Review

Economists and other analysts seek to measure expectations of future interest rates because such expectations have important effects on economic behavior. Changes in expectations can lead to changes in economic activity, both at the level of the individual firm or consumer, and at the level of the national economy. For example, interest rate expectations enter into investment decisions of firms, portfolio decisions of financial intermediaries and other investors, and borrowing decisions of state and local governments. If these groups alter their expectations of the future level of interest rates, changes in investment, portfolio, and borrowing decisions will occur which affect not only each group individually, but which also affect the level of economic activity in the economy as a whole.

The dramatic change in supply conditions for energy resources since 1973 had a substantial effect on the productive capabilities of the U.S. economy. Higher prices of energy resources, relative to the prices of labor and capital resources, resulted in a loss of economic capacity and higher output prices. It has been estimated that four to five percentage points of both the higher price level and reduction in national output in 1974 were due to the increased scarcity of energy resources entailed by the quadrupling of OPEC petroleum prices.

This volume contains the papers presented at a conference on “Financing Economic Growth: The Problem of Capital Formation,” held at the Center for the Study of American Business, Washington University on November 30, 1976. Cosponsored by the Center and the Federal Reserve Bank of St. Louis, the conference considered the problems of generating sufficient flows of saving and investment to finance economic growth and development in the future. Included here are the luncheon address by Lawrence Roos of the Federal Reserve Bank of St. Louis and the major papers presented by Robert Eisner of Northwestern University, Allen Sinai of Data Resources, Inc. and Massachusetts Institute of Technology, and Jai-Hoon Yang of the Federal Reserve Bank of St. Louis.

It is a real pleasure to be here as a co-sponsor, along with Murray Weidenbaum and the Center for the Study of American Business, of this important meeting on capital formation. I must admit to a certain feeling of apprehension in attempting to deal with a subject of this complexity in the company of so many distinguished members of the academic community. As president of a Federal Reserve Bank, I think it appropriate that I direct my remarks to the role of the Federal Reserve System in the process of capital accumulation. Although the Fed is usually viewed as playing a relatively minimal part in that process, some of our actions in monetary policymaking do have significant long-term effects on capital accumulation.

There is nothing that cripples business investment like a recession. From the beginning of 1974 to the third quarter of 1975, while unemployment rose from 5.2 percent to between 8.5 and 9 percent, real nonresidential business fixed investments fell 17.5 percent. While gross national product in constant dollars declined 6.6 percent from the fourth quarter of 1973 to the first quarter of 1975, the total of fixed investment, including residential as well as nonresidential structures, dropped 23.6 percent from the first quarter of 1973 to the second quarter of 1975.

Three years ago the physical capacity, supply of labor, and financial resources of the U.S. economy were insufficient to satisfy demands. Symptoms of these capital shortages included sharply rising prices, peaks in factory operating rates, increased unfilled orders, long delivery delays, higher wages, low unemployment rates, rapidly accelerating interest rates, widening yield differentials between risky and “safe” financial assets, surging loan demands, decumulation of financial assets, and credit rationing. Indeed, the unprecedented inflation of prices, wages and interest rates was the principal cause of the deep recession that followed.

The year 1776 gave birth not only to a great nation but also to a great book which shaped our science. In his Wealth of Nations, Adam Smith made growth in income the central explanandum of his inquiry and identified capital formation as the prime mover of growth in income. It is most fitting, therefore, that the subject matter of this conference in this bicentennial year of the Wealth of Nations is capital formation.