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For Release on Delivery
{Approximately 4:00 p.tru
Thursday, July 14, 1966)
The Role of a Central Banker
Remarks by J* Dewey Daane
Member, Board of Governors of the Federal Reserve System
Before the Third International Investment Symposium
Harvard Business School
Boston, Massachusetts
on Thursday, July 14, 1966
The Role of í3 Central Banker
When I first discussed T.:ith Dr. Shairo my appearance at
this Symposium, he suggested that I soeak to you on the subject
"The Role of a Central Banker of a Key Currency Country".
The
title on the program, or at least my advance co^y of it, not: is
shorter; it says nothing about any key currency.
Perhans this is
sirmly a Freudian slip since after all the problems confronting the
central banker of any country are basically much the same.
Thus the
abbreviation of the title of my talk may simply be an invitation for
me to speak more broadly on some of the ■'iroblems confronting a central
banker than I might have done with the longer title.
At the same time,
I cannot avoid the viewpoint of the central banker of a key currency
country because the dollar of course is just that:
it serves as the
principal means of oayment throughout the world and as a major source
of international reserves in many countries.
As I look back over the more than 25 years that I have been
associated with our central banking system in the United States, I am
impressed by the old French nroverb that "Plus ca change, plus e'est
la memo chose".
Having said that, I would hasten to add that the
role of a central banker first and foremost is, and of necessity
has to be, one of adapting to iieet problems that are constantly
changing in a dynamic and changing society.
At all times a central
banker must be billing to changc his ovn concents with respect to
his role, to try to devise and design new instruments and techniques
to meet the challenges of a changing vorld.
On that score, as you
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may know, the System is now engaged in special studies of the workings
of its various instruments of monetary and regulatory policy.
One
such study involves a comprehensive re-evaluation of the lending
function of the Federal Reserve Banks; another a joint study with
the U. S. Treasury of the market for IL S. government securities--the
market in which System open market operations and Treasury financings
must take place.
The Concerns of a Central Banker
Frequently, the central banker of any country is accused
of being preoccupied with inflation to the point of being insufficiently
concerned with growth.
Just a week before I joined the Federal Reserve
Board in the fall of 1963, Professor Samuelson addressed a public
letter to nMy Son, the Central Banker11.
The concluding paragraphs
of his letter of advice read as follows:
’ ’S t o p
o f
l a s t
T h e
u n i v e r s e
o f
p o w e r s :
t o
u s e
r e a l
t o
b e i n g
u s e
o f
w a s
T h e
i t s
i t s
t h e
t h e
n o t
i n t o
c r e a t e d
p o l i c i e s
F e d e r a l
m o n e t a r y
t h e
s t a b i l i t y
G o v e r n m e n t
f i s c a l
o u t p u t ;
p r i c e
j o c k e y e d
d e f e n d e r
w i t h
b e i n g
t o
t o
a
t h e
u n d e r
e n s u r e
i n d e x .
d i v i s i o n
o b l i g a t i o n
h i g h
b e i n g
p o s i t i o n
p r i c e
b a s i c
p r o d u c e
R e s e r v e
p o l i c y
u n d e r d o g
o f
a n d
u n d e r
g r o w i n g
o b l i g a t i o n
s t a b i l i t y
o f
t h e
l e v e l .
“Such logic leads--indeed it did lead, even in
the days before gold was a problem--to credit policies
that are too tight and fiscal policies that have
thereby to be so much the looser. The result, even
at full employment, x^ill be a bias against capital
formation and a bias toward present consumption.
“ T h e
d i d n f t
F o u n d e r s
k n o w
w h a t
o f
t h e y
t h e
w e r e
F e d e r a l
d o i n g .
R e s e r v e
B u t
r e a l l y
s u r e l y
n o n e
- 3 of them thought they were designing an engine that
would be a bulwark against grox/th.
"Son, do something about it.M
In fact, we in the Federal Reserve System have done a great
deal about it*
Along with fiscal policy, monetary policy has con
tributed to the longest peace-time expansion that this country has
known.
Thus, our presumed preoccupation with inflation simply does
not exist.
In those times when we have been concerned over inflation--
and I am thinking of a time when inflation has appeared a real threat
to Professor Samuelson along with ourselves and others--that concern
reflects our belief that fundamentally inflation interrupts grox^th.
And, as a central banker of a key currency country whose liabilities
constitute international money, I am quite willing to state my belief
that inflation in the United States can only serve to interfere xtfith
groxith throughout the world.
