speeches · November 18, 1971

Speech

Darryl R. Francis · President

CURRENT ECONOMIC SITUATION Speech by Darryl R. Francis, President Federal Reserve Bank of St. Louis Before The Oklahoma Mortgage Bankers Association Tulsa Club, Tulsa, Oklahoma Friday evening, November 19, 1971 I am pleased to have this opportunity to present to you some of my views regarding attempts since 1968 to restore stability in the American economy. We presently find our economy, as well as the world economy, in a serious state of disarray. First, let us examine briefly cur major economic problems. Economic Problems In the last six years, the American economy has suffered a high and accelerating inflation. This inflation has proven very difficult to bring under control. The rest of the world has also faced serious inflation, with leading industrial countries experiencing very rapid price rises. interest rates in the United States have been at historically high levels for much of the last six years. However, it was not until the late 1960's that interest rates surpassed those of the early 1920's. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -2 - Accompanying the nigh and rising interest rates and the inflation, there have been many serious problems in the financial markets. wrocmms nave included financial "crunches" and disintermediation of funds from cur savings institutions into money market instruments. The housing industry and small businesses have been particularly hard-hit by these deveicpments. The stock market also underwent a major downward adjustmen in the late 19u3's and in early 1973. Unemployment has been relatively high for two years, but this unemployment has net been as large as in other recessions in the posa-Tfcria War i 1 era. The nation's bslanos-ef-payments position has been deteriorating for the past ter. years with respect to other major industrial countries. The first nine-month figures indicate that the year 1971 may show the first trade deficit that our country has experienced since 1893. Repeated crises have occurred in foreign exchange markets, which in turn, have led to increased restrictions to the free flow of international trade and finance. This sad state of economic affairs has develop« ed despA ite a supA oA osed better understandingw* of economic processes and well meaning attempts to fine-tune the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis " j " American economy. In the decade of the 1960’s, econo mists had high hopes for the use of traditional monetary and fiscal tools for promoting high employment, price stability, and a viable balance-cf-payments. It became very fashionable to claim that we could turn the American economy around on a dime. In the early and middle 1960's most confidence was placed on the use of fiscal actions, that is, changes in Federal tax rates and spending. Later in the decade, as.the power of fiscal actions began to be questioned, more stress was placed on the use of monetary actions, that is, managing the nation's money stock. The New Economic Program Our recent experience with the prolonged simultaneous occurrence cf high inflation and high unemployment, has led to a widespread disillusionment with traditional tools of economic stabilization. As a result, a drastic new program has been developed for the American economy. This program includes re strictions of price and wage movements for the control of inflation. First, there was a complete price-wage freeze, and more recently we have had the announcement that in Phase 11 there will be price and wage restrictions. Fiscal Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -b- actions have been proposed to stimulate the domestic economy, end major actions have been taken to improve our baiance-of-payments position, pending a basic reappraisal of the international payments mechanism. Background in attempting to analyze cur present economic situation, I find it useful to examine the history of our current state of economic disarray. Such a review should provide us with insights into the causal forces and likely cures, and aid us in preventing the same events from happening again. First, ! will examine the main cause of our economic dislocations, as we at the St. Louis Federal Reserve Bank see it. This will be followed by a dis cussion of the forces which allowed this basic cause to come into