Speech

For Release on Delivery Saturday, June 20, 1970 10:00 a.m. (E.D.T.) ECONOMIC POLICY AND THE RESTORATION OF PRICE STABILITY IN THE UNITED STATES Remarks By Andrew F. Brimmer Member Board of Governors of the Federal Reserve System Before the Annual Convention of the Vermont Bankers Association Equinox House Manchester, Vermont June 20, 1970 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis ECONOMIC POLICY AND THE RESTORATION OF PRICE STABILITY IN THE UNITED STATES By Andrew F. Brimmer* The campaign to restore price stability in this country has now moved onto the crucial testing ground. The next few months may well determine whether we stay on the field until the objective is achieved -- or whether we lose heart as the real costs of fighting inflation become increasingly evident. For me, personally, the proper course is clear: national economic policy should continue to give a high priority to checking the inflation that has plagued this country for the last five years. Unfortunately, it appears that this objective no longer enjoys the widespread support evident as recently as last winter. Of course, few people-- if any -- would advocate publicly the abandonment of the effort to restore price stability. However, it is also becoming evident that this target is being downgraded by some observers, and public officials are being urged to revamp policies to reverse the slowdown in economic activity that has been underway for the last year. ^Member, Board of Governors of the Federal Reserve System. I am grateful to several members of the Board's staff for assistance in the preparation of these remarks. Mrs. Mary Smelker and Mr. William Costello helped with the analysis of price trends. Mr. James R. Wetzel helped to trace labor market developments, and Miss Harriett Harper assisted in the analysis of changes in national income. Messrs. Henry S. Terrell and Jared J. Enzler made separate contributions (through the use of econometric techniques) to the analysis of the effects of changes in real output on prices and employment, respectively. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -2- I can understand these concerns. The pace of economic expansion has slowed considerably. There has been little -- if any -- growth in real output for the last nine months; in fact, there was an actual decline during the six months ending in March. The expansion of employment has slackened, and the unemployment rate has risen significantly. The margin of unused industrial capacity has also widened appreciably. Thus, measured by any standard, the economy is operating well below its potential, and prospects are for a continua- tion of this trend for a number of months -- regardless of the course of public policy over the near term. Yet, there is an element of dissonance in all of this: the ravages of inflation are still wasting the income and wealth of the nation. An inflation which had its origins in the excess demand created by an investment boom and the acceleration of the Vietnam War five years ago has been transformed into a cost inflation whose tenacity has been consistently underestimated. The distortions resulting from the persistent rise in prices have become deeply rooted. So, in my opinion, the time and effort required to correct these strains will be both long and difficult. Given this outlook, I think it is far better that we rededicate ourselves to this task -- rather than use our energies and imagination in a vain pursuit of measures which might promise relief from inflation while failing to redress the imbalances that inflation itself has created. In the rest of these remarks, I will try to share my own assessment of the magnitude of the unfinished assignment which we Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -3- still face. I will also indicate my own view of the appropriate role for monetary policy over the months ahead. In the meantime, the principal conclusions of the analysis can be summarized briefly: Serious inflation still exists, and there is little prospect of eradicating it in the near future. While the pressures of excess demand have been dampened significantly, the pressures on costs and the shrinkage of real income have transformed the inflation into a type that is even more difficult to master. The element that is the most difficult to overcome is the expectation that inflation may -- in fact -- continue. Yet, the mainsprings of the current inflation are being drained. The business investment boom is finally waning, and outlays for fixed investment in the current year may rise at a rate only half that recorded a year ago. Federal Government expenditures in the current year may actually decline. The main reason centers in defense spending. While the debate over the Vietnam War has intensified, the unwinding of the military effort is becoming increasingly evident in economic terms. For example, almost one-third of the decline in industrial production since last July and about the same proportion of the rise in unemployment in manufacturing in the last year can be traced directly to the waning impact of defense spending. The real costs of fighting inflation are mounting rapidly. Among these, the sizable increase in unemployment is undoubtedly the most visible. The unemployment rate (which averaged 4-1/2 per cent in the January-May months) probably will rise steadily during the second half of the year; it may average 5-1/2 per cent over the next six months and 5 per cent for 1970 as a whole. