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CHAIRMAN O F T H E BOARD O F G O V E R N O R S
FEDERAL RES E R V E SYSTEM
W A S H IN G T O N , D . C . 2 0 5 5 1

N o v e m b e r 6, 1973

The Honorable William F r o x m i r e
United States Senate
Washington, D. C.
D e a r Senator P r o x m i r e :
I a m writing in further response to your letter of
S e p t e m b e r 17, 1973, w h i c h requested c o m m e n t s on certain
criticisms of m o n e t a r y policy over the past year.
A s stated in your letter, the criticisms are:

(1) "that

there w a s too m u c h variation f r o m time to t i m e in the rate of
increase in the m o n e y supply, that m o n e t a r y policy w a s too
erratic, too m u c h characterized by stops and starts"; a n d (2)
"that the m o n e y supply h a d increased m u c h too m u c h last year,
in fact that the increase w o u l d h a v e b e e n too m u c h e v e n if w e
h a d b e e n in the depths of a recession instead of enjoying a fairly
vigorous e c o n o m i c expansion. "
T h e s e criticisms involve basic issues with r e g a r d to the
role of m o n e y in the e c o n o m y , a n d the role that the m o n e y supply
should play in the formulation and execution of m o n e t a r y policy.
T h e s e issues, along with the specific points y o u raise, require
careful examination.




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C r i t i c i s m of O u r Public Policies
D u r i n g the past t w o y e a r s the A m e r i c a n e c o n o m y h a s
e x p e r i e n c e d a substantial m e a s u r e of prosperity.

R e a l output

ha s i n c r e a s e d sharply, jobs h a v e b e e n created for millions of
additional w o r k e r s , a n d total p e r s o n a l i n c o m e -- both in dollars
a n d in t e r m s of real p u r c h a s i n g p o w e r -- h a s risen to the highest
levels ever reached.
Y e t the prosperity h a s b e e n a troubled one.
h a v e b e e n large a n d w i d e s p r e a d .
rate r e m a i n e d u n duly high.
since the spring of 1972.

P r i c e increases

F o r a time, the u n e m p l o y m e n t

Interest rates h a v e risen sharply

M o r t g a g e m o n e y h a s recently b e c o m e

difficult to obtain in m a n y c o m m u n i t i e s .

A n d confidence in the

dollar at h o m e a n d a b r o a d ha s at t i m e s w a v e r e d .
M a n y o b s e r v e r s h a v e b l a m e d these difficulties o n the
m a n a g e m e n t of public e c o n o m i c policies.

Certainly, the F e d e r a l

budget -- despite vigorous efforts to hold expenditures d o w n -continued in substantial deficit.

T h e r e ha s also b e e n a n e n o r m o u s

g r o w t h in the activities of F e d e r a l l y - s p o n s o r e d age n c i e s which,
although technically outside the budget, m u s t still b e financed.
T h e results of efforts to control w a g e s a n d prices during the




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past yea r h a v e b e e n disappointing.

Partial decontrol in early

1973 a n d the s u b s e q u e n t freeze failed to bring the results that
w e r e h o p e d for.
M o n e t a r y policy h a s b e e n criticized o n s o m e w h a t c o n ­
tradictory counts -- for being inflationary, or for permitting
too high a level of interest rates, or for failing to bring the
e c o n o m y b a c k to full e m p l o y m e n t , or for permitting excessive
s h o r t - t e r m variations in the g r o w t h of the m o n e y supply, a n d
so on.
O n e indication of dissatisfaction with our public policies
w a s p r o v i d e d b y a report, to w h i c h y o u refer in y o u r letter, on
a questionnaire s u r v e y c o n d u c t e d b y the National Ass o c i a t i o n of
Business Economists.

O f the respondents, 38 per cent rated

fiscal policy " o ver the past y e a r " as "poor"; 41 p er cent rated
m o n e t a r y policy " o v e r the past y e a r " as "poor"; only 14 per
cent felt that the w a g e - p r i c e controls u n d e r P h a s e I V w e r e
" about right. " If this s a m p l i n g is at all indicative, the public
policies o n w h i c h w e h a v e relied a r e being w i d e l y questioned.
M a n y m e m b e r s of the a b o v e group, in fact, w e n t o n r e c o r d for
a significant c h a n g e in fiscal policy.

In r e s p o n s e to a question

w h e t h e r they f a v o r e d a variable i n v e s t m e n t tax credit, 46. 5
per cent said "yes, " 40 per cent said "no, " a n d 13. 5 pe r cent
e x p r e s s e d "n o opinion."




-4-

L e t m e tu rn now to the q u estion s r a i s e d in y ou r l e t t e r
and in so m e o th er r e c e n t d isc u ssio n s about m o n e ta ry p o licy .
I s h a ll d is c u s s , in p a r tic u la r , the ro le of m oney supply in the
con d u ct of m o n e ta ry p o licy ; the ex te n t and s ig n ifica n ce of
v a r ia b ility in the grow th of the m oney supply; and the a c tu a l
b e h a v io r of the m oney supply during 1 9 7 2 - 7 3 .

R o le of M oney Supply
F o r m any y e a r s e co n o m ists h av e debated the r o le of the
m o n ey supply in the p e rfo rm a n c e of e co n o m ic s y s te m s .

