or, more particularly, the inflation outlook to warrant much of a change, if any. And certainly nothing in the international situation as far as the strength of the dollar is concerned would call for an easier posture.

Assuming, and I think it is a safe assumption, that the Federal Reserve will continue to be alert to any signs of increased inflation in an expanding economy, interest rates inevitably will go up. To be more specific I think that by year end short term rates will be up at least another 100 basis points and long rates another 50 basis points. And on that cheerful note I could conclude my remarks, but I am reminded that my old monetarist friend, Gene Leonard, formerly of the St. Louis Fed, told my seminar in Monetary and Fiscal Policy at Vanderbilt University not too long ago that at least a monetarist could sleep nights because all he had to worry about was one variable! As for me, discretion in both domestic and international monetary management, which involves worry about a variety of variables, is imperative in today's complex world—even if it keeps me awake nights!

Senator SASSER. Dr. Modeste, could we call on you now, please, sir, for your comments. And I don't wish to hurry anyone, but I might say that I for one am going to have to get to Knoxville later on this afternoon, and the weather conditions are bad. So we would greatly appreciate it if you could abbreviate your statements as much as possible in order to save time for discussion and questions. You may proceed.

STATEMENT OF DR. NELSON MODESTE, DEPARTMENT OF ECONOMICS AND MANAGEMENT, FISK UNIVERSITY, NASHVILLE, TENN.

Dr. MODESTE. First of all, let me express my pleasure this morning for the opportunity to appear before the Senate Budget Committee in order to examine along with other distinguished persons drawn primarily from the State of Tennessee, the state of economy and its potential for the next fiscal year.

GNP GROWTH

I'm happy to say that the economy in 1977 continued the expansionary trend which was started in 1975. In fact, the level of the real GNP increased by 5.7 percent for the year. And it is my anticipation that in 1978 that trend in growth and real income will be maintained.

GOVERNMENT SPENDING

The reasons that I base those sorts of conclusions on is basically that Government spending will serve as a leverage factor in offsetting any decline which occurs in consumer expenditures and business expenditures.

TAX CUT

The proposed tax cut by the Government I think will do a fairly good job in terms of alleviating any downturn in economic activity which develops on account of the size of the current deficit in our present trade balance.

CONCERN FOR UNEMPLOYMENT IN BLACK COMMUNITY

The particular concern that I have with regard to the policy for this year and for coming years is with regard to the unemployment rate. The unemployment rate has declined from 7.8 percent in December 1976 to about 6.4 percent. However, my main concern is

with the unemployment rate for the black community, which has remained at a traditionally very high level.

no specific programs which have been mentioned which will attempt to deal with this high rate of unemployment. My emphasis on the unemployment problem does not negate the equally important factor of inflation. And granted that the combination of inflation and unemployment, until recent years, was a known phenomenon in the area of economics, I think that one of the first priorities for 1978, should be the reduction in unemployment rate, particularly within the black community.

Thank you.

Senator SASSER. Thank you very much, Dr. Modeste. I might say that the unemployment rate in general is a source of great concern to those of us in the Congress, and I am confident I'm speaking for my distinguished colleague, Congressman Allen, when I say that, because I know he is very much concerned about it. But the unemployment rate among black Americans specifically is of great concern to us. Recent figures indicated that the black unemployment rate in January was 12.5 percent, as against 6.4 percent for the population as a whole. And that with regard to black teenagers, there was 41.4-percent unemployment rate.

SOCIAL DYNAMITE

In my judgment that is social dynamite, a time bomb just ticking away. And we certainly want to do what we can to fashion such programs as would be effective to put these young people to work and give them gainful employment; employment in which they can take pride participating.

[Prepared statement of Nelson C. Modeste follows:]

PREPARED STATEMENT OF NELSON C. MODESTE

First, let me express my pleasure this morning for the opportunity to appear before the Senate Budget Committee in order to examine along with other distinguished persons drawn primarily from the State of Tennessee, the state of the economy and its potential for the next fiscal year.

INCREASE IN GNP

I am happy to say the economy in 1977, continued the expansionary trend which was started in 1975. In fact the level of real G.N.P. increased by 5.7 percent during 1977. This increase in economic activity for the year 1977 is also reflected in a very tangible way by a 4.1 million increase in employment. Or, to put it differently a reduction in the unemployment rate for the economy from 7.8 percent in December, 1976 to 6.4 percent in December, 1977.

