APPENDIX

Xctes

f o r FOMC' H e e t i n g Februsry 6, 1979 S c o t t E. P a r d e e

I

i

months o f

1.978.

L e a d s and l a g s w e r e a m a j o r a d v e r s e f a c t o r .

In effect,

a i r n o s t e v e r y o c e w h o v a s ~ o i n gt o s e l l d o i l z r s i n

ezr!~y 1 9 7 9 had s o i d them i n ].ate stabilized of ir: t h e f i r s c w e e k s o f

1978.

T h u s dollar r a t e s t h e lack

J 2 c u i r v oore on

n e w s e l l i n g p r e s s u r e t h a n iis a r r s u ! :

of buyirig.
cone.,
SCEE

T r k i n f advanta:.
on Janusr?

0-

of

the o'c.lla+'s b e t t e r

18 t h e B u z d e s b a n k t c o k s t e p s c s a b s o r b

of

t h e e x c e s s l i q u i d i t y i n t h e G e r n a n b ~ n k i n gs y s t e ~ h r o u g h t
2

ti$hten<rg

pi

r e s e r v e r e q u i r e m e n t s an.$

a

hfke i n the

Lo~bs1-2 a t e , r

T h e S v i s s 2 n d .Ii?p,ai:c;~e a u t ; : o r i t i e s

2150

r e l a x e i s o m e sf t h e = o r e c n e r c 3 s b i r r i e r s t o i z f l s x s o f
f u n d s v k i c h rkej- had
impose6 l e s t y e s r .
2

T 5 e C ? r m a n cl;.cttar:;
rez:.

p s i i c y s t e p I n p e r t i c u l a r gave u s a l :

?care,

but
'3 ;

tliz

2 c t l i z z ' s resiliency i n : k c in;r2ss
the marker.

$ : i c e r f su:h

z c t i ~ n% G ? Z E

T h e n e ~ rt ; ~ r d ; e i c r t h e m a r k e t

xes

tiis

pres;<enr!s
sit::

5 T 6 t C cf

!?c

L r i o n adciress and budget pre

foilow-up

t e s t i m o n y b y senior c i f i c i a l s , S e c r e t a r y Bl.um2nthal.

including
tke

Z h 2 i r x s . r ; E : i l l e r ,:a n;srket reinained
h'ashiiigton

A t first,

s k e p t i c a l n h o c t t h e ~ . e s s a r ec o r n i n g o u t o f p o l i c y arid r c s i r s l . n L j a

01 austerity i n : I s c a l

monetary p o l i c y .
a receptive

B u t r e p o r r s t h a t Congress was p e r h a p s i n
added
t o t h e c r e d i b i l i t y of

mood

t h a t rressige. zbroad t h e

Moreover,

io many m a r k e t

participants h e r e 2 n d

f a c t t h a t t h e F e j e r a l f u n d s r a t e remained s t e a d y even after s o m e w e e k s o f weak ~ o n e t a r ya g g r e g a t e s w a s
see^

as tangible

3

e v i d e n c e of

the det-rmination

of

t h e Z1.S.

authcrities to

d e a l w i t h t h e i n f l a t i o n and d c l l a r p r o b l e m s . A t t h e 6.ime t i m e , the prolonged p o l i t i c a l

u p l i f ; > \ : a l i n I r a n !:ch*,an t c i - ; ; i s e s e r i o u s e c c n o r n i c q u e s ~ i c . r ! c ,
stemming f r o m t h e h z l t of t h e cil. e x p o r t s from t h a t c o u n t r y m a i o r import

on o n e h a n d ,

and

t h e p c t e n t i ~ lc a n c e l l a t i o n o f

(Lintracts by t h e i r a n i a n government and the other.
ho.2

I r a n i a n f i r m s on

Mcreover,
:c

t h e r e w a s t h e i ~ m e d i a t ep r o b l e ~o f
~ u y y i - ~ l t lls. bi

Ire? 3 2 s

7sy i t s
i s 1

T h e rn.r::er

~ , r r 2 : - ;.. i.v
3ece~ber

came t o t h e
-:eeting,

vie^:,

G o \ - e r n a r h n e e s u ~ a e s t e 2 I n :he

t h a t r5e
t3

T r z n i a a ~ i f x 2 t i ~ w?s ~ o t e n t i s l l ym C r e i : rhac the 2.S.
13
SOTE

dangerous
,-o 3 s e q u

J a ~ a r2 n d l i ~ s t e r aE u r o p e
tFE ,

cr n t 1 v , 2

1r 2 n i I e -e 1 r. , Ji:

e r . t j.;?

iarse

shif:s

of

funds i n t o "iinrs. ::er:s;c)against

par:,

rhis

as s t t r i b u t e d

t c c - s p o r t e r c ; i: :

2nd

2'3j!jn w h o h a 3 z l r e a d p s c l d

d o l l a r s icrward

:heir

0%-n c u r r e n c i e s a n d n3w r e v e r s e d

t h e : c s e i v e s c n ?.he p o s s i b i l i t y t k a t t h e y w o u l d n c , t b e r e c e i v i n g dollars after
who s a v t h z

all.

In part, situ;tir;n

i t w a s b y some p o r t f o l i o m s n s g e r s ,
as

Iranian

being a major u n c e r t a i c r y not

f o r those c u r r e n c i e s fcr s e v e r a l mo3ths i f r u s n lias n o t a l l i r r s d o l l z r s ;
commodity p r i c e s
/is

!~onger.

T.

~r,e

the gold

?rice ane o t h e r

have. b e e n

scrony,.
n,zrk.et f o r c c s b e g a n
January bite,

t h e ? ~ a l s i ~ c p - exci:afigil ci
r k e do1li.r

t o ti?

i n f a y o r of

ii-. !a:€
t3

tho ixterest

rate differential month Eu:--dollnr

siiddenly began

vjth the threefor

r a t e i i i o ~ e t l i n r , 6 p e r c ~ n rn b o v e t h s t

4

i!uru-isarlis,

UII'TF

~ 1 1 3 1 1ij

p?cri.t';i:

o v e r tile ra:c

ir;r

!;uro-yel;,

and 10 percenr over three-months

f o r Euro-Swiss

francs.

The m o v ~ n e n t i n t o d o l l a r s o n t h e l a s t d a y s o f

J s n o a r y and t h e f i r s t d a y s o f
t a c t i a l v o l u m e arid w o u l d

F e b r u a r y was i n v e r y s u b s tc a sharp r a l l y f c r cextral

have l e d

t h e d o l l a r except Eor t h e massive i n i e r r e n t i o n of banks.