One

sch o o l of thought, often te r m e d " m o n e ta r is t, " c la im s th at ch an ges
in th e m oney supply influ en ce v e ry im p o rta n tly , p erh ap s even
d e c is iv e ly , the p ace of e co n o m ic a c tiv ity and the le v e l of p r i c e s .
M o n e ta ris ts contend th a t the m o n e ta ry a u th o ritie s should pay
p rin c ip a l atten tion to the m oney supply, r a th e r than to o th er
fin a n cia l v a ria b le s su ch a s i n te r e s t r a t e s , in the conduct of
m o n e ta ry p o licy .

T hey a ls o contend th at f i s c a l p o licy h a s only

a s m a ll independent im p a ct on the eco n o m y .
A nother sch o o l of thought p la ce s le s s em p h asis on the
m on ey supply and a s s ig n s m o re im p o rta n c e to the exp en d itu re
and ta x p o licie s of the F e d e r a l G o v ern m en t a s f a c t o r s influencing
r e a l e co n o m ic a ctiv ity and the le v e l of p r i c e s .

T h is sch o o l

e m p h a siz e s the need fo r m o n e ta ry p o licy to be co n ce rn e d w ith




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the money supply should be defined, a r e m a t te r s on which
m o n e ta rists s till differ,

And there a r e a lso - m o n e ta r ists who

would allow som e -- but infrequent -- changes in the ra te of
growth of the money supply, in a cc o rd a n c e with changing
econom ic conditions.
It s e e m s self-e v id en t that adherence to a rig id growth
r a te ru le , or even one that is changed infrequently, would
p r a c tic a lly prevent m o n etary policy fro m playing an active
ro le in econom ic stab ilizatio n .

M o n e ta rists re co g n iz e this.

They believe that m o st econom ic d istu rb a n ce s tend to be
s e lf- c o r r e c t in g , and they th e re fo re argu e that a constant or
n e a rly constant ra te of growth of the money supply would
r e s u lt in re a so n a b ly s a t is f a c t o r y econom ic p e rfo rm a n c e .
But neither h is t o r ic a l evidence, nor the th ru st of
exploratio n s in b u s in e s s - c y c le theory over a long century,
give support to the notion that our economy is inherently stab le.
On the c o n tra ry , e x p erie n ce has d em o n strated re p e a te d ly that
blind re lia n c e on the s e lf- c o r r e c t in g p r o p e rtie s of our econom ic
s y s t e m can lea d to s e r io u s troub le.

D is c r e tio n a r y econom ic

policy, while it has at tim e s led to m is t a k e s , h a s m o r e ore­
proved re a so n a b ly s u c c e s s f u l .

The d is a p p e a r a n c e of b u sin e ss




d e p r e ssions, w h i c h in earlier t i m e s spelled m a s s u n e m p l o y ­
m e n t for w o r k e r s a n d m a s s bank r u p t c i e s for b u s i n e s s m e n , is
largely attributable to the stabilization policies of the last
thirty years.
T h e fact is that the internal w o r k i n g s of a m a r k e t
e c o n o m y tend of t h e m s e l v e s to g e n e r a t e b u s i n e s s fluctuations,
a n d m o s t m o d e r n e c o n o m i s t s r e c o g n i z e this.

F o r example,

i m p r o v e d p r o s p e c t s for profits often spur unsustainable bursts
of i n v e s t m e n t spending.

T h e flow of p e r s o n a l i n c o m e in a n a g e

of affluence allows a m p l e latitude for c h a n g e s in discretionary
expenditures a n d in savings rates.

During a business-cycle

e x p a n s i o n various i m b a l a n c e s tend to dev e l o p within the e c o n o m y
b e t w e e n a g g r e g a t e inventories a n d sales, or b e t w e e n a g g r e g a t e
b u s i n e s s i n v e s t m e n t in fixed capital a n d c o n s u m e r outlays, or
b e t w e e n a v e r a g e unit costs of p r o d u c t i o n a n d prices.

Such i m ­

b a l a n c e s give rise to cyclical m o v e m e n t s in the e c o n o m y .
Flexible fiscal a n d m o n e t a r y policies, therefore, a r e often
n e e d e d to c o p e with un d e s i r a b l e e c o n o m i c d e v e l o p m e n t s , a n d
this n e e d is not d i m i n i s h e d b y the fact that o u r available tools
of e c o n o m i c stabilization leave s o m e t h i n g to b e desired.




-8-

T h e re is g e n e ra l a g re e m e n t among e co n o m ists that,
a s a ru le, the effects of sta b iliza tio n p o lic ie s o ccu r g rad u a lly
over tim e , and that econom ic f o r e c a s t s a r e an e s s e n t ia l tool
of policy m aking.

However, no eco n o m ist - - o r sch ool of

eco n o m ics -- h as a monopoly on a c c u r a te fo r e c a s t in g .

At

t im e s , f o r e c a s t s b a se d la r g e l y on the m oney supply have
turned out to be s a t is f a c t o r y .

