Boom Raises Three Challenges
Economy will continue to set new records if solutions are found for these problems
The main challenge before the United States today is to maintain our pace of economic growth. This means we must prevent an inflationary wageprice spiral which, if not stopped, would eventually cause a decline in business.
It is of the utmost importance that wage increases not exceed the rise in productivity. If this is achieved, there will be no need to increase most prices. The rise in business volume, coupled with economies in production and distribution, will lead to higher profits without an increase in prices.
The immediate outlook is favorable. Disposable personal income is rising, spending on goods and services is increasing and the consumer views the tuture with optimism. Corporate profits after taxes have risen and the outlook for capital expenditures is favorable. Total government expenditures-federal, state and localalso are increasing.
The new tax law is estimated to reduce the tax liability of individuals by $8.8 billion, and that of corporations by $1.5 billion. Because 92 to 94 per cent of disposable personal income is spent by consumers, an increase in consumption spending can be expected with a fair degree of certainty.
An increase in corporate profits will stimulate capital expenditures by corporations. According to the latest report of the Department of Commerce and the Securities and Exchange Commission, capital outlays by corporations for 1964 are estimated at $43.2 billion, an increase of 10 per cent over 1963.
It is apparent that the economy in the months ahead will move to new peaks. In that light, it is appropriate to examine the possibilities of maintaining anticipated growth and to single out the problems that lie ahead. The trend of business toward the end of this year and particularly the early part of next year will depend on how we solve them.
The most important tasks before the country are:
• To prevent inflation.
• To create job opportunities for the rapidly rising labor force and particularly for young, unskilled and displaced workers.
• To make a further improvement in the balance of payments.
Administration and Federal Reserve authorities will be obliged to prevent an inflationary spiral. In the first place, although the U. S. balance of payments has considerably improved during the past six months and more improvement is expected, an inflationary price movement would have a damaging effect on the balance of payments. It would stimulate imports and curtail exports. It could also lead to an outflow of funds to countries where inflationary pressures are kept in check. A deterioration in the balance of payments would force the Reserve authorities to adopt a policy of credit restraint. However, experience demonstrates that a policy of credit restraint and reduced availability of bank credit in time brings a boom to an end and sets recessionary forces in motion.
There is a lag between the time that restrictive credit measures are adopted and their impact on the economy. The duration of the lag depends on the liquidity of commercial banks and other lenders. The liquidity of commercial banks was reduced during 1963 since the banks sold government securities in order to acquire higher yielding assets, such as tax-exempt obligations and mortgages. A reduction in the availability of credit will not only force the member banks to borrow more from the Reserve banks, but also to sell nongovernment securities in order to meet credit requirements of their customers.
This cannot last indefinitely. Sooner or later the losses from the liquidation of securities become so great as to preclude further sales. Once this situation is reached, the banks themselves adopt a conservative credit policy and begin to ration credit. Eventually, this has a restraining effect on the accumulation of inventories and capital expenditures by corporations, and business activity in general.
Thus there is the danger that the present rather satisfactory rate of business activity may be accelerated and reach an unsustainable level, which would have to be curbed by the monetary authorities. Unless the inflationary pressures are checked promptly, there is a danger that the high level of business activity will not last long and will trigger forces which could bring about a decline in business toward the end of this year or early in 1965.
Credit and unemployment
Of the various powers at the disposal of the government to influence business activity, credit control is the simplest and quickest that can be employed. However, under present conditions severe political pressures may prevent the monetary authorities from adopting a policy which would stem the inflationary pressures as soon as they become evident. This danger arises out of the fact that, while business activity is at a high level, unemployment is also still high. Some congressional leaders argue that an increase in interest rates and a tightening of credit would cancel out the benefits expected from the tax cut, thus preventing the creation of more job opportunities. Unemployment has been a problem throughout the entire period of recovery. The greatest number of unemployed, however, can be found either in distressed areas, which have suffered from the exhaustion of certain raw materials, or among the young and unskilled.
Automation also has contributed to unemployment. An increase in total demand for goods and services would assuredly create new job opportunities. However, automation will be accelerated, thus eliminating some jobs, primarily those for the unskilled. Low money rates and a policy of credit ease will not cure unemployment among the unskilled. The solution here lies in education, retraining, and making labor more mobile. This cannot be achieved overnight. The credit policies of the monetary authorities now need not be one of rigid restraint, nor assume the character of stringency as in 1959 and the early part of 1960. Rather, as the Economic Report of the President stated: "The monetary policy must remain flexible so that it can quickly shift to the defense if unexpected inflation threatens or the balance of payments worsens."
A gradual tightening of credit and a moderate increase in short-term rates of interest are not likely to exercise a depressing effect on the economy, nor on the creation of new jobs. It should be intended merely to prevent an increase in the money supplythrough the lending and investing activities of the commercial banks. Such a rise in money supply would increase wages and prices without creating additional goods, services and employment. Under current conditions the cost of long-term capital is of greater importance than that of shortterm credit.
The former affects home building as well as public works. Present supply and demand forces in the capital market, aided by a sound debtmanagement policy of the Treasury, will leave longterm rates practically unchanged, and any increase that may take place will, under today's conditions, be only minor. With the reductions in taxes, the stimulus to the economy should come from this force and not from the reliance on active credit ease, which is not suitable at present and if pursued could lead to serious consequences.
The decisions of the monetary authorities should be guided by the best interests of the country as a whole and not by day-by-day political pressures. As indicated before, the balance of payments of the country will continue to exercise a considerable influence on our credit and debt-management policies. Measures have already been taken to prevent a speculative raid on any key currency, and the potential amounts of foreign exchange available in case of need to the Federal Reserve authorities and the Treasury are large. But it must be kept in mind that unforeseen international political or financial developments could create conditions which might force Reserve authorities to take measures to maintain the integrity of the dollar abroad. Such measures could unsettle the trend of business activity. Whether such an emergency will arise is impossible to predict.
The fact remains that the political situation in many parts of the world is fraught with danger and any disturbance will have repercussions on international money markets. It is, however, within the power of the Administration and the Federal Reserve to minimize the impact of such developments on the dollar: that is, to continue ceaselessly to improve the balance of payments, to reduce the present deficit, and to strive for equilibrium in the near future. Despite the huge short-term dollar claims owned by foreigners, a material improvement in our balance of payments, the strong net international investment position of the U. S. and the great productive powers of its economy would make the dollar practically immune from any international disturbance.
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