L e s t week,

we and

t h e Cerman,

Swiss,

and Japanese

c e n t r a l banks s o l d a t o L J 1
T h i s w a s p a r t l y tc a v o i d

of

$1.8 b i l l i o n i n t o o u t b r e a k of

Lhe C13rket.

:he

disertrrly znd 7 2 ~ t ~ e1 a b l e o n ~

c o n i i t i o n s o r t h e upside f o r t h e d o i l s r
us

t o repay sxap debt. today.
~~2

The r ' o i i a r

s e t z l s d b a c k somewhat peak

y e s t c r d s y and

Ir: a l l ,

iron t h e earl:> 2tnua.r:
B

of

S5.i b i l l i i . n ,

have r e p i f d

t c t e l of
tt:e

$1.5 > i l l i o z .
Japanese
PEC

T t i S w i s s f r a r i c d e b t h a s beer? h a I v e 2 ,
d.5:

cleared
h.- ( - 1 -!

a x a y c o ~ ; p i e t e I p :a n d
' '

t h e %a:&:

deb:

h.zs b e e n

I.El!.iiPz

L . j _ i

n j l l i ~ ,i:o ~ S.3.?> k , 5 l l j c ~ : . ~ ~
however, t l i i t ;-!1at

; ~;'ist s;rcjs,
was a s h i f t o f

w e saw l a s t r;eek

p e r c e p t i o n sf r i s k o n t h e p a r t
7:1t
;I

of

market

partici~~::n:s
CF

c)i~~:,i. n i

:nr

mnrkrt's

rv~luntion
U.S.

: ~ ~ ; J ~ i ; > e n i i ~ S sg ! i i l i : ~ n : l l .

~ . i ~ p ~ ~ ~ . : c ; 5 ne n t : . t!ie

rrale And

d e f i c i t i s sti.11 a expectations about the U.S. It's
jEst

forecast rather

t h a n an a c t u a l i t y . inflation

t h e n e a r - t e r ~ i io u t l o o k f o r

i.n

are 2 s gloomy i n t h e exchange market a s b e t o r e .
that
2

the market's

a t t e n t i o n was d i v e r t e d

to other

concerns f o r very quickly.

whiie,

and b e a r i s h p s y c h o l o g y

could resurface

F.O.M.C. MEETING FEBRUARY 6, 1979
R E P O R T OF OPEN MARKET O P E R A T I O N S

Reporting on open market operations, Mr. Sternliqht made the following statement: During the seven weeks since the December 19 Conunittee meeting, the Account Management has aimed for conditions of reserve availability consistent with Federal funds trading at or slightly above 10 percent. This represented a slightly firmer stance than Despite a progress-

-

was sought just prior to the December meeting.

ive weakening in estimated growth of the aggregates, the System's funds rate objective was maintained--in response to supplementary instructions from the Committee. Thus in late December, when the

aggregates, taken together, were estimated to be slightly to the soft side of the specified ranges, the Desk was directed to hold its objective steady pending a further review at the Committee.'s telephone conference call on January 12. At that time, growth was

estimated to be even a bit weaker but after reviewing broader factors such as the state of the economy, price behavior and the international position of the dollar, the Committee left the objective unchanged. Significant further weakening for M1 and M 2

in the two months ending in January showed up in the data becoming available late last week, but with today's meeting so close, the Account Management continued its approach unchanqed.
As it worked out, the funds rate was in fact at or slightly

above 10 percent on most days.

The exceptions were several days

a r o u n d year-end when t h e combination of l a r g e d o l l a r flows and c a u t i o u s bank r e s e r v e management produced u n u s u a l demands f o r

excess r e s e r v e s which t h e D e s k could n o t f u l l y meet, l e a v i n q t h e
f u n d s r a t e h i g h e r t h a n d e s i r e d , and a few Wednesday a f t e r n o o n o c c a s i o n s of u n d e s i r e d ease o r t i g h t n e s s . t h e whole p e r i o d was a b o u t 1 0 . 1 5 p e r c e n t . The a v e r a g e r a t e o v e r D i s c o u n t window b o r r o w i n g s e v e r a l hundred

a v e r a g e d a l i t t l e o v e r $1 b i l l i o n f o r t h e period--up m i l l i o n from t h e p r e v i o u s i n t e r m e e t i n g p e r i o d .

To a c h i e v e r e s e r v e o b j e c t i v e s , t h e System Account was a

v e r y s u b s t a n t i a l o u t r i g h t seller o f s e c u r i t i e s over t h e p a s t seven

weeks--to

a n e x t e n t t h a t r e q u i r e d two i n c r e a s e s i n t h e leeway t o Sales

c h a n g e o u t r i g h t System h o l d i n g s between Committee m e e t i n g s .

were n e a r l y c o n t i n u o u s t h r o u g h t h e p e r i o d , e x c e p t f o r t h e s e v e r a l
days o f t i g h t n e s s around year-end, and a g a i n y e s t e r d a y , when t h e

Desk p r o v i d e d t e m p o r a r y reserves t h r o u g h r e p u r c h a s e agreements.

T o t a l s a l e s and redemptions came t o n e a r l y $5.7 b i l l i o n . c l u d e d s a l e s of a b o u t $1.6

This in-

b i l l i o n of b i l l s and $360 m i l l i o n o f

a g e n c y i s s u e s i n t h e m a r k e t , a b o u t $2,750 m i l l i o n of b i l l s s o l d t o f o r e i g n a c c o u n t s , and $ 9 0 0 m i l l i o n of b i l l s redeemed a t m a t u r i t y . The f i r s t of t h e l a r g e s a l e s of b i l l s i n t h e m a r k e t caused some t e m p o r a r y u n c e r t a i n t y among t h e l e g i o n s o f Fed w a t c h e r s , l a r g e l y

because of t h e i n f r e q u e n c y of such s a l e s , b u t t h e second s a l e of
b i l l s and t h e s a l e of a g e n c i e s w e n t off w i t h b a r e l y a r i p p l e .

I

S e v e r a l f a c t o r s combined t o produce t h e abundance o f r e s e r v e s , i n c l u d i n g d e c l i n e s i n Treasury b a l a n c e s , h i g h f l o a t ,

s e a s o n a l r e t u r n flows of c u r r e n c y a f t e r t h e year-end,

and l a t e r

i n t h e p e r i o d r e d u c t i o n s i n r e q u i r e d r e s e r v e s and warehousing o f
f o r e i g n c u r r e n c y f o r t h e Treasury. Reserves a r e expected t o be

a b u n d a n t through t h e n e x t s t a t e m e n t week, b u t a f t e r t h a t we e x p e c t

t o s u p p l y reserves f o r some weeks.

