1970— economy m transition

1970— Economy m Transitionby NORMAN N. BOWSHLER

NFLATION gradually intensified in this countryfrom late 1964 to early 1970, and expectations offuture inflation were progressively revised upward.The interruptions to output and the inequities causedby redistributions of wealth and income resulting fromthe inflation and inflationary expectations became aserious domestic economic problem.

During 1970 inflation remained strong and per-vasive, but the rate of price advance began receding

slowly. Inflation has become imbedded in thinking,expectations, policies, contracts, and regulations. Thisarticle: 1) points out some of the effects of inflation;2) reviews the period during the inflation build-up;3) examines actions taken to resist inflation before1970; 4) discusses alternative courses of monetaryaction for 1970; 5) traces the monetary actionstaken; 6) analyzes spending, production and pricedevelopments in 1970; and 7) presents three coursesof monetary action for 1971.

I:~ffectsof Inflation

Inflation is a rise in the averagelevel of prices or, stated in anotherway, a decline in the purchasingpower of money.’ Because of the keyroles money and money-denominatedassets play, an unanticipated de-cline in the value of money hasmany effects on production and dis-tribution. It affects holders of moneyadversely, reduces the relative valueof outstanding bonds, mortgages,savings accounts, and other dollar-denominated assets, while givingwindfall gains to debtors. Those onpensions and others having relativelyfixed incomes have less real buyingpower with inflation.

1AII price increases are not inflationary. ina dynamic growing economy with overallprice stability, some prices rise while othersdecline. Factors affecting individual pricesinclude advances in technology, changesin resource availability, amounts of capi-tal invested, and changing consumertastes and preferences. Movements of in-dividual prices serve the very useful func-tions of equating supply and demand forindividual products and services and ofallocatinfi the nation’s resources. Attack-ing inflation by controlling individualprices does not get at the cmx of theproblem. Such a policy usnally createsinequities and shortages and tends to stiflegrowth and progress.

Page 2

FEDERAL RESERVE BANK OF ST. LOUIS DECEMBER 1970

Just as thcre are costs and inequities of adjustingto a higher rate of inflation, there are costs andinequities involved in adjusting to a rate of inflationlower than anticipated. Contracts and other commit-ments made on the expectation of continued inflationbecome more burdensome to fulfill if inflation is lessthan anticipated. When excessive spending is damp-ened, many prices continue to move upward as anadjustment to past excesses and inequities, causingdeclines in production and unemployment.

The current inflation is likely to have pervasiveeffects on redistributing income and wealth for a longtime. Costs of adjusting to inflation can be minimizedif the rate of inflation is stabilized for a prolongedperiod. If inflation were stabilized at a zero rate, noadjustments would be required to protect against achanging purchasing power of money.

Accelerating Inflation

Total spending on goods and services rose at anaverage 8 per cent annual rate from late 1964 to thefall of 1969. Since there was little available excesscapacity. increases in real output were constrained bythe growth in the nation’s capacity to produce. Therise in spending was roughly double the estimatedrate of real growth, and prices were gradually bid upuntil, in 1969, overall prices rose more than 5 per cent.

The economy received many expansive shocks be-ginning in 1964. Expenditures of the Federal Govern-ment rose progressively relative to receipts untilmid-1968. Income tax rates were reduced in early1964 to eliminate a “fiscal drag” and get the economymoving. Reflecting the war in Vietnam, defense out-lays of the Government, which had risen at a 1.3 percent annual rate from 1957 to 1964 (national incomeaccounts basis), increased at a 14 per cent rate from1964 to mid-1968. Growth in nondefense outlays of theFederal Covernment was also stepped up from the9.8 per cent rate from 1957 to 1964 to a 12 per centrate from 1964 to mid-1968.2

Studies at this Bank indicate that these fiscal actionsalone were not sufficient to accomplish the rapidgrowth in total spending and the acceleration of infla-tion. Such Government actions may reallocate incomeand resources and may effect the trend growth in

2A summary measure of the Govermnent’s budgetary influ-ence on the economy is provided by the high-employmentbudget (a concept which eliminates the effect of changinglevels of business activity on the budget). This measureshifted dramatically from a $13 billion surplus in 1963 to a$14 billion annual rate of deficit in the first half of 1968.

Federal Budget lnfluenceaeon.

B I — cF_c c’, ~ B.nr — — —__—

a

p

capacity. Initially they also have some influence ontotal spending. However, the aggregate influence ofthe Government budget on total spending is relativelysmall if the resulting deficits or surpluses are financedby the public out of planned saving rather than ac-companied by changes in the money stock.3

Monetary actions were also very expansive begin-ning in late 1964. By supplying more money thanthe public desired to hold, given current levels ofincome, wealth, and interest rates, the public’s de-mand for other financial assets and for goods andservices was stimulated. From late 1964 to early1969 money rose at a 5.3 per cent average rate, upfrom a 3 per cent rate earlier in the decade and a2 per cent rate in the Fifties. Except for the nine-month period of restraint from the spring of 1966 toearly 1967, monetary expansion was at a very rapid7 per cent average rate.

