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An Approach to Monetary Policy Formulation

The Case of the Vanishing Metals
Return to the City— Fact or Fancy?

BUSINESS REVIEW is p ro d u c e d in th e D e p a rtm e n t o f R esearch. K a th ryn K a lm b a c h w as p rim a rily re s p o n s ib le
fo r th e a rtic le , “ Th e Case o f th e V a n is h in g M e ta ls ” and S h irly G oetz fo r “ R etu rn to th e C ity — Fact or Fancy?” The a u th o rs w ill
be g lad to re ceive c o m m e n ts on th e ir a rtic le s .
R equ ests fo r a d d itio n a l c o p ie s s h o u ld be a d dresse d to B ank and P u b lic R e la tio n s, Federal R eserve B a n k o f P h ila d e lp h ia ,
Digitized
ford FRASER
P h ila
e lp h ia , P e n n s y lv a n ia 1 9 101.

AN APPROACH
TO MONETARY POLICY
FORMULATION
by Albert R. Koch*
There has been renewed interest in monetary

and Credit, and some thought-provoking works

theory, monetary processes, and monetary pol

by academic contributors to hearings and pub

icy in the past decade. This has been worldwide

lications of the House Banking and Currency

and not national in character— witness the work

Committee, particularly those of Meltzer and

of the Radcliffe Commission in England, the

Brunner.

Royal Canadian Commission in Canada, and

I intend to focus my remarks this morning

the Commission on Money and Credit and the

on two of the most challenging criticisms of re

Committee

cent monetary policy raised by these critics,

Financial

Institutions

in this

country.

first, that the System has “ money market my

Reasons for this renewed interest in monetary

opia,” that is to say, that it puts too much stress

matters are numerous, but I would put in the
forefront the lack of complete satisfaction with

on short-term money market conditions as a
guide to monetary policy formulation, and, sec

economic performance in general, and monetary

ond, and even more important, that it does not

performance in particular. In the United States,

have a satisfactory theoretical framework upon

there has been also the re-emergence of a bal-

which to base its monetary operations. To put

ance-of-payments problem and a number of im

it another way, these criticisms question the

portant structural and institutional economic

nature and validity of current objectives of and
guides to monetary policy.

and financial changes, including the sharp and
sustained growth in nonbank financial institu

Before I get into substantive comments, let

tions and the development of a number of new

me stress that the views I express today are my

money and capital market instruments.

own and not necessarily those of all of my col

This renewed interest in monetary matters

leagues at the staff or the policy-making level of

has prompted a number of significant academic
contributions to the literature, including a mon

the Federal Reserve. Having said this, however,
let me add that I think that as a whole these

umental analysis of post-Civil War monetary de

views can probably be said to represent the

velopments in the United States by Friedman

most common ones held within the System. I

and Schwartz, the large number of valuable

say this because you are, of course, more inter

papers prepared for the Commission on Money

ested in what might be termed the “ official”
Federal Reserve view than of one member of its

* Mr. Koch, Associate Director of the Division of Research
and Statistics, Board of Governors of the Federal Reserve
System, presented this paper at a Monetary Seminar of the
Federal Reserve Bank of Philadelphia on December 12, 1964.

staff. But I think it is probably impossible to
express adequately such an official view.

business review

This is true for two main reasons. First, as

But in buying and selling U.S. Government

the story unfolds, you will see that it suggests

securities, the Federal Reserve creates or absorbs

a complicated rather than a simple answer to

bank reserves. Under our system of requiring

the monetary policy formulation problem, and

banks to hold specified percentages of their de

one that involves much individual judgment as

posits in the form of legal reserves, that is, in

well as quantitative measurement. In such a

vault cash or deposits at the Federal Reserve

situation, there are bound to be gradations of

Banks, the Federal Reserve thus influences the

viewpoint. Secondly, there are a score of policy
makers within the System and even more eco

outstanding volume of bank credit, bank de
posits and the money supply. The process by

nomic advisers. It would be strange, indeed, if

which changes in bank reserves affect deposits

they all had the same views on any subject,

involves the way in which banks that are mem

much less on one as complicated as monetary

bers of the Federal Reserve System manage

policy formulation.

their liquidity positions, that is, their holdings

“ M o n e y M a r k e t M y o p ia ”

the ability of such banks to make loans and

Turning now to the substantive issues at hand,

acquire longer-term investments. This transmis

and taking up first the recent criticism that ac

sion process can be illustrated by the diagram

cuses the Federal Reserve of “ money market

on the following page.

