Speech

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Federal Reserve Bank of St. Louis

For release on delivery

10:00 a.m. E.S.T.

Statement by

G. William Miller

Chairman, Board of Governors of the Federal Reserve System

before the

Joint Economic Committee

December 15, 1978

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Mr. Chairman, members of this Committee, thank you for the

opportunity

to participate in this important dialogue.

At present,

the economy is at a critical juncture. Economic growth has continued

at a moderate pace, but the rate of inflation is unacceptably high

and poses an ever-growing

ture.

threat to our social and economic struc-

While the challenge for public policy is clearly formidable,

these problems are not insurmountable.

The Federal Reserve, for its

part, is continuing to pursue a monetary policy that aims at a reduction

of inflationary pressures while encouraging continued economic growth

and high levels of employment.

The rise in economic activity has been both vigorous and

generally well balanced

1975.

ended

The sharp

previous

since the present expansion began in early

swings

cyclical

in inventories and production that have

upswings

have

been avoided.

Growth in

the latter part of this year—-well into the fourth year of expansion—

has moderated, but this represents a desirable adjustment in the pace

of activity, given the intensification of inflationary pressures,

the rise in capacity use, and the decline in unemployment that has

occurred over the expansion period.

The persistence and recent intensification of high inflation

has been the most serious problem in the present expansion.

Consumer

price increases generally remained in the 6-1/2 per cent range over

the 1975-77 period, but these prices have risen at a 9-1/2 per cent

-2pace thus far this year.

to weather-related

the farm sector.

Some of this acceleration can be attributed

disturbances

and to unexpected developments

Labor cost pressures also have played an important

role as wage gains have moved up to about 8-1/2

per cent during a

period when productivity growth has slowed to a virtual

At the same

standstill.

time. Government-mandated increases in the minimum wage

and in payments

for social security and unemployment insurance have

added a further premium to labor compensation.

tive depreciation of the dollar's

adverse

in

impact on domestic prices

Finally, the cumula-

foreign exchange value has had an

that has yet to run its course.

Looking ahead, there is a threat that wage demands could

be further escalated, especially with a heavy collective

calendar

bargaining

for 1979 in an environment where inflationary expectations

are intense. Cost pressures are also likely to be further exacerbated

by another

round of legislated

increases

in payroll taxes and the

minimum wage. However, the Government's over-all anti-inflation program holds out the real hope that inflationary pressures can be contained, and that the groundwork can be laid for gradual attainment of

price stability.

The success of the program requires

cooperation,

perseverance, and patience from all. groups of our society. An important

new ingredient of the program is the quantitative standards. If adhered

to, these standards could very well help unwind the intractable spiral

of wages and prices. But it is particularly important that the program

recognizes

that Government actions can, in themselves, be important

sources of inflation; consequently, fiscal restraint and regulatory

reform are essential components of this comprehensive set of proposals.

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-3Inflation in the United States not only has eroded the

value of the dollar domestically, but has also been associated with

a decline in its international value.

As the exchange value of the

dollar dropped, this in turn adversely affected the domestic price

level.

It raised the cost of imported goods, and also resulted in

a further ratcheting up of domestic prices for those goods competing

with imports. While the dramatic drop of late October underscored the

problem of deteriorating

international

confidence

in the value of

the dollar, the period of decline in this current episode dates back

to late September of 1977.

From that date to its

low in late October of this year,

the dollar's exchange value declined by 21 per cent on a weighted

average

basis against

Switzerland.

Against

the currencies

some individual

of

the G-10 countries and

currencies, of course, the

decline was even greater, amounting to 26 per cent against the German

mark, 34 per cent against the Japanese yen, and 38 per cent against

the Swiss franc. Since important external imbalances between the United

States and major foreign countries have existed for several years—most

notably differential growth and, more recently, disparate inflation

trends—some depreciation of the dollar could be viewed as a necessary

correction.

However, by mid-summer it was clear that the dollar's

decline was continuing in trading that was increasingly disorderly.

Consequently, in August the Federal Reserve announced a half point

increase in the discount rate and an elimination of reserve requirements on Euro-dollar borrowings.

At the same time, the Treasury

indicated that it would increase and extend its regular monthly gold

auctions.

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-4These measures, which produced a brief rally

and then a

few weeks of stability for the dollar, were followed by another threequarter percentage point rise in the discount rate between mid-September

and mid-October, But the dollar's slide soon resumed, and it dropped

alarmingly

to a level well below that warranted by basic economic

considerations.

As a result, the severity of this latest decline

threatened to undercut the anti-inflation program at home and lead

to an even greater erosion of confidence abroad.

Under these circumstances, more forceful action was clearly

necessary. Accordingly, on November 1 the Federal Reserve increased

the discount

rate by 1 percentage point and

imposed

a 2 per cent

supplementary reserve requirement on large time deposits. In addition,

the Federal Open Market Committee voted to take further actions to

tighten conditions in the money market

expansion of money and credit.

and thereby resist excessive

Furthermore, in order to provide a

substantial increase in foreign exchange available to finance exchange

market intervention* swap lines were increased with the central banks

of Germany, Japan, and Switzerland by a total of $7.6 billion.

