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A |P H A ^ O F ' T H E B O A R D O P - O O V E R I n > R S
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WASHINGTON, D. C . 2 0 5 5 1

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•M a y 14,

1971

The Honorable William Proxmire
Committee on Banking, Housing and
Urban Affairs
United States Senate
Washington, D. C. 20510
Dear Senator Proxmire:
Your letter of May 3, attaching a reprint of an article by Milton
Friedman, asks for comment on the issue of whether the substantial
rate of growth in money supply over the past few months is related
to "obsolete procedures" in carrying out monetary policy, with too
much emphasis being placed on money market conditions and interest
rates. I would say that the monetary growth experienced is not
the product of a procedural problem, but rather that it reflects
fundamental forces in the economy and has to be evaluated in
relation to these forces.
The recent rapid growth rates in money, both narrowly defined to
include currency and demand deposits (M^) and more broadly defined
to include also time and savings deposits at commercial banks other
than large CD ’ (M2 ), may be attributed mainly to two conditioning
s
circumstances. First, particularly with respect to narrowly defined
•money, the recent rapid growth has reflected the temporary surge in
demand for cash balances to accommodate enlarged transactions needs
of the public resulting from the post-auto-strike rebound in
economic activity. In the fourth quarter of 1970, because of the
auto strike, the nation’ gross national product valued in current
s
prices rose at less than a 2 per cent annual rate; in the first
quarter of 1971, with production recovering from strike-depressed
levels, GNP rose at about a 13 per cent annual rate. Over the
course of those two quarters, and roughly paralleling the swing in
GN? growth rates, rates of increase in M^ were around 3-1/2 per
cent and 9 per cent, respectively.
While temporary variations in transactions demands for cash in the
economy were central in explaining
behavior over the past few
months, it should also be noted that Treasury cash management
practices have been a factor. There was a sizable net transfer of




The Honorable W i l l i a m Proxmire

-2-

funds from the U.S. Government to private sectors late in the first
quarter, indicated by a considerable drop on average in Government
deposits from February to March* As often occurs, such net transfers
led to a temporary enlargement of cash balances in private h a nds., *
Since peaking in early April, the outstanding amount of M-^ has
declined on balance, in part reflecting replenishment of the Treasury
cash balance.
The second principal explanation for rapid growth in money pertains
mainly to M . In the early months of 1971, there was a sharp spurt
in net inflows of time and savings deposits other than large CD*s to
banks. For the most part these are consumer-type time and savings
deposits. We believe this spurt was largely the result of one-time
transfers of savings by consumers out of market instruments, on which
yields had dropped sharply during the fall and winter, to time and
savings deposits at banks, whose yields had been maintained. Accord­
ing to preliminary estimates contained in the Board*s quarterly flowof-funds accounts, households sold or redeemed, net, about $17-1/2
billion of credit market instruments, principally U.S. Government
securities, in the first quarter.--—
InrsubstitUt£on,—and reflecting
also a continued high rate of net new personal saving, they added
about $15 billion to their holdings of time and savings deposits at
commercial banks and about $12 billion to deposits at nonbank savings
institutions.
2

2

To slow down the growth in money--either M^ or M ~-over the winter
period of very rapid growth would have required the Federal Reserve
to hold back on the provision of bank reserves. Total reserves of
banks rose at about an 11 per cent annual rate in the first quarter,
which accommodated--at the interest rates prevailing during the
period--the temporary rise in demands for cash and the large shift by
consumers in the forms in which their savings are held. If expansion
in reserves had been at a slower rate, money market conditions would
have been considerably tighter and, more broadly, both short- and
long-term interest rates would have been higher than they were. As
it turned out, the yield on new high-grade corporate bonds reached a
low point in late January and has since risen by over one full per
cent. And in short-term markets, Treasury bill rates were at lows
in mid-March and have since risen, depending on maturity, by 60 to
almost 100 basis points.




2

Photocopy fro
m Gerald R. Ford Library

Most recently, net inflows to banks of consumer-type time deposits
have slowed to more moderate proportions as many banks adjusted their
offering rates down and as the amount of savings available for shift­
ing was, in any event, worked off. This has led to a substantial
moderation in the growth rate of M following an unusually rapid 18
per cent annual rate of increase over the first quarter as a whole.