At other t im e s , such f o r e c a s t s

have been quite poor, m ainly b e c a u s e of unanticipated changes
in the intensity with which the existin g m oney stock i s u s e d by
b u s in e s s fir m s and c o n s u m e r s.
Changes in the r a t e of turnover of money have h is t o r ic a lly
played a l a r g e ro le in econom ic fluctuation s, and they continue
to do so.

F o r exam ple, the n arro w ly -d efin ed m oney sto ck --

that i s , dem and d e p o sits plus c u rre n c y in public c irc u la tio n --

grew by 5. 7 per cent between the fourth q u a rte r of 1969 and the
fourth q u a rte r of 1970.

But the turn over of money declined

during that y e a r , and the d o lla r valu e of GNP r o s e only 4. 5 per
cent.

In the following y e a r , the growth ra te of the m oney supply

i n c r e a s e d to 6. 9 per cent, but the tu rn ov er of m oney picked up
b r is k l y and the dollar value of G NP a c c e le r a t e d to 9. 3 per cent.
The m o vem en t out of r e c e s s i o n in 1970 into r e c o v e r y in 1971




was thus c lo s e ly re la te d to the g r e a t e r intensity in the u se of
money.

O c c u rre n c e s such a s this a r e v e ry com m on b e c a u s e the

w illingness to u se the existin g stock of money, e x p r e s s e d in its
ra te of turnover, is a highly dynamic fo rce in economic life.
F o r this a s well a s other r e a s o n s , the F e d e r a l R e s e r v e
u s e s a blend of fo r e c a stin g techniques.

The behavior of the

money supply and other fin an cial v a r ia b l e s is a cc o rd e d c a re fu l
attention.

So a l s o a r e the r e s u lt s of the m o st recent su rv e y s on

plant and equipment spending, co n su m e r attitu d es, and inventory
p la n s.

Recent tren ds in key producing and spending s e c t o r s a r e

analyzed.

The opinions of b u s in e s sm e n and outside econom ic

a n a ly sts a r e c a n v a s s e d , in p a r t through the nationwide contacts
of F e d e r a l R e s e r v e B an k s.

And an a s s e s s m e n t is m ade of the

p ro b ab le c o u r s e of f i s c a l po licy, a ls o of la b o r - m a r k e t and
a g r ic u lt u r a l p o lic ie s , and their effec ts on the economy.
Evidence fro m a ll these s o u r c e s is weighed.

E ffo rts

a r e a l s o m ade to a s s e s s econom ic developm en ts through the
use of l a r g e - s c a l e eco n o m etric m o d e ls.

An e clectic appro ach

is thus taken by the F e d e r a l R e s e r v e , in recognition of the fact
that the sta te of econom ic knowledge does not ju stify re lia n c e
on any single fo r e c a stin g technique.

As econom ic r e s e a r c h

-10-

has cumulated, it has b e c o m e increasingly clear that m o n e y
does indeed matter.

But other financial variables also matter.

1
\

In recent years, the F e d e r a l R e s e r v e has placed s o m e ­
wh a t m o r e e m p h a s i s on achieving desired g r o w t h rates of the
m o n e t a r y aggregates, including the narrowly-defined m o n e y
supply, in its conduct of m o n e t a r y policy.

But w e h a v e c o n ­

tinued to give careful attention to other financial indicators,
a m o n g t h e m the level of interest rates on m o r t g a g e s and other
loans and the liquidity position of financial institutions and the
general public.

This is n e c e s s a r y b e c a u s e the e c o n o m i c impli­

cations of any given m o n e t a r y grow t h rate d e p e n d on the state
of liquidity, the attitudes of b u s i n e s s m e n , investors, and co n ­
s u m e r s t o w a r d liquidity, the cost a n d availability of b o r r o w e d
funds, and other factors.

Also, as the nation's central bank,

the Fed e r a l R e s e r v e can never lose sight of its role as a lender
of last resort, so that financial crises and panics will be averted.
I recognize that one advantage of maintaining a relatively
stable grow t h rate of the m o n e y supply is that a partial offset
is thereby provided to unexpected a n d undesired shifts in the
aggregate d e m a n d for goods a n d services.

T h e r e is always

s o m e uncertainty as to the e m e r g i n g strength of aggregate
demand.




If m o n e y growth is maintained at a rather stable rate,




a n d a g g r e g a t e d e m a n d turns out to b e w e a k e r than is consistent
with the nation's e c o n o m i c objectives, interest rates will tend
to decline a n d the easing of credit m a r k e t s should help to
m o d e r a t e the u n d e s i r e d W e a k n e s s in d e m a n d .

Similarly, if -

the d e m a n d for g o o d s a n d services threatens to o utrun p r o ­
ductive capacity, a rather stable rate of m o n e t a r y g r o w t h will
p rovide a restraining influence o n the supply of credit a n d thus
tend to restrain e x c e s s i v e spending.
H o w e v e r , it w o u l d be u n w i s e for m o n e t a r y policy to a i m
at all t i m e s at a constant or n early constant rate of g r o w t h of
_ m o n e y balances.

