Page images
PDF
EPUB

of policy. I personally consider that the policies that are being recommended this time are short of the target. In fact. I don't think anybody is even talking of doing something about the problems of unemployment on the one hand-except to wait and see what happens—and inflation on the other hand. Any policy that isn't directed toward those two evils is no policy.

Now, Mr. Greenspan, you have equal time. You can have 50-50.

STATEMENT OF HON. ALAN GREENSPAN, CHAIRMAN, COUNCIL

OF ECONOMIC ADVISERS, ACCOMPANIED BY PAUL W. MacAVOY AND BURTON G. MALKIEL, MEMBERS Mr. GREENSPAN. That means that I am a loser if I'm only going to get 50-50, Mr. Chairman.

Chairman HUMPHREY. Well that is a good confession.

Mr. GREENSPAN. As always, I appreciate your candor. I must say we will endeavor to do the same. Mr. Chairman, and members of the committee, we are always pleased to appear before the Joint Economic Committee to discuss the annual report of the Council of Economic Advisers.

Instead of a lengthy discussion of the report I would like to make some general remarks on behalf of the Council about current economic conditions and policy, and our expectations for the balance of the year.

As you know, this is the second time that I have appeared before this committee to present an annual report, and the circumstances today are more propitious. Last year at this time the economy was in the late stages of the most severe recession of the postwar period. The very sharpness of the decline made it difficult to gage future developments. Final sales, following the sharp decline of late 1974, bottomed out in the first quarter of last year. Production continued downward until April, as the very heavy overhang of excess inventories which had been built up in 1974 was being knocked off. The economy began to turn around decisively in the second quarter of the year as final sales began to recover. Real final sales rose at a 4.5 percent annual rate in the final three quarters of the year. As the extraordinarily rapid inventory liquidation drew to completion production and employment rose rapidly.

The economy is now in the ninth month of recovery. Production has been rising rapidly since the spring of last year. Real gross national product rose at an 8.6 percent rate in the second half of last year. Industrial production has risen as you know at a 12.0 percent rate since the low point of last April. Total employment in December was up by 1.3 million from the low of last March. Prices, which rose by slightly more than 12 percent between December 1973 and December 1974 rose by 7 percent during comparable months of last year. Increasing employment, lower inflation and the tax reductions have each contributed to significant gains in real disposable incomes.

This recovery started from very low levels of resource utilization. Hence, unemployment will almost surely remain distressingly high this year even though large gains in employment are expected

during 1976. Accordingly, we must seek to lower unemployment as rapidly as is consistent with the need to ensure that the reductions will be lasting. Policies that might speed the decline in unemployment in the short run should not be so expansionary as to lead to increased stability and greater social hardships in the long run. Thus policies for 1976 must attempt to sustain the recovery now in progress but at a pace sufficiently moderate to prevent renewed imbalances and a rise in inflation. They must also continue to mitigate the hardships associated with high unemployment. At the same time, our present policies must lay the foundations for a long period of steady growth.

Because we began the present recovery with more slack than in any of the previous postwar cycles, a much longer period of aboveaverage growth will be required for a return to full resource utilization. Even under the best circumstances the return to full employment cannot realistically be accomplished this year or next. To ensure that we return to high levels of resource utilization—as is our objective-the recovery must therefore be a durable one.

Our best estimate is that real gross national product, GNP, will be 6 to 61,2 percent higher in 1976 than in 1975. This growth rate is not a goal. Rather, it is a projected outcome of the forces of recovery that were set in motion in 1975, by stimulative fiscal measures and by a return of consumer and business confidence and by external economic factors. With real GNP estimated to grow by 6 to 612 percent from 1975 to 1976, the unemployment rate should fall by almost a full percentage point during this year. The rate of inflation is expected to continue with little change from late 1975 throughout this year; and hence the GNP deflator, which had risen by 9 percent from 1974 to 1975, should rise by only about 6 percent from 1975 to 1976.

Thus far the recovery has been accelerated by a sharp change in the behavior of inventories, while real final sales have shown fairly steady growth since the first quarter of last year. The sudden cessation of high rates of inventory liquidation in mid-1975 accounted for a substantial part of the growth in real GNP during the last half of that year. The bulk of excess inventories appears to have been worked off, and more normal rates of inventory accumulation should become evident in 1976. Nevertheless, year over year, almost 11, percentage points of the growth in real GNP is still likely to be due to the inventory swing. Once inventories reach desired levels, the continued strength of the recovery will depend on the vigor of final demand for goods and services.

