View PDF

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

h t U L K / A L

i N u J L K

> i—

s* T»o— '■A
D ale
F ebru ary.3, 1972
to/2- 7 2-^F
Subject - Comment on Use of a Fixed

. \ »
jj .

Chairman Burns

T o___

[\c ?




Rule for Monetary Growth

J. Charles Partee


~ y*

kvave asked me for a comment on the deficiencies of adopting
presoJj K'
a fixed rule guiding monetary growth and also for a brief review of the

Pro^ fa'JV

record as to policy flexibility at critical junctures over the postwar

Milton Fri edman published a column in the current issue of

b r b l '<* H V t S
e f o •-" v i C
atKjjr Newsweek arguing in favor of a fixed monetary rule (copy attached), so
■J f L
w "»
f<raat0f f r s £t^ac the subject could well come up in Congressional questioning at the o
> « r5
t,< fT\je.
u JL
JEC hearing and in other situations.
Friedman's arguments are the ones that he and others have useJ
time and time again.
He asserts tnAt on the basis of past Federal Resegye
performance and in view of the limits of our ability to predict the future

and to specify the precise nature and timing of the lags with which morffit
tary changes affect the economy, it would be preferable to aim policy at
the achievement of "a steady and moderate rate of growth of the quantity
of money".

This cannot be done from day to day or week to week, but "no

serious student of money denies that the Fed. . .can come very close from
month to month and quarter to quarter".

Additional advantages cited for

a steady rate of monetary growth would be that it would promote business
confidence in monetary stability and neutralize the Federal Reserve from
political pressure.
We, of course, have always denied that monetary policy operating
on a fixed rule would work as satisfactorily as a,flexible policy, although

there is more s ^ ^ o r t in the System now than

a long time past for

achieving rates of growth over time that vary around normative valies

and H 2 relative to CNP.

There have been numerous arguments

advanced in favor of flexibility, but the ones that appeal most to me
are as follows:
; 1)

Adoption of a fixed monetary growth rule would require

that all other factors affecting credit markets be ignored.


Federal Reserve does have a responsibility to encourage appropriate
credit conditions, and it also has responsibilities for Treasury
finance, the viability of financial institutions and the conditions 2



influencing international capital flows.

These considerations argues


that we cannot ignore interest rate and credit flow developments ang

2 •
that, at times, such developments will put constraints on our abil-^
ity to follow a fixed course as to monetary growth.

Every instinct argues that we should be capable of providjT

ing ©ore assistance to our national economic objectives than is
implied by the neutralist policy of an unchanging monetary stance.
In contra-cyclical terms, particularly, we should be prepared to
give more support to the economy in recession and less in boom, and
ve should be able to anticipate these developments with sufficient
accuracy to alter policy in advance of the needs of the economy.
It seems to me that our ability to do this has improved steadily
over the years, and that it would be most unfortunate to surrender to

a fixed rule approach now.

I would also argue that national

Chairman Burns


priorities as to the allocation of credit might well create
situations in which we should be prepared to depart somewhat
for a time from our notions-as- to the appropriate rate of
overall monetary growth.

Use of a fixed monetary-rule assumes that there is a

fairly constant relationship between monetary growth and its
influence on economic activity.

This may be correct as a generality

over time but it cannot be true in the short run.


The public's

appetite for liquidity obviously shifts from time to time, depending
on the confidence with which they view the future, changes, in


inflationary expectations, and the like.


If we do not provide

the additional liquidity associated with an upward shift in



preferences, or absorb the liquidity released by downward shifts,t-a
constant rate of growth in money is likely to result in variable ^
rates of growth in the economy.

In other words a constant monetary

growth, if precautionary demands for liquidity are shifting, would
be a source of economic instability.


A monetary rule requires that the monetary variable, or

the weighted combination of variables, to be controlled be specified
in advance.

Friedman does not specify which variable is to be

controlled in the Newsweek article, but in the past he has sometimes
focused on M , and sometimes on M 2 .

would be an equally good

candidate, since depositers in thrift institutions surely regard

these dep^^.ts as the equivalent of bank^^.me deposits in all
respects. . And

would also be a likely candidate, since



including CDs and other money market instruments do we incorporate
a measure of corporate liquidity.

All of these, quantities do not

and down at anything like the same rates in the short-run,

of course, so it is not enough to use one M as a proxy for all of
the o hers.

Nor is expansion i . all of the Ms closely felated to the

provision of bank reserves.


The relationships between rates of change in the various

Ms, and between these definitions of money and economic activity, gre
’ ^ ’
clearly subject to a host of influences, including structural,
competitive and technological change.