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -4- Yet, the pace of inflation may slacken only moderately. By the end of the year, prices will most likely still be rising at rates well beyond what the public would find acceptable in the long-run. Thus, a serious dilemma is posed: how much unemployment is the public willing to endure as a by-product of the campaign to check inflation? Some of the analytical work I have done suggests that a significant impact on the pace of infla- tion can be achieved only if we are prepared to see the economy run well below capacity -- including a somewhat higher level of unemployment -- for quite some time. The implications of these results for national economic policy are clear. While pressing on with the fight against inflation, we should also press on With the adoption of the necessary measures to ensure that the burdens will not fall unduly on a few segments of society. With respect to monetary policy, in my personal judgment, we should see that the growth of bank credit is kept moderate enough to avoid reinforcing an inflation whose successful checking remains to be accomplished. Origins and Transformation of Domestic Inflation We need not dwell on the genesis of the current inflation, for this has already been explained many times. It is sufficient to remind ourselves that its mainsprings center in a business investment boom and the acceleration of the Vietnam War in mid-1965. At that time, the economy was already on the eve of full employment, having been propelled forward partly by public policies designed to stimulate Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -5- fuller use of the nation's resources. The rapid rise in demand for goods and services for military purposes (unmatched by higher taxes to pay for the war) made the Federal Government a principal source of infla- tion. For three years -- until the passage of the 10 per cent income tax surcharge in mid-1968 -- this situation continued. Under the circumstances, most of the burden for fighting inflation fell on monetary policy. Year-by-year, the pace of inflation has accelerated. This trend can be seen most clearly in the behavior of the gross national product (GNP) implicit deflator, the most broadly based of the various price indexes. During the long period of substantial price stability between 1961 and 1964, the GNP deflator rose at an average annual rate of 1.5 per cent. But beginning the next year, the advance quickened: 1965, 1.9 per cent; 1966, 2.7 per cent; 1967, 3.2 per cent; 1968, 4.0 per cent; 1969, 4.7 per cent. During the first quarter of this year, the deflator rose at a seasonally adjusted annual rate of 6.2 per cent. (Excluding the effects of the Federal pay increase, the rate of advance was 5.2 per cent). In the first quarter of last year, this index rose at an annual rate of 4.7 per cent. Expressed differently, nearly four-fifths of the increase in GNP (measured in current dollars) between 1961-64 represented the growth of real output, and just over one-fifth reflected the effects Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -6- of inflation. Even in 1965, the division between real output and prices was not appreciably different: three-fourths vs. one-fourth. In contrast, in the four years ending in 1969, the rise in current dollar GNP was split about 50-50 between real output and prices. Taking last year alone, less than two-fifths of the increase reflected a gain in real output, and over three-fifths reflected the rise in prices. By the first quarter of this year, all of the increase in current dollar GNP (3.1 per cent at an annual rate) was due to prices, since real output fell by 3.0 per cent (also at an annual rate). As we look ahead, it appears that the GNP deflator may advance by as much as 5 per cent for 1970 as a whole -- thus continuing the year-to-year acceleration stressed above. However, by the closing quarter of the year, the pace of inflation probably will have moderated somewhat, and this index may be advancing at an annual rate of approxi- mately 3-1/2 per cent -- while further moderation might be expected as we move through the first half of 1971. Nevertheless, for the current year, we may well experience virtually no increase in real output -- in the face of a 5 per cent rise in the general level of prices. Thus, during 1970, for the first time since 1958, real GNP might fail to grow. So this nation, for the first time in well over a decade, may fail to achieve any improvement in its real economic welfare. Under the impact of rising prices -- as one woaUl expect -- virtually every group has made an effort to protect its own income Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -7- position. In numerous sectors of the economy, this has resulted in a substantial increase in costs and has thus become a major source of inflationary pressures. For example, for the private nonfarm economy, hourly compensation costs -- including both wages and fringe benefits -- rose at an annual rate of about 7 per cent in the first quarter of this