Speech

For Release on Delivery Wednesday, August 7, 1974 10:3Q a.m. (E.D.T.) INFLATION IN THE UNITED STATES The Record and Outlook Remarks By Andrew F. Brimmer Member Board of Governors of the Federal Reserve System Before NATIONAL TOWN MEETING Kennedy Center for the Performing Arts Washington, D.C. August 7, 1974 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis INFLATION IN THE UNITED STATES The Record and Outlook By /V Andrew F. Brimmer Virtually everyone now agrees that inflation is the central economic problem faced by the United States today. Over the last year, consumer prices rose by 11 per cent, and wholesale prices jumped nearly 15 per cent—the fastest rates of increase since the Korean War. By all measures, the current inflation is as serious and will probably be more prolonged than any experienced in the postwar era. This current inflation differs from previous experience in a number of respects. Although inflation originated from conditions f of excess demand in the late 1960s, we are now experiencing severe price pressures in the context of sluggish economic activity—a markedly different economic environment than that which prevailed during World War II and the Korean War when war-created excess demand strained our resources. Not only is the current inflation relatively intense, but it is also of relatively long duration. Thus, it has tended to create its own momentum--fed by inflationary expectations among consumers and businessmen. The gravity of the current inflation problem cannot be over- estimated: the consequences are already apparent in the economy. Inflation has had debilitating effects on the purchasing power of consumers, on the efficiency of the business sector, on the condition of financial markets— * Member, Board of Governors of the Federal Reserve System. I am grateful to Ms. Diane Sower of the Board's staff for assistance in the preparation of these remarks. However, the views expressed here are my own and should not be attributed to the staff—nor to my colleagues on the Board. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 2 - and on confidence in general. Consequently, I think it is important for all of us to understand the nature of the problem and to appreciate the outlook in the months ahead. Origins of the Present Inflation By way of background, our present inflationary environment f may be traced to the mid-1960 s when the demands of the Vietnaiu War combined with a strong business expansion and resulted in an overheating of the economy. The unemployment rate was brought down to 4 per cent at the end off 1965, and it dropped further in the next three years to an exceptionally low 3.4 per cent in late 1968 and early 1969. Aggregate demand expanded rapidly during this period as business fixed investment advanced briskly and Federal expenditures (notably defense outlays) increased sharply. The Federal budget, on a full employment basis, changed from a $7-1/4 billion surplus in the first half of 1965 to a $12 billion deficit in the first half of 1967. The pressure on resources resulting from excess demands caused bottlenecks to emerge in a number of important sectors, and prices began to move up at a fast pace. Prices (as measured by the implicit GNP deflator--probably the broadest overall measure of price change in the economy) had risen by less than 2 per cent in 1965; but by 1968 prices were increasing at an annual rate of more than 4 per cent. Demand pressures subsided during the recession which got underway at the end of 1969, and unemployment rose substantially. However, inflation did not decelerate during the economic slowdown. In fact, between 1969 and early 1971, the GNP deflator increased by about 5 per cent a year as wages and other costs rose rapidly—probably in response to the protracted period of inflation and pushed prices up further. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 3 - Economic developments over the first half of 1971 (the early phase of recovery from the recession) increasingly brought into question whether traditional monetary and fiscal policies were adequate to make progress in combating cost-push inflation while at the same time continuing to promote a more vigorous recovery in the economy. The consumer price index had increased at an annual rate of about 4-1/2 per cent in the first half of the year; at the same time wages were rising by more than 7 per cent at an annual rate. In an attempt to cope with this situation, a general wage-price freeze was imposed for 90 days in August, 1971, followed by a comprehensive program of mandatory wage and price controls in Phase II. The subsequent moderation in the uptrend of wages and prices was probably due in part to the mandatory controls and in part to the previous prolonged period of little economic growth. Through most of 1972, wage increases slowed to about 5-1/2 per cent at an annual rate—from about 6-1/2 the previous year; the rise in consumer prices dropped from a 5 per cent annual rate to less than a 3-1/2 per cent rate during the same period. However, the momentum of wage and price increases picked up sharply again in 1973. This renewed acceleration of inflation was the result of a number of special factors as well as the consequence of a worldwide boom in economic activity which produced increased pressures on supply capacities in a number of key industries—thereby bidding up prices sharply. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 4 - Special Factors and Inflationary Pressures During the last two years, the general price level has been influenced greatly by a number of special factors, especially those affecting the prices of food and fuels. In 1973 about 60 per cent of the increase in consumer prices was accounted for by rising prices of these two i/ commodities. The rise in food prices felt by consumers reflected even more pronounced increases in farm prices for food and feeds. These, in turn, stemmed from an extraordinary surge in world grain prices. Grains played a central role in the inflationary process because they are a food staple—particularly in less developed countries—and a basic feed for livestock and poultry. The jump in grain prices was the result of several factors operating simultaneously. Total world grain production declined in 1972 as droughts in South and Southeast Asia, Africa, and the U.S.S.R. caused disappointing harvests. At the same time, United States agricultural policy entailed restriction of grain supply through acreage allotments. The massive Russian wheat deal exacerbated the shortages. (The sale amounted to 15 million tons and represented about one-third of our annual production in 1972.) These factors coincided with a surge in worldwide demand for our food and feedstuffs because of the droughts as well as rising affluence in Western Europe and Japan which stimulated strong demands for meat and thus, for feed grains. The higher prices for grains and soybeans, together 1/ Specifically, in 1973, the consumer price index (CPI) increased by 8.8 per cent (December, 1972-December, 1973). Food prices rose 20 per cent and accounted for half of the advance in the CPI. Gasoline prices rose nearly 20 per cent and fuel oil 47 per cent; together they accounted for about 10 per cent of the increase in the CPI in 1973. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 5 - with the disappearance of the Peruvian anchovies (a prime source of protein feed) increased costs to livestock producers, forcing meat prices up and curtailing supplies. Farm prices continued to advance rapidly until August, 1973, when they reached a peak of 66 per cent above a year earlier. Prices at the wholesale level have receded through June, but retail food prices continued to advance at a 11 per cent annual rate through the end of 1973 as increased production costs continued to work their way through to final products. Adding to the inflation problem, in the fall of last year, the oil embargo and the sharp increase of oil prices—as we know—led to huge increases in the price of gasoline and other fuel-related products. Prices of imported oils have tripled since last fall, and large increases in prices of domestically produced oil have been allowed. Mainly as a result of these increases in crude oil prices, gasoline prices in June were nearly 40 per cent above last June's level, and prices of fuel oil were up more than 60 per cent. Aggregate Demand, Devaluation, and Inflation In addition to these special factors, the worldwide boom in economic activity caused demands to outstrip supplies in a number of key industries in 1973 resulting in a bidding up of prices. In the United States, larger foreign orders for industrial materials and capital equipment augmented strong domestic demand. Pressures became particularly intense in major materials industries. For instance, in steel, aluminum, cement, and paper (where capacity utilization rates moved up to very high levels) Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 6 - production was 94 per cent of available capacity in the fall of 1973, As one would expect, the increasing strain on supplies resulted in mounting price pressures. Moreover, materials shortages are likely to remain N relatively acute throughout 1974—especially in the steel, petrochemical and paper industries—as slow capacity growth coupled with a surge in foreign demand has caused extremely tight supplies. New impetus to the inflation also resulted from the decline in the exchange value of the dollar relative to other currencies. It will be recalled that the Smithsonian Agreement in December, 1971, resulted in about an 8 per cent devaluation of the dollar. This added to inflationary pressures by raising the dollar price of imported goods. In addition, the devaluation made the prices of our goods relatively more attractive in world markets. Our export trade was thus stimulated by strong worldwide demand for our goods, reinforcing the pressures of domestic demand on available resources. However, the devaluation of the dollar did not improve our balance of trade in the short-run, as the depreciation initially increased the dollar price of imports more than it reduced the volume of imports. At the same time, export controls on certain agricultural commodities (primarily soybeans) restricted to some extent the rise in export earnings. Our trade position worsened in 1972, and consequently, in February, 1973, the dollar was devaluated for a second time—by about 10 per cent. The impact of these two devaluations spread throughout the economy: immediate price pressure was felt on primary products such as food and raw materials, but gradually these increases were reflected in the prices of manufactured goods. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 7 - Relaxation of Wage and Price Controls The relaxation of wage and price contols under Phase III in January, 1973, and their removal in April this year also lead to sharp upward adjustments in prices. It will be recalled that, under Phase III, 11 increased costs were allowed to be "passed through to prices, with profit margins restrictions lessened somewhat. Large price increases followed, generated in part by several forces. Undoubtedly, prices at the end of Phase II were below what they otherwise would have been; thus, there was a catch-up phenomenon. Additionally, demand pressures were apparent in a number of sectors as noted above, and scarcities and bottlenecks were increasingly becoming a source of cost and price pressures. Also, since the Phase III decontrol was not unequivocal, it is likely that some price increases were generated by widespread anticipation of a new set of controls. In