploym ent rather than the 5.6% we use, the 1983
high-em ploym ent deficit w ould be about $65 billion. It is w orth noting, however, that the partic­
ular definition of high em ploym en t is not of great significance for m easuring the im pact of fiscal
policy. It is the swing tow ard higher or low er deficits rather than the level of those deficits that
measures the degree of fiscal stim ulus or fiscal restriction.
T h e swing tow ard deficits now p rojected for fiscal 1984 and 1985 after adjustm ent for the recent
budget com prom ise is no longer very dram atic. T h e high-em ploym ent deficit m oves up from 1% of
G N P this year to 1.7% in those years.
H ow does this swing com pare w ith other m ajor swings tow ard high-em ploym ent budget deficits in
the past 20 years?
T h e first swing occu rred w ith the buildup in Vietnam W ar spending under President Johnson.
From a high -em ploy m en t surplus averaging 0.7% o f G N P in 1962-64, the budget m oved into a
high-em ploym ent deficit o f 1.7% in 1967-68, a swing o f 2.4 percentage points. T h is stim ulated an
econ om y already at full em ploym en t and is a w ell-docum ented exam ple o f perverse and inflation­
ary fiscal policy.
T h e next big swing, under President N ixon, was from a 0.1% surplus in 1969-70 to a 0.9^ deficit
in 1971-72, a shift that helped pull the e con om y back to full em ploym en t from a m ild recession.
T h e third swing, under P resident Ford, was a shift from a 0.6^ high-em ploym ent deficit in 197374 to a 1.3^ deficit in 1975-76. Again, this was a response to the steep recession that follow ed
the first O P E C oil price explosion , a response that helped initiate recovery. It was a m ove in the
right direction and was follow ed by a return to virtual high-em ploym ent balance in the budget
under President Carter in fiscal 1979.
T h e swing we now p ro je ct is no greater than those in the early and m id-seventies. It is scheduled to
occu r in an econ om y characterized by huge excess capacity and unem ploym ent. W hile hew ing to the
goal of elim inating the high-em ploym ent deficit in the longer run, the W hite H ouse and Congress should
take care not to do to o m uch to o soon. A s im plied earlier, we do not w ant to slam on the brakes just
when the econ om y is beginning to m ove again.

C O N C L U S IO N
As our reappraisal o f e con om ic prospects m akes clear, we believe that the odds on an econom ic
recovery starting in the secon d half o f this year have dropped considerably and that the od d s on reces­
sion contin uin g into 1983 have corresp ondingly risen. T o som e extent, we are in uncharted waters, for
the com bin ation of a deep slum p and high real interest rates has no preceden t since the start o f the
G reat D epression of the 1930s (w hen prices de clin e d ). All in all, then, there is considerable uncertainty
and unease surrounding to d a y ’s e con om ic ou tlook.
But even if our best estim ates prove to o pessim istic, the balance o f risks clearly
fight recession and su pport expansion. E ven the rosy forecasts by the W hite H ouse and
only a weak recovery and stu bborn ly high unem ploym ent. A n d real progress has been
inflation to heel. So the case for shifting p olicy, especially Federal Reserve p olicy, to
stance now seems airtight.

favors policies to
Treasury p ro je ct
m ade in bringing
an expansionary

A s this is w ritten, the indications are that the Fed has decided not to constrain the m on ey supply
during the current period o f churning am ong various m oney m arket instrum ents. T h is cou ld be ju st a
short-term adjustm ent. B u t a num ber of observers believe that it m ay signify that the Fed is backing
aw ay from its exclusive em phasis on the m onetary aggregates and shifting to a m ore accom m od ative
posture. If this were to bring interest rates dow n substantially from current levels, we w ould p ro je ct a
considerably less bleak o u tlo o k for the U .S. econom y.




32

Representative R euss. Thank you , Mr. Heller.
Mr. Marshall.

STATEMENT OP BAY MARSHALL, PROFESSOR OF ECONOMICS AND
PUBLIC AFFAIRS, UNIVERSITY OF TEXAS, AUSTIN
Mr. M a r s h a ll. Thank you, Mr. Chairman, Congressman Hawkins.
I have a prepared statement which I have submitted for the record
but will not read it. Therefore, I would like to summarize it, a task
which is made much easier by my colleagues, who have done an ex­
cellent job of outlining a position that I agree with.
I think it is very clear that there is no easy solution to the problem
of unemployment and other problems that face our economy. But ex­
perience suggests much better approaches than the combination of
monetarism and supply-side economics, commonly known as Reagan­
omics, which clearly has failed and is not likely to work.
DEFECTS IN REAGANOMICS OUTLINED

The main defects in Reaganomics are, in my judgment, three:
First, it’s based on unrealistic assumptions, lacking credible support
in both economic theory and the experiences of industrial economies.
Second, it’s very inefficient, relying on the theory that tax breaks
for the wealthy and large corporations will “trickle down” to ordinary
working people and the poor.
Third, it is extremely regressive in its impact on our society, redis­
tributing wealth and power from the middle class and the poor to the
rich and shifting more of the tax burden away from business and
high-income groups and onto low- and middle-income consumers.
The economic consequences of the administration’s policies are
fairly clear.
The incapability of its monetarist policies and its supply-side
policies have kept real interest rates very high and led us into the
present “repression.” It’s not a recession because, as my colleagues
have emphasized, it didn’t just happen, it was caused by the policies
of this administration. They halted the recovery that was underway
in July 1981, leading to the present very difficult economic
circumstances.
Contrary to President Reagan, unemployment was declining when
he entered the White House, from 7.8 percent in July 1980 to 7.3
percent in December. It averaged 6.7 percent between 1977 and 1980,
and has averaged 8.5 percent since that time.
The unemployment rate of 10.1 percent is only part of the problem.
Altogether, there are about 19.5 million wTorkers who are either dis­
couraged, unemployed, or who are working part time when they would
like to be working "full time.
In addition, bankruptcies have quadrupled because many businesses
cannot pay the real interest rates that we presently have.
And I think it’s important to emphasize, as Walter Heller has done,
that the real interest rates have not come down, that the CPI has
declined much more than the nominal rates of interest and they remain
far too high, and that this has caused trouble not only for the United
States but for the entire world economy. In fact, the international
economic situation, it seems to me, is one that we should be very, very




33

concerned about. And part of that problem is caused directly by high
interest rates in the United States.
Reduced expenditures for government infrastructure, nonmilitary
research and development, information, and human resource develop­
ment clearly will weaken our economy. The rate of inflation has mod­
erated considerably, mainly because of the recession and smaller in­
creases in energy, food, and import prices because of an overvalued
dollar.
Now, as my colleagues have emphasized, to criticize these policies is
like shooting fish in a barrel. They clearly wTill not work; history has
demonstrated that. There is no support for the policies, either in logic
or in experience.
ALTERNATIVE TO REAGANOMICS PROPOSED

The need, therefore, for a coherent, effective alternative to the fail­
ures of Reaganomics is urgent. A cogent alternative must realistically
address the specific problems facing our economy: unemployment; in­
flation; high interest rates; low productivity growth; and now, the
need for a rapid recovery from a deep economic recession. It must be
fully comprehensive and internally coordinated, not just a string of
band-aids and not a collection of contradictions, such as massive tax
cuts to spur investment and high interest rates that choke off
investment.
The preeminent objective of economic policies should be full em­
ployment. But first, in achieving this objective, we must recognize
that general or macroeconomic policies, while the most powerful in­
struments of economic policy, cannot do the job alone. Well-honed
macro policies must be matched by specific measures targeted to spe­
cific sectors and problems in our economy.
General credit, tax, and spending policies must be complemented
in a major way by policies targeted to specific sectors.
Second, the solutions to economic problems should be built on a
sensible division of labor between government, the market, and mech­
anisms that promote cooperative problem solving. And I would give
heavy weight to the latter, because I think it’s one of the main disad­
vantages the United States faces relative to other countries. And one
of the reasons that our economic policies lack coordination and con­
tinuity is that we have no such mechanisms.
While the market can be a marvel of promoting short-run efficiency,
it cannot solve larger problems. It cannot prevent recession, inflation,
or create open end fair trade and competition. Markets, by them­
selves, cannot protect the environment, secure the health and safety
of workers, eliminate discrimination, promote equal opportunities and
adequate income for our people, foster our long-run basic research and
innovation, and insure the national security.
Indeed, without government intervention to preserve competitive
conditions, markets would be less effective than they are.
While we must rely primarily on market forces, there can be little
doubt about the need for positive government partnership with the
private sector in addressing important national problems. There is
an important range of problems, particularly in fighting inflation and
strengthening the international competitiveness of American indus­




34
try, that will not yield to the uncoordinated actions of either the pub­
lic or private sector alone. Public and private partnership must be
forged, establishing a new institution of governance.
Third, a coordinated macropolicy, complemented by targeted sec­
toral policies developed on a cooperative basis, must be matched with
strong policies directed toward our most pressing problems, fighting
inflation, rebuilding our productive industrial base and, particularly
after the recession of 1981-82, reducing unemployment.
The absence of specific anti-inflation policies in the Reagan program
has left the entire burden of fighting inflation to monetary policy, with
disastrous results of record real interest rates producing near depres­
sion conditions. Expanding supply and reducing costs in concentrated
inflationary sectors can do a much more efficient job in lowering in­
flation, as can developing a consensus among industry, labor, and
government on the appropriate interplay between prices, incomes, and
economic policy.
Rebuilding our productive industrial base can make America’s in­
dustries more competitive and its jobs more secure, while reducing
inflationary pressures for the long run. And fighting the effects of
recession through reducing unemployment can help us move more
rapidly toward a healthy, stable economy.
Full employment means full utilization of our material resources,
such as industrial plant and equipment, and the full employment of
our human resources, a meaningful job for every person able to work.
I f done properly, this would do more than anything else to improve
productivity and reduce inflationary pressures.
The policy mix should be heavily toward direct measures to reduce
unemployment and selective policies in areas such as energy and trans­
portation. Targeted investment and job creation on population groups,
geographic areas and industrial sectors that are underutilized or where
shortages now exist, or could exist, is good employment policy, good
anti-inflation policy, and good social policy. Providing job skills and
opportunities for all groups and regions is the single most important
step that can be taken to improve education, combat crime, and enhance
the standing of and opportunity for all of our citizens.
It’s fashionable these days to argue that Federal employment and
training programs have failed and cannot be effective instruments of
national policy. Critics point out correctly that private sector employ­
ment and training is the best option for unemployment, but this option
is not always available— especially when unemployment is over 10
percent— so, public employment and training is better than
unemployment.
This negative assumption about selective programs continues to in­
fluence policy, despite numerous detailed, sophisticated evaluations to
demonstrate that these programs were good public investments, despite
incredible funding instability of these programs because of constant
chancres in laws and regulations and conflicting congressional
mandates.
In order to overcome funding problems, new Federal employment
and training programs must have greater funding stability— either
through earmarking Federal funds, as is proposed by the MoynihanMathias national conservation bill to put young people to work in




35
conservation projects, or forward funding of these programs in order
to give them more stability.
In working out our monetary fiscal policy, we must, clearly, have
much better coordination then we have had before. Because money is
difficult to define and more difficult to control and because high and
volatile interest rates, leading to recession, are the most likely result
of restricting the growth of money supply, the focus of overall eco­
nomic policy should not be on an input of policy; namely, money,
but on the outcome of policy; namely, the gross national product.
After all, money is merely a means to an end, real output.
Concentrating on GNP and employment will focus greater attention
on the real ends of economic policy and require greater coordination
to achieve those ends, because that is an objective that cannot be
achieved by one economic agent, like the Federal Reserve, alone.
The most important immediate macro policy objective should be
to reduce real interest rates. Indeed, the favorable output for nearterm inflation and oil prices creates an excellent environment for the
reduction of overall interest rates, an opportunity that will be missed
by the Reagan economic program.
One inadequately appreciated benefit of such a policy is that it
would allow interest rates to be lowered in other countries as well.
The primary goal in monetary policy should be interest rates that are
stable and just a little bit above the rate of inflation. High interest
rates discourage capital investment. Lower, more stable rates would
be the most effective and equitable means to stimulate investment and
also reduce inflation by cutting the costs of borrowing.
Further, the large and unproductive expenditures required to pay
interest on the huge Federal debt— now over $100 billion— would be
significantly reduced.
A major defect of monetarism, as well as other policies that would
rely on fixed formulas to control economic activities is their focus
on means; that is, money or budget deficits— which destabilize out­
comes— gross national product, employment, and investment. It would
be much better to focus on outcomes.
The Congress, in cooperation with the Federal Reserve and the
White House, and in consultation with such private sector groups as
labor and management, should select compatible employment, growth
and price targets and coordinate monetary and fiscal policies to achieve
those objectives.
As the creature of the Congress, the Federal Reserve should not
pursue a completely independent course and force the Congress to
adjust economic policy goals to fit that course regardless of the out­
come.
Indeed, the Humphrey-Hawkins Act requires the Federal Reserve
Board to report on how its policies will respond to the goals set by
Congress.
As I recall, when we were fighting to pass that bill, we felt one of
the important outcomes would be to have more coordination. But
there’s very little evidence of it.
Some might object that increasing the money supply would fuel
inflationary expectations and therefore increase, rather than lower,
interest rates. But I do not accept that analysis. Increasing monetary
growth probably would increase inflationary expectations in the long




36

run, but a one-time increase in money growth would increase infla­
tionary expectations only slightly, if at all, especially when combined
with coordinated monetary and fiscal policies to stabilize interest
rates, prices, economic growth, and employment.
As Don Nichols testified before this committee in June, an increase
in the money supply probably would increase prices less than the
increase in the money supply, causing an increase in the real money
supply and probably would cause a substantial lowering of interest
rates. You recall his estimate was perhaps a 3-percentage-point reduc­
tion for a 1-percent increase in monetary targets.
The American economy's economic performance has worsened con­
siderably since the 1950’s and 196Cfs, when policymakers concentrated
on outcomes rather than budgets and the money supply. The present
high interest rates are not because of inflationary expectations, but
because of restrictive monetary policies in the fact of huge budget
deficits. Inflationary expectations are about 6 percent according to a
poll taken by the New York Stock Exchange.
I also applaud the recent action by the Federal Reserve, if it’s really
a change in course, to increase the money supply in order to try to
bring tne real rates of interest down. I do not, however, think this
course is adequate, because it is not the consequence of a coordinated
policy with the Congress and the White House on overall economic
objectives.
Adjustments in this overall objective of monetary policy will be
required as economic circumstances change.
NEED FOR MORE AUTOMATIC STABILIZERS

In order to enhance the flexibility of fiscal policy, several major
changes should be adopted. I believe one of the most important ones is
to adopt more automatic stabilizers because, as you well know, it takes
a long time to get action by the Congress, and timing is terribly im­
portant. Forecasting is a very difficult problem.
I think we should have done a lot more to have automatic stabilizers
and to have cyclically responsive employment and training programs.
I think that’s very important. I spell out some of the things that need
to be done in my prepared statement, so I won’t go into it.

Second, fiscal policy should be restructured to reduce or eliminate
tax preferences that serve as incentives for speculation or unproduc­
tive investment. Likewise, expenditure programs should provide
strong incentives for people to move from dependency to self-support.
Retraining disadvantaged workers or those dislocated by permanent
layoffs with skills needed by industry are examples of proper program
design. By simply cutting programs or reducing benefits for the work­
ing poor and, most important, providing a 95-percent tax on the earn­
ings of welfare recipients, the Reagan program creates strong dis­
incentives to either work or adjust to new economic situations.
Now, with respect to fighting inflation, I think the same kind of
approach is needed. We need comprehensive macropolicy, but we also
need to target on those sectors that cause the greatest trouble. I be­
lieve we also need to develop an equitable wage-price policy developed
on a cooperative basis and a fair sharing of those sacrifices needed to




37
bring inflation under control and to keep it under control if we do
pursue a full employment policy.
Fourth, we need a policy to insulate the American economy as much
as possible from external financial, energy, and food price shocks. This
administration has no policy to deal with those problems, and those
were very important causes of recent inflation and they could very
well occur again, especially in the food area.
As a final sectoral concern, the acceleration of military spending
proposed by the Reagan administration and endorsed by the Congress
must be examined as an independent source of inflationary pressure.
A third element of our comprehensive anti-inflation policy is a
mechanism for agreement among Government, labor, and industry
at the highest levels on wage, price, and income growth rates that are
consistent with steadily reducing overall inflation levels.
For such a consensus-based policy to work, all of the key players
must take part directly; and all forms of income must be on the table,
not just wages and prices, but rents, dividends, and interest as well.
The Government’s role in such a system goes beyond enforcement to
upholding its end of the bargain— fair and effective economic policy
consistent with economic growth and reduced inflation.
Finally, I believe we need to develop an industrial policy to rebuild
American industry.
CREATE NATIONAL ECONOMIC POLICY BOARD FOR COORDINATING POLICIES

The essence of a sound economic policy in the future will be to
integrate the wide variety of public and private sector decisions that
bear on the Nation’s capacity to achieve full employment, economic
growth, and stable prices. A means must be created to establish and
discuss realistic long-term goals, review private sector responses to
public sector stabilization policies, resolve conflicting objectives and
construct the proper mix of general and selective policies. To be effec­
tive, such discussions must involve all the major concerned parties—
industry, labor, and the Government.
W e’ve had considerable experience with the tripartite mechanisms,
and they have been successful. I don’t know why we don’t try to build
on the experiences that weVe had in this country and other countries.
Since the existing formal and informal institutions are not sufficient,
however, a National Economic Policy Board should be created. The
members of the Board would include labor, business, Government, and
independent experts. The Federal Reserve Board also should plan an
active role in any such activity. First, the NEP board should provide
a means through which discussions would be held regularly on eco­
nomic performance and forecast, stabilization policies and the reaction
of private sector institutions.
In addition, it would be a major mechanism for providing continu­
ity of economic policy, particularly as administrations change.
Second, the board would provide the right framework for working
out an incomes policy needed in the fight against inflation. It is not at
all clear that a wage-price policy can be made to work. There are
enormous difficulties, but I am convinced that the only time that can
work is when there is broad consensus among major economic factors,
and we need some mechanism to do that. The NEPB could also be




38

the vehicle for framing a coherent industrial policy. The United States
already has an industrial policy, but it is not coherent. It is not the
result of clear and systematic thinking. Trade policy, taxes, regulation,
energy, and even interest rates have a significant impact on the struc­
ture of the economy and the opportunities or lack of them for indus­
tries and firms.
In order to resolve structural problems, anticipate future needs,
and integrate sectoral policies with stabilization policies, it is time to
coordinate these decisions, and at the least, understand their conse­
quences.
One of America’s major disadvantages relative to countries like
Germany and Japan is its failure to develop systematic industrial
policies. In fact, foreign export driven industrial policies, in the ab­
sence of a more systematic U.S. industrial policy, have undermined
the future of American industry in sectors ranging from steel and
machine tools to semiconductors and fiber optics. The core of Ameri­
can industry will not long survive such unequal competition.
INDUSTRIAL POLICY GOAL OF MAXIMIZING ECONOMY-WIDE GROWTH
POTENTIAL AND COMPETITIVENESS

I also agree with Professor Galbraith that we need to have a lender
of last resort. Industrial Development Bank, I think, would be an
important part of this overall policy.
Let me emphasize that the concept of industrial policy does not
imply picking the winners or picking the losers among industries or
regions. I believe that that is purely a hypothetical argument that
people raise against such policy. To the contrary, our goal should be
to maximize the growth potential and competitiveness of every part
of our economy. This means providing needed stimulus to basic in­
dustries like steel and autos and high-growth, high technology indus­
tries, such as large-scale semiconductors, where aggressive foreign
industrial policies threaten to wipe out the lead the United States es­
tablished in the 1970’s.
Two of the main arguments against an industrial policv are that
it cannot be insulated from political pressures which would cause it
to support inefficient industries, and that American Government and
society are too fragmented and adversarial to support such a policy.
I think both of these arguments are wrong. You can insulate the
mechanism from undue political pressures. In fact, the second argu­
ment that we’re too fragmented and adversarial makes the case for
such a policy, because I believe an industrial policy and a consensusbuilding mechanism could help overcome the excessive adversary re­
lationships that currently damage our economic performance.
Another important part of this is to recognize, as you, Mr. Chair­
man, and several of my colleagues have emphasized, that the public
infrastructure investment is also vital to strong productive growth.
Our bridges, ports, water systems, not to mention rail beds, tracks, and
rolling stock are in urgent need of upgrading. I invite your attention
to the work by Pat Choate and Susan Walter, who completed a sur­
vey of urgent^infrastructure investment needs totaling over $3 tril­
lion for the 1980’s and 1990’s.
Countries such as France and Japan have used public investment
in profitable high-speed rail transportation as a spur to new indus­




30

trial innovation and export, in addition to their direct beneficial
impact on improved domestic transportation.
Finally, it must be recognized that the greatest single determinant of
business investment in new productive plant and equipment is not
special tax gimmicks but rather steady growth of demand and avoid­
ance of recession.
Moving our economy toward full employment is the single most
important contribution we can make toward strengthening industry
and improving productivity growth. Thank you, Mr. Chairman.
[The prepared statement of Mr. Marshall follows:]




40

P repared St a t e m e n t of R ay M arshall

T h e re a r e no e a s y s o l u t i o n s
s u g g e s ts much b e t t e r

to

th e u n e m p lo ym e n t p r o b le m , b u t e x p e r ie n c e

a p p ro a c h e s th a n

th e c o m b in a t io n o f m o n e ta ris m

s id e e c o n o m ic s , com m only known as R e a g a n o m ic s , w h ic h c l e a r l y
not lik e ly

(1 )

to

It

w o rk .

is

and s u p p ly

has f a i l e d

and i s

The m ain d e f e c t s o f R e a g a n o m ic s a r e :

ba sed on u n r e a l i s t i c

a s s u m p tio n s ,

la c k in g

c r e d ib le

s u p p o rt

in

b o th e c o n o m ic t h e o r y and th e e x p e r ie n c e o f i n d u s t r i a l e c o n o m ie s ;

(2 )

It

is

v e ry in e f f ic ie n t ,

r e ly in g

w e a lt h y and l a r g e c o r p o r a t i o n s w i l l

on th e t h e o r y t h a t

" t r ic k le

ta x b re a k s

fo r

d ow n " t o o r d i n a r y w o r k in g

th e

p e o p le

and th e p o o r ;

(3 )

It

is

r e d is t r ib u t in g
and s h i f t i n g

e x t r e m e ly r e g r e s s i v e

in

w e a lt h and p o w e r fro m

m ore o f th e

ta x

b u rd e n

its

im p a c t on o u r s o c i e t y ,

th e m id d le c la s s
aw ay fro m

and th e p o o r t o

b u s in e s s and h ig h

th e r i c h

in co m e g ro u p s

and o n to l o w - and m id d le -in c c m e c o n s u m e rs .

The e c o n o m ic c o n s e q u e n c e s o f th e A d m i n i s t r a t i o n 's

p o lic ie s

a re

f a ir ly

c le a r

(1 )

Th e huge

ta x r a t e s

1981 t a x

f o r c o r p o r a tio n s

cut

(b a s e d

and h ig h e r

th e econom y and b a la n c e th e b u d g e t b y
t h a t m e r e ly in c r e a s e d
g o o d s and s t im u la t e d
jo b -c r e a t in g
r e la t iv e

to

s a le s ,

s p e c u la t io n

in v e s tm e n ts .

In

p e rs o n a l

s a v in g s ,

b u s in e s s

fla w e d

s t im u la t e
concept

and th e s a le o f l u x u r y
lit t le

in v e s t m e n t in

to

in c r e a s e

1982 d e c lin e d

The s a le o f l u x u r y g o o d s in c r e a s e d

an econom y on th e b a s is o f th e

in a d e q u a te t o s u s t a in

s a le o f y a c h t s , m i l l i o n - d o l l a r

W ith r i s i n g

b y th e A d m i n i s t r a t i o n ’ s r a d i c a l

r e s u lt in g

t h a t r e d u c in g m a r g in a l

inco m e g ro u p s w e re made b e t t e r o f f b y R e a g a n o m ic s , b u t we ::a n n o t

and th e b r o k e r a g e b u s in e s s .

r e s t r a in

1984) was a s e r i o u s l y

and m e r g e r s w h i l e d o in g

fa c t

1981 an e s tim a te d

b e c a u s e h ig h
s u s t a in

s to c k

on th e a s s u m p tio n

in co m e g ro u p s w o u ld g r e a t l y

e c o n o m ic p o l i c i e s ,

th e eco n o m y,

houses

u n e m p lo ym e n t and u n c e r t a i n t y c a u s e d

M o re o v e r ,

c o n s u m e r demand i s

th e h ig h r e a l

from th e A d m i n i s t r a t i o n ’ s b u d g e t d e f i c i t s

in te r e s t ra te s

and t i g h t m oney p o l i c i e s

b o th in v e s t m e n t and co n s u m e r dem and.

(2 ) The c a u s e s o f h ig h




and f l u c t u a t i n g

in te r e s t ra te s

a re

f a ir ly

c le a r

41

The t a x c u t r e d u c e d g o v e rn m e n t r e v e n u e s , c r e a t i n g a h u g e b u d g e t d e f i c i t
d e s p it e

th e $ 9 8 .6 b i l l i o n

f o llo w in g

th e l a r g e

1982 t a x

in c r e a s e .

t a x c u t th e p r e v io u s

and u n c e r t a i n t y o v e r

e c o n o m ic p o l i c y . )

g o v e r n m e n t's demand f o r m oney a t th e
B o a r d 's r e s t r i c t i v e

g r e a tly

lim it e d

fo r c e d

to

ta x

in c r e a s e ,

F e d e ra l

th e
r e ly

c o n f u s io n

in c r e a s e s th e
R e s e rv e

fu n d s a v a i l a b l e

r e d u c in g th e s u p p ly o f m oney

and i n c r e a s in g

its

c on su m er p r i c e

in d e x h a s d e c l in e d much m ore th a n n o m in a l i n t e r e s t r a t e s .

re a l

to

on th e b a n k s ( m a in ly

a u to d e a l e r s , home b u y e r s and p u r c h a s e r s o f

The c o n s e q u e n c e o f g r e a t l y
demand i s

t h is

th e p u b l i c 's

Th e b u d g e t d e f i c i t

th e g o v e rn m e n t and t h o s e b o r r o w e r s who a r e
s m a ll b u s in e s s , home b u i l d e r s ,

fa c t,

added t o

same tim e t h a t th e

m o n e ta ry p o l i c i e s

c o n su m e r d u r a b l e s ) ,

(In

ye a r,

t o c a u s e v e r y h ig h r e a l

i n t e r e s t r a t e s h a ve had d is a s t r o u s

i n t e r e s t r a t e s — th e
H ig h

n a t i o n a l and i n t e r n a t i o n a l

consequences:

( 1 ) T h e y h a lt e d

th e r e c o v e r y t h a t was u n d e rw a y in

th e p r e s e n t d ee p r e c e s s io n .
d e c lin in g

when he e n te r e d

Decem ber

It

t h a t t im e ,

C o n tra ry

a d d it io n ,

P r e s id e n t

J u ly

Reagan

th e W h ite H o u s e — fro m 7.8 % in

a v e ra g e d 6.758 b e tw e e n

In

to

J u ly

b a n k r u p t c ie s h a ve q u a d r u p le d

r a t e s h a v e been b e tw e e n 2 and 3%) when i n f l a t i o n a r y
le s s

in v e s t

th a n 658.

M o re o v e r

e s p e c ia lly d u r in g

n o t e ve n l a r g e

o f in s t a b ilit y
(o n ly

p r o fita b le

fro m

r e la tiv e ly
th e

r is k le s s

fa c t th a t la r g e

b e c a u s e many b u s in e s s e s

(2 )
m a rk e ts .

to

H ig h

in te r e s t ra te s

and th e

in te r e s t ra te s

In te r n a tio n a l

un e m p lo ym e n t in
a r r a n g e m e n t,




e c o n o m ie s .

w h ic h s u b s id iz e s

o u r p r o d u c ts t o be o v e r p r i c e d
te m p o r a ry r e l i e f

a ls o cause t r o u b le

f in a n c ia l c r is e s

th e U .S . and o t h e r w o r ld

t o be o v e r v a lu e d ,

fro m
e x p o rt

a v a ila b ilit y

in

in f la t io n

c o u ld

when h ig h r e a l

s e c u r it ie s ,

to

ra te s

A m a jo r s o u r c e

f in a n c e

in t e r n a lly

1980) a re l e s s

o f m oney th a n

in

re a l

s m a lle r

in t e r n a t io n a l

fir m s .

f in a n c ia l

ca u se v e r y s e r io u s d i s r u p t i o n s

H ig h i n t e r e s t r a t e s c a u s e t h e d o l l a r

im p o r t s and re d u c e s o u r e x p o r t s b y c a u s in g

w o r ld m a r k e ts .
by lim it in g

in d u s tr ie s .

lo n g - t e r m

b u s in e s s e s a r e l i k e l y

f ir m s t h a t

2 3 % o f in v e s t m e n t s came fro m p e r s o n a l s a v in g s in

s e n s it iv e

fo r

r e s u lt s

8.5% s in c e

e x p e c t a t i o n s h a v e d e c lin e d

p e r io d s o f s u ch u n c e r t a i n t y ,

can be e a rn e d on s h o r t - t e r m ,

to

7, 3% in

’ 980 t o

1977 and 1980 and has a v e ra g e d

c a n n o t p a y r e a l r a t e s o f i n t e r e s t a p p r o x im a t in g 7—10% ( t h e

to

1981, l e a d i n g

u n e m p lo ym e n t was

T h is

is ,

T h i s o v e r v a lu a t io n

im p o r t p r i c e s ,
m o re o v e r

b e c a u s e o u r e x p o r t im b a la n c e w i l l

g iv e s

b u t c o n t r ib u t e s

some
to

a v e r y u n s t a b le

u ltim a t e ly

le a d

to

p r e s s u r e s to

42

d e v a lu e

th e d o l l a r

im p o r t p r i c e s

as i t

w ill

A d m in is t r a t io n 's

d id

la is s e z -f a ir e

p r e v e n t w id e f l u c t u a t i o n s

(3 )

The d e f i c i t s

caused deep c u ts

in

A d m i n i s t r a t i o n 's
p ro g ra m s t o
p r o g ra m s .

in

T h e re a ls o

in d u c e d b y th e A d m i n i s t r a t i o n ' s

w o u ld

s h ift

r e d u c in g

g e n e r a lly r e g r e s s iv e

each o th e r

is

lo c a l le v e ls

th e

th e

ta x

in d u s t r y d u rin g
w ill

such n a t i o n a l o b j e c t i v e s

c u ts

to

a ls o have
th e

r e s p o n s ib ilit y

t a x e s o r d is c o n t i n u e

no g u a r a n te e t h a t t h e r e
fo r

th e

in t e r v e n e

M o re o v e r

fu n d s a v a i l a b l e

c o m p e t i t iv e d e v a lu a t io n

fo r

to

to

fo r

p u b lic

pay fo r

s o u rc e s ,

th o s e

th e y w i l l

s e r v ic e s ,

The "N ew

o f p ro g ra m s as s t a t e s

p e r io d s o f h ig h

u n e m p lo ym e n t

be c o n s t i t u e n c i e s

a t th e

s ta te

a s c o m b a t t in g d i s c r i m i n a t i o n

and

and

th e d is a d v a n t a g e d .

(4 )

D e s p it e

o u r back,

th e A d m i n i s t r a t i o n ' s

F e d e r a l e x p e n d it u r e s w i l l

w h a t t h e y w o u ld
Th e m ix w i l l

h ave been i f

m e r e ly s h i f t

R educed e x p e n d it u r e s
and d e v e lo p m e n t,

in v e s t m e n t in

its

and l a i s s e z - f a i r e
u n fo rtu n a te

fo r

The r e a l

p e o p le
p h il o s p h y

and s m a lle r

th e r e c e s s io n
p e r c e n ta g e

it

fo rc e

been a d o p te d .
s p e n d in g .

n o n m ilit a r y

th e A d m i n i s t r a t i o n 's

to re d u c e th e s e

re s e a rc h
w ii:

budget d e f ic it s

in v e s t m e n t s ,

In d e e d ,

it

v ie w s g o v e rm e n t n o n -d e fe n s e

o f as p u b lic

in v e s t m e n t s .

h as m o d e ra te d c o n s i d e r a b l y , m a i n ly b e c a u s e o f th e
in

e n e rg y,

n e c e s s a ry to

p o in t r e d u c tio n




it

in s t e a d

fo r 2 y e a rs a t a c o s t to

p e r c e n ta g e

)ff

t o GNP a b o v e

s e c r e t o f A m e r ic a 's e c o n o m ic s u c c e s s has been

in c r e a s e s

is

p ro g ra m s t o d e fe n s e

g o v e rn m e n t i n f r a s t r u c t u r e ,

h a s been v e r y c o s t l y .

p o in t,

th e g o v e rm e n t

r e la t iv e

and human r e s o u r c e d e v e lo p m e n t c l e a r l y

t h a t th e A d m i n i s t r a t i o n

The r a t e o f i n f l a t i o n

about g e t t in g

in c r e a s e

1981 t a x m e a s u re s had n e v e r

U n fo r tu n a te ly ,

e x p e n d it u r e s as o f no v a lu e

r e c e s s io n

th e

r h e t o r ic

p r o b a b ly

fro m d o m e s tic

in fo rm a tio n ,

w eaken o u r eco n o m y.

it

u n w illin g

im p o r t a n t g o v e rn m e n t p r o g ra m s .

w o u ld r i s k

tim e h ig h e r

U n fo r t u n a t e ly ,

exchan ge r a t e s .

s t a te s w h ile

a ls o

co m p e te w it h

h o ld

1970s, a t w h ic h

p re s su re s .

S in c e th e s t a t e s do n o t h a ve a d e q u a te re v e n u e

F e d e r a lis m "

is

th e e a r l y

p o l i c i e s make i t

New F e d e r a lis m

th e

have to r a is e

s e r v in g

d u rin g

p ro d u c e i n f l a t i o n a r y

in

fo o d

and im p o r t p r i c e s .

to re d u c e

increase

u n e m p lo ym e n t b y one m i l l l i o n

n a tio n a l

in f la t io n

H ow e ver

In o r d e r

o u t p u t o f $200 b i l l i o n

t h e C P I and an in c r e a s e

in

th e

b y one
and

f o r e a ch

F e d e ra l d e f i c it

43

o f $30 b i l l i o n

fo r

each

1 p e r c e n ta g e

p o in t

in c r e a s e

in

u n e m p lo ym e n t

a lte r n a tiv e

to

th e

THE F U LL EMPLOYMENT A L T E R N A T IV E

The need f o r a c o h e r e n t ,
R e a g a n o m ic s i s
s p e c if ic
ra te s ,

u rg e n t,

e f f e c t iv e

p ro b le m s f a c i n g o u r e c o n o m y :

lo w p r o d u c t i v i t y g r o w t h ,

d e e p e c o n o m ic r e c e s s io n .

ra te s

u n e m p lo y m e n t,

a n d , n o w , th e need

I t m u st be f u l l y

c o o r d in a t e d , n o t j u s t a s t r i n g
c o n t r a d ic t io n s

fa ilu r e s o f

A c o g e n t a l t e r n a t i v e m ust r e a l i s t i c a l l y
in f la t io n ,

fo r

r a p id

a d d re s s th e
h ig h

fro m a

c o m p r e h e n s iv e and i n t e r n a l l y

o f b a n d -a id s and n o t a c o l l e c t i o n

su ch a s m a s s iv e t a x c u t s

in te r e s t

re c o v e ry

to

of

s p u r in v e s t m e n t and h ig h

in te r e s t

t h a t ch o k e o f f in v e s t m e n t

W it h o u t a n y c r e d i b l e
and w it h o u t a p a in l e s s

s in g le

e x p l a n a t io n

s h o rt-te rm

e m p lo y s a v a r i e t y o f m e a s u re s t a i l o r e d
u n e m p lo ym e n t can be s u c c e s s f u l ,
o f th e eco n om y,
s e le c t iv e

s h o u ld

th e m u l t i p l e

p r o b le m s ,

s h o rt o f a p o lic y

In

ones,

s h o rt,

be s t r u c t u r e d

An e f f e c t i v e

and

th e c o m p le x n a t u r e
w it h

e n c o u ra g e e x p e r i m e n t a t i o n , and a d o p t a
m a c ro o r s t a b i l i z a t i o n
p o lic ie s .

p o l i c i e s m u st be

T h e s e co m b in e d a p p ro a c h e s

w it h e q u i t y a s an im p o r t a n t c o n c e r n .

a lte r n a tiv e

p o lic y

e c o n o m ic p o l i c i e s o f p r e v i o u s
m a c ro e c o n o m ic v e r s io n

th a t

causes o f in f la t io n

The p o l i c y m ust r e c o g n iz e

t o m ic r o and s u p p l y - o r i e n t e d

c re a te d

to

n o t h in g

co m p le m e n t and s o m e tim e s s u p p la n t g e n e r a l p o l i c i e s

and s e c t o r - s p e c i f i c

lo n g e r ru n p e r s p e c t i v e .
m a r r ie d

f o r c o m p le x eco n om ic

m ir a c l e c u r e ,

fo r

th e

1980s c a n n o t be a r e t u r n

A d m i n i s t r a t i o n s o r th e

o f K e y n e s ia n demand management t h e o r i e s .

an i n t e l l e c t u a l o p e n in g

fo r

ill-f o u n d e d

to

th e

a lm o s t e x c l u s i v e l y

s u p p ly -s id e

The l a t t e r

had

and m o n e t a r i s t

id e a s .

F ir s t ,

we m ust r e c o g n i z e

t h a t g e n e r a l o r m a c ro e c o n o m ic

t h e m o s t p o w e r fu l in s t r u m e n t s o f e c o n o m ic p o l i c y ,
W e ll-h o n e d m acro p o l i c i e s
s p e c if ic

m ust be m a tc h e d b y s p e c i f i c

s e c t o r s and p r o b le m s

m e a s u re s t o

s t a b iliz e

m o s t o f th e p o s t -w a r

i n o u r e co n o m y.

e c o n o m ic p e r fo r m a n c e ,
p e r io d ,




s in c e

w h ile

a lo n e

m e a s u re s t a r g e t e d

to

F o r e x a m p le , m a c ro e c o n o m ic

w h ile

r e a s o n a b ly s u c c e s s f u l d u r in g

h a ve becom e i n c r e a s i n g l y

c o n d i t i o n s we h a ve e x p e r ie n c e d

p o lic ie s ,

c a n n o t do th e jo b

th e end o f th e

in e ffe c t iv e

1960s.

u n d e r th e

E n e rg y p r ic e

44

shocks

fo r

im p o rte d o i l

in

1979 in c r e a s e d

1974 and

econom y as a r e s u l t o f i n d i r e c t e n e r g y c o s t
c a u s e d b y t i g h t m oney p o l i c i e s
The s u b s e q u e n t in c r e a s e
to r e s t r a in
w e re th e

fis c a l

p o lic y

s t a g f la t io n s

u n e m p lo ym e n t r a t e

in

d e s ig n e d

th e o v e r a l l
and t o

fig h t

p r ic e

fu rth e r

and in

H ie r e c e s s io n

of

th ro u g h o u t th e
in te r e s t ra te s

an e n e r g y - in d u c e d

t i g h t e n m o n e ta ry p o l i c y ,

th e

in f la t io n .

l e v e l moved e c o n o m ic a u t h o r i t i e s

1974-1975 and 1980.

of

s o a re d h ig h e r ,

h ig h e r th a n b e f o r e .

to

p r ic e s

im p a c t s and h ig h

In

each o f th e s e

re c o v e ry ,

1 9 81-1 98 2,

The r e s u l t s

r e c e s s io n s ,

th e

u n e m p lo y m e n t re m a in e d

th e

p ro d u c t

(a n d m is d ir e c t e d ) m a c ro e c o n o m ic m e a s u r e s , h a s become th e

o f e x c lu s iv e ly

w o r s t d o w n tu rn

s in c e

th e G r e a t D e p r e s s io n .

G e n e ra l c r e d i t ,

ta x ,

m a jo r w ay b y p o l i c i e s

and s p e n d in g p o l i c i e s m ust be c o m p le m e n te d

ta rg e te d

at

p a r tic u la r

s e c to rs .

c o m p la in t a b o u t K e y n e s ia n e c o n o m ic s a s p r a c t ic e d

in

th e

v a lid .

to

ig n o re

K e y n e s ia n p o l i c i e s

p r o d u c tiv ity
w it h b o th

h a ve s o m e tim e s te n d e d

and o t h e r " s u p p l y "

s u p p ly and dem and,

m u st c o n c e n t r a t e on i m p r o v in g
hum an.

c o n c e rn s .

o u r p r o d u c tiv e

s e c t o r p r o g ra m s ,

fu ll

th e

e c o n o m ic

a

1970s i s

la r g e ly

re s o u rc e s ,

e c o n o m is t s m u st be c o n c e rn e d

and p a r t i c u l a r l y d u r i n g

Th e se p ro b le m s m u st be a d d r e s s e d ,

and t a r g e t e d

A ll

in

One s u p p l y - s i d e

p e r io d s o f

r e c e s s io n ,

r e s o u r c e s , b o th m a t e r ia l

we

and

b u t w it h o u t b o th demand m anagem ent

e m p lo y m e n t and s t a b l e

p r ic e s

w ilJ

n o t be

p o s s ib le ,

Second,
d iv is io n

s o lu t io n s to

o f l a b o r b e tw e e n g o v e rn m e n t,

c o o p e r a tiv e
s h o r t-r u n

p r o b l e m - s o l v in g .

e f f ic ie n c y ,

r e c e s s io n ,

in f la t io n ,

it

W h ile

la r g e r

open and f a i r

b y th e m s e lv e s c a n n o t p r o t e c t th e e n v ir o n m e n t ,
w o rk e rs ,

e lim in a te

in co m e l e v e l s

fo r

d is c r im in a tio n ,
h o u s e h o ld s ,

and e n s u re n a t i o n a l
p re s e rv e

c o m p e t i t iv e

s e c u r it y .

be b u i l t on a s e n s ib le

and m e c h a n is m s t h a t p ro m o te

th e m a rk e t can be a m a r v e l a t p r o m o t in g

c a n n o t s o lv e

o r c re a te

p r o b le m s s h o u ld
th e m a rk e t,

p r o b le m .

It

cannot p re v e n t

t r a d e and c o m p e t i t io n .
s e c u r e th e h e a lt h

p ro m o te e q u a l o p p o r t u n i t i e s

fo s te r

lo n g -r u n

b a s ic

re s e a rc h

M a rk e ts

and s a f e t y o f
and a d e q u a te

and i n n o v a t i o n ,

In d e e d , w it h o u t g o v e rm e n t i n t e r v e n t i o n

c o n d i t i o n s , m a r k e ts w o u ld be l e s s e f f e c t i v e

to

th a n

th e y

a re

W h ile we m ust r e l y
a b o u t th e need




p r i m a r i l y on m a rk e t f o r c e s ,

fo r a p o s it iv e

g o v e rn m e n t p a r t n e r s h ip

th e re
w it h

can be l i t t l e
th e

p r iv a t e

doubt

s c c to r

45

in

a d d r e s s in g

im p o r t a n t n a t i o n a l p r o b le m s .

p r o b le m s — p a r t i c u l a r l y

in

fig h tin g

i n t e r n a t i o n a l c o m p e t it iv e n e s s o f A m e ric a n
u n c o o r d in a t e d
and p r i v a t e

a c t io n s o f e i t h e r

T h e re

in f la t io n

is

an im p o r t a n t r a n g e o f

and s t r e n g t h e n in g

th e

in d u s t r y — th a t w i l l

th e p u b l i c

p a r t n e r s h ip s m ust be f o r g e d ,

o r p r iv a t e

not y ie ld

s e c t o r a lo n e .

e s t a b lis h in g

t o th e

P u b li c

a new i n s t i t u t i o n

or

g o v e rn a n c e .

T h ir d ,

a c o o r d in a t e d m acro p o l i c y

co m p le m e n te d

by ta rg e te d

p o lic ie s

d e v e lo p e d on a c o o p e r a t i v e b a s is m u st be m a tc h e d w it h

d ir e c t e d

to w a rd o u r m o s t p r e s s in g

p r o d u c tiv e

in d u s tr ia l base,

p r o b le m s :

fig h t in g

and, p a r t ic u la r ly

s e c to ra l
s tro n g

in f la t io n ,

a fte r

p o lic ie s

r e b u ild in g

t h e r e c e s s io n

our

of

1 9 8 1-1 98 2, r e d u c in g u n e m p lo ym e n t

The ab sen ce o f s p e c i f i c
le ft

th e

e n tir e

d is a s t e r o u s

a n t i-in f la tio n

b u rd e n o f f i g h t i n g

r e s u lt s o f re c o rd

c o n d it io n s .

re a l

in te r e s t

E x p a n d in g s u p p ly and r e d u c in g

s e c t o r s can do a much m ore e f f i c i e n t
d e v e lo p in g

p r o d u c tiv e

And

fig h tin g

th e e f f e c t s

u s move m ore r a p i d l y

of

to w a rd

em p lo ym e n t means th e

fu ll

p la n t and e q u ip m e n t,

r e s o u r c e s — a m e a n in g fu l jo b

fo r

in f la t io n a r y

p re s su re s ,

e c o n o m ic p o l i c y

e ls e

to

The p o l i c y m ix

d i r e c t m e a su re s to re d u c e u n e m p lo y m e n t,
as e n e r g y and t r a n s p o r t a t i o n .
p o p u la t i o n

g r o u p s , g e o g r a p h ic

u n d e r u t iliz e d
p o lic y ,

17-871 0




T a r g e t in g
a re a s ,

83

4

p o lic y ,

R e b u ild in g

p re s su re s

fo r

our

th e

lo n g

u n e m p lo ym e n t

s h o u ld

be f u l l

o f ou r m a te ria l

and

run

;an h e lp

e m p lo ym e n t

re s o u c e s ,

s u c h as

e m p lo ym e n t o f o u r human
a b le

t o w o rk ,

If

im p ro v e p r o d u c t i v i t y
s h o u ld

be h e a v i l y

and s e l e c t i v e

d on e p r o p e r l y ,
and re d u c e

w e ig h t e d

p o lic ie s

in

to w a rd
a re a s such

in v e s t m e n t and jo b c r e a t i o n

and i n d u s t r i a l

o r w he re s h o r t a g e s now e x i s t ,

good a n t i - i n f l a t i o n

p o lic y ,

r e d u c in g

v e r y p e rs o n

w o u ld do more th a n a n y t h in g

in f la t io n a r y
as can

i n d u s t r i e s m ore c o m p e t i t iv e

eco n om y,

fu ll

n e a r d e p r e s s io n

in f la t io n ,

s ta b le

and th e

ho:

w it h

c o n c e n tra te d

th ro u g h

u t iliz a t io n

R eagan p ro g ra m

and g o v e rm e n t on th e a p p r o p r i a t e

in f la t io n a r y

r e c e s s io n

The p re e m in e n t g o a l g u id i n g

t h is

la b o r

a h e a lt h y ,

th e

p r o d u c in g
in

l o w e r in g

i n d u s t r i a l b a se can make A m e r i c a 's

jo b s m ore s e c u re w h i l e r e d u c in g

in d u s t r ia l

ra te r
c o s ts

in

in

t o m o n e ta ry p o l i c y ,

in c o m e s , and e c o n o m ic

its

F u l.

jo b

a co n s e n s u s among i n d u s t r y ,

i n t e r p l a y b e tw een p r i c e s ,

p o lic ie s

in f la t io n

o r c o u ld

and good s o c i a l

on

s e c t o r s t h a t a re
e x is t,
p o lic y ,

is

good e m p lo ym e n t

P r o v id in g

jo b

46

s k ills

and o p p o r t u n i t i e s

fo r

a l l g ro u p s and r e g io n s i s

im p o r t a n t s t e p t h a t we can t a k e
en h a n ce th e

It

is

to

s t a n d in g o f and o p p o r t u n i t y

f a s h io n a b le

th e s e d a ys to

tr a in in g

p ro g ra m s h a ve f a i l e d

p o lic y ,

C r itic s

t r a in in g

is

fo r

is

s e le c t iv e

t h a t p r iv a t e

e v a l u a t io n s
d e s p it e

th e s e

in s t a b ilit y

and c o n f l i c t i n g

fu n d in g

g re a te r

c o n s e r v a tio n

C o n g r e s s io n a l m a n d a te s .

s t a b ilit y — lik e

p r o je c t s ,
t h is

d if f ic u lt

s h o u ld be t h e

g r e a t e r a t t e n t io n

on th e r e a l

to a c h ie v e

m a c ro e c o n o m ic p o l i c y
In d e e d , th e

p u t youn g p e o p le

o p p o rtu n ity th a t w i l l

in te r e s t ra te s to

t o r e c e s s io n

A fte r

in

th e

t o w o rk in
p a rk s and

as h e r e ,

a ll,

e n d s o f e co n o m ic p o l i c y

in

fo c u s o f o v e r a ll
m e r e ly a

and r e q u i r e

fo c u s

g re a te r

The m ost im p o r t a n t im m e d ia te

n e a r -te r m

in f la t io n

th e r e d u c tio n o f o v e r a ll

in te r e s t ra te s ,

and o i l

p r ic e s

o t h e r c o u n r ie s ,

is

th a t i t

p a r t ic u la r ly

in te r e s t ra te s

c re a te s

i n t e r e s t r a t e s — an

b y th e Reagan e co n o m ic p r o g ra m .

lo w e r

and

a r e th e m o s t

m oney i s

s h o u ld be t o re d u c e r e a l

fo r

th e

to c o n t r o l,

on GNP and e m p lo ym e n t w i l l

b e n e f i t o f such a p o l i c y

be lo w e r e d

W o r ld ; t h e r e ,

le a d in g

C o n c e n t r a t in g

be m is s e d

in a d e q u a t e ly a p p r e c ia t e d

to d e f i n e and m ore d i f f i c u l t

th o s e e n d s .

f a v o r a b le o u t lo o k




to

P o lic y

l e v e l o f GNP.

o b je c t iv e s

an excellent e n v ir o n m e n t f o r

T h ir d

B ill

g r o w th o f th e money s u p p ly ,

an en d — r e a l o u t p u t

c o o r d in a t io n

t o o v e rc o m e

p ro g ra m s m u st h a v e

e a rm a rk e d F e d e r a l fu n d s (a s s u g g e s te d

in te r e s t ra te s

r e s u lt o f r e s t r ic t in g

m eans t o

In o r d e r

in v e s t m e n t s ,
la w s and

w h ic h w o u ld e a rm a rk r e v e n u e s from F e d e r a l

and v o l a t i l e

e c o n o m ic p o l i c y

about

p u rp o s e ),

B e c a u s e m oney i s
b e c a u s e h ig h

n o t a lw a y s

e m p lo y m e n t and

n u m e ro u s d e t a i l e d

because o f c o n s ta n t changes in

C o o r d i n a t i n g M o n e ta r y and F i s c a l

lik e ly

p o l i c y , d e s p it e

p r o b le m s , new F e d e r a l e m p lo ym e n t and t r a i n i n g

f u n d in g

fo r

is

10%— so p u b li c

T h i s n e g a t iv e a s s u m p tio n

i n f lu e n c e

M o y n ih a n -M a th ia s N a t i o n a l C o n s e r v a t io n

fo re s ts

over

t o d e m o n s tra te t h a t th e s e p ro ra m s w ere good p u b l i c

in c r e d ib le

r e g u la t io n s

in s t r u m e n t s o f n a t i o n a l

s e c t o r e m p lo y m e n t and

u n e m p lo y m e n t, b u t t h i s o p t i o n

b e t t e r th a n u n e m p lo y m e n t.

p ro g ra m s c o n t in u e s t o

and

a rg u e t h a t F e d e r a l e m p lo y m e n t and

a v a i l a b l e — e s p e c i a l l y when u n e m p lo ym e n t i s
t r a in in g

s in g le m ost

fo r a l l our c it iz e n s .

and c a n n o t be e f f e c t i v e

p o in t o u t c o r r e c t l y

th e b e s t o p tio n

th e

im p ro v e e d u c a t io n , com ba t c r im e ,

w ould h e lp

One

w o u ld a l l o w
in

E u ro p e and th e

s t im u la t e o u t p u t

#

47

and a l l e v i a t e

u n e m p lo y m e n t, th u s r a i s i n g

o v e r s e a s demand f o r

U .S .

e x p o rt

in d u s t r ie s .

Th e p r im a r y g o a l o f m o n e ta ry p o l i c y
s ta b le

and j u s t a l i t t l e

i n t e r e s t r a t e s r a n g in g

fro m

s ix

to

i n t e r e s t r a t e s d is c o u r a g e c a p i t a l
be th e m ost e f f e c t i v e
re d u c e

in f la t io n

F u rth e r,
on th e h uge

s h o u ld be i n t e r e s t

ab ove th e r a t e o f i n f l a t i o n
12 p o i n t s

a b o v e th e

in v e s t m e n t ;

lo w e r ,

and e q u it a b l e means t o

by c u t t in g

th e l a r g e

ra te s

th a t a re

th e

19 81-1982

( u n lik e

in f la t io n

ra te ),

m ore s t a b l e

s t im u la t e

ra te s

H ig h
w o u ld

in v e s t m e n t and a ls o

th e c o s t s o f b o r r o w in g .

and u n p r o d u c t iv e e x p e n d it u r e s r e q u i r e d

f e d e r a l d e b t — now o v e r $100 b i l l i o n

to

a n n u a l l y — c o u ld

pay in te r e s t

be

s i g n i f i c a n t ly re d u ced .

A m a jo r d e f e c t o f m o n e ta ris m
f ix e d

as w e l l

as o t h e r p o l i c i e s

f o r m u la s t o c o n t r o l e co n o m ic a c t i v i t i e s

o r budget d e f ic it s )
e m p lo y m e n t,
C o n g re s s ,

w h ic h d e s t a b i l i z e

in v e s tm e n t,

in

c o o p e r a t io n

c o n s u lta t io n

It

is

w it h th e F e d e r a l

w it h such p r i v a t e

C o n g re s s ,

c o u r s e and f o r c e

th e

r e ly

f o c u s on o u tc o m e s .

on

The

House and in

and m an a gem en t,

ta rg e ts

t o a c h ie v e th e s e o b j e c t i v e s .

s h o u ld

and c o o r d in a t e m o n e ta ry

As t h e c r e a t u r e o f th e

n o t p u rs u e a c o m p l e t e l y in d e p e n d e n t

th e C o n g re s s to a d j u s t e c o n o m ic p o l i c y g o a ls

c o u r s e r e g a r d le s s o f th e o u tc o m e .

In d e e d ,

to

fit

th a t

th e H u m p h re y -H a w k in s A c t r e q u i r e s

F e d e r a l R e s e rve B oard to r e p o r t on how i t s

g o a ls

to

R e s e r v e and th e W h ite

s e c to r g ro u p s as la b o r

th e F e d e r a l R e s e rv e s h o u ld

t h a t w o u ld

fo c u s on m eans (m o n e y

o u tc o m e s — g r o s s n a t i o n a l p r o d u c t ,

w o u ld be much b e t t e r

s e l e c t c o m p a t ib le e m p lo y m e n t, g r o w th and p r i c e
and f i s c a l p o l i c i e s

th e ir

p o lic ie s

w ill

re s p o n d

t o th e

s e t b y C o n g re s s .

Some m ig h t o b je c t t h a t i n c r e a s in g
in f la t io n a r y

th e m oney s u p p ly w o u ld

e x p e c t a t io n s and t h e r e f o r e

in c r e a s e

r a t e s , b u t I do n o t a c c e p t t h a t a n a l y s i s .
w o u ld

in c r e a s e

in c r e a s e

e x p e c ta tio n s

i n m oney g r o w th w o u ld

s lig h t ly ,if
fis c a l

in f la t io n a r y

at a ll.

p o lic ie s

e m p lo y m e n t,




2

in c r e a s e

ra th e r

to s t a b i l i z e

in te r e s t

I n c r e a s i n g m o n e ta ry g r o w t h
in

th e

lo n g r u n .

in f la t io n a r y

e s p e c i a l l y when co m b in e d w it h
in te re s t r a te s ,

As Don N ic h o l s t e s t i f i e d

fu e l

th a n lo w e r

b e fo re

e x p e c ta tio n s o n ly

c o o r d in a t e d m o n e ta ry and

p r ic e s ,
t h is

p r o b a b ly

B u t a one t im e

e c o n o m ic g r o w th

C o m m itte e

in

Ju n e,

and
an

48

in c r e a s e

in

t h e m oney s u p p ly p r o b a b ly w o u ld

in c r e a s e

in

th e m oney s u p p ly ,

c a u s in g

p r o b a b ly w o u ld c a u s e a s u b s t a n t i a l
p e r c e n ta g e

p o in t r e d u c tio n

fo r

in c r e a s e p r ic e s

an in c r e a s e

in

le s s

l o w e r in g o f i n t e r e s t r a t e s

a i p e r c e n t in c r e a s e

th a n

th e

th e r e a l m oney s u p p ly and
(p e r h a p s a ^

in th e m o n e ta ry t a r g e t

^

As N ic h o l s d e m o n s t r a t e s , e c o n o m ic p e rfo rm a n c e has w orse ned c o n s id e r a b l y s in c e
th e

1950s and 1960s when p o lic y m a k e r s c o n c e n t r a t e d on o u tc o m e s r a t h e r th a n

b u d g e ts and th e m oney s u p p ly .
of

in f la t io n a r y

th e

The p r e s e n t h ig h

s p e c u la tio n s ,

fa c e o f h u g e b u d g e t d e f i c i t s — i n f l a t i o n a r y

a c c o r d in g

t o a p o l l b y th e

w e lc o m e ,
to

it

is

e x p e c t a t io n s a r e

in

a b o u t 6%

a p p a r e n tly has r e c e n t ly t e m p o r a r ily r e la x e d

b y f o c u s in g on M2 and M^ as w e l l as M ^; w h i l e

no s u b s t i t u t e

fo r

an e f f e c t i v e

t h is

its

is

and c o o r d in a t e d m o n e ta ry p o l i c y

s u p p o r t e c o n o m ic ou tco m e g o a ls .

A d ju s tm e n t s

in

t h is

o v e r a ll

o b j e c t i v e o f m o n e ta ry p o l i c y

as e c o n o m ic c ir c u m s t a n c e s c h a n g e
th e

p r im a r y

to o l

fo r

h ig h

in f la t io n

can r e d u c e

econom y and th e n o n l y b y

u n e m p lo ym e n t and l o w e r in g
waged m ore d i r e c t l y
e x c lu s iv e

r e lia n c e

In o r d e r
c h a n g e s s h o u ld
in s u r a n c e

w it h

th e b u d g e t c y c le

th e

in

to

be r e q u i r e d

th a t

b e g in s

s h o u ld

demand when

in v e s tm e n t and i n c r e a s in g
a g a in s t

in f la t io n

p ro g ra m s r a t h e r

o f fis c a l

a u to m a tic

p o lic y ,

s t a b iliz e r s

be

s e v e r a l m a jo r

s u s t a in

Due t o

fo r e c a s ts th a t g e n e r a lly
f u t u r e , d is c r e t io n a r y

im p le m e n t in

in te n d e d

s h o u ld

th a n w it h

s u c h as u n e m p lo ym e n t

as th e m ost e f f e c t i v e means t o

th e

S in c e

s e c to rs o f

t i g h t money p o l i c i e s .

f le x ib ilit y

in

be

to o u t s t r i p

in te r e s t -s e n s it iv e

fig h t

a n t i-in f la t io n

and e c o n o m ic

v e ry d if f ic u lt

w ill

p o lic y

s t im u la t in g

im p a c t o f an e c o n o m ic d o w n tu rn .

p o l i c y c h a n g e s t h a t a re




th e o n g o in g

F ir s t

b e yo n d tw o q u a r t e r s

ta x in g — is

fis c a l

( u s u a l l y m ore th a n a y e a r t o c o m p le te b o th

C o n g r e s s io n a l a c t i o n )
a c c u ra te

o n ly

r e d u c in g p r o d u c t iv e

on a c r o s s - t h e - b o a r d

m ust be r e c o g n iz e d

p o w e r and c u s h io n

c o n v e r s e ly ,

in f la t io n

ta rg e te d

be a d o p te d .

is

u n e m p lo ym e n t need t o be c o u n t e r a c t e d ) ,

s a le s ,

t o en h a n ce th e

it

a g g r e g a te demand when i t
(o r

c a p a c it y and h ig h

in te r e s t ra te s

H ow ever

r e s t r a in in g

c a p a c i t y and g e n e r a t e
u n d e r u t iliz e d

th e

r a te s a re n o t because
m o n e ta ry p o l i c i e s

New Y o rk S to c k E x c h a n g e d

The F e d e r a l R e s e r v e B o a rd
m o n e ta ry r e s t r i c t i o n s

in te r e s t

b u t because o f r e s t r i c t i v e

th e

p u r c h a s in g

le n g t h

E x e c u t iv e

of

and

a re n o t v e r y

p o l i c y — s p e n d in g o r

a t i m e l y f a s h io n .

In

a d d it io n ,

t o be t e m p o r a ry o f t e n h a ve a w ay o f b e c o m in g

49

p e rm a n e n t.

C o n s e q u e n t ly ,
r e s p o n s iv e .
d e v e lo p e d .
s h a rin g .

fis c a l

T h e y w o u ld

be d e s ig n e d

le v e l,

le v e l,

T h is d i s t r i b u t i o n

p a r t ic u la r ly

p r im a r y b e n e f i c i a r i e s .

h ig h

a u t o m a t ic d e s t a b i l i z e r s

ra th e r

f o r m u la s

in c re a s e s

th a n th e

a u to m a t ic

and o t h e r

1981,

fis c a l

b u d g e t s t a n d a r d , and i t
A c c o r d in g

to

a u to ,

re m a in e d r e s t r i c t i v e

th e C o n g r e s s io n a l B u d g e t O f f i c e ,

$11 b i l l i o n

in

o u tla y s

r is e

s u r p lu s .

W ith th e

v i g o r o u s l y b y th e F e d e r a l

as d e lib e r a t e

Second,

as i t

f is c a l

c u rre n t

in d u s t r ie s

and s t i m u l a t i v e

fis c a l

on a h ig h -e m p lo y m e n t

th r o u g h

fir s t

each

th e

h a lf o f

i p e rc e n t r is e

1982.

in

fis c a l

in

lo s t

re v e n u e s )

10 p e r c e n t w o u ld
d e f ic it s

of

th e re fo re
1981 and

im p ro v e t h e b u d g e t b y a f u l l

b r a k e s on and th e m o n e ta ry b r a k e s

R e s e rv e B o a r d ,

th e

1981-1982 r e c e s s io n

was

red u ce o r e lim in a te

ta x

was u n n e c e s s a ry .

p o lic y

s h o u ld be r e s t r u c t u r e d
fo r

to

s p e c u la tio n

o r u n p r o d u c t iv e

b u s in e s s i n c e n t i v e s t h a t g e n e r a t e

lit t le

s a v in g s and in v e s tm e n t f o r o u r econom y m u st be r e p la c e d




h e re

r e s tric tiv e

Ta x g iv e a w a y s t o th e w e a lt h y s u ch a s " A l l

and m is d ir e c t e d

11%, and t h e

b y some $120 b i l l i o n ,

p r e f e r e n c e s t h a t s e r v e as i n c e n t i v e s
in v e s t m e n t .

to

a d v o c a te d

in t e r e s t -s e n s it iv e

and $ 1 9 b i l l i o n

M o vin g t o 5 p e r c e n t u n em p loym en t w o u ld

$150 b i l l i o n ,

th e m oney s u p p ly o r a

f e d e r a l b u d g e t d e f i c i t b y a b o u t $30 b i l l i o n

in c r e a s e d

re d u c e th e c u r r e n t f e d e r a l d e f i c i t

a p p li e d

a
and jo b

Th e se w o u ld be

s t a b iliz e r s

M o vin g eve n t o a m od est 6 p e rc e n t u n e m p lo ym e n t fro m

1982.

th a t

w o u ld be th e

t o c o n t a in

in

im p le m e n t a m ore r e s p o n s iv e

p o l i c y was a c t u a l l y

u n e m p lo ym e n t in c r e a s e s th e
(r o u g h ly

fo r

b a la n c e d b u d g e t s .

w h ic h c o u ld

th e c o n s t r u c t i o n ,

show th e need to

and s h u t o f f

in v e s t m e n t t r a i n i n g

10.1 p e rc e n t u n e m p lo ym e n t,

In

be

on when

fo r m u la w o u ld e n s u r e

a l s o be r e v i s e d

in

p a in f u lly
p o lic y .

s h o u ld

C o n s e r v a t iv e s who do n o t t r u s t g o v e rn m e n t and th e

p ro c e s s p r e fe r r i g i d

c o n s t i t u t i o n a l amendment t o r e q u i r e

The

jo b s

w o r k s , and re v e n u e

u n e m p lo ym e n t r a t e s

Tax p o l i c y c o u ld

d u r in g r e c e s s io n s .

d is a s t e r

p u b lic

f o r e x a m p le 6 p e r c e n t ,

c o u n t e r c y c l i c a l d im e n s io n to p ro m o te in c r e a s e d

p o litic a l

be much m ore c y c l i c a l l y

f o r th e s e p ro g ra m s w o u ld be t r i g g e r e d

d r o p s b e lo w t h i s

c r e a t io n

to

th a t d ir e c t l y c re a te

jo b s and t r a i n i n g ,

to a c e r t a i n

g r o u p s and a re a s w it h

s h o u ld

s t a b iliz e r s

i n c lu d e

E x p e n d it u r e s

u n e m p lo ym e n t r i s e s
when i t

p o lic y

New a u t o m a tic

S a ve rs C e r t i f i c a t e s "
o r no in c r e a s e d
w it h

ta rg e te d

50

in c e n t iv e s
s h o u ld

t h a t a r e b o th e f f i c i e n t

p r o v id e

s u p p o rt.

s tro n g

w it h

s k ills

By s im p ly c u t t i n g
p r o v id in g
c re a te s

f u t u r e , c u t t in g

c o rp o ra te

be e x e r c i s e d
P r e s id e n t

on th e t a x

in co m e t a x

f e d e r a l b u d g e t,

In c r e a s e d

be r a i s e d

a u t o m a t ic

y e a rs a f t e r

ta x c u ts

fo r

in e f f ic ie n t

The s t a t e d

s a v in g s

and p r o d u c t i v e

s k e w in g

in co m e d i s t r i b u t i o n

In d e e d , r e a l i z i n g

p h y s ic a l c a p it a l
in v e s t m e n t in
t r a in in g .
th e

F in a lly ,

F u rth e r,

is

is

s im p ly

needed.

le s s c o s t ly

It

th e

s u b s t it u t e s

f o r c o r p o r a t i o n s and th e w e l l -

fro m a f u l l

ta rg e te d

ta x

p ro g ra m — i n c e n t i v e s

fo r

i n c e n t iv e s

f o r p r o d u c tiv e

in v e s t m e n t in

in c e n t iv e s

f o r e d u c a t io n and s k i l l s

i n c e n t iv e s

p r o d u c tiv ity

f e d e r a l g o v e rn m e n t

em p lo ym e n t eco nom y w o u ld be

s h o u ld be m atched w it h

p a r t ic u la r ly

in v e s t m e n t and

th e c u r r e n t

t ilt in g

fo r

and jo b

f o r e m ploym en t and t r a i n i n g

w it h o u t u n f a i r l y

fe d e ra l d e f ic it

p r iv a t e

c o u n t r ie s

h a ve

th e

e c o n o m y.

to o u r

in f la t io n

s h o u ld be r e p la c e d

The s iz e
ra te

in

o f th e U .S .

th e

d e b a te

im p a c t o f

budget d e f ic it

b e a rs

o v e r th e p a s t s e v e r a l y e a r s .

s u c h a s Ja p a n and G erm any h a v e much lo w e r

M o re o v e r ,

p u b lic

to th e econom y o r o f t h e

th a n o u r s .

l a r g e l y u n a v o id a b le r e s u l t o f c o n t i n u in g




ye a rs

and w it h o u t b a n k r u p t in g th e

w it h much h ig h e r g o v e rn m e n t d e f i c i t s
and

th e

o f th e

lo o p h o le s , e l i m i n a t i n g

s u p p ly - s id e

( p l a n t and e q u ip m e n t)

r e la t io n s h ip

u n e m p lo y m e n t.

fu tu re

cut

th e

o f in c o m e .

g o v e rn m e n t on th e

M o re o v e r ,

in to

p e r s o n a l incom e t a x e s

ta x c u ts

w i t h m ore m e a n in g f u l m e a s u re s o f s t im u lu s

lit t le

ye a rs

l e v e l s , and r e d u c in g

1984, and f i n d i n g

th e s o c i a l d iv i d e n d

a d v a n ta g e o f a d d in g t o

d is t r ib u t io n

fo r

in v e s t m e n t — can c e r t a i n l y be a c h ie v e d w it h o u t u n f a i r l y

human c a p i t a l

P u b li c

b y c lo s in g

o b j e c t i v e s o f th e

m uch m ore e f f e c t i v e .

and

R eagan p ro g ra m

O v e r ly a m b it io u s t a x

e x te n d

re v e n u e f o r

s u p p ly -s id e

t o -d o ,

p o o r,

th e

The v i r t u a l e l i m i n a t i o n

and a 25 p e r c e n t c u t in

ir r e s p o n s ib ilit y .

f o r th e w o r k in g
r e c ip ie n t s ,

s id e .

R e a g a n 's t a x b i l l

g o v e rn m e n t in co m e b e lo w v i a b l e

p o w e r o f th e

th e h i g h l y

s e lf

b y p e rm a n e n t

t o w o rk o r a d j u s t t o new e c o n o m ic c o n d i t i o n s .

m ig h t m ost e f f e c t i v e l y

fo r

w o r k e r s o r t h o s e d i s lo c a t e d

on th e e a r n in g s o f w e l f a r e

s h o u ld

im p o se d as p a r t o f

p ro g ra m s

ne ed ed b y i n d u s t r y a r e e x a m p le s o f p r o p e r p ro g ra m d e s ig n .

s tro n g d is in c e n t iv e s

s t a b iliz in g

L ik e w is e , e x p e n d it u r e

p ro g ra m s o r r e d u c in g b e n e f i t s

a 95% t a x

C a u t io n

and f a i r

f o r p e o p le t o move from d e p e n d e n c y t o

R e t r a in i n g d is a d v a n t a g e d

la y o ffs

fis c a l

in c e n t iv e s

H ig h d e f i c i t s

in f la t io n

ra te s

a re a n a t u r a l

s lo w g ro w th and e x c e s s iv e

s i z e o f th e d e f i c i t

is

d o u b ly d i s t o r t e d

b y h ig h

51

in f la t io n
s e r v ic e

and h ig h i n t e r e s t r a t e s ;

h a v e been th e

o v e r th e

p a st d ecad e , o u t la y s

an a n n u a l r a t e o f 19 p e r c e n t com pared w it h
p ro g ra m s and 11 p e r c e n t f o r
f e d e r a l g o v e rn m e n t w i l l
t r a ilin g

15 p e r c e n t

th e b u d g e t a s a w h o le .

fo r

T h is

spend m ore th a n $110 b i l l i o n

o n l y th e m i l i t a r y

F ig h t in g

fo r debt

f a s t e s t g r o w in g m a jo r se g m e n t o f th e b u d g e t ,

r is in g

at

in co m e t r a n s f e r
y e a r a lo n e ,

on i n t e r e s t

th e

p a y m e n ts —

and S o c i a l S e c u r i t y among f e d e r a l e x p e n d it u r e s .

In fla t io n

A c o m p re h e n s iv e a n t i - i n f l a t i o n
in f la t io n -f ig h t in g

s t r a t e g ie s

p o lic y

s h o u ld c o m b in e f o u r b a s ic

(n o n e o f w h ic h a r e used

( 1 ) A b a la n c e d g e n e r a l e c o n o m ic p o l i c y
in v e s t m e n t in p h y s i c a l and human c a p i t a l ,

in

th e

Reagan p r o g r a m ):

aim ed a t s t e a d y g r o w t h ,

and h ig h

s tro n g

le v e ls o f c a p a c it y

u t iliz a t io n ;

(2 ) A ta rg e te d
c o s ts ,

s e c to ra l

p ro g ra m d e s ig n e d

and im p ro v e e f f i c i e n c y

in

( 3 ) An e q u it a b le w a g e -p r ic e
ba s e d on a f a i r

s h a r in g o f th e

to

in c r e a s e

in f la t io n -le a d in g

p o l i c y d e v e lo p e d

s a c r if ic e s

need ed

s u p p ly ,

and re d u c e

s e c to rs ;

on a c o o p e r a t i v e
to b r in g

b a s is

in f la t io n

and

under

c o n t r o l ; and

(4 ) A p o lic y to

in s u la te

th e A m e ric a n econom y a s much a s p o s s ib le

e x t e r n a l f i n a n c i a l and e n e r g y and fo o d

p r ic e

Th e m ost a p p r o p r ia t e m a c ro e c o n o m ic p o l i c y
is

su m m a rize d in th e p r e v io u s

h o w e v e r,
in f la t io n

s e c t io n .

c a n n o t m eet s p e c i f i c
we have e n d u re d

te x tb o o k case o f i n f la t io n

in

th e

fo r

th e

f ig h t

a g a in s t

in f la t io n

G e n e r a l m a c ro e c o n o m ic p o l i c i e s

in f la t io n a r y

in

fro m

shocks.

p re s s u re s

1970s and e a r l y

an o v e r -h e a t e d

in

o u r e c o n o m y,

1980s i s

a lo n e ,
The

n o t th e c la s s ic

e c o n o m y, w h e re m any p r o d u c t and

l a b o r m a r k e ts a re pushed up a g a in s t t h e i r c a p a c i t y l i m i t s .

A p o l i c y o f e x c e s s iv e m o n e ta ry and f i s c a l
a g a in s t th e s e c t o r a l c a u s e s o f i n f l a t i o n ,
a t g r e a t u n n e c e s s a ry c o s t t o
r e c e s s io n

is




r e s t r a i n t c a n n o t succeed

or w ill

th e econom y and th e

n o t th e s o l u t i o n .

In d e e d , r e c e s s io n

s u c c e e d o n l y b y a c c id e n t and
p e o p le .

S im p ly s t a t e d ,

o n ly e x a c e rb a te s th e

lo n g -r u n

52

in f la t io n

p ro b le m b y c u t t i n g

in v e s t m e n t in

human r e s o u r c e s

and new p r o d u c t i v e

c a p a c it y

An a n t i - i n f l a t i o n a r y
fo c u s

on th e

fo u r

p o lic y

s e c to rs

fo r

a p r im a r ily s e c to ra l

in f la t io n

t h a t a c c o u n t f o r 60 p e r c e n t o f U .S .

s h o u ld

in f la t io n :

1.

E n e r g y : E n c o u r a g in g e n e r g y c o n s e r v a t io n o f a l l k i n d s , r e s i d e n t i a l ,
in d u s t r ia l
c o m m e r c ia l
t r a n s p o r t a t i o n , e t c . , p r o m o tin g th e
d e v e lo p m e n t o f new d o m e s tic s u p p li e s , p a r t i c u l a r l y th o s e o f a
r e n e w a b le n a t u r e , and b u i l d i n g up p e tr o le u m r e s e r v e s as r a p i d l y as
p o s s ib le t o re d u c e v u l n e r a b i l i t y t o e x t e r n a l e n e r g y s u p p ly and
p r ic e sh o c k s.

2.

H o u s in g : A c t i v e l y e x p a n d in g — n o t r e s t r i c t i n g — new s u p p ly and
d e v e lo p in g t e c h n o l o g i e s f o r r e d u c in g c o s t s in th e c o n s t r u c t i o n
new h o u s in g .

of

3.

F o o d : U s in g p e r i o d s o f h ig h p r o d u c t io n and lo w p r ic e t o b u i l d g r a in
r e s e r v e s d o m e s t i c a l l y and i n t e r n a t i o n a l l y , and d e v e lo p in g a g r a i n
e x p o r t b o a r d , a s used in th e o t h e r tw o l e a d in g g r a in e x p o r t i n g
c o u n t r i e s , Canada and A u s t r a l i a , t o manage e x p o r t s a le s t o l a r g e
fo r e ig n b u y e rs ,

4.

H e a lt h C a r e : E n c o u r a g in g f u r t h e r p r e v e n t iv e h e a lt h c a r e t h r o u g h
h e a lt h m a in te n a n c e o r g a n i z a t i o n s (HMOs) and m o v in g to w a rd a s y s te m
o f n a t i o n a l h e a lt h i n s u r a n c e t h a t w i l l re d u c e r a t e s o f i l l n e s s and
d is e a s e and c o n t a in th e c o s t s o f t r e a t i n g th e m .

As a f i n a l
p ro p o s e d b y th e
a n n u a l ly

in

s e c t o r a l c o n c e rn ,

re a l

in f la t io n a r y

s u b je c t

b id s ,
fa c t

te r m s )

p re s s u re

th e n a t u r e o f th e

The r e a s o n d e fe n s e

p r o c u re m e n t p r o c e s s .

p ro c u re m e n t

is

th e

la s t

w eapons s ys te m s t o t a l l e d
e n tir e

p r o d u c tiv e

p ro g ra m s ; i t
w e ll

so u rce

s h ift s

c iv ilia n

fo r

1982.




lie s

in

h a r d ly

60 p e r c e n t o f
ba sed on c o m p e t i t iv e

is

illu s t r a t e d

th e o v e r r u n

a b o u t e q u a l to th e

in d u s trie s

th e re b y

1980 a lo n e ,

is

b y th e

on 40

A d m in is t r a t io n ’ s

The d e fe n s e s e c t o r can d r a in

k e y human r e s o u r c e s ,

up p r i c e s ,

(7 p e r c e n t

so i n f l a t i o n a r y

p ro c u re m e n t p ro b le m

$4 7 .6 b i l l i o n ,

as s c a r c e m a t e r i a l s aw a y fro m

s h o r t a g e s b id

s p e n d in g i s

and o n l y 8 p e r c e n t i s

t h r e e m on th s o f

d o m e s tic b u d g e t c u t s

aw a y fro m

s p e n d in g

The p ro c u re m e n t p r o c e s s

p r e s s u r e s o f th e m a r k e t p la c e ;

s o le

The m a g n itu d e o f th e d e fe n s e
t h a t d u r in g

o f m ilit a r y

and e n d o rs e d b y C o n g re s s

m ust be e xa m in e d as an in d e p e n d e n t s o u r c e o f

t o th e c o m p e t i t iv e

m ilit a r y

th e a c c e le r a t io n

Reagan A d m i n i s t r a t i o n

c a p ita l

and aw ay from o t h e r g o v e rn m e n t
su ch as s c i e n t i s t s

th e c i v i l i a n

i n c r e a s in g

econom y.

in f la t io n .

and e n g i n e e r s ,

as

These r e s o u rc e
W h ile

we m u st m a in t a in

53

an a d e q u a te n a t i o n a l d e f e n s e , we m u st a l s o
o f r a p id ly e s c a la tin g m i l it a r y
arm s r e d u c t i o n
to

The t h i r d

r e d u c in g
w o rk ,

in f la t io n

le v e ls .

m ust be on th e t a b l e — n o t j u s t

its

f o u n d a t io n o f th e

F o r s u c h a c o n s e n s u s -b a s e d

p o lic y

in

and a l l

s u c h a s y s te m

end o f t h e b a r g a in — f a i r

is

in

in

b r in g in g

t h e y see a l l o f us s h a r in g th e b u r d e n .

T h is

on

to

fo rm s o f in co m e
and

goe s beyond

and e f f e c t i v e
in f la t io n .

a p a rtic ip a to ry

s h a r in g o f s a c r i f i c e s

A m e ric a n s a r e r e a d y t o a c c e p t s a c r i f i c e
if

s t e a d ily

s u c c e s s o f s u c h a s y s te m
and a f a i r

a m ech an ism

t h a t a r e c o n s is t e n t w it h

c o n s is t e n t w it h e c o n o m ic g r o w th and r e d u c in g

m a k in g d e c i s i o n s

is

th e w ages o r p r i c e s , b u t r e n t s , d i v i d e n d s ,

The g o v e rm e n t’ s r o l e

e n fo rc e m e n t to u p h o ld in g

p o lic y

and i n d u s t r y a t th e h ig h e s t l e v e l s

w age , and incom e g r o w th r a t e s

i n t e r e s t as w e l l .

im p a c t

p u rs u e

and p e rs u a d e o u r o v e r s e a s a l l i e s

th e k e y p l a y e r s m ust ta k e p a r t d i r e c t l y ;

p o lic ie s

t h e c r u s h in g
v ig o r o u s ly

e le m e n t o f a c o m p r e h e n s iv e a n t i - i n f l a t i o n

th e o v e r a l l

a ll

le s s e n
s h o u ld

s h a re o f th e d e fe n s e b u r d e n .

a g re e m e n t among g o v e rn m e n t, l a b o r ,

th e p r i c e ,

We a l s o

and d is a rm a m e n t n e g o t i a t i o n s

s h o u ld e r a f a i r

fo r

se e k t o

s p e n d in g .

e c o n o m ic

The

p ro c e s s

fo r

im p le m e n tin g t h e r e s u l t s .
down i n f l a t i o n ,

p e rc e p tio n

but

o n ly

does n o t e x is t

u n d e r R e a g a n o m ics .

Re b u il d in g A m e ric a n I n d u s t r y

The e s s e n ce o f sound e c o n o m ic p o l i c y
th e w id e v a r i e t y o f p u b li c

and p r i v a t e

n a t i o n ’ s c a p a c it y to a c h ie v e
p r ic e s .

g o a l s , r e v ie w p r i v a t e
p o lic ie s ,

a ll

th e m a jo r c o n c e rn e d

S uch c o n s u l t a t i v e
T r ip a r t it e
s te e l

C o m m itte e ,

in d u s try ,

i n d u s t r y 's

la b o r

e m p lo y m e n t,

o b je c t iv e s ,

p o lic ie s .

w ill

s e c to r

p a r t ie s — in d u s t r y ,

in

in v e s tm e n t t a x e s ,

lo n g - t e r m

p r o p e r m ix o f

s u c h d is c u s s i o n s m ust
la b o r

t h is

to g e th e r

and g o v e rn m e n t

c o u n try ,
th e

The S t e e l

l e a d e r s h ip o f' th e

and th e heads o f th e g o v e rn m e n t a g e n c ie s t o

e n v ir o n m e n t a l p r o t e c t i o n ,

integrate

s t a b iliz a t io n

and c o n s t r u c t th e

1977- b r o u g h t

be t o

t h a t b e a r on th e

and d is c u s s r e a l i s t i c

To be e f f e c t i v e ,

fo ru m s h a ve w o rk e d w e l J
form ed in

fu tu re

e c o n o m ic g ro w th and s t a b l e

p u b li c

p ro b le m s o f i n t e r n a t i o n a l t r a d e ,




th e

to e s t a b l i s h

s e c to r resp o n se s to

r e s o lv e c o n f l i c t i n g

g e n e r a l and s e l e c t i v e
in v o lv e

fu ll

A means m ust be c r e a t e d

in

s e c to r d e c is io n s

o c c u p a t io n a l

e x a m in e th e

s a f e t y and h e a lt h ,

p la n t c lo s in g s

and

54

w o r k e r / c o m m u n ity a d ju s tm e n t p r o g ra m s ,
In

th e summer o f

and new t e c h n o lo g y f o r

1980, t h e S t e e l T r i p a r t i t e

o f re c o m m e n d a tio n s t o th e
th e w id e l y a c c la im e d

"s te e l

In d u s tr y

C o o r d in a t io n

c o n s t r u c t i o n m anagem ent,

o f f ic ia ls

re d u c e th e e x tre m e s e a s o n a l

t o d e v e lo p w a ys t o

a c t i v i t y — f lu c t u a t io n s

c r e a t i n g m anpower and r e s o u r c e

P r o d u c t io n

B r i n g in g

th e

to g e th e r

a s ta k e
to

In may a r e a s we s u f f e r
but ra th e r

r e s o u r c e s among i n d u s t r i e s
fo ru m

fo r b u ild in g

t r a n s p o r t a t io n ,

o fte n

in d u s tria l

g e n e r a t io n

o b s e rv e d

In

d e v a s t a t io n
s tre n g th

c o u n t r ie s




our

such as

o f th o s e

to d a y c a l l s

fo r

a

o f o u r a g in g and weakened i n d u s t r i a l b a s e ,

th a t

Ja p a n ,

G erm any and o t h e r

lie s

fa r

in

E u ro p e a n c o u n t r i e s
th e ir

t h e ir

t h ir d

by a l l

to r e s t o r e

and in

d u rin g

and

th e p a s t and d oes n o t a c c o u n t f o r

fo u rth

th e ir

t h e s e c o u n t r i e s d id

o f th e g ro u p s i n

t h e ir

c o n s e n s u s -b u i ld in g

a c tio n ,

in d u s tr ie s ,

in

su p p osed " a d v a n t a g e " o f t o t a l

B u t one e n d u r in g g a in

w o rk t o g e t h e r

f a c ilit ie s .

c a p a c it y d e s t r o y e d

th o s e c o u n t r ie s a r e now i n t o

to d a y .

c o n c e rte d

o f t h e ir

The c h a lle n g e

c o m m u n ic a tio n and e n e r g y - p r o v i d i n g

q u i c k l y p ro d u c e d

c o n s u lt a t io n ,
fu tu re

t a r g e t s c a r c e r e s o u r c e s and r e v i t a l i z e

e x p e r ie n c e was a r e c o g n i t i o n

t h a t t h e y had t o

m anagem ent

n o t fro m a s h o r t a g e o f r e s o u r c e s ,

o f i n d u s t r i a l e q u ip m e n t; t h i s

e c o n o m ic
t h is

o f la b o r

f u t u r e o f o u r econom y w o u ld

a s a r e s u l t o f h a v in g t h i s

fa c t,

m ilit a r y

fro m

th e

and th e N e t h e r la n d s w ere g iv e n a g r e a t b o o s t

c a p a b ilit y

W o r ld V/ar I I .

and th e War

a p o l i c y c o n s e n s u s t o a d d re s s such n e c e s s a r y q u e s t io n s as

and th e r e c o n s t r u c t i o n

is

O th e r

and g o v e rn m e n t we h a ve th e

fro m an i n e f f i c i e n t a l l o c a t i o n

i n c lu d in g

It

in

and among u s e r s .

in f la t io n

s u c h as A u s t r i a

in d u s try .

F o r m ore g e n e r a l

(R F C )

th e e x p e r ie n c e and e x p e r t i s e

u n d o u b t e d ly im p r o v e o u r a b i l i t y

in v e s tm e n t c a p i t a l ,

th e c o n s t r u c t i o n

in

p re s s u re s by

1930s and 19 40s.

g o v e rn m e n t and o t h e r s w it h

e c o n o m y.

f lu c t u a t io n s

and c o a l i n d u s t r i e s .

F in a n c e C o r p o r a t io n

C o m m itte e s

and c o n c e rn e d g o v e rn m e n t

in f la t io n a r y

among b u s in e s s , l a b o r ,

R e c o n s tru c tio n

B oard fro m

t h a t add t o

s h o r t a g e s in

th e a i r l i n e

e c o n o m ic p o l i c y c o n s u l t a t i o n
e x a m p le s o f th e

set
to

s t r e t c h - o u t ” f o r m e e tin g e n v ir o n m e n t a l d e a d lin e s
The C o n s t r u c t io n

have b ro u g h t to g e th e r la b o r ,

r e c e n t e x a m p le s i n c l u d e

p r o d u c tio n .

P r e s id e n t , many o f w h ic h w ere a c c e p t e d , le a d i n g

and o t h e r p o l i c y c h a n g e s .

c o n s t r u c t io n

s te e l

C o m m itte e made a w id e - r a n g i n g

s h a tte re d

in s t it u t io n s

t h e ir

e c o n o m ie s .
fo r

r e c e iv e
s o c ie t ie s
Th e se

jo in t

some c a s e s j o i n t d e c i s i o n - m a k i n g

r e g i o n s , and n a t i o n a l e c o n o m ie s .

on th e

55

S in c e e x i s t i n g

fo rm a l o r

N a t io n a l E co n o m ic P o l i c y
b o a rd w o u ld

in c lu d e l a b o r ,

F e d e r a l R e s e rv e B oard a ls o

F ir s t ,
h e ld

in fo rm a l

B oard

(N E P B )

in s t it u t io n s
s h o u ld

a re n o t s u f f i c i e n t ,

be c r e a t e d .

a

The m em bers o f th e

b u s in e s s , g o v e rn m e n t,

and in d e p e n d e n t e x p e r t s .

s h o u ld

r o le .

p l a y an a c t i v e

th e b o a rd w o u ld p r o v id e

a m eans t h r o u g h w h ic h d is c u s s i o n s c o u ld

r e g u l a r l y on e co n o m ic p e rfo r m a n c e and f o r e c a s t s ,

and th e r e a c t i o n o f p r i v a t e

s e c to r

m a jo r m echanism f o r p r o v i d i n g

The

in s t it u t io n s .

c o n t in u it y

in

In

s t a b iliz a t io n
a d d it io n ,

e c o n o m ic p o l i c y ,

it

be

p o lic ie s

w o u ld be a

p a r tic u la r ly

as

A d m in is t r a t io n s change .

S e c o n d , th e b o a rd w o u ld p r o v id e
in c o m e s p o l i c y needed in th e

th e r i g h t

th e econom y w ou ld be r e p r e s e n t e d , and in
r e s p o n s ib ilit y
and p r i c e

It

is

not at a ll

c le a r

t h a t a w a g e -p ric e

fo r m id a b le o p e r a t io n a l p r o b le m s t o

t h e y w o u ld a l s o

in to

p o l i c y can be made t o w o r k .

is

e it h e r e s c a la tin g

in f la t io n

c o n tr o ls .

N e v e r t h e le s s ,

o r h ig h l e v e l s

th e c o n s e n s u s p r o c e s s r a t h e r

c o n s e n s u s no s ys te m w i l l

T h ir d ,

e ith e r

The U .S .

o f c le a r

and s y s t e m a t ic

and eve n

in te r e s t

to

r e s o lv e

s e c to r p o lic ie s

t h in k in g .

s tru c tu ra l
w it h

in d u s tr ia l




p o lic y .

I w o u ld

b e c a u s e w it h o u t

f r a m in g a c o h e r e n t i n d u s t r i a l

p o lic y ,

p o lic ie s ,

l e a s t u n d e r s ta n d

th e ir

but

ta x e s ,

it

fo r

is

fa c t,

t im e

th e a b s e n c e o f a m ore s y s t e m a t ic

its

e n e rgy,

o f th e

and f i r m s .

n e e d s , and

In

in te g ra te

t o c o o r d in a t e

th o s e

One o f A m e r i c a 's
fa ilu r e

e x p o rt-d riv e n

U .S .

n o t th e r e s u l t

s tru c tu re

consequences.

f o r e ig n

is

in d u s tr ie s

fu tu re

t o G erm a ny and Japan i s
In

it

r e g u la t io n s ,

im p a c t on th e

o r l a c k o f th e m ,

s t a b iliz a t io n

p o lic y .

f o r m u la ,

p o lic y ,

p r o b le m s , a n t i c i p a t e

m a jo r d is a d v a n t a g e s r e l a t i v e

p o l i c i e s — in

T ra d e

r a t e s h a ve a s i g n i f i c a n t

d e c i s i o n s and a t th e

s y s t e m a t ic

fo r

a l r e a d y h as an i n d u s t r i a l

econom y and th e o p p o r t u n i t i e s ,

th e

be a d o p te d o r w o rk s a t i s f a c t o r i l y .

th e b o a rd w o u ld be th e v e h i c l e

p o lic y .

o rd e r

th a n a s p e c i f i c

if

o f u n e m p lo y m e n t, i t

im p o r t a n t t o a tte m p t t o g a in c o n s e n s u s on some w a g e - p r i c e

s tre s s

h a ve

w h ic h s u c c e s s f u l w age

a n y s u c h p o l i c y — w h e th e r a t a x -

in co m e s p o l i c y o r d i r e c t wage and p r i c e

a lte r n a tiv e
is

th e b o a rd

f o r th e o v e r a l l e c o n o m ic p o l i c i e s

o u t th e

Th e m a jo r e le m e n ts o f

p o l i c i e s m ust f i t .

T h e re a r e
based

fra m e w o rk f o r w o r k in g

f i g h t a g a in s t i n f l a t i o n .

in d u s t r ia l

t o d e v e lo p a

in d u s t r ia l
p o l i c y — h ave

56

u n d e rm in e d t h e
m a c h in e t o o l s

f u t u r e o f A m e ric a n
to

The c o r e o f A m e ric a n
c o m p e t i t io n .

in d u s t r y

s e m ic o n d u c t o r s and f i b e r

in d u s try w il l

in

s e c t o r s r a n g in g

fro m

s t e e l and

o p tic s .

n o t lo n g s u r v i v e

The w o rk o f th e b o a rd and i t s

su c h u n e q u a l

i n d u s t r y c o m m itte e s s h o u ld be

au gm e n te d b y an i n d u s t r i a l d e v e lo p m e n t ba n k t o c h a n n e l in v e s t m e n t i n t o
te rm

e c o n o m ic d e v e lo p m e n t,

r e s o u r c e s w it h
H o w e v e r,

it

s p e c i a l c o n s id e r a t i o n g iv e n

w o u ld be in

a p p ro p ria te d

Such a bank c o u ld

th e n a t i o n a l

be fin a n c e d

t o u s in g p o o le d

in te r e s t

fu n d s and be a u t h o r i z e d

la r g e ly
p e n s io n

f o r th e ba n k t o

to b o rr o w a d d i t i o n a l

lo n g ­

b y p r iv a t e
fu n d m on e y,

r e c e iv e

fu n d s .

The

d e v e lo p m e n t ba n k c o u ld

c o m b in e e x i s t i n g

g iv e

t o th e c r e d i t n e ed s o f s m a ll b u s in e s s e s and s t a t e

s p e c ia l a t t e n t io n

l o c a l g o v e rn m e n ts .
R e c o n s t r u c t io n

The b a n k c o u ld

F in a n c e

be p a tt e r n e d

C o r p o r a t io n

The c o n c e p t o f i n d u s t r i a l
" p ic k in g

e s t a b l is h e d

o f o u r eco n om y.

th e g r o w th

s c a le

T h i s m eans p r o v i d i n g

s e m ic o n d u c t o r s ,

in

th e

le a d

t e x t ile

r e in v ig o r a t in g
e ro d e d

in

in d u s t r y ,

U .S .