year. This was about the same rapid rate recorded in 1969. At the same time, the available figures show slight declines in productivity (defined as output per manhour) in the private nonfarm sector of the economy. Compared to a year earlier, the decrease amounted to 0.4 per cent in the first quarter of this year and to 0.7 per cent in the closing quarter of 1969. For last year as a whole, there was an increase of only 0.4 per cent. Over the post-World War II period, productivity had risen nearly 3 per cent annually for the private nonfarm sector. Reflecting the very rapid increases in hourly compensation and the absence of productivity gains, unit labor costs have risen at an extremely rapid rate in the last year. By the first quarter of 1969, such costs were 5.1 per cent above the level in the same period of 1968; by the January-March period of this year, unit labor costs were 7 per cent higher than a year earlier. In the important manufacturing sector, however, the productivity and unit labor cost picture appears to have changed in recent months. Productivity increases have resumed after a dip in late 1969, and unit labor costs have been stable since Jast December. These developments are largely a result of the very Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -8- substantial employment and hours reductions of recent months. While such a pattern is consistent with sharply higher unemployment, it has also been the harbinger of easing cost and price pressures in other periods of economic contraction. So, while the pressure of excess demand which has plagued the economy during most of the last five years has subsided, the actual impact on inflation has been modest -- so far. But the emerging evidence suggests that real progress is possible -- if we remain stead- fast in the task ahead of us. Waning of the Business Investment Boom The unfolding evidence also suggests that the strong infla- tionary pressures generated by business demand for facilities may be lessening -- finally. In the first quarter of this year, outlays for fixed investment (structures and producers durable equipment) were at a seasonally adjusted annual rate of $104 billion. This level was $8.7 billion (about 9 per cent) above that recorded a year earlier. For 1969 as a whole, the growth amounted to $10.4 billion, or 11.7 per cent. In every year since 1964, business fixed investment has accounted for between 10 per cent and 11 per cent of GNP measured in current dollars. The ratio in the first quarter of this year was 10.8 per cent. However, the critical role of business investment can be seen most clearly in the impact of changes in investment outlays Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -9- on the overall rate of economic activity. In 1961, such expenditures accounted for about 9 per cent of GNP, and they represented 10 per cent of the increase in GNP in the 1961-63 period. But in 1964, the first wave of the investment boom got underway, and the increase in fixed investment outlays represented 16 per cent of the rise in GNP. The next year, the proportion climbed further to 18 per cent. In 1966, partly reflecting the impact of monetary restraint in that year, the ratio declined to 16 per cent. It fell further in 1967 (to 5 per cent) and recovered moderately (to 7 per cent) in 1968. But last year, despite the existence of a policy of severe monetary restraint, the advance in fixed investment expenditures again accounted for 16 per cent of the rise in GNP in current dollars. Measured in real terms (and thus adjusting output for the effects of price changes), the impact of the business investment boom on economic activity was even more dramatic. In the period 1961-63, the rise in such expenditures was equal to 12 per cent of the increase in real output. In 1964, it jumped to 19 per cent and climbed further to 22 per cent the next year. It remained just under 20 per cent through 1966. In real terms, business fixed investment declined slightly in 1967, and a modest increase in 1968 represented about 7 per cent of the expansion in real output. Last year, however, the rise in such expenditures was equal to 28 per cent of the increase in GNP after correcting for changes in prices. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -10- But, as I mentioned above, it now appears that the invest- ment boom is waning. Although quarterly rates of growth (measured in current dollars) have varied considerably since early 1969, the overall trend has been generally downward. From an increase of 17 per cent (at a seasonally adjusted annual rate) in the first quarter of last year, the rate of expansion was down to 6 per cent in the same period of this year. Moreover, in the current quarter (and perhaps in the summer quarter as well), the annual rate of increase may not exceed 4 per cent. For 1970 as a whole, the percentage advance may be roughly half that recorded a year ago, when it amounted to 11.7 per cent. But as the investment boom recedes, it leaves behind a legacy of serious distortions in the economy. This is seen no- where more clearly than in the record of price increases for invest- ment goods. For example, from the fourth quarter of 1964 through the fourth quarter of 1969, the implicit deflator for total GNP rose by 19 per