Speech

For Release on Delivery Friday, November 9, 1973 12:30 p.m., EST INFLATION AND ECONOMIC WELFARE IN THE UNITED STATES Implications for Monetary Policy Remarks By Andrew F. Brimmer Member Board of Governors of the Federal Reserve System Before The City Club Cleveland, Ohio November 9, 1973 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 2 - of monetary policy or of money market and credit developments. We also refrain from detailed forecasting of the general economic outlook. Prudence would suggest the wisdom of this position at any time, but it is especially necessary to be cautious in the present environment 0 Conflicting signals are being given off by the economic indicators — which is normally the case in the advanced stages of economic expansion Q The situation is further clouded by the uncertainties stemming from the Middle East military situation—as well as by the continuing uncertainties on the domestic political front« Moreover, any assessment of the economic outlook and the prospects for inflation must be conditioned on the future of the Administration's wage and price controls program—a future which is by no means clear at this time Despite these uncertainties, however, c I believe that those of us who share responsibility for the conduct of economic stabilization policies have an obligation to explain to the public the reasons underlying our actions 0 In my personal view, the basic objective of national economic policy should continue to be the moderation of inflationary pressures. I am not unmindful that evidence is accumulating which suggests that the pace of economic activity is already moderating. I am also aware of the emerging concern on the part of some observers about the likelihood of a rise in unemployment during the coming year. On the other hand, I am highly conscious of the persistence of strong inflationary pressures which seem likely to be with us for quite some time. So, as I weigh the need to combat inflation and the need to be sensitive to the danger of precipi- Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis INFLATION AND ECONOMIC WELFARE IN THE UNITED STATES Implications for Monetary Policy By Andrew F. Brimmer* A few weeks ago, I was asked by an interviewer on a television program: "When will the Federal Reserve reduce interest rates so people 11 can buy houses? After explaining that the Federal Reserve did not control such rates, I went on to explain as well as I could the connection between the persistence of inflation and high interest rates in the United States, I also emphasized the continuing need for national policies — and the need for public support of such policies—to end the inflation that has plagued this country for almost a decade. It is to this same topic that I wish to return today. In so doing, I want to look beyond the short-run question of whether interest rates are likely to be higher or lower tomorrow, next week, or next month. I can appreciate the genuine interest that so many people have in such questions. However, I am unable to provide any guidance as to the likely prospects. By long-standing tradition (one which I share), Members of the Federal Reserve Board do not attempt to forecast the future course * 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. Susan Burch undertook the principal responsibility for the analysis of price developments and the assessment of inflationary expectations,, Mrs. Mary Smelker also provided some assistance in the examination of price changes. Mr. John Austin and Mrs. Ruth Robinson helped with the analysis of income changes and the differential impact of inflation. However, while I am grateful for the staff's support, the views expressed here are my own and should not be attributed to the Board's staff. Nor should they be attributed to my colleagues on the Board. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 3 - tating a downturn in the economy, I come out at the present time on the side of continuing the fight against inflation,, As we all know, prices this year have risen at extraordinary rates—thus further intensifying inflationary expectations. This year's inflation, in turn, will add more fuel to the wage-price spiral which got underway in the late 1960's and which was not eradicated during the 1969- 70 recession. There was an excessively rapid expansion of activity earlier this year, and an increasing number of sectors have come to operate at or close to capacity. Under these circumstances, it was imperative that the Federal Reserve moderate the expansion of money and credit. Monetary policy—which had already been in a tightening phase—moved further in the direction of restraint in late 1972, and this became increasingly more vigorous as 1973 progressed. Specific efforts have also been made to increase the cost and reduce the attractiveness of bank lending to businesses, financed through the acquisition of money market funds. And the instruments of monetary policy have been supplemented recently with a less expansionary fiscal policy and a renewed effort at direct controls over the rise in wages and prices. While I would prefer to be hopeful, I see little cause for optimism with respect to the near-term price outlook. The Federal Reserve System in its official statements has stressed the continuing need to check inflation, and the System has also stated that it is committed to continuing its efforts to help bring inflation under control. Unfortunately, success in this effort Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis will take some time. And as past experience has suggested, the burdens will probably weigh disproportionately on housing, smaller businesses, and the younger or less-advantaged workers Consequently, positive steps 0 need to be taken at the national level to spread the sacrifices« In the meantime, inflation has had a noticeably uneven effect on different income groups in the economy Again—as one might expect on the basis of experience- 0 inflation seems to have favored profit recipients and wage earners in strong bargaining positions—while those dependent on fixed incomes and public assistance appear to have carried much of the burden caused by the sharp rise in the general price level. In the rest of these remarks, I will present my assessment of recent price developments and the impact of inflation on major types of income recipients. I will then explain why I believe monetary policy can— and should—make a significant contribution to the restoration of price stability in the United States. The Record of Inflation The origins of the current inflation have been explained many times, but it may be helpful to refresh our memories: its roots are to be found in the excess demands arising from a business investment boom and the marked step-up in the Vietnam War effort in mid-1965. At that time, the economy was close to full