Tape 126 - Overheating of the economy and that money crunch

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-	Welcome once again as MIT professor Paul Samuelson	0:02
	discusses the current economic scene.	0:05
	This program is produced	0:07
	by Instructional Dynamics, Incorporated.	0:08
	Today's program was recorded April 20th.	0:11
-	Well, as Gabriel Heatter used to say,	0:14
	there's bad news today.	0:17
	This is the day that the official first estimates	0:20
	of the gross national product for the first quarter	0:23
	of 1973 have been announced, and the news is dreadful.	0:27
	What, you say, the news is dreadful?	0:34
	This is a record increase for the quarter.	0:37
	The money, or nominal GNP, has increased by 14.3%.	0:41
	The real GNP, that is the GNP corrected	0:48
	for any price inflation, and there has been a good deal	0:52
	of price inflation this last quarter,	0:56
	is a good 7.9%.	0:58
	That's almost precisely the 8%	1:02
	of the strong growth quarter at the end of 1972.	1:05
	How then can I speak of this as bad news?	1:13
	Well of course you can have too much of a good thing.	1:18
	First, and not my primary meaning,	1:22
	there is the sad fact that the rate of increase	1:25
	of prices by the implicit price deflator was terrible.	1:30
	There are about four different measures	1:37
	of overall price inflation which come to us	1:40
	with the GNP statistics.	1:42
	There is the ordinary deflator,	1:45
	which includes a wage increase for government employees	1:47
	that was in the data.	1:51
	That of course is high.	1:52
	There is the private gross national product deflator.	1:54
	That also is high.	1:59
	There is the chain index method	2:01
	of computing the overall GNP deflator,	2:04
	and the chain method of computing the overall	2:09
	gross private deflator.	2:14
	The chain method allows for no weight shifts,	2:17
	and so if something unusual is happening	2:22
	in the automobile industry,	2:24
	and the automobile industry is having something unusual	2:25
	in the way of prices, the so-called distortion	2:28
	which some people think are then	2:31
	in the data will be removed	2:35
	by giving the automobile industry just the same weight	2:37
	in both quarters, the weight	2:41
	which it normally has in the economy.	2:43
	Well on the basis of those measures,	2:46
	and I don't care which one you take,	2:49
	the rate of inflation in the first quarter	2:51
	of the year was extremely disappointing,	2:54
	namely the four measures range from 5.5%.	2:56
	That's the biggest we've seen for some time,	3:01
	up to 6 2/3%, which is the biggest that we've seen	3:04
	for a long time.	3:07
	But it's not merely the rate of price increase,	3:12
	because we were prepared for that.	3:17
	All the meat trauma that has been catching the headlines,	3:19
	all the jumps in food prices.	3:27
	Those were not revealed to us this week	3:29
	or this month.	3:32
	We've been going through that process	3:33
	for, well, since the beginning of the year really.	3:36
	What I think think is disturbing	3:41
	about the numbers is the strength	3:43
	in the real output growth.	3:45
	This is too much of a good thing.	3:47
	I've been saying repeatedly in these tapes	3:51
	for more than six months now that	3:54
	what we want is lots of 5 to 6% quarters	3:58
	of real growth that will be maintainable	4:04
	and not a few quarters of 7.5%	4:08
	which will blow the top from the system,	4:13
	which will set the stage for a inventory slowdown,	4:16
	for a period of relaxation, and which will be	4:22
	themselves producing current demand pull inflation,	4:28
	current demand pull inflation which	4:32
	I would say inevitably will be followed	4:35
	by a re-emergence of cost push inflation	4:39
	on the part of collective bargaining wage settlements,	4:44
	on the part of administered wage changes,	4:48
	and on the part of changes in administered prices.	4:53
	Well, the news from this point	4:58
	of view could hardly be worse.	5:02
	If I were clutching for straws,	5:06
	if I were reaching to find some saving feature	5:09
	in the present situation, I guess it would have	5:14
