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reduce the spread of inflationary price increases generated by regulations.

Senator PROXMIRE. Including environmental regulations of the kind

Mr. MacAvoy. Now, they attempted to examine early-on those that might be leading to price increases. Their activities, most recently, have centered on the Consumer Products Safety Commission, because CPSC findings have been closest to the consumer. They took a major position against the 50 to 100 percent increase in the price of lawnmowers that is generated by CPSC's requirements. They have worked diligently in the transportation equipment industry. They have had a great deal to do with the turnaround of the early decisions of the Highway Safety Board on requiring computerized $130,000 truck rigs. The activities are difficult to assess in any quantative fashion, because they analyze and resist regulation which would increase prices.

I believe first and personally they have had some effect in the last year, the effort is new, and it is going to be next year or the year afterward where they will really begin to have some price restraining effects.

Senator PROXMIRE. I realize the time is very late, but I will just take a couple of minutes. I do want to ask some questions on one particular area, and that is monetary policy. The administration's most widely publicized economic initiative is, I suppose, in the budget, the $394.2 billion budget, which is regarded as a restraining change from what we have had in the past, at the very least. And I support that. In fact, I think it should be lower.

But, I think if you are going to make that realistic in the kind of economy we are in, we ought to have a stimulating monetary policy. Now, as you know, for the last 6 months we have had an increase in the money supply at about a 2.3 percent rate. Over the last vear, it has been below the goals set by the Chairman of the Federal Reserve Board. In spite of that, we have had a drop in interest rates. Now, doesn't this suggest that the rcovery is weak, is weaker than perhaps would seem superficially? There doesn't seem to be much demand with interest rates falling. And in spite of the drop in money supply, the only way, it seems to me, that makes sense is that the demand for money is also dropping and

Mr. GREENSPAN. I will let my colleague answer that.

Mr. MALKIEL. First of all, let me say, Senator, I would certainly agree with you entirely that this kind of shift, to the extent that we are able to get some rein on the budget, would in fact permit a more expansive monetary policy with less fear of inflationary consequences. It would loosen the capital markets. It would facilitate investment. And I believe it would have some very beneficial effects on the economy.

The question, however, of an appropriate monetary policy, of what it is, and whether in fact the monetary policy we have had in the last 6 months can be characterized as tight or easy, is in fact, a very difficult and very complicated one. As you said in your remarks, interest rates have fallen. And it is highly unusual for interest rates to fall during a vigorous recovery such as we have had during the last two quarters of last year. The reasons, I think, are

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precisely the ones that you have suggested; namely, that there may be something that has happened to the demand for money or more generally there may well be some fundamental kinds of things that have happened in the economy that have changed the general relationship between money and other economic variables. Technological changes, if you wish, have taken place which enable us to get along with much less money, and therefore, makes a monetary policy with a particular rate of growth of the monetary aggregates, in fact, more expansionary than it may appear.

Senator PROXMIRE. Let me just interrupt at this point to say that one of the most desirable effects in getting the economy to grow, two of the most desirable effects to get it to grow in times of falling interest rates are in persuading business to invest more money in equipment and that does not seem to be developing. As the Chairman indicates in his statement, the prospects are that that won't increase that it will decrease during the coming year, although he thinks there may be a change, with higher profits—and the other is housing, where he expects to have a higher increase and much better than anybody else expects.

But still, on a historical basis, it would be a low number of housing starts, and I see nothing in your statement, Mr. Greenspan, indicating that increase would be fueled by a significant fall in mortgage interest rates. What I am saying is the function that lower interest rates should be performing; namely, stimulating economic activity just doesn't seem to be there, either in housing or in business investment.

Mr. GREENSPAN. I am not sure that is true. I think one of the reasons we are getting low interest rates, at a time of low monetary growth and a rapidly expanding economy, is because I think inflation is beginning to fall. The level of interest rates has not been unreasonable in view of the substantial and seemingly intransigent inflation rates. Another piece of evidence is the stock market which has reflected the same type of phenomena. It may well be that what we are looking at now, however, are the very first signs that the inflation psychology is beginning to break. And if that is, in fact, happening that is a most important force which will move the economy upward.

