AMERICAN BANKERS ASSOCIATION

(By J. Rex Duwe*)

We welcome this opportunity to present our views on some of the important economic issues addressed in the Economic Report of the President. In our opinion, the primary economic issue currently facing the country is how to keep the economy on a stable growth path without once again raising the rate of inflation to the level where severe social and economic disruption occurs. The economic news of the past months has restored our confidence that this can be done and, in fact, is being done. The rate of unemployment, although still unacceptably high, has decreased by 1.5 percentage points in 9 months. The rate of inflation after reaching 12.2 percent in 1974 declined to 7 percent in 1975 and in recent months has declined even further.

During late 1975 the moderate pace of the recovery in some sectors led many to question whether the recovery was in the process of aborting. Events of recent months indicate that the recovery is becoming stronger. There are signs that it is spreading to those sectors such as business investment which lagged somewhat during the early phase of the recovery. Moreover, consumer spending, spurred both by consumers' rising real incomes and renewed confidence, is likely to maintain the momentum of recovery for some time to come.

Since the recovery has become more robust we would caution against any further liberalization of fiscal policy at this time. In addition, we would urge that the Federal government move in the direction of less stimulative fiscal policy as the recovery continues. As economic activity increases and unemployment falls, tax receipts will rise and some recession related expenditures will fall. No steps should be taken to offset the resulting decline in the Federal deficit as long as the recovery continues. Failure to allow the Federal deficit to decline as the recovery continues could result in the inability of capital markets to supply funds needed for private investment during later stages of the recovery,

We would also urge the Federal Reserve to maintain a moderate growth rate in the money supply. The evidence is quite clear that excessive growth in the money supply leads in the long run to unacceptably high rates of inflation. On the other hand, the reduced rate of inflation during 1975 appears to be at least partly the result of moderation in the growth of the money supply during the year. We feel that public discussion of the proper role of monetary policy such as that generated by the quarterly disclosure to Congress of the Federal Reserve's monetary targets has been beneficial and should be continued.

In general, we would urge less reliance on attempts to fine-tune the economy. We feel that increased stability in both monetary and fiscal policies will result in reduced uncertainty and increased economic stability. for example, experience with the effects of fiscal policy shows

* President, American Bankers Association.

that there can be rather long delays in implementation and further delays before these policies take effect. In addtion, it is often difficult to reverse these policies once they are put into operation. Thus, counter-cyclical fiscal policies may have lagged effects with their greatest impact felt at a time when no longer needed. In some cases, these delays are long enough that the effect of fiscal policies actually aggravates later phases of the business cycle.

In addition to stable monetary and fiscal policies, we feel that rational allocation of government resources is an important goal. The budgetary process recently adopted by Congress is a major step in achieving both the rational allocation of government resources and stability in fiscal policies. We urge that Congress continue to use this new budgetary process.

Some would argue that a moderate course for monetary and fiscal policy under present circumstances places the burden of economic adjustment on the unemployed. We would agree that the rate of unemployment remains unacceptably high, particularly in certain segments of the population. Nevertheless, there are several factors which help to reduce the burden of unemployment. A good deal of unemployment even during recessions is of short duration and a part occurs in families in which one member of the family remains employed. Unemployment compensation programs and certain transfer programs reduce the burden for a large number of the unemployed. Coverage of these programs was expanded and benefits liberalized during the past recession. More liberal unemployment benefits allow unemployed workers to spend a longer time in search of a better job, resulting in a more efficient job market. In addition, it appears that the problem of unemployment is exacerbated among some groups by the minimum wage laws. For example, the minimum wage results in some young persons with few work skills being priced out of the labor market.

Like unemployment, the costs of inflation are high. Although inflation affects nearly all segments of the population, it is particularly severe on those living on fixed incomes which includes many of the older members of society. In addition, high rates of inflation give rise to considerable uncertainty for both households and businesses. This uncertainty appears to have been an important factor in the past. recession. Finally, inflation causes disruption of the housing markets with its consequent hardships. It is because of these potentially disruptive effects of an increased rate of inflation that we have recommended a moderate course for both monetary and fiscal policy.

The banking industry, like the rest of the economy, was strongly affected by the 1974-75 recession. The industry's problems are, perhaps, best illustrated by the large increases in loan losses during 1975. Although such loan losses are of major concern, they are the inevitable consequence of a severe recession. Banks supply funds to finance expansion and innovation in all types of economic activity. In doing

So, banks take risks in the same manner businessmen take calculated risks in making investment decisions. Our private market system makes it uncertain which ventures will be successful and which will be unsuccessful. Since most businesses rely to some extent on borrowed funds, failures during periods of severe recession result in loan losses for the banks. Nevertheless, even during periods of recession, the bulk of these loans are repaid and most banks are able to absorb loan losses out of current income. Furthermore, all banks put side reserves which they can then use to absorb exceptional losses. As the recovery proceeds, we expect loan losses to decline to more normal levels.

While we are optimistic about the future of the U.S. economy and particularly about the current recovery, we are concerned about two problems which potentially could reduce the rate of long-term growth in our economy, namely energy and capital formation. In the energy area, we would like to see a more serious conservation effort undertaken. We feel the best way to reduce our dependence on foreign energy and to insure conservation of our energy resources is to allow the domestic prices of the various energy sources to begin to rise towards the market levels. We believe this will be much more efficient in the long run than any system of rationing. Such price adjustments would encourage the development of alternative energy sources which will be absolutely necessary for the longer range increased prosperity of the American people.