1932.

o r r e g io n s .

fo r e ig n

e s t a b l is h e d

in

in d u s t r ia l
th e

p o lic ie s

to
a re

s u p p o rt i n e f f i c i e n t
to o

fra g m e n te d

r e s p e c t to

th e

p r e s s u r e s w h ic h w ou ld ca u se i t

in d u s tr ie s

it

on C o n g r e s s io n a l r e v i e w

is
is

fro m

not at a ll
in f e r io r

b a n k fro m u n d e s ir a b le
R e s e r v e B o a rd .




a b ro a d .

p o litic a l

h a s been

a re t h a t

it

cannot

t o make d e c i s i o n s

and t h a t th e A m e ric a n g o v e rn m e n t and s o c i e t y
s u p p o rt in d u s t r ia l
c le a r

p o lic ie s ,

th a t a p o lit ic a l

W ith

d e c is io n

based

to e co n o m ic d e c i s i o n s b a s e d on s h o r t - r u n

m a r k e t c o n s id e r a t i o n s t h a t w o u ld d e s t r o y b a s ic
u n f a i r c o m p e t it io n

to

seen

i n s t a l l m odern e q u ip m e n t and t e c h n o l o g y ,

and a d v e r s a r i a l t o

fir s t ,

th re a te n

a n n u a l ly ,

p o s it io n

Two o f th e m ain a rg u m e n ts a g a in s t an i n d u s t r i a l p o l i c y
fro m p o l i t i c a l

lik e

su c h as l a r g e -

1970s, w h ic h h a s been

i n d u s t r i e s w hose c o m p e t it iv e
to

our goal

in d u s t r ie s

in d u s t r ie s

now a n e t e x p o r t e r o f some $3 b i l l i o n

e s t a b l is h e d

p a rt by a f a ilu r e

be in s u l a t e d

th e w in n e r s ” o r

To t h e c o n t r a r y ,

needed s t im u lu s t o b a s ic

h ig h -t e c h n o lo g y ,

w h e re a g g r e s s iv e

t h a t th e

in

and

s u c c e s s fu l

p o t e n t i a l and c o m p e t it iv e n e s s o f e v e r y p a r t

s t e e l and a u to and t o h i g h - g r o w t h ,

w ip e o u t th e

a f t e r th e

p o l i c y d o e s n o t im p ly " p i c k i n g

th e l o s e r s ” among i n d u s t r i e s

s h o u ld be t o m a x im iz e

F e d e r a l c r e d i t p ro g ra m s and s h o u ld

Even s o ,

it

in d u s t r ie s , o r

s u b j e c t them to

w o u ld be p o s s ib le

p r e s s u r e s as has been done w it h

to

in s u la t e

th e F e d e r a l

th e

57

W ith r e s p e c t to th e secon d a r g u m e n t,
p o lic y

is

to o

to o a d v e r s a r i a l ,

but th a t is

o v e rc o m e th e s e p r o b le m s .

p r e c is e ly

c o m p e t it iv e n e s s and th e f u l l

As th e

t e x t ile

b u s in e s s .
p o lic y

(in c lu d in g

g o o d s ),

p r o v id in g

s p e c if ic

lim it e d

and s t e e l

th e

p r iv a t e

e c o n o m ic
s e c to r

a re

needed— to

to e c o n o m ic

s t a b ilit y ,

g ro w th ,

liit o r n n t lo n n I

use o f o u r human and m a t e r i a l r e s o u r c e s .

i n d u s t r y e x a m p le s d e m o n s t r a t e ,

R&D to w a rd a r e a s w i t h

f o r c in g

t h a t A m e ric a n

w it h

o t h e r c o u n t r ie s

a n t i t r u s t w a iv e r s

p r o v id in g

m any e le m e n ts o f

c a p ita l

c o m m e r c ia l p r o m is e ,
to

s u b s id ie s t o
a d ju s t in g

lo w e r u n f a i r b a r r i e r s

fo r jo in t

R&D a c t i v i t i e s

in

to

tra d e

U .S .

la r g e -s c a le

and a d o p tin g e n v ir o n m e n t a l and o t h e r r e g u l a t o r y r e q u ir e m e n t s t o

c o n d it o n s

le g is la tio n
c o s t-fre e

tru e

w hy s u c h a m ech an ism i s

i n d u s t r i a l p o l i c y do n o t i n v o l v e

T a r g e t in g

in d u s t r ie s ,

is

C o o n H n a t J o r j at)4 Qonzerawti

b u t t h e y p r o b a b ly a re e s s e n t i a l

a s u c c e s s fu l

it

fra g m e n te d and g o v e rn m e n t r e l a t i o n s

in

in d iv id u a l

in d u s tr ie s

(e .g .,

f o r i n d u s t r y c le a n a i r c o m p lia n c e )

in s t r u m e n t s o f i n d u s t r i a l

e co n o m ic r e s o u r c e s in

d e v e lo p m e n t and f u l l

p o lic y .

th e " s t e e l

illu s t r a t e s

O ur n a t io n

a w ay t h a t w i l l

s tre tc h -o u t"

th e v a r i e t y

needs to

of

ta rg e t

a s s u r e h e a lt h y i n d u s t r i a l

em p loym en t f o r th e A m e ric a n econom y o f th e

1980s and

beyond.

P u b li c
g ro w th .

in fra s tr u c tu r e

in v e s tm e n t i s

O ur r o a d s , b r i d g e s ,

p o rts ,

a ls o

v ita l

to

s tro n g

p r o d u c tiv ity

and w a t e r s y s te m s n o t t o m e n tio n r a i l

bed s, tra c k s ,

and r o l l i n g

r e p la c e m e n t,

Pat C h o a te and Susan W a lt e r h a ve c o m p le te d a s u r v e y o f u r g e n t

in fr a s t r u c tu r e

s to c k a re

in

u r g e n t need o f u p g r a d in g

in v e s tm e n t n e e d s t o t a l l i n g

o v e r $3 t r i l l i o n

1 9 9 0 s.^ C o u n t r ie s s u ch as F ra n c e and Ja p a n h a ve used p u b li c
p r o fita b le

h ig h speed r a i l

t r a n s p o r t a t io n

in n o v a tio n

and e x p o r t s ,

a d d it i o n

in

to

or

f o r th e

1980s and

in v e s t m e n t in

a s a s p u r t o new i n d u s t r i a l

t h e ir d ir e c t b e n e f ic ia l

im p a c t on

im p ro v e d d o m e s tic t r a n s p o r t a t i o n .

F in a lly ,

it

m ust be r e c o g n iz e d

b u s in e s s in v e s t m e n t in

t h a t th e g r e a t e s t

new p r o d u c t i v e

s in g le

p l a n t and e q u ip m e n t i s

d e t e r m in a n t o f
n o t s p e c ia l

g im m ic k s b u t r a t h e r s t e a d y g ro w th o f demand and a v o id a n c e o f r e c e s s i o n s .
M o v in g o u r econom y to w a rd
c o n t r ib u t io n

p r o d u c t i v i t y g r o w th .




f u ll

e m p lo ym e n t i s

we can make to w a rd s t r e n g t h e n in g

th e

s i n g l e m ost i m p o r t a n t

in d u s t r y

and i m p r o v in g

ta x

58

E q u i t y and E f f i c i e n c y : A F u l l Em p lo ym e n t S o c ie t y

C o n s e r v a t iv e
e f f ic ie n c y

a re

and s u p p l y - s i d e

in c o m p a t ib le

m ore im p o r t a n t t o
e q u it y ,

g o a ls

u n d e r s ta n d

and t h a t e q u i t y

e c o n o m is ts o f t e n

c o n te n d

f o r o u r econom y.

In t h e

t h a t e q u i t y and
1980s,

it

is

fa r

t h a t e f f i c i e n c y may be u n o b t a in a b le w it h o u t

and e f f i c i e n c y

g o a ls m ust be m erged

to

a c h ie v e

a m ore

s u c c e s s f u l econom y and a m ore humane s o c i e t y .

A f u ll

e m p lo ym e n t s o c i e t y b e s t r e p r e s e n t s th e p r a c t i c a l

and e f f i c i e n c y .
p r o d u c tiv ity

F u l l e m p lo y m e n t i s

and re d u c e d

in f la t io n .

A m e ric a n a b le and w i l l i n g
a c h ie v in g

fu ll

th e d i g n i t y

fu ll

u n e m p lo y m e n t can be b r o u g h t i n t o
th a t o n ly

in d u s tria l

A c h ie v in g

u rb a n

ta x b a s e s ,

em p lo ym e n t f o r a l l

to

th e

th e

fu ll

th e w o r k in g

econom y and
F u l'

g ro u p s o f o u r

as w e l]

em p lo ym e n t a ls o p r o v id e s

c it iz e n s ,

w e lfa r e ,

th e m ost

c r im e ,

d e t e r io r a t in g

e d u c a t io n a l a c h ie v e m e n t

p o lic y

to p r e p a re o u r w o rk e rs

jo b s o f t o d a y and to m o rro w .

ta x

re w a rd s

W h ile th e A d m i n i s t r a t i o n

on im p r o v in g th e p h y s i c a l
fo r

p r o d u c tiv ity

p r o d u c t io n

s id e o f th e

lik e ly

to h a v e .

We s h o u ld

m is ta k e n a rg u m e n t t h a t th e
in v e s t m e n t in

p e o p le ,

c a p ita l

p ro c e s s :

th e

n e c e s s a ry fo r

The F e d e r a l e m p lo ym e n t and t r a i n i n g

s y s te m

d e s p it e num erous p ro b le m s t h a t a n y new p ro g ra m
c o n c e n t r a t e on s o l v i n g
p ro g ra m s do n o t w o rk ,

f in a n c ia l

and u n d e rm in e s p r o s p e c t s




th e w o r k e r s and s k i l l s

o r human c a p i t a l ,

A d m i n i s t r a t i o n ’ s m a s s iv e

and

p r o d u c t io n

new p l a n t and e q u ip m e n t and r e s e a r c h and

and e c o n o m ic g r o w t h .

h a s w o rk e d r e a s o n a b ly w e l l ,

b y an

and p o t e n t i a l

d e v e lo p m e n t— t h e y h a ve s im u lt a n e o u s l y t u rn e d away from a co m m itm e n t t o
human s id e o f th e

In

t im e s o f

fra m e w o rk o f e c o n o m ic p o l i c y n e ed s t o be com p le m e n te d

C o n g re s s h a ve c o n c e n t r a t e d
p r o c e s s -^ w it h

in c r e a s e d

in o u r m odern s o c i e t y ,

p ro b le m s o f p o v e r t y ,

e m p lo ym e n t and t r a i n i n g

w o rk e rs f o r

to w a rd

p o t e n t ia l,

and d e c l i n i n g

The o v e r a l l
a c t iv e

a jo b can p r o v id e

and m a i n t a i n in g

" e f f i c i e n t !l s o l u t i o n

u n i t y o f e q u it y

F u l l em ploym en t a l s o m eans t h a t e v e r y

g r o u p s t h a t a re h a rd t o e m p lo y in

e m p lo ym e n t t h u s m eans f u l l
as o u r

ro u te

t o w o rk can e n jo y th e d i g n i t y o f a d e c e n t jo b ,

e m p lo y m e n t,

r e c e s s io n s o r h ig h
g iv e n

th e m ost e f f i c i e n t

d ir e c t ly

i n c e n t iv e s

fo r

fo r

th e p r o b le m s r a t h e r

U n d e rm in in g o u r c o u n t r y 's
c o n t r a d ic t s

t h is

in v e s t m e n t in

any p r o g r e s s to w a rd

p h y s ic a l

im p r o v in g

is

th a n a

u ltim a te

59

p r o d u c tiv ity ,
s e n s ib le

th e s t a t e d

t a r g e t o f th e A d m i n i s t r a t i o n ' s m a s s iv e t a x c u t s .

e c o n o m ic p o l i c y m ust r e v e r s e

p r o d u c tiv ity -e n h a n c in g
n u t r it io n ,

and s k i l l

R e a g a n o m ic s '

d e s tru c tio n

p ro g ra m s f o r e d u c a t i o n , c h i l d r e n ,

t r a in in g .

A m e r ic a ’ s h i s t o r i c a l

e d u c a t i o n a l s ys te m m ust be re n e w e d , n o t a b a n d o n e d .
t r a in in g

a ll

and c h ild h o o d

c om m itm en t t o

a s tro n g

And o u r e m p lo y m e n t and

p ro g ra m s need t o be im p ro v e d and e x p a n d e d , n o t w ip e d o u t i n

o f d e e p r e c e s s io n

and r a p id

e co n o m ic c h a n g e .

A

of

In v e s t m e n t i n

t h is

tim e

"hum an c a p i t a l "

is

th e m ore im p o r t a n t as o u r econom y becom es e v e r m ore t e c h n o l o g y - i n t e n s i v e

and c o m p le x .

In
w o rk e rs

th e

i n t e r e s t o f b o th e f f i c i e n c y and e q u i t y ,

s t r e n g t h e n e d , n o t w e a ke n e d , f o r th e
th e

19 80s.

p r o t e c t i o n o f u n em p loym en t in s u r a n c e

o rd e r

th e

p ro g ra m s t h a t p r o t e c t

fro m th e a d v e rs e c o n s e q u e n c e s o f e c o n o m ic d i s l o c a t i o n

t o make a t r a n s i t i o n

in to

e x p e r ie n c e can be u t i l i z e d
w o rk e r

P la n t c lo s i n g s

p ro g ra m s common i n
and move i n t o

a p p r o p r i a t e new jo b s w h e re t h e i r

and d e v e lo p e d — and n o t l o s t

th e s e

lin e s

e m p lo ym e n t,

to

jo b s need

s k ills

s o c ie t y

r e t r a in in g

in v e s tm e n t s

and t h e

and m o b i l i t y

w o r k e r s t o u p g ra d e t h e i r

in o u r c h ild r e n

( in c lu d in g

p r o d u c tiv ity w i l l

c o n s c io u s l y c o n s id e r e d , c o h e r e n t i n d u s t r i a l
a c c i d e n t a l and in c o h e r e n t i n d u s t r i a l

lo w

in te r e s t ra te s )

be s t r e n g t h e n e d
p o lic ie s

p o lic ie s ,

in

needed p u b li c

in v e s t m e n t in

th e p e o p le who make up o u r c o u n t r y and o u r w o r k f o r c e ,

o p t im is t ic
p e rc e n t,
S t e in ,
N ix o n :

A d m in i s t r a t i o n

"If

it s e lf

o f s a ilin g

P r e s i d e n t 's

th e c a p t a in
n o rth




o f th e

t o M ia m i,

s tro n g

p u b li c

n o t be m ore u r g e n t th a n a t

o f p e o p le a r e o u t o f w o rk and a c o n s i s t e n t l y
p r e d ic t s

u n e m p lo ym e n t c o n t i n u in g

We a re w e l l down th e c o u r s e d e s c r ib e d

c h a i r o f th e

th e

by s u b s t it u t in g

th e n e c e s s it y o f

c h a n g e o f c o u r s e c o u ld

In
to

p la c e o f t o d a y ’ s

b y u n d e r t a k in g

and b y r e c o g n i z i n g

g e a re d

in f r a s t r u c t u r e

The need f o r a d e c i s i v e

s k ills

and i n o u r w o r k e r s can

p r o d u c t iv it y g ro w th .

in v e s t m e n t i n

a tim e when r e c o r d m i l l i o n s

in
and

o f e m p lo y m e n t,

a v a i l a b l e means o f r e v i v i n g

c o n t e x t o f s t a b le m acro p o l i c i e s
fu ll

fo r

E u ro p e t h a t a l l o w d is p l a c e d

Ta ken t o g e t h e r

s h o u ld be
t h e ir

and o t h e r a d ju s t m e n t a s s is t a n c e

s h o u ld be a s t im u lu s

new p r o d u c t i v e

be seen as th e t h i r d

r e a c h in g

W o r k e rs who l o s e

C o u n c il o f E c o n o m ic A d v is o r s
s h ip s e t s o u t

'S t e a d y as y o u g o '

above 9

some m o n th s a g o b y H e r b e r t

fro m
w ill

u n d e r R ic h a r d

New Y o r k h a r b o r w it h
n o t be a s u s t a in a b l e

a p la n

60

p o lic y ,

and t h a t w i l l

p r e d ic t e d

be c l e a r b e f o r e th e

i c e b e r g s a re

s ig h t e d ."

when th e com pass s e t t i n g s o f R e a g a n o m ics w ere f i r s t

ic e b e r g s

a r e now a ro u n d u s , w it h

P r e s i d e n t 's

a b ilit y

A m e ric a n p u b l i c ,

to

s e ll

h is

e x c e ll e n c e

in

a ven ge an ce .

As many had

announced,

th e

W h ile m any a d m ire th e

p ro g ra m s t o a d is o r g a n iz e d
th e p u r s u i t o f e r r o r i s

C o n g re s s and

h a r d ly

a com m endable

v ir tu e .

i

fe e l

th e

fu ll

e m p lo ym e n t a l t e r n a t i v e

p a p e r p r o v i d e s a much m ore s o l i d

and c r e d i b l e

to

R e a g a n o m ic s o u t l i n e d

f o u n d a t io n

fo r

in

t h is

e c o n o m ic

re c o v e ry ,

The p ro p o s e d c o m b in a t io n o f c o o r d in a t e d
ta rg e te d

a n t i-in f la t io n

p o lic y ,

and a c t i v e

m ost d ir e c t

p o lic ie s ,

g e n e r a l e c o n o m ic

e m p lo y m e n t, e d u c a t io n and t r a i n i n g

p a th t o a f u l l

p o lic ie s ,

c o n s e n s u s b u i l d i n g m e c h a n is m s ,

em p lo ym e n t s o c i e t y .

It

is

p o lic ie s

in d u s t r ia l

r e p r e s e n t s th e

a p a th t h a t t h i s

c o u n try

m ust t a k e .

One o f th e b e s t in v e s t m e n t s a s o c i e t y can make i s
its
T h is

c it iz e n s
is

t o d e v e lo p

in

a c c o rd a n c e w it h

th e e s s e n c e o f th e

th e ir

F re e m a r k e ts re w a rd

n o t im p r o v e o p p o r t u n i t i e s
C r e a t in g

th e c o n d i t i o n s

fo r

fo r

r e s p o n s i b l i t y o f g o v e rn m e n t.
fro m w a n t,
ig n o r a n c e

fro m

and fro m




p e o p le — t o

a llo w

and i n t e r e s t s ,

k in d s o f fre e d o m s and

th o s e who h a ve m a rk e t p o w e r,

t h o s e who h ave . l i t t l e

w e a lt h o r

e q u a l o p p o r t u n i t y m ust t h e r e f o r e

b u t t h e y do

in c o m e ,
be a m a jo r

The f e d e r a l g o ve rn m e n t h as in c r e a s e d

d is c r im in a tio n ,

fro m p o o r h o u s in g ,

e c o n o m ic e x p l o i t a t i o n .

e m p h a s iz e o n l y t h o s e

its

fre e d o m we d e s ir e ,

The n a t i o n a l g o v e rn m e n t c a n n o t e m p h a s iz e c e r t a i n
fo rg e t o th e rs .

in

a b ilit ie s

fro m t y r a n n y ,

Freedom i s

fre e d o m

fro m

in d iv is ib le .

We c a n n o t

fo rm s o f fre e d o m t h a t b e n e f i t m a in ly th e p o w e r f u l

61

^ee
S e t t in g

C h a r le s S c h u l t z ,

^See R o b e r t J .
U n it e d

" L o n g Term B u d g e t S t r a t e g i e s

N a t i o n a l P r i o r i t i e s , W a s h in g to n ,

S ta te s ,"

B a rro ,

" U n a n t i c ip a t e d

D .C . :

Don N i c h o l s ,

A S tra te g y

E c o n o m ic C o m m itte e ,

Ju n e 2,

J.

Pechm an, e d .,

1982, p p .

M o ney, O u t p u t and P r ic e

J o u r n a l o f P o l i t i c a l Econom y 86 (1 9 7 8 ),

3

in

B r o o k in g s ,

1 8 7 -2 2 0 .

Level

in

th e

PP* 5 4 9 -8 0 .

f o r M o n e ta r y P o l i c y , T e s t im o n y b e f o r e

th e

J o in t

1982.

4I b i d .

5

* T a t C h o a te and Susan W a lt e r ,

A g e n c ie s ,

1982.

17-871 0




83

5

A m e r ic a i n

R u in s , C o u n c il o f S t a t e

P la n n in g

62

Representative R e u s s . Thank y o u , Mr. Marshall.
Mr. Wirtz.

STATEMENT OP WILLARD WIRTZ, CHAIRMAN OF THE BOARD,
NATIONAL INSTITUTE FOR WORK AND LEARNING, WASHING­
TON, D.C.
Mr. W i r t z . A personal note first, Mr. Chairman. I submit, quite
respectfully, that I was totally taken aback by your introduction of
such a strongly partisan note into this debate right at the outset of the
hearings. Mrs. Wirtz is here. Her home is St. Louis, and I dedicate my
remarks to the St. Louis Cardinals. [Laughter.]
Representative R e u s s . Let’s dedicate them to beer, and we’ve got
everybody. [Laughter.]
Mr. W i r t z , I guess four economists and one lawyer is about an
equal deal.
I have only a few “minumental” footnotes to add to these macroeconomic comments, some of which I don’t understand, but I am so
impressed when four economists agree on everything, that I am will­
ing to take all of it for granted, and only to add a few little, much
smaller notes on my part, to summarize very briefly what’s in the
longer paper.
You asked first for an assessment of the overall economic condition.
Responding in terms of the announcement last week of a 10.1-percent
unemployment rate, I can only say to you that from everything I
know that figure grossly understates the situation.
When you mention the prospect of the committee submitting a pro­
gram for the Congress’ broader consideration I hope, first, that there
is included in it a suggestion that we develop some better measure­
ments of this situation. Congressman Hawkins and I were talking a
little informally before the hearing. We were thinking back to some
14 years ago, when we were trying to develop a “hardship index.
There’s been great progress in that, and there are now two quite re­
sponsible developments of w^hat is called, I think, most generally, an
employment-related hardship index.
One of those is by the Center for Social Policy Studies at George
Washington University, the other, by MDC, Inc., in Chapel Hill, N.C.,
working in cooperation with the Research Triangle. What is being
done is to take the unemployment figures, the poverty figures and
other indexes, and bring them together to try to develop whatever may
be the human implications of what wTe’re talking about.
I don’t know how much effectiveness there is in any statistics in this
particular area. I don’t know whether the 100 million decisionmakers
in this country make up their minds on the basis of a statistical index.
Yet we ought to have the best possible index we can. If we bring to­
gether the figures on poverty and the figures on employment, tie in the
relationship between them, as these new studies are doing, we get some
very interesting results.
As nearly as I can read these hardship index figures, if you take into
account multiple earning wage earners in a particular family and all
of these other things, the number of workers in families whose earnings
won’t pay the bills now is about twice the number suggested by the
unemployment statistics themselves.




63

If you go on and look at the situation a little further, adding in
the members of the family, there are between 25 and 30 million people
in this country— members of families in which one or more persons is
working or trying to work— who are seriously adversely affected by
the current unemployment situation. That is about 1 out of 7. You get
some very interesting figures when you move beyond the mechanics
or beyond the sterility of these traditional economic indicators and
try to figure out what they mean in terms of people’s lives.
There is another difficulty about the traditional index. Because it
doesn’t tell us anything about the causes of unemployment, it in itself
suggests nothing about the cures. More specifically, it doesn’t break
down at all the difference between what the economists identify as
cyclical unemployment on the one hand and structural unemployment
on the other. This country is hurt seriously today by the prevalent
assumption that unemployment is essentially a matter of ups and
downs and will respond quickly to whatever is done, as far as the
economy as a whole is concerned.
Two of my colleagues have already made this point, so there is no
reason to develop it more fully. I believe it was Professor Eisner who
mentioned what is suggested here as the likelihood that if we should
get economic recovery in this country by every other measure, the
unemployment rate would probably still be between 6 and 8 million
people.
I hesitate to mention this, because of the possibility that somebody
is going to misuse it, to say we can’t get below a 6- or 8-percent level.
I have been testifying before this committee for almost 20 years now,
and my position has been every single time, as it is today, that the only
decent definition of full employment is someplace between 3 and 4
percent. We can’t get below that, because there are people moving in
and out of jobs. But it is time for somebody to start talking about full
employment again. It is a realistic goal, yet it is going to require to
reach it, putting employment in the first place, instead of someplace
else on down the line.
The committee has also asked for comments on particular possible
constructive measures that can be taken, and really my colleagues have
mentioned almost all of those which I have in mind, so I refer to only
one or two. I think the Job Training Partnership Act which has just
been passed is a good act. It is a training act, and it leaves out jobs
entirely. The attempt in the last few days to suggest to the country
that this administration has passed a jobs act just isn’t right. What
has happened, of course, is that as far as the public employment bill
is concerned, this Senate has, in effect, rejected what the House did as
far as that employment bill is concerned.
I can’t understand how in any circumstances there wTill be a decision
made what would be about 200,000 or 250,000 jobs to the people who
need them most, doing things which the country needs badly. I can
only interpret the rejection of that bill as a decision that it is perfectly
all right to place the burden of removing inflation on those who are
least in a position to support it or to carry it.
As far as the temporary measures are concerned, I would suggest
only one thing that hasn’t been mentioned here. The unemployment
insurance program is seriously in need of attention. It is really a kind
of sad commentary on our creativity that all we do about unemploy­




64
ment insurance legislation is wait until we are in the middle of a de­
pression which we knew was coming, and then get into a debate about
whether to extend the benefits or not. And we don’t do anything about
the structure of that program.
NEED ELEMENT IN UNEMPLOYMENT INSURANCE PROGRAM FOR RETRAINING

Quite simply, I think there ought to be added a program, as a sub­
stantial element in the insurance program, which makes it a retraining
program. W e are spending about $23 billion this year on unemploy­
ment insurance benefits that will go to about 10 million people. It is
just protection. Most of it is not being used to support a retraining
or job placement program.
There are some exciting things going on around the country, all
of them involving cooperation between employers and unions and the
educational authorities. And without taking more time to develop
the point, I would hope very much, Mr. Chairman, that considera­
tion is given to making the unemployment insurance program in this
country a constructive as well as a protective program.
Moving on to the longer range aspects of this matter, I am not a
good witness. When the talk is about monetarism, and so forth, I ’m
lost. You will get better counsel than mine. I don’t mean to duck the
point. It seems to me we are in trouble in this country because we
are spending far, far too much money on suicidal munitions, and not
passing the bill for it on to the taxpayer. My reaction is quite simple.
It is that a very large amount of the military budget, including par­
ticularly what is going into nuclear weapons, ought to be diverted
through public and private channels to making things which people
in this country need and which they can use, instead of making things
that threaten to blow up the rest of the world. I f that were done,
employment would go up and inflation would go down. I know those
are oversimplifications.

You do include in your letter of invitation, and you, Mr. Chairman,
referred in your introductory remarks to investments in education,
training, infrastructure, research and development and that’s really the
only point on your agenda to which I can speak with any particular
competence.
Professor Eisner has already referred to the importance of human
capital theory and to the development of the human resource. In your
point No. 1, Mr. Chairman, you identified the importance of the
infrastructure, in terms of physical assets of one kind or another. I
know from all you have done that you would count the development
of the human infrastructure equally important. Instead of talking,
under the circumstances, about the nuances or intricacies of human
capital theory, let me suggest just four little items which will illus­
trate other much more important things which it seems to me we ought
to be doing.
There is pending before the Congress what is called, I think, the
American Defense Education Act, appearing under the sponsorship
of Congressman Perkins and Senator Pell. It is modeled on the Na­
tional Defense Education Act of 1958. It is directed particularly
toward the very significant current and prospective shortage in this
country of scientists, engineers, and technicians. There are a lot of




65

jobs in those particular areas which it is very important that we till.
I would suggest the country’s serious consideration, paralleling its
response to Sputnik, however many years ago that was, of an identifi­
cation of all of the needs which are going to develop as we move
into an information society and the taking, then, of whatever steps
are necessary at the Federal, State, and local levels to gear educa­
tional training to the meeting of a lot of needs which only the futur­
ists are talking about now.
A second point, along a somewhat similar line, involves the whole
matter of adult education. With the economy changing as rapidly as it
it now, as the content of work shifts as markedly and rapidly as it is,
we are going to have to recognize that a substantial part of formal
education should be made available to people after they become
adults. It seems to be critically important that we develop continuing
education.
In an only slightly connected line, I expect it won’t be long before
this country is giving serious consideration to the European experi­
ments with the introduction of sabbaticals into other than the educa­
tional occupation. I f employees were to have an opportunity to renew
themselves, retrain themselves at recurrent intervals, it would have a
variety of important effects.
And of a seemingly almost entirely different dimension, I believe
it is only a matter of time until we seriously consider a Youth Service
Act in this country. A great deal of our unemployment is concentrated
among youth. The phrase “national service” has accumulated so many
barnacles that I ’m not suggesting that. I ’m suggesting a local com­
munity-based service program, which would mean the introduction
that can possibly be done. It’s a matter not of constricting opportunity,
which, it seems to me, would be a very important element, as far as
they are concerned and as far as the communitj^ is concerned.
Just a word, perhaps personal, on behalf of Professor Galbraith’s
74th and myself— I think we are going to have to rethink the whole
subject of the uses of the last chapters of people’s lives. People are
simply not going to settle for security as life’s door prize. Further­
more, I doubt whether the ultimate answer is to extend the right to
continue in a job which the individual had previously held. I think
we’re going to find tremendous opportunities for older people, seniors,
to make contributions to their community.
I close with just two notes. First, it is critically important that when
we are talking about employment, we keep in mind one simple fact,
and that is that there is much more in this country that needs doing
that can possibly be done. It’s a matter not of constricting opportunity,
but of a little architectural engineering, systems engineering initia­
tive, as far as the leadership is concerned.
Then one perhaps overly personal note in conclusion. It comes from
having looked back in preparation for this testimony to a hearing
which was held before this committee in February 1968. The subject
then, too, was unemployment. This committee was very critical of
what it considered the inadequate efforts being made by the admin­
istration to do something about the unemployment. There was talk,
particularly, about the concentration of unemployment among minor­
ity groups, the economically disadvantaged, the handicapped, and




66

the teenagers. The witnesses that day in no way went on the defensive,
but welcomed the sharpest criticism from this committee.
You know my only point in telling this story: that the unemploy­
ment rate in this country then was 3.5 percent. You begin to wonder
whether our most serious problems lie less in whatever policies are
being advocated at the moment than in some loss temporarily of our
sense of national purpose and our realization of our infinite potential.
I don’t see any less reason for fighting for 3y2 or 4 percent unem­
ployment today than there was 14 years ago. If you should call up the
Secretary of Labor to speak to the subject, I hope you will give him
as hard a time as you did one of his predecessors.
[The prepared statement of Mr. Wirtz follows:]




67

P r e p a r e d S t a t e m e n t o f W i l l a r d W irtz
With so much being said every day now about unemployment, but with
almost all of it keyed to votes rather than jobs, it is hard to know where
to pick up in addressing this Committee's serious concern.

So these remarks

will be b rie f r leaving as much time as possible for whatever more specific
inquiry you may consider worthwhile.
Your first request is for my "assessment of the overall economic
situation."

Responding in the context of last week's announcement of a

10.1 percent unemployment rate, I find it substantially more serious than
this statistic indicates.

The unemployment index has two weaknesses,

particularly so far as providing the public with adequate information is
concerned.
F irsts it doesn't tell the story in terms enough people understand,
which means human terms, and its real meaning is being deliberately covered
up.

The idea is encouraged that with more than one wage earner in many

families, and with various shock absorbers having been built into the
system, being out of work doesn't hurt as much as it used to.
I assume the Committee is following the evidence which is now emerging
from two highly responsible developments of what is being called an "employ­
ment related hardship index.”

The work on this index is being done by the

Center for Social Policy Studies of The George Washington University and
MDC, Inc.. at Chapel Hill, North Carolina, in collaboration with the




68

Research Triangle Institute and with the support of the Charles Stewart
Mott Foundation snd the Rockefeller Brothers Fund.
This hardship index is designed to supplement the economic indicator
unemployment figures with information regarding the affected individuals'
personal and family situations.
different factors:

It makes adjustments for a number of

multiple wage earners, part-time workers, discouraged

workers, unemployment insurance and welfare payments, and so forth.
Although under-funding limits both the comprehensiveness and the
currency of this critical hardship supplement to the traditional unemploy­
ment index, a substantial body of reliable evidence has already emerged.
At some risk of oversimplification, it indicates:
* That even when
are taken into
families whose
bills is about
employed": and

multiple wage earners in the family
account, the number of workers in
earnings a r e n ’t enough to pay the
twice the number reported as '’un­

* That even after all earning supplements are taken
into account -- income from savings, from government
support programs, and all — the number of workers
left at below-poverty levels is substantially larger
than the unemployment figures themselves indicate.
These computations invite as many arguments as they resolve, perhaps
more —

especially about what earnings and income levels are to be considered

adequate.

Yet as fairly as I can evaluate them, they indicate that between

25 and 30 million people in this country

—

members of families in which one

or more individuals are working or looking for work and unable to find it —
are adversely and seriously affected by the current unemployment situation.
I d o n ’t know how important any statistical index is in stimulating action
by the country's hundred million decision-makers.




But it is imperative that

69

this unemployment picture be described in terms people understand.

I

respectfully urge the Joint Committee's encouragement of the fuller develop­
ment of this supplementary employment-related hardship index.
The other weakness in the traditional unemployment index is that it
shows nothing about the causes of unemployment and therefore nothing about
what will be required to cure it,

The prevailing assumption is that un­

employment in this country is essentially "cyclical” —
and downs, responsive to general economic conditions.

a matter of ups
The country was told

again night before last that if the 11 million people who are out of work
will just wait until some other things are taken care of there will be jobs
for them.
Will there be?

One of the critical questions, which pitifully few

political leaders of whatever persuasion appear willing to face, is how
much employment is now being built in (so that it is "structural" rather
than "cyclical")

to our assumptions about the future.

A good deal more,

I'm afraid, than any except a few people realize.
This is essentially the question of the effects of advancing technology,
and of broader changes in the nature of work, on the need for the human
membership of the work force.

Studying this question carefully in the 1960s,

we concluded, rightly I think, that new machines were creating more jobs than
they were destroying.
the earlier 1970s.

I think this was also clearly true during at least

It is not at all clear that it is true today.

risk of irresponsibility,

for no rel:i

At the

ile analysis of this development is

available, and only to emphasize the importance of .the point:

my best guess

is that what would now be considered economic recovery by all other measures




70

would leave an unemployment rate of between five and seven percent, which
means 6 to 8 million people.
I don't need to add that in my judgment ,Tfull employmentM still means,
as it did when I was testifying before this Committee 10 and 15 and almost
20 years ago, no more than something like 3 or 4 percent unemployment
the inevitable "frictional" factor, people entering the work force and moving
from one job to another.

This still seems to me a totally realistic goal,

But it is going to require putting full employment in the first place instead
of someplace else on down the line.

Turning now to the Committee’s request for comment and suggestion regard­
ing specific action programs:

Certain emergency measures have to be taken.

Even larger importance attaches to revitalizing the economy,
So far as meeting immediate needs is concerned, I would endorse strongly
-- though this is now gratuitous
ship Act.

—

the recently adopted Job Training Partner­

There is reason for encouragement in g o v e m m e n t a l l y supported job

training becoming once more a principal of bipartison policy.

Separating

the training and income transfer elements makes good sense,
The defeat in the Senate of the minimal public employment bill adopted
by the House seems to me, and I believe to most people, simply wrong.

To

accept and affirm the principle of reducing government expenditures leaves
all of the important questions of priorities.

Putting 250,000 of the most

seriously unemployed workers in this country to doing some things which badly
need doing seems to be plain good business.




Reversing that decision can only

71

be interpreted as a conclusion that the burden of stopping inflation is to
be placed on those who are suffering from it most seriously.
More attention should be given, I suggest,

to improving the unemployment

compensation program, not just extending its benefits but making it more
responsive to present and prospective needs. It is a sad commentary that our
creativity is limited to debating on extension of unemployment insurance benefits
when we are in the middle of a depression and seriously concerned about whether
many of the old jobs will be there when it is over.

In fact we know a lot of

them won't be.
We ought to be using this down time to permit those who are unemployed,
with little prospect of returning to their previous jobs, to upgrade their skills
or to develop new ones for which there is larger demand.

Instead of this, the

present unemployment insurance legislation virtually precludes such re-training.
Serious attention should be paid to what are so far only scattered exper­
iments with constructive, rather than simply protective, measures to meet unemployment,

The collective bargaining agreement between Ford and the United
A
Automobile Workers offers an example.
Governor Dupont is developing in Delaware
a constructive linkage between the unemployment insurance, employment service,
and educational systems, to set up training programs for unemployed and probably
displaced workers,

In several of the southeastern states, perhaps particularly

South Carolina, closer working relationships between employers, vocational educa­
tion offices, and community colleges are resulting in substantial reductions in
the waste of re-training opportunities,
We manage the unemployment aspects of recessions very poorly in this
country.

Compensation isn't enough.

and for renewal.




These ought to be times for re-training

72

So far as longer range economic policies are concerned, my qualifi­
cations are so limited regarding most of them that I can add nothing to
the Committee's deliberations.
important.

This isn't to duck what is obviously most

It seems to me plain, personally, that part of the answer to

inflation is to reduce government expenditures; and that the way to do this
is by taking the action which will permit curtailing sharply the budget for
suicidal munitions, particularly and specifically nuclear weapons.

Re­

directing those expenditures to domestic enterprise, through private as
well as public channels, would increase employment and would curtail in­
flation.

Yet I recognize that these are oversimplifications involving

issues on w hich the Committee will be taking more competent counsel,
Y ou refer in your invitation, however,

to "investments in education,

training, infrastructure, research and development."

This has been the subject

of a good deal of my personal experience, and it seems to me an area in which
those of otherwise conflicting economic persuasions, including "supply-side
economics," should find broad common ground.
The one limitless resource this country possesses lies in the development
of people's talents.

Yet instead of attempting here to get into the intricacies

of "human capital theory," let me suggest several specific programs which seem
to me to warrant much more consideration than they have received so far.
are selected from a number of other possibilities to illustrate different
aspects of the potential.

Listing them in summary form will permit your

questioning in whatever detail may seem worthwhile.
Both houses of the Congress have before them, with the sponsorship of
Senator Pell, Congressman Perkins, and others, proposals for an American




They

73

Defense Education Act, patterned to some extent on the National Defense
Education Act of 1958.

This legislation is directed most specifically at

meeting the present and prospective serious shortage of engineers, scientists,
and technicians.

I would urge serious consideration of an even broader

approach which would start from the clearest possible identification of the
educational and training needs which the advent of an "information society"
will magnify, and then make arrangements for whatever combination of local,
state, and federal forces will lead to better meeting those needs.
One of the most encouraging developments in contemporary education in­
volves the large scale extension of the educational opportunity to adults,
A great deal more can and should be done along this line.

Sooner or later

consideration will be given in this country to some form of extension of the
"sabbatical" concept to other occupations than teaching.
The concentration of so much current unemployment among young people
in this country is bound to lead eventually to fuller consideration of a
youth service program.

The "National Service" phrase has accumulated some

unfortunate and unnecessary barnacles.

There are a variety of ways of

using a local community base to build a one-or-two year service component
into young people's preparatory experience.
We are going to have to re-think completely the uses and the usefulness
of the last chapters of people's lives,

"Security" i s n ’t enough.

Extending

the right to go on working at whatever was being done before probably i s n ’t
the ultimate answer.
These may appear,
suggestions.




There are potentials of infinite magnitude here.
in such brief reference to them, entirely disparate

Yet they illustrate, however inadequately,

the underdevelopment

74

so far of the human resource.

Add the fact that with all of the statistics

about unemployment and with proper concern about its impact, there clearly
remain an infinite number of things which need to be done in this country
and in the world.

It i s n ’t a matter of constricting opportunity, but of

whether we have what It takes to maintain the authentic American sense of
purpose.

One perhaps overly personal note in conclusion comes from having looked
back to the record of hearings which the Joint Committee held in February,
1968.

The subject was unemployment.

The Committee was critical of what it

considered the inadequate efforts being made by the administration to meet
certain aspects of the situation, particularly the concentration of unemploy­
ment among minority groups, the economically disadvantaged, the handicapped,
and teen-agers.

The witnesses that day, in no way defensive, welcomed the

CommitteeTs criticisms and suggestions.
You know the only point in making this reference.

The unemployment rate

for January, 1968, which had just been announced, was 3,5%,

You wonder

whether our most serious problem today is less in any particular policies than
in our having mislaid

-■ temporarily

our limitless potential.




—

our sense of national purpose and of

75

Representative R e u s s . Thank y o u , Mr. Wirtz.
And thank you all for some fine, stimulating and heart-warming
testimony.
As I said earlier, the Democratic leadership of the House and Sen­
ate has requested us, of the Joint Economic Committee, to be prepar­
ing policy recommendations for the lameduck session that starts on
November 29. I personally welcome that assignment, because if we
don't do something in that month-long session, what with the time
that is consumed in organizing a new Congress, we may not be able
to approach a first-phase emergency program for many, many months
of 1983— and I don’t believe we can or should wait, drawing on the
reports of the Joint Economic Committee of the last couple of years
and personal conversations with the members who have participated
in those reports, and having in mind the fact that the lameduck ses­
sion is necessarily limited in time, and less in scope. And we shouldn’t
try to do everything.
LAMEDUCK SESSION AGENDA

I have thrown on the table this morning a first— rough draft of
what might be done. And I will repeat it very briefly, and then ask
you whether you think that’s the right way to go, whether you think
any of the four proposals are misguided and whether you think, given
the constraints of the lameduck session timing, there should be any­
thing added to it.
So, the proposed package is :
One, a program to stimulate investment in infrastructure— put, m
some appropriate financial way, some of the 11 million unemployed to
work preparing and building the streets, bridges, water systems, ports,
and other public facilities which are now in a desperate state of
disrepair.
Two, housing: The housing outlook continues to be bleak at a time
when there’s a tremendous need for housing. And the suggestion there
is that, by some cost-effective subsidy, moderate-priced housing be
brought within the reach of the millions who need it.
Three, jobs programs: This has been much referred to, but there
does, in my judgment, need to be on the books an immediate public
employment program— and if we went back 50 years to F.D.R.’s CCC,
we could do worse— which will grapple with the immediate, appalling
social problem in our cities and areas of rural poverty.
And fourth and last, some expression from Congress on monetary
policy. There the leadership in both the Senate and the House, with
widespread Democratic support, have put in bills that would, in a
nutshell, ask the Federal Reserve to get off its monolithic monetarist
kick and also take into account interest rates. I f they would do that,
then there would be a good chance of a healthy prolongation of the
election-month burst of monetary activity which we are now seeing in
the Federal Reserve.
As many have forgotten, the Federal Reserve, egged on by the
administration, is still proudly boasting that right after the elections,
starting January 1, they are going to forget all about the 16 percent
Mi ebullient growth, that was too much of a good thing which they




76
have been achieving in recent weeks, and go back to a 4-percent mone­
tary target.
I believe the passage of some such legislation as I have just referred
to would signal to the Fed that they should not do that, they should
not bring; the high-interest-rate regime which, coupled with the ad­
ministration’s feckless deficit policy, has brought about our deep re­
cession and thrown the world in a turmoil.

Well, that’s the four-point, quick program which I have put on the
table.
Now, let me ask, members of the panel, whether any of you disagrees
with any of those four points, whether any of you would formulate
them in any different way, and whether you think there are other
short term, immediately achievable objectives which ought to lead to a
more expansive lameduck session program ?
I ’ll just go across the panel.
Mr. Eisner.
Mr. E is n e r. I think, Mr. Chairman, the four points are excellent. I
would comment briefly on a couple of them.
On housing, the Chairman-designate of the Council of Economic
Advisers, Martin Feldstein, has been on record in many of his writings
as suggesting that tax incentives or the tax structure has been overly
favorable to housing, as compared to business investment, a position
which I don’t think, policy wise, is sound.
It s true the middle classes, upper classes have had substantial
benefits in terms of tax treatment. I think the remedy is not to take
those away from them, in view of the tremendous slack in the housing
industry, and need for housing, but rather to add something for the
poor. I have in mind in particular efforts to subsidize ownership of
housing by the poor. I think we’ve had rather unfortunate examples.
I know Cabrini-Green and much of the low-rent housing in the city
of Chicago have all kinds of problems— I won’t dwell on it. It would
be very important to have subsidies for poor people to own homes, to
own housing units so they will have an interest in preserving and
investing in and maintaining them. It will aid a great deal to unmeas­
ured income and welfare.
On the jobs program, I would suggest that jobs programs by Gov­
ernment will certainly be very important. But I would like to see, in
addition— and I think perhaps one could get some bipartisan support
of this— major efforts to subsidize employment of the hard to employ
of the unemployed in the private sector. We have all to easily given
up or been very sparse in efforts to have incentives for employment.
It’s very easy to give incentives for business investment, which I think
are unwarranted. Businesses would invest in themselves adequately if
left to themselves. But I would pick up on Mr. Wirtz’ remarks— it’s
really a scandal to spend $23 billion or more a year on unemployment
insurance. We, indeed, should be spending more, given the amount of
unemployment— but not just leaving people idle, without an effort to
offer firms incentives to hire the unemployed, without an integrated
effort to retrain and give them work.

On monetary policy, I would emphasize again now, as several of
my colleagues have, the tremendous importance of real interest rates.
We must not quickly take comfort in the fact that nominal interest
rates have gone down.




77

To the extent they have gone down belatedly, because of decline in
expected inflation, that is not, in itself, going to help the economy. It’s
simply going to mean we won’t be that much worse off. You have to
get the difference between the nominal rate of interest and expected
inflation down. And there’s a long way to go in the Federal Reserve
policy in that direction.
And it’s up to the Congress— it’s up to the administration to begin
with, but the Congress has some responsibility for having asked the
Fed at one point to report monetary targets. You should go much
beyond that and ask them to follow a policy that will keep the economy
moving.
Representative R e u s s . Yes; as you say on housing, that particular
portion of your response, a few quick strokes of the pen could do a lot
of good.
For example, I ’m not saying this is necessarily the way to do it, but
right now, if you take a 30-year-old structure and develop it for an
office building or for shops, you get a very nice 15-percent tax credit,
which induces you to do it. I f you take a 40-year-old building, you get
a 20-percent tax credit, but you don’t get it if you develop it for lowmoderate-income housing.
So, a quick stroke of the pen, by adding low-modest-income residen­
tial, could give a tremendous incentive to people in cities, towns, and
even countryside to take an older structure and develop it into decent
housing.
So, I welcome your suggestion.
Mr. Galbraith.
Mr. G a l b r a i t h . Mr. Chairman, I would only add my support to all
four items.
I ’m led to make one suggestion that will be part of the debate on
them. We must admit that the administration has had a certain meas­
ure of success— and that is in creating the impression that public
activities on behalf of the economy and on behalf of the compassionate
services of the Government are somehow an exercise in bumbling in­
competence. By iteration and reiteration, that impression has some­
how been established, and it has even penetrated into the convictions
of people who should know better.
W e must begin now to counter that particular bit of nonsense to
remind ourselves that we have had and have in the United States an
extraordinarily good civil service, people of very high quality and
motivation. We haven’t solved the problems of vast organization either
in the public or in the private sector. W e have the problems of the
vast bureaucratic governmental organization still unsolved as well
as those of our great private organizations.
These are part of the problems of the age of organization with which
we have still to contend.
But I would hope that we would remind ourselves, as part of the
effort that is reflected in these four proposals, that the public service
in the United States is a prideful thing, one in which we should have
confidence. We shouldn’t hesitate over the fact that these measures
which you propose, and with which I concur, require administration.
W e have, perhaps, been negligent in the past in taking their ad­
ministration too much for granted; we cannot, in fact, do useful
things without it.

17-871 0




83

6

78
We must continue to remind President Reagan, who presumes to be
in support of the economic system, that it sure as hell wouldn't have
survived this long if the market and the private sector had not been
supplemented by the energetic, humane efforts of Government.
While Pm in full flush of oratory, I would like to add my word to
what Willard Wirtz— Secretary Wirtz— said, in such admirably blunt
language, about the need to transfer resources to purposes such as these
from our present, passionate inducement, with the whole idea of blow­
ing up ourselves and the world. He said that with marvelous clarity.
And as he said it, I sat here wishing to God that I had said it first.
[Laughter.]
Representative R e u s s . Mr. Heller.
Mr. H e l l e r . Mr. Chairman, I don’t think you are going to get
much disagreement on your four-ply program from this panel, wThose
spectrum of views runs from A to A-plus-----Mr. G a l b r a i t h . May I interrupt to remind Professor Heller, it
runs from A to A-plus, but there is no legitimate B. [Laughter.]
Mr. H e l l e r . I accept that intervention and approve of it. Well, 1
just wTant to comment a little bit on infrastructure and housing. On
infrastructure, I am just delighted to see this panel and the chairman
of this committee raise that to the status it deserves. One of the great
inconsistencies of so-called supply-side economics espoused by this
administration is that it pays no attention whatsoever to the supplyside impact of the spending side of the budget, of the constructive
investment that is absolutely necessary as a counterpart to the in­
vestment in the private sector that they put all of their exclusive
emphasis on. And, of course, the supply siders have preempted a per­
fectly good classical economic approach— that of beefing up our abil­
ity to grow and our ability to produce more— by going to extremes
that have earned them the designation, in Martin Feldstein’s words
of “extremists.” I noticed Kevin Phillips calls them the supply-side
absurdists. I rather like that. And others call them radicals.
They are neglecting the fundamental supply-side contributions that
can be made through public investment. By the way, this committee
is probably aware of an excellent article in the October 7 Wall Street
Journal, “ Crumbling America— Put it in the Budget,” bv Mr. Hoff­
man, executive director of the Republican House Wednesday Group.
Perhaps there could be a bipartisan consensus on this.
Also, since personal notes have entered here from time to time, I
would like to cite an example. We hear so much about these dead-end
public jobs. But let me cite an example that the chairman may recall,
since he comes from Milwaukee and since I have previously cited it
before this committee; namely, my father. He was a civil engineer.
He was employed by A. O. Smith in Milwaukee. He was out of a job
for 2 or 3 years during the Great Depression.
Apart from the fact that he took differential and integral calculus
during that period at the Milwaukee branch of the University of Wis­
consin, he was employed under the Federal Emergency Relief Act,
the precursor of W P A and the Public Works Act, His job was to help
design an addition to the famous Milwaukee sewage plant which pro­
duces milorganite and which is one of the outstanding plants of its
kind in America.




79
In other words, F E E A took men with obvious skills that were
going to waste and put them to work on an infrastructure job that
needed doing. Federal money brought the two together, and there
was nothing but gain, no loss whatsoever.
On housing, just this thought. Yes, we need housing stimulus for
the poor— and particularly now that it takes some 40 percent rather
than 20 percent of a family’s median income to finance acquisition of
a house— but we should couple it with a reduction of the mortgage
interest deduction under the income tax. I see no reason why I should
get a reduction for either the property taxes or the mortgage interest
payments on a cottage or a second home. Now I know that cuts many
Members of Congress to the quick, because they have to maintain two
homes, but there ought to be some kind of a limit, perhaps a dollar
limit, in terms either of the value of the home or the amount of the
deduction.
And that alone could raise many millions of dollars and could help
finance the positive program for the lower income groups, the people
who cannot afford a decent house or decent housing. And I believe
there we could do a redistributive job that would improve the whole
housing structure.
Representative R e u s s . Thank y o u . Mr. Marshall.
Mr. M a r s h a ll. Mr. Chairman, I think your list is a very good one,
and therefore, endorse it.
Let me make some observations about it, particularly the jobs part.
I had thought much about how to make the jobs program work. One
of the perplexing things to me these days, in the light of numerous
detailed and sophisticated evaluations showing that the programs
were a good investment for the country, is the pervasive idea in the
Congress, the media, and among the public that the programs didn’t
work.
And I think it relates partly to Professor Galbraith’s point about
the idea that all public programs have not worked. I think it's par­
ticularly true with respect to the jobs program. There’s no evidence
for that. Experts from across the political spectrum have evaluated
these programs, some expecting to find that they were worse than they
were and have all found what you would expect, that these were good
investments. They were cost-effective, some more than others, but they
did the most for those who needed it most, and not as is the case with
so many other public programs, the most for those who needed it least.
I f the committee could do anything to counter that impression with
the facts, maybe take a look yourselves at all these evaluations, syn­
thesize them and put the record straight about the accomplishments
of employment and training programs that would serve a useful
function.
There is no doubt in my mind that we have learned from these
programs and were in the process of improving them. The Job Corps,
for example, is a much better program today than it was when it
started, partly because we learned, and we learned a lot about other
programs and kinds of things to do, and therefore, ought to try to
get that message across to the people.
One of the basic problems is that many people don’t look at these
programs as investments. They look at them as all costs. In fact, even
some of the evaluations of the jobs programs tend to count the output




80

of those jobs as zero. That is ridiculous, when you look at the wide
range of things that the people were involved in, going back to the
CCC programs, the W P A and on into public service employment pro­
grams more recently. And they have made a tremendous contribution
to the country. And I think that investment attitude about the jobs
program mignt be able to overcome some of the negativism about
them.
With respect to your comments about monetarism, what I think
needs to be done is to go far beyond that. I think that until we take a
look at the machinery for economic policymaking in the country and
the problems caused by the structure of it, we are going to have great
difficulty pursuing a consistent course. It would be a stop-and-go and
short run, like many of our private decisionmaking processes, which
are driven too much by short-run profit maximizing to the detriment
of long-run viability.
Now I think we’ve got the same kinds of problems in the economic
policymaking in the country, and I don’t think it’s going to come from
any place other than the Congress, because you are responsible for the
economic policy of the country. And I don’t think that you ought to
dance to the Federal Reserve’s tune or that the White House ought to
dance to it either. I think there is something to be said for relative
independence of the Federal Reserve, but not dominance of policy,
and having the economy in a condition that it is now, simply because
of a misguided theory; they admitted when they adopted at that they
didn’t have the vaguest idea whether it would work or not. And those
kinds of decisions seem to me to require debate before they are made.
It would be much better to agree on the desired outcomes of the econ­
omy, and then have the Federal Reserve adjust its policy to achieve
those outcomes, rather than the reverse.
But I think that that is going to require more than simply telling
them to abandon monetarism.
Representative R e t js s . Thank y o u . Mr. Wirtz.
Mr. W i r t z . Just two points, and very brief.
The first one has really already been made. The public employment
bill came up, was passed in the House, rejected in the Senate. I would
agree with what has been said, that there are probably more attractive
ways of packaging that program. It would be possible to add both
local community and private sector elements to that bill, which I think
would make it much more attractive.
My other point is simply that I would hope that a program of the
kind you are developing would include some recognition or some re­
flection of what I think is the importance of education in any program
of this kind. It can be fitted in any of several places here, but I really
believe it is one of the important long-range recovery revitalization
elements. But in short, I subscribe completely to the proposal.
Representative R e u s s . Thank you.
I now recognize our new and distinguished member of the commit­
tee, Congressman Gus Hawkins, author, among many other things, of
the Humphrey-Hawkins bill. Never has so good a piece of legislation
been ignored by so many for so long.
Representative H a w k i n s . Thank y o u , Mr. Chairman.
May I first express my appreciation to many of the witnesses today
who, I think, over a long period of time have helped us in the drafting




81
and eventual passage of the Full Employment and Balance of Growth
Act of 1978. I think the contribution made by many of these witnesses
certainly was responsible for the success which we had in the passage
of that act ; however, I think they will reflect on the manner in which
we have reacted once the act was passed. I f there is any bipartisan
aspect to it, I think many of them will recognize that we, too, were
critical of President Carter in 1980, in particular, because we felt that
he did not support the provisions of the act. And I personally believe
that some of his difficulties, political difficulties, were due to the fact
that there were many of us critical of President Carter at that time.
So I think that it gives greater weight to what we say now in being
critical of the current administration. I think the witnesses have done
an excellent job; however, I feel that in their restraint, they have not
brought out some of the things that some of us who don’t have pro­
fessional credibility to protect would say, even though it may be classi­
fied as politics— I would say that I think we are being very kind to
the administration. I think the witnesses have been overly kind in
showing the restraint that they did. I f there is anything, it seems to
me, that comes out of this hearing, it is that we are in deep trouble,
that this trouble is directly traceable to the current administration,
that to heap the blame on previous administrations is of no conse­
quence at this time. Mr. Carter is not seeking any reelection. So the
solution is not to vote against Mr. Carter. That would be very ideal.
We can only confront conditions as they do exist at this time. Cer­
tainly, Mr. Reagan knew when he became President of the difficulties
of overcoming what he claims to be some of the things which he in­
herited, yet very loud in the statements made about what he proposed.
I think gleaning from what the witnesses have said that we are in
deep trouble because this recession is not over. We are facing another
one which will come out of this current one, and at the same time, we
will not have the protective safeguards that w^e had, because most of
them are going to be eliminated.
And I tnink there has been an assumption made this morning that,
in some way, the President, perhaps, is acting out of good motives. I
wTould certainly challenge that to indicate, Mr. Wirtz, as you did, that
we can, with some degree of minor changes, make the public works
bill more acceptable— I certainly think your suggestion is in good
faith— to the administration ; to make it more acceptable to the admin­
istration I think is really stretching it. Because if we assume that one
of the difficulties that we face today is that unemployment is unrea­
sonably high, I think everyone concludes that that is true. And if we
relate that to the deliberate policy of the administration, as I think
most witnesses did, to the creation of unemployment as a means of
solving the problem of inflation, then it's obvious that the conclusion
is that if the administration believes that unemployment will solve
our problems, then any program to create jobs is antithetical to the
objective of the administration.
I think the experience is borne out by the fact that not only did
the administration oppose the public service jobs of CE TA, not only
did the administration bad-mouth C E T A as a viable program, and
falsify reports and statements in relationship to CETA, so that it
was successfully, let us say, destroyed in the public image as a viable
program, but he has gone on to do the same thing with every other




82

program. This was not the only program that was opposed by the ad­
ministration. As a matter of fact, not a single jobs program, I haven’t
heard anyone credit the administration with supporting a single
jobs program. I think it is very significant that these programs should
not be destroyed at a time when no substitute is being ottered to help
the victims of the monetary and fiscal policies that rest upon creating
a recession. The W IN program, the Jobs Corps, I think Mr. Marshall
referred to that, which the administration says is an excellent pro­
gram, has been reduced 50 percent. The W IN program is practically
destroyed, the senior citizens program under the Older Americans
Act has been wiped out. As a matter of fact, the bill was vetoed after
Congress approved it. So we are going to be without any of these pro­
grams, eventually, when the next recession happens, as I think the
evidence indicates that it will come about.
So it just seems to me as what we are witnessing is a very disgraceful
and very deceitful expression of public responsibility at a time when
such a leadership is certainly needed.
I certainly appreciate the program being offered this morning by
the chairman of this committee, Mr. Reuss, but it seems to me that
to deal in terms of single programs is, again, going to piecemeal the
solution. I don’t think there is a shortage. I think Mr, Eisner in his
prepared statement dealt with it very beautifully, in which he said
we are now being intimidated by disowning programs that have been
very successful instead of standing up for them, and being apologetic
because the President says you are not offering any new programs.
Every time one is offered, as was done this morning, it’s opposed by
the administration. Certainly, that is accomplishing nothing.
So it just seems to me that we are getting back to the point where
we were prior to 1978, when we had most of you as witnesses before
the committee, before we acted on the Full Employment and Balanced
Growth Act.
And we can’t overlook the fact that both Republicans and Demo­
crats supported the act in 1978, its goals and timetables. They thought
it was feasible within 4 or 4 y2 years, we could get unemployment
down, we could get inflation down at the same time. The President
signed the act, and then from then on, we go off in an opposite direc­
tion. Now no one can say it’s going to be solved overnight, but we
are not even moving in the proper direction at the present time. In­
stead of reducing unemployment, we are increasing it. I think it has
been well said that inflation has seen some slight— that is, the rate ol*
increase has decreased, nobody believes the prices aren’t increasing,
but this was accomplished again in violation of the act, because a re­
cession was induced in order to accomplish this reduction in the infla­
tion rate of increase. So that was a direct violation of the act.
I would say. before we seem to get into dealing with the individual
programs, many of which we already have but are not being used, that
what we need to do is, get a recommitment to the goals of it, of the
Full Employment Act, which is still in the statute books: it has not
been repealed. We need a coordinated approach in dealing with policies
rather than dealing with them on an ad hoc piecemeal basis. We need
to adopt the concept of planning, because without planning for
achieving these goals, obviously they are not going to be achieved, and
what we need most of all deals with the question of accountability.




S3
There is no penalty for the violation of the act. There is only the
question of accountability. We have said, as a people, that we can
achieve low unemployment and low inflation at the same time, but
we are not attempting to do it, and we are dealing, it seems to me, with
piecemeal programs rather than making a definite commitment that
we can get unemployment down, and at the same time not create
inflation.
Now it is understandable that the current administration has a fear
of inducing inflation, but the Full Employment Act said that you deal
with inflation by attacking its causes.
I think we have got to admit the administration is not attacking the
causes of inflation, but only using unemployment as a means of fight­
ing the inflation. This is pretty obvious. And why this is not said
over the media and why this is not picked up and why we will allow an
individual to violate an act without calling attention to it— it just does
seem to me to be contrary to our democracy and our way of handling
things.
Congressman Reuss wanted to deal with some of the questions
brought out by some of the witnesses.
I admit I have gone far afield. But it just seems to me— the only
point I am making is that, as individuals w7ho are critical of the ad­
ministration, it seems to me we have got to recommit ourselves to the
specific objectives of the Full Employment and Balanced Growth
Act, which calls for the reduction of both inflation and unemployment
and prohibits the tradeoff.
I just can’t, for the life of me, believe that we can make a defense
for unemployment, although the President says so.
Now, I think we did talk about the public wrorks bill. But let me
quote from Mr. Reagan in October in 1980— that is before he was
President. He says:
The government, with actual needed public works, uses those public works in
times of unemployment.
WPA, some people have cal’ed it a boondoggle and it was probably one of
the social programs that was most practical in those New Deal days.
So, if the government, instead of inventing these new programs, had a back­
log of government projects, they would say, “Well, now, this is the time to put
those into effect.” I think it could be most helpful.

Now, this is what Mr. Reagan said in 1980. It wasn’t what he said
the night before last. We know what he is engaging in is the technique
of the i6,big lie.” And I think we’ve got to label it as such.
I f this was true in 1980, if he felt this in 1980, how can he be so
far afield that he can take a little simple bill, such as the public works
bill, passed in the House, and oppose it in the Senate, when it called
for the expenditure of only $1 billion of money, which was already
made available under the budget restraint, and to use it as a time when
lie must have known that unemployment was going to exceed 10
percent ?
It just seems to me to be the height of hypocrisy— anymore than
his demonstration of signing the job training bill a few days ago and
having behind him some trainees. Where they came from, I don’t
know. He introduced them as trainees who were going to be helped
by the bill that he wras going to be signing.
Actually, the bill that he was signing doesn’t become effective until
October 1983. How can a bill which is going to become effective in




84
1983 help these exhibits that he had lined up behind him on a bill
which he was signing this week ?
Now, this, to me, is the depth of lack of credibility of leadership
and certainly of good commonsense.
And I just think the witnesses this morning have reinforced the
need to move ahead with current policies— with a change in policy.
I think, Mr. Heller, you made a statement here which 1 wasn’t so
sure of. I would like, for the sake of the record, to ask you to clarify it.
Your statement— of course, you, first of all, said the U.S. economy
has been on a hold for 3y2 years. I assume, by that, that you feel
that the course has been stayed already for too long a time and we
need to get off the course now and change action.
But the statement I was not so sure about— and I want to get some
explanation of it— in which you said: “A tradeoff between unemploy­
ment and inflation still lives.” I wasn’t so sure what that meant. I was
agonizing over the statement. Perhaps you can put me out of my
agony.
Mr. H e l l e r . I was simply trying to make the point that this admin­
istration is using unemployment as its primary— indeed, almost its
only weapon against inflation.
And there is no doubt, when you generate 14 percent unemploy­
ment— as I say, it’s not 10, it’s 14— that it tends to reduce demand in
the economy, it tends to increase competition of the unemployed for
the available jobs. There’s no doubt that it has a deflating effect on
the wage and price indexes.
When President Reagan claims credit for having reduced inflation,
he totally ignores the contributions to the reduction of inflation by
good luck on crops, which, after all, is a contribution of nature and
God; the reduction of oil prices, which is a result, in very large part,
of policies of the Carter administration; and the reduction of hous­
ing prices induced by Federal Reserve tight money policies.
The only contribution he’s made, really, is by sinking us into an
abyss of unemployment, the likes of which we haven’t seen since the
Great Depression.
By the way, I might note that you are missing, Mr. Chairman, the
prime witness who should have been here this morning. I f you recall,
in signing the Export Trading Company Act of 1982, the President,
after opposing it during most of its path through Congress, said it’s
a great job-creating instrument, one of the main tenents of the Presi­
dent’s program.
He went on to say— and I ’d like to be sure you get this in the
record— “I guarantee you wTe are going to accept responsibility in this
administration for finding jobs for all of the 10.1 percent of the work
force without jobs.”
You should have had him here this morning to explain exactly how
he was going to do that.
Representative H a w k i n s . Getting back to the statement, you did
not mean the statement taken as support for the trade-off theory?
Mr. H e l l e r . I think just plain arithmetic tells us that if you have
policies that generate unemployment, you are going to have reduction
in inflation.
Representative H a w k i n s . Let me rephrase the statement— the
question.




85
Would you suggest that there is a better way of reducing inflation
than by creating unemployment? And if so, what are some of the
other ways?
Mr. H e l l e r . I think that’s been very well covered here this morning.
I f we had had a policy—¡I don’t object to a policy of sensible mone:
tary fiscal restraint to curb inflation if it is coupled with a sensible
policy of wage-price restraint, if it’s coupled with a landing net that
hasn’t been torn to shreds as has been done in this administration.
I don’t see that we can, in the longer run, hold inflation down unless
we exercise restraint on all of those fronts: monetary, fiscal, wage,
and price. And that is, in essence, what that statement implies.
Representative H a w k i n s . The theory behind the Full Employment
Act was that we first had to create a healthy economy, without a
healthy economy that we could not hope to solve the other problems,
that to do so— to create a healthy economy— obviously brought up the
question of curbing inflation.
How could you create a healthy economy and at the same time not
induce unreasonable inflation ?
So, the act attempted to set out at least some of the ways in which
to do that. But in doing that, it has also prohibited the tradeoff
outright.
The other ways it could be done— obviously, I think many of you
have discussed those already today, so I won’t belabor that— but I
would say if there’s anything that has been violated, it is, in fact— I
think that's been brought out this morning— that our monetary policy
has been too restrictive.
But on the fiscal policy, we have indulged in untargeted budget cuts,
even to the extent of cutting those programs that offered very costeffective results.
Would you, in general, agree with that ?
Mr. H e l l e r . I agree entirely with that.
O f course, what we’ve done is we’ve cut taxes beyond any reasonable
or responsible degree, given the tremendous needs of the country.
I
think it’s often, forgotten—and particularly by this administra­
tion— that we have one of the lowest ratios of public spending and
taxes to gross national product of any industrial country in the world.
Japan is 1 or 2 percentage points behind us. They’re at about 31 or
32 percent.
But total government in this country— Federal, State, and local—
is now 33 percent of the gross national product. And yet, we find that
when people deal with the overall levels of government spending,
there seems to be an enormous amount of public outcry against it, as
against, as I say, in other countries, that a lot of them admire, Ger­
many and others, where public spending is up to 45 percent, 50 per­
cent of GNP.
When it comes to individual programs, of course, they protest.
As you know, there are strong majorities for many of these pro­
grams of w^hich you are talking about. It’s that old contradiction be­
tween our general druthers and our specific beliefs.
So, I w^ould entirely agree that in diverting so much of our resources
to the military, in giving absolutely unconscionable tax cuts, in under­
cutting our public infrastructure, we are running a policy that is both
antigrowth and antijobs.




Representative H a w k i n s . Mr. Marshall, you, as Secretary of Labor
in the years 1979 and 1980— not only those 2 years, but you were those
2 years.
Mr. M a r s h a l l , The whole time, yes.
Representative H a w k i n s . With respect to the Comprehensive Em­
ployment and Training Act which the President has labeled to be
very wasteful, mismanaged— and its elimination he achieved at the
very beginning of his administration— and also without any alterna­
tive being worked out, would you agrée with this assessment of the
Comprehensive Employment and Training Act?
I don't know of any act that has been more bad-mouthed and mispresented than that or one that has been more investigated or
scrutinized.
Mr. M a r s h a l l . That's right.
And you know the results. I've looked at all the investigations that
have been done by G AO, by the National Science Foundation, by
Brookings, Princeton, the Urban Institute— any number. I ’ve got,
probably. 100 pounds of them. And I have yet to find one that said
it was not a good investment. We had problems with these programs,
but we were trying to work those problems out. And, as you know,
we were improving with them.
We started out with the big problem of substitution, but we cor­
rected that in the 1978 Act.
All of the evaluations show that. Not only was it cost-effective for
the government, because they got more back than they paid out ; this
also is the cheapest way to reduce unemployment, and benefited the
people who went through the programs, especially for the disad­
vantaged, the people that we intended the programs to serve.
And that's the reason that I am perplexed by the prevailing attatude that they didn’t work.
As you know, they weren’t Carter administration programs, but we
worked hard to t,ry to make them work. And 1 think we were evolving
them in that direction.
But in my perspective, in order to make such a program work you
have to give it greater financial stability than we were giving it with
the annual appropriations process.
I ’m convinced, therefore, that we will have a public employment
program if we ever get to full employment— there’s no other way
to do it in my judgment : you can do a lot with general programs, but
you cannot reach everybody. Public employment programs are good
investments ; but wTe ought to learn from our experiences.
As you know, under our youth bill, we built in learning. We didn’t
call it “ Youth Employment Act of 1977” ; it was called the Youth
Employment and Demonstration Projects Act. And we appear not to
want to have learned any of our lessions. But I think one of the main
things we need to do is to deal with the question of financial stability
in a program that is very complex and needs some time.
In my 4 years as Secretary of Labor, we got our appropriation at
the beginning of the fiscal year once, the first year. And it’s very dif­
ficult to manage a program as complicated as that one was, as CETA
was, with that kind of financial instability.
But in spite of all the problems that it had and the exaggerations
about the fraud and abuse in the program— the evidence was over­
whelming that the programs were successful.




87
R e p r e s e n ta tiv e

H

a w k in s .

W hat

p e r c e n ta g e o f

fr a u d

and

abuse

w o u ld y o u sa y w a s in th e p r o g r a m ?

Mr. M a r s h a l l . There was very little fraud. There was some abuse.
But I estimated at one point— we had our people take a hard look at
it— it was less than 1 percent abuse, which meant that people didn’t
carry out the letter of the law, which is different from fraud— for
instance they didn’t keep the records, or didn’t provide some informa­
tion about the eligibility of enrollees.
One of the big problems we had at one time, as you recall, was the
loose early administration of the program. We tightened that up in
1978.
Representative H a w k i n s . I don’t know of any other agency that
has any lower percentage, including the Department of Defense.
Mr. M a r s h a l l . I had our people take a rough look at it. And the
bankers had a lot more problem than we did with fraud in banks than
we had in the CETA program.
Representative H a w k i n s . Thank y o u .
Thank you, Mr. Chairman.
Representative R e u s s . Thank you.
I just have one brief question.
Mr. Heller called a moment ago for monetary restraint. I certainly
think nobody up here or on your panel is advocating emitting jets of
printing press money to solve our problems.
Wouldn’t you, Mr. Heller, agree that an important part of our antiinflationary arsenal ought to be some informal system of what has
been called— I think by you— credit conservation ?
One observes, for instance, that in recent years the businessman who
wants to put in a new piece of productive equipment, a family farmer
trying to keep the farm together, the homebuilder and homeowner, the
auto purchaser, the construction industry have— all have found it
impossible to get credit or, if they can get it at all, only at murderously
high interest rates.
Meanwhile, the Bunker Hunts have found the banks, fairly slobber­
ing over the chance to earn a high interest rate, grubstaking their silver
speculations. And the merger addicts now invest the land— have found
it very easy— the other day, for instance, in the Bendix-Martin Marrietta case, it turned out that the leading banks were immobilizing
$5.6 billion in very scarce credit, keeping it from going through that
period to productive uses— to grubstake that merger. Some banks
were not just on one side of that piece of cannibalism, but were on
two sides. And in some cases, three sides.
Hasn’t it been your observation— in that most other civilized western
industrial democracies, the government and the central bank use their
moral authority and appeal to the patriotism of the major lending
institutions to deemphasize destructive speculation loans and thus
have more available to lend at lower interest rates to productive loans ?
Mr. H e l l e r . I would say that civilized financial systems should put
an end to corporate cannibalism, that—.and I like the way you put
it— the central banks should use their moral authority, not put in a
rigid structure of credit controls.
A word to the wise from Paul Volcker to the leading bankers of
the country could do a great deal. And I believe that kind of guidance
would be a good thing.




88

I suppose it's even more important in times of real credit stringency,
which at the moment wTe don’t have in this slack economy. But you
are quite right, the spectacle that we have recently seen in the BendixMartin Marrietta, et cetera, case is an extreme example of the misuse
of credit in the economy.
So, I agree with the general thrust of what you say.
I do find it hard to structure a formal system of credit controls.
That is an extremely difficult thing. But the use of moral suasion,
moral authority— just as we ought to be doing it in the wage-price
field— is part of the broader need to develop some social compacts in
this economy.
Representative R e u s s . I don’t think we need a formal structure. All
of this lending is done by the 50 largest banks in the country.
Mr. H e l l e r . That’s right.
Representative R e u s s . You’ve got 12 Federal Reserve banks. That’s
four banks to a district. They ought to be able to have friendly chats
from time to time which would achieve a very wholesome effect.
Mr. H e l l e r . Friendly chats held in the woodshed.
Representative R e u s s . And the discount window and other niceties
they have available.
Mr. H e l l e r . Right.
Representative R e u s s . Well, gentlemen, you have made a remark­
able contribution.
I think the totality of what you have put on the table here does
constitute the constructive Democratic alternative to the administra­
tion’s policies for which the country is yearning.
I ’m going to take the liberty of sending the transcript of this testi­
mony to President Reagan and ask that he tell the Nation what is
wrong with it, what he disagrees with and why.
And I think I can say that this request for national major network
television time without teleprompters would be seconded by the Dem­
ocratic leadership. And that would be a very constructive debate.
Representative H a w k i n s . D o you plan, Mr. Chairman, to give them
equal time in these hearings?
Representative R e u s s . We have had abundant testimony from the
administration witnesses. And we will again. There certainly will be
more than equal time.
And specifically, I hope that within the next fewTdays we can have
our friend, Chairman Volcker of the Federal Reserve, up, because
the Federal Reserve is a very important part of this.
So, with many thanks for your constructive contribution, we now
stand in recess.
[Whereupon, at 12:35 p.m., the committee recessed, to reconvene at
10 a.m., Wednesday, October 20, 1982.]




THE UNEMPLOYMENT CRISIS AND POLICIES FOR
ECONOMIC RECOVERY

W ED N ESD AY, OCTOBER 20, 1982
C ongress

of

the

J o in t E

U

n it e d

c o n o m ic

S tates,
C o m m it t e e ,

Washington, D.C
The committee met, pursuant to recess, at 10 a.m., in room 2128,
Rayburn House Office Building, Hon. Henry S. Reuss (chairman of
the committee) presiding.
Present: Representatives Reuss and Mitchell.
Also present: James K. Galbraith, executive director; Louis G
Krauthoff II, assistant director; Charles H. Bradford, assistant di­
rector ; Betty Maddox, assistant director for administration; and Paul
B. Manchester, professional staff member.

OPENING STATEMENT OP REPRESENTATIVE REUSS, CHAIRMAN
Representative R e u s s . The Joint Economic Committee will be in
order for further hearings on the unemployment situation.
In early March the President told us that the economy was “poised
for recovery.” 1 Three months later he reassured us that economic re­
covery was “imminent.” 2 After another 3 months we were told that
“recovery has been sighted.” 3 In spite of this, signs of recovery are
conspicuous by their absence:
First: The unemployment rate reached 10.1 percent last month.
Second: Industrial production has fallen by 10.8 percent since the
President’s tax bill was passed by Congress in July 1981, and in Sep­
tember it was at its lowest level since April 1977.
Third: Initial claims for unemployment insurance peaked at
703,000, a record, in the week ending September 18. They remained
near this level in the 2 most recent weeks.
Fourth: Capacity utilization in manufacturing fell to 69.1 percent
in September, the lowest rate in 7 years.
Fifth: Workers on part time rose by nearly 1 million last month
to a record 6.6 million. The number of discouraged workers also
reached a record level of 1.6 million last quarter.
Sixth: The index of leading indicators fell by 0.9 percent in Au­
gust, the most recent month for which data are available.
Seventh: Corporate profits have been decimated by the Reagan re­
cession, falling by more than 25 percent between the first quarter of
1981 and the second quarter of 1982.
J Chicago Tribune, Mar. 4, 1982.
2 New York Times, June 4, 1982.
a New York Times, Sept. 10, 1982.




(89)

90
Eighth* Yesterday the Commerce Department reported that in
August, the most recent month for which data are available, total
real disposable income fell by 0.3 percent. The economy has been so
weak that on a per capita basis real disposable income in August was
barely 0.3-percent above the July 1981 level.
Ninth: Retail sales, unadjusted for inflation, rose slightly in Sep­
tember, but are still 1.5-percent below the May level. In real terms
the decline has been much greater.
Tenth: Real business capital spending is projected by the Commerce
Department to decline by 4.4 percent this year.
Eleventh: W e have just learned that according to preliminary
data, real GNP in the third quarter increased at a rate of only 0.8
percent, less than half the 2.1 increase for the second quarter. The
little increase that there was was largely due to an inventory buildup
that was undesired. Final sales actually fell at an annual rate of 0.6
percent.
Since producers didn’t anticipate the drop in sales, they produced
more than they could sell, which adds to their inventory. This is bad
news, for now they will have to reduce their excessive inventories.
Thus even if sales turn up in the fourth quarter, output may not, as
producers work off their inventory. Real GNP growth, at an abysmal
rate of 0.8 percent, corresponds to higher unemployment. Output
would have to grow at least three times as fast simply to keep the
unemployment rate where it is today.
On July 30 the administration forecast real GNP growth in the last
half of 1982 at a 5.3 percent rate. To achieve this we would now need
growth at a rate of nearly 10 percent in the fourth quarter, and no
one, even in the administration, is predicting this.
The one bit of good newTs was yesterday’s news about housing starts.
They were up 14.4 percent in September over August. This is for two
reasons: The Federal Reserve, yielding to congressional urgings, has
modestly eased credit; and in September the Department of Housing
and Urban Development unleashed a flood of subsidies for the new
housing construction industry— 30,000 units in September alone,
treble the amount of the month before, leading some to suggest that if
we had elections every month the housing industry would be in much
better shape.
The net result of all this is that in the first 6 quarters in office Presi­
dent Reagan has had the worst record of economic growth of any
President since the beginning of the collection of quarterly data way
back in 1947.
Based on the preliminary estimate of a 0.8 percent change in real
GNP for the third quarter, the record shows the following economic
growth in the first 6 quarters of recent Presidential terms: President
Eisenhower, negative 1.0 percent; President Kennedy, plus 9.2 per­
cent; President Johnson, plus 8.4 percent; President Nixon, plus 0.8
percent: President Ford, plus 3.1 percent; President Carter, plus
8.0 percent ; and President Reagan, negative 1.8 percent.
Today we are honored to have with us five leading economic analysts
to discuss the current economic situation and outlook. Our witnesses
are Francis Bator, professor of political economy, Kennedy School,
Harvard University; Raymond Dalio, president, Bridgewater Asso­
ciates ; Michael Evans, president of Evans Economics; Donald Rata-




91
jczak, director of Economic Forecasting Project, Georgia State Uni­
versity; and Allen Sinai, senior vice president, Data Resources, Inc.
We are delighted to have these leading analysts of the Nation’s
economy before us this morning. We appreciate your getting your
prepared statements into us in timely fashion. They will be, without
objection, received in full into the record.
We will ask each one of you to summarize after our colleague,
Congressman Mitchell, makes an opening statement.
Representative M i t c h e ll. Thank you, Mr. Chairman. I really don’t
have an opening statement. I merely wanted to inform you that the
times are so perilous that I am going into extracurricular activities;
I am doing some research that is not really related to my congressional
duties.
I am fascinated by the story of the Titanic, and I am doing some
research to determine whether the captain of the Titanic stayed un­
swervingly on course before the Titanic went to the bottom of the
ocean, and I will share that research with you. It is a fascinating
thing to do every once in a while, to look at those who stay on course
despite the icebergs and other perils that are in the way.
I also just wanted to renew my prediction that come the end of
February 1983 the unemployment rate will be 11.2 percent unless there
is a significant midcourse change. That’s inevitable. I ’ve run my data
again, and it clearly showed it’s 11.2 for the end of February unless
the captain of the— well, unless the captain decides to correct and
make a change and not stay on the disastrous course that he is now
following.
I am anxious to hear from the witnesses.
Representative Reuss. Thank you very much.
Before we call our first witness this morning, I will include Senator
Jepsen’s opening statement for the record at this point, without
objection.
[The opening statement of Hon. Roger W Jepsen follows:]
O pening

St a t e m e n t

of

Senator

J e p s e n , V ice

C h a i r m a n

Today’s report of a 0.8 percent annual rate of growth in gross national product
in the third quarter of this year is welcome newTs. Together with yesterday’s
news that housing starts and permits were up sharply in September, this signals
the “light at the end of the tunnel,” a resurgence in the American economy that
can be translated into additional jobs for America’s workers. It is the second
consecutive quarter of real growth in output and, combined wTith the substantial
fall in both the rate of price inflation and levels of interest rates in recent
months, confirms that the recession is over.
The experience of recent times indicates that a 1 percentage point increase in
gross national product means approximately 400,000 jobs for American workers.
Today’s news should give hope to the American public, a public that has been
beset by naysayers who have been emphasizing anything that could be construed
as a negative feature of recent American economic performance. Crude attempts
have been made to compare present economic circumstances wTith those of the
Great Depression of the 1930’s, ignoring the fact that during that period employ­
ment fell by almost 20 percent while during the first 9 months of 1982, average
employment is virtually unchanged from January 1981. Even the September level
of employment is only twTo-tenths of 1 percent less than the January 1981 level.
Today’s news, coming on top of yesterday’s housing statistics, should cause
those who have been waving the “bloody shirt” of depression for partisan politi­
cal advantage to pause and consider the potential impact of their demagoguery
on the state of the nation. Political license is one thing, but the deliberate twist­
ing and distorting of the realities of American economic life— the conjuring of




92

shadows on the wall—the economic rhetoric of the past fewTwTeeks—those are
something else.

Representative

R eu ss.

Mr. Bator, would you lead off, please.

STATEMENT OF FRANCIS M. BATOR, PROFESSOR OF POLITICAL
ECONOMY, JOHN F. KENNEDY SCHOOL OF GOVERNMENT, HAR­
VARD UNIVERSITY, CAMBRIDGE, MASS.
Mr. B a t o r . I hope you will allow me to begin by saying how difficult
it is to think about this committee without you, and indeed without
you as chairman. It will be a loss to the country and especially, I think,
a loss to the cause of economic enlightenment.
I am grateful for this opportunity to comment on the prospects of
the U.S. economy. I will concentrate on the domestic rather than the
international dimensions of our troubles, and on their cyclical aspects,
on the timing and pace of recovery from the 1980-82 minidepression.
Except for inflation I will say little about longer term structural
difficulties.
First, the next few months. When will the U.S. economy turn, and
will it turn up or down ?
Absent a further change in policy, I believe that the chance of an
upturn the next 3 to 6 months is at best 50-50. Another substantial
decline that would drive the unemployment rate to 11-12 percent is
entirely possible. I believe the economy is near stalling speed.
I f the above judgment is right, and considering the damage that a
further decine would inflict, there exists a powerful case for downside
insurance. Specifically, I would urge that:
First. During the next few weeks the Federal Reserve actively drive
down short-term interest rates and thereafter that it continue to ac­
commodate the demand for Mi, M2, and M3 until there is available
reliable evidence that total output and real final spending have
turned up.
Second. I f the statistics that become available during November
suggest continued weakness, the postelection Congress should change
to January 1 the effective date of the personal income tax reduction
now scheduled to take effect on July 1. It would be a modest, and in
some respects awkward move, but by giving the economy a small up­
ward push it might just help avert another decline. A t the same time,
it would be useful if the legislative record reflected congressional
awareness that the prospective outyear, midrecovery deficit will have
to be reduced.
Under current economic circumstances, the chance is in my opinion
negligible that the above actions would trigger an uncontrollable
spending boom that would tighten markets too fast and thus cause the
underlying wage-price inflation to accelerate. Like a coiled spring the
economy is not. In the near term the balance of danger is, I believe, all
the other way.
Argument. Most of the serious forecasts I have studied say that
real output will increase during the fourth quarter by a little and
pick up speed during the winter and spring. My reasons for concern,
nevertheless, are as follows:
How aggregate spending will behave during the next few months is,
I believe, much more uncertain than has usually been the case just




93

before a cyclical upturn. For many months the economy has been
operating outside the range of postwar observation. The U.S. record
does not contain evidence on spending behavior in an environment of
double-digit unemployment, less than 70 percent capacity utilization,
still near record high real interest rates, and widespread business
illiquidity. It is the only record available. The most likely story drawn
from it is the most likely story. But it is only that. We should take at
least low-cost steps to hedge against unpleasant surprise.
When considering the arithmetic of an upturn, it is important to
keep in mind that as long as inflation persists at an annual rate of,
say, 5 percent, annualized nominal spending has to increase by about
$40 billion each quarter merely to keep output level, and by $60-$65
billion to keep the unemployment rate from increasing.
What is the likelihood of such spending growth during the next two
quarters ? The optimistic forecasts rely on large increases in Federal
purchases, in residential construction, and in personal consumption,
and also on a reduction in inventory disinvestment. The change in in­
ventory investment is predicated on substantial inventory liquidation
during the third quarter. On the evidence available at this writing—
and as I now look at the figures on the basis of the evidence announced
this morning— one has to wonder whether any such liquidation took
place. A more likely bet, I think, is that final sales and production have
been in approximate balance.
Consumption is critical. For an appreciable upturn it will have to
increase during the next 6 months much faster than disposable income.
W ill it ? I think the answer is unknowable. The monthly figures do not
suggest that personal saving rates took an uncharacteristically large
post-tax-cut jump in July or August, There is therefore no reason to
count on a larger than characteristic delayed effect from the July 1
tax cut and social security increase. The fear and uncertainty caused
by record unemployment, though difficult to gage, must be reckoned
a very large minus.
Concerning monetary policy, it may seem churlish to ask the Fed
to change its policy once again. But if I read Chairman Yolcker right,
while they intend to accommodate above-target increases in the de­
mand for money at current nominal interest rates, and to allow belowtarget increases to cause interest rates to decline further, they do
not intend to expand the monetary base fast enough actively to drive
short-term interest rates down if demand for money happens to grow
at above-target rates. Yet doing that in the near term would be the
right medicine. At least it would be the right medicine if I am right
that the economy is near stalling speed and that the damage caused
by its further decline would far outweigh the negligible danger that
such active easing would produce a difficult-to-control spending boom.
I recognize that the proposal to cut taxes as of January 1 is both
awkward and quite possibly too modest to matter. It is awkward, be­
cause if the economy does turn up soon, by 1984 we will probably have
to raise taxes. The recommendation looks like an attempt at fine tun­
ing, and it may be much too fine in two senses: As preventive, it may
well be too late as well as too small; and if it fails and the economy
takes another dive— not a probability, but a 1 in 4 possibility— we
would have to take much more expansionary fiscal action.

17-871 0




83

7

94
So why bother ? Because it might help. Because with idle capacity,
business illiquidity and unemployment, lower interest rates may not
alone suffice quickly to stimulate much extra spending for goods and
services. It’s like trying to push on a string. Because it accommodated
by the Federal Reserve it cannot do much harm. Because if we don't
bother and the economy stays flat or weakens some more, we wall re­
gret not having tried.
Now let me turn, Mr. Chairman, to the next 1 to 4 years. What kind
of a recovery will we get?
What kind of a recovery wye will get depends on what kind of fiscal
and monetary policies we adopt. That in turn should reflect the kind
of recovery we want; on which of the feasible one-to-four paths of
output, employment, and associated inflation we like best or dislike
least. The choices are many. I will sketch just four.
One choice would be a relatively rapid recovery with worsening in­
flation. Because we are currently suffering a $300 billion per annum
gap between the actual output of the economy and its potential out­
put we could opt for a path of rapid growTth, say 6y2 to 7 percent per
year for the next 2 years, and a consequent one and a half to two
points annual reduction in the unemployment rate. Real income would
grow rapidly in the absence of direct wage restraint so I ’m afraid
would the price level. A t best the underlying wage-price inflation
would stop slowing down. Much more likely, such a rapid though not
atypical recovery would cause wage-price inflation to reaccelerate.
As a second choice, we could aim for a spending-output-employment
path that would slow down the core inflation even more, to perhaps
around 2 percent per year by 1985. To bring that about without direct
wage restraint would require enormous quantities of slack during the
next 2-3 years.
One possible target path would entail trying to hold the average
unemployment rate around 9 to 10 percent for another 2 years. That
would require that real spending be allowed to grow only a little faster
than 21/2 percent per-year. The direct 2-year cost would be in the
neighborhood of $500 billion in unproduced real output and income.
I f we follow this opinion we will have reduced the underlying inflation
rate from 9 percent to about 1-2 percent, but the 6-year direct cost
will have been about $1 trillion, approximately $15,000 per American
family. And that does not count the continuing productivity loss due
to the consequent loss in capital formation.
As a third possibility we could aim for a gradual recovery, modest
by historical standards, especially in light of the current size of the
utilization gap. A growth rate of 4 ^ to 5 percent per year during the
next 3 years would draw the unemployment rate down by, at best, one
point a year. Barring changes in real oil or food prices, core inflation
would probably get stuck somewhere between 5 and 7 percent.
The fourth option: We could add direct wage restraint to the policy
mix. I f we were walling to supplement fiscal and monetary policy with
a serious program of wage restraint we would have a good chance of
achieving both a relatively rapid recovery and further improvement
in.the core inflation. That is the option, Mr. Chairman, I would vote
for. But I fear it is a losing vote. Middle-of-the-road opinion seems
to favor the third approach, a very gradual recovery with no deterior­
ation in core inflation, and if that is to become our choice, changes




95
have to be made in both fiscal and monetary policy beyond the emer­
gency measures recommended above.
Fiscal policy. It is generally thought that for gradual growth, what
I called option 3, the prospective 1984-86 deficits are still too large.
While forecasting 2 to 3 years ahead is hazardous, I tend to share thait
view.
Mr. Chairman, if I am to discuss fiscal and monetary policy it will
take me about 4 or 5 minutes longer, I could skip fiscal and go to mone­
tary. What would be your preference ?
Representative R eus s. Let’s hear you. I think the others would
like to.
Mr. B a to r. I tend to share the view that, for gradual recovery, the
out-year deficits are too large, and will come back to it. First, however,
I would like to make two preliminary points about deficits in general.
Both are familiar to members of this committee, but they are often
misunderstood elsewhere.
First. The size of a deficit reveals little about what the budget is
doing to the economy. Because it reflects also what the economy is
doing to the budget, it is consequence as well as cause. For a usable
one-number indicator one has to look to changes in a construct called
the high employment deficit, or better still, to changes in the ratio of
the high employment deficit to GNP. It is called fiscal thrust.
Second. Budget deficits of any particular size, including high em­
ployment deficits are not good or bad as such. They are too large, too
small, or about right, according to what one wants the budget to do to
the economy. For example, one must, I think, be thankful for the very
large deficits of calendar 1982. I f we had tried to make them smaller
by cutting spending or raising current taxes, we would have reduced
the sum of private plus public spending and caused a reduction in
output and employment; we would have made the recession worse.
To be sure, as a consequence of the deeper recession inflation would
be a little slower. Moreover, because nominal income would also be
lower, so would the demand for money. As a result, with no change
in the supply of money, interest rates would be somewhat lower, but
not enough lower— and that is the critical point— to cancel the nega­
tive effect of the tighter budget on total spending and output. For
that the Fed would have had to make the money supply grow much
faster than it did, driving interest rates still lower by positive ac­
tion. Until 2 weeks ago there was no reason to believe that the Fed
might be walling to cooperate in such a shift in the fiscal-monetary
mix. It follows that the 1982 deficits have been and are good deficits.
What about the prospective deficits ? I have suggested above that a
risk-averting strategy calls for making the early 1983 deficit larger.
For 1984 and thereafter the answer depends again on which of the
feasible paths of output and core inflation we wish the economy to fol­
low, and, once again, on Federal Reserve policy.
I f we wish to opt for the moderate 4 to 5 percent growth path— a
one-point-a-year reduction in unemployment, no appreciable deter­
ioration in wage-price inflation, but not further improvement either—
then the consensus view is probably right that the deficits presently
programed for fiscal 1985 and 1986, and maybe even for late 1984, are
likely to produce too much fiscal thrust. For a while at least total
spending for goods and services would tend to grow rapidly. If the




96
consequent demand for money were to be accommodated by the Fed,
we would have cheerful results with respect to the real economy, but
unpleasant results with respect to inflation. If, alternatively, the Fed­
eral Reserve chose to step on the monetary brakes, the combination
of slow money growth with initially fast, fiscally induced growth in
spending, and therefore in the demand for money, would force interest
rates to rise and the interest and credit sensitive components of spend­
ing would be squeezed. Within a few quarters tight money would win
out over loose fiscal policy, recovery would stall, and we w7ould suffer
another nasty recession.
So if we want the gradual growth option, the midrecovery 1985
and 1986 fiscal deficits will probably have to be reduced.
Monetary policy in support of a gradual recovery. To bring about
a gradual, 1-point-a-year reduction in the unemployment rate during
the next 3 years output would have to grow at a rate of about 4y2 to
5 percent per year. I f along such a growth path the underlying rate of
inflation were to remain in the 5 to 7 percent range— and that is the
most likely outcome, barring supply-price shocks— then total nominal
spending would have to grow at an average rate of 9y2 to 12 percent.
That will not happen if the Federal Reserve, after choosing a new
base period for money supply some time this winter, persists in trying
to adhere to its previously announced objective for the growth rate of
the money stock, that is a 5y2 percent growth calling for Mi during
1983 and still lower ceilings beginning in 1984.
In the short run, quarter by quarter the demand for money is ex­
tremely volatile. That is why it does not make sense for the Federal
Reserve to try to track a fixed money supply target. But over a period
of a year or two 5y2 percent M x growth will not sustain a 9y2 to 12
percent rate of nominal spending growth. I f a shortfall in spending
could be relied on to slow down prices directly, in proportion, that
would be fine. But in a sticky price economy like the United States
a shortfall in spending will reduce output and employment quickly
and reduce wage and price inflation only very gradually.
The conclusion. I f we want a gradual recovery— the third option
above— the Fed will have to abandon for good its announced growth
rate ceilings for money supply. It could announce new, much higher
ceilings and explain why that is necessary if we are to achieve a
gradual recovery. Better by far it could announce that after 3 years
of experimentation, experimentation that produced a 3-to 4-point
improvement in the underlying inflation at the cost of 6 point years
of extra unemployment and $450 billion of lost real income and out­
put, that henceforth it intends to supply base money in whatever
volume seems appropriate to the fiscal monetary task of making total
spending track an agreed and announced 1- to 3-year target.
It could explain further that in support of that objective it will
pay attention to interest rates, credit supply, to M t, M 2, M 3, and
any other economic indicator that might improve its forecasts of
spending behavior. Such a policy would require that there be all­
government agreement on a total spending target and on the forecast
consequences for output, employment, and the price level.
For the Fed the hardest part would be the loss of protection now
afforded by the sometimes useful pretense of a kind of technocratic,




97
apolitical value neutrality that helps protect its quasi-independent
status and wards off questions of legitimacy,
Mr. Chairman, I will stop there. The last part of this testimony
consists of a taxpayer's reflections on how to reduce the 1984-87 budget
deficit. My conclusion, very briefly, is— and this entails value judg­
ments— that (1) nondefense Federal spending ought to increase, not
decrease. I can comment on that later if that would be of interest to
you. (2) I believe we should stretch out the defense buildup, but only
to a point. I think we do need a buildup focused mainly on conven­
tional forces, mobility, maintenance, operation, and training. Cer­
tainly we should not spend money on things like the M X . (3) It fol­
lows that virtually all of the deficit reduction that we probably will
have to undertake for late 1984,1985, and 1986 should come in the form
of higher taxes. I do not believe that the United States is an overtaxed
society. I think we should remember Justice Homes proposition that
“taxes are what we pay for civilized society.” Thank you, Mr. Chair­
man.
[The prepared statement of Mr. Bator follows:]




98

P r e p a r e d St a t e m e n t of F rancis M. B a t o r
I am grateful, Mr. Chairman, for this opportunity to comment on the nearterm and mid-term prospects of the U.S. economy.

I should like first to say

something about the immediate future, and then to go on, in Part II, to some
questions concerning the pace and shape of a recovery once the economy has
turned around.

