Economic conditions - United States ; Monetary policy

Darryl R. Francis

English

Research Papers in Economics

The Economie Outlook
Remarks by DARRYL R. FRANCIS, President,
Federal Reserve Bank of St. Louis,
Before the Financial Analysts Federation Conference,
Cincinnati, Ohio, October 9, 19720
AM PLEASED to have this opportunity to present
to you my views regarding the economic outlook, My
remarks will first be devoted to a brief presentation
of the general outlook. Then, I will discuss some of
the problems facing the nation because of a Federal
budget which is generally acknowledged to be “run-
ning out of control.” Decisions made in response to
these budget problems will have a great effect on the
course of our economy over much of the l97Os.
General Outlook
Let us now examine the general economic outlook
for the next few quarters. The President’s Council of
Economic Advisers, in their Annual Report of last
January, projected a rapid advance in total spending
(GNP) for 1972. They projected strong real product
growth and a significant decline in the rate of inflation
by the end of the year.
Progress •in• Achieving the 1972 Forecast
Substantial progress has been made in achieving
this optimistic forecast, Total spending has advanced
rapidly since late 1971, largely in response to stimula-
tive monetary and fiscal actions taken earlier. Growth
in the money stock has been uneven, but has averaged
a 7 percent annual rate since early 1971. In compari-
son, money increased at a 4,5 percent rate from early
1969 to early 1971, Fiscal actions have also been ex-
pansionary, \vith Federal expenditures rising at a 9
percent rate since the first quarter of 1971, faster than
the 7 percent rate of increase in the previous two
years.
A significant portion of the recent advance in total
spending has been manifested in real product growth,
with the associated rate of price inflation being mod-
°This presentation has been revised to take into account the
most recent data available,
crate. Real product growth accelerated to a 7 percent
increase from third quarter 1971 to third quarter
1972, more than triple the increase in the previous
year. The rate of inflation, as measured by the GNP
price deflator, has been at about a 3 percent rate since
mid-1971, compared to a 5 percent increase in the
preceding year.
The rapid rise of real product has fostered a strong
advance in employment. Payroll, employment has in-
creased at a 3.5 percent annual rate since last fall,
compared to little growth in the previous year and a
trend rate of growth of 2 percent from 1957 to 1971.
The relative strength of these employment gains is
noteworthy since the population of working force age
is estimated to be growing at less than a 2 percent
annual rate. Total employment in mid-summer was
over 64 percent of the population of labor force age,
higher than in the prosperous year of 1965.
These developments through the third quarter in-
dicate that substantial progress has been made toward
realizing the Council’s goals for 1972. Moderated
growth of both total spending and real product in the
final three months of the year, and continuation of
price increases at about the average rate of the past
three quarters would he consistent with attainment of
the goals.
Evaluation of Developments in 1972
In evaluating the healthy turn of the economy thus
far in 1972, I will now present briefly my vie’tvs regard-
ing the prospects for sustaining such a rapid expansion
of output, the advisability of relying solely on mone-
tary and fiscal actions to bring the unemployment rate
down much further, and the contribution of controls
to reducing inflation.
First, the very rapid gro\vth of real output in the
first nine months of the year is probably not susta.ina-
Page 5FEDERAL RESERVE BANK OF ST. LOUIS
ble over the longer-run. There is some evidence that
a slowing has already occurred. For example, real
output has grown at a 6 percent rate in the last
quarter, compared to an 8 percent growth rate from
fourth quarter 1971 to second quarter 1972. Also, in-
dustrial production has grown at a 7 percent rate
since April, down from a 14 percent rate over the
preceding four months, Payroll employment has risen
at a 3.6 percent rate since April, after rising at a4
percent rate from December to April. These slower
rates of increase are desirable, I beheve, because they
are more consistent with preserving the gains that
have been made in slowing the rate of inflation than
would be an attempt to continue the faster growth
rates experienced earlier in the year.
Some will criticize this slower rate of employment
growth because the unemployment rate has fallen
onlyto the neighborhood of 5.5 percent. These critics
cite as a desirable goal an unemployment rate of 4
percent or less. As laudable as such a goal may be,
these critics overlook the costs of attaining such a
target through the use of overall economic stimulus.
Post-war experience demonstrates that whenever the
unemployment rate has moved below 5 percent, infla-
tion has become a serious problem. Given the struc-
ture of our labor markets and the way they function,
using monetary and fiscal actions exclusively to achieve
significant further reductions in unemployment runs
a serious risk of renewed inflationary pressure.
On this point Ia min agreement with the Chairman
of the Council of Economic Advisers, who, in an inter-
view with First National City Bank last August,
pointed out that “there are a number of other policies
which may be involved in getting the rate of unem-
ployment down,.,.” He indicated that what he had
in mind was various types of manpower programs.
Apparently there was a realization of this point
when price and wage controls were instituted fifteen
months ago as part of a program designed to promote
economic recovery and a slowing of inflation. Some