R i g h t now i t a p p e a r s t h a t a

r e t u r n t o t h e u s u a l $ 3 b i l l i o n o f leeway t o change o u t r i g h t h o l d i n g s between Committee meetings--down level--should from t h e temporary $ 6 b i l l i o n
A t some

provide s u f f i c i e n t operational flexibility.

t i m e though, t h e Committee may wish t o c o n s i d e r e n l a r g i n g t h e
normal leeway l i m i t a t i o n g i v e n t h e p r o s p e c t o f l o n g e r i n t e r v a l s between Committee m e e t i n g s and t h e growth i n t h e s i z e o f f a c t o r s affecting reserves. D e s p i t e t h e s t e a d y F e d e r a l f u n d s r a t e , most market i n t e r e s t r a t e s d e c l i n e d during t h e period s i n c e t h e l a s t meeting, especially i n t h e l a t t e r p a r t of t h e i n t e r v a l .
A t f i r s t , yields

on a number of i n s t r u m e n t s moved h i g h e r , p a r t l y i n r e a c t i o n t o t h e System's s l i g h t f i r m i n g a t t h e December m e e t i n g , a s w e l l a s t o i n d i c a t i o n s o f s t r e n g t h i n t h e economy and p e r s i s t e n c e of i n f l a t i o n .
A f t e r a b o u t mid-January t h e t r e n d i n r a t e s w a s downward a s t h e

m a r k e t became more i m p r e s s e d w i t h t h e l a c k of growth i n t h e a g g r e g a t e s , t h e improvement i n t h e d o l l a r o v e r s e a s , and t h e prospect

of more moderate c r e d i t demands from t h e T r e a s u r y and o t h e r borrowers
t h a n had been a n t i c i p a t e d e a r l i e r .

Most Treasury issues m a t u r i n g i n 1 t o 5 y e a r s d e c l i n e d a b o u t 25 t o 5 0 b a s i s p o i n t s i n y i e l d o v e r t h e p e r i o d . T r e a s u r y i s s u e s were down a b o u t 1 0 t o 3 0 b a s i s p o i n t s . Longer In t h e

s h o r t - t e r m a r e a , t h e r e h a s been a n e s p e c i a l l y marked d e c l i n e i n r a t e s on bank CD's which had been b i d up a g g r e s s i v e l y i n t h e f i n a l months of 1978 b u t came down by 5 0 t o 1 0 0 b a s i s p o i n t s s i n c e midDecember. P a r t of t h e rise and s u b s e q u e n t d e c l i n e was p r o b a b l y

s e a s o n a l , b u t a l s o banks a p p a r e n t l y o v e r - p r e p a r e d f o r a n t i c i p a t e d c r e d i t demand and r a t e p r e s s u r e s which f a i l e d t o d e v e l o p a s e x p e c t e d . On t h e o t h e r hand, T r e a s u r y b i l l r a t e s came down a more m o d e r a t e

25 b a s i s p o i n t s o r so f o r l o n g e r b i l l s and t h e r e w a s l i t t l e n e t
change i n r a t e s on 3-month b i l l s , where s u p p l i e s were e n l a r g e d by System s a l e s and a s w i t c h from f o r e i g n o f f i c i a l a c c o u n t p u r c h a s e s

t o s a l e s a s t h e d o l l a r improved.

Y e s t e r d a y , 3- and 6-month b i l l s

were a u c t i o n e d a t a v e r a g e r a t e s of a b o u t 9.19 and 9.31 p e r c e n t ,
compared w i t h 9.24 and 9.52 p e r c e n t t h e d a y b e f o r e t h e December meeting. Today t h e market i s b i d d i n g on $2.25 b i l l i o n of 8 - y e a r T r e a s u r y n o t e s , t h e f i r s t p a r t of t h e F e b r u a r y r e f u n d i n g o p e r a t i o n

t o replace $3 b i l l i o n m a t u r i n g n o t e s h e l d by t h e p u b l i c and r a i s e
a b o u t $1 1/4 b i l l i o n . The second p a r t o f t h e o p e r a t i o n w i l l b e p e r c e n t b o n d s of

t h e s a l e tomorrow of $2 b i l l i o n a d d i t i o n a l 8 3/4 2008.

-

W e expect t o r o l l o v e r t h e S y s t e m ' s $ 1 . 7 b i l l i o n h o l d i n g of

m a t u r i n g n o t e s , d i v i d e d between t h e t w o i s s u e s i n a b o u t t h e prop o r t i o n s they a r e offered t o t h e public.

There i s c u r r e n t l y a d i v e r s i t y o f view i n t h e m a r k e t s about r a t e prospects. Few p a r t i c i p a n t s a r e c o n v i n c e d t h a t w e

have a l r e a d y seen t h e p e a k s i n t h e c u r r e n t c y c l e , b u t a number

seem t o f e e l t h a t r a t e s a r e c l o s e enough t o t h e i r h i g h s t h a t some
moderate moves t o g e t i n v e s t e d are a p p r o p r i a t e . Others believe
be a p p r o a c h e d

t h a t s i g n i f i c a n t f u r t h e r i n c r e a s e s could l i e ahead--to

when monetary a g g r e g a t e s resume t h e i r growth and t h e monetary a u t h o r i t i e s continue t h e i r a n t i - i n f l a t i o n a r y e f f o r t s .

James L. K i c h l i n e February 6 , 1979
INTRODUCTION

--

F M CHART S O O C HW

For t h i s meeting of t h e Committee t h e s t a f f has r e a s s e s s e d t h e f o r e c a s t of economic and f i n a n c i a l developments i n 1979 and extended t h e f o r e c a s t through 1980. This r e p r e s e n t s an u n u s u a l l y long p e r i o d

f o r t h e judgmental f o r e c a s t , b u t we f e l t i t would be h e l p f u l t o t a k e a n e a r l y look a t a l l of 1980, p a r t i c u l a r l y i n l i g h t of t h e HumphreyHawkins Act. The f o r e c a s t has been prepared i n a n environment o f more

t h a n u s u a l u n c e r t a i n t y regarding t h e i n t e r p r e t a t i o n and i m p l i c a t i o n of r e c e n t econoxic and f i n a n c i a l developments. Thus a good d e a l o f

r i s k a t t a c h e s t o t h e f o r e c a s t we w i l l be p r e s e n t i n g today. The f i r s t c h a r t in t h e m a t e r i a l s d i s t r i b u t e d t o you d i s p l a y s t h e p r i n c i p a l p o l i c y assumptions t h a t u n d e r l i e t h e f o r e c a s t . Interest

r a t e s a r e assumed t o remain n e a r c u r r e n t l e v e l s i n t h e f i r s t h a l f of 1979 and t o move moderately lower t h e r e a f t e r .
This assumption i s

c o n s i s t e n t w i t h t h e midpoints of t h e l o n g e r - r u n i n t e r e s t r a t e r a n g e s f o r 1979 p r e s e n t e d as A l t e r n a t i v e B i n t h e Bluebook.

