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CONTEMPORARY MONETARY POLICY Remarks by Ralph A. Young, Associate D i r e c t o r , D i v i s i o n of Research and S t a t i s t i c s , Board of Governors of the F e d e r a l Reserve System, before the T h i r d Annual Public A f f a i r s Conference of the Yale Law School Student Association New Haven, Connecticut^-December 10, 19U8 •miIMMMWM*—"1 i Monetary p o l i c y i s a subject o f t e n discussed i n terms of a mechanical r e l a t i o n s h i p between goods and money* Prices i n the market place are t h e t a n g i b l e expression of t h i s r e l a t i o n s h i p * created by or under governmental a u t h o r i t y * Money i s a medium On the other hand, goods represent a conglomerate output o f m i l l i o n s of a u t h o r i t i e s , private* primarily Accordingly, i t would seem e n t i r e l y l o g i c a l f o r government to exercise i t s c e n t r a l power t o adjust the supply of money to the supply of goods* Such a t h e o r y appeals strongly to our sense of an i d e a l w o r l d , f o r i f adjustment of the money supply to the supply of goods were e f f e c t i v e l y made, c e r t a i n d e s i r a b l e r e s u l t s would s u r e l y f o l l o w * would be more s t a b l e * Prices on average And i f average p r i c e s were more s t a b l e , markets would become more c l e a r l y d e f i n a b l e , and u n c e r t a i n t i e s of production -would be lessened* I n t u r n , these developments would l i k e l y be r e f l e c t e d i n a g r e a t e r o v e r - a l l economic and s o c i a l stability. This i s v e r y a t t r a c t i v e d o c t r i n e , and i n a good many economics textbooks i t i s e l u c i d a t e d w i t h c l a r i t y and persuasion* I n f i n a l essence, the monetary problem i s made one of p r o p e r l y organized government. KVhat i s needed t o c o n t r o l the issuance or c r e a t i o n of money i s merely t h a t government should e s t a b l i s h some agency—for i n s t a n c e , a c e n t r a l banking system---equipped w i t h a panoply of d i s c r e t i o n a r y powers* ifciministered by men of " a b i l i t y and wisdom," t h i s agency can s u r e l y r e g u l a t e the supply of money i n the i n t e r e s t of a sustained high l e v e l of employment, p r o d u c t i o n , and t r a d e a t stable market values* The problem o f monetary p o l i c y i s not q u i t e as simple as appealing dogma would make i t * To begin w i t h the money supply i s a k i n d of amorphous mass, and not a q u a n t i t y of r e a d i l y i d e n t i f i a b l e and a d d i t i v e itemst Witness the r e c e n t spectacle of a prominent monetary c o n t r o l l e r f i n d i n g l i t t l e change i n the money supply over the past year w h i l e an e q u a l l y prominent f i n a n c i e r found a s u b s t a n t i a l increase during the same period. We have currency money issued by the Treasury and by the F e d e r a l Reserve Banks, and we have the demand deposit money created by the commerc i a l banks* We have a l a r g e a d d i t i o n a l amount of l i q u i d assets i n the form of time deposits and savings accounts, b u i l d i n g and loan shares, and the cash value of insurance p o l i c i e s c o n v e r t i b l e i n t o other money a t par and v i r t u a l l y on demand* We have an even l a r g e r volume of l i q u i d assets i n the form of Government s e c u r i t i e s , r e a d i l y exchangeable i n t o money a t p a r , by redemption or sale* We have s t i l l other assets t h a t are v e r y high i n l i q u i d i t y , and t h e r e f o r e i n nature close t o money* Some of our money, moreover, when lodged i n the reserves of Federal Reserve Banks and comm e r c i a l banks, possesses the p r o p e r t y of m u l t i p l y i n g through loans and investments i n t o s t i l l more money* Then there i s the f a c t t h a t Government c r e d i t p l a y s so l a r g e a p a r t as asset backing f o r the money supply* This makes p u b l i c confidence i n the whole monetary mechanism h e a v i l y dependent on p u b l i c confidence i n - 3 - Government c r e d i t * I might observe i n passing t h a t t h i s p a r t i c u l a r con- d i t i o n i s p r i m a r i l y the r e s u l t of having financed a recent and v e r y c o s t l y war* This i s not a l l * A sizeable p a r t of outstanding money balances and a sizeable segment of