have cited the 3 percent increase in the consumer
price index for the year ending with September as
evidence of the contribution of these controls to price
stability. This was down from a 4.5 percent increase
in the year prior to controls. It is not clear whether
this reduction in the rate of inflation has been due to
controls or to natural economic forces set into motion
by the monetary restraint of 1969 followed by mod-
erate growth in money in the period immediately
thereafter.
I tend to place emphasis on this latter development.
Inflation reached a peak in early 1970. In February
Page 6
NOVEMBER 1972
of that year the consumer price index was over 6 per-
cent higher than a year earlier The rate of inflation
has been decelerating since then declining to 4 5 per
cent in thc year ending August 1971 when the con-
trols wcre imposed The dccclcration in consumer
prices was only a little more in the following twelve
months than in thc year prior to controls
Oalooh s/in cisj, ‘.5%
With regard to the economic outlook for the bal-
ance of this year and through 1973, most pnvate
cconomic forccasters expect a continuation of strong
economic expwsion through the end of next year
They do not howcver expect the expansion to con-
tinue at the rapid r ites of earlier this year These
forecasters generally do not expect much further im-
provcment in the rate of inflation In fact many fore-
cist the reemergence of accelcrating mflation by the
second half of next ycar
Ia min agreement with the general contours of
output and price movements projected by most pnvate
forecasters However the course of monetary expan
sion especially as related to Federal budget develop-
ments can alter this outlook considerably
Our research indicates that thc ai erage rate of ex-
pansion of the money stock over a period of five or
more years is the major determinant of the rate of
inflation This research also indicates that a change m
the rate of money growth for a penod exceeding two
quarters exerts a significant short run but temporary
influence on growth m output and employment So
let us look at some implications of recent monetary
developments in light of these findings.
Money his grown at a 6 percent trend rate since
1966 Our research indicates that the rate of inflation
in the neighborhood of 4 percent expected by many
forecasters for late next year is consistent with this
trend in money growth Over a shorter period, rnouey
has increased at an 8 percent rate thus far in 1972. If
this rate of growth were to continue much longer, I
would expect inflation to intensify more next year
than is currently forecast. On the other hand, if we
were to revert abruptly to a considerably slower
growth rate of money I would expect less expansion
of output next year from that expected by most fore-
casters. You can see the problems facing those who
have responsibility for promoting both high employ-
ment and price stability.
The Federal Budget and the Outlook
These problems ‘ire further comphcated by the out
look for the Federal budget The unified budgetFEDERAL RESERVE BANK OF ST. LOUIS NOVEMBER 1972
moved sharply from a surplus in fiscal year 1969 to a
deficit in fiscal year 1971. This shift from surplus to
deficit reflected virtually no growth in receipts while
expenditures increased $27 billion. If the economy had
remained at a high level of resource utifization, and if
no change in tax laws had occurred, receipts would
have been $40 billion higher than was realized. Almost
half of this short-fall in receipts resulted from tax
changes following elimination of the income tax sur-
charge and the Tax Reform Act of 1969. The re-
mainder of the short-fall was due to the slowing in
economic activity during the recent recession. Some
have cited this move toward budget deficits, which
was augmented by further tax reductions in the Rev-
enue Act of 1971, as a desirable development in view
of the softness in the economy existing at that time.
The Problem: Budget Deficits
Once getting into this situation, what are the pros-
pects of getting out of it now that economic activity
is expanding quite rapidly? In the fiscal year ending
June 1972, the deficit was $23 billion. With increased
expenditures for existing programs only, including
recently enacted revenue sharing, and revenues from
existing tax laws, it is generally estimated that the
deficit will approach $35 billion in the present fiscal
year. The proposed ceiling of $250 billion on expendi-
tures, which failed in Congress, would have reduced
this deficit to around $27 billion. This ceiling would
thus have contributed little to eliminating the deficit.
Looking further ahead, budget experts outside the
government estimate for fiscal year 1975 that existing
spending programs and taxing provisions will result in
a deficit of $15 to $20 billion if we have full employ-
ment. I believe, along with many others, that the
Federal budget is virtually out of control.
Alternative Solutions to the Budget Problem
Reduce Expenditures — Let us now examine the
alternatives which face us as a result of this bleak
budget picture. An obvious step would be to get the
budget back into balance this fiscal year by cutting
Government expenditures about 14 percent. This is
considerably more than the 3 percent spending cut
implied by the proposed ceiling. In view of the con-
cern expressed over the proposed $250 billion ceiling
and the ever mounting pressures for expanded pro-
grams, such a marked reduction in spending is
unlikely.
Increase Taxes ..- A budget balance could also be
achieved by increasing taxes. This would require a 16
percent increase in Federal Government tax collec-
tions from all sources. This alternative would also be
difficult to achieve in view of the pressures for tax
relief. Furthermore, it may not be desirable for longer-
run control of the budget. Ia mafraid that expansiou
