Past experience has shown that unexpected developments in military requirements, budgetary trends, or economic conditions sometimes call for rapid adjustments in Federal tax policies. But prompt changes in tax rates, either up or down, are typically difficult to obtain under present procedures. In order to permit more rapid adjustments in tax levels, we would urge that consideration be given to some flexible mechanism to permit removal of the renewed 10 percent surcharge by the President before the end of the 1970 fiscal year, if changing circumstances warrant such action. The precise form of such a mechanism would be a question for discussion between the Congress and the new administration. While we do not presently visualize the emergence of conditions that would call for early removal of the surcharge, we feel that this type of flexibility would represent a potential improvement in our fiscal controls.

3. Monetary restraint is vitally needed to hold down the growth rate of money and credit, perhaps for a considerable period ahead. Beginning last December with an increase in the discount rate, the Federal Reserve authorities have moved in the direction of more restrictive monetary policy which has slowed the growth rate of money supply and brought greater pressure on member bank reserve positions in recent weeks. We believe that monetary restraint should be applied in a gradual fashion, in order to avoid the violent disruptions of a "credit crunch" but should be presistently maintained for a sufficient period to break the inflationary psychology which has gripped the financial markets in recent months.

As noted earlier, the upsurge of inflation during 1968 has quickened the desires of consumers, homebuyers and corporations to purchase goods in anticipation of rising prices, and to borrow to finance such purchases. The rise in interest costs of recent months has been outweighed in the minds of many borrowers by the expectation of higher prices for goods if the purchase were delayed. At the same time, lenders have become increasingly aware that they must obtain a higher return on fixed-debt obligations if they are to be repaid in dollars that have been cheapened by inflation. While precise measurement is difficult, it appears that these attitudes have produced an "inflation premium" on fixed-dollar investment, which has been an important force working toward higher interest rates in recent months.

The Annual Report of the CEA expresses the hope that as fiscal restraint is continued through fiscal 1970, monetary policy may gradually be able to shift to a less restrictive stance and that a decline in interest rates may take place. In our opinion there is a grave danger that premature easing of monetary policy, at the first signs of economic slowdown or rising unemployment, would revive inflationary expectations among savers and lenders and lead to higher interest rates rather than lower rates. The prospect of continuing inflation under these circumstances would impel the public to borrow more, while lenders would shun fixed-dollar investments or build in an "inflation premium" in their fixed-debt lending rates. For these reasons, we believe it is imperative to maintain a restraining monetary policy until present inflationary psychology has disappeared from the financial markets. This may require a considerable period to accomplish against the background of recent developments.

4. Other policies for price stability can also contribute to the objective of reducing the inflation rate, in addition to the aggregative effects from fiscal and monetary restraint. Chapter 3 of the Annual Report of the CEA contains a discussion of the effect on price levels of wage rates, labor efficiency and mobility, utilization rates of plant capacity, and competitive pricing policies. We endorse the perceptive analysis of the Council in that discussion, and feel that the suggestions put forward by the Council deserve the careful consideration of business and labor groups as well as the Congress. Improvements in the areas described in that chapter should also be pursued in the search for price stability consistent with high levels of employment of manpower and utilization of productive capacity.

THE QUESTION OF UNEMPLOYMENT

The Economic Report expresses the fear that "an overdose of fiscal and monetary restraint" might bring on a recession with rising unemployment and growing social unrest. The life insurance business shares the concern over the economic waste and the damage to family stability and individual dignity that would result from deliberate policies to increase unemployment as a means of halting price inflation. It is for these reasons that we urge gradual and persistent policies of restraint that will permit adjustments in production and labor markets without the violent disruptions that an economic downturn. would bring.

Recent discussion of these questions has centered on the "trade-off" or choice between inflation and unemployment. According to this argument, in the short run, unemployment can be reduced to nominal levels if demand is allowed to expand rapidly, at the cost of upward pressure on wages and prices; conversely, if demand is restrained to curb inflation, unemployment may increase. In our view, this argument overlooks the fact that unsustainable growth rates lead to distortions in the economy which can bring on extremely painful downward adjustments with a steep rise in the unemployment rate. In a longer run analysis, an overheated economy that produces inflation will lead to higher unemployment in the subsequent economic downturn which follows as a corrective aftermath of unsustainable growth.

The present 3.3 percent unemployment rate represents the lowest level in recent years. However, the social consequences of even this degree of unemployment should not be ignored. A great part of the present joblessness reflects the problem of "unemployables" who lack skills or training, as well as pockets of structural unemployment in certain urban or rural poverty areas. However, this type of unemployment does not respond readily to variations in aggregate demands. The social and economic problem of the "unemployables" should be attacked through redoubled efforts to bring this group into the labor force through programs of job training and relocation. Similarly, hard-core unemployment among minority groups in urban ghetto areas should be approached not through pressing harder on total demand but through direct programs for providing new skills and new job opportunities for these workers.

It should also be recognized that inflation exacts a heavy toll on the meager living standards of the jobless and the low-income family

through higher costs of food, shelter and clothing. Efforts to develop low-income housing are stymied by rising construction costs. Welfare payments and unemployment benefits provide less help when the prices of essential goods continue to mount. Those who are socially and economically disadvantaged could be benefited most through a combination of broad policies to curb inflation together with manpower programs to bring them into the labor force and provide them with needed job skills. Efforts should also be made to improve Government employment services and to develop a data bank on job vacancies in order to identify job opportunities and increase labor mobility.