I will concentrate on the d.omes.tic rather than the equally impor­

tant international dimensions of our problems, and on their cyclical aspects
the timing and pace of recovery from the 1980-82(?) mini-depression.

—

Except

for inflation, I will say little about possible, longer-term structural diffi­
culties.

(In my opinion, symptoms of the former are too often misdiagnosed

as evidence of the latter.)

I.

The Next Few Months:

When Will The U.S. Economy Turn,

And Will It Turn Up or Down?
To state the case very briefly (I will make the argument at greater length below):
#

Unless a further change is made in monetary policy, and perhaps
also in fiscal policy, I believe that the chance of an upturn
in real total spending and output during the next three to six
months is at best fifty-fifty.

Another substantial decline, that

would drive the unemployment rate to 11 to 12%, is entirely possible.
I believe that the economy is near stalling speed.
•




If the above judgment is right, and considering the damage that
a further decline would inflict, there exists a powerful case

99

for some downside insurance.

«

Specifically, I would urge that

(1)

During the next few weeks, the Federal Reserve
actively drive down short term nominal interest
rates, and thereafter, that it continue to accom­
modate, the demand for M-l, M-2.
until there is
available reliable evidence that total output and
real final spending have turned up.

(2)

If the statistics that will become available during
November suggest continued weakness, the post-elec­
tion Congress should change to January 1, 1983
the effective date of the personal income tax re­
duction now scheduled to take effect on July 1.
It would be a modest, and in some respects awkward
move, but by giving the economy a small upward push,
it might just help avert another decline.
(At the
same time, it would be useful if the legislative
record reflected Congressional awareness that the
prospective out-year, mid-recovery and late-recovery
deficits will have to be reduced.)

Under current economic circumstances, the chance is negligibly small
that the above actions would stimulate, or exacerbate, an uncontrol­
lable spending boom that would tighten labor markets and goods markets
too fast, and thus cause the underlying wage-price inflation to
accelerate.

Like a "coiled spring,"

the economy is not.

near term, the balance of danger is all the other way.
in Part II below

In the

(I will argue

that in a year or so, if in the meantime the

economy does turn up, we will confront difficult choices involving a
trade-off between the speed of recovery and the speed of inflation.)
Argument
I am aware that most of the serious forecasts say

-- or at least most of

those I have studied -- that the recession has run its course, that real out­
put will increase during the fourth quarter by a little and pick up speed
during the winter and spring.

My reasons for concern, and for suggesting a

prompt, short-term policy change as a hedge, are as follows:
•

How aggregate spending will behave during the next few months is,
I believe, much more irreducibly uncertain than has usually been
the case just before a cyclical upturn.




For many months, the

100
economy has been operating outside the range of post-war obser­
vation.

Forecasts are based on regularities found in the record

of the past.

The U.S. record does not contain much direct

evidence on household and business spending in an environment
of double-digit unemployment, less than 70% capacity utiliza­
tion, still near record high real interest rates, and widespread
business illiquidity.

It is the only record available; the most

likely story drawn from it, by the use of good economics, good
econometrics, and good sense, is the most likely story.
it is only that,

But

We should be prepared for surprise and take

at least low-cost steps to hedge against unpleasant surprise.
When considering the arithmetic of an upturn (or downturn), it
is important to keep in mind that, as long as inflation persists
at an annual rate of, say, 5%, total annualized nominal spending
has to increase by about $40 billion each quarter merely to maintain
output constant,

(Five percent is a low estimate of the present

pace of the inertial drift in the price level, a consequence of
the wage-price spiral.)

To keep the unemployment rate and idle

capacity from increasing, the quarterly increment in annualized
nominal spending has to be $60 to $65 billion at current levels.
(Because the labor force and productivity^ are both increasing, real
output has to grow at an annual rate of about 2^% merely to keep the
unemployment rate and idle capacity level; with inflation at 5 to 6%,
total nominal spending has to grow at a rate of at least 5 + 2 \ = 7^%.
At current levels that translates into quarterly increments of
$60 to $65 billion.)
What is the likelihood of such spending growth during the next two
quarters?

With state and local purchases, business fixed invest­

ment, and net exports predictably weak (the last perhaps very weak),
the optimistic forecasts rely on large increases in Federal pur­
chases, in residential fixed investment (at least on a seasonally
adjusted b a sis), and in personal consumption, and also on a
reduction in inventory dis-investment.

The Federal purchase

1 I.e., cyclically adjusted productivity (in other words, productivity
evaluated at any constant rate of capacity utilization and employment.)




101
estimates are tolerably reliable, and so is a part of the pro­
jected increase in residential construction (it is driven by
housing starts already on the books).

But the change in inven­

tory investment is predicated on substantial inventory liquida­
tion during the third quarter.

On the evidence available at

this writing, one has to wonder whether any such liquidation
took place; a more likely bet, I think, is that final sales and
production have been in approximate balance.
Because it accounts for two-thirds of the total, consumption expendi­
ture is critical.

For an appreciable upturn, consumption will

have to increase during the next six months much faster than dis­
posable income.

Will it?

I think the answer is unknowable.

The

(unreliable) monthly figures do not suggest that personal saving
rates took an uncharacteristically large post-tax-cut jump in
July-August.

There is therefore no reason to count on a larger

than characteristic delayed effect from the July 1 tax cut and
social security increase.

The wealth-effect of the recent stock

market boom will be a (very small) plus.
liquidity will be a bigger plus.

Aggregate household

The reductions in consumer in­

terest rates will be a plus if they appreciably exceed the re­
duction in anticipated inflation.

The reduction in household net

worth since 1981, and the current decline in interest income, will
be a minus.

Most important, the fear and uncertainty caused by the

record unemployment rate, though difficult to gauge, must be reck­
oned a very large minus.
Concerning monetary policy, it may seem churlish to ask the Federal
Reserve to change policy once again, so soon after it has at long
last assured us that, for the time being,

it would not respond to

a run of large Friday afternoon M-l statistics by tightening its
base-money tourniquet and driving interest rates higher.

Moreover

Mr. Volcker is a master of ambiguity, not necessarily a bad thing




102
in a central banker.

But if I read him right, while the Federal

Reserve intends to accommodate above-target increases in the de­
mand for money at current nominal interest rates (and to allow
below-target increases to cause interest rates to decline further),
they do not intend to expand the monetary base fast enough actively
to drive short-term interest rates down
happens to grow at above target rates.
near-term, would be the right medicine.
the right medicine

if demand for money
Yet

doing that, in the

At least, it would be

if I am right that the economy is near stalling

speed, and that the damage caused by its further decline would far
outweigh the negligible danger that such active monetary easing
during the next few months would produce a difficult-to-control
spending boom.

(I recognize that this last point contains both

a contingent prediction and a value judgment that the anti-inflationary benefit of letting the unemployment rate go to 11-12% is
not worth the damage done to the real economy.

For more com­

ment on the inflation versus unemployment tradeoff see Part II
below.)
•

I recognize also that the proposal to cut taxes as of January 1, 1983
is both awkward and, quite possibly, too modnest to matter.

It is

awkward because, if the economy does turn up soon, by 1984 we will
probably have to raise taxes in order to avoid an excessive, short­
lived boom that would lead to a credit crunch, and thence to another
recession.

The recommendation looks like an attempt at "fine tuning,"

and it may be much too "fine" in two senses.

As a preventive, it

may well be too late as well as too small, even in combination with
active monetary ease.

And if it fails, and the economy takes another

dive (not a probability, but in my opinion a one-in-four possibility),
we would have to take much more aggressive expansionary fiscal action.
(If successful, that policy too would have to be reversed in a couple
of years.)




103

•

So why bother with the tax-date change?

Because it might help.

(I am aware of the permanent income hypothesis, but only half
believe it.)

Because idle capacity, business illiquidity, and

unemployment may frustrate even a policy of aggressive monetary
ease; lower interest rates by themselves may not quickly stimulate
much extra spending for goods and services.

Because, if accom­

modated by the Federal Reserve, as it should be, the tax-date
change cannot do much harm; given the state of the economy, it
certainly w o n ’t be too expansionary.

Because, if we d o n ’t make

the effort, and the economy stays flat or weakens some more, we
will regret not having tried.
II.

The Next One to Four Years:

What Kind of Recovery?

What kind of recovery we will get depends on what kind of fiscal and mone­
tary policies we adopt.
covery we want —

That choice in turn should reflect the kind of re­

which of the feasible one to four year paths of output, em­

ployment, capacity utilization, and associated inflation we like best, or dis­
like least.

The choices are many; I will sketch just four.

(For the sake of

schematic clarity, and at the risk of an excess of numerical precision, I
will rely on the persistent regularities that have characterized the rela­
tions between output, employment, and core inflation in the United States
during the past two or three decades, and will omit the usual caveats.

Those

are the best-bet numbers available; the macroeconomic managers have no choice
but to make use of them in a gingerly and continuously observant way.

I will

also assume that the economy does turn up this winter, that the unemployment
rate doesn’t rise much above 10%, and that during the next three years we are
not once again confronted by enormous supply price shocks of the sort that
damaged us in 1972-4 and again in 1979.)
(1)

Relatively rapid recovery and worsening inflation.

Because we

are currently suffering a gap of $300 billion per year between
the actual output of the economy and its potential output
(i.e., the output that the economy would be producing if the un­
employment rate were 6% rather than the current 10%, and capacity
utilization in manufacturing about 85% rather than the current 69%),




104

we could opt for a path of rapid growth in total real spend­
ing and output, say 6^ to 7% per year for the next two years,
and a consequent relatively rapid reduction in the unemploy­
ment rate on the order of 1% to 2 percentage points each year.
Real wages, real profits, capacity utilization, and realized
productivity would all grow rapidly.

Unfortunately, in the

absence of direct wage restraint, so would the price level.
At best, the underlying wage-price inflation, having been slowed
down from about 9% per year to about 5 \ to 6^% by the 6 point-years
of excess unemployment since 1979 (i.e., that in excess of 6%),
would stop slowing.
atypical)
(2)

Much more likely, such a rapid (though not

recovery would cause wage-price inflation to reaccelerate.

High unemployment and decelerating inflation.

Alternatively, we

could aim for a spending-output-employment path that would slow
wage-price inflation down to around 2%(-) per year by 1985.

To

bring that about without direct wage restraint would require
that the macromanagers continue to operate the economy with enor­
mous quantities of slack during the next 2 to 3 years.

One possi­

ble target path would entail trying to hold the average unemployment
rate at around 9 to 10% for another two years.

That would require

that real spending and output be allowed to grow only a little
faster than the approximately 2^% per year needed to keep the unem­
ployment rate constant.

The direct two-year cost of such a program

of continuing disinflation would be in the neighborhood of $500
billion in unproduced real output and income (as compared to a 6%
unemployment path).

If we choose this option, we will have reduced

the underlying inflation rate from 9% in 1979 to about 1 to 2%.

The

six-year direct cost will have been about one trillion dollars,
approximately $15,000 per American family.

And that does not count

the continuing productivity loss due to the reduced volume of
capital formation.




105

(3)

Gradual recovery with core inflation stuck at 5 to 7%
As a third possibility, the macromanagers could aim for a gradual
recovery, modest by historical standards, especially in the light
of the current size of the employment and utilization gap.

A growth

rate of 4 to 5% per year during the next three years would draw down
the unemployment rate by, at best, one point a year.

Barring adverse

changes in real oil or food prices, core inflation would probably
get stuck somewhere between 5% and 7%.

As compared to the rapid re­

covery path, the real output and real income cost would come to about
$200 to $300 billion.
(4)

Adding wage restraint to the policy m i x .

If we were willing to

supplement fiscal and monetary policy and sensible old-fashioned
supply-side measures with a serious program of wage restraint, we
would have a good chance of achieving both a relatively rapid re­
covery and further improvement in the core inflation.

The object

of such a program would be to shrink directly the gap between the
rate of increase in money wages and salaries on the one hand, and
the (only slowly alterable) underlying rate of increase in pro­
ductivity on the other.
My own vote is for the fourth option, but I fear it is a losing vote.
Direct wage restraint does not seem to be in the political cards, at least
during the next two years.

Middle-of-the-road opinion seems to favor the third

approach: a very gradual recovery with no deterioration in core inflation.

If

that is to become our choice, changes will have to be made in both fiscal and
monetary policy, beyond the immediate emergency measures recommended above.^

Some people believe that the ’80-82 double-dip recession has already brought
about an appreciably larger than 3 point "norm-shift" in wage inflation and,
further, that we could manage even a fairly rapid recovery without causing in­
flation to reaccelerate.
A variant of that view asserts that we can combine
moderate recovery with continuing fairly rapid improvement in inflation.
They
rest their case on the relatively rapid deceleration shown by the (noisy) wage
statistics during the past 9 months.
Maybe so. We have no sustained postwar
experience of 9 to 10% unemployment rates; perhaps they are causing a qualitative
break in wage inflation.
If so, the numerical tradeoffs outlined above are all
too pessimistic.
It would not be prudent to bet that way.
As of now, the hope
that we could have both rapid recovery and continued deceleration in core infla­
tion without a serious policy of direct wage restraint strikes me as a low pro­
ability bet,




106

Fiscal Policy in Support of a Gradual Recovery
It is generally thought that, for gradual growth, the deficits built
into the prospective Federal budgets for '84-'86 are likely still to be too
large.

While forecasting two to three years ahead is hazardous (and in this

instance not entirely necessary), I tend to share that view, and will come
back to it.

First, however, I would like to make two preliminary points

about deficits in general.

Both are familiar to members of this Committee,

but they are often misunderstood elsewhere.
(1)

The size of a deficit reveals little about what the budget is
doing to the economy.

Because it reflects also what the

economy is doing to the budget, it is consequence as well as
cause.

For a useable one-number indicator of what the budget

is doing to the macroeconomy, one has to look to changes in a
construct called the high-employment deficit (or surplus), or,
better still, to changes in the ratio of the high-employment
deficit to GNP —

it is called "fiscal thrust."

(Actually,

for any given short period, changes in any standardized, incomeadjusted deficit would do.

One need not normalize relative to

some estimated "high employment" income.)
(2)




Budget deficits of any particular size, including high employment
deficits (or changes therein), are not good or bad as such.
are good or bad —

too large, too small, or about right —

They
accord­

ing to what one wants the budget to do to the economy: to total
public plus private spending for produced goods and services,
and thus to total output, employment, and inflation.
For example, and in light of the recently abandoned (one hopes)
money supply objectives of the Federal Réserve, one must

I think

be thankful for the very large deficits of calendar 1982.

If we

had tried to make them smaller by cutting spending, or raising
current taxes (thereby reducing after tax income), we would
have reduced the sum of private plus public spending, and caused
a reduction in output and employment.
have made the recession worse.

In other words, we would

107

To be sure, as a consequence of the deeper recession,
inflation would be a little slower.

Moreover, because

nominal income would also be lower, so would the demand
for money, i.e., for currency and checkable deposits.

As a

result, with no change in the supply of money provided by the
Federal Reserve, interest rates would be somewhat lower.
not enough lower —
misunderstood —

But

and that is the critical point so widely

to cancel the negative effect of the tighter

budget on total spending and output.

For that, the Fed would

have had to make the money supply grow much faster than it did,
driving interest rates still lower by positive action.

Until

two weeks ago, there was no reason to believe that the Fed
might be willing to cooperate in such a shift in the fiscalmonetary mix by significantly and persistently breaching or
revising its money-supply targets.

It follows that the 1982

deficits have been and are good deficits.
What about the prospective deficits?

I have already suggested that,

even if the Federal Reserve follows an actively expansionary policy during
the next few months (as I think it should), a risk-averting strategy calls
for making the early 1983 deficit larger.
answer depends again

For 1984

and thereafter, the

on which of the feasible paths of output, employ­

ment, and associated core inflation we wish the macro-economy to follow
(and, once again, on the Federal Reserve’s intentions with respect to the
supply of base m o ney),
If we wish to opt for the moderate, 4 to 5% growth path -- the path of
gradual recovery, a one-point a year reduction in unemployment, and no appre­
ciable deterioration in wage-price inflation, but no further improvement
either

—

then the consensus view is probably right that the

deficits presently programmed for fiscal years ’85 and '86, and maybe even
for late f84, are likely to produce too much fiscal thrust.

For a while at

least, total public plus private spending for goods and services would tend
to grow very rapidly.

If the consequent rapid growth in the demand for

money were to be accommodated by the Federal Reserve at declining or even
constant real interest rates, we would have cheerful results with respect




108

to output, real income, employment, and profitability, but unpleasant results
with respect to inflation.

If, alternatively, the Federal Reserve chose to

step on the monetary brakes, the combination of slow base-money growth with
initially fast fiscally-induced growth in total spending (and therefore in
the demand for money) would force interest rates to rise and credit to be­
come tight.

All the interest- and credit-sensitive components of spending

would be squeezed.

Within a few quarters, tight money would win out over

loose fiscal policy, recovery would stall, and we would suffer another nasty
recession.
brakes.

As Arthur Okun used to point out, tight money makes for grabby

It is especially so when tight money is accompanied by a stimulative

fiscal policy.
Monetary Policy In Support of a Gradual Recovery.
To bring about a gradual, one-percentage-point a year reduction in
the unemployment rate during the next three years, output would have to
grow at a rate of about 4^ to 5% per year.

If, .along such a growth and em­

ployment path, the underlying rate of inflation were to remain in the
5 to 7% range —
price shocks —

and that is the most likely outcome, barring large supplythen total nominal spending would have to grow at an

average rate of 9^ to 12%.

That will not happen if the Federal Reserve, after

choosing a new base period for money supply sometime this winter (it is
called "re-basing"), persists in trying to adhere to its previously
announced objectives for the growth rate of the money stock (e.g..

a 5%

growth-rate ceiling for M-l during 1983, and still lower ceilings beginning
in 1984) ,
In the short run, quarter by quarter, the demand for money is ex­
tremely volatile in relation to interest rates and income growth

-- that is

why it does not make sense for the Fed to try to track a fixed money supply
target.

But over a period of a year or two, 5^% M-l growth will not sus­

tain a 9 h to 12% rate of nominal spending growth.




If a shortfall in spending

109

could be relied on to slow down prices directly, in proportion, that would
be fine. But in a sticky price economy like the U.S., a shortfall in spend­
ing will reduce output and employment quickly, and reduce wage and price
inflation only very gradually.
The conclusion:
above

—

if we want a gradual recovery —

the third option

the Fed will have to abandon for good its announced growth-rate

ceilings for money supply.

It could announce new, much higher ceilings and

explain why that is necessary if we are to achieve a (gradual) recovery.
Better by far, it could announce that after three years of experimentation —
experimentation that produced a 3 to 4 point improvement in the underlying
inflation rate at the cost of 6 point-years of extra unemployment and
$450 billion of lost real income —

henceforth it intends to supply base

money in whatever volume seems appropriate to the fiscal-monetary task of
making total spending and its main components track an agreed and announced
1 to 3 year target,

It could explain, further, that in support of that ob­

jective, it will pay attention to interest rates, credit supply, M-l, M - 2 ...,
and any other economic indicator that might improve its forecasts of spend­
ing behavior.

Such a policy would require that there be agreement within

the government on a total spending target and on the forecast consequences
for output, employment, and the price level.

For the Federal Reserve, the

hardest part would be the loss of protection inherent in the fiction (in a
sticky price economy it _is a fiction) that monetary policy is value neutral,
and therefore apolitical.

Once the Fed is seen as making explicit choices

between unemployment and inflation, questions of legitimacy are likely to
threaten its often useful quasi-independent status.
III.

Postscript:

A Taxpayer's Reflections on How to Reduce

the '84-87 Budget Deficit
Evidently, we can try to cut real non-defense Federal spending still more,
stretch out the defense buildup, and/or raise tax rates and thereby repair the
damage done by the tax-cutting orgy of 1981.
ments.

The choices entail value judg­

My own values say that:
•

Real non-defense Federal spending needs to be increased,
not decreased.

17-871 0




83

8

While I would eliminate the over-indexing

110
of social security and tighten up on some other entitle­
ment programs, spending on a variety of activities that
benefit the poor, the central cities, the quality of public
services, the public capital stock, education, and research
and development ought in my opinion to go up rather than down.
•

We should stretch out the defense buildup, but only to a
point.

I believe we need a buildup, mainly centered on

maintenance and operations, on the readiness and mobility
of forces, on inventories, on conventional combat capa­
bilities in general.

Given the bomber and submarine force

(with cruise missiles and Trident II), and a cheaply en­
hanced Minuteman force, the "window of vulnerability"
notion is I think absurd, and therefore irresponsible.
We should certainly not be spending money on a vulnerably
based and therefore destabilizing MX.
9




It follows that virtually all of the deficit reduction
should take the form of higher taxes.

It is not true that

the United States is an over-taxed society.
measures it —

However one

by the ratio of total taxes to national in­

come, of government purchases to GNP, of total government
expenditure to GNP —

government in the United States takes

a substantially smaller cut than in virtually any other
major advanced industrial country except Japan:

West

Germany, Canada, France, Britain, Italy, Sweden, Austria,
Belgium, and the Netherlands all pay a higher proportion of
their national income in taxes.

By one measure, the Swiss

government does less; by another it does more.

Undoubtedly

a lot of what the government does is done inefficiently;
the same is true about a lot of what private industry does
producing for private use.

But it is not true that our

economic troubles of the past fifteen years have been caused
by too much government taxing and spending.

When considering

what we should do about the Federal budget in the next few
years, we had better remember Justice Holmes' proposition that
"taxes are what we pay for civilized society."

Ill
Representative
Mr. Dalio.

R eu ss.

Thank you, Mr. Bator.

STATEMENT OF RAYMOND T. DALIO, PRESIDENT, BRIDGEWATER
ASSOCIATES, WILTON, CONN.
Mr. D a l i o . Mr. Chairman, Congressman Mitchell. It’s a great plea­
sure and a great honor to be able to appear before you in examination
of what is going wrong with our economy.
Following the economy of the last few years has been rather like
watching a mystery thriller in which you can see the dangers lurking
around the corner and want to yell a warning but know it won’t be
heard.
The danger in this case is depression. Unfortunately, depression is
a word which is used sensationalistically and not enough diagnostically. Although it’s been a long time since the economy has suffered
from one, there is such a disease as depression which we as economists
should know how to diagnose. Today’s economists are about as famil­
iar with depressions as today’s physicians are with long dormant
plagues. Just as a physician wouldn’t want to treat pneumonia as
though it were a cold, an economist wouldn’t want to make the mistake
of misdiagnosing a depression by thinking it’s a recession.
Contrary to popular belief, a depression is not simply a more severe
version of a recession; it’s an entirely different degenerative process.
I f depressions were simply more severe versions of recessions, and
one just used measures of severity such as the rate of unemployment
or tlie rate of falling real GNP to differentiate between them, there
would be no means of distinguishing the early stages of a depression
from the late stages of a recession as they both are comparably severe.
However, by understanding the processes that cause depressions to
become more severe than recessions it’s easy to distinguish between
them. While a recession is a self-correcting economic contraction in
which liquidity increases, a depression is a self-feeding contraction
in which liquidity is being reduced. Normally in a recession inventories
are liquidated, borrowings decrease, money supply growth slows, and
interest rates decline. Various measures of liquidity, such as the ratio
of current assets to current liabilities and the percentage of corporate
debt which is short term in turn reflect this reliquification in a reces­
sion. However, in a depression in order to raise liquidity inventories
are liquidated and borrowings increase; as a result, inflation falls
while interest rates rise. Measures of liquidity in turn show it declin­
ing rather than increasing in a depression.
Since 1800 there have been 14 major depressions in the United
States, all progressing in a similar manner. This is what we call the
depression process. This process can be segmented into four phases.
In phase 1 the economy becomes debt burdened and illiquid, which
makes it what we call depression prone. In other words, the demand
for money becomes highly inelastic and money becomes tight.
This leads to what we call phase 2, or a liquidity crisis, at which
time borrowings increase and inventories are liquidated. This causes
interest rates to rise while the economy contracts, thereby worsening
the economy’s liquidity problems.




112

The depression process advances from phase 2, liquidity crisis, to
phase 3, which we call failure, when it moves from gasping for
liquidity to failing for lack of it. Failure is a lending crisis motivated
contraction in which the economy is no longer responsive to monetary
stimulation. In other words, it’s not a traditional recession; that is,
it's not a contraction primarily motivated either by reaching a high
level capacity or reaching a level of illiquidity; it’s a contraction
which is motivated by a lending crisis in which the economy is not
responsive to monetary stimulation.
After this contraction runs its course the depression enters what we
call phase 4, the period of economic stagnation.
As it would take a considerable amount of time to examine the econ­
omy’s evolution to this point, suffice it to say that from the late 1940’s
until 1979— the July 1979 appointment of Paul Volcker— the ratio
of total debt to GNP increased to the highest level since the Great
Depression at the same time as liquidity was severely reduced.
I f you would be kind enough to turn to chart 1 at the rear of the
prepared statement you can see ratio of total debt to GNP at the top
portion of the chart. That ratio goes back to 1916. The large spike up
in the 1930’s was a result primarily of a falling GNP and it conveys
how a falling economy increases the debt burden. But debt doesn’t
decline as GNP does and so, as a result, the ratio of debt to GNP
increases. You can see that the debt to GNP ratio has increased con­
sistently from the early 1950’s until the 1979 period.
Since the October 1979 shift in monetary policy the Fed, in its
battle against inflation, substantially further drained liquidity. As a
result, for the last 3 years the economy has been in a protracted liquid­
ity crisis. Interest rates have consistently held higher than at any time
in the previous 100 years at the same time as capacity utilization has
declined to near the lowest level since the Great Depression.
Extended severe illiquidity inevitably causes economic failure. I
repeat, that’s a lending crisis motivated contraction in which the
economy ceases to be responsive to monetary stimulation. This hap­
pens when large numbers of borrowers are unable to meet their debt
service obligations. This reduces both the ability and the willingness
of lenders to extend credit, which further constricts the flow of funds
to illiquid borrowers, in turn causing more failures.
Since the banking system is the Federal Reserve’s only conduit for
reliquifying the economy, if bankers are less willing to lend it follows
that the Federal Reserve is less able to revive the failing economy.
This signals the beginning of wdiat we call the failure phase—¡phase 3
of the depression process.
The economy is now teetering on the brink of failure. Like the last
months of 1979, most recently, or the middle months of 1929, more
appropriately, the economy is now in a brief yet critically important
transition period. In late 1979 the transition was from a decade of
inflationary expansion to 3 years of liquidity crisis. In mid-1929 the
transition was from a decade of extraordinarily rapid economic
growth to 5 years of failure.
The economy is now in transition from 3 years of liquidity crisis to
a period of either failure or much higher levels of inflation. The econ­
omy’s extreme illiquidity and leveraged condition implies that a large
enough injection of liquidity to avoid failure would cause hyperinfla­
tion. By that I mean 15 to 18 percent by 1984.




Iil3
The economy is now too illiquid to allow a return to stagflation,
which is the successful balancing of the inflation and weak economy
alternatives.
Virtually all statistics reflecting the economy's rate of activity indi­
cate it is essentially flat. The rate is consistent with capacity utilization
around 70 percent, real GNP about $1,480 billion, and the index of
industrial production around 137.
Unfortunately, at this level of activity a stable economy is a dete­
riorating economy. While it is widely assumed that an economy which
is expanding is getting stronger, changes in the economy’s health are
not primarily a function of changes in its direction but rather the
rate at which it is operating. For example, a falling economy operating
at 85 percent of capacity will be strengthening while a rising economy
operating at 70 percent of capacity will be deteriorating. While the
economy is now essentially flat, businesses are failing at a rate which is
higher than at any time since 1933.
I ’d like to turn your attention to chart 20, then also ask to turn your
attention to charts 11 and 12, flipping between them.
Chart 11, if you were to use real GNP— that’s that dashed line
there— shows that essentially the economy has been roughly flat since
the beginning of the year.
Turn to chart 20. You see that through that period of time there has
been a consistent increase in business failures. This reflects that a flat
economy is a deteriorating economy.
This failure rate will continue to rise until capacity utilization in­
creases to at least 78 percent. However, rather than thinking of the
economy as being homogeneous, it would be more accurate to think of
it as being two-tiered, with interest rate sensitive sectors on the brink
of failure and noninterest rate sensitive sectors still strong.
Since there is no way for the economy as a whole to remain immune
from a bankruptcy crisis among the interest rate sensitive sectors, in
order to assess the probability of failure it’s this latter group which
should be examined.
While it is important to recognize that the economy as a whole is
headed for failure operating at under 70 percent of capacity, it’s even
more essential to consider the implications of little or no improvement
among the interest rate sensitive sectors of the economy, such as autos,
construction, airlines, lumber, steel, heavy equipment, et cetera, which
are operating at less than 55 percent of capacity, and mining compa­
nies and farmers who are selling substantially below their costs of
production.
In aggregate, the financial health of this large, interest rate sensitive
sector of the economy is deteriorating rapidly. Its health will continue
to deteriorate and failures among this sector will continue to rise un­
less there is an enormous reliquification.
We estimate that if the economy remains flat or improves only
modestly the rate of business failures will increase by over 50 percent
in the next 6 months. With the rate of business failures already unsustainably high, and given the fact that it would have to decline
significantly in order to avoid failure, we can continue to assess that
the odds are in favor of failure.
Since we’re forecasting failure— we say the odds are in favor of
failure— while other economists are forecasting imminent recovery,
obviously our understanding of how the economy works must be ap­




114
preciably different from theirs. Specifically, our disagreement con­
cerns liquidity.
Based on our understanding of economics, the popular forecast that
the economy will turn up at the same time as interest rates and infla­
tion fall is impossible. We don’t understand where the increased
liquidity needed to both fuel an expansion and cause interest rates to
decline will come from if not accompanied by an inflationary accelera­
tion in the money supply.
The popular explanation that when the economy turns up over the
next few months it will somehow produce enough liquidity to finance
the expansion and allow interest rates to decline but that this increased
liquidity will not show up in accelerated, hence inflationary, money
suppy makes no sense to us.
By contrast our projections are based on the following three simple
assumptions:
(1) Over the last 3 years the economy has been in a liquidity crisis.
(2) Unless there is an immediate reliquification there can be no
economic upturn accompanied by lower levels of interest rates. As
a result, the rate of business failures and loan defaults will continue
to rise and cause failure. Again, failure is a lending crisis motivated
contraction in which the economy isn’t responsive to monetary
stimulation.
(3) There is no such thing as a noninflationary reliquification.
There is no way for capacity utilization to significantly increase at the
same time as interest rates fall without the Federal Reserve flooding
the banking system with liquidity, the banking system in turn flood­
ing the economy with loans, and the money supply growth and infla­
tion accelerating.
The economy is now flat, teetering on the brink of failure. The Fed,
growing more concerned about this precarious position, has shifted
its posture from pushing the economy toward the brink to simply
watching it teeter. I f it starts to go over, they’ll attempt to save it, and
if it moves away, they’ll push it right back. Where this balancing act
will lead will become more apparent over the next several weeks.
Although we’re confident that failure and much higher levels of
inflation are now the alternative, we are by no means certain which
of these alternatives will come to pass.
Whether we are headed for an extended period of failure or much
higher levels of inflation hinges first on whether the economy responds
to the Federal Reserve’s stimulation, which there are real doubts
about— the Federal Reserve has basically pursued a stimulative mone­
tary policy since May, and as of yet there has been no significant re­
sponse— and if it does respond, on whether the Fed is willing to
finance monetary growth at more than double its targeted rates.
Given a normal 2- to 4-month lag between stimulation and response,
we’d certainly expect to know if the economy is responding within
a few weeks, and if it does, with all the aggregates above the Fed’s
targets, we’d expect to see how the Fed will react shortly thereafter.
I f the Fed pursues its policy we’ll get a recovery much like the third
and fourth quarter 1980 recovery in which interest rates, the prime
rate, bottomed at 11 percent and inside of 8 months doubled to 22
percent as thev choked off the recovery.
That, Mr. Chairman, is the end of my statement.
[The prepared statement of Mr. Dalio, together with an attach­
ment, follows:]




115
P repared S t a t e m e n t

of

R a y m o n d T. D a l io

Just as a physician wouldn’t want to treat pneumonia as though it were a cold, an
economist wouldn’t want to make the mistake of misdiagnosing a depression by thinking
it’s a recession. Contrary to popular belief, a depression is not simply a more severe
version of a recession ■■it’s an entirely different degenerative process. If depressions were
simply more severe versions of recessions and one just used measures of severity such as
the rate of unemployment or the rate of fall in GNP to differentiate between them, there
would be no means of distinguishing the early stages of a depression from the late stages
o f a recession as they are both comparably severe. However, by understanding the
processes that cause depressions to become more severe than recessions it’s easy to
distinguish between them.* While a recession is a self-correcting economic contraction in
which liquidity increases, a depression is a self-feeding contraction in which liquidity is
reduced. Normally, in a recession, inventories are liquidated, borrowings decrease, money
supply growth slows and interest rates decline. Various measures of liquidity such as the
ratio of current assets to current liabilities and the percentage of corporate debt which
is short term in turn reflect this reliquification. However, in a depression, in order to
raise liquidity, inventories are liquidated and borrowings increase; as a result, inflation
falls while interest rates rise. Measures of liquidity in turn show it declining rather than
increasing.
Since 1800 there have been fourteen major depressions in the U.S., all progressing in
a similar manner. This is what we call the depression process. This process can be
segmented into four phases. In Phase 1, the economy becomes debt burdened and illiquid
which makes it depression prone in other words, the demand for money becomes highly
inelastic and money becomes tight. This leads to a liquidity crisis (Phase 2) at' which
time borrowings increase and inventories are liquidated. This causes interest rates to rise
while the economy contracts thereby worsening the economy's liquidity problems. The
depression process, advances from Phase 2 (liquidity crisis) to Phase 3 (failure) when it
moves from gasping for liquidity to failing for lack of it. Failure (Phase 3) is a lending
crisis motivated contraction in which the economy is no longer responsive to monetary
stimulation. After this contraction runs its course the depression enters what we call
Phase 4 or economic stagnation.
As it would take a considerable time to examine the economy’s evolution to this
point, it’s sufficient to say that from the late forties until, the July 1979 appointment of
Paul Volcker the ratio of debt to GNP increased to the highest levels since the Great
Depression at the same time as liquidity was severely reduced.




116

Since the October 1979 shift in monetary policy, the Fed, in its battle against
inflation, substantially further drained liquidity. As a result, for the last three years the
economy has been in a protracted liquidity crisis: interest rates have consistently held
higher than at any time in the last 100 years at the same time capacity utilization has
ceclined to the lowest level since the Great Depression.
Extended severe illiquidity inevitably causes economic failure i.e. a lending crisis
motivated contraction in which the economy ceases to be responsive to monetary
stimulation. This happens when large numbers of borrowers are unable to meet their debt
service obligations. This reduces both the ability and willingness of lenders to extend
credit which further constricts the flow of funds to illiquid borrowers in turn causing moré
failures. Since the banking system is the Federal Reserve’s only conduit for reliquifying
the economy, if bankers are less willing to lend it follows that the Federal Reserve is less
able to revive the failing economy. This signals the beginning of what we call the failure
phase (Phase 3) of the depression process. The economy is now teetering on the brink of
failure. Like the last months of 1979 (most recently) or the middle months of 1929 (more
appropriately), the economy is now in a brief yet critically important transition period. In
late 1979 the transition was from a decade of inflationary expansion to three years of
liquidity crisis. In mid-1929 the transition was from a decade of extraordinarily rapid
economic growth to five years of failure. The economy is now in transition from three
years of liquidity crisis to a period of either failure or hyper-inflation. The economy’s
extremely illiquid and leveraged condition implies that a large enough injection of liquidity
to avoid failure would now cause hyper-inflation (i.e. 15-18% by 1984).
Virtually all statistics reflecting the economy’s rate of activity indicate it’s
essentially flat. This rate is consistent with capacity utilization around 70%, real GNP
around $1,480 billion and the indéx of industrial prodution around 137.
Unfortunately, at this level of activity, a stable economy is a deteriorating economy.
While it's widely assumed that an economy which is expanding is getting stronger, changes
in the economy’s health are not primarily a function of changes in its direction but rather
of the rate at which it's operating. For example, a falling economy operating at 85% of
capacity will be strengthening while a rising economy operating at 70% of capacity will
be deteriorating. While the economy is now essentially flat, businesses are failing at a
rate which is higher than at any time since 1933. This rate will continue to rise until
capacity utilization increases to at least 78%.
Rather than thinking of the economy as homogeneous, it would be more accurate to
think, of it as being two-tiered with interest rate sensitive sectors on the brink of failure
and non-interest rate sensitive sectors still strong. Since there is no way for the economy
as a whole to remain immune to a bankruptcy crisis among the interest rate sensitive
sectors, in order to assess the probability of failure it's the latter group which should be
examined. While it’s important to recognize that the economy as a whole is headed for
failure operating at under 70% of capacity, it's even more essential to consider the
implications of little or no improvement among the interest rate sensitive sectors such as
autos, construction, airlines, lumber, steel, heavy equipment, etc.v which are operating at
less than 55% of capacity and mining companies and farmers who are selling substantially
below their costs of production. In aggregate, the financial health of this large, interest
rate sensitive sector of the economy is deteriorating rapidly. Its-health will continue to
deteriorate and failures among this sector will continue to rise unless there is an enormous
reliquification". We estimate that if the economy remains flat or improves only modestly,
the rate of business failures will increase by over 50% in the next six rrionths. With the
rate of business failures already unsustainably high and given the fact that it would have
to decline significantly in order to avoid failure, we continue to assess the odds in favor
of failure.




117

Since we’re forecasting imminent failure while other economists are forecasting
imminent recovery, obviously our understanding of how the economy works must be
appreciably different from theirs. Sepcifically, our disagreement concerns liquidity.
Based on our understanding of economics, the popular forecast that the economy will
turn up at the same time interest rates and inflation fall is impossible. We don’t see
where the increased liquidity needed to both fuel an expansion and cause interest rates to
decline will come from if not from an inflationary acceleration of the money supply. The
popular explanation is that when the economy turns up over the next few months it will
somehow produce enough liquidity to finance the expansion and allow interest rates to
decline but this increased liquidity will not show-up in accelerated, hence inflationary,
money supply growth.
By contrast, our projections are based on the following three assumptions:
(1) Over the last three years the economy has been in a liquidity crisis
i.e.
extreme illiquidity is the reason the economy is now operating at the lowest level of
capacity since the Great Depression at the same time as interest rates are still (for the
third consecutive year) higher than at any* time in the previous 100 years.
(2) Unless'there is an immediate reliquification, there can be no economic upturn
accompanied by lower interest rates; as a result the rate of business failures and loan
defaults will continue to rise and cause ’’failure" - i.e. a lending crisis motivated
contraction in which the economy is unresponsive to monetary stimulation.
(3) There is no such thing as a non-inflationary reliquification i.e. there is no way
for capacity utilization to significantly increase at the s a m e tim e as interest rates fall
without a) the Federal Reserve flooding the banking s y ste m w ith liq u id ity , b) the banking
sysiem in turn flooding the economy with loans and c) money supply growth and inflation
accelerating.
The economy is now flat, teetering on the brink of failure. The Fed, growing more
concerned at this precarious position, has shifted its posture from pushing the economy
toward the brink to simply watching it teeter if it starts to go over, they’ll attempt to
save it and if it moves away, they’ll push it right back. Where this balancing act will lead
will become more apparent over the next several weeks. Although we’re confident that
failure and hyper-inflation are the alternatives, we’re by no means certain which of these
alternatives will come to pass. Whether we are headed for an extended period of failure
or hyper-inflation hinges first on whether the economy responds to the Federal Reserve’s
stimulation and second
if it does
on whether the Fed is willing to finance monetary
growth at more than double its targeted rates. Given a normal two to four month lag
between stimulation and response, we’d certainly expect to know if the economy is
responding within a few weeks and, if it does, with Ml, M2, M3 and L above the Fed's
targets, we'd expect to see how the Fed will react shortly thereafter.










CHART 2




CHART 3




121
CHART 4

48 50 52 54 56 58 60 62 64 66 68 70 72 74 76 78 80 82




CHART 7

123

CHART 8

bil.
Ml
460

bil.
M2
2000

455

1950

450

1900

445

1850

440

1800

435

1750

430

1700

425

1650

420

1600

415

1550

162

665

161

660

160

655

159

650

158

645

157

640

156

635

155

630

154

625
j f
m a m j j a s o n d j
f m a m j j a s o n d
1981
1982




124

CHART 9

j f m am
j j
a s o n d
j f m a m j j a s
1981
1982
♦Unadjusted for changes in reserve Requirements.




125

j f m a m j j
1981

j f m a m j j
1981

■1.7-8 71 0




83

9

a s

a s

o n d j

f m a m j
1982

j

a s o n d

o n d j

f m a m j
1982

j

a s o n d

126

CHART 11

j f
1981




m a

m j

j

o

n d j f
1982

m

m j

j

a

127

CHART 13

1981




1982

CHART 14

128

CHART 15

1,600
1,400
1,200

1,000

800
j f m a m j
1981




j

a s o n d j

f m a m j j a s o n d
1982

CHART 16

129

CHART 17

1981




1982

CHART 18




130

CHART 19-







132

133

v^nnxvi

lo

CHART 24

j f m a m j j a s o n d j
f m a m j j a s o n d
1981
1982




134

CHART 25

j f m a m j
1981




j

a s o n d j

f m a m j j a s o n . d
1982

CHART 26

135

CHART 27

j f
1981

m

CHART 28

j f m a m j j a s o n d j
f m a m j j a s o n d
1981
1982




136

CHART 29

CHART 30

j f m a
1981




m j

j

s

o

n d

j f m
1982

m j

j

137

CHART 31

I thous.

160,000

150.000

ftj
^

1|lrHi ifft |1!i41ril iFWp

1;itii +
r^

3 10 17 24 31/ 7 14 21 28/ 4 11 18 25/1
July
August
September October

140.000
130.000
120.000
110,000
100,000

90.000
80.000
70.000
60.000




CHART 32

BRDGEWATER ASSOCIATES, INC.
RELIQUIF ICAT ION

OCTOBER 1982

AT THE CROSSROADS

In our August report we explained why
leveraged condition implies that an injection
e c o n o m ic fa ilu r e 2 would cause h y p e r -in fla tio n 3 .
to steer a middle course between the inflationary
alternatives, we described the economic outlook

the economy's extremely illiquid and
of liquidity1 large enough to prevent
Seeing no way for the Federal Reserve
expansion and disinflationary contraction
as diagramed below:

1. W e e s tim a te th is w ould re q u ire M l to g ro w at a r a te o f a p p r o x im a te ly 15% and M2 to
g ro w a t around 18% f o r a t le a s t six m onths.
2. A lending c r isis m o tiv a te d c o n t r a c tio n in w hich th e e c o n o m y c e a s e s to b e re sp o n siv e to
m o n eta ry stim u la tio n .
3.
1 5-18 % in fla tio n w ithin e i g h t e e n m onths.
4. B y r e s t r i c t i v e , w e m ea n tryin g to rou g h ly a d h ere to its ta r g e ts
i.e . M l g ro w th around
6 % and M2 g r o w th around 9% .




2740DG

emuflOAD. WILTON. CONNECTICUT 06697 (203) 762-8511

139

W hether or n o t you agre'e w ith the t im e ta b le or p ro b a b ilitie s we assigned is less
im p orta n t than a g r e e in g that th ese are the a lte rn a tiv e s . A t the risk o f o v e r s im p lify in g 5 ,
our rea son in g is as fo llo w s :
(1) O ver th e la st th re e y e a r s 6 the e c o n o m y has b e e n in a p r o t r a c te d liqu idity crisis
i.e . e x t r e m e illiq u id ity is th e reason th e e c o n o m y is now o p e r a tin g a t the lo w e s t le v e l
o f c a p a c it y s in c e the G rea t D epression at th e sa m e tim e as in te re s t ra te s are s till (fo r
the third c o n s e c u t iv e y e a r ) higher than a t any tim e in th e p re v io u s 100 y ears.
(2) U nless th e re is an im m e d ia te r e liq u ific a t io n , th e r e ca n be no e c o n o m ic upturn
a c c o m p a n ie d by lo w e r in te re s t r a te s ; as a re su lt the r a te o f business fa ilu re s and loan
d e fa u lts w ill co n tin u e t o rise and cau se "fa ilu r e ” - i.e . a len din g crisis m o tiv a te d
c o n t r a c tio n in w hich th e e c o n o m y is unresponsive to m o n e ta ry stim u la tio n .
(3) T h ere is no such thing as a n o n -in fla tio n a r y r e liq u ific a t io n
i.e . th ere is no way
f o r c a p a c it y u tiliz a tio n to s ig n ific a n tly in cre a se at the sa m e tim e as in te re s t ra te s fa ll
w ith ou t a) th e F e d e ra l R e s e r v e flo o d in g the banking sy ste m w ith liq u id ity , b) the banking
sy stem in turn flo o d in g the e c o n o m y w ith loans and c ) m o n e y supply g ro w th and in fla tio n
a c c e le r a t in g .
For th ese rea son s w e co n c lu d e d that the e c o n o m y is "a t the c r o s sr o a d s "
i.e . like the last
m onths o f 1979 (m o st r e c e n t ly ) or th e m id dle m onths o f 1929 (m o re ap p ro p ria te ly ), the
e c o n o m y is now in a b r ie f y e t c r it ic a lly im p o rta n t tra n sitio n p e r io d . In la te 1979 the
tran sition was fro m a d e c a d e o f in fla tio n a ry expan sion (in w hich be in g in d eb t and ow nin g
hard a ssets paid) t o th re e y e a rs o f liqu id ity c risis (in w hich having liq u id ity and investing
it in sh ort term d e b t in stru m en ts was b e s t). In m id -1 9 2 9 th e tran sition w as fro m a d e c a d e
o f ex tr a o r d in a r ily rapid e c o n o m ic gro w th (during w hich ow nin g s to c k s w as b e s t) to fiv e
y e a r s o f fa ilu re (at w hich tim e the bond m arket was th e p la c e t o b e ). The e co n o m y is
now in tran sition fro m th re e y e a rs o f liqu id ity c r is is t o a p e r io d o f e ith e r fa ilu re or hyper­
in fla t io n ? .
The diagram on the fro n t page show s the e c o n o m y ’s a lte rn a tiv e d ir e ctio n s through
this tran sition p e r io d . A s show n, w h eth er we are h ead ed fo r an e x te n d e d p eriod o f fa ilu re
or h y p e r -in fla tio n hinges fir s t on w h eth er the e c o n o m y resp on d s t o the F ed era l R e s e r v e ’s
stim u la tion and s e c o n d
i f it d o e s
on w h ether the F ed is w illin g t o fin a n c e m on etary
g row th at m ore than do u b le its ta r g e te d r a te s .
G iv en a n orm al tw o to fou r m onth lag
b e tw e e n stim u la tio n and re sp o n se , w e ’ d c e r ta in ly e x p e c t t o know i f th e e c o n o m y is
resp on d in g w ithin a fe w w eek s
and, i f it d o e s, w ith M l, M 2, M3 and L a b o v e the F ed 's
ta r g e ts , w e ’ d e x p e c t to s e e how the Fed w ill r e a c t s h o r tly th e r e a fte r .

5.
For a complete explanation of the reasoning and evidence in support of these
conclusions see our August report.
6.
Since the July 1979 appointment of Paul Volcker.
7.
Liquidity is now too reduced to allow a return to stagflation. Stagflation was the
successful balancing of the high inflation, weak economy alternatives.




140

STIM U LATION
S in ce the la st th re e y e a r s ' o v e r ly r e s t r ic t iv e Fed p o lic ie s m ade liq u id ity the m ost
im p ortan t in flu e n c e on the e c o n o m y , the art o f e c o n o m ic f o r e c a s t in g has b e c o m e the art
o f in terp retin g Fed policy® .
P a rticu la rly in ligh t o f r e c e n t d e v e lo p m e n ts , w e think it 's
ap p rop ria te to begin this r e p o r t w ith an ex a m in a tio n o f this p o lic y .
A lth ou gh " s tim u la tiv e " and " r e s tr ic tiv e " are a m on g e c o n o m is t s ' m o st fre q u e n tly used
w ords, th ey h ave no a g re e d upon m eaning. S om e say the Fed is s tim u la tiv e when m oney
supply is risin g w h ile o th e rs use t o ta l re s e rv e s as th eir g a u g e . W ithout d igressin g in to an
ex a m in a tion o f the r e la tiv e m e rits o f these ga u g e s, w e sim p ly want to m ake our ow n
te r m in o lo g y c le a r . When w e d e s c r ib e the Fed as b e in g s tim u la tiv e w e m ean that th e y 'r e
pursuing a p o lic y design ed t o in c re a s e n et fr e e re s e r v e s and lo w e r in te re s t ra te s , when w e
say t h e y 'r e r e s t r ic t iv e w e m ean that t h e y 'r e tryin g t o r e d u c e n e t fr e e r e s e r v e s and raise
in teres t r a te s and when w e d e s c r ib e them as be in g n eu tral w e m ean t h e y 'r e tryin g t o hold
both n et fr e e r e s e r v e s and in te re s t r a te s r e la tiv e ly ste a d y .
A lth ou gh m o st p e o p le think o f the Fed as having pursued a p o lic y p rim a rily desig n ed
to s t e e r m on eta ry g ro w th in lin e w ith its s ta te d t a r g e ts , it w ould b e m o re a c c u r a t e to
think o f th eir p o lic y as bein g t o "lea n against the w ind"
in o th e r w ord s, t o drain re s e r v e s
and f o r c e in te re s t r a te s up when m on ey supply g ro w s t o o rapidly and t o add re s e rv e s and
fo r c e in te re s t r a te s dow n when m on ey supply d o e s n 't g row ra p id ly enough . Thus, as
exp lain ed in past r e p o r t s 9 , the F e d 's la te spring m o ve t o s tim u la tiv e p o lic ie s (i.e . p o lic ie s
design ed t o in c re a s e n e t fr e e re s e r v e s and lo w e r in te re s t r a te s ) w as e a s y t o c a l l 10 sim p ly
b eca u se it was in re sp o n se both to m on ey supply fa llin g and the w orld e c o n o m y tip pin g
o v e r the brin k 1 1 ; h e n c e it w as p e r f e c t ly in k e e p in g w ith th eir p o lic y o f "lea n in g against
the w ind".

8.
Probably the largest single cause of interest rate volatility is uncertainty over Fed
policy.
This is particularly true since, rather than explaining exactly what the Fed's
policies are, Chairman Volcker has added a dimension of intrigue by leaving it to us to
interpret innuendos and uncover leaks.
Statements such as "interest rate declines of
recent weeks reflect a consistent deflationary monetary policy and confidence in the
future inflation outlook rather than a new decision to ease tight money" are designed to
camouflage what's really happening rather than to enhance the public's understanding.
9.
For a more detailed explanation of the Federal Reserve's stimulative policies, see
our June and August reports.
10.
It's when some gauges point in favor of loosening while others point in favor of
tightening that one's understanding of the Fed is put to the test.
11.
There is virtually no evidence in support of the popular theory that pre-election
politics were the primary cause of the Fed's turning stimulative. This interest rate decline
is reminiscent of the II Q 80 decline which resulted from that quarter’s 9.9% tumble in
real GNP with Ml and M2 both falling, but was popularly misinterpreted as pre-election
hype.




141

A ll the gauges w hich the Fed has used to s e t its r e s e r v e and in te re s t r a te ta r g e ts
then poin ted in fa v o r o f turning s tim u la tiv e . O bse rv e how in A p ril-J u ly r e a l and nom inal
M l and real M2 fe ll sharply (see C hart 1) and how the d e c lin e in M l ca m e a lm o s t e n tire ly
as th e result o f a sharp fa ll in the m u ltip lie r 1 2 (see C h art 2). W ith the fa ilu re r a te high
(see C h art 13) and the e c o n o m y w eakening (se e C h arts 4 -6 ) th e F e d 's s h ift to s tim u la tiv e
p o lic ie s was a fa it a c c o m p li. N et fr e e re s e r v e s w e re in turn f o r c e d up (see C h art 2) and
in te re s t rates w ere f o r c e d dow n (see C h art 3)
a t le a s t until this stim u lation c r e a t e d a
resp on se.

C H A R T 1 - M O N EY SU PP LY

12.
The falling Ml multiplier signified that the decline in money supply was more demand
motivated than a response to a shortage of reserves.

17-871 0




83

10




142

CHART 2 - RESERVES

143

Then, in August and S e p te m b e r, re a l and nom inal M l jum ped sharply and
the
e c o n o m y exh ibited som e signs o f respon se thus raisin g the q u e stio n o f w hether the F ed
w ould adh ere t o o r abandon its p o lic ie s .
A t this p oin t tw o p o lic ie s w ere c a lle d in to
qu estion
the w idely fo llo w e d p o lic y o f try in g t o ad h ere t o its ta rg e ts and th e m o re
fundam ental p o lic y o f "lea n in g against the w in d ". W hile i t ’s b e e n c le a r fo r o v e r six m onths
that the Fed w ould a c c o m m o d a te gro w th in e x c e s s o f th eir t a r g e t s 1^ it 's s till n o t c le a r
t o what e x ten t th e y 're w illin g to abandon th eir p o lic y o f "le a n in g against the w ind" and
instead "lean in to the w ind" (i.e . add re s e r v e s and push in te re s t r a te s lo w e r w hile m oney
supply is a c c e le r a tin g ) in order to assure a r e c o v e r y .
In r e a c tio n t o the sharp upturn in M l in A u g u s t-S e p te m b e r the Fed turned fro m
stim u la tiv e to neutral
i.e . in co n tra st to th e J u ly -A u g u st p e rio d when in te re s t ra te s f e ll
and n et fr e e re s e rv e s w ere stea d ily in c re a s e d (to n early plus $100 m illion ), in the
S ep tem b er to ea rly O cto b e r p eriod Fed funds w e re held at a sh ade o v e r 10% and re s e r v e s
w ere added and drained s t r ic t ly w ith the o b je c t iv e o f adh erin g t o this in te re s t r a te ta r g e t
(as a resu lt n et fr e e re se rv e s swung w ildly, a v e ra g in g m inus $300 m illion throughout this
p eriod ).
This sh ift to a neutral p o lic y w as e x a c t ly w hat o n e w ould have e x p e c t e d on the basis
o f the F ed 's past beh a vior. Unable to turn r e s t r ic t iv e fo r fe a r o f elim in a tin g any p r o s p e c t
fo r r e c o v e r y , they also fe a r e d that by rem ain in g s tim u la tiv e they m ight spark t o o s tro n g
a resp on se w hich w ould cau se m oney supply t o e x p lo d e (le a v in g them fa c e d w ith th e
unpleasant altern a tiv e o f fo r c in g in te re st r a te s sharply h igh er o r fe e d in g an in fla tio n a ry
m on etary explosion ). W alking a tig h tro p e , th ey d e c id e d to^w ait and sen se the d ir e c t io n o f
the n ext gust o f wind b e fo r e leaning o n e way or the o th e r . If this h e sita tio n to rem ain
s tim u la tiv e even tu ally p ro ve s to be the e c o n o m y 's kiss o f d e a th , the A d m in istra tio n m ust,
to som e ex te n t, also be held cu lpable. A t the end o f S e p te m b e r the T reasury w as in t o ta l
a g re e m e n t w ith this p o lic y . Speaking o f the F e d 's handling o f m on etary p o lic y T reasu ry
S e c r e ta r y Regan said, "I d o n 't think they have to lo o s en it any m o re to be ab le to sustain
this r e c o v e r y ."
On the o th e r hand, he m ade c le a r that he d id n 't w ant them t o turn
r e s t r ic t iv e by saying, "W ere they to tig h ten it, th ey w ould c h o k e o f f the r e c o v e r y ." In
oth er w ords, the Treasury and the Fed w e re then in c o m p le t e a g r e e m e n t that a neu tral
m on etary p o lic y was a p p rop ria te, o n c e again m aking the tr a g ic e rro r o f pu ttin g t o o m uch
em phasis on a c c e le r a t in g m oney supply r e la tiv e t o fa llin g v e lo c it y .
As w e 'll s e e in the
n ext s e c tio n o f this r e p o r t, only the m ost a n e m ic signs o f the e c o n o m y respon din g to the
F e d 's stim u lation w ere ap p arent, w hile signs o f fa ilu re w e re a ls o in cre a sin g .
Then, during the firs t w eek o f O c t o b e r , th e re w e re signs that the Fed m ight s h ift
from neutral to stim u la tiv e . First, s e v e ra l disa p p oin tin g s t a t is t ic s s u r fa c e d . F or e x a m p le ,
industrial p rod u ction , fa c to r y orders, the index o f le a d in g in d ica to r s and a w h ole host o f
o th e r in d ices fe ll w hile in itial cla im s fo r u n e m p lo y m e n t sh ot up. G row th o f th e m o n e ta ry
base began to slow and the M l m ultiplier s ta rte d t o fa ll. C o n ce rn s abou t c o u n try d e fa u lts
in crea sed in respon se t o M exican P resident P o r t illo 's s p e e c h t o th e U .N . and A rg e n tin a n ot
paying its d ebts. European bankers o p e n ly ta lk e d o f an im p ending E u rod ollar cris is .

13.
We concluded our May report by saying, " While the Fed is stubborn, we do not believe
that they are as uncompromising as they maintain.
We have no doubt that the Fed's
governors now realize that their targets are set unrealistically low (surely they can’t be
planning to hold M l’s growth to around 2.3% through the rest of the year). Over the next
several months the pressure to ease will also increase to unprecedented levels. Therefore,
we expect them to accommodate growth in excess of their targets, but not nearly enough."




144

T reasury S e c r e ta r y R e a ga n , in his O cto b e r 6th s p e e ch to m em bers o f the D ealer
Bankers' A s s o c ia tio n , in ten ded t o alla y grow in g fe a rs o f a fin a n cia l c risis by saying that
although U.S. banks f a c e six m onths to a y ear o f "seriou s p rob lem s", th ey can depend on
help from the g o v e rn m e n t i f d e b to r nations d e fa u lt. He ex plain ed that "A ll these problem s
one by o n e ca n be handled and are m an agea ble" but " c o lle c t iv e ly , they presen t qu ite a
risk ." If the banks have fin a n c ia l p roblem s "ca u se d by o u tside pressu res... and we can be
h elp fu l, I think it is up to the go v e rn m e n t both through the C en tral Bank as w ell as the
through the T reasu ry to be h e lp fu l."
He added, "It c a m e on very u n e x p e cte d ly , m uch
d eep er than any e c o n o m is t had f o r e c a s t and it's goin g to last lon ger than m ost e c o n o m is ts
f o r e c a s t .n l4 The s t o c k and bond m arkets in turn shot up in r e a c tio n to gro w in g p ro s p e cts
o f r e liq u ific a tio n . On O c t o b e r 7th, the FOM C held a p o lic y s e ttin g m e e tin g and in d ica te d
that they w ou ld a c c o m m o d a t e m on ey supply g row th in e x c e s s o f their ta rg e ts . W hile Paul
V olcker w ould m ake a b e t t e r p ok er p layer than D onald R eg an, it w as c le a r that he was
c o n c e r n e d w hen he said, "T h e fo r c e s are th ere that w ould push th e e c o n o m y tow a rd
r e c o v e r y . I w ould think th at the p o lic y o b je c tiv e should be to sustain r e c o v e r y ."
E x a ctly w hat this m eans is n ot y e t apparent. It can be in te rp re te d that the Fed w ill
not turn r e s t r ic t iv e in o rd e r to bring m oney supply w ithin its ta r g e te d ran ge o r, m ore
s ig n ific a n tly , it can m ean that th e y w ill turn as stim u la tiv e as n e ce ssa ry in o rd er to bring
abou t a r e c o v e r y . S in ce th e re are various d e g re e s o f being stim u la tiv e , w e w ill w atch w ith
g re a t in terest t o s e e w h eth er the O cto b e r 1982 sh ift in Fed p o lic y w ill have the sam e
s ig n ific a n c e as the O c t o b e r 1 9 7 9 * 5 s h ift.

14.
The greatest tragedy is that all this could have been prevented. The blame rests
squarely on the shoulders of those economists in and outside of government who influence
policy yet don’t have a truly sound grasp of how the economy works.
How could
competent economists have so misunderstood the implications of these tight money
policies? Consider that, eighteen months ago, they all forecast uninterrupted economic
growth through 1985. For example, in July 1981, in the face of real interest rates being
the highest since 1929, the President's Council of Economic Advisors forecast real growth
in 1982 of 3.6%. The projections of most private economists were equally off base. For
example, Allen Sinai of Data Resources forecast the 1982 economy to grow by 3.5%,
Albert H. Cox of Merrill Lynch and George McKinney of Irving Trust forecast it to grow
by around 4%, Wharton Econometrics and Townsend Greenspan were both a shade less
optimistic and Evans Econometrics was a bit more optimistic.
In other words, the
consensus then forecast 1982's economic growth at around 3.5%. There were no surprises
such as war, drought or an oil crisis to throw off their projections. These problems were
purely the result of the Fed's overly restrictive policies and the primary reason that these
policies were overly restrictive was that most economists influencing policy simply didn't
understand the implications of these targets.
15.
If one were to judge simply by the Fed's open market activities and half point
discount rate cut last week, it would appear that they had shifted from neutral to only
modestly stimulative and, as said openly by Chairman Volcker and Governor Wallach, does
not signify a major policy shift.




14 5

RESPONSE
A s a result o f the F e d 's e arlier s tim u la tio n , a ll th e c la s s ic in g redien ts fo r e c o n o m ic
r e c o v e r y are now in p la c e . M ost im p o rta n tly , the ban kin g system is flush w ith liqu id ity
(en cou ra g in g bankers to in cre a se th eir len d in g a t lo w e r r a t e s ) and c a p a c it y u tiliz a tio n is
e x t r e m e ly low (m aking it both e c o n o m ic a l and p o s s ib le t o in c re a s e p ro d u ctio n ). O rd in a rily,
on e w ould e x p e c t that fa llin g in te re s t r a t e s w ould f r e e pen tu p dem and fo r in te re s t r a te
s e n s itiv e ite m s * 6 and slow the ra te o f in v e n to ry liq u id a tio n 1 * and that th e se in flu e n c e s
w ould spark a respon se w hich, if p ro p e rly fin a n c e d through rapid g ro w th in th e m on ey
supply, w ould d e v e lo p in to an in fla tio n a ry e x p a n s io n 18. S in ce the last tim e the e c o n o m y
fa ile d t o respond to stim u lation was o v e r f if t y y e a r s a g o , i t 's n ot u n reasonable t o e x p e c t
that it w ill o n c e a g a in 19. On the o th e r hand, s in c e i t 's im p o s sib le f o r the e c o n o m y to
sustain a r e c o v e r y unless it 's r e liq u ifie d and r e liq u ific a t io n re q u ire s 1) banks t o in c re a s e
th eir lending to risk ier b o rro w e rs and 2) th e Fed t o pum p r e s e r v e s in to the banking system
a t a r a t e w hich w ould fu e l m oney supply g r o w th a t m o re than d ou b le its ta r g e te d r a t e ,
t h e r e 's reason t o fe a r that this tim e th e e c o n o m y w ill n o t resp on d . The o n ly thing that
can b e said fo r c e r ta in is that the Fed has a d m in is te re d a stro n g s tim u la n t* 0 and w e 'll
have t o w ait and s e e i f the e c o n o m y resp on d s.

16.
Most obviously, real estate, durables and storable commodities.
17.
The economy is stimulated when the rate of inventory liquidation slows not at the
point when inventories are being rebuilt. For example, consider the clothing store that has
an inventory of 300 suits selling at a rate of 50 per month and wants to reduce its
inventory by 10%. The store would buy 20 suits, sell 50 and in turn cut its inventory by
30 (i.e. 10% of 300). Now let’s suppose the store owner wanted to cut his inventory by
5%. He would buy 35 suits, sell 50 and cut his inventory by 15 suits (i.e. 5% of 300).
Although he increased his order by 75% (from 20 to 35 suits), he is still reducing his
inventory, but at a slower rate.
In response to his ordering more suits, the suit
manufacturer will increase his workers' hours and, if enough other stores increase theirs,
the manufacturer will hire some of the unemployed.
18.
We find "the consumer recovery" scenario (like the "we can dispose of inflation and
high interest rates without disposing of the economy" scenario) an illusory product of
wishing rather than a well thought out expectation. Any student of the business cycle
knows that increasing retail sales never lead the economy out of a contraction
they
improve roughly coincidentally with the expansion.
19.
An additional reason for optimism could be that with most loans on a variable rate
basis, recent interest rate declines will ease the financial strain o f leveraged companies
and governments. Additionally, refinancings will be helped. For example, corporate bond
issues rose to $4.4 billion in August, up from $2.9 billion in July (although in September
the rate once again fell). This should help relieve the corporate demand for bank credit.
20.
i.e. lower interest rates and increasing net free reserves.




146

Virtually all s t a t is t ic s r e fle c t in g the e c o n o m y 's ra te o f a c t iv it y in d ica te it's
e ssen tia lly f l a t 21. A s show n in C h arts 4 -6 , this ra te is co n siste n t w ith c a p a c it y u tiliz a tio n
around 70% , r e a l G N P around $1,480 billion , the index o f industrial p ro d u c tio n around 137,
du ra b le g o o d s o r d e r s around $32 b illion and consum er g o o d s orders around $29 billion .
W hile the e c o n o m y as a w h ole is fla t 22 ? th ere are in crea sin g signs o f b o th re sp o n se and
fa ilu r e .

C H A R T 4 - C A P A C IT Y U TILIZATION

21.
As indicated on the front page diagram of this transition period, we believe that
whether or not the economy responds will be reflected in its behavior during the
September-October period. However, since most statistics for October won't be released
until November, not until then will all the facts be available.
22.
To be more precise, over the last few months it has been expanding at an annualized
rate of 1-2% which is statistically insignificant.




147

C H A R T 5 - IND U STRIAL P R O D U C T IO N A N D R E A L GNP

C H A R T 6 - NEW O RD ERS FO R C O N SU M E R A N D D U R A B LE G O O D S




148

As on e m ig ht h o p e , the dem and fo r in te re st ra te sen sitive item s such as housing (se e
C h art 7) and a u to s (se e C h art 8) has firm e d , a lb e it m o d e stly , and the r a te o f in ven tory
liqu ida tion has b een slo w in g (see C hart 9). S im ilarly, in crea ses in the index o f leadin g
e c o n o m ic in d ica to r s (se e C h art 10), m oney supply (see Chart 1) and a w h ole host o f o th e r
w eek ly in d ic e s 2 ^ h ave s to p p e d fa llin g and ov e r the past tw o m onths h ave turned m od estly
higher.
W hile to s o m e e x te n t th e in cre a se s in housing sta rts, a u to sa le s, the index o f
leading e c o n o m ic in d ica to r s and m oney supply o v e r s ta te the m a g n itu d e 2^, all things
co n sid e re d , th ey r e f l e c t an a n e m ic respon se.

C H A R T 7 - HOUSING STAR TS

1,600

1,400

1,200

1,000

800
j
f m a m j
1981

j

a

s

o

n

d

j

f m
1982

a

m

j

j

a

s

o

n

d

23.
See charts at back of report.
24.
For example, the July jump in housing starts was attributable to increasing federally
subsidized apartment construction (as will the September increase which we're projecting).
The September jump in auto sales was boosted by promotions designed to help move dealer
inventories in order to make room for new models and slipped to 5.4 million annualized
rate in early October.
Like the housing and auto figures, when one examines the
composition of the index of leading indicators the improvement is far less significant than
it would first appear. For example, the average work week, average initial claims for
unemployment, new orders for consumer goods, vendor performance, net business
formation and contracts for plant and equipment all show little or no improvement. The
index was boosted primarily because of increases in building permits, a declining rate of
inventory liquidation (both explained above), a sharp jump in stock prices (explained in the
appendix to this report) and a significant increase in sensitive crude materials prices (more
a harbinger of increasing inflation than of an expanding economy).
Similarly, the
increasing money supply overstates the economic response as the velocity continues to
decline and much of the growth is directly attributable to high debt service payments.







149

CHART 8 - DOMESTIC AUTO SALES

10
8
6

2

0

j f m a m i
1981

i

a s

o

n d j

f m a m i
1982

i a s o n d

C H A R T 9 - C H A N G E IN INVENTORIES

30
20
10

0
-10
-20
-30

C H A R T 10 - INDEX OF LE AD IN G EC O N O M IC IN D IC A T O R S

150

H o w ev er, t o the e x t e n t th at one in terp rets the e c o n o m y ’s sp u tterin g as e n cou ragin g,
ea rly in d ica tion s o f S e p te m b e r ’ s a c t iv it y must be co m p a ra b ly dish earten in g. Virtually all
prelim in ary m easures o f e c o n o m ic a c t iv it y (e .g . c a p a c ity u tiliz a tio n , industrial p ro d u ctio n ,
e t c .) slipp ed in S e p te m b e r. W hile in iso la tio n this slip w ou ld n 't hold m uch s ig n ific a n c e , it's
p a rticu la rly d is c o n c e r tin g th a t, a ft e r six m onths o f stim u lation , the e c o n o m y s till hasn't
respon ded.




C H A R T 11 - INITIAL CLAIM S FO R U N EM PLO YM EN T

151

Additionally disconcerting is the fact that the slowing rate of inventory liquidation
(which helped to stabilize the economy) has pushed up the inventory sales ratio, thereby
increasing the risks of another inventory liquidation based contraction.
C H A R T 12 - IN V E N TO R Y /S A LE S R A T IO

j f m a m j
1981

j

a s o n d j

f
1982

m a m j j a

s o n d

S in ce a c o n tr a c tio n fro m th ese de p re sse d le v e ls is t o o frig h te n in g t o c o n t e m p la te ,
n ot n early enough a tte n tio n is g iven to it as a p o s s ib ility and lit t le is be in g d o n e t o insure
it w on ’ t happen.
It w ould ce r ta in ly take the e c o n o m y o v e r th e brink t o fa ilu r e (i.e . a
len din g c r is is m o tiv a te d c o n tr a c tio n in w hich th e e c o n o m y is no lo n g e r re sp o n siv e to
m on eta ry stim u la tio n ), i f it is n o t o v e r a lre a d y .




152

FAILU RE
U n fortu n a te ly , at this le v e l o f a c t iv it y , a stable e co n o m y is a d e te r io r a tin g e c o n o m y .
W hile it's w id ely assum ed that an e c o n o m y w hich is expanding is g e ttin g stro n g e r, ch an ges
in the e c o n o m y 's h ealth a re not prim arily a fu n ctio n o f changes in its d ir e c t io n but rath er
o f the ra te at w hich it 's o p e r a tin g . For ex a m p le , a fa llin g e co n o m y o p e ra tin g at 85% o f
c a p a c ity w ill be stre n g th e n in g w hile a rising e c o n o m y op eratin g at 70% o f c a p a c it y w ill
be d e te r io r a tin g .
W hile th e e c o n o m y is fla t, businesses are failin g at a ra te w hich is
higher than at any tim e s in c e 1933 and is rising (se e C hart 13), and c o u n tr ie s are unable
to s e r v ic e th eir d e b ts in u n p re ce d e n te d num bers (in 1982 ap p ro x im a te ly th irty c o u n trie s ,
roughly on e in e v e r y fiv e , w ill e ith e r seek "re sch e d u lin g” or sim ply r e fu s e to pay).




C H A R T 13 - BUSINESS FAILU RES

153

This risky environ m en t has c r e a te d a tie r in g e f f e c t in th e c r e d it m arkets (s e e C h art
14)
i.e . risk ier b orrow ers are having a tou gh er tim e o b ta in in g fin a n c in g and having t o pay
prem iu m s r e la tiv e to s e cu re borro w e rs. F or e x a m p le , B ra z il, M e x ico and A rg e n tin a are
lu ck y t o obtain fin a n cin g at prem ium s (to the L ondon Interbank r a te ) trip le la st y e a r 's
le v e ls (e .g . at 2 1 /2 % , 2% and 1 1 /2 % r e s p e c t iv e ly ).
C h an ges in c o v e r e d in te re s t ra te s
b e tw e e n cou n trie s also r e f l e c t the c r e d it m a r k e ts ' in cre a s in g s e n s itiv ity to b oth e c o n o m ic
and p o lit ic a l risks. It is b e c o m in g m ore a p p aren t t o in v e s to rs th a t, as co u n trie s slip m ore
d eep ly in to crisis, the b a ttle in te n sifie s b e tw e e n "th o s e w ho h a ve it " and "th ose w ho d o n 't " .
The c le a r e s t ba ro m e te r o f th ese co n ce rn s is th e m o v e m e n t o f m o n e y . It used t o be th at
prudent "w orld m on ey" w ould stay out o f the e c o n o m ic a lly and p o lit ic a lly m ore v o la t ile
"banana r e p u b l i c s " 2 5 ancj mo v e be tw e e n the m ore s e c u r e in d u stria liz e d c o u n trie s , ch asin g
the h ighest c o v e r e d yie ld s.
H ow ever, as the in d u stria lize d c o u n tr ie s b e c a m e ris k ie r 2®,
c o v e r e d yield s have b e c o m e o f se co n d a ry im p o rta n ce
th e p rim a ry a ttr a c tio n t o "w o rld
m on ey " is now a sta b le and co n s e rv a tiv e e c o n o m ic and p o lit ic a l en v iro n m e n t27 (i.e . an
en v iron m en t in w hich th ose w ith m oney are w inning th e b a t t le t o hold o n to it).

C H A R T 14 - E U R O D O L L A R t T -B IL L R A T E 28

25.
Typically, commercial bankers (who invested the funds of small depositors unable to
evaluate the risks) and development organizations (both public and private) invested in
these countries. Quite ironically, the same foreign banks who were pouring money into
these countries also handled the funds of locals who wanted to get their money out.
26.
Europe has recently been the largest source of "flight money” into the U.S. This
influx is directly the result of increasing economic and political risks, particularly in
France, Italy, Germany and the U.K. While heretofore reducing or eliminating taxes and
getting the highest returns were the primary advantages of having one's money offshore,
there is a growing sense among Europeans that having money onshore in a bad economic
environment is like standing among a pack of starving wolves eating a steak.
27.
Similarly, one only has to reflect on the 1973-78 flight from the dollar to realize how
quickly the money which has been pouring into the U.S. would leave if the environment
ceased being economically and politically conservative.
28.
In response to Donald Regan's October 6th speech assuring bankers that the Treasury
and Fed were prepared to stand behind the System and the October 7th shift in monetary
policy, recently there has been narrowing in these spreads.




154

This flig h t t o q u a lity is by no m eans just an in tern ation a l p hen om en a. A s business
failu res in c re a s e and b a la n c e sh e e ts d e te r io r a te a t h om e, d o m e s tic lending p r a c t ic e s
c h a n g e29. The ’’tie r in g ” w h ich has been taking p la c e in the c r e d it m ark ets is a natural
and una voida ble c o n s e q u e n c e o f g ro w in g d ic h o to m ie s in the fin a n cia l health o f b o rro w e rs .
It’ s in crea sin g ly d e c e p t iv e t o lo o k at the e c o n o m y "as a w h ole” . R a th e r than thinking o f
the e c o n o m y as be in g h o m o g e n e o u s , it w ould be m ore a c c u r a te to think o f it as bein g t w o tiered w ith in te re s t r a te s e n s itiv e s e c to r s ^ 0 on the brink o f fa ilu re and n o n -in te re s t r a te
sen sitive s e c t o r s s till s tro n g . S in ce th ere is no w ay fo r the e c o n o m y as a w hole t o rem ain
im m une to a ban k ru ptcy c r is is a m o n g the in te re st ra te sen sitive s e c t o r s , in o rd er t o assess
the p rob a b ility o f fa ilu re i t ’ s th e la tte r group w hich should be e x a m in e d .
W hile it 's
im p ortan t t o r e c o g n iz e that th e e c o n o m y as a w h ole is headed f o r fa ilu re o p e ra tin g at
under 70% o f ca p a city«* 1, i t ’s e v e n m ore essen tia l to con sid er the im p lica tio n s o f lit t le or
no im p rov em en t a m o n g th e in te re s t ra te sen sitiv e s e c to rs such as au to s, c o n s tr u c tio n ,
airlin es, lu m b er, s t e e l, h e a v y eq u ip m en t, e t c ., w hich are o p e ra tin g a t less than 55% o f
c a p a c it y and m ining c o m p a n ie s and farm ers who are sellin g substan tially b e lo w th eir c o s t s
o f p rod u ction .
In a g g r e g a t e , th e fin a n c ia l health o f this la rg e , in te re st ra te s e n s itiv e s e c t o r o f the
e c o n o m y is d e t e r io r a tin g ra p id ly .
Its health w ill con tin u e to d e t e r io r a t e and fa ilu re s
am ong this s e c t o r w ill c o n tin u e t o rise unless th ere is an enorm ous r e liq u ific a tio n .
We
es tim a te th at i f the e c o n o m y rem ain s fla t or im p rov es only m o d e stly , the r a te o f business
fa ilu res w ill in c re a s e by o v e r 50% in the n ext six m onths.
S ince the ra te o f business
fa ilu res is a lrea d y unsustainably high and, in order to avoid fa ilu re, w ould have t o d e c lin e
s ig n ific a n tly , w e co n tin u e t o assess the odds in fa v o r o f failu re.

CON CLU SION
If th e r e w as e v e r a tim e o f g r e a te r u n ce rta in ty, we c a n 't r e m e m b e r it. The e c o n o m y
is now fla t , t e e t e r in g on th e brink o f fa ilu re. The Fed, grow in g m o re c o n c e r n e d at the
p re ca rio u s p o s itio n , has s h ifte d its p osture from pushing the e c o n o m y to w a rd the brink to
sim p ly w a tch in g it t e e t e r
i f it sta rts to g o o v e r , t h e y 'll a tte m p t to sav e it and if it
m oves a w a y , t h e y 'll push it rig h t ba ck .
W here this b a la n cin g a c t w ill lead w ill b e c o m e m ore apparent o v e r the next s e v e ra l
w eeks. A lth ou g h w e 'r e c o n fid e n t th at the a lte rn a tiv e s are as diagram ed on th e fro n t p a g e ,
w e ’re by n o m eans c e r ta in w hich o f these a lte rn a tiv e s w ill c o m e t o pass. C e rta in ly , w e
h ave our e x p e c t a t io n s (h e n ce ou r assigned p ro b a b ilitie s^ 2) but as tra d e rs we learn ed lon g
a g o th at it ca n be c o s t ly t o le t o n e ’ s e x p e c ta tio n s clo u d o n e 's ju d gm en t
w e 'r e t o o
in te re ste d in b e in g rig h t t o be p roud. O ver the next s e v e ra l w eeks the e v id e n c e w ill build
and the odds w ill s h ift c le a r ly in fa v o r o f one o f th ese alte rn a tiv e s. Just as the la te 1979
tran sition p er io d p r e c e d e d th re e y e a rs o f liqu idity c risis and the m id -1 9 2 9 period p r e c e d e d
fiv e y e a r s o f fa ilu r e , th e e c o n o m y is now abou t to e n te r an e x te n d e d p eriod o f e ith e r
fa ilu re o r h y p e r -in fla tio n . It's t h e r e fo r e a tim e t o ca u tio u sly o b s e rv e the in terp lay o f the
cr o s sc u r r e n ts in o r d e r to d e te r m in e the d ir e ctio n o f the e co n o m y as it e m e rg e s from this
tran sition p e r io d .

29.
This is reflected in the slow decline in the price rate relative to the declines in CD
rates and the widening spreads (both discounts and premiums) relative to prime that bank
borrowers are paying.
30.
By interest rate sensitive sectors we mean all those affected adversely directly or
indirectly by high interest rates and tight money.
31.
We estimate that an immediate increase to over 78% of capacity is needed to bring
the failure rate down.
32.
Given the Fed's shift in policy, we would now assess the odds of response as about
even and the odds of fueling a monetary expansion if they have the opportunity also at
about even, implying a 75% chance of failure and a 25% chance of hyper-inflation.




155

AP PE N D IX - THE M A R K E TS
A s th e m arkets have a profou n d im p a c t on the p u b lic p s y c h o lo g y and v ic e v e rs a , it
w ould b e foolis h fo r any e c o n o m is t t o ig n o re th e ir b e h a v io r .
W hile m ark ets are by no
m eans p e r f e c t in th eir a b ility t o d isco u n t th e fu tu re , th e y a r e an e x c e lle n t r e fl e c t io n o f
the s h ifts in the b e ttin g .

ST O C K S
P rob a b ly the g r e a te s t single s o u r c e o f r e li e f t o g r o w in g a n x ie ty o v e r e c o n o m ic
c o n d itio n s has been th e last tw o m onths' sharp a d v a n ce in s t o c k p r ice s .
A s it 's w id e ly
r e c o g n iz e d that s to c k m arket a dva n ces t y p ic a lly p r e c e d e e c o n o m ic upturns, th e re is a
g row in g fa ith that a r e c o v e r y is around th e c o r n e r b ased on th e m agn itu de o f this
p a rticu la r a d v a n ce . The im p lied p rem ise is that th ose w ho buy s t o c k s h ave in the past
been g o o d a t a n ticip a tin g upturns in the e c o n o m y .
H o w ev er, as show n in our August r e p o r t , s t o c k p r ic e s ris e in re sp o n se t o fa llin g
in te re st r a te s , not a n tic ip a te d e c o n o m ic upturns.
W hile fa llin g in te re s t r a te s (and th e
in crea sed liqu idity th e y r e fl e c t ) n orm a lly stim u la te the e c o n o m y , t h e r e 's n o d ir e c t
c o n n e c t io n b etw e e n rising s to c k p rice s and an e xpan din g e c o n o m y . In o th e r w ord s, ra th e r
than s t o c k p rice s risin g in a n ticip a tio n o f e c o n o m ic e x p an sion s th e y rise in re sp o n se t o
lo w e r in te re s t ra tes w hich ty p ic a lly s tim u la te exp a n sion s. 1929 w as a c la s s ic e x a m p le o f
fa llin g in terest r a te s ca u sin g s to c k p r ice s t o ris e but fa ilin g t o s tim u la te an e xp an sion .
When in te re st ra te s began t o fa ll in M ay 1929, s t o c k p r ic e s r o s e .
This p r ic e a d v a n ce
e x te n d e d 15% in m agnitude and lasted until O c t o b e r 1929.
P erhaps the sim p lest w ay to show the re la tio n s h ip b e tw e e n s t o c k p r ic e s and in te re s t
r a te s is t o look at th e ir r e la tiv e yie ld s. F or e x a m p le , prio r t o th e bull m o v e s in th e s to c k
and bond m arkets, th e earnings y ie ld o f th e s t o c k m a rk et w as 13% , w hich w as equ a l to
the 13% then available in high grade bond s. F rom th eir lo w s , th e s t o c k and bond m ark ets
e a c h r o s e abou t 25% and now both y ie ld around 10% . S im ila rly , p rio r to th e in te re s t r a te
f a ll /s t o c k m arket ra lly , the gap be tw e e n th e y ie ld in 3 -m o n th tre a su ry b ills (1 0 % ) and the
d ividen d y ie ld o f s to c k s (8 % ) was 2% , th e s a m e as it is to d a y (w ith t -b ill y ie ld s around 7
1 /2 % and th e dividend y ie ld at 5 1 /2 % ).
When returns fo r b e in g liquid w e re high and
illiq u id ity was sq u e e zin g c o r p o r a te p r o fit a b ilit y , it paid to h av e a high p e r c e n ta g e o f o n e 's
p o r t fo lio in cash. H o w e v e r, w ith the returns fro m be in g in cash fa llin g and p r o s p e c ts fo r
r e liq u ific a t io n im p rov in g, la rg e m oney m an agers have b e e n s h iftin g t o s to c k s .
S in ce
liq u id ity is the m ost im p ortan t in flu e n ce on the w orld e c o n o m y , it 's not surprising th at all
m ark ets r e a c t v io le n tly in respon se to ch a n gin g p r o s p e c ts fo r r e liq u ific a t io n . A lth ou gh to
s o m e it m ight seem odd that the s to c k m a rk e t ra llie s on bad n ew s (e .g . the M e x ica n c ris is
and Penn Square), s in ce the s u rfa cin g o f e a c h new c r is is p ro m p ts the F e d e ra l R e s e r v e to
in je c t a n oth er dose o f liqu id ity in to the s y s te m , th e se ra llie s a r e n 't as fo o lis h as th e y fir s t
a p p ea r. O bserv e how last w e e k 's surge in th e s t o c k m a rk e t b egan in re sp o n se to T reasury
S e c r e ta r y R egan te llin g bankers that th ey " f a c e six m onths t o a y e a r o f d i ff i c u lt p ro b le m s
but ca n depen d on help fro m the g o v e r n m e n t i f d e b to r n a tion s d e ta u lt".
T h is bullish




156

r e a c tio n to bad new s is the ru le, n o t the e x c e p tio n . The se qu en ce is w e ll esta b lish ed : bad
new s g e ts the Fed to push in te re s t r a te s dow n and lo w e r in terest r a te s ca u se the s to c k
m arket to ra lly .
Just as bad new s is bullish fo r the s to c k m arket, g o o d new s is bearish.
O bserve how on any signs o f e c o n o m ic strength (e .g . a jum p in d urab le g o o d s ord ers)
in terest r a te s ris e (fe a r in g the Fed w ill take this as a sign that the e c o n o m y can w ithstand
s om e m ore tig h te n in g ) and th e s t o c k m arket fa lls .
W hile this p e rv e rs e r e a c tio n to the
F e d 's p o lic ie s s e e m s od d , it 's n o n e -th e -le s s ju s tifie d .
Since the odds o f an e c o n o m ic
c o lla p s e a re r e d u c e d and the odds o f an in flation ary expan sion are e n h a n ced by the Fed
turning s tim u la tiv e , it 's bullish t o have the Fed s ca re d .
This has n ot b een a s t o c k m ark et rally buoyed by optim ism . L o o k a t the groups that
le d the a d v a n ce
blu e chips (fo r se c u r ity ), m ining and o il com p an ies (as in fla tio n hedges)
and high d ivid en d y ie ld in g c o m p a n ie s (in response to lo w e r in te re st ra te s )3 3 .
it's also
in terestin g t o o b s e r v e how th e U.S. s to c k m arket s ig n ifica n tly o u tp e r fo rm e d all o th er s to c k
m arkets th rou gh ou t the bull m o ve d esp ite the dolla r strengthening again st all o th e r
c u r r e n c ie s e x c e p t th e C anadian d o lla r (r e fle c tin g the flo w o f m oney fro m nervous fo re ig n
in vestors in to the U .S .). The exp re ssio n "buying p a n ic" seem s a p p ro p ria te in that the m ov e
was su p p orted by in stitu tio n a l in v e sto rs who w ere s ca re d to be l e f t on th e side lin es,
fo re ig n in v e sto rs w ho w ere a fr a id t o k eep their m oney e lse w h e re and sh orts^ 4 who r e a liz e d
th at s tick in g w ith such a p o s itio n c o u ld prove le th a l.

G O LD
If o n e assu m es that the Fed ca n stim u late
have to be bullish on g o ld .
R eg a rd le ss o f how
b e c o m e , fo r g o ld t o in cre a s e in valu e re la tiv e to
m ust d e c lin e r e la tiv e t o g o o d s and s e r v ic e s (i.e .
im p orta n t t o u nderstand th at th e r e c e n t dolla r
d ev e lo p e d p rim a rily in a n tic ip a tio n o f in crea sin g

and w ill nurture a r e c o v e r y , on e w ould
bad p o litic a l and e c o n o m ic disruption s
any c u rre n cy the valu e o f that cu rre n cy
in fla tio n must in c re a s e ).
It's th e r e fo r e
d en om in ated strength in the g o ld p r ice
U.S. in fla tio n ^ 5.

A lth ou gh s o m e e c o n o m is ts argu e that re d u ce d in fla tion a ry e x p e c t a t io n s and the low
r a te o f c a p a c it y u tiliz a tio n w ill p re v e n t an in fla tio n a ry a c c e le r a tio n , th e r e is no p r e c e d e n t
in su pport o f th is co n c lu s io n . The e n tire d e clin e in in fla tio n is d ir e c t ly a ttr ib u ta b le t o the
F e d 's e x t r e m e ly tig h t m on ey p o lic ie s . High rea l in te re st r a te s re d u ce d in fla tio n by cau sin g
rapid in ven tory liq u id a tio n , w eaken in g final dem and and a stren gth en in g dolla r (w hich
r e d u c e d th e c o s t o f im p o rts). A lth ou gh the c o r e in fla tio n ra te has re m a in e d co m p a r a tiv e ly
s te a d y , c o m m o d it y d e fla tio n h e lp e d to re d u ce the a v e r a g e ra te
i.e . a v e ra g in g p o s itiv e
num bers w ith n e g a tiv e num bers c r e a t e s low er p o s itiv e num bers. As th e r a te o f c o m m o d ity

33.
During the week ended October 7th, bank stocks did exceptionally well in response
to hopes of reliquification and pledges of government support, gaining 15% on average.
34.
The short interest in August, at the bottom, was an exceptionally large 96 million
shares.
35.
Declining interest rates are also bullish for gold because of the lower carrying costs.




157

d e fla tio n s l o w s ^ the o v e r a ll rate o f in fla tio n w ill rise (unless there is a sign ifica n t
d e clin e in the c o r e in fla tio n ra te w hich w ould take an e c o n o m ic c o lla p s e ).
If the F ed 's
s tim u lation c r e a t e s an e c o n o m ic response and real in terest r a te s are held dow n, inventory
rebuilding, in crea sin g fin a l dem and and a w eakening dolla r w ould lead to an in flation ary
a c c e le r a t io n .
While the in fla tio n ra te w ould at firs t (ov er the n ext six m onths) increa se
m o d era tely , by II Q 83 it w ould app roa ch dou b le d igit le v e ls and by 1984 rea ch 15-18% .
As show n in our August re p o r t, m ajor in te re st ra te d e c lin e s fo llo w in g periods o f
illiqu idity trig g e re d sig n ific a n t g o ld p r ice ra llie s (i.e . 32% to 44% ). From the low s, this
rally e x ten d ed o v e r 65% b e fo r e c o r r e c t in g (it 's now up 42% ). W hile a long s to ck position
is one w ay o f b e ttin g that 1) the F e d ’ s stim u lation w ill trig g e r an e c o n o m ic response and
2) the Fed w ill nurture the r e c o v e r y by "lea n in g into the w ind", buying gold is a far b e tte r
w ay. 15-18% in fla tio n and low real in te re st r a te s im ply a g o ld p r ic e o f around $800-900
by 1984.

BONDS
A lthough the sharp a d v a n ce in the s to c k m arket a t t r a c te d the m ost a tte n tio n , the
ad va n ce in the bond m arket w as equally sharp and on a t o ta l return basis^7 bond holders
sig n ific a n tly o u tp e r fo rm e d s t o c k holders.
We con tin u e to f e e l stro n g ly that high grade lon g term bonds are the b e st p la c e for
o n e 's m on ey. A s w e 'v e said so m any tim es b e fo r e , if you c a n 't ow n bonds you c a n 't own
anything. In terest r a te s must c o m e dow n e ith e r be ca u se the Fed r e liq u ifie s (fo r c in g them
dow n ) or b eca u se th ey d o n 't r e liq u ify (and the e co n o m y c o lla p s e s ). C on trary to popular
b e lie f , near term bonds w ill g o up in respon se to r e liq u ific a tio n sim ply b e ca u se real
in teres t ra te s w ould d e c lin e by enough to ca u se nom inal ra te s to fa ll d esp ite increa sing
in fla tion . On the o th e r hand, i f re liq u ific a tio n o f the e c o n o m y d o e s n ot o c c u r , both falling
rea l r a te s and a fa llin g in fla tio n ra te w ould cau se bond p r ice s to e x p lo d e . By co n tra st,
having your m oney in the s to c k or gold m arkets is a b e t that 1) the F e d 's stim u lation w ill
cau se a respon se and 2) that the Fed w ill "lea n into the w ind" (th ereb y preven tin g an
in terest ra te in cre a se ) w hile the e c o n o m y is expanding.
In our M arch r e p o r t, we p r o je c t e d "By m id -y e a r we w ill se e the F ed era l R eserve
m ove t o in crea se m em ber bank re se rv e s w hile p rivate loan dem and w ill be fa llin g. The
resu lt w ill be a sharp fa ll in in te re st ra te s w hich w ill take the prim e rate to around 8%
by m id -1 9 8 3 ...T h e m ajor lon g term peak in in te re st ra te s w ill be seen so m e tim e b etw een
la te spring and m id -su m m er. The p r o fit o p p ortu n ities w hich w ill resu lt from the secon d
h alf 1982 drop in in te re s t r a te s w ill be en orm ou s. F or e x a m p le , le v e ra g e d in vestors who
are lon g treasury bill, C D and eu rod olla r fu tu res w ill m ake upw ards o f f ift e e n tim es their
m oney w hile in v e sto rs w ho are lon g bonds w ill m ake around 60% during this tim e ."
A lthough this m ove is now w ell underw ay, d o n 't le t the f a c t that it's c o m e this far so fast
p reven t you from g e ttin g on board i f you h a v e n 't alread y. Bond y ie ld s are s till, even a fte r
their tum ble, higher than at any tim e prior to Paul V o lck e r's a p p o in tm e n t. Th ey have been
r e fle c t in g the last th ree y e a r s ' liqu idity c ris is w hich is d e fin ite ly ending. W hile there w ill
be c o r r e c t io n s in this bull m o v e , th ese should be taken as buying op p ortu n ities.

36.
Commodities in aggregate are now, in real dollars, lower than at any time daring the
Great Depression and lower relative to the cost of production and government support
levels than ever before.
37.
As contrasted from reliquification of the banking system which has already occurred.