Mr. Chairman, we have discussions in the prepared statement on various different areas of real GNP that I will skip over, but I felt that I would perhaps insert in the record.

Chairman HUMPHREY. Yes, we will do that.

Mr. GREENSPAN. I would just like perhaps to move to some general discussion of economic policy and then

Chairman HUMPHREY. Yes, and anything you might have, Mr. Greenspan, on manpower policy, I imagine that fits in your general discussion?

Mr. GREENSPAN. Yes. Let me just move ahead a few pages.

Once in real Gnover

[ocr errors]

ets. Asparmit a direct transth and inflation

The availability of much unemployed labor and unused plant capacity requires that economic policy should continue to support an economic expansion at growth rates significantly above the longterm growth of capacity output. But our knowledge of the interdependence between real growth and inflation is not sufficiently precise to permit a direct translation from general goals to specific targets. As a consequence, policies cannot be designed to reach any particular targets with a high degree of confidence.

We believe however, that policies consistent with a moderate but sustained recovery offer a far safer and surer route to full employment than policies which attempt to engineer a very rapid return to full capacity. What we need is a durable recovery-not a boom that carried the seeds of renewed stability in prices, incomes, and employment. This view is based on several considerations.

The difficult inflationary period through which we have come makes is likely that overly expansionary policies, which risk increasing inflationary pressures, will quickly influence consumers' and producers' expectations. High rates of inflation have made price expectations a much more important determinant of consumer and business behavior than they formerly were. It is a harsh fact of economic life that expectations of inflation are built into labor and other contracts in such a way as to be partly self-fulfilling.

Moreover, increased inflationary expectations could restrain both consumption and investment expenditures and thus jeopardize longterm economic goals. High and variable rates of inflation not only create imbalances and sectoral distortions by capriciously changing the real value of existing contracts, but they also raise risk premiums investment decisions and in wage bargains.

The recovery begins with a very high rate of inflation. We expect prices to rise at about a 6-percent rate during the year. Our ability to forecast is at best imperfect and I should like to point out again, as I have on a number of previous appearances before this committee, that economists have not done well over the years in forecasting wage and price trends. A poor understanding of the inflation process is one of the major problems in forecasting and hence in economic policy analysis. We believe that this is the largest area of uncertainty in our forecast and as such, inflation could pose a major threat to the viability of the present recovery.

Policies that are perceived to entail higher inflation risks may not, therefore, affect economic activity and employment in a way that would normally be expected. Even if such policies should succeed in accelerating the recovery in the short run, it would be difficult to decelerate from unusually rapid growth rates to sustainable rates without running the risk of amplifying future fluctuations in economic activities.

There is a lesson to be drawn from past policy mistakes. The history of monetary and fiscal policies demonstrates that we have a great deal to learn about implementing discretionary policy changes. Our ability to forecast is at best imperfect, especially in an increasingly complex and interdependent world, and the difficulties in forecasting grow larger as we extend the period for which the forecast is made. This is a significant problem because of the time lags in

[ocr errors]

al complice will policies once theyw long

volved in altering the pace of economic activity through discretionary monetary and fiscal actions. There is a perception lag in diagnosing the problem, a reaction lag in selecting the appripriate response, and an implementation lag in having the policy prescription accepted and put into effect through our political and administrative processes.

We also lack reliable estimates of how long it takes before the economy responds to policies once they are undertaken and how large the response will be. With respect to fiscal policy there is the additional complication that countercyclical increases in Government expenditures are difficult to check during later upswings. Because countercyclical policy changes may be slow to take hold and then difficult to reverse, their effects may extend well beyond the time when they are most needed. Consequently, a significant danger exists that, instead of smoothing economic fluctuations, discretionary changes in policy aimed at demand management may themselves become a source of economic instability.

The proper conclusion is not that we should forswear the use of discretionary policy. Some external shocks to the economic system can and should be offset. Furthermore, provided the growth in Federal outlays becomes more moderate than in the years just past, occasional discretionary adjustments of the income tax schedules are called for in order to prevent excessive growth in Federal taxes. In fact these changes may have to be more frequent if the rate of inflation continues at a somewhat higher average level than at comparable levels of economic activity in the past. But we must be mindful of the great difficulties in successfully executing countercyclical policies.