Actions Taken BiAarc 1979 to Resist Tnfiation

As the inflation problem built up, the Governmentbecame concerned and took a number of actions de-signed to restrain it. Unfortunately, many of theactions were insufficient in magnitude, were based on

3”Monetary and Fiscal Actions: A Test of Their RelativeImportance in Economic Stabilization,” this Review (Novem-ber 1968), pp. 11-24, and “Monetary and Fiscal Influenceson Economic Activity — The Historical Evidence,” this Re-view (November 1969), pp. 5-24.

Effects of changes in Govemment activities tend to becrowded out by opposite movements in private spendinwhen the Government finances its deficits with increasedebt to the public. See “The Crowding Out of Private Ex-penditures by Fiscal Actions,” this Review (October 1970),pp. 12-24.

Page 3

FEDERAL RESERVE BANK OF ST LOUIS DECEMBER 1970

poor economic analysis, or had only delayed effects. the higher rates would restrain the expansion of in-Thus they proved to be largely ineffective before1970. Chief actions presumed and intended to beanti-inflationary were using moral suasion to moderatewage and price increases, permitting higher interestrates, regulating credit, raising tax rates, reducing therate of growth of Government spending, and finally,slowing the growth in money.

Moral Suasion — Before the acceleration of inflationbegan in the mid-Sixties, the President’s Council ofEconomic Advisers had presented a set of guidepostsfor labor and management.’ The guideposts and otherappeals to the public were not effective in holdingdown wages or prices when pressures became strong.Workers and businessmen would not forgo returnswhich were available to them. Even if they had, theeconomy would have become less efficient, incentiveswould have been reduced, shortages would havedeveloped, and resources would not have been at-tracted into areas of greatest demand.

Interest Rates — Market interest rates increasedgreatly from 1964 through 1969. Yields on highest-

St*M tStes...t’~’ A ~I. S II E ~k

t~6 1~53 P64 9~fl P44 3M? P44 P4* 3

grade seasoned corporate bonds for example, wentup dramatically from 4.5 per cent in the early Sixtiesto nearly 8 per cent in late 1.969. It was thought that

•Wages were to be raised no faster than the national trendof productivity growth (estimated at about 3 per cent ayear), and prices svere to be established so as not to raiseprofit margins.

vestment and other spending while stimulating saving.

The risc in interest rates was in response to a greatdemand for loan funds by both the Government andprivate sectors, The private sector demand derivedfrom the rapid growth in total spending and anticipa-tions of inflation. With expected inflation. borrowerswere willing to pay higher rates to buy plants andequipment because these items were likely to costmore later.5 Rapid monetary expansion resulted, inpart, from the central bank attempting to moderateinterest rate increases in the short run. But the rapidmonetary expansion. by stimulating total spendingand thereby increasing inflation, led to still greater de-mands for credit and higher interest rates than wouldhave occurred without such monetary expansion.

Credit Regulation — Regulation Q was administeredon the basis of a belief that it would help limit infla-tion. This Regulation, which originated in 1935 underquite different circumstances, was used to keep therates that banks were permitted to pay on time de-posits below market rates during most of 1969, As aresult time deposits in commercial banks fell 5 percent in the year, after rising at a 14 per cent annualrate in 1967 and 1968. Largely a~a result, total creditextended by commercial banks rose only 3 per centduring 1969, following an 11 per cent rate in the twoprevious years.

The total supply of funds, however, was not di-minished; they flowed from supplier to ultimateuser through other channels, such as direct loans,commercial paper, and the Eurodollar market,°Regu-lation Q probably had little or no effect on eithertotal credit extended or total spending. Yet, by di-verting funds through alternative routes, inefficienciesand inequities developed. Homebuyers, small busi-nesses, and consumers, who must rely on local finan-cial institutions to obtain credit, were at a disadvan-tage. Large businesses which could obtain funds incentral money markets received more funds and prob-ably at lower rates than in the absence of the disin-termediation. Small savers were penalized by thelow regulated rates received, while larger lenderswho have more alternatives received higher returns.

5”Interest gates and Price Level Changes, 1952-69,” thisReview (December 1969), pp. 18-38.61n suspending the ceilaig on 30- to 89-day large certificatesof deposit the Board of Govemors noted on June 23, 1970that an expected increase “. . . in bank loans would notconstitute an increase in total credit flows, to the extent thatthey simply represented a transfer of borrowings from otherfinancial avenues Federal Reserve Bulletin (July1970), p. 605.