outstanding Government debt i s regarded by holders as temporary lodgment of v a l u e — t h a t i s , i s h e l d f o r reasons of short- or l o n g e r - t e r m l i q u i d i t y * At the h o l d e r ' s v o l i t i o n , the money a t r e s t may be r e a c t i v a t e d or the Government s e c u r i t i e s i n temporary ,holdings may be converted i n t o money* The r e s u l t i s t h a t a c t i v e money flows i n the economy, and indeed the t o t a l money supply, are subject t o change by the independent decisions of many i n d i v i d u a l and i n s t i t u t i o n a l holders* Added to the f e a t u r e of money e l a s t i c i t y through c r e d i t extension, the independent i n f l u e n c e on monetary conditions of l i q u i d asset holders has important consequences* I t means t h a t , i n a d d i t i o n to a governmentally e s t a b l i s h e d a u t h o r i t y , we have many p r i v a t e monetary a u t h o r i t i e s of l e s s e r or g r e a t e r importance* I t f u r t h e r means t h a t p u b l i c monetary p o l i c y today, a t l e a s t i n i t s s h o r t - r u n aspects, i s v e r y much a game of o f f s e t t i n g e f f e c t s on money flows and the money supply of decisions by the numerous p r i v a t e monetary a u t h o r i t i e s * A corollary implication i s that public monetary p o l i c y i s i n p a r t a game of avoiding undesirable e f f e c t s of a c t i o n s on p r i v a t e monetary d e c i s i o n s . Governing our e x i s t i n g complex mechanism of money and near money, we have an e q u a l l y i n t r i c a t e framework of law and p u b l i c supervision. Our money and r e l a t e d f i n a n c i n g agencies, moreover, have developed t h e i r own s p e c i a l p a t t e r n s of o p e r a t i o n . Monetary p o l i c y has also t o be shaped i n the l i g h t of these i n s t i t u t i o n a l elements. - h - The impression obtained from even casual observation of t h e s t r u c t u r a l f e a t u r e s of our present money system i s p l a i n l y not one of s i m p l i c i t y ; i t i s anything e l s e , depending on one's sense of p r o p o r t i o n . No set r u l e s or p r i n c i p l e s f o r the conduct of p u b l i c monetary p o l i c y i n these circumstances i s e a s i l y formulated and agreed upon. Besides i t s f r u s t r a t i o n s on account of a h i g h l y complex money s t r u c t u r e , monetary p o l i c y has a thorny path t o f o l l o w because of the nature of modern money c r e a t i o n and extinguishment. Major changes i n the economy's money flows and i n i t s money supply are h e a v i l y dependent on c e r t a i n s t r a t e g i c f o r c e s , such as the Treasury's surplus or d e f i c i t , c a p i t a l f o r m a t i o n by p r i v a t e business, consumer expenditures f o r durable goods and housing, and i n t e r n a t i o n a l t r a d e . These forces i n t u r n have many aspects and the money a u t h o r i t y must respond t o them as best i t can by i n f l u e n c i n g the terms and conditions on which new money, through c r e d i t extension, i s made a v a i l a b l e to borrowers. Government surplus, f o r example, serves as an a i d to r e s t r i c t i v e monetary p o l i c y , tary factors. since i t may be used to o f f s e t or temper expansive mone- Government d e f i c i t , on the other hand, works t o handicap restrictive policy. I n f a c t , unless savings of t h e p u b l i c are a v a i l a b l e i n adequate amounts f o r the purchase of Government s e c u r i t i e s , Government d e f i c i t tends to b r i n g about monetary expansion, whether desired or n o t , and the known weapons of monetary p o l i c y f a t l e a s t those t h a t may be a p p l i e d under such c o n d i t i o n s , are only capable of o f f s e t t i n g i n p a r t the tionary effects. infla- - 5 - The volume of business c a p i t a l formation i s a f f e c t e d by current expectations of f u t u r e business a c t i v i t y , and investment plans are sub- j e c t to commitment, a l t e r a t i o n , or withdrawal as the economic outlook changes, despite the wishes or the instruments of the monetary p o l i c y makers* Consumer durable goods demands* stem from wants t h a t are now deeply imbedded i n the American standard of l i f e , and the matter of i n t e r e s t r a t e s i n the n a t i o n f s money market has l e s s e f f e c t on the strength of these demands