BALANCE OF PAYMENTS PROBLEMS

The year 1968 produced the first surplus in our balance of payments since 1957, but there was little cause for elation in view of the continued weakening of our merchandise trade balance from a $3 billion surplus in each of the years 1966 and 1967 to less than $500 million last year. A heavy inflow of foreign capital was primarily responsible for converting the deficits of earlier years into a narrow surplus in 1968. However, there is little or no assurance that these offsetting capital inflows will continue in the future, since they arose to a considerable degree from political disturbances in Europe rather than from basic economic relationships.

Inflation and excess demand have doubtless played an important role in the deterioration of our trade balance this past year, by attracting an increased flow of imported goods while making our exports more expensive to many foreign buyers. If we are to maintain our competi tive position in world markets, it is essential that we regain control over inflation to prevent rising export prices.

The Economic Report recommends that controls over foreign lending and direct investment be maintained and that the interest equalization tax be renewed. While these measures may be unavoidable under present circumstances, we should not lose sight of the desirability of removing these restrictions on international capital flows as quickly as circumstances permit. The persistence of this type of "temporary" capital control illustrates the need to achieve domestic price stability and to restore a viable balance in our international trading position.

MANAGEMENT OF DOMESTIC MONETARY AFFAIRS

The Economic Report offers proposals to modify the organization of policy formation within the Federal Reserve System with a view to enhancing its effectiveness. If any modifications are to be made, however, we believe it is highly important to maintain the independence of Federal Reserve policy from political supervision or direct control by either the executive or legislative branch. This independence permits monetary policy to respond to changing economic conditions with a speed and flexibility which would be sacrificed if the System operated under fixed political directives.

In a related field, greater flexibility is also desirable in the management of the public debt and Treasury borrowing operations. For the past three years, the Treasury has been unable to market securities with a maturity beyond 7 years, because of the 414 percent interest rate

ceiling on bond issues. As a result, the average maturity of the public debt has been steadily decreasing.

In our view, the Congress should consider changes that would provide Treasury access to the longer term capital market as a regular part of its debt management function. One method would be to raise or remove the 44 percent bond ceiling; another would be to extend the maximum maturity of note issues beyond the present 7-year limit. Regardless of the method, the ability of the Treasury to lengthen the maturity of the debt would help not only to improve the debt structure but also to reduce the frequency and size of Treasury financing operations in the money and capital markets.

In conclusion, we believe that the foremost objective of economic policies in 1969 must be a reduction in the rate of inflation. Antiinflation policies should be applied in a gradual fashion, to avoid a downturn in economic activity or sharply increased unemployment. But the campaign against inflation must be pursued with persistence, to rid the economy of the inflationary psychology which threatens to distort the spending, lending, and borrowing decisions of the public. The economy has enjoyed a prolonged period of rapid growth and prosperity over the past several years. Employment, production and incomes have advanced to record high levels. But the pressure of excessive demand has outrun our capacity to produce, leading to an unhealthy and continuing rise in wages, costs, and prices. If we are to return to the path of sustainable economic growth with high employment and price stability, it is essential that we achieve a significant reduction in the rate of inflation in the months ahead.

COMMITTEE FOR ECONOMIC DEVELOPMENT

By EMILIO G. COLLADO, CHAIRMAN, RESEARCH AND POLICY COMMITTEE

We are especially pleased at this opportunity to comment on the Economic Report of the President and the annual report of the Council of Economic Advisers, because the subject matter of these important documents relates to many of the issues discussed in a January 1969 statement of CED's Research and Policy Committee, "Fiscal and Monetary Policies for Steady Economic Growth." *

This statement, prepared by a subcommittee headed by Douglas Dillon, was the result of intensive analysis of the opportunities and problems facing the U.S. economy now and in the years ahead. It represents a modernization and restatement of our analysis and recommendations for maintaining a steady rate of noninflationary growth, and is the latest in a series which began with our first stabilization statement in 1947. Since our analysis and comments on the Economic Report of the President and the annual report of the Council of Economic Advisers will draw heavily on the positions taken in this recent CED document, it is useful to briefly outline its contents and recommendations.

In "Fiscal and Monetary Policies for Steady Economic Growth," the CED Research and Policy Committee asserts that the four basic economic objectives of the country are a high level of employment, general price stability, economic growth, and balance-of-payments equilibrium.

In defining "high employment," the report notes that for many years an unemployment level of 4 percent of the labor force has been widely used to represent a high-employment situation. However, there is little economic justification for setting a target for high employment in terms of a constant fraction of the labor force. Rather, the ultimate objective requires the maintenance of a level of demand for labor which will provide a number of jobs equal to the number of workers looking for employment at wages which the marketplaces are willing to pay for their capabilities; that is, their productivity.

With this employment objective, additional measures may be necessary to increase the productivity of those workers whose productivity is insufficient to earn a decent standard of living. Before shifting away from the familiar measure of unemployment as a percent of the labor force, it will be necessary to compile and utilize data on unfilled job vacancies, and on unemployment, by both location and skill. Until this is done, we shall have to use the present measure of unemployment, keeping in mind that a satisfactory level of employment will imply lower levels of unemployment as the adjustment of workers to job opportunities improves.

*Copy in committee files.