Page 4


Fiscal Actions — The Revenue and ExpenditureControl Act was signed into law on June 28, 1968.The major features of the Act were a 10 per centsurtax designed to reduce the amount of disposableincome and thereby slow private spending, and a re-quirement that the growth of Government spendingbe restricted. Federal outlays in the national incomeaccounts budget rose at a 6 per cent annual rate inthe last half of 1968 and in 1969, compared with a13 per cent trend rate from late 1964 to mid-1968.As a result of these actions, growth in total spendingwas expected to slow by some mnultiple, placing im-mediate downward pressure on prices.

These fiscal actions of mid-1968 did not producethe results expected by their sponsors. Excessivegrowth in total spending continued at only a slightlyreduced rate. Slower growth in spending by the Fed-eral Government was largely offset by greater outlaysof those who were able to attract the funds formerlyflowing to the Government to finance its deficits.

Monetary Actions — Growth in the nation’s moneystock was slowed markedly in early 1969 in anotherattempt to reduce the inflationary surge. Following arapid 7.6 per cent annual rate of money growth during1967 and 1968, growth in money slowed in the firstseven months of 1969 to a 5.1 per cent rate, and toa 1.2 per cent rate from July to February 1970. Withthe money stock growing at a slower rate than th&

/ \

ne~/ 14*

*

¶~,r~a~3

~

/4~

iii

~~-

-

~-

1....

~

7

/-

T

~7

//—

~—--

±4~\

2OO~\

1\

~

\k~/a~~— -~

\~ ~.- ~.- 6 I \

1~*\

\

~k

~i ,—.. 4. .1_t___ £~

‘‘II N M~$~ 6a~\~4Us?S.a

N / N) NI I N

demand for money, spending was expected to slow asbusinesses and consumers attempted to conserve cashbalances.

As usually occurs after a change in the growthtrend of money, spending continued to be influencedprimarily by the previous trend of money growth forabout six months. Hence, spending continued to riseexcessively until the early fall of 1969, and inflationarypressures intensified despite the monetary restraint.Later in the year, total spending slowed, but pricescontinued to rise in delayed response to the previousexcessive spending. Despite the actions taken, theupward surge of prices continued to acceleratethrough 1969.

Policy Alternatives at the Beginning of 1970

As 1970 began, the economic sjtuation was sufferinggreatly from the fiscal and monetary actions of 1965through 1968. The rate of overall price increase wasabout 5.5. per cent a year at the end of 1969, afteraccelerating for five years. Real production was notexpanding, unemployment was rising slightly, andcorporate profits were declining. Both bond and stockprices were lower than a year earlier. On the favorableside, the battle against inflation had begun to showthe first signs of success. The excess demand, whichwas the major causal link to inflation, had beenmoderated.

The crucial consideration for the nation in the com-ing year was to determine how rapidly the priceeffect of the past excesses could and should be extin-guished. If restrictive monetary actions were aggres-sively pursued, the rise in total demand for goodsand services might slow rapidly, and inflationarypressures might be extinguished sooner than other-wise. However, the transitional costs in terms of lowerproduction, employment, and incomes would be se-vere, and the temptation would be strong to restimu-late the economy before the task was completed, ashad been done in 1967.

On the other hand, if demand grew so rapidly asto permit growth in production, employment, and realincomes to continue at near their long-run optimaltrends, moderation of inflation might never beachieved. In such a case, the country would continuefor a prolonged period to suffer inefficiencies and in-equities caused by a continuous erosion of the valueof the dollar. Some middle course seemed more ad-visable than either a quick vigorous correction or thetoleration of endless, and possibly increasing, inflation.

Page 5

‘1 In P1 r In In U, 2 0 U, -I C It)

,~—

t

S.

~“cm

cm cmcm -.

~.

-i

on

~~

~.

Er

QA

~g

uczt

cm—

.

04~

U In

cm°

0 m In

—

0

-t


cent in late 1970 and to about 5.5 per cent in late1971. After two years of such a policy, the simulationindicated the rise in prices would slow only graduallyfrom the 5.3 per cent rate in late 1969 to about a5 per cent rate in late 1970 and to about a 4.5 percent rate in late 1971.

The choice was difficult. No policy alternativepromised a quick, painless elimination of inflation.Fewer real goods and services would be availablebecause of lost production and unemployment, andpain caused by inequities and inefficiencies of infla-tion would continue. One lesson from the experiencewas obvious; more care should be taken in the futureto avoid such mistakes as those of 1965 through 1968which generated the strong inflationary momentum.

Monetary Actzonh. Dnring .1 970

Early in 1970 the Federal Reserve System adopteda more expansive policy and began placing moreemphasis on monetary aggregates in policy formula-tion and implemncntation. Late in 1969 the System’sOpen Market Committee (the chief policymaldnggroup) had directed the operating manager to main-tain the prevailing firm conditions in money markets.8

This was a continuation of the policy which had re-sulted in the slow growth of the money supply be-ginning in July 1969.