11-1 growth i s

assumed t o average 6-1/4 p e r c e n t o v e r t h e n e x t two y e a r s , a f t e r a d j u s t i n g f o r t h e e f f e c t of ATS s h i f t s on M - 1 growth. In addition,

some f u r t h e r downward s h i f t o f money demand i s assumed as d i s c u s s e d i n t h e Bluebook. For f i s c a l p o l i c y we have assumed o u t l a y s of $493

b i l l i o n i n t h e c u r r e n t f i s c a l y e a r and $538 b i l l i o n i n FY 1960. The d i f f e r e n c e s between t h e s t a f f ' s F e d e r a l budget o u t l o o k and t h a t o f t h e Administration are shown i n t h e n e x t c h a r t .

Our

e s t i m a t e o f o u t l a y s i n 1979 i s s i m i l a r t o t h a t of t h e A d m i n i s t r a t i o n

-2b u t w a n t i c i p a t e l a r g e r o u t l a y s i n 1980 r e f l e c t i n g o u r somewhat h i g h e r e i n t e r e s t r a t e s and l e v e l of unemployment, as w e l l a s an assumption t h a t c e r t a i n c o s t l i m i t i n g measures w i l l n o t be a c c e p t e d by t h e Congress.

On t h e r e c e i p t s s i d e , t h e d i f f e r e n c e i n 1980 i s accounted f o r mainly
by o u r e x c l u s i o n of t h e c o s t s of a r e a l wage i n s u r a n c e program--which p r e s e n t l y does n o t appear t o have much s u p p o r t i n t h e Congress. r e s u l t i n g budget d e f i c i t i s shown i n t h e bottom p a n e l . The

Even though

t h e p r o j e c t e d d e f i c i t i n 1980 i s about $4 b i l l i o n l a r g e r t h a n t h e Administracion p l a n , we would view our f i s c a l assumptions g e n e r a l l y a s being r e s t r i c t i v e . The n e x t c h a r t d i s p l a y s s e l e c t e d i n d i c a t o r s of r e c e n t e c o n o n i c activity. P r o d u c t i o n , employment, and r e t a i l s a l e s a l l r o s e strongl!. Over-all, r e a l G P r e p o r t e d l y r o s e a t N Thus we a p p a r e n t l y e n t e r e d

i n the f i n a l q u a r t e r o f 1976.

a s u r p r i s i n g l y s t r o n g 6 p e r c e n t annual r a t e .

t h i s y e a r w i t h a good d e a l o f momentum.

The l i m i t e d i n f o r m a t i o n a v a i l a b l e

f o r a c t i v i t y i n January, n o t a b l y t h e employment s i t u a t i o n , s u g g e s t s
appreciable strength.
blr.

Zeisel w i l l continue the presentation with a discussion

of t h e s t a f f ' s domestic n o n f i n a n c i a l f o r e c a s t .

Joseph S. Z e i s e l February 6, 1979 FOMC CHART SHOW

Although t h e economy a p p a r e n t l y e n t e r e d t h i s y e a r w i t h a

good d e a l of momentum, fundamental f o r c e s s t i l l appear t o s u g g e s t a

d i s t i n c t slowing of a c t i v i t y by s p r i n g .

The f i r s t c h a r t of t h e

n o n f i n a n c i a l s e c t i o n p r e s e n t s t h e average a n n u a l rates of growth o f real

GNP and i t s major s e c t o r s o v e r t h e p a s t two y e a r s , and our p r o j e c t i o n s
f o r t h e n e x t two.

A s i s e v i d e n t , we 2 r e f o r e c a s t i n g a s i g n i f i c a n t l y

weaker r a t e of re21 growth i n each of t h e key income g e n e r a t i n g s e c t o r s - -

housing, b u s i n e s s f i x e d i n v e s t m e n t , and government--and

an a s s o c i a t e d

s o f t e n i n g of consumer demand.

Over t h e n e s t two y e a r s , r e a l GNP i s

p r o j e c t e d t o expand a t l e s s t h a n a 2 p e r c e n t a n n u a l r a t e .

While a

slowing t o such a pace i n c r e a s e s t h e economy's v u l n e r a b i l i t y t o s h o c k s ,

we a r e n o t f o r e c a s t i n g a r e c e s s i o n , given t h e p o l i c y a s s u m p t i o n s , and t h e

a p p a r e n t a b s e n c e o f s u b s t a n t i a l d i s t o r t i o n s i n t h e economy a t t h e p r e s e n t

time

.
A major f a c t o r r e t a r d i n g growth i n o u r f o r e c a s t i s t h e

weakening of housing.

A c t i v i t y i n t h i s s e c t o r h a s s o f a r remained

- 2 s u r p r i s i n g l y s t r o n g , r e f l e c t i n g i n no small measure t h e s u p p o r t t o

d e p o s i t growth a t t h r i f t i n s t i t u t i o n s p r o v i d e d by t h e money m a r k e t

c e r t i f i c a t e s i n t r o d u c e d l a s t June.

But,as i s i l l u s t r a t e d in the t o p

panel of t h e n e x t c h a r t , growth of s a v i n g s inflows h a s slowed i n r e c e n t

months.

As i n d i c a t e d i n t h e middle p s n e l , o u t s t a n d i n g mortgage commit-

ments may have topped o u t , and t h i s month's Redbook confirms o t h e r

reports

of t i g h t e n i n g mortgsge markets.

1.10reover, it i s o u r judgment t h a t

d e s p i t e t h e a t t r a c t i v e n e s s of homeownership a s a hedge a g a i n s t i n f l a t i o n ,

t h e s u b s t a n t i a l l y i n c r e a s e d c o s t s of t a k i n g on l a r g e r mortgages a t

h i g h e r i n t e r e s t r a t e s w i l l i n c r e a s i n g l y p u t a damper o l housing demand i

t h i s year.

A s t h e bottom p a n e l d r a m a t i c a l l y p o r t r a y s , t h e monthly

c a r r y i n g c o s t f o r an average new c o n v e n t i o n a l mortgage r o s e t o $500

by t h e end of 197S--a 50 p e r cent i n c r e a s e over t h e p a s t 3 y e a r s .