T h e m o n e y g r o w t h rate that c a n contribute

^ r n o s t to national objectives will v a r y with e c o n o m i c conditions.
F o r e x a m p l e , if the a g g r e g a t e d e m a n d for g o o d s a n d services
is unusually w e a k , or if the d e m a n d for liquidity is unusually
strong, a rate of i n c r e a s e in the m o n e y supply well a b o v e the
desirable l o n g - t e r m t r e n d m a y b e n e e d e d for a time.

Again,

w h e n the e c o n o m y is experiencing s e v e r e c o s t - p u s h inflation,
a m o n e t a r y g r o w t h rate that is relatively high b y a historical
yardstick m a y h a v e to b e tolerated for a time.

If m o n e y g r o w t h

w e r e s e v e r e l y c o n s t rained in o r d e r to c o m b a t the e l e m e n t of
inflation resulting f r o m s u c h a cause, it m i g h t well h a v e seriously




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a d v e r s e effects on production and em ploym ent.

In short,

what growth r a te of the money supply is a p p ro p ria te at any
given tim e cannot be_ determ in ed sim p ly by e xtrap olatin g p a st
tre n d s or by som e p re co n c eiv ed a r ith m e tic a l sta n d a rd .
M o re o v er, for p u r p o s e s of conducting m o n eta ry policy,
it i s never sa fe to re ly on ju s t one concept of m oney -- even if
that concept happens to be fa sh io n a b le.

A v a rie ty of p la u sib le

concepts m e r it c a re fu l attention, b e c a u s e a num ber of fin an cial
a s s e t s s e r v e a s a convenient, s a f e , and liquid s to r e of p u rch asin g
power.
The F e d e r a l R e s e r v e pub lish es data c o rre sp o n d in g to
th re e definitions of money, and ta k e s a ll of them into account
in determ ining policy.

The three m e a s u r e s a r e :

(a) the

n a rro w ly -d efin e d money stock (M j), which e n c o m p a s s e s
c u rre n cy and demand d e p o sits held by the nonbank public; (b)
a m o r e b ro ad ly -d e fin ed m oney sto ck (M^), which a ls o includes
tim e and sav in g s d e p o sits at c o m m e r c ia l banks (other than
l a r g e negotiable tim e c e r t ific a t e s of d e p o sits); (c) a still b r o a d e r
definition (M 3 ), which inclu des s a v in g s d e p o sits at m utual s a v in g s
banks and sav in gs and loan a s s o c i a t i o n s .

A definition e m b racin g

other liquid a s s e t s could a lso be ju st ifie d -- fo r e x am p le , one
that would include la rg e -d e n o m in a tio n nego tiab le tim e c e r t ific a t e s




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of deposit, U .S . savings b o n d s a n d T r e a s u r y bills, c o m m e r c i a l
paper, a n d other s h o r t - t e r m m o n e y m a r k e t instruments.
T h e r e a r e m a n y assets closely related to cash, a n d the
public can switch readily a m o n g these assets.

However mo n e y

m a y b e defined, the task of d e t e r m i n i n g the a m o u n t of m o n e y
n e e d e d to m a i n t a i n high e m p l o y m e n t a n d re a s o n a b l e stability
of the general price level is c o m p l i c a t e d b y shifting p r e f e r e n c e s
of the public for c a s h a n d other financial assets.

Variability of M o n e y S u p p l y G r o w t h
In the short-run, the rate of c h a n g e in the o b s e r v e d
m o n e y supply is quite erratic, a n d cannot b e trusted as a n
indicator of the c o u r s e of m o n e t a r y policy.

Thi s w o u l d b e so

e v e n if there w e r e no e r r o r s of m e a s u r e m e n t .
T h e r e c o r d of h e a r i n g s hel d b y the Joint E c o n o m i c
C o m m i t t e e o n June 27, 1973 includes a m e m o r a n d u m w h i c h
I s u b m i t t e d o n p r o b l e m s e n c o u n t e r e d in controlling the m o n e y
supply.

A s indicated there, w e e k - t o - w e e k , m o n t h - t o - m o n t h ,

a n d e v e n q u a r ter-to-quarter fluctuations in the rate of c h a n g e
of m o n e y balances a re frequently influenced b y international
flows of funds, c h a n g e s in the level of U.S . G o v e r n m e n t deposits,
a n d s u d d e n c h a n g e s in the public's attitude t o w a r d s liquidity.




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S o m e of these variations a p p e a r to b e essentially r a n d o m -a pr o d u c t of the e n o r m o u s eb b a n d flow of funds in our m o d e r n
economy.
B e c a u s e the d e m a n d s of the public for m o n e y a r e
subject to rather w i d e s h o r t - t e r m variations, efforts b y the
F e d e r a l R e s e r v e to m a i n t a i n a constant g r o w t h rate of the
m o n e y supply could lead to s h a r p s h o r t - r u n s w i n g s in interest
rates a n d risk d a m a g e to financial m a r k e t s a n d the e c o n o m y .
Uncertainties about financing costs could r e d u c e the fluidity of
m a r k e t s a n d i n c r e a s e the costs of financing to b o r r o w e r s .

In

addition, w i d e a n d erratic m o v e m e n t s of interest rates a n d
financial conditions could h a v e undesirable effects o n b u s i n ess
a n d c o n s u m e r spending.