Senator PROXMIRE. And yet, you have this reflection from the Dun & Bradstreet survey that a very large number of executives—and that is a tremendous sampling of 1,400 executives—and almost 60 percent now expect price increases. They are talking about their own prices. Mr. GREENSPAN. Yes, I am not certainSenator PROXMIRE. Where they know what is going to happen. Mr. GREENSPAN. I must say I have seen some of the results of that survey in the past. And on some occasions it has been accurate, on some it has not. .

There is a big difference between what corporations plan on price increases and what they actually do. I have seen many examples of price increases planned 2 months in advance that never came about. Market conditions at the time made it impossible to put them

in place. And if the attempt was made the increase did not stick. So, I would certainly say that while the evidence that you cite indicates that the intention is there, past history suggests that the potential for these increases to be implemented is rather loose. But, I grant you, we will have to wait and see how that develops.

At this point the behavior of industrial prices is a lot more favorable than I think would ordinarily be expected. We are coming out of a significant inventory liquidation, which ordinarily would depress prices abnormally. And when inventory liquidation pressures ease, as they have done, you might expect prices to accelerate.

Senator PROXMIRE. Not when you are operating so far below capacity.

Mr. GREENSPAN. I would say even under those conditions, because it is a relative thing which would operate even when you are at low levels of capacity. You can put that 25 percent idle facilities in place quickly and in a 2-, 3-, or 6-week plane, the actual operative capacity may be only, say, only three or four points higher. Those capacity figures we have been talking about are available only after some period of time, during which you can bring on labor, raw materials, and other operations. So, that when we think in terms of the rate of operation, we tend to ignore that it is not immediately available. Another way of saying they can't bring those facilities on that quickly is that backlogs begin to fill up and leadtimes on deliveries begin to stretch out. And that type of phenomena tends to increase prices. So, even when you are dealing with subnormal operations, you still have those price pressures. But even in this context, I think they have been less than one ordinarily would expect.

Senator PROXMIRE. Well, I could argue with you on that, but let me ask one final question.

One of the most conspicuous changes in the budget is there is an increase in real defense spending, while civilian spending is going down. That represents a shift in priorities, which has been widely publicized, and we are aware of that part of the debate. But, I wonder if anybody on the Council has analyzed the economic effects of that kind of change in priorities, such as possibly the inflationary effects. One aspect of defense spending is you are not producing economic goods. If you increase in housing, you are producing more housing; if you increase spending on manpower training, you are getting more skilled people that can go out and work. So you tend to have both an inflationary effect of spending more money, but a deflationary effect of increasing the supply. But that is not true in defense spending. Defense spending is strictly inflationary.

Have you made any analysis of this kind of shift in the budget to more defense spending?

Mr. GREENSPAN. Well, Senator, first of all, let me say that it is certainly true that a small increase is projected in real defense outlays in the final 1977 budget. Nonetheless, the share of real national defense outlays in the total budget is still far below past years. And I think we lose sight of the fact

Senator PROXMIRE. Well, I don't want to argue with you on military strategy. I have a very strong feeling on that, as you may

have, too. What I am talking about is the change from last year and the economic aspects.

Mr. GREENSPAN. T'he economic aspects, I would say, is impact largely on the military procurement side. For example, the manpower costs issue is not relative to this. It is obviously the same sort of thing

Senator PROXMIRE. I understand there is a 7-percent real increase in the nonpay portion of the military budget?

Mr. GREENSPAN. I think that is an obligation. I have forgotten what the figure was, but I think probably there is a significant

Senator PROXMIRE. Oh, I understand. The staff tells me that is in outlays.