17-871 0




83

11

15 8

CHART 15 - STEEL, CAPACITY UTILIZATION %

CHART 16 - STEEL, CAPACITY UTILIZATION, % CHANGE YEAR AGO




159

CHART 17 - AVERAGE INITIAL CLAIMS STATE UNEMPLOYMENT INSURANCE

CHART 18 - INITIAL CLAIMS FOR UNEMPLOYMENT, % CHANGE YEAR AGO




n

d

j

f

1982

m

a

m j

j

160

CHART 19 - ADVANCE PLANNING

j

f

m

a

m

j

j

a

s

o

n

d

j

1981

f

m

a

m

j

j

a

s

o

n

d

1982

CHART 20 - ADVANCE PLANNING, % CHANGE YEAR AGO

j

f

1981




m

a

m

j

j

a

s

o

n

d

j

f
1982

m

a

m

j

j

a

s

o

n

d

161

CHART 21 - U.S. AUTO OUTPUT, AVERAGE WEEKLY SALES

80,000
70.000
60.000
j

f

1981

m

a

m

j

j

d

j

f

m

a

m

j

j

1982

CHART 22 - U.S. AUTO OUTPUT, % CHANGE YEAR EARLIER




162

CHART 23 - PETROLEUM REFINERY % UTILIZATION

j

f m a m j

1981

j

a

s

o

n

d j

f

1982

m

a

m

j

j

a

s

o

n

d

CHART 24 - PETROLEUM REFINERY % UTILIZATION, % CHANGE YEAR AGO

j

f

1981




m

a

m

j

j

a

s

o

n

d

j

f m a m

1982

j

j

a

s

o

n

d

163

CHART 25 - ELECTRIC POWER PRODUCTION

50
45
40
3 10 17 24 31/ 7 14 21 28/ 4 11 18 25/ 1
July

j

f m a m j

1981

j

a s

o n d j

August

f

1982

m

a

m

September

j

j

a

s

o

October

n

d

CHART 26 - ELECTRIC POWER PRODUCTION, % CHANGE YEAR EARLIER

1981




1982

164

CHART 27

j

f m a m j

1981

CHART 28




j

a s

PAPER PRODUCTION

o n d j

f

1982

m

a

m

j

j

a

s

o

n

d

PAPER PRODUCTION, % CHANGE YEAR EARLIER




BRIDGEWATER ASSOCIATES. INC
BANKING STATISTICS
a) C om m ercial & Industrial Loans at Banks (mil. $)
b) C om m ercial Paper, Non-Financial (mil. $)
c) C om m ercial Paper, Financial (mil. $)
d) A - B
e) A
B ■ C
f) Total R eserves (bil $)
g) Excess Reserves (mil. $)
h) Net Free R eserves (mil. $)
i) Monetary Base (bil. $)
j) M l Multiplier
k) Ml (bil. $)
1) M2 (bil. $)
m) Consumer Price Index
n) Ml f CPI
o) M2 t CPI
p) T-Bill Rate
q) Fed Funds Rate
r) CD Rate
s) Prime Rate
t) Long Term T-Bond Rate
u) CD - T-Bill Rate
v) Prime Rate - CD
w) T-Bill Rate ’• T-Bond Rate

Jly 3

Jly 10

Jly 17

Jly 24

207.985
58.932
120.913
266.917
387.830
41.785
597.0
-548.0
172.600
2.605
449.6
n/a
—
153.9
—
13.01
14.81
15.25
16.50
—
2.24
1.25

208.384
60.003
121.594
268.387
389.981
41.672
694.0
40.0
172.430
2.583
445.4
n/a
—
152.4
—
12.59
14.47
15.13
16.50
—
2.54
1.37

207.769
61.047
120.238
268.816
389.054
40.770
165.0
- 92.0
171.607
2.633
451.8
n/a
—
154.6
—
11.88
13.18
14.13
16.50
—
2.25
2.37

206.508
206.285
60.576
59.024
122.802
122.301
267.0.84
265.309
389.385
388.111
41.710
41.688
0.350
0.271
17.0
65.0
172.640
172.819
2.616
2.607
451.6
450.5
n/a
1,923.3
—
291.4
154.6
154.6
—
660.0
11.06
10.51
12.14
11.02
13.34
12.08
16.00
15.50
—
12.97
1.57
2.28
2.66
3.42
.81

ECONOMIC ACTIVITY (monthly)
a) Capacity Utilization
b) Durable Goods Orders (bil. $)
c) Housing Starts (thous. annual)
d) D om estic Auto Sales
e) Index o f Leading Indicators
f) Industrial Production
g) Retail Sales, 1972 dollars (mil. $)
ECONOMIC ACTIVITY (weekly)
h) initial Claims for Unemployment (thous.)
i) Business Failures
j)
(% Change from Year Earlier)
k) Auto Output
1)
(% Change from Year Earlier)
m) Electrical Power Production
n)
(% Change from Year Earlier)
o) Paper Production
p)
(% Change from Year Earlier)
q) Petroleum R efinery % Utilization
r)
(% Change from Year Earlier)
s) Steel, % Capacity Utilization
t)
(% Change from Year Earlier)
u) Advance Planning (mil. $)
v)
(% Change from Year Earlier)

Jly 31

Aug 14

Aug 21

Aug 28

Sept 4

Sept 11

Sept 18

Sept 25

206.831
206.862
59.355
59.268
120.219
120.903
266.186
266.130
387.089
386.349
41.665
41.676
0.358
0.333
-161.0
+186.0
173.376
173.247
2.616
2.618
453.5
453.5

207.120
58.420
119.898
265.540
385.438
42.073
0.281
52.0
174.019
2.614
454.9

206.069
57.802
118.844
263.871
382.715
41.771
0.239
-158.0
173.775
2.626
456.3
1,946.2
292.4
156.1

207.618
57.864
116.054
265.482
381.536
41.999
0.387
91.0
174.603
2.618
456.9
—

208.334
57.280
113.914
265.614
379.528
39.554
0.719
- 82.0
171.340
2.696
461.9

211.086
58.325
114.123
269.411
383.534
39.562
0.422
-702.0
171.790
2.681
460.6
—

212.231
58.303
115.818
270.534
386.352
39.767
0.204
-387.0
172.001
2.680
461.0

8.00
10.15
10.11
13.50
—
2.11
3.39

8.31
10.14
10.53
13.50
—
2.22
2.97

Aug 7

—
155.1
—
9.92
11.15
11.63
15.00
—
1.71
3.37

—
155.1
—
9.99
10.90
11.65
14.00
—
1.66
2.35

—
155.1
—
8.68
10.11
10.51
13.50
—
1.83
2.99
-

33.02
1,195.0
5.1
129.8
138.7
44,301.0

510.0
536.0
494.0
517.0
341.0
383.0
540.0
343.0
r 52.2
22.4
r 60.7
- 0.9
87,752.0 114,614.0 116,648.0 106,354.0
- 19.7
h
^ 4.9
n/a
h- 17.0
44,971.0 48,644.0 49,824.0 49,073.0
- 10.8
- 6.7
- 2.1
-i- 1.5
414.0
505.0
569.0
576.0
3.0
3.1
11.3
5.0
71.1
70.5
70.0
69.8
4.4
4.1
4.2
3.3
40.5
43.8
42.3
42.3
- 47.4
- 46.1
■ 43.7
- 45.6
2,446.4
2,063.4
1,994.7
2,535.0
11.6
28.9
- 23.0
8.1

-

8.16
10.27
10.81
13.50
—
2.65
2.69
-

7.75
10.31
10.84
13.50
11.58
3.09
2.66
0.72

O ct 9

7.50
10.12
10.53
13.25
—
3.03
2.72

7.82
10.77
10.58
13.00
—
2.76
2.42

O ct 16

39.243
0.515
+342.0
172.331
2.698
464.9

7.58
9.60
9.59
12.25
—
2.01
2.66

69.4
31.68
1,002.0
5.4
128.6
138.4
43,817.0

69.9

532.0
522.0
+207.1
119,852.0
- 15.7
44,657.0
- 3.0
573.0
3.9
71.2
4.9
43.9
- 45.4
2,925.1
27.5

7.43
9.04
9.59
13.50
12.15
2.16
3.91
0.61

O ct 2

212.603
214.922
57.023
58.333
115.426
115.297
269.626
273.255
385.052
388.552
39.642
39.936
0.607
0.291
+230.0
-222.0
172.164
172.408
2.677
2.659
458.0
460.9

568.0
512.0
+ 44.6
73,302.0
+ 10.4
49,136.0
- 1.5
570.0
3.7
72.3
5.6
42.6
- 44.5
2,271,2
- 41.3

608.0
494.0
+ 41.6
62,273.0
- 30.4
42,285.0
- 6.0
565.0
6.8
70.9
0.0
40.9
- 46.8
2,280.4
1.5

621.0
572.0
+ 70.8
72,751.0
- 30.1
46,786.0
+ 2.2
588.0
4.1
68.8
3.8
40.5
- 48.9
1,829.1
- 36.6

658.0
629.0
696.0
563.0
+148.57
+ 85.2
93,320.0 76,941.0
- 7.64
- 24.3
46,002.0 45,180.0
- 2.0
- 2.5
587.0
579.0
4.9
7.6
70.2
71.0
1.9
0.6
39.9
40.6
- 47.3
- 49.8
4,004.8
2,699.4
- 42.00
-

613.0
703.0
657.0
453.0
+ 46.6
+ 68.0
90,537.0 98,336.0
- 3.8
+ 5.1
41,699.0 44,427.0
- 2.98
+ 1.9
505.0
593.0
8.8
3.3
73.9
71.6
8.7
3.3
39.8
40.5
- 45.7
- 47.4
2,510.4
1,760.9
- 2.8
- 29.8

695.0
697.0
598.0
579.0
491.0
+ 68.8
- 2.1
+ 27.78
99,028.0 87,089
79,938.0 94,543.0
- 23.01
- 10.46
- 19.0
- 29.29
40,274.0 39,797.0 41,266.0
.57
- 3.26
- 5.70
602.0
606.0
589.0
2.59
1.94
6.06
72.7
71.8
71.3
6.9
9.12
9.02
41.0
41.0
39.9
- 43.50
- 45.0
- 44.6
2,237.2
2,727.7
3,715.9
3,086.2
- 21.7
- 28.36
9.34
- 42.5

166

Kepresentative R euss . Thank you , Mr. Dalio.
Mr. Evans.
STATEMENT OP MICHAEL K. EVANS, PRESIDENT,
EVANS ECONOMICS, WASHINGTON, D.C.

Mr. E vans . Thank you very much, Mr. Chairman. It’s always a
pleasure to appear before this committee, although this is the first
time I ever heard anybody more pessimistic than I am. It’s a new
experience for me.
I will briefly discuss where I think the economy is going and then
answer some of your specific questions about fiscal-monetary policy.
I will, of course, abstract from my prepared statement.
I think the U.S. economy is at least 1 year and possibly 2 years
away from a sustained recovery.
In my 20 years as a professional forecaster I have seen many re­
coveries emerge and mature and I have never seen one start like the
position that we are currently in: New orders for capital goods, down
22 percent the past year; the Federal budget deficit threatens to engulf
the entire supply of new saving; long-term real interest rates are 6
percent instead of their normal 2 to 3 percent; the number of initial
unemployment claims has risen 35 percent in the past 2 months; the
Commerce Department’s own index of leading economic indicators,
down 0.9 percent in most recent months.
This is only a short list, Mr. Chairman. Your list in the introduc­
tion was longer but conveys the same impression.
I think the surge in the stock market stems from weakness rather
than strength and it has occurred entirely because interest rates have
fallen. In the past 3 months stock prices are up 20 percent but interest
rates are down 24 percent, indicating that the other factor which
moves stock market prices; namely, expected future profitability, has
actually deteriorated in the past 3 months, and I think this will con­
tinue.
Kepresentative M itch ell . Mr. Evans, excuse me. Will you run
through that again for me, please, on the performance of the stock
market ?
Mr. E van s . Oh, sure. As I said, over the past 3 months the stock
market is up about 20 percent but interest rates are down 24 percent.
So the other component of stock market performance, which is ex­
pected future profitability, has actually deteriorated over the past 3
months, and I expect it will continue to do so.
As far as the GNP figures go few will take joy from the 0.8 percent
increase that occurred. In my own forecast I have predicted a slight
decrease. Just comparing my numbers with the ones that were released,
I see that my numbers agreed exactly with the decline in final sales of
$2 billion.
I had not estimated the degree to which inventories had increased.
But this is clearly bad new rather than good news, because with these
new figures we have approximately $20 billion worth of inventories
that have to be worked off over the next few quarters and this will
result in a decline in GNP in the fourth quarter, very little growth
in the first quarter, and a continued rise in the unemployment rate. My
figure of 11 percent unemployment is not reached until later in 1983




16 7

than yours, Congressman Mitchell, but I share the same opinions that
the unemployment rate will continue to increase.
Furthermore, I believe that the Fed will once again reverse signals.
We have heard Mr. Volcker speak on many occasions, and I would
just like to read something that Mr. Volcker told a national audience
on Issues and Answers on October 29, 1979. I quote directly from his
remarks on that date. He said:
As inflation comes down, which is the whole object of our policy, that is the
only fundamental way to get interest rates down. * * * I have no hesitation in
saying that the kind of policies that we are following will bring interest rates
down quicker and lower than if we took any other approach.

Now that’s October 29, 1979. The rate of inflation was 13 percent;
it has indeed declined to the 5 to 6 percent level. The triple A corpo­
rate bond rate was 10.5 percent then; now it is 12.1 percent. The
mortgage rate was 11.3 percent then; it is now, according to the latest
Federal Reserve figures, 14.6 percent.
So I submit that Mr. Volcker’s method of bringing down interest
rates quicker and lower than any other approach has not worked. As
wre know, monetary policy has focused very closely on the monetary
aggregates.
1 believe that the switch away from the monetary aggregates is only
temporary, and that after election time, as money supply, Mi, grows
at double digit rates between July and the end of the year that Federal
Reserve policy will tighten again and that we will have an increase
in interest rates in the first quarter of 1983, with the prime rate rising
to perhaps 15.5 percent in March or April or next year. This will be
sufficient to choke off any recovery which might have otherwise oc­
curred and will result in real GNP for 1983 growing at a rate of ap­
proximately only 1 percent, with the other details given in my tables
in the appendix to my prepared statement.
I don’t want to spend a lot of time going over all of the various
reasons the GNP is low. I will touch on them very briefly, summarizing
my comments here.
Consumer spending will not lead the way out of the recession. Con­
sumers are (a) scared, and (b) broke. They are scared for good reason.
The unemployment rate, 10.1 percent, is, of course, the highest since
1940, but continues to move up, it will be higher in coming months as
indicated by the rise in initial unemployment claims. Consumers are
broke in the sense that real per capita wage and salary income has de­
clined steadily now for almost 3 years. The personal income numbers
show an increase, but most of that increase occurs in interest payments
which are additions to savings accounts, money market funds, and so
forth. The average rank and file worker doesn’t have very much in­
vested. It’s his income or her income which is going down.
Because of this I think that the tax cut will have only a moderate
effect on consumer spending. The tax cut, we should all be reminded,
amounted to approximately $4 a week for the average American
worker on July 1, 1982, and while I have some kind things to say
about tax cuts in general, it would be fatuous in my opinion to ex­
pect that a $4-a-week increase would have all by itself served as a
miracle drug to turn the economy around. The negative psychological
implications of the continuing recession and the double digit unem­




168

ployment rate have far outweighed this modest increase in income, as
we have seen in the past few months.

As far as the inventory situation goes, I’ve already referred to the
fact, based on the recent figures, that we have a $20 billion decline in
inventory investment to occur in the next few months.
Fixed business investment is in very bad shape. The Commerce
Department surveys show a 4.4 percent decline in real terms this year.
When the new investment surveys which come in November are re­
leased next month, they will in my opinion show a decline of at least
5 percent in capital spending in real terms next year. It is rumored
that some surveys even show as much as a 10 percent decline.
Finally, we have heard some good news about the housing industry
because housing starts were up 14 percent yesterday. I would submit
that the housing market is still far away from equilibrium. For many,
many years, through the 1950’s and the 1960’s, the average ratio of
the average monthly payment to household disposable income re­
mained constant at about 20 percent. This ratio has now risen to ap­
proximately 32 percent. Even if you adjust for creative financing, it’s
about 30 percent. Four out of five average American families still
cannot afford the monthly payment on a new mortgage even though
interest rates have declined. In my opinion we will have no complete
recovery in the housing industry until those mortgage rates and hous­
ing prices have declined to put the ratio of monthly payments to in­
come back to their old levels. And I do not expect this to happen
until 1985.
Thus with consumer spending weak, with housing weak, with
capital spending weak, and not so incidentally, with our net export
balance deteriorating sharply because of the strength of the dollar,
with our offsetting cost reductions or productivity improvements, no
sector is going to lead us out of this recession.
The only thing that has increased in the past quarter is inventory
investment. Everybody knows you don’t start a recovery by stock­
piling excess, unwanted inventories. This has never happened before.
The reason it happened at all was that, although I find this hard to
believe, many businessmen believed the consensus forecast back in
April and they started stockpiling inventories in advance of this
great boom which was going to come from this $4-a-week tax cut.
But when it didn’t happen they found themselves with excess inven­
tories. We have to go through yet another leg of the recession which
w’ill take us well into 1983.
Economists are supposed to have solutions to what ails us. This is
not as easy a part of the talk to give as it used to be. But I would
like to suggest that we need a radical restructuring of our fiscal policy.
Some of the economists on this panel and elsewhere have indicated
that budget deficits don’t really matter. I would like to say that under
the present circumstances, under the present set of laws for fiscal
policy which currently exist, not only will we have a $175 billion
budget deficit next year, but the budget deficit as a proportion of GNP
will continue to increase even after the economy recovers, if in fact
it does. We have built-in increases in spending: we have tax laws
which are structured so that the increase in tax receipts will be lower
than the increase in GNP.




169
I have long been associated with the general thrust of supply-side
economics, and I ’m not going to back off and say I don’t believe in
that, although admittedly I ’m one of the few people that even men­
tions the term anymore. But I do believe that the high marginal tax
rates which wTe have had in the past have impeded the advancement
in saving and investment and productivity and have to a certain ex­
tent hindered work effort and individual incentive. What I would like
to propose is an increase in average tax rates coupled with a decrease
in marginal tax rates. This would occur through a modified flat rate
income tax.
I have worked out a number of figures, which are shown in these
tables. I f those who are following my statement would turn to table 2,
I have calculated a flat rate income tax, modified as follows: A $2,500
personal exemption, retention of deductions for charitable contribu­
tions, catastrophic medical expenses, home mortgage interest, and
State and local taxes paid, but closing of all other tax preferences,
deductions, loopholes, whatever you call them. Such a flat rate tax
would bring the same amount of revenue as our current tax laws will
in 1984 at a rate of 16 percent.
That assumes that there would be no advantages to the flat rate tax.
However, we are now under a system where approximate $550 billion
worth of personal income has no taxes paid on it. About $350 billion
of this represents unreported income or overstated deductions. These
are not my figures; these are from testimony offered by Commissioner
Roscoe Egger of the IRS last March. In addition to this $350 billion
in unreported income, we have an additional $200 billion in tax
shelters, loopholes, tax-free municipal bonds and all the other areas
with which we are familiar. I believe that the introduction of a flat
rate tax would in fact close the gap and that two-thirds of the unre­
ported income would indeed be reported at a 16-percent marginal tax
rate.
In table 4 I have indicated the effect of a flat rate tax on Federal
tax receipts. Table 4 shows that the total tax receipts which would
be collected in 1984 under current law are $311 billion; the amount of
tax receipts that would be collected under a 16 percent flat rate tax,
according to my estimates, would be $430 billion— an increase of $119
billion, even if we ignore supply-side effects. If we then bring in
supply effects, which might add an extra $30 billion, we would come
very close to balancing the budget through a flat rate tax.
So I submit that one way out of our dilemma would be to change
our tax structure, to implement a flat rate tax, to close off our tax
loopholes, but to lower high marginal tax rates. I believe this would
reduce our budget deficit without impeding on the flows of savings
and investment. I believe that this would then provide the strength
for a balanced recovery, a sustained growth with no deterioration in
the inflation rate, and it would also lead to a balanced budget in per­
haps 3 or 4 years.
Without a radical change in fiscal policy, however, I believe that the
economy is likely to endure several more years of stagnation, because
I believe the budget deficit is so large, and with the reluctance to cut
spending either for social welfare or defense programs, I believe that
we will continue to have increasing deficits as a proportion of GNP.




170

Now, as long as the economy is in recession, as long as there is no
increase in private sector borrowing, then the Government can borrow
os much as it wants without raising interest rates. However, as soon as
the economy starts to improve, as soon as we have an increase in con­
sumer borrowing and corporate borrowing, this borrowing will reach
a collision course with the Government borrowing and send interest
rates up once again,
I expect that this pattern will be repeated in early 1983 and perhaps
again m early 1984, leading to a period of sustained stagnation with­
out fiscal reform. Thank you.
[The prepared statement of Mr. Evans follows:]




171

Prepared Sta t em en t

of

M

ic h a e l

K. Evans

The U.S. economy is a t least one year, and possibly tw o years, away fro m a
sustained re co ve ry.
In my 20 years as a professional fo re c a s te r, I have seen many recoveries
emerge and m a tu re .

B ut I have never seen one s ta rt in a situ a tio n when new

orders fo r c a p ita l goods have declined 22% during the past year, when the Federal
budget d e fic it threate ns to e n gulf the e n tire supply o f new saving in the fo llo w in g
year, when lo n g -te rm real ra tes o f in te re s t are s till 6% instead o f th e ir norm al 2%
to 3%, when the num ber o f in itia l unem ploym ent claim s has risen 35% in the past
tw o m onths, and when the C om m erce D epa rtm e nt's own index o f leading econom ic
indica tors has ju s t fa lle n 0.9% in the m ost re cent m onth.
The surge in the stock m a rk e t stems fro m weakness, not fro m stre ngth .

It

re fle c ts the fa c t th a t in te re s t rates have fa lle n because o f lack o f demand in
consumer purchases, in housing, and in c a p ita l spending.

In fa c t, during the past

three m onths, stock prices have risen less than bond prices — in d ica tin g th a t the
oth er com ponent o f stock m a rk e t behavior, nam ely expected fu tu re p ro fita b ility ,
has a c tu a lly d e te rio ra te d .
To be sure, the econom ic signals are never unequivocal, and some have
managed to take h e a rt fro m the recent increases in stock prices, the decline in
in te re s t ra tes, and the apparent fu rth e r re duction in in fla tio n .

And o f course the

"p ro s p e rity is ju s t around the co rn e r" fo lks, who are never absent even in the
w orst econom ic tim e s, are c h e e rfu lly rem inding us th a t things m ust soon get
b e tte r because the econom y is c u rre n tly so fa r down.




172

In fa c t, the economy probably w ill show a m odicum o f stre ngth in the next
few months. Lo w e r in te re s t rates w ill probably re s u lt in an increase o f 2% to 3%
in real consum ption, and the c u rre n t phase o f in v e n to ry liq u id a tio n should com e to
an end s h o rtly a fte r the fir s t o f the year.

When th is happens, it is lik e ly th a t real

GNP could increase as much as 4% fo r a fe w m onths. B ut it is our po sitio n th a t
this increase is not sustainable. For the rise in consum er spending and bo rrow in g
w ill bring about renewed congestion in fin a n c ia l m a rkets.

Interest rates w ill rise

anew and any chance o f sustained re co ve ry w ill be ab orte d.
O rd in a rily the net national saving ra te — personal saving, net c o rp o ra te
saving, and governm ent saving - - averages about 6% o f net national p roduct. N ext
year, however, the Federal budget d e fic it w ill reach a p p ro xim a te ly $175 b illio n ,
w hich w ill account fo r 6% o f GNP a ll by its e lf.

A ll o th e r savings flow s in the

economy w ill be about 3%. As a re s u lt, the to ta l net na tional saving ra te w ill be
3% instead o f 6%.

We are facin g a s h o rtfa ll o f a p p ro xim a te ly $100 b illio n in

saving.
As long as the economy is weakening and p riv a te sector loan demand is
stagnant or d e clin ing, the Federal governm ent can bo rrow v irtu a lly a ll it w ants
w ith o u t pushing up in te re s t rates fu rth e r.

H ow ever, once the p riv a te secto r

begins to recover, a c o llis io n course is all bu t in e v ita b le . W ith inadequate supplies
of savings, in te re s t rates are forced back up, and the econom y enters y e t another
leg o f th is already over extended recession.
In a d d itio n to the likelihoo d o f higher in te re s t rates snu ffing out any chance
o f re covery in consumer spending, the p o rte n ts rem ain dim fo r oth er com ponents
o f GNP.

The housing industry cannot re cover u n til the ra tio o f the average

m o nthly paym ent to household disposable incom e re turn s to a p p ro xim a te ly 20%;
c u rre n tly it is about 32%.

C apita l spending w ill de clin e alm ost 5% in real term s

this year, according to the la te st C om m erce D e p a rtm e n t survey results, and is




173

poised to fa ll a t least another 5% next year.

Our net e xp o rt po sitio n continues to

d e te rio ra te as a strong dollar is not m atched by cost savings in our basic industries
here at home; indeed, union demands con tinue to escalate even as c a p a c ity
u tiliz a tio n rates fa ll to 45-year lows.

S tate and local governm ents con tinue to

reduce th e ir expenditures in real term s as Federal grants and s ta te and local
revenue bases dim inish.
Based on this grim outlook it is a ll but c e rta in th a t the unem ploym ent ra te
w ill continue to rise throughout 1983 and probably in to 1984 as w e ll.

If real GNP

increases only 1% next year, then w ith labor fo rc e grow ing a t about a 2% ra te , it
is a m a tte r o f sim ple a rith m e tic th a t unem ploym ent w ill increase another 1% in
1983. This would put the ra te near 11% by the end o f 1983. Even i f the economy
does pe rform somewhat b e tte r in 1984, the unem ploym ent would s till rem ain
above 10% tw o years fro m now.

We would not see a decline to the 7.4% ra te o f

January 1981 u n til m id-decade at e a rlie s t, w ith the p o s s ib ility th a t th is m ig h t not
o ccu r u n til alm ost 1990.

Even the h ig h ly successful Kennedy-Johnson program ,

during which real GNP grew at an annual average increase o f 5.4% fro m 1962
through 1966, only reduced the unem ploym ent ra te by 2.9% over this period. Thus
even an a ll-o u t boom would not bring the unem ploym ent ra te much below 7%, and
we are fa r fro m having programs in place w hich w ould insure such a boom.
The next section o f these rem arks covers the se c to r-b y -s e c to r o u tlo o k fo r
the U.S. economy fo r the next year.

In the concluding section we then tu rn to a

possible way out o f the cu rre n t morass.

The Consumer Sits On The Sidelines
It should now be apparent to a ll th a t the in itia l e ffe c t o f tax cuts is to raise
saving and lower in te re s t rates, not to raise consum ption. F u rth e rm o re , we th in k
th a t anem ic consumer grow th w ill continue throug hou t 1983 as w e ll because o f the
fo llo w in g fa c to rs :

17-871

0




83

12

174

1. V irtu a lly no g ro w th in real per cap ita wages and salaries;
2. Low er g ro w th in tra n s fe r payments due to low er in fla tio n ;
3. N ega tive psychological im plica tions o f do uble-digit unem ploym ent rates;
and
4. The lo n g -te rm e ffe c t o f a higher real ra te o f re tu rn on saving.

The fir s t ite m

may appear to be somewhat a t variance w ith th e 2.3%

increase in real disposable incom e fo r 1983 contained in our fo re c a s t. H ow ever,
th a t fig u re must be m o d ifie d in several ways.
ra th e r than spent.

F irs t, the ta x cuts w ill be saved

Second, m ost o f the increase in real personal incom e stems

fro m higher in te re s t incom e, w hich is income in an N IPA sense but not in a
spending sense. In o th e r words, most o f th a t income is accrued to savings deposits
o f one fo rm or another and is not even considered to be p a rt o f the s h o rt-te rm
spending stream by its re c ip ie n ts .

T hird, w ith no increase in p ro d u c tiv ity , both

wages and prices w ill rise about the same am ount, and w ith gains in em ploym e nt
being m atched by g ro w th in the labor fo rc e , per ca p ita income w ill n o t increase.
The second p o in t is som ewhat more com plicated in the sense th a t low er
in fla tio n is usually considered to be a boon fo r consum ption. A fte r a ll, the m ajor
reasons fo r th is extended recession is to lower in fla tio n , is i t not?

F or on ly w ith

low er in fla tio n can we have higher saving and investm ent, g re a te r p ro d u c tiv ity ,
and an increase in the real standard o f living.
A ll

tru e

enough

when

lower

in fla tio n

is

caused

by

p ro d u c tiv ity ; then real wages rise and everyone is b e tte r o ff.

an

increase

in

Y e t now th a t the

in itia l excess demand has been squeezed out o f the system, any fu rth e r re duction
in in fla tio n w ill be accom panied by lower gains in wages and no im provem ent in
p ro d u c tiv ity . As a re s u lt, liv in g standards fo r labor w ill not rise a t a ll.
In a d d itio n , tra n s fe r paym ents which are linked to the cost o f liv in g w ill also
rise less ra p id ly n e x t yea r. As a fir s t approxim ation, one m ight argue th a t th is too




1 75

is a wash, since the low er be nefits received are o ffs e t by sm a lle r p ric e increases
o f the goods and services which are purchased. H ow ever, fo r those whose sole or
even p rim a ry support is social s e c u rity b e n e fits , th e CPI is a very poor in d ic a to r
o f w hat things cost.

For the most p a rt, the e ld e rly do not buy new houses,

p a rtic u la rly w ith m ortgages.

They do not have to bear the cost o f m edical care

services.

They are presumably finished

education.

They do not partake o f bu sin ess-in flated tra v e l, lodging, and food and

e n te rta in m e n t expenses.

paying

fo r

th e ir

c h ild re n ’s colleg e

Hence the tru e cost o f liv in g fo r the re tire e rises much

less than th e CPI during periods o f rapid in fla tio n .

In com parison, when in fla tio n

m oderates and the be nefits are correspondingly less generous in nom inal term s,
aggregate purchasing power suffers.
It used to be generally accepted th a t high unem ploym ent rates caused
reduced spending, as consumers saved m ore fo r the ra in y day when the y too m ig h t
be laid o f f or fire d .

D uring the 1970's th is e ffe c t appeared to be m uted, as the

lo n g -te rm secular increase in unem ploym ent appeared to have l it t le e ffe c t on
consum ption. H ow ever, the recent sharp increase in unem ploym ent — 2.5% in the
past

12 months — has once again raised the spe ctre o f depression, and has

convinced an increasing number o f consumers to be much more cautious and
t h r if t y than they have been over the past tw o years. We do not see th is cloud o f
pessimism liftin g as long as the unem ploym ent ra te rem ains above 10%, w hich is
to say a t least through next year.
The fo u rth fa c to r represents the e ffe c t o f the a fte rta x re al ra te o f re tu rn on
personal saving. The o rig inal estim ates in our supply-side m odel showed th a t a 1%
change in the ra te o f re tu rn would change the personal saving ra te by about 1%, a
re su lt s till incorporated in the present version. H ow eve r, the real ra te o f re tu rn is
calc u la te d as the Aaa bond y ield on an a fte rta x basis m inus the in fla tio n ra te over
the past fo u r years. Hence the increase in th e real ra te o f in te re s t w hich s ta rte d




176

in 1980 w ill ju s t begin to have its fu ll e ffe c t on the saving ra te in 1983 and la te r
years; a lis tin g o f these variables is given in Table I.
To be sure, most econom ists do not accept th is argum ent; the supply-siders
are

ge nera lly on the defensive, and everyone else dismisses it

as so much

hogwash. H ow ever, an a lte rn a tiv e sociological the ory has grown up in its place to
explain the obvious econom ic fa c ts which few wish to acknowledge. We now hear
th a t it is not sm a rt, not "c h ic " to spend so much money on spacious real estate,
o ste ntatio us je w e lry , o ve rp rice d m otor cars, lavish pa rties, and so fo rth . W ith the
economy in such bad shape, it is claim ed, even the rich are w ith d ra w in g th e ir
horns som ewhat

in order

to blend in b e tte r w ith the ge nera lly low er living

standards o f the m idd le class and the poor.
Perhaps.

B ut a m ore fo rc e fu l, d ire c t reason is sim ply th a t when the real

ra te o f in te re s t moves fro m -5% to +5%, the e x tra $100,000 spent per year on
durables no longer can be ju s tifie d even as a quasi-investm ent. D uring the 1970’s,
money spent on fixe d -su p p ly assets was an e xce lle nt hedge against in fla tio n ; even
Mercedes Benz and R o lls Royces cars generally appreciated in nom inal term s.
Today they are a te rrib le investm ent, and the best thing one can do w ith his
money is to put it in to liquid assets.

W hile the rich themselves may p re fe r a

sociological exp la natio n to an erudite discussion about a fte rta x real rates o f
re tu rn , the un derlyin g econom ic fa c to rs are, we believe, the p rim a ry ones.
Our forecasts show only a m oderate increase in the saving ra te , fro m 6.7%
in 1982 to 7.9% and 8.0% in 1983 and 1984, p a rtic u la rly in view o f the th ird stage
o f the tax c u t.
th e

H ow ever, th is is in line w ith the slow increase in our d e fin itio n o f

real ra te o f re tu rn .

In a d dition, it represents the fa c t th a t people are in

general g e ttin g po orer, so the y have less to save - - ju st as in the G re at Depression

the personal saving ra te was a c tu a lly negative even though the real ra te o f re tu rn
was high. In any case the p ic tu re is not very a llu rin g , w ith real consum ption rising
only 1.0% in 1983.




177
TA B LE I
PERSONAL SAVING RATE A N D R E A L R ATE OF R E TU R N

Y ear

Personal Saving
R ate, Annual

RR

Y ear

Personal Saving
R ate , Annual

RR

1955

5.9

0.1

1969

6.3

1956

7.3

0.4

1970

8.0

0.7
1.1

1957

7.3

0.3

1971

8.1

0.2

1958

7.4

-0.1

1972

6.5

0.1

1959

6.2

0.1

1973

8.6

-0.1
-0.8

I960

5.6

0.1

1974

8.5

1961

6.3

0.6

1975

8.6

-1.7

1962

6.0

0.8

1976

6.9

-2.2
-2.8

1963

5.4

0.9

1977

5.9

1964

6.7

1.2

1978

6.1

-1.7

1965

7.1

1.2

1979

5.9

-1.9

1966

6.9

1.3

1980

5.8

-2.1

1967

8.1

1.3

1981

6.4

-1.9

1968

7.1

0.9

I982P

6.9

-0.8

I983E

7.8

+0.3

We do expect some im provem ent in consum ption during the fo u rth q u a rte r,
the cause being the usual 4- to 5-m onth lag fo llo w in g the re duction in in te re s t
rates in July.

Y e t the odds are against a sustained im provem ent in consumer

spending, both fo r the reasons given ju s t above and because any s tre n g th in the
economy w ill result in higher in te re s t rates s h o rtly th e re a fte r.

Another Leg Down For Inventories
A nother clear m a nifesta tion o f this sw itch fro m op tim ism to pessimism can
be seen in the inventories and orders fig u re s.




The in ven tory/sales ra tio usually

178

peaks e a rly in the recession, then declines gradually but ste a d ily during th e la te r
stages o f recession and fir s t months o f recovery, and then stays a t the trough
level fo r a t least a year or tw o , som etimes rem aining there u n til the beginning o f
the n e xt c y c lic a l de clin e.
Y e t this p a tte rn has been badly disto rte d in the c u rre n t recession period.
The 1/S ra tio did de clin e fro m 1.54 in January to 1.46 in May, but then sta rte d
back up again, c lim b in g to 1.52 in August, as shown in Figure I; note in p a rtic u la r
th a t the wholesale and re ta il trade I/S ra tio are p a rtic u la rly high.

N or was this

rise due solely to the slump in sales. Inventory stocks, a fte r d e clin ing fro m $516
b illio n in January to $510 b illio n in May, turned around and increased to $515.6
b illio n in A ugust, although a d m itte d ly some o f th a t gain represents in fla tio n .

FIGURE I

INVENTORY TO SALES RATIOS, JANUARY 1977 TO JULY 1982
2 .0

111im m ri !i 11nrr n rnrriTTTTrnn nrrrrnu imi mrm finnnr
-

TOTAL ----MANUFACTURING - -

t.e

5.-6
T

I
0

1.4

1.2

1.0 In 1111111 m 111111111111111 n n 111MI m 11m i|Y1[iYn 11m 1111111

JAN JUL. JAN JUL JAN JUL JAN JUL JAN JUL JAN JUL




179

To a c e rta in e x te n t one can only s it and w onder a t anyone's decision process
w hich w ould p e rm it inven tory stocks to accu m ulate w ith real rates o f in te re s t
near 10% and any recovery a mere prom ise ra th e r than a fa c t.

B ut nonetheless

th a t is w hat did happen, and we can only a ttrib u te it to the widespread im pression
th a t the economy would indeed undergo robust g ro w th in th e second h a lf.
Now tha t it is clear th a t nothing o f the s o rt w ill happen, we m ust go through
alm o st another com plete inven tory decum ulation c y c le , as th e I/S ra tio must fa ll
fro m 1.52 to 1.40 before liquid ation is co m p le te — a process w hich w ill probably
take u n til February or March o f 1983. To tra n s la te th is in to d o lla r term s im plie s
some forecast about the underlying trends in sales. A reasonable e stim a te is th a t
nom inal sales w ill increase at a 6% annual ra te over the next tw o qu arte rs, w hich
is to say fro m $345 to $361 b illio n . Then in v e n to ry stocks would have to de clin e
to $505 b illio n fro m th e ir August level o f $515.6 b illio n , or m ore than a $10 b illio n
re d u ctio n .

IVA over the same period w ill probably be about $10 b illio n , w hich

means NIP A inventory disinvestm ent o f about $20 b illio n w ill have to take place
over the next several months.
Whether this takes tw o, three, or even fo u r qu arte rs, th is $20 b illio n
re duction in inventories w ill put a trem endous dam per on g row th and productio n
during the next several months.

It now seems ve ry u n lik e ly th a t inven tory

re duction w ill be over by the end o f th is year, and hence both o f the tw o essential
c r ite r ia fo r the ending o f any recession -- in v e n to ry liq u id a tio n and a s u ffic ie n t
decline in in te re s t rates - - s till rem ain unm et.

Fixed Investment To Weaken Further
The standard ru le o f thumb fo r recoveries states th a t once in te re s t rates
de clin e, housing turns up three months la te r, consum ption six m onths la te r, and
c a p ita l spending one year la te r. Thus even i f the o p tim is ts on consumer spending




180

tu rn out to be c o rre c t, we would see no upturn in ca p ita l spending u n til m id 1983.

As it is, we may see no upturn in this sector a t a ll next year.

The

investm ent a n tic ip a tio n s fo r 1982 have fin a lly declined to -4.4% and could w ell
continue low er, as shown by the disappointing drop in A ugust new orders for
nondefense c a p ita l spending.
The investm ent a n tic ip a tio n s have lagged fa r behind actu al developm ents
th is year, as shown in the fo llo w in g b rie f table.

The Decem ber figu res shown

there a c tu a lly are e xtra p o la te d fro m a n ticip ation s fo r the fir s t h a lf o f 1982, and
hence are not tru e survey results — although given th a t most expected a robust
1982 a t the tim e , they probably underestim ate what a fu ll-y e a r survey would have
shown.

By M arch, however, the BEA a n ticip ation s are usually an a ccu rate guide

to the a ctu al numbers; 1982 ap pare ntly represents the largest single e rro r ever in
th a t series (we w on't know fo r c e rta in u n til the year is over). By com parison, the
EEI

figures

fo r

M arch c o rre c tly

gauged the

m agnitude o f c a p ita l

spending

weakness, and in fa c t may have even overestim ated the actual decline th is year.
This substantial gap between what corporations said the y w ould do and w hat
a c tu a lly occurred is yet another piece o f evidence th a t the business com m unity
was unprepared fo r the second h a lf weakness.

Once burned, they are lik e ly to

become e x tre m e ly shy about increasing cap ital spending u n til conclusive evidence
is at hand th a t the re st o f the economy is im proving. That w ill not be fo r another
year at the e a rlie s t.

P R ED IC TED PER CENTAGE CHANGE IN INVESTMENT BY
D ate o f P re d ic tio n




D ecem ber 1981

EEI_________
Cur $
Const $
5.3
-1.2

BEA________
Cur~$
Const $
11.3
2.6

M arch 1982

I .6

-5.6

7.3

-1.0

June ! 982

0.7

-4.7

2.2

-2.4

Septem ber i 982

1.3

-4.1

0.7

-4.4

181

Turning to residential co n stru ctio n , i t is a l it t le too e a rly to te ll w hether the
de clin e in in te re s t rates w ill lead to any pickup in housing s ta rts . La st fa ll, rates
sta rte d down in September, but the bulk o f the decline occu rred in O ctober and
N ovem ber.
Febru ary.

P erm its rebounded in D ecem ber w h ile s ta rts did not p ick up u n til
Hence we would not expect any s ig n ific a n t p o sitive re a ctio n to low er

rates in the housing industry u n til the fo u rth q u a rte r.
H aving said th is, the plunge in both housing s ta rts and p e rm its in August
does not bode w ell fo r th a t sector, since i t indica tes to us th a t cost ra th e r than
fin a n c ia l considerations continue to dom inate the housing in d u stry.

The ra tio o f

the average m onthly paym ent to household disposable incom e now stands a t 32%
— 30% even w ith p rice discounting through c re a tiv e fin a n cin g — com pared to the
1947-1970 average o f 20%.

As a re s u lt, housing s ta rts are expected to average

only 1.1 m illio n next year. F u rthe rm o re, we w ould not exp ect much im provem ent
in th is fig u re even i f in te re s t rates were to stay a t c u rre n t levels throug hou t 1983,
since the imbalance in th a t industry is p rim a rily on the cost side.

A decline in

m ortgage rates w ill bring about a flu r ry o f re fin a n cin g a c tiv ity , as opposed to
lit t le

im provem ent in new con structio n a c tiv ity .

B uilders, like consumers and

businessmen generally, are now more w o rrie d than ever th a t any decline in
in te re s t rates is lik e ly to be tem porary, w hich means th a t the houses sta rte d now
at low er in te re st rates could not be sold because rates would have risen again by
the tim e they were finished.

More Trouble Ahead For Foreign Trade
F in a lly , we should not close out th is section w ith o u t a b rie f co m m entary on
th e August foreign trade figures, w hich soared to a record one-m onth $7.1 b illio n
d e fic it.

These figures do not get as much p u b lic ity as m ost o f the o th e r

go vernm ent




releases, p a rtly because they are v irtu a lly

un pred ictable , p a rtly

182

because they are v e ry e r ra tic and subject to much w ider m o n th ly swings and
revisions than most oth er m o nthly numbers, and p a rtly because o f a m isplaced
b e lie f th a t th e fo re ig n secto r is not q u ite as im p o rta n t as dom estic a c tiv ity .
H ow ever, a $1 b illio n swing in net exports has ju s t as much e ffe c t as a $1 b illio n in
dom estic consum ption or investm ent, and considering the o u tc ry being raised over
higher im po rts o f m a nufa cture d goods, this sector c e rta in ly deserves a t least a
b rie f m e ntion.
We w ill s ta rt by o ffe rin g the usual caveats.
usual, screwed up.

The seasonal fa c to rs are, as

Im ports re p o rte d ly declined $2.1 b illio n in Ju ly; hence about

h a lf o f the $3.3 b ilio n surge in August is misplaced.

Last year the ne t trade

balance declined fro m -$1.8 b illio n in July to -$5.4 b illio n in A ugust, and then rose
again to -$2.8 b illio n in Septem ber. The August d e fic it is s ig n ific a n tly ove rstate d.
Y e t to co n c e n tra te on these blips and ignore the underlying trends w ould in
our opinion be a serious m ista ke. The great stre ngth o f the d o lla r is beginning to
take its to ll, both in term s o f lessened exports and increased im p o rts, although o f
course the w o rld recession also con tributes to weak exports. Some A d m in is tra tio n
clow ns th in k the y have to pu t a good face on eve rything ; the sharp rise in im po rts,
they said, was evidence th a t the economy was turning around, presaging an
increase in dom estic demand.

In fa c t, alm ost h a lf o f th e August increase in

im po rts cam e in m a chinery, hardly the leading edge o f any re covery.

For those

in te n t on gleaning w hat useful in fo rm a tio n exists in these figu res, as opposed to
making up excuses why the y were not re a lly so bad a fte r a ll, the numbers are very
d isqu ieting .
The net tra d e d e fic it w ill probably re tu rn to the $3fc-$4 b illio n range in
Septem ber, and perhaps the August fig u re w ill be q u ie tly fo rg o tte n .

B ut the

spectacular change in purchasing power pa ritie s over the past tw o years w ith o u t
the accom panying s h ift in cost perform ance is not so easily ignored.




Since the

183

trough in 1980.3, the value o f the d o lla r has increased 26% re la tiv e to stro ng
fo re ig n currencies and 35% on a tra d e -w e ig h te d average basis. Thus net exp orts
w ill con tinue to weaken during 1983 as th e lagged e ffe c ts o f th e stronger d o lla r
become m ore s ig n ific a n t.

We look fo r a re d u c tio n in ne t exp orts o f m erchandise

fro m -$22 b illio n last qu a rte r to -$32 b illio n by th e end o f 1983.
The the ory o f in te rn a tio n a l trade suggests th a t these higher values o f the
d o lla r,

w h ile a d m itte d ly helping oth er nations e x p o rt m ore

in itia lly ,

should

e v e n tu a lly h u rt them because i t induces a higher ra te o f im p o rte d in fla tio n . A fte r
a ll, the U.S. experience during the

1977-1980 era serves as E x h ib it A , when

B lum enthal's infamous "a weak d o lla r is good fo r A m e ric a " was one o f the reasons
fo r d o u b le -d ig it in fla tio n by the end o f th e C a rte r presidency.
H ow ever, we see v irtu a lly no evidence o f th is p a tte rn w orkin g in reverse.
The in fla tio n ra te in the U.S. has fa lle n fro m 13.5% in 1980 to an estim a te d 6.3%
th is year; everyone agrees this is real progress although not a ll support the means
used to accom plish it . B ut oth er countries have had alm o st as much im provem ent
despite weakened currencies.

In the U .K ., fo r exam ple, the ra te o f in fla tio n has

fa lle n fro m 18.0% in 1980 to an estim ated 9.6% th is yea r. In Japan, w here the yen
has been devalued fro m 225 to ap p ro xim a te ly 270 per d o lla r, the in fla tio n ra te has
declined fro m 8.0% in 1980 to an estim ated 3.1% th is yea r. The in fla tio n ra te in
G erm any has not dim inished, but it has rem ained a t 5%.
It is tru e th a t perform ance has not been ou tstand ing in o th e r co u n trie s.

In

France, fo r example, in fla tio n rem ains above 12%, b u t th a t is because o f the
in itia lly in fla tio n a ry policies o f M itte ra n d — and even these have been reversed
a fte r only a few months o f tr ia l.
worsen.

The C anadian in fla tio n ra te also continues to

Y e t when fiscal and m onetary p o lic y have rem ained tig h t, in fla tio n has

declined as much in countries w ith d e p re c ia tin g cu rre n cie s as it has in the U.S.
w ith its ra p id ly ap precia ting currency.




184

This a ll harkens back to a point which I fir s t made in an in te rn a tio n a l
forecast in 1973, when L a ffe r and his bunch were try in g to peddle the th e o ry th a t
the weak d o lla r w ould lead to more in fla tio n in the U.S., w hich indeed happened to
occur.

Our po in t at th a t tim e , which is equally va lid today, is th a t the e la s tic itie s

o f im po rted in fla tio n vary g re a tly depending on the state of the dom estic economy
in general and fis c a l and m onetary p o licy in p a rtic u la r.

If the co u n try in question

tre a ts devaluation as an unpleasant m istake, as som ething which is "n o t th e ir
fa u lt" and trie s to o ffs e t it by re storing purchasing power to those harm ed by
devaluation through c o s t-o f-liv in g increases and other sim ila r mechanism s, then o f
course higher dom estic rates o f in fla tio n w ill re sult.

On the oth er hand, i f the

governm ent tre a ts devaluation as a sign th a t firm discipline is needed a t home to
c o n tro l in fla tio n a ry excesses -- or if it tre a ts it as a subtle but e ffe c tiv e to o l to
sw itch productio n fro m dom estic to export m arkets -- then very lit t le if any o f
the higher cost need be passed along in the form o f higher dom estic prices.
Hence the argum ent about devaluations is not necessarily s y m m e tric a l.
w eaker U.S. d o lla r
c o m p e titiv e

posture

A

led to higher in fla tio n and hence no im provem ent in our
during

the

1977-1980

period

because

of

the

inchoate

m o netary and fis c a l p o licie s o f the period. H owever, the stronger do lla r does not
necessarily mean higher in fla tio n or lack o f im provem ent in c o m p e titiv e posture
fo r Germany and Japan
balanced.

-

since th e ir m onetary and fiscal po licie s are b e tte r

Some co u n trie s , notably France and Canada, w ill not gain an exp ort

edge in spite o f w eaker currencies because inte rnal in fla tio n w ill a cce le ra te . B ut
th a t w ill not be the case fo r our m ajor trading partners, and hence the strong
do lla r w ill continue to put g re a te r pressure on our net trade po sitio n.




185

Optimal Fiscal Policies For The 1980*5
I have long been associated w ith the general th ru s t o f supply-side econom ics,
w hich is to say I favor reduction o f high m a rgina l ta x rates w hich impede saving
and investm ent, p ro d u c tiv ity , and w ork e ff o r t and individ ual in ce n tive .

I s till

believe th a t the economy suffers fro m c u rre n t high m arginal ta x rates.
It is equally cle a r, however, th a t the econom ic program s o f the Reagan
A d m in is tra tio n have been a dismal fa ilu re .

W hile the ra te o f in fla tio n is down, so

are real incomes. Most consumers are fa r worse o f f now than the y w ere tw o years
ago.

The m ounting budget d e fic its have led to a lack o f saving, higher in te re s t

ra tes, and the decim ation if not de structio n o f many o f our basic industries. In my
opinion, continuing present programs w ould prom ise m ore o f the sme fo r the
in d e fin ite fu tu re .
Y et

reversing

the Reagan programs e n tire ly

would, in my opinion, be

throw ing the baby out w ith the ba thw ate r. The problem is not in the re duction o f
high m arginal tax rates per se.
balanced by spending cuts.

The problem is th a t these ta x cuts w ere not

While tax re c e ip ts grew only 1.8% in F Y 1982, to ta l

Federal governm ent spending rose 10.7%.

The p rim a ry reason why the K ennedy-

Johnson ta x cuts worked so w ell was th a t governm ent spending rose only 1% in F Y
1965. I have no doubts th a t the Reagan program would have been q u ite successful
if governm ent spending had increased only 1% in the year ju s t ended, but th a t
turned ou t to be p o litic a lly impossible.
Indeed, fu rth e r cuts in governm ent spending over the next tw o years seem
ju s t as u n like ly as ever.

A gradual program o f raising the re tire m e n t age fo r

social s e c u rity benefits, ending the over inde xation o f e n title m e n ts , phasing in the
increase in defense spending more gradua lly, and providing some sort o f indexed
bonds makes a great deal o f sense to me but e v id e n tly not to any elected
representatives in the U.S. Congress. Hence we tu rn our a tte n tio n to the question




186

o f how

to raise taxes w ith o u t increasing the high m arginal ta x rates which

damaged g row th and p ro d u c tiv ity during the 1970's. The solution to this problem ,
I w ould su b m it, is a m o d ifie d fla t ra te income tax.
The a rith m e tic o f the fla t ra te tax is a c tu a lly qu ite s tra ig h tfo rw a rd and
consists o f tw o issues.

F ir s t, the ra te at which the fla t tax would have to be set

to generate an equal am ount o f revenue ex ante - - i.e., before takin g in to account
a ll the b e n e fic ia l aspects o f the fla t ta x .

Second, how the changing ta x burden

would fa ll on the incom e d is trib u tio n scale. For it is im m e d ia te ly obvious th a t if
the tax is to raise the same am ount o f revenue, and some people pay less ta x,
others w ill have to pay m ore.

A ta x increase which fa lls d isp ro p o rtio n a te ly on

those w ith less than m edian incom e w ill prove to be much less popular than one
w hich somehow avoids th is blem ish.
A ccord in g to J o in t Tax C o m m itte e calcula tions, the average tax ra te - c a lc u la te d as actual incom e ta x paid divided by taxable incom e -- was 24.6% in
1980, as shown in Table 2. By 1984 it w ill be reduced to 22.3% as a re sult o f the
25% across-the-board re d u ctio n in personal income tax rates. It is q u ite obviously
th a t a re duction fro m 24.6% to 22.3% is more like a 10% ra th e r than a 25% c u t,
but th a t is b ra c k e t creep in a c tio n . W ithout the tax ra te c u t, the average ta x ra te
w ould have risen to a p p ro x im a te ly 28.3% fo r the same tax ra te schedule.
A ccord in g to our fo re ca sts, personal income in 1984 w ill be $2976 b illio n and
Federal

personal

incom e

taxes w ill be $311

b illio n .

Our fo re ca st is more

p e ssim istic than m ost, but th a t re a lly doesn't a ffe c t the average ta x ra te ; under a
m ore

buoyant scenario, both

figures would be more or less p ro p o rtio n a te ly

higher. Thus under the very sim plest ca lcu la tio n o f a ll, the fla t ta x ra te w ould be
10.45%, w hich we could round down to 10% w ith o u t doing g re a t violence to e ith e r
the concept or the a r ith m e tic .




187
TABLE 2

Personal Income

1980

1981

1982

1983

1984

2160

2415

2578

2765

2976

F la t 19*
2976

Less:

T ransfe r payments, untaxed

276

312

345

370

390

Less:

F ringe b e nefits, untaxed

127

140

154

170

187

(187)

Less:

U nreported income

151

174

200

230

265

(265)

1606

1789

1879

1995

2134

2524

AGI on nontaxable returns

59

59

59

59

59

0

M edical deduction

12

13

14

14

14

0

Tax deduction

67

73

80

88

97

0

In te re s t deduction

85

106

121

133

141

0

C h a rita b le deduction

25

27

29

31

33

0

O th e r item ize d deductions

15

16

17

18

19

Personal exemptions

186

190

194

197

201

592

Zero bra c k e t, net

126

130

134

138

142

0

27

28

29

30

31

1004

1147

1202

1287

1397

Equals: A djusted Gross Income
Less:

0

Tax c re d its
Equals:: Taxable Income
Income ta x
Average ta x ra te

247

288

291

289

311

311

25.1

24.2

22.5

22.3

16.1

1980, J o in t Tax C o m m itte e ; 1981-1984, EEI estim ates

Even those who favor the fla t ra te ta x agree th a t the poorest should not
have to pay any income ta x ; the usual solutio n is to a llo w a personal exem ption,
w hich could be the $1,000 c u rre n tly allow ed, o r some larger am ount to o ffs e t the
fa c t th a t fe w if any deductions w ill rem ain.

Our ca lcu la tio n s assume a $2,500

personal exem ption.
A second issue is the ca lc u la tio n o f un repo rted incom e.

One could indeed

make a case th a t at very low m arginal ta x ra tes, less incom e w ould go unreported;
we c e rta in ly




0
1932

24.6

A ll figu res in b illions o f dollars
Source:

0

have no quarrel w ith th a t con cept.

H ow ever, fo r purposes o f

188

c a lc u la tin g the ex ante ra te needed to produce the same revenue, it seems m ore
con servative

to assume th a t unreported income remains the same, and then

c a lc u la te the be n e fits la te r.

In th a t case, we would su b tra ct the J o in t Tax

C o m m itte e e s tim a te o f un repo rted income fro m to ta l personal incom e.
T h ird , the question o f how to tre a t untaxed frin g e be n e fits -- m a in ly
em ployer c o n trib u tio n s fo r he alth and life insurance and pension plans ~ rem ains a
s tic k y one in the fla t tax ca lcu la tio n s. Some b ills have s p e c ific a lly assumed th a t
these be n e fits would be included in taxable income, and the Treasury calcula tions
have also assumed th is .

H ow ever, in our more conservative calcu la tio n s we have

also excluded them fro m the taxable income base.
W ith these three adjustm ents -- $2,500 personal exem ption, no re duction in
unreported incom e, and frin g e benefits rem aining untaxed -- we c a lcu la te th a t a
fla t ra te ta x o f only 16.1% w ould produce the same ex ante revenue in 1984.
If frin g e b e nefits are taxed, th a t would drop the fla t ta x ra te fro m 16.1% to
14.7%.

If we fu rth e rm o re assume th a t 2/3 o f unreported incom e would then be

reported, as discussed in the economics section, then the ra te would drop fu rth e r
to 13.5%.
One o f the biggest argum ents thus fa r has been w hether the deductions fo r
m edical care, fo r sta te and local taxes, fo r home m ortgage in te re s t, and fo r
c h a ritie s should rem ain in ta c t.

It turns ou t, a t least on an a rith m e tic basis, not to

make a ll th a t much d iffe re n c e .

C ontinuing a ll o f these deductions would reduce

the taxa ble base by some $238 b illio n in 1984 (home m ortgage in te re s t is about 2/3
o f to ta l in te re s t deductions).

This would raise the fla t ra te ta x fro m 16.1% to

18.4%, perhaps not an unduly high price to pay fo r ob taining the widespread
p o litic a l

support

necessary

fo r

the

oth er,

beneficial

aspects

of

the

b ill.

F u rth e rm o re , if one w anted to "tra d e " keeping these deductions fo r taxin g frin g e
be nefits, as indeed some have proposed, the fla t tax rate w ould then rise only to




189

16.5%.

It is clear th a t w hether one keeps c e rta in deductions or no t is a m a tte r o f

e q u ity , but not one o f a rith m e tic . E very $100 b ilio n change in the taxa ble incom e
base only changes the fla t ta x rate by about 1%.
We now turn to the e ffe c t o f the f la t ra te ta x on in divid ual taxpayers. R ig h t
at the outset we must sta te th a t no unequivocal answer is possible; it depends on
one's present deductions and e x a c tly w hat fo rm the fla t ra te ta x w ill take .

For

th is reason we have c alcula ted the tax due fo r fla t rates ranging fro m 17% down
to 14%. To keep the exposition manageable, however, we w ill co n ce n tra te on the
16% ra te .
W ith in this range, the basic p ro file shows th a t taxes are s lig h tly higher fo r
the m iddle class and much low er fo r the upper class. H ow ever, th is is som ewhat
o f a m irage in the sense th a t the upper-incom e taxes are ca lcu la te d using the
standard ru le o f deductible expenses equal to 23% o f gross incom e; th is assumes
no fu rth e r tax avoidance, which c le a rly is not the case.

Indeed, fra g m e n ta ry

estim ates suggest th a t many upper incom e people pay about 20% o f th e ir actu al
incom e in taxes, which is not fa r d iffe re n t fro m w hat would be the case under the
fla t ra te ta x .

The incen tive and tax avoidance results would be q u ite d iffe re n t,

but we leave that p a rt o f the discussion to the econom ics sectio n.
Under the 16% fla t rate tax, the average fa m ily o f fo u r w ith an incom e
under $18,000 would b e n e fit, providing th a t we exclude the e ffe c t o f the incom e
tax c re d it fo r very poor fa m ilie s . A t $10,000 per year, th is fa m ily w ould owe no
taxes at a ll, compared to $283 under present law.

A t $15,000, taxes would be

reduced by $136 per year.
As we move into the m iddle-incom e brackets, the 16% fla t ra te ta x would
s lig h tly increase the tax b ill fo r the average fa m ily .

A t $20,000, fo r exam ple,

taxes would be some $69 per year higher in 1984 than under c u rre n t law , although
th is is s till $413 less than would have been paid had the re been no ta x c u t a t a ll.

17-871

0




83

13

190

For the $25,000 fa m ily , taxes would be $173 higher; fo r the $30,000 fa m ily , $169
higher; and fo r the $40,000 fa m ily , $81 higher. Above th a t, taxes are low er w ith
the fla t ra te , providing th a t the fa m ily in question does not c u rre n tly sh e lte r very
much o f th e ir incom e. A ll these figures are given in Table 3.
A ta x increase fo r the $18,000 to $40,000 fa m ilie s, even i f slig h t, may not
prove to be very popular p o litic a lly . H ow ever, as a m a tte r o f sim ple a rith m e tic it
stands to reason th a t if taxes are going to be lower a t the upper end o f the scale,
then the y w ill be higher somewhere else. One way around th is dilem m a w ould be
to low er the fla t ra te to 14%, in which case taxes would be low er fo r v irtu a lly a ll
fa m ilie s (although not fo r single individuals), based on the argum ent th a t the
am ount o f unreported incom e a t a 14% ta x ra te is like ly to decline d ra m a tic a lly .
As we have already pointed o u t, taxing frin g e be nefits and assuming th a t 2/3 o f
unreported incom e would be reported would p e rm it dropping the fla t ta x ra te to
13.5%. In th a t case, how ever, the tax would not be much o f a revenue ra ise r.







T A B LE 3A
EFFECT OF A F L A T R A TE T A X
FO R
FO UR-PERSON F A M IL Y , VARIOUS INCOME LEVELS
(dollars)
Wage
Income

W ithou t The
Reaqan Tax C ut

W ith 25% Tgx
R ate C u t

F la t R ate Tax O f
16%
15%

17%

14%

5,000

-500

-500

0

0

0

0

10,000

374

283

0

0

0

0

15,000

1,233

936

850

800

750

700

20,000

2,013

1,531

1,700

1,600

1,500

1,400

25,000

2,901

2,227

2,550

2,400

2,250

2,100

30,000

3,917

3,031

3,400

3,200

3,000

2,800

40,000

6,312

4,881

5,100

4,800

4,500

4,200

50,000

9,323

7,228

6,800

6,400

6,000

5,600

100,000

27,878

22,154

15,300

14,400

13,500

12,600

200,000

66,378

57,399

32,300

30,400

28,500

26,600

Source: O ffic e o f the S ecre tary o f th e Treasury
O ffic e o f Tax Analysis

Assumes d e ductible expenses equal to 23% o f gross incom e.
— E xisting low




TA B LE 3B
A F L A T RATE T A X EFFECT
OF THE ADM IN ISTR ATIO N 'S PROPOSED FOR
SINGLE IN D IV ID U A L , VARIOUS INCOME LEVELS
(dollars)
Wage
Income

W ithout the
Reagan Tax C ut

W ith 25% Tax
C ut R ate

17%

F la t R ate Tax O f
16%

15%

14%

5,000

250

188

425

400

375

350

10,000

1,177

873

1,275

1,200

1,125

1,050

15,000

2,047

1,565

2,125

2,000

1,875

1,750

20,000

3,115

2,381

2,975

2,800

2,625

2,450

25,000

4,364

3,341

3,825

3,600

3,375

3,150

30,000

5,718

4,391

4,675

4,400

4,125

3,850

40,000

8,886

6,826

6,375

6,000

5,625

5,250

50,000

12,559

9,682

8,075

7,600

7,125

6,650

100,000

31,792

26,814

16,575

15,600

14,625

13,650

200,000

70,292

64,976

33,575

31,600

29,625

27,650

Source: O ffic e o f the S ecretary o f the Treasury
O ffic e o f Tax Analysis

X Assumes de ductible expenses equal to 23% o f gross incom e.
.2 E xisting low

193

The fla t ra te tax which I propose would have the fo llo w in g fe tu re s:
1.

The basic fla t ra te ta x should be set low enough so th a t, based on the

standard ta x tables, most taxpayers who did not previously have unusually high
deductions w ill pay less ta x .

That would mean th a t the basic fla t ra te would be

set at 15% or 16%.
2. The basic deductions - - home m ortgage in te re s t, c h a rita b le c o n trib u tio n s ,
c a ta s tro p h ic medical expenses, and state and local taxes — would be re ta in e d .
3. An end to the miscellaneous deductions, p a rtic u la rly those w hich lead to
so-called abusive tax shelters.

To a c e rta in e x te n t th is also involves acce le ra te d

d e p re c ia tio schedules and tax c re d its fo r c a p ita l expenditures, providing we also
have in te g ra tio n o f the personal and c orpora te ta x schedules.
4.

The increased revenues necessary should com e fro m e ith e r (a) taxin g

frin g e be nefits, (b) taxing social s e c u rity and oth er re tire m e n t b e n e fits, or (c)
keeping some graduated fea tu re o f the incom e ta x ra te schedule.

How The Flat Rate Tax Can Balance The Budget
Considering th a t we have chosen the ra te o f the fla t tax to equal the ex ante
revenues generated fro m c u rre n t tax laws, our headline c la im may seem not only
grandiose but akin to the alleged alchem y o f the L a ffe r curve. H ow ever, we have
calcula ted th a t a fla t rate tax o f 16% would bring in $150 b illio n m ore per year in
1984 than the cu rre n t tax s tru c tu re , w ith the gap w idening in each successive
year. The details are found in Table 4.
Some o f these calculations are q u ite s tra ig h tfo rw a rd .

For exam ple, taxin g

frin g e be nefits would bring an ad ditiona l $30 b illio n in to the Treasury c o ffe rs .
The oth er calculations, however, re quire some assumptions about the various
e la s tic itie s o f response to low er tax rates.




194

We have estim a te d th a t ap p ro xim a te ly 2/3 o f c u rre n tly unreported incom e
and ta x avoidance incom e w ould be reported a t a fla t ra te ta x o f 16%.

To a

c e rta in e x te n t th is sim ply represents s tra ig h t p ro p o rtio n a lity since top m arginal
ra tes are now at 50%; our figu res exclude any income generated fro m ille g a l
sources.
We do have some ad d itio n a l evidence, however, other than sim ple s tra ig h tline e x tra p o la tio n . A c c o rd in g to IRS testim ony last M arch, during the period fro m
1973 to 1981 the average m arginal tax ra te grew fro m 27.6% to 35.0%.

Over the

same period, according to IRS estim ates, unreported income grew about 5% per
year, or 40% fa s te r than re ported incom e.

Using the e la s tic ity im p lie d in those

numbers means th a t a re duction in the average marginal ra te fro m 35% to 16%
would re s u lt in only 27% o f c u rre n tly reported legal source incom e rem aining
unreported; th is also im plie s th a t a ll legal source income w ould be re ported a t a
10% m arginal ta x ra te . Hence our fig u re o f 1/3 is ra th e r conservative.

TA B LE 4
EFFEC T OF F L A T RATE T A X ON FE D ER AL T A X RECEIPTS
C u rre n t Law
Ex A n te Revenue

311

17%

16%

15%

14%

328

309

290

270
26

Taxing Fringe B e n e fits

32

30

28

2/3 U nre ported Income

45

42

40

37

2/3 Tax Avoidance

52

49

46

43

457

430

404

376

14

15

15

16

8

8

9

9

Total

311

Supply-Side E ffe c ts Increase
In G ro w th Due To
G re ater w ork e ff o r t
G re ater c a p ita l funds
H igher p ro d u c tiv ity
fro m o th e r sources

Total Supply-Side Effects
TOTAL PERSONAL INCOME TAXES




7

7

7

7

29

30

31

32

486

460

435

408

1 95

Table 4 also indicates the m agnitudes o f the increases w hich w ould occur
fro m supply-side e ffe c ts :

g re a te r w ork e ff o r t, g re a te r c a p ita l fo rm a tio n , and

o th e r im provem ents in p ro d u c tiv ity .

These are based on the e la s tic itie s in the

supply-side model. A reduction in the average m arginal ta x ra te on labor incom e
fro m 31% to 16% would raise w ork e ff o r t by 3%, w hich w ould increase GNP by
2%. Since tax re ceipts are ap p ro xim a te ly 20% o f to ta l GNP, th is w ould raise to ta l
ta x re ceipts by 0.4% o f GNP, or about $15 b illio n a t 1984 levels o f GNP.
The average m arginal ta x ra te fo r saving w ould decline fro m 43% to 17%,
w hich would increase the a fte rta x ra te o f re tu rn fro m 0.84% to 3.96% , assuming a
12% in te re s t ra te and 6% in fla tio n ra te . This w ould increase the personal saving
ra te by about 3%, w hich would eve n tu a lly raise c a p ita l stock by 3%. This in tu rn
w ould increase GNP by 1%, so th a t ta x re c e ip ts w ould rise by about $8 b illio n . We
also c a lc u la te th a t the reduction in ta x rates w ould raise p ro d u c tiv ity by an
ad ditio n a l 1% in ad dition to the gains associated w ith higher labor and c a p ita l
inputs.

Hence real GNP would be about 4% higher than would be the case in the

absence o f the fla t ra te ta x c u t. This process w ould probably happen over a three
to fiv e year period, representing an increase o f a p p ro xim a te ly 1% per year in the
o ve ra ll grow th ra te .
The net e ffe c t o f a ll these changes - - ta x in g frin g e b e n e fits, less unreported
incom e, less use o f tax shelters, and the supply-side e ffe c ts — w ould be to raise
ta x revenues by $150 b illio n

in

1984 and m ore in la te r years.

This would

e sse ntially lead to a balanced budget -- even i f the supply-side e ffe c ts are
m in im a l.

If they are re a lly much m ore substantial than we have e stim a te d , the

budget would a c tu a lly be in surplus, and the fla t ra te ta x could be c u t even
fu rth e r.

But we are try in g to keep the c la im s fo r the fla t ra te ta x w ith in the

bounds o f reasonableness.




196

The dem and-side e ffe c ts are somewhat mixed, a t least in itia lly .

We must

bear in mind th a t a $120 b illio n increase in taxes (excluding supply-side e ffe c ts )
means th a t someone w ill be paying $120 b illio n more in taxes, and the fa c t th a t
much o f this w ill com e fro m h e re to fo re unreported and ta x-shelte red incom e does
not dim in ish the fa c t th a t this w ill be qu ite a jo lt in reduced purchasing power. In
the absence o f any o ffs e ttin g fa c to rs , this would reduce consum ption by about $30
b illio n the firs t year and $60 b illio n per year a fte r three or fo u r years.
O f course the o ffs e ttin g fa c to rs w ill be enormous.

W ith the budget and

savings flow s once again esse ntially in balance, inte rest rates w ould re tu rn to
th e ir h is to ric a l p a rity w ith in fla tio n , w hich means s h o rt-te rm rates 0% to 1%
above the ra te o f in fla tio n , and long-term rates 2% to 3% above in fla tio n .

W ith

the c u rre n t am ount o f unused c a p a c ity and excess resources, we would expect no
in fla tio n a ry e ffe c t a t a ll; indeed, w ith lower tax rates, the net e ffe c t should be to
reduce in fla tio n even fu rth e r.

Thus long-term inte rest rates should fa ll about 6%

fro m c u rre n t levels, which w ould raise real GNP by about 2h% a fte r ta kin g in to
consideration the usual lag o f a year or tw o.

W ith GNP in 1984 expected to be

about $3600 b illio n in 1984, th a t would increase investm ent and in te re s t-s e n s itiv e
sectors o f consum ption by about $90 b illio n , easily o ffs e ttin g the $30 b illio n to $60
b illio n decline in consum ption which would have occurred in the absence o f low er
in te re s t rates.

Thus on balance the demand-side factors would raise real GNP

g row th rates by 1% to 2% per year, meshing nicely w ith the 1% annual increase in
aggregate supply w hich would be brought about through lower ta x rates.
This could be ju s t another pipe dream which would disappear much as did the
Reagan program prom ulgated w ith so much fa n fa re in early 1981 — but we don't
th in k so.

The f la t ra te ta x c u t is not by any stre tch of the im ag inatio n being

proposed as another ta x re d u ctio n -- indeed it is a revenue ra ise r.

H ow ever, it

reduces high m arginal ta x rates at the same tim e it raises the average ta x ra te .




197

Thus un like the Reagan three-year 25% across the board c u t in personal incom e
ta x ra tes, which turned out to be balanced only by th in a ir, the econom y w ill not
head fu rth e r into the depths o f trip le -d ig it d e fic its and d o u b le -d ig it real ra tes o f
in te re s t.

The m iddle class A m erican w ill no t re ceive a ta x c u t on an ex ante

basis, but his real income w ill rise and the de clin e in in te re s t rates fro m the
reduced budget d e fic its w ill be w o rth fa r more to him than was the Reagan ta x
c u t — according to our estim ates, about tw ic e as m uch.







EVANS
O C T O B E R 11 :
1982.2

VARIABLE NAHE

GROSS NATIONAL
GROSS NATIONAL
H D E X OF INCUS

PPODUCT
PPODUCT, 1 9 7 2 i
PROOUCT I ON» TOT AL

CONSUMPTION EXPENDITURES
DURABLE GOODS
AUTOMOBILES AND PARTS
OTHER DURABLE GOODS
NONDURABLE GOODS
SERVICES
NEW CAR SALES, SAAR
RETAIL SALES

E C ON OM IC S F O R E C AS TI NG SERVICE
THE F ED L O W E R S THE D I S C O U N T RATE

198?.3

1982.4

1984.1

1984.?

1984.3

1984.4

3045.2

3092.7
1475.1
137.9

MAJOR ECONOMIC INDICATORS
TABLE 1 . 1
3 1 3 4 . 7 31 99 . 9 3 2 5 8 .4 3 3 0 5 . C 3 3 6 7 . 5 3 4 3 4 . 9
1474 .4 1482.0 1487.2 14 87 .6 1493 .8 1505.2
1 3 7 . ft
139.7
140.8
140.7
14?.1
144.3

1983.1

19 83.?

¿524.9
1525 .2
147.1

3610.9

¿7 0 3 .f

1947.8
240.7
103.3
137.4
755.0
952.1
7.4
267.0

1989.9 20 34.0
247.2
239.1
102.9
107.2
136.2
140.0
784.9
771.4
979.3 1001.9
7.8
8.3
266.9
273.3

2057.4 20 87.5
241.1
245.5
105.4
107.9
135.7
137.5
790.9
803.3
1021.0 1043.1
8.5
8.7
273.2
272.8

1983.3

1983.«

2122.4 2164.9
237.1
237.2
103.5
102.3
133.6
134.9
822.2
840.5
1063.1 1 0 87 .2
8.3
8.2
274.9
279.0

2202.7 2 2 49 .2
253.9
243.8
107.8
115.2
136.0
138.7
863.1
850.4
1108.6 1 132.2
8.9
8.5
283.0
289.3

GROSS PRIVATE INVESTMENT
FIXED INVESTMENT
NONRESIDENTIAL
STRUCTURES
EQUIPMENT
RESIDENTIAL STRUCTURES
CHANGE IN INVENTORIES
TCTAL PRIVATE HOUSING STARTS

431.5
447.7
352.2
143.6
208.6
Q5 . 5
-16 .2
0.05

423.6
443.8
347.9
141.3
206.6
95.9
-2 0 .2
1. C5

406.9
443.6
345.4
139.8
205.6
98.2
-36 .7
1.08

438.8
449.4
344.0
137.9
206.2
105.4
-10 .6
1.25

454.5
451.5
344.4
136.7
2 T7 , 7
107.1
3.0
1.07

452.6
452.0
342.5
133.9
208.6
10 9 . 5
0.6
1.09

451.1
453.7
345.0
134.0
211.?
108.7
-2 .6
1.05

465.6
468.0
349.6
136.1
213.5
118.4
-2.3
1.^7

494.1
489.4
360.6
140.5
220.1
128.8
4.7
1.48

NET EXPORTS,
EXPORTS
IMPORTS

34.9
365.6
330.9

34.3
368.4
334.1

31.6
370.6
338.9

?8. 4
374.4
345.9

27.8
362.8
355.0

392.2
364.2

30.8
402.9
372. 1

32.6
413.9
381.3

33.1
424.6
391.5

630.9
244.3
176.2
68.2
386.6

644.9
251.7
181.5
70.2
393.2

662.1
263.8
191.3
72.5
398.3

675.3
270.7
197.3

688.6
277.6
203.3
74 .3
411.0

702.0
284.5
209.3

720.6
296.7
219.1

734.0
303.5
225.1

748.5
311.5
232.1

417.5

GOODS

AND SERVICES

GOVERNMENT PURCHASES
FEDERAL
NATIONAL DEFENSE
OTHER
STATE AND LOCAL
FEDERAL GOVT SURPLUS OR DEFI CIT
PERSONAL INCOME
DISPOSABLE PERSONAL INCOME
CCRP PROFITS BEFORE TAXES
CCRF PROFITS AFTER TAXES
CAPACITY U T IL I Z A T I O N , PCT
UNEMPLOYMENT RATE
SAVING RATE
IMPLICI T
CONSUMER
PRODUCER
PRODUCER
PRODUCER

GNP DEFLATOR
PRICE INDEX
PRICE INDEX, TOTAL
PRICE I NOE X, FI NI SH GCS
PRICE INDEX, IND COMM

MCNEY SUPPLY. Ml
MCNEY SUPPLY, M2
FEDERAL FUND RATE
TREASURY BILL RATE, 91- DAY
CCMM PAPER RATE, 4 - 6 MONTH
PRIME COMMERCIAL BANK RATE
AAA CORF RATE

-11 9.6
2552.7
2151.5
171.7
116.3
72.6
9.5
6.7

-14 5.0
2603.5
2206.7
173.4
115.0
71.5
9.9
7.1

-15 5.6
26 42 .9
2239.0
168.2
111.6
71 .1
10.1
6.5

-14 4.9
2685.1
2278.0
173.8
106.5
72 .0
10.2
7.0

-15 5.5
2733.8
2326.4
1P3.3
112.5
72.3
10.3
7.6

206.0
286.8
298.7
278.3
310.0

209.7
292.3
298.9
281.8
311.6

212.6
295.2
300.7
285.6
313.8

215.9
299.6
303.4
288.2
316.7

219.1
305.0
306.6
291.6
320.8

451.8
1895.7
14 .5 1
1?.42
13.48
1É.5C
1 4 . 5C

466.0
456.1
1944.0 1 9 7 7 .8
11 .0 4
10 .4 8
7.35
9.57
11.53
10.72
12.91
14.81
1 3 .c 4 12.47

474.2
470.4
2011.1 2058.1
13.03
12.00
9.33
10 . 3 9
1 2 .3 6
13.58
15.45
14.07
13.84
14.37

424.0

430.5

436.9

-190.5 -1 9 9.0
2 7 82 .9 2833 .1
2391.3 2432.4
178.9
173.6
108.0
102.6
71.8
72.1
10.4
10.6
8.6
8.4

-18 7.4
2880.3
2466.1
187.2
110.8
72 .6
10.6
8.1

-18 5.2
29 35 .4
2511.1
209.6
127.0
74.0
10.4
7.9

225.4
312.9
313.0
299.1
327.8

228.2
315.7
317.1
303.4
332.0

231.1
319.4
321.7
307.4
337.1

222.2
309.1
309.9
2 9 5 .c
324.4

478.4
484.5
2091 .5 21 2 0 .9
11.58
9.73
8.90
9 . 6 fc
10.07
11 .8 °
14 .3 1
12.72

13.54

1?.9*

490.1
496.5
2157.7 2199.1
8.81
8.81
8 . T4
8.10
9.36
9.42
11.85
11.74
12.68 1 2 . 5 5

22°4.5 23 42 .f
261.2
266.3
120.5
12 2 . 6
140.7
14 3 . 8
877.8
894.2
1155.5 1182.1
9.3
9.1
300.7
2 Q4 •8
524.5
511.2
372.9
144.7
228.2
138.2
13 .4
1.50

761.0
317.6
237.1
443.4

552.4
532.3
388.5
149.9
238.7
143.8
20.1
1.51

778.6
328.7
247.2
81 . 5
449.9

-18 7.5 -18 7.9
30 01.0 3365 .1
2 5 6 5 . 2617.6
226.4
234.8
143.2
138.3
75.8
75.1
10.3
10.1
8.1
8.0

ft

234.0
323.3
326.6
311.9
342.3

237.5
327.7
330.7
315.7
746.9

510.0
503.2
2240.8 2 2 86 .3
9.31
8.92
8.73
8.28
9.55
9.88
11 .8 6
12.16
12 .5 4
12.56

3? 82. 7 3568.4
3067.
14 74 . ■ 1 4 8 7 . 6 1 5 3 3 . 2
139.:
140.8
148.9
1972. 2108.0
240.2
241.:
10 4 . 8
104.2
135.4
137.1
814.2
765.1
Q66 . 4 1 C 5 3 . 6
8.T
P .4
266. P 275.0
419.1
446.4
350.6
141.5
209.1
95.8
-27 .2
1.00

642.0
252.4
178.»
73.6
389.6

2272.3
256.3
116.5
139.8
871.4
1144.6
9.0
292.0

449.2
451.7
344.0
135.6
208.4
107.7
-2 .4
1.12

5 "9.2
500.2
367.9
142.8
225.1
132.3
9.0
1.47

28.8
388.1
359.3

31.5
429. 7
396.2

696.6
282.3
207.2
75 .1
414.3

755.5
315.3
235.4
79.9
440.2

-13 4.7 -1 7 2 .5 -18 7.0
2 5 77 .4 275 8 .7 2970.4
2 1 7 8 .6 2 3 5 7 .G 2540.1
171.2
177.4
214.5
107.4
129.8
114.7
7 2.0
74.4
72.4
10.4
10.3
9.6
7.9
8.0
6.7
208.0
289.5
299.1
280.8
311.7

220.7
306.7
308.2
? 9 3 •6
322.4

232.7
321.5
324.0
3 r 9• 6
339.6

476.9
455.5
19 1 7 ." 2070.4
12.56 1 1 . 5 9
10.5*
9.58
12.36
11.97
15.12
14.13
13 .6 7
13 .97

500.0
2221.0
8.96
8.36
9.55
11 .9 0
12 .5 8

ID
00




EVANS
O C T O B E R l i:

ECONOMICS F C RECASTING SERVICE
T H E F E D L O W E R S T HE D I S C O U N T R A T E

1982.2 1982.3 1982.4 1983.1 19P3.2 1983.3 1983.4 1984.1 1984.2 1984.3 1984.4

VARIABLE NAME
ta bl e 2.1

10.1
4.8
9.5
10.1

10.6
4.3
8.5
R.e

4.4
-1
-7. T
-ft. ?

7.0
0.9
1.2
1.5

8.7
3.1
5.7
6.4

8.3
0.2
-4 .4
3.9
9.2
9.4
- 4 .9

7.2
11.5
23.2
3.3
4.8
8.1
16.1

8.7
17.6
30.1
8.4
6.1
8.8
19.2

8.3
12.1
20.0
5.8
7.0
8.5
10.7

8.7
8.1
7.0
8.9
7.7
9.5
5.3

7. f
2. ^
5.7
o. <■
4. ;
10.f
-7 . £

6.9
-0.4
0.6
- 1. 2
6.4
9.0
5.8

7.8
6.7
11.2
3.2
7.0
8.6
6.6

- 1 .7
0.4
- 2. 2
-7 .9
1.7
9.2

- 1.3
1.5
3.0
0.2
4.8
- 2 .9

13.5
13.2
5.4
6.4
4.8
40.6

26.8
19.6
13.2
13.6
12.9
40.2

27.0
19.0
14 .4
12.7
15.5
32.6

23.0
17.6
17.8
14.9
19.7
17.1

-11.1
-1. '
1. 3
9. 1
-3.4
-P. 8

7.2
1.2
-1 .9
-4 .2
- 0. 3
12.5

13.3
10.8
7. 0
5.3
8.0
22.9

9.2
10.8

10.2
10.8

11.4
8.9

11.3
10.3

10.8
11.1

10.2
13.5

9.8
12.2

- 0. 3
- 2 .4

6.0
7.R

10.7
10.8

8.2
10.9
13.2
5.0
6.4

8.1
10.6
12.7
4.9
6.5

8.0
10.3
12.3
4.9
6.4

11.1
18.3
20.2
13.0
6.3

7.6
9.6
11.4
4.7
6.3

8.1
10.9
13.0
5.1
6.2

6.9
8.0
8.9
5.3
6.1

9.6
14.7
18.1
5.2
6.0

7.5
10.?
16.3
-2.2
5.9

8.5
11.9
15.9
2.1
6.3

8.5
11.7
13.6
6.4
6.3

6.2
6.0
0.7

6.5
7.1
1.5

7.5
8.8
2.7

7.4
11.6
5.5

7.4
7.1
1.5

6.8
5.7
0.9

7.9
7.5
2.6

9.2
9.0
4.3

8.8
8.3
3.0

6.7
7. 4
1.3

7.0
8.2
2.3

7.7
7.8
2.6

-11.5
-11.3

13.9
-16 .9

23.7
24.6

- 9 .2
-15.0

-11.3
-18.8

35.1
36.3

57.4
72.4

36.1
40.6

15.7
15.0

-2 6. L
-24 . C

3.6
- 6 .3

20.9
2C.8

5.5
-0.2
-0 .4
-1 .4

R.6
2.1
5.5
6.6

7.5
1.4
3.4
3.8

5.8
0.1
-0 .3
-1 .0

CONSUMPTION EXPENDITURES
DURABLE GCCCS
AUTOMOBILES AND PARTS
OTHER DURABLE GOODS
NONDURABLE GOODS
SERVICES
NEW CAR SALES» SAAR

6.1
4.8
0.4
8.3
3.2
8.7
-35.1

8.9
- 2. 6
- 1. 4
- 3.4
9.0
11.9
25.2

9.2
14.1
17.6
11.5
7.2
9.6
23.9

4.7
- 2. 7
2.8
- 6 .8
3.1
7 . ft
19.3

6.0
-7.0
- 9. 2
-5 .3
6.4
9.0
- 8 .7

6.9
- 6 .4
-6.9
-6. 0
9.7
7.9
-6 .1

GROSS PRIVATE INVESTMENT
FIXED INVESTMENT
NONRESIDENTIAL
STRUCTURES
EQUIPMENT
RESIDENTIAL STRUCTURES

17.1
- 2 .4
- 5 .3
6.4
-12.4
9.3

-7.1
-3.4
- 4 .8
- 6 .2
- 3 .e
1.8

-14.9
- 0. 2
- 2 .8
-4 .1
-1.9
9.7

35.2
5.3
- 1. 6
-5 .6
1.2
32.6

15.1
1.9
0.4
-3 .3
2.9
6.9

6.7
2.8

2.9
4.0

2.3
5.9

4.2
8.5

0.5
- 8. 4
26.3
-55.5
6.7

9.2
12.7
12.7
12.0
7.0

11.1
20.7
23.2
14.3
5.3

PERSONAL INCOME
DISPOSABLE PERSONAL INCOME
DISPOSABLE PERS INCOME ♦ 1972*

6.9
6.7
3.1

8.2
10.7
2.6

CCRP PROFITS EEFORE TAXES
CCRP PROFITS />FTER TAXES

0.2
1.4

4.0
- 4 .5

PRODUCT
PRODUCT, 1972 $
PRODUCTION,TOTAL
PRODUCTION, MFG

EXPORTS
IMPORTS
GOVERNMENT PURCHASES
FEDERAL
NATIONAL DEFENSE
OTHER
STATE AND LOCAL

TABLE 2.2
IMPLICIT
IMPLICIT
CONSUMER
PRODUCER
PRODUCER
PRODUCER

GNP DEFLATOR
CONSUMPTION DEFLATOR
PRICE INDEX
PRICE INDEX♦ TOTAL
PRICE INDEX.FINISH GDS
PRICE INDEX. IND CCMM

MCNEY SUPPLY, Ml
MONEY SUPPLY, M2

1984

10.9
5.4
7.9
11.4

6.4
- 0. 9
- 3. 8
-2 .5

NATIONAL
NATIONAL
OF INDUS
OF INDUS

1983

8.3
3.1
6.6
6.5

6.8
2.1
-6.e
- 4 .9

GROSS
GROSS
INUEX
INDEX

19P2

MAJOR ECONOMIC INDICATORS, PRODUCT AND INCOME (PERCFNT CHANGE, ANNUAL PATE5)
7 •R
1.7
3.9
3.9

MAJOR ECONOMIC INDICATORS, PRICE AND MONETARY (PERCENT CHANGE♦ ANNUAL RATES)
4.6
3.6
4.7
0.5
0.9
- 1. 8

7.4
7.8
8.0
0.3
5.1
2.0

5.7
5.3
4.0
2.5
5.6
2.9

6.4
5.6
6.0
3.6
3.6
3.8

6.0
5.9
7.5
4.3
4.9
5.3

5.7
5.8
5.5
4.3
5.4
4.6

6.0
5.4
5.0
4.0
4.9
4.2

5.0
4.7
3.6
5.4
5.9
5. ?

5.2
4.8
4.8
5.9
5.4
6.3

5.1
4.5
5.0
6.3
5.9
6.3

6.1
5.2
5.6
5.1
5.0
5.4

6.4
6. r
6.3
1. ?
4.1
2.6

6.1
5.8
5 . 'i
3.0
4.5
3.4

5.5
5.1
4.8
5.1
5.5
5.3

3.3
9.9

3.9
10.6

9.0
7.1

3.9
6.9

3.2
9.7

3.6
6.6

5.2
5.8

4.7
7.1

5.4
7.9

5.5
7.8

5.5
8.4

É. C
9. 7

4.7
8.0

4.8
7.3

I




I

.3

VARIABLE NAMF

19 82 .4

3. 1
1478 .4

14 75 .1

CCNSUMPTION EXPENDITURFS
DURABLE GOODS
AUTOMOBILES AND PARTS
OTHER
H O N O U R ABLE GOODS
SERVICES

955.0
17P.3
54.4
83.9
36 4.5
452.2

95 7. 2
13 5.9
5 3 .4
8 2 .5
36 5.9
45 5. 4

GROSS PRIVATE INVESTMENT
FIXED INVESTMENT
NONf-ESIOENTIAL
STRUCTURES
EQUIPMENT
RESIDENTIAL STRUCTURES
NONF ARM
FARM
PROD DURABLE EQUIP
CHANGE IN INVENTORIES
NONFARN
FARM

202.3
206.7
16 6 . 7
5 3 .7
11 3.0
4 0 .1
3 7 .0

196. 1

NET EXFORTS* GOODS & SERVICES
EXPORTS
IMPORTS

GROSS NAT I UNAL PRODUCT

.

202 0
16 2. 3
52 .4
109.9
3 9 .8
3 6 .8

1.1

19 83 .1

19F3 .2

1 9 83 .?

GROSS NATIONAL PRODUCT

1^ 74 .4

1482 .0
963.8
1 3 6. 9
5 5 .5
79.5
36 7. 2
463.8

83 .8
368.3
458.0
186.;
199.
158.

195.1
19 9. 5
156.9

19 9. 0
19 7.8
155. 1
48 .8
106. 3
42 .7
3 9 . <t

1.1

96 6 . 2
129. 0
5 1 .6
7 7 .3
370. 1

467.;
195.5
195.2
152.3
47 .1
105.2
43.0
3 9 .7
1. 2
2.1
0.2

19 83 .4

19 84 .1

IN CONSTANT DOt
14 9 3 .8

15 05.2

972.6
12 8. 3
5 1 .0
7 7 .4
37 3. 1
471.1

978. 3
130. 3
5? . 8
7 7 .5
37 3. 2
474 . 8

19 2.9
19 4.P
15 1.4
46.6
10 4. 8
42.6
39.2
1.2
2.1
-1.0
-1.0
0.0

19 6.3
19 7. 2
15 1.3
46 .7
10 4. 6
46 .0
4 2 .5
1.3
2.2
-0.9
-0.9
0.0

32 . 2
15 8. 2
126. 0

3 2 .6
16 0. 4
12 7.8

1.9
-6 . 0
- 6.0

1.9
- 12 .8
- 12 .8

3 5 .7
15 4. 4
118.7

34 .7
15 3. 9
11°.2

33 .6
15 3.2
11 9.7

GOVERNMENT PURCHASES
FEDERAL
STATE AND LOCAL

285.3
110.3
175. 0

28 7.1
288.7
11 1.8
11 3. 4
17 5. 3
17 5. 3
TABLE 3 . 2

GROSS NATIONAL PRODUCT

206.0

209.7

212.6

215.9

21 9. 1

222.2

225.4

228.2

CONSUMPTION EXPENDITURES
DURABLE GCCDS
NONDURABLE GOODS
SERVICES

204.0
174. 0
20 7.1
210.6

20 7.9
176.0
21 0.8
215.0

210.6
177.1
21 3.1
218.7

213.5
179. 4
215.6
221.9

216.6
18 1. 4
21 8.8
224.9

219.7
183.9
222.2
227.5

222.6
184.9
225.2
230.8

225.2
187. 1
22 7. 8
233.5

FIXED INVESTMENT
NONR ES IDE NT IA L
STRUCTURES
EQUIPMENT
RESIDENTIAL
NONFARM
FARM
PROD DURABLE EQUIP

216.6
21 1.3
267.6
184.6
238.6
24 2. 1
242.0
168. 1

219.7
214. 4
26 9. 5
18P.0
24 1.3
244.9
24 4.7
17 0.0

222.9
217.4
272.8

225.2
219.3
275.6
19 2.9
247.0
250.6
250.5
174.0

228.3
222.0
28 0.1
19 5.4
251.0
25 4.7
254.5
17 6. 8

284.4
198.3
255.0
258.9
258.6
179.6

233.9
237.3
227.9
23 1.1
2 8 7 . fa 2 9 1 . 5
201.3
204. 1
255.3
257.7
259.3
261.5
258.9
261.3
17 9. 9
18 1.5

0.2
0.0
31 .9
154. 4
12 2. 4

31.6
15 6. 1
124.5

296. 0
292.3
11 6. 7
1 2 C. 1
17 6. 0
175.7
IMPLICIT PRICE DEFLATORS FOR GNP

23 9. 5

GOVERNMENT PURCHASES
FEDERAL
STATE AND LOCAL

229.4
232.7
227.2

232.3
235.1
23 0. 4

23 5.5
23 7.9
234. 0

238.5
24 0 . r
237.5

24 3. 5
24 7 . 1
24 0. 9

GOVT OUTPUT CR I G

213.9

216.0

21 8. 4

220.6

22 6. 4

246.3
249.3
244.2

19 8 4 .2

19 84 . :

1984 . 4

1 962

1474.

lgs7

1984

.LARS
14 87 .6 1533.2

15 25 .2

1 5 43 .0

15 59.3

987.4
13 3 .9
55.3
78 .7
374.2
47 9.2

996.1
136.4
56.9
79.5
375.7
484.0

10 04 .2
138.?
57 .6
8C.7
37 7.4
48 8. 5

9?6..
137.t
ü-4.f
83 .2
365.2
453.8

q 66 « 6
131.8
52.9
78 .9
369.3
465.6

991.5
13 4. 7
**.(.
7^ . 1
375. 1
481.6

205.0
20 3 .2
15 3.7
47.4
10 6. 3
49 .5
45 .9
1.3
2.3
1.8
1.8

213.7
208.5
156.7
47.9
108.8
5 1 .8
48.2
1.3
2.3
5.2
5.2

221. 8
214. 1
16 1. 0
4 8 .S
11 2.2
53 .1
49 .4
1.3
2. 3
7.7
7.7

195«.
2 0 4.c
16 5.
52 .7
112.3
39 .7
36.7
1. 1
1.9
-9.7
-9.6
- 0. 1

195.6
196.6
153.9
48.1
105.8
42 .7
3 9 .4
1.2
2.1
-1.0
-1.0
0.0

2 0 9.j
205.7
155. 7
47 .7
10 8. 0
50 .1
46 .5
1. 3
2.3
3. 4
3.4
0.0

15 3. 3
118.3

3 2 .0
155.4
123. 4

32 .1
16 3. 3
13 1.2

29 3. 3
117. 6
17 5. 8

124. 1
17 6. 3

3 2 .7
16 2. 4
1 2 9. 7

31 . 1
166. 0
13 4. 9
301.4
12 5.0
176.4

30 2. 2
126. 0
1 7 6. 3

231.1

234.0

237.5

20 8.

220.7

23 2. 7

227.8
189.6
230.6
236.3

230.3
191.5
233.7
23 8 .7

23 3.3
19 2.5
237.0
24 2. 0

2 06 .2
17 5. 0
209.5
212 9

21 8.1
18 2.4
220.5
226.3

229.1
19 0.2
23 2. 3
23 7. 6

240.9
234.6
296.4
207.0
260.5
2 6 4. 1
264.2
18 3. 5

245.2
238.0
302.0
209.8
266.9
270.5
270.7
188.0

248.6
241.3
30 7 .2
212.6
271.0
274.7
274.8
190.9

218.2
212.7
2b8. 6
18 6. 4
241.3
244.9
244. 7
16 9. P

229.7
223.5
281.9
197. 0
25 2.1
255.9
255.7
177.6

24 3.0
236.2
299.3
20 8.4
264.0
267.7
267.8
186.0

261.4
301.8

26 4.8
305.2

268.2
308.4

238. 8

249.4
251.7
24 7. 8

252.5
254.0
25 1 .4

257.6
260.9
255.2

230.8

232.9

23 8.4

300.1
123.8
176.3

.

249.6

2 82 .2

291.1

263. 1
30 3.4

22 3. 2
224.4

222 1

237.5
240.0
235.7

25 1.5
25 4.0
249.7

20 7.

220.4

23 2. 1

.




t\3
oO




EVANS
O C T O B E R 11:

VARIABLE NAME

ECONOMICS FORECASTING SERVICE
T H E F E D L O W E R S THF D I S C O U N T R A T E

1982.2 1982.3 1982.4 1983.1 19P3.2 1983.3 1^83.4 1984.1 19P4.2 1984.3 1984.4
TABLE 4.1

1°82

1983

1984

GROSS NATIONAL PRODUCT IN CONSTANT DOLLARS (PERCENT CHANGE» ANNUAL RATES)
2.1

-0.9

- 0. 2

2. 1

1.. 4

1.7

3.1

5.4

4.8

4.3

-1.

