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Mr. Chairman, my testimony today will cover three interrelated topics that are treated in greater detail in the CBO report The Economic Outlook for 1979-1980: An Update distributed to you earlier this morning. First, I will review recent developments in the economy; second, 1 will provide an update of the CBO forecast of last January; and third, I will discuss briefly possible changes in fiscal policy.

The details of the CBO forecast have altered because of recent economic developments, but its basic message has not changed since I testified before this Committee six months ago. We still expect a mild recession to occur this year, followed by a recovery in 1980. At the same time, we expect inflation to recede from its current double-digit pace, although remaining high by historical standards.

Current Developments

The most far-reaching development occurring since January has been the rapid acceleration of inflation. The rate of increase of prices has been on a steep upward trend in the past few years. In 1977, consumer prices rose by 6.8 percent; in 1978, by 9 percent. During the first five months of this year, inflation has been running above a 13 percent annual rate.

Inflation has accelerated so far this year for several reasons:

• Energy prices have surged since the end of 1978, reflecting the sharp rise in OPEC oil prices and contributing about 2-1/2 percentage points to the inflation rate.
  
  
• Food prices have risen significantly, in large part resulting from the shortage of beef and contributing 1/2 percentage point to the acceleration of inflation.
  
  
• Home mortgage interest costs have jumped in the first five months of the year, adding roughly 1 percentage point to the inflation rate.

The effects of the acceleration of inflation have been pervasive. Rapid price increases have eroded household purchasing power and undermined consumer confidence. In addition, high inflation has discouraged an easing of monetary policy despite a weaker economy and relatively slow money growth. These factors have played--and will continue to play--important roles in the slowing of economic activity. Constant-dollar GNP rose only slightly in the first quarter and possibly declined in the April-to-June quarter.

The weakness in economic growth during the first half of 1979 was earlier than expected and was largely traceable to reduced spending by the household sector--both for personal consumption and for home purchases. Retail sales, adjusted for inflation, dropped at an 11 percent annual rate between December and May, and apparently continued their slide in June. The domestic automobile industry has been especially hard hit. Unit auto sales in June were down at a 40 percent annual rate from six months ago, as energy uncertainty helped depress purchases of larger models. Because of this weakened demand, auto inventories have reached record high levels.

Home purchases are also off from the end of last year. On the basis of partial data, sales of new single-family houses in the second quarter appear to be below the fourth quarter of 1978 by roughly 20 percent, at an annual rate.

Household spending is weak for several reasons:

• The drop in real personal income that has occurred since the end of last year because wage and employment growth have been insufficient to offset the acceleration of inflation;
  
  
• The high debt of households, which as a percent of disposable income reached a record high level last winter;
  
  
• High interest rates, which dampened housing activity; and
  
  
• The slump in consumer confidence, which appears rooted in the acceleration of inflation and--more recently--in uncertainty about energy supplies.

In contrast to the household sector, business spending has continued fairly robust this year, although there has been some weakening in new contracts and orders recently. Business inventories have been rising, but, with the exception of autos, the ratio of inventories to sales still remains low by historical standards. This apparent lack of speculative inventory building has led most analysts to conclude that any recession occurring in 1979 would be mild compared with the 1974-1975 downturn.

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