At the January 1970 meeting a slight easing ofpolicy was adopted, and the manager was requested,among other things, to seek a modest growth in moneyand bank credit.° At the February meeting (andmost subsequent meetings for which directives havebeen made public, after about a three-month lag) themanager was requested to seek a moderate growth inmoney and bank credit.1°The word “moderate” pre-sumably implied more expansion than ‘modest.”

The word “moderate” in the directive was inter-preted to nmeau different rates of expansion from onemeeting to another. In general, policy in terms ofmoney was initially to seek about a 3 per cent annualrate of increase; at the May 5 meeting, the target wasraised to 4 per cent.” During the late Spring andearly Summer when fears of financial panic arosesvith the declines in security prices, the Committeetemporarily agreed that operations should be adjustedas necessary to moderate unusual pressures in finan-cial markets, should they develop. The money mar-

8Federal Reserve Bulletin, March 1970, pp. 273 and 278.

°FederalReserve Bulletin, April 1970, p. 339.‘0Federal Reserve Bulletin, May 1970, p. 442.

“Federal Reserve Bulletin, August 1970, p. 631,

ket conditions specified in the meeting of May 26were thought to be consistent \vith a 7 per cent rateof money expansion from March to June.” At themeeting of June 23, the Committee adopted a targetrate of about a 5 per cent growth rate in the moneysupply from June to September.13 This target wasreaffirmed at meetings of July 21 and August 18 (thelast released record) ~14

The directives, however, were not without ambigu-ity. Money was not the only aggregate to be con-trolled; the Manager was also directed to obtain amoderate growth in bank credit. Because of the re-intermediation of time deposits following relaxationsof Regulation Q in January and in June and declinesin market interest rates, bank credit rose very rapidly.It became clear that the System could not count onobtaining the specific objectives with respect to bothmoney and bank credit. The primary emphasis wasplaced on the money objective in the directive ofAugust 18. The bank credit effects of the reintermedia-tion were viewed as a substitution of bank credit forother credit.

Even though the Committee sought a given rateof growth in money, it was not intended that themanager was to seek this trend rate each day, eachweek, or even each month, The reason for not rigidlyapplying the aggregate guide in the short run was toavoid the gyrations in interest rates that was thoughtmight be produced by a strict adherence to the ag-gregates. In these shorter periods the manager wasto operate, as previously, with an eye to moneymarket conditions. The conditions selected were thosethought to be consistent with a growth in the ag-gregates at the desired rate over a period of aboutthree months. Whenever the aggregates appeared tobe deviating significantly from the desired path, themanager was to permit changes in the money marketconditions to develop with an objective of getting theaggregates on course. This procedure was not precise,but largely a trial and error .approach. Also, moneymarket conditions were not always used merely as ameans to obtain the desired growth rate in money;at times money market conditions became an end inthemselves to be considered along with the aggregatetargets.

From December 1969 to the four weeks endingDecember 4, 1970 the mnoney stock rose at a 5.5 per

2Federal Reserve Bulletin, September 1970, pp. 711-13.

l3Ibid., pp. 717-19.

“Federal Reserve Bulletins, October 1970, pp. 762-3 andNovember 1970, p. 820.

Page 7


N N / ~M~aYHStO&NN N N~ N~

/ NNI~ N~r $4

NNfl~—--~ -_____

N~

~t

1N86

\

~r~---~---~

4,~ I iiI,~ ~‘i’,i~’iti litil lit !I,I i/NS Mt

N

N

cent annual mate. This rate of increase was calculat don the basis of the revised series (November 1970)and was slightly faster than the rate calculated usingthe old series. Even though money grew on averageat about the desired rate, the performance may havebeen accidental. From February to the four weeksending June 17, a period when there was an inten-sification of money market pressures and some inter-est rates rose, money expanded at a rapid 9 per centannual rate. From the four weeks ending June 17 tothe four weeks ending November 25, when moneymarket conditions eased markedly and interest ratesfell, money rose at a 3.7 per cent rate. This wassimilar to the previous pro-cyclical tendency of theSystem to inject money rapidly at times of hugecredit demands (usually acconmpanying strongerbusiness conditions), and to withdraw money or in-ject it slowly at times of weak credit demands (usu-ally accompanying contractions in business activity).The pro-cyclical tendency of System actions whenformulated in money market conditions terms wasone reason for the System to shift to monetary aggre-gates in the formulation and implementation ofmonetary policy.

Studies at this bank indicate that temporary varia-tions from trend, of the magnitude and duration ofthose experienced during 1970, have no significanteffect on total spending, prices, production, or em-ployment. If the deviations were larger or were al-lowed to persist longer, they would have undesirableresults.