existence. And, finally, there is an analysis of what 1 believe to be the basic requirement ror success in restoring economic staoiiity. Basic Causal Force Let us now turn to the first topic, the basic cause of our serious economic problems. At the Federal Reserve Bank of St. Louis, we have been conducting many studies into economic fluctuations. Considerable evidence has been developed indicating that the economy Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -5 - is basically stable and resilient and net naturally subject to great inflation or recession. Our studies indicate that the course of monetary expansion has been the major destabilizing factor underlying the problems which I have just outlined. According to these studies, the trend growth of money-stock, over several years, determines the rate of inflation, inflation is a monetary phenomena. in addition, variations of a few quarters in the rate of money growth around the trend, as well as a shift In the trend rate of monetary expansion, have an important bearing on movements in output and employment. Chart I, which was passed out, demonstrates these two propositions and helps to illustrate why we have experienced a high rate cf inflation and a high unemploy ment rate at the same time. This paradox has led many commentators and economists to conclude that the character cf cur economy has been so changed in recent years as to render traditional economic stabilization tools useless, and has caused these individuals to look for additional tools to curb inflation. As you can see, Chart i covers the period since early 1952 and contains four panels. The top pane! presents the money stock, which consists of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - o - demand deposits and currency he'd by the nonbank public. The second panel Is labeled "The General Price Index," the broadest measure of price mcvements available. The third pane! is labeled "Real Output." This is total output of goods and services in our economy, measured by Gross National Product in con stant cellars. And the bottom panel contains the unemployment rate, that Is, unemployment as per cent of the labor force. Also cn the charts, you will observe four shaded vertical bars. Each cf these shaded bars indicates a period of economic recession, as determined by the National Bureau cf Economic Research. It is the period from the ceak to the trough of the business cycle. First, let us fccus our attention on the top panel, i have divided the period since early 1952 into three subperiods and have shown the trends of money stock for each. The money stock grew at a 1.7 per cent annua! rate from the first quarter of 1952 to the third quarter cf 1962. Then, the trend rate c? growth was accelerated to a 3.7 per cent annua! rate to the fourth quarter of 1966. Then, it was further accelerated to a 5.7 per cent annual rate to the first quarter of 1971. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 7 - New, observe that on the Genera! Price Index pane! i have also pla cGG tfl ree trend rates. We had a period cf relative price stability from the first quarter of 1952 to the fourth quarter of 1965. During this period, prices rose at a very moderate 1.8 per cent trend rate, with only one outburst of a rapid price rise, in '955 and S956. Following the acceleration cf the trend growth rate cf money, prices rose at a 3.9 per cent annua! rate from the fourth quarter of 1965 to m id-1969. Since m id-1969 the prices have risen at a5.1 per cent annual rate. While this Is not conclusive evidence that a change in the trend growth rate of money causes a change in the trend growth rate of inflation, it is quite consistent with that view. This chart also illustrates my second point, that short-run variations in the growth rate of money have an important bearing on output and employment. On the third pane! labeled "Real Output", i have placed the trend growth rates of potential real Gross National Pro duct. This shows the practical maximum growth of output given the growth in the labor force, technology, capital resources, and natural resources. The President's Council cf Economic Advisers has estimated that tin e potential GNP rose at a 3.5 per cent rate from the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis o O rnn^n fnarfor r • -t ‘-t Vf" 3 7?'»>?