0.9

3.1

CONSUMPTION EXPENDITURES
DURABLE GCCDS
AUTOMOBILES AND PARTS
OTHER
NONDURABLE C-OODS
SERVICES

2.5
2.3
-3 .6
6.4
2.6
2.4

0.9
- 6 .8
-7.0
- 6 .7
1.5
2.9

3.7
11.2
18.5
6.7
2.7
2.3

- 0 .9
-7 .5
-1.4
-11.4
-1 .7
1.9

0.>0
-11.. 0
-14,.7
-8..5
0 ..5
3..2

1.0
-11.4
-12.F
-10.6
3.2
3.0

2.7
- 1. 9
-5.U
0.2
3.4
3.4

2.4
6.2
15.0
0.8
0.1
3.2

3.7
11.7
20.0
6.2
1.1
3.8

3.6
7.6
12.3
4.4
1.6
4.1

3.3
5.8
5.4
6.C
1.8
3.7

1 .. 0
-1.. 6
C,, 7
-3.
0., 8
1.■c

1.0
-4 .4
- 3. 2
-5.2
1.1
2.6

2.6
2. 3
5.2
0.3
1.6
3.5

GROSS PRIVATE INVESTMENT
FIXED INVESTMENT
NONRFSIDENTIAL
STRUCTURES
EQUIPMENT
RESIDENTIAL STRUCTURES
NONFARM

14. c
-7.6
-11.8
1.5
-17.3
12.9
11.6

-11.R
- 8 .7
-10.2
-9.1
-IP .7
- 3. 4
-2 .6

- 18.7
- 5. 8
-8 .1
-8 .6
-7.8
3.7
3.5

20.6
1.0
-5 .0
-9 .5
- 2 .8
27.7
28. 2

8 ,.2
-3..4
-4«.5
-9..3
-2..1
0..4
-0..1

- 6 .9
-5 .1
-7.1
-13.4
-4.1
2.<*
2.1

-5 .1
- 2 .5
-2.3
- 4. 1
-1 .5
-3.4
-4.1

7.2
6.9
- 0 .3
0.8
- 0. 8
35.6
37.0

19.0
12.6
6.6
6.2
6.7
34.3
36.8

17.9
10.9
8.0
4.5
9.5
20.3
21.5

16. 1
11.2
11.6
7.5
13.4
10.2
1C.5

-13.
-5. , (
-4. , 1
2.,2
-6., 7
-11. , f
-12.

0.3
-3 . °
-6 . 7
- 8 .7
-5 .7
7.6
7.5

6.9
4.6
1.1
- 0 .9
2.1
17.2
17.9

7.3
14.7

-1.4
1.6

-1 .6
1.6

- 0 .4
3.6

T,. 4
5.. 8

4.4
6.8

5.6
5.0

5.7
5.9

5.2
6.1

4.6
8.6

4.2
7.7

-3.
1.

1.4
4.5

5.0
6.3

-5 .3
-13.6
0.2

2.5
5.6
0.6

2.2
5.7
0.1

2. 9
6.4
0.7

2..2
5.,5
0..1

2.7
6.4
0.2

2.4
5.3
0.5

2.7
5.8
0.6

2.9
6.8
0.2

1.8
4.1
0.1

1.1
3.0
- 0 .2

0.(2
1 ., ?
-0.. c-

2.0
4.6
0.4

2.4
5.6
0.3

GROSS NATIONAL PRODUCT

EXPORTS
IMPORTS
GOVERNMENT PURCHASES
FEDERAL
STATE AND LOCAL

TABLE 4.2

0.1

IMPLICIT PRICE DEFLATORS FOR GNP i[PERCENT CHANGE» ANNUAL RATES)

GROSS NATIONAL PRODUCT

4.6

7.4

5/7

6.4

6..0

5.7

6.0

5. 0

5.2

5.1

6.1

6. , 4

6.1

5.5

CONSUMPTION EXPENDITURES
DURABLE GCODS
NONDURABLE GOODS
SFRVICES

3.6
2.3
0.6
6.3

7.8
4.6
7.4
8.7

5.3
2.6
4.4
7.1

5.6
5.2
4.8
5.9

5.,9
4..5
5,.9
5..6

5.8
5.6
6.4
4.7

5.4
2.2
5.7
5.8

4.7
5.0
4.7
4.8

4.8
5.3
5.0
4.9

4.5
4.2
5.3
4.2

5.2
2.2
5.8
5.6

6.,0
4., 5
3., 3
8.

5.8
4.2
5.2
6.3

5.1
4.3
5.4
5.0

5.7
7.3
4.8
6.1
-3.1
-3.6
-2.9

5.8
5.9
2.9
7.6
4.6
4.7
4.6

6.0
5.7
4.9
6.4
5.8
5.9
5.8

4.3
3.6
4.3
4.1
3.9
3.6
3.9

5.,5
5..1
6,.6
5.,2
6.,5
6.,7
6.,5

5.8
5.3
6.3
6.1
6.6
6.7
6.6

4.1
5.4
4.5
6.3
0.5
0.7
0.5

5.9
5.8
5.5
5.7
3.8
3.4
3.8

6.2
6.2
7.0
5.8
4.4
4.1
4.4

7.3
6.0
7.8
5.4
10.2
10.1
10.2

5.8
5.6
7.0
5.5
6.3
6.3
6.3

5..7
6. o
3., 7
3.. 3
3., 1
4., 0

5.3
5.1
5.0
5.7
4.5
4.5
4.5

5.8
5.7
6.1
5.8
4.7
4.6
4.7

-0 .8
-1Û.2

4.6
2.3

4.0
4.2

4.6
4.É

5.,7
4 ..8

5.6
3.7

5.4
3.8

5.3
4.1

5.3
4.8

5.3
4.5

5.3
4.2

3.
-3. >?

4.5
3.2

5.4
4.2

GOVERNMENT PURCHASES
FEDERAL
STATE AND LOCAL

6.2
6.2
6.4

6.5
6.5
6.3

8.7
14.2
5.2

5.1
4.2
5. 7

5..8
4,.8
6,

5.2
3.7
6.?

8.5
12.3
5.8

4.8
3.6
5.7

5.1
3.9
6.0

5.0
3.7
5.9

8.4
11.4
6.2

7., 4
8., 3
6 .. R

6.4
7.0
5.9

5.9
5.8
5.9

GOVT OUTPUT ORIG

5.8

6.9

9.3

4. 1

4..4

4. 1

10.9

3.9

3.9

3.9

9.7

8.

6.0

5.6

FIXED INVESTMENT
NONRES IDENTIAL
STRUCTURES
EQUIPMFNT
RESIDENTIAL
NONFARM
FARM
EXPORTS
IMPORTS

A.,0
,

202

Representative R e u s s . Thank you very much, Mr. Evans.
Mr. Ratajczak.
STATEMENT OF DONALD RATAJCZAK, DIRECTOR, ECONOMIC FORE­
CASTING PROJECT, GEORGIA STATE UNIVERSITY, ATLANTA

Mr. R a t a j c z a k . Thank you, Mr, Chairman.
Before going into my statement, I would like to just make some
quick observations about the (iiNP release.
I think it is a little bit unfortunate that we do not have real per­
formance by sector of the economy, because I've been forced to go
through here to iigure out what the nonfarm economy has done. Tne
evidence appears to be, since the Commodity Credit Corporation was
responsible largely for a $7.7 billion reduction in the second quarter
and a $2.3 billion increase in the third quarter, and since there was a
shift in farm inventories from a negative to an unchanged posture,
that basically the nonfarm economy in real terms declined in the
third quarter, and there is absolutely no way that anyone can call that
an economic recovery. And if they want to call it an economic recov­
ery because the farmers are getting $1.97 for corn and not getting
appropriate numbers for wheat, then that’s fine—say it in Nebraska.
But basically the economy simply has not shown any of the funda­
mental conditions of economic recovery at the present time.
By the way, I agree with the observation as well in the nonfarm
economy that basically any improvement there—and as it turns out
it does appear that the nonfarm economy declined—that in the nonfarm economy we have had unbalanced development in the sense that
we have had an addition of unwanted inventories, and under those
circumstances clearly we would have to expect a continuation of eco­
nomic weakness through the next quarter, or certainly through the
next month. I think we are already seeing evidence of that in the form
of very high initial unemployment claims.
Indeed, my forecast for GNP for the fourth quarter is at most a 1
percent gain, and given my analysis of the nonfarm activity, I prob­
ably will drop that to a negative GNP performance for the fourth
quarter. Therefore, there is no economic recovery at this stage.
What I would like to do before getting to some of the specific issues
that have been addressed is first of all talk about those two appendages
that were on my prepared statement which has to do with the inflation
rate, because there is considerable discussion about what is happening
to inflation at the present time.
Of those two releases, No. 1 talks about producers’ price changes
by stage of processing, and they give us a lot of detail as well as an
extended forecast for the next year. That particular release shows that
after the decline of one-tenth of 1 percent that was announced recently
for September we’ll have an increase of four-tenths of 1 percent for
October.
Now I view that as actually a very modest performance. And the
reason why we are going to have an acceleration in October is funda­
mentally because the decline in September was as the result of techni­
cal conditions related to the end of model year dealer incentives and
is not really a measure of the underlying fundamental inflationary
forces in the industrial economy.




203

We do feel that there has been significant progress in industrial
inflation. Our estimates of underlying industrial inflation for this year
are the lowest since 1972. There is no question that we have made
significant inroads.
Furthermore, we do anticipate next year that industrial inflation
will be in the 4.5 percent range. The consumer price index we are
anticipating for the month of October will actually show no increase
whatsoever. The reason for that: Significant declines in mortgage in­
terest rates, both government-supported mortgage interest rates and
the conventional mortgage rates, which in the appropriate reference
period declined by three-quarters of a percent.
There has been some improvement in inflation. However, I must
raise the same issues that were raised by Professor Bator, and that is
basically that the cost has been very high. The accomplishments are
there, but the cost may very well be excessive.
In addition, the decline of commodity inflation more rapidly than
the decline of interest rates has in fact increased economic stress in the
system, and that indeed raises interesting questions.
There have been some people naturally assuming that if you can
get a decline in inflation rates that you necessarily will see a concomi­
tant decline in interest rates. Clearly this has not been the case, and
indeed early this year, in the second quarter of this year, we had some
of the highest real rates of interest that have existed since the Depres­
sion, and unquestionably this has been a contributing factor to the
liquidity problems that have also been discussed today.
I really think that the fundamental problem is one of the high real
rates of interest.
I don’t share the viewpoint that the economy is about to collapse, al­
though obviously when you are dealing witH unemployment rates—
10.1 percent this month, probably in the 10.3, 10.4 range next month,
certainly 11 percent cannot be ruled out by end of vear or early next
year—that basically the economy simply is not performing very well.
I think one of the items I would like to point out, because I think I
can give a slightly different perspective here, is first of all, why didn’t
the tax cut do anything? According to our analysis the tax cut did
something. And in fact it did it about the time economic theory nor­
mally would have anticipated that it would do it basically when the
fundamental tax liabilities for dollar earned were changed. And al­
though we know withholding was changed July 1, the fundamental
tax liabilities were changed in the calendar year. And indeed, if you
take a look at the ratio of consumption to GNP, real consumption to
GNP, you find in the first quarter of 1982 that ratio showed its sec­
ond largest increase since 1950. The only period where it showed a
larger increase was the first quarter of 1975. Coincidentally, a tax re­
bate was very much discussed and then came forward at that period
of time.
So in point of fact the reason why the tax reduction has not yet
worked is it already has worked. Why hasn't it been more successful ?
That’s the right question. And the answer to that is fundamentally
that tax reductions are nice if you have a job, and if you don't have
a job, if employment is falling, then the gain from tax reductions is
totally wiped out from the losses of reduced incomes.




204

Let me say a little word here about some economic theories that are
going around. First of all, one that I call the monetary expectationists,
because I can make some comments on that. Basically this is that if you
can get a credible Federal Reserve performance, what will happen is
that prices will magically respond to this reduced inflation expectation.
I am not arguing against inflationary expectations. What I am
arguing against is that inflationary expectations can be fully reflected
in inflation in any reasonable period of time. What that means is that
if you knock down inflationary expectations, let’s say even one for
one, by the slowing of monetary policy, you do not knock down infla­
tion one for one. Then where does the fallout go ? Obviously you do
knock down expenditures; you’re not knocking down inflation as
rapidly, so it must go into some form of real economic activity.
There is no painless way of extracting inflation from the economic
system. It can’t be done in a painless way. It can be done in a less
costly way than the current way that we have been pursuing.
The next issue: Why did the real rates of interest stay so high ? I
think if you take a look at interest rate movements you can get an
idea. Clearly the Federal Reserve was a factor, but not the total
factor. In June of last year short term interest rates were 14.6 percent;
in October they were 13.9. Yet over that period of time long term
interest rates increased 2 percentage points. What that says is that
something fundamental was being expressed in the savings-investment
relationship in the overall economy, and what was happening, of
course, was that was the period of time where we passed tax changes
that were not fully compensated by expenditures changes and there­
fore created a secular deficit in the underlying budget. And that is
really what has thrown the long term interest rates out of kilter; that
is one of the major reasons why real rates of interest have stayed so
high so long, and therefore why the recession has remained so much
intact.
One other issue, and then I’ll get off of this and get back to your
questions raised, is basically there is also a feeling afoot that because
of the role of expectations that we no longer can control the business
cycle. I think there probably is a little bit of truth to the fact that
the relationships are not as stable as we would like to pretend that
they are, and as a result fine tuning really is something that cannot
easily be done.
Nevertheless, I think the evidence does show that we can influence
the business cycle. We can make some differences in its performance.
Moreover, there is no reason to assume that even if we cannot control
the business cycle that we can in fact ignore it, that we can continue
to pass multiyear tax reductions, multiyear expenditures programs
without regard for its impact upon the underlying dynamics of the
economic system. Sooner or later those multiyear programs are going
to come into conflict with the basic dynamics of economic develop­
ment. Unfortunately, this time around they came sooner.
I think now I will go to address your basic points. There are a few
other comments I want to make, but they are fairly well covered in
my prepared statement.
Basically, when will the economic upturn become apparent? Well,
as of this testimony my feeling was the first quarter. Given what ap-




205

pears to be deterioration in the nonfarm economy, I may have to scale
down my presumptions of economic recovery early in the year.
I still believe that we will have a reasonable recovery, fairly vigor­
ous about midyear and moving through the end of the year. The rea­
son for that fundamentally being that inflation rates have been
knocked down. Once we finally get to inventory balance and therefore
get to employment balance the improved real purchasing power will
start to increase consumer activity. However, that will basically put a
floor upon the interest rates. I don’t believe that interest rates can con­
tinue to move downward in a consumer-led economic recovery under
the kinds of deficits that currently persist.
I do think that the declines in interest rates will stimulate some
housing activity. We also will see some increases in automoble activ­
ity, although not because of interest rates, but rather after 3 years of
basically ignoring what has been happening to the relative prices of
automobiles we will now see some reduction in prices of automobiles
relative to other commodities, and that, according to our analysis,
would start finally to stimulate automobile demand.
When will unemployment get back to 7.4 percent ? Our forecasting
only goes out through 1984, so I can’t answer that question. Clearly it
will be some time after that period of time, because we are talking
about ending 1984 in the vicinity of 8.5 percent unemployment rates.
I do not think that 1984 probably will show 4 percent real growth.
I do think also we will have significant increases in productivity. As
the workweek extends, that 4-percent growth will not significantly
reemploy the people currently unemployed.
Finally, talking about monetary policy, monetary policy at the pres­
ent time seems to be appropriate. That is a little bit at odds with some
of my other colleagues, but I ’m not sure that it’s going to go that much
at odds, because the question is which Federal Reserve activity are you
going to choose, and I am choosing the current Federal Reserve activ­
ity, which is, in fact, easing while saying it is not, and that particular
Federal Reserve activity I view as being appropriate.
By the way, I would argue that there are ways of determining it.
The market system does give us some information on the performance
of our policies. Basically, if short-term interest rates continue to fall
and to pull long-term interest rates down with them, I think that
monetary policy can continue to move in an easing direction. At the
point of time that declines in short-term interest rates no longer drag
long-term interest rates down with them, then we can start to raise the
question as to whether the Federal Reserve has overeased. I think the
evidence overwhelmingly at this period of time is that the Federal
Reserve has not overeased, has not reinstituted inflationary pressures.
I hope that some of these remarks have been useful. I thank you for
inviting me.

[The prepared statement of Mr. Ratajczak follows:]

17-871

0




83

14

206

P r epa r e d St a t e m e n t of D o n a l d R a tajczak

Thank you fo r in v itin g me to share my views on economic con d itio n s during
t h i s day when we re c e iv e our f i r s t measure o f economic performance fo r the
summer q u arte r.
The Economic F orecasting P ro je c t a t GSU uses monthly estim ate s
o f economic con d itio n s to a n tic ip a te th ese q u a rte rly GNP announcements. No
su rp rise s are a n tic ip a te d in t h i s r e le a s e .
N e v e rth e le ss, a d e ta ile d fo r e c a s t at
t h i s time should f u l l y in corporate the economic c o n d itio n s that are ju s t now
being revealed to u s.
For th a t reason , I should li k e to d efer providing
d e ta ile d p r o je c tio n s with my testim ony on the s ta te o f economic c o n d itio n s u n t il
the P ro ject has absorbed the im p lic a tio n s o f the GNP report and has incorporated
a l l the l a t e s t inform ation in to our fo r e c a s tin g system .
At that tim e, I intend
to forward d e ta ile d ta b le s o f our n a tio n a l fo r e c a s t to a l l members o f the
Congress.
Of c o u rse, I am merely r e lu c ta n t to provide d e t a i l w ithout current in fo r ­
m ation.
This does not a l t e r my p erceptions o f developing economic c o n d itio n s .
The economy f i n a l l y i s beginning to develop the precond itions fo r economic
recov ery.
Normal re ce ssio n ary flow s tend to generate se v e ra l fo rc e s that u l t i ­
m ately lead to economic re cov ery.
F i r s t , re c e s s io n s ig n if ic a n t ly reduces the
demand fo r b a sic m a te ria ls and la b o r .
This reduced demand i s transm itted in to
moderation in wage in cre ase s and in to p ric e d e c lin e s .
Commodity i n f l a t i o n
co lla p se d in the spring and i s now showing no s ig n if ic a n t s tre n g th .
As shown in
the appended ta b le s on the Producer Price Index, p r ite s o f fin is h e d goods are
expected to in crease le s s than 3.5% t h i s year and rebound only to a 4.5% gain in
1983. Wages continue to show m oderation.
The hourly earnings index c u rr e n tly
stands only 6.0% above previous year l e v e l s .
This i s the low est y e a r-o v e r -y e a r
change sin ce the e a rly months o f 1974.
D espite the slowing o f both wage and
commodity i n f l a t i o n , the slump in raw commodity p ric e s has created a gap between
the two.
As a r e s u l t , purchasing power earned fo r each hour worked i s beginning
to in c r e a se .
Of cou rse, t h is i s on ly a p recon d itio n fo r increased consumer
a c t i v i t y , as the hours worked a ls o must s t a b i l i z e b efo re r e a l household incomes
begin to expand.
Normally, re c e ssio n s a ls o reduce c r e d it market p re ssu re s.
The p r iv a te
demand fo r funds u ltim a te ly recedes more ra p id ly than the re c e ssio n induced
Increase in p u b lic borrowings o f funds.
As a r e s u l t , in te r e s t ra te s tend to
fa ll.
I n i t i a l l y , the reduction in commodity in f l a t i o n may be more s u b s ta n tia l
than d e c lin in g in t e r e s t r a t e s .
Indeed, i f commodity i n f l a t io n f a l l s dramati­
c a l l y r e la t iv e to wages, as occurred e a r ly in 1982, the s tr a in on corp orate
li q u i d i t y may be so severe th a t p r iv a te borrowings may in crease fo r a short
period o f tim e.
Thus, in t e r e s t r a te s may r i s e e a rly in a r e c e s s io n .
I f the




207

on set o f re c e ssio n immediately spawned the fo rc e s leadin g to economic recovery,
then re c e ssio n s would not be very lo n g .
W hile a stock market r a l l y may not be a precon d itio n fo r economic recovery,
such a r a l l y norm ally s ig n a ls that the precon d itio n s e x i s t .
As in te r e s t ra te s
d e c lin e , the a lt e r n a t iv e s to e q u ity ownership become le s s a t t r a c t iv e .
Moreover,
as wage i n f l a t i o n slo w s, corporate li q u id it y begin s to improve.
Although pro­
f i t s may d e c lin e fo r a few more q u a r te rs, the unanticip ated surge in short-term
corp o rate debt th a t was generated e a r ly in the re c e ssio n i s beginning to be
re tir e d .
Moreover, reduced in t e r e s t ra te s lower the in te r e s t expenses paid by
b u s in e s s .
Indeed, i f in t e r e s t r a te s f a l l sharply enough, corporate p r o fi t s
could in cre ase even b efo re revenues begin to expand.
O bviously, e q u ity owners
are encouraged by reduced in t e r e s t expenses and a g g r e s s iv e ly seek eq u ity
ownership when those con d itio n s d evelop.
C u rre n tly , c orp o ration s have s i g n if ic a n t ly shortened the m aturity o f th e ir
debt as they await favo rab le bond market c o n d itio n s .
The economic li v e s o f
th e ir a s s e ts g r e a tly exceed the average age o f t h e ir d e b t, although the c a p ita l
base o f American in d u stry a ls o i s becoming le s s d u rab le.
Much as banks d iscover
th a t an unbalancing o f the m a tu ritie s in th e ir a s s e t s and l i a b i l i t i e s in creases
the s e n s i t i v i t y o f th e ir earnings to changes in in t e r e s t r a t e s , the unbalanced
fin a n c in g o f corporate a s s e ts has increased the in t e r e s t s e n s i t i v i t y o f cor­
porate e a rn in g s.
T h is, in tu rn , has increased the in t e r e s t s e n s i t i v i t y o f stock
v a lu e s .
The stock market r a l l y i s responding to th ese fin a n c ia l con d itio n s more
than to a n tic ip a tio n s o f economic recov ery.
R isin g e q u ity va lu es generate some d ir e c t economic b e n e f i t s .
A $100 b i l l i o n
in cr e a se in the market value o f e q u itie s held by households w i l l in crease £on sumption by $3 b i l l i o n in the same ye a r. Equity va lu es held by households have
improved by more than $200 b i l l i o n sin ce the market r a l l y began in August. Thus,
p ro sp ects o f in creased consumer a c t i v i t y are im proving.
Furthermore, r is in g
e q u ity va lu es may lead to in creased e q u ity fin a n c in g .
I f the market evaluates
a s s e t s a t more than i t c o s ts to b u ild or acquire them, entrepreneurs w i l l be
encouraged to in cre a se th e ir investment a c t i v i t y .
(At the present tim e,
however, the c o s t o f a s s e t a c q u is itio n i s le s s s ig n if ic a n t than the u t i li z a t i o n
o f e x is t in g a s s e t s in determ ining investment a c t i v i t y .)
P recond itions fo r economic recovery now are alm ost in p la c e .
However, eco­
nomic recovery has not yet begun.
In the week o f October 2 ,
in itia l
unemployment claim s ro se to 6 9 5 ,0 0 0 .
These fig u r e s suggest that p a y ro ll
employment i s continuing to d e c lin e by nearly 2 0 0 ,0 0 0 jo b s a month.
In d u s tria l
a c t i v i t y probably w i l l d e c lin e in October.
Automobile s a le s fo r the f i r s t ten
days o f October were d isa p p o in tin g .
The important f l e e t s a le s that normally
occur a t t h i s season remain la c k lu s t e r .
Our own measures o f r e t a i l a c t i v i t y
suggest th at most o f the stre n g th in non-auto s a le s during September occurred
e a r ly in the month, during the Labor Day weekend, and were generated by substan­
t i a l marketing in c e n t iv e s .
R e ta il s a le s may e x h ib it l i t t l e growth in October.
Thus, consumer expenditures probably w i l l not grow more ra p id ly than 2% a t
annual r a te s a f t e r adjustment fo r I n f la t io n in the important f a l l q u arter.
In cre a se s in housing a c t i v i t y , with the a id o f su b sid ized m u lti-fa m ily u n its
and a modest expansion in s in g le fam ily c o n str u c tio n in response to d e c lin in g
mortgage r a t e s , could generate some improvement in c o n stru c tio n expenditures
during the f a l l .
However, l i t t l e growth in p u b lic c o n stru c tio n and d e c lin es
a f t e r adjustment fo r i n f l a t i o n in p riv a te n o n re s id e n tia l a c t i v i t y w i l l prevent
c o n str u c tio n from c o n tr ib u tin g s ig n if ic a n t ly to economic g a in s .




208

Defense expenditures continue to expand.
Shipments should now begin to
a c c e le r a te in response to the strong growth in d efense orders that ofcdurred
e a r l i e r in the ye a r.
However, the only other s ig n if ic a n t growth area in the
fe d e r a l government i s in purchases by the Commodity Credit C orporation.
S ta te and lo c a l governments sim ply do not have the operating surp luses with
which to in cre ase t h e ir exp en d itu res.
State and l o c a l p a y r o lls probably w i l l
continue d e c lin in g w e ll in to 1983.
Plant and equipment expenditures should continue to f a l l sh a rp ly , as orders
c u rr e n tly are la g g in g shipments by more than $ 2 .4 b i l l i o n per month.
Although
d e c lin in g in t e r e s t ra te s and an improving stock market normally would generate
in creased c a p it a l exp en d itu res, the low u t i l i z a t i o n o f p re v a ilin g equipment
fo r e s ta lls
any
s ig n if ic a n t
response
to
improving
fin an cin g
arrangements.
C a p ita l expenditures are very s e n s it iv e to tax and in t e r e s t ra te con sid e ra tio n s
when u t i l i z a t i o n r a te s exceed 77%, according to our investment r e la tio n s h ip s .
In the range between 73% and 77%, both the c o st o f C a p ita l and the u t i l i z a t i o n
o f c a p it a l become s ig n if ic a n t f a c t o r s .
Below 73%, u t i l i z a t i o n becomes para­
mount.
At the current 69% u t i l i z a t i o n o f a v a ila b le equipment, dramatic reduc­
tio n s in in t e r e s t r a te s must be forthcoming b e fo re orders fo r C a p ital goods
begin to expand.
Shipments normally la g orders by nearly two q u a r te rs.
(Of
c o u r se , any aggregate u t i li z a t i o n measures remain v a lid only so long as the Com­
p o s itio n o f a c t i v i t y remains n early unchanged.
E a r lie r th is ye a r, when u t i l i z a ­
tio n ra te s were below 50% fo r most nonferrous m e ta ls , ferrou s m e ta ls , and
a u tom o b iles, spending on c a p it a l equipment was stro n ger than our r e la tio n s h ip s
norm ally would suggest because o f continuing expansion in o i l e x p lo r a tio n .
That
p a r tic u la r se c to r now has entered the same c a p it a l spending bust that p r e v a ils
in most oth er economic s e c to r s . Thus, c a p it a l expenditures may grow more slo w ly
than our aggregate re la tio n s h ip s suggest in the next few q u a r te r s ).
The most d i f f i c u l t se c to rs o f the economy to an alyze on a sh o rt-term b a s is
are in ventory investm ents and net e x p o r ts .
During the second q u a rte r, strong
earnings from investm ents abroad o f f s e t continuing modest d e te r io r a tio n in
merchandise trade b a la n c es.
In the th ird q u a rte r, an u nsu ally strong d o lla r has
fu rth e r reduced the com petitiveness o f American goods abroad.
Merchandise trade
d e f i c i t s are now r i s in g sh a rp ly.
Reductions in in t e r e s t ra te s worldwide suggest
th a t fa c to r incomes from abroad no lon ger w i l l be a b le to o f f s e t the adverse
impact upon exports generated by a strong d o l la r .
As a r e s u l t , net exports
should co n trib u te to economic weakness through much o f 1983.
Changes in d e sire d inventory ho ldin g s have caused three attem pts at economic
recovery during t h i s y ea r.
In February, production momentarily aCfcelerated to
o f f s e t w inter induced production d isr u p tio n s in January.
In v e n torie s again
s t a b i li z e d in May, as manufacturers and r e t a i l e r s reached stock le v e l s that were
j u s t i f i e d by p r e v a ilin g o rd e rs.
U n fortu n ate ly, some o f those p re v a ilin g orders
were the in creased inventory h oldings o f w h o le s a le rs .
When in t e r e s t ra te s
remained h ig h , w h olesa lers reduced those in v e n to r ie s by c a n c e llin g o r d e rs .
In
J u ly , r e t a i l e r s expected the change in w ithholding ra te s to s i g n i f i c a n t ly
improve consumer spending.
A fte r a weather re la te d f lu r r y o f a c t i v i t y e a r ly in
J u ly , consumer s a le s once again slumped.
In v e n to rie s now are again being
a g g r e s s iv e ly reduced.
Producers no longer are assuming that a c t i v i t y w i l l
expand.
This l a t e s t round o f in ventory liq u id a tio n s should be s u f f i c i e n t to
e s t a b li s h a production base from whiCh a c t i v i t y can expand e a r ly in 1983.
In summary, the economy s t i l l i s being b u ffe te d by C ro ssc u rre n ts.
During
the f a l l , stren g th w i l l be in consumer spending, housing, and d e fe n se .
Weakness




2 09

continues in n o n re sid e n tia l s tr u c tu r e s , plan t and equipment expenditures, inven­
to ry in vestm en t, net e x p o rts, and s ta te and lo c a l exp en d itu res.
We cu rren tly
b e lie v e the p lu se s w i l l outperform the m inuses.
However, the p ro je c tio n o f 3 to
4% r e a l growth in GNP during the fourth quarter that has re c e n tly been presented
by the Secretary o f the Treasury i s very u n lik e ly . Real growth i s not expected
to exceed 1.0% in the f a l l .
Why has the Consumer not responded to the tax reduction?
According to our
a n a ly s is the answer i s that the consumer has responded and at about the time
th a t current th e o rie s o f consumer behavior normally would p r e d ic t.
Although
w ithholding r a te s were reduced in J u ly , tax l i a b i l i t i e s were reduCed for a l l o f
1982 under the assumption th a t tax ra te s f e l l by 10% in J u ly . The inCome earned
in January was su b je c t to the same tax Code as the income earnerd in October.
Households w ithout severe li q u id it y c o n str a in ts were a b le to increase spending
in January, a n tic ip a tin g the w ithholding reduction that was to take plaCe in
J u ly .
This ex p la in s why consumption as a share o f GNP showed the second highest
q u a rte rly in crease o f any quarter sinCe the Korean C o n flic t during the f i r s t
quarter o f 1982. (The only higher response occurred in the f i r s t quarter o f 1975
when consumers were a n tic ip a tin g a tax r e b a t e .)
Consumption as a percentage of
GNP a f t e r adjustment fo r i n f l a t i o n C urrently i s at a 35 year h igh .
The share
has in crease by 2.8% during the la t e s t ye a r.
Thus, the o b je c tiv e o f increasing
savings and investment as a proportion o f GNP has not been achieved.
Those s t i l l w aiting fo r the consumer to respond to the 1982 tax reduction
w i l l be s o r e ly disa p p oin ted .
On the other hand, the 1983 tax reduction should
begin to stim u la te consumer a c t i v i t y during the f i r s t quarter o f that year.
If
in ventory li q u id a t i o n s , Indeed, are Completed by th at tim e, r is in g purchasing
power a ls o w i l l begin to con trib u te to Consumer expansion.
P a r tia lly o f f s e t t in g
th ese p o s itiv e fo r c e s w i l l be a slowing in the growth o f In te r e s t income by more
than $11 b i l l i o n in 1983.
On balanCe, 1983 w i l l be the year o f the Consumer,
w ith expenditures growing a t a r e a l annual ra te o f 3 .5 % .
Inventory in vestm en t, housing, and defense a ls o w i l l be s ig n ific a n t C ontri­
butors to economic growth. Expenditures fo r n o n re s id e n tia l Construction, produ­
cers* d u ra b le s, and s ta te and lo c a l a c t i v i t y are expected to Continue d eclin in g
in in f l a t i o n ad ju sted term s.
Net exports should f a l l sharply through most of
1983.
Although f i n a l demand may expand le s s than 2% in 1983, C ontributions from
in ventory re sto ck in g w i l l lead to GNP growth o f 3%.
In crea ses in inventory re sto ck in g w i l l be a l e s s s ig n if ic a n t con trib u tor in
1984.
Consumer a c t i v i t y w i l l not be a b le to su s ta in sharp ra te s o f increase
r e la t iv e to GNP in th at y e a r.
Because in t e r e s t ra te s are expected to remain
very h ig h , notw ithstanding th e ir Current downward tren d , recovery in the C ap ital
equipment area i s expected to be modest.
Housing should continue to be a strong
c o n trib u to r to economic growth, however, in 1984. As a r e s u l t , f in a l demand
should in crease more than 3.5% and GNP should grow 4% in 1984.
The more in te r e s tin g qu estio n i s how we got to where we are today rather
than where are we going from h e re .
I f the monetary a u th o r itie s wish to slow
i n f l a t i o n they must f a l l short o f accomodating expenditures C onsistent with pre­
v a ili n g i n f l a t i o n . Some monetary e x p e c ta tio n is ts thought that priCes rather than
r e a l a c t i v i t y would be reduced by any F ederal Reserve p o lic y that e sta b lish e d
c r e d ib ility .
Later these monetary th e o r is t s added the p roviso that poliCy a ls o
must be s t a b le .
At GSU, our a n a ly sis o f priCe determ ination C lea rly suggests
that p re v a ilin g p ric e s depend upon muCh more than expected i n f l a t i o n .
I f p rice s




210

d e c lin e b e fo re c o s t s , p r o f i t s must f a l l .
ReduCed p r o f i t s r e s t r i c t the in v e s t­
ment and h ir in g d e c isio n s o f c o r p o r a tio n s.
Moreover, C ontractual or in t e r ­
n a tio n a l arrangements may prevent c o s t s from responding quiCkly to a Change in
the in fla t io n a r y environment. Because o f impediments to Complete priCe a d ju s t­
ment to changing in fla tio n a r y e x p e c ta tio n s , le s s than f u l l aCComodation o f
in fla t io n a r y expenditures p attern s must lead to some reduction in eConomiC a c t i ­
v ity .
I n f la t io n Cannot be e x tracted p a in le s s ly from the economic system .
I f on ly monetary p o l it y were Changed to wring i n f l a t i o n out o f the economy,
sh o rt-te rm in t e r e s t r a te s would r i s e sh a rp ly , as a sC a rc ity o f funds needed to
m aintain p r e v a ilin g expenditures p attern s would in cre ase sh o rt-term loan ra te s
u n t i l money was d iv e rte d from p o r t f o li o u s e s .
Long-term in te r e s t r a t e s , on the
other hand, would be b u ffe te d by o f f s e t t i n g fo rC e s .
Some borrowers would
in cre ase th e ir long-term debt to escape the higher y ie ld s from sh o rt-term
in stru m en ts.
However, r i s in g sh o rt-te rm r a te s would disCourage in v e s to r s w hile
the tig h te n in g o f monetary p o lic y ought to lower the in fla tio n a r y premiums
sought by le n d e r s . In f a c t , sh o rt-term Treasury b i l l s yie ld e d 14.6% in June 1981
and a s l i g h l y sm aller 13.9% in October o f l a s t y e a r.
Long-term in t e r e s t r a t e s ,
on the oth er hand, surged by n early 2 percentage p o in ts , reaching a peak y ie ld
in September 1981.
As re c e n tly as t h i s June lon g-term ra te s were w ithin o n eh a lf percentage p oin t o f that peak d e sp ite a v i r t u a l C ollap se o f Commodity
in fla tio n .
Measured in terms o f purchasing power, long-term in te r e s t ra te s had
the h ig h e st y ie ld s during June 1982 o f any time in the p o st-d e p r e ssio n e r a .
C le a r ly , t h i s dramatic in crease in r e a l r a te s o f in t e r e s t extended the duration
o f t h is re c e ssio n and increased unemployment.
Why did r e a l ra te s o f in te r e s t
sta y so high fo r so long?
The Treasury Department suggests that the v o l a t i l i t y o f money growth pre­
served high r a t e s . I have observed no s ig n if ic a n t Change in that v o l a t i l i t y in
the p ast few months.
Y e t, in t e r e s t r a te s now are d e c lin in g sh a rp ly.
Other eco­
nom ists argue th at in fla tio n a r y e x p e c ta tio n s had not been broken u n t il reCent
weeks.
That i s an e s p e c ia lly d istu rb in g argument, fo r GSU and other fo r e c a s te r s
have been p r o je c tin g a 5 to 6% in fla t io n a r y Clim ate in the next se v e ra l years
fo r most o f t h is y e a r.
Why should we not be b e lie v e d u n t il July and then beCome
stro n g ly b e lie v e d sin ce then?
In a le c tu r e I was honored to g iv e in C e le b ra tio n o f Haverford C o lle g e 's
se sq u ic e n te n n ia l, I observed that King Canute d iscovered two things about the
tid e s .
F ir s t he could not c o n tr o l them.
Second, he Could not ignore them.
Most o f the economic stu d ie s whiCh m aintain th at eConomiC p o l ic ie s have l i t t l e
a b i l i t y to a l t e r the b u sin ess c y c le are based upon d im ensionless behavior in an
i n s t i t u t i o n l e s s etonom it w orld.
Most s t a t i s t i c a l t e s t s o f the theory o f p oliC y
n e u tr a lity draw t h e ir ob serv atio n s from r e a l world b eh avior.
Not s u r p r is in g ly ,
they show th at c a r e f u lly se le c te d p o lic y can in flu e n c e the b usin ess CyCle,
although f in e tuning o f the Cycle may not be p o s s i b le .
Business CyCles Cannot
be c o n tr o lle d but they Can be in flu e n c e d .
M u lti-y e a r expenditures and ta x p o l i c i e s not on ly deny the n e c e s s ity to
engage in c y c l i c a l p o lic y in te r v e n tio n , but they a ls o ignore any d is t o r tio n s
being cre a te d by underlying c y c l i c a l f o r c e s .
A m u lti-y e a r tax red uction a t a
time when r e a l r a te s o f in te r e s t alread y were r i s in g sharply was almost C ertain
to generate d e s t a b i liz in g C redit market p re ssu r e s .
(The L a ffe r Curve argument
th at improved ta x in c e n tiv e s would le a d to in creased eConomiC a c t i v i t y that
insured o n ly a momentary need to in cre a se borrowing must be re le g a te d to that
d im ensionless economic n e v e r la n d .)




211

Can i t always be ap propriate to reduce tax d is in c e n tiv e s even where the
a lt e r n a t iv e i s in creased d is in c e n tiv e s created from borrowing?
I f so , we should
fin a n ce our e n tir e expenditures program through borrow ings.
Without any taxes
we would e lim in a te a l l s h e lte r in g a c t i v i t y and a l l subterranean economic beha­
v i o r , except to the exte n t th a t s ta te taxes j u s t i f i e d suCh b ehavior.
Of Course,
even with c u r r e n tly f a l l i n g in t e r e s t r a t e s , in t e r e s t expenses alone would be
in creased by more than $80 b i l l i o n in the next f is C a l year under suCh a
fin a n c in g program.
Furthermore, few economic models would in d ic a te that
i n t e r e s t r a te s could remain unchanged under suCh a d r a s tic financing r u le .
If
t o t a l debt fin a n c in g o f government expenditures i s so absurd as to be ruled
in ap p ro p ria te out o f hand, then th e ir must be an optim al financing ru le fo r
government ex p e n d itu re s.
I t i s not reasonable to d eclare that d e f i c i t s do not
m atter and then m aintain th a t f i s c a l prudence req u ires a balanced budget
amendment. With such con fu sion over the fin a n cin g o f government, appropriate
fin a n ce r u le s w i l l be achieved on ly by acC ident.
Let me e s t a b li s h a b a s is fo r an optimum fin a n cin g r u le .
When re a l in te r e s t
r a te s are f a l l i n g , an in cre ase in government d e f i c i t s may be ju s t i f i e d without
in te n s ify in g d is t o r t i o n s in the economy.
In the experiment proposed by Keynes,
r e a l in t e r e s t r a te s remained unchanged both b efo re and a f t e r governments used
d e f i c i t fin a n c in g .
I f those C onditions p re v a ile d in the 1 970s, the Keynesian
p r e s c r ip tio n would not have created the degree o f economic d is t o r tio n that in
f a c t i t did c r e a t e .
As r e a l in t e r e s t ra te s Currently are f a l l i n g moderately
(remember, underlying i n f l a t i o n ra te s are d e c lin in g n early as ra p id ly as market
i n t e r e s t r a te s ) the need to re scin d the tax reduction in 1983 to reduCe the bur­
den o f government d e f i c i t s i s le s s Compelling.
On the other hand, r e a l ra te s o f
i n t e r e s t were in cr e a sin g sharply before ta£ enhancements were enaCted th is year.
As that tax in g program reduced the c r e d it market d is t o r tio n s created by
in ap p ro p ria te fin a n c in g , r e a l in t e r e s t ra te s responded favo rab ly to that aC tion .
Although the above d isc u ssio n i s about aggregate budget C ondition, a strong
argument can be advanced toward reducing government C a p ita l expenditures during
a period o f r i s in g r e a l r a te s o f in t e r e s t ju s t as p riv a te d e c isio n s have been
force d to d iverge from i t s optimum expansion p a th s.
The le v e l o f defense expen­
d itu r e s and the speed o f d efense buildup Cannot Continue to be excluded from
economic e v a lu a tio n .
In the l a s t two y e a r s , the p ro je c te d growth o f r e a l
defense expenditures has in creased even as r e a l in t e r e s t r a t e s , and th e re fo re
the economic burdens created by fe d e r a l government borrow ings, a ls o continued to
expand.
Of c o u r se , economics should not be the only fa c to r d ic ta tin g defense
e x p e n d itu re s.
However, an in cre ase in the growth ra te o f r e a l resources
d iv e rte d to d efense even as the burdens o f government borrowings are in te n ­
s if y i n g must be defended in terms o f why those purchases are even more com­
p e lli n g now than they were in a le s s d is t o r t in g economic environment.
Although the recent d e c lin e in r e a l r a te s o f in t e r e s t makes the issu e o f a
government d e f i c i t le s s com p ellin g, the magnitude o f p ro je cte d d e f i c i t s , $165
b i l l i o n in FY 1983 and $150 b i l l i o n in FY 1984, and the f a ilu r e o f those d e f i ­
c i t s to s i g n i f i c a n t l y d e c lin e as economic a c t i v i t y expands s tro n g ly suggests
th a t in t e r e s t r a te s cannot remain under downward pressure fo r any s ig n if ic a n t
len g th o f tim e.
That i s why I f e e l th a t a slow ing in the growth o f defense
spending must be addressed .
In p lace o f a move to rescin d the th ird year o f the
m arginal ta x ra te re d u c tio n s, some o f whiCh have in c e n tiv e s toward increased
savings and work e f f o r t , I f e e l a more productive approach to revenue enhan­
cement i s the re c o n sid e ra tio n o f e x c ise tax in c r e a s e s .
Some means o f reducing
consumption expenditures w hile reducing in t e r e s t ra te pressures through d e f i c i t




212

reduction i s e s p e c ia lly com pelling because o f the high concentration o f economic
a c t i v i t y c u rr e n tly in consumer spending.
( I f Consumption i s fu rth er adju sted to
separate consumer investm ents in fu r n itu r e , autom obiles and other durables from
a c tu a l consumption o f the s e r v ic e s provided by those d u r a b le s, the exhaustion o f
nondurable goods and se rv ic e exp e n d itu re s, the r a t io o f th is adju sted Con­
sumption to ad ju sted GNP would be even more d i s t o r t e d .)
Can there ever be an
econom ically more d e sir a b le time to r a is e g a so lin e e x c is e taxes than now?
The
p ric in g and production o f na tu ral gas C urrently i s so Confused that the Imme­
d ia te p ric e d econ trol su b je c t to a w in d fa ll p r o f i t s tax would soon r a t io n a liz e
production in that in d u stry , r a is e n a tu ral gas p ric e s l e s s d ra m atically than the
c u rren tly ev o lv in g process o f d e c o n tr o l, and s i g n i f i c a n t ly add to government
revenues.
I would now li k e
posed.

to

Conclude

by

s p e c ific a lly

responding

to

the q u estio n s

A s ig n if ic a n t upturn in the economy w i l l not be apparent u n t il the f i r s t
h a lf o f 1983.
Economic a c t i v i t y should grow about 41/2% in the f i r s t h a lf o f the
year b efo re slow ing to a 3V2% growth path in the second h a l f .
I n te r e s t ra te s
should again begin r i s in g soon a f t e r the beginning o f the ye a r, e s p e c ia lly as
consumer spending in a n tic ip a tio n o f fu rth e r red u ction s In tax l i a b i l i t i e s w i l l
provide some th ru st to economic growth.
I c u rr e n tly b e lie v e the prime ra te w i ll
not f a l l below 11% and may be trending m odestly upward during the seCond h a lf o f
1983 i f no e x c is e taxes are enacted to reduce p ro je c te d government d e f i c i t s .
Long-term in t e r e s t ra te s probably w i l l p la te a u during the f i r s t h a lf o f 1983
near curren t l e v e l s .
A dramatic in cre a se in in t e r e s t ra te s in 1983 C urrently
appears to be u n lik e ly .
However, the in t e r e s t s e n s i t iv e p ortion s o f the eConomy
c le a r ly w i l l not re c e iv e s ig n if ic a n t stim ulus from sharp d e c lin e s in r e a l ra te s
o f in te r e s t.
Only housing i s expected to show any s ig n if ic a n t resp o n se,
although gain s there may be r e la t i v e l y r o b u st.
Our Current p ro je c tio n s are fo r
housing s t a r t s to average 1 .3 m illio n in the f i r s t h a lf o f 1983 and then acce­
le r a t e to 1 .5 m illio n in the second h a l f .
S ta r ts are expected to be in the 1 .6
m illio n range in 1984.
Automobiles are expected to expand to a 9 .3 m illio n
s a le s ra te in 1983 and a 10 m illio n s a le s ra te in 1984, although moderation o f
r e la t iv e p r ic e s w i l l be more important in reaching those le v e l s o f a c t i v i t y than
any s ig n if ic a n t d e c lin e In in t e r e s t r a t e s .
According to t h is current o u tlo o k , unemployment r a te s probably w i l l peak
s l i g h t l y in exCess o f 10.5% with the peak occurring about the end o f 1982.
Of
c o u r se , i f fou rth quarter GNP shows l e s s stre n g th than the 1.0% maximum pro­
je c te d h e re , unemployment ra te s Could r i s e fu r th e r .
An 11% unemployment ra te Is
not out o f the realm o f p o s s i b i l i t y .
We C u rrently p r o je c t that unemployment
r a te s w i l l remain above 9.5% a t the end o f 1983 and f a l l to on ly 8.5% by the end
o f 1984.
Our fo r e c a s tin g process does not go beyond th a t p e riod , but a return
to 7.4% does not appear to be l i k e l y u n t i l the l a t e s t months o f 1985 or beyond.
As mentioned above, I c le a r l y b e lie v e th a t the growth o f government spending
should continue to slo w , with more c o n sid e ra tio n being given to slow ing the
b u ild -u p s in defense spending than has occurred in the p a s t.
Further attem pts
to reduce the d e f i c i t are appropriate because r e a l r a te s o f i n t e r e s t , w hile
d e c lin in g , remain h i s t o r i c a l l y h ig h .
I would p re fe r the use o f e x c is e ta x e s ,
e s p e c ia lly on energy consumption.
Of c o u r se , the s o c ia l s e c u r ity is s u e must be
addressed .
Given current economic C o n d itio n s, curren t b e n e fit form u la s, and
curren t tax p r o v is io n s , the next Congress w i l l fa c e a n ega tiv e Cash p o s itio n in
the s o c ia l s e c u r ity funds.




21 3

Monetary p o lic y probably has been too r e s t r i c t i v e in the p a s t, when sh o rt­
term in t e r e s t ra te s remained s i g n i f i c a n t ly above long-term in te r e s t ra te s long
a f t e r re c e ssio n began.
Now that the y ie ld curve has begun to show more normal
upward slo p in g c h a r a c t e r is t i c s , monetary p o lic y no longer can be s ig n if ic a n t ly
c r it ic iz e d .
While i n f l a t i o n has been s u b s ta n tia lly re s tr a in e d , the Federal
Reserve should not end i t s o b je c tiv e o f grad u ally squeezing a l l in fla tio n a r y
fo r c e s from the economy.
A return to c o n tr o llin g in t e r e s t ra te s i s not
a p p ro p ria te , but I b e lie v e th at co n sid e ra tio n about the stru ctu re o f in te r e s t
r a te s may provide h e a lth ie r monetary g u id e lin e s than a pure money growth formula
can a c h ie v e .
For example, d e c lin in g sh o rt-term in t e r e s t ra te s while long-term
r a te s are r i s in g may in d ic a te th at monetary p o lic y i s too r e s t r i c t i v e (or i t may
r e f l e c t e x c e ssiv e d e f i c i t fin a n c in g ).
Monetary p o lic y c u rr en tly appears to be
appropriate fo r the p r e v a ilin g co n d itio n s in an economy s t i l l s u ffe r in g from
some in fla t io n a r y p re ssu r e s.
I hope these comments w i l l stim u la te some thoughts concerning p o lic y ob jec­
t i v e s that prudently can be pursued to improve the h e a lth o f the n a tion *s eco­
nomy.
As my P ro je ct has done e x te n siv e work in an alyzing in fla tio n a r y
c o n d itio n s , I have taken the li b e r t y to append the l a t e s t inform ation we can
generate on consumer and producer p rice movements.
I hope th is inform ation w ill
h elp your d e lib e r a t io n s .
Thank you.




214

CPI DETAIL

Aug.
(E s t.)

Aug.
(Actual)

12 mos.
to Aug.

Sept.
(E s t.)

Oct.
(P roj.;

0 .6

0 .3

----

0 .2

0 .0

0 .2
-0 .3

5 .9
3.6

0.2
-0 .1

- 0 .2
0.1

( - 0 .0 )
-0 .1
- 0 .3
0 .2
- 0 .3
1.5
- 0 .2
0 .3
0 .0

( - 0 .7 )
0 .2
-1 .2
0 .0
-2 .8
0 .2
- 0 .4
0 .2
0 .7

( 2 .9 )
3.8
1.5
1.9
2.4
- 4 .0
2.6
4.7

( - 0 .4 )
“O ’
- 0 .2
0 .3
- 2 .8
0 .9
- 0 .4
0 .0
0 .3

( - 0 .1 )
0 .0
- 0 .0
0.1
- 1 .0
0.2
- 0 .2
0.1
0 .3

(Food Away From Home)

( 0 . A)

(0 .4 )

(5 .1 )

( 0 .3 )

(0 .4 )

(A lcoholic)

( 0 .2 )

(0 .4 )

(4 .3 )

( 0 .4 )

(0 .3 )

Other Commodities

0 .3

0.1

4.1

0.2

0 .4

0 .3
- 0 .7
0 .5
0 .5
0.1
0 .9
0 .0
1.0
0 .4

1.2
- 0 .4
0.4
0 .3
-0 .7
0.1
0.1
0 .7
-0 .2

1.6
- 3 .0
9.2
9 .9
3.8
5 .6
3.5
14.1
6.2

1.7
- 0 .2
1.2
0 .6
0.2
0 .6
- 1 .9
0.1
0.2

0.7
- 0 .5
1.7
0.8
0.1
0 .8
0 .9
0.2
0.2

0 .5

0.6

8 .6

0.2

- 0 .9

0 .8
0 .4
0 .4
0 .3
0 .8
1.0
0 .5

0.5
0 .5
0 .6
0 .6
0.2
1.0
0.7

7 .5
10.1
12.1
5.1
8 .0
11.6
8 .6

0.7
- 1 .4
1.0
0 .4
0 .2
0 .9
2.4

0.7
-4 .7
0.1
0.3
0 .2
1.1
0 .3

Index Less Home and Mortgage

0 .3

0 .2

5.6

0 .3

0 .2

Index on Rental Equivalent

0 .4

0 .2

5.9

0 .4

0 .3

Total Index S.A.
Not Seasonally Adjusted
Index
Food & Beverages
(Food at Home)
Cereals
Meat8
Dairy
Fruits & Vegetables
Sugar
Fats & Oils
Nonalcoholic Beverages
Other

Apparel
Energy (commodities)
Tobacco
Medical
Furnishings
Home (purchase)
New Cars
Used Cars
Entertainment
Services
Rent
Mortgage Interest
Energy
Other Household
Transportation
Medical
Other

*E st.
Proj.

- Estimated
- Projected




0 .A
0 .2

215

EXTENDED CPI PROJECTIONS
(NOT SEASONALLY ADJUSTED)

Cumulative Changes
(Not Annual Rates)

Index of All Items
Food & Beverages

Dec. 1980Oct. 1981

8.3
4.2

Dec. 1981Oét. 1982

Dec. 1980Dec. 1981

Dec. 1981Deé. 1982

Dec. 19
Deé. 19

4.0
3.5

8.9
4.3

4.5
4.4

5.5
5.6

(Food at Home)
Cereals
Meats
Dairy
Fruits & Vegetables
Sugar
Fats & Oils
Nonalcoholic Beverage
Other

(3.1)
6.4
0.3
2.8
7.7
-6.8
6.6
2.4
7.5

(2.8)
2.8
4.4
1.2
1.6
4.1
-1.7
2.8
3.3

(3.0)
7.4
-0.8
3.2
8.1
-7.0
3.7
1.8
8.4

(3.9)
3.2
6.1
2.0
2.2
4.6
-2.3
4.3
4.2

(5.7)
4.5
6.3
4.4
5.6
6.5
5.3
6.5
5.9

(Food Away From Home)

(6.7)

(4.4)

(7.2)

(5.2)

(5.6)

(Alcoholic)

(5.1)

(4.4)

(5.8)

(5.1)

(5.3)

Other Commodities

6.5

3.5

6.8

4.2

5.8

3.5
10.7
6.9
9.7
5.8
2.0
4.3
18.7
6.3

2.5
-3.2
8.8
8.2
2.5
7.8
-0.1
8.3
4.7

2.7
10.6
7.6
11.3
6.1
1.2
6.8
20.3
7.1

2.0
-2.8
9.1
9.7
2.9
8.9
1.9
9.3
5.3

2 .6
5.3
7.6
9.3
4.1

11.9

4.6

13.0

4.7

5.1

7.0
19.0
14.9
9.3
9.9
10.7
8.6

5.8
-2.0
13.5
5.0
5.2
9.5
6.8

8.5
20.0
14.7
10.7
11.1
12.7
9.4

7.3
-4.6
12.6
5.8
6.1
11.3
7.5

7.5
-3.7
10.7

Index Less Home and Mortgage

7.8

4.2

8.5

5.2

6.4

Index on Rental Equivalent

7.7

4.6

8.5

5.5

6.5

Apparel
Energy (commodities)
Tobacco
Medical
Furnishings
Home (purchase)
New Cars
Used Cars
Entertainment
Services
Rent
Mortgage Interest
Energy
Other Household
Transportation
Medical
Other




8 .2

5.3
6 .6

5.0

6.8
7.4

11.0
7.0

216

PRICE CHANGES BY STAGE OF PROCESSING

September
(estimated)
% Change

September
(actual)
% Change

NSA

NSA

SA

Oct.
(estimated)
% Change
NSA

SA

-0.1

3.6

0.8

0.4

-0.1

3.3

0.6

0.4

0.1
0.1

-0.4
0.5

CO

-0.5
0.1

1.4
4.0

-0.6
1.0

0.1
0.4

-0.2

0.1

-0.7

-0.4

5.4

1.5

0.2

0.5

0.6

-0.1

0.0

0.3

0.1

0.2

Foodstuffs
Industrials

-0.9
0.6

-1.7
0.8

-0.9
-0.1

-1.8
0.1

-2.1
0.4

-0.7
0.2

Crude Materials

-0.8

-0.8

-1.3

-1.5

-3.4

-1.3

-0.7

Crude Foods
Other Crude
Material s

-1.8

-2.8

-3.1

-3.8

-4.1

-3.0

-2.2

0.1

0.5

0.7

1.0

-2.4

0.4

0.7

Consumer Finished

Capital Equipment
Intermediate Goods

1

Consumer Foods
Consumer Nonfoods

Next Release Date: Thursday, November 18, 1982




INS

-0.4
-0.2
C

0.3
0.3

Finished Goods

o o’

0.1
0.1

i
o o

SA

% Change
9/81-9/82

217

ESTIMATED PRICE CHANGES RY SECTOR

Total Index
Food
Farm Product
Processed Foods
Industrial Commodities
Textile
Leather
Fuel s
Chemicals
Rubber
Lumber
Paper
Metals
Machinery
Furniture
Nonmetal lie Materials
Transportation
Miscellaneous

Sept. (est)
% Change

Sept. (act)
% Change

% Change
9/81-9/82

Oct. (est)
% Change

0.0

-0.3

1.3

0.1

-0.8

-1.0

-1.1

-1.2

-0.9
-0.8

-3.1
0.0

-6.7
1.9

-2.2
-0.7

0.3

-0.2

1.8

0.4

0.3
0.2
-0.2
0.2
0.0
1.9
0.1
0.8
0.2
0.8
0.2
-1.2
3.1

-0.0
0.6
-0.6
-0.1
-0.1
-0.5
0.0
0.5
0.2
0.1
0.1
-2.5
2.9

0.4
1.2
-0.2
-0.6
3.2
-2.2
4.1
-1.0
4.6
3.3
2.4
5.7
5.0

0.2
0.4
-0.1
0.4
0.4
-0.3
0.0
0.1
0.3
0.5
0.1
2.3
0.6

PERCENTAGE PRICE CHANGES, INDUSTRIAL COMMODITIES, UNADJUSTED

Unchanged
October 1982
September
August 1982
July 1982
June 1982
May 1982
April 1982
March 1982
February 1982
January 1982
December 1981
November 1981
October 1981




73%
78%
72
76
74
76
72
74
65
70
71
77
72

Decreased
16%
10%
18
12
16
16
15
16
24
20
20
19
18

Increased
11%
12%
10
12
10
8
13
10
11
10
9
4
10

Index Change
Est.
Act.
0.4
0.3
0.1
0.6
0.4
0.1
-0.2
0.1
0.1
0.1
0.2
0.1
0.5

-0.2
0.1
0.7
0.4
-0.1
-0.4
-0.1
-0.1
0.5
0.3
0.1
0.5

218

EXTENDED PPI PROJECTIONS
SECTOR PRICES
(Not Seasonally Adjusted)

Cumulative Changes
(Not Annual Rates)
Ino^.. of All
Commodi ties
Farm Prices
Farm Products
Processed Foods
Industrial Commodities
Textiles
Leather
Fuels
Chemicals
Rubber & Plastics
Lumber
Pulp & Paper
Metals
Machinery
Furniture
Non-Metallic Materials
fansportation
Miscellaneous Products

Dec. 1980Sept 1981

Dec. 1981Sept 1982

Dec. 1979Dec. 1980

Dec. 1980Dec. 1981

Dec. 1981Dec. 1982

Dec. 19
Dec. 19

5.4

1.3

12.5

5.3

2.0

-4.3

1.6

9.5

1.6

-8.4
-1.9

-2.0
3.4

9.4
9.7

-6.2
—
-11.6
-3.1

-3.1
4.0

5.8
4.1

7.8
---

1.3
---

13.2

8.2

2.1

5.2

7.1
1.2
13.4
9.1
6.3
-5.0
8.8
5.1
7.8
4.2
7.6
9.0
1.2

0.4
1.9
-0.2
0.2
2.5
-1.2
2.9
-0.4
3.3
2.8
2.4
1.6
5.3

10.0
3.1
26.2
12.6
8.5
3.2
10.8
6.2
11.8
8.5
12.2
14.7
16.7

6.8
1.5
14.1
8.8
6.7
-4.7
9.5
4.4
8.9
5.1
7.7
10.0
0.9

0.8
2.4
0.6
0.5
3.1
1.3
3.7
0.5
4.2
3.7
2.7
2.7
5.6

3.4
4.3
5.0
5.3
5.6
7.4
6.3
5.7
4.9
3.5
5.9
5.0
4.6

5.1
--4.7
■

STAGES OF PROCESSING
(Not Seasonally Adjusted)
Finished Goods
Consumer Finished Goods
Consumer Foods
Consumer Nonfoods

6.6
---

2.9

11.8

7.1

3.3

5.4

6.3

2.8

11.9

6.5

3.0

5.2

1.9
7.9

2.2
3.1

7.5
14.2

1.4
8.5

1.5
3.6

5.3
5.2

8.2

3.5

11.4

9.2

4.3

6.0

6.0

0.6

12.6

6.0

1.2

4.8

-11.4
Intermediate Foods
7.2
T'^rmediate Industrials

0.8
0.6

16.1
12.4

-12.9
7.3

-0.6
1.3

7.4
4.6

-1.1

0.3
---

12.8
---

-3.7

0.6

“

7.7

-9.5
10.5

1.3
-0.5

8.6
19.1

-14.0
10.3

0.2
1.0

6.3
9.2

Capital Equipment
Intermediate Goods

!Crude Materials
Crude Foodstuffs
Crude Nonfoods




"

219

Representative R euss. They have, indeed, been useful. Thank you.
Finally, Mr. Sinai.
STATEMENT OF ALLEN SINAI, SENIOR VICE PRESIDENT,
DATA RESOURCES, INC., LEXINGTON, MASS.

Mr. S in a i . Thank you, Mr. Chairman.
It is nice to be here again. I recall that the last time I was here in
January I was quite gloomy. I suspect that my remarks today will be
more optimistic than the panel of colleagues, although they are, I
would say, cautiously optimistic.
I think the patterns of recession are giving way to patterns that
foreshadow an economic expansion. Despite the fact that we really
have almost no immediate signs of an imminent end to the long down­
turns that we have been suffering through, the necessary preconditions
for an upturn.are emerging, and these are, most importantly, a funda­
mental turn in the financial markets during this past July, sparked by
the dawning realization that inflation rates are permanently down to
midsingle digits or below. When I say permanently I mean as far as
our forecasting goes, which is for a few years. A tilting away from the
original loose fiscal-tight money policy mix of Reaganomics to a
tighter fiscal-easier money configuration also is a major factor.
Since midyear short-term interest rates have dropped by 5 to 6 per­
centage points, bond yields are down about 300 basis points, the stock
market has risen by over 30 percent, and the critical process of reliquefication for the financial positions of households, businesses, and
financial institutions is really underway.
Borrowing costs for businesses are much reduced, down 4y2 to 6
percentage points in the prime and commercial paper rates, and long­
term corporate bond yields for top quality debt are down 3 percentage points. The volume of new issues for corporate bonds was around
$39 billion, at an annual rate, in the summer quarter, evidence that
a restructuring of debt maturities to a longer term is in process.
Mortgage rates are down 3 to 5 percentage points in terms of stated
rates, and this reduces the average monthly loan repayment burden
by $150 to $200 for the typical 80 percent long-term loan on $60,000
of borrowing.
Consumer loan rates have dropped as well, by 1 to 3 percentage
points. That reduces the monthly payments on auto loans by $15 to
$25. Not a lot of money, but it is a move in the right direction.
The stock market surge has increased household net worth, by our
estimates, $120 billion in real terms, or almost 5 percent. If these
patterns in the financial markets are sustained, the pressure on the
financial positions in the private sector of our economy should ease
up, then flow through to raise spending and housing, consumption,
and business capital outlays eventually.
Another important factor is that the Federal Reserve is now acting
to sustain this fundamental turn in the financial markets, having
relaxed in its slavish pursuit of monetarism, and for good reason.
Mi has really been a poor proxy for nominal GNP, which is the
ultimate target of the Federal Reserve, and an imperfect indicator
for monetary policy, at least during the past year.




220

Greater demand for precautionary money balances and increased
liquidity preference in a period of exceptional uncertainty has raised
Mi without a corresponding rise in GNP. And the changes in deposi­
tory instruments makes the measure of transactions balances in the
economy very, very difficult.
And so, under these circumstances the central bank has acted
prudently and correctly in temporarily departing from its monetary
growth targets since following them rigidly would only prolong the
recession, as was the case in January and April of this year.
What makes me encouraged, cautiously encouraged at this point
in what otherwise is a very grim picture for the economy at this
moment of time, is that these patterns of behavior in the financial
markets are really very familiar, and they always have preceded
economic recovery. And they are not just indicators; they actually
have cause and effect impacts on the economy although with variable
lags.
Until midyear the patterns of financial market behavior, these
patterns that I ’ve described, hadn’t yet begun to appear, and that
really meant that the economy could not begin to recover without
those basic preconditions in the financial markets having existed.
But now the patterns have started. W e’ve never had a recovery with­
out most or all of them in place. It has occasionally happened that
once the conditions have turned we have not had a recovery, but that
really has been quite rare.
The problem is that the lags between when these patterns emerge
and a broad-based improvement in economic activity occurs can be
quite long. The average length of time elapsed between the turn in
the financial markets and recovery for all business-cycle episodes since
1953 is about 9 months. The variance has been 4 to 15 months. In this
particular episode the transition from recession to recovery is likely
to be painfully slow and probably 2 to perhaps as much as 6 months
more before spending responds enough to lower interest rates, the
stock markets and the tax cuts to really give us what you would call
a significant or meaningful recovery.
The traditional lags are there, which is one reason for these delays.
There is another problem special to this episode, and that is the un­
usually severe fallout of failures and joblessness and deteriorated
financial positions from this unprecedented downturn.
I think Mr. Dalio really has described the very negative potential
of those possible risks.

The third risk is the possibility of debt deflation, should we have
prices actually falling, something Irving Fisher talked about in the
thirties. And you really can’t dismiss that either. Prices go down so
fast, profit margins are squeezed, and a number of businesses can’t pay
their debts and then banks go under as well. I think basically most of
that is behind us now and already has happened.
So in coming months we would expect these financial market pat­
terns to continue, and I ’m going to identify them and highlight them
as the big part of my remarks because I think these really haven’t
been touched upon by most of the other panelists.
We would expect further declines of short- and long-term interest
rates in this transition.




221
We would expect continuing moves by the Federal Eeserve to sup­
port an easier tone in financial markets. This is likely and indeed nec­
essary, and I read Chairman Volcker as saying that monetary policy
will now encourage a recovery until one is clearly in view, and that’s
the next time the Federal Eeserve will have to then reassess the policy.
But I think they are going to accommodate the recovery until it’s ac­
tually there and all of us can agree that it’s there before they might
then think about turning another way.
The third risk, reliquefication by households, businesses, and finan­
cial institutions, is in process and will occur over the next year to re­
store deteriorated balance sheets, and as that happens, then stronger
spending patterns will evolve.
This includes reducing debt service ratios as outstanding debt is
repaid, and lower interest rates impact on balance sheets.
This includes a sizable reintermediation of funds to depository in­
stitutions from the new lower interest rates and new deposit instru­
ments that have now been created.
This includes improvement in affordability parameters for consum­
ers because monthly loan repayments will go down and incomes will
rise from the lagged effects of the tax cut.
This includes improving business cash flow relative to expenditures
because business will be spending less in the next 6 to 9 months, but
their cash flow will jump up because inflation rates are lower and
because of the tax cuts of last year.
And the stronger stock market will help businesses to really re­
structure their debt and to get more equity financing and to lower
leverage.
It will also improve sentiment and confidence, eventually more
than offsetting the negative effects on consumption from the psycho­
logical impact of high joblessness.
And then these bankruptcy problems should, although they remain,
fade somewhat in the next 6 to 9 months as well.
So, we are cautiously optimistic on the beginning of a recovery
for the economy late in the fourth quarter, with a numerical predic­
tion on real GNP that I would not conclude has really shown a signifi­
cant recovery, 2 to 2y2 percent. Eeally, the first quarter of a good
recovery will be the first quarter of next year. We now think the
profile of recovery will take on a traditional cast, with housing ac­
tivity and increased consumption the leaders, then inventory accu­
mulation and rising employment. Business capital spending will be
late, as always, because utilization rates will be low and businesses
won’t believe the sales are there permanently until they have been
there for quite a long time.
Improved affordability of big ticket items from lower interest rates
and rising income will help move the economy higher in autos and
housing. It really doesn’t take much of an improvement in those two
categories to get some greater growth.
For 1983 as a whole we are forecasting a 3-percent increase in real
GNP. We think the growth rate will be uneven. There will inevitably
be another bump up in interest rates because the Fed will have to
come to grips in the first half with the monetary aggregates and their
relation to policy. But we don’t think the blip upward in interest

17- 87: )

o




83

15

223
rates will be sufficient to turn and push the economy into another
recession or depression in 1983 or 1984.
Now for policy. Policy has really gotten us here and policy has to
get us out of the particular problems in the economy. In fairness to
policy, it also has, especially monetary policy, given us a magnificent
improvement on inflation. The rest of the theory is that interest rates
go down, purchasing power rises, and then we get a recovery. And
weVe got to wait to see that. But that fundamental break in inflation
and in inflation expectations, as is now being shown in the financial
markets, is not something to take lightly. That is a very fundamental
key to eventual recovery and not having a depression.
For policy, the mix of policy and size of the Federal budget deficits
will continue, of course, to play a critical role in the prospects for
a sustainable recovery. To assure a sustained recovery, both fiscal and
monetary policy will have to continue tilting toward a tighter fiscaleasier money mix. This will require further reductions of Federal
spending in the fiscal year 1984 budget; that is, the administration
should not propose anything less than some very tough budget medi­
cine in January, and in particular, they will have to tackle entitle­
ments and military outlays and the growth in those areas, because that
is the onlv place now for big savings in the budget.
Should they fail to present a budget that really attacks those two
areas in a serious way, then the financial markets will send them back
to the drawing boards just as they did with President Carter and with
President Reagan a year ago.
You know, the financial markets are really neutral; they’re bipar­
tisan. No matter what party presents a loose fiscal policy to the finan­
cial markets, back to the drawing board the party president will go if
it is too loose of a budget.
The Federal Reserve must continue to compensate for any budget
tightening by promoting monetary growth somewhat above the upper
range of its target limits. Indeed, I think the Federal Reserve will
make a fundamental change in policy now that it has realized the folly
of slavishly following Mx. It will be good if they look more at those
targets in the economy, inflation, and unemployment that they are
ultimately shooting at. In fact, I don’t even understand why they use
Mi, M2, or M3, because I think there is enough information content in
the economy in the monthly data and real GNP and what we see in
inflation and what we know about unemployment to guide policy
through those, which are really their ultimate targets. I would wish
they would stop using the monetary aggregates and go to those ele­
ments in the economy that they really are shooting for.
So this is very critical, and one way or another the Federal Reserve
will have to continue to be more accommodating over the next year or
two to sustain the kind of recovery that we see in our forecast.
Joblessness—you asked about the unemployment rates. Our current
forecast of the peak is 101/2 percent. I thought that was a terrible num­
ber ; it now sounds wildly optimistic here today. We would expect that
before the end of the year, and really after that there will be only a
cautious pace of rehiring because corporations will be slow to rehire
after having been devastated so much in this downturn. We are
projecting unemployment rates above 9 percent throughout 1983 and




223

in excess of 8 percent until the end of 1984. Like Mr. Ratajczak, we do
not see an end or a 7.4 percent unemployment rate until late 1985.
We do think productivity should show an above average cyclical
upturn, and that may be a sleeper in lowering unit labor costs and pro­
viding us with very low inflation rates over the next year.
The interest sensitive sectors that you asked about, such as housing,
automobiles, and capital formation, should respond favorably to the
lower interest rates, although it lags, and improve financial market
conditions and rise gradually from the current depressed levels.
However, the rebounds in these areas will be much less and the levels
ultimately reach much lower than the previous peaks in 1979 and 1980.
We show housing at 1.38 million units in 1983, 1.65 million units in
1984. Those are good increases. That will help the growth rates. But
it is far below the level of activity in 1979.
We forecast auto sales of 9 million units by mid-1983 and almost 10
million for the year 1984, but that is far below the 10.6 million unit
pace of 1979.
Business capital formation really will not respond until late 1983,
and the first good year we see is 1984.
Indeed, 1984 looks to us to be the first basically excellent year for
the economy, with broad-based improvement throughout. We really
will have rather slow growth until that point.
For the approach of policy, which you also asked about, I’ve indi­
cated the mixes. Continuing to tilt the mix toward tighter fiscal-easier
money is quite critical. I would encourage the Federal Reserve not to
worry about the monetary aggregate so much and to permit 6y2 per­
cent growth in Mx. That would not be horrible; that will not reignite
inflation expectations when there is so much slack now in the economy.
It will take us a long time to reignite inflation, which is now funda­
mentally broken down in much lower levels.
But tilting the mix of policy toward a tigher fiscal and easier
money approach alone is no longer sufficient, because we have so much
fallout of failures and joblessness. I think now—and this is a change
of mind—the tax cut scheduled for 1983 should be permitted to take
effect. I had really been opposed to that before, but I believe now we
have so much slack in the economy that we really have to have that
kind of Keynesian stimulus on July 1, 1983, to keep the expansion
going. That makes biting the bullet on Federal Government spending
again, in particular entitlements and military spending, very, very
essential in helping to keep our expansion going, and, of course, the
role of the Federal Reserve as well.
The major task of policy now should turn to insuring expansion
without reigniting inflation. This has always been an impossible task.
But it is true. We unfortunately now have the opportunity once again
to deal with that problem, and I would, I guess, share a view that sug­
gests that it would be better to grow slowly at first if one can grow
slowly without causing a stall; it would be better to have a gradual
expansion at first, which would then permit the supply-side potential
output growth in later years to perhaps keep distance with the in­
crease in aggregate demand.
But I would favor not getting us approaching full employment
potential too fast. I think we really have to start looking for new
kinds of ways that government, business, and labor can work together




224

to prevent a resurgence of wage costs. It is essential that inflation rates
stay low for a sustained recovery. And then we are going to need spe­
cific programs to absorb pockets of unemployment that will be left
even after the economy recovers.
If you look at the composition of unemployment, it’s clear wTe’ll get
a reabsorption of the generally well-trained workers. But the economy
has been so shaken up by the last 3 years, we are having such a change
in where growth is and where growth isn’t, such a change in our tradi­
tional industrial structure, that we are going to have a lot of lack of
reabsorption of workers in heavy industry, and they are not going to
work well in high tech. And we’re going to have problems with re­
gard to minority groups and with this new structure of the economy
in terms of reabsorbing workers.
The Fed will have to come to grips with whether to continue the
new Fed policy. That really was appropriate if the goal was to break
inflation. It is no longer appropriate; that automatic reaction to the
monetary aggregates is no longer appropriate since inflation is no
longer public enemy No. 1; unemployment is.
I think we are seeing the Fed make that shift now away from the
new Fed policy of October 1979. I would regard it in its current form
as temporary, but I believe they will make a permanent change and
we will not be back in any form whatsoever to this very quick tighten­
ing of monetary policy anytime we have a hint or a little bubble of
growth in the economy. If we do, then I would be a lot more pessimistic
than our numbers now show.
[The prepared statement of Mr. Sinai follows:]




225

P r e p a r e d St a t e m e n t o f A l l e n S inai *

I.

In trodu ction and Summary

The patterns of recession are giving way to patterns that foreshadow an economic
expansion. Despite, as yet, few immediate signs of an imminent end to the long downturn
of the U.S. economy, the necessary preconditions for an upturn are emerging. Most
importantly, a fundamental turn in the financial markets this past July is laying the
groundwork for recovery. The catalysts for this turn have been the dawning realization
that inflation rates are permanently down to mid-single digits or below and a tilting away
from the original "loose fiscal-tight money" policy mix of Reaganomics to a "tighter
fiscal-easier money" configuration.
Since midyear, short-term interest rates have dropped from five to six percentage points,
bond yields are down about 300 basis points, the stock market has risen by over 30%, and
the critical process of reliquefication for the financial positions of households, businesses,
and financial institutions is underway. Borrowing costs for business are much reduced,
ranging from k-Vi to 6 percentage point declines in the prime and commercial paper rates
to near 3 percentage point reductions in long-term corporate bond yields. The volume of
new issues for corporate bonds rose to an estimated $39 billion annual rate in the summer
quarter, evidence that a restructuring of debt maturities to a longer term is in process.
Mortgage rates have dropped from three to five percentage points, reducing average
monthly loan repayment burdens by $150 to $200. Consumer loan rates are lower by one
to three percentage points, reducing the monthly payments on a typical auto loan by $15
to $25. The stock market surge has increased household net worth by an estimated $120
billion in real terms, or almost 5%. If sustained, these changes should considerably ease
the pressure on the financial positions of households, business, and financial institutions,
then flow through to raise spending on housing, consumption and business capital outlays.
In addition, the Federal Reserve is now acting to sustain the fundamental turn in the
financial markets, relaxing its slavish pursuit of monetarism and for good reason. Ml has
been a poor proxy for nominal GNP, the ultimate target of the Federal Reserve, and an
imperfect indicator for monetary policy during the past year. A greater demand for
precautionary money balances, or increased liquidity preference, in a period of
exceptional uncertainty has raised Ml without a corresponding rise in GNP. And,
numerous changes in depository instruments have made the measurement of transactions
balances in the U.S. economy extremely difficult. Under these circumstances, the central
bank has acted prudently in temporarily departing from its monetary growth targets since
a rigid pursuit of them could only continue to prolong the recession, as was the case in
January and April of this year.
The recent patterns of behavior in the financial markets are quite familiar and always
have preceded economic recovery, providing justification for cautious optimism about the
future performance of the U.S. economy, especially in 1983 and 1984. Until midyear,
these patterns of financial market behavior had not yet begun to appear, casting doubt on
the ability of the economy to mount a meaningful recovery despite the personal income
tax cuts of July 1. But now the fundamental financial market behavior that is a
precondition for expansion has moved into place, aided by the modest easing in Federal
Reserve policy. No recovery has ever occurred without most or all of these financial
market underpinnings in place. The necessary turn in financial market conditions has
sometimes occurred, however, without a corresponding recovery in the economy.
♦Senior Vice President, Data Resources, Inc.
and Andrew Lin is gratefully acknowledged.




The research assistance of Michael Evelyn

226
U n fo r t u n a t e ly , t h e la g s b e t w e e n th e e m e r g e n c e o f t h e s e p a t t e r n s and a b r o a d -b a s e d
i m p r o v e m e n t in e c o n o m i c a c t i v i t y c a n b e q u it e lo n g . T h e a v e r a g e le n g t h o f t im e th a t has
e la p s e d b e t w e e n a tu rn in th e f in a n c ia l m a r k e ts and r e c o v e r y fo r a ll e p is o d e s s in c e 1953 is
a p p r o x im a t e ly 9 m o n t h s , w ith a v a r ia n c e o f 4 t o 15 m o n th s . In th is p a r t ic u la r e p i s o d e , t h e
t r a n s itio n f r o m r e c e s s i o n t o r e c o v e r y is lik e ly t o b e p a in fu lly s lo w , w ith t w o and p e rh a p s
a s m u ch as s ix m o r e m o n th s t o g o , and s till c o n s id e r a b le risk s t h a t n o m e a n in g fu l o r
s u s ta in e d r e c o v e r y w ill o c c u r p r io r t o m id -1 9 8 3 . O n e r e a s o n is th e t r a d it io n a l la g s t h a t
o c c u r b e f o r e s p e n d in g r e s p o n d s t o lo w e r in t e r e s t r a t e s , an im p r o v e m e n t in t h e s t o c k
m a r k e t , an d t a x c u t s . A n o th e r is s p e c ia l t o th is e p is o d e : th e u n u su a lly s e v e r e f a ll o u t o f
f a ilu r e s , j o b le s s n e s s , and d e t e r io r a t e d f in a n c ia l p o s it io n s f r o m
th e u n p re ce d e n te d
d o w n tu r n in th e U .S . and w o r ld e c o n o m ie s s in c e 19 7 9 . A th ird risk a r is e s as a s id e e f f e c t
f r o m t h e m a jo r s u c c e s s so fa r a g a in s t in fla t io n , th e p r o c e s s o f d e b t d e f la t i o n o r ig in a lly
d e s c r ib e d by I r v in g F is h e r , w h e r e d e c lin in g p r ic e s s q u e e z e p r o f it m a r g in s , r e d u c e th e
v a lu e o f a s s e t c o l l a t e r a l , and r a is e th e b u rd e n o f d e b t e n o u g h to c r e a t e e x c e p t i o n a l ly h igh
risk s o f b a n k r u p t c ie s f o r d e b t o r s . T h u s, d e s p it e th e e n c o u r a g in g sig n s fr o m t h e fin a n c ia l
m a r k e t s , n o i m m e d i a t e r e c o v e r y is lik e ly t o a p p e a r . In s te a d , s o m e f u r th e r b o t t o m in g o u t ,
th e n a g r a d u a l u p tu rn is th e m o s t p r o b a b le p a t t e r n .
W ith h i s t o r i c a l p a t t e r n s as a g u id e , w h a t c a n b e e x p e c t e d in c o m in g m o n t h s ?
F ir s t ,
fu r th e r d e c l in e s o f s h o r t - and lo n g - t e r m in t e r e s t r a t e s sh o u ld o c c u r in th e t r a n s itio n f r o m
r e c e s s io n t o r e c o v e r y , t h e r e s u lt o f a d e p r e s s e d e c o n o m y , lo w s i n g le - d i g i t r a t e s o f
i n fl a t i o n , a n d an i n c r e a s e d v e l o c i t y o f m o n e y b e c a u s e o f r e li q u e f i c a t io n by t h e p r iv a t e
s e c t o r . S e c o n d , c o n t in u in g m o v e s by th e F e d e r a l R e s e r v e t o s u p p o r t an e a s ie r t o n e in
fin a n c ia l m a r k e t s a r e lik e ly and in d e e d n e c e s s a r y , e v e n th ou gh m o n e y g r o w t h and le v e ls
m a y b e a t u p p e r t a r g e t lim it s o r a b o v e t h e m .
T h ir d , a m a jo r r e li q u e f i c a t io n by
h o u s e h o ld s , b u s in e s s , an d f in a n c ia l in s t it u t io n s w ill o c c u r t o r e s t o r e s e v e r e ly d e t e r io r a t e d
liq u id it y and b a la n c e s h e e t p o s it io n s .
F o u rth , d e b t s e r v ic e r a t io s w ill b e r e d u c e d as
h o u s e h o ld s an d f ir m s p a y d o w n o u t s t a n d in g d e b t and th e e f f e c t s o f lo w e r in t e r e s t r a t e s
im p a c t on b a l a n c e s h e e t s .
F i f t h , a s iz e a b le r e in t e r m e d ia t io n o f fu n d s t o d e p o s i t o r y
i n s t it u t io n s s h o u ld r e s u lt f r o m
th e new lo w e r p la t e a u o f in t e r e s t r a t e s and th e
e s t a b lis h m e n t o f n e w d e p o s it in s t r u m e n ts th a t w ill b e m o r e c o m p e t i t i v e w ith m o n e y
m a r k e t m u tu a l fu n d s .
S ix th , a f f o r d a b il i t y p a r a m e t e r s f o r c o n s u m e r s s h o u ld g r a d u a lly
b e c o m e m o r e f a v o r a b l e t o p u r c h a s e s o f d u r a b le g o o d s , as m o n th ly a u t o and m o r t g a g e lo a n
r e p a y m e n t s d r o p an d in c o m e s r is e f r o m th e t a x c u t s . S e v e n th , b u s in e s s c a s h f lo w s h o u ld
im p r o v e r e la t i v e t o o u t la y s w ith c o r p o r a t e tr e a s u r e r s m o v in g q u ic k ly t o r e s t r u c t u r e d e b t
m a t u r it ie s t o a l o n g e r t e r m .
T h e s t r o n g e r s t o c k m a r k e t w ill p e r m it b u sin e ss fir m s t o
r e d u c e le v e r a g e th r o u g h m o r e e q u it y f in a n c in g , le a d in g to s t r o n g e r b a la n c e s h e e t s .
E ig h th , lo w e r i n fl a t i o n and a s t r o n g e r s t o c k m a r k e t w ill im p r o v e s e n t im e n t and
c o n f i d e n c e , e v e n t u a lly m o r e th a n o f f s e t t i n g th e n e g a t iv e e f f e c t s on c o n s u m p t io n fr o m
h igh j o b le s s n e s s .
N in th , th e p r e s s u r e s w h ich h a v e g iv e n r is e t o a r is in g t id e o f
b a n k r u p t c ie s , c o m m e r c i a l ban k f a ilu r e s , and s h a k e u p o f t h r ift s w ill g r a d u a lly s u b s id e a s
d e b t s e r v ic e b u r d e n s b e c o m e le s s o n e r o u s and th e p r iv a t e s e c t o r r e li q u e f i e s .
T h ese
p a t t e r n s in t h e f in a n c ia l m a r k e t s and risin g re a l i n c o m e w ill b rin g in c r e a s e d h o u s in g and
c o n s u m e r s p e n d in g , a g r e a t e r p a c e f o r r e t a il s a le s , in c r e a s e d o r d e r s , p r o d u c t io n , and
fin a lly r is e s in e m p l o y m e n t .
T h e p e r s o n a l i n c o m e t a x c u t s o f m id -s u m m e r sh ou ld p r o v id e m o r e s tim u lu s t o c o n s u m p t io n
o v e r th e n e x t s ix m o n t h s , a lth o u g h h o u s e h o ld s w ill re m a in c a u t io u s b e c a u s e o f h igh
jo b le s s n e s s and s t r o n g s a v in g s in c e n t iv e s . In r e t r o s p e c t , th e m in im a l im p a c t o f th e t a x
c u t s on c o n s u m e r s p e n d in g in J u ly and A u g u s t s h o u ld h a v e b e e n no r e a l s u r p r is e .
C o n t e m p o r a r y t h e o r ie s o f c o n s u m e r b e h a v io r a lm o s t u n iv e r s a lly s u g g e s t la g s in s p e n d in g
o f a t le a s t s e v e r a l m o n th s b e h in d c h a n g e s in re a l d is p o s a b le i n c o m e . In a d d it io n , u n til
r e c e n t ly f in a n c ia l m a r k e t c o n d it io n s w e re n o t c o n d u c iv e t o a m o r e ra p id p a c e o f s p e n d in g .




227
Major incentives to save in the form of high real aftertax returns on saving and
disincentives to borrow from high real aftertax costs of mortgage and consumer loans
deterred borrowing and spending. Over a 5% decline in the real net worth of households
between 1981:2 and 1982:2 also limited the response to the tax cuts, with falling home and
stock prices the major causes for the reduction. Rising joblessness slowed the growth of
income and the macro risk of potential joblessness restrained household spending. Indeed,
these factors still remain to limit and delay the response of consumption to the October
1981 and July 1982 tax reductions, but will gradually be overcome by the easier financial
markets.
The prospects for economic recovery thus are now considerably enhanced, with the likely
profile of expansion to be of a traditional variety. Rises in housing activity, retail sales.,
and consumption activity should lead the recovery. Sharp rises in military spending will
provide a sizeable stimulus. Then, increased production for sale and inventories will
occur, eventually tending to raise employment. The business sector should join the
expansion late, as is typically the case, with capital spending not rising much until
reliquefication is almost complete, sales steadily rising, and capacity utilization rates
much higher.
The question marks now must focus upon 1) the lags between the fundamental turn in the
financial markets this summer and timing of its impacts on the economy; 2) whether the
feedback effects of failure fallout and joblessness on confidence and spending will more
than offset the stimulus of the lower interest rates, stronger stock market and July 1
personal tax cuts; and 3) the choice of policies to sustain expansion without reigniting.
inflation.
Some specific conclusions are:
The U.S. economy should begin an upturn yet in the fourth quarter, although
anemic, with sustained but uneven growth to come during subsequent quarters. The
profile of the recovery now is likely to take on a traditional cast, with increased
housing activity and consumption leading the upturn, then inventory accumulation,
and rising employment. Business capital spending will not rise until well after the
expansion is under way, in response to permanently higher sales, rising utilization
rates, and improved corporate financial positions. The greater affordability of bigticket items from lower interest rates and rising income will help move the
economy higher, as will the impacts of the tax cuts on consumption in general.
Real economic growth is forecast at 2 to 2&96 in the fourth quarter, rising to a
3-1/2 or 4% rate of growth early in 1983, then accelerating during the second half
of next year with the third stage of the personal income tax cuts. Real economic
growth for 1983 is projected at 3%, with the largest rises occurring in residential
construction, consumption, and military spending.
The economy will grow
unevenly, however, accelerating the pace of expansion during the second half of
1983 and in 1984. By then, the expansion should be broad-based, with almost all
areas of the U.S. economy participating, and good-sized rises in sales, production,
and employment. However, the expansion is expected to be considerably weaker
than the typical postwar experience. The slack generated in the economy by the
recessions of 1980 and 1981-82 will still leave a large gap between actual and
potential GNP in 1984, however.
The mix of economic policy and size of the federal budget deficits will continue to
play a critical role in the prospects for recovery and its sustainability. Indeed, it is
the policy errors of the past, embodied in the budget impasse of earlier this year
and slavish pursuit of monetarism by the Federal Reserve, that brought the
economy to the brink of a major collapse. To assure a sustained recovery, both
fiscal and monetary policy will have to continue tilting toward a tighter fiscaleasier money mix. This will require further reductions of federal spending in the
FY1984 budget, including entitlements and military outlays.




22 8

T h e F e d e r a l R e s e r v e m u st c o n t in u e t o c o m p e n s a t e fo r a n y b u d g e t t ig h t e n in g by
p r o m o t in g m o n e t a r y g r o w t h at or s o m e w h a t a b o v e th e u p p e r r a n g e o f its t a r g e t
lim i t s . A fu n d a m e n t a l c h a n g e in th e a p p r o a c h t o p o lic y by th e F e d e r a l R e s e r v e is
p r o b a b ly r e q u ir e d , g iv e n t h a t t h e m o n e t a r y a g g r e g a t e s M l and M 2 w ill c o n t in u e t o
g iv e f a l s e r e a d in g s on th e e c o n o m y and in fla t io n in th e n e w d e r e g u la t e d
e n v ir o n m e n t and w ith s o m a n y c h a n g e s in m o n e t a r y an d n e a r - m o n e y f in a n c ia l
in stru m e n ts.
I n d e e d , it w o u ld p r o b a b ly be b e t t e r f o r th e c e n t r a l ban k t o f o c u s
d i r e c t l y on its u lt im a t e t a r g e t s o f r e a l e c o n o m ic
g r o w t h , i n fl a t i o n ,
and
u n e m p lo y m e n t ra th e r than an i n t e r m e d ia t e p r o x y s u ch as M l , M 2, o r M 3.
S u f f ic i e n t m o n t h ly d a ta a r e now a v a ila b le o n th e p e r f o r m a n c e o f th e e c o n o m y ,
i n fl a t i o n , a n d u n e m p lo y m e n t t o m a k e u n n e c e s s a r y th e f o c u s in g o f m o n e t a r y p o l ic y
e x c l u s iv e l y on t h e m o n e t a r y a g g r e g a t e s .
T h e l ik lih o o d th a t a n o th e r s e r ie s o f rise s o f in t e r e s t r a te s w ill o c c u r t o a b o r t an
e c o n o m i c r e c o v e r y in 1 9 8 3 is m u ch d im in is h e d n ow g iv e n th e p e r m a n e n t ly l o w e r
r a t e s o f w a g e and p r ic e in fla t io n in p l a c e , n e w t ilt o f m o n e t a r y p o l ic y , and
r e li q u e f i c a t i o n in p r o c e s s f o r th e p r iv a t e s e c t o r . N e v e r t h e le s s , t h e N e w F e d P o l i c y
s u g g e s t s th a t i n t e r e s t r a t e s w ill ris e a g a in d u rin g th e f ir s t h a lf o f 1983, in r e s p o n s e
to t h e f o r e c a s t e d e x p a n s io n . C u r r e n t D RI f o r e c a s t s sh ow a n o t h e r 100 t o 150 b a sis
p o in t d e c l in e s in s h o r t -t e r m in t e r e s t r a te s d u rin g th e f o u r t h q u a r te r and a 100 b a s is
p o in t r e d u c t io n o f bo n d y ie ld s . A p r im e r a t e at 1 1 % , f e d e r a l fu n d s r a t e o f 8 % , and
7% r a t e on T r e a s u r y b ills sh o u ld be th e t r o u g h s . S u b s e q u e n tly , i n t e r e s t r a te s a r e
f o r e c a s t t o d e c l in e , on a v e r a g e , fa llin g t o w a r d a n e w lo w e r p la t e a u o f i n fla t io n but
n ot w it h o u t o c c a s io n a l u p w a rd s p ik e s . R e c o r d f e d e r a l b u d ge t d e f i c i t s p r o p in t e r e s t
r a te s by a b o u t 100 b a sis p o in ts in 198 3 and 1 9 8 4 , s u g g e s t in g th a t a fu r t h e r
t ig h t e n in g o f th e b u d g e t is d e s ir a b le .
J o b le s s n e s s w ill e m e r g e o v e r th e n e x t y ear as th e m o s t t r o u b l e s o m e p u b lic p o l ic y
p r o b le m , an i n e v i t a b le f a ll o u t f r o m th e b r e a k in g o f th e d e b ilit a t in g d o u b le - d ig it
i n fla t io n o f th e 1970s w ith a su s ta in e d tig h t m o n e t a r y p o l ic y . In d e e d , th e c u r r e n t
u n e m p lo y m e n t r a t e o f 1 0 .1 % u n d e rs ta te s th e p r o b le m .
A d d in g 1.6 m illio n
d i s c o u r a g e d w o r k e r s t o th e 11.3 m illio n u n e m p lo y e d and in c lu d in g 2 .6 m illio n p a r t t im e e m p l o y e e s w h o n o r m a lly w o rk f u ll - t im e b rin g s th e jo b le s s t o t a l t o 1 5 .5 m illio n
p e r so n s or 1 4 .1 % o f th e la b o r f o r c e , an a w e s o m e f ig u r e . T h is r e c o r d jo b le s s n e s s fo r
t h e p o s t w a r p e r io d is c u r t a ilin g g r o w t h in in c o m e and c o n s u m p t io n and o f f s e t t i n g
th e p o s it iv e i m p a c t s f r o m th e J u ly 1 t a x c u t s .
A p e a k a p p r o a c h in g 1 0 - 1 /2 % f o r th e u n e m p lo y m e n t r a t e is lik e ly in c o m in g m o n t h s ,
and e v e n h ig h e r r a t e s c a n n o t b e ru le d o u t if th e r e c o v e r y is v e r y a n e m ic . O n c e
r e c o v e r y is in p l a c e , a c a u t io u s p a c e o f r e h irin g w ill lik e ly b e f o ll o w e d w ith th e
u n e m p lo y m e n t r a t e r e m a in in g w e ll a b o v e 9 % th r o u g h o u t 1 9 8 3 and in e x c e s s o f 8 %
f o r 198 4.
P r o d u c t i v i t y g r o w t h sh o u ld sh o w an a b o v e a v e r a g e c y c l i c a l u p tu rn ,
r e f l e c t i n g t h e i n c r e a s e d o u t p u t o b t a in e d w ith a s m a lle r w o r k f o r c e an d th e usual
e f f i c i e n c y g a in s f o r th e e a r ly s t a g e s o f r e c o v e r y .
I n t e r e s t - s e n s i t i v e s e c t o r s o f the e c o n o m y su ch as h ou sin g , a u t o m o b i le s , and c a p it a l
f o r m a t i o n s h o u ld re s p o n d f a v o r a b l y t o lo w e r in t e r e s t ra te s an d im p r o v e d f in a n c ia l
m a r k e t c o n d i t io n s , r is in g g r a d u a lly fr o m the c u r r e n t d e p r e s s e d l e v e ls .
H ow ever,
s till r e la t i v e l y high re a l and re a l a f t e r t a x in t e r e s t r a te s w ill lim it th e r e b o u n d s in
t h e s e and r e la t e d a r e a s . T h e D RI p r o je c t io n s fo r h ou sin g sh o w 1.38 m illio n u n its in
1 98 3 and 1 .6 5 in 1 9 8 4 , l e v e ls b e lo w th e a c t iv it y r e a c h e d d u rin g 1 9 7 9 . A u t o s a le s
a r e f o r e c a s t at 9 m illio n units by m id -1 9 8 3 , up fr o m the c u r r e n t 7 .7 m illio n units
but fa r b e lo w th e 10.6 m illio n unit p a c e o f 1 97 9. B usiness c a p it a l f o r m a t i o n w ill
r e s p o n d o n ly s lo w ly t o th e m o r e fa v o r a b l e f in a n c ia l c o n d it io n s d e s p it e th e t a x




229

stimulus o f A C R S , given sluggish sales grow th , r e la tiv e ly high in terest rates, and
low rates o f ca p a c ity u tilization . N o sharp in cre a s e in business cap ital spending is
p ro je cte d until 1984, when a 7.1% rise is e x p e c t e d in real term s.
The r eliq u e fica tio n process will be m ore substantial than in 1975-76, as the private
s ector adjusts to a new disin flation ary e n v iron m en t. The se ve re dow nturn, now
m ost easily understood by observin g the c o m p le te business c y c le history sin ce 1979,
has resulted in so much slack in th e U.S. e c o n o m y that the odds have risen on a
low er p ro file o f inflation and in te re st rates than previou sly had appeared possible.
In such an environm ent, spending and the dem and fo r funds must rem ain w eak, with
low er rates o f inflation r e in fo rcin g an in crea sin g am ount o f slack in the m arkets
fo r m oney and c r e d it. With a m ajor re liq u e fic a tio n by the private s e c t o r , even the
p rosp ectiv e large fed era l budget d e fic it s fo r fis c a l years 1983 and 1984 m ight be
absorbed w ithout any resurgence o f in te re st rates.
The mix o f e c o n o m ic po licy is being tilte d tow ard a m ore a pp ropriate track for
expansion then previously was the ca s e . A fu rth er tig htenin g o f the budget and
easing o f m onetary policy is essen tia l to a sustained revival o f the in terest
sensitive areas o f the e con om y and fo r contin uin g expan sion . But, tiltin g the mix
o f policy tow ard a tighter fis c a l and easier m oney alon e is no longer s u ffic ie n t
given the dow nward m om entum fro m the u n p re ce d e n te d , fo r the postw a r p eriod ,
fallou t o f failures and joblessness. For this reason and given the enorm ous slack in
the eco n o m y , the tax cuts scheduled fo r 1983 should b e p e rm itte d to take e f f e c t
and not be postponed. But "b itin g the bu llet" on fe d e r a l govern m en t spending, in
particular e n titlem en ts and m ilitary spending, is essen tia l.
Should the
A dm inistration fail to ta ck le these issues in the F Y 1984 bud get, the fin a n cial
m arkets will again re a ct in fam iliar n egative fash ion , w ith large rises o f in terest
rates threatening the re co v e ry .
The m ajor task o f p o licy now is to insure expansion w ithout reigniting in flation .
This involves inducing 1) gradual g row th in the e c o n o m y w ithout causing it to stall;
2) a new colla b o ra tio n betw een business, go v e rn m e n t, and labor to prevent a
resurgence o f w age co sts; and 3) s p e c ific program s to absorb p o ck e ts o f
unem ploym ent that will be le ft even a fte r the e c o n o m y re c o v e r s . The Federal
R eserve will have to co m e to grips w ith w hether to con tin u e the N ew Fed P o licy ,
now that the back o f inflation has been broken. That p o licy was designed as a
major an ti-in fla tion to o l, but no longer m ay be n eeded in what now is
fundam entally a disin flation ary en viron m en t.
M ost likely, by 1984, the m ajor p aram eters o f the
d irection s set by the goals for e c o n o m ic p e rfo rm a n ce ,
of in flation . The odds overw h elm ing fa v o r e c o n o m ic
w ithin a backdrop o f a ch ron ica lly weak e co n o m y , in
a v erage, showing steady im p rov em en t.

e c o n o m y w ill be m oving in the
w ith ou t any m ajor r e a c c e le r a tio n
r e c o v e r y next year and in 1984
fits and starts to be sure, but, on

S uccess on inflation is fo r sure. The ro le o f the fe d e r a l g o vern m en t is being w hittled
dow n. But the co sts o f the in flation im p ro v e m e n t, includ ing jo b s, the po te n tia l fo r high
in terest rates becau se o f large d e fic its , and ch ro n ic w eakness in ce rta in areas and s e c to rs ,
w ill be sizable. The "w ild card" is the fa llo u t on w ages, in fla tio n , in te re st rates, saving,
and produ ctivity from the deep downturn o f 1980-82. If all breaks right, there will be
con siderable success in the longer run, despite the shaky start in the short run.