T h e s e a d v e r s e effects m a y not b e of

m a j o r d i m e n s i o n s , but it is better to avoid t h e m .
In a n y event, for a variety of r e a s o n s explained in the
m e m o r a n d u m for the Joint E c o n o m i c C o m m i t t e e , to w h i c h I
h a v e previously referred, the F e d e r a l R e s e r v e doe s not h a v e
p recise control ov e r the m o n e y supply.

T o give o n e e x a m p l e ,

a significant part of the m o n e y supply consists of deposits
lo d g e d in n o n m e m b e r b a n k s that a r e not subject to the r e s e r v e
r e q u i r e m e n t s set b y the F e d e r a l R e s e r v e .

A s a result there




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15 -

is s o m e slippage in m o n e t a r y control.

F u r t h e r m o r e , since

deposits at n o n m e m b e r banks h a v e b e e n reported for only two
to four days in a year, in contrast to daily statistics for m e m b e r
banks, the data on the m o n e y supply -- w h i c h w e regularly pre s e n t
on a weekly, monthly, a n d quarterly basis -- a r e estimates rather
than precise m e a s u r e m e n t s .

W h e n the infrequent reports f r o m

n o n m e m b e r b a n k s b e c o m e available, they often necessitate c o n ­
siderable revisions of the m o n e y supply figures.

In the past

two years, the revisions w e r e upward, a n d this m a y h a p p e n
again this year.
S o m e indication of the extent of short-term variations
in the re c o r d e d m o n e y supply is provided below.

Table 1 s h o w s

the ave r a g e and m a x i m u m deviations (without rega r d to sign) of
f r o m its a ve r a g e annual g r o w t h rate over a three a n d a half
yea r period.

A s w o u l d be expected, the degree of variation

diminishes as the tim e unit lengthens; it is m u c h larger for
m o n t h l y than for quarterly data, a n d is also larger for quarterly
than for s e m i -ann u a l data.




-16Table 1
DEVIATIONS IN M j FROM ITS AVERAGE RATE OF GROWTH,
1970 T H R U M I D - 1973

A n n u a l Rates of C h a n g e in per cent
Average
Deviation

F o r m of Data

Maximum
Deviation

Monthly

3.8

8.8

Quarterly

2.4

5.5

Semi-annual

1.8

4.1

In our judgment, there n e e d be little r e a s o n for concern
about the short-run variations that occur in the rate of change in
the m o n e y stock.

S u c h variations h a v e m i n i m a l effects on the

real e c o n o m y .

F o r one thing, the outstanding supply of m o n e y

is very large.

It is also quite stable, even w h e n the short-run

rate of change is unstable.

This October the average outstanding

supply of M j , seasonally adjusted, w a s about $264 billion.
O n this base, a m o n t h l y rise or fall in the m o n e y stock of
eve n $2-1/2 billion w o u l d a m o u n t to only a 1 per cent change.
But w h e n such a t e m p o r a r y change is e x p r e s s e d as an annual
rate, as is n o w c o m m o n l y done, it c o m e s out as about 12 per
cent and attracts attention far b e y o n d its real significance.




-

17 -

T h e F e d e r a l R e s e r v e r e s e a r c h staff h a s investigated
carefully the e c o n o m i c implications of variability in

growth.

T h e e x p e r i e n c e of the past t w o d e c a d e s suggests that e v e n a n
a b n o r m a l l y large or a b n o r m a l l y s m a l l rate of g r o w t h of the
m o n e y stock o ver a p e riod u p to six m o n t h s or so ha s a negligible
influence o n the c o u r s e of the e c o n o m y -- p r o v i d e d it is s u b ­
sequently offset.

S u c h s h o r t - r u n variations in the rate of

c h a n g e in the m o n e y supply m a y not at all reflect F e d e r a l
R e s e r v e policy, a n d they d o not justify the attention they often
r eceive f r o m financial analysts.
T h e thrust of m o n e t a r y policy a n d its pro b a b l e effects
o n e c o n o m i c activity c a n only b e d e t e r m i n e d b y o b s e r v i n g the
c o u r s e of the m o n e y supply a n d of other m o n e t a r y a g g r e g a t es
o v e r periods lasting six m o n t h s or so.

E v e n then, c a r e m u s t

b e ta ken to m e a s u r e the g r o w t h of m o n e y bal a n c e s in w a y s that
t e m p e r the influence of s h o r t - t e r m variations.

F o r example,

the g r o w t h of m o n e y b a l a n c e s o v e r a quarter c a n b e m e a s u r e d
f r o m the a m o u n t outstanding in the last m o n t h of the pre c e d ing
q uarter to the last m o n t h of the current quarter, or f r o m the
a v e r a g e a m o u n t outstanding during the p r e c e d i n g quarter to the
a v e r a g e in the c urrent quarter.

T h e first m e a s u r e captures

the latest tendencies in the m o n e y supply, but m a y be distorted




-

18 -

by random ch an ges that h ave no lastin g s ig n ific a n c e .