■•? .fjspr^op r- -C<9 a Lz s— • L 2 4 V L% C4 • L Lz - Lz i — s *S L a - -z i V v. . L X J L LX v-* 4 L Lz i L> i X / L' X— , no•>" pc. n-’- r?’*'£j ■>■?■/’??. ’?■•''? p.'mpp"’c,'p p? ;0-~ ? /I rop pppy jzL/ 4 L/Lz a a L X L4 LLz LL/ L t h SZ 4 L? a Lal V’ La '-— i S <Z a L/ X «~ / y La / VZLZ J Lz W 4 2 L r??» r* • t " '*<<’• ,iArs P *■-> i ? » G lv<»> “i,«rJ\ •k’ i ikz -c• /0> i V>J •./* •<G 1 rV*iL iw*l< *•U'/*V, y:* zCv*l —i /. <-J i J•) . 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On the unemployment rats panel, you will find that despite slow money growth in the 1950's and early 1960‘s and very rapid, accelerating, money growth throughout much of the 196j's that the unemployment rate averaged about the same, 4.9 per cent in the first period and 4.6 per cent In the last period. Despite all the fine-tuning we had in the 1960’s plus the stimulation received from an accelerating inflation, the average level of the unemployment rate was little affected. What caused this pattern of monetary expansion ever the last two decades, which has had an important bearing cn inflation and cn output and’employment? There are three chief causes, and I will discuss each. First, is the method of financing the rising Government debt, second is concern over interest rates, and third is concern ever unemployment. Let us now look at Chart II, which has five panels. T’ne top panel labeled "Public Debt" is the Federal Government debt outstanding, net o? the debt held by U. S. Government agencies and trust funds. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 10 - The second panel is the "Public Debt Held by Federal Reserve Banks." This is the debt which the System acquires in the course cf our Open Market operations. The third panel Is the portion cf Public Debt Held by Federal Reserve Banks. The fourth, panel contains the "Monetary Sass" which Is the major determinant of movements In the money stock, and the bottom panel replicates the movements of the money stock that you have seen In the first chart. Let us look now at the role of the method of financing Federal Government debt and the course of monetary expansion. In the early 1950’s we find that the public debt outstanding changed little, varying between $215 and $250 billion. it Lagan to rise ? ~ I n - j • rapidly in the lace isobA's Aand continued to rise throughout the 15'cO’s and early 1970's. At the time of relative stability in the national debt, the Federal Reserve did not change aooreclsb’v its holdings cf U. S. Government securities. In the late 1950's the Federal Reserve began to add an ever increasing amount of Federal debt to its portfolio, in fact, the rate of acquisition cf debt by the Federal Reserve System was more rapid than the expansion of the national debt itself. This is illustrated in the third panel, which Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis ! < 11 shows the share of public debt he'd by the Federal Reserve Banks. This ratio held nearly constant, at around ii pet up to the late 1950's. Since then it has been constantly rising, reaching about 22 per cent at the present. Movements in the monetary base parallel this acquisition ot reoera; Reserve ceo oU Zt. nc.n iie rre^ursa! Reserve buys Government securities, it adds to the monetary base. as i mentioned earlier, the monetary base is the major determinant of the money stock. , With these greater purchases of Government securities, there has-been an acceleration in the trend growth of the monetary base ever the last two decades, from at a 1.6 per cent annual rate from early 1952 to the fall of 1951, then to a 4.4 per cent rate to the end of 1956, and since then to a 5.4 per cent rate. You will also observe that a trend growth in money changed in a roughly parallel fashion as the trend growth for the monetary base. So what we had in the 1953‘s was rising Government expenditures, both for the Vietnam War and for expanding welfare programs. A decision was made to not finance these outlays fully by taxes, but by borrowing. 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'-J t . <Z a a X.4 t a a W V Vz » a A tz • • (a«> « A 1 k» 4<Z i i! kJ* J A Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 13 - What can account for the variability around the trend movements in the money stock? 