of revenues to meet present levels of spending would
tend to reduce the prospects for close evaluation of
the appropriateness and effectiveness of existing spend-
ing programs. Furthermore, such an expansion would
tend to establish a bad precedent for evaluating the
long-run costs of new programs.
Borrow From Public — if the prospects are not very
good for a marked reduction in forthcoming deficits,
what are the remaining alternatives? The inflationary
impact of the deficits could be reduced considerably
by financing the entire deficit by borrosving from the
public. To attract the funds required from competing
uses would, however, result in a marked rise in inter-
est rates. If past experience is any guide, such a de-
velopment would be strongly opposed by large seg-
ments of the general public and by many politicians.
Accelerate Monetary Expansion — In the face of
such opposition, there would be considerable pressure
to finance the deficits by another alternative, that is
by monetary expansion. This is what happened in the
1965-1968 period when the Federal Reserve System
attempted to resist an upward movement in interest
rates by acquiring an ever increasing proportion of a
constantly growing national debt. Just as in this earlier
period, the rate of monetary expansion would acceler-
ate under this alternative, resulting in accelerating
inflation and eventually in higher interest rates.
Rely on Gontroli — In such a case, another alterna-
tive is to rely on price and wage controls to reduce
the rate of price increase. Such measures, however,
merely treat the symptoms of inflation and not its
underlying cause, which is a rapid trend rate of mone-
tary expansion. With a rapid rate of monetary expan-
sion, controls would have to become progressively
more restrictive if continued progress were to be made
in reducing the rate of price increase. Past experience,
both here and abroad, indicates that price and wage
controls have not been every effective in reducing the
rate of inflation for any extended period of time.
Accept Inflation — Some have given up on the fight
against inflation, and recommend still another alterna-
tive which I find to be particularly objectionable.
They suggest that the best course of action at this time
is to maintain the present trend rate of money growth
and to learn to live with the current rate of inflation.
Page 7FEDERAL RESERVE BANK OF ST. LOUIS
They argue that once a rate of inflation becomes fully
anticipated, as may be possible in the present situa-
tion, individuals can take steps to protect the pur-
chasing power of their income and savings from the
ravages of inflation. On the other hand, they argue
that the short-run costs in terms of reduced output
and employment, \vhich would be expected to accom-
pany steps taken to reduce inflation further, would
be too great to bear.
Id onot accept this alternative. I see no evidence
that our labor, commodity, and financial markets are
such as to permit all individuals equal opportunity to
protect their purchasing power from erosion by infla-
tion. Furthermore, it is not just the case of holding
the rate of inflation constant that the country now
faces, but the more likely case of accelerating infla-
tion. There is no assurance that the economic policy
errors of the past which caused the present inflation
will not be repeated. If such errors were repeated
after we had decided to try to live with the present
inflation, the result would most likely be an even
higher rate of price advance.
Seek Economic Stability Without inflation — There
is one final alternative that I would like to present.
This alternative is to decide to learn to live with eco-
nomic stability without inflation. Our research indi-
cates that it is possible, with appropriate monetaiy
actions, to achieve output and employment growth at
our economy’s potential without inflation. I sec no
reason to settle for anything less than such a goal.
But I realize that attaining this objective in the near
future would entail some temporary, transitional costs
in terms of somewhat slower growth in output and
employment for a while,
Page 8
Conclusion
NOVEMBER 1972
The big question remains is to whether or not our
people have the intestinal fortitude to bear these short-
run costs These costs of curbing inflation were borne
in the late l9SOs and early 1960s As a result our
economy began to experience economic stability with-
out inflation in about 1964 Then a stabilization mis
take occurred with the acceleration of Government
spending in the mid l9 Os Steps were taken to cor
rect this mistake by a sharp reduction in the rate
of monetary expinsion in 1966 and again in 1969
Twice a 1 irge portion of the transitional costs of con
trolling inflationwas borne In each instance the stage
w ~s set for a resumption of output growth at our
country s potential without inflation if money growth
had been resumed at a lower trend rate Following
1966 however prospective short rnn costs were
deemed to be too gieat and the trend rate of mone-
tary expansion was accelerated Following 1969 there
was concern over the short rnn costs that had oc
cured and money growth was resumed at a moderate
r ite for a while But then it accelerated and the trend
rate established earlier was not altered
In conclusion the outlook for 1973 and beyond is
for continued strong growth in output and employ-
ment In view of Federal budget conditions however,
there is also a very pessimistic aspect to the outlook
Unless courageous steps are taken to bring Govern
ment spending under control thcre is a great likeli
hood of nsmg taxes higher interest ratcs more infla-
tion or tougher controls — separately or in various
combinations

The economic outlook

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The economic outlook

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