than the monetary a u t h o r i t i e s might desire* The s t a t e of i n t e r n a t i o n a l trade i s a r e f l e c t i o n of world p o l i t i c a l tensions as w e l l as the product of r e c i p r o c a l needs between nations f o r goods and s e r v i c e s , and monetary p o l i c y can do l i t t l e but absorb i t s c u r r e n t impact* I n p o r t r a y i n g p u b l i c monetary p o l i c y i n i t s contemporary s e t t i n g as an involved compound of many elements, i t i s not my purpose to despair over i t s r o l e or i t s prospects* Rather the o b j e c t i v e i s merely t o stress t h a t t o have constructive p o l i c y by the p u b l i c monetary a u t h o r i t i e s under postwar conditions r e q u i r e s a comprehension and understanding on t h e i r p a r t t h a t i s indeed profound* I t i s also reasonably obvious, I t h i n k , t h a t a good dose of f l e x i b i l i t y i n weapon and a c t i o n i s a f u r t h e r essential element of p o l i c y . I n t h i s k i n d of monetary s i t u a t i o n , the adequacy and a d a p t a b i l i t y of p o l i c y instruments i s a v e r y c r i t i c a l issue* I t need be no matter of surprise t h a t contemporary monetary controversy takes so much the form of "there i s not enough a v a i l a b l e power" and "monetary p o l i c y i s not making use of the power i t has*" Each of the present instruments of monetary p o l i c y , and some of them are r e l a t i v e l y new as monetary h i s t o r y goes, was - 6 - evolved to meet some p a r t i c u l a r type o f monetary problem. Once f i r m l y e s t a b l i s h e d i n t h e armory of p o l i c y weapons, these instruments have been r e t a i n e d f o r f u t u r e use* But monetary conditions change and p o l i c y weapons lose t h e i r a p p l i c a b i l i t y and e f f e c t i v e n e s s , or t h e y reach the l i m i t o f use p e r m i t t e d by s t a t u t e or t e c h n i c a l circumstances* We may i l l u s t r a t e some important changes since prewar times by r e f e r e n c e t o the s o - c a l l e d t r a d i t i o n a l instruments of c e n t r a l bank monetary policy* Because of l a r g e holdings of short-term Government s e c u r i t i e s , acquired through the processes of war f i n a n c e , commercial banks no longer have extensive need f o r borrowing funds from the F e d e r a l Reserve Banks• Reserve Bank discount r a t e s , as a r e s u l t , do not have the same e f f e c t s on the cost of c r e d i t i n the money markets as t h e y d i d , say i n the 1 twenties* Again, because of t h e l a r g e s t outstanding p u b l i c debt i n our h i s t o r y and the wide d i s t r i b u t i o n of i t s ownership, open market operations today are more devoted to assuring stable market values on t h i s debt than as a companion weapon to discount r a t e s i n r e g u l a t i n g the cost and supply of c r e d i t funds, and t h e r e b y of changes i n t h e money supply* This f a c t i s much deplored by some, but the very size of the p u b l i c debt makes confidence i n i t s market value a keystone o f stable f i n a n c i a l o r g a n i z a t i o n . Postwar f i n a n c i a l experience has shown a r e s i d u a l buyer i n the market t o be an important reinforcement of needed confidence. L a s t l y , power t o v a r y reserve requirements of F e d e r a l Reserve Banks, while a v e r y e f f e c t i v e weapon, has been u n a v a i l a b l e during most of t h e postwar p e r i o d because of p r a c t i c a l exhaustion of s t a t u t o r y d i s c r e t i o n on the upward side* A d d i t i o n a l power was b e l a t e d l y granted by - 7 - Congress t o t h e monetary a u t h o r i t i e s o n l y l a s t summer, and, as you know, use has a l r e a d y been made of i t — w i t h some c o n s t r u c t i v e r e s u l t s i t may be added. During t h e postwar p e r i o d , the monetary problem i n t h i s country as w e l l as other countries may be described i n a word as "redundancy of money and other l i q u i d assets.