	to be, one, the unbelievable moderation	5:18
	that seems to be offstage with respect	5:25
	to the collective bargaining contracts	5:29
	for this year.	5:31
	I think that the accommodation, the deal,	5:33
	the arrangement, that was made explicitly	5:39
	or implicitly, I think explicitly,	5:44
	between the administration and the very top leaders	5:47
	of organized labor, between George Meany	5:50
	and the president, I think that	5:54
	that must be a very firm agreement indeed.	5:57
	I realize that George Meany goes through the motions	6:03
	of saying that the official guidelines	6:05
	on wages will not be enough.	6:09
	He goes through the motions of twitting the Secretary	6:11
	of Labor, Brennan, from one of the New York unions,	6:16
	as if he were a renegade from the labor movement,	6:22
	as if he were a patsy of the administration.	6:25
	I won't pronounce on either of those questions,	6:28
	but nevertheless, when you actually look	6:32
	at the rhetoric and the indications with respect	6:35
	to the Teamsters strike, with respect	6:40
	to the provisional agreement on next year's	6:42
	steel negotiations, the rubber workers' negotiations	6:47
	now underway, which will be a bellwether	6:52
	for the auto industry settlement later	6:56
	in the year, I think that you must marvel	7:01
	at the moderation that seems to be	7:05
	in the picture from that side.	7:09
	In other words, we have as favorable a relationship	7:11
	on the side of cost push as we're likely	7:15
	again to have for a very long time.	7:20
	This favorable relation, by the way,	7:25
	has not been helped one bit, as you can see	7:27
	from the real output statistics,	7:29
	by any slack in the labor market.	7:31
	Somebody who tried to explain cost push wage negotiations	7:34
	by the state of the labor market will	7:38
	not infrequently find some bits of evidence	7:42
	in the direction of his hypothesis,	7:46
	but I don't think that if we look at	7:49
	what's been happening in the field of construction	7:52
	and look at construction wages	7:54
	under the Dunlop jawboning negotiations,	7:56
	if we look at what's been happening generally	8:01
	to the wage drift above union rates	8:03
	in the areas of manufacturing which are very tight,	8:06
	then we do not see in the wage picture strong signs	8:10
	of demand pull as yet.	8:17
	But I don't think you'd better hold your breath	8:21
	and expect that good luck to last.	8:24
	It may but all past experience suggests	8:26
	that there is a considerable probability	8:31
	that it will not last.	8:33
	Now these numbers are are very great.	8:37
	They're not numbers, I may say,	8:39
	which surprise the close follower	8:42
	of business conditions.	8:46
	The increase in nominal GNP is estimated	8:50
	to be $43.6 billion.	8:57
	Most of the estimators that I have been reading	9:01
	since I got back from Australia, just a few weeks ago,	9:05
	have been estimating that the increase	9:10
	for the quarter would be high.	9:14
	They've been saying more than $35 billion,	9:16
	and $35 billion for one quarter is a whopping increase.	9:18
	Still, I don't know any who, up until the last few days,	9:24
	and there the leak might be in,	9:29
	were giving numbers this much above $40 billion.	9:32
	However, if we turn to the typical longer-run	9:40
	GNP model estimators, and look to see	9:48
	what it was just a quarter ago or two quarters ago,	9:53
	they were estimating for the rate	9:56
	of increase in the first quarter of this year.	9:58
	Then we realize how really high the numbers have been.	10:02
	In fact, I have to go back to the second quarter	10:08
	of 1972 for a comparable outlier.	10:10
	You may remember how surprisingly high was the rate	10:16
	of real growth in that quarter.	10:19
	I believe it was over 9% then.	10:21
	I said on these tapes that,	10:23
	when they come to revise it I suppose	10:25
	they'll revise it downward,	10:26
	and in the event they revised the real number upward.	10:27
	This was still of course in the phase two stage.	10:31
	Well, to take one horrible case	10:38
	to show the perils of relying upon any one method	10:41