employment, and 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 inflation. Countervailing monetary policy actions were taken fairly promptly, but Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 5 - fiscal policy did not provide much assistance until the passage of the 10 per cent income tax surcharge in mid-1968. The better meshing of fiscal and monetary policies reduced the pressures on aggregate demand. However, these stabilization measures were less effective in controlling wages and prices, which by then were responding strongly to inflationary expectations. As the cumulative impact of these restrictive policies was registered, the annual rate of growth in real —^ gross national product (GNP) declined from 33 in the first quarter of 1969 to a minus 2.5 per 0 cent in the latter part of that year and into early 1970. The rate of unemployment rose during this period and continued upward during the subsequent sluggish recovery—from 3.4 per cent to about 6 per cent of the labor force. Yet the pace of inflation did not slacken significantly until the middle of 1971. The intractability of the inflation is clearly seen in the behavior of the GNP implicit deflator, the most broadly based of the various price indexes. During the period of substantial price stability between 1961 and 1965, the GNP deflator rose at an average annual rate of 1.5 per cent. But beginning the next year, the advance quickened: during 1966 and 1967, 3.5 per cent; 1968, 4.1 per cent; 1969 and 1970, 5.3 per cent. Finally, in 1971 as a whole, the rate slowed to 3.6 per cent, and in the third quarter of that year (when Phase I of the direct wage-price control program took effect) it dropped to 2.8 per cent. In 1972, it seemed that inflationary pressures were being dampened appreciably—despite the recovery of the economy which was then 1/ Real GNP is defined as GNP in current dollars corrected for inflation. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 6 - in its second year The GNP implicit price deflator rose a more moderate D 3.3 per cent during the year, and consumer prices climbed 3.4 per cent for the second consecutive year. Average hourly earnings increased 6.2 per cent-- the smallest percentage rise since 1967. Part of the improvement in price performance probably stemmed from the delayed impact of the 1969-70 economic slowdown. However, the wage-price restraints introduced as a part of the economic stabilization program also contributed to the better performance. During this period, the size of price and wage increases undoubtedly was lower than would otherwise have occurred. The requirement for pre-notification of wage and price increases by large unions and business corporations was clearly an important element in the success of controls. But it should also be recalled that the initial public reaction to the program was highly favorable, and inflationary fears at that time were somewhat allayed«, Rekindling of Inflation At the same time, however, developments during 1972 worked against price stability and helped to rekindle inflationary expectations. Wholesale prices behaved far less well than did retail prices. In fact, the rise of 6.5 per cent in wholesale prices was the fastest since 1950. Of major importance was a developing world scarcity of grains and oilseeds. Except in the United States, harvests were poor in most of the world last year-- inducing a sizable increase in U.S. exports of wheat, corn, and soybeans. Prices of wheat, feed grains, and oilseeds began rising in the second half of 1972, and they reached record levels about a year later. Although corn and soybean prices have since dropped, prices are still far above those of a year ago. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 7 - Deficient domestic supplies of food commodities contributed to the extremely sharp wholesale price increases. A major problem was the failure of the number of meat animals available for slaughter to keep pace with the rising demand for meat. In contrast to other recent years, the per capita supply of red meat declined last year. Unfortunately, supplies of other foods (such as eggs, broilers, and most fresh and processed fruits and vegetables) were also less than normal. As a result, food prices rose 19 per cent between September, 1972, and the same period this year--with meat increasing 37 per cent. Pressures on farm and food prices (which rose by almost 24 per per cent between January and October of this year) were augmented by an acceleration in industrial price increases which accompanied an expansion of economic activity on a world-wide basis. The degree of sychronization in cyclical expansions in the industrial nations that we have witnessed over the last year or two is most unusual. Worldwide materials shortages of unprecedented severity (except for wartime) developed during 1972--with the prices of hides, steel scrap, textiles, ana lumber rising sharply. In 1973, the rise accelerated noticeably, and nonferrous metals, natural rubber, and basic chemicals were added to the list of commodities in short supply. The devaluation of the dollar in relation to many foreign currencies aggravated our price situation by making it more expensive for Americans to buy materials produced abroad and less costly for foreigners to buy our already scarce corn, wheat, and soybeans as well as industrial materials Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 8 - and products. It is impossible to estimate with any precision how much the currency realignment —amounting to a 20 per cent decline in the value of the dollar against other currencies since August, 1971--have added to inflation in the United States, but it has clearly been a factor. In short, by early 1973, scarce supplies of foodstuffs and animal feeds, rising world demand, domestic prosperity, and the reduced value of the dollar in international trade all converged to produce sharply heightened inflationary pressures. Hence, when Phase II was replaced by the more relaxed controls of Phase III in January of this year, producers found it relatively easy to translate increases in costs into higher prices as well as to widen profit margins. Consumer prices increased 7.5 per cent, in the 12 months ending in September, and wholesale prices (including farm products) rose 17 per cent. Between January and June of this year, wholesale industrial prices rose at a 12 per cent annual rate. This resurgence of inflation prompted the Administration to impose a second temporary price freeze in mid-June while a more comprehensive control program was being worked out. The freeze was followed in mid-August by Phase IV--a controls program stiffer in many respects than that of Phase II. When Phase II was imposed, profits and profit margins were abnormally low--due mainly to almost 3 years of sluggish economic activity. Because of this, and in order to support economic expansion, businesses were allowed not only to raise prices to reflect increases in materials and labor costs--but also to add the usual mark-up, generally expressed as a percentage of costs. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 9 - Profit margins and total profits rose sharply last year and have improved further in 1973. The regulations for Phase IV generally permit a dollar- for-dollar passthrough of higher direct costs, so that profits can only increase on volume. Consequently, the Phase IV rules could limit the rise in profits more severely than those of Phase II. A 30-day rule requiring pre-notification of price increases by the larger corporations was also imposed in Phase IV, during which the authorities can challenge the cost basis of the proposed increase. This requirement is having the effect of postponing price increases for automobiles, metals, and other important commodities. Farm and food prices were left uncontrolled at the farm level, but the controls for processors and distributors permit only a dollar-for- dollar passthrough of costs. Relative prices had moved badly out of balance earlier this year, so that the more rigorous controls program is bringing increasingly serious distortions in markets. In some industries, price increases in domestic markets are being suppressed, and producers reportedly are diverting to exports materials which are also under strong demand pressures in this country Indeed, this problem has already led to the total decontrol of 0 prices in the fertilizer industry,, Complaints are also heard that below- market prices for some products (such as steel and paper) are serving to retard capital outlays to expand capacity in such critical basic materials industries. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 10 - Strengthening of Inflationary Anticipations As 1973 progressed, a significant proportion of the public came to expect continued substantial inflation—not only for the next few months but extending for some time into the future. These changing attitudes can be traced to the legacy of the wage-price spiral and the inbalances f between wages and prices caused by 1973s inflationary outcome Measures 0 of inflationary anticipations are somewhat elusive, but there are clear indications of a worsening in the attitudes of trade unions, consumers, and businessmen. The changing attitude of trade unions obviously reflect the recent deterioration in the real earnings position of wage recipients Adjusted 0 for the increase in consumer prices, average weekly earnings have actually declined thus far this year. Wage rate increases in recent months have been accelerating in response to this situation.. For example, in the March- October period, seasonally-adjusted average hourly earnings rose 75 per C cent at an annual rale, compared to an increase of 66 per cent in the C previous nine months The pressure for higher wages is likely to be even 0 greater next year as more workers make an effort to regain or improve on the purchasing power that their wages had obtained in 1972 0 Trade unions are also seeking better cost-of-living escalators which were a permanent feature of the recent automobile contract. Other unions can be expected to press strongly for the inclusion or continuation of such clauses in new contracts. There also is some interest in eliminating entirely the limits on these provisions. Following a period of extensive use Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis ! in the late 1950s, escalator provisions became less prevalent in the early f 1960s—when they were discontinued in the steel, aluminum, can, and railroad industries. By 1966, about 2 million workers were covered by contracts containing escalator clauses—only half the number reported for 1958. Since then, however, the number of workers affected by escalator clauses has more than doubled. In 1973, over 4 million workers — the same number as in 1958— were covered. Much of the increase occurred when the provisions were reestablished in steel, aluminum, and cans, and introduced in communications during 1971. Earlier this year, consumer demand was much stronger than many observers had expected. This strength has been attributed at least in part to consumer hoarding or "buying in advance of price increases." For instance, the Michigan Survey Research Center reports that inflationary anticipations by consumers are now more intense than at any other time in the almost 25 years of the surveys. Over 20 per cent of the households surveyed in August and September thought that prices during the next 12 months would increase 10 per cent or more. Given their decidedly pessimistic evaluations of their own financial situations and of the outlook for business conditions, a surprisingly large number of consumers also responded that it was a good time to buy household durables because of the likelihood of future price increases. By the third quarter of this year, pessimists considerably outnumbered optimists in the population, and 44 per cent of all families thought that the Federal Government was doing a poor job in handling the crucial economic issues of inflat ion and unemployment. At the time of the freeze in August, 1971, about 24 per cent of the respondents gave the Government low marks. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 12 - The price expectations of households find a counterpart in the anticipations of businessmen. For example, Dun and Bradstreet reports that in July more than 80 per cent of manufacturers foresaw the price of their products rising through the fourth quarter of 1973. This is in sharp contrast to the situation at a similar stage of the previous business cycle when only 50 per cent of manufacturers were expecting continued inflation. Moreover, the most recent Livingston survey (reporting interviews as of last June) indicates that average weekly wages in manufacturing are expected to increase at an annual rate of 7 per cent through the period ending June, 1974; respondents to this survey also expect the consumer price index to rise 5.2 per cent in the same period. Finally, the recent consensus forecast of the National Association of Business Economists anticipated that the GNP deflator would grow at an increasing rate through 1974, averaging 5 per cent for the year as a whole. One must assume that businessmen's investment decisions are generally affected by such price expectations. Thus, the projections by the major private surveys of a significant increase in plant and equipment spending in 1974 (in the range of 12 to 15 per cent) may reflect an attempt by firms to compensate for continued inflation. Of course, capacity constraints are of paramount importance in certain industries, and these problems have also become increasingly severe during the current year. For example, the percentage