23 0

n.

Patterns of Recession - The Current Situation

Patterns o f rec e ssio n have been p la ce sin ce la te 1979.
The current business c y c le
dow nturn, perhaps b e st vie w e d o v er the full p e rs p e ctiv e o f the last fe w years, is the m ost
s ev ere sin ce th e 1930s. In the U .S., the real grow th o f the e con om y has been near z e r o
sin ce early 1979; re ta il sales, in real term s, have dropped 1.2% per qu a rter; industrial
produ ction has d e clin e d by 2.8% per period; business fix e d in vestm en t, in real term s, a
m ajor ta rg et fo r im p ro v e m e n t fro m the R ea ga n om ics p o lic e s , has d e clin e d by 1.1% per
qu a rter; and e m p loy m e n t has only risen 0.5% per period.

Table 1
Recent U.S. Economic Performance
(Percent chg., cpd. annual growth rate from 1979:1 to 1982:3)
Real GNP
Implicit 6NP Deflator

0.2
8.2

-1.2
Retail Sales (1972 dollars)
Industrial Production
-2.8
Business Fixed
Investment (1972 dollars)
-1.1
Employment (Household Survey) 0.5

The series o f dow nturns sin ce 1979 is u n p receden ted fo r the postw ar p eriod, probably the
m od ern -d ay cou n terp a rt to a d epression . A fte r ta x c o r p o r a te profits w ill be down over
30% in 1982 c o m p a re d w ith 1979. N um erous industries and areas o f the cou n try are
essen tia lly in d ep ression . C o r p o r a te ban kruptcies and fa ilu res o f fin a n cial in stitutions are
the m ost num erous s in ce the 1930s. Joblessness is at re c o rd le v e ls fo r th e postw ar period,
w ith over 15 m illion persons w orking less than desired. N ot sin ce the 1930s have there
been th ree s u c c e s siv e years o f r e ce s sio n ; in this ca s e , 1980 and 1981-82.

Chart 1
New Car Sales-Total
(Millions of Units, SAAR)




Chart 2
Retail Sales
(Billions of 1972 Dollars, SAAR)

Chart 3
Federal Reserve Industrial Productioi
Index - Total (SA, 1967 = 1.0)

231

C h art 4
C a p a city U tilizatio n • M anufacturing
T o ta l (P ercen t, S A )

C h a rt 5
H ousing S tarts
(M illions o f U n its, S A A R )

I n d e e d , n o t on ly th e U .S ., bu t th e r e s t - o f - t h e - w o r l d as w e ll has b e e n s u f fe r i n g t h r o u g h 'a
p e r io d o f s ta g n a tio n and risin g u n e m p lo y m e n t as th e c u r e f o r t o o high in fl a t i o n .
M o st o f th e in d u s t r ia liz e d w o rld has s h o w n l i t t l e o r n o e c o n o m i c g r o w t h s in c e e a r ly 197 9,
r e la t i v e l y high r a t e s o f i n fla t io n , and e s s e n t ia lly u n c h a n g e d e m p l o y m e n t . R e a l o u t p u t in
t h e U n ite d K in g d o m and C a n a d a a c t u a lly has d e c l in e d , o n a v e r a g e , s in c e th e f ir s t q u a r t e r
o f 197 9. E m p lo y m e n t has b e e n f a llin g in th e U n it e d K in g d o m and G e r m a n y .
I n fla t io n
r a t e s h a v e a v e r a g e d in d o u b le -d ig it s f o r th e U n it e d K in g d o m , I t a ly , F r a n c e , and C a n a d a .
T h e b e s t p e r f o r m a n c e has b e e n f o r J a p a n , w h e r e t h e g r o w t h in r e a l G N P has a v e r a g e d
3 .6 % a q u a rte r w ith a r e la t iv e ly lo w in fla t io n r a t e o f 5 .7 % p e r p e r io d . B u t, by h i s t o r ic a l
c o m p a r is o n , e v e n th is p e r f o r m a n c e is d e t e r io r a t e d c o m p a r e d w ith e a r l ie r p e r io d s .

T able 2
E conom ic Perform ance in th e R e s t -o f-t h e -W o r ld Since 1979
(P ercent ch g ., cpd. annual grow th rate from 1979 :1 to 1 9 8 2 :3 )




United Kingdom
Germany
Italy
France
Japan
Canada

Real GNP

Consumer
Price
Index

Industrial
Production

Employed
Persons

-0 .1
0 .9
1.3
1.6
3.6
-0 .2

13.5
5.6
19.1
12.7
5.7
10.9

-2 .5
-0 .2
0 .2
0 .3
4 .6
-2 .9

-2 .8
-0 .2
0 .7
0 .3
2 .0
0 .7

232

T h e U .S . is e x h ib it in g a la r g e t r a d e o f f b e t w e e n u n e m p lo y m e n t and in fl a t i o n , in an
a p p a r e n t r e - e m e r g e n c e o f t h e P h illip s c u r v e . In th e U .S ., th e
u n e m p lo y m e n t r a t e has
r is e n f r o m 5 .9 % in l a t e 1979 t o a c u r r e n t r a te o f 1 0 .1 % a t th e s a m e t im e th a t in fla t io n
r a te s h a v e d e c l in e d f r o m 15 t o 1 7 % , a t ann ual r a t e s , t o th e c u r r e n t 4 .9 % y e a r - t o - d a t e f o r
th e C P I -U .
T h e U n it e d K in g d o m , F r a n c e and C a n a d a h a v e h igh er u n e m p lo y m e n t r a te s
n ow c o m p a r e d w ith e a r ly 1 9 7 9 , and lo w e r in fla t io n r a t e s . But in fla t io n o f t h e C o n s u m e r
P r i c e In d ex is n ow h ig h e r in G e r m a n y , Ita ly and J a p a n , a lo n g w ith th e u n e m p lo y m e n t r a t e .
T h u s, th e U .S . a p p e a r s t o b e e x h ib it in g a r e la t i v e l y g r e a t e r b e n e f i t o n i n fla t io n f r o m
e x c e s s s la c k and s t a g n a t io n th an in m o s t o t h e r c o u n t r ie s , a m a jo r r e a s o n f o r c o n t in u in g
s t r e n g t h o f t h e d o lla r .
H o w e v e r , it is c le a r th a t jo b le s s n e s s has e m e r g e d n ow as a
w o r ld w id e p r o b le m , a m a jo r f a ll o u t o f th e r e s t r i c t iv e m o n e t a r y p o l ic i e s f o l l o w e d by th e
U .S . c e n t r a l ban k t o t h r o t t l e b a c k in fla t io n in th is c o u n t r y .

Table 3
World Economic Performance: 1979:1 to 1982:3
79:1____________

United Kingdom
Germany
Italy
France
Japan
Canada

Unemployment
Rate
(X)

Real
GNP
(X)

5.1
4.0
7.5
5.6
2.3
7.8

-3.8
2.3
5.1
0.5
5.3
3.0

Unemployment
Rate
(X)

Real
GNP
(X)

Consumer
Price
Index (X)
12.6
4.5
16.3
9.6
-1.3
9.8

_______________ 80jJ____________
Unemployment
Rate
(X)

Real
GNP
(X)

5.2
3.5
7.7
6.0
2.1
7.5

-0.5
7.5
8.4
2.0
6.7
-1.0

Unemployment
Rate
(X)

Real
GNP
(X)

82:1

United Kingdom
Germany
Italy
France
Japan
Canada

11.0
6.7
9.2
8.2
2.4
8.6

4.4
-0.9
5.9
-0.9
4.0
-8.9

Consumer
Price
Index (X)
19.6
5.0
27.8
16.7
8.7
9.5

_______________ 8hl.
Unemployment
Rate
(X)

Real
GNP
(X)

8.8
4.5
7.6
6.9
2.4
7.3

1.8
2.2
3.3
-0.5
3.0
5.0

6.2
3.5
16.5
12.4
2.9
10.6

11.2
7.3
9.0
8.4
2.4
10.2

-3.2
-1.4
-5.4
2.4
5.1
-8.0

9.2
6.0
22.0
13.1
4.5
13.8

Latest

82:2
Consumer
Price
Index (X)

Consumer
Price
Index (X)

Consumer
Price
Index (<)
9.7
4.7
12.4
13.0
6.7
11.8

Unemployment
Rate
(X)
12.7
7.8
9.6
8.4
2.4
12.3

Real
GNP
(X)
2.8
-0.1
-4.3
3.3
3.7
0.6

Consumer
Price
Index (X)
8.5
5.9
25.2
5.7
4.5
8.1

It s h ou ld b e n o t e d t h a t th e c u r r e n t p e r f o r m a n c e f o r th e U .S.
e c o n o m y and fin a n c ia l
m a r k e t s is th e r e s u lt o f s w e e p in g c h a n g e s in m o n e t a r y and f is c a l p o l ic i e s , n e w
in s t it u t io n a l a r r a n g e m e n t s and r e g u la t io n s , e m e r g in g n e w tr e n d s in la b o r m a r k e t s , new
t e c h n o l o g y , a c h a n g in g p o l it i c a l s t r u c t u r e , and im p a c t s fr o m w h a t n o w a r e t ig h t ly
i n t e r r e l a t e d in t e r n a t io n a l e c o n o m ie s . F ir s t , th e c u r r e n t lo n g and d e e p d o w n tu rn is t o a
la r g e e x t e n t th e r e s u lt o f an h i s t o r i c a t t e m p t by th e U .S .
c e n t r a l ban k t o c o n t a in a
s e v e r e , d e b ilit a t in g i n fl a t i o n . T h e 1970s w e r e c h a r a c t e r iz e d by th e w o r s t i n fla t io n r e c o r d
s in c e e a r ly in th is c e n t u r y , in c lu d in g w a r tim e p e r io d s , w ith p r ic e s , as m e a s u r e d by th e
W h o le s a le P r i c e In d e x , r is in g 9 .4 % p e r annum f o r th e d e c a d e . W ith o u t a c t io n t o lim it th e
ru n a w a y i n fla t io n o f t h e 197 0s, th e r e s u lt, b o th e c o n o m ic a l l y and p o l it i c a l ly , m ig h t h a v e
b e e n a d is a s t e r . T h e N e w F e d P o l i c y o f O c t o b e r 1979 c o n s t it u t e d a m a jo r s h ift in th e
s t r u c t u r e o f th e U .S . e c o n o m y , w ith th e p o t e n t ia l f o r u n c h a rte d e f f e c t s s in c e t h r o u g h o u t
m o d e r n A m e r ic a n h is t o r y th e r o le o f th e c e n t r a l ban k had b e e n t o s t a b i li z e fin a n c ia l
m a r k e ts and t o m o d e r a t e f lu c t u a t i o n s o f in t e r e s t r a t e s . T h e new a p p r o a c h t o m o n e t a r y
p o l ic y c r e a t e d an u n p r e c e d e n t e d v o l a t il i t y f o r in t e r e s t r a t e s and p e r m it t e d n e w , h is t o r ic
h igh le v e ls th a t c h a n g e d th e p a t t e r n o f b e h a v io r in th e U .S. e c o n o m y t o a m o r e v o l a t il e
p a t t e r n w ith s t a g n a n t r e a l e c o n o m i c g r o w t h . T h e F e d e r a l R e s e r v e has b e e n s u p p o r te d by
th e A d m in is t r a t io n in its e f f o r t s to r e d u c e in fla t io n , unusual fo r th e U .S . w h e r e in m o s t
in s t a n c e s c o n s i d e r a b l e p r e s s u r e has b e e n a p p lie d t o e n c o u r a g e an e a s in g o f m o n e t a r y
p o l ic y .




23 3

Second, m assive shifts in fed era l tax and spending p o lic y have been in stitu ted. H uge
reduction s in personal taxes w ere le gisla te d in 1981 fo r the next fiv e years, w ith m ost o f
the stim ulus set to o c c u r fro m 1983 to 1985. A m ajor sh ift in spending prio ritie s from
nondefense to the m ilitary is in p r o ce ss, but w ith o v e ra ll grow th in fe d e ra l spending
m oving low er. The re ce n t tax increa ses o f $98.3 billion le g is la te d in the Tax Equity and
Fiscal R esp on sibility A c t o f 1982 w ill only o f fs e t abou t o n e -fift h o f the tax redu ction s in
the original E co n o m ic R e c o v e r y Tax A c t o f 1981, thus not disturb the basic new thrust
tow ard low er taxation by the fe d e ra l g overn m en t. The tax and spending changes o f the
Reagan Adm inistration are w ithout p re ce d e n t in th e postw ar p eriod , qu a lita tive ly and
quantitatively d iffe r e n t from any other tim e in m odern e c o n o m ic h istory.
Third, deregu lation , enhanced co m p e titio n , and a changing in stitu tion al fra m ew ork fo r
c o lle c t iv e bargaining are im p actin g on p rice and w a g e -s e ttin g p r a c t ic e s .
The airlin e,
trucking, and fin a n cial industries ail have been d e re gu la te d in re c e n t years, helping to
low er prices and w ages fa ste r and enhancing saving through m uch higher returns to savers.
Fourth, a new com puter te ch n o lo g y is re v o lu tio n izin g d e cisio n -m a k in g and in form ation
processing, both fo r business and households. N ew m ethods o f in fo rm a tio n p rocessin g and
retriev a l, a changing te ch n o lo gy fo r fin a n cial tra n sa ctio n s, and w idespread use o f sm all
com pu ters should make possible a leap in p ro d u ctiv ity grow th during the 1980s.
F ifth , m ore tig h tly interw oven intern ational e c o n o m ic and fin a n cia l system s are quickly
transm itting im pulses from cou n try to cou n try, truly opening the w orld e c o n o m y . T hese
changes are the m ost m assive in 50 years, so that the shakup in the U.S. e co n o m y and
financial m arkets that has resulted should be no surprise.
The downturns o f 1980 and 1981-82 have brought depression to num erous industries and
geograph ical areas o f the U .S.. A t least 13 industries are o p e ra tin g at the m ost depressed
levels of a c tiv ity fo r the postw ar period or at c a p a c it y u tilization rates o f less than 50% .
Whole sectors o f the e con om y are under e x tr e m e pressure, including sm all business, the
th rift industry, and state and lo ca l govern m en t. The unem ploym ent rate e x c e e d s 10% in
19 states, in con trast with the previous peak m onth fo r u n em ploym en t, May 1975, when 8
states had dou b le-digit unem ploym ent rates. M uch o f the M idw est (au tos, a g ricu ltu re,
farm equipm ent, retailers, s te e l, and trucking), W est (building m a te ria ls, c o p p e r, fo re s t
products, lead and zin c, mining, real esta te and hom ebuildin g, r e ta ile rs) and South
(agricu ltu re, real e sta te and hom ebuilding, r e ta ile rs, sm all businesses, truckin g) are in a
state o f depression. The fin a n cial strain from high in te re st rates and w eak balan ce sheets
has crea ted a "w a ve o f bankruptcies" fo r A m erican business, w hich has been su ffe rin g
from the greatest d eterioration in fin a n cial position o f the postw ar era. Failing real net
w orth for households, principally from d eclining equ ity in h om es, re fin a n cin g d iffic u lt ie s ,
and record hom e fo re c lo s u r e and loan d elin quency rates have strained consum ers,
contribu ting to a weak spending response to the July 1 personal in c o m e tax cu ts. And
now, the lengthy period o f stagnation fo r so many o f the w orld e c o n o m ie s , contin uin g
disin flation , increased joblessness, high in terest rates, and low e x p o rt earnings are
threatening the viability o f many cou n tries. The debt problem s o f the LD Cs and som e
advanced coun tries provide chilling p rospects fo r c o m m e r c ia l banks as a result.




234

Table 5
"Casualty" List of Sectors, Industries,
States, and Countries

T a b le «

Unemployment Rates by State
(Percent)
Current Unemployment Rates(l)

Unenploynent Rates 1n May. 1975

Michigan**
Alabama*
Nest Virginia
Mississippi*
Ohio**
Washington
Illinois
South Carolina
Tennessee
Kentucky
Indiana*
Pennsylvanla**
Louisiana*
Wisconsin*
Rhode Island
Nevada*
Oregon*
New Mexico*
Arizona

Arizona
Rhode Island
Michigan
Massachusetts
Florida
New Jersey
Del aware
Maine

14.5
14.2
13.7
12.5
12.3
12.2
12.1
11.7
11.6
11.2
11.1
10.9
10.9
10.4
10.4
10.2
10.1
10.1
10.0

12.4
12.3
12.3
11.6
11.4
11.3
10.2
10.2

Industri es

Sectors

Agri cui ture
Agri cui ture Machi nery
A ir Transport
Autos
Bui 1ding Materi al s
Copper
Forest Products
Lead and Zinc
M iscellaneous Metals and Mining
Real Estate and Hanebuilding
R etailers
Steel
Trucki ng

Small Business
Mortgage Finance - Th rifts
State and Local Government

States and Latest Uner>pl oynent R ate, I %'
-ate

Rate

(1) As of July 1982, otherwise:
*As of August 1982
**As of September 1982




Midwest
Mi chi gan
Ohi o
I llin o is
Indi ana

14.5
12.3
12.1
11.1

West
Was hi nqton
Wisconsin
Nevada
Oregon
New Mexi co
Ari zona

12.2
10.4
10.2
10.1
10.1
10.0

Northeast
Rhode I si and

10.4

Mid-At! antic
Pennsylvania

South
Alabama
West V irgin ia
M ississip p i
South Ca-ol ina
Tennessee
Kentucky
Louisiana

Countr-i es
Argenti na
Brazi 1
C hile
Mexi co
Peru

Pol and
Phi 11 ioi nes
Ror ani a
South K c-ea
Venezuel ?

10.9

* -.2
1 2 .:
1 !. 7
11.6
11.2
"l ‘'. 9

235

A major beneficial fallout of the most recent business cycle episode has been the breaking
of the severe inflation that plagued the U.S. economy during the 1970s. The tight
monetary policies of the central bank are almost solely responsible for the improvement.
Essentially, the battle against inflation by the Federal Reserve has been waged as a threestage process. First, the institution of the New Fed Policy permitted interest rates to
rise high enough to break the back of a speculative inflation that was rampant throughout
the Western World. The sharply higher costs of inventory financing and the attractivenéss
of high-yielding financial assets broke the speculative fervor in precious metals and basic
commodities. Speculation in bonds and stocks also was undercut. The high interest rates
strengthened the U.S. dollar and weakened the rest-of-the-world economies, leading to an
oil glut and downward pressure on crude oil and energy prices. Speculation in housing and
real estate also was subjected to severe pressure, with high financing costs depressing
effective prices to squeeze the 1970s bubble of shelter inflation.
The diminuition of inflation from this cause and deep recession in Spring 1980 helped set
the stage for exceptional downward pressures on wages, especially in the cyclically
sensitive industries such as autos, steel, construction, and trucking. Indeed, the pressure
on wages from rising unemployment, givebacks and concessions has constituted the second
stage of the battle against inflation, since wage costs are the major cost-side factor in
prices. No lasting improvement on inflation could be possible without a major downward
turn on wages to limit rises in unit labor costs during the next cyclical upturn.
The final stage for the Federal Reserve in containing inflation permanently most likely
will be to permit only a gradual recovery of the economy so that the forces of excess
demand will not quickly be unleashed to bring about a sharp reacceleration of inflation.
This was the mistake of central bank policy in 1977-1979 when the gains on inflation from
the severe recession of 1973-75 could have been propelled forward if monetary policy had
not been so accommodative.




T a b le 6
Sources o f Im provem ent in th e Consum er P rice Index
Annual Percent Chanqe
Dec. 78- ^ l o v . 8 i :
Dec. 80
August 82
CPI

All Items

Contribution
to Slowdown
(Percentage
points)

12.9

5.1

7.8

Food and Beverages
Energy
Gasoline
Heating Fuels
E lectricity and Gas

10.0
27.4
35.1
37.0
15.3

3.4
8 .8
-8 .3
7.9
6 .9

1.2
2.1
2 .6
0.4 0 .3

Home Ownership
Homes Prices
Finance, Taxes, Insurance

18.1
13.6
25.4

8 .5
6 .4
5 .8

2 .5
0 .7
2 .5

All Other

2 .0

23 6

Table 7
Wage Negotiation Timetable and Settlements
Union

Date

Workers

Results

1981
October
December

Machinists
(airlines)

44,800

1982
Oil, Chemical, Atomic
Teamsters
(motor freight transport)
Teamsters
(California Food Processors)
Rubber Workers
Ladles Garment Workers
Electrical Workers
Auto Workers (UAW)

January

55,000

Jan. 82: 9* wage Increase
Jan. 83: 7.It Increase

March
April
November

187,850
55,050
15,000

Mar. 1: No specified wage
Increase. Lower starting
for new employees.

June
April
May
June
July
September
October

55,000
55,250
220,000
66,950
150,000
628,000
109,000

State and Local
Governments
Building Trades

All Year
All Year

1,900,000
750,000

Food I Commercial
Teamsters

All Year

40,000

7* Wage Increase
19* Wage and benefit Increase over 3 yrs.
26* Wage and benefit Increase over 3 yrs.
Ford-UAW, early agreement
No specified wage Increase
Cost of living Increases
delayed. New employees start
at 85* of standard rate
21* Wage and benefit Increase over 3 yrs.(although most
contracts are for less than 3yrs.)
8-10* Wage and benefit Increase over 3 yrs.

1983
Steelworkers
Ccxmunlcations Workers
(telephone)




August

45,000

August

149,950

Table 8
Wages, Productivity, and Unit Labor Costs:
History and Forecast

1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984

Growth in
Compensation
Per Hour
Index
(XCH)

Growth in
Productivity
(XCH)

Growth in
Unit Labor
Costs
(XCH)

4.3
3.2
3.9
3.5
4.5
3.4
6.0
5.5
7.5
6.6
6.9
6.6
6.7
7.6
9.4
9.6
8.1
7.6
8.6
9.3
10.3
9.6
7.0
6.5
7.0

0.8
3.0
3.5
3.3
3.9
3.1
2.5
1.9
3.2
-0.2
0.3
3.3
3.7
2.4
-2.5
2.0
3.2
2.3
0.6
-1.3
-0.9
1.4
-0.2
2.0
1.8

3.4
0.3
0.3
0.3
0.6
0.3
3.4
3.5
4.1
6.8
6.7
3.1
2.9
5.1
12.2
7.4
4.8
5.1
8.0
10.8
11.2
8.1
7.3
4.3
5.0

237

T h e c o s t s o f so m u ch p r o g r e s s a g a in s t in fla t io n h a v e b e e n g r e a t , h o w e v e r . In p a r t ic u la r ,
th e f a ll o u t in c lu d e s a r e c o r d le v e l o f jo b le s s n e s s , w ith t h e 1 0 .1 % u n e m p lo y m e n t r a t e th e
h ig h e s t in th e U .S.
s in c e th e 1 4 .6 % o f 1 94 0.
T h e r e c o r d jo b le s s n e s s is no d o u b t
c o n t r ib u t in g t o th e sh a rp d e c e l e r a t i o n o f i n fla t io n , but a ls o is p r o lo n g in g th e r e c e s s io n by
h o ld in g d ow n th e g r o w t h o f i n c o m e and c o n s u m p t io n s p e n d in g .

Chart 6
Unemployment Rate
(Percent)

E c o n o m y - w id e s la c k e x c e e d s th a t o f any o t h e r t im e in th e p o s tw a r p e r io d , w ith re a l
o u t p u t fa r s h o r t o f p o t e n t i a l, a $ 1 9 6 .5 b illio n s h o r t fa ll in th e th ird q u a rte r or g a p o f
1 1 .7 % .
T h e A ll M a n u fa c t u r in g f a c t o r y u t iliz a t io n r a t e , a t 6 9 .1 % d uring S e p t e m b e r , is
a lm o s t a t th e p r e v io u s p o s t w a r lo w o f 6 9 .0 % s e t in M a r c h 1 9 7 5 , and w o u ld be lo w e r e x c e p t
t h a t c o m p a n y a f t e r c o m p a n y has shut d o w n p la n ts . T h e p r im a r y p r o c e s s in g and m a t e r ia ls
s e c t o r s do sh ow th e lo w e s t u t iliz a t io n r a t e s o f th e p o s t w a r p e r io d .

Chart 7
Real GNP vs. Potential Real GNP
(1960 to 1982:3)

17-873

0




83

16

23 8

An unprecedented number of business bankruptcies for the postwar period, failures of 25
commercial banks, and a shakeout of thrift institutions has been another fallout of the
tough policy against inflation.




T able 9
Business Failures Since 1925
Number of
Failures

Year

21,214
21,773
23,146
23,842
22,909
26,355
28,285
31,822
19,859
12,091
12,244
9,607
9,490
12,836
14,768
13,619
11,848
9,405
3,221
1,222
809
1,129
3,474
5,250
9,246
9,162
8,058
7,611
8,862
11,086
10,969
12,686
13,739
14,964
14,053
15,445
17,075
15,782
14,374
13,501
13,514
13,061
12,364
9,636
9,154
10,748
10,326
9,566
9,345
9,915
11,432
9,628
7,919
6,619
7,564
11,742
17,040
19,170

1925
1926
1927
1928
1929
1930
1931
1932
1933
1934
1935
1936
1937
1938
1939
1940
1941
1942
1943
1944
1945
1946
1947
1948
1949
1950
1951
1952
1953
1954
1955
1956
1957
1958
1959
1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981*
1982**
♦Preliminary
**To Date
Source: Dun

& Bradstreet

Failure Rate
Per 10,000
Listed Concerns
100
101
106
109
104
122
133
154
100
61
62
48
46
61
70
63
55
45
16
7
4
5
14
20
34
34
31
29
33
42
42
48
52
56
52
57
64
61
56
53
53
52
49
39
37
44
42
38
36
38
43
35
28
?4
28
42
62
86

!

239

T h rou gh S e p t e m b e r Dun <5c B r a d s tr e e t s h o w a t o t a l o f 1 9 ,1 7 0 fa ilu r e s in th e U .S . e c o n o m y ,
t h e h ig h e s t fig u r e s in c e 1932 an d c e r t a in t o p r o d u c e f o r th is y e a r a v o lu m e o f
b a n k r u p t c ie s s e e n in th e 1920s. A lth o u g h th e f a ilu r e r a t e re m a in s w e ll b e lo w th a t o f th e
G r e a t D e p r e s s io n and is a c o n s e q u e n c e o f th e lo n g d o w n tu r n , it is n o w a ls o a c a u s e o f th e
p r o lo n g e d r e c e s s io n and fa ilu r e o f th e e c o n o m y t o r e c o v e r . T h e la r g e n u m b e r o f b u sin e ss
fa ilu r e s has c r e a t e d e x c e p t i o n a l c r e d it risk s f o r U .S . c o m m e r c i a l ba n k s, m ak in g le n d in g
p o l ic i e s c a u t io u s and im p o s in g fu r th e r r e s t r a in t . O th e r b u s in e s s e s a r e e n g a g e d in a m a jo r
s e r ie s o f c u t b a c k s , d e s ig n e d t o p r e s e r v e v ia b ilit y . T h e 25 f a ilu r e s o f c o m m e r c i a l ban k s
th a t h a v e b e e n r e c o r d e d a r e th e g r e a t e s t n u m b e r in th e p o s t w a r p e r io d . A n d, d o z e n s o f
t h r if t in s t it u t io n s h a v e b e e n f o r c e f u l l y m e r g e d o r a c q u ir e d , in a m a jo r c o n s o lid a t io n o f th e
t h r if t s e c t o r .
E c o n o m i c w e a k n e s s has b e e n e x p o r t e d b y th e U .S . t o th e in t e r n a t io n a l e c o n o m ie s th ro u g h
th e high and v o l a t il e in t e r e s t r a te s o f th e p a s t f e w y e a r s , w ith s im ilia r p r o b le m s o f s lo w
g r o w t h , jo b le s s n e s s , b u sin e ss and ban k fa ilu r e s in th e r e s t - o f - t h e - w o r l d . In d e e d , w h o le
c o u n t r ie s n ow f a c e p r o b le m s a s s o c ia t e d w ith r e p a y in g o u ts t a n d in g d e b t u nd er c o n d it io n s
w h e r e e x p o r t e a r n in g s a r e s h a rp ly lo w e r , t o o w e a k t o c o v e r e x is tin g d e b t s e r v ic e and lo a n
r e p a y m e n t s c h e d u le s . A s a r e s u lt, th e u n d e rp in n in g s o f t h e in t e r n a t io n a l fin a n c ia l s y s te m
a r e t h r e a t e n e d , w ith p o t e n t ia l d e f a u l t and c r e d i t risk s t o th e ban ks th r o u g h o u t th e w o r ld .
T h e IM F and IB R D h a v e n o t y e t r e a lly c o m e t o g r ip s w ith th is p r o b le m , a m a jo r risk t o
s u s t a in a b le r e c o v e r y if sharp ris e s o f in t e r e s t r a t e s o c c u r a g a in .
C u r r e n t ly , t h e r e a r e f e w d e f in it i v e sign s o f any r e c o v e r y in th e U n ite d S t a t e s a n d
w o r ld e c o n o m ie s .
T h e r e c e n t e v i d e n c e sh o w s v e r y l i t t l e c h a n g e in r e t a il s a le s a n d '
c o n s u m p t io n f o r th e th ird q u a r t e r , w ith th e in c r e a s e s o f S e p t e m b e r p r im a rily d u e t o a u t o
s a le s th a t m ay n o t r e c u r during O c t o b e r .
In d u stria l p r o d u c t io n c o n t in u e d t o s lid e and
i n v e n t o r y - t o - s a l e s r a t io s , in b o th n o m in a l and r e a l t e r m s , w e r e h ig h e r in A u g u s t. G iv e n
th a t th e in v e n t o r y a c c u m u la t io n w a s in v o lu n t a r y , b u sin e ss m ust still d e c u m u la t e
in v e n t o r ie s b e f o r e r e s t o r in g th e le a n r a t io s th a t a r e n o w n e c e s s a r y . G ro w th in in c o m e has
s lo w e d fr o m th e la r g e in c r e a s e th a t o c c u r r e d e a r ly th is s u m m e r w ith th e ta x c u t s and
in c r e a s e d S o c ia l S e c u r it y p a y m e n t s .
T h e w e a k n e s s f o r in c o m e is th e re s u lt o f r is in g
jo b le s s n e s s , lo w e r w a g e s and s a la r ie s , an d a s t ill w e a k e c o n o m y , s u g g e s tin g a lim it e d
r e b o u n d in c o n s u m p t io n sp e n d in g f o r y e t a n o t h e r m o n th o r t w o .
E m p lo y m e n t is l it t l e
c h a n g e d s in c e Ju n e and u n e m p lo y m e n t is n o w 11.3 m illio n p e r s o n s . C o n s u m e r s e n t im e n t,
a lth o u g h r isin g s o m e w h a t la t e ly , r e m a in s r e la t i v e l y w e a k . F in a lly , a f t e r fo u r c o n s e c u t iv e
m o n th s o f r is e s , th e C o m p o s it e In dex o f L e a d in g I n d ic a t o r s d r o p p e d in A u g u st by 0 .9 % .
T h e r e c e n t e v i d e n c e d o e s c o n t a in s o m e h in ts o f a p o t e n t ia l r e c o v e r y , h o w e v e r .
R e ta il
s a le s h a v e risen in .4 o u t o f th e p a s t 6 m o n th s . H o u s in g s t a r t s r o s e in S e p t e m b e r and a r e
n o w 1 ,1 4 6 ,0 0 0 , 2 6 4 ,0 0 0 u n its a b o v e t h e 8 8 2 ,0 0 0 u n it t r o u g h in A p r il. C o n s u m e r sp e n d in g ,
in r e a l t e r m s , r o s e $ 7 .5 b illio n d u rin g S e p t e m b e r , m o r e than d o u b le th e a m o u n ts in July
and A u g u s t.
T h e lo w e r in fla t io n f o r p r o d u c e r p r i c e s and a l m o s t ' c e r t a in fu r th e r
d e c e l e r a t i o n in th e C P I -U o v e r th e n e x t f e w m o n th s a u g u rs w e ll f o r r e a l p u rc h a s in g p o w e r
and s u b s e q u e n t r is e s in c o n s u m e r s p e n d in g . T h e m o s t a p t d e s c r ip t io n fo r th e c u r r e n t s t a t e
o f th e e c o n o m y is a p r o lo n g e d b o t t o m in g - o u t in t r a n s itio n f r o m r e c e s s io n t o r e c o v e r y .







240

Table 10
R e c e n t E vidence on the Econom y
1982
Sep.

Aug.

1982
Apr.

Jun.

May

89.4
1.6
20.9
2.5

88.0
-3.1
-31.3
0.9

90.8
2.9
40.7
5.2

88.3
1.2
15.5
2.4

7.3
65.5
-11.0

7.0
-85.0
-10.3

8.2
376.2
2.5

Jul.

Mar.

III

II

87.2
-0.2
-2.4
1.3

89.2
0.1
0.5
1.7

89.1
2.8
11.5
2.8

86.7
0.1
0.4
l.S

7.2
-55.3
-11.1

7.7
-64.8
-22.2

7.7
14.7
-14.2

7.5
-24.1
-6.3

8.0
34.?
-13.1

I

Demands :
Retail Sales - Total
(Bils. of S, SA)
89.5
88.6
X
1.0
-1.0
XCH
13.2
-11.2
XCHYA
Latest*
1.9
0.7
(First Domestic
Auto Sales - Total Ten Days)
(Mils, of Units, SAAR) 7.4 8.3
7.6
XCH
-74.0 179.2
62.1
-24.0
XCHYA
0.0 -5.9
Housing Starts - Total
(Mils, of Units, SAAR)
XCH
XCHYA

1.002
-87.9
5.9

1.195
2600.1
14.9

0.908
-85.4
-13.2

1.066
871.5
-9.0

0.882
-47.7
-32.2

0.931
-16.4
-29.4

0.952
14.5
-18.8

0.920
23.0
-34.2

New Orders for Durable Goods
(Bils. of S, SAAR)
X
XCH
XCHYA

-4.1
-39.3
-13.5

2.5
35.2
-12.7

-1.5
-16.9
-14.2

-0.6
-7.4
-13.4

-2.1
-22.8
-11.8

2.0
27.3
-7.2

-1.2
-4.8
-13.1

-1.3
-5.0
-9.0

Personal Consumotion Expenditures
1937.9
(Bils. of S, SA)
XCH
9.2
XCHYA
6.0

1973.4
12.1
6.7

1954.7
0.5
6.8

1954.0
12.5
7.7

1934.8
8.0
6.7

1922.4
-3.6
6.0

1947.8

6.1
7.1

1919.a
7.6
6.6

-1.7
-6.6
-8.6

-3.1
-11.7
-6.6

Production and Inventories:
Industrial Production - Total
X
-0.6
XCH
-6.7
XCHYA
-9.4

-0.5
-5.9
-10.1

0.1
0.9
-9.8

-0.4
-4.2
-9.3

-0.7
-8.2
-8.8

-1.1
-12.0
-7.7

-0.8
-9.6
-6.8

Inventory-to-Sales Ratios Manufacturing and Trade (*1)
Nominal
XCH
XCHYA

1.520
27.7
5.7

1.490
6.4
4.9

1.482
17.4
5.4

1.462
-34.9
3.9

1.516
13.6
8.2

1.500
-7.2
6.7

1.487
-7.8
5.8

1.517
2.0
S.2

1.783
31.1
4.4

1.743
3.0
3.5

1.739
24.3
4.1

1.708
-35.1
1.8

1.771
13.4
6.9

1.752
-6.0
5.9

1.739

1.77?
-0.2
7.5

0.?
2.9
7.0'

2.0
26.9
7.7

0.1
1.7
7.3

0.3
3.5
8.0

1.0

13.1
8.1

0.3
4.0
7.5

6.7

7.1
12.7

6.9
9.5

6.7
9.8

15.3

6.7
17.5

11.5

6 .8

6 .7
21.2

69.5
-23.9
-1.1

71.1
-1.7

71.2
38.3

71.1
-23.4
6.9

6 9 .9
- ’ .6
5 .7

71.3

0.6

69.3
3.5
9.1

69.1
-29.0

-1.8

0.3
3.3
5.9

0.6

7.3
6.5

13.3
7.1

1.0
12.0

0.2

3.0

-0.3
-3.3

6.6

6 .7

1.1
4 .6
6 .8

0.6

0.6

1.0
12 .8

0.1
0 .9

- 0 .1

Real
XCH
XCHYA

-0.9
-3.7
-9.9

-8.2

4.3

Incomes:
Personal Disposable Income
X
XCH
XCHYA
NIA Saving Rate
(Percent)
XCHYA

6.8

1.6

’.8

0.7
3.0
3.1

Prices:
FHIBB Sales Price for
Existing Sinale-Family
Homes (§1,000, NSA)
XCH
XCHYA
Consumer Price Index All Urban Consumers
X
XCH
XCHYA
Producer Price Index Finished Goods
X
XCH
XCHYA

-0.1 •'
-1.7
3 .7

7.5
<J.0

7.1
3.7

1.0

3.5

6.7

-n .l
- 0 .9
3 .0

11.1

3.3

-1.7
4 .2

1.6
6 .5
3 .9

0 .2
0 .8
3 .3

5 .4

:.s
7.*6

0 .7
2 .9

24 1

Table 10 (C ontinued)
1982
Sep.

Aug.

Jul.

Jun.

1932
May

Apr.

Mar.

III

II

I

Employment and Utilization:
Employment Household Survey
(Mils, of Persons, SA)
<CH
ttHYA

99.7
-1.4
-0.5

99.3
1.3
-1.0

99.7
-0.4
-1.1

99.8
-4.1
-0.7

100.1
9.8
-0.9

99.3
-1.8
-1.5

99.5
-1.2
-0.9

99.8
0.1
-0.9

99.7
0.7
-1.0

99.6
-1.9
-0.6

Unemployment Rate
(Percent)

10.1

9.8

9.8

9.5

9.5

9.4

9.0

9.9

9.5

8.8

69.1
-11.8

69.6
-12.6

69.9
-12.4

69.9
-12.2

70.2
-12.2

70.8
-11.3

71.6
-10.3

69.5
-12.2

70.3
-11.9

71.6
-10.3

Commercial and Industrial
Loans at Large Weekly
Reporting Commercial Banks
(3ils. of S, SA) 222.0 218.8
XCH
18.3 19.5
*CHYA
17.0 16.0

215.6
6.2
15.4

214.5
5.1
16.3

213.6
20.6
18.0

210.3
21.5
18.0

206.9
30.4
18.4

202.4
4.8
17.8

216.5
12.3
16.0

210.3
21.6
18.1

200.3
20.3
15.7

Money 'Ml)
iBils. of S, SA)
XCH
XCHYA

455.2
10.9
5.6

451.3
-0.3
5.1

451.4
-0.3
5.4

451.5
-2.4
5.2

452.4
11.5
4.4

448.3
2.7
5.6

455.7
3.6
5.8

451.3
3.3
5.0

448.1
10.8
6.5

7.92

3.68

11.35

12.47

12.09

12.70

12.68

9.32

12.42

12.81

Average Yield on New
Issues of High-Grade
Corporate 3onds
(°ercent)
11.09 12.78

13.82

15.66

15.51

14.39

15.54

14.61

14.09

15.15

15.25

122.43
275.4
3.5

109.65
3.0
-15.4

109.38
-3.4
-15.3

109.70
-50.7
-17.1

116.35
0.4
-11.7

116.31
78.3
-13.5

110.84
-32.3
-16.8

113.82
-1.0
-9.4

114.12
-0.3
-14.1

114.21
-23.6
-13.2

Consumer Sentiment Index 'J. of Michigan Survey
0.693
<CH
100.4
SCHYA
-5.2

0.654
0.0
-15.3

0.654
-5.3
-11.7

0.657
-27.7
-10.1

0.675
43.5
-11.5

0.655
93.3
-9.5

0.620
-56.9
-6.8

0.667
2.3
-10.8

0.662
-1.6
-10.4

0.665
5.0
-2.6

Vendor Performance CoTioanies Reporting
Slower Deliveries
Percent)
%CHYA

40.0
-16.7

37.0
-19.6

38.0
-20.8

30.0
-42.3

31.0
-44.6

35.0
-32.7

•39.0
-14.6

33.0
-36.5

34.3
-30.4

-0.9
-10.5
-4.1

1.2
15.0
-3.7

0.5
5.8
-5.1

0.9
10.9
-6.1

1.2
15.4
-7.8

-0.1
-1.0
-7.9

1.3
7.2
-6.3

-2.0
-7.8
-7.2

Caoacity Utilization Manufacturing - Total
(Percent)
tCHYA
Money And Finance:

464.9 460.7
11.5
15.5
7.4
6.8

Three-Momh Treasury
Bill Rate (Percent) 7.45

Standard I Poor's
Stock Price Index Composite 500
tCH
XCHYA
Sentiment and Expectations:

40.0
-7.0

Leadinq Indicators:
'.ead’
ig Indicators
Comoosite Index
•tCH
»CHYA

(*1) The quarterly inventory-to-sales ratios are averages of the
monthly data.
* As of October 6, 1982; Three Month Treasury Bill Rateas of October 15;
Coroorate Issues Rate as of October 13._________________________________




242

Why is there still no recovery? There are two reasons for the failure of the U.S. economy
to recover so far in 1982. First, the budget impasse earlier this year helped sustain a
gridlock of high interest rates which pushed the economy lower. In retrospect, the failure
to tighten the budget until mid-year and tight monetary policy until that time were
egregious policy errors that undoubtedly prevented a recovery from occuring sooner. The
high interest rates and deteriorated balance sheets that resulted severely damaged the
economic and financial system.
Second, the tax cuts were quite small and not fully reflected in withholding schedules, and
were offset by rises in tax receipts from other sources. Federal personal tax receipts fell
only $6.2 billion in 1982:3 instead of the expected $25 to $28 billion. Third, the high
interest rates, depressed net worth, and increased risks of bankruptcy and joblessness for
households limited the response of consumption. In other periods when consumers have
responded quickly to tax reductions, e.g., in 1963-65, financial market conditions were
more supportive.
What is the impact of the tax cuts so far? The data through September show only modest
increases of real consumer spending in July and August. The marginal consumption out of
increased real disposable income was only 22.3% in July. By the end of August there was
a cumulative rise in this ratio to 55.3%. Then, in September it was over 100%. For the
third quarter, the ratio was 57.8%, below the likely 70% to 80% of increased real
disposable income that will eventually be spent. The response would have been even
smaller had the growth in income more fully reflected the expected reductions in taxes.
However, the data for September indicate a $7.5 billion rise in real consumption
expenditures compared with the $3.1 billion increases in each of July and August,
suggestive of an accelerating response of consumption to the tax reductions. It is safe to
say that the full brunt of the July 1 tax cuts has yet to occur, with only a relatively small
impact during the third quarter.
This result points up again that a necessary ingredient before a recovery can begin must
be a break to lower interest rates. In the 1973-75 downturn, interest rates only broke
sharply lower in October 1974. The recovery began six months later. In Spring 1980,
interest rates began to droD sharply in April. The expansion began three months later, in
July.
Table 11 shows that sharp declines for interest rates have occurred since midyear, with
reductions of 5 to 6 percentage points in short-term interest rates and about 3 percentage
points for long-term rates. This pattern is familiar as is the surge of stock prices that has
followed. With the rate declines not so sharp as in Spring 1980, longer lags can be
expected before an upturn.
But the reductions are consistent with the qualitative
patterns of late 1974, early 1975 and Spring 1980, suggesting that the first essential
precondition for expansion is now well in place.




24 3

Table 11
Interest Rate Behavior In Spring 1980 and Summer 1982
Interest Behaviior Since Mid-•1982

Interest Rate Behavior In Spring 1980

4/2/80

5/7/80

6/18/80

Change
4/2/826/18/80

7/2/82

8/6/82

10/15/82

7/2/82 10/15/82

Short-term:
3-month Treasury Bills
Federal Funds
90-Day CDs
90-Day Eurodollars
90-Day Comnercial Paper
Back *s avg. cost of funds
Prime

14.80
19.39
17.97
19.60
17.22
21.80
20.00

9.67
12.96
11.30
12.96
11.07
14.04
17.50

6.49
8.99
8.17
8.99
7.97
9.44
12.00

-8.31
-10.40
-9.80
-10.61
-9.25
-12.36
-8.00

12.52
14.00
15.20
15.81
14.50
15.50
16.50

10.35
10.63
11.65
12.63
10.75
11.90
15.00

7.45
9.38
9.40
10.13
8.25
9.86
12.00

-5.07
-4.52
-5.80
-5.68
-6.25
-5.64
-4.50

Long-term:
AA Utility
10-Yr. U.S. Govt.
20-Yr. U.S. Govt.
Bond Buyer Index

15.04
12.62
12.43
9.44

12.70
10.08
10.32
7.11

11.71
9.51
9.59
7.55

-3.33
-3.11
-2.84
-1.89

16.37
14.39
13.96
12.58

15.65
13.87
13.46
11.87

13.54
11.15
10.95
9.25

-2.83
-3.24
-3.01
-3.33

Mortgages:
New Conni tment

16.34

16.23

13.25

-3.09

17.00

16.25

14.50

-2.50

III.

Change

Patterns of Recovery and Prospects for the U.S. Economy

T h e p a t t e r n s o f r e c o v e r y b e g in e v e n as a r e c e s s i o n is s till in p r o g r e s s . T h e m o t io n o f a
t y p i c a l b u s in e s s c y c l e in c lu d e s a la t e r e s p o n s e by th e b u sin e ss s e c t o r in r e c e s s io n a f t e r
s a le s and o r d e r s h a v e b e e n d e c lin in g f o r q u it e s o m e t im e . M o s t t y p i c a ll y , d e c lin in g p r o f it s
and r is in g i n t e r e s t r a te s a ls o le a d t o a s u b s t a n t ia l d e t e r io r a t i o n in th e f in a n c ia l p o s it io n s
o f c o r p o r a t io n s , w ith risin g risk s o f b a n k r u p tc y and an o v e r w h e lm in g n e c e s s it y t o r e s t o r e
b a la n c e s h e e t s t r e n g t h and liq u id it y b e f o r e a n e w u p turn c a n b e g in .
I n v e n t o r ie s a r e
d e c u m u la t e d , c a p it a l o u t la y s c u t b a c k , an d e m p lo y m e n t r e d u c e d in th e b u sin e ss s e c t o r
d o w n tu r n , u s u a lly a b o u t h a lfw a y o r t h r e e -q u a r t e r s t o th e e n d o f r e c e s s io n . T h e r e s t r a in t
on b u sin ess u ses o f fu n d s f o r sp e n d in g on g o o d s , s e r v ic e s , and e m p lo y m e n t is th e n f e l t
th r o u g h o u t th e r e s t o f th e e c o n o m y , e x t e n d in g and in t e n s ify in g th e d o w n tu r n th a t
p r e v io u s ly b e g a n w ith w e a k n e s s in o t h e r s e c t o r s . T h is la t e b u s in e s s s e c t o r r e s p o n s e is th e
r e a s o n w hy th e u n e m p lo y m e n t r a t e ris e s b e y o n d th e en d o f r e c e s s io n f o r a n y w h e r e f r o m
o n e to t h r e e m o n th s . In a d d it io n , th e r e d u c e d g r o w t h in w a g e s and s a la r ie s a t th is s t a g e
o f th e d o w n tu r n c a u s e s s lu g g ish g r o w t h o f i n c o m e and a w e a k p a c e o f s p e n d in g on
c o n s u m p t io n g o o d s , w h ic h s e r v e s t o p r o lo n g th e r e c e s s i o n .
S o m e t im e d u rin g th e la t t e r s t a g e s o f a r e c e s s i o n , u n d e rp in n in g s o f r e li e f in th e fin a n c ia l
m a r k e t s b e g in t o o c c u r . T y p ic a l l y , th e c e n t r a l ban k sp a rk s d e c lin e s o f in t e r e s t r a t e s in
o r d e r t o s t im u la t e r e n e w e d e c o n o m i c g r o w t h o r a c c o m m o d a t e s f i s c a l stim u lu s d e s ig n e d t o
r e v iv e th e e c o n o m y .
In th e e a r ly s t a g e s o f r e c e s s i o n , d e c lin e s o f in t e r e s t r a t e s m o s t
t y p i c a ll y a r is e f r o m w e a k fin a l d e m a n d s , a d im in u it io n o f in fla t io n , and r e d u c t io n s o f
c r e d it d e m a n d s . B ut a t s o m e p o in t an e a s in g by t h e F e d e r a l R e s e r v e has a lw a y s b e e n a
n e c e s s a r y in g r e d ie n t t o any in c ip ie n t r e c o v e r y , a lt h o u g h w ith la g s s till o c c u r r i n g b e f o r e
th e e x p a n s io n a c t u a lly ta k e s h o ld .




I
1

244

F or r e c o v e r y t o o c c u r it is n e c e s s a r y f o r t h e fa m iiia r p a t t e r n s in fin a n c ia l m a r k e t s t o
o c c u r . W hat a r e t h e s e p a t t e r n s ? F ir s t , s h o r t - and l o n g - t e r m i n t e r e s t r a te s m u st d e c lin e
(T a b le 11). T h is has o c c u r r e d .
S e c o n d , th e F e d e r a l R e s e r v e m u st e a s e o n m o n e t a r y p o l ic y t o s u s ta in th e l o w e r in t e r e s t
r a t e s , r e li q u e f y th e b a n k in g s y s t e m , and e n c o u r a g e t h e r e p a ir o f d e t e r io r a t e d b a la n c e
s h e e t s . T h is n ow a ls o has h a p p e n e d w ith th e m o s t r e c e n t t il t i n g o f m o n e t a r y p o l ic y a w a y
fr o m s la v is h a d h e r e n c e t o t h e m o n e t a r y a g g r e g a t e s and a m o r e e c l e c t i c a p p r o a c h th a t
d ep en d s on g e n e r a l e c o n o m i c and f in a n c ia l m a r k e t c o n d it io n s .
T h ird , t h e s t o c k m a r k e t m u s t e n t e r th e e a r ly s t a g e s o f a bull m a r k e t , s in c e im p r o v e d
s t o c k p r ic e s n ot o n ly h e lp s e n t im e n t and c o n s u m e r s p e n d in g b u t a ls o s e r v e t o r a is e w e a lt h
and s p e n d in g , a lth o u g h w it h la g s .
A n i m p r o v e d s t o c k m a r k e t is a b o o n t o c o r p o r a t e
fin a n c e , o p e n in g a n o t h e r s o u r c e o f l o n g - t e r m fu n d in g w h ic h p e r m it s a r e s t r u c t u r in g o f
b a la n c e s h e e t s and r e d u c e s t h e c o s t o f c a p it a l. T h is p r o c e s s , t o o , is n ow in e f f e c t , w ith
o v e r a 3 0 % r is e in th e S & P 5 0 0 c o m m o n s t o c k in d e x s in c e m id -A u g u s t and an a p p r o x im a t e
$12 0 b illio n i n c r e a s e in t h e m a r k e t v a lu e o f h o u s e h o ld n e t w o r t h , in c o n s t a n t d o lla r s .
F o u rth , r e d u c t io n s o f i n t e r e s t r a t e s a f f e c t a f f o r d a b il i t y p a r a m e t e r s f o r h o u s e h o ld s ,
lo w e r in g th e m o n t h ly m o r t g a g e lo a n and c o n s u m e r lo a n r e p a y m e n t bu rd en s as w e ll as
r e d u c in g th e a f t e r t a x c o s t o f b o r r o w in g .
T h e se e f f e c t s a lw a y s h a v e b e e n im p o r t a n t t o
co n s u m e r p u r c h a s e s o f b ig t i c k e t i t e m s , w ith s o m e o f t h e la r g e s t r e s p o n s e s in c o n s u m e r
sp e n d in g on a u to s and h o u s e s o c c u r r i n g o n c e th e lo a n r e p a y m e n t b u rden s h a v e d e c lin e d .
P r ic e d e c lin e s f o r t h e s e it e m s a ls o can e n h a n c e a f f o r d a b il i t y , a lo n g w ith r is in g d is p o s a b le
in c o m e . In th is e p i s o d e , a c o m b in a t io n o f all th r e e has begu n w it h th e 3 t o 5 p e r c e n t a g e
poin t r e d u c t io n s in m o r t g a g e r a t e s s in c e Ju ly and 1 t o 3 p e r c e n t a g e p o in ts d r o p in
c o n s u m e r lo a n r a t e s , s t a b i li t y in a u to p r ic e s , f a llin g p r ic e s f o r r e a l e s t a t e , an d r is in g
d is p o s a b le i n c o m e f r o m th e p e r s o n a l t a x c u t s .
F ift h , th e p r o c e s s o f r e l i q u e f i c a t io n m u st be o c c u r r i n g b e f o r e h o u s e h o ld s r e s u m e a ra p id
p a c e o f s p e n d in g .
T h e r e b u ild in g o f b a la n c e s h e e t s , p a y in g o f f o f in d e b t e d n e s s , and
a c c u m u la t io n o f fin a n c ia l a s s e ts is th e m ir r o r im a g e in th e f l o w - o f - f u n d s o f th e in c r e a s e d
sa v in g th a t o c c u r s d u rin g r e c e s s i o n . E a ch s e c t o r m u st g o t h r o u g h th is p r o c e s s , a lth o u g h
fo r bu sin ess a lo n g e r p e r io d o f t im e is r e q u ir e d . In an y c a s e , th e c o r p o r a t e s e c t o r is th e
la st t o r e s p o n d in an u p tu r n , n e e d in g s u f f i c i e n t tim e t o r e li q u e f y b e f o r e a d d it io n a l
sp en d in g c o m e s a b o u t. O n e p r o b le m w ith th e d o w n tu rn o f S p r in g 1980 is th a t it did n ot
la st lo n g e n o u g h t o p e r m it a fu ll r e li q u e f i c a t io n f o r th e v a r io u s s e c t o r s in th e e c o n o m y , so
th at th e a p p r o p r ia t e p r e c o n d it io n s f o r a s u s ta in e d r e c o v e r y w e r e n o t e s t a b lis h e d .
O th e r p a t t e r n s in c lu d e m u c h l o w e r in fl a t i o n r a t e s , risin g r e a l i n c o m e s , and m o s t t y p i c a ll y
p r iv a t e s e c t o r a b s o r p t io n o f la r g e f e d e r a l b u d g e t d e f ic i t s w it h o u t a s u b s t a n t ia l in c r e a s e s
o f in t e r e s t r a t e s . A ll o f t h e s e p r o c e s s e s a r e in p la c e n o w . S o lo n g as t h e F e d e r a l R e s e r v e
rem a in s m o r e a c c o m m o d a t i v e , t h e r e is no r e a s o n w hy th e p a t t e r n s o f r e c o v e r y in th e
fin a n c ia l m a r k e t s c a n n o t e v o l v e t o an e c o n o m i c u p tu rn . T h u s , t h e o u t l o o k f o r t h e U .S .
e c o n o m y has ta k e n a s i g n if i c a n t turn f o r th e b e t t e r .




245

Table 12
Data Resources Forecast of the U .S. Economy CO N TR O L102682

.....
IV

III

II

III

II

1981

1982

1983

2323.i
388.7
157.9
24.3
10.2
306.5
432.2

1843.1
346.1
105.0
20.4
26.1
228.9
368.0

1970.7
346.4
98.4
-14.6
24.5
255.4
389.7

2138.6
348.0
129.5
10.7
18.1
281.3
410.7

IV

1984 ‘1985

GNP and Its Components
Billionsi of Dollars ~ SAAR
2026.3
334.6
107.3
-6.2
18.6
270.1
399J

2068.4
336.7
116.8
5.1
21.6
272.5
401.2

2111./
341.1
124.1
8.6
18.6
276.2
408.9

2161./
351.2
134.1
11.6
15.0
283.5
414.3

2212.5
362.8
143.2
17.4
17.3
293.0
418.6

2265.6
375.6
150.4
23.3
15.2
297.9
425.4

2350.8
395.9
162.6
27.2
13.3
311.0
436.7

2581.«»
.453.1
193.0
34.2
10.9
347.8
476.5

Total Consumotion......
Nonres. Fixed Investment.
Res. Fixed Investment.
Inventory Investment.
Net Exports.....
Federal Purchases.............
State and Local Govt. Purchases.

1989.S
341.6
97.4
-0.5
13.2
257.5
392.6

Gross National Product..
Real GNP (1972 Dollars)..

3091.4 3149.7 3222.2 3289.1 3371.5 3464./ 3553.4 3642.8 2937./ 3070.4 3336.9 3697.5 4096.8
1481.2 1488.8 1501.2 1512.8 1529.3 1546.9 1562.9 1579.7 1502.6 1479.8 1522.5 1589.8 1652.5
Prices and Wages

Implicit Price Deflator...
CPI - All Urban Consuners.........
Producer Price Index - Finished Goo<
Compensation per Hour.
Core Inflation.

5.4
7.6
6.5
6.4
7.6

5.6
2.7
2.6
6.0
7.2

6.0
5.6
4.0
7.0
6.8

Annual Rates of Change
5.3
5.7
4.6
6.4
6.5

5.7
5.9
5.6
7.0
6.2

6.6
5.9
6.1
6.8
6.0

6.2
6.5
7.4
7.7
5.9

5.8
6.2
6.9
6.9
5.9

9.4
10.3
9.3
9.6
9.0

6.1
6.1
3.9
7.1
7.8

5.6
5.3
4.3
6.6
6.4

6.1
6.1
6.4
7.2
5.9

6.6
6.4
7.2
8.0
5.?

Production and Other Key Measures
Industrial Production (1967*1.000).
Annual Rate of Change...
Housing Starts (Mil. Units).....
Retail Unit Car Sales (Mil. Units)
Unemoloyment Rate (X)..... .
Federal Budget Surplus (NIA),

..381 *.375 1.400 t.423 ...458 1.494 .522 i.543 1.509 ..392 1.444 ..560 i.647
6.7 10.0 10.2
-3.7 -1.6
7.7
5.8
2.6 -7.8
3.7
8.0
5.6
7.6
..034 ..393 1.675 1.837
’.114 1.149 ..226 .333 1.474 1.531 i.573 L.637 i.100 ’
8.7
7.7
8.4
9.3
9.5
7.8
8.1
8.9
9.8
8.5
7.8
9.9 10.4
9.4
9.7
9.9
9.2
9.6
9.8
8.6
7.3
9.9 10.3 10.2
8.8
7.6
•157.7 -173.3 -153.5 -147.6 -169.4 -160.3 -152.9 -146.0 -60.0 -142.2 -157.7 -144.6 -122.6

Money Supply (M-l).............
X Change, 4th-Qtr. to 4th-Qtr.
New AA Corp. Utility Rate (X)....
New High-Grade Corp. Bond Rate (X).
Federal Funds Rate (X).
Prime Rate (X).

455./ 467.3 471.8 475.0
3.5 10.6
3.9
2.8
15.02 12.55 13.10 12.92
14.09 11.62 12.17 11.99
11.01 9.20 10.17 10.22
14.72 11.72 12.42 12.36

Money and Interest Rates
499.0
3.5
12.57
11.98
10.06
12.94

505.1
5.0
11.69
11.15
9.48
12.15

436./
5.0
16.25
15.01
16.38
18.87

467.3
7.0
15.13
14.03
12.24
14.80

494.'/
5.9
12.64
11.84
9.-86
12.23

519.8
5.1
11.59
11.07
9.39
12.15

546.0
5.0
10.94
10.48
9.91
12.29

2636.8 2689.5 2744.5 2815.4 2889.0 .2953.1
1.7
1.5
4.4
2.8
8.3
3.1
6.6
6.3
6.3
7.2
7.3
7.2
177.9 184.9 193.2 204.1 217.8 229.8
119.8 120.1 125.1 131.8 140.1 147.3
87.2 93.2 97.7 103.6 110.8 112.2
-17.2
3.7 10.4 10.7 27.1 20.4

3026.3
3.5
7.0
240.1
153.8
116.4
19.2

2415.8
2.5
6.4
232.1
150.9
107.2
2.6

2574.4
1.3
6.7
174.0
117.4
89.8
-16.3

2784.6
3.0
6.8
200.0
129.3
101.3
12.9

3067.4
4.2
7.1
246.5
157.8
119.7
18.?

3364.6
3.2
7.0
282.8
177.2
139.9
16.9

1.9
1.0
1.8
3.5
2.4
6.3
-4.9
-0.5
7.2
3.7
-0.8

-1.5
-0.6
1.0
-4.6
-7.3
1.8
-9.0
-4.3
1.1
3.7
-1.0

2.9
2.2
2.9
-3.3
-1.2
-7.7
24.8
1.6
3.4
3.2
-1.0

4.0
3.8
7.4
9.6
2.1
16.7
5.5
6.6
2.9
-0.3

4 .4

3.9
3.9
3.3
7.3
8.5
4.2
9.3
5.1
5.7
4.2
1.9

Incomes
Personal Income............
Real Disposable Income (XCh).
Saving Rate (X)....
Profits Before Tax.
Profits After Tax.
Company Profits...........
Four-Qtr Percent Change.

2597.9
2.3
6.9
174.9
118.5
93.6
-11.5




0.8
2.1
-0.6
2.9
1.4
3.1
-13.0 -10.5
-15.0 -8.3
-8.6 -14.7
4.1 40.5
-10.4 -0.9
2.7 -5.4
19.4
9.1
-0.7
0.9

3.4
2.0
2.6
-0.8
3.6
-9.5
32.7
4.0
2.8
-1.8
-4.1

494./
10.1
12.37
11.75
9.85
12.53

Billions of Dollars

Composition of Real GNP
Gross National Product.
Pinal Sales.....
Total Consumption......
Nonres. Fixed Investment.
Equipment..........
Nonres. Construction.
Res. Fixed Investment.
Exports.
Imports..........
cederal Government........
State and Local Governments...

483.0
6.9
12.15
11.44
9.18
11.59

3.1
2.8
3.1
1.2
5.6
-7.8
19.0
4.5
7.3
0.0
1.3

Annual Rates of Change
4.5
4.2
4.0
6.6
10.0
-0.8
26.3
4.0
7.2
5.1
-1.1

4./
4.1
3.9
7.7
9.9
2.6
21.1
6.3
5.0
1.1
-2.2

4.2
3.6
3.3
7.9
10.1
3.0
12.7
6.1
5.9
0.6
-0.2

4.4
4.3
4.4
8.0
9.8
3.7
13.3
5.7
11.2
6.2
0.0

246

Table 13
U .S. Economic Prospects: CONTROL 102682

Major econo* 1c Indicators:
Gross national product (percent change, fourth quarter over fourth quarter):
Current dollars . . . .
Constant (1972) d o l l a r s .........................................................................
GNP deflator (percent change, fourth quarter over fourth quarter).
Consumer Price Index (percent change, fourth quarter over fourth
quarter) 1 / ......................................................
Unempl oy»«nt rate (percent, fourth quarter)
Annual economic assumptions:
Gross national product:
Cirrent dollars:
Am o u i t ..........................................
Percent change, year over >ear
Constant (1972) dollars:
A m ount..........................................
Percent change, year over year

Income:

Personal Income . .
Wages and salaries .
Corporate p rofits 2/
Price level:
CMP deflator:
level (1972-100), annual average
Percent change, year over year
Cons user Price Index 1/:
Level (1967-100), annual average
Percent change, year over year
Unemplojment rate:
Total, annual average .
Insired, annual average.......................
Federal pay r a ise , October (percent j 3 /:
Civilian
7
M i l i t a r y ..................................................................
interest rate, 90-day Treasury b i lls (percent) 4 /
0«f 1c it (NIA, b its , of S 's ).

9.4
-0 .3
9.8
12.6
7.5

2626
8.8

3337
8.7

4496
9.7

1481
-0.2

1523

1702

2160
1344
246
177.4
9.0

207.5

6.1

219.1
5.6

247.0
13.5

289.1

304.5

7.1
3.8
9.1
11.7
11.4
-59.6

14.3
14.0
-60.0

-157.7

-144.6

CPI for urban wage earners and c lerica l *>rkers. T*» versions of the CPI are now publ ished. The index shown here Is that currently used, a
required by 1 « , in calculating automatic c o s t-o f-liv in g increases fo r indexed Federal progrms.
Excludes the direct accounting e ffe c t of the A dnlnistration's depreciation proposal t i business Income, although all categories of economic
assunptions do re fle c t the economic impact of this proposal.
This indicator measures unemploynent under State regula* unemployment insurance as , percentage of covered employment under that program.
It does not include recipients of extended benefits under that progran.
Pay raises became e ffe ctiv e in October of each year - - the f ir s t month of the f iscal >ear.
scales that will be in e ffe c t during fisca l year 1982.

Thus, the October 1981 pay raise will set new pay

Average rate on new issues within period. The projections assune that Interest rates decline with the rate of inflation and inflationary
expectations. These projections do not represent a forecast of interest rates.
ource:

Budget of t he United States Government. Fiscal Tear 1983. Office of Management and

Budqet. February 1982, pp. ?-S. 2-7. 9-6?.

The pattern s o f r e c o v e r y a re ingrained in the D RI fo r e c a s t , although w ith still a resid ue o f
restra in t on the upturn s in ce a gradual r e c o v e r y is likely to be a g o a l o f p o lic y . R e la tiv e ly
high nom inal and real in te re st ra te s, although dow n substantially fr3 m previou s peaks, w ill
restrain the r e c o v e r y in in te re st sen sitiv e s e c to rs s u ffic ie n tly to k eep the expan sion to
abou t h alf the p a ce e x p e r ie n c e d in the ty p ic a l postw a r r e c o v e r y .




24 7

T he DRI fo r e c a s t o f th e U.S. e co n o m y show s a contin uin g b o tto m in g -o u t o f the recession
for another m onth or tw o , then m eaningful r e c o v e r y la te this y ear. R eal GNP should rise
fro m 2 to 2 -1 /2 % in th e fou rth qu a rter, then a c c e le r a t e to a 3 or 4% pace o f grow th in
ea rly 1983, p ick in g up speed in the se co n d half o f next year as the last stage o f the
personal in c o m e tax cu ts takes e f f e c t . The fu ll im p a cts o f th e lo w e r in terest rates and
im p rov ed s to c k m arket o f this sum m er should im p a ct tow a rd the end o f the year and
through m ost o f 1983, provided any upward spike th at m ight o c c u r fo r in terest rates is
only m o d e r a te and quickly erased. The p r o file o f the r e c o v e r y is m ainly a traditional one,
w ith rises of housing starts and consum ption spending leading th e w ay, in crea sed
in ven tories con trib u tin g to grow th in the fir s t half o f 1983, and a stron g pace o f m ilitary
spending providing support throughout. R e a l e c o n o m ic grow th is p r o je cte d at 3% fo r
1983, although w ith only a m o d e ra te pace o f expansion until the s e co n d half. 1984 is the
first really good year fo r the e c o n o m y since 1978, w ith real G NP up 4.4% .
The F ed era l R e se rv e is assum ed t o a c c o m m o d a te a r e c o v e r y until it is in p la c e , then
tighten up som ew h a t, bringing rises o f in te re st rates in th e first half o f 1983. A n oth er
round o f d eclin es this quarter from 100 t o 150 basis points fo r s h ort-term in terest rates
and 100 basis points in bond yields insures that a r e c o v e r y will take p la ce . The prim e rate
is fo r e c a s t at 11%, 90-day Treasury bills at 6 -1 /2 t o 7% , and the fe d e r a l funds rate at 8%
b e fo r e the end o f this quarter. L on g-term bond yields con tin u e to d e c lin e , r e fle c t in g the
r e a liz a tio n o f investors that in flation rates are now down in to m id -sin gle digits rather
than the 8 or 9% p reviously discou n ted in to bond p rice s. T he large d e fic its o f 1983 and
1984, e stim a te d at fro m $150 t o $161 b illio n , p rop in te re s t rates so m e 100 basis points
higher than w ould oth erw ise be the c a s e , but an assum ed heavy r e liq u e fica tio n by th e
p riva te s e c to r helps the d e f ic it to be absorbed w ith ou t fu rth er rises o f in terest ra te s.
A ls o , the app arently perm anent d isin flation ary environ m en t is o f m ajor help in keeping
bond yields lo w e r . The s to c k m arket is p ro je cte d t o contin ue rising, w ith the D ow Jones
surging in to the 1100 to 1200 area o v e r the next year.
T h ese fin a n cia l m arket patterns serve t o p ro m o te a m ending o f de te rio ra te d
balance
sh eets fo r households and business. The banking s e c t o r b e n e fits fro m th e lessening cr e d it
risks.
The r e s t -o f-t h e w orld also is a b e n e ficia r y , w ith lo w e r in terest rates abroad
possible w ithout m ajor harm to fo re ig n c u r r e n c ie s , thus easing pressure on th e w orld
e c o n o m ie s . W ith so m e r e c o v e r y in basic c o m m o d ity p rice s , the ex p o rt earnings o f L D C ’ s
m ove higher. L ow er in te re st rates th e w orld o v e r m ake the burden o f debt s e r v ic e and
loan repaym ents som ew hat easier fo r th ese co u n trie s , lessen in g the potential fo r a dire
crisis of defau lts by fo re ig n co u n ties.
The in terest sen sitive areas in the U .S. e c o n o m y , housing, a u to s, and business capital
fo rm a tio n , all show m od est rises com p a red w ith other periods o f r e c o v e r y . U.S. a u to
sales, both d o m e s tic and im p o rte d , rise t o 8.8 m illion units in 1983, a large in cre a se over
this year, but far below the 10.6 m illion units o f 1979. H ousing starts m ove o v e r 30%
higher in 1983, re ach in g 1.38 m illion units, but also rem ain fa r below previous peaks such
as th e 2 m illion units o f 1978.
Business ca p ita l fo rm a tio n is slow to respond to the
im p rov in g e c o n o m y w ith no real p rosp ects fo r a revival until the secon d half o f 1983.
Indeed, it is not until 1984 that a r e c o v e r y -lik e p a ce o c c u r s fo r real nonresidential fix e d
in v estm en t. The U .S. trade balance rem ains n eg ativ e through the rest o f this year and
in to 1983, b e fo r e the e f fe c t s o f a w eakening dollar cause a re v e rsa l. Even then, th e r e is
still a slight n egative balance on fo re ig n a c c o u n t.
The ou tlo o k fo r in te re st rates show s a "d o w n ," "u p ," then "d o w n ," p attern , with lo w e r
in terest ra tes, on a v e ra g e , prog re ssiv e ly o ver the fo r e c a s t h orizon . Interest rates are
low er a year fro m now than cu rren tly and also f o r m ost o f 1984. The reasons are:




248

T a b le 14
H istory and F o r e c a s t o f K ey In terest R a te s
(P e rce n t)
Years

1983

1982

1980

1981

1982

1983

1984

9,.85
9,.15
10,.43
10,.74
12,.53

13,.36
11,.43
12,.66
13,.05
15,.27

16,.38
14,,03
15.,33
15..92
18.,87

12 .24
10,.52
11 .97
12,.35
14,.80

9.86
9.04
10.41
10.66
12.23

9,.39
8..80
9,.98
10..27
12..15

9,.43

10,.09

11..51

14..34

13,.13

10.57

9..72

12.92

12..15

12,.37

13..14

16.,25

15,.13

12.64

11,.59

10.02

9..67

9,.87

8..58

11.,33

11,.51

9.91

9..18

11..50
11..56

11.04
11.37

10..30
10..98

10,.53
10..86

11..46
11..39

13..91
13.,72

13,.11
13,.02

10.85
11.20

10..10
10..54

14,.72

14.46

14..16

14..51

14..00

16.,71

16..67

14.46

14,.06

1980

1981

1982

1983

1984

-1.0 3
9.86

-0.7 5
9.39

IV

IV

II

I!tl

10,.17
9,.39
11,.07
11,.30
12..42

10.22
9.10
10.49
10.74
12.36

9..18
8,.50
9,.64
9,.88
11,.59

10.99

12,.07

10.69

15,,02

12.55

13..10

11.,39

9.33

10..06

13,.93
13,.74

13.,12
12.,94

11.08
11.14

17,.28

16.,75

15.18

II

11[I

14,.23
12..81
13..81
14,.24
16,.27

14 .51
12 .42
13 .81
14 .24
16,.50

11..01
9..32
11..15
11..60
14,.72

9.20
7.53
9.12
9.32
11.72

14..45

14,.10

13.,00

16,.78

16,.17

13..04

12,.28

14,.29
14,.27
17,.45

Short-Term:
Federal Funds...................
3-Month Treasury B i l l s . .
3 Month Conmercial Paper
3-Month CD's........
Prime Bank Loans.
Intermediate-Term:
3-5 Year U.S.
Government Bonds.
Long-Term:
A A -U tility ...................
Bond Buyer Index o f
20 Municipal Bonds..
U.S. Government Bonds
(Constant M aturity)
10-Year.
20-Year.........................
Mortgage Cocmitment Rate
Conventional Loans___

T a ble 15
C r it ic a l F a cto r s in the Interest R a te F o r e c a s t

1982

......

1983

II

III

IV

-1 .2 6
14.23

-0.9 8
14.51

-0 .3 8
11.01

-0 .2 9
9.20

- 0 .9

4.2

11.

10.3

4.3

4.6

5.4

5.6

Years

II

III

IV

-1 .1 0
10.17

-1 .1 9
10.22

-0.9 3
9.18

-0.9 1
9.85

-1 .1 4
13.36

-1 .0 5
16.38

-0.7 3
12.24

5.0

5 .0

8.0

8 .0

6.1

6 .:

5.6

6 .0

5.3

5.:

6 .6

9.3

9.4

6 .:

Factor
Fed Policy
Free Reserves
( B ils . o f d o l l a r s ) . . .
Federal Funds Rate (X ).
Nonborrowed Reserves
XCH.
In fla tio n (XCH - Im p licit GNP

e f la t o r ) ,

The Economy
Real Growth
XCH.

6.5
3.6

6.::

- 5 .]

2.:

0 .8

2.1

3.4

3.!

4.5

4 .:

-0 .4

.9

1.5

’ .9

4.4

Unemployment Rate (X).

8.8

9.5

9.9

10.3

10.2

9.9

9J

9.4

’ .2

r.6

9.6

9.8

8.6

The O ollar
Morgan Guaranty Trade
Weighted Exchange Rate
XCH.,

8.9

9.4

0.4

-2 .2

13.6

15 .'

1.5.1

3.2

- 4 .0

-4 .0

-6 .0

- 3 .0

-0.1

C redit Demands (*1)
XCH..

70.6

-1 5 .8

72.?

35.6

-43.1

-1 2 .3

42.9

44.8

- 6 .5

4.4

6.8

..6

27.4

Monetary Growth
Ml (XCH, SAAR).
M2 (XCH, SAAR).

10.8
10.1

3.3
9.8

3.5
10.1

10.6
11.8

3.9
6.6

2.8
6.4

6.9
9.4

10.1
9.1

/. 3
9.2

5 .0
9.5

7.0
10.4

5.9
7.8

5.1
8.2

Banking System
L iqu id ity Tension Index ( * 2 ).
Federal D e f ic it
(NIA, B ils , o f d o lla r s ) .

115.:
■118.4

100.0

74.9

64.9

59.4

85.8

80.4

92.:

78.2

143.:

88.8

-11 9.6

- 157.:

173.3

•153.5

•147.6

■169.4

■160.:

-6 1 .4

-6 0 .0

•142.2

(*1) Credit Demands are defined as the domestic c r e d it demands of
the household, nonfinancial corp o ra te , and Federal and State and
local government s e c to rs .
(*2) The L iqu id ity Tension Index is based on the changes in
bank loans, including CM loans, plus real e sta te and
individual loans and the flow o f to ta l reserves less changes in
demand and savings and smal1-denomination time d e p osits - index
number, 1977:2 = 100.




79.4
■157.

80.7
•144.6

249

A s ta g n a n t e c o n o m y , w ith w e a k r e a l e c o n o m i c g r o w t h and risin g u n e m p lo y m e n t
w e ll in t o a u tu m n , p r e s s in t e r e s t r a t e s l o w e r .
I n fla t io n r a t e s m o v e b a c k d o w n t o w a r d th e n e w lo w e r p la t e a u e s t a b lis h e d e a r lie r
th is y e a r and a c t t o k e e p s h o r t - and l o n g - t e r m i n t e r e s t r a t e s lo w e r u n til n ea r y e a r
end.
M o r e and m o r e , r e d u c t io n s in e x p e c t e d r a t e s o f in fla t io n sh ou ld h e lp th e
fin a n c ia l m a r k e t s .
T h e m o n e t a r y p o l ic y s t a n c e o f th e F e d e r a l R e s e r v e h o ld s t o a r e la t i v e l y t ig h t
p o s it io n s o lo n g as th e e c o n o m y d o e s n o t d r o p in t o y e t a l o n g e r , d e e p e r r e c e s s io n
th a n th e s e v e r e d o w n tu r n a lr e a d y in p l a c e , an d u n til th e sh a rp d e c lin e s o f in fla t io n
a r e p e r m a n e n t . B u t t h e e a s ie r t a c k f o r m o n e t a r y p o l i c y t a k e n r e c e n t ly s h o u ld h o ld
w e ll in t o th e f o u r t h q u a r t e r e v e n if M 1 is s o m e w h a t a b o v e t a r g e t .
M o n e t a r y g r o w t h re m a in s e s s e n t ia lly u n d er c o n t r o l t h r o u g h th e r e s t o f th e y e a r ,
w ith p e r i o d ic b u lg e s o n ly t r a n s it o r y in th e w e a k e c o n o m i c e n v ir o n m e n t .
The
J a n u a r y an d A p r il b u lg e s in M l tu r n e d o u t t o b e a t r a n s ito r y o c c u r r e n c e , th e
e x p e c t e d s u m m e r s p ik e in M l w as a n o n e v e n t , and s u r g e s th is f a ll w ill b e
t e m p o r a r y w ith th e e c o n o m y s o w e a k .
T h e a g g r e g a t e s , a lth o u g h m o r e b r o a d ly
d e f in e d , b e c o m e im p o r t a n t a g a in in t h e f ir s t h a lf o f 1 9 8 3 .
A r e s ilie n t d o lla r , lo s in g o n ly a m o d e s t a m o u n t o f its g a in s as in t e r e s t r a t e s w o rk
l o w e r , is a p o s i t iv e f a c t o r h e lp in g t o k e e p U .S . i n fl a t i o n and i n t e r e s t r a t e s d o w n .
T o t a l c r e d i t d e m a n d s in th e p r iv a t e s e c t o r e a s e w it h th e e c o n o m y in a f u ll - f l e d g e d
r e c e s s io n th is y e a r ; t h e r e is n o b ig r e s u r g e n c e u n til 1 9 8 4 . R e l i q u e f ic a t i o n and h igh
s a v in g s p r o p e n s it ie s p e r m it a r e la t i v e l y c o m f o r t a b l e a b s o r p t io n o f T r e a s u r y d e f i c i t
f in a n c in g th is y e a r .
P r e s s u r e on t h e b a n k in g s y s t e m s h o u ld b e le s s e n e d f o r th e r e s t o f th e y e a r and
d u rin g 198 3 as b u sin e ss lo a n d e m a n d e a s e s , h e lp in g t o k e e p s h o r t -t e r m in t e r e s t
rates dow n.
T h e f e d e r a l b u d g e t d e f i c i t and T r e a s u r y f in a n c in g w ill b e a t r e c o r d le v e ls , th e
b ig g e s t n e g a t iv e f o r t h e fin a n c ia l m a r k e t s u n d er th e N e w F e d P o l i c y , but o f f s e t t o
a s i g n if i c a n t e x t e n t by lo w e r r a t e s o f in fl a t i o n , i n c r e a s e d v e l o c i t y g r o w t h , and
r e li q u e f i c a t io n b y th e p r iv a t e s e c t o r .
C o n tin u in g lo w in fla t io n r a t e s a r e a p o s s ib le e s c a p e v a lv e fr o m th e p o t e n t ia l c la s h
b e t w e e n b ig d e f i c i t s , h e a v y T r e a s u r y fin a n c in g and t h e r e s t r a in t o f th e c e n t r a l ban k in
1983 an d 1 9 8 4 , w ith s u r p r isin g ly lo w m o n e t a r y g r o w t h an in c r e a s in g ly p o s s ib le o u t c o m e .
T h e s a lie n t q u a lit a t iv e f e a t u r e s o f th e fin a n c ia l f o r e c a s t s in c lu d e : 1) d e c lin in g n o m in a l
in t e r e s t r a t e s , on a v e r a g e , th r o u g h o u t th e f o r e c a s t h o r iz o n ; 2) h is t o r ic a lly high n o m in a l,
r e a l, and r e a l a f t e r t a x r e tu r n s on s a v in g s an d c o s t s o f b o r r o w in g ; 3) w e a k p r iv a t e s e c t o r
c r e d it d e m a n d s , e s p e c i a ll y by b u s in e s s ;
4) a g r a d u a l, b u t s t e a d y and e x t e n d e d ,
r e li q u e f i c a t io n b y th e p r iv a t e s e c t o r ; 5) no c a v in g in b y th e F e d e r a l R e s e r v e on a c h ie v in g
s u s ta in e d lo w e r g r o w t h in th e m o n e t a r y a g g r e g a t e ; and 6 ) a f l o o r un d er n o m in a l and r e a l
i n t e r e s t r a t e s s e t by h u g e f e d e r a l b u d g e t d e f i c i t s , d e r e g u la t io n o f d e p o s it and lo a n r a t e
c e il i n g s , h i g h - c o s t fu n d in g f o r le n d in g in s t it u t io n s , an d ris k p r e m ia in in t e r e s t r a t e s fr o m
v o l a t il i t y in th e fin a n c ia l m a r k e t s .
F e d e r a l R e s e r v e p o l ic y has d e f in it e l y e a s e d w ith 1) a l o w e r d is c o u n t r a t e d e s p it e M l
a b o v e th e u p p er t a r g e t l im it ; 2) a w a v e o f b a n k r u p t c ie s t h r e a t e n in g a f u l l - f l e d g e d
d e p r e s s io n ; 3) c r a c k s in th e d o m e s t ic and i n t e r n a t io n a l f in a n c ia l s y s t e m ; 4) a t ig h t e r f is c a l
p o l ic y t r a c k f o r t h e A d m in is t r a tio n and C o n g r e s s ; and 5) th e lo w s in g le - d ig it i n fla t io n
r a t e s n ow in p l a c e .




250
The tem porary abandonm ent o f M l as a guide to policy m akes sense since that m easure
for money is now so distorted by the e f f e c t s o f seasonal fa c to r s , increased liquidity
preference, and changes in deposit instrum ents. C u rren tly, M l is $ 9 .7 billion above its
upper bound and M 2 ex c e e d s by $ 1 2 .3 billion its upper bound. H ow ever, M 2 as w ell is
undoubtedly d istorted , w ith proceeds o f tax cuts flow in g into this m onetary a gg reate and
bulging it higher.
For the cen tral bank to au to m a tica lly tighten m onetary policy in
response to ex c essiv e grow th in these aggregates when the econom y has not yet recovered
would be to repeat the m istakes of earlier this year when policy was tightened in January
and April in response to transitory changes in the m onetary a g g reg a tes. In retro sp ect, the
e f f e c t o f this type o f m onetarism was to prolong the w orldw ide recessio n .

Table 16
Monetary Aggregates: Actual and Targeted
190?

Latest

Seo.

Auq.

July

Lower Bound

446.98

4 4 5 .SO

4 4 1 .8 9

44 3 .9 *

443.07

Actual Monthly Level

46 7. 70

460.50

4 5 5 .?n

4 5 1 .™

45 1.40

Upner Bound

4 5 9 .0 7

4 5 6 .7 ?

454.71

45 ?.7 1

450.71

June

Apr.

Mar

Feb.

Jan,

44 9.16

44 1.95

44 0.34

43 9.43

4 3 8 .i ?

1 5 1.50

15 9 .4 0

4 4 « . 30

44 7.30

4 4 « .60

1 4 « .71

416.71

414.71

44 9.70

44 0.70

1 ,« 9 5 .0 7

May

Ml

M?

Lower Bound

1,.*107.35

1,R*W.31

1 , «79.9*1

1 ,3 7 0 .? 1

l.R R l .? ]

,« 5 9 .1 7

1 , « 4 3 .14

,3 3 4 .1 0

Actual Monthly Level

1 ,9 5 4 .5 0

,9 4 5 .1 0

1 ,9 ? 3 .4 0

1,9 0 7 .9 0

I , « « 7 . 50

1 ,« « 0 .7 0

1 ,« 6 5 .9 0

, « 4 « . 00

,« 4 1 .3 0

Unner Bound

1 ,9 4 7 .5 3

1 ,9 ? 8 .9 7

1 ,9 1 5 .4 ’

1 ,9 0 1 .«7

1 , 'W . l ?

1 ,.«74 .76

1,« 6 1 .? !

,»>47.66

,"3 4 .1 !

For i o « 1;1 to !««>'>:4, tarqet«; are as follows:
Lowpr Ml tar'iptpri q r o w t h r*te:?.5"', U n n e r qrowt.h r a t e : 1;.';*
Lower '-P tarnetQj o r o w t h r a t e ^ . O « , H o n o r g r o w t h r a t P ^ . O i ;

The resulting policy course for the Federal R eserve thus will b ec om e m ore e c le c t ic , with
a flexible "upper lim it" m onetarism the goa l.

''




Chart S
Ml and Its Targets:
"Upper Limit Monetarism"
(Billions of Dollars, SA)

251

The "stra y in g from m on e ta rism " of the Federal R eserve has cla rifie d itself m ore rece n tly.
The easing o f m onetary policy through the tem porary abandonm ent o f M l appears to have
been quite m od e st, with the federal funds rate still trading above 9 % and bank reserves
and the m onetary base actu ally dropping for the w eek ending O cto b er 13. The cen tral
bank is being m ost vocifero u s about its adherence to long-run goals o f m oderate m onetary
grow th and low inflation rates, although hinting that M 1 m ay be abandoned as the veh icle
by which these goals are to be ach ieved.
For the m o m en t, direct indicators of the
eco n om y, in flatio n , and unem ploym ent will provide the cen tral bank with the necessary
inform ation upon which to base policy. T h ese, a fte r a ll, are the ultim ate targets of the
Federal R e se rv e . M 2, M 3 and various cred it agg regates w ill be m ore closely follo w e d . O f
cou rse, on ce the reco very is in p lace, the cen tral bank will again have to fa c e up to. how
the m onetary a g g regates are behaving, perhaps becom in g m ore restrictive if the various
a g g reg a tes, including M l , are still above ta rg e t. The "fo r g iv e n e s s " on interest rates now
to g et recovery going is very likely to m ean rises som ew here down the road, once an
expansion is in p lace , unless inflation rates stay quite low .
A s for in flatio n , the back of the p ric e -w a g e -p ric e spiral of 1 9 6 5 -8 0 is broken. Inflation
rates are prim arily down in low single digits, w ith the key to sustained im provem ent, the
perfo rm an ce on w ages and productivity grow th in 1982 and 198 3 . The exceptional turn for
inflation rates to low er lev els is also having a m ajor im p act on inflation exp ectation s,
with investors in the financial m arket sensing the fun dam en tally low pace for inflation
now for several yea rs.
The perm antly lower ex p ected rate o f inflation now being
discounted into the financial m arkets is a m ajor reason for the huge rallies since mid­
sum m er.

Chart 9
Consumer Price Index ■
All Urban: History and Forecast
(Percent Change)

Chart 10
Consumer Price Index
INTERIM 1019 vs. CONTROL12248Q

The prospects suggest that no quick reac celera tio n o f in flation
reasons include:

rates

is likely.

The

Philips curve tra d e o ff in process on unem ploym ent and inflation— trem endous
downward pressure on wages
record slack in econom y— in labor and cap ital m ark ets, with actual real GNP far
short o f potential
a n ti-in fla tio n policy bias
fo o d , o il, en ergy, and shelter costs under control
productivity grow th to rebound.




252

For the international eco n om ies, no recovery appears likely until 1983 and even then only
low real eco n om ic grow th, relatively low inflation ra tes, and rising joblessness will be
major c h a ra cteristics.

Table 17
International: Major European Economies
(Seasonally Adjusted at Annual Rates)
1982

I

1983

IV

III

II

I

II

Years

IV

III

1980 1981 1982 1983 1984

REAL GOP GROWTH *
West Germany..
France........
United Kingdom.
Product Basis.
Italy........

-0.9
-0.9
4.4
-1.5
5.9

-1.4 -0.1 0.3
2.4 3.3 2.1
-3.2 2.8 -1.7
0.8 2.4 -3.5
-5.4 -4.3 0.0

2.4 2.5 1.9 3.1 1.8 -0.3 -0.2
1.1 0.0 1.3 0.1 1.1 0.7 1.7
3.9 4.1 4.1 7.1 -1.4 -2.0 1.1
2.1 5.0 5.1 7.8 -2.9 -2.5 0.3
2.1 4.3 4.5 8.2 3.9 -0.2 0.6

1.5
1.4
2.5
2.3
1.5

3.0
2.0
3.6
3.7
4.6

1.3
1.6
1.8
1.0
0.1
3.1

3.4
2.5
3.3
3.9
2.6
2.1

GROWTH IN INDUSTRIAL OUTPUT
West Germany..
5.1 -3.1 -7.8 1.1 1.7 5.5 6.0
France........ -10.8 -2.4 6.0 3.8 2.2 -1.0 -2.0
United Kingdom. -1.8 0.9 -0.6 0.9 0.3 3.6 3.0
Italy......... -6.3 -0.9 -6.8 -1.0 4.4 3.2 0.3
The Netherlands -7.0 -3.1 4.5 6.2 -6.9 0.0 1.8
Belgium......
9.6 5.3 -4.6 4.8 -3.8 14.8 3.4

3.1
3.2
8.1
7.3
3.7
6.2

0.0
-0.2
-6.5
5.6
-0.6
0.0

-2.1
-1.3
-4.7
-2.3
-1.6
-6.0

-1.3
-1.1
0.5
-1.8
-0.4
1.4

CONSUMER PRICE INFLATION
West Germany..
France........
United Kingdom.
Italy.........
The Netherlands
Belgium......