From this standpoint, I make no apology for abhoring inflation
in the United States.
Not long ago my friend Henry Wallich said that
he and some others x^ere sitting around one evening rating Reserve Board
Governors on their respective allergies to inflation on a scale of one
to ten.
While I apparently did not score quite as high as Chairman Martin,
my oxrm rated allergy was reasonably high on their scale.
I cheerfully
admit this because I believe that inflation has at least two adverse
results*
One, and most importantly, it undermines steady economic groxith.
Tx;o, it brings about an imbalance in international payments which is
particularly unfortunate for a country whose liabilities serve as the means
of payment and reserves for others, and this, in turn, has adverse reper
cussions on the functioning of the international monetary system.
Examples of how inflation can undermine steady economic
growth are studded all over the landscape of recent economic history,
in every part of the globe.
One of the most striking examples can
be found here in the United States, in the record of the period
from 1954 through 1964.
This example is a particularly impressive
one, I think, because it illustrates not only the proposition as I
have stated it, but also it's converse, which is this:
in the absence
of inflation, economic growth can be uninterrupted and great strides
can be made in raising a country's income and wealth.
The period from 1954 to 1960 in the United States and the
period from 1961 to 1964 show some very striking contrasts despite
the fact that both periods began with recession and high rates of
unemployment.
In the first span of six years--1955-60--there were
two years of extremely rapid rise in U. S. industrial production, more
rapid than in any single year of the later period.
Yet the net advance
in industrial production from the start of the upswing in the summer
of 1954 to the end of the 1960 recession was only 21 per cent, an
average of less than 4 per cent a year.
This left a legacy of under
utilized capacity and manpower which had to be absorbed in the
national interest.
In contrast, from February 1961 to December 1964 the rate
of industrial output increased 33 per cent, an average of 8-1/2 per
- 5 cent a year, and it was still rising at the end of 1964.
The vital
difference between the two parts of this decade was that two recessions
took place within the first six years, but no such setback occurred
during the next four years.
(I might have said during the next five
or six years, but I want to draw a rather sharp distinction between
the years just before and after 1964--for reasons that will become
clear in a moment.)
Everyone knows that booms and recessions are very complicated
phenomena.
I do not want to over-simplify.
But I do believe that
our failure to achieve steady economic growth in 1955-to-1960 was in
no small measure a consequence of the inflationary environment and
atmosphere that prevailed in most of that period, despite the efforts
of fiscal and monetary policy to lean against the inflationary wind.
The wholesale price index for industrial products rose 12 per cent,
and the consumer price index 11 per cent*
Conversely, the general
stability of prices and the absence of inflationary expectations
from 1961 on into 1964 go a long way toward explaining the remarkable
growth achievement of that period.
Elimination of the inflationary
atmosphere and expectations was crucial to subsequent uninterrupted
growth, growth \7hich was clearly facilitated by fiscal and monetary
policies*
The consumer price index did rise 5 per cent, largely
because of the increasing cost of services, but the industrial whole
sale price average was only a shade higher at the end of 1964 than
it had been in February 1961.
In the non-inflationary atmosphere of those years be
ginning in 1961, economic expansion was remarkably well balanced--in
great contrast to what happened in the mid-150*s.
From 1961 on into
1964, the rates of growth of output and sales of consumer durables,
of residential construction, and of business outlays for plant and
equipment were at no time really out of line with the general rate
of growth of GNP*
Partly for that reason, none of these key branches
of economic activity suffered any severe setbacks.
was cautious and moderate.
Inventory investment
Productivity gains were substantial in
industry, and these large gains in productivity continued long beyond
the initial recovery period.
Competition was active--within industries,
betx/een industries, and against imports.
The stock market advanced,
with some interruption, but its net gains over the period as a whole
were based pretty solidly on rising corporate profits.
Unemployment,
while still too high to be tolerable, by the end of 1964 had shrunk
to the 5 per cent level.
The speculative fevers of an inflationary
environment were largely missing during this period.
And so we had
favorably stimulative fiscal and monetary policies and steady growth,
with no recession.
One cannot speak so confidently about the economic conditions
that have developed in the United States since the end of 1964.
Early
signs have appeared of an incipient spiral of inflationary anticipations,
inflationary demands and inflationary cost pressures.
Inventory
investment is no longer quite so cautious and moderate.
Ordering
and spending for industrial plant and equipment have been mounting,
at a rate of acceleration that obviously is not sustainable.
