CONDUCT OF MONETARY POLICY THURSDAY, FEBRUARY 3, 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 committee) presiding. Present: Representatives Reuss, Moorhead, St Germain, Neal, Patterson, Blanchard, Hubbard, Spellman, AuCoin, Tsongas, Hannaford, Evans, Allen, Lundine, Badillo, Pattison, Cavanaugh, Oakar, Vento, Barnard, Watkins, Stanton, Brown, Wylie, McKinney, Hansen, Hyde, Kelly. Grassley, Fenwick, Leach, Steers, Caputo, and Hollenbeck. The CHAIRMAN. Good morning. The House Committee on Banking, Finance and Urban Affairs will be in order for its semiannual dialog with the Federal Reserve System. We want to welcome Chairman Arthur F. Burns here, who has always been so helpful to this committee and whom we all know shares this committee's concern about the economy and the desire for a new start toward recovery. If recovery is to work, it is clear that the Federal Reserve must play a leading role on the economic team. We are anxious that we don't repeat past mistakes on either the fiscal or monetary side. Since the passage of House Concurrent Resolution 133 in March 1975, this committee has monitored the course of monetary policy closely. The Federal Reserve's presentation to us of its monetary projections for the following 12 months on a quarterly basis has made for a most constructive dialog. I am not going to take time to quarrel over 2 years of monetary statistics and discuss the technical niceties of M1, M2 and all the other M's. What most people, quite understandably, are much more concerned about is the end result, measured in terms of jobs, economic activity, availability of credit, and lower interest rates. But the past can occasionally instruct the future, so let me go back in history long enough to examine the Federal Reserve's interpretation of its responsibilities in late 1975 and early 1976 as the Nation was attempting to pull itself out of the recession. Although the Fed announced goals for the growth of M1, the basic money stock, before this committee in March 1975 for the 12-month period ending March 1976 of 5 to 7 percent, the growth rate actually realized in that year, as the chart over there shows, was 4.9 percent. For the 12 months ending in the second quarter of 1976 the target range was 5 to 712 percent, while (79) actual monetary growth was barely over the minimum and in fact was 5.2 percent. For the 12 months ending in the third quarter of 1976, where the range was 411⁄2 to 71⁄2 percent, the bottom limit was missed. The actual growth rate was at about the bottom, 4.4 percent. Since then, because of increased growth in the fourth quarter, for the year ending in the fourth quarter of 1976, the actual growth rate was up off the bottom of the range. The point I make is, was it in the best interest of all concerned to hold to the bottom side or something below the bottom side of the M1 targets during the critical period of late 1976 and early 1977? What, in short, is a band for if you hover around the bottom of it in the time of recession instead of getting closer to the middle or indeed in the upper part of the range. Thus, I suggest that perhaps we can profit by this experience in the future. The Federal Reserve is going to be truely accommodative in the months ahead because, as Secretary Blumenthal indicated yesterday, an accommodative monetary policy is needed. I'm convinced that it will be necessary for the Fed to look more to the middle and upper range of its monetary targets, in short, to get all the various M targets off the bottom of their target ranges. Whatever the supply of money, we must not lose sight of the importance of the cost of that money to businesses, consumers, and home buyers. It is of small comfort to tell the American people that their institutions are awash with liquidity when mortgages are priced at 9 percent or more, well out of the range of millions of working families. Mortgage rates have remained high while rates on U.S. bonds, municipal bonds, and corporate bonds have all gone down. In my judgment, mortgage interest rates should come down, too. Similarly, the rates commercial banks charge businesses for loans have in the last year been out of line with other market rates of interest. The prime rate has been about 150 basis points higher than the commercial paper rates since June 1976, even though the prime rate has been lowered 4 times. This is a larger than normal spread, by historical standards. The monetary authorities could help bring about lower interest rates through their regulatory power and through their ability to exert moral suasion on the financial community. They have direct monetary tools which allow for a direct effect on the Federal Funds' interest rate, currently at under 5 percent, which I hope is in a range where it will remain throughout at least this year. I was somewhat discouraged by the Federal Reserve's response of last September to my call for lower business loan rates. The Fed's suggestion was that higher rates on business loans by commercial banks were being continued in order to strengthen the commercial banks' financial condition and to