3.5 4.7 5.9
12.4 13.0 5.7
6.2 9.7 8.5
16.5 12.4 25.2
6.9 4.7 4.1
6.5 11.9 9.8

West Germany..
France........
United Kingdom.
Italy.........
The Netherlands

1627
1948
2817
2094
465
434

2.9 1.6 2.8 6.0 3.0 5.5 5.9 5.1 3.4 4.2
8.0 15.6 11.9 11.6 9.5 13.5 13.3 12.2 11.2 10.4
6.5 3.3 9.5 6.3 9.0 18.0 11.9 9.3 6.8 8.2
8.9 15.2 15.8 15.3 14.8 21.2 19.5 16.6 15.1 14.7
5.0 5.6 6.3 5.7 3.9 6.5 6.8 6.1 5.3 4.4
8.1 5.6 10.3 7.5 7.4 6.7 7.6 8.8 8.2 7.8

UNEMPLOYMENT (000)
1773
2002
2877
2046
521
466

1911
2007
2923
2187
553
472

2053
2016
3106
2248
590
480

2164
2014
3198
2276
622
497

2206
2060
3233
2302
643
499

2151
2100
3259
2287
664
513

2108 891 1281 1841
2107 1447 1768 1993
3226 1648 2539 2931
2331 1697 1912 2144
677 248 386 532
529 322 392 463

2157
2070
3229
2299
652
510

2168
2184
3131
2435
683
535

* Rea) GNP Growth fn West Germany

Table 18
The Japanese Economy

teal 6 r w t * Rates
Cross national .
Qwest 1c Oaund
Private Constaptlon
Plant t Equip. Investment
R esidential Construction
fiovt. C o n s u lt 1on
Govt. F I u d Investment
b fo rti

79

•0

SI

•4

«

St

7»

SI

82

S3

$4

85

»6

1.2
(.4
S .9
11.8
•1 .0
4 .3
3.1

4.2
0 .4
0 .«
i.S
-9 .4
2.3
-3 .5
18.7
- 4 .0

3.0
0 .9
0.7
1.7
-1 .1
3.5
4 .7
lft.C
1.9

2.4
4 .0
1.«
3.2
3.3
3.5
1.9
C.9
-3.1 -0 .7
0.1 -1 .3
- 2 .2 . 1.1
6 .7
7.2
3.5
3 .8

4 .4
4 .1
4.3
4.8
10.3
-0 .6
1.7

4 .3
4.1
4.7
3.3
10.2
5 .0
4 .8
7.5

S .3
4 .7
4 .«
9 .8
-0 .1
3.5
-1 .0
12.8
9.7

3.7
0 .4
0 .3
5.7
•10.1
2.7
-0 .5
IS .«
-3 .9

2.7
1.1
1.4
0.7
-0 .4
3.1
2.«
1C.0

4 .6

4 .7
S .l
« .0
2.«
9.3
2 .3
3.1
S .2
7 .6

s.s

2.7
1.9
3.2
3.8
-2 .3
-1 .2
-0 .9
5.1
1.1

4.1
3.4
3.7
C.6
0.9
-1 .3
0.7
7.8
5.4

4.6
4.3
4.3
3.S
10.8
0.1
3.2
5.6
4.2

4.5
4 .9
5.1
4.2
9.8
0 .6
4.7
5.3
8.1

5.4
5.3
6.1
2.4
9.8
3.1
3.7
«.7
7.0

0.75

0.42
3.2
2.1
3.5
7.2«

0 .(5
3.4

2.8
«.89

0.77
4.2
2.4
4 .0
C.42

0.9«
2.1
1.4
2.5
4.17

1.03
3.1

17.8
2.9
1.27

0 .(8
4 .«
1.8
2.9
7.85

3.3
«.4«

1.«

0.75
4 .8
12.8
2.0
«.85

0.73
7.8
13.3
3.8
8.42

0.67
4 .0
1.4
2.4
7.70

0.59
3.1
2.1
3.2
7.12

0.87
3.8
1.2
3.0
«.81

0.83
3.9
3.1
4.1
«.32

0.96
2.0
0.7
2.1
«.19

1.0S
3.0
1.9
3.4
C.51

-10 .7
«.1
7.0
1.27
227

4 .8
C.2
3.1
1.15
221

C.2
5.1
2.3
1.11
233

13.1
5.8
5.5
1.11
209

23.1
4.1
4.8
1.23
19«

22.3
5.1
4.5
1.3«
190

17.«
7 .3
3.8
1.47
180

•1 3.9
« .4
9.3
1.48
230

-7 .0
t.O
4.5
1.21
217

5.9
«.1
3.7
1.14
227

5.9
«.2
2.3
1.10
2)0

13.3
5.5
5.7
1.13
204

21.9
«.4
4.8
1.26
19S

17.8
5.2
4.2
1.37
187

20.2
7.3
3.9
1.50
178

«.«

14.7
Constaer Price Index •
Wholes»!* Price Index •
6NP Deflator *
Current 8alance*(91ll S)
C«Pensat1on per Employee •
Industrial Production •
Housln8 Start* (SAAR.N111.)
Ten fachtngt Rate (per »
• «muai Rate of Cfcmtge




0.71
3 .6
7.3
1.7
».S3
4 .1

6.2

.1.3
..
1.49
219

1.0

12

•3

1.«

1.1

0.«

SO

253

T h e e n e r g y o u t lo o k is q u it e p o s i t iv e f o r th e n e x t f e w y e a r s . L o w g r o w t h in d e m a n d sh ou ld
p r e v e n t a n y r is e , in r e a l t e r m s , f o r o il p r ic e s u n til 198 4. T h e r e w ill b e m u ch le s s in fla t io n
in e n e r g y p r i c e s , e x c e p t f o r n a tu r a l g a s .

Table 19
Energy
IV

1980 »81

1982 1983 1984

« For All Fuels - Quadrillion It«
Total Energy Demand................
Annual Rate of Chang*......
»Ml SHF (tth).........

72.0 73.8 71.6 71.8 72.2 72.5 73.0 73.3 76.0 73.9 72.3 72.7 74.0
-3.9 10.6 -11.3
1.3 1.8 2.0 2.5 1.5 -3.6 -2.8 -2.2 0.6 1.7
-5.1 2.1 0.8 3.0 3.0 3.3 3.9 4.6 -0.4
1.9 -1.5
2.9 4.1

Energy Um Ratios:
Million Btu por Capita.....................
Thousand Btu For 1972 S GNP............
P«troleum and Natural Gas as a
Forçant of Total Energy Demand.......

69.9 69.0 69.0 69.0 68.9 68.7 68.5 68.3 71.4

70.0 69.2 68.6 67.3

Prices - Dollars per Barrel
U.S. Refiners' Acquisition Frlco
for Crude Oil - Cavoslte.
Annual Rate of Chang«...
Domestic..............................
Annual Rate of Chong«...
Foreign...............................
Annual Rate of Change...,
Foreign • Real (1972 S)..
Annual Rate of Change...,

33.05
-13.2
32.39
-12.5
35.03
-9.0
17.20
•12.7

31.04
-22.2
30.35
-22.9
32.90
-22.2
15.97
-25.6

31.33
3.8
» .5 3
2.4
33.28
4.7
15.92
-1.4

31.40
1.0
30.67
1.9
33.13
-1.8
15.60
-7.6

31.43
0.4
30.78
1.4
32.93
-2.4
15.28
-8.0

31.65
2.8
31.02
3.2
33.05
1.5
15.14
-3.6

31.71
0.8
31.07
0.6
33.10
0.6
14.96
-4.6

31.86
1.9
31.21
1.8
33.25
1.8
14.80
-4.2

1.7 7.2 I
6.5 7.9 i . j
10.8 20.0 11.6
10.3 13.7 12.9
' '
' » 3.2
1 2.6

o .j
11.2
11.2
0.6
2.1

5.6
u.o
11.1
10.0
1.8
2.3

6.2

6.8

28.22 35.28 31.71
59.8 25.0 -10.1
24.23 34.37 30.99
69.3 41.9 -9.8
33.97 37.07 33.59
57.8 9.1 -9.4
19.0218.98 16.17
44.9 -0.2 -14.8

31.66
-0.2
31.02
0.1
33.08
-1.5
15.05
-7.0

34.29
8.3
33.69
8.6
35.55
7.5
15.26
1.4

Prices • Perçant Change
-1.5 -17.9 20.1
14.2 0.9 3.6
7.2 30.5
5.7
18.8
‘ ‘
-9.6 -23.3 0.3
-4.8 -X .5 27.2

MholesaIt Fuel and Power Frlce :
Coal..........................................
Natural Sas..............................
Electricity..............................
Domestic Crude Oil (NSA).......
Refined Petroleum Products...

-0.4

Wholesale Frlce Index - Industrials...

-1.9

-4.7 -10.9
-14.6 -27.4
-8.1 -16.1
12.2
25.5 28.2

Personal Consumption Deflator - Energy
Gasoline...............................................
Fuel 011 and Coal................................
Electricity..........................................
Natural Gas..........................................
Personal Consiaptlon Deflator..............

4.9

Gasoline Tax (Cents Per Gallon)...........
Federal.................................................
State 4 Local......................................

5.9

3.4

5.8

5.9

2.4 7.0
6.9
■2.1
3.5
3.8
1.0
2.6
3.4
9.4 11.4 11.2
15.1 14.1 15.6 13.7

17.2
24.4
11.3

3.6

7.1

15.0 15.2
4.0
4.0
11.0 11.2

15.6
4.0
11.6

4.9

6.0

5.4

16.3 16.6 16.9
4.0 4.0 4.0
12.3 12.6 12.9

6.1
6.1
3.6
3.5
3.0
3.2
9.8
9.1
12.5 11.6
5.5

40.6
j.e
39.8
19.0
47.8
51.7

21.0
o.«
23.5
14.2
44.4
19.5

16.2 10.7
29.0
38.6
37.7
15.7
19.2

5.5 10.3

-0.3 5.4
/•> o.o o.o
11.2 15.3 12.0
11.4 10.7 10.8
-9.0 -0.2 8.6
-5.3
1.1 6.7
2.7

5.0

12.2
11.3
21.4 -2.4
15.0 10.2
13.5 18.5 14.9
8.6

5.9

7.5

12.5

5.6

5.8

17.1 17.4 13.5 14.5 15.5 17.0
4.0 4.0 4.0 4.0
4.0 4.0
13.1 13.4 9.5 10.5 11.5 13.0

18.0
4.0
14.0

Real Personal Consiaptlon - Percent Change
Household Energy Consumption...........
Gasoline..........................................
Fuel 011 and Coal..........................
Electricity.....................................
Natural Gas.....................................

4.3 -2.5
3.6 -4.9 -0.6
6.7 15.7
0.2 -6.9 -1.5
-28.1 19.3
5.2 -1.9
0.1
8.9 -19.22.1
2.9 0.9
0.2 -25.8 24.8 -19.2 -1.7
2.4

Total Consult Ion..............................

2.5

1.7

3.3

2.6

-0.3
0.5 -0.8 -3.8
0.6
1.6 -0.9 -0.3
-2.2 -1.1
-3.5 -6.2
1.3 - l .i
-0.4 -0.3 -0.1 -14.7 -14.4 •8.61.3 -1.2
2.9
3.4 2.8 2.2 6.0 1.3 0.8 3.1
-1.5 -0.8 -0.2 -1.3 -2.5 ■3.4-3.9 -0.3
3.9

3.9

3.4

0.3

1.8

1.0

3.1

3.5

Energy Share of Consuaptlon (*)
1972 Oollars......................................
Current Dollars...................................
Average Mies per Gallon Achieved
by Ne«-Mode1-Vear Cars............................ 20.4 20.4 20.4 21.5 21.5 21.5 21.5 22.5 17.4 19.1 20.7 21.B
Total Gasoline Consumption (811. Gallons) 99.4 102.1 103.6 101.9 101.6 101.1 100.9 100.1 101.4 101.4 101.7 100.9
Gasoline Consumption per Car'
Gallons per Year......................................
932 957 970 954 950 944
Percent Change.......................................... -5.9 10.9 5.7 -6.4 -1.6 -2.6
¡■ports of Fuels and Lubricants
..
...
Import Bill as a Percent of GNP ...........

4.8 4.3 5.2 5.1 5.2 5.2 5.4 5.4 6.3 5.6 4.9 5.3 5.6
67.7 57.4 70.9 68.8 69.0 70.2 72.1 72.8 83.8 82.1 66.2 71.0 80.3
2.26

1.88 2.29 2.17 2.13 **.12 2.13 2.10 3.19 2.80 2.15 2.12 2.17

Ft ant and Equipment Investment - Billions of Dollars
Petroleum...................................................
Public Utilities...................................... ,.
Energy Share of Investment (* )........... ..

28.6 27.8 26.7 26.2 25.3 24.8 25.426.3 20.5
26.4 27.325.5 29.7
40.1 41.4 39.7 39.0 39.1 39.5 40.4 41.5 35.5 38.3 40.0 40.1 44.5
21.0 21.4 21.0 21.0 20.7 20.3 20.220.0 18.9 20.1
21.1 20.3 19.8

Industrial Production - Percent Change
..

17-871

-7.2 -31.7 -20.7
5.7 -0.9 -0.9

7.9
1.0

5.0
0.9

3.3
2.0

2.8
2.1

1.4
1.4

9.5
1.3

10.1
0.6

Total Production...................................

•11.7 -6.8 -3.6

2.4

8.2

8.5

9.1

8.5 -3.6

2.6

Electric Ut1l1ty Fuel Use: * From
Coal....................................................
Natural Cas........................................
Petroleum Products............................
Hydro, Nuclear. Solar, and Exotic..

52.3 51.1 51.7
14.1 13.7 14.0
8.1 8.3 7.6
25.4 26.9 26.7

0




83

17

.
..
.

52.1 52.1 52.2 52.3 52.4 49.6 51.6
14.0 13.9 13.8 13.914.0 15.6
15.3
7.0 6.4 6.1 5.8 5.5 10.8 9.0
26.9 27.6 27.9 28.0 28.124.0 24.2

-9.1 -1.8
0.71.0
-7.6

4.8

2.0
1.8
7.5

51.8 52.3 53.0
13.913.9 13.6
7.86.0 4.9
26.5 27.9 28.5

25 4

C o r p o r a t e p r o f it s s h o u ld r e b o u n d in 1983 an d
d e c lin e s , b u t le v e ls w ill s t ill b e c h r o n i c a ll y lo w .




198 4

a fte r

th ree

c o n s e c u t iv e

Table 20
Profits: Economy, Sector, Industry
(% chg.)*
1980
Economy:
Corporate Profits Before-Tax
Corporate Profits After-Tax
Company Profits

1981

1982

1983

-4.0
-4.4
-1.2

-4.3
-4.4
2.3

-25.5
-22.5
-16.0

NM
9.3
1.6
5.8
12.1
9.2
13.6
-7.5
6.5
11.1
-6.8
-1.5
-21.8
14.4
NM

NM
17.5
-6.4
10.6
5.4
16.3
-2.1
7.5
6.7
-9.9
19.0
9.7
-26.9
-49.3
NM

2773.8
6.2
-2.2
-2.6
-3.6
-6.6
-9.4
-12.8
-13.4
-26.1
-29.6
-40.8
-48.0
-78.1
-132.0

130.3
7.9
15.8
17.1
11.7
12.8
12.0
14.6
16.5
9.7
41.0
20.8
43.0
166.0
NM

-30.7
-51.4
NM

16.6
200.1
68.2

-24.7
-50.6
NM

20.5
27.1
502.9

13.7
14.1
5.7

22.3
17.4
16.5

7.2
6.6
5.7

10.4
7.9
7.3

0.2
7.8
-56.8

-29.9
5.3
NM

30.5
-1.8
-13.8

20.0
3.0
NM

Miscellaneous Services
Restaurants
Publishing
Rat1o-TV Broadcasting
Vending Machines ft Food Services
Hotel ft Motel

2.5
2.2
0.0
-2.0
31.3

18.5
10.1
9.0
-22.1
14.7

3.5
-0.7
-1.0
-18.3
-18.5

13.1
15.8
15.0
23.7
34.9

Cons umer-Househo1d
Medical Supplies ft Equipment
Tobacco
Cosmetics
Drugs
soaps

12.2
19.4
5.1
11.9
g,]

16.4
10.1
-2.3
5.0
5.5

8.4
3.7
2.0
0.3
-0.6

5.5
10.5
11.7
11.7
10.6

Sector:
Auto Related
Utilities and Conmunications
Financial
Miscellaneous Services
Consumer-Household
Food and Beverages
Technology Related
Retail Stores
Miscellaneous Manufacturing
011 Related
Specialty Machinery
Primary Processing Manufacturing
Construction Related
Metals and Mining
Transportation

13.8
9.5
16.6

Industry:
Auto Related
Auto Accessories
Tire and Rubber
Automobl1es
Utilities and Communications
Gas
Electric Companies
Te1ecomnun1cat1ons
Financial
Small Loans
Banks
Savings ft Loans

♦Sector and Industry Ranked Relative to 1982
Source: ORI Industry Financial Service

years o f

255

D e s p it e th is c a u t io u s o p t im is m o n t h e o u t lo o k f o r th e e c o n o m y , t h e r e r e m a in s
m a jo r
h u r d le s t o a p o t e n t ia l r e c o v e r y . F ir s t , c o n s u m e r s m a y c o n t in u e s p e n d in g v e r y l i t t l e o u t o f
t h e t a x c u t s and in c r e a s e s a v in g c o n s id e r a b ly , g iv e n s t ill s t r o n g i n c e n t iv e s t o s a v e th ro u g h
high i n t e r e s t r a t e s , d is in c e n t i v e s t o b o r r o w b e c a u s e o f h igh r e a l a f t e r t a x b o r r o w in g c o s t s ,
an d h igh u n e m p lo y m e n t .

Chart 11
Real Aftertax Return on
Savings vs. Real Aftertax
Cost of Borrowing (Percent)

S e c o n d , t h e m ix o f e c o n o m i c p o l ic y w ill b e a c r i t i c a l in g r e d ie n t t o w h e t h e r a r e c o v e r y ca n
b e s u s t a in e d . A " t ig h t e r f i s c a l - e a s i e r m o n e y " c o n f ig u r a t i o n is b e t t e r th an th e o r ig in a l
" l o o s e f i s c a l - t i g h t m o n e y " p o l i c y m ix o f R e a g a n o m i c s . T h is m e a n s th a t th e b u d g e t m ust
b e t ig h t e n e d in J a n u a r y 1 9 8 3 , w h en t h e F Y 1 9 8 4 b u d g e t is p r e s e n t e d t o C o n g r e s s . S in c e
f u r t h e r i n c r e a s e s o f t a x e s w o u ld b e d e t r im e n t a l t o s u s ta in in g t h e r e c o v e r y , th e m o s t
im p o r t a n t r e m a in in g p o s s i b il i t ie s a r e in r e d u c in g s p e n d in g . T h e 1 0 % t a x c u t s f o r n e x t July
a r e im p o r t a n t t o th e e x p a n s io n , th u s th e A d m in is t r a t io n an d C o n g r e s s w ill h a v e t o t a c k le
th e e n t i t l e m e n t s p r o g r a m s as w e ll as th e b u r g e o n in g e x p e n d it u r e s f o r t h e m ilit a r y . T iltin g
t h e b u d g e t t o w a r d a t ig h t e r c o n f ig u r a t i o n w ith a c o m p e n s a t i n g e a s e in m o n e t a r y p o lic y
w ill p r o d u c e lo w e r i n t e r e s t r a t e s and s t im u la t e i n t e r e s t s e n s i t i v e a r e a s o f th e e c o n o m y ,
a lth o u g h n o t n e c e s s a r il y r a is in g o v e r a l l r e a l G N P .
T a b le 21 s h o w s t h e im p a c t o n th e e c o n o m y and its m a jo r p a r a m e t e r s o f s h ift in g t h e m ix o f
p o l ic y t o a t ig h t e r f i s c a l - e a s i e r m o n e y c o n f ig u r a t i o n .




256

T h ir d , th e p o t e n t i a l r e m a in s f o r a c la s h b e t w e e n w o r s e f e d e r a l b u d g e t d e f i c i t s and
m o n e t a r y p o l i c y in 1983 an d 1 9 8 4 . A lt h o u g h m o s t p r e v io u s y e a r s o f la r g e d e f i c i t s h a v e
b e e n a s s o c ia t e d w ith d e c lin in g in t e r e s t r a t e s , a n o n a c c o m m o d a t i v e F e d e r a l R e s e r v e p o l ic y
w o u ld s u g g e s t t h e p o t e n t i a l f o r s h a r p ly h ig h e r i n t e r e s t r a t e s g iv e n s u c h la r g e d e f i c i t s .
T h e k e y is h o w m u c h o f th e n e w d e b t is b o u g h t by t h e F e d e r a l R e s e r v e , a m a jo r b u y e r in
m o s t y e a r s o f h e a v y T r e a s u r y fin a n c in g ( T a b le s 22 , 2 3 ).




Table 21
"Tighter Fiscal-Easier Monetary" Policy Mix:
$119.1 Billion Package of Higher Taxes, Lower Expenditures
and Ml Growth at Upper Targeted Limits
(Changes relative to baseline simulation "High Deficits")*
Tears

le a l m
( * < H .)
■1A D e f ic it
( H i t . o f * 1 1 a r s . SMR)
Treasury Oebt Issues
( H i t . o f tftollars)
T r p n u r y *111 la t e ( * )
■t» Issue Rate on Corp. lends ( f )
U .S. fiovt. lond la te ( * )
Mortgage CoaMtaent Kate (S)
W » P rice » r fla t o r ( f )
Constnc P rice Index
- A ll Urtan ( I )
foanployaent Rate (1 )
Mousing S tarts
(N H s . o f u n its )
Business Fixed I w s f e n t
( I l l s , t f 11 d o lla rs , SAAR)
Auto Soles
( M ils , o f U n its. SAAR)
Personal C o n niptio n Expenditures
(111s. o f 72 t o l l a ? , SAAR)

1N 2

19U

0 .3

- 0 .1

- 0 .3

M .)

»7 .1

141.4

1904

•3 7 .0

-llf.S

-1 0 4 .0

- 1 .0
- 2 .0
- 0 .7
- 0 .1

- 3 .3
- 1 .3
- 1 .3
- 1 .0

- 1 .0
- l.C
- 1 .1
- 1 .«

-C .l

• 0 .1

4 .1

4 .4
0 .0

4 .)
- 0 .1

4 .1
0 .0

0.11 7

0.407

0 .0 0

1 .0

1 .1

3 .4

3 .7

- 0 .0

- 7 .3

• f m l d e n t Msgan 1s U t i M d to announce an ex-ante reduction 1« tfw fe d eral
ftudgct d e f ic it th at reaches S119.1 »11 Hon t r f is c a l 1984. Spending reductions
o f M 7 .0 b illio n and rlso s 1n taxes of SS2.1 p ill io n t r * recoanended and
•pproved. Die r*d e r« l
t ilt r«sff-v«s M C l M i r « to ra ise HI to I t »
O SS*< e l upper ta rge t U n i t s o f 5.51 , SX. and 4 . SI f o r H E? . 1983, and 1984. THe
t ig h te r fis c a l-e a s ie r l o n e t a r * p c lle y n i t Is t s i m d to reduce Hie expected r $to
• f In fla tio n l.S percentage points *jr 1982:4, as the ra tio n a l expectation to tne
changes la p o lic y .

257

Table 22
Deficit and Interest Rates: History and Forecast

($ 811s.)
NIA
Deficit
1950
1951
1952
1953
1954
1955
1956
1957
1958
1959
1960
1961
1962
1963
1964
1965
1966
1967
1968
1969
1970
1971
19 72
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985

9.250
6.500
-3 .675
-7 .075
-6 .075
4.500
5.975
2.225
-10.375
-1 .125
3.025
-3.875
-4 .225
0.250
-3 .275
0.525
-1 .8 0 0
-13.175
-6 .075
8.425
-12.425
-22.025
-1 6.80 0
-5 .575
-11.525
-69.300
-53.100
-45.850
-29.475
-16.100
-61.375
-59.975
-137.703
-159.680
-151.200
-140.255




(«)
Deficit
Relative
to GNP

(*)
Treasury
8111
Rate

New
Issue
Corporate
Bond
Rate (t)

3.2
2.0
-1 .1
-1 .9
-1 .7
1.1
1.4
0.5
-2 .3
-0 .2
0.6
-0 .7
-0 .7
0 .0
-0 .5
0.1
-0 .2
-1 .6
-0 .7
0 .9
-1 .3
-2 .0
-1 .4
-0 .4
-0 .8
-4 .5
-3 .1
-2 .4
-1 .4
-0 .7
-2 .3
-2 .0
-4 .5
-4 .8
-4 .1
-3 .4

1.20
1.52
1.7 2
1.89
0.9 4
1.7 3
2.6 3
3.22
1.77
3.39
2.88
2.35
2.77
3.16
3.55
3.95
4.8 5
4.30
5.33
6.66
6.3 9
4.3 3
4.07
7.03
7.8 3
5.77
4.9 7
5.27
7.19
10.07
11.43
14.03
10.48
8.9 4
9.39
10.30

NA
3.04
3.10
3.42
2.9 0
3.17
3.68
4.45
4.02
4.77
4.68
4.42
4.23
4.25
4.4 0
4.54
5.44
5.77
6.4 8
7.68
8.50
7.36
7.16
7.65
8.9 6
9.01
8.33
8.06
8.88
9.86
12.47
15.01
14.17
11.93
10.94
10.79

U.S.
Govt.
Bond
Rate (* )
20 Year
Constant
Maturity
NA
NA
NA
NA
2.64
2.9 0
3.14
3.54
3.48
4.13
4.06
3.92
3.99
4.05
4.19
4.27
4 .7 7
5.01
5.45
6.33
6.86
6.1 2
6.01
7.12
8.0 5
8.1 9
7.86
7.67
8.4 8
9.3 3
11.39
13.72
13.00
11.07
10.65
10.27

25 8

Table 23

Federal Deficit Financing and the Holders:
Who Buys the New Debt?
(Billions of Dollars, SAAR, except as otherwise indicated)
1*6

1987

1968

1969

1960

1*1

1%2

1963

1964

1*5

1K£

1*8

1869

1970

1.1

1.4

0.5

-2.3

•0.2

0.6

-0.7

-0.7

0.0

-0.5

0.1

-0.2

-1.6

-0.7

0.9

-1.3

Total I ss u s (Pi and
off budpt; also
sponsored agenda*)

0.2

-5.3

-1.7

Purchas ad by:
Federal Reserve
{ Percent of total)

-0.1
NN

N1A OeflcU Relative
to m (*)

0.1
NN

-0.9

9.0

9.0

-0.7
73.1

2.1
23.5

0.3
3.3

0.7
NN

7.7

8.4

5.6

6.7

3.9

9.2

13.2

17.4

6.2

21.7

1.5
19.5

1.9
23.2

2.8
49.9

3.5
51.4

3.7
95.5

3.5
38.6

4.8
36.7

3.8
21.7

4.2
68.5

5.0
23.0

Private Ooaastic
Nonf inanclal
Household
Corporation*
State* t Localltlai

•0.8
7.4
2.4
4.1
1.0

•6.6
-2.0
1.8
•4.5
0.7

-0.3
0.2
0.6
-0.7
0.3

6.7
•2.8
-3.3
0.3
0.2

5.5
13.3
5.9
6.1
1.3

-3.2
•5.9
-0.5
•6.0
0.7

5.8
-1.0
0.2
-1.5
0.3

4.8
1.4
1.8
•1.8
1.4

1.8
4.8
0.1
3.2
l.S

3.2
1.0
2.1
-1.3
0.2

0.1
3.3
1.9
-1.7
3.1

5.8
7.7
7.2
-1.7
2.1

6.3
-1.1
1.1
-2.5
0.2

14.1
8.6
5.7
0.8
2.2

5.8
17.7
16.6
-3.1
4.2

6.4
-7.3
-4.6
0.2
-2.9

Financial
Banking
Nenbenk Financial

-8.2
•8.1
-0.1

-4.7
-3.5
•1.2

-0.5
-0.3
•0.2

9.5
8.8
0.7

-7.8
-8.8
1.0

2.6
2.5
0.1

6.9
6.3
0.6

3.4
1.3
2.1

•3.0
•2.9
-0.1

2.2
0.3
1.9

-3.2
-2.8
•0.4

-1.8
-3.1
1.3

7.4
9.5
-2.1

5.5
3.4
2.1

•11.8
-10.0
1.8

13.8
10.8
3.0

1.1
0.1

0.8
0.3

0.2
•0.1

0.1
0.1

3.0
0.1

0.5
0.1

0.5
-0.1

1.3
0.4

0.6
0.4

0.4
-0.4

•0.1
0.1

-2.5
0.9

2.1
0.0

-0.5
-0.1

-2.0
•0.6

9.3
1.1

1971

1972

1973

1974

1975

197£

1977

19Z8

1979

1«0

19U

1982F

1983F

•2.0

-1.4

-0.4

-0.8

-4.5

-3.1

-2.4

•1.4

•0.7

-2.3

-2.0

-4.5

-4.8

-4.1

226.1

217.4

Ra*t-af-Mor1d
Sponsored Credit Agmcla*

NIA Deficit Relative
to 6HP (S)
Total Issue* (On and
off budget; also
sponsored agencies)

30.9

23.6

28.3

31.9

94.9

83.8

79.9

90.5

M.B

Purchased By:
Federal Ra*er«a
(Percent of total)

8.7
28.1

0.4
1.8

9.3
32.8

5.2
16.4

8.4
8.9

10.0
11.9

7.2
9.0

7.3
8.1

7.6
8.9

-3.S
•10.9
-12.3
2.S
-1.0

16.0
4.2
0.4
-2.1
5.9

18.8
19.2
18.9
-3.4
3.7

22.5
19.4
20.0
2.3
-2.9

76.9
25.4
18.8
8.7
•2.1

60.1
15.9
9.7
2.1
4.1

45.1
24.6
19.7
-6.4
11.3

54.3
36.3
29.5
-4.5
11.3

7.3
7.1
0.2

11.8
6.5
5.3

-0.4
•1.3
0.9

3.2
0.7
2.5

51.4
30.0
21.4

44.8
20.2
24.6

20.5
-1.1
21.6

Private O nestic
Nonf inanclal
Households
Corporations
State* t Local Iti a*
Financial
Banking
Nonbank Finane«

122.9 132.6

-2.0*
NN

91.1
61.4
45.7
0.1
15.6

107.2 115.4
50.4
38.3
36.8
28.3
-1.2
1.2
12.4
11.1

159.1*
60.2
34.8
3.1
22.3

18.0
0.5
17.5

29.7
7.9
21.8

68.8
25.6
43.2

65.0
11.7
53.3

Rast-of-Uorld

26.3

8.4

0.2

3.7

8.1

11.6

31.5

28.2

-14.1

10.6

7.1

Sponsored Credit Agende*

-0.5

-1.2

0.0

0.4

1.5

1.5

•3.8

0.6

0.2

0.7

0.4

*Awragi through 1982:2




177.3

9.8
7.5

sl 6

96.9*
8.1
90.8
9.5*
-6.5

1964F

259

Fourth, the potential of a prolonged downturn from the fallout of failures and joblessness
cannot be minimized. Both are a cause now as well as a consequence of the current long
downturn of the economy, with potentially uncharted impacts on spending since so great a
failure fallout has not previously occured in the postwar period.
Fifth, should inflation actually decline, a process of deflation rather than disinflation, the
potential for the debt deflation envisioned by Irving Fisher will be enhanced. Already, a
considerable number of bankruptcies have arisen because of profit squeezes engendered by
lower prices and still high costs, both financial and real. Widespread declines of prices
could bring about a crash, similar to the process that occurred in the 1930s.
Finally, the international economic and financial system problem cannot be minimized,
especially since the mechanism for imposing austerity on countries in trouble has not yet
been established through the IMF and IBRD.
Table 2*
Country Risk Threatens the International Financial System
Country

Debt owed ($
811s. End of
1981)

Argentina
Brazil
Chile
East Germany
Mexican
Peru
Poland
Ph1l11p1nes
Romania
South Korea
Venezuela
Yugoslavia

25.0
53.0
10.5

11.0

57.0
5.0
15.0

10.2
4.5

20.0
26.0

10.8

Due 1n 1 Year
or Less
(S Blls.)**
11.8 (47*)
18.6 (35*)
4.2 (4M )
6.0 (54.52)
27.9 (49*)
3.0 (60*)
10.0 (67*)
5.7 (56*)
2.5 (56*)
11.6(58*)
15.9 (61*
7.0 (6 4 .8 *)

Exports
1982F

($ 811s.)
11
28
5

8

33
5.5
4.0
9.0
5.0
32.0

11.0
10.8

Short-term Debt as
Percent of Exports
107.2
66.4
84.0
75.0
84.5
54.5
250.0
63.0
50.0
36.3
144.5
64.8

♦Source: Morgan Guaranty Trust, New York Times, IMF
♦♦Percent of owed

These risks all add up to a minefield for the economy in coming months and the necessity
for a delicate application of policy in order to sustain an economic expansion.




260

IV.

Role of Economic Policy and the Policy Choices

E s s e n t ia lly , R e a g a n o m i c s and t h e F e d e r a l R e s e r v e p o l ic i e s s in c e 1979 h a v e p r o d u c e d th e
re s u lts and c u r r e n t p o s it io n o f th e e c o n o m y and fin a n c ia l m a r k e t s . N o w , it is a n e w t w is t
o f e c o n o m i c p o l i c y o v e r th e la s t s ix m o n th s th a t is r e s t o r in g t h e h e a lth o f th e e c o n o m y .
J u st as p o l i c y b r o u g h t a b o u t a d e e p r e c e s s io n o f th e U .S. e c o n o m y , s o w ill p o l ic y b e an
e s s e n t ia l in g r e d ie n t t o s u s t a in e d r e c o v e r y . T h e t ilt in g o f th e " l o o s e f i s c a l - t i g h t m o n e t a r y "
p o l ic y m ix p u t in p l a c e d u r in g 1981 to w a r d a " t ig h t e r b u d g e t - e a s ie r m o n e t a r y " p o l ic y
c o n f ig u r a t i o n is a m a jo r c a t a l y s t f o r th e r e c e n t im p r o v e m e n ts o f f in a n c ia l m a r k e t s and
e v e n t u a l r e c o v e r y o f t h e e c o n o m y . It w ill b e n e c e s s a r y f o r a c o n t in u e d t ilt in g o f p o l ic y in
th is d i r e c t i o n in t h e m o n th s a h e a d .
Th is w ill b e an im p o r t a n t w a y t o s u s ta in lo w e r
in t e r e s t r a t e s , r e v i v e th e i n t e r e s t r a t e s e n s itiv e d e p r e s s e d in d u s tr ie s and a r e a s o f th e U .S .
e c o n o m y , r e v e r s e t h e p r o lo n g e d d o w n tu r n , and t o bu ild a b a se f o r s u s t a in e d e x p a n s io n .
T h e i m p li c a t io n is th a t t h e F e d e r a l G o v e r n m e n t m u st c o m e up w ith s e r io u s n e w p r o p o s a ls
to c u t e x p e n d it u r e s o r r a is e r e v e n u e s f o r F Y 1 9 8 4 and F Y 1 9 8 5 . W ith o u t f u r t h e r r e d u c t io n s
in t r a n s fe r p a y m e n t s , in p a r t ic u la r e n t it le m e n t s , and a r e t r e a t o n th e m ilit a r y b u d g e t, now
s e t t o r is e a t n e a r 7 % a n n u a l r a t e s , in r e a l t e r m s , a n e c e s s a r y tig h t e n in g o f t h e b u d g e t
w ill b e h a rd t o a c h i e v e . L o w e r in t e r e s t r a t e s sh o u ld sh a v e $5 t o $ 1 0 b illio n f r o m p r e v io u s
e s t im a t e s o f o u t la y s . B u t w it h o u t s iz e a b le r e d u c t io n s in m ilit a r y e x p e n d it u r e s and n e w
fo r m u la s t o r e d u c e th e p a c e o f r is e s in e n t it le m e n t s p r o g r a m s , th e f e d e r a l b u d g e t d e f i c i t
a p p e a r s s e t f o r N IA d e f i c i t s o f $ 1 5 0 t o $ 1 7 0 b illio n . T h e D R I fu ll e m p lo y m e n t b u d g e t
m o d e l s h o w s a m a jo r s w in g t o s tim u lu s in 1983 as a r e s u lt o f th e c u r r e n t f i s c a l p r o g r a m s .
A d d it io n a l in c r e a s e s in t a x e s a r e s t ill a p o s s ib ilit y o r p o s t p o n e m e n t o f th e 10% ta x h ik e
s c h e d u le d f o r J u ly 1, 19 8 3 , b u t u n less th e e c o n o m y is r is in g m u ch m o r e r a p id ly than
c u r r e n t ly a p p e a r s , r e d u c in g t h e p e r s o n a l in c o m e t a x r e d u c t io n s l e g is la t e d f o r 1983 s h o u ld
not be a tte m p te d .
T h e b e s t o p t io n l ie s in a s o m e w h a t m o r e a c c o m m o d a t iv e s t a n c e o f m o n e t a r y p o l ic y than
had p r e v io u s ly b e e n e n v is io n e d b y th e F e d e r a l R e s e r v e .
T h e lo w e r in t e r e s t r a t e s and
s t r o n g e r e x p a n s io n t h a t w o u ld a r is e fr o m p u rsu it o f a m o r e f l e x i b l e " u p p e r lim it "
m o n e t a r is m w o u ld m a k e a b s o r p t io n o f th e d e f i c i t e a s ie r and a c t u a l ly e n c o u r a g e a lo w e r
fe d e ra l b u d get d e fic it .
T h r o u g h lo w e r in t e r e s t r a te s and a s t r o n g e r e x p a n s io n , ta x
r e c e ip t s w o u ld r is e , e a s in g t h e d e f i c t p r o b le m u n t i l'a m o r e g r a d u a l a p p r o a c h t o r e d u c in g
e x p e n d it u r e s c o u ld i m p a c t .
M l g r o w t h as high as 6 - 1 /2 % c o u l d b e p e r m it t e d w it h o u t
d a m a g e t o t h e e c o n o m y o r a m a jo r r e a c c e le r a t i o n o f in fla t io n .
T h e k e y t o g e t t in g t h r o u g h t h e n e x t f e w y e a r s w it h o u t a m a jo r f a ilu r e o f p o l ic y lie s in th e
i n fla t io n p a t t e r n s t h a t e m e r g e in th e r e c o v e r y . S h ou ld in fla t io n r a t e s h o ld in lo w s in g le
d ig it s , th e n th e c e n t r a l b a n k c a n p e r m it an e a s ie r m o n e t a r y p o lic y ., s t im u la t in g re a l
e c o n o m i c g r o w t h and h e lp in g t o lim it th e d e f i c i t .
If t h e r e is a r e la t i v e l y q u ic k
r e a c c e le r a t io n
o f in f l a t i o n , t h e e c o n o m y w o u ld b e t h r o w n b a c k in t o * s t o p - g o
c o n f ig u r a t i o n , f a c i n g th e s a m e in s o lu b le d ile m m a s as b e f o r e . T h u s, th e f o c u s f o r p o l ic y in
c o m in g m o n t h s s h o u ld s w in g b a c k t o m e t h o d s by w h ic h w a g e and p r i c e in fla t io n ca n b e
p r e v e n t e d f r o m r e a c c e l e r a t i n g a t a ll w ith s o m u ch s la c k in th e e c o n o m y .
I n c o m e s p o l i c i e s , a T IP , a n d g u id e lin e s r e m a in a lt e r n a t iv e s w o r t h c o n s id e r in g e s p e c i a ll y
g iv e n th e c u r r e n t s la c k in t h e e c o n o m y .
T a x in c e n t iv e s t o r e s t r a in w a g e c o s t s , as a
" d i s in f l a t io n a r y " s h o c k , is m y o w n f a v o r i t e . M ic r o - o r ie n t e d p o l i c i e s t o h o ld d o w n w a g e
an d p r i c e i n fl a t i o n in t h e b a c k d r o p o f a g r a d u a lly r e c o v e r in g e c o n o m y n e e d t o b e
e x a m in e d , e . g ., a r e d u c t io n in m in im u m w a g e s .




261

T h e r e a p p e a r s t o b e n o o t h e r c h o i c e th an t o e n c o u r a g e o n ly a g r a d u a l r e c o v e r y in th e
e c o n o m y s o t h a t i n fla t io n r a t e s w ill r e m a in lo w an d p r o d u c t i v it y g r o w t h m o v e sh a rp ly
h ig h e r .
A la r g e a m o u n t o f s la c k in la b o r m a r k e t s m a y w e ll p r o d u c e a m u ch g r e a t e r
c y c l i c a l u p s w in g in p r o d u c t i v it y g r o w t h th a n
is c u r r e n t ly e x p e c t e d .
T h is , a lo n g w ith
c o n t in u in g d o w n w a rd p r e s s u r e o n w a g e s , w o u ld r e d u c e u n it la b o r c o s t s s u b s t a n t ia lly and
p e r m it a lo n g , s u s ta in e d p e r io d o f r e d u c e d i n fla t io n t o b e in e f f e c t . I n t e r e s t r a te s c o u ld
th e n r e m a in s t a b le f o r q u it e s o m e t im e , p e r m it t in g a v e r y s t r o n g e c o n o m i c e x p a n s io n
t o w a r d t h e m id -1 9 8 0 s . B y th a t t im e b u s in e s s c a p i t a l f o r m a t i o n w o u ld b e o n - s t r e a m a g a in ,
w ith s u p p ly -s id e b e n e f i t s a id in g t o p r o m o t e s u s t a in e d e x p a n s io n . A g r a d u a l e x p a n s io n has
m a n y v ir tu e s w ith t h e s in g le d r a w b a c k o f s u s ta in e d h igh l e v e ls o f u n e m p lo y m e n t . O v e r
th e lo n g e r run, h o w e v e r , u n e m p lo y m e n t r a t e s m ig h t a v e r a g e lo w e r if in fla t io n and in t e r e s t
r a t e s w e r e s u s ta in e d a t r e la t i v e l y lo w an d s t a b l e l e v e ls f o r a c o u p l e o f y e a r s .

V.

Concluding Comments

T h e U .S . e c o n o m y is h e a d e d f o r a r e c o v e r y b e c a u s e a fu n d a m e n t a l tu rn in th e fin a n c ia l
m a r k e t s is u n d e rw a y . T h e u n c e r t a in t ie s n o w f o c u s u p on 1) th e la g s b e t w e e n th e tu rn in
t h e f in a n c ia l m a r k e t s th is s u m m e r and t h e t im in g o f its im p a c t s o n t h e e c o n o m y ; 2 )
w h e t h e r t h e f e e d b a c k e f f e c t s o f f a ilu r e f a ll o u t an d jo b le s s n e s s on c o n f i d e n c e and s p e n d in g
w o u ld m o r e th an o f f s e t t h e s tim u lu s o f t h e lo w e r in t e r e s t r a t e s , s t r o n g e r s t o c k m a r k e t ,
an d J u ly 1 p e r s o n a l i n c o m e t a x c u t s ; an d 3) th e c h o i c e o f p o l ic i e s t o su sta in e x p a n s io n
w it h o u t r e ig n it in g i n fl a t i o n .
A m a jo r r e a c c e l e r a t i o n o f i n fla t io n w o u ld c a u s e any n ew
e x p a n s io n t o b e a b o r t e d , so m u st b e a v o id e d .
S o f a r , t h e p r o c e s s s in c e th e sh arp d e c lin e s o f in t e r e s t r a t e s b e g a n in m id s u m m e r a p p e a r s
q u it e f a m il i a r . L a r g e r e d u c t io n s in s h o r t - and lo n g - t e r m i n t e r e s t r a t e s p r e c e d e d a m a jo r
s t o c k m a r k e t r a lly by o n e t o t w o m o n th s . H o u s in g a c t i v i t y and r e t a il s a le s a r e b e g in n in g
t o m o v e h ig h e r . B a la n c e s h e e t s a r e b e in g r e li q u e f i e d , b o r r o w in g c o s t s a r e d o w n , and n e t
w o r t h p o s it io n s a r e s t r e n g t h e n in g . P a s t e x p e r i e n c e s u g g e s t s th a t im p a c t s o n th e e c o n o m y
s h ou ld a p p e a r by y e a r e n d and in t o e a r ly 1983 so lo n g as t h e F e d e r a l R e s e r v e p r o v id e s
a c c o m m o d a t io n t h r o u g h c u r r e n t le v e ls o f i n t e r e s t r a t e s o r s o m e w h a t lo w e r in t e r e s t r a t e s .
S u b s e q u e n t ly , th e p a c e o f i n fla t io n w ill b e th e k e y t o w h e th e r th e e x p a n s io n c a n b e
s u s t a in e d . A r e a c c e l e r a t i o n o f i n fla t io n w o u ld b r in g s i z e a b le r is e s o f in t e r e s t r a t e s and an
a b o r t in g o f th e e x p a n s io n .
S u s ta in e d lo w in fl a t i o n r a t e s in m id -s in g le d ig its o r b e lo w
w o u ld p e r m it e x p a n s io n t o c o n t in u e , a l b e i t u n e v e n , b u t s t e a d y th r o u g h o u t th e n e x t t w o
years.
T h e m a jo r risk s t o r e c o v e r y in c lu d e th e h u g e f a ll o u t o f
b u sin e ss fa ilu r e s , fin a n c ia l
in s t it u t io n d i f f i c u l t i e s , jo b le s s n e s s , and i n t e r n a t io n a l f in a n c ia l m a r k e t r e p e r c u s s io n s o f th e
lo n g d o w n tu r n in th e U .S . e c o n o m y . S in c e th e r e c e s s io n s o f th e p a s t t h r e e y e a r s w e r e
b r o u g h t a b o u t by h ig h in t e r e s t r a t e s , th e p a r t ic u la r d e t e r io r a t i o n in f in a n c ia l p o s it io n s o f
in s t it u t io n s in th e U n it e d S t a t e s an d a b r o a d is d a n g e r o u s t o a p o t e n t ia l r e c o v e r y .
A
c o n t in u in g rash o f f a il u r e s , c r e d it lo s s e s f o r f in a n c ia l in s t it u t io n s , f o r e c l o s u r e s in th e
h o u s e h o ld s e c t o r , a n d d e f a u l t by f o r e i g n c o u n t r ie s c o u ld b r in g a b o u t a m in i-v e r s io n o f th e
1 9 3 0 s. H o w e v e r , n o w th a t th e F e d e r a l R e s e r v e has b e g u n t o a c c o m m o d a t e a r e c o v e r y ,
th e o d d s o n su c h an e v e n t m u st b e a s s e s s e d a t le s s th a n s e v e r a l m o n th s a g o .
T h e m a jo r p o l ic y p r o b le m f o r th e U n it e d S t a t e s and w o r ld e c o n o m ie s w ill m o s t c e r t a in ly
b e jo b le s s n e s s . T h e e m e r g in g t r e n d s a r e s im ilia r t h o u g h o u t t h e w o r ld , g e n e r a lly lo w e r
in fl a t i o n r a t e s and r is in g u n e m p lo y m e n t . O f c o u r s e , th is t r a d e o f f has a lw a y s b e e n a m a jo r
p o l ic y d ile m m a f o r th e m o d e r n i n d u s t r ia liz e d w o r ld . B u t n o w , a n e w o p p o r t u n it y a f f o r d s
i t s e l f t o d e v is e p o l ic i e s t o su s ta in e x p a n s io n w it h o u t r e a c c e l e r a t i n g in fl a t i o n .
T h e e a r ly y e a r s o f g r o w t h w ill b e r e la t i v e l y e a s y , s in c e s la c k in m o s t e c o n o m ie s is so
g r e a t and th e d o w n w a r d m o m e n t u m on in fl a t i o n s o p r o n o u n c e d . B ut th e t r ic k w ill b e t o
d e v is e m a c r o e c o n o m i c an d m i c r o e c o n o m i c p o l ic i e s t o a c c e l e r a t e th e g r o w t h in s u p p ly ,
m o d e r a t e e f f e c t i v e d e m a n d , and r e d u c e t h e c o r e o f c o s t s t h a t p r o p in fla t io n r a t e s .
A
f i r s t n e c e s s it y is f o r a r e s t r a in e d e x p a n s io n in th e e c o n o m y , o n e th a t fu lly p e r m it s a
c o m p le t e

17-871

0




83

18

262

r e li q u e f i c a t io n o f th e p r iv a t e s e c t o r an d in c r e a s e s in p o t e n t i a l o u t p u t t h a t a r e n o t f a r
b eh in d th e r is e s in t h e r e a l e c o n o m y . A s e c o n d p illa r o f p o l i c y w ill b e c o n t in u e d m o n e t a r y
r e s t r a in t in th e f o r m o f g r a d u a l t a r g e t e d r e d u c t io n s in th e p e r m is s a b le g r o w t h f o r n o m in a l
G N P . A t h ird n e c e s s it y is f o r a c o n t in u in g t ig h t e n in g o f t h e f e d e r a l b u d g e t , c e r t a in l y in
s p e n d in g and p e r h a p s a ls o t h r o u g h r a is in g t a x e s . R e d u c t i o n s in th e i n d e x e d e n t it le m e n t
p r o g r a m s a r e a b s o lu t e ly n e c e s s a r y , th e m ilit a r y b u d g e t m u s t g r o w m o r e s lo w ly , and
p e r s o n a l i n c o m e t a x e s sh o u ld n o t b e in d e x e d in 1985 an a b e y o n d . T h e c o s t s c o n t r o ls o f t e n
u sed in th e p r iv a t e s e c t o r n e e d t o b e a p p lie d , in a s u s t a in e d m a n n e r , t o th e p u b lic s e c t o r .
F in a lly , a n o t h e r lo o k a t w a g e - p r i c e i n c o m e s p o l ic i e s is in o r d e r . T a x i n c e n t iv e s t o lo w e r
w a g e c o s t s w o u ld p r o d u c e a d is in fla t io n a r y s h o c k an d p r o m o t e d e c l in e s in b o t h
u n e m p lo y m e n t an d i n fl a t i o n . M i c r o e c o n o m i c p o l ic i e s t h a t i m p a c t on la b o r m a r k e t s and
r e d u c e la b o r c o s t s a r e a n o t h e r p o s s i b il i t y . L o w e r in g t h e m in im u m w a g e is a p o l ic y t h a t
d e s e r v e s n ew c o n s i d e r a t io n .
W ill R e a g a n o m ic s s u c c e e d ? T a b le 25 s h o w s t h e s c o r e c a r d - t o - d a t e , a r a t h e r d is m a l p ic t u r e
o f th e s t a t e o f t h e e c o n o m y c o m p a r e d w ith e a r ly 1 9 8 1 .
T h e o n ly g o o d g r a d e is o n
i n fla t io n ; in v ir tu a lly e v e r y o t h e r a r e a th e R e a g a n o m i c s p r o g r a m has n o t y e t s u c c e e d e d in
a c h ie v in g its g o a ls .

Table 25
Reaganomics: The Scorecard to Date
Chg. Since
1981:1
(X Chg. or
percentage points)

1981:1

1982:3E
or
Latest

1,507.8
7.9

1,481.3
0.8

-26.5; -1.8*

Industrial Production
Growth Rate

8.3

-5.9

-14.2; -8.9«

Inflation
Implicit GNP Deflator
i Chg.

10.9

6.2

-3.7

9.7

3.3

-6.4

7.4

10.1

2.7

The Economy
Real GNP
(Bils. of 72 Js)
Growth Rate

CPI-U
i Chg.
Unemployment Rate
Money and Interest Rates
Ml (X Chg.)
Prime Loan Rate (%)
New High-Grade Corp.
Bond Rate (*)
Stock Market
S&P 500

10.8**
12.0

0.5
-8.2

13.5

12.8

-0.7

132.97

134.44

10.3
20.2

Federal Government
Nondefense Purchases
(Bils. of 72S‘
s)
36.9
Growth Rate (*)
20.8
Defense Purchases
71.0
(Bils. of 72$'s)
Growth Rate IX)
8.3
Federal Spending/Real GNP
(Percent)
23.0
Oeficit (NIA)
(Bils. of $)

-39.7

1.1*

33.7
20.9

-3.2; -8.7*

78.8
2.8

7.8; 11.0*

24.7

1.7

-147.7

-108.0

*1981:1 is first quarter or first month; 1982:3 refers to the latest month available
or third quarter estimate.
♦♦September estimate

H o w e v e r , t h e b o t t o m - l i n e is th e f in is h in 1 9 8 4 , n o t t h e s t a r t in 1981 o r 19 8 2 . By t h e n , th e
D R I f o r e c a s t s h o w s t h e m a jo r p a r a m e t e r s o f e c o n o m i c p e r f o r m a n c e m o v in g in th e r ig h t
d i r e c t i o n , a lt h o u g h n o t f u ll y s u c c e s s f u l . T h e r e is m o r e r o o m f o r o p t im is m n o w th a t a t an y
o t h e r t im e in t h e p a s t t w o or t h r e e y e a r s , if o n ly t h e p o lic y m a k e r s s t a y o n t h e c u r r e n t
t r a c k and e x t e r n a l s h o c k s d o n o t i n t e r f e r e w ith th e turn in th e e c o n o m y th a t n o w a p p e a r s
t o b e in p r o s p e c t .




263

Representative R eu,ss. Thank you, Mr. Sinai, and thanks to all the
members of the panel.
UNEMPLOYMENT OUTLOOK

It is a depressing tale on unemployment that you all have to tell
us. The most optimistic of the five witnesses, Mr. Sinai, says that
unemployment is terrible and it’s getting worse. He points out that
the current rate of 10.1 percent understates the problem and that
it actually is something like 14.1 percent. Mr. Sinai further points
out that it is going to get worse, and very much worse, if the recovery
is anemic.
Is there any member of the panel who thinks Mr. Sinai is being
too pessimistic about unemployment ?
FOURTH QUARTER GNP GROWTH

Let’s look then for a moment at what is being advertised as a ray
of hope; namely, the fact that gross national product in the third
quarter didn’t go down; it barely went up by a hair, according to
today’s preliminary estimate. But the reason it didn’t go down is that
inventories were very considerably increased. In other words, the
business world believed the Reagan administration when it said that
prosperity is just around the corner and a roaring boom is going
to happen and then they got ready for it, but now they are stuck
with excessive inventories. What does that portend for the fourth
quarter in terms of growth ?
Mr. E van s . I think that real GNP will be down approximately
2 percent in the fourth quarter. I think we’ll basically have little
change in final sales, just as we did this quarter, but that inventory
investment will be reduced substantially.
INVENTORY INVESTMENT

Representative R euss . Aren’t business and industry, having shown
remarkable faith in Mr. Reagan, increasing inventories in the third
quarter, going to believe him when he says that the stock market
improvement signifies that recovery is at hand ? And aren’t they going
to increase their inventory even more waiting for the new boom ?
I ’m trying to get some ray of hope out of this mess.
Mr. E vans . Well, I think they have pretty much given up. Three
months ago when I traveled around the Midwest and talked to clients
they were more optimistic than I was. I think in the past 3 months,
with no improvement at all in sales in the third quarter, they have
become more pessimistic. We see this in the sharp turn in new orders;
we see this in the sharp reduction in the Commerce Department survey
of business anticipations.
I think most businessmen are now saying for the first time we’re
going to let somebody else go first, we’re just going to retrench and
wait for some other sector to lead us out of the slump that we are in
and then maybe we will start thinking about expanding.




264
CONSUMER SPENDING

Representative R e u s s . Turning to a related point, Mr. Ratajczak
made an interesting point when he testified a moment ago that con­
sumption is at a postwar high relative to gross national product.
Mr. R a t a j c z a k . Well, at least in terms of post-Korean conflict.
Representative R e u s s . Post-Korean, right. The last quarter century.
Mr. R a t a j c z a k . Last 35 years.
Representative R e u s s . I’m trying to bring this into focus. Obviously
the poor 14 million unemployed aren’t adding to consumption; the
people who are working in the lower middle class are not adding
appreciably to consumption. Could it be that the big buying spree one
reads about on Rodeo Drive in Beverly Hills and the great increase in
imports of luxury goods, Mercedes and what not, means that Mr.
Stockman’s Trojan Horse proposition is now coming true? Namely,
that with large discretionary income being put in the pockets of the
top 5 percent of income receivers they are now spending it in a very,
very rapid fashion, and that that answers the mystery of why, when
all is gloom, consumer expenditures apparently are at a post-Korean
war record high in terms of GNP ?
Mr. R a t a j c z a k . Well, we have noticed for some time that there has
been a split consumer market. The high end and the low end have both
shown some strength, the low people going to the discount houses, the
high end going into the boutiques, with the middle of the ranto show­
ing considerable weakness. Lately, however, the high end has started to
go to the high end discount houses. So that we are, in fact, starting to
see a little bit of convergence there.
Some of the luxury items, such as boats and planes, are deeply
depressed, although there is no question that the home entertainment
products, the personal computers are well above projections at the cur­
rent time, and they do get into the consumption stream.
Mr. B a t o r . May I say something about that, Mr. Chairman. I
haven’t looked at the figures, but one reason why real consumption in
relation to the real gross national product is up is because the real
gross national product is down, because the other components of the
gross national product are down. Business fixed investment is miser­
able; so is residential investment ; net exports are down. The major
reason w’hy the consumption-gross national product ratio is up is be­
cause the economy is in miseraWe shape. The built-in counter-cyclical
increase in the budget deficit during a recession—a consequence of
the decrease in tax collections and the increase in unemployment com­
pensation, et cetera—cushions the decline in personal disposable in­
come. That in turn helps contain the decline in personal consumption.
CAPPING THE 1983 TAX CUT

Representative R e u s s . You can keep the mike, because I want to
turn to a point you made which follows from the progression of our
thinking.
You’ve made the recommendation that the third-year tax cut, the
10 percent due next July 1,1983, be accelerated to January 1. You ob­




265

viously make that recommendaition with the realization that there
will be a lame duck session of Congress. I f a certain configuration in
the voting patterns appear, the Democrats are likely to be less supine
than they have been, and conceive of themselves as people who have
some sort of a duty to get unemployment down and not let the terrible
situation which you all have painted come to pass.
You’ve recommended the acceleration of the July 1, 10 percent tax
cut to January 1. Would not your recommendation, which I find econ­
omically attractive, be even better if you provided that there should
be a cap on the tax cuts, so that while the full benefits go to the aver­
age person, income recipients making more than $50,000 should have
the tax cut leveled off so that they don’t get an inordinate addition to
the big tax cuts they got in the early years ? In the 1981 tax act those
with income over $50,000 got a big reduction in the capital gains tax
right away, and a huge reduction in the top bracket, from 70 to 50 per­
cent, right away. Wouldn’t the billions of dollars that such a cap
would realize in revenues be an excellent signal that Congress was
serious about getting the out-year budget deficits under somewhat bet­
ter control?
Sure, you may say yes, but that attack on out-year deficits depends
on what you do about spending and a number of other things. But
here is an opportunity in this lame duck session to not only bring
to focus more demand via accelerating the tax cut now when it is
needed, but an opportunity to get the out-year budget in better shape.
Would you accept the Reuss gloss on either proposition?
Mr. B a t o r * I f it were entirely a question of fair income distribu­
tion, I would like it, Mr. Chairman, especially in the light of what
the Reagan-Volcker inflation-curing recession, and the 1981-1982
Federal tax and expenditure changes have done to the distribution
of real income. Moreover, a tax reduction aimed at middle and lower
income-groups would induce a little more extra consumption spend­
ing, and that is the purpose of advancing the effective date to Janu­
ary 1. However, is the Congress likeJy to adopt a complicated tax
measure during late November, as distinct from a simple measure?
Advancing tjie effective date of the personal income tax cuts now
scheduled to go into effect on July 1, 1983, so as to make the effective
date January 1, seems to me a relatively simple act. I would not I
think want to lose the macroeconomic stimulus because the Congress
got bogged down in a debate on tax structure and tax reform.
M IX OF FISCAL AND MONETARY POLICY

Representative R e u s s . Mr. Sinai, your relatively less depressing
view of things than your colleagues at the table was due to bits of
hope which you obtain from two recent events. You said that the
fiscal-monetary policy mix, which was atrocious, with a very loose
fiscal policy and a very tight monetary policy, appears to have been
improved. Your evidence of that, which I find unexceptionable, is
that on the fiscal side Congress, led by Republican Senator Dole, did
put a $98 billion revenue raising tax measure on the books, and on
the monetary side the Federal Reserve is obviously easing up on its
super tight monetarist fetishism. Everybody concedes that.




266

My question to you is this. In neither the field of supply-side fiscal
policy, with which the tax increase is associated, nor in the field of
monetary policy, with which the retreat from monetarism is associ­
ated, has the perpetrator admitted that they have been doing wrong
and showed the slightest sign of permanent attitude improvement.
For example, President Reagan keeps saying he won’t yield an
inch on military expenditure or on taxes. The Fed persists in stating
that there has been no change, that the rule under which they have
been operating, which has been “though shalt look at the monetary
aggregates and the monetary aggregates alone,” is still their rule of
life. So I just ask you, doesn’t your relatively less gloomy projection
encompass a permanent change of attitude, whether self-generated or
enforced by outside forces on the part of the perpetrators of the super
easy fiscal-super tight monetary policy mix?
Mr. S i n a i . Yes, I think actions do speak louder than words, and
I have watched very carefully the President’s stance on the loose
fiscal issue. I recall back in January, I had some very chilling words
for this committee, that if they stayed on the same policy track, that
is the President and the Chairman of the Fed, that they were risking
an unprecedented collapse, unprecedented for the postwar period,
and those were very gloomy and chilling words.
We did go through 6 months of that. Unfortunately the compro­
mise, the tilt of policy to a tighter fiscal-easier monetary policy stance
didn’t come until midyear. I think that is one of the reasons why we
are still mired in a no-recovery stage of growth.
But I do think actions speak louder than words, and the President
did make a major turn and very publicly supported the higher taxes,
and that is significant, because I don’t think he can really reverse field
again after having reversed field once within a very short time on that
issue.
So, I think he is going to be a proponent of tighter budgets, bal­
anced budgets, and really mean that quite seriously for coming months.
He may say that he doesn’t want to cut military spending and he
doesn’t want to postpone the tax increase, but I do think the Congress
has to be very tough on the military spending side. As an economist
and as a layman it is kind of inconceivable to me that there are not
efficiencies to be gained in a military budget that’s going to grow at
7 percent in real terms for the next 3 years. And I do think the Con­
gress has to stand up and take a very strong stand on that, because
that is an area that can be cut. It can be cut without compromising
our national defense.
Now, as for Chairman Yolcker, too, his actions speak louder than
words. I don’t think the central bank wants to preside over another
Great Depression, or major depression, and the Fed has eased, despite
what they say, and I think they will remain accommodating. So there
is really a permanent change in their positions. But why?
If you really look at the economic world, there are a couple of funda­
mental facts of life that make it easier for both the President and
Chairman Volcker to take a new stance. It is that inflation rates—
we really have broken the back of that horrible inflation of 1965-80.
You know, we have so much slack in the economy now and in the
labor markets there is virtually no way to reignite inflation fast
in the next several years, and in that kind of world the tilting of




267

policy priorities really does change, and I think that has now hit
home to the Fed. They have basically mastered the inflation battle
and they now have much more leeway to be accommodative and we
think they will essentially follow that path. And that’s part of the
relative optimism on our part here today.
Representative R euss . You’ve been a valued adviser of us all for
a long time, and I think what I hear you say to us in the Congress is
that we’ve made a good start in telling the Federal Reserve, “Don’t
just look at the monetary aggregates. That’s what has been ruining
us.” And in telling the revenue authorities, “ You’ve got to collect
some more taxes, otherwise the budget deficit is way out of control.”
Here I refer to Congressman Addabbo of New York, chairman of
the Subcommittee on Defense of the Appropriations Committee, who
vows that in the lame duck session he will move meaningfully with
measures to reduce the rate of increase in military spending.
So those are things that Congress has been doing. I take it what
you are saying is that Congress has not been doing all that bad and
that you encourage us to attempt more of the same.

Mr. S in a i . Yes; absolutely. The budget impasse was a failure to
compromise on the budget and a monetary policy, and it’s like all solu­
tions, every side has to give a little bit, and I think you really must stay
on that track. Just as proof of it, if you recall, the financial markets
turned so negative just after the President’s program was passed in the
summer of 1981, and then the financial markets really did deteriorate,
looking at those large deficits in the face of the new Fed policy, which
would not accommodate them.
Notice how well the financial markets reacted the next day after the
President made his speech and Congress supported it. In fact, there
was bipartisan support of that tax increase. And notice how the finan­
cial markets and stock markets have responded to the tilting of policy
in the other direction in the summer.
Investors really do know something about the processes by which
healing takes place, and I think the President actually can justifiably
take some solace in the positive reaction of the financial markets to
these moves. I would encourage you to stay on that same track of
keeping the budget tight and easing up some more monetary policy.
Representative R euss. Congressman Mitchell.
wage

and

p r ic e r e s t r a i n t

Representative M itch ell . Thank you, Mr. Chairman.
I appreciate hearing from all of you, and I must confess that with
the first four witnesses I could not help but think of a bit of scripture
that said: “Is there no balm in Gilead; is no physician there?” And
then when we get down to Mr. Sinai, he offers us a balm, which is
probably just a little bit better than Vaseline or some sort. I must
confess that I share your pessimism.

Mr. Bator and Mr. Sinai both alluded to the necessity for some kind
of wage restraint, and that may well be required. I ’m not sure that it is.
But on the other hand, in my opinion prices were abnormally high
even before this enormous inflation set in. Why is it that you do not
argue for some kind of price restraint also ? It seems to me that these
two are inexorably linked. Why should we just fall on one side, on




268

wages, rather than looking at the essential linkage? Would you recom­
mend some kind of a price restraint ?
Mr. S i n a i . Well, my own feeling has been that tax-based incomes
policies would be helpful. If we would put that on the wage side we
would reduce one of the major cost-push elements in inflation. That
plus increased productivity growth would lower unit labor costs and
price inflation would fall sufficiently so we would get real wage growth
for most people.
The cost-push phenomenon is part of the terrible inflation of 196580. That’s really perhaps the major reason for that.
Representative M i t c h e l l . I think I mentioned that in my humble
opinion prices were significantly high even before the inflationary
spiral set in, and, therefore, it would seem to me to be incumbent on
all of us to think about restraining both ends in some f ashion.
Mr. Bator, do you have a comment, sir ?
Mr. B a t o r . Yes, sir. Prices, relative prices, play a very important
signaling role in the economy. Much of the jump in the speed of in­
flation during 1972-75, and 1979-80, was caused by the big increases
in the price of oil, food, and other raw materials. The fact that
OPEC increased the price of oil was not a good thing for us; it was a
very bad thing for us. But since there was nothing we could do to stop
them, it was very important that that increase in the real economic
cost of oil to the United States be reflected in the final energy prices
faced by American businesses and consumers. For that to happen,
with other prices generally sticky downwards, the entire price level
had to rise. Trying to suppress that kind of transient inflation by con­
trolling prices produces enormous economic inefficiency.
On the other hand, in the absence of any large supply-price shocks
like that, and as long as we make effective use of fiscal and monetary
policy to avoid excess demand and excessively tight labor and goods
markets, the general price level will tend to move in line with normal
unit labor costs. If we can make normal unit labor costs slow down,
the price level will slow down.
In order to slow down normal unit labor costs, one has to shrink the
gap between the rate of increase in money wage rates, and the trend
rate of increase in average labor productivity. The rate of increase in
trend labor productivity can be altered only very gradually and by
small absolute amounts. That leaves wages. There are only two ways
to slow down wage increases. One way is to use fiscal and monetary
policy to produce a recession and an awful lot of unemployment. That
is what we are doing now. It is a very costly method. The alternative
would be to restrain wages directly by some kind of a wages policy.
Now, why not be fair and put controls on prices also? The danger
is that if we do adopt some kind of price controls as well, as distinct
from very general price oversight, we will interfere with the work­
ing of relative prices. That would soon produce a mess of shortages
and excess supplies. After a year or two, the control system would be­
come discredited. That’s what we did in 1971-73.
To balance wage restraint in a politically acceptable way, we should
perhaps think about controlling dividends. It’s not clear that that
would do very much harm. But I would be very careful about impos­
ing any kind of direct restraint on prices. It might once again dis­
credit the whole scheme.




260
Representative M itchell . Let me say that I certainly was not en­
visioning or contemplating a kind of a wage-price control fixed in
some bureaucratic setup. You suggested wage restraint, and I’m mere­
ly suggesting price restraint. Perhaps I’m just being obstinate this
morning, but as a tyro in this field of economics I find myself in dis­
agreement with you.
And as an aside, I must point out that it’s almost un-American to
talk about 6-perceTLt unemployment as being acceptable, but that’s
what we’re doing right now.
reliquefication

Mr. Dalio, I was fascinated by your testimony. You were even more
grim than the ghost of Hamlet’s father in these proceedings. But I
was struck by something. It was really very important, it seems to me,
and that was your statement that we had to move immediately, we
liad to achieve immediate reliquefication, and I think almost every­
body on the panel would agree with that. But how ? How do we do
this t If you were captain of the Titanic, what orders would you give
in order to achieve immediate reliquefication ?
Mr. D alio . I think one of the things that we have got to recognize—
I would say I would be in agreement and disagreement with Mr.
Sinai. I would be in agreement in that monetary policy has basically
been myopic in that it looks at aggregates when it is interested in
fighting inflation, and it looks at interest rates when it is interested
in trying to stimulate the economy.
Instead, it would be a good idea if they looked beyond those targets
and perhaps set levels of economic activity and levels of inflation as
targets. And if you did that when the economy was too weak and
inflation, you were oversucceeding your battle with inflation, had a
lower level of inflation, then you might be more inclined to turn
stimulative. In fact, if they had followed those policies they would
have turned stimulative before; they wouldn’t have made the error,
which I think is most fundamental, of perhaps overlooking the decline
in the velocity of money.
Where I would disagree with Mr. Sinai is in the fundamental
tradeoff between inflation and economic activity. When we have high
levels of inflation, that is the primary target, and we find our way
of how we can keep the economy robust while we dispose of inflation,
and now when we dispose of inflation we see how we can stimulate
the economy without rekindling it.
If you turn to chart 4—I think there are some fundamental rela­
tionship here. Chart 4 is at the rear of my prepared statement. Al­
though it has been mentioned that inflation got a goose up because
of the bad harvests and the oil crisis, I should like to point out by
observing chart 6 that there has been a steady increase in the rate
of inflation, from 2 percent in the 1950’s, from 3 percent on average
in the 1960’s, 7 percent on average in the 1970’s, and then we had the
sharp increase at the appointment of Paul Volcker.
In fact, the level of inflation doesn’t necessarily have to reflect
higher oil prices or higher costs, because if money supply were kept
constant, if we lived in a world where people had the same number
of dollars to spend, so to speak, although they would have to be spend­




270
ing more dollars for oil, they would have to by constraint, or the re­
striction of the number of dollars, spend less money elsewhere. So that
most of the movements in the inflation rate are directly attributable
to movements in the money supply.
The economy now is so illiquid—I think that this is one of the most
important things. We all agree that the outlook is essentially for a
flat economy.
What are the implications of a flat economy? How long can the
economy sustain operating at 70 percent of capacity, or less than 70
percent of capacity, without triggering a bankruptcy crisis? What
are the implications?
My numbers show that you would have a 50-percent increase over
the next 6 months in business failures as a result of a flat economy.
How long can the steel industry operate at 39 percent of capacity
and so on?
In answer to your question, I would say that if I were sitting in
that position I would try to formulate a policy that recognizes that
there is a tradeoff between inflation and rate of economic activity,
and that I would try to set targets for both economic activity and
the inflation rate, and any time the inflation rate fell below those
targets and the economy was weaker I would turn more stimulative.
I would like to add one point. As far as the Federal Reserve becom­
ing stimulative, there are various degrees to what that could mean;
there are various degrees to becoming stimulative. I think we have
an economy which is teetering on what I call failure. In other words,
if lenders become more cautious about making loans, and if the flow
of money to those who need it the most is constricted because of the
high failure rate, you will have a bankruptcy crisis which the
economy as a whole can’t avoid.
The Fed has basically taken a posture—you can see it in open
market operations and so on—of turning very modestly stimulative.
By that I mean they will come in the market as net buyers when Fed
funds get down on the order of 914 percent and the like. So they have
turned very, very modestly stimulative. To me the risk is so much
greater of a downturn from these levels than an upturn from these
levels and inflation being rekindled. The fact that there has been
virtually no response to the stimulation that has taken place so far—
if anything, you look at the numbers, there’s weakness—would seem
to indicate to me above all else we have to avoid the possibility of
a sharp decline in economic activities from these levels caused by a
bankruptcy crisis.
So if I was running monetary policy I would definitely run it with
the hope of trying to avoid that type of error, becoming much more
stimulative.
I also agree that too much attention is being placed on the aggre­
gates and not enough attention on the velocity of money and not
enough attention on credit as a whole. So that I would like to see
more attention being given to nominal GNP rather than just simply
the money supply components of that.
Representative M i t c h e l l . Mr. Bator seems to be involved in dis­
agreement, and before you respond—I know that the hour is late,
and I have made copious notes, have many questions—I would like
to raise just one more question in another area after my friend who




271
is involved in apparent violent disagreement with you has an
opportunity to speak.
Mr. Bator, weren’t you in disagreement? You seemed to be in dis­
agreement with several of the things that Mr. Dalio had to say. Or
was I misreading you?
Mr. B a t o r . I liked Mr. Dalio’s conclusion, sir. What he said at the
very beginning troubled me a little. It also shows up in his prepared
statement. And that is the notion that somehow the Fed faces a
terrible dilemma.
In order to support a decent recovery, business balance sheets have
to be—it’s a terrible word—“reliquefied.” I agree. The Fed’s role in
that is to make sure that the supply of money grows fast enough to
keep real interest rates from going up and, in my judgment, fast
enough to make real interest rates go down some more. To support
even a very moderate recovery: 1 point a year improvement in the
unemployment rate, real output has to grow by 4 to 5 percent each
year. With the core inflation stuck, I believe, along that path at, say,
around 5 to 6 percent, total nominal spending would have to grow at
9 to 12 percent. For that, the Fed would have to increase the money
supply a lot faster than by 5 percent a year.
The question is: Will such a faster growth in money supply neces­
sarily rekindle inflation in the sense of making the core inflation rate
go up again? That is where I disagree with my colleague. There is
no automatic year-by-year connection between money supply growth
and the price level. The current rate of change in the price level is a
function of the recent rate of change of inflation, and tightness in
labor and goods markets. My judgment would be that if, during the
next 3 years, we follow a path of gradual recovery, 4 or 5 percent
real growth a year, and a consequent reduction in the unemployment
rate by a point a year, that then, whereas the underlying rate of
inflation would probably not improve, I doubt that it would get much
worse. It would not get much worse even though money supply would
be growing at 7 or 8 percent. Of course, if we should get hit by another
big increase in oil prices, all bets would be off.
So, assuming no oil price shock, I would be a good deal more opti­
mistic than Mr. Dalio with respect to the inflation-recovery tradeoff.
Money supply growth fast enough to support real growth of 4y2 to 5
percent during the next 3 years would not, in my opinion, cause infla­
tion to reaccelerate.
Representative M i t c h e l l . Of course, I ’m a little discouraged,
though, when you talk about a modest reduction in unemployment.
Because unless this Nation had abandoned all its compassion and
sympathy, a 1-percent reduction in unemployment is going to still
leave us paying out $25 billion to $30 billion for the other 10 percent.
Therefore you are almost building into your fiscal side a permanent
kind of burden that would obviously be alleviated or diminished if
we were more vigorous in our pursuit of reducing unemployment.
FEDERAL RESERVE POLICY

Let me just get in one other statement. It seems inevitably threaded
throughout your testimony and the question and answer period that
we come back to that pristine, pure, Promethean entity in Government




272

known as the Federal Reserve. And you, Mr. Sinai, have indicated
that you believe the Fed has shifted, will retain that shift and will
sustain a policy that would be supportive of a recovery. Yet, at best,
someone has described Mr. Volcker as being characterized by am­
biguity. At worst he has been described as being locked into an in­
flexible position. I just have some concern about your optimism,
primarily because it seems to me that you are assuming that this recent
shift was absolutely devoid of any political implications. You know
what I mean.
Mr. S i n a i . That’s really something I can’t speculate on.
Representative M itch ell . Well, I think we are forced to speculate
on that.
Mr. S i n a i . There is a coincidence there. But the facts of the state
of the economy----Representative M itc h ell . Well, I’m almost ready to assume that
there is a correlation, but be that as it may.
Mr. S in ai. The lack of recovery and the state of the economy and
the improvement on inflation was so great that I think any central
banker—and I think this is more than Chairman Yolcker—would
feel a little foolish in pursuing a policy that said “thou shalt decrease
reserves and increase interest rates” when they could see full well what
the state of the world was. Now the fact that it falls iy2 months be­
fore the elections may or may not be the reason why they did it. But
the economic facts of life were very clear, and the Federal Reserve
did w’hat a central bank should. It doesn’t want to preside over a
major depression.
The question of permanence of that, I think again they will find
out as they study it—and I think they are finding this out already—
that the policy they followed that worked so well to cut inflation rates
down so fast, faster than anyone expected, are just no longer appro­
priate in the kind of economy we now have, and they will find a way
to tilt not fully away from the new Fed policy of October 1979, but
in a direction that will give us a recovery that we can all see. Then
at that point they have another problem to reassess.
Representative M itchell . Well, I just hope your speculation is
right. I recall under Chairman Burns, when there was some slight
variation in monetary policy at the prodding of the Congress, and
then at the first opportunity he immediately seized the chance to re­
vert to a money policy that I think was inimical to the economic
growth of this country.
Maybe you’re right.
Mr. S i n a i . Well, you know, Congress has the responsibility to keep
offering its views and advice. With regard to monetary policy and fis­
cal policy and the budget, I would encourage the Congress to take
very forceful stands on what you think is right. It can have an im­
pact, and you should do it.
Representative M itch ell . I thank you, and I thank you for your
faith in Chairman Volcker’s rebornness in monetary policy. I hope
you are right. I have reason to suspect that you are not.
Thank you, Mr. Chairman.
Representative R euss . Thank you, Mr. Bator, Mr. Dalio, Mr.
Evans, Mr. Ratajczak, and Mr. Sinai. You have, as we expected when
we invited you, contributed enormously to our education and helped




273

us in our determination to do a little better in the future, starting
right in the lame duck session.
We now stand in recess.
[Whereupon, at 12:25 p.m., the committee recessed, to reconvene
at 10 a.m., Wednesday, November 24, 1982.]
[The following information was subsequently supplied for the
record:]




274

SHARE THE WORK COALITION
We represent the twenty million unemployed persons o f the Free World.
Wallace D. B arlow
Executive D irecto r

6 2 1 0 Massachusetts Ave.
Washington, D.C . 2 0 0 1 6

Tel: (301) 2 29-6066
Cables: Intresecon

PREPARED STATEMENT OF WALLACE D. BARLOW, EXECUTIVE DIRECTOR, SHARE THE WORK
COALITION, FOR THE JOINT ECONOMIC COMMITTEE OF THE UNITED STATES CONGRESS.
Subject: The Unemployment Problem
We are strongly opposed to the many temporary solutions which have been proposed
for the unemployment problem. We are not dealing with a situ ation that changes with th
business cycle. The real need is for job careers, not for temporary jobs.
A summary o f our proposal follow s:
The simple, cheap solution to the unemployment problem is to increase the labor
content of the goods and services we produce. This can best be done by a discriminator;
corporation tax. The rates would be inversely proportional to the labor content of eaci
industry. The industries that employ many humans and very few robots, would enjoy a mu<
lower corporation tax.
For s ix ty -fiv e years, the corporation tax burden has been carried on the backs of
the labor-intensive in dustries. (In 1980, the taxes actually paid were at the rate o f 3‘
for the labor-intensive industries and only 19% for the c a p ital-in ten siv e in d u stries.)
The Share the Work C oalition now proposes le g is la tio n to TILT THIS TAX IN THE
OPPOSITE DIRECTION] The re su lt: The employers, in order to survive, would chose more
labor-intensive modes of production. This CAN be done, without wiping out the "high
technology" industries. The cost? Zero; since the average corporation tax rate would
remain at 46%.,f
In the la st election we polled the Federal candidates. The affirm ative vote of tt
respondents was in the high 8 0 's . An adequate number of the winners are pledged to the
support of "TILT".
We resp ectfu lly request that this le tte r and the attached a r tic le , "FEDERAL TAX­
ATION IS TILTED IN FAVOR OF THE CAPITAL INTENSIVE INDUSTRIES" be inserted into the
record of your October 15/16 hearings.
Very truly yours,

Wallace D. Barlow

Enc: A rtic le presented at the A tlantic Economic Conference on October 10th, 1982.




275

Telephone:

Cables: INTRESECON

(301) 229-6066

INTERNATIONAL INSTITUTE

Managers of International
Commodity Agreements

(or
RESOURCE ECONOMICS

6210 Massachusetts Avenue
Washington, D. C. 20016

Wallace D. Barlow, P.E., D irector

FEDERAL TAXATION IS TILTED IN FAVOR OF THE
CAPITAL INTENSIVE INDUSTRIES
By Wallace D. Barlow
For presentation at the Miami Beach Conference
of the
Atlantic Economic Society
October 7-10, 1982
Konover Hotel
Miami Beach, Florida

NOT for release to the press before 10 A.M. on October 10th, 1982




276
FEDERAL TAXATION IS TILTED IN FAVOR OF THE CAPITAL-INTENSIVE INDUSTRIES

By Wallace D. Barlow
D irector, INTERNATIONAL INSTITUTE FOR RESOURCE ECONOMICS

Figure One shows that the corporation taxes actually paid by the average
labor-intensive industry in 1980 amounted to a rate of 3 2 .1 % of net earnings;
(The statutory rate is 467») . The average capital intensive industry paid only
18.8%. We see that the labor-intensive industries are paying almost twice as
much in corporation taxes as their competitors. Therefore, a million dollars
spent by a very high labor content industry creates almost six times as many
job careers as a very low labor content industry. (These data are from the U.S.
Commerce Department and the U.S. Treasury Department.)
This gross discrimination has been going on for sixty-five years. It started
in 1917, when the War Excess Profits Tax granted corporations a deduction of 87«
of their invested capital. (In 1915 the rates of tax were 4% for individuals and
6% for corporations.) Since 1962, there has been a veritable bonanza for the firms
that invest in short-lived equipment. The Kennedy administration increased these
subsidies, as did the Nixon administration and the Reagan administration.(President
Reagan's 1982 Economic Report to the Congress lists Mining, Motor Vehicles and
Transportation Equipment as having negative corporation tax rates.
These rates
can be as high as 11.37».)
The cost of these subsidies is now approaching thirty billion per year. In
these years, since 1917, the average labor content of U.S. industry fell from 38%
to 277». (It was 46% in 1870). Today, the worker is faced with robots having fifteen
times the productivity of humans and costing only one-third as much in wage equivalent.
Figure Two confirms Figure One. It shows the correlation between the corpor­
ation tax actually paid by typical U.S. industries and the labor content of these
industries. Both variables are shown as percentages of the maximum. Accordingly,
a vertical line at the center of the page would have the capital-intensive industries
on its left and the labor-intensive industies on its right. The coefficient of
correlation, (r) = .754.
In 1980, the labor content of U.S. industries varied from 12.77» for Oil and
Gas Extraction to 69.97» for Holding and Other Investment Companies.
A selective
approach, based on labor content, is surely a better approach than the shotgun
approach of conventional legislation.
Let's look at Table One, which shows typical labor contents in the top and
bottom deciles:




277
Table One
WAGES AS A PERCENTAGE OF VALUE ADDED IN THE UNITED STATES

Part A

The Top Decile

SIC Number

Ship or Boat Building or Repairing
Rubber and Plastic Hose and Belting

373

Wages as a % of Value Added

56.4%

3041

52.8

332

51.9

3021

51.1

Ordnance and Accessories

348

50.8

Aircraft and Parts

372

50.6

2211

49.8

336

49.5

Rubber and Plastic Footwear

Weaving Mills, Cotton
Nonferrous Foundries

Part B

The Bottom Decile

Itidüstrÿ

Agricultural Chemicals

Typical Capital-■Intensive Industries

SIC Number

287

Wages as a % of Value Added

19.6%

Cigarettes

2111

15.5

Petroleum Refining

2911

15.3

46

15.2

Pipelines, except Natural Gas
Soaps, Cleaners and Toilet Goods
Oil and Gas Extraction

284

14.9

13

12.7

1/ "Labor Content of U.S.\ Industries", Share the Work Coalition, 1981

17-871

0




8 3 - 1 9

1/

Typical Labor-Intensive Industries

Industry

Iron and Steel Foundries

1980

278

F I G U R E ONE

TILT the U.S. Corporation Tax!
For 65 years the Federal Government has been tilting the corporation tax in favor of the capitalintensive industries. A tilt in favor of the labor-intensive industries would solve the unemployment
problems of the free world.
TAX RATE

(percent)

LABOR-INTENSIVE
INDUSTRIES

CAPITAL-INTENSIVE
INDUSTRIES

?"u n e m p l 5 y m e n t F
F
RATE
(as a percent
of the work
force)

■1%

60 —

50 —
■3%

40%

40 —

32.7%

Average Rate
Actually Paid
in 1980 by the
Labor-Intensive
Industries

Proposed Average
Rate for the
Capital-Intensive
Industries

■ 4%

5%

30.
8%

^ERAGEWATerAGrUAE&YSPAIDUNH9

20

.

10

.

Proposed Average
Rate for the
Labor-Intensive
Industries

Average Rate
Actually Paid
in 1980 by the
Capital-Intensive
Industries

.INTERNATIONAL IN S TITU TE FOR R E SO U R C E ECONOM ICS • 6210 MASSACHUSETTS AVENUE • W ASHINGTON, D C.




279

FIGURE TWO

**********

CORRELATION BETWEEN CORPORATION TAX ACTUALLY PAID IN 1980 AND THE LABOR CONTENT OF THE INDUSTRY PAYING THE TAX

Wages as a % of Value Added (“Labor Content") Unit: Percent of Maximum
0

2 4

6

8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40 42 44 46 48 50 52 54 56 58 60 62 64 63 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98100




280

I visualize our task as economists as the improvement of the quality of life
on this planet. A part of the quality of life is the right to the satisfactions that
come from participating in the production of goods and services.
I hold that 407»
unemployment among black teen-agers is dangerous, inhuman and intolerable.
In the
Free World there are now twenty-five million persons unemployed.
In our poll, taken in 197 6, 82% of the respondents, all candidates for federal
office, answered YES to the question, " I believe that the right to employment is a
basic human right."
In 1980, the same group was polled.
The affirmative vote was

100%.
In my judgement, the free enterprise system will be abandoned within ten years,
unless action is taken to deal with what Samuelson defines as "structural unemployment".
His discussion of this problem concludes: "Increasing the fraction employed at what is
defined as feasible full employment would be a powerful way of increasing the quantity
of labor and would be conducive to growth. (Its social benefits would, of course, out­
weigh its mere growth benefits.)" Since this was written it has become apparent that
the survival of the free enterprise system itself is at stake.
Under socialism, an effort is made to share the work. The socialist nations also
try to provide free health insurance and adequate pensions. I suggest that we consider
borrowing the share the work principle without compromising the free enterprise system
and without a loss of efficiency.
In England, in 1538, the concept of using taxation to achieve economic objectives
was conceived. Our proposal, known as "TILT", is the most radical application of this
principle since 1538.
It is revolutionary. We propose to TILT THE CORPORATION TAX IN
THE OPPOSITE DIRECTION. It is brutally simple and we expect it to be highly effective.
The only way to control unemployment is to INCREASE THE LABOR CONTENT OF GOODS AND
SERVICES.
The most effective way to increase the labor content is to make it worth­
while for the employers to adopt more labor intensive modes of operation. Every pro­
posal to buy equipment fits into the following pattern: "We want to spend x dollars
for equipment. This will eliminate y dollars in wages. The net gain is z dollars."
When TILT is adopted, z will become negative, after taxes, in many instances.
Figure One approximates the proposed effective tax rates at 40% for the capitalintensive industries and an average of 20% for the labor-intensive industries.
The
actual tax rates would be an inverse function of wages as a percentage of value added.
Table III of "Labor Content of U.S. Industries", a booklet published in 1981 by the
Share the Work Coalition,lists the labor content of U.S. industries, their SIC number
and our proposed corporation tax rate. The range of the proposed statutory rates is
from 307, to 62%.
The degree of tilt would be changed from year to year, to provide
the necessary "fine tuning"; also to provide equitable treatment for employers who
may have changed their labor content during the year.
The corporation tax would continue to yield about fifty billion per year, but
resources would be transferred from the automated industries to the non-automated.
The impact on the consumer would be that he would pay more for his cigarettes and
less for his T-shirts.




28 1

I t appears that a l l industrialized countries have a corporation tax. The level
varies from fifty -tw o percent in the United Kingdom to 307« in Ita ly . In West Germany
a . 1977 law established a range from f i f t y - s i x percent to fo rty -fo u r percent.
In the
United States, the rate for large corporations id 467». In a l l in dustrialized countries
a part o f this tax is passed on to the consumer in the form of higher p rices. The b a l­
ance is passed on to the stockholders in the form- o f lower dividends.
Table Two gives the la te st figures on unemployment for the in d ustrialized nations,
adjusted to U.S. concepts. I t is no coincidence that the nations hating the lowest
unemployment, do NOT have investment tax c re d its.
TABLE TWO

UNEMPLOYMENT RATES IN THE INDUSTRIALIZED FREE WORLD

Nation

Unemployment Rate in Percent

Great Britain
Canada
United States
Ita ly
France

13.87»
1 1.9
9 .8
9 .3
8 .7

West Germany
Japan

7 .6
5 .7

Investment Tax Credit?

Yes
ii

(Average * 8.90%)

ii
ii
ii

No
(Average - 6.65%)

ii

I have discussed this plan with the White House. They showed in te r e s t, but
were concerned about possible losses o f productivity. They are rig h t, in a sense,
since UNIT productivity w ill f a l l under any plan for sharing the work
untrained
persons w ill enter the work force. Total production w ill r i s e , o f course, since
the work force w ill be larger.
I hold that unit productivity is not sacred. The
survival o f the free enterprise system is far more important.
The reaction of a friend who represents General Motors in Washington was th is :
"This would wipe us o u t ." The U.S. Chamber o f Commerce said , " By d e fin itio n , h a lf
o f our membership w ill be opposed". Other persons claim to favor "ta x n e u tr a lity ".
These are the real dreamers.
Part Two of my paper deals with the seventy percent o f the work force which is
employed by the service industries. The " t i l t i n g " o f the corporation tax w ill surely
b en efit these persons. However, a d irect approach is also suggested. This must involve
the shortening of the work week or the work year.
In addition to "f le x it im e " and the
32 hour week, there has been progress in one plan for shortening the work year. Three
plans have been suggested for the reform o f the antiquated Gregorian Calendar, which
has been a heavy burden for the Western World since 1582. In the 19th Century two plans
were suggested; the equal months plan and the equal quarters plan. (Comte and Armelin
were the inventors. In the 20th Century, a third plan was suggested. I t has equal months
and equal quarters. I t would also tr ip le the holidays, thereby reducing the length of
the work year by 5.57«. The d e ta ils are shown on Page 7 , an excerpt from "Future F a c ts ",
by Stephen Rosen.




28 2

THE

C ^'O .lcu&ii'c d ^e ^o t-n t

'ai
political
c^J-ctcon

301 -229-60f)f)
6210 M a s s a c h u s e t t s A v e n u e

BARLOW

W a s h i n g t o n , D. C. 20016

E xecutive Director
W allace D . B a rlow

y

1

CALENDAR
Calendar Reform

O n w hat date will Easter fall next year? On w hat day of the w eek
is your birthday? For the answers you’ll have to com ult your
calendar. As an alternative, however, several organizations
recommend settling these questions of tuning once and for alL
They propose a variety of reforms—from regularizing the Cregorian calendar to scrapping it altogether.
T h e Western calendar is a hand-me-down from the ancient
Egyptians, who adopted a solar calendar in 4236 B.C. The
Romans had a ten-month system until 46 a-c., when Julius Caesar
remodeled it after the Egyptian pattern. Pope Gregors' X III re­
vised it again in aj>. 1582 to stabilize the date of the spring
equinox. Still irregularities remain.
One inconsistency that peeves computers is the w ide variation
in the number of working days in each month. First, there’s the
problem of whether the mouth has 28, 29, 30 or 3» days. Then the
machine must worry about how many weekends there are.
Finally, there are the holidays to consider. Th e total num ber of
w orking days can vary as much as 19 p erce n t
As far back as 1849, the French philosopher Com te proposed
what is now known as the International Fixed Calendar. H e
suggested a year divided into 13 months, each exactly 28 days
long; the extra month, Sol, w ould be squeezed between June and
July. T o make a total of 365 days, an extracalendar holiday, with
no designation as to month or day, w ould occur after December
28. In leap year there w ould be a second extracalendar feast. The
first day of every month would always be a Sunday, and the last
a Saturday. Unfortunately, Com te’s year w ould not divide evenly
into quarters, a major draw back from a business view point
Th e W orld Calendar, devised by the French astronomer
Armeliu in 1884, keeps the 12-month system and equalizes the
quarters. E very quarter has 91 days: January, April, July and
October have 31 days, and all other months have 30. T h e provi­
sions for a 365th day and leap year resemble Comte's calendar.
Although during the 1930s, 47 nations endorsed the concept of
the W orld Calendar, no action was taken. Tw o recurring criti­
cisms have been that cach month spans parts of five different
weeks, and each month of a given quarter begins on a different
day.
An American industrial engineer, W allace Barlow, has ex­
tended the idea of the extracalendar day into 29 extracalendax
days. He conceives of a working month of 28 days; every month
begins on Monday, and there are no holidays (except Saturdays
and Sundays) in this period. All holidays are gathered together
into a series of extracalendar festivals at the end of each month.
The Christmas holiday, for instance, begins on Saturday, Decem­
ber 27, and runs through the 28th and five extracalendar feast
days. The total work year is shortened b y 14 days, but Barlow
argues productivity w ill actually increase because there are no
"broken weeks" (m idw eek holidays). This is the equivalent of
reducin" the workweek to 38 hours.




A first step to calendar reform in the United States was the
passage of the Monday holiday bill. Polls show over 90 percent of
the population support this change. The Calendar Reform Foun­
dation, which endorses the Barlow Calendar, advocates setting a
fixed Jate for Easter, and changing Christmas and Thanksgiving

THE BARLOW CALENDAR
M

T

W

T

F

S

S

1

2

3

4

5

6

7

8

9

10 11 12 13 14

15 16 17 18 19 20 21
22 23 24 25 26 27 28
««•pithatth«2Sm of April 1« Euur Sundty
Th« Edra-catondar 0«y*

(

^

Mimi
M xw y a«..

..H«Im IH

Th9 Barlow Calandar haa 12 montha ot 28 days «»eft and t stria* ot *xtr*calandar holiday* that would tall at tho and ot a*eh month.
so they too are Monday holidays. Th e Vatican’s ecumenical coun­
cil has voted overwhelmingly not to oppose a fixed date for
Easter or a perpetual calendar.
"The cost of accomplishing this calendar reform is substantially
nil,” the Calendar Reform Foundation reports. "The savings in the
cost of accounting operations alone will approxim ate S1.5 billion:
however, as Maurice Maeterlinck wrote, "At every crossway on
the road tlu t leads to the future . . each progressive spirit is
opposed by a thousand men appointed to guard the p ast* "

Excerpt from "Future Facta" by Stephen Rosen
Published by Simon <& Schuster, NY 10020

283

The latter plan has been adopted, in part, by the Soviet Union and Brazil.
Such a shortening of the work year could create eighteen million jobs in the Free
World, of which six million would be created in the United States.
F r o m time to time bills are introduced into the U.S. Congress which would
finance a study of these calendar reform proposals.
The supporters of such bills
have noted a strong inverse correlation between the number of holidays in the
nations of the industrialized Free World and the levels of unemployment. For
example, the United States has 16 holidays, (including the two week summer vacation),
and 9.87» unemployment. West Germany has 27 holidays and 7.6% unemployment, Sweden
has 29 holidays and 3.57» unemployment.
May I conclude with a brief cost-benefit analysis:
I. The present system is costing about twenty-six billion per year in unemployment
benefits and five billion in investment tax credits.
We are therefore squandering
thirty-one billion per year to destroy the work ethic and to create a caste system
in America. Children are conceived for the purpose of qualifying for ADC, (Aid to
Dependent Children). They are born and raised on welfare. Upon maturity, they accept
public service employment and become members of a parasitic caste.
II. My plan would cost a few dollars for administration. That is all. It would s u b ­
stantially increase the overall demand for labor in a controlled mann e r . It would
preserve, or rather restore, the dignity of the individual and rescue the free ent­
erprise system. It would greatly improve the quality of life in America.
III. All of us must adjust to a new set of facts:
A. A way has been found to define and measure the labor content of economic
activities.
B. A book showing the labor content of U.S. industries has been published
and will be updated, as neccessary.
C. A method has been available to the Western Democracies since 197 6 for
establishing and maintaining a firm control over the levels of unemployment.
D. The refusal of governments to accept and use this technique must be
countered by the votes of the workers and all other voters to deny power
to such governments.
I have kept this presentation brief, with the hope that I may have some good
constructive criticism. Thank you.