The n e s t c h a r t p r e s e n t s i n t h e t o p p a n e l o u r p r o j e c t i o n o f

housing s t a r t s .

lie now a n t i c i p a t e t h a t s t a r t s w i l l bottom o u t a t a b o u t

1,650,000, a n n u a l r a t e a t t h e end o f t h i s y e a r and t h e n edge

up d u r i n g

1980 a s somewhat z a s i e r f i n a n c i a l c o n d i t i o n s p e r m i t s a reemergence of t h e
s t r o n g u n d e r l y i n g demand a s s o c i a t e d w i t h a h i g h r a t e o f f a m i l y f o r m a t i o n .

- 3 -

The key p o i n t made i n t h e bottom p a n e l i s t h a t w h i l e housing

s t a r t s remained a t a high l e v e l f o r much of 1978, r e a l housing e x p e n d i t u r e s were no longer c o n t r i b u t i n g t o economic growth. And r e s i d e n t i a l c o n s t r u c t i o n

i s expected t o be a n o t i c e a b l e drag on r e a l a c t i v i t y through most of

t h i s year.

Turning to t h e b u s i n e s s s e c t o r , t h e top tvo p a n e l s of t h e n e s t c h a r t i n d i c a t e r e c e n t t r e n d s i n r e a l o r d e r s f a r c a p i t a l equipment and c o n s t r u c t i o n c o n t r a c t s . They suggest s u b s t a n t i a l upward momentum

f o r c a p i t a l spending i n t h e s h o r t term.

However, t h e r e a r e i n d i c a t i c n s

t h a t t h i s may be temporary ; both s e r i e s appear to be e i t h e r l e v e l i n g o f f or t u r n i n g doxm. I n a d d i t i o n , a slower pace of c a p i t a l spending

over t h e b a l a n c e of 1979 i s i n d i c a t e d by t h e l a t e s t Commerce Department

survey of p l a n t and equipment o u t l a y s , i l l u s t r a t e d i n t h e bottom panel.

The outlook f o r c a p i t a l spending i n 1980 i s o b v i o u s l y more

speculatiuc.

A s i n d i c a t e d i n t h e n e s t c h a r t , o u r p r o j e c t i o n s of o v e r - a l l

activity are consistent w i t h a decline i n capacity u t i l i z a t i o n r a t e s

i n manufacturing from t h e p r e s e n t 86 p e r c e n t t o a b o u t 8 3 p e r cent

- 4 toward t h e end of 1980. I n t h i s environment t h e r e should be l e s s

p r e s s u r e f o r expansion of c a p i t a l s t o c k , and g i v e n a n expected

weakening of p r o f i t s , we a r e f o r e c a s t i n g a v i r t u a l l e v e l i n g o u t

of t h e s e o u t l a y s i n r e a l terms over t h e c o u r s e of 1980.

The n e x t c h a r t i l l u s t r a t e s t h e diminished c o n t r i b u t i o n t o o v e r - a l l expansion expected from government spending d u r i n g t h e n e x t

two y e a r s .

As t h e top p a n e l shows, t h e annual growth of t o t a l S t a t e and l o c a l - - i n r e a l terms i s

government purchases--Federal,

expected t o average l i t t l e above 1 p e r c e n t d u r i n g 1979 and l9EO;

t h i s r e f l e c t s an a c t u a l d e c l i n e of such F e d e r a l f i n a n c i n g programs as c o u n t e r c y c l i c a l revenue s h a r i n g and p u b l i c s e r v i c e employment, and a more moderate r i s e i n o u t l a y s f o r a wide r a n g e of o t h e r governmental

programs.

A s t h e bottom p a n e l shows, t h e F e d e r a l Government h i g h

emp1o)rment budget s u r p l u s i s p r o j e c t e d t o show o n l y a modest change

between 1978 and 1979 s i n c e p e r s o n a l and b u s i n e s s tax c u t s a r e a b o u t

o f f s e t by mandated p a y r o l l t a x i n c r e a s e s and t h e impact of i n f l a t i o n

i n r a i s i n g income t a x r e c e i p t s .

However, w i t h no new t a x c u t i n i t i a t i v e s

- 5 i n 1980--but w i t h the e f f e c t s of i n f l a t i o n and t h e scheduled p a y r o l l

t a x i n c r e a s e s - - t h e high employment budget moves f u r t h e r i n t o s u r p l u s

n e x t year.

O r p r o j e c t i o n s of i n v e s t m e n t and government a c t i v i t y a r e u

r e f l e c t e d i n a s u b s t a n t i a l f u r t h e r moderation of d i s p o s a b l e income

growth, a s shown i n t h e t o p p a n e l o f t h e n e x t c h a r t .

This slowing

does n o t bode w e l l f o r consuner spending p r o s p e c t s .

Growth of c o n s u n e r

s o u t l a y s ~ 2 a l s o s u s t a i n e d i n t h e r e c e n t p a s t by a s u b s t a n t i a l r i s e

i n consumer c r e d i t .

A s i n d i c a t e d i n t h e second p a n e l , t h e r a t i o of

t o t a l household d e b t t o d i s p o s a b l e income h a s r e a c h e d r e c o r d l e v e l s ,

i n c r e a s i n g t h e v u l n e r a b i l i t y of consumer o u t l a y s , p a r t i c u l a r l y f o r

d u r a b l e s , t o any weakening i n t h e r i s e of d i s p o s a b l e income.

Further-

more, w i t h t h e s a v i n g s r a t e a l r e a d y a t t h e lower end of h i s t o r i c a l

experience--the

third panel--it

seems u n l i k e l y t h a t growth of r e a l

consumer o u t l a y s w i l l o u t p a c e income.

Consequently, a s t h e bottom

panel shows, w e have p r o j e c t e d a r i s e i n r e a l consumer s p e n d i n g of

o n l y about 2 p e r c e n t , a n n u a l r a t e , o v e r t h e n e s t two y e a r s - - a b o u t

in

l i n e w i t h t h e r i s e o f r e a l d i s p o s a b l e income.

- 6 W do e x p e c t a f u r t h e r improvement i n t h e t r a d e d e f i c i t e

d u r i n g t h e p r o j e c t i o n p e r i o d which w i l l h e l p t o s u s t a i n o v e r - a l l

economic a c t i v i t y .

But on b a l a n c e , as shown i n t h e n e x t c h a r t , w e

a n t i c i p a t e r e a l GNP growth to moderate d u r i n g t h i s y e a r , a v e r a g i n g a b o u t a 2 p e r c e n t annual r a t e of growth over t h e f o u r q u a r t e r s , and t h e n

t o l e v e l o f f a t about a 1-1/2 p e r c e n t r a t e i n 1980. C o n s i s t e n t w i t h t h e slower pace of o v e r - a l l a c t i v i t y , w e a n t i c i p a t e s m l l e r employment g a i n s over t h e p r o j e c t i o n p e r i o d - - a s shown

i n the top panel of t h e next chart.