of productive capacity utilized for basic materials production (including Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 13 - steel, woodpulp, paperboard, and manmade fibers) rose to 963 in the third 0 quarter compared to 91.0 a year earlier The third quarter rate of capacity 0 utilization was the highest on record During the previous periods of 0 strong expansion, the utilization rate stopped short of the present level. In the first quarter of 1951--the peak of activity during the Korean War— the rate reached 933 per cent, and the same percentage was recorded in the c first quarter of 1956. In the second and third quarters of 1966, the utili- zation rate was 92.0 per cent, and it was at 91.6 per cent in the last quarter of 1969. Long-Run Impact of Inflation on Income Distribution In the meantime, the inflation that has plagued the United States since the mid-1960's has had widely differing effects on particular groups in the economy. This is by no means surprising. As is generally known, inflation (especially when it is unforeseen) tends to redistribute income away from creditors and fixed-income receivers to debtors and profit receivers. In periods of deflation, the situation is reversed. Of course, it is very difficult to measure the specific effects of inflation on particular segments of the population since individual situations vary so widely from the average experience. If inflation is generated primarily by the expansion of demand for output in the face of limited resources (as is frequently the case), it may be accompanied by an increase in jobs for persons who were previously unemployed. So workers as a group may very well experience both an absolute and relative rise in their money income. The latter may even climb faster than the general Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 14 - level of prices. But for those who already had jobs, compensation may not rise as fast as prices, so their relative position may deteriorate. On balance, however, inflation is likely to have its most noticeably adverse effects on those groups that are out of the labor market—or that occupy marginal positions on its fringes. A general idea of the way in which particular groups in the population have fared in the inflationary environment of the last decade can be traced in broad outline in Table 1 (attached). This table shows annual average rates of change in prices and national income in selected sub-periods between 1960 and 1972. Three measures of the general price level are shown: the GNP implicit deflator; the wholesale price index (WPI), and the consumer price index (CPI). All of them tell essentially the same story. National income is total earnings of labor and property generated in the current production of goods and services in the economy 1 as a whole. It is composed of compensation of employees, proprietors income, rental income, corporate profits and net interest. The behavior of the various price indexes and the different types of income is examined for four time periods: 1960-65; 1965-70; 1970-72, and 1960-72. The differential effect of inflation is also shown, being indicated roughly by the difference between the percentage change in a particular type of income and the percentage change in the CPI. Several conclusions are suggested by these data. During the period of relative price stability between 1960 and 1965 (when the rise in the CPI averaged 1.3 per cent per year), all principal types of income rose faster than the general price level. The largest relative gain was recorded by Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 15 - net interest. A sizable .gain was also registered by corporate profits after taxes. This was reflected in both dividends and undistributed profits. Employees as a group kept well ahead of inflation, but the variation among them was considerable. Both fringe benefits and total wages and salaries rose rapidly, averaging 8.5 per cent and 5.8 per cent, respectively. Among types of employees, government civilian workers (with an average annual increase of 8.0 per cent) did appreciably better than workers in the private sector (whose income rose at an annual average rate of 5.4 per cent). The least relative gain in income was experienced by owners of real estate (3.7 per cent annual average rate of increase), and the income of proprietors rose only slightly more rapidly (4.4 per cent). The latter rate of increase was recorded for farmers as well as for proprietors in nonfarm fields of activity. The years 1965-70 witnessed a considerable expansion of military activity in Vietnam as well as a strong rise in economic activity in the United States. Toward the end of the period, military outlays began to grow more slowly, and the pace of domestic expansion eased appreciably during the 1969-70 recession. Nevertheless, as indicated above, inflationary pressures did not moderate very much until 1971. The impact of this inflation on different income groups can also be seen in Table 1. Wholesale prices (which had remained essentially stable between 1960 and 1965) rose at an annual average rate of 2.7 per cent in the 1965-70 period. The GNP deflator and the CPI rose at an average rate Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 16 - of 4.1 per cent and 4.3 per cent, respectively. Reflecting the strong upsurge of economic activity, national income climbed at an annual average rate of 7.2 per cent. However, after adjusting for the rate of inflation, real income expanded by an average rate of only 3 per cent. Among principal income components, net interest recorded the largest relative gains. This was traceable to higher interest rates as well as to a greatly expanded volume of borrowing by both the Federal Government and the private sector. Compensation of employees rose at an average rate of 8.9 per cent. Again, payroll supplements increased more rapidly (12.0 per cent) than wages and salaries themselves, but the latter also registered a sizable advance (at an average rate of 8.6 per cent). During this period, earnings of civilian government workers as well as military pay rose significantly faster than earnings in the private sector—i.e., 10.8 per cent for civilian government workers and 10.1 per cent for military personnel vs. 8.0 per cent for employees on private payrolls. All of these rates of increase were well above the advance in the general price level. However, the story for owners of property and the owners of unincorporated enterprises was quite different. In the case of property owners, rental income barely kept pace with the rate of inflation--rising at an annual average rate of only 4.7 per cent while the advance in the CPI averaged 4.3 per cent. Among unincorporated enterprises, the income of the farm sector rose at an average rate of 2.7 per cent--considerably below the rate of inflation. The lag in prices