Money rose roughly 5 per cent in 1970, based onquarterly averages of daily figures, increasing at an-nual rates of 4 per cent from the fourth quarter of1969 to the first quarter of 1970, 7.2 per cent fromthe first to the second quarter, 5.3 per cent from thesecond to the third, and an estimated 4 per centfrom the third to the fourth. During the Fifties andearly Sixties, a 5 per cent growth of money wasextraordinarily high and, if long maintained, tendedto cause accelerating inflation, With the strongly im-bedded inflation in 1970, however, spending could bepermitted to expand faster than the growth of produc-tive capacity and still place some downward pressureon prices. By permitting a growth in spending at arate faster than in previous attacks on inflation, costsin terms of lost production and unemployment mnaybe expected to he kept at relatively low levels.

Short-tenn interest rates declined sharply during1970. There was a slowing in the demand for funds,reflecting a moderated growth in spending followingfrom the monetary restraint of 1969. Also, there wereincreasing supplies of short-term funds resulting frwnthe more rapid injection of money during 1970 andfrom the temporary use of proceeds of long-termfinancing. Yields on prime 4- to 6-month commercialpaper averaged 5% per cent in early December, downfrom 9 per cent in early January. The three-monthTreasury bill rate was below 5 per cent in earlyDecember, compared with nearly 8 per cent at thebegiuning of the year. Reflecting the same forces, therate charged prime business customers by commer-cial banks was lowered from 8½per cent earl)’ inthe year to 8 per cent in March, to 7½per cent inSeptember and to 7 per cent in November. The dis-count rate (the interest rate charged member banksby Reserve Banks) was out of touch with marketrates early in the year, but as market rates declinedmarkedly, the discount rate was reduced from 6 percent to 5½per cent in November and early Decemberto keep it in line with other rates.

Long-term interest rates remained relatively highduring 1970; mnortgage rates changed little on bal-ance while yields on municipal and Govermnent secu-rities declined from peak levels. Yields on highest-grade seasoned corporate bonds averaged about 7.8per cent in early December, about the same as ayear earlier. The continued high rates, despite someslowing in the growth of spending and presumably inoverall credit demands, reflected in considerablemeasure the strongly imhcdded inflationary expecta-tions. With great inflationary expectations, incentives

Page 8


to borrow long are increased while incentives to lendat long term are reduced. Demands for long-termfunds may also have been bolstered by an attemupt toimprove liquidity.

Economic Developments in 1970

Total spending on goods and services rose at a 4.6per cent annual rate during the four quarters endingwith the third quarter of 1970, despite some largecutbacks in production of war goods. This was ap-proximately the growth in spending the St. Louismodel had simulated given the monetary expansionwhich occurred. In the fourth quarter spending wasinterrupted by the major automobile strike, but muchof the loss is expected to be made up within a fewmonths after resumption of full production. By com-parison spending rose at an excessive 8 per centaverage rate from late 1964 to late 1969.

/ N N N N

/ ~I )N ~N NNS/9$It

‘u — S~LN N /\ \/\\ I 1’ I#~ N~ ~,,-

Prices continued to rise in 1970 as a result of pre-vious expansionary fiscal and monetary actions andconsequent excessive total spending. However the ac-celeration of price increases was stopped early in 1970,

and in the fall of the year signs became widespreadthat inflation was receding moderately. Prices of thesensitive thirteen raw industrial commodities havedeclined since early 1970. Overall prices rose at a 4.4per cent annual rate from the first to third quarterand probably continued to rise at approximately thatpace in the fourth quarter. By comparison, theseprices went up at a 5.3 per cent rate from late 1968to early 1970. Consumer prices have risen at a 5 percent rate since April, after increasing 6 per cent inthe previous twelve months.

Hourly earnings in manufacturing, adjusted to ex-clude effects of overtime and intcrindustry shifts,have risen 6.6 per cent in the last twelve months.Adjusted for price increases, these earnings have in-creased about 1 per cent. When the value of fringebenefits is added, real earnings have probably in-creased more than estimated output per man hour.Nevertheless, these figures raise some doubt aboutthe belief that the recent inflation has been the resultprimarily of a wage-push situation,

With prices rising about as fast as total spending,production \vas changed little on balance during thefirst three quarters of 1970. There was a small netdecline in the first quarter largely offset by slightrises in the second and third quarters. Productionprobably fell again in the final quarter of the year,but this was mainly the result of the automobile strikeand probably did not reflect cyclical influences.

During 1970 the labor force grew, capital was in-vested, and there were advances in technology. Asa result, productive capacity was rising while totaloutpnt changed little on balance. Accordingly, re-sources not utilized or underutilized increased. Com-petition fromn these resources was the main forcewhich tended to reduce the upward momentum ofprices.

One indication of the utilization of capacity is pro-vided by the employment rate. Employment declinedfrom 95.8 per cent of the labor force in the firstquarter of 1970 to about 94.5 per cent in the earlyFall. Later in the year employment drifted a littlelower in response to the interruption caused by theauto strike, In terms of married men, employmentdeclined from 98 per cent early in the year to 97.1per cent in the Fall.