	for forecasting, let me take a method	10:45
	which in the subset of methods that	10:49
	you might generally call monetarist has	10:53
	usually been considered to be one of the best methods.	10:56
	I'm referring to the Federal Reserve Bank of St. Louis.	10:59
	I'm looking at their most recent release	11:03
	on quarterly economic trends.	11:07
	This was released on March 9th, 1973,	11:08
	and they know the data up to the fourth quarter	11:14
	of the year, they have to estimate the data beyond.	11:19
	And they make estimates using their standard method	11:23
	for the quarter by quarter nominal increase	11:27
	in the GNP.	11:33
	Now how do they do that?	11:36
	Since their method, as you know, as any regular listener	11:38
	to these tapes will know,	11:42
	their method relies very heavily on changes	11:45
	in the money supply, the money supply narrowly defined, M1,	11:48
	demand deposits and currency outside the banks,	11:55
	certain obvious adjustment, seasonal and otherwise.	11:59
	In order for them to forecast first quarter increase	12:04
	in GNP in 1973, they can practically do it	12:08
	on the basis, using their method,	12:13
	of the previous quarter, because most	12:15
	of the determinants of that quarter,	12:18
	according to this particular long-lagged method	12:20
	of forecasting are already germinated	12:23
	in the womb of history.	12:26
	They're in the past.	12:28
	But they do need as a final bit of salt,	12:30
	so to speak, an estimate of the what the first quarter	12:34
	increase in the money supply was going to be.	12:39
	We now know what that was, seasonally adjusted,	12:44
	at least we know the first estimates of it.	12:47
	They didn't know.	12:49
	They are very loath to forecast what it will be.	12:51
	If I were a monetarist,	12:56
	my principal preoccupation would be	12:59
	in forecasting the future of the money supply.	13:01
	And if I were a monetarist and said I was unable	13:05
	to forecast the increase in the money supply,	13:09
	that this depended upon something	13:14
	so whimsical as the unpredictable decisions	13:16
	of the Open Market Committee of the Federal Reserve Board,	13:20
	or on something so unpredictable	13:23
	as what happens in the foreign exchanges,	13:26
	then I would not be very much interested	13:29
	in monetarism as a practical way of forecasting.	13:32
	Now I had a notion as to what was going	13:37
	to happen to the money supply.	13:40
	The Federal Reserve Bank of St. Louis didn't.	13:42
	It's just as well they didn't because	13:46
	their first quarter estimate is not very sensitive	13:47
	to what they would have selected.	13:50
	And what they've done, and this they've done all the time,	13:53
	is to say suppose it's one of the following three things.	13:55
	It's low, medium, high, low being defined	14:00
	as at a 3% annual rate, medium being defined	14:05
	as at a 6% annual rate, high being defined	14:10
	as a 9% annual rate.	14:15
	By the way, there isn't any question in my mind	14:18
	if I were a monetarist, which of these three numbers	14:20
	I would be aiming for in terms of policy.	14:23
	That is, which of the three numbers	14:27
	I would have been aiming for in terms of policy	14:29
	at the beginning of the quarter	14:32
	if I could set the money supply at one of them.	14:34
	I would have been aiming at the low number,	14:39
	at the 3%.	14:42
	Actually I don't have the very latest Federal Reserve	14:46
	Bank of St. Louis numbers on the money supply.	14:51
	These numbers wobble a great deal	14:53
	from even week to week, and particularly	14:56
	when we get around Easter, as we now are	14:58
	as I'm speaking.	15:02
	But the general consensus is that the money supply	15:03
	grew fast the whole first part of last year.	15:09
	That's seems to be a very common pattern,	15:14
	or was a common pattern.	15:17
	Then in the fall of the year it slowed down,	15:18
	I think justifiably.	15:22
	Then suddenly in November, and not intended	15:26
	by the Federal Reserve as far as	15:30
	its money aggregate target was concerned,	15:32
	the money supply went back again	15:35