of farm commodities was mainly responsible for this outcome. In the nonfarm sector of unincorporated enterprises, the largest proportion of income originates in services, with Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 17 - retail trade a distant second. In both areas, many proprietors pay themselves salaries or establish fees for services which rise roughly in line with the general price level. Reflecting this general tendency, the increase in business and professional income fell only slightly short of the average rise in the CPI. Book profits of corporations declined on average by 1.0 per cent between 1965 and 1970. This was partly attributable to the impact of the recession at the end of the period, but the sizable rise in capital consumption allowances during those years also exerted an influence on corporate profits. Corporate profits tax liability rose at an average rate of 2.1 per cent, so after-tax profits recorded an average decrease of 3.3 per cent over the 1965-70 years. Corporate dividends rose about in line with prices, and undistributed profits recorded a sizable decrease 0 During the 1970-72 period, a quite dramatic change occurred in the relative position of different income recipients. The rate of inflation (as measured by the CPI) was somewhat less than that registered in the preceding period, easing off to an average annual rate of 3.8 per cent from a rate of 4.3 per cent. Total national income rose at an accelerated rate (averaging 8.5 per cent vs. 7.2 per cent in the previous period), and the rate' of increase in real income climbed to over 4-1/2 per cent. The rise in the compensation of employees (at an average rate of 8.2 per cent) expanded somewhat more slowly than in the earlier period (when the rate was 8.9 per cent). Fringe benefits continued to increase faster than Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 18 - wages and salaries• The pay of government civilian workers again rose somewhat more rapidly than the pay of employees on private payrolls (9.2 per cent vs. 7.5 per cent). However, both of these rates of increase were below those recorded in the 1965-70 period (when the gains were 10.8 per cent and 8.0 per cent, respectively). In both cases, the moderation in the uptrend of compensation was undoubtedly influenced by the mandatory restraints on wages. Nevertheless, the rise in compensation was well ahead of the advance in the general price level. In the case of unincorporated enterprises, the farm sector experienced a sizable increase in income during the 1970-72 period— averaging 8.8 per cent per year. This was principally a reflection of the strong increase in demand for agricultural products which began in those years. Rental income of persons (which had risen roughly in line with prices) experienced virtually no increase during the most recent period. The explanation of this behavior is rather complicated, but basically it appears that rents have been much more sticky than market prices of owner-occupied houses—which have risen sharply in 2/ recent years. 2/ Moreover, in the national income accounts, a considerable proportion of the amounts reported as rental income is imputed rent assigned to home-owners. Increased interest charged on the growing amount of equity accumulated in owner-occupied houses and higher capital consumption allowances have largely contributed to the slow rate of growth of rental income. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 19 - A sharp turn around occurred in the case of corporate profits in the 1970-72 period. Book profits (which had declined slightly in the earlier years) expanded at an annual average rate of 15.1 per cent over the 1970-72 years. Although corporate profit tax liability also rose sharply, after-tax profits increased at a rate averaging nearly 19 per cent. All of these rates of growth were substantially greater than the increase in the general price level. On the other hand, corporate dividends during this period rose at an annual rate of only 2-1/2 per cent, and undistributed profits expanded at an annual rate of 42 per cent. This sharp divergence between the growth of after-tax profits and dividends paid out was clearly a result of the restraints imposed on dividends by the Administration's Committee on Interest and Dividends. Net interest increased at an average rate of 11.3 per cent between 1970-72. So, on balance, it appears that in the most recent period one result of inflation has been a significant shift in the distribution of national income more in favor of profit recipients relative to those whose income is derived from wages and salaries. Inflation and Fixed Income Even sharper insights into the impact of inflation on income distribution is provided by an analysis of the experience of those groups in the economy who rely primarily on fixed incomes. Changes in three of these types of income (Social Security, private pensions, and public assistance payments) are shown in Table 2, along with total personal income and the three principal price indexes. The same time periods set out in Table 1 are reproduced here. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 20 - These data cast in bold relief the impact of inflation on fixed- income groups—especially during the last few years. For example, in 1960-65, total personal income rose at an annual average rate of 6 per cent. Personal tax and non-tax payment rose somewhat more slowly and disposable personal income advanced at an annual rate of 6.2 per cent. Since the average increase in the CPI was 1.3 per cent, real disposable income expanded by roughly 5 per cent. In contrast, incomes in the form of transfer payments lagged considerably behind. Social Security payments advanced at roughly 3 per cent in that period, but the rise in prices shaved the increase to less than 2 per cent. Private pension fund payments rose at an annual rate of somewhat over 5 per cent, but after allowance for the price change the advance was just over 4 per cent. The experience of various groups of public assistance recipients varied widely. However, these types of transfers generally kept ahead of the rate of inflation. During the 1965-70 period, personal income rose at an annual average rate of 8.4 per cent, but personal taxes rose even more rapidly (at an average rate of 12.2 per cent). Consequently, disposable income advanced on the average by about 8 per cent. Since the CPI increased at an average annual rate of 4.3 per cent,the real purchasing power of disposable income advanced at an annual rate of about 3-1/2 per cent. Social Security benefits increased at roughly a 7 per cent annual rate—only slightly less than the rise recorded by total personal income—so that the purchasing power of this type of income rose at an annual rate of about 3 per cent. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 21 - In contrast, private pension funds transfers recorded an average annual gain of less than 4 per cent in the 1965-70 period, and this resulted in a modest decline in the relative income position of this group of retirees after taking account of the price increase. The experience of public assistance recipients was again varied. Those receiving old age assistance just about broke even after allowing for inflation. Payments to recipients of aid to families with dependent children increased at an annual average rate of about 7 per cent—which was shaved to just over 2 per cent by inflation. Other forms of transfer payments also showed a net increase after allowing for the advance in the general price level. During the 1970-72 period, a markedly different pattern of income changes was etched by inflation. Again, however, partly responding to controls on wages, total personal income expanded at an annual average rate of about 8 per cent. Since prices increased by almost 4 per cent real personal income also rose at a rate of about 4 per cent. While personal tax and non-tax payments rose somewhat more slowly than in the previous period, the average increase was still 10-1/2 per cent. So disposable personal income increased at an annual average rate of 7.3 per cent during the 1970-72 years. After allowing for inflation, the average gain was 3-1/2 per cent. The income experience of some of the fixed income groups was substantially better than that recorded for personal income as a whole- while for others the experience was considerably worse. For example, Social Security payments rose at an average rate of over 17 per cent during the 1970-72 period; and even after adjusting for the increase in prices, the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 22 - gain was about 13-1/2 per cent. Payments to recipients of private pensions also rose by an average rate of about 6 per cent and by 3/ roughly 2 per cent after eliminating the impact of higher prices.— In sharp contrast, income of recipients of public assistance either just broke even or fell behind the advance in prices. This was especially true of those receiving old age assistance and aid to families with dependent children. In weighing the significance of the latter relative changes in income, it should be noted that the figures refer to cash receipts, and they do not include the value of food stamps and other non- cash benefits. Nevertheless, these data demonstrate again the extent to which inflation in the last few years has lead to a significant redistribution of income in the United States. Inflation and Short-Run Changes in Income Distribution Some of the longer-run changes in income distribution resulting in part from inflationary pressures have become even more pronounced in the last year. Some appreciation of the effect of these changes can be gotten from Table 3, which shows changes in consumer prices and personal income from the third quarter of 1972 to the third quarter of this year. Over that 12 month period, the CPI rose by about 8 per cent. Total personal income expanded by 11 per cent and real income by just over 3 per cent. The increase of total wage and salary disbursement was approximately of the same magnitude. Within this category, however, the relative experience of employees in different industries varied appreciably. For example, wages and salaries in the manufacturing sector rose by 12-1/2 per cent; those in services by 11 per cent, and earnings in the distributive industries by 9-1/2 per cent. Government payrolls rose by 8.2 per cent. 3/ As indicated in Table 2, the growth rates for private pensions are for 1970-71. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 23 - In general, the income of workers on private payrolls increased by slightly more than 3 per cent after allowing for inflation. In contrast, workers in public services experienced virtually no net gain as virtually all of their pay increase was eroded by inflation. In the case of unincorporated enterprises, the income of farmers took an extraordinary jump during the 12 months ending last September- rising by 37 per cent. Even allowing for the effects of inflation, farm income still advanced by nearly 30 per cent. On the other hand, the increase in business and professional income fell slightly short of the rise in prices. Rental income of persons rose by about 1-1/2 per cent—a rate of increase substantially below the advance in the general price level. Dividend income rose by just over 7 per cent, but this too was slightly less than the rate of inflation. On the other hand, personal interest income (reflecting the substantial increase in interest rates and the sizable expansion in credit demands) rose about 13 per cent—again substantially more than the increase in the general price level. The se data on transfer payments are much less complete than the statistics summarized in Table 2. However, total transfer payments increased by 17-1/2 per cent—and by 10 per cent after allowing for the climb in prices. A substantial part of this gain reflected higher Social Security benefits. For example, old age, disability, health and survivors insurance payments (which include Social Security benefits) rose by 28-1/2 per cent. Although the advance in prices cut the purchasing power of these payments, the real gain was still over 20 per cent. Figures Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 24 - on private pensions and public assistance payments are not available on a quarterly basis; however, they are included in the "other" transfer payments classification. This category of payments rose by 11 per cent in the 12 months ending last September and by slightly more than 3 per cent after allowing for the general ri6e in prices. The foregoing review of the income statistics points to a clear conclusion: the persistent inflation in the United States during the last decade has produced a significant redistribution of income in favor of recipients of profits although well-situated workers have also shared in the relative gains. In contrast, while recipients of Social Security benefits have kept well ahead of the advance in prices, other groups dependent on fixed incomes (particularly public assistance payments) have fallen substantially behind, especially in the last few years. Economic Policies to Restore Price Stability Returning to the present and looking ahead, I see continued inflation reinforced by deeply rooted inflationary expectations. Thus, I am personally convinced that it will take a considerable time to bring about an orderly moderation in price performance, so that inflation is reduced to an acceptabledly low level. This means that we must be prepared to accept the use of our resources at less than full capacity. The Federal Government's budget must not be overly expansive. Monetary policy must continue to pursue a responsible role. Both fiscal and monetary policy must continue to be supported by some type of discipline in the wage and price area. And above all, we as a nation must be prepared to live through the time required for a winddown of the current inflation. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 25 - Despite the unexpected decline in the unemployment rate from 4.8 per cent in September to 4.5 per cent in October, the accumulating evidence suggests that the growth of the economy is already slowing in response to a less expansionary Federal budget and the restrictive monetary policy measures put into place over the last year or so. For example, during the last two quarters, real GNP rose at an annual rate of only 3 per cent, compared with a gain averaging about 8 per cent in the two preceding quarters. In current dollars, GNP rose at an annual rate of 14.4 per cent in the first quarter; 9.5 per cent in the second quarter, and 10.1 per cent in the third quarter. But the pace of inflation was also rapid. The GNP deflator climbed at an annual rate of 5.9 per cent during the first quarter; 7.1 per cent in the April-June period, and 6-1/2 per cent in the third quarter. For 1973 as a whole, current dollar GNP may advance by 11-1/2 per cent; the general price level may rise by over 5 per cent, and real output may expand by more than 6 per cent. Still other indications of moderating economic activity can be observed. For instance, Federal purchases of goods and services in the third quarter were actually 9 per cent lower in real terms than at the beginning of last year, and the budget on a national income accounts (NIA) basis moved into surplus for the first time since 1969. Growth of industrial production slowed in the last two quarters, increasing at an annual rate of just under 6 per cent--or slightly over half the rate in Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 26 - the previous six months (Part, but not all, of this slower growth reflected 0 capacity limitations and materials shortages.) Expenditures for personal consumption in real terms, which grew at an annual rate of more than 8 per cent from October, 1972, to March, 1973, rose less than 1.5 per cent further in the last six months. Housing starts have declined from a peak annual rate of 2.4 million units in the fourth quarter of last year and the first quarter of this year to an average of 2.0 million units in the third quarter. In September, housing starts were at a 1.8 million unit annual rate. In talking about the prospects for slower growth, I want to make it clear that I do not foresee a full-scale recession—certainly not of the magnitude of 1969-70. Moreover, assuming that appropriately restrictive monetary and fiscal policies are kept in place--reinforced by the continuation of some form of meaningful restraints on prices and wages—a better price picture could emerge for 1975. Favorable factors which at that time should work against inflationary pressures and which should dampen inflationary anticipations include the following: —The beef cycle will be in the stage which produces an enlarged volume of meat. World supplies of food and feed grains, given normal growing conditions, are likely to come into better balance. --The effects of the dollar devaluation on domestic prices should be largely behind us. --Some expansion in capacity should be in place in those industries for which devaluation and other factors have increased demand the most. —Economic activity abroad, which seems likely to climb further in 1974, may be leveling off. —Finally, with the passage of time, domestic price and wage relationships will probably come into better and more sustainable balance. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 27 - Unfortunately, however, fiscal and monetary policies which impose the degree of restraint on the rate of economic expansion needed to help check inflation, are likely to have uneven distributional effects on particular groups in the economy. The impact is most pronounced in curtailing additional employment opportunities for disadvantaged groups in our populatiori--for older workers, new entrants into the labor force, blacks, poorly skilled persons, and those living in economically depressed areaso As a nation, we have a special responsibility to assist these groups when we adopt measures to combat inflation--but which also dampen economic progress. Summary and Conclusions In summary, as I scan the horizon of the American economy, several elements stand out: --Growth in economic activity appears to be slowing toward a more sustainable pace. Real output increased at an annual rate of about 3-1/2 per cent in the third quarter, and the increase in the closing months of this year seem likely to be in the same order of magnitude. In the year ahead, the rate of expansion may continue somewhat below the long-run trend, but I personally would not expect an actual decline in real GNP. --Unfortunately, inflationary pressures have not yet responded to the moderating trend of real economic activity. A number of industries are operating at or close to capacity, and this exerts substantial upward pressure on the general price level Moreover, inflationary c expectations appear to have strengthened in recent months. The deterioration in attitudes seems widespread--affecting businessmen, investors, trade unions, unorganized workers, and consumers. The strong expansion of spending on plant and equipment apparently was stimulated by anticipated demand growth and profits, although inflation has also 1 played a role. The erosion of purchasing power of workers earnings has also induced numerous trade unions to step- up their demands for wage increases, and the trend may accelerate during the coming year. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 28 - --The persistent inflation in the United States during the last decade has produced a significant redistribution of income in favor of recipients of profits although well- situated workers have also shared in the relative gains. In contrast, while recipients of Social Security benefits have kept well ahead of the advance in prices, other groups dependent on fixed incomes (particularly public assistance payments) have fallen substantially behind. --The rate of inflation in the United States during the current year may exceed 5 per cent (measured by the GNP implicit deflator). During 1974, unfortunately, the overall rate of inflation may continue in roughly the same magnitude. --Given these prospects, the need to maintain firm stabilization policies seems clear. I am not unmindful of the emerging concern on the part of some observers about the possibility of some increase in unemployment next year. On the other hand, I am also highly conscious of the likely persistence of strong inflationary pressures. So as I weigh the need to combat inflation and the need to be sensitive to the danger of an economic downturn, I come out at this time on the side of continuing the fight against inflation. —At the same time, I know that policies to moderate economic growth have a disproportionately adverse impact on some sectors, in depressed areas, and on younger or disadvantaged workers. To cushion these adverse effects, the appropriate policy is one aimed at lessening the structural defects-- rather than one which relies primarily on the provision of excessive stimulus to the economy via easy money or large deficits in the Federal budget. --In the meantime, however, the restoration of price stability requires the maintenance of appropriate restraint in monetary and fiscal policies. Moreover, these need to be supported by the continuation of some form of direct Government influence on the setting of wages and prices in the private sector. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 29 - So, returning to the question to me which I reported at the outset, the answer appears fairly clear: high interest rates in the United States today reflect the persistence of severe inflation. When genuine progress is made toward checking the excessive rise in the general price level, interest rates will be lower, and the nation can afford to press harder on the task of improving the real economic welfare of its citizens. Monetary policy can make a meaningful contribution in pursuit of this goal. - 0 - Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Table 1. Annual Average Rates of Change in Prices and National Income, Selected Periods, 1960-72 (Percentages) 1960-65 1965 -70 1970-72 1960-72 Differential Differential Differential Different Category Change Effect 1/ Change Effect 1/ Change Effect 1/ Change Effect Price Indexes GNP Implicit Deflator 1.4 4.1 3.9 2.9 Wholesale Price Index 0.3 2.7 3.9 l.S Consumer Price Index 1.3 4.3 3.8 2.9 National Income 6.4 5.1 7.2 2.9 8.5 4.7 7.1 4.2 Compensation of employees, total 6.0 4.7 8.9 4.6 8.2 4.4 7.6 4.7 Wages and salaries, total 5.8 4.5 8.6 4.3 7.6 3.8 7.3 4.4 Private 5.4 4.1 8.0 3.7 7.5 3.7 6.9 4.0 Military 4.1 2.8 10.1 5.8 1.8 - 2.0 6.2 3.3 Government civilian 8.0 6.7 10.8 6.5 9.2 5.4 9.4 6.5 Supplements to wages & salaries 8.5 7.2 12.0 7.7 13.5 9.7 10.7 7.8 Proprietors income, total 4.4 3.1 3.1 - 1.2 5.3 1.5 4.0 1.1 Business and professional 4.4 3.1 3.4 - 0.9 3.9 0.1 3.9 1.0 Farm 4.3 3.0 2.7 - 1.6 8.8 5.0 4.4 1.5 Rental income of persons 3.7 2.4 4.7 0.4 0.4 - 3.4 3.6 0.7 Corporate profits before tax, total 9.4 8.1 - 1.0 - 5.3 15.1 11.3 5.8 2.9 Corporate profits tax liability 6.4 5.1 2.1 - 2.2 10.8 7.0 5.3 2.4 Corporate profits after tax 11.7 10.4 - 3.3 - 7.6 18.7 14.9 6.3 3.4 Dividends 8.1 6.8 4.5 0.2 2.6 - 1.2 5.7 2.8 Undistributed profits 12.4 11.1 -11.4 -15.7 42.0 38.2 6.9 4.0 Net Interest 16.7 15.4 14.9 10.6 11.3 7.5 15.1 12.2 1/ The differential effect of in flation is the percentage change in a particular type of income less the Fp ercenta5g e chanee m the consumer price index, Sources: U.S. Department of Commerce, Bureau of Economic Analysis, Survey of Current Business. U.S. Department of Labor, Bureau of Labor Statistics, Monthly Labor Review. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Table 2. Annual Average Rates of Change in Prices and Personal Income, Selected Periods, 1960-72 (Percentages) 1960-65 1965-70 1970-72 1960-72 Differential Differential Differential Differential Category Change Effect 1/ Change Effect 1/ Change Effect 1/ Change Effect 1/ Price Indexes 1.4 4.1 3.9 2.9 GNP Implicit Deflator 0.3 2.7 3.9 1.9 Wholesale Price Index 1.3 4.3 3.8 2.9 Consumer Price. Index Personal Income Total personal income 6.0 4.7 8.4 4.1 7.8 4.0 7.3 4.4 v Personal tax and nontax payments 5.2 3.9 12.2 7.9 10.4 6.6 9.0 6.1 Disposable income 6.2 4.9 7.9 3.6 7.3 3.5 7.1 4.2 Personal outlays 6.0 4.7 7.4 3.1 8.4 4.6 7.0 4.1 Personal saving 10.8 9.5 14.6 10.3 • 6.3 -10.1 9.4 6.5 Selected Transfer Payments Social Security 2/ Male 2.5 1.2 7.1 2.8 17.1 13.3 6.7 3.8 Female 3.4 2.1 7.6 3.3 17.5 13.7 7.4 4.5 Private Pensions 3/ Insured 4.8 3.5 3.6 0.7 6.5 4/ 2.7 4.4 5/ 1.5 Uninsured 5.9 4.6 3.8 0.5 5.2 4/ 1.4 4.9 5/ 2.0 Public Assistance 2/ Old Age Assistance 1.7 0.4 4.4 0.1 1.3 • 2.5 2.7 0.2 AFDC - per family 5.5 4.2 6.5 2.2 0.8 - 3.0 5.1 2.2 per recipient 4.1 2.8 8.7 4.4 3.9 0.1 6.0 3.1 Aid to the blind 3.9 2.6 5.1 0.8 4.2 0.4 4.4 1.5 Aid to permanently, totally disabled 4.0 2.7 7.9 3.6 4.1 0.3 5.6 2.7 General Assistance 0.6 0.7 10.2 5.9 1.5 - 2.3 4.6 1.7 1/ The differential effect of inflation is the percentage change in a particular type of income less the percentage change in the consumer price index. 2/ Average monthly payments. 3/ Average monthly payments per beneficiary. 4/ Latest data are for 1971', thus these growth rates are for 1970-71. 5/ Growth rates are for 1960-71. Sources? U.S. Department of Commerce, Bureau of Economic Analysis, Survey of Current Business. U.S. Department of Labor, Bureau of Labor Statistics, Monthly Labor Review. Social Security Administration, Social Security Bulletin. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Table 3. Consumer Prices and Personal Income, Third Quarter, 1972 and 1973 (Amounts in billions of dollars) Percentage Differentials JL Category 1972 1973 Change Effect _LLL_ (3) (4) Consumer Price Index 125.8 134.4 7.7 Personal Income Total personal income $943.7 $1,046.7 10.9 3.2 Wage & salary disbursements 632.7 698.9 10.5 2.8 Commodity-prod, industries 227.3 255.3 12.3 4.6 Manufacturing 177.0 199.2 12.5 4.8 Distributive industries 152.5 166.8 9.4 1.7 Service industries 117.9 130.7 10.9 3.2 Government 135.0 146.1 8.2 0.5 Other labor income 41.3 45.3 9.7 2.0 Proprietors income 74.1 85.1 14.8 7.1 Business 6c professional 54.3 58.0 6.8 - 0.9 Farm 19.8 27.1 36.9 29.2 Rental income of persons 24.9 25.3 1.6 - 6.1 Dividends 26.2 28.1 7.2 - 0.5 Personal interest income 78.6 89.0 13.2 5.5 Transfer payments 101.1 118.7 17.4 9.7 Old-age, disability, health 6c survivors insurance 48.0 61.7 28.5 20.8 State unemployment ins. benefits 5.3 4.2 -20.8 -28.5 Veterans benefits 12.6 13.8 9.5 1.8 Other 35.2 39.0 10.8 3.1 Less: Personal contribution for social insurance 35.2 43.6 23.9 16.2 17 Tke diffetferitial effect of inflation is the pe change in a particular type of income less the percentage change in the consumer price index. Source: U.S. Department of Commerce, Bureau of Economic Analysis, Survey of Current Business and unpublished data. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Andrew F. Brimmer (1973, November 8). Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/speech_19731109_brimmer

@misc{wtfs_speech_19731109_brimmer,
  author = {Andrew F. Brimmer},
  title = {Speech},
  year = {1973},
  month = {Nov},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/speech_19731109_brimmer},
  note = {Retrieved via When the Fed Speaks corpus}
}