Although w are a l s o p r o j e c t i n g e

slower l a b o r f o r c e growth than i n t h e p a s t few y e a r s , r e f l e c t i n g b o t h

poorer j o b p r o s p e c t s and smaller p o p u l a t i o n g a i n s , t h e unemployment

rate--shown i n t h e bottom p a n e l - - i s

p r o j e c t e d t o move up s t e a d i l y begin-

ning t h i s s p r i n g , r e a c h i n g a l e v e l o f a b o u t 7 p e r c e n t toward t h e end

of 1960.

D e s p i t e growing l a b o r market s l a c k , i n f l a t i o n i s e x p e c t e d

t o c o n t i n u e t o be a c r i t i c a l problem f o r t h e economy.

I n the next chart

a r e p o r t r a y e d t h e c o r e e l e m e n t s o f t h e p e r s i s t e n t i n f l a t i o n problem--the

- 7 c o n t i n u i n g r i s e i n wages and t h e poor p r o d u c t i v i t y performance o f

t h e economy.

As t h e t o p p a n e l shows, we e x p e c t t h a t h o u r l y compensa-

t i o n w i l l r i s e about a s r a p i d l y on average i n 1979 a s i n 1978,

r e f l e c t i n g t h e lagged i n f l u e n c e of r e c e n t c o s t of l i v i n g i n c r e a s e s ,

t h e r e s u l t s of t h e heavy round of c o n t r a c t n e g o t i a t i o n s and t h e h i k e s

i n minimum wage and i n s o c i a l s e c u r i t y t a x e s t h a t went i n t o e f f e c t on

January 1.

Some modest e a s i n g of compensation i n c r e s s e s i s e x p e c t e j

i n 1980, i n response t o s m a l l e r p a y r o l l t a x i n c r e a s e s , t h e c o n t i n u e d

s l a c k f i l i n g o f l a b o r market p r e s s u r e s and some impact of t h e g u i d e l i n e s

program.

As t h e middle p a n e l i n d i c a t e s , w e e x p e c t l i t t l e h e l p from
improved p r o d u c t i v i t y performance i n damping t h e impact of r i s i n g wages

on l a b o r c o s t s and p r i c e s .

The c o n t i n u e d abysmal performance of p r o -

d u c t i v i t y remains b a f f l i n g .

Eut i n any e v e n t , only modest p r o d u c t i x - i t y

growth i s t o be e s p e c t e d i n an environment of such s m a l l g a i n s i n o v e r - a l l

output.

A s a r e s u l t , we a r e p r o j e c t i n g c o n t i n u e d r a p i d i n c r e a s e s i n

u n i t l a b o r c o s t s , t o t a l i n g a b o u t S-1/2 p e r c e n t d u r i n g 1979 and 7-1:2

p c r c e n t i n 1980, p a r a l l e l i n g t h e p a t t e r n o f wage movements.

- 8 -

The top panel of t h e n e x t c h a r t i l l u s t r a t e s GNP p r i c e s

excluding food and energy, which a r e p r o j e c t e d t o move g e n e r a l l y i n

l i n e with u n i t l a b o r c o s t s .

W e remain moderately o p t i m i s t i c i n r e g a r d

t o food s u p p l i e s and p r i c e s l a t e r t h i s y e a r and i n 1980, r e f l e c t i n g

p r o s p e c t s f o r good g r a i n crops and some improvement i n pork s u p p l i e s .
Our p r o j e c t i o n s c a l l f o r a 9-114 p e r c e n t food p r i c e i n c r e a s e t h i s y e a r

a s opposed t o t h e 12-112 p e r c e n t r i s e d u r i n g 1078. an 8 p e r c e n t i n c r e a s e in 1980.

W are projecting e

Energy p r i c e s a r e p r o j e c t e d t o

a c c e l e r a t e i n response t o t h e 14-112 p e r c e n t OPEC p r i c e i n c r e a s e d u r i n g

e 1979; f o r 1980 w a r e assuming a r i s e i n o i l import p r i c e s of 7-112
p e r cent--about equal t o average i n f l a t i o n . Over-all, w a r e pro j e c t i n g e

a modest d e c e l e r a t i o n i n GNP p r i c e i n c r e a s e s , from 8-314 p e r c e n t d u r i n g 1978 t o 8 p e r c e n t t h i s y e a r , and a b o u t 7-112 p e r c e n t i n 1980.

Mr. Truman w i l l now review t h e i n t e r n a t i o n a l s i t u a t i o n .

FOMC PRESENTATION E.M. Truman February 6, 1979

The upper left-hand panel of the f i r s t international c h a r t
shows the decline i n the weighted-average foreign exchange value of
the d o l l a r since the middle of 1976.

The decline began t o accelerate

i n the fourth quarter of 1977 and was only p a r t i a l l y reversed follow-

i n g the November 1 i n i t i a t i v e s .

Over the past two months the d o l l a r

has been r e l a t i v e l y stable.

The foreign exchange value of the d o l l a r ,

in nominal terms, i s now about 17 per cent below i t s level i n mid-1976
a n d about 15 per cent below i t s level in September 1977.

As i s shown i n the lower left-hand panel, i n the f i r s t quarter of l a s t year the average price level i n foreign industrial countries began t o f a l l r e l a t i v e t o the U.S. price level. This

deterioration i n the r e l a t i v e price performance of the United S t a t e s

has o f f s e t some of the competitive advantage resulting from the decline
i n t h e d o l l a r ' s nominal value.

As i s shown in the c h a r t , w expect e

t h a t , over the projection period, the U.S. i n f l a t i o n r a t e will remain r e l a t i v e l y h i g h , b u t the d i f f e r e n t i a l should narrow t o about 1% per cent per year--compared with almost 3 per cent over the past year. The upper r i g h t - h a n d panel of the chart shows the s t a f f ' s outlook f o r real economic a c t i v i t y abroad.
Average growth i n real GNP

i n foreign i n d u s t r i a l countries picked u p somewhat i n 1978, and r e a l

growth i s expected t o continue a t an average annual r a t e of about
3%per cent over the projection period, while growth in the United

-2-

S t a t e s slows.

The expected r e l a t i v e r i s e i n the level of economic

a c t i v i t y abroad i s summarized i n the l a s t panel.