Thus, the postwar emergenceoof

the savings and loans clearly'impinged on the growth of bank time^
Similarly, the increasing sophistification with which gpney
is managed, partly a function of the upward trend in interest ratSs,


has served to reduce idle non-interest bearing cash balances (M^)
relative to total liquid assets (M^).

Technological improvements,

such as jet aircraft and bank automation, must have reduced the float
of checks in transit on which depositers formerly counted (we measure
money in terms of balances on the bank’s books, not in customer
records), and future advances (such as wire transfer) clearly will
reduce such float dramatically further.

All of this makes it

extremely difficult to measure the real impact of monetary policy
i .)

over time.

It also strongly suggests to me that targeted growth

rates in money--however defined--need to be modified in order to
produce a^^nchanged secular stimulus to^^onomic activity.


would think that this need is most pronounced in the case of M p
since cash balances are most subject to technological obsolescence.
For the purpose of reviewing the responsiveness of flexible
monetary management over the post-war period, we have developed the attachec
two tables--one on monetary aggregates and the second* on_ interes t rate and
credit market indicators.

Both show changes in the variables in the six

months before and after each upper cyclical turning point and before and
after the three points at which excess aggregate demand threatened


generalized inflation.

(These three points were arbitrarily chosen as .
May 1951, when the unemployment rate had declined to 3 percent under wa§*4
time conditions, and June 1955 and January 1966, when the unemployment 3
rate in each case had dropped to 4 percent, )

My conclusions on the recgrd
of performance for each of these nine periods, taken chronologically, t3
as follows. .


November 1948 cyclical peak.

The record is not good.

drifted off both before and after the turning point, and M 2
showed no net growth.

Net free reserves did move in the correct

directions, though only slightly, but the discount rate was raised
Just prior to the turning point and not reduced after.

Interest rates

did not show appreciable cyclical variation.

May 1951 period of excessive detrand.

The record is r.ot

good, despite the accord reached with Treasury on debt manage
support in March 1951.


M lt M 2 and bank credit all increased more

rapidly a i ^ r May 1951 than before.

Net W e e

reserves expanded in

the six months after May, following an earlier tightening, -a"dinterest rates stabilized.

No change during period in the discount


July 1953 cyclical peak.

The record is not good.

M^, M2

and bank credit increased less in the six months after the cyclical
peak t'an in the six months befoie.

Free reserves also increased

less rapidly after the turn--though still substantially--and the
discount rate was not changed.

Both short- and long-term interest g
rates did decline substantially after the peak, however, reflecting


reduced credit demand.


June 1955 period of ex,cess demand.

The record is quite g<god,


. assuming that a primary national objective was to curb aggregate
M^, M 2 and bank credit all increased at lower rates afterf-.
June 1955 than before.
Free reserves declined substantially, and<3

the discount rate was raised by a total of one full percentage
point over the one year period.

Interest rates moved upward both

before and after June 1955, on balance, with a particularly sharp
rise in short-term rates over the six months following that date.

July 1957 upper turning point.

The record is quite bad.

turned strongly negative in the six months following the turning
point, after having shown no growth before.

M^ and bank credit

also grew at smaller rates after July 1957.

The discount rate was

raised after the turning point (it was subsequently lowered), but
free reserves expanded substantially.

Interest rates declined,



being increased both before and after the turn, and the discount
rate w a s ^ ^ t once, by 1/2 per cent, in



rates declined substantially after January, but long-term r^tes - ^ rose following an earlier decline.

In retrospect, one could argue

that the easing was overdone, since tha recession movement was very

nd relatively brief.

Also it may be argued that monetary

ease persisted too long into the year, producing large increases
*n M

(6. 77. and M 2 (107.) for .he year as a whole.

Bui in time­

liness and speed, the initial policy turn seems to me to have been


November 1969 upper turning point.


• v
The record appears


Expansion in M^, M 2 and bank credit all accelerated g
in the six months after the turn, but to rates that were still
relatively moderate (perhaps a bit below normal in M, and bank
Net free reserves increased both before and after the £7

quite good.


turn, again moderately, but the discount rate was not reduced.


Short-term interest rates declined after the turn, but again—
as in 1967--long-terra rates continued upward (The major decline
in long-term rates, you will recall, commenced in the summer of
1970 and continued to the early months of 1971.)
In summary, I would conclude that the best performances in
monetary policy,

in terms of timing, were in the two most recent periods

of inflation--following June 1955 and January 1966--and the two most
recent periods of recession--following January 1967 and November 1969.
Ihe performance in the early stages of the 1960 recession was also fair,
but in all earlier postwar episodes it was poor.
In the 1967 episode^

<r *
j drop in long-term Treasuri<^^was not much greater than


the rise in the preceding



month period.

Hay 1960 upper turning point.

notably better than in 1957.

The record was fair, and.