	to a high rate of increase, nearer the 9%	15:38
	than the 3%.	15:42
	But since the December period,	15:46
	you've been much nearer the 3% than the 9%,	15:48
	so I think that you would do well	15:52
	to put in for, if you had to put in one	15:54
	of these three numbers, you would do well	15:57
	to put in 3%.	15:59
	Let's, however, go half way between the 3%	16:01
	and the 6% because we know that the Federal Reserve Bank	16:05
	of St. Louis model has been predicting rather badly	16:10
	for some time.	16:12
	It's been on the low side and let's doctor	16:13
	up the data a little bit in its favor.	16:18
	In its favor, of course, only to see how badly	16:21
	its prediction then was, but what does it show?	16:23
	What is the best that this monetarist model can show	16:29
	for a period as short as one quarter ahead prediction?	16:35
	It shows an increase of about 28 billion.	16:41
	That would actually be the lowest number	16:45
	that I've seen any practical forecaster forecast.	16:47
	I've seen nobody for example outside the monetarist camp	16:52
	who has predicted anything as low as that	16:56
	for the first quarter of the year.	16:58
	You may say, well, they were surprised	17:01
	by the increase in the price of food,	17:05
	and that would then affect their real rate of increase.	17:07
	Now let me just look at the real rate of increase	17:14
	for the quarter.	17:21
	There they've under-predicted by 1.5%.	17:23
	It's not as bad.	17:27
	No, I'm sorry.	17:29
	No, I'm sorry.	17:33
	I withdraw that remark.	17:34
	I just notice here that they've lost confidence	17:36
	in the ability of their other equations	17:41
	to predict price increases and real product increases.	17:45
	They say that because of the phase two interferences,	17:50
	and so forth, that they are no longer using	17:56
	their equations to make predictions,	18:00
	so we don't actually know how to break this down.	18:04
	But to a monetarist, that shouldn't matter,	18:07
	because the monetarists say it's the amount	18:09
	of money in at the top, and that determines the total	18:12
	of nominal spending.	18:15
	It's other considerations, which in the short run,	18:16
	determine the breakdown, and of course in the long run,	18:20
	since the level of real output, according	18:24
	to at least a subset of the monetarists,	18:26
	is always at about the same average percentage	18:29
	of full employment, and we know	18:33
	what the rate of increase of output	18:35
	at full employment is, somewhere around 4%,	18:38
	maybe a little bit more than 4% in real terms.	18:40
	Then the money supply equation should predict	18:44
	the price level for you.	18:49
	But in the short run it predicts for you,	18:50
	at best, the nominal GNP.	18:52
	Well, this is a very large, very large shortfall.	18:57
	Let's turn and see that the more elaborate GNP models	19:05
	also under-predict the increase in the GNP	19:13
	for the quarter.	19:20
	I look for example at the Eckstein,	19:23
	no, the is the Townsend Greenspan model.	19:30
	This is released also in March,	19:34
	but later in the month, and we can assume	19:40
	that they really had more data to go by at this stage,	19:43
	particularly since Alan Greenspan	19:47
	does monthly GNP forecasting.	19:49
	I must say, he didn't do too badly,	19:53
	because as I look at these numbers	19:56
	I see that he predicted about a almost 37 billion increase.	19:59
	Not badly, 37 as compared to 43.	20:08
	I say that's good, even though he is off	20:13
	by more than he is usually off	20:17
	in one quarter, but remember that	20:20
	this has been a very surprising quarter.	20:25
	Let's see whether we can tell how	20:28
	he did on his real product forecast.	20:32
	That will take a little percentage calculation.	20:38
	He has the increase there of the order	20:44
	of magnitude of 13 and 1/2 billion on something	20:48
	over 800 billion.	20:58
	If we apply our mental slide rules to that	21:00
	that will work out very close to 1.5% for the quarter	21:03
	or 6% for the year.	21:08
	Well you see, he also is in the ballpark	21:11
	but he's not far enough up there because	21:15
