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Secretary Simon. No, I don't think so. Well, you asked two questions there. When we have very great inflationary expectations, which we had a year ago, savings rates increase because people become fearful about the future. They are becoming a little less fearful now about the future than last year. The inflationary expectations are beginning to be reduced, to be wrung out of the economy but that is going to take time.
No, I would suggest that people are becoming more efficient in the use of their money. As I said, they are keeping lower balances, at least primarily the corporations, in the way they handle their money. This has been something that has been occurring gradually over the last 10 years.
Representative Long. Thank you.
Secretary SIMON. Witness the overdrafts in commercial banks with individuals. You know they will keep $100 in their savings account and have the rest invested in interest bearing securities and then they will run overdrafts if funds are needed. I don't necessarily consider that dangerous.
Representative Long. As long as they can cover their overdrafts.
Secretary SIMON. Presumably they can with their private savings. If it is temporary enough, they don't want to interrupt the interest they are receiving in their investment.
Representative Long. I see. Thank you. Go right ahead. Do you want to complete your statement now?
Secretary SIMON. I only have a few more comments.
Secretary SIMON. Given the fact that monetary growth in 1975 was moderate, the Federal Reserve has considerable flexibility in managing monetary growth in the months ahead and still be within its target range on a cumulative basis. Given the anticipated velocity increase and this flexibility in near-term policies, the Federal Reserve's target range of 5 to 71/2 percent for growth in the money supply is consistent with the sustained recovery we anticipate for 1976. However, over the longer run, this range is not compatible with bringing down the level of inflation. Therefore, the monetary targets, as I explained a second ago, will need to be reduced in the future as the recovery proceeds.
For both fiscal and monetary policies, the problem of instability is compounded by the present inflation psychology that permeates our society. All too readily the economy will move to a higher level of prices, but only grudgingly will it move to lower prices despite slack demand. This inflation psychology has been building for a decade and its unwinding will not be easy. The achievement of economic growth without accelerating inflation could be upset by fiscal and monetary policies that are, or even appear to be, overly stimulative.
In addition, such excesses will lead to bottlenecks developing in certain key industries well before the economy as a whole reaches full employment. This occurred in 1973 in such industries as chemicals, steel, paper, and fertilizers. The dislocations caused by bottlenecks send inflationary tremors throughout the economy and lead to inefficiencies which ultimately can curtail a recovery in real terms.
I believe that by excessively concentrating on short-term economic stabilization goals rather than on the long-term allocation of re
sources, stop-go fiscal and monetary policies in the past have been a disruptive influence which has accentuated the business cycle. Too often fiscal policies and, to a lesser extent, monetary policies have lagged economic developments so that when the stimulus or restraint arrives the business cycle has changed. As a result, these policies accentuate rather than dampen the ups and downs in the economyjust the opposite of the intended purpose of these changes.
We must act wisely and responsibly in bringing stability to our economy. The excesses of the past are not easily undone. Excessive spending, excessive credit creation, excessive stimulation all may provide a short-term palliative, but before long additional inflation and production bottlenecks set in and economic performance declines. The stop-and-go policies of the past 15 years have led to an instability which now is deeply rooted in our society. We can undo this problem only through a moderate and steady economic recovery which restores confidence in the prospect for longer run prosperity in a noninflationary environment.
There can be confusion about what is necessary to deal with a current problem and the effect of that action on future fiscal flexibility. Too often we in Government are prone to make decisions without proper consideration of the cumulative impact of those decisions on the future. To deal with this problem, I am proposing—and I go at this point to the accrual accounting that I spoke about to the chairman a few minutes ago; that is, what the purpose is of accrual accounting and the consolidated statements that I believe are critical.
In summary this country has developed the most efficient and prosperous economic system the world has ever known. Over the past 15 years the U.S. economy has increased the real output of goods and services by 60 percent; the real income of the average American has increased by over 50 percent; the number of Americans living in families with incomes below the poverty level has declined from 20.7 to 10.2 percent-197+of the population; and 20 million new jobs have been created.
Unfortunately, that impressive performance was marred by: (1) A sharp increase in inflation beginning in the mid-1960's; (2) continued unemployment in excess of 5 percent throughout the first half of the 1960's and again in the 1970's, and a sizable GNP gap between actual and potential output during those same time frames; and (3) occasional disruption of international trade and investment. While we clearly are justified in having a great deal of pride in our economic system, there also are sufficient reasons to have concern about the future pattern of economic progress.