The

secon d m e a s u r e tends to a v e ra g e out te m p o r a r y flu ctu atio n s
and is co m p a ra b le to the data provided on a wide ra n g e of
n o n -m o n e ta ry e co n o m ic v a r ia b le s , such a s th e g r o s s n atio n al
p rod u ct and r e la te d m e a s u r e s .
A co m p a riso n of th e s e two w ays of m e a s u rin g the r a t e
of grow th in

is shown in T ab le 2 fo r s u c c e s s iv e q u a rte r s

in 1972 and 1 9 7 3 .

The f i r s t colum n, la b eled M , show s annual

ra te s c a lc u la te d fro m en d -m on th s of q u a r t e r s ; the seco n d
colum n, la b e le d Q, show s annual r a te s c a lc u la te d fro m
q u a rte r ly a v e r a g e s .
T a b le 2
GROWTH R A T E S O F M ONEY S U P P L Y ON TWO BASES
Annual R a te of C hange, in p er cen t
M_
9 .2

5. 3

6. 1

8 .4

HI

8 .2

8. 0

IV
1973

I
II

1972

Q_

8.6

7. 1

I

1. 7

4. 7

II

10. 3

6 .9

in

0. 3

5. 1




A s m a y b e seen, the quarterly a v e r a g e s disclose m u c h
m o r e clearly the developing trend of m o n e t a r y restraint -- which,
in fact, b e g a n in the s e c o n d q uarter of 1972. .Also, the g r o w t h
of M j , w h i c h o n a m o n t h - e n d basis a p p e a r s v e r y erratic in the
first three quar t e r s of 1973, is m u c h m o r e stable o n a quarterly
a v e r a g e basis.

F o r e x a m p l e , while the level of M j did not

e x p a n d significantly b e t w e e n J u n e a n d S e p t e m b e r , the quarterly
a v e r a g e figures indicate further sizable g r o w t h in the third
quarter.

F o r p u r p o s e s of e c o n o m i c analysis, it is a n a d v a n t a g e

to r e c o g n i z e that the m o n e y available for u s e w a s a p p r e c i a b ly
larger in the third q uarter than in the s e c o n d quarter.

E x p e r i e n c e of 1 9 7 2 - 7 3
D u r i n g 1972, it w a s the responsibility of the F e d e r a l
R e s e r v e to e n c o u r a g e a rate of e c o n o m i c e x p a n s i o n a d e q u a t e
to r e d u c e u n e m p l o y m e n t to acceptable levels.

A t the s a m e

time, despite the d a m p e n i n g effects of the w a g e - p r i c e control
p r o g r a m , inflationary p r e s s u r e s w e r e gathering.

Monetary

policy, therefore, h a d to b a l a n c e the twin objectives of containing
inflationary p r e s s u r e s a n d e n c o u r a g i n g e c o n o m i c gro w t h .

These

objectives w e r e to s o m e extent conflicting, a n d m o n e t a r y policy
alone could not b e e x p e c t e d to c o p e with both p r o b l e m s .

Continuation




-20-

of a n effective w a g e - p r i c e p r o g r a m a n d a f i r m e r policy of
fiscal restraint w e r e urgently needed.
T h e n a r r o w l y - d e f i n e d m o n e y stock i n c r e a s e d 7. 4 p e r
cent during 1972 { m e a s u r e d f r o m the fourth quarter of 1971
to the fourth quarter of 1972).

B e t w e e n the third q uarter of

1972 a n d the third quarter of 1973, the g r o w t h rate w a s 6.1
p e r cent.

B y the first half of 1973, the annual g r o w t h rate

h a d declined to 5. 8 p e r cent, a n d a further slowing o c c u r r e d
in the third quarter.
Evaluation of the a p p r o p r i a t e n e s s of these g r o w t h rates
w o u l d r equire full analysis of the e c o n o m i c a n d financial objectives,
conditions, a n d policies during the past t w o years, if not longer.
S u c h a n analysis cannot b e u n d e r t a k e n here.

S o m e pe rspective

o n m o n e t a r y d e v e l o p m e n t s during 1 9 7 2 - 7 3 m a y b e gained,
h o w e v e r , f r o m c o m p a r i s o n s with the e x p e r i e n c e of other
industrial countries, a n d b y recalling briefly h o w d o m e s t i c
e c o n o m i c conditions e volved during this period.
T a b l e 3 c o m p a r e s the g r o w t h of M j in the United States
with that of other industrial countries in 1 972 a n d the first half
of 1973.

T h e definitions of M j differ s o m e w h a t f r o m c o u n t r y to

country, but a r e as n e a r l y c o m p a r a b l e as statistical s o u r c e s
permit.

It g o e s without saying that e a c h co u n t r y faced its o w n




-21-

s e t of e co n o m ic conditions and p ro b le m s.

Y e t it is u sefu l to

note th a t m o n e ta ry grow th in the United S ta te s w as m u ch low er
than in o th er m a jo r in d u stria l c o u n trie s , and th a t it a ls o w as
s te a d ie r than in the o th er co u n trie s.

T ab le 3
AN N UAL P E R CEN T R A T ES O F GROWTH IN M O N EY S U P P L Y
4th Q u a rte r 1971
to 4th Q u a rte r 1972
U nited S ta te s

4th Q u a rte r 1972
to 2nd Q u a rte r 1973

7 .4

5 .8

U nited Kingdom

14.1

10.0

G e rm a n y

14.3

4.2

F ran ce

15.4

8.7

Ja p a n

23. 1

28.2

T h e n e x t tab le show s, in s u m m a ry fash io n , the r a t e s of
chan ge in the m oney supply of the U nited S ta te s , in its to ta l
p ro d u ctio n , and in the co n su m e r p r ic e le v e l during 1972 and
1973.