1 believe this can be attributed in considerable measure to alternating con cern ever unemployment and inflation. Whenever the System sought to resist inflation vigorously the growth rate of the money stock was markedly slowed for a short period of time. As we saw in Chart 1 whenever the growth rate of the money stock slowed relative to the trend, we entered into a period of economic slowdown and the unemployment rate would rise. Then, whenever the unemployment rate rose, the monetary authorities shifted objectives and became much more expansive in order to bring the unemployment rate down. This haecened several times throughout the !950:s and svcj's, ana eacn time we had a raacneung-uo or tne trend growth rate of the money stock. These expansive actions also help to explain the rising trend growth cf money. Cn n t r/rd! s r- r, U i i S. J V S S 1 i i M x i i t 5Cil iUl I Now, I will turn to my last topic, which is what do I believe to be the basic requirement for success in controlling inflation? if we are to have a successful program in controlling inflation, the basic cause of inflation must be eliminated by achieving a moderate trend rate of growth in the money stock Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis i c. “So ns .cir! s*. ?“A '■-^fp'v> c n*’* ztJ « i n a i.uc-.nci ann t > . v» SL/vj'C/ii'.Lj u.. i ivu.. .vvu (.i i v..ii i U» UVj iU V* i ii i J vJv.'^ u i it. iro rprA/iOrpcnlc v'f’{S hz ’■'a e: procch s1 vn^ AIn £ hay/ C?i K skxO I i i kZ ii/kx i I i kx ] I k«} \rJ I . i U ! <x'i»>Hx L» a y axV txi Vxkxkx a> j a_£ 5 I kx I kZ (qu/ mnnfhc, tp xc thp u~cn-: sn^.^inn v/n’^n * kz v tf i U v i i k i j »J v-u i 4 4 \x o k < . >x u/ a» x i kz kx Ct *x kz - • i ; ; v. < *\J i j v«J4&4\z44 1C pv r> • r- r' 2V2 vv/ o?zc c nc 1A c !c 2 5 • cc ? pj or jJ I * C i i « v> . i kx i. 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C4 4 V ’ Cz \ J V/ <2Z 4'r 4C i — 1P 4C O P>*5" P^/2P *^ — — ’C PC C’i* 5 * .-/ 'Sc O *2 Y2' r i C* M ’ -2 52 C s C 2 *2.2 "■*** z~ \ / 4 kz 4 4 L C* kx -Z K fi k a <Z C ^a 4 4 ii\\Z <Jy «•<> LZVZ Ci 2 Sa. <Z bC 4 i 4 • 4 i Ci V . . <Z li i 1 a 2 kz 4 • Cz J •CJ 5I22 i I J\7 Cr? j• /•C<•z• pb V. f » / 4 c i 4» • s r.4*. — " £ 3 . yU. x/ C/ e c 9 * 1 ‘ « C ’ . Vk , i ■ Ci vz2 Ca’rkQzCCz <V2 z2.i kk s T k f - •- i h 1 ? i . k A z i i a C/ «J k y i e kvy C*<yzC<z^^~C^xCk.' * ’ — pre nrnj.or* p rn p ri-Ahr.ni ’neprnp H?c je kz 4 jXa W J kxkz k. k-4 CikZ 4 .kz • k. « k> 4 1 Vxi 4i«.~b.akX4iK*4 b4 4<zkxi*akz C. <✓ VX kX <ai i & <b O a^Zbaa^.O^ in thp no»r«hhprhr^^ nf r?H.^dcr 1Q7? 2 2 2 k 4 I kz 4 i V i J i . Ax-k/’ » • . C/kX Val Cz 4 C » * . .kz( i i kJ 4 kxkai 4 bX M « C« V« 4 ^kX^II J- / 4 i-. » Vhic ic cSnii’/ hsSa’SAn H'iAh.O'z vh^n vha oc'*’*~nA"ors I i i 4 *X to V. O kJ C» k C/.klS\>4« iiak^i.bx; k 4 2 Vb . 1 k 1 4 kz kzOkSiaiOkkxCi C. kx 4 • KX 4 U ; C2 < 2 • ^ 2’/22 r “f i < V ■'.. / •“ Z / *7 f s r V -w r » C O r?Ti !•A AT z f * — - 22 ’ 2 ^2? *r p > ACO^l/O 4 \J 1 Vx<*4 . >Z a i Ca aai 4 /VX*4m C. ✓ 4 —« a 1 V i akz i C vlk/ kx. 2 kz <x% '•X 4 k* 4 I k «bZ «X kX 4 W kz holdings cf Gcvernment codt to the total outstanding remains Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 12 - constant at 22 per cent, ths latest figure, such a deficit could result in a sizeable in Cz • O V4 *2 e In the money stock. Let us now look at the. interest rate impediment, which could result in an increase In the ratio from its present 22 per cent level. There Is considerable pressure to prevent Increases In interest rates. Interest rates could be controlled in two ways. One, there could be ceilings fixed by law, as in the case of usury laws, or by regulation of some administrative body. The second way would be for actions of the Federal Reserve to prevent temporarily Interest rate increases by permitting more rapid monetary expansion. it is likely that imposition of Interest rate con trols would create an Impediment to the maintenance cf moderate monetary growth. Whenever you fix a price, ,2C * 5 ffC problems of allocating scarce r s amona com set ix we uses arise. Assuming interest rate controls were effective, demand for funds, in response to rising economic activity, would outpace the supply at the celling rates. If rate ad justments were not permitted, the need for rationing would arise. Because of problems of allocating the limited funds among competitive uses and cf enforcing interest rate con trols, pressures would mount for the Federal Reserve System to expand the total volume of