Demand -
pull has been affecting prices, and there is cause to be concerned
that cost-push may become increasingly active.
In short, the private economy and the public economy, taken
together, have been trying to do too much too quickly, and the strain
is showing up in a gradual rise of prices--though up to now this
rise is still not at so rapid a pace as the price rises in most other
industrial countries.
If we are to get the various segments of the
economy back onto a track of balanced growth at sustainable rates we
must halt the incipient inflation of prices.
On a second front--the international as well as the domestic-the central banker, particularly in a key currency country, has cause
for abhorring the emergence of inflationary conditions.
He abhors the
way inflation affects the external balance of payments.
There are of course many reasons why the U. S. balance of
payments deficit soared, beginning in 1S58, and why we have had
difficulties since then in our efforts to redress the imbalance.
But
among the many reasons, surely one major one is the price inflation
that we suffered in the mid-1950's, which worsened our international
competitive postion both in the export and import fields.
The
possibility of something like that recurring and worsening our competitive
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position still further is a major reason for our present concern
about inflationary pressures in the United States.
Inflationary pressures, however, can hurt the balance of
payments even before any lasting harm has been done to the competitive
position*
Even before they bring overt inflation, excess demands suck
imports into the country at an abnormal rate.
This has been happening
in the United States during the past year and a half.
Our trade
balance ought to have been showing further improvement, in order to
close the gap in our over-all balance of payments.
Instead it has
been worsening because imports have risen more than exports.
As a
result, the restoration of equilibrium has once again been postponed.
To minimize inflation and maximize economic growth requires
a harmonious blending of many sorts of policies--monetary policy and
fiscal policy and the private policies of businesses and of labor
unions.
Ideally, the economy should be expanding along a steady
path, always with enough spare capacity to avoid bottlenecks, but
never with so much spare capacitv as to cause a general slump in the
current flow of outlays to enlarge or improve productive capacity.
Individual prices should be flexible, so as to facilitate smooth
adjustments of supply to changing demand; but broad averages of in
dustrial wholesale prices should remain stable, so as to discourage
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speculative and unproductive uses of the country*s resources.
The
efficiency and the productivity of the economy ought to be improving
constantly*
To get the economy onto that kind of track, and then to keep
it there, is indeed a challenging aspiration.
But this grand design
is not one that monetary policy can fulfill single-handedly.
As I
have said in recent speeches, good fiscal policy makes good monetary
policy work better, and vice versa.
Under present day conditions in
the United States, as in many other countries, monetary policy is being
called upon to carry too much of the burden of restraining demand and
of avoiding inflation.
Despite the potential for coordination of
monetary and fiscal policies to provide the proper kind and amount of
demand stimulus or restraint, such ideal coordination is not easy to
achieve.
Judgments of reasonable men can, and frequently do, vary as
to the stage of the business cycle in which we find ourselves and, more
specifically, as to
economy may be.
j u s t
how
u n d e r s t i m u l a t e d
or "overheated” the
Moreover, a whole panoply of policy judgments and
social values must also be brought into play.
The end result is that
the intragovernment coordination of policies affecting aggregate
demand can be almost as tricky--and occasionally almost as unnerving-as attempts to bring about some coordination of aggregate demand
policies internationally through international cooperation.
So far I have been speaking in very general terms.
While
I have made reference to our key currency status and drawn some ex
amples from experience in the United States, most of what I have said
could very well apply to any of the major industrial countries*
I should like now to comment more specifically on some special feature
that arise when a country*s domestic currency is also widely used in
foreign exchange markets, and when liquid investments payable in that
currency are not confined to domestic holders but also form a consider
able part of the official monetary reserves of other countries.
One of these features that the central banker in a reserve
currency country has to always keep in mind is that his monetary
reserves are also serving, indirectly, as the monetary reserves of
many other countries.
This makes him extremely sensitive with regard
to the liabilities of his banking system to foreign official agencies
and private individuals.
He is especially concerned that the growth
of such liabilities not be so fast that it adversely affects the con
fidence of foreign holders.
A second special feature for a reserve currency country is
that an improvement in its external current account--due, let us say,
to a rise in its exports--can often be offset by additional capital
outflows that are set in motion by the needs of other countries for
financing their increased deficits.
The reserve currency country is
a large country, so when its balance of payments tends to improve
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there are bound to be some other countries whose balances of payments
worsen appreciably.
