and perhaps given to see the brighter side of his stingy monetary policies.

Now, in reckoning the cost of unduly restrictive or insufficiently expansionary policy, one really has to go beyond just the gross loss of jobs and GNP. When the Fed runs too tight a monetary policy and holds interest rates unduly high, it inhibits private capital spending in three ways.

First, the higher cost of money undoubtedly tips the balance against some marginal investment decisions..

Second, to the extent that common stock prices fall in response to rising interest rates, price-earnings ratios also fall, and the costs of capital investment to business rises.

Now, let me interpolate there. If anyone doubt the impact of raising interest rates on the stock market, one need only to look at the neurotic kneejerk reaction of Wall Street to the money supply numbers each week; and yesterday's drop in the stockmarket, for example, is attributed in part to the inference that the Federal Reserve is somehow or another turning the monetary screw up another notch.

Let me add parenthetically that I'm sure that Chairman Burns and the FOMC deplore this monetary myopia in the financial community just as much as I do. A good way to scotch this obsessive preoccupation with weekly ups and downs of M, and M2 would be, first, to let the financial world know that the Fed is as concerned with interest rates and in a slack economy presumably with low and stable interest rates as it is with money supply; second, not to give credence to the money switch-doctors by its own quick markup of the Fed funds rate in response, for example, to the annual April showers of money supply; and third, perhaps not to publish the money supply figures so often or publish them with an economic health warning that would say "dangerous if inhaled or swallowed."

I suppose it is not very realistic to assume that this will come about because if they don't have the money supply figures, they will infer them, but that preoccupation certainly does the economy no good in any discernible way.

Well, let me return to my main theme and say, it is most important, third, that, to the extent that monetary and fiscal restraint keeps aggregate demand under wraps and therefore holds sales volumes well below capacity, the major ingredient for vigorous growth in plant and equipment spending is missing. Since business liquidity today is high and profit margins have made a substantial comeback, this lack of strong markets and the consequent damage to business confidence stands out as the chief culprit for the poor performance of business fixed investment in the recovery so far.

Now, the repercussions of this lag in plant and equipment spending are really very serious. Without robust investment, the stepup in productivity and the avoidance of bottlenecks which are our best defense in the long-run battle against inflation will be harder to come by.

Further, President Carter's battle for a balanced budget by fiscal 1981 rests heavily-even crucially on a strong investment performance in the private sector. If the cost of money is high, if the demand for products is weak, if the stockmarket prices are eroded, the pros

pects that the current upswing in private capital spending will turn into the robust and sustained boom we need will be dim indeed.

If, instead, the Fed runs an easier monetary policy, it will facilitate not only vigorous capital expansion, but it will also facilitate the running of a tighter fiscal policy and the achievement of budget balance.

Now, let me turn to today's setting. I am again at a bit of a disadvtange, not knowing what Chairman Burns will say, but, given his long-stated long-term monetary goal, and given the inflationary smog that continues to foul the air that the FOMC breathes, one can venture a guess or two.

Against the background of two quarters of virgorous economic expansion the Fed might well be tempted to shave off a thin slice of monetary salami somewhere from its target ranges and possibly snug up policy just a bit.

But it is fair to ask Dr. Burns what in present economic circumstances or prospects would justify doing anything less than evenkneeling or even, better yet, drawing back a bit from the spring runup in rates, as they did in 1975 and 1976.

The facts lend very little if any support for further tightening. Inflation is dropping back into its hardcore range. I doubt that Dr. Burns and his colleagues expect more than 6-percent inflation in the coming year. I don't say that with any satisfaction. All I am saying is that there doesn't seem to be any acceleration of inflation in the works. Second, there is no sign that the economy is about to exceed its speed limits. Indeed, the economic patterns of the second quarter suggest that there has been some slowing of both output gains and the inflation rate during those 3 months, and the $20-billion rate of inventory accumulation in the second quarter even suggests the possibility of a miniinventory cycle.

As for the economic landscape ahead, most forecasts for the next 12 months fall in the range of 412 to 52 percent real growth, and I would agree that that is the right range.

But most important, there are still no signs that the economy is nearing its capacity, nor that it is about to be bedeviled by bottlenecks. And I cite the usual evidence here. I particularly note that in the materials industries, we are running 10 percentage points below the levels of capacity utilization that we hit in 1973.

And then, when you turn to the broadest measure of available capacity namely, our GNP potential at full employment-and I use the modest definition of 5-percent unemployment as full employment— actual output in the second quarter was running $116 billion a year below potential, if one accepts Alan Greenspan's conservative formula, and $148 billion if one uses George Perry's formula as a guide.