THE UNEMPLOYMENT CRISIS AND POLICIES FOR
ECONOMIC RECOVERY

W EDNESDAY, NOVEMBER 24, 1982
C ongress of t h e U n it e d S t a t e s ,
J o in t E c o n o m ic C o m m it t e e ,

Washington, D.C.
The committee met, pursuant to recess, at 10 a.m., in room 2128,
Rayburn House Office Building, Hon. Henry S. Reuss (chairman of
the committee) presiding.
Present: Representatives Reuss, Wylie, and Kemp; and Senator
Proxmire.
Also present: James K. Galbraith, executive director; Bruce R.
Bartlett, deputy director; Richard F Kaufman, assistant directorgeneral counsel; Charles H. Bradford, assistant director; Betty Mad­
dox, assistant director for administration; and Mark R. Policinski,
professional staff member.
OPENING STATEMENT OF REPRESENTATIVE REUSS, CHAIRMAN

Representative R e u s s . The Joint Economic Committee will be in
order for a hearing on monetary policy.
I might welcome back our Republican member, Representative
Wylie, and Senator Proxmire will also be here. We are delighted to
have you this morning.
I am happy and sad to be presiding over what will probably be my
last occasion to voice my appreciation to Paul Volcker. You know how
much I value our friendship and how splendid a public servant you
are. You have served well for this country.
We meet today because our committee is disturbed about the conduct
of the economic policy, monetary policy in particular, and its respon­
sibility for the unemployment and recession that we are now in.
Interest rates have frequently been intolerably high in recent years.
I recall two bouts of over 20 percent prime rates since January 1981.
Interest rates have also been excessively volatile. They have jumped
around much more after the great change in monetary policy in
October 1979 than they did before.
Finally, the course of the monetary aggregates has been enough to
drive a market watcher to distraction.
The chart shows [indicating] the growth ranges and actual behavior
of Mi in 1981 and 1982. The Reagan administration in its February 18,
1981, Program for Economic Recovery called for—growth rates of
money and credit
. steadily reduced from the 1980 levels to onehalf those levels by 1986. The Federal Reserve agreed. But the actual
result for Mx was to be consistently under the target in 1981 and con-




(285)

286
sistently over the target' in 1982. It has been some years, in short, since
the Federal Reserve has been able to throw its fast one over the plate.
FIVE PROPOSED REFORMS

In an effort to see whether Congress may not more adequately dis­
charge its constitutional monetary responsibilities, I wrote Chairman
Volcker a week ago proposing five reforms in Federal Reserve prac­
tice which, if adopted by the Federal Reserve, could help produce
a healthy economy. Each one of these reforms could, I emphasized,
be adopted by the Federal Reserve without any change in existing
law.
With respect to the first reform, the chart at my right [indicating]
is helpful. At* the highest level are the national goals—maximum em­
ployment, production, and purchasing power, as stated in the 1946
Employment Act, and then the “ full employment and production,
price stability, 1978.”
CONGRESS NEEDS FED FORECAST

Presently, the Federal Reserve in its monetary policy reports sets
forth—not its estimates of what the level of GNP, employment, un­
employment, inflation should be—the range of forecasts of the 12
individual members of the Federal Open Market Committee. This
gives us no basis for comparing the objectives and goals of the Federal
Reserve System with those of the President and the Congress.
We would not accept from the administration a set of estimates
of these very important goals, which consisted of the separate guesses
of President Reagan, Treasury Secretary Regan, Mr. Stockman, Mr.
Baldrige, and several others. I have felt aggrieved that we have had
to accept disparate views from the Fed.
We would be better served by a single composite forecast of the
Federal Open Market Committee. I am sure, on a motion of the Chair­
man, they could get together on a single forecast so we can see the
relationship between that forecast and the forecast of the President
and the Congress. We could then, if necessary, adjust our own actions
or adopt appropriate policy guidelines.
That is the first area.
a

c r e d it

tar get

Second, we need a proper aggregate for credit, including the full
array of lenders and borrowers, rather than restricting ourselves to
bank credit as we do now.
I have set forth a number of things—credit by mortgage compa­
nies, et cetera—which seem to us to be part of this vital intermediate
target and, indeed, one specifically set forth in the law. I would hope
that the Fed would not continue to ignore nonbank credit, because it
is so important.
lo n g -term

in t e r e s t

rates

The third element has to do with long term interest rates. These, as
the schematic chart shows [indicating], are not quite an overall, over­
arching goal, like the top of the box, nor are they quite an intermedi­
ate target like monetary and credit aggregates are.




287

In fact, they partake of both, and earnestly do we plead with the
Federal Reserve to give us what they think are a set of long term in­
terest rates, particularly, which will be conducive to meeting your
goals of maximum unemployment reduction and maximum purchas­
ing power.
I notice the Treasury—yesterday, Treasury Secretary Donald
Regan told a meeting with reporters that he expected interest rates
t'o fall on a gradual basis if the Fed continues its current policies. If
Regan can do it, why can’t the Fed do it ? We really ought to have this
information. Had we had it in 1981, as you can see from the chart, the
Open Market Committee’s merciless squeezing of Mx would have been
more difficult. Had they been required to indicate the consequences of
that monetary squeeze on long term interest rates, they would have
had, in all candor, to predict the disastrous 18 percent mortgage rate
which shortly ensued, the equally disastrous higher rates for corporate
borrowing, and everything else.
Had they done that, they might have recoiled in horror from the
monetary tightness which they were visiting upon us. Therefore, I re­
new my exhortation that the Fed not conceal from us that which the
Treasury Secretary is glad to share with reporters at breakfast.
OPERATING PROCEDURES

Item 4 relates to the bottom box, operating procedures. There the
Fed and, I think, this committee would agree that it should be flexible
in its operatng procedures. There is no innate virtue in exclusively
relying either on monetary reserves, as it does at the moment, or on
interest rates, as it did a few years ago.
Why not take them and anything else that is relevant into account
in operating procedures and focus on whichever works best ?
CONSULTATION AND COORDINATION

Fifth, and last, Congress and the Fed need closer and fuller con­
sultation and coordination. A more precise menu of policy informa­
tion in the semiannual reports would help. Beyond this, we would
hope that the Federal Reserve would report to the Congress any
changes in its expectations for the big items—money, credit, interest
rates, or the ultimate economic objectives.
Nothing in these points presumes to specify for all time the direc­
tion which the monetary policy should take or the strength with which
it should be applied. That must be left to Congress and the Federal
Reserve to agree upon in light of the facts of each situation.
[The letter referred to by Representative Reuss follows:]
C ongress of t h e U nited States,
Joint E c o n o m i c Committee,

Washington, D.C., November 17,1982.
Hon. P aul A. V olcker,
Chairman, Board of Governors,
Federal Reserve System, Washington, D.C.
D e a r M r . C h a i r m a n . This week, the Joint Economic Committee is concluding
a series of hearings on how we can enhance coordination and cooperation between
the separate branches of our government in order to improve the effectiveness of
economic policy. Within that spirit, I would like to make a number of suggestions
for strengthening the working relationship between Congress and the Federal




288

Reserve Board and the Federal Open Market Committee, which I hope we can
discuss during your appearance before the Joint Economic Committee next
Wednesday.
As you know, a number of bills have been introduced recently wThich would
mandate changes in the procedures of the Federal Reserve and alter the nature of
the dialog between the Fed and Congress on the conduct of monetary policy. I
believe we could accomplish under existing law many of the improvements sought
by Members of Congress in these bills.
The highest level of Federal Reserve decisionmaking concern is the national
goals— “maximum employment, production, and purchasing power” under the
Employment Act of 1946 and “full employment and production . . (and) price
stability” under the Full Employment and Balanced Growth (Humphrey-Hawkins) Act of 1978. Presently, the Federal Reserve in its February 20 and July 20
Monetary Policy Reports sets forth the range of forecasts of the 12 “individual
members of the FOMC” with respect to the year’s goals for employment, produc­
tion, and purchasing power. We would be better served if the FOMC would pre­
sent Congress with a single composite forecast of its members; if such a forecast
differs from that of the President or of the Congress in its Budget Resolution, we
in the Congress can then take account of such important differences between the
Federal Reserve and the executive and legislative branches.
At the second level, constructive changes could also be made in the way in
which the Federal Reserve reports on its intermediate targets— “the ranges
of the monetary and credit aggregates”—mandated by present law. Here I have
two suggestions. First, present Congress with a single numerical target for each
of the aggregates, along with the upper and lower boundaries that you think
would be consistent with the goals delineated and set forth in the previous para­
graph. Second, “credit aggregates” includes not just bank credit, which you cur­
rently target, but the entire range of credit by lenders other than banks as well.
We should appreciate you including total credit in your report.
Long-term interest rates fall somewhere between the ultimate objectives of
policy and the intermediate targets discussed in the previous two paragraphs.
You should include in your report your best estimate of the array of long-term
interest rates that is both consistent with your intermediate targets and con­
ducive to achieving the ultimate objectives of policy. Long-term interest rates
have a critical effect on our economic performance, and they should be part of the
dialog between Congress and the Federal Reserve on monetary policy.
Finally, we should agree that the Federal Reserve should be more flexible in
its operating procedures. The present exclusive focus on reserves as an operating
procedure has produced significantly worse shortrun interest rate volatility. Why
not an operating procedure which focuses either on reserves or short-term inter­
est rates whichever currently works best ?
In the event that the Federal Reserve’s projections as to the monetary aggre­
gates, credit aggregates or long-term interest rates should change after its
February 20 or July 20 reporting dates, the Federal Reserve should promptly
report such changes to the Congress.
Sincerely,
H e n r y S. R e u s s , Chairman .

Representative

Reuss.

Congressman Wylie.

OPENING STATEMENT OF REPRESENTATIVE WYLIE

Representative W y l ie . May I say that I feel very sad to contem­
plate the fact that this is your last meeting as chairman of the Joint
Economic Committee. It has been a great honor and a magnificent
pleasure for me to be associated with you, both as chairman of the
Banking Committee and chairman of the Joint Economic Committee.
I know the association—in our association we have not always
agreed on everything, but your leadership has been most beneficial
to the Banking Committee and the Joint Economic Committee, Mr.
Chairman.
Representative R euss . I am most grateful.




289

Representative W y l ie . Mr. Volcker, you certainly have one of the
toughest jobs in Washington these days handling monetary policy.
It is also one of the most important and one of the most difficult
economic jobs in our government. I, for one, think you have done
a commendable job over the last 2 years.
Inflation has been cut more than half, from the 12.4 percent in
1980 to around 5 percent now. The prime, which reached 21^ per­
cent in December of 1980 is now at liy 2 percent. That is a good sign.
I say keep up the good work.
I think your policies, along with fiscal policies of the adminis­
tration, are good. We have some problems, as we had in the late
1970’s—we had a dizzy roller coaster at the time—but it seems to
me you have things under control, and I look forward to your ex­
plaining what you have done, why you think what you have done is
the right course. And what you have done has helped reduce inflation
and has helped bring the interest rates lower.
Mr. Chairman, I welcome you to the committee here this morning
and look forward to your testimony and the opportunity to ask some
questions later on.
Thank you.
Representative R euss. Senator Proxmire.
Senator P roxmire . Thank you, Mr. Chairman. I do not have any
opening statement. I would like to join Representative Wylie.
I realize this is not your swan song; you will be back; but this may
be the last time I have an opportunity to pay tribute to a remarkable
man. You are a very able economist, outstanding Congressman.
One of the great things about Henry Reuss is his sense of humor
and his ability to disagree without being disagreeable.
Henry and I have disagreed on many issues, as Henry has dis­
agreed with the Chairman of the Federal Reserve Board. It has al­
ways been pleasant. We have always been able to work things out on
a friendly, logical, civil basis.
I am sure I will see you in the coming session, but I want to take
this opportunity formally, with the television cameras in front of us—
what have you, maybe for the last time for the rest of the year with
this receptive audience here—to tell you what a great job you have
done.
You have done a great service in this Congress.
Representative R euss . Thank you very much.
All right. Chairman Volcker, would you proceed with your state­
ment, which we appreciate your giving to us. It will be received in
full.
STATEMENT OF HON. PAUL A. VOLCKER, CHAIRMAN, BOARD OP
GOVERNORS OF THE FEDERAL RESERVE SYSTEM

Mr. V olcker . I would like to proceed by reading the statement,
which is rather complicated, partly in light of the questions that you
asked, Mr. Chairman, and I think it does direct itself in large part
toward those questions.
I appreciate this opportunity to discuss with you today the cur­
rent stance of monetary policy and some problems for the future. Be­
fore responding to certain questions directed to me about monetary




200

policy in your letters of October 18 and November 17, Mr. Chairman,
I should first emphasize that the basic thrust and goals of our policy
are unchanged since I testified before the Congress on July 20. The
precise means by which we move toward our goals must take account
of all the stream of evidence we have on the behavior of—and distor­
tions in—the various monetary aggregates, the economy, prices,
interest rates, and the like. But we remain convinced that lasting re­
covery and growth must be sought in a framework of continuing prog­
ress toward price stability—and that the process of money and credit
creation must remain appropriately restrained if we are to deal ef­
fectively with inflationary dangers.
For that reason, we must continue to set forth targets for growth
in money and credit and to judge the provision of bank reserves—our
most important operating instrument—in the light of the trend in the
growth of these aggregates. This process necessarily involves con­
tinuing judgments about just what growth in those magnitudes is ap­
propriate in the short and longer run, matters affected by institutional
change as well as by more fundamental economic factors.
As you are aware, the current job of developing and implementing
monetary policy has been complicated by regulatory decisions as well
as by recent developments in the economy and in our financial
markets. We have, as a consequence: (1) made some technical modifi­
cations in our operating procedures to cope with obvious distortions
in some of the monetary data—particularly Ml5 and (2) accommo­
dated growth in the various M’s at rates somewhat above the targeted
ranges. The first of those decisions was essentially technical. The latter
decision is entirely consistent with the view I expressed in testifying
before the Banking Committees in July that the Federal Open Market
Committee would tolerate “growth somewhat above the targeted
ranges * * * for a time in circumstances in which it appeared that
precautionary or liquidity motivations, during a period of economic
uncertainty and turbulence, were leading to stronger than anticipated
demands for money.”
Unfortunately, the difficulties and complexities of the economic
world in which we live do not permit us the luxury of describing policy
in terms of a simple, unchanging numerical rule. For instance, the
economic significance of any particular statistic we label money can
change over time—partly because the statistical definition of money
is itself arbitrary and the components of the money supply have differ­
ing degrees of use as a medium of exchange and liquidity. That
doesn’t make much difference in a relatively stable, economic, financial,
and institutional environment, but, at times of rapid change, like
the present, it can matter a great deal.
We also have to take account of varying lags—never known with
precision—between actions today and their consequences later. We
have to try to disentangle the temporary and cyclical from more per­
sistent trends in relationships among different measures of money and
inflation and economic activity. And we have to evaluate the signifi­
cance of developments abroad as well as at home, as reflected in trade
accounts and the exchange rate, and of strains in the financial
structure itself.
As this suggests, the economic environment in which we set policy—
or policy itself—cannot be condensed into a simple, one-dimensional




291

statement. Perhaps the essence of the problem and our approach can
be better captured by a few yes-but phrases.
(1) Yes, we have broken the inflationary momentum—but con­
tinuing vigilance and effort will be essential to continue progress
toward price stability.
As you know, the broad price indices this year have been running
at about one-half or less of the peak levels reached 2 or 3 years ago.
As part of this disinflationary process, growth in worker compensa­
tion in nominal terms has declined to the 6 to 7 percent area—but
that slower growth in nominal income has been consistent with higher
real wages as inflation has moderated.
Price and cost trends in particular sectors of the economy are
mixed—reflecting in part lags in the process of disinflation, the effects
of long wage contracts, international and exchange rate developments,
and the immediate effects of recession on some prices—most partic­
ularly commodities. But there is, it seems to me strong reason to believe
that the progress toward price stability can be maintained—albeit at a
slower rate—as the economy recovers. For a time, unemployment and
excess capacity should restrain costs and prices and, of more lasting
significance, productivity growth should improve from the poor per­
formance of most recent years. Taken together, restraint on nominal
wage increases and productivity growth should moderate the increase
in unit labor costs, which account for about two-thirds of all costs.
Real incomes can rise as inflation slows, paving the way for further
progress toward stability.
To be sure, as the economy grows, some factors holding down prices
over the past year or two will dissipate or be reversed. But large new
price shocks in the energy or food areas appear unlikely in the foresee­
able future, suggesting that a declining trend in the rise of unit labor
costs should be the most fundamental factor defining the price trend.
That analysis would not hold, however, if excessive growth in money
and credit over time came again to feed first the expectation, and then
the reality, of renewed inflation. Too much has been invested in turn­
ing the inflationary momentum to lose sight of the necessity of carry­
ing through. There are clear implications, as I will elaborate in a
moment, for fiscal as well as monetary policy.
(2) Yes, exceptional demands for liquidity can reasonably be
accommodated in a period of recession, high unemployment, and
excess capacity—but guidelines for restrained money and credit
growth remain relevant to insure against renewed inflation.
A variety of specific and general evidence strongly suggests that the
desire to hold cash and other highly liquid assets, relative to income,
has increased this year. Much of the more rapid increase in Mi has
been in interest-bearing NOW accounts, which did not exist a few
years ago but which provide the basic elements of a savings, as well as
transaction, account. With market interest rates falling, those accounts
have been relatively more attractive on interest rate grounds alone, and
they are a convenient means of storing liquidity at a time of economic
and financial uncertainty. At the same time, the broader aggregates
appear to reflect some of the same liquidity motivations, as well as the
stronger savings growth in the wake of the tax cut.
Most broadly, we can now observe, over a period of more than a year,
a distinct decline in velocity—that is, the relationship between the




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GNP and monetary aggregates. The velocity decline for Mx, which is
likely to amount to about 3 percent from the fourth quarter of 1981 to
the fourth quarter of 1982, stands in sharp contrast to the average
yearly rise in velocity of 3 to 4 percent over the past decade; it will be
the first significant decline in velocity in about 30 years. M2 and M3
velocities—which had been relatively trendless earlier—have also
declined significantly. While some tendency toward slower velocity is
not unusual in the midst of recession, the magnitude and persistence of
the movement in 1982 is indicative of a pronounced tendency to hold
more liquid assets relative to current income. Without some accom­
modation of that preference, monetary policy at the present time
would be substantially more restraining in its effect on the economy
than intended when the targets for the various aggregates were origi­
nally set oilt earlier this year.
At the same time, policy must take into account the probability that
the demands for liquidity will, in wThole or in major part, prove tem­
porary, and that an excessive rise in money or other liquid assets could
feed inflationary forces later. Elements of judgment are inevitably
involved in sorting out these considerations—judgments resting on
analysis of the economy, interest rates, and other factors. But broad
guidelines for assessing the appropriate growth on the basis of his­
torical experience will surely remain relevant and appropriate.
In that connection, I must note the implications of the future Fed­
eral budgetary position. To put the point briefly, the prospect of huge
continuing budgetary deficits, even as the economy recovers, carries
with it the threat of either excessive liquidity creation and inflation in
future years, or a crowding-out of other borrowers as monetary
growth is restrained in the face of the Treasury financing needs, or a
combination of both. The problem flowing from the future deficits are
simply not amendable to solution by monetary policy. Moreover, the
concern engendered in the marketplace works in the direction of
higher interest rates today than would otherwise be the case, contrary
to the needs of recovery. I know something of how difficult it is to
achieve further budgetary savings, but I must emphasize again how
important it is to see the deficit reduced as the economy recovers. The
fact is those looming deficits are a major hazard in sustaining recovery.
(3)
Yes, lower interest rates are critically important in supporting
the economy and encouraging recovery—but we also want to be able to
maintain lower interest rates over time.
Since early summer, short-term interest rates have generally
declined by 5 to 6 percentage points, and mortgage and most other
long-term rates have dropped by 3 to 4 percentage points. While con­
sumer loan rates administered by banks and other financial institu­
tions have lagged, they are also now moving lower. There are clear
signs of a rise in home sales and building in response to these interest
rate declines, and other sectors of the economy are benefiting as well.
We have also had experience in recent years of sharp increases in
interest rates curtailing economic activity at times when recovery was
incomplete and unemployment high. Sudden large fluctuations in in­
terest rates contribute to other economic and financial distortions as
well. And no doubt the fact that many interest rates remain histori­
cally high, relative to the current rate of inflation, reflects continuing
skpeticism over prospects for carrying through the fight on inflation.




293

In this situation, the Federal Reserve has welcomed the declines in
interest rates both because of the support they offer economic activity
and because they seem to reflect a sense that the inflationary trend has
changed. However, we do not believe that progress toward lower interest rates should—or for long in practice can—be forced at the expense
of excessive credit and money creation. To attempt to do so would
simply risk the revival of inflationary forces; renewed expectations of
inflation would soon be reflected in the longer term credit markets,
damaging prospects for the long-lasting expansion we all want.
Turning to your explicit questions, Mr. Chairman, against this gen­
eral background, I believe most policymaking officials in the Federal
Reserve share the general view that economic recovery will be evident
throughout 1983, but at a moderate rate of speed—probably slower
than during previous postrecession years. Unambiguous evidence that
the recovery is already underway is still absent, although encouraging
signs are evident in some rise in housing, in the improved liquidity
and wealth and reduced debt positions of consumers, and in surveys
reporting that attitudes and orders may be stabilizing or improving.
The Federal deficit, while fraught wdth danger for the future, is of
course providing massive support for incomes at present.
What is crucially important—particularly in the light of the ex­
perience of recent years—is that we set the stage for an expansion that
can be sustained over a long period, bringing with it strong gains in
productivity and investment and lasting improvement in employment.
I have already emphasized the importance of progress toward price
stability to that outlook, and the evidence that, with disciplined mone­
tary and fiscal policies, we can sustain that progress.
So far as the specific questions about monetary policy in your Octo­
ber 18 letter are concerned, we have not, as you know, set any new
monetary targets for 1982. Current trends do indicate that the vari­
ous M’s will end the year above the upper end of the target ranges,
probably by y2 to 1 percent for M2 and M3and more for Mx given the
current distortions. Bank credit will be close to the midpoint of its
range. As I indicated at the start, the overshoots, in the context of
today’s economic and financial conditions, are consistent with the ap­
proach stated in my July testimony.
No decision has been to change the tentative targets for 1983. That
matter will, of course, be under intensive scrutiny over the next 2
months, and the targets will be announced in February.
For the time being, we are placing much less emphasis than usual
on Mi. That decision was precipitated in early October entirely by
the likelihood that the data would be grossly distorted in that month
by the maturity of a large volume of all-savers certificates, part of the
proceeds of which might be expected to, at least temporarily, be placed
in checking accounts included in Mi.
In about 3 weeks, the introduction of a new ceilingless account at
financial institutions—highly liquid and carrying significant trans­
action capabilities—is likely to distort further Mx data. Judging by
comments at the last Depository Institutions Deregulation Commit­
tee meeting, that account could rapidly be followed by a decision to
approve a ceilingless account with full transaction capabilities. These
new accounts could have a large, but quite unpredictable, influence on
Mx for a number of months ahead as funds are reallocated among var-

1 7 - 8 7 1

0

-




8

3

-

2

0

204

ious accounts. Moreover, the introduction of market-rate transaction
accounts will very likely result in a different relationship and trend
of Mi relative to GNP over time. Increasing confidence in the stability
of prices and a trend toward lower market interest rates might also
affect the desire to hold money over time.
Obviously, some judgments on those matters will be necessary in
setting a target for Ma in 1983 and in deciding upon the degree of
weight to be attached to changes in Mx in our operations. Those prob­
lems should appropriately be described as technical rather than policy
in the sense that we will need to continue to be concerned with the rate
of growth over time of the monetary aggregates, including transac­
tions balances.
The decisions taken in early October do point to greater emphasis
on M2 and (M3) in planning the operational reserve path during this
transitional period. The link between reserves and M2 is looser and
more uncertain than in the case of Mi, in large part because reserve
requirements on accounts included in M2, apart from transactions
balances, are very low or nonexistent (Transactions balances are about
17 percent of M2). Therefore once a reserve path is set, deviations of
M2 from a targeted growth range may not, more or less automatically,
be reflected in a substantial change in pressures on bank reserve posi­
tions or in money markets as in the case with Mx. Consequently, “dis­
cretionary” judgments may be necessary more frequently in altering a
reserve path than when that reserve path is focused more heavily on
Mi. In that technical sense, the operational approach has necessarily
been modified.
In sum, the broad framework of monetary targeting has been re­
tained, but greater emphasis is for the time being placed on the
broader aggregates. The specific operating technique that had been
closely related to Mx has, by force of circumstances, been conformed
to that emphasis. Obviously, entirely apart from questions of economic
doctrine and contending approaches to monetary control, so long as
Mi is subjected to strong institutional distortions our techniques must
be adapted to take account of that fact.
An alternative operating approach suggested by some of supplying
and withdrawing reserves with the intent of achieving a particular
interest rate target would suffer from several fundamental defects.1
The body of theory or practices does not provide a sufficiently clear
basis for relating the level of a particular interest rate to our ultimate
objectives of growth and price stability.
The implication that the Federal Reserve could in fact achieve and
maintain a particular level of relevant interest rates in a changing
economic and financial environment is not warranted.
The very concept and measurement of a “ real” interest rate, as
called for in some proposals, is a matter of substantial ambiguity.
As a practical matter, attempts to target and fix interest rates
would make more rigid and tend to politicize the entire process of
monetary policy.
1 That was not, as sometimes mistakenly thought, the operating approach used prior to
October 1979. Then, reserves were provided with the aim of achieving and maintaining
a particular Federal funds rate thought to be consistent with targets for the m onetary
aggregates. The Federal funds rate was a means to achieving a monetary target and in
principle was to be handled flexibly. In practice, among other difficulties, there appeared
to be a reluctance to permit rates to vary rapidly enough to maintain control of the
aggregates.




295

In current circumstances, with huge budget deficits looming, a re­
quirement that the Federal Reserve set explicit interest rate targets
is bound to be interpreted as inflationary, and the rekindling of infla­
tionary expectations will work against our objective.
I realize the several legislative proposals addressed to targeting
interest rates would, on their face, seem to call for interest rates as
only one of several targets. But interest rates would certainly be the
most obvious and sensitive target, and those targets would be difficult
to change. Other evidence for a need to “tighten” or “ease” would be
subordinated, if not ignored.
As we approach the target-setting process for 1983, our objectives
will—indeed as required by law—continue to be quantified in terms
of growth in relevant money and credit aggregates. We will have to
decide how much weight to place on Mj and other aggregates during
a transitional period, assuming new accounts continue to distort the
data. In reaching and implementing those decisions, the members of
the FOMC necessarily rely upon their own analysis of the current
and prospective course of business activity; the interrelationships
among the aggregates, economic activity, and interest rates; and the
implications of monetary growth for inflation. In other words, the
process is not a simple mechanical one, and it seems to me capable
of incorporating—within a general framework of monetary disci­
pline—the elements of needed flexibility. We will also, as part of that
process, review whether technical adjustments in procedures for
establishing and changing the reserve paths are appropriate. I will
be reporting our conclusions to the Congress in February.
Mr. Chairman, you have suggested that our monetary targets
might reasonably be specified as a single number, with a range above
and below. At times we have debated within the FOMC the wisdom
of such an approach (or setting forth a single target number without
a range). My own feeling has been, and remains, that a single num­
ber, with or without a range, would convey a specious sense of pre­
cision, with the result of greater pressure to meet a more or less
arbitrary number to maintain “credibility,” even if developments
during the year tend to indicate some element of flexibility is
appropriate in pursuit of the targets.
To me, our present practice of setting forth a range is preferable.
Where appropriate, we can and should suggest the probability of
being in the upper or lower portion of the range, or suggest what
conditions could evolve in which something other than the midpoints
(or even an over or undershoot) would be appropriate. That ap­
proach seems to me to provide more information—and more realism—
than a single number and is broadly consistent with present practice.
For similar reasons, I believe we need to measure and target a
variety of aggregates because, in a swiftly changing economic envi­
ronment, any single target can be misleading. In that connection, I
believe an indication of total credit flows broadly consistent with the
monetary targets could be helpful. As you know, we now provide
such estimates for bank credit alone.
G iven the lim its o f forecastin g and analysis, and the volatility o f
the data, I w ould question the usefulness o f further sectoral estimates.
E ven w ith respect to total cred it flows, there is considerable loose­
ness in relationships to econom ic a ctivity fo r periods as lo n g as a




296

year—and still more for shorter periods. The theoretical framework
relating credit flows to other variables such as the GNP or inflation
is less fully developed than in the case of monetary aggregates, and
credit flows are less directly amenable to control. The enormous flows
across international borders pose large conceptual and statistical
problems. Our credit data are typically less complete and up to date
than monetary data.
However, so long as those difficulties and limitations are recog­
nized—and some of them are relevant with respect to the monetary
aggregates as well—I share the view that analysis of credit flows
can contribute to policy formulation. To assist in that process, I will
propose to the FOMC that estimates of the expected behavior of a
broad credit aggregate be set forth alongside the monetary targets in
our next report.
I do strongly resist the idea of the Federal Reserve as an institution
forecasting interest rates. No institution or individual is capable of
judging accurately the myriad of forces working on market interest
rates over time. Expectational elements play a strong role—funda­
mentally expectations about the course of economic activity and infla­
tion, but also, in the short run, expectations of Federal Reserve action.
We could not escape the fact that a central bank forecast of interest
rates would be itself a market factor. To some degree, therefore, in
looking to interest rates and other market developments for informa­
tion bearing on our policy decisions, we would be looking into a
mirror. Moreover, the temptation would always be present to breach
the thin line between a forecast and a desire or policy intention, with
the result that operational policy decisions could be distorted.
While it seems to me inappropriate for a central bank to regularly
forecast interest rates, analysis of key factors influencing credit con­
ditions and prices can be helpful at times. On occasion, we have pro­
vided such analysis in the past. My concern about the outlook for fiscal
policy is rooted in major part in such analysis because the direction
of impact on interest rates seems to me unambiguous. I have also, on a
number of occasions, indicated that the recent and even current level
of interest rates appears extraordinarily high, provided, as I believe,
we continue to make progress on the inflation front. Perhaps, in our
semiannual reporting, we can more explicitly call attention to major
factors likely to influence short- or long-term interest rates and the
significance for various sectors of the economy. But I do not believe
interest rate forecasting would be desirable or long sustainable, and
would in fact be damaging to the policy process.
Finally, Mr. Chairman, you have requested a single composite
forecast of the major economic variable by FOMC members. As you
are well aware, our present practice is to set forth a range of fore­
casts of individual FOMC members of the nominal and real GNP.
prices, and unemployment. The fact is we have no single Federal
Reserve forecast, and there is no mechanism, within a committee or
board structure, to force agreement on such a forecast by individual
members bringing different views, typically backed by separate staff
analysis, to the table. A simple average—possibly supported by no
one—seems to me artificial. The process of attempting to force a con­
sensus would certainly dilute the product.




20.7

I would put the point positively. A range of forecasts by individual
FOMC members more accurately conveys the range of uncertainty
and contingencies that must surround any forecast. The seeming neat­
ness and coherence of a single forecast too often obscures the reality
that a variety of outcomes is possible; the very essence of the policy
problem is to assess risks and probabilities—what can go wrong as
well as what can go right. A point forecast would likely be treated
more reverently than it would deserve, and could even distort policy
judgments in misguided efforts to hit a forecast.
I can understand your concern that a range of forecasts may be
misleading if strongly influenced by outlying opinions rather than
reflecting a more even dispersion of views. For that reason, I would
be glad to explore with the Open Market Committee a procedure by
which we indicated the central tendency of members’ views—assuming
such a central tendency exists—as well as indicating the range of
opinions. Conversely, if the forecasts were evenly distributed within
the range, we could so indicate. I believe that approach would meet
the objectives you seek in a realistic and helpful manner.
In concluding this already long testimony, let me say that we share
the common goals of achieving, in the words of the Employment Act
of 1946 and the Humphrey Hawkins Act of 1978, “Maximum employ­
ment, production, and purchasing power” and “ full employment * * *
(and) reasonable price stability.” Those objectives have eluded us for
too many years. We meet again today in particularly difficult cir­
cumstances, and there is a sense of frustrating and uncertainty among
many.
But I also happen to believe we have come a long way toward lay­
ing the base for economic growth and stability; economic recovery
should characterize 1983, and that recovery can mark the beginning
of a long period of stable growth.
Obviously there are obstacles—interest rates are still too high;
inflation is down but not out; there are strains in our financial system;
we face budget deficits that are far too high; we are tempted to turn
inwards or backwards for guick solutions that ultimately cannot work.
But it is also plainly within our capacity to deal with those threats—
provided only that we have a strong base of understanding among
us, that we resolve to act where action is necessary, and that we have
the patience and wisdom to refrain from actions that can only be
destructive.
You are leaving the Congress after 28 years, Mr. Chairman.
Through that time, you have consistently provided constructive lead­
ership to the effort to raise the level of economic discussion in gen­
eral—and of the dialog between the Congress and the Federal Reserve
in particular. I happen to believe strongly in the independence that the
Congress has provided the Federal Reserve through the years—but
also in the need for close and continuing communication with the Con­
gress and the administration. I presume that this is the last time I
will appear before you personally in this forum, but the dialog will
continue to benefit from your efforts, your initiative, and your sense
of commitment in more ways than you may realize.
Representative R ettss. Thank you so much.




208

I want to thank you, Chairman Volcker, for your responsive reply
this morning in your statement to the five points I raised in my Novem­
ber 17 letter which I reiterated in my opening statement this morning.
On many of the points, you have, indeed, been very forthcoming.
On others, I’m, at the moment, not entirely pleased. And that may
simply be my difficulties with communication, which maybe we can
straighten out.
FIVE POINTS REVISITED

So, let’s take the five points. The first one was our point that we’d
appreciate in Congress from the Fed—as we get from the executive
branch and from ourselves—a composite forecast of employment,
production, and purchasing power. There are the same vulcanizing
techniques in the other branches, but somehow the 535 Senators and
Congressmen have the budget resolution. I take heart from the fact
that you say—and I ’m quoting from your statement—that you “ would
be glad to explore with the open market committee a procedure by
which we indicate the central tendencies of members’ views, assuming
such tendencies exist. Conversely, if the forecast were evenly distrib­
uted, we could so indicate.”
That is great progress. And let me just suggest that in your con­
versations with your colleagues on the Open Market Committee, you
see whether they would agree, after full discussion and after giving
the range of their individual views, that you do try what the Execu­
tive and Congress tries; namely, to get a sense of a meeting.
If the Open Market Committee, by a vote of 7 to 5, were to estimate
4 percent growth, 5 percent inflation, 6 percent unemployment, so
be it. And if there are extremes at either end of a range, fine. This com­
mittee is long on dissenting views, additional views, supplementary
views. Those could be added.
Can we try to reach a compromise along those lines ? I don’t think
I ’ve said anything very different from what you said in your state­
ment this morning.
Mr. V olcker . I ’m not sure, whether we can; it depends on how it is
interpreted. I can discuss it with members of the committee.
I generally feel that the kind of “solution,” if that is the right word,
that I mentioned in my statement is, broadly, the right one. You re­
ferred to the fact, for instance, that Congress has to come up with a
single-point estimate in setting the budget; that is a fact of life, be­
cause you have got to present a budget in numbers.
I would say to you that I think while, as a practical matter, you have
to come up with a single number in presenting the budget—simply
because it is too hard to handle if you present a variety of possibili­
ties—that does not, on balance, contribute to the realism of the eco­
nomic dialog because a lot of attention is put upon that single number,
as if it were graven in stone. But indeed, there is a range of uncertainty
around it, to the extent that the budgetary outcome, for instance, fluc­
tuates simply because the employment or the inflation estimate was
wrong, it has different policy significance than otherwise.
While you have to set a single figure in the budgetary process, as
a practical matter, what I would urge you to consider is that, in terms
of considering economic policy, a range—with its sense of uncertainty
as a best guess or a central tendency in my words— gives you what you




299

are really looking for, and gives it a way that assists the policy proc­
ess and does not damage it.
Representative R euss. I like what you have just said so much. It
is p erfect fo r me except fo r your emphasis on so-called central ten­
dency as a corolla ry suggestion, that where you have extremes, the sub­
lim e and the ridiculous on either end, y o u ’re g o in g to back off from get­
tin g a sense o f the m eeting.

Why can’t you give us a central tendency, however, scattered it is,
and also give them in ranges?
COMPROMISE AGREED TO ON FORECASTS

Mr. V olcker. What I am implying is that when we give you a cen­
tral tendency, we will give it to you however scattered it is.
I can imagine situations where each person’s forecast is a quarter
of a percent different, exactly evenly dispersed. We would have to tell
you everybody’s forecast is evenly dispersed in this range. There is
an arithmetic average, but it doesn’t mean much.
Representative R euss. Enough said by me. You seem to be doing
fine.
What you are suggesting is that you give us both, give us the central
point and then tell us as much as you care to, the more the better, about
the values, the individual views of President Smith of the Dallas bank,
and President Jones of the Atlanta bank.
Mr. V olcker . I don’t think I want to get into any President’s views.
TOTAL CREDIT TARGET AGREED TO

Representative R euss. Let’s g o to point 2.
There I am delighted that you agree with our point, that just giving
us bank credit can be improved upon, and you are willing to give us
the full range of credit. Agreed, statistics are not all that perfect. In
my statement, I gave a number of sources. I thank you for agreeing.
Mr. V olcker . For purposes of clarity, by the full range, my inten­
tion would be to give you the total. We could continue with a bank
credit section, but we would not attempt to give you separate figures
for insurance companies or money market funds.
Representative R euss. Total credit, bank, and nonbank, absolutely.
LONG-TERM INTEREST RATES: DIFFERENCES REMAIN

Point 3, I guess represents the greatest difficulty between us—in
part, I think—because of my own maladroit presentation in asking
that the Federal Reserve consider the consequences of its intermediate
targets on the vital goal of long-term interest rates.
I am not suggesting that you target interest rates. I am not suggest­
ing that you forecast interest rates. I am suggesting that you set forth
the consequences of the given monetary policy adopted in any one time
by the Federal Reserve on long-term interest rates, because they are,
indeed, important to this country and to the great goals of employ­
ment, production, and purchasing power.
I point out again that Treasury Secretary Regan yesterday, at the
breakfast meeting said: “ I expect interest rates to fall on a gradual




300

basis if the Fed continues its current policies.” Who knows better than
the Fed what the current policies are ?
Why can’t you indicate what effect you believe those policies will
have on long-term interest rates, taking into account your assumptions
on fiscal policy, on foreign trade and investment, on exogenous shocks
and inflation, and all the variables that you have to use ?
That’s all I ’m asking.
Wouldn’t you discuss with your Open Market Committee and col­
leagues whether it would not only be possible but constructive and
helpful to Congress to do that ?
Mr. V olcker. We may be dealing with a thin line, but I think it is
an extremely important line, Mr. Chairman. I understood that you
were not suggesting targeting, but I did understand that you were
suggesting a forecast.
If you want a general forecast, I give these all the time, in a sense,
about the effect of monetary policy on interest rates. Monetary policy
is directed broadly toward restraining of inflation and restoration of
price stability. There is no doubt in my mind that in time that is fun­
damental to bringing down interest rates, and that policy would be
reflected in a much lower, long-term interest rate over a period of time.
I have said that on numerous occasions. I will say it again.
I think that analysis is shared by members of the commitee. That is
quite different from saying, “ In 1983, we expect the long-term interest
rates to go down in the early part of the year and level off,” or vice
versa. We give a general direction of influence that we think is ap­
parent over time.
I can make similar comments about fiscal policy, but I do not think
it is wise for us to get into the business of trying to outguess the mar­
ket about the effect of the near-term direction of interest rates.
Representative R euss . I hope you will discuss it with your col­
leagues, the precise long-term interest rate emphasis that our col­
loquy has indicated is in our minds.
May I say that had I been a member of the Open Market Com­
mittee—God forbid—in 1981, when that redline indicated actual crea­
tion of new Mi, if we had envisioned that undertarget monetary policy
was going to result in 18 percent mortgage interest rates and 15 per­
cent long-term and corporate bond rates, we would have, perhaps,
thought twice as to whether we did not want to keep M : a little more
ebullient. I hope in your discussion with your colleagues you will at
least present the point I am making.
AGREEMENT ON FLEXIBLE OPERATING PROCEDURES AND ACCOUNTABILITY

I pass on now to the last two points on which I believe—though I
want you to confirm—we are in good accord. Proposition No. 4 was
that the Federal Reserve ought to feel free to be flexible in its choice
of operating procedures. I personally have no quarrel with your
present operating procedures, which center upon reserves. Earlier,
the emphasis was on the funds rate. All we say here is that the Federal
Reserve should feel free to exercise its sound discretion as to what
is a good operating procedure, and should not feel inundated by any
assumed iron maiden in Congress. How about that?




301

Mr. V olcker . I think, as you worded that, I can agree emphatically.
I certainly think we should use whatever operating technique ap­
pears to us to be most suitable to the circumstances.
I am not quite sure what you mean by “operating procedure.” We
do have a law which says: Set out the aggregate targets for the ag­
gregates ; and we agree with that. We need that kind of discipline and
guidepost and signpost for our actions in setting those targets. To
exercise judgment, we have got to look at a lot of factors. As to choos­
ing what I think of as the operating techniques—how to proceed on a
day-to-day basis—we certainly have to adapt that to what the cir­
cumstances call for.
Representative R euss. You would agree—here I am saying that
Congress is telling you to follow your own good instincts as to operat­
ing procedures. I cannot imagine your objecting to that. Now that I
hear you don’t, that is fine.
The fifth and last point we made is one, again, that I believe the
Open Market Committee would welcome. That is, when you make a
change in your targets, or your estimates of the ultimate goals and
policies, inform the Congress. As it is now, you do inform people like
business councils down at Hot Springs, and that’s fine----[Laughter.]
Representative R euss [continuing]. But let us in on the secret.
[Laughter.]
That surely would not be taken amiss by your colleagues, would it ?
Mr. V olcker . I don’t think I addressed the point directly. This gets
into the fine line between what is the kind of change that should
properly demand a congressional hearing, and what can be handled
by some other kind of an announcement.
I did not interpret the change that we made in October with respect
to Ml—knowing in October that that distortion was coming up in
Ml, not knowing it earlier—nor the fact that for the time being we
would follow an above-target growth in the broader end of the range,
as being outside the framework that I discussed with the Congress in
July.
Representative R euss. Since you chose to say that you kept your
target, you do not owe us a report under the regimen I am suggesting.
We could argue it at another time—where you could have said: Look,
we are changing our targets.
Mr. V olcker. If we decided that we faced a basic change in trend,
let’s say, of these targets, that we wanted to change them, that we
would change them between the semiannual reporting dates, then I
think what you suggest would be the procedure followed.
Representative R euss. My time is expired, but let me say I think
this has been a valuable colloquy.
FOMC WILL DISCUSS THESE ISSUES IN DECEMBER

Are your mind and my mind in synchronization that you will bring
up at the Open Market Committee meeting, which will be held, I
believe, in a few weeks, various points discussed with this committee
today ? To what extent do we have a meeting of the minds? I am very
hopeful that we do.




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Mr. V olcker . I can bring those points up at that meeting, as I
indicated in my statement I would do. They are operationally relevant,
I suppose, but perhaps not for the December meeting. I can bring them
up m the January or early February meeting, prior to the regular
report that we bring to the Congress.
Representative R euss. Because they do affect relationships between
the Congress and the Fed, I would hope that you would produce a
sense of the meeting as soon as possible. Indeed, if you do it by tele­
phone, before late December, that would be appreciated.
Mr. V olcker . I can discuss these points with the committee. W e
would not have a new forecast, we would not have new targets, we
would not have a credit target, in December.
Representative R euss. Agreed. What I would expect and hope for
is some agreement on the principles.
Senator Proxmire.
Senator P roxmire . Thank you , Mr. Chairman.
PSYCHOLOGY OF UNEMPLOYMENT IS DEPRESSING THE ECONOMY

Mr. Volcker, toward the end of your statement, you say the follow­
ing : Obviously there are obstacles in the way of stimulating growth
of the economy, you say; interest rates are still too high; inflation
is down but not out; there are strains in our financial system; we face
budget deficits. We are tempted to turn inwards or backwards for
quick solutions that ultimately cannot work.
Isn’t one of the biggest obstacles the one that you have not stated
here, and that is the feeling on the part of millions of Americans that
they may be out of work tomorrow? Recognition that we have 11*4
million people out of work right now, that the unemployment has been
increasing, and shouldn’t we face that obstacle and try to adopt
policies or state polices that clearly and conspicuously overcome it?
For instance, there is nothing to indicate that it’s the responsibility
of monetary policy to put people back to work in home building. In
the automobile area, where interest rates are also an enormously im­
portant factor—farm implements, and so forth, small business gen­
erally—interest rates, in the view, certainly, of millions of Americans,
have been the element that has crucified them. Shouldn’t we in a state­
ment from the Chairman of the Federal Reserve have a recognition
that this psychological feeling on the part of people, which is cer­
tainly based on hard and bitter experience, say something that mone­
tary policy has the responsibility to meet ?
Mr. V olcker . Let me say, Senator, that perhaps my statement is
not direct enough, but I do on a number of occasions refer to a sense
of uncertainty, a sense of frustration. I do think that that affects eco­
nomic behavior, and I refer to it explicitly in connection with the de­
sire for liquidity, to hold cash, and I point out that because of that
fact—that is apart from institutional technicalities—we are willing
to run above target ; we feel that particular response of people to the
very concerns that you mention leads to behavior that, in a sense, has
to be offset or partially offset by monetary policy. I certainly believe
that the factor you mentioned is a factor in the business situation.
Looking at it as a policy problem, apart from the excessively tech­
nical points I make, how do we indicate what you suggest ? We have




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had interest rates really very sharply lower since summer, down from
very high levels, to be sure. I think we see the effects of that in the
housing area particularly. That is where the signs are the clearest, and
we seem to have an upturn there—from a low level, indeed but still
a reasonably well established uptrend in the housing area.
Interest rates in the consumer credit area, as I mentioned in the
statement, are slowly coming down, and this has affected the automo­
bile industry.
We come back to the whole dilemma that we face, the whole policy
problem. Yes; we want to deal with the problems that you mentioned.
We have to do that in a way that does not set off either the concern or
the reality of inflation, after so much progress has been made there. I
would fear that if that happened, you would not get the result that you
want and that I want. The uncertainty would arise in a different direc­
tion. It would not be dissipated. It would be contrary to economic
recovery.
Senator P roxmire , My difficulty is I think that most Americans,
when we are talking about Mi, M2, the changes in Mx and M2, and so
forth—it is gobbledygook. If we explain the shift in monetary policy
based on the fact that Mi is not quite the same factor it was, rather
than on a plain, simple recognition that the economy is in trouble and
the people are not out of work, that we have to do something to pro­
vide for better utilization of capacity. One-third of our capacity now
is idle. It is a situation where we need stimulus.
What concerns me is that the stimulus is going to come whether you
like it or not, as long as we have this kind of a situation from fiscal
policy. The President has proposed, as we all know, moving the July
1983 income tax cut up to January 1, as his kind of stimulus. And he
also proposed a jobs program; he does not like to call it that, but it is
a jobs program, to increase the gasoline tax. Members of Congress pro­
posed other jobs programs. That will come on unless we have a clear
definition and expression of the monetary policy as a better way to go,
and I certainly think it is.
PROPOSAL TO ACCELERATE JULY 1, 1983, TAX CUT

Now, let me ask you: You said on many occasions that your job
would be a lot easier if fiscal policy were tight. What is your opinion
of the proposal floating around the White House to move the July
1983 income tax cut forward to January ?
Mr. V olcker. I have some concern about it, because I think it ob­
viously makes life at least marginally more difficult from the monetary
policy side that you are referring to.
It depends upon the context, I suppose, in which it came. If there
were some speedup of that tax cut and at the same time vigorous action
were taken to cut down the future deficits out there in 1984 and 1985,
where I think the problem is, then maybe you have got a balance.
But I do not think signals that the deficit is going to get worse and
not better are what we need now. If that were going to be considered
at all, I would hope that it would be considered as part of a package
where action is also taken in dealing with the deficit in those out years,
where the risks to continuing recovery seem to me very great. At the




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moment, we already have a very large deficit, of course. You can argue,
as I mentioned in the statement, that that is a support to economic
activity at the moment, but let’s not forget about the deficit out there in
the future.
Senator P roxm ire . Y ou are saying that as far as you are concerned
it would be acceptable fiscal policy, that you would not object to if we
did move the tax cut up to January 1, and at the same time took
action, for example, in terms of procurement, which would have little
effect in 1983 but can have a very big effect in 1984, 1985, and 1986,
to reduce the deficit at that time ? I am not asking you to take a posi­
tion on procurement, but as an example.
Mr. V olcker . I think if sufficiently strong actions were taken—I do
not know just how I would quantify those—but if sufficiently strong
actions were taken in a number of areas that affected not fiscal 1983,
but fiscal 1984, fiscal 1985, and the years beyond, a large part of my
concern would be dissipated.
I do not know whether that is reasonable and feasible. I obviously
have a concern about it as it stands.
EFFECT OF NEW DEPOSIT ACCOUNTS

Senator P roxm ire . Y ou mentioned a new deposit account. That will
take effect on December 15. You said at the DIDC meeting that the
new instrument would destroy Ma. Your statement today carries the
same implication, and goes further to say that M2 is too loose a guide
for monetary policy.
Now, the distinction between transaction balances, Mx savings
balances, M2, and M3 is probably gone forever, as you imply. What
does that mean for monetary policy ? Where are you going to conduct
monetary policy, given the changes in financial instruments, and the
inexactness of Mi and M2?
Mr. V olcker . If I recall correctly, I made that statement in re­
sponse to a question during discussion of a further new instrument
that would have full transactions capability. Certainly the instrument
already approved will have an important distorting influence for a
period of time.
But I think I made that comment in reference to the additional in­
strument that would have full transactions capabilities—at least I had
that in mind. You can imagine a situation where, in practice—and that
is what I was imagining when I said that—to a substantial degree,
we could not statistically distinguish between a transactions balance
and a basically savings-type deposit.
If you are in that position, you have got great difficulties with Mx,
because you have not got a statistic that reflects the transactions nature
of the instrument. And I think you are then forced to put much more
weight—and continue to put much more weight—on the broader mone­
tary aggregates, and, to some extent, as we discussed earlier, on the
credit aggregates—if that is the way it goes, institutionally.
I regret that from a monetary standpoint, because I think there is
certainly a very significant body of analysis over the years that says
that there is something special about a transactions balance, if you
can measure it. I was facing the possibility you could not measure it.




305

FOREIGN LOANS

Senator P roxmire . You and the Comptroller of the Currency and
the FDIC are responsible for the soundness of the U.S. banking sys­
tem. The public looks to the Fed to make sure that the banking indus­
try engages in sound practices. It is no secret that the larger banks
have a large volume of nongrowing assets. We are all aware of the
problem with loans to Mexico, Argentina, Poland, other countries
that are delinquent in paying their loans. Under the circumstances,
it seems essential that banks not send good money after bad, not en­
danger further their capital position by making more loans to shaky
foreign countries.
The reason I am making the statement is, I was surprised to read
your remarks of November 16 in the New England Council. You told
the Council that if a foreign country has agreed on an economic pro­
gram with the International Monetary Fund, quote:
Where new loans facilitate the adjustment process, enabling a country to
strengthen its economy and service its international debt in an orderly manner,
new credit should not be subject to supervisory criticism.

I have two problems with that statement. First, despite the caveats
you attach, you seem to be saying that the Federal banking supervisor
should look the other way while U.S. banks go deeper and deeper
in risk in lending abroad. And second, there is obviously a double
standard at work here.
I had not heard you to encourage banks to lend to American
farmers, home builders, or other small businesses. Are you applying a
looser supervisory standard to bank loans to foreigners than to loans
for Americans ?
Mr. V olcker. No, sir; I do not think so. Let me explain the state­
ment. Maybe we do have a disagreement.
The issue I was addressing was not past practices in this respect,
although I think what has happened in this area obviously raises
questions with the banks. It raises questions with the supervisory
authorities, about what changes we might make in the future in terms
of supervisory approaches toward particular concentrations of credit.
That is a relevant question, and one that we will be addressing. We
have addressed it in the past, and we will continue to address it in the
future and try to learn from experience.
The sentence you quote was directed toward a rather more immedi­
ate problem. A number of countries that are obviously having debt
servicing difficulties. They have had large balance-to-payment deficits,
which are related to the buildup in loans. They are engaged in very
difficult and aggressive adjustment programs which are fundamental
to a restoration of their health, fundamental to their capacity to serv­
ice that debt in the future. It also happens to be true that a country
in that position cannot overnight go from a large deficit and a very
heavy dependence on external financing for repaying bank loans, to
absolute current account or overall balance-of-payments equilibrium.
It takes time. Since there is a transitional period, and assuming the
caveats are an absolute part of that statement and not separate from
it, then if a country is undertaking an adjustment program—very dif­
ficult, but ultimately very healthy—a program that is going to
strengthen its economy and its capacity to service its debt, I do not




306

think it is a matter for supervisory criticism for the banks to provide
additional credit to make that program working and viable.
The alternative is an inability of those countries to service the debt,
and it will make the loans bad instead of making them good.
Senator P roxmire . What w ou ld that d o to the banks’ position?
Mr. V olcker . When you get the strong adjustment programs, what
you will find in every one of these cases is that the amount of new
credit that is necessary is sharply reduced from what the banks have
been providing in recent years.
You will find that they are able to provide this additional bank
credit consistent with a reduction of their exposure relative to assets
or capital. It is not going to be a dramatic reduction in the short run,
but what you will end up with is, typically, some reduction in their
relative exposure, and a much stronger base—if these programs are
successful—for servicing those loans. We will be in a sounder position,
not in a weaker position.
You refer to other sectors of the economy. Banks have a self-interest,
obviously, in dealing with other distressed borrowers. If they are en­
gaged in a program of writing a company or an individual some addi­
tional credit, that may be important; it is quite different from just
throwing, as you say—good money after bad.
The adjustment program is absolutely essential to that process.
We have countries that are coming to the IMF, getting international
endorsement of their adjustment programs. We are, in effect, saying
collectively, officially, through the IMF, that this country is doing
the right thing; that it is getting its economy, its finances, back on a
sound footing. Some credit is required during that period, but sharply
reduced credit from the rate of growth in the past.
Representative R euss. Representative Wylie.
Representative W ylie . Thank you, Mr. Chairman.
Mr. Volcker, may I say that I am very encouraged by the exchange
between you and Chairman Reuss a little earlier. I had sensed earlier
this morning that there might be not quite as much of an agreement
between the two of you, as far as your judgment is concerned, and use
of it. To me, that was encouraging to see.
NEED FOR FLEXIBLE MONETARY TARGETS

Mr. Volcker, you suggest that monetary policy not be guided by a
simple numerical rule. You suggest that setting targets for growth of
money and credit is a matter of judgment.
Could you elaborate on that a little bit? What variables do you
consider particularly significant in that connection ?
Mr. V olcker . Let me take as an example w^hat has happened in the
last 6 months or so. We have had a situation in which recovery has
obviously been slower to come about than we and most others antici­
pated 6 months ago, 12 months ago. We have had some strains on the
financial system that added to the kinds of concerns, that Senator
Proxmire mentioned.
We had, for a while, interest rates seemingly extraordinarily high
relative to past relationships between important variables, which sug­
gested a desire for liquidity, among other things. We have had,
increasingly—while these figures jump around from quarter to




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quarter or over a period of quarters, reflecting technical factors—a
decline in velocity, the overall relationship between money and eco­
nomic activity.
That does not bother you for one quarter; maybe it is understand­
able for two quarters and you expect when that happens that it will
bounce back, and you must be cautious about it bouncing back. But
wiien it persists, you have to take it as a further indication that some­
thing is going on which for a significant period of time is changing
the relationship between Ml, M2, the economy, and inflation.
As you arrive at that conclusion in this particular instance, you
say:
We will be more tolerant of an overshoot, because the relationships that we
were counting on have been changing demonstrably in the course of the year.

You also have to exercise judgment in the opposite direction. Based
upon a lot of history, your first assumption may be that if velocity
changes it may bounce back, so you do not want to overdo it. You have
to balance that against the risk that looking ahead 6 months or what­
ever you will find out that velocity is moving strongly in the other
direction, and you may have too much liquidity in the system. I don’t
know how to approach that problem other than with judgment.
Representative W y lie . I want to follow up on that. I think that is
a very important point you are making. You said that in 1982, this
year, Mi velocity has now leveled. So it will fall for the first time
in 30 years or so.
Mr. V olcker . I think there was a decline in 1 year in the last 30 years
of one-tenth of 1 percent.
Representative W y l ie . I am told in the past, in the years immedi­
ately following the median or low, we had unusually big increases;
for example, 1954. Mt velocity fell by 1y% percent, and then rose in 1955
by 5.7 percent. In 1958, velocity growth was zero and in 1959 it was
6.3 percent.
Why should we think that at this time it would be different? Why
should 1983 see a decrease in velocity ?
Mr. V olcker . Y ou are looking at a different velocity figure than
what I have before me. My annual figures are measured from fourth
quarter to fourth quarter and on that basis there are no declines in
velocity during the 1970’s.
Representative W y lie . For an annual period.
Mr. V olcker . The point that you are making is similar to the point
I made at the end of my previous answer. You get a lot of bouncing
around in velocity in the short run, and you get some tendency for
velocity to be slower than it otherwise would be; it does not actually
drop during a' recession period on an annual basis for a long while, but
you have a slower growth during recession periods. The normal ex­
pectation is that it will bounce back during a recovery period and be
exceptionally fast during a recovery period.
That may happen this time and, in fact, I wTould not expect this
velocity decline to continue. I would expect, as the economy recovers,
velocity would go back. We are talking about a matter of degree. We
have a velocity change here that is larger than any we have had in
the postwar period, I think. It is the first significant one for 30 years.
Yes; I would expect some movement back in the other direction. We
have to be cautious about that. We have to prepare for it. There may




308

also be something else going on here that says we cannot simply af­
ford to ride through this period without any allowance for what
we have observed going on in velocity for five quarters now.
TAX POLICY AND DEFICITS

Representative W y l ie . I want to get on to a question that Senator
Proxmire asked a little earlier. I think your judgment is important,
and I want to understand your position on this.
Senator Proxmire asked if you favor the speeding up of the tax
cut from July 1 to January 1, and as I understand, you said that you
would oppose that unless spending could be reduced accordingly.
Mr. V olcker . I would make a distinction in timing. What I would
like to see is important action—I would prefer to see it on the spending
side, but if it has to be taken on the revenue side, all right—dealing
with what I believe is the structural deficits, which is going to exist
even when the economy recovers; even if we go back to something we
can call full employment, we are going to have a big deficit.
What worries me is whether that deficit is, in fact, consistent with
sustaining a recovery, so if there were important actions taken to deal
with that problem—not today, in terms of current expenditures—but
to deal with the problem that is inherent in the budget in 1984 or 1985
or 1986, then I do not think speeding up a tax cut by 6 months is
going to complicate our lives in terms of expectations, in terms of com­
plicating the budgetary problem. I am afraid it would complicate
matters if it were just taken as an action that, in a sense, moves
toward bigger deficits, I am afraid that would be the interpretation.
Representative W y l ie . I am somewhat worried about the short-term
revenue reduction which might result from a speedup of the tax cut.
What would be your position about deferring the tax cut?
Mr. V olcker . I would be inclined to leave things as they stand
now, so far as the tax cut is concerned, but I would also have to add
promptly that it leaves you in an unsatisfactory budget position. So
leaving that tax cut where it is, is not at all inconsistent with my
feeling that you still need strong action for 1984 and 1985 to deal
with the structural deficit.
I would hope that action would----VOLCKER COMMENTS ON REPUBLICAN INTEREST TARGETING PLAN

Representative W y l ie . Mr. Volcker, while you are here and while
I have the opportunity, I would like to refer to a bill which was in­
troduced called H.R. 7218, if I may. The reason I would like to bring
it up here is because it does have distinguished authors, famous and
distinguished authors.
It says on page 3 of this bill that—if we could go back a little earlier,
the bill says: “It is the purpose of this act to return predictability and
stability to financial markets and provide lower real rates of interest.”
And it says: “Targets for short-term interest rates are achieved on
a monthly basis.”
What is your position with respect to that bill ? The so-called target
of real interest rates on a monthly basis.




309

Mr. V olcker. I attempted to address it in the middle of my state­
ment. I did not recall it was literally targeting real interest rates on a
monthly basis. I have the problem that I do not know what a real
interest rate is.
Representative W y lie . The principal authors of the bill said on
page 3, “short-term interest rates are achieved,” and the word
“monthly”—it says, “on a monthly basis.”
Mr. V olcker. I did not recall that, but that makes it worse, from
my standpoint. What is a real interest rate? We use the term; I use
the term, usually with a footnote, in my mind.
You have some conception that it is the relationship between interest
rates and the rate of inflation. But, expressed a little more precisely,
what you really have in mind is interest rates against the expected
rate of inflation during the time that the interest rate is relevant.
We have a lot of current inflation figures, and they bounce around
even more than the money supply from month to month. What infla­
tion rate are you comparing, let’s say, a 1-month interest rate to?
Last month's CPI? This month’s CPI? The CPI averaged over 6
months ? Then you get into a little longer term perspective.
Maybe you really are interested in CPI, assuming the CPI was a
good index—which it is not, always—over the next 6 months. But you
don’t know; you may get a different story from the wholesale price
index. It may be affected by temporary factors that nobody takes into
account.
You are not dealing with a figure that anybody can identify;
maybe more accurately, if you sit a dozen people down, they will have
a dozen identifications of what the real interest rate is at any particu­
lar point in time.
I think it has just that technical problem. I would repeat, given
my own expectations of inflation, I think long term interest rates are
going to turn out to be high in real terms, but that is not an operational
target for the next 2 months.
Representative W ylie . I think there will be further discussion on
that. I did want to take the opportunity to get your view on it.
I think what we are all trying to achieve is the same goal, although
we may have different opinions on how we might get there.
Thank you very much, Mr. Chairman.
Representative R euss. Thank you, Congressman Wylie.
DESIRABILITY OF SHIFTING TIMING OF FISCAL STIMULUS RESTRAINT

I have just one question for you, before proceeding to Congress­
man Kemp. I agree completely with your outlook on the proposal to
accelerate the July 1, 1983, 10-percent tax cut, as set forth in your
answers to Representative Wylie and Senator Proxmire.
Your view is that just to do that would increase the current year’s
budget deficit from its already outrageous dimensions by another $13
or $14 billion. The second part of your view is if, however, such an
acceleration were accompanied by locked-in measures to reduce the
budget deficit in the out years, you might viewTthe whole thing favor­
ably. Then you would be getting the stimulation where admittedly a
stimulus is needed right now, but you would be reducing the stimulus
from fiscal 1984, fiscal 1985, and succeeding years.

1 7 - 8 7 1

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8

3

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2

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Mr. V olcker . And therefore, I think, having a different impact on
interest rates and the problems of monetary policy.
Representative R euss . Exactly. I agree entirely with what you said.
I would ask this question: I have suggested that a possible way of
doing that would be to accelerate the July tax cut but to cap it to
provide in effect that it would go to people making less than $50,000 a
year. People making more would, of course, get at least $700. But it
would taper off at about that level. That would markedly decrease the
current deficit by several billion over what President Reagan is mus­
ing about, and in the out years, next year and 1985, it would reduce
the deficit now contemplated by $7, $8, or $9 billion a year. The net
deficit reduction would continue.
Again, without asking you to give your views of that particular ap­
proach, is not the arithmetic of that appealing?
Mr. V olcker . I have not looked at the arithmetic. If the arithmetic
shows trading a reduction now for an insured improvement later, I
think that goes in the right direction.
I am clearly not commenting on your particular proposal, which I
think has other aspects that would be inappropriate in my opinion.
Representative R euss . Your answer to Senator Proxmire about the
rate in growth of military, you were not prepared to suggest weapons
systems, et cetera.
Mr. V olcker . Exactly.
Representative R euss . Congressman Kemp.
Representative K e m p . Thank you, Mr. Chairman.
I, too, want to join my colleagues, Henry, in thanks to you, in your
last hearing. We all wish you well. You have been a friend, highly
respected on both sides of the aisle. I appreciate my colleague, Repre­
sentative Wylie, alluding to that fact earlier.
Welcome, Chairman Volcker. It is a tremendous opportunity to sit
in on these hearings. There is tremendous interest in monetary policy.
Bill Proxmire has the ability to cut through many of the problems,
and get right to the heart of the matter, and that is the concern that
we all have over the economy and the role that monetary policy plays
in the economy.
There is tremendous interest in your testimony today. It could be
said that you are outdrawing the NFL at this moment, Mr. Volcker.
All of the markets are watching what you and we do.
To that end, I think it is important that I not be tempted to get into
fiscal policy. I think the issue is monetary policy. That is why I really
wanted to be here today. So I will resist the temptation to defend the
third year of the tax cut and defined moving it up and defend my argu­
ments against trying to redistribute income through a more steeply
graduated income tax.
Much of your testimony, many of your remarks, many of your
answers to Chairman Reuss, Senator Proxmire, and Representative
Wylie, have been articulate in enunciating the problems you have
in narrowly targeting either interest rates or a quantity of money.
You mentioned the All Savers Certificates coming due, which has
caused technical aberrations in the supply targets. You have men­
tioned problems in other areas. I think if you look at those charts there
on the wall you will find that the definition of money changed between
1981 and 1982. You make the statement, and then you allude to it again




311

later on, that in setting targets, as a practical matter, attempts to target
and fix interest rates would make a more rigid monetary policy,
politicize the process. I think from your statement it can equally be
said that narrowly targeting a definition of money and holding to it,
irrespective of what happens to the economy and interest rates and
exchange rates, would also be rigid and political. Part of the frustra­
tion, Mr. Volcker, part of the reason for introducing bills like H.R.
7218, is not to politicize the Fed, not to make you less independent,
not to go back to a preset 1979 interest rate target, but to come to a
balance so that we can, as Bill Proxmire pointed out, achieve economic
growth.
And if we do not achieve economic growth, if we don’t get the Na­
tion back to high levels of output and production, there is going to
be, I ’m afraid, not just a sense of frustration in the Congress, but
overt attempts to reduce the independence of the Fed.
I am pleased by your testimony, at least that part in which you
have suggested that for technical and nontechnical reasons, you have
moved away from that experiment in monetarism for 3 years or so,
or narrowly trying to define money and control its quantity.
My concern is for the future. Much of your testimony has been
looking backward, and my concern is about the future.
You have mentioned the problems you have had with targeting
interest rates. Again, to mention H.E. 7218, we are not interested
in exclusively targeting interest rates. I do not even think Chairman
Reuss, if I heard him correctly, has suggested that you can narrowly
target interest rates. It is true, however, Mr. Volcker, is it not, that
the Federal Open Market Committee, on a month-to-month basis, over
different periods of the year, does target the Federal funds rate, which
is an interest rate ?
Mr. V olcker. I would not interpret what we are doing now as
setting targets for the Federal funds rate. We used to do that prior
to 1979, as a means of reaching the monetary target. It turned out
not to be a very good means, in my judgment, but that is what we used
to do.
We do not target it now. We do, in our directives, set down a rather
wide band for the Federal funds rate, which is as a signal; if it reached
the outer ends of those bands, we would want to review the situation.
We have done that on a number of occasions, usually when it has hit
the outer ends of those bounds.
It goes through—the directive does not say, “Hold it there.” It says,
“ Consult if that happens.” I do not determine that as a target.
Representative K e m p . Thank you, Mr. Volcker. As I have tried
to suggest in the past, interest rates, exchange rates, even, indeed, the
quantity of money or other aggregates, are not directly targets, as
much as they are tools of policy. Why use a quantity target when the
goal is price stability ? Why not use prices themselves ?
In other words, whv not find some price that you think could be
used as a proxy for the price level? I ’m not saying what it should
be, but you can find in history that there are proxies for the general
price level, and what we are seeking is price stability, a stable unit of
account, and honest money.
Whv couldn’t we abandon money quantity, abandon interest rates,
or at least use them only as tools, and target the one thing that the




312

American people want us to look at, and that is maintaining the
purchasing power of the dollar ?
Mr. V olcker . I fully agree with you as to what the purpose is in
the end: We wTant a stable currency, a sound currency, stable pur­
chasing power of the dollar along with a growing economy.
The question is how you best get there, which brings up operational
questions, tactical questions. There is no disagreement on the goal. The
reason that we use these quantities has a long history. It has a long
history of congressional interest in these monetary targets of increas­
ing interest over the 1970's which was finally incorporated into law
in the Humphrey-Hawkins Act. That history is based upon two
notions: One, that over periods of time there is a relationship between
these quantities in a lot of different economic circumstances and what
we are ultimately interested in, the price level, which corresponds
with lags of unknown duration; and two, we cannot directly control
money, but we can strongly influence it, at least one removed, through
changes in bank reserves.
We have not got a similar instrument to work directly on prices.
We have got a whole lot of price indices which we will affect in the
end. But how do we link up what we do today with the broadest price
indices that we are interested in, and whose stability we are interested
in ? It is a period of, unfortunately several years, before you get the
results.
So we are looking for an intermediate stage that goes toward the
objective that you and I share.
Representative K e m p . I am glad to hear that, I think. And I would
like to explore it a bit more.
COMMODITY PRICE TARGETS

I am not talking about sluggish measures like the CPI or the WPI,
the wholesale price index. But let's go back to 1979, Mr. Volcker,
and look at commodity prices. Take the Commodity Research Bureau,
the Bureau of Labor Statistics, the Dow-Jones Commodity Price
Index, and you will see tremendous rise in commodity price index
measured on any one of a number of commodity indices in 1979. It
peaked in 1980 and has dropped from 1980 to 1982 at an incredible
rate. Commodity prices are significantly under the level that they
were at in 1980 and 1981.
My question is: Would you be concerned for the future if com­
modity prices continued to fall ? If the price of gold goes much under
$400—I understand it is about $404—what would be the reaction?
Would you then inject reserves to expand the supply of money ?
Mr. V olcker . Yes.
Representative K e m p . S o you need some other target because of the
problem that you have mentioned with regard to the demand for
money. Doesn’t the price level, as measured, say, without trying to
exactly define it, by commodity prices, doesn’t that take into account
both the supply of money and the demand for money? Doesn’t that
solve a little bit of your problem ?
Mr. V olcker . Commodity prices certainly give you information.
The way commodity prices were behaving in 1979 and early 1980 was
certainly an indication to me of inflationary pressures and inflationary




313

expectations. They were certainly a factor in my mind, anyway, in
policy formations.
I think you can say the same thing about the subsequent rise in
late 1980 and 1981. Certainly, I take the rather long period of decline,
now, since early 1981 and really continuing into the present, as an
indication that there is this inflationary pressure on the economy, and
we take that into account.
In that general sense, commodity prices are relevant, yes. That is
quite a long way—a tremendous distance—from saying, as I have
heard some people say, “Why not use commodity prices as a kind of
day-by-day indication of whether you should add or subtract
reserves?”
The trouble with that is that this is a very highly volatile series
over time, and you expect fluctuations in commodity prices. I would
guess—more than guess—that some commodity prices are, certainly in
a sense, too low, relative to the average price levels. It is not very
profitable, for instance, to mine copper, at the moment. If prices just
leveled out today at general price levels, presumably at some point the
copper price would have to rise to go back into equilibrium.
Representative K em p . I understand the problem with copper.
Mr. V olcker. I think you can say that about the whole commodity
price index at the moment, because it is affected by the fact that we are
m a recession. I don’t think that we can assume, let’s say, the com­
modity prices are in equilibrium today and therefore should be stabi­
lized from this day on.
Representative K em p . I made that point myself. Commodity prices
are somewhat lower.
My question really, Mr. Volcker, is, What are you going to do ? What
rule ? The reason that Chairman Reuss, Senator Proxmire, Represent­
ative Wylie, and all of us are desperately looking to you is because
we want to know what you are going to do in 1983 ? It is not enough
to go back to Mxor even M2.
My wife has money market funds. She thinks they are a savings.
I have got a sweep account. I don’t think you can tell the difference
between which is money and which is savings.
Mr. V olcker. I can’t.
Representative K em p . My question is, What are you going to do in
1983 ?
Mr. V olcker . Y ou are asking me a question in the same way Sen­
ator Proxmire asked me a question: Won’t you please give us a simple
rule that you will follow ?
I am afraid I am in the position of telling you I am suspicious of
any rule that is that simple. It would be very nice to say: “We could
just follow commodity prices, or target interest rates.” I don’t think
life is quite that simple. These relationships change.
What we do say is that among all of these relatively simple rules
there is a big body of history behind the monetary quantity. Cur­
rently, it is getting distorted by all of these institutional changes; we
have to be very cautious about it. What I am saying in a good part of
my statement, as you accurately note, is that there is a lot of doctrine,
history, experience, behind that rule. Beware of making it too simple;
beware of making it too simple in these disturbed periods.




314

So then you say: “ Give me another rule.” I would like to give you
another rule that is very mechanical, that will tell you that we will
stabilize commodity prices between x and y, or the Dow Jones index,
or the gold price. But any of those rules would suffer from oversimplicity, more so than the quantitative rules.
So I have said, “I suppose if we have a rule of that sort, you could
replace the Federal Reserve with a computer.” I don’t think we are
going to reach that stage very soon.
We have to apply some judgment using the very points that you
mentioned, they are very relevant to me, but they do not provide a
simple operating rule.
Representative K e m p . I have been a critic of monetary policy in
the past. I want to say in recent history, that is at least since July
and June, and even to look at an earlier date, I have been applauding
what you have been doing. I think there has been a significantly
broader approach to the conduct of monetary policy.
What I was suggesting a little bit earlier is that it seems to most
Fed watchers there has been a shift away from a fix on just the quan­
tity of money, and that is applauded by many of us.
I am also suggesting that just fixing interest rate targets is not
possible. We have introduced a modest Monetary Policy and Price
Stability Act, just to vent a little of our frustration, which is assuaged
somewhat, Mr. Volcker, by your approach recently, to monetary policy.
My real questions are about the future. I am not asking for a simple
target. I am not asking for simplicity, or taking away your inde­
pendence, or turning you into a computer. But the American people—
at least the people I represent—are interested in several things. They
want stable money, stable prices, they want a fixed unit of account
upon which they can base contracts, so they can save once again, and
provide for the future. They want a world in which Americans can
trade with a sense of confidence that the unit of account will not change
internationally.
The world is in economic anarchy with a very dangerous trend
toward protectionism. Part of the problem is the breakdown in the
confidence that that unit of account is going to be preserved, not only
by the United States, but indeed the world, and the world, of course,
trades in dollars, 75 percent of the world’s economy, in one way or
another, is denominated in U.S. dollars.
Is there some way that this country can work with our trading
partners in an international sense, to get back to more stable exchange
rates, get back to more confidence in the ability of nations to engage
in commerce and industry without seeing those policies changed from
day to day by the zero-sum, beggar-thy-neighbor approach?
Mr. V olcker . I hope so, and believe so. In saying that, I would think
we have to get to the fundamental bedrock upon which international
stability must rest in a monetary sense.
It is on the stability of the dollar itself. The dollar is extremely
important, not just for us, but for the world economy. It is going to
be stable. We have to have stability at home, but that does not solve all
problems. As we return to that stabilitv at home, I would hope that
we would find, franklv, mechanisms and techniques for avoiding some
of the extreme fluctuations in exchange rates we have had.




m
I continue to hope that they will damp down by themselves, given
more stability in domestic currencies, and I think that is absolutely,
fundamentally important. I am not at all allergic to the idea of find­
ing other techniques to help encourage that process as well.
Representative R euss. Any additional questions ? Congressman
Wylie.
Representative W yl ie . Mr. Chairman, I would like to follow up
on that. Ideally, we are all interested in stability. As far as inflation
rates are concerned, a low inflation rate and stability as far as interest
rates are concerned, lower interest rates.
WHY DID FED LOWER DISCOUNT RATE?

Last Friday—may I say that I do not want to oversimplify the
discussion, or to suggest that what we are interested in—but how it
impacts on unemployment. What considerations led the Fed to lower
the discount rate last Friday ?
Mr. V olcker. We obviously are aware of the economic environment
in which that action was taken. We referred in our statement to the
continued sluggishness of the economy. We referred to the fact that
we do interpret these aggregates in the light of the liquidity trends
that we see, and we also, importantly, refer to the fact that we think
we have seen progress on inflation and that the prospect for that
continuing are pretty good.
Taking all those factors into account, we certainly do not want to
be an obstacle to lower interest rates. We can reduce the discount rate
modestly in the climate of market rates, and we did so.
If I could add in that connection, and thinking of Senator Proxmire’s earlier comments as well, I think the problem is illustrated by
the Senator’s comments about the need for stimulus. I think he put it
very directly, considering what is going on in the economy, considering
the uncertainty that is there. Congressman Kemp has emphasized, also
rightly, in my view, the need for a stable currency.
The fact is, we have to be worried about both. We have got to devise
some way of dealing with the situation such that we can see the eco­
nomic recovery, encourage the economic recovery, without losing the
gains on inflation—in' fact, making more gains on inflation. If we do
not do that, I fear that we will lose both goals.
Representative W y l ie . Y ou just made the point I wanted to make.
Thank you very much.
Representative R euss. Senator Proxmire.
FOREIGN LOANS BY U.S. BANKS

Senator P roxmire . What troubled me about your remarks at the
58th annual meeting of the New England council in Boston, that I was
asking about, with respect to loans by American banks, international­
ly, and to foreign countries, was the statement you made, quote:
It is equally a fact that given strong and necessary adjustment programs,
borrowing countries will not require bank financing in amounts nearly as large
as the sums provided by banks over recent years. Indeed, lending banks working
effectively together with transitional needs should be able to provide the neces­
sary margin of finance by reducing the standing loans.




316

It is my understanding that many of these countries are in very, very
difficult financial straits. We have extended the loans, in fact. We have
let them roll over, even interest that was due us. And I wonder if you
have any documentation, any supporting data, that would—any study
that would indicate that these countries are going to require less.
It would seem to me if you assumed the growth is going to continue,
it would require more.
Mr. Y o l c k e r . No, I can provide you data in that connection, for the
record, Senator. I will not remember all the data off the top of my
head, but take the Mexican case. Mexico, if I recall correctly, in 1981,
borrowed n6t abroad around $20 billion, something like $14 billion
from banks. The adjustment program that they have entered into with
the IMF looks toward a current account deficit of one-half or onethird of what they had in 1981.1 do not remember the exact compari­
son with this year, which is not completed. It implies little or no
growth in Mexico for a year or two, explicitly, and it will require an
amount of financing that will be only a fraction of what was required
in 1981 and a considerable reduction from what was required this year.
I can provide you the numbers.
Senator P roxm ire . If you would do that in other areas, too, not only
Central America, but South America, Asia, and so forth.
[The information referred to follows:]
F ederal

R eserve

Sy s t e m ,

Washington, D.G., November SO, 1982.

Hon.

William

Proxmire,

U.S. Senate,
Washington, D.G.
D e a r S e n a t o r P r o x m i r e : During my recent appearance before the Joint Eco­
nomic Committee you asked me to explain in greater detail how international
banks could continue to provide new credits to developing countries in the context
of effective adjustment programs while at the same time reducing their exposure
to those countries relative to their capital or assets. I welcome this opportunity to
respond to your question about this important topic.
The enclosed table presents as background estimates of international bank
claims on all non-OPEC developing countries and on certain major borrowers in
this group of countries. The data in the top panel indicate that as of mid-1982
bank claims on non-OPEC developing countries amounted to about $240 billion.
Claims of U.S. banks on these countries were estimated at $100 billion as of
mid-1982, about 40 percent of the total for the BIS reporting area. The data in
the middle panel show the increases in international bank claims in recent years
and for the first six months of this year. These figures understate somewhat
actual increases in claims since the end of 1980 because the strength of the dollar
has reduced the dollar value of outstanding claims denominated in other cur­
rencies. The data in the bottom panel translate these dollar increases into per­
centages and show on average annual growth of such claims of 25 percent per
year in the 1978-81 period. This rate of growth of bank claims on developing
countries is not sustainable, since bank assets and capital have been growing at
much slower rates.
Turning to immediate prospects, it is reasonable to expect that the capital of
the lending banks will increase at a rate of about 10 percent per annum. For
large U.S. banks this increase would result from an after-tax rate of return
on capital of about 14 percent, a retention of about 60 percent of after-tax earn­
ings, and an additional iy2 percent per year in increased capital raised from
external sources. These assumptions appear reasonable by historical standards,
particularly when banks should be paying more attention to profitability rather
than to expanding their total assets. Asset growth of the major banks would
probably be close to (but desirably a bit below) capital growth.
>A 10 percent rate of increase in banks’ capital in 1983 would be consistent
with a net increase in bank claims on non-OPEC developing countries of about *$25
billion with no increase in the exposure of the banks relative to their capital.
The combined current account deficits of these countries may well be $30 billion




ai7
smaller in 1983 than in 1981, declining from about $75 billion in 1981 to about
$45 billion next year. (You will note from the table that international bank
claims on these countries increased by at least $37 billion in 1981.) In this
context, it is reasonable to expect that the percentage increase in bank lending
required by these countries next year under their adjustment programs will be
substantially reduced and should be less than the rate of growth of bank capital,
thereby resulting in a small decline in exposure relative to capital for inter­
national banks in the aggregrate.
To put these figures in perspective, consider the outlook for the three major
borrowers— Mexico, Brazil and Argentina— all of which are in the process of
establishing strong IMF-approved adjustment programs and presumably will
come within the criteria mentioned in my Boston speech that you quoted at
the JEC hearing. The IMF stabilization program for Mexico assumes net new
bank lending to Mexico of about $5 billion in 1983. Such lending would imply
an increase in international bank claims on Mexico of about 8 percent in 1983
from the level at the end of June 1982— less than the expected increase in banks’
capital next year— without making any allowance for net new lending in the
second half of 1982. This outcome would be a dramatic reduction from increases
of more than $10 billion per year in 1979-81. Moreover, while the quantitative
implication for years beyond 1983 have not been fully developed, the IMF pro­
gram plainly looks toward further reductions in the current account deficit
(and implicitly in borrowing requirements) in future years.
In the case of Brazil, the Foreign Sector Program adopted on October 25 by
Brazil’s National Monetary Council calls for a net increase in loans from inter­
national banks of $4.2 billion in 1983, also 8 percent of outstanding claims in
June 1982. By comparison these banks’ claims increased more than $6 billion per
year in 1980-81.
For Argentina, the IMF has projected that international banks* exposure
need only increase by about $1V
2 billion by the end of 1983, after little apparent
increase this year. Such an increase would be 6^5 percent of outstanding claims
in June 1982 and could represent a dramatic decline from the pace of recent
annual increases, which averaged more than $5 billion in 1979-31. Again 1983
would be an “adjustment” year, implying a reduction of arrears, and would be
consistent with lesser borrowings in future years.
Based on these kinds of calculations and consistent with IMF-approved adjust­
ment programs, it is feasible to expect that an increase in the level of interna­
tional bank claims to non-OPEC developing countries in general, and to the
major borrowers in particular, need not, and should not, increase the exposure of
banks relative to their capital base. Rather, some declines would appear more
likely. In specific cases, the loans may be essential to the success of the IMF
program and the net result should be to strengthen the economies of the borrow­
ing countries.
Sincerely,
P a u l A . V olcker.

Enclosure.




318

November 30, 1982

International Bank Claims on Non-OPEC Developing Countries
(Billions of dollars)

1977

1978

4.8
23.8
19.9

6.7
31.7
23.2

December_______________
1980
1979
1981

June 2/
1982

Outstanding Claims
Argentina
Brazil
Mexico

13.1
36.9
30.7

18.9
43.3
41.0

22.9
49.6
55.4

22.9
52.2
61.8

Subtotal

48.5

61.6

80.7

103.2

127.9

136.9

Total

98.7

120.8

155.6

193.3

229.9

241.7

Increase in Amount
Argentina
Brazil
Mexico
Subtotal
Total

In 12 months to date above
1.1
1.7
1.4

1.9
7.9
3.3

6.4
5.2
7.5

5.8
6.4
10.3

4.0
6.3
14.4

0
2.6
6.4

4.2

13.1

19.1

22.5

24.7

9.0

11.3

22.1

34.8

37.7

36.6

Percentage Increase
Argentina
Brazil
Mexico

In 6 months

In 12 months to date above
32
8
8

40
33
17

96
16
32

Subtotal

12

27

Total

14

22

11.8
In 6 months
0
5

44
17
34

23
15
35

31

28

24

7

29

24

19

5

_12_

jVInternational bank claims normally increase relatively slowly in the first half of the
year.
Source:

Bank for International Settlements.




319

Mr. V olcker. I am not saying that is true of every country in the
world. It is true of these major borrowers that have been very large
users of bank credit in recent years.
Brazil has announced an external adjustment program that would
cut their balance-of-payments deficit about in half, as I recall it, in
1983, from this year and last year.
Senator P r o x m i r e . Can you tell me, would there be a global net
increase in U.S. dollar loans needed in 1983 and 1984 ?
Mr. V olcker. I have not looked at it in those terms, but my pre­
sumption would be yes, in 1983, consistent with all of these adjust­
ment programs there would be a net increase, but a much smaller
increase.
Senator P roxmire. There will be an increase.
Mr. V olcker. I have not looked at countries closely, for example,
in the Far East, where you have some growing, strong countries that
have done external financing. I just do not recall offhand how that
trend would look compared to last year. Certainly if one looks at
Latin America or Eastern Europe it would be comparable.
Senator P roxmire . The U.S. trade deficit is a drag on the economy
already, and is likely to get worse before it gets better. As the U.S.
economy begins to recover, imports are likely to rise, the dollar ex­
change rate is likely to decline. New York Federal Reserve estimates
that the U.S. current deficit can be widened by $45 billion—that is
1y2 percent of the gross national product—by the end of next year.
Do you agree with the New York Fed’s estimate of what are the
implications of the U.S. economic recovery ?
Mr. V olcker. I have not looked at that in detail. I am aware that
most estimates, looking ahead at our trade or current accounts balance,
would show a sharp deterioration. I think as things look now I cer­
tainly agree that that trend will be toward a widening of the current
account deficit.
W e have had a relatively strong current account position for several
years.

Senator P roxmire . That’s right, and that is one of the things that
I think has been encouraging about the economic performance. If it
were worsened that dramatically, by $45 billion, it seems to me that
could have a severe effect on our economic recovery.
Mr. V olcker. It is moving in the direction of worsening. I think,
importantly worsening. It is a reflection, in part, of the very steep
climb in the exchange rate in the past year or so.
To the extent that climb doesn’t continue, that may moderate the
trend, but the trend is in the direction of worsening.
Let me say, while I have the chance, because it is relevant to both
of your questions, that there are pressures for protectionism in the
world, and that affects the prospect for our trade balance. It also affects
the possibilities and the probabilities of these borrowing countries in
the midst of big adjustment programs turning their situation around
in the healthiest way, which is by approving their trade and current
account positions.
It seems to me—and I understand the pressures, we all do—but I
just want to record my own view that these financial problems are
tied with trade problems and include the temptation of moving toward
protectionism, of not moving ahead in negotiations that are going on




320

now toward maintaining the elements of liberal trade. That will com­
plicate all of the financial problems, complicate the borrowing pro­
blems, that you are worried about.
Senator P roxm ire . A s you know, there is a strong tendency to move
in that direction now, and 1 am quite sympathetic with it, as are
others. But if our current account deficit worsens to $45 billion, the
pressure is going to be very hard to resist.
jobs/ gas t a x

program

Let me ask you, what is your view on the $5 billion program of
highway and bridge repair to put the unemployed to work—and first,
with the 5-percent increase in the gasoline tax----Mr. V olcker . If there is a need ior that infrastructure work, and I
assume there may well be, I think it has got to be paid for, given our
budgetary situation. The increase in the gasoline tax to balance those
needed expenditures seems to me quite reasonable.
Senator P roxmire . D o you share the view, or have any opinion on
the view, of Chairman Feldstein, that this would probably, in his
judgment, decrease the number of jobs net, because of taking the
money out of other sectors of the economy ?
Mr. V olcker . We had a little discussion about that recently. One
of his concerns, which I understand, is that the way we do these
indexes—and T am not sure this makes a lot of sense, conceptually—
if you rely on an excise tax instead of an income tax, let’s say, it will
show up m the price index; and if you aim toward the same price
level, along the lines of Representative Kemp’s thinking, there is a
little less money to go around for other things, because oi the impact
on the price level.
I think that is probably small enough so it does not strike me as a
major element of consideration. I think essentially the program would
be balanced if the taxes balance the expenditures.
In terms of its effects, its employment impacts, I think it should be
viewed as a program to improve the highway system, the mass transit,
or whatever.
Representative R euss . Thank you. Congressman Kemp.
Representative K em p . Let me once again thank you, Chairman
Reuss, for your allowing me to sit in today. Also, to Senator Jepsen,
with w^hom I talked, and I appreciate his Hospitality as well.
I know it is getting on in the day, Mr. Chairman. Mr. Volcker, I
too share your belief, and I think many people’s goal, of a liberal
trade policy. I think part of the problem in supporting liberal trade
policies in the Congress and in the world is due to the change in
currencies that has been a result of this floating paper standard experi­
ment since the breakdown of Bretton Woods in 1971. But really, my
question has to do with your statement, where you say you are
required by law to give us the targeted aggregates, in the relevant
money and credit area. Would it help, Mr. Volcker, if the law were
changed ?
Is there something we can do in Congress to help you provide a
more balanced approach ? Are you encouraged by the rally in bonds
and stocks since you have moved, even temporarily, away from the
aggregates? Can we do anything to encourage that? What changes




321

in law could be made to help you move toward a balanced monetary
policy, price stability—all the goals that we have for this Nation?
Mr. V olcker. I don t want to provoke any disagreement, but I
think I had better put a footnote on your comments. You refer to
moving away from the aggregates. I would express it as maintaining
concern about the aggregates, but using common sense in interpreting
them.
I certainly am encouraged, particularly by the long-term rates, be­
cause I think that must have an element of more conviction about the
price outlook; I am even more encouraged about that than the decline
in short-term rates, which I also would like to see.
I am not at all unhappy, obviously, about seeing higher stock prices.
I might comment that the volatility of those markets concerns me. I
would like to see high stock prices and low interest rates, because I
think that is in accordance with what I see as the outlook.
I do not like to see the degree of volatility from day to day that exists
in those markets, because I think it is still a reflection of uncertainty
and unsettlement, and I look forward to the day when we see low in­
terest rates and high stock prices, but in a framework of greater
stability.
Now, you specifically asked, very kindly, what you could do to help
us. I do not think I would suggest any changes in the law at this
point. I would, in effect, plead—if that is a proper interpretation of
my statement—for the need for judgment in interpreting these things,
and taking account of some of the very variable that you have men­
tioned this morning.
Representative K em p . Again, I am encouraged by that.
But it seems to me what you are telling us is that we are not going
to have much of a standard at all. We are going to have a Paul Yolcker
standard, and I do not mean that to be acrimonious. But the Con­
gress must know, the markets must know, the philosophy around
which the central bank is going to conduct monetary policy here and
abroad. I remember somebody saying if we even abandoned M1? in­
flationary expectations would rise, bond prices would fall, and all
sorts of malevolent things would occur.
Well, we moved away in June, from a slavish devotion to Mi. In
July and August we moved further away from Mi. We are told here
today that you, for technical reasons and other reasons, want to look
at a broader array of targets. There has been a rally. Stocks and bonds
and interest rates have all been more optimistic, more positive, more
bullish, if you would.
And my question simply goes back to something that I probably
asked before, but nonetheless I want to reiterate it. It seems to me that
the success that you have had in moving away from the aggregates
should not be revised—we should not go back to that mistake.
We should have learned by the mistakes over the past 2 or 3
years. I guess what I want you to do is to tell me, can’t Congress help
codify those changes? Can’t we help institutionalize those changes?
Can’t we tell the world that from now on we will be more interested in
stable prices, an honest unit of account, a world in which we can have
liberal trade around a more stable exchange rate, rather than this
standard of how you or the Open Market Committee wakes up in the
morning ?




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M r. V olcker . Apart from any interpretation of exactly what we
have been doing recently, I have repeatedly emphasized the impor­
tance I attach to these aggregates as kind of a discipline, properly in­
terpreted. You cannot interpret them in too simple-minded a fashion;
I refer to the problem of any rigid, very simple rule.
You raise, again, the question of what Congress can do. Let me say
it is an old debate, it is an old question, but in connection with the
philosophical approach that you have mentioned; and I agree: the
world has got to know what our philosophy is toward the basic ob­
jectives of our policy.
We have talked about price stability. That could appear in the law
more clearly than, in fact, it does, I think. It is not clear in the Federal
Reserve Act, the original act, where it was not mentioned. The question
is sometimes raised about the priority that goal has.
I was talking about legislative changes in the broadest sense, which
I think is the sense you might be raising them. It might be worth look­
ing at that point.
Representaive K e m p . You and I had lunch a couple of months ago,
and you said that you cannot control the demand for money. So the
aggregate is not a target. It is only a tool. So we agree on that.
My sense is that one good that may come out of this meeting is that
if Ml or M2 were rising, it is important to know whether a demand for
money and liquidity is causing the rise or whether it’s due to your
having expanded reserves, by buying government securities. It seems
to me the only way you can tell whether it is inflationary or consistent
with price stability is to have some measure—not now knowing what
that should be.
I happen to prefer commodity prices, or gold as a proxy, or what
Zelle Fiilstra suggested as a band for the price of gold around which
you would operate. Unless you use another tool for monetary policy,
how can you measure whether the “M’s” are going up or down, ac­
cording to the demand or the supply, without looking at prices ?
Mr. V olcker. I don’t think we can. Let me just complicate the ques­
tion a little more. You’re quite right, one of the variables you want to
look at is whether this is being influenced by a change in demand or a
change in supply. You can look to a variety of things to help interpret
that. You can look, among other things, at interest rates; that gives
you a clue. Prices certainly give you a clue. The direction of the
economy gives you a clue.
I complicate the question even further, because in present circum­
stances we also have to consider to what extent entirely extraneous
changes in institutions from regulations are causing it. We have got
to take that into account, too.
My only difference—it may not be a difference—is that I think that
we have to look at a variety of things to make that judgment, certainly
including prices. We have to keep very much in mind—and this comes
back to the whole philosophy, I suppose, of targeting these aggre­
gates—is that what might be chosen today, what we might accurately
judge today—maybe inaccurately—may be inappropriate tomorrow,
if a change in the demand for money quickly reverses itself. We do
not want to do things today that aggravate the problem tomorrow, to
the extent we can help it.




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There is some presumption, in history, if you will, as was mentioned
earlier, that changes in velocity, to use that particular measure, will
reverse themselves.
I have already indicated that I am not sure that everything we are
seeing now, in terms of the extent and length of change in the velocity,
implies that that is going to be fully reversed.
Representative K emp. I could not agree more, except it seems to
me, if I were part of the process of the central bank, and prices were
falling and interest rates were falling and the price of gold was
falling, and velocity were down, that that would be a signal of some
sort, and that you could measure when to expand or withdraw reserves
in the system around some designated target that is better than
or M2.

M2 rose at a 13.1 percent rate iji 1976-77. The growth went down
to 8.5 percent in 1978-80, while inflation was going up. That is un­
believable. When I started looking at this, I came to the conclusion
that there was no use in targeting M2, because M2 was slowing in 1978
and 1979, when the dollar was collapsing, and people in Europe were
mad at us for allowing the dollar to be too soft, and something had to
be done. M2 has dropped from a 13.1 percent increase in 1976-77 down
to 8.5 percent By 1980.
Now, clearly, as you point out, the demand for liquidity, money and
cash and money market or instruments was changing.
I appreciate this opportunity, Chairman Reuss. You have been
very kind.
And Mr. Volcker, again, this debate is not over. I appreciate the
contribution you are making.
1951 ACCORD RECALLED

Representative R euss. Both Senator Proxmire and Representative
Wylie in the last couple of minutes have whispered to me that they
think this is the most instructive hearing held in many years between
the Joint Economic Committee and the Federal Reserve, and I
heartily agree. I congratulate you and remind myself that it was
about 31 years ago that the Joint Economic Committee helped rescue
the Federal Reserve and enabled the Fed to be in a position to do a
job on maximum employment, production, and purchasing power.
And I end up here today with the hope that it wTill continue with
the Open Market Committee and perhaps of this discussion here
today and out of that colloquy with your colleagues can emerge a new
accord which will get Congress, the Federal Reserve, and the country
going in the same direction: toward full employment. Thank you very
much for your testimony.
Mr. V olcker. Thank you, Mr. Chairman.
Representative R euss. The committee stands adjourned.
[Whereupon, at 12:20 p.m., the committee adjourned, subject to
the call of the Chair.]




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