This overall expansion in economic activity and the subsequent reduction in the unemployment rate, also translated itself into a 5.9 percent expansion in industrial production. The level of capacity utilization in the manufacturing sector, and the level of corporate profits increased by 2 percent and 9.5 percent respectively.

The nature of the continued growth which occurred in 1977 stems from the following factors: (a) The rebuilding by business of depleted stocks and the restoration of inventory investment; (b) the expansion in construction activity after the quarter; and (c) the increase in government spending.

PAUSE IN THE ECONOMY

The magnitude of these factors, particularly that of government spending, helped mitigate the pause in the economy, which occurred in the middle of 1977. This pause in economic activity was a reflection of the significant leakages which were occuring in the flow of income. Namely by the end of the first half there was an increase in the level of savings which tended to dampen business activity. Furthermore the high current account deficits, which occurred as a result of our slow

growth in exports and rapid growth in imports, also placed effect on economy activity. The surplus in many state and local governments' budgets also tended to dampen the pace of economic recovery.

INCREASE IN INFLATION RATE

The rate of inflation despite existence of a large pool of unutilized resources, and signifcant leakages from the income flow still increased by 6.4 percent during 1977. This overall increase in the rate of inflation is a reflection of the increases in the prices for food and fuel due to the harsh winter of 1977.

ECONOMIC DOWN-SWING FACTORS

In the year 1978, it is anticipated that the path of economic growth which was charted during 1975, 1976, and 1977 would continue. However because of the leveling off of consumer expenditures for durable and non-durable goods, along with a slowing down in activity in the construction industry, the rate of economic expansion which was set in 1977 is not expected to be a secured phenomena for 1978. Other factors which would determine the down-swing in economic activity in 1978 are: (a) The size of the current account deficit which is expected to be substantial for 1978; (b) The budget surpluses which the State and local governments are expected to generate; (c) The reduction in consumer expenditures resulting from higher payroll taxes and the application of higher effective personal tax rates due to inflationary increases in money income; and (f) The likelihood that business investment would not expand significantly.

Consequently, the government in an effort to prevent the possible down-swing in economic activity from occuring, proposes a $25 billion tax cut for individuals and businesses for the fourth quarter of 1978, along with a major reform of the taxstructure.

BLACK UNEMPLOYMENT

In closing, let me say that although the economic success in 1977, 1976 and 1975 is indeed welcome. There is still need for the formulation of some sort of strategy which is designed to eliminate the unemployment rate amongst black people, which remains at an intolerably high level. For the year 1977 the unemployment rate amongst black families fell from 13.5 percent in December, 1976 to only 12.7 percent in December, 1977.

Senator SASSER. Dr. Thomas Depperschmidt, if you would be kind enough to give us your testimony now we would like to hear it. STATEMENT OF DR. THOMAS DEPPERSCHMIDT, DEPARTMENT OF ECONOMICS, MEMPHIS STATE UNIVERSITY, MEMPHIS, TENN.

Dr. DEPPERSCHMIDT. Thank you, Senator Sasser, for the invitation to appear this morning. I don't propose at all to represent Tennessee's largest city, but I am from that area.

LOWERING UNEMPLOYMENT AND INFLATION

I consider the overriding question addressed to economists invited to appear at this hearing to be the feasibility of the objective of simultaneously lowering unemployment and inflation, while achieving a budget surplus by 1981. And, frankly, I'm skeptical about those prospects for reasons I will note in a moment.

FISCAL POLICY-IMPACT ON THE SYSTEM

I have a prepared statement. I will try to summarize as you suggested a moment ago. First of all, I think we have often characterized fiscal policy in terms of the principal components: taxing, borrowing, debt administration. I think it is worthwhile describing fiscal policy according to its impact on the system.

EXPENDITURES FOR INDIVIDUAL COMPONENTS OF SOCIETY

I believe we can talk about three types of fiscal policy impact. The first would be tax expenditure policy changes addressed to individuals or individual components of society. I think, for example, that funds for the disadvantaged, for youth, minorities, for education, training, or health purposes would be examples of this type of fiscal policy.

It is thought, I believe, that such funds would shore up these programs; and these funds then would filter through the system providing some floor under total spending.