improve their liquidity. What this is saying is that today's generation of loan customers are being asked to pay a premium for past bank errors on loans to real estate trusts and foreign speculation. Liquidity ought to be rebuilt for normal profits on market interest rates and not from artificially inflated rates exacted from customers, particularly small businessmen who cannot. raise funds from other sources. In short, I hope that the Fed will manage its monetary and regulatory policies in the months ahead so as to provide ample support for economic stimulus and a better delivery of credit at lower interest rates. While severe unemployment and idle plant capacity remain, I am convinced that such accommodative action by the Fed can be accomplished without creating a new round of inflation. Dr. Burns, you have an excellent statement here, which I thank you for getting to us yesterday. Many of us have had a chance to read it, and under the rule, it is incorporated into the record in full, without objection. STATEMENT OF HON. ARTHUR F. BURNS, CHAIRMAN, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM Dr. BURNS. I am pleased to meet once again with this distinguished committee to present the report of the Federal Reserve Board on the condition of the national economy and the course of monetary policy. When I last met with you in July 1976, the growth of economic activity had begun to slow perceptibly, after a year of brisk recovery. At that time, I noted that the balance of economic forces suggested an early return to stronger rates of expansion in production and employment. The favorable turn of events during the past several months indicates that our economy is, in fact, emerging from the recent pause. Periods of retardation in economic growth, followed by a renewed upsurge of economic activity, have been a fairly common feature of business-cycle expansions. In 1962, for example, the growth of output slowed markedly for several quarters, but a more rapid pace resumed in 1963. Earlier, economic expansion appeared to falter in late 1951 and early 1952, and then picked up with some vigor. Looking back still further to the business cycles before World War II, we find that periods of retarded growth and subsequent resurgence frequently occurred during the longer phases of economic expansion. The improvement in the condition of the national economy over the past several months is due in some measure to the impetus provided by governmental policies. Monetary policy remained accommodative throughout 1976. Indeed, open market operations by the Federal Reserve sought late last year to encourage somewhat more ample supplies of money and credit. Also, the discount rate on loans to member banks was reduced in November, and reserve requirements on demand deposits were again lowered in December. By promoting some easing of conditions in the money and capital markets at a time of business hesitation, these actions helped to bolster the state of business and consumer confidence. Fiscal actions also became more stimulative during the latter half of 1976. Expenditures of the Federal Government, as measured in the national income and product accounts, fell short of official projections during the first half of last year. Later in the year, as a part of the earlier short fall was made up, Federal expenditures rose rather rapidly. These facts deserve only passing notice. The noteworthy feature of the recent pickup in business activity is that it mainly resulted from the normal workings of self-corrective forces within the private econ omy. Last summer, many manufacturers curtailed production of items. for which inventories were rising too rapidly. Retailers, in their turn, offered price concessions to consumers and increased their advertising in order to stimulate sales. Before long, consumers began to respond energetically. Retail sales regained strength in October, and then moved up substantially further in the closing months of the year. Homebuilding activity, which has been in an upward trend since early 1975, also rose significantly late last year, in response to improving conditions in the mortgage and real estate markets. The strong underlying demand for housing especially in sections of the country experiencing rapid population growth-led to a rapid increase in sales of new and existing homes and to a rising level of new starts for both single-family and apartment dwellings. Total housing starts during the last 3 months of 1976 advanced nearly 15 percent from the preceding quarter and reached the highest level in more than 3 years. Thus, despite some weakening in the pace of business investment in fixed capital, the physical volume of final purchases-that is, all purchases of goods and services except for additions to inventories—rose at an annual rate of almost 5 percent in the fourth quarter. This was the most rapid advance of any quarter during 1976. The strengthening of final purchases enabled business firms across the Nation to work off a good part of the excess inventories that had accumulated over the preceding months. True, the