	he's only got 3/4 of the increase.	21:19
	I may say that the amount above his estimate is	21:22
	what I consider to be an ominous increase.	21:26
	Also please don't go by my mental slide rule arithmetic.	21:31
	I could easily be off in what I've been saying there.	21:37
	The situation, though, is even worse	21:45
	than I've described as far as the economy is concerned	21:47
	because, turn to final demand, that is	21:51
	to the increase in GNP divorced from inventory change.	21:55
	If there had been a temporary surge	22:01
	in inventory accumulation in this quarter,	22:04
	if that explained the strength in the quarter,	22:06
	then it would be more explicable.	22:09
	I don't say that it wouldn't be ominous	22:12
	because there would be certain implications	22:15
	for the near future in that,	22:17
	however, that wasn't at all the reason	22:22
	why the GNP went up so much.	22:25
	Actually, inventory accumulation was down.	22:28
	You say inventory accumulation was down	22:33
	in an economy which is as tight as this,	22:34
	which is as strong as this?	22:38
	Well, yes, of course the desire	22:39
	for inventory accumulation undoubtedly	22:41
	one must say was up.	22:45
	But the degree to which they succeeded	22:46
	in getting delivery, and this is ominous,	22:49
	was down, so that final demand,	22:53
	which is purified of inventory,	22:58
	that rose by almost all of the increase	23:02
	in the quarter, by $43 billion in the first quarter,	23:05
	and that compares with what was a very strong quarter	23:09
	in the fourth quarter of last year,	23:12
	with $28.5 billion.	23:15
	Well, as I think back now to what	23:20
	I've been telling all policy makers,	23:23
	what I've been telling the Federal Reserve	23:27
	for six months now, really for more than six months now.	23:29
	I've been telling them that he economy is overly strong,	23:32
	that we want to lean against the wind.	23:35
	We want to moderate the economy.	23:38
	Don't be afraid of letting short term costs	23:41
	of borrowing money go up.	23:46
	Don't be afraid of having credit accommodation	23:49
	from the friendly banker go down.	23:53
	Now is the time to lean against the wind	23:59
	in the interests of stretching out	24:03
	and having a healthy boom.	24:05
	That advice, as I look back in retrospect,	24:08
	was good advice, and I think that it was	24:10
	as contractionary as one had a right,	24:14
	on the basis of the evidence then available,	24:18
	to give, but of course with the virtue of 20/20 hindsight	24:21
	it would have been desirable of the Fed,	24:25
	in my judgment, to have been even tighter	24:28
	in this past period, and I see no evidence	24:31
	that the time for tightness, on the part of the Fed,	24:34
	has come to an end.	24:37
	My time is almost up, but let me relay	24:38
	on to you an interesting viewpoint.	24:43
	Two days ago at the Boston Economics Club,	24:46
	at the ancient and staid Union Club in Boston,	24:48
	I had the advantage of listening to	24:56
	at lunch one of the more penetrating analysts	25:00
	and observers of the passing scene.	25:05
	I don't go to all the luncheon meetings,	25:09
	but when Albert Wolgenaur of the First Boston Corporation	25:12
	comes to town, I do go.	25:17
	And what I heard there was extremely interesting.	25:19
	I am not able to make up my mind,	25:23
	since I'm just back from Australia,	25:27
	the degree to which I would agree	25:29
	with his analysis, the degree to which	25:31
	I would have to differ, but I think it's always interesting	25:34
	to listen to somebody who has a pretty good track record	25:39
	and who also spends his every day keeping very close	25:41
	to the pulse of the money market	25:45
	and of the economy generally.	25:47
	In a nutshell, what he's been saying is	25:50
	that the economy is overly strong,	25:52
	that the increases in short term interest rates	25:55
	on ordinary prime rate borrowers,	25:58
	on commercial paper, that will not choke	26:03
	off the strength in the economy,	26:06
	the strength in autos and in housing,	26:09
	that what you have to do,	26:11