The other problem which we view with concern is that of capital formation. Some have argued that there can be no such thing as a capital shortage in a free market economy. In one sense this is true because the rate of interest will move to equilibrate the supply and demand of capital. However, such an equilibrium may occur at a rate of growth in the capital stock which would preclude our meeting some important social goals such as reducing unemployment, improving our environment, expanding and improving our housing stock and reducing our dependence on foreign energy sources. Thus, when we say there is a capital shortage we mean that we have the option of increasing the rate at which we save and invest or abandoning some of our economic goals. Since we agree that many of these goals are quite important, we would prefer to see incresed incentives for savings and investment. One of the most effective ways of doing this is to change the tax structure to provide these increased incentives. In addition, a reduction in the rate of inflation would reduce the uncertainty which has dampened capital formation in recent years. Finally, we note with some apprehension that the Federal government has become a significant user of funds which would otherwise be available for capital formation. While this may not result in serious problems during recession periods when private investment is at low levels, it may prevent increases in the volume of private investment which are necessary to sustain the recovery. Thus, we would reiterate the need to allow the Federal deficit to decline as the recovery continues.

AMERICAN FEDERATION OF LABOR AND CONGRESS OF

INDUSTRIAL ORGANIZATIONS

(By I. W. ABEL*)

The AFL-CIO is pleased to have this opportunity to place our views in the record of the Joint Economic Committee's consideration of the state of affairs of the national economy.

The meetings of the AFL-CIO Executive Council and the Economic Policy Committee, several weeks ago, devoted a good deal of attention to economic developments and issues.

Despite modest improvements since last Spring, the American economy remains in weakened condition, with a vast amount of slack, after the longest and deepest recessionary decline in 40 years. Thus, the economy is vulnerable to possible adverse events at home or abroad.

The Labor Department reported 7.7 million unemployed workers or 8.3 percent of the labor force in December. For January, the government agency officially reported that joblessness declined to 7.3 million or 7.8 percent. The Administration ignored the likelihood that a statistical fluke exaggerated the decline, and it also ignored a rise of 240,000 in the number of workers compelled to work part-time because fulltime work was not available.

Even the officially-reported unemployment count for January was higher than in any earlier period since 1941, when the economy was coming out of the Great Depression. Moreover, the Labor Department also reported that 131 of the 150 major labor market areas still had substantial unemployment-this figure was unchanged from December and down only slightly from the peak of 135 in September. Substantial unemployment was also reported in 1,046 smaller job market areas, which means that nearly four-fifths of approximately 1,500 labor market areas in the nation were still in bad shape.

American industry was operating only 71 percent of its productive capacity in the fourth quarter of 1975, according to the Federal Reserve Board-leaving 29 percent of industry's plant and equipment idle. This was a much lower level of operations than in any pick-up from a post-World War II recessionary decline.

The Department of Commerce conservatively estimates that the gap between total national output and the economy's potential to produce at high-level operations was at a yearly rate of $221 billion in the fourth quarter of 1975. This staggering loss comes to $1,000 per man, woman and child in the country.

A significant number of banks and large companies remain severely strained, leaving the possibility of some major bankruptcies in 1976. The financial plight of most large cities and many state governments is resulting in widespread cuts in urban services and public employ

*Chairman. Economic Policy Committee, American Federation of Labor and Congress of Industrial Organizations.

ment eliminating major employment-growth in 1976, from this sec tor, which provided a lift during pick-ups from previous post-World War II recessions. Moreover, a default or bankruptcy by New York City, several other large cities and New York State remain a distinct possibility.

Numerous poor nations, further impoverished by the cartel-controlled price of crude oil, are in severe financial strain. One or more may default on loans in 1976-with adverse impacts on American banks and world money markets.

More than two years after the Arab-dominated oil cartel imposed on oil embargo on the U.S. and a five-fold boost in the price of imported crude oil since 1973, America still has no comprehensive energy policy. The nation is now even more dependent on imported crude oil that in 1973 and remains vulnerable to continued oil-blackmail.

So the American economy survived the near-disaster of the winter of 1974-1795 and there have been modest improvements since the spring of 1975. But no basic economic problems have been solved. Weakness, vulnerability and uncertainty remain.

THE ADMINISTRATION'S POLICIES AND FORECASTS, 1976-77

President Ford's economic policies and programs—as revealed in the Budget for fiscal year 1977 and the Economic Report-show the following for 1976 and 1977:

For 1976.-Continuation of the go slow, don't rock the boat negativism of 1975. The Administration's official economic forecast for this year is a modest 6.2 percent increase in the real volume of total national production, following declines of 2 percent in 1975 and 1.8 percent in 1974. The Administration also forecasts merely a small decline in unemployment from 8.5 percent of the labor force or 7.8 million jobless in 1975 to 7.7 percent or about 7.3 million unemployed in 1976 and a modest reduction in the rate of inflation to a 6.3 percent rise in the Consumer Price Index. This forecast also includes a 32 percent boost in corporate profits, presumably based on the modest rise of sales and production, combined with a sharp increase in productivity. For 1977.-A marked shift to economic restraint in the Administration's policies and programs starting with the new fiscal year on October 1, 1976, with spreading impacts after the November elections.

The President's Budget proposes cuts in the general level of real federal expenditures for fiscal year 1977, concentrated in such programs as employment, education, health, income security and grantsin-aid to state and local governments. The Administration's official economic forecast for 1977 is for a 5.7 percent increase in the real volume of national output; a further small reduction in unemployment to 6.9 percent or about 6.7 million jobless; a further slight reduction in inflation to a 6 percent rise in the Consumer Price Index and an additional 16 percent increase in corporate profits.

The Administration's forecast for 1976, as spelled out in the Economic Report, is shaky. It includes a step-up in the rise of real consumer spending from 3.9 percent in 1975 to about 6 percent in 1976. largely based on a prediction that consumers will save considerably less of their incomes and spend more. It also includes a forecast that