aggregate volume of business inventories rose further in the fourth quarter, but the rate of advance was much slower than in the summer and much slower also than the increase in final sales. This reduced pace of inventory accumulation, along with strikes in some major industries, was responsible for a disappointing performance of physical output during the final quarter of last year. But it set the stage for a return to a more vigorous rate of economic expansion by bringing sales and stocks into better balance. Actually, the pace of orders and production has already begun to quicken. New orders for durable goods began moving up in November and rose sharply further in December. The output of our Nation's factories, mines, and powerplants also rebounded sharply in November, as the depressing impact of major strikes abated; and another strong advance of production was registered in December. Conditions in labor markets were improving noticeably around yearend. Employment rose briskly in December, and unemployment declined across a range of industries. The reduction in unemployment among heads of households was particularly encouraging. A strengthening of demand for labor has also been evident in the recent declining rate of layoffs and the rising pace of new hires at manufacturing establishments. With employment growing more rapidly, the volume of personal income during the fourth quarter rose at an annual rate of nearly 11 percent-half again as fast as in the previous 3-month period. Activity in the current quarter is being adversely affected by plant shutdowns in many parts of our country as a result of shortages of natural gas and other fuels. The difficulties imposed on many American families by the bitterly cold winter will be long remembered, but I do not expect large or lasting effects on the performance of the economy during 1977. Thus, further good gains in economic activity seem very likely during the course of this year. Consumers are now spending more freely the percentage of disposable personal income spent on goods and services during the fourth quarter was the highest in several years. Except for areas where the weather has been unfavorable, retail sales during January appear to have continued at a satisfactory pace. Moreover, consumers have built up their stock of liquid assets substantially during the past year, and they have also been cautious in adding to their debts. The overall financial condition of the household sector has thus improved, and this will contribute to stronger consumer markets in the months ahead. Prospects for residential construction are also bright. Construction of single-family homes has already rebounded sharply, and production of multifamily units is now gradually recovering from overbuilding and the other problems that had been troubling this sector. Mortgage credit is in ample supply. Commitments by thrift institutions for home mortgage loans are at record levels; the inflow of savings to these institutions is continuing at a high rate; and mortgage interest rates are gradually declining. Housing starts should therefore continue to move up at a good pace. а Our export trades, too, can be expected to improve during 1977. Many foreign economies experienced a retardation of growth last year just as we did, and they too are likely to enjoy a pickup in the tempo of activity relatively soon. The demand for our exports should therefore increase. Of course, our imports will also be increasing as the domestic economy continues to expand, so that our net trade balance may not improve appreciably during the course of this year. The growth of imports, however, is not expected to be as rapid as it was in 1976, and net income from services should increase further. Thus, our deficit on current account with other countries will probably be rather moderate in 1977. Business spending should contribute substantially to economic expansion this year. Inventory investment may proceed at a cautious pace for a little while longer; but with consumer purchases continuing to grow satisfactorily, business firms will soon have to add substantially to their inventories. Outlays for plant and equipment should also strengthen as 1977 unfolds. During the course of this recovery, businessmen have been planning for the future with considerable caution. Additional hesitancy developed last summer when the pace of expansion slowed, and a few firms postponed new projects while some others stretched out their capital expenditure programs. These attitudes are now changing. Confidence has been strengthened by President Carter's firm statement rejecting wage and price controls, as well as by the recent trend of business developments. I feel reasonably confident that 1977 will be a good year for the nation's economy, but this is no time for complacency. Much remains to be accomplished. Although the proportion of our adult population holding jobs has been rising, more than 7 million people are still out of work, and our labor force is growing very rapidly. Last year, women entered the labor force in exceptionally large numbers, and |