ances which results is a purely internal Government bookkeeping entry which does not reduce or drain off private purchasing power. Lending. A further and vital difference between the NIA budget, on the one hand, and the consolidated cash and administrative budgets, on the other, involves the treatment of lending, loan repayment, and sales of financial assets. Such financial transactions are excluded from the NIA budget because they do not change the net worth or incomes of private parties, but only their liquidity. The reasoning follows the same line applied above to tax accruals and profits on coinage. Just as businesses do not regard themselves as becoming poorer at the time they actually pay taxes they already owe, neither do they consider repaying a Government loan as a current expense. Nor conversely, do their incomes rise when they obtain loans from the Federal Government. Yet, in the administrative budget a new Federal loan increases the deficit as much as an outlay that directly raises private income, and sale or repayment of the loan diminishes it just as much as a tax payment. To be sure, many Federal loan transactions have important effects on private spending. But they work in a less direct way than the incomegenerating transactions. They channel funds at low costs to various activities deemed to be of particular social or economic importance, such as exports, college, housing, and farm production. Given the level of tax revenues, when the Government lends more, it must also borrow more. The net impact of a Federal loan financed by Government borrowing is that Government liabilities-Treasury and agency issues are substituted for private debts. Such substitution is likely to improve the terms and lower the interest rates available to some borrowers. But other borrowers may be displaced, depending on credit conditions and monetary policy. Federal lending is best regarded as an aspect of monetary, credit, and debt management policy—not of fiscal policy. When it lends borrowed funds, the Government is acting as a financial institution, much like private financial institutions. Borrowers from private financial institutions also increase their liquidity. They acquire cash by incurring debts. They are, indeed, better off for the opportunities to borrow, and they may spend more as a result; but they do not regard the borrowing as an addition to their incomes. In the past year, the Federal Government was a net lender, partly because of the scarcity of funds in private financial markets. The difference between the two budgets on this account amounted to $6.6 billion. Chapter 2 Prices and Wages in 1966 Expanding production and fuller employment brought gratifying ad vances in the incomes of most Americans in 1966. But satisfaction with higher incomes was marred by concern over the first significant rise in prices in 7 years. The shift away from price stability actually began early in 1965, when sagging farm prices suddenly reversed direction, followed shortly by a climb in food prices, first at wholesale and then at retail. During the course of the year, prices of many other items turned upward. But it was only in 1966 that price movements were sufficiently disturbing to arouse public concern. The public sensed what every economist knows—that a reasonably stable price level is essential if balanced prosperity and full employment are to be continued at home and if the strength of the dollar is to be maintained abroad. Experience proves that rising prices can generate distortions that can eventually topple an economy from boom to recession. Experience also shows that rapidly rising prices can quickly erode a country's competitive position in international markets. The critical economic problem to be solved in the year ahead is that of maintaining income growth and full utilization of resources without becoming trapped in an inflationary pricewage spiral. The recent advance in prices was due in large measure to the acceleration in the growth of demand which began in mid-1965 and to the particularly rapid increase in output of capital goods and defense products. The step-up in the rate of price increase cannot be explained by any simple formula. It was a by-product of the complex process by which additional resources are drawn into production and adapted to the changing composition of demand. That process is now largely completed, leaving the economy with a much higher rate of utilization of resources. But in the process of adjustment, forces were set in motion which will continue to push up prices for a time even though the pressure on resources has now relaxed. Demand had, of course, been rising steadily since 1961. But that rise began when there were abundant supplies of idle labor and unused equipment. In addition, productive capacity was being steadily increased through the installation of new plant and equipment; accretions to the labor force; and the steady rise of productivity as a result of better management, an increasingly educated and skilled work force, new industrial processes, and increased capital per worker. Thus, throughout the early 1960's production could expand freely to match growing demand. Moreover, the pattern of expansion of industrial capacity was well balanced with the pattern of rising demand, so that few specific points of pressure on the price structure developed. By mid-1965, prices