CONDUCT OF MONETARY POLICY FRIDAY, JULY 29, 1977 HOUSE OF REPRESENTATIVES, COMMITTEE ON BANKING, FINANCE, AND URBAN AFFAIRS, Washington, D.C. The committee met at 10 a.m., in room 2128 of the Rayburn House Office Building; Hon. Henry S. Reuss (chairman of the subcommittee) presiding. Present: Representatives Reuss, St Germain, Gonzalez, Hanley, Neal, Blanchard, Hubbard, LaFalce, Spellman, Derrick, Lundine, Pattison, Cavanaugh, Oakar, Mattox, Vento, Barnard, Stanton, Wylie, Hyde, Kelly, Grassley, Fenwick, Leach, Steers, Evans of Delaware, and Caputo. The CHAIRMAN. Good morning. The House Committee on Banking, Finance and Urban Affairs will be in order for its quarterly dialog with the Federal Reserve System on the present and future course of monetary policy. We are delighted, as always, to have Chairman Burns with us, in this case, for the second time this week. I have not had an opportunity fully to read your statement. Dr. Burns, but it is as always a very comprehensive one. It is 25 pages. I do hope that in it you clear up something that has been mentioned in the press in the last few days since you were here earlier this week. Earlier this week, in response to a question from the gentleman from Texas, Mr. Gonzalez, you gave an answer which has led to two different sets of conjectures in the press and elsewhere about what you might have meant. You said that the U.S. dollar must be kept sound, a proposition which I think everyone would agree with; but there has been some speculation that you think that the way to keep the international dollar sound is for the Federal Reserve to intervene, to put a floor under it, absent disorderly market conditions. Others are speculating that your concept of how to keep the dollar sound is to raise interest rates in this country for the purpose of attracting capital from abroad which, it is argued, would then make our overall balance of payments account look better. I would hope that neither of those things are in fact in your mind or in the mind of the Federal Reserve System, because I think they would be counterproductive. I hope you will try to set the record at rest on that. I say that because I have read what you said Tuesday in the record. I don't think it has justified all the speculation and comment made about it, but that is what hearings are for. I hope in the course of your testimony you will set that straight. (61) 94-542 O - 77-5 Under the rule and without objection, your entire statement will be placed in the record. I would now ask you to proceed. I think you usually like to follow your statement closely. We will be delighted to have you do that. Mr. Derrick? Mr. DERRICK. We have a rollcall. The CHAIRMAN. Thank you for calling my attention to that. There is a vote on. Therefore, if you will bear with us for about 6 minutes, we will return. I ask Members to return as soon as they can. We will stand in recess. [Recess.] The CHAIRMAN. The committee will be in order. STATEMENT OF HON. ARTHUR F. BURNS, CHAIRMAN, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM Dr. BURNS. Thank you, Mr. Chairman. I will keep your questions in mind, and I hope before the hearing is over that The CHAIRMAN. May we have order, please? Dr. BURNS. I hope that before the hearing is over the questions you put to me will have been answered clearly and that any uncertainty or ambiguity will have been cleared away. Mr. BARNARD. Mr. Chairman, I believe that Dr. Burns' microphone is not working. Dr. BURNS. Let me try again. Are they working now? Thank you. If the microphone isn't working, I will learn how to shout before the meeting is over. [Laughter.] I need hardly say that I welcome the opportunity to present to this committee the Federal Reserve's report on the condition of the national economy and the course of monetary policy. I am not going to read the entire statement, Mr. Chairman, but I will read a large portion of it. It has been worked on very intensively, because I believe I have an obligation to this committee to present a rather full report, particularly on financial developments within the economy. Since the closing months of 1976, our Nation has experienced a vigorous and broadly based economic expansion. The gains in the industrial sector have been especially impressive; during the past 8 months, the combined output of factories, mines, and powerplants has risen at an annual rate of 9.5 percent. Activity in other sectors of the economy also has increased briskly. As a result, total employment in June was almost 3 million higher than last October-an unprecedented gain in so short a period. The unemployment rate remains high; but it has declined in recent months by nearly a full percentage point, despite rapid growth of the labor force. The rate of utilization of our industrial plant capacity also has risen significantly, and now exceeds 83 percent in manufacturing. In general, financial developments have favored economic expansion in our country, and they are continuing to do so. However, some familiar cyclical patterns have begun to emerge since the turn of the year. Borrowing by households has been growing very rapidly. Installment credit has expanded at a 16-percent annual rate thus far this year. Measured relative to disposable personal income, growth of installment credit has reached a pace comparable to past peak rates. Mortgage credit flows have been of record magnitude. Mortgage credit has in fact grown much faster than could be expected on the basis of past relationships between borrowing and residential construction, thus suggesting that households have been putting mortgage funds to a broad variety of uses. Despite the rapid growth of consumer and mortgage credit, measures of household debt burden generally remain within the range of