All unemployment does not represent excess capac-ity. Workers leave jobs in search of better opportuni-ties; some activities are seasonal; some people havebut marginal production capacity; and some become

Government spending rose more rapidly than pri-vate spending in 1970. Federal Govermnent expendi-tures rose at a 7.4 per cent annual rate in the firstthree quarters of the year, state and local governmentoutlays expanded at an 11.1 per cent rate, and privatespending increased at a 4.4 per cent rate. Defenseoutlays were reduced at a 5 per cent rate, whilespending on all other programs of the Federal Gov-ernment rose at a rapid 16 per cent rate.

Page 9


Unemployment Rates

Woth~

-

range. In the economic expansionbetween the 1958 and 1960 reces-sions, unemuployment reached alow of 5 per cent. In 1958 and againin 1960 when downward pressurewas applied to inflationary pres-sures, unemploymnent rose tempo-rarily to 7 per cent and above. Whenunemployment remained below a5 per cent rate in 1965 through 1969,inflationary pressures intensified.Given minimum wage laws andother features of American labormarkets, it may be that 5 per centrather than4 per cent or less unem-ployment is about the practicalnon-inflationary minimum. Attemptsto maintain the unemployment rateat some artificially low level maysucceed temporarily but ultimatelywill only assure accelerating inflation,& N N~

N \\~N\N\NN\ \N

N N A~#toi/tMrn8cnN I I I

unemployed temporarily when bus-inesses are forced to cut back orclose because they are no longercompetitive. Comparisons with pre-vious periods may be helpful inevaluating the present unemploy-ment rates. The recent 5.8 per centrate of unemployment (includingstrike effects) compares with a 5.2per cent rate in 1964, the last yearof pronounced economic expansionwithout accelerating inflation, In1962 and 1963 unemployment re-mained in the 5½ to 6 per cent

N N\ ~ \-\~N~ N/ /<

~ct~m m 5 N N\ /1 N

1*/I N // /

Tn caampln.mtnt N N

t8

rat ~ I cat tBA~ ~ ~N N N ~I ~ N

N~tI>/~/

--~--~- ----~

Nfl3 9 9 / NN N N N N \N/N\// / I//N

Page 10

FEDERAL RESERVE BANK OF ST. LOUIS

Another measure of the utilization of labor is thenumber of people actually working relative to thecivilian population of workmng force age. The Novem-ber level of 63.7 per cent is down from the peak,but still higher than anytime in the Fifitics or Sixtiesbefore late 1966. Another indication of the magnitudeof the cmploymnent situation is the duration of un-employment. This past fall the average length ofuneniployment was about 9 weeks, up from about 8weeks in 1969, hut still substantially below the 12weeks or longer from 1958 to early 1965.

Corporate profits, after taxes, declined from a peakof $49.7 billion in the second quarter of 1969 to $45.4billion in the third quarter of 1970. Since the inflationbegan increasing in 1965, corporate profits have de-clined from 6.8 per cent of gross national product to4.6 per cent.

Policy Choices for 1971

As the new year begins, the critical question stillremains, “How rapidly should the nation proceed inreducing inflation?” Prices arc rising more slowlynow than a year ago, and sonic further downwardpressure has been accumulated that may be expectedto reduce the inflation further in 1971. Even so, pricesare likely to continue rising at a rather fast pace. Atthe same time, production is below capacity, someare unemployed, and the economy is sluggish.

The choice for the nation, as a year ago, is oneof the lesser of evils. It serves no purpose to pretendthere is an easy, costless, quick cure to inflation. Theadverse consequences of the mistakes of 1965-68 con-tinue to bear heavily on the nation. To focus solelyon either the inflation or the capacity utilization prob-lem is apt to intensify the pain and suffering fromthe other. Sonic comnpromise has to be made. ThisBank has again made simulations of prospective eco-nomic conditions, assuming various courses of mone-tary action. For the model simulations, FederalGovernment expenditures through second quarter of1971 have been estimated by this Bank and havebeen projected thereafter to grow at an 8 per centannual rate. The calculated figures were smoothedjudgementally in the lower half of the table on page12 to remove irregular fluctuations.

One course of action which might be followedwould be to continue to seek a 5 per cent growthrate of money, the rate planned in the last-releasedrecord of pohcy actions. With such a growth of money,total spending growth might accelerate from the 4.5

DECEMBER 1970

per cent rate of the past year to about a 6.5 per centrate in late 1971. If such a growth of money weremaintained, spending might be expected to continueto grow at about the 6.5 per cent rate in the first halfof 1972. Real output. which declined slightly in thepast year, would probably be growing at about a2.5 per cent rate a year from now. These simulationsare designed only to project most probable cyclicaland trend influences of money and the Federal budgeton the economy. They do not purport to projecterratic short-term developments, such as a bulge inspending and production after the auto strike andany dip in case of a steel strike.