TAX POLICY AFFECTING MARKET GROUPS

The second type of tax or expenditure policy would be that affecting broad classes of individuals or market groups not addressed to specific financial needs. I think, for example, the $25 billion tax cut proposed in this budget message would be illustrative. The idea here again is that in broad sectors there would be spending generating still further spending, and so on. I think this is the type of fiscal policy that economists traditionally regard most often when they speak of fiscal policy.

TAX CHANGES TO ASSIST DISADVANTAGED ECONOMIC SECTORS

The third type of fiscal policy would be tax or expenditure changes to assist particularly disadvantaged economic sectors, and I think this is the least tested form of fiscal policy. And I would like to say more about that subsequently. I think the more important point is that the type of spending or tax changes that have been made historically within Federal budgetary areas have been made after the fact. And I think that, in regard to this third type of fiscal policy, we could move in the direction of more exact forecasting within existing programs to pinpoint sectors of specific policy need.

NO IMPACT ON AGGREGATE ECONOMIC ACTIVITY

A second general area of concern, by way of background analysis, is the percent of GNP represented by the fiscal year 1979 budget. It does not, I think, show a significantly changed Government impact on aggregate economic activity compared to recent years. The planned reduction from 221⁄2 percent or so to an estimated 22 percent of GNP represented by the budget will not, I believe, change the structure of aggregate economic activity appreciably. I have some additional observations on this. I think that the budget is relatively cautious in terms of the old charge of, "throwing dollars at problem areas." I think it's cautious in that respect. It's also cautious in terms of problems to be solved or problems recognized to be solved by expenditures. Of course, the true cost of maintaining existing programs is going to rise in future years just to offset the inflationary trends anticipated.

NO BASIC REFORM IN ROLE OF GOVERNMENTAL FISCAL ACTION Third, I would note that despite this first half-trillion budget, it's clear that the proposed budget does not attempt any basic reform

in the traditional role of governmental fiscal action. In terms of the first two types of fiscal policy I have identified, I think the budget message contains more hope than substance in its declaration of fiscal policy. The telling observation, I believe, is on page 12 of the budget where the statement is that the effort in the fiscal policy area cannot be successful, and I'm quoting, "cannot be successful in the absence of a healthy economy." I think that statement distills the essence of the skepticism I am revealing here. This doubt is in spite of the fact the President's intent is stated that policies that support economic recovery will continue to receive high priority in the years ahead.

INCREASE IN SOCIAL SECURITY WOULD ABSORB HALF OF TAX CUT

Frankly, in sifting through the rest of the budget document, I do not find much that reveals specifically what policies are to be aimed at general economic recovery and well-being. For example, the proposed $25 billion tax cut, if approved, would provide only a slight structural offset to the increased volume of taxes automatically generated as taxable incomes rise. The increase in social security taxes would absorb at least half of that tax reduction. So I don't particularly see any net impact in that direction.

REAL INCREASE OF 2 PERCENT IN BUDGET EXPENDITURES

The increase in the budget itself of approximately 8 percent might be considered a rather sizable increase. But as it turns out, when viewed against the projected general price increase for fiscal year 1979 of a little over 6 percent, so hence the real increase in budgeted expenditures, if these figures hold true, would yield about a 2-percent increase. I do not see this as sizable as compared to the GNP projected of over $2 trillion. We are talking about 0.1 percent of that total being represented by this real increase in deficit spending. So I'm not terribly optimistic about the net impact when it's realistically measured against the expected unemployment rate of 5.9 percent for fiscal year 1979. Frankly, I would say that there is relatively little if any general fiscal policy at all contained in the budget recommendation for these reasons I have noted.

BUSINESS INVESTMENT

I do agree and support the President's fiscal policy declaration that a vigorously expanding private sector can do far more than any single Government program to solve human and social problems. I think that is unquestionably a sound policy course and, in my prepared statement, I have some ideas associated with these particular expenditure areas. I would like to call attention now, however, to one of these. The administration's hope is that the $6 billion tax cut out of the total $25 billion tax reduction program that is addressed to business would build business confidence and stimulate investment. If new investment rises above the 4 percent estimate for this year and continues strong for fiscal year 1979, the present recovery likely will stay on course. But clearly the level of response that is made by planners as a result of this stimulus is a big key to the short-run course of business activity and the prospects of avoiding either a slowdown or renewed inflationary forces.