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years should bring about an early reversal of the downward trend, as they did in 1949, without any additional action by Government.
If trouble develops in the economy by 1955, it will be due to conditions, international or political, which are outside the ordinary processes of the domestic economy, which cannot be foreseen now, and which will not be cured by the kind of supporting policies discussed in chapter IV. (End of separate note by Mr. Clark.)
Chapter IV. Needed Policies for Sustained
THE GENERAL NATURE OF THE ADJUSTMENT PROBLEM
"HE foregoing needs and prospects analysis raises the possibility that,
outlook, the predominant economic risks to be counteracted may be defiationary rather than inflationary. And while the preceding analysis offers some clues regarding offsets, further interpretation is desirable before coming to policy issues. The size of the problem
While the problem ahead has been identified, the discussion thus far has not measured its size. For there is inherent in the economy one set of forces which would tend to aggravate a deflationary problem if it first emerged in one sector. And mostly in consequence of relatively recent changes in our institutional structure, there is another set of forces which would tend to cushion the effects.
Cumulative aggravating forces. The first working assumption, upon which the foregoing analysis of component-by-component prospects has been based, is that incomes will be generally high, markets healthy, and business conditions prosperous in the 3-year period ahead. The prospects for private investment and consumption which have been identified rest heavily on this assumption. But the total prospect into which this piece-bypiece analysis adds up may challenge somewhat the underlying assumption itself. For while this first approximation of the adequacy of demand does not seem to indicate a large deficiency, it does indicate some slackness in markets, some shortfall from full employment incomes, and an increase in unemployment to an unacceptably high level. Both reason and experience tell us that this kind of situation, if left alone, could degenerate into a far more serious deflationary spiral. Although reflecting investor and consumer assumptions of high prosperity, when the components of demand fail to add up to a total which justifies such attitudes, businessmen and consumers speedily bring their assumptions into line with reality. And if this causes a contraction of investment and consumption still further below needed levels, total demand is further weakened, and a down-spiral may be on its way.
This danger could be greatly accentuated by a bunching of whatever declines are in prospect. If moderate declines in national security spending, plant and equipment expenditures, housing, and other items, should be spaced out over a considerable period, the effect might not be serious. If such declines should be more or less simultaneous, the result would be more than additive. One area of weakness would aggravate another.
Reductions in investment tend to bring reductions in employment, incomes, and consumption. Then shrinking profits can compound into greater losses of income by inducing both investment declines and wage cuts. Certain kinds of price reductions can be healthy, but prices which go into an out-of-control tailspin frighten buyers away rather than bring them to market, and accelerate the collapse. And finally, all of these mechanisms, and others, can be speeded along their destructive paths by contractions of credit or the collapse of financial institutions.
Sustaining institutional dampeners and shock-absorbers. The fact that a variety of forces in the American economy can magnify the impact of what might otherwise be a moderate or even minor discrepancy in total demand does not have to be belabored. Certainly it would be foolhardy to conclude that a cumulative economic decline in the United States is no longer possible. The risk, however, is much less than it was a generation ago, and the tools to deal with it are vastly superior.
Since World War II, the United States economy has shown a remarkable capacity for unleashing the new demand forces needed to sustain a growing total demand when previous front-runners have fallen back. Much of this buoyancy—though not so much as sometime ascribed—undoubtedly has been the work of demands accumulated during the war, and of exceptional expenditures associated with the international stresses of the postwar period. Nonetheless, this record of recent resiliency does justify our facing the period ahead with more confidence than would have been possible in the twenties or thirties. Specifically, it directs attention to a number of recent institutional changes which, taken as a whole, provide arrestors to the kind of cumulative shrinking of demand just indicated.
As the Council has discussed in earlier Reviews, a number of "built-in stabilizers,” such as unemployment compensation, farm price supports, and a progressive tax system have become commonplaces of public policy. The expanded fiscal role of the Federal Government increases the amount of spendable income which the progressive tax system releases to the private economy when before-tax incomes fall. And if Federal expenditures can be counted as a relatively firm element of demand, their higher level makes their stabilizing influence far greater than it was prewar. Other significant braking mechanisms have developed in the private economy. The 1949 recession suggested a willingness on the part of consumers, in the face of moderate declines in income, to resist declines in living standards by cutting their saving rate rather sharply. Also during the 1949 setback, the increased strength of organized labor, coupled with more far-sighted business policies, made for a minimum resort to wage and payroll cutting-two of the swiftest engines of deflation in the past. In addition, the pronounced business trend during the postwar period toward longer-run capital planning and budget
ing based on long-run market projections probably has made private investment somewhat less sensitive to short-run market fluctuations.