Mr. GREENSPAN. I can't dispute that, because I don't have that. But it does, obviously, affect various basic materials requirements and the like. But, I might add that the earlier part of this discussion was a discussion talking about creating jobs. And to the extent that there is a significant increase in materials purchased, it does affect the materials producing industries, which are operating below capacity. And while I do agree with you that you get a somewhat greater inflationary impact, the reason you are getting it is because of the basic impact on the demand for materials.

Senator PROXMIRE. Well, do you have an analysis of this kind, or is this kind of off the top of your head?

Mr. GREENSPAN. No, this is basically on the basis of numerous analyses that have occurred over the years. As you well know, Senator, the differential impact multiplier for various types of defense outlays has been extensively examined in the past and we know of no reasons why those conclusions do not still apply.

Senator PROXMIRE. Thank you.

Representative BROWN of Michigan. Just an observation. It seems to me, when you consider the President's budget and our looking at the defense versus nondefense portions, that you've almost got to feed in the extra tax reduction. Because if you are looking at actual dollars, as you seem to be with respect to the defense budget, those things are negative expenditures, I guess, for negative receipts. And it seems to me, therefore, your proportions change as you look at the total budget and what is contemplated by the budget. I think we tend to oversimplify these things, but just looking at the figures you see that.

Just one further thing, on the problem of monetary growth. Now, do not really feel that when you look at M, and M., et cetera, that you really have a handle on the money supply situation, in view of the tremendous change in philosophy, and the things that are not encompassed in the M, and M,?

Mr. MALKIEL. No, sir; I would agree with you entirely. I think we do not have a handle. One must recognize the kinds of changes that have taken place in some places, such as the so-called NOW

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accounts, where one can use a savings account essentially as a checking account. We have the liquid assets mutual funds, which occur in none of the M's now. This is where an individual can buy a share of mutual funds or invest in certificates of deposit and commercial paper and so forth, and can actually, in many cases, write checks against the liquid assets mutual fund in the sene that you can have it go right into a checking account and then write checks on the checking account. Well, again, this is a way in which one can store money and yet it doesn't appear in any of the money supply figures.

Since November of last year, corporations have been allowed to have time deposits of commercial banks. And, in a sense, they can by telephone, transfer this money into their demand deposits.

Representative Brown of Michigan. They are only talking about the difference between the M, and M2.

Mr. MALKIEL. That is a shift between M, and M2, right, but I think the point of issue then is one has to be very careful about talking about any one of the M's, because these are very large shifts that have taken place in recent months. And, in some cases, we are talking about instruments that are not in any of the M's at all. So, I think we have to be very careful about taking any specific M and saying that is the answer, that is the money supply.

Senator PROXMIRE. Well, that view is hotly disputed by monetary economists who testified before our Banking Committee in the last few months, who said that no matter how you dodge and duck, the fact is that M, does measure significantly the change in the availability of credit and the availability of money. It is still, by far, they fell—and I am talking about Mr. Freedman and Mr. Bruner and a number of other economists that you would recognize as being very able, and they feel this is the best single measure. And the difficulty is that all of us in Congress and in the public are pretty overwhelmed by monetary policy, anyway. Economists have made it very complicated and confused and difficult. And when we try to find out exactly what the availability of money is by that one measure, we're told we have to look at M, through M, through M, and then you've got to throw in some other things.

Representative BROWN of Michigan. Mr. Chairman, what I was saying was not so much that this is not the best indicator that we have; but rather its significance today, compared with times in the past, when it hada greater credibility with respect to

Mr. MALKIEL. Yes, I think that is exactly the point. The recent empirical evidence seems to suggest that the demand for money functions, which we thought had been so terribly stable in the past have, in fact, been running off significantly. And let me say, I don't mean to suggest this is a settled issue, because I think it is not. And frankly, it is an issue that we are now doing a good deal of work on at the Council. But, it is definitely the pace that these stable demands for money functions are now very definitely running off and have been running off since sometime in 1974.

Senator PROXMIRE. Well, gentlemen, thank you very much. The committee stands recessed.

[Whereupon, at 1:15 p.m., the committee recessed, to reconvene at 10 a.m., Thursday, January 29, 1976.]

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