credit. But, if the business Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis ■J ~ 16f - recovery is as strong as generally expected and if the Federal Reserve supplies the funds which people demand at the controlled interest rate levels, the System would have to acquire an increasing orooortlon of Government debt outstanding. As happened in the last decade, the trend rate of money crowth would increase and inflation -z would be intensified. The outlook for market forces on interest rates curing the balance of 1971 and into 1972 is not clear. On the one hand, there most likely will be downward pres sures on rates as expectations of inflation are revised downward. On the ether hand, large Government deficits ih ft H'<* V/V * J W ft ft V* i i i uz kz c\zx't’ •h•/ ’b! t-vZ J C* i Lz ft v W it Cz Li *i’nL/ ft « Cl ft ii K.Z ft • $ i<Z CiU upward pressures on interest rates, in view of the un certainty as to the direction and extent of net market pressures on rates, it would seem best that rates of interest be allowed to find their own levels in the market, if the System contracts money to avoid a decline in interest rates, a recession may develop. If the System expands money rapidly to avoid higher interest rates, additional inflationary pressure will develop. Let us now take up the unemployment impediment, which results from the public having unrealistic aspir ations with regard to the unemployment rats. Much of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis n the uneise'eypent is structural caused by monopolistic f » ” i C "V A b i ' . v3 A o C A V s i ! L ! H ii i J A v i i "■ . 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IV LkZ AZ a • K/ kZ A w a k • a K • i » 2 kZ »Z.V # A Lx. • k . • kZ 2 4 . X V<> X KZ wnnW h,- r ftiHv pp^cyppv -ppn- pptt p I b V La 1 Li kZ k/ L V «Z A a a a a’ \Z C. V. O v t- La I Li a i kzL/«.<ZA.A— «Xk a . L/ i A inf'jyHpp<,z,v psrP’,/"H "pro p.-i* fbo rnp^pp' " *':’~n I iiiiaLikiWi.Li^ V i Vii J AM I 2 k— KkZ k/ . k i A kz 3;* Vl 4 V ; *-/ I«Vv *L —Zk/ a. a“^ A c > n V v VV H V u U H i k. ai -/ A ' * k p Z . L '/ kZ o - p - f *. < . . ? < o Z r i j A = k_x ’ , H %Z X- K- - X A— ' A. p A %Z A e . i ? A A • r ' z\r r;-*p’w-p A kZ / ‘-i^A.'M-A which have been the chic? factor causing prcaucticn pnrl prnPsPvrrpp’ • '* •;?!’ p*,on "hoir pp^pp?*-i i*o\ro;c L. i 2 L Lzkl2L/Ak> A..>AZA.>. wkZ . U i « i « vi ( 1 k t (iz u >'*X’».'\Z a . k . 2<Z.kz«<Za i conciudc that success in the fight against inflation ever the next few years will ascend greatly on V C H-* c/’T*./ ’T' i ’fc1‘v ° *2 r* Ci Vv I lO i. k i kz i i 2 - kz 3 V C; L. 2kz i £ i.. AZ Ltvz v y i i S . O'< ’L» a >.O a. La L-’ \z V V a J k., kz k a 2 Af HOAA-OV fP P ! «M'O * P fK?C ?A’,.’FO^ P"* TV •; •■ p k> ak -k1z kCx- -'I aH 2 h 2 • k- 2 2 3 kkk £ 3 a L I I 2 O a k> A kz '-’ . Vz A . 4 A b I J Va J7 I a fhon VfO ppsO rpp!?p’’/ ■/ fho p^p'* - , uS P Cl k kz k B L kz 2 i V V O Oc' •p ip kzh L»e 2 HL- A-^kZkZ i A il L, i i J< kr/ i kbakz O.O—; 4 ipz p1 i p 4 p a> ’J W a a is kpz i B have ied to disarray In our economy, ar.a the world economy, disappear frem the scene. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 195? 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 RATIO SCALE BILLIONS OF DOLLARS Money Stock 1 1 1 1 — 1 1 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 Shaded areas represent periods of business recessions as defined by the National Bureau of Economic Research. Latest data plotted: 111/197' □ 1 1 u 1 1st qtr 5 h 1 i Prepared by Federal Reserve Bank of St. Louis Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 320 RATIO SCA^E BILLIONS OF DOLLARS 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 Shaded areas represent periods of business recessions as defined by the National Bureau of Economic Research. Latest data plotted: public debt 11/1971; money stock, monetary base - 111/1971 Prepared by Federal Reserve Bank of St. Loui Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Cite this document

APA

Darryl R. Francis (1971, November 18). Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/speech_19711119_francis

BibTeX

@misc{wtfs_speech_19711119_francis,
  author = {Darryl R. Francis},
  title = {Speech},
  year = {1971},
  month = {Nov},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/speech_19711119_francis},
  note = {Retrieved via When the Fed Speaks corpus}
}