M , ll and bank credit all increased


eignificantly on an algebraic basis,

though growth in

was still

quite nominal in the six months following the turning point.
discount rate was cut twice, by a total of



per cent, in the six

months following the turn, and free reserves increased substantially
both before and after the turn.

Interest rates also were declining

substantially both before and after the May 1960 cyclical peak.


January 1966 period of excess demand.

The record is q u i ^

M , M0 and bank credit all rose substantially less rapidly 3







in the six months after than £fefore January 1966.

The discount


rate was raised 1/2 per cent in early December— a notable conflict
vith Administration desires.
Net free reserves declined

substantially in the six months after January 1966 and long-term
interest rates were rising throughout.

(Interestingly, the

Treasury bill rate dropped slightly from January to July, following
a sharp earlier increase.)


January 1967 informal cyclical peak.

very good.

The record looks

As signs of economic slowing developed,

the Federal

Reserve turned promptly and substantially toward ease.


reaction probably was stronger because of the severe squeeze that
had been promoted in 1966.

M^, ^

and bank credit all expanded

sharply faster in the six months after January 1967 than before,
and all vere at historically high rates.

Net free reserves were


policy remainea easy too long into the year.
growth in money (both

Moreover, although the

and M^)did slow in the last quarter of 1967

and in early 19681 it then accelerated sharply, producing two consecu-tive
years of relatively rapid monetary growth. 'Friedman refers in the
Newsweek article to this 1967-68 period as an example of too rapid

Next page contains copyright-protected content

ho com panies reacted to the ctjmp la in t w ith outrage. K e lln e r, the largest
producer w ith 4> \K'T cent of ih e f lfc p a l
f it J ilc t . an grily noted that it h a s i^ R jc q u ir t'd another cereal c o m p an y since
19 M , a n d a \icv pti-sidcnt of C e n tr a l
F<*>ds said of the a d v e rtisin g chariies:
~Thcy*re ISO drv*rtvv ulf course, an d
\vc*fc £<’inc lo court t«» prove it." But the
com panies were fran k ly w o riie d that the
IT C ; seemed to Ik* sav in g that bigness in
iiv tir is had . ’ The charges w o u ld ap p ly
lo mavl>e 00 per cent <*t A m erican industry/* one c v e c u th c said. T he 1 T C has
b itte n off ail en orm o u s new theory of
an titiu s t la w , an d if carried out, it w o u ld
re v o lu tio n ize 4 he A m e rica n econom y a n d
break up all kinds of industries.*’
T hat m ay well I k * just w h a t the F T C

.. ...



u x «'

T~t •
V ; -- .



r * * * r= \ w ^
f **

| ! .... .. ^ pn' ‘ 3

*. ?fh’
« vy


*. ^v- i f

Ci \*
-—* ■









•• •/

C ereal con?unier: ?^o fa ir ch oice?
h as in m in d . Prev ious an titru st cases have
focused on one-com pany m onopolies, a n d

last w e eks m ove ag ain st the cereal ti­
tans was the first tim e th at direct covem-

fncut action has been taken ocam st an
oligopoly, a few larce corporations d o m ­
in a tin g an industry. T h e im p lic a tio n is
ih at if such firms use th e ir pow er u n fa ir ­
ly . they have in cifcct created a ‘shared
ti»onoj>oly, even if th e v have plotted no
V to n g d o m g s ~We d o n 't have to de p e n d
o n an y Lind of a c o n s p ira c y ,” an acency
official told N t w s w n
Jam es Bishop Jr.
\\v are saving that in view ot the conse­
quences for the m ark etplac e, it m ig h t
just as well have been a conspLracv.**
Still, the F T C has a lone wav to go befotc it proves that existing law can be
tt*cd against shjred monopolies, if the
Companies decide to fi^ht, the case could
crap c>n for \ears belore ending up m*
the Supreme Court. A nd it an out-ofCM ift settlement is negotiated, as is more
Iiiely. no iu%v le^al piecvdent would be
C^tabhsltevi at all.
February 7, 1972