early 1973, prices rose faster than anyone had anticipated. Ceilings on red meats prices were introduced in late March, and in June, a general price freeze was reimposed for 60 days. But price increases resumed at a rapid pace following the termination of the freeze. Farm and food prices continued up at a dramatic rate through the fall when the Arab oil embargo began to lift the price of petroleum products. Price Developments in 1974 Consumer prices generally accelerated early in 1974 under the impetus of the increased costs of food and fuels. Although the pace of increases in the consumer price index slowed somewhat in the spring, the rate of advance remained in the double digit range. Just when Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 8 - the direct impact of fuel price increases were disipating somewhat and food prices were beginning to recede, the prcies of industrial commodities started accelerating—reflecting the ending of controls in Apirl and the effects of previous increases in fuel and other costs being passed through to end products. Price advances in services also speeded up. Wages have also begun to contribute more to price pressures. Wage rates began to rise somewhat more rapidly in 1973 following the relaxation of Phase II controls in January of that year. During 1972, pay increases had been generally moderate—increasing at an annual rate of about 5-1/2 per cent, in line with Pay Board standards. Wage increases moved up to an annual rate of 6.7 per cent in 1973 as collective bargaining settlements took place in several key industries—notably in the automobile industry—and workers attempted to keep wages advancing in line with the cost-of-living. But the pay increases lagged the rapid rise in prices, and real weekly take home pay began to decline in the Spring of 1973. This erosion of the purchasing power of workers has continued so far in 1974, although wage rate increases stepped up sharply. The average real take home pay of a nonfarm worker with three dependents is now about 6-1/2 per cent below the peak reached in the Fall of 1972. This loss of real earnings is now the major factor behind the pressure for larger wage increases. It is somewhat surprising that demands for higher pay were not more evident earlier. In the second quarter of 1974, wages (as measured by the average hourly earnings index, which is the closest available measure of average wage rates) grew at an annual rate of 9.4 per cent—compared with a 6.7 per cent rate of increase Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 9 - over the four quarters of 1973, The largest wage increases recently have been in manufacturing where settlements in several key industries became effective, and large cost-of-living adjustments were reflected in pay rates. However, acceleration has been marked in construction and the less unionized service and trade sectors as well. The larger wage advances have put upward pressure on unit labor costs and prices. The situation has been exacerbated by the poor performance of productivity where growth has been well below trend. Productivity gains had moderated after the second quarter of 1973 (as often occurs when output growth slows) and turned negative in the first part of 1974. With hourly compensation rising substantially over the same period, unit labor costs increased rapidly (at an annual rate of 13.5 per cent in the first half of 1974)--the largest half-year increase since the Korean War. The Outlook for Inflation The outlook for moderating inflation is not completely bleak. The bulge in prices following the removal of controls on all commodities (except petroleum) on April 30 is undoubtedly temporary. Also, fuel prices should stabilize, and the largest part of the direct impact of higher energy prices on goods and services may be behind us. A slower rate of real output growth may also moderate excessively high demand pressures. Nevertheless, it does not appear that inflation will recede to a tolerable rate in the near future. Many of the extraordinary increases in labor costs and in materials and fuels that we are now experiencing Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 10 - will be working their way through into prices of finished goods in coming months. The 1975 model automobiles will cost substantially more. Recently announcements have been made of further substantial price increases for steel mill products, lead, and fabricated aluminum. In addition, many products—such as synthetic textiles, rubber, plastics, and fertilizers—depend on derivatives of petroleum, and these prices are now much higher than a few months ago. Although food prices at the wholesale level had receded somewhat through the spring, there are two factors which are certain to put upward pressures on retail prices later in the year: droughts in the Midwest will result in lower than anticipated grain harvests in the fall, and this is likely to maintain or increase costs for livestock feeds. More- over, continuing food shortages in many parts of the world—especially in India and Africa—may maintain strong demand for our wheat exports. Thus, relatively high world prices for foodstuffs are likely to persist. Farm prices are also likely to be bolstered by the much higher costs of petrochemical fertilizers and the costs of operating farm machinery. The wholesale price index for July (to be released in the next day or so) will almost certainly indicate a sharp rise in farm prices—which unless reversed, will be reflected to some degree in retail prices in the months ahead. Wages and labor costs are also likely to continue to increase rapidly. Much of the uptrend has been stimulated by a number of settlements in key industries which have set the pattern for bargaining in other areas this year and next. And, with about 45 per cent of the 10-1/2 million