Throughout much of this period the concept that the Government must continuously intervene to stabilize the U.S. economy has dominated policy decisions. The repeated use of fiscal and monetary stimulus too often has turned out to be counterproductive because of the lagged impact of such actions. The temporary programs created to respond to current problems have frequently become a permanent Government activity with the result that fiscal flexibility and control have been continuously eroded.
The debate over the proper role of the Government in the total economy will continue. But there is an even more fundamental issue involving the total size and growth of Government spending which
has led to chronic deficits and periodic disruption of the entire economy. Merely ranking priorities within the Federal budget is not enough. We must expand the analysis to evaluate total Government outlays as they relate to the priorities of the entire economy. I emphasized the need for considering the combined private and public demand for goods and services in my testimony before the Subcommittee on Priorities and Economy in Government of the Joint Economic Committee on April 3, 1975.
The second basic requirement is to lengthen the time horizon of policy planning. And that is important.
There is a natural tendency to concentrate too much on short-run needs without adequate consideration for the cumulative impact of decisions into the future. This point is particularly important at this time because of the short-term benefits claimed for rapidly stimulating the economy with the slack that still remains at this stage of the recovery.
However, because of the painful inflation recently experienced there must be greater concern about the reactions in the private sector to actual and potential Government policies. Employees are anxious. to restore their real wage gains and business wants to restore profit margins which have been eroded by inflation. If the real growth in the economy is accelerated too rapidly, both real and perceived inflation pressures could quickly escalate because of concerns about the future. Another repetation of inflation and recession would result in even more unemployment and lost output. Lower rates of unemployment and inflation are obviously the desired goal, but we must consider the prospects over the next few years not the next few months. A mix of policies designed to provide temporary relief at the expense of higher rates of inflation and unemployment in future years is inappropriate.
It is particularly important to consider the longer run Government spending trends. The amount of adjustment in any specific Federal budget may appear to be relatively limited because of the legislative decisions of the past.
However, decisions to better control Federal spending today will have major significance on the levels of outlays in 1978, 1979 and beyond as existing programs continue to expand. It will never be easy to make these fundamental shifts and there is a tendency to wait for a more convenient” time to begin the painful process of regaining fiscal control, but I am convinced that the longer we permit the existing trends to continue, the more difficult the ultimate correction process will be. To come to grips with this issue we have designed a responsible mix of economic policies that will bring about a durable, lasting economic prosperity which will benefit our Nation with sustainable and increasing employment.
Representative Long. Thank you, Mír. Secretary. We appreciate your comments today. [The prepared statement of Secretary Simon follows:]
PREPARED STATEMENT OF Hon. WILLIAM E. SIMON Mr. Chairman and Members of this Distinguished Committee: I am pleased to appear before you to discuss the current economic situation and, more importantly, to consider some of our longer-term economic goals and policies.
The importance of economic issues in shaping the future gives the Joint Economic Committee a basic role in determining these goals and policies. I hope that my analysis of the current economic outlook and of the policies needed to provide permanent prosperity and employment will contribute to a calm, reasoned, and perhaps, dispassionate discussion of these issues.
The Nation's economic goals were summarized in the Employment Act of 1946: "To promote maximum employment, production, and purchasing power" through actions consistent with "other essential considerations of national policy" in ways "calculated to foster and promote free competitive enterprise and the general welfare ..." It is obvious that we all support the same basic goals of sustaining the current output and employment gains, of further moderating the still unsatisfactory rate of inflation, of reducing the unacceptable rate of unemployment, and of correcting the monetary, trade and investment problems which have periodically disrupted the international economic system, But there can be disagreement about what tradeoffs will be required to achieve simultaneous progress toward all of these goals, about the best mix and timing of fiscal and monetary actions and about the proper time horizon for planning current policies.