of farm products and of some industrial raw materials were already rising, partly because of growing demand, but also for such unrelated reasons on the supply side as the stage of the hog production cycle or impediments to minerals production abroad. Moreover, by that time, margins of idle labor and underutilized plant and equipment were shrinking. Under these circumstances, the rapid spurt in demand and production that began in mid-1965 could not fail to affect prices. The sharp rise in demand for defense products and capital goods imposed special pressures on the metals and machinery industries. In some branches of these industries, the limits of efficient utilization were surpassed, and, in a few, output was close to absolute limitations on capacity. Even where productive resources were not fully used, it was often difficult to adjust production rapidly enough to keep pace with soaring demands. Time is needed, even when there are no special problems affecting supply, to increase the output of farm products and of industrial raw materials, especially metals. It takes time to hire workers, activate additional machines, or increase the rate at which purchased supplies are delivered. In the second half of 1965 and in early 1966, the expansion of demand for many products and services was pushing against these speed limits on the expansion of output. Moreover, the growth of demand was less balanced than previously, so that pressure points multiplied. For some products and services, production could keep up with demand only at somewhat higher costs-using standby, semi-obsolete equipment, paying overtime rates, mining lower grade ores, and so on. There were also imbalances in labor markets which created increasing difficulties as unemployment declined. Workers in low-paid occupations could not be retained without substantial upward adjustments of wage scales. Moreover, reduced unemployment strengthened the bargaining position of unions and weakened that of employers. Wages generally began to rise faster at a time when productivity gains were slowing down. Prices of services of all kinds continued to rise, and at an accelerated rate, as wages in many service occupations were increased substantially. The broad upswing in prices must therefore be explained in terms of a complex interaction between a general increase in the pressure on productive resources and special factors impinging on a limited range of product and labor markets. Had the increase in demand been slower and more evenly balanced, the rise in the price level would certainly have been less, although some increase would still have occurred. Farm products and raw materials would surely have risen in any event, given the supply problems at home and abroad. Wage adjustments for low-paid occupations would still have been necessary, though they could have been more gradual. Although the pressures that developed in early 1966 have now abated somewhat, they have left their mark on the structure of costs and prices. Prices of most farm products and of many industrial raw materials move more or less freely in both directions. The same is true, though to a lesser degree, of many products at early stages of fabrication. But it is unlikely that past price increases in most other parts of the economy will be reversed so long as the economy remains strong. Moreover, price advances for such items as metals and industrial equipment tend to fan out and become built into the structure of industrial costs. And even temporary increases in farm and food prices, through their impact on consumer prices, materially affect the pattern of wage negotiations. The resulting higher wage settlements also tend to be permanently built into the cost structure. Consequently, the return to price stability can only be gradual. However, as 1966 drew to a close, there were signs of progress. Prices of farm products and some raw materials had leveled off. Thanks to the enormous strength and adaptability of the economy and the skill and ingenuity of workers and managements, many of the industrial pressure points had been alleviated. With the slower pace of growth in the second half of 1966, much of the necessary adaptation was accomplished. More of it will be accomplished in 1967. THE RECENT PRICE RECORD The year 1965 marked the end of a long period of price stability (Charts 6 and 7). After having remained virtually constant since 1958, the wholesale price index rose by 3.4 percent during 1965 (i.e., December 1964 to December 1965) and 1.7 percent during 1966. Consumer prices increased by 2.0 percent during 1965 and by 3.3 percent during 1966. Between December 1964 and September 1966, the wholesale price index was dominated by a rise of 142 percent in the average price of farm products, foods, and feeds (Table 6). This group of products accounted for over 60 percent of the total increase in the index over this period. In the fourth quarter of 1966, wholesale prices of farm products and foods dropped sharply and by the end of the year were only 1 percent higher than at the end of 1965. Prices of the other commodities included in the wholesale price index increased by 1.8 percent during 1966 (Table 7). Because of the strong demand for investment goods, the largest price increases came in the machinery producing sector, though prices of metals and metal products also rose appreciably. |