The factors I have just reviewed a r e among the major
determinants of t h e s t a f f ' s outlook f o r U.S. t h a t i s presented i n the next chart. international transactions

A depicted i n the upper l e f t s

hand panel, the value and volume of non-agricultural exports a r e expected t o increase briskly over the next two years, though not a s rapidly a s i n recent quarters. The volume of such exports i s expected

t o increase a t an a n n u a l r a t e of around 9 per cent and the value a t a r a t e of about 18 per cent. A t the same time, a s shown i n the lower left-hand panel, the volume of non-oil imports i s expected t o expand r e l a t i v e l y slowly reflecting the slower growth of the U.S. e f f e c t s of the d o l l a r ' s depreciation. economy as well a s the lagged Even w i t h substantial price

increases, the value of these imports should increase over the next

two years a t an average r a t e of l e s s than 9 per cent per year.
The upper right-hand panel i l l u s t r a t e s the e r r a t i c upward trend of U.S. o i l imports. In our forecast w have t r i e d t o take e

account of recently announced, and prospective, OPEC price increases and t o make some guesses about the e f f e c t s of the Iranian production situation--which we have assumed will mainly a f f e c t the time pattern of o i l imports i n 1979.
On t h i s b a s i s , we expect t h a t the U.S.

oil

import b i l l will r i s e $5-6 b i l l i o n per year in both 1979 and 1980.

Most of the increase will r e s u l t from higher prices.

-3As shown in the f i n a l panel, the net e f f e c t of the components

t h a t I have just reviewed, together w i t h l i t t l e expected change in our a g r i c u l t u r a l exports, yields an improvement in the trade balance i n 1979 and 1980. The top l i n e in the c h a r t depicts the gradual r i s e

over the projection period in net exports of goods and services as
measured i n the GNP accounts. The f i n a l international chart summarizes U S . international transactions over the past three years. The left-hand column shows

the current account balance f o r these years as well a s the s t a f f ' s projection f o r 1979 and 1980.
You will note t h a t w expect the e

United S t a t e s will record i t s f i r s t current account surplus i n 4 years i n 198U. The middle column indicates t h a t i n 1977 and 1978 capital inflows i n the form o f increases i n foreign o f f i c i a l reserve a s s e t s held i n the United S t a t e s were about twice as l a r g e a s our current account d e f i c i t s . However, t h e pattern of these increases

has been e r r a t i c ; the l a r g e s t inflows have roughly corresponded t o periods of sharp downward pressure on the d o l l a r i n exchange markets
d u r i n g the l a s t quarter of 1977 and the f i r s t and f o u r t h quarters of

1978.

The t h i r d column shows other t r a n s a c t i o n s , derived e s s e n t i a l l y
These a r e mostly p r i v a t e c a p i t a l transactions.
Such

as a residual.

transactions a t times a r e a source of downward pressure on the d o l l a r . However, the s i z e o f any actual net outflow i s inversely r e l a t e d t o
the volume of o f f i c i a l purchases of d o l l a r s .

Given the improved outlook for the U.S. c u r r e n t account t h a t
I have presented, the s t a f f expects l i t t l e further change in the

-4-

average nominal foreign exchange value of the d o l l a r over the projection
period, a l t h o u g h w i t h the expected r e l a t i v e l y high U.S.
i n f l a t i o n rate

t h i s implies a small real appreciation of the d o l l a r .

I would draw

two inferences from this outlook f o r a stable d o l l a r and a d e c l i n i n g U.S. current account d e f i c i t .
F i r s t , foreign monetary a u t h o r i t i e s

will have less inducement t o purchase d o l l a r s t o add t o t h e i r holdings of reserve a s s e t s in the United S t a t e s . Second, the lower current

account d e f i c i t i n 1979 should be accompanied by a s u b s t a n t i a l l y reduced net private c a p i t a l outflow o r , even, by a modest net inflow.

Mr. Kichline will now conclude our presentation.

James L. K i c h l i n e February 6 , 1979

C!JNCLUSION

--

FOMC CHART SHOW

Total c r e d i t flows c o n s i s t e n t w i t h t h e s t a f f ' s economic f o r e c a s t a r e shown i n t h e f i r s t c h a r t of t h e l a s t s e c t i o n of y o u r packet.
Funds r a i s e d by n o n f i n a n c i a l s e c t o r s i n 1979 a r e p r o j e c t e d t o

recede from the high l e v e l s of l a s t year.

The htlk of t h e d e c l i n e i s

a t t r i b u t a b l e t o reduced demands by t h e F e d e r a l Government, which i s expected t o f i n a n c e a p o r t i o n o f t h e d e f i c i t t h i s y e a r by drawing down i t s cash b a l a n c e s . T o t a l borrowing by o t h e r s e c t o r s i s n o t

expected t o grow i n 1979 and 1980, r e f l e c t i n g t h e e f f e c t s of f i n a n c i a l r e s t r a i n t s and d e c e l e r a t i n g growth of economic a c t i v i t y .
As shown i n t h e bottom p a n e l , commercial banks and t h r i f t

i n s t i t u t i o n s a r e expected t o s u p p l y a somewhat s m a l l e r volume of c r e d i t i n t h e n e x t two y e a r s than i n 1978. These i n s t i t u t i o n s w i l l l i k e l y be

l e s s w i l l i n g l e n d e r s t h i s y e a r i n l i g h t of reduced l i q u i d i t y p o s i t i o n s and a n expected f u r t h e r need t o r e l y upon borrowed f u n d s r a t h e r t h a n d e p o s i t flows t o meet c r e d i t demands. Other s u p p l i e r s of c r e d i t ,

p a r t i c u l a r l y i n s u r a n c e companies and pension funds, are expected t o be i n a more comfortable p o s i t i o n t o f i n a n c e economic a c t i v i t y . T o t a l borrowing by n o n f i n a n c i a l c o r p o r a t i o n s , shown i n t h e next c h a r t , i s p r o j e c t e d t o r i s e a p p r e c i a b l y i n both 1979 and 19SO from the a l r e a d y high l e v e l s reached l a s t year. Although t h e economic f o r e c a s t

p r o j e c t s a slowing of growth i n c a p i t a l e x p e n d i t u r e s , e s p a n s i o n o f i n t e r n a l l y g e n e r a t e d funds i s a l s o expected t o moderate, t h e r e b y maint a i n i n g p r e s s u r e s on e x t e r n a l f i n a n c i n g . The i n c r e a s e d volume o f funds

-2r a i s e d i s expected t o come from long-term s o u r c e s , where funds s h o u l d be a v a i l a b l e . Short-term markets seem l i k e l y t o be r e l a t i v e l y t i g h t e r ,

p a r t l y because o f t h e p r e s s u r e s on banks.