cent; the increase for the private sector was 17 per cent, while that for the general government sector was 35 per cent. Prices of business fixed investment goods advanced by 16 per cent during the same period -- with the results being heavily weighted by the rise in prices of structures (25 per cent), compared with a rise of 12 per cent in prices of producers1 durable equipment. While prices of residential structures also rose substantially (by 22 per cent), those for consumer durable goods registered only a moderate increase Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -11- (6-1/2 per cent). So, over this five year period, the pressure on resources generated by the investment boom was a principal source of the current inflation in the United States. Waning Impact of Defense Spending As indicated above, one of the main sources of lessened pressure on aggregate demand is the reduction in the use of economic resources for defense purposes. These smaller claims are evident in a number of indicators. For example, in the first quarter of this year, national defense spending was at a seasonally adjusted annual rate of $78.9 billion. This represented 8.2 per cent of GNP -- about the same proportion recorded m the second quarter of 1966 and well below the peak of 9.2 per cent reached in the second quarter of 1967. After setting a record annual rate of $80.3 billion in the third quarter of 1969, defense outlays have declined steadily -- by $1.1 billion in the final three months of last year and by $300 million in the first quarter of this year. Moreover, the latter decline would have been considerably larger in the absence of the military pay increase, and the current quarter may see a further decrease of at least $2 billion. If defense spending keeps on the track implied by the most recent official Federal budget projections, by the final quarter of this year, such expenditures would account for approximately 7-1/2 per cent of GNP -- about the same proportion that prevailed when the Vietnam War was accelerated in the summer of 1965. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -12- In response to the downtrend in defense spending, a substan- tial reduction has also occurred in the output of defense related industries. Measured in the broadest terms, it appears that at least 30 per cent of the decline in the Federal Reserve Board's index of industrial production from the peak in July, 1969, through May of this year centered in defense industries. In contrast, these sectors accounted for about 10 per cent of the rise in industrial production in the long upswing from July, 1965, through July last year. In both cases, only the direct effects are estimated; the indirect impact of reduced defense production on other sectors (such as capital goods) -- particularly during the last ten months -- would raise the estimate. The reduced military claims can also be seen in human terms. Last month, 3,228,000 men and women were in the armed forces. This level was 293,000 below that reported in May last year and 375,000 below the peak reached in October, 1968. Nevertheless, the number in the armed forces in May was nearly 550,000 above the level in June, 1965. The effects of reduced defense outlays can also be seen in the downtrend in civilian employment in defense industries. For example, in the twelve months ending in May, employment in manufacturing declined by about 600,000. Of this drop, an estimated 230,000 occurred in establishments which are important producers of defense goods. For this group as a whole, the cutbacks were equivalent to roughly 10 per cent of the jobs held a year earlier. Among the establishments producing ordnance products, the decline was much larger (over one-fifth) and it was somewhat larger (just under ope-seventh) in the aircraft industry. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -13- So, by whatever yardstick one judges -- the level of spending, military prime contracts, employment or layoffs in defense products industries -- the evidence is clear: the defense sector is exerting a waning influence on the economy, and the impact is expected to weaken further. Trends and Outlook for Prices Unfortunately, while the principal sources of excess demand have become less critical, inflation is still with us. There is little evidence of a slowdown in the rate of increase in consumer prices. How- ever, the relative contribution that is being made by different groups of commodities and services is shifting, and several factors now operating could lead to a moderation in the pace of inflation in the consumer sector. In May, the Consumer Price Index (CPI) was 6.2 per cent above the level a year earlier. While the rate of increase in consumer prices slowed somewhat in the last half of 1969 (to a seasonally adjusted annual rate of 5.8 per cent compared with 6.3 per cent in the preceeding six months), the pace accelerated to 6.2 per cent during the first five-months of this year. Looking ahead, it appears that grocery store prices, which stabilized recently (although there was a 0.3 per cent rise in May), could give some price relief — since supplies of fresh vegetables and many fruits will be large this summer and fall. Supplies of meats and eggs are expected to expand further above last