So other countries, whose balances of payments
have worsened enough to become deficits, are very likely to come to
the reserve currency country to borrow more.
A third related special feature--in my judgment in reality
more of a "non-feature11— for a reserve currency country is found in
the argument put forth by many Europeans that whenever a reserve cur
rency country has an external payments deficit financed in part by a
rise in its liquid liabilities to other countries, it is enabled by
that rise to avoid monetary discipline and ipso facto "export inflation"
to the rest of the world,
I find this argument not really very compelling despite its
superficial appearance of reality.
On the one hand, of course, I would
assert vigorously that the United States has made every effort, and is
still currently making every effort, to restore equilibrium in its
balance of payments entirely independently of its reserve currency
status.
On this score, our position is clear--we intend to restore
equilibrium.
Thus we do not expect our liabilities to contribute in
the same way as in the past to the needed growth of international
reserves.
But what is even more mysterious to me is why it seems to be
so difficult for countries that have surpluses in their balance of
payments either to correct the surpluses they claim are forced on them
and producing undesirable monetary effects, or to neutralize their
monetary effects in such a way as not to attract larger surpluses.
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Certainly by facilitating imports or by opening up and broadening
its own capital markets and assuming a greater responsibility for
capital exports in the form of money rather fchan goods, a surplus
country does not have to accept passively an imbalance between its
receipts and payments.
True, a mere onward shifting of dollars, say to the Euro
dollar market, does not correct the underlying attraction that a
country may have for capital.
X recognize there may be a dilemma be
tween the use of tight monetary policy to combat domestic inflation
on the one hand, and the tendency of such a policy to attract foreign
money.
But our program of voluntary restraint on bank lending has
operated to permit greater latitude to European monetary policies
with less danger of attracting U, S. capital.
Indeed, in some periods
there has been a return flow of short-term funds to the United States.
Beyond that, the contribution of any surplus--whatever its
origin--to a country's own domestic inflationary pressures depends
on the kinds of steps that may be taken in the way of fiscal and mone
tary policies to neutralize such impact.
For example, if the govern
ment were to siphon off such funds by borrowing or taxing without
corresponding increases in expenditures, the economy would be left
relatively unaffected.
In a sense, it seems to me that the talk about
"imported inflation" may basically reflect the inadequacies of fiscal
policies in the surplus countries.
- 13 International Monetary Arrangements
A central banker, especially in a reserve currency country,
is inevitably involved in those international monetary arrangements
that are integrally related to the functioning of the international
monetary system.
International discussions on the subject of inter
national monetary reform have gone far enough now to convince me that
the really important issues tied up with this subject are not questions
of the mechanics of a new system, but rather questions of objectives
and of the spirit in which countries will cooperate to achieve their
objectives.
No system for the financing of international payments im
balances, or for the creation and maintenance of value of monetary
reserves, will succeed in the long run unless it contributes, in the
international sphere, to those objectives which it has been the role
of the central banker to strive for in the domestic sphere.
These
objectives are partly means to an end, and partly ends in themselves.
The overriding objective, as the central banker sees it, is economic
growth, to raise the levels of well-being for all.
His subsidiary
but closely related objectives can be summed up in the concept of
financial stability, domestic and international.
The old gold-standard mentality will not work, in the longrun, any better internationally than on the national level.
There is
no automatic formula that can resolve once and for all the continuing
problem of achieving growth without inflation.
On the other hand, international cooperation toward the
goal of economic growth with financial stability depends on a
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willingness of nations to submit to some degree of self-discipline and,
if necessary, some degree of international discipline.
No change in
institutional arrangements can automatically guarantee stability and
discipline.
No orderly system of international economic and financial
cooperation can work unless individual countries do their part to
maintain financial stability.
Concluding Comment
This brings me full circle in my remarks this afternoon on
the role of a central banker.
I began by stressing the central banker’s
concern with growth as well as inflation and the need for continued
adaptation and ingenuity in meeting changing problems.
And my main
conclusion from these remarks is that the role of a central banker is
constantly becoming harder instead of easier as the economic and
financial environment becomes more complicated and the problems more
complex.
Thus I think the credo of a central banker might very well
be the same as the words which as I recall are inscribed on the facade
of the Harvard Medical School Building not too far from where we are
now meeting, namely:
Life is short
And art long;
Occasion instant;
Experiment perilous;
Decision difficult.
Central banking is indeed a long art and the occasions are often instant.
Experiment is perilous but frequently necessary and decisions are
always difficult.
@FedFRASER