The ta b le is b a se d on the la te s t d a ta .

It m a y be noted,

in p a ss in g , th a t, a cco rd in g to data a v a ila b le as la te a s Ja n u a ry
1973 , the r a t e of grow th of M j during 1972 was 7 . 2 % , not 7 . 4 % ;
and th a t th e r a t e of in c r e a s e in r e a l G N P w as 7 . 7%, not 7 . 0%.




-2 2 -

In o th er w o rd s, on the b a sis of the data a v a ila b le during 1972,
the r a t e of grow th of M j w as below the r a t e of grow th of the
p h y sica l volum e of o v e r - a l l p ro d u ctio n .

T a b le 4
M ONEY S U P P L Y , G N P, AND P R IC E S IN T H E U. S.
(P e r cen t change at annual r a t e s )
4th q u a rte r 1971 to
4th q u a rte r 1972 to 5
4th q u a rte r 1972
2nd q u a rte r
3 rd qu^rte
of 1973
of 197$
M oney supply (Mj )

7.4

5*
5. G
§
o

5.8

G r o s s N ational P ro d u c t

Ou
&

C u rre n t d o lla rs

10.6

12.1

H*?
2.

C on stant d o lla rs

7 .0

5 .4

4.cp

C on su m er pr i c e index (C P I)

3 .4

7. 1

7 .8

C P I excluding food

3 .0

4 .0

4. 1

P ric e s

The tab le in d ica te s th a t grow th in M j during 1972 and
1973 a p p ro x im a te ly m a tch e d the grow th of r e a l output, but w as
fa r below the exp an sion in the d o lla r value of the n a tio n 's output.
Although m o n e ta ry p olicy lim ite d the a v a ila b ility of m on ey r e la tiv e
to the grow th of tr a n s a c tio n s d em an d s, it s till e n co u ra g ed a sub­
s ta n tia l expan sion in e co n o m ic a c tiv ity ; r e a l output r o s e by about




-

7 pe r cent in 1972.

23-

E v e n so, u n e m p l o y m e n t r e m a i n e d u n ­

satisfactorily high throughout the greater part of the year.
It w a s not until N o v e m b e r that the u n e m p l o y m e n t rate d r o p p e d
b e l o w 5 - 1 / 2 per cent.

F o r the y e a r as a whole, the u n e m p l o y ­

m e n t rate a v e r a g e d 5. 6 per cent.

It m a y b e of interest to

recall that u n e m p l o y m e n t a v e r a g e d 5. 5 pe r cent in 1954 a n d
I960, w h i c h ar e c o m m o n l y r e g a r d e d as r e c e s s i o n years.
Since the e x p a n s i o n of

in 1972 w a s l o w relative to

the d e m a n d s for m o n e y a n d credit, it w a s a c c o m p a n i e d b y
rising s h o r t - t e r m interest rates.

L o n g - t e r m interest rates

s h o w e d little net c h a n g e last year, as credit d e m a n d s w e r e
satisfied m a i n l y in the s h o r t - t e r m m a r k e t s .
In 1973, the g r o w t h of M j m o d e r a t e d w h ile the t r a n s ­
actions d e m a n d s for c a s h a n d the t u r n o v e r of m o n e y accelerated.
G N P in current dollars r o s e at a 12 per cent annual rate as prices
r o s e m o r e rapidly.

In credit m a r k e t s , s h o r t - t e r m interest rates

r o s e s harply further, w h i l e l o n g - t e r m interest rates also m o v e d
up, t h o u g h b y substantially less than s h o r t - t e r m rates.
T h e extr a o r d i n a r y u p s u r g e of the price level this y e a r
reflects a variety of special influences.

First, there h a s b e e n

a w o r l d - w i d e e c o n o m i c b o o m s u p e r i m p o s e d o n the b o o m in the
United States.

Second, w e h a v e e n c o u n t e r e d critical shortages




-

of basic materials.

24*

The expansion in industrial capacity needed

to produce these materials had not been put in place earlier
because of the abnormally low level of profits between 1966 and
1971 and also because of numerous impediments to n e w investment
on ecological grounds.

Third, farm product prices escalated

sharply as a result of crop failures in m a n y countries last year.
Fourth, fuel prices spurted upward, reflecting the developing
shortages in the energy field. A n d fifth, the depreciation of
the dollar in foreign exchange markets has served to boost
prices of imported goods and to add to the demands pressing on
our productive resources.
In view of these powerful special factors, and the cyclical
expansion of our economy, a sharp advance in our price level
would have been practically inevitable in 1973.

The upsurge of

the price level this year hardly represents either the basic trend of
prices or the response of prices to previous monetary or fiscal
policies -- whatever their shortcomings m a y have been.