The

U,S 9 Treasury simultaneously announced its intention to draw a portion

of the U.S. reserve position in the IMF, to sell SDR's, and to issue

foreign currency denominated securities.

key

Over-all, $30 billion in

foreign currencies was mobilized by the United States for forceful,

coordinated

intervention to support the dollar in foreign exchange

markets,, In addition, the Treasury announced

its rate of gold sales.

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a further step-up in

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-5The objective of this coordinated

set of measures was to

correct the excessive depreciation of the dollar as part of the governmental effort

to reduce upward pressures on domestic prices and to

restore confidence at home and abroad.

When viewed in its entirety,

the policy initiatives of the Administration and the Federal Reserve

provide a clear message that U.S. economic policy is one that recognizes

fully the need for an integrated approach in dealing with foreign and

and domestic economic problems.

The measures taken on November 1 produced a dramatic jump in

the dollar ! s exchange value. On that day alone the dollar advanced by

5 per cent on a weighted average basis, and by about the same amount

against the mark, yen, and Swiss

franc.

Substantial

cooperative

central bank intervention over the following few weeks provided support

for the dollar as market participants tested the authorities1 resolve.

The strength of the dollar generally has been sustained as the market

appears

to have adjusted to a more

favorable outlook generated by

the recent policy measures.

To date, the observable repercussions in domestic capital

markets also have been generally favorable.

In the stock market, most

composite share price measures are up from the November 1 announcement

date following relatively sharp declines in the preceding two weeks.

Short-term interest rates have moved

as much as 1 percentage point

higher since the announcement; however, over this same period interest

rates for longer-term maturities have been essentially unchanged.

comparative stability of most long-term bond

The

rates, as well as the

improvement in the dollar's exchange value, is most encouraging and

suggests that we may be beginning to reduce inflationary expectations.

-6A downward adjustment of price expectations is an essential

condition to slow the treadmill of inflation, and monetary policy has

an important role to play in this regard.

the Federal Reserve will

continue to encourage a moderate expansion

of over-all activity, thus also

Nation's

However, at the same time,

facilitating the achievement of the

longer-run goals of growth and full employment.

Moreover,

as I have emphasized before, monetary policy should not be expected

to shoulder the burden alone, and to be effective, it must also be

accompanied by prudent restraint of fiscal policy.

Since April, credit conditions have become

progressively

tauter as Federal Reserve policies have allowed market rates to rise

appreciably in order to help

Yields on most

restrain expansion in money and credit.

short-term market instruments, such as Federal funds

and commercial paper, have risen more than 3 percentage points during

this period, while interest

rates at the longer end of the maturity

spectrum generally have risen by less than a percentage point.

Experience over recent years has

taught us, however, that

in an inflationary environment, expectational considerations tend to

buffer the impact of high interest rates on spending.

of rising prices of real assets may induce borrowers

Expectations

to incur high

interest costs, as is illustrated by the sustained pace of activity

in the housing market thus far this year,

Indeed, real

interest

rates—or observed rates adjusted to take account of inflation—appear

to be generally lower than in prior periods, especially if taxes are

taken into consideration.

Not only have expectations of borrowers and lenders changed

in the course of the current expansion, but also monetary institutions

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have been given additional flexibility

to compete

for funds.

This

has helped smooth adjustments of credit markets to developing tightness

and, as a result, has helped avoid the repetition of "credit crunch"

episodes such as in 1969 and 1973-74. The new 6-month money market

certificates, introduced half a year ago, have buttressed deposit

growth at mortgage lending institutions when prevailing market interest

rates might otherwise have produced disintermediation. Consequently,

total housing

starts have remained at a very high rate—2 million

units—during the first three quarters of this year. Building activity may soon begin to decline, but the drop-off next year should be

relatively moderate, making

it unlikely

that the economy will be

thrown into a recession by a sharp housing cycle.

Furthermore, signs generally remain on the positive side

for consumer spending, as real consumption outlays currently are rising

at about the pace of over-all demands. Nonetheless, this represents a

marked

slowdown from the rate of expansion earlier in the current

upswing. Near-term growth in consumer spending probably will be somewhat restrained by high debt repayment burdens as well as by efforts

to boost personal savings rates back to more normal levels.

In the business sector, capital spending activity continues

to be characterized by substantial momentum as equipment orders have

moved up briskly in recent months and construction contracts have been

maintained at a high level. However, the early surveys of 1979 investment plans suggest that businessmen maintain a lingering caution about

embarking on major expansion programs.

These surveys—largely

taken

before the November 1 measures—undoubtedly reflected the uncertainty

associated with an economy plagued by high inflation.

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On balance, private demands appear healthy at present, but

a further moderation of growth is likely over the year ahead. In this

environment the Federal Reserve will continue to strive for a gradual

deceleration of monetary and credit expansion in an effort to facilitate

an easing of inflationary pressures. We believe that the actions taken

in late October and early November will prove to be instrumental in the

restoration of both domestic price stability and orderly conditions in

foreign exchange markets.

At the same time, you can be assured that

recent measures in the international area were designed to reinforce

and not to sacrifice the achievement of longer-term domestic

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aims.