The model indicates that with the 5 per cent growthof money, inflation would most likely still remainstrong at the end of next year, with overall pricesrising at about a 4 per cent annual rate. Recently,prices have been rising ~tt about a 4.5 per cent pace.Unemployment would most likely move up from therecent 5.5 per cent of the labor force (excludingstrike effects) to around a 6 per cent level.

If the nation desired a quicker approach to reduc-ing inflation, a 2 per cent growth rate of moneymight be undertaken. The simulation indicates thatspending under this policy might be down to abouta 3.7 per cent growth rate a year from now. In-flation would be reduced slightly faster than ‘withthe 5 per cent rate of growth of money, dropping toabout a 3.5 per cent rate a year from now and toabout a 2.8 per cent rate by mid-1972. Production,however, would be very sluggish, and unemploymentmight rise to about 6.5 per cent of the labor force inlate 1971 and to over 7 per cent by mid-1972. Withunemployment at such a level, the temptation torestimulate the economy would become great re-gardless of inflationary consequences.

If it is desired to attempt to hold the adjustmentcosts in terms of lost production as low as possiblein 1971 and early 1972 while placing some down-ward pressure on prices, a faster 8 per cent rate ofmnoney growth mnight be selected. In this case, modelsimulations indicate that spending might rise to abouta 9.5 per cent growth rate in the Fall of next year andremain at that pace in the first half of 1972. Produc-tion would be rising at faster than an assumed 4 percent long-term trend in late 1971 and in early 1972,and unemployment would probably not reach 6 percent and would be declining in late 1971 and in early1972. Prices, however, would continue to rise for along, long time, since the rate of increase would beinching down very slowly. The total cost in lost pro-

Page Il


Table II

Current Projections of Total Spending, Real Produci, Prices, Unemployment, and lnteresf Rates

1970 1271. 1972

Ill IV I, II Ill IV I, II

Actual EmIl mated . Proj.:ctionAssumed R&es of Chance

i,n Marcy Stock AS GENERATED DIRECTLY BY THE ST. LOUIS MODEL2 Per Cent

Annual Rate of Change in:Nominal GNP 6.1’ 6.3;: 55~ 4.3 6.2 ‘ 3.1 2.7 3.5Real GNP 1.4 16 1.0 0.1 2.) 0.6 --0.6 0.6

GNP Price Deflator 4.6 4.6 4.5 4.2 4.0 3.7 3.3 2.9Unemployment Rate 5.2 5.4 5.6 5.9 6.2 6.3 6.7 7.0Corporate Aoa Rate 8.2 7.9 8.0 8.0 7.9 7.7 7.5 7.3

5 Per Cent

Annual Rote of Change in:Not&nal GNP 6.) 63 6.1 6.1 9.0 6.4 5.8 6.5

Real GNP 1.4 1.6 1.6 1.7 47 2.3 2.0 3.0GNP Price Deflator 4.6 4.6 4.5 4.3 4.2 4.0 3.8 3.5

Unemployment Rate 5.2 5.4 5.6 5.8 6.0 6.0 6.1 6.3Corporate Aaa Rate 8.2 7.9 7.9 7.9 /.9 7.7 7.6 7.4

Per CentAnnual Rate of Change Inc

Nominal GNP 6.1 6.3 6.8 78 ii 9 9.6 8.9 9.6

Real ClIP 1.4 1.6 2.2 3.4 7.3 5.2 4.6 5.3ClIP Price Deflator 4.6 4.6 4.5 4.4 4.3 4.3 4.2 4.1

unemployment Rate 5.2 5.4 5.6 5.7 5.8 5.6 5.5 5.5Corporate Aaa Rate 8.2 7.9 7.7 7.8 7.8 7.7 7.6 7.5

AS SMOOTHED TO REMOVE IRREGULAR FLUCTUATIONS2 Per Cent

Annual Rate af Change inNominal C-NP 5.6. 6.0 5.7’~ 4.8’. 4.1 3.7 . 3~ 3.5.Real GNP 0.9 1.4 1.2 0.6 01 —-0— 0.3 0.7ClIP Price Deflator 4.7 4.6 4.5 4.2 4.0 3.7 3.3 2.8

Unemployment Rate 5.2 5.4 5.6 5.9 6.2 6.3 6.7 7.0corporate Aaa Rate 8.2 7.9 8.0 8.0 7.9 7.7 75 7.3

5 Per Cent

Annual Rate of Change n:Nominal GNP 5.6 6.0 6.3 6.4 6.5 6.5 6.5 6.5Real GNP 0.9 1.4 1.8 2.1 2.3 2.5 2.7 3.0GNP Price Defla’ar 4.7 4.6 45 4.3 4.2 4.0 3.8 3.5

Unnrrplayner.t Rotc 5 7 5.4 5 6 5.8 5.9 6.0 6.1 6.2Corporate Aaa Rote 8.2 7.9 7.9 7.9 7.8 7.7 7.6 7.4