In

particular, as the above tables shows, the explosion of food prices
that occurred this year is in large part responsible for the
accelerated rise in the over-all consumer price level.

f




-

25-

T h e s e v e r e rate of inflation that w e h a v e e x p e r i e n c e d
in 1973 cannot responsibly b e attributed to m o n e t a r y m a n a g e ­
m e n t or to public policies m o r e generally.

In retrospect, it

m a y well b e that m o n e t a r y policy should h a v e b e e n a little less
e x p a n s i v e in 1972.

B u t a m a r k e d l y m o r e restrictive policy

w o u l d h a v e led to a still s h a r p e r rise in interest rates a n d
r i s k e d a p r e m a t u r e ending of the b usiness expansion, without
limiting to a n y significant d e g r e e this year's u p s u r g e of the
price level.

Concluding Observations
T h e p resent inflation is the m o s t serious e c o n o m i c
p r o b l e m facing our country, a n d it p o s e s great difficulties for
e c o n o m i c stabilization policies.

W e m u s t recognize, I believe,

that it will take s o m e t i m e for the forces of inflation, w h i c h n o w
engulf our e c o n o m y a n d others a r o u n d the world, to b u r n t h e m ­
selves out.

In today's e n v i r o n m e n t , controls o n w a g e s a n d

prices cannot b e e x p e c t e d to yield the benefits they did in 1971
a n d 1972, w h e n e c o n o m i c conditions w e r e m u c h different.
P r i m a r y reliance in dealing with inflation -- both in the n e a r
future a n d o v e r the longer t e r m -- will h a v e to b e placed on
fiscal a n d m o n e t a r y policies.




-

26-

T h e p rospects for regaining price stability w o u l d be
e n h a n c e d b y i m p r o v e m e n t s in our m o n e t a r y a n d fiscal instru­
ments.

T h e conduct of m o n e t a r y policy could be i m p r o v e d if

steps w e r e t a k e n to i n c r e a s e the precision with w h i c h the m o n e y
supply ca n b e controlled b y the F e d e r a l R e s e r v e .

P a r t of the

p r e s e n t control p r o b l e m s t e m s f r o m statistical inadequacies -chiefly the paucity of data o n deposits at n o n m e m b e r banks.
Also, h o w e v e r , control ov e r the m o n e y supply a n d other m o n e t a r y
a g g r e g a t e s is less precise than it c a n or should b e b e c a u s e n o n ­
m e m b e r b a n k s a r e not subject to the s a m e r e s e r v e r e q u i r e m e n t s
as a r e F e d e r a l R e s e r v e m e m b e r s .
I h o p e that the C o n g r e s s will support efforts to rectify
t hese deficiencies.

F o r its part, the F e d e r a l R e s e r v e B o a r d

is e v e n n o w c arrying o n discussions wit h the F e d e r a l D e posit
I n s u r a n c e C o r p o r a t i o n about the n e e d for better statistics o n
the nation's m o n e y supply.

T h e B o a r d also expects shortly to

r e c o m m e n d to the C o n g r e s s legislation that will put d e m a n d
deposits at c o m m e r c i a l b a n k s o n a u n i f o r m basis f r o m the
standpoint of r e s e r v e r e q u i r e m e n t s .
I m p r o v e m e n t s in our fiscal policies a r e also ne e ded.
It is i m p o r t a n t for the C o n g r e s s to put a n e n d to f r a g m e n t e d
consideration of expenditures, to place a f i r m ceiling o n total
F e d e r a l expenditures, a n d to relate these expenditures to




-27-

p ro sp e c tiv e reven u es and the nation’ s econom ic n eed s.

F ortun ately,

there is now w id e sp re a d recogn ition by m e m b e r s of the C o n g re ss
of the need to r e fo r m bud getary p ro c e d u re s along these broad
lines.
It a ls o is high time for f i s c a l policy to becom e a m o re
v e r s a t ile tool of econom ic sta b ilizatio n .

P a r t ic u la r ly a p p ro p ria te

would be f i s c a l in stru m e n ts that could be adapted quickly, under
s p e c ia l le g is la t iv e r u l e s , to changing econom ic conditions -such a s a v a r ia b le tax c r e d it for b u s in e s s investm ent in fixed
cap ital.

Once again I would u rg e the C o n g r e ss to give s e r io u s

c o n sid e ratio n to this urgently needed r e fo rm .
We m u st striv e a l s o for better understanding of the
e ffects of econom ic sta b iliza tio n p o lic ie s on econom ic activ ity
and p r i c e s .

Our knowledge in this a r e a is g r e a t e r now than it

was five or ten y e a r s ago , thanks to exten sive r e s e a r c h u n d e r­
taken by eco n o m ists in a c a d e m ic institution s, at the F e d e r a l
R e s e r v e , and e lse w h e re .

The keen in te r e st of the Jo in t Econom ic

C om m ittee in im proving econom ic sta b iliz a tio n p o lic ie s h a s, I
b e lie v e , been an influence of g r e a t im po rtan ce in stim ulatin g
this w id e sp r e a d r e s e a r c h effort.

-

28-

I look f o r w a r d to continued cooperation with the C o m m i t t e e
in a n effort to achieve the kind of e c o n o m i c p e r f o r m a n c e our
citizens expect a n d deserve.




Sincerely yours,

A r t h u r F. B u r n s

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