* 1 This redundancy of l i q u i d assets has l a r g e l y represented expansion of p u b l i c debt t o finance war. Correction of redundancy, t h e r e f o r e , has been contingent mainly on r e t i r e m e n t of Government d e b t . Confronted w i t h t h i s s i t u a t i o n , monetary p o l i c y has-, been o b l i g e d to recognize the f a c t s , make the most of whatever weapons could be used—without d i s r u p t i n g confidence i n Government c r e d i t — t o restrain a d d i t i o n a l monetary expansion from p r i v a t e c r e d i t demands, and urge the immediate primacy of f i s c a l surpluses i n r e s t r a i n i n g i n e v i t a b l e pressures# inflationary To speak more b l u n t l y , monetary p o l i c y has had t o take a secondary p o s i t i o n i n coping w i t h the economy's f i n a n c i a l problems i n the wake of w a r . This p o s i t i o n of monetary p o l i c y has not been viewed w i t h comp l e t e s a t i s f a c t i o n by some n o s t a l g i c observers, impatient t o see f r e e e n t e r p r i s e economy r e s t o r e d promptly t o i t s prewar p a t t e r n of f u n c t i o n i n g . These i n d i v i d u a l s a p p a r e n t l y b e l i e v e t h a t the record would have been b e t t e r i f monetary p o l i c y s h o r t l y or even l a t e r a f t e r h o s t i l i t i e s had sent market i n t e r e s t r a t e s i n " h o t , " or a t l e a s t " o r d e r l y , " p u r s u i t of expected p r o f i t r a t e s and the marginal propensity to consume—until some n a t u r a l , i n any case, n o n i n f l a t i o n a r y e q u i l i b r i u m p o i n t were found between the t h r e e . ^Jhatever m e r i t s t h i s subtle economic theory may have, its a p p l i c a t i o n i n a w h o l l y abnormal s i t u a t i o n has appealed t o the monetary - 8 - a u t h o r i t i e s as a h i g h l y r i s k y experiment* Considering the u n p a r a l l e d p u b l i c debt of 250 b i l l i o n d o l l a r s which monetary p o l i c y has had t o assume some p a r t i n managing, t h e r e i s assuredly something t o be said i n favor of the p o s i t i o n t h e y have t a k e n , namely, t h a t postwar inflationary forces have not been amenable t o treatment by t r a d i t i o n a l p o l i c y prescription. Ifilhile monetary p o l i c y may be said t o have groped i t s way i n t h i s r e c e n t p e r i o d of t r a n s i t i o n from war, i t cannot be accused of dormancy* Monetary p o l i c y , w i t h i n s t a t u t o r y l i m i t a t i o n s , has v i g o r o u s l y used i t s r e l a t i v e l y modern accessories—control over stock market c r e d i t and c o n t r o l over consumer instalment c r e d i t * i n f l u e n c e over short-term i n t e r e s t r a t e s * I t has used moderately i t s I t s a u t h o r i t y to conduct open market operations r e s u l t e d on a t l e a s t one occasion i n a rude shock t o long-term i n v e s t o r s and i t has prevented d i s r u p t i v e f i n a n c i a l conditions from developing as a r e s u l t of w i d e l y f l u c t u a t i n g Government s e c u r i t y p r i c e s and shaken confidence i n p u b l i c c r e d i t * I t has a p p l i e d w i t h g r e a t e r aggressiveness than the banking community has desired a v a i l a b l e a u t h o r i t y to r e g u l a t e member bank reserve requirements* statutory F i n a l l y , i t has used i t s i n f o r m a t i o n a l resources t o inform the Congress and the p u b l i c of the nature of the postwar monetary problem, and t o urge both the f i r s t importance of a strong f i s c a l p o l i c y and the need f o r a basic of a v a i l a b l e monetary powers* strengthening These measures have a d m i t t e d l y not been enough to prevent a considerable postwar i n f l a t i o n , but i t may be t h a t h i s t o r y w i l l accord them a more than i n c i d e n t a l r o l e as r e s t r a i n i n g e l e ments i n the i n f l a t i o n process taken as a whole, Our postwar monetary problem continues t o be a c r i t i c a l p u b l i c issue. The supply of money and other l i q u i d assets i s s t i l l d i s p r o - p o r t i o n a t e l y l a r g e i n r e l a t i o n t o c u r r e n t output and incomes, even a t present p r i c e l e v e l s , and i n r e l a t i o n also t o foreseeable economic needs* This supply has the p o t e n t i a l , moreover, o f f u r t h e r vast expansion* R e s t o r a t i o n of an e f f e c t i v e a u t h o r i t y f o r i t s c o n t r o l i s e s s e n t i a l i f the w i d e l y accepted o b j e c t i v e of economic s t a b i l i t y at the highest sust a i n a b l e l e v e l s of production and employment i s ever t o become, f o r the present g e n e r a t i o n , an a t t a i n a b l e goal*
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