current economic situation: speech before the oklahoma

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

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wrocmms nave

disintermediation

Accompanying the nigh and rising interest

rates and the inflation, there have been many serious

problems in the financial markets.

included financial "crunches" and

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 developed«despite a supoosed better understanding of economicA A A w*processes and well meaning attempts to fine-tune the


" 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


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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


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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


- 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.


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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

neCouncil cf Economic Advisers has estimated that ti

potential GNP rose at a 3.5 per cent rate from the


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toward capacity output wa: reiatiyely sicw, but this

paries fc'iowsd two recessions only two years apart.

Also, the economy received a .minor additional shock two

years later, in 1962, when money declined relative to

the trend.

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.


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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 - jA A •rapidly in the lace isob's and 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


! < 11

at around ii pet

shows the share of public debt he'd by the Federal

Reserve Banks. This ratio held nearly constant,

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 thiso U Zacquisition ot reoera; Reserve ceot. nc.n iie reusr^ra!

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. And the borrowing was carried on in such

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- 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


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holdings cf Gcvernment codt to the total outstanding remains

- 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 ffCproblems 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


■J f~ 16 -

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-zwould 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 deficitshH c\zx'’h/’!tv *i’ni ft '<* V/V JW ft ft V* i i i kz ft ii K.Z ft • $ i<Z CiU t •• b J C* i Lz v W it Cz Li L/ « Cl* uz -Z ft ft

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

f ” "V A ' A C As ! ! H J Ai "■ C »iCbi.v3o Vi Liiivi.J

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abandoned, particularly with regard to monetary actions

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i conciudc that success in the fight against

inflation ever the next few years will ascend greatly onV C H-* c/’T*./ ’T' i ’fc1‘v ° *2 r* CiVv I lO i. k i i kz i i 2 - a kz <La 3 V C; L. Ltvz v y i a. i S . O'< ’L» a La >.O Af HOAA-OV Ca-1C-'IHh fP P ! «M'O * P fK?C ?A’,.’FO^ P"* TV •; •■ pk> k kz kx- Va a 2 7 I 2 • k- 2 2 3 kkk £ 3 a L I I 2 O a k> A kz a '-’ . Vz A . 4 A b J J

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have ied to disarray In our economy, ar.a the world

economy, disappear frem the scene.


L4ili.il

195? 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972RATIO SCALE BILLIONS OF DOLLARS

Money Stock

1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972Shaded areas represent periods of business recessions as defined by the National Bureau of Economic Research.Latest data plotted: 111/197'

—

11

1

1

11

□

1

1

u

1st qtr 51

1

h

i

Prepared by Federal Reserve Bank of St. Louis


3201952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972RATIO 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 1972Shaded 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


current economic situation: speech before the oklahoma

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