And, by the way, I asked the people who developed those formulas to give me those numbers. Those are their numbers, not mine.

Now, to get from here to there, from today's high unemployment to 5-percent unemployment by 1980, will require somewhere between 514percent and 534-percent annual growth from now until 1980.

Now, to avoid rekindling demand inflation calls for gliding, not crashing, into the 5-percent unemployment range. So, if we are serious about full employment by 1980-and Lord knows that is a modest

enough objective-the near-term growth target should be 6 percent or somewhat above, so that we can be prudently tapering down to the basic growth rate of the U.S. economic potential, between 32 and 4 percent a year, when the full employment goal heaves into sight.

Let me turn from the domestic to the international scene, which is, at the moment, causing a fair amount of furor.

Earlier this week, Dr. Burns expressed his view to this committee, his concern over the international position of the dollar and the inflationary implications of higher import costs. I hope he is not implying that this calls for tighter money or higher interest rates. That would be exactly the wrong medicine, for several reasons.

It would discourage the capital spending that helps us cut costs and boost productivity and expand capacity-all of which strengthen our foreign trade position. It would retard U.S. expansion and thereby reduce the attraction to foreign investors. It would be an open invitation to other countries to retaliate by raising their interest rates; and finally, as the strongest and safest haven in the world, the U.S. economy is already pulling in lots of foreign funds into bank accounts, securities markets, and real estate.

Frankly, I hope, in making this point, that I am attacking a strawman, but it is kind of important to keep it a strawman.

Well, finally, on the matter of the management of policy, I would just very briefly summarize what I have to say there, partly because you have already negotiated with Dr. Burns on this subject, namely, on monetary velocity.

You know, it is M times V. It is not just M alone. It is money times velocity that determines the wherewithal for economic expansion. And I thought it was a good idea for you to have it in the bill as you did, a requirement that they come clean on the projected velocity.

Velocity has been bailing them out. Dr. Burns has been brilliant in forecasting that velocity would do the trick in bridging the gap. He has confounded his critics on that.

But somewhere along the line, that string is going to run out. These improvements so-called, in monetary technology, converting transactions, balances into interest-bearing deposits and so forth, that string is going to run out. And I think the Federal Reserve should tell you very plainly what it will do if the rise in velocity increases drop from 4 and 5 percent to 1 and 2 percent. Are they willing, then, to widen their monetary ranges? And I would have liked to have seen that kept in the legislation, because I don't think Dr. Burns is going to bealthough you sometimes wonder-I don't think he is going to be Chairman in perpetuity of the Federal Reserve System, and a personal deal with him does not strike me as quite enough assurance.

The CHAIRMAN. Would the gentleman yield very briefly at that point?

Dr. HELLER. Yes, indeed.

The CHAIRMAN. This committee, earlier this morning, by a 40 to nothing vote did report out a Federal Reserve bill, in which section 1 relates to the dialogs. It is very clear from the debate in the committee and the legislative history thus far-and it will be made crystal clear in the report that we will expect the Federal Reserve in its quarterly hearings before the Senate and the House Banking Committees to give us the missing V in MV=Py formula.

Admittedly, velocity is not mentioned in the bill, but it was agreed that you can't tell what is going to happen to production, employment, and prices unless you get a V.

So, I am satisfied.

Dr. HELLER. I am delighted to hear that in the monetary Darwinian process of evolution the missing link is going to be provided. [Laughter.]

Dr. HELLER. I then make the point that I think one ought to even go beyond that and be explicit about the jobs targets and GNP targets and price-inflation targets. I don't see how this much-wanted coordination between the Congress, the Federal Reserve, and the White House can be accomplished unless each of the three units comes clean on what its targets are and how it is trying to get there.

That doesn't mean they have to absolutely agree on them, but it does mean that there ought to be candor, sunshine ought to be poured on what these objectives are, and they should not be hidden behind monetary aggregates.

The CHAIRMAN. There again, if you would yield again, the language adopted speaks of present and prospective movements in production, employment, prices, et cetera, which again, in my judgment, does require the Fed to tell us what it is talking about and the things that really matter to people, which is whether or not you have a job and how much you have to pay at the grocery store.

Dr. HELLER. And that goes to the floor with a 40-to-0 vote?

The CHAIRMAN. Yes. I think, to get unanimity-and the gentleman sitting next to me, Mr. Stanton, played a good role in that-that it is a good trade. I don't think it was obtained by selling out, which you have just suggested. Mr. Stanton nods agreement.

Dr. HELLER. I will just conclude with the following observations. I am not suggesting that the Fed give up its independence or that it be subordinated, in a substantive sense, to the White House and the Congress in the economic policy process.