A year ago at this time, we were concerned with an economy in the midst of a serious recession. Fortunately, the turning point in the U.S. economy occurred somewhat earlier than anticipated and the pace of recovery during the transition period has been stronger than expected. Economic historians will likely identify last April as the low point for the recession. Since then, real sales have increased at an annual rate of 4.9 percent and industrial output has risen at an annual pace of 12 percent after having declined at an annual rate of 10 percent since late 1973. The aggregate pattern of this recov. ery has matched the pace of earlier cyclical upturns and I believe that expansion will continue throughout 1976 and 1977 if responsible policy decisions are made. Significant progress has also been made in reducing the rate of inflation, in expanding employment opportunities while gradually cutting the overall unemployment rate and in moving ahead on important international monetary and trade reforms. This is an impressive turnaround from the situation at yearend 1974 when construction, personal spending and business investment were all declining.
Despite the impressive progress of the economy during the second half of 1975 no one can be satisfied with current conditions. An annual rate of inflation of approximately 642 percent or an unemployment rate of 8.3 percent in December are totally unacceptable. Furthermore, great concern has developed over the impact of Federal fiscal, monetary and regulatory policies which have increased the impact of government decisions on the total economy. Therefore, every economic initiative should be more carefully evaluated to determine: (1) whether the proposed action is consistent with the Nation's overall prior. ities and resources; and (2) whether the policy recommended contributes to the long-term achievement of basic goals rather than merely providing temporary relief. Using these two guidelines more effectively would help reduce the constant fine-tuning of economic policies and would properly shift the government's attention to longer-term requirements rather than concentrating on "crisis" management. If we fail to apply this discipline, governments will continue to promise more than can be delivered and the chronic Federal deficits reported in sixteen of the last seventeen years (for the period ending with Fiscal Year 1977) will persist and the continuation of past trends will eventually make the necessary adjustments even more difficult and costly.
As we attempt to further our economic growth and to reduce inflation and unemployment in 1976, current economic policies must avoid creating even more difficult problems for subsequent years. The severe recession of 1974–75 was a harsh reminder that the costs of serious economic distortions are greater than the temporary benefits provided by excessive stimulus used to achieve short-term goals. In what follows, I will review the current economy and then move on to consider certain basic underlining problems as they affect current policy needs.
I. ECONOMIC BACKGROUND AND PROSPECTS The recent recession resulted in a drop in real output of goods and services of 6.6 percent stretched over five consecutive quarters; unemployment rose to a postwar high of almost 9 percent; basic patterns of domestic and international consumption and investment were disrupted; the entire financial structure was severely tested; and inflation continued to be a distorting force
despite the sharp decline of economic activity. In planning for 1975 the Administration anticipated that an accelerating economic recovery would begin by midyear if three fundamental adjustments could be accomplished: (1) the unwanted accumulation of inventories could be liquidated and new orders increased; (2) "real incomes" of consumers could be restored by reducing the double-digit level of inflation and initiating tax reductions and rebates which would stimulate personal consumption; and (3) employment would begin to increase rapidly enough to reduce the unemployment rate and strengthen consumer confidence.
These expectations were summarized in the economic assumptions underlying the budget published one year ago:
The actual results were not very different from the earlier expectations. Moreover, the forecast for calendar year 1976, as contained in last year's budget, and the forecast in the current budget also are not very different. If anything, continued and better progress is anticipated now than anticipated one year ago.
The basic turning point in the U.S. economy occurred during the second quarter of 1975 when real output rose at an annual rate of 3.3 percent following five consecutive quarterly declines. Then in the third quarter real GNP increased at an unusually high annual rate of 12.0 percent. However, over one half of the gain reflected a massive swing in inventories toward less liquidation. During the last three months of 1975, preliminary figures indicate that real output expanded at an annual pace of 5.4 percent as the liquidation of inventories effect was largely over. Real final sales increased at a 5.0 percent annual rate, compared with 4.7 percent in the third quarter of 1975.
The forecast for real economic growth in 1976 is now 6.2 percent with the pattern of recovery continuing throughout the year and into 1977. The major strength of the U.S. economy will continue to be personal spending, which represents approximately two-thirds of our GNP. Real personal consumption expenditures are expected to increase 5 percent this year, compared to a rise of about 1 percent in 1975 and to a decline of almost 1 percent in 1974. As consumers increased their spending in early 1975 and continued to purchase a variety of durable and nondurable goods throughout the year, this fundamental shift has proven to be a crucial element in the recovery to date. Personal incomes are expected to rise strongly in 1976, and real purchasing power should continue to improve if inflation does not accelerate. After falling 142 percent in 1974, real disposable personal income increased approximately 2 percent in 1975.