a n d m ost other m onetarists have
lon g favored a poiicy of a steady
a n d m oderate rate of gro w th of the
q u a n tity of m oney. W e have strongly
op pose d the Fed's trying- to fine-tune
the econom y.
R ecent po licy conform ed to our pre­
scription only in 1970.
C ritics ask w h y we are so m odest.
W h y not use the po w erful instrum ent
o f m o n e tary policy to oflset other
forces p u s h in g the econom y tow ard in ­
flation or recession? W h y tie the
h a n d s of the F ed ? W 'hv not trust their
d iscretion in a d a p tin g to ch a n g in g
circum stances?
W ’e favor the rule of steady m o n e ­
tary gro w th for several reasons.
1. T h e post p erform ance of the
Fed. T h ro u g h o u t its history, the F ed
lias p ro c la im e d that it was using its
pow ers to prom ote econ om ic stability.
H ut the record does not support the
c la im . O n the contrary, t h e 'F e d has
b e e n a m ajor source of instability.
T h e F e d was responsible for con­
v e rtin g w h a t wou^d have been a seri­
ous recession after 1929 into a m ajor
c atastrophe by p e rm ittin g the q u a n ti­
ty o f m on ey to decline by one-third
fro m 1929 to 1933, even thou e h it h ad
a m p le po w er to prevent the decline.
In recent years, the Fed set otf the
ac cele ra tin g inflation that M r. \L\on
in h e rite d by ex p a nd in g the m oney
s u p p ly too ra p id ly in 1967 an d 196S,
th e n stepped too hard on the brake in
1969, an d too hard on the accelerator
in the first seven m onths of 1971. F e d ­
eral Reserve officials have often a d ­
m itte d th e ir errors after the fact—as
c h a irm a n Burns d id in Ju ly 1971, in
te stim o n y before the Jo int E co no m ic
C o m m itte e —a n d have prom ised b e t­
ter p e rfo rm ance in the future. But
then the same forces have produced a
re p e titio n of the same errors.
W e c o n c lu d e t in t the urgent need
is to prevent the F ed from being a
source of e con om ic disturbance.
2 T h e limitations o f our knowledge.
E c o n o m ic research has established
tw o propositions: ( 1 ) there is a close,
reg ular an d p red ictable relation b e ­
tw e en the q u a n tity of m oney, n atio nal
in c o m e an d prices over an y considera­
b le pe riod of years; ( 2 ) the same re­
la tio n is m u c h looser from m o n th to
m o n th , q u arte r to quarter, or even
year to \ear. In particular, m onetary
changes take tim e to artect the econo­
m y , a n d the tim e de lay is itself h ig h ­
ly v ariable.



T h e first proposition m eans that a

steady price level over the lo n g pi
requires that the q u a rU i’y of mon*
grow' at a fairly steady rate rou^r
e q u a l to the average rate of grew
of o u tp u t.
T h e second pro position rr.jans fh
an y a tte m p t to use m onetary poti;
for fine-tuning is likely sim ply to inti
d u c e a d d itio n a l in stability . A n d this
indeed-w hat has h ap p e n e d . ~ 3. T h e p ro m o tio n o f confidence. /
a n n o u n c e d , an d ad h e re d to, policy
steady m o n e tary g ro w th w o u ld pr
v id e the business c o m m u n ity with
firm basis for co nfidence in moneia
sta b ility that no discretionary pol:<
co u ld pro vide even if it h*),gper:c
to p ro d u c e ro u g h ly steady nwncta
g ro w th .
4. N eu tra liza tion o f the Fee§ Aa i
d e p e n d e n t F e d m ay at t im e ^ b e ti
in su late d from p o litica l pressures—
it was in the early ’30s—an<*| yet
othe r tim es u n d u ly allected l^v poll
cal pressures. If w e reallj| kne
e n o u g h to use m on e tary p S ic v f
fine-tuning, w e w o u ld p r o b a c y e.\
rience a tour-year cycle, wit]} uner
p lo y m e n t re a ch in g its troug lQ in ye;
d iv isib le by four an d intfatiQ j reac
in g its peak in the succeedmcQtear.
A m on e tary rule w ouldB insuL.
m o n e tary p o licy bo th f r o m ^ h e ar:
trary po w er of a sm all croup of av
not subject to control by the electc
ate a n d from the short-run pressor
o f partisan politics.
Is the rule that w e have propos
technically feasible? C a n the Fed cc
trol the q u a n tity of m oney? N o seric
stu d e n t of m o n e y —w hatever his pc
cv v ie w s- d e n ie s th a t the Fed can,
it wishes, control the q u a n tity of me
ey. It ca n n o t, of course, achieve a p:
cise rate of grow th from day to c.
or w eek to week. B ut it can cc;
very' close from m o n th to m o n th a,
q u a rte r to quarte r.
As I w rote some five years ago,
the m on etary rule were follow*
“other forces w o u ld still ailect t
econom y, require chang e an d ad;V
m e n t, an d distort the even tencr
our ways. B ut steady m onetary grew
w o u ld pro vide a m onetary climc
favorable to the ettective operm:
of those basic forces of enterprise. ;
ge n u itv , in v e n tio n , hard ivork a ’
th rift that are the true s p r igs of ec
n o m ic grow th. T h at is the most tr
we can ask from m on etary poiicy
our present stage of k n o w le d e e /i'
th at m u c h - a n d it is a great dealclearly w ith in our reach/*

Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102