The resistance of our monetary and credit institutions to deflationary collapse is far greater than it was only a couple of decades ago. Our securities markets are less susceptible to influence by purely speculative factors, and the banking system is greatly strengthened against failures and rapid monetary contraction. While the monetary system often initiated or aggravated recessions in the past, in the future it can be expected to be at least neutral and perhaps positively stabilizing.
More profound than any of these specialized changes, and in part the consequence of all of them, there has taken place during this generation a broader distribution of national income among families and among functional economic groups.
There is still room for debate among economists as to whether this trend has not proceeded far enough, or whether it has proceeded too far in terms of incentives to reward ability and to stimulate risk-taking. But there would be rather general agreement that the current and prospective distribution of income, under our free institutions, is more conducive to a fairly steady rate of economic growth than the conditions of income distribution which prevailed two or three decades ago. The concurrence on this point may be almost as important as the changes in the income structure which have taken place; in fact one of the happiest omens for the future is the increasing realization of the relationship between mass consumption and mass production on the part of those who make the basic decisions within the private economy.
Cumulators versus arresting forces: the net effect. While the institutional changes just indicated have reduced the economy's susceptibility to deflation, it would be easy to rely on them too heavily. Although their existence probably has contributed to the climate of business and consumer confidence which has stimulated the emergence of new elements of demand during the postwar period, they are not essentially recession-preventing or recession-reversing forces. Their direct effect is only to slow or check a decline once it starts. Also, this new institutional apparatus does not yet constitute a rugged enough set of brakes to set any sure limit on a major downturn. It is only certain to retard a decline. If the basic deficiency of demand were large and nothing remedial were done, or if the traditional accelerators should begin to feed on a growing and then rampant deflationary psychology, eventually the stabilizers would prove to be feeble in proportion to the need, the brakes would wear thin, and "bottom" might turn out to be almost as far down as it used to be.
Thus, our new institutional safeguards are no substitute for positive anti-deflation policy. But beside mitigating hardships while their effectiveness lasts, they do—and this is supremely important to successful policymaking-give us time. One of the tragedies of many past business downturns has been the suddenness and sharpness with which recession has struck. The plunge often was well under way and gathering speed before
counter-measures could be devised and made effective. In this respect the economy is now better off. If the problem ahead should be that hypothesized above, our institutional apparatus should provide a reasonably adequate interval for diagnosis and decision. And the effectiveness and timeliness of private and public policy-making may largely determine whether the cumulators succeed in magnifying, or the arrestors in minimizing, any developing weakness in total demand. The primacy of private adjustments
The problem under study has been identified simply as a possible shortage of total spending emerging within the next 2 or 3 years. An analysis of workable offsetting adjustments, however, must be more specific than this. It scarcely can be content with the principle that any additional demand will do. It is necessary to survey a variety of relatively specific policy courses, and to decide on grounds of desirability and feasibility what relative emphasis they should be assigned. In doing this, it will be helpful first to formulate certain broad priorities for guiding policy choices. Two such matters of general priority will be suggested, one having to do with the choice between public and private measures, and the other concerning our comparative needs for investment raising and consumption raising.
A dollar spent by private hands is not, by definition and regardless of circumstance, a more virtuous dollar than one spent out of the public treasury. However, the country has a general preference for private economic adjustments rather than public policies which expand the economic role of government. The Council shares this preference, on general grounds of dynamism, flexibility and free-wheeling. This preference is likely to be especially pronounced in the period after a large defense acceleration, during which it has been necessary to operate more elaborate and direct economic controls than Americans like and when, under the relentless pressure of national security needs, the Federal budget has run at unprecedentedly high levels for peacetime or even semi-peacetime conditions. If, on top of this, an incipient deflationary problem brought immediate and substantial resort to additional Federal spending programs, the difficulties of readjusting at any early date to a level of Federal activity more in line with the country's desires would be correspondingly magnified. Finally, if we adhere to the present national security program, and if present tax laws are followed, the outlook already is for deficits in the next 2 or 3 fiscal years which, although reasonably moderate in comparison with the size and strength of the economy, are nevertheless a source of legitimate concern.
The present analysis therefore recognizes, for a problem of the scope projected, a general preference for solutions which rely mainly on private rather than public policy. It also recognizes, however, the risk of relying solely on such actions and the necessity of taking stock of what supporting public policies will be available.