Over the past year or so we have examined a large number of specific proposals such as public service employment programs, which often advocated to reduce unemployment directly and rapidly. One thing that stands out in our analysis is that public service employment programs have very large displacement effects. There is, therefore, an important distinction to be made between the gross number of jobs paid for or funded under the programs and the net number of new jobs that are created. Public service employment funds tend to be used for financing employment of people who would ordinarily be hired with State and local funds. Even after the first year only 40 percent of the jobs funded represent net new job creation, and after several years the net new job figure declines to about 10 percent. Consequently, a public service employment job funded at $9,000 per year actually costs the Federal Government more than $20,000 per new job at the end of the first year and somewhere in the neighborhood of $90,000 after several years have passed. Moreover, once in place, Public Service Employment programs are difficult to remove, so that they become permanent policies. In our view, therefore the Public Service Employment approach is not a viable solution to our unemployment problem.

What is called for in our judgment is a steadier course in macroeconomic policies broadly consistent with sustainable long-term noninflationary growth.

The severity of the recent recession does call for maintaining stimulative economic policies to accommodate an expansion of real

output at a rate above that sustainable in the long run. But departures from the policies that are appropriate in the long run should be moderate. We should try to limit the size and duration of any policy deviations that promise short-term benefits but risk interfering with our long-run goals. If we do not commit ourselves to moderate policies we may increase economic instability and lose our chance for sustainable growth, which we believe offers the sa fest and surest route to full employment in future years.

Mr. Chairman, I asked that the full text of my prepared statement be inserted in the record.

Chairman HUMPHREY. Of course.
[The prepared statement of Mr. Greenspan follows:]

PREPARED STATEMENT OF HON. ALAN GREENSPAN We are pleased to appear before the Joint Economic Committee today to discuss the Annual Report of the Council of Economic Advisors. Instead of a lengthy discussion of the Report I would like to make some general remarks on behalf of the Council about current economic conditions and policy, and our expectations for the balance of the year.

As you know this is the second time that I have appeared before this Committee to present an Annual Report, and the circumstances today are much more propitious. Last year at this time the economy was in the late stages of the most severe recession of the postwar period. The very sharpness of the decline made it difficult to gage future developments, Final sales, following the sharp decline of late 1974, bottomed out in the first quarter of last year, Production continued downward until April, as the very heavy overhang of excess inventories which had been built up in 1974 was being worked off. The economy began to turn around decivisely in the second quarter of the year as final sales began to recover. Real final sales rose at a 4.5 percent annual rate in the final three quarters of the year. As the extraordinaryily rapid inventory liquidation drew to completion production and employment rose rapidly.

The economy is now in the ninth month of recovery. Production has been rising rapidly since the spring of last year. Real gross national product rose at a 8.6 percent rate in the second half of last year. Industrial production has risen, as you know, at a 12.0 percent rate since the low point of last April. Total employment in December was up by 1.3 million from the low of last March. Prices, which rose by slightly more than 12 percent between December 1973 and December 1974 rose by 7 percent during comparable months of last year. Increasing employment, lower inflation and the tax reductions have each contributed to significant gains in real disposable incomes.

This recovery started from very low levels of resource utilization. Hence, unemployment will almost surely remain distressingly high this year even though large gains in employment are expected during 1976. Accordingly, we must seek to lower unemployment as rapidly as is consistent with the need to ensure that the reductions will be lasting. Policies that might speed the decline in unemployment in the short run should not be so expansionary as to lead to increased instability and greater social hardships in the long run. Thus policies for 1976 must attempt to sustain the recovery now in progress but at a pace sufficiently moderate to prevent renewed imbalances and a rise in inflation. They must also continue to mitigate the hardships associated with high unemployment. At the same time, our present policies must lay the foundations for a long period of steady growth.

Because we began the present recovery with more slack than in any of the previous postwar cycles, a much longer period of above-average growth will be required for a return to full resource utilization. Even under the best of circumstances the return to full employment cannot realistically be accomplished this year or next. To ensure that we return to high levels of resource utilization-as is our objective-the recovery must therefore be a durable one.

Our best estimate is that real gross national product (GNP) will be 6 to 642 percent higher in 1976 than in 1975. This growth rate is not a goal. Rather, it is a projected outcome of the forces of recovery that were set in motion in 1975, by stimulative fiscal measures and by a return of consumer and business confidence and by external economic factors. With real GNP estimated to grow

« PreviousContinue »