The Honorable W i l l i a m Proxmire

-3-

I hope these comments will prove useful to you. I recognize that
there can be room for difference in analyses of the appropriateness
of financial developments, even taking account of the economic environ­
ment in which they have occurred. The essential point, however, is
that the recent rapid growth in the aggregates is not a matter of the
procedures used in carrying out open market operations, but must be
viewed in relation to credit market conditions generally, to an
appraisal of what such conditions would have been if efforts had been
made to reduce growth rates under the circumstances of the time, and
to o n e ^ assessment of current economic conditions and economic
prospects. I can assure you that we are watching the behavior of the
monetary aggregates carefully, as well as the performance of the money
and capital markets, and that we are prepared to move if that behavior
should appear to threaten the prospects for orderly economic progress.




Sincerely,

Arthur F. Burns

Photocopy from Gerald R. Ford Libi

During the past several’ o n t h s , then, it has been necessary to weigh
m
behavior of the monetary aggregates against the behavior of interest
rates, and to assess them both in relation to the prospects for the
strength of economic recovery and in light of the international
position of the dollar. The Federal Reserve has not committed itself
to a single financial indicator or objective in gauging monetary
policy, but seeks instead to relate over-all financial conditions to
the specific economic developments and prospects of the time. In the
- period under review, there were"specific explanations for behavior of
the aggregates which indicated that the rapid rates of growth would
tend to be self-correcting. Moreover, since the economy was in the
beginning tender stage of recovery, we judged that there was undue
risk that any significant tightening in credit markets--particularly
long-term markets--might hamper progress toward the expansion in
economic activity and in job opportunities toward which we are all
striving.

JOHN S P A R K M A N , A L A .. C H A IR M A N
W iL L lA M P d b X M l R E . W I S .
H A R D IS O N a . W IL L IA M S , J R . , N J .
T H O M A S J . M C IN T Y R E , N .H .
W A L T E R F . M O N D A L E , M IN N .
A L A N C R A N S T O N ,C A L IF .
A D L A IE . STEV EN SO N III, IL L .
O A V IO H . G A M B R E L L , G A .

JO H N G . T O W E R . T E X .
W A L L A C E r . D H N N E T T , UTAH
EDW ARD W . EROOKE, M A SS.
BOO P A C K W O O O . O R E O .
W IL L IA M V . R O T H , J R ., D £ L »
B IL L B R O C K . T E N N .
R O B E R T T A F T , J R . , OHIO

O U O L E Y L . O’N E A L , J R .
S T A F F D IR E C T O R A N D G E N E R A L C O U N S E L

\S10roieb J & t a t e s J & e r x a le
C O M M IT T E E O N B A N K IN G , H O U S IN G A N D U R B A N A F F A IR S
W A S H IN G T O N . O .C .

20510

May 3, 1971

-Honorable -Arthur F. Burns
'Board of Governors of the
Federal Reserve System
Washington, D C. 20551
.
Dear M Chairman:
r.
I am enclosing a copy of a recent article by Milton
Friedman on the Federal Reserve Board's monetary policy over the
last few months. Dr. Friedman points out that the m
oney supply,
narrowly defined, grew at the rate of 13% a year in the two months
from January to March. Also enclosed is a table prepared by the
Federal Reserve Bank of St. Louis indicating am annual growth rate
of 1 8 . 1 $ from February to April.
The Federal Reserve Board table also indicates that the
m
oney supply has been growing at an annual rate of 9 , % from
6
November, 1 9 7 0 through April, 1 9 7 1 * The St. Louis Federal Reserve
Bank figures would thus seem to bear out Dr. Friedman's contentions
that the m
oney supply has been expanding at an extremely sharp rate
in recent months.
In the article, Dr. Friedman argues that the reason the
money supply has been expanding at an excessive rate is due to the
obsolete,procedures used by the N York Federal Reserve Bank in
ew
carrying out monetary policy. Dr. Friedman contends that the N York
ew
Fed places too m
uch emphasis on m
oney market conditions and interest
rates. I would appreciate your comments on Dr. Friedman's assessment
of the reasons for the substantial increase in the growth rate of the
money supply over the last few months.
With best wishes, I am

Enclosures




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