workers under major contracts covered by cost-of-living escalators, wage Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 11 - increases will automatically be paid out as consumer prices increase. Other large segments of the population also have their income automatically increased as prices rise. * For example, 29 million social security recipients, 2 million retired military and Federal Civil Service employees and postal workers and 13 million food stamp recipients--all receive cost-of-living allowances. In the case of private pensions, steel workers recently negotiated partial cost-of-living protection for their pensions. In addition to these trends, real weekly take home pay continues to decline. Consequently, "catch-up" pressures are likely to influence wage adjustments for the foreseeable future. And, as wage increases result in rising labor costs, employers are likely to raise prices to maintain profit margins. Public Policy to Combat Inflation Given this pessimistic near-term outlook for inflation, the task of public policy is clear: our aim should be to reduce over time the rate of price increase--while remaining sensitive to the adverse impact on employment and incomes. Since inflation has been underway for so long—extending back nearly a decade —it has become deeply rooted in the very fabric of the economy. Consequently, we should have no illusions about our ability to bring about its quick and easy end. Quite the contrary, it will take several years of vigorous—and hopefully enlightened—public policies and geniune sacrifices by all segments of the private economy. This means that traditional monetary and fiscal policy must be restrictive, and increases in both wages and prices must be moderated. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 12 - As far as the Federal Reserve is concerned, our basic position has been stated explicitly many times: we will provide bank reserves sufficient to accommodate an orderly expansion of economic activity. But we will not allow excessive growth in money and credit which would further stimulate the prevailing inflationary pressures. Of course, opinions differ widely with respect to the degree of success we have achieved in pursuit of this goal. In my judgment, however, I believe monetary policy has contributed about as much to the fight against inflation as one could have reasonably expected—given the conjuncture of special factors such as the sharp rise in food, oil and materials prices discussed above. The record of monetary developments during the last year can be traced in a few key statistics. The narrowly-defined money supply (consisting of currency and checking accounts owned by the public) rose by 5-1/2 per cent—while the general price level has climbed by 11 per cent. Bank credit (measured by loans and investments of commercial banks) expanded by 12 per cent. During the first half of 1974, the rate of growth of both of the measures quickened somewhat. The money stock rose at an annual rate of 6-1/4 per cent, and bank credit rose at an annual rate of 13-1/2 per cent. However, bank loans to businesses increased at an annual rate of more than 20 per cent during the same period. Since the Federal Reserve has not allowed bank reserves to increase at a rate fast enough to enable all of the strong credit demands to be met, market interest rates have risen substantially. For instance, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis in recent weeks, short-term commercial paper rates have been in the range of 11-1/2 to 12-1/4 per cent. In the long-term market, interest rates have also climbed significantly. Thus, the highest-grade corporate bonds are offering around 10 per cent. Yields on tax-exempt issues sold by State and local governments have been averaging roughly 6-1/2 per cent. Interest rates on home mortgages are at 9 per cent or more. I assure you that interest rates at these levels (some of which 1 are at the highest levels in the nations recorded history) and the tight credit conditions from which they arise do not bring any pleasure to anyone in the Federal Reserve System. We know that—because of the pressures in money and capital markets—many potential borrowers have not been able to obtain funds in the amounts needed or in a timely fashion. For example, since the beginning of June alone, almost $2 billion of corporate bond and stock offerings have been cancelled or postponed. Over the same period, State and local governments have cancelled or post- poned about $800 million of offerings. The housing sector has already been carrying the burden of rising land and construction costs and over- building in some sections of the country, while also suffering from fears of a gasoline shortage. On top of these troubles, sharply higher interest rates and the reduced availability of mortgage credit at savings institutions and commercial banks have brought still more adverse effects to the housing sector. In passing, I should note that these adverse effects of monetary restraint on particular sectors of the economy did not come as a surprise. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 14 - Iri my case, I have devoted a great deal of time and effort to documenting the adverse effects of monetary restraint on sectoral credit flows. In \ essence, during periods of substantial monetary restraint, the resulting higher costs and lesser availability of bank credit strike different sectors of the economy most unevenly. In general, banks show a strong preference for lending to long-standing business customers (particularly large corporations) while other types of borrowers receive a reduced share of the available funds. At the same time, there is typically a sharp shift in the flow of funds away from housing, State and local governments, small business, finance companies, and farmers. In contrast, business borrowers are affected to a much lesser extent—although the cost of funds to them does rise substantially. Given this situation, as long ago as April, 1970, I suggested that the Federal Reserve Board be given authority to establish supplemental reserve requirements on bank assets. Such supplemental reserves would have been set on a differential basis—thus allowing the Board to encourage banks to channel funds into areas of high national priority and to discourage bank credit lending in areas of lesser importance. Unfortunately, although in 1970 Congressional hearings were held on a bill containing many of the features of the proposal which I advanced, little came of it. Consequently, I was delighted to see Congressman Henry S. Reuss introduce a bill a short time ago which seeks to achieve the same objectives. In fact, his proposed legislation is superior to the earlier approach because it would provide for the establishment of a system of both Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis supplementary reserves a^d credits. This provision would v .dow the Board with an additional instrument which would make it possible to cope more effectively with the distortion in the sectoral distribution of bank credit which typically occurs during periods of monetary restraint. I was personally pleased to support the proposed legislation, although the Board believes that it would be inappropriate to grant the central bank this discretionary power. In the meantime, despite the adverse side effects of monetary restraint, I personally believe that we have no real alternative to continued reliance on monetary policy for a significant contribution to the fight against inflation. Yet, I can also assure you that I am personally convinced the Federal Reserve will be ever alert to the strains on our financial institutions and will act with the sensitivity that the situation requires. Given the serious inflation problem, a firm fiscal stance is also necessary. The budget currently calls for a slowdown in Federal spending in the second half of 1974--and for even greater restraint in the first half of 1975. The Federal deficit, however, is still expected to increase significantly—primarily because the slower growth of the economy tends to have an adverse effect on tax receipts. On a full employment basis, the budget outlook is clearly in the direction of fiscal restraint. And that is as it must be. In addition, the Administration has recently announced plans to reduce the size of the projected budget by paring spending by some $5 billion to a $300 billion level. This would be of some help—if it can be accomplished. Congress for its part should resist any temptation to stimulate economic activity by cutting personal taxes because this would run counter to the requirements of an appropriate fiscal policy. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 16 - It is clear that the monetary and fiscal restraint will have an adverse effect on levels of economic activity and employment generally and particularly on certain sectors of the economy, especially housing. These by-products of tight policies can be minimized to some extent, but not avoided entirely. Corrective action can be taken directly in some areas. To this end, I would recommend alleviating unemployment problems, when necessary, by expansion of the Public Employment Program and the strengthening of the unemployment insurance system. The incidence of credit restraint has been disproportionately heavy on housing, and further selective aids to this sector may be necessary. Nevertheless, I am convinced that traditional monetary and fiscal policy should not be our only weapons in the fight against inflation. For this reason, I was delighted to join with my colleagues earlier this week in recommending to Congress that machinery be revised which would enable the Federal Government to intervene in wage and price developments in pace-setting industries. We took note of the fact that the pace of wage advances in the construction industry is again accelerating--threatening to erase the gains achieved under the Construction Industry Stabilization Committee. We urged the reestablishment of that Committee. The Board also urged "... the Congress to reestablish the Cost of Living Council and to empower it, as the need arises, to appoint ad hoc review boards that could delay wage and price increases in key industries, hold hearings, make recommendations, monitor results, issue reports, and thus bring the force of public opinion to bear on wage and price changes that appear 11 to involve an abuse of economic power.... Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis - 17 - Concluding Observations In conclusion, inflation is the most acute economic problem facing the United States (and much of the world as well). It cannot be ended quickly. There are special obstacles to bringing it under control when the economy is already sluggish, with unemployment rising- yet, with cost pressures continuing strong. But progress can be made with prudent use of monetary and fiscal policy—supplemented by some form of direct Government influence in the determination of key wage and price decisions. The fight against inflation cannot be waged without costs, but the consequences of not ending the inflationary spiral would impose a far heavier burden on the long-run economic welfare of the American people. - 0 - Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Andrew F. Brimmer (1974, August 6). Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/speech_19740807_brimmer

@misc{wtfs_speech_19740807_brimmer,
  author = {Andrew F. Brimmer},
  title = {Speech},
  year = {1974},
  month = {Aug},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/speech_19740807_brimmer},
  note = {Retrieved via When the Fed Speaks corpus}
}