S Per cent

Annual Rate of Change inNominal ClIP 5.6 60 7.2 8.5 9.5 9.5 9.5 9.6Real GNP 0.9 1.4 2.7 4.1 5.2 5.2 5.3 5.5ClIP Price Deflator 4.7 4.6 4.5 4.4 4.3 4.3 4.2 4.1

unemployment Rata 5.2 5.4 5.6 5.7 5.8 5.6 5.5 5.4Corporate Aaa Rate 8.2 7.9 7.7 7.8 7.8 7.7 7.6 7.5

b::’ ‘ ..‘. nc..,,’— c_’ ‘he .1,1 Ii’ ‘.ini ‘‘‘:,,,c,~ “.1 1: ‘cc’’. :l ci.::. sh—,s::h~ ,..,..,. ~ 11:,...:. .rc.~ .—— nIt—I ic,T —nil,.:,:. i’ t

1fl 1,1.1 Ii:’2’.—cr,..c..’,.,c’,:’c., rU

,‘‘i’,idaL I,,.,, .~‘rI;I’’j(’,.,,(~~ i fl~J•I~~ ~ j’.. . fl.,.n~ ,: Pc’’~: ,.~rcc.—. .1,.

Page 12

FEDERAL RESERVE UANI< OF ST. LOUIS DECEMUER 1070

duction might be as great or greater under this course,if price stability is ever to be achieved, as it would heunder a more aggressive approach, since actions todampen inflation would have to be continued muchlonger.

Conclusions

Inflation in recent years has been one of thenation’s most serious domestic economic problems. Itcauses inequities and inefficiencies, and prejudicesthe future viability of the economic system. Theprocess of its elimination is inevitably causing anunderutilization of labor and other resources. Thefirst effective steps in eliminating the inflationary mis-takes of 1965-68 were taken by the monetary authori-ties in 1969, yet price increases continued unabatedthroughout that year. Monetary actions were relaxedin early 1970 but have continued to be anti-inflation-ary. During 1970 the rate of inflation began ebbing,with overall prices rising at an estimated 4.5 per centrate no~v,compared with a 5,5 per cent rate a yearago.

The transition to a lower rate of inflation has beenpainful for many. Real product has increased little, ifat all, and contracts based on expected continuedrapid inflation are costly to fulfill. Yet, given thestrongly imbeddcd inflation, the costs of reducing it

have not been so great as one might have anticipatedfrom previous attempts at arresting inflation in thiscountry. Studies at this Bank indicate that the cut-backs in production and employment in the 1969-70battle against inflation were smaller because the na-tion’s money stock was not permitted to decline, asit did in previous periods of correction. Since early1969 money has expanded at an average 4 per centannual rate.

Simulations using the Bank’s model indicate that ifmoney continues to rise moderately, further progresswill be made in 1971 in reducing the pace of priceincreases. However, the battle will not be won easilyand without cost. Expectations of rising prices arestill strong. Some prices, such as those in term con-tracts and union wages, were relatively inflexibleduring the excessive spending of the late 1960’s. Otherprices were temporarily held back by inertia, a money

illusion, lack of knowledge of costs, public opinionand Government regulation. As these wages and pricesnow move toward equilibrium levels, the increasedproduction costs place upward pressure on otherprices.

Some believe that prices and wages could be heldstable with much less cost by merely “controlling”them. It seems so simple to just have the Governmentoutlaw inflation. Suggestions have taken a variety offorms from a broadscale rigid control of all prices,with severe penalties for violations, to a temporaryfreeze, to a control of certain key prices, and even tousing persuasive tactics called “jawboning.” Yet, pastattempts to control prices both here and abroad in-dicate that such controls have been largely ineffective.Controls are frequently circumverted through black-markets, quality deterioration, clever pricing, or otherdevices. Controls are costly to adminster, impinge onfreedom, create shortages (usually requiring ration-ing), mnisallocatc resources, and frequently slow therate of economic growth.

A contribution can be made to a more rapid solu-tion of the problems of inflation and underutilizationof capacity by improving the market system. Such ac-tions might include reducing subsidies, tariffs andimport quotas, wideuing the scope of the anti-trnstlaws to cover more monopolistic practices, increas-ing the skills of workers, eliminating outdated build-ing codes and other barriers to greater productivity,and modifying the minimum wage laws in the inter-est of improving job opportunities for teenagers andthe handicapped.

Progress has been made on the inflation problem.Costs have occurred in reducing it, but so far theyhave been less than in any previous attempt. Con-tinued perseverance along the general course chartedin the past two years would seem to be appropriatein 1971. As long as total spending continues to growat a moderated rate, both the inflation and the capac-ity utilization problems wifi he gradually solved asthe effects of past maladjustments atrophy. Experi-ence demonstrates that Government actions designedto shock the economy into a quicker adjustmenthave usually had net adverse consequences.

Page 13

1970— economy m transition

Documents