historical experience. Moreover, delinquency and bankruptcy rates have declined significantly from their recession highs. At this juncture, debt burdens do not appear to constitute a serious impediment to further gains in household expenditures but we must not overlook the possibility of excesses in this area. Business firms also have placed heavy demands on credit markets this year. Their overall need for external financing has grown because capital outlays have risen much faster than profits. The net funds raised by nonfinancial corporations increased by about 30 percent between the second half of 1976 and the first half of this year. The character of business borrowing has also shifted considerably. Until the latter part of 1976, business firms concentrated on repayment of short-term debt with the proceeds of long-term borrowing. Since last fall, long-term indebtedness has continued to grow, but not nearly so rapidly as short- and intermediate-term borrowing. Bank loans to businesses have increased at an annual rate of 11 percent since last September, and commercial paper and finance company loans have increased even faster. These developments have caused liquidity ratios of corporate balance sheets to decline somewhat-a normal cyclical development, although delayed in this case. Still, the state of corporate liquidity remains relatively comfortable because of the extensive improvement achieved during the preceding 2 years. Credit demands by State and local governmental units have been very large this year. About a fifth of the record bond offerings has been devoted to advance refunding of debt issues that were sold in earlier years when interest rates were appreciably higher. The remainder has included substantial amounts to finance construction of public powerplants, hospitals, and water and sewer facilities. Federal Government borrowing, in contrast, has declined from last year-a development which, among other things, reflects the recovery of Treasury revenues and an expenditure pattern still characterized by shortfalls. However, both the administration's projection and the first concurrent resolution indicate that the deficit for fiscal year 1978 will substantially exceed that in the current year. If actually realized, this would be an unusual development. Normally, of course, Federal borrowing diminishes in the course of an economic expansion. In view of the probable need to finance an increasing volume of private capital formation, the prospect of greater demands for funds by the Federal Government in the next fiscal year has been a cause of some disquietude in financial circles. The strong demands for money and credit that have accompanied our economic expansion have been reflected in a rise of short-term interest rates since the turn of the year. The Federal Reserve might have accommodated credit demands by providing bank reserves more liberally. However, such a course would only have postponed briefly the rise in interest rates because the resulting build-up of liquidity would have intensified inflationary expectations. By responding promptly to the enormous expansion of the monetary aggregates in April, the Federal Reserve gave clear notice that it was alert to the danger of a new wave of inflation. This reassurance to the business and financial community that the Federal Reserve would not permit the money supply to run riot was well received by credit markets. Long-term interest rates, of course, are of much larger significance to the economy than short-term rates; but the long-term rates are also especially sensitive to inflationary expectations. It is well, therefore, to take note of the fact that interest rates on corporate and municipal bonds, instead of following the recent rise in short-terms rates, remained fairly stable and are actually a little lower now than they were in April. These developments in credit markets are, I believe, attributable in significant part to public confidence in the Federal Reserve's monetary policy. It is noteworthy that, in general, interest rates still remain below levels prevailing at the beginning of the economic recovery. During the past half year, the Federal Reserve has managed to keep the growth of the major monetary aggregates on a moderate path. M-which consists of currency and checking accounts at commercial banks increased at an annual rate of 6.4 percent. This is a faster rate of growth than occurred last year, and it reflects the very intense demand for transactions balances in recent months. Growth of the broader aggregates, on the other hand, has been slower than last year-a deceleration due partly to the low personal saving rate that has evolved and partly to some modest redirection of savings flows away from deposit accounts to market securities as short-term interest rates have risen. Despite the moderate slowing of the broader monetary aggregates, financial institutions-both commercial banks and the thrift institutions-remain relatively liquid and in a good position to continue supporting economic expansion. During the next few quarters it is improbable that overall economic growth will proceed as rapidly as it did during the past 6 months. Typically, bursts of consumer spending of the kind witnessed this year are followed by phases of moderation. Such moderation, indeed, seeins to be signaled by recent data on retail sales. Nor, of course, is it to be expected that inventory investment will be adding as much to economic expansion as it did in preceding quarters. And in view of the high rate of single-family housing starts already attained, it is likely that housing will contribute less to growth. These probable developments, however, do not portend an end to general economic expansion. We at the Board anticipate continuing |