	and this despite the fact that he would describe himself	26:12
	as spiritually more of a Chicago-type economist	26:16
	than let's say a Harvard-type economist.	26:21
	He believe that what you have to do is	26:24
	to use special credit controls.	26:27
	He would for example welcome a frozen prime rate,	26:30
	not just for the little fellow,	26:35
	but for everybody, because he wants	26:36
	to have money become unavailable at that prime rate.	26:39
	Since I must warn you that he thinks policy should go	26:43
	in this direction, you must perhaps discount the fact	26:46
	that he think that policy is going	26:50
	to go into the following direction	26:52
	that I'm going to describe, namely	26:53
	that there's going to be elements of a money crunch,	26:55
	a credit crunch, in the middle of the year.	26:59
	If it doesn't come after May 15th	27:02
	in his view it'll come by Labor Day.	27:04
	And for a brief period of time it will be very rough	27:06
	on the money market.	27:09
	It will be very rough maybe for a brief period of time	27:11
	on the bond market.	27:15
	It will break the back of the housing boom,	27:19
	of the automobile boom, and it will pave the way	27:22
	so that by the fourth quarter of this year the real growth	27:26
	of the GNP will be down from the 8%	27:31
	that we've just been talking about to 2.5%,	27:34
	and if you take final growth in GNP,	27:38
	because at that time he thinks	27:41
	people will be getting the inventory	27:43
	which they now want and which they then will	27:45
	not be so eager to have, that could even be worse.	27:46
	Now, my only reaction that I will give is	27:52
	it's interesting, and it seems to me	27:55
	that the time scenario is too crowded.	27:58
	I can't see it happening that fast,	28:01
	even though it may eventually happen	28:04
	in a way that he described.	28:07
	My last thought, I tried to ask him the kind	28:10
	of question that people ask me when I give talks	28:14
	before financial groups.	28:17
	I may say I never give the answer.	28:18
	I never give the answer because I'm	28:20
	too old a hand to give the answer.	28:21
	And the other reason I don't give the answer is because	28:23
	I don't now the answer.	28:25
	I tried to get him to say what he thought the implications	28:26
	of that were for the stock market.	28:29
	And this he was reluctant to do.	28:31
	That he did not do, but when I tried	28:37
	on him the hypothesis that that degree	28:39
	of tightness in the interest rate market,	28:42
	that degree of unsettlement in the money market generally,	28:44
	that degree of anticipatable slow down	28:48
	in the economy might be rough on the stock market	28:54
	so that one might well, in taking some new position,	28:57
	say I'd rather wait until the Labor Day period	29:02
	before I do it, he did not supply	29:05
	cogent argument against that.	29:09
	I think that if the Wolgenaur scenario works itself out,	29:13
	we're gonna have some very interesting things	29:17
	to talk about in the months to come.	29:19
-	If you have any comments or questions	29:22
	for Professor Samuelson, address them	29:24
	to Instructional Dynamics, Incorporated,	29:26
	166 East Superior Street, Chicago, Illinois, 60611.	29:28

Item Info

Title:

Tape 126 - Overheating of the economy and that money crunch

Date:

1973

Contributor:

Samuelson, Paul A. (Paul Anthony), 1915-2009

Subject:

Format:

audiocassettes

Language:

English

Digital Collection:

Paul A. Samuelson papers, 1933-2010 and undated

Source Collection:

Paul A. Samuelson papers, 1933-2010

Series:

Economics Cassette Series: Paul Samuelson

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Limited Re-Use

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Identifier:

RL10082-CS-0123
ref2385_95r
samuelsonpaul
duke:325146
pstau001123
ark:/87924/r44m91s8h
830c5a53-cd84-412f-9603-6296f3dc5243

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Tape 126 - Overheating of the economy and that money crunch

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Economists' Papers Archive

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