In a d d i t i o n , however, t h e

bottom panel shows t h a t heavy s h o r t - t e r m borrowing i n t h e p a s t two y e a r s h a s pushed t h e r a t i o of s h o r t - t e r m t o t o t a l d e b t o u t s t a n d i n g t o f a i r l y high levels. L a t e r t h i s y e a r and i n 1980 t h e r e p r o b a b l y w i l l be s t r o n g

p r e s s u r e s t o begin funding such d e b t i n long markets t o r e l i e v e b a l a n c e sheet distortions. I n c o n t r a s t t o t h e c o r p o r a t e s e c t o r , t h e next c h a r t shows t h a t household s e c t o r borrowing i s p r o j e c t e d t o d e c l i n e somewhat t h i s y e a r and n e x t from t h e e x t r a o r d i n a r y l e v e l i n 1978. Despite expected

f u r t h e r r a p i d growth of house p r i c e s , mortgage borrowing i n 1979 and 1980 i s e s p e c t e d t o remain around t h e l e v e l of t h e p a s t two y e a r s , which r e f l e c t s t h e e f f e c t s of f i n a n c i a l r e s t r a i n t . The s h a r p con-

t r a c t i o n of mortgage borrowing t h a t h a s o c c u r r e d d u r i n g p a s t p e r i o d s of monetary r e s t r a i n t is p r o j e c t e d t o be a v o i d e d , a s a r e s u l t of b o t h t h e p a r t i a l i n s u l a t i o n of t h e mortgage market from t h e d i r e c t e f f e c t s of monetary r e s t r a i n t and s u s t a i n e d demands f o r h o u s i n g . Consumer

i n s t a l m e n t and o t h e r borrowing i s p r o j e c t e d t o d i m i n i s h l a t e r t h i s y e a r and i n 19S0, given p r o j e c t e d s l o w e r growth of d u r a b l e goods p u r c h a s e s . R e l a t i v e t o income, however, consumer borrowing i s p r o j e c t e d t o remain q u i t e high.

The economic f o r e c a s t and a s s o c i a t e d c r e d i t : f l o w s assume
growth of E l - 1 a v e r a g i n g 6-1/’4 p e r c e n t i n 1979 and 19SO. t h e n e x t & a r t , nominal GNP expandcd a t
d

A s shown i n

f a s t pace i n t h e l a s t q u a r t e r

- 3o f 1978 while M - 1 growth a d j u s t e d f o r the e f f e c t s of ATS slowed.
nus

t h e income v e l o c i t y of money r o s e s u b s t a n t i a l l y and a s t r o n g v e l o c i t y i n c r e a s e i s a l s o expected t h i s q u a r t e r . L a t e r t h i s y e a r and i n 1980

t h e f o r e c a s t assumes t h a t s t r o n g e r demands for money r e l a t i v e t o GNp w i l l be e v i d e n t .

I n o r d e r t o hold money growth t o 6-114 p e r c e n t t h e

3-month b i l l r a t e i s expected t o d e c l i n e o n l y a l i t t l e t h i s y e a r and n e x t , sho1.m i n t h e bottom panel. The A d m i n i s t r a t i o n i n i t s f o r e c a s t

assumes 3-month b i l l r a t e s about 1/2 p e r c e n t a g e p o i n t lower on average t h i s y e a r than shown on t h e c h a r t and more t h a n a percentage p o i n t lower i n 1980. The economic f o r e c a s t of t h e A d m i n i s t r a t i o n and t h a t o f t h e s t a f f a l s o d i f f e r i n a number o f ways, a s shown on t h e n e x t c h a r t . Growth of nominal GXP expected i n 1979 i s q u i t e c l o s e , b u t i n 1980 t h e s t a f f f o r e c a s t i s s i g n i f i c a n t l y below t h a t of t h e Administration. N The d i f f e r e n c e i s even g r e a t e r f o r r e a l G P i n 19SO when t h e Administ r a t i o n p r o j e c t s growth of 3-114 p e r c e n t , o r more than twice t h e s t a f f ' s f o r e c a s t e d r a t e of growth; b u s i n e s s f i s e d i n v e s t m e n t , r e s i d e n t i a l c o n s t r u c t i o n o u t l a y s and consumption e x p e n d i t u r e s a r e a l l growing a t a p p r e c i a b l y f a s t e r r a t e s i n 1980 t h a n i n o u r own f o r e c a s t . The Adminis-

t r a t i o n a l s o e x p e c t s c o n s i d e r a b l e improvement i n i n f l a t i o n t h i s y e a r and n e x t w i t h t h e GNP i m p l i c i t d e f l a t o r i n 1980 p r o j e c t e d t o r i s e a b o u t
6-112 p e r c e n t compared t o 7-112 p e r c e n t i n t h e s t a f f f o r e c a s t .

Pre-

sumably t h e l e s s r a p i d p r i c e i n c r e a s e s s t e m from t h e assumed g r e a t e r e f f e c t i v e n e s s o f t h e wage-price r e s t r a i n t program, s i n c e t h e p r i c e deceleration occurs w i t h l i t t l e a d d i t i o n a l slack i n resource u t i l i z a t i o n

-4t h a n now e x i s t s , a s i l l u s t r a t e d by maintenance of a 6-114 p e r c e n t unemployment r a t e i n 1979 and 1980 i n t h e i r p r o j e c t i o n .

M-1 growth assumed i n t h e s t a f f ' s f o r e c a s t i s 6-114 p e r
c e n t a d j u s t e d t o t a k e account of t h e e f f e c t s of ATS. Judging from

t h e econometric e x e r c i s e s w e have u n d e r t a k e n , nominal GNP growth a s i n t h e Administration f o r e c a s t could a l s o be f i n a n c e d by r o u g h l y s i m i l a r monetary growth. The model s i m u l a t i o n s , however, s u g g e s t v e r y

low p r o b a b i l i t i e s of j o i n t l y a c h i e v i n g t h e lower i n f l a t i o n and lower unemployment f o r e c a s t s by t h e A d m i n i s t r a t i o n . The f i n a l c h a r t i n t h e package d i s p l a y s t h e r e s u l t s o b t a i n e d from model s i m u l a t i o n s employing 1 p e r c e n t a g e p o i n t slower and f a s t e r r a t e s of M1 growth t h a n i n t h e 6 - 1 / 4 p e r c e n t b a s e f o r e c a s t . -

Each

of t h e f o r e c a s t s p r e s e n t s a p i c t u r e of slow or moderate economic growth accompanied by s t i l l h i g h r s t e s o f i n f l a t i o n even i n t o 1 9 S l . There

seems t o be l i t t l e i n t h e way of a t t r a c t i v e o p t i o n s f o r monetary p o l i c y . Tightening f u r t h e r would b r i n g on t h e l i k e l i h o o d of a r e c e s s i o n l a t e r t h i s y e a r o r n e x t w h i l e an e a s i e r p o l i c y would p r o b a b l y produce h i g h e r r a t e s o f i n f l a t i o n o v e r t h e l o n g e r run.