year's levels. The Depart- ment of Agriculture estimates that retail food prices in 1970 as a whole Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -14- will probably average about 4-1/2 per cent above 1969 (last year they averaged 5.2 per cent above the level of 1968), with restaurant foods accounting for much of the rise. Increases in mortgage interest rates, which have been important in recent increases in the CPI, slackened markedly in April and May as did their influence on the rate of advance in the CPI. Prices of services are expected to continue to increase at high rates, but the climb should be substantially below the annual rate of nearly 11 per cent registered during the first quarter of 1970. Transportation costs have risen sharply in recent months, due mainly to increases in costs of public transportation and higher costs of automobile ownership. These increases should be smaller in coming months, but prices of new 1971 automobiles will probably be higher and thus give an upward push to the index for transportation as well as to the total CPI. For the rest of the year, we might expect consumer prices, seasonally adjusted, to present a picture something Tike the following: Prices of durable commodities to increase some- what faster than in the first quarter when they posted an increase of 3.0 per cent at an annual rate. Increases in prices of food sharply lower than during the first quarter, especially in the fourth quarter. Rates of increase for other nondurables somewhat higher than during the first quarter. And the rate of increase for services down sharply from that in the first quarter. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -15- Given these movements, the overall advance in the CPI in 1970 would be somewhat below last yearf s 6 per cent increase. The main change from 1969 would center in the reduced rate of increase in prices of foods. Other major changes involve the rate of increase for durables (which is expected to be somewhat lower than in 1969) and that for services (which is projected at a somewhat higher rate) the latter rate of increase would reflect higher mortgage interest costs as well as advances in the costs of medical care and transportation services. In recent months, the rate of rise in average wholesale prices has slowed dramatically -- as farm products have switched from large increases in the period November through January to more moderate increases in February and March and to overall declines in April and May. Mainly for this reason, the total wholesale price index, which rose about 9-1/2 per cent in January (at an annual rate), leveled off in April and rose only slightly in May. Monthly price increases for industrial commodities have been fluctuating around a 4 per cent rate this year (January was a little higher and March a little lower). This was a more moderate rise than in the last half of 1969, but it was also about the same rate registered over the last year (May, 1969 - May, 1970, 3.9 per cent). Price increases for metals and metal products have continued to run very large, averaging almost 10 per cent at an annual ^ate in the period December through April. The May rate was slower, but that for June will reflect a further large rise in certain steel prices. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -16- However, increases are expected to be at a lower rate in the second half of this year. Supplies of nonferrous metals (even copper) are now more ample. In the last two months, however, fuel prices have risen strongly, and these advances have contributed significantly to the rise in prices of industrial materials, a trend which may continue. Lumber and wood product prices turned up in April, probably reflecting seasonal influences. These had been declining since April a year ago. However, some declines have again been reported in recent weeks. Among finished goods, machinery and equipment prices have been rising less rapidly in the last few months following an accelerated increase in the latter part of last year. Consumer nonfood commodity prices have continued to rise at a rate of about 2-1/2 per cent annually. Thus, on the basis of the evidence now available, it seems that some moderation in the pace of inflation might be expected as the year progresses. But this same evidence also makes it obvious that the task of bringing inflation under control will remain a formidable assignment. The Costs of Restoring Price Stability How rapidly we can travel on the road to price stability will depend crucially on our willingness to endure some of the real costs associated with the fight against inflation. There is no need here to develop a lengthy catalog detailing such costs. In general, they involve available but unused physical resources and available but less than fully used manpower. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -17- In the broadest terms, the American economy has been operating well below capacity for some time. Over the long-run, we have been able to increase real output by 4 to 4-1/2 per cent annually, but since the second quarter of 1968, the actual rate of growth has been below this historical trend. For 1968 as a whole, the gain was 4.9 per cent; it amounted to only 2.8 per cent last year, and in the fourth quarter real output declined by 0.4 per cent at a seasonally adjusted annual rate. In the first three months of 1970, the decline accelerated to 3 per cent, again at an annual rate. While real output probably will expand moderately during the next six months, there may be little or no net increase for the year as a whole. Clearly then, this element of cost in the fight against inflation is sizable. Another indication of real costs is given by the rising margin of unused industrial capacity. For example, in the first quarter of this year, about 79.9 per cent of manufacturing capacity was being used. A year earlier, the proportion was 84.5 per cent. As the current year progresses, the utilization rate might ease off further. But undoubtedly the most striking indications of the real costs we are paying in the campaign against inflation are being registered in the labor market. Thus far in 1970, this sector of the economy has eased substantially. Since last December, the level of unemployment has risen nearly 50 per cent, reflecting layoffs in the industrial sector, slower employment growth in the nonindustrial area, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -18- and continued large increases in the work force. Nonfarm payroll employment declined in both April and May this year. Although declines were widespread, the bulk of the drop resulted from continuing weakness in the industrial sector, where employment and average weekly hours have been trending down since the summer of 1969. In the nonindustrial sector, employment continued to increase in the first five months of this year, but in the last few months growth has been considerably slower than in 1969 when the demand for labor was still strong. In May, the unemployment rate increased for the fifth consecutive month and reached 5 per cent of the civilian labor force. This was the highest level in over five years. The rate climbed by 1.5 percentage points between last December and May of this year -- the sharpest advance for a five-month span in more than a decade. Virtually the entire rise in unemployment occurred among persons seek- ing full-time jobs. The increase in unemployment since last December totaled about 1.25 million -- 600,000 adult men, 425,000 adult women, and 225,000 teenagers. Three-fifths of the total increase in unemployment occurred among persons who had lost their last job, mainly through blue-collar jobs in manufacturing. Just under one-third of the rise was among persons who had recently entered the labor force, and the remainder occurred among persons who had quit their last joo All of the increase in unemployment in May was among white workers. The jobless rate among Negroes fell from 8.7 per cent to Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -19- 8.0 per cent. Yet, it was still substantially higher than the 5.7 per cent rate of December, 1969. In seven out of the last eight months, the ratio of the Negro to white unemployment rates was less than 2 to 1; the ratio has generally been more than 2 to 1 since the Korean War. Looking ahead, it seems reasonable to expect that the unemployment rate for 1970 as a whole may average close to 5 per cent. Since the turn of the year, it has mounted steadily: January, 3.9; February, 4.2; March, 4.4; April, 4.8, and May, 5.0 -- for a five-month average of 4.5 per cent. Over the last half of the year, the rate may average 5-1/2 per cent. Thus, as we move through 1970 and into 1971, the nation will face a serious dilemma: with both prices and unemployment continuing to rise, how much unemployment is the public willing to endure as a by-product of the campaign to check inflation? Response of Unemployment and Prices to Declines in Economic Growth Some of the analytical work I have done suggests that a significant impact on the pace of inflation can be achieved only if we are prepared to see the economy run well below capacity -- including a somewhat higher level of unemployment -- for quite some time. This conclusion is based on the results of statistical studies showing the way in which unemployment responds to changes in the rate of x:eal output. The findings of these studies (which I conducted with the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -20- assistance of several members of the Board's staff) were presented initially in early 1969.* The analysis was recently updated. In general, a step increase in the rate of growth of real GNP of 1.00 per cent might lead to a decline of roughly .30 points in the rate of total unemployment. However, a decrease of 1.00 per cent in output might raise the total unemployment rate by .63 percentage point --an amount twice that for an expansion of output. The same pattern is evident when unemployment is classified by color -- simply more dramatic: for whites the responses are -.29 and .53 points for a 1.00 per cent rise and decline, respectively, of the rate of growth of real GNP. The corresponding responses for nonwhites are -.37 and 1.50 points. Using these ratios as a rough guide, what differential pattern of unemployment should we expect to emerge during the current year? Without dwelling on the underlying details, it appears that -- if the observed statistical relationships continue to apply -- the *The statistical technique used to derive the estimates was a multiple regression equation relating the change in the unemployment rate to rates of growth in real output. Regressions were fit to seasonally adjusted quarterly unemployment data for the period IV 1954 to IV 1969, cross- classified by age, sex and color. To test for asymmetrical effects of increases and decreases in the rate of growth, positive and negative rates of growth of output were entered separately. These results were first presented in early 1969. See A. F. Brimmer, "Stabilization Policy and Employment,11 a paper given at the University of California, Los Angeles, January 10, 1969. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -21- total unemployment rate might be expected to fall between 5.0 and 5.5 per cent in 1970. For whites the range might be 4.3 to 4.8 per cent, and for nonwhites it might be 7.0 to 9.0 per cent. Given the trends so far in 1970, these estimates appear reasonable. Between last December and May of this year, the total unemployment rate rose from 3.5 per cent to 5.0 per cent. For white workers, the rise was from 3.2 per cent to 4.6 per cent, and for nonwhites it climbed from 5.7 per cent to 8.0 per cent. So both the logical and statistical evidence suggest that we can reasonably expect a definite increase in unemployment during the rest of the year. Yet, the impact of slower growth on prices may be less hope- ful than many might expect. Thus, it is useful to ask: what kind of impact on prices should we really expect in response to the reduced rate of growth of real output? Again, no hard and fast answer can be given, but it is possible to get a general idea on the basis of careful statistical analysis. For this purpose, it was possible to turn to the comprehensive model of the economy on which the Board's staff has been working for several years.* In general, the results provide little basis for optimism. For example, even with little or no increase in real output during the *The characteristics of -- and types of results obtainable from -- this large-scale econometric model have been described numerous times. See, for example, Frank de Leeuw and Edward Gramlich, "The Federal Reserve - MIT Econometric Model," Federal Reserve Bulletin, January, 1968, pp. 11-40. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -22- current year, the GNP deflator may still be rising in the range of 3.4 - 3.6 per cent (at a seasonally adjusted annual rate) in the final quarte r of 1970. While this would be well below the 4.5 per cent increase recorded in the last quarter of 1969, it would still be a rate of inflation above what the public probably would be willing to accept in the long-run. Looking farther ahead, the question was asked whether it would appear reasonable to aim for the achievement of a degree of price stability by the end of next year roughly comparable to that which prevailed in the period 1961-64. (It might be recalled that the GNP deflator rose at an average rate of 1.5 per cent in those years.) Again, without going into details, the answer is not as optimistic as many observers would like to hear. Even if the rate of growth of real output were to be held below its long-run potential through 1971, it apparently would not be possible to reach such a price target. To do. so apparently would involve allowing real output to fall to a point, and unemployment to rise to a point, that the public most likely would not accept the real costs this would imply. Consequently, it seems clear that it will take a considerable time to bring inflation under effective control. So it also seems wise for all of us to settle down and prepare ourselves for a long and taxing assignment. Role of Monetary Policy The responsibility of monetary policy under these circumstances is plain: in my opinion, the availability of bank credit should not be Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -23- allowed to become so great as to give a new boost to inflation. As is widely known, commercial bank credit so far this year has grown much more rapidly than it did in the last half of 1969. After taking account of loans sold to affiliates, the rate of growth was 1.5 per cent, at a seasonally adjusted annual rate, in the June-December period of last year. In the first quarter of 1970, the annual rate of expansion was 2.7 per cent; it climbed sharply to 6.5 per cent in April and rose further to 8.5 per cent in May. Banks1 holdings of securities continued to rise last month, although more slowly than during March and April. The turn-around in loan expansion was a major source of stimulus, since loans had declined in the two previous months. Last month total loans at commercial banks rose at an annual rate of about 6-1/2 per cent. A sharp rise in business loans was principally responsible for the expansion. In May, such loans increased at an annual rate of 12 per cent, compared with only 1 per cent in April and 6.3 per cent in the first quarter. In the second half of 1969, the annual rate of increase was 7.1 per cent. To some extent, the rise in business loans last month probably reflected capital market pressures. In particular, as yields on market financing rose appreciably, some borrowers -- who otherwise would most likely have relied on capital market financing -- turned to the commercial banks for assistance. Partly to meet these demands, banks in turn greatly expanded the volume of commercial paper sold through their affiliates. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -24- Last month, the money supply rose at a 4.1 per cent seasonally adjusted annual rate. This was far below the annual growth rates recorded in the previous two months, which amounted to 13.2 per cent in March and 10.7 per cent in April. There were noticeable fluctuations i n private demand deposits during May, but on balance such deposits were about unchanged over the month as a whole. To some extent, these swings can be traced to sizable fluctuations in U.S. Government deposits. Currency in the hands of the public (possibly reflecting the disturbed conditions in securities markets) also rose substantially in May. Since late May, there has been a small decline in the money supply. However, because of the sizable expansion in April and the moderate increase in May, the second quarter as a whole may see an - increase in the range of 4-5 per cent, at an annual rate. In the first quarter, the rise was 3.8 per cent. In the capital markets, the demand for funds remains heavy. In the case of corporate securities, public offerings may average $2.2 billion per month during the second quarter -- more than two- fifths higher than the first quarter average. However, the volume in June may be only slightly more than half the $3.0 billion rate recorded in May. The latter total was greatly influenced by the $1.5 billion AT&T rights offering, and with its passing the June Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -25- figure would have been smaller in any case. But the reluctant buying of institutional purchasers, as they waited for successively higher yields, has also limited sales of corporate issues so far in June. Historically, the summer months have seen a slackening in the volume of corporate offerings. But this year -- as was the case during the last two summers -- the supply reaching the market may not lighten appreciably. In fact, partly because of postponements and cancellations and partly because of the continued strong demand for funds to restore corporate liquidity, the potential supply of securities remains heavy. If market yields were to decline (perhaps on the order of 1/2 percentage point), the volume in July could turn out to exceed that expected for June. As yields on tax-exempt securities rose sharply in May (to over 7 per cent), new issues of long-term municipal bonds declined sharply. The monthly average during the first quarter had been about $1.4 billion, and this might ease off to roughly $1.2 billion for the second quarter. The May volume was down to $1.0 billion, and the June total probably will fall slightly. Here, also, the supply of new issues reaching the market during the summer may not shrink appreciably. In the face of these continuing demands for funds -- which might be augmented by demands originating with the Federal Government and its agencies -- it seems clear that the capital markets will remain under considerable pressure during the months ahead. On the other hand, as the waning of the business investment boom proceeds -- and if Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -26- corporate managements accordingly revise their financing plans -- the capital markets might experience some relief as the year progresses. But, as I survey the unfolding terrain, I personally cannot foresee how such relief could develop on an appreciable scale. Concluding Observations As I indicated at the outset, I believe that national economic policy -- including its monetary policy component -- should continue to set a high priority on checking inflation. Because of the tenacity of inflationary forces now at work, and particularly because of the transformation from an excess demand to a cost-based inflation, it will take considerable time and effort to achieve this goal. So, while pressing on with the campaign to restore price stability, we should also press on with the adoption of the necessary measures to ensure that the burdens will not fall unduly on a few segments of society. There is no need to catalog such measures here; they must obviously include greatly strengthened unemployment insurance provisions and improved programs for training -- and I personally would add special arrangements to provide work opportunities for those young people with no record of previous employment. But, in the final analysis, the costs of checking inflation really must be borne. To this end, our stabilization efforts must be dedicated. While these can be assisted to some extent by some variety of incomes policy, we cannot escape reliance on general monetary and fiscal policies, and we must be prepared to pursue them until the task of restoring price stability has been completed. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Andrew F. Brimmer (1970, June 19). Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/speech_19700620_brimmer

@misc{wtfs_speech_19700620_brimmer,
  author = {Andrew F. Brimmer},
  title = {Speech},
  year = {1970},
  month = {Jun},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/speech_19700620_brimmer},
  note = {Retrieved via When the Fed Speaks corpus}
}