Rather, I'm suggesting that it be coordinated in the interest of a balanced and responsible policy.

And let me add also that I have often said that in an inflationprone economy, it is not such a bad idea to have an institution-and I thought agency seemed a bit inadequate to describe the Fed-but an institution somewhat insulated from political pressures, that has a decidedly anti-inflationary bias. But especially when the other institutions like the White House and Congress become more restrained and anti-inflationary in their fiscal policy, as they have-I don't think that can be denied under the new congressional process nor under the Carter White House and the Ford White House before it-I think the Fed can afford to relax its tight grip just a bit and let the economy breathe a bit easier.

So, in conclusion, I believe it is reasonable to ask the Fed, as it goes about its duly self-appointed rounds in its crusade against inflation, first. to recognize the difference between the fact or threat of excess demand inflation. which aggregate demand management can do something about, and the largely autonomous, structural cost-push inflation which it cannot do very much about.

Second, that it count the cost in jobs, output, and investment, of its curbs on expansion.

Third, the point we just discussed, that it state its money targets in terms, not just of the increase in M1 and M2, but in velocity as well, and demonstrate its readiness to boost the M's faster if the V's falter.

And finally, to follow the lead of the White House and Congress and come clean on its jobs, GNP growth, and inflation targets so that the prerequisite for monetary-fiscal coordination will be met. Thank you, Mr. Chairman.

[The prepared statement of Dr. Heller follows:]

PREPARED STATEMENT OF DR. WALTER W. HELLER OF THE UNIVERSITY OF MINNESOTA ON "AN APPRAISAL OF FEDERAL RESERVE POLICY"

In appraising the Federal Reserve System's economic policy performance, let me begin with some lefthanded compliments:

The record of the past 21⁄2 years, except for the annual “spring offensives”— the Fed's overreaction to the tax cut in 1975 and to the April run-ups in the money supply in 1976 and 1977-is surely a great improvement over the excesses of 1972-74, over the swing from the openhandedness of 1972 to the tightfistedness of 1974.

Although we can quarrel with the norms or targets of monetary policy over those 21⁄2 years, one can also compliment the Fed on (a) the relative stability and serenity of policy during those years, (b) its success in staying within the bounds (though at the low end) of its target ranges. and (c) its willingness to back off from premature tightening in June 1975 and May 1976.

Further, to the surprise of most everyone but Chairman Burns, money velocity-the rate of turnover of money balances"-has obligingly speeded up enough during this period to bridge the gap between an average rise of about 6 percent a year in M1 and nearly 12 percent in nominal or money GNP.

BALANCING BENEFITS AGAINST COSTS

Yet in terms of a reasonable cost-benefit test-the cost in jobs and output set off against the benefits in reduced inflation-the restrictive (or, at best, grudgingly expansionary) tilt of monetary policy in 1975-77 has been a poor bargain for the country.

As to benefits, Federal Reserve (and fiscal) policy, relying on the harsh "discipline" of weak labor and product markets, has given us precious little relief from inflation in the past 22 years. Throughout the recovery, basic inflation (fuel and food excluded) has orbited in a 5 percent and 6% percent range, while the annual advance in average hourly compensation has held stubbornly at or above 8 percent for the past 30 months.

In other words, once the excess-demand pressures of 1972-73 and the external shocks of 1973-74 (mainly oil and food price explosions and devaluation) worked their way through the system, the residual inflation boiled down to hard-core, Burns-resistant, cost-push pressures. Triggered by the fierce double-digit inflation of 1973–74, wage advances moved into an orbit about 5 percent to 6 percent above productivity advances. Meanwhile, conditioned by the cost-pass-through philosophy of the 1971-74 price controls, the business practice of pricing via mark-up over costs became more and more firmly intrenched even in the face of weak markets.

The upshot: a self-propelled cost-price merry-go-round that is largely impervious to macro-economic policies. Perhaps such inflation would slowly succumb to the sado-masochism of sustained tight money and tight fiscal policy. But even that is doubtful. It defies both the weight of the evidence and the dictates of common sense to assume that structural inflation arising out of market rigidities and excess market power will yield to aggregative policies and overall economic slack.

This in no way denies that well-modulated policies of demand management are a necessary condition for non-inflationary expansion. But they are obviously not sufficient. To remove the inflationary roadblock to full employment also demands direct action to reduce cost pressures and promote competition, overcome structural unemployment, improve productivity, forestall supply shortages and bottlenecks, and most urgently, to de-escalate the price-wage spiral. I know of nothing in the Federal Reserve arsenal that will get at these stubborn roots