of money market assets. This, in turn, affects

myopia,” it is true that the System uses what is

Contrary to some critics, the Federal Reserve

commonly referred to as “ money market con
ditions” as day-to-day guides to policy. But the

does not assess money market conditions solely,
or even mainly, on the basis of judgment. There

reason for this is not that such conditions are

is a set of quantitative measures that have been

ends or objectives in and of themselves, but

found to convey accurately the state of the

rather that the effects of Federal Reserve actions

money market. No one of these indicators in

are most immediately and clearly reflected in

and of itself tells the whole story, but the entire

them.

family of them conveys quite a clear and rea

I can perhaps explain this best by describing

sonably accurate picture of conditions.

briefly the first steps in the transmission process

One of these indicators of money market con

between Federal Reserve actions and basic eco

ditions is the reserve position of the banking

nomic and financial developments. The most

system and this is usually measured by the out

common and usual method by which the Federal

standing volume of free or net borrowed re

Reserve influences the economy is through buy

serves available in the system, that is, the excess

ing and selling U.S. Government securities in

reserves of member banks less their borrowings

the open market.* In a sense, one can say that

from the Federal Reserve Banks. Since the rela

the only variable over which the Federal Re

tionship between free or net borrowed reserves

serve has complete control in its open market

and more basic monetary and banking develop

transactions is its holdings of such securities.

ments varies over time with the intensity of
both the demand by bank customers for credit

* The Federal Reserve also has certain oth er general powers
to influence c re d it con ditio ns, m a in ly th e powers to set
reserve requirem ents and disco u n t rates, bu t these are
changed only infre que ntly.

and the demand of banks for excess reserves, it
is best used as an indicator of short-run changes

business review

in bank reserve availability. As such, the free

The activities of dealers in U.S. Government

reserves concept is exceedingly useful, partly

securities are particularly important in this ad

because data on it are available so promptly.

justment process since Government securities are

Other quantities or relationships that are of

one of the main money market instruments

particular use in measuring the state or condi

through which banks, other financial institutions

tion of the money market include: (1) the level

and business corporations normally make day-

of Treasury bill rates, particularly that on 3-

to-day adjustments in the reserves or short-term

month maturities, (2) the level of the Federal

funds available to them.

funds rate relative to the discount rate of the

Having said that money market conditions are

Federal Reserve Banks, (3) the volume of Fed

the guide to day-to-day Federal Reserve opera

eral fund flows, par

tions and explaining

FIRST STEPS IN THE MONETARY PROCESS

ticularly through the
New

York

market,

mainly

ground

on
that

the
the

and (4) the volume

money market is the

of, and rates charged

first

point

the

on, New York com

transmission process

mercial bank loans to

between Federal Re

dealers in U.S. Gov

serve action and eco

ernment securities. In

nomic activity, let me

addition, daily

add that the System’s

pro
BANK DEPOSITS, INCLUDING
MONEY SUPPLY AND TIME AND
SAVINGS DEPOSITS

jections of the bank

-.
,
f m V -t O -f lr lV
U tV

, .
O n lP P t lV P
O U JC C IX V C

reserves likely to be absorbed or provided by

is normally to prevent sharp changes in money

such market factors affecting reserve availability

market conditions in the short run. The System

as float, currency flows, gold flows, and Treasury

contributes to significant changes in such con

balances with the Federal Reserve Banks are

ditions only when it seeks a change in the more

made by the Federal Reserve for several weeks

basic monetary or bank credit developments.

ahead.
You will note that most of these quantitative

The short-run objective of smoothing out
sharp changes in money market conditions is an

measures of money market conditions focus on

old one. It was in fact one of the original pur

conditions in New York City. The reason for

poses for establishing central banks. This was

this is that New York is the focal point of pres

because of the belief that short-run, erratic fluc

sure or ease in bank reserves throughout the

tuations in interest rates and money market

country, regardless of the origin of such pres

conditions

sure or ease. Even if the pressure or ease origi

flows.

disturb

basic trade and financial

nates in isolated areas, local banks make their

In seeking to avoid instability in money mar

reserve adjustments in part through their corre

ket conditions as a short-run objective of mone

spondent banks in financial centers other than

tary policy, the Federal Reserve does tend to

New York, which banks in turn make their ad

offset some market influences on financial be

justments in part through the New York money

havior that might give clues as to developing

market.

changes in underlying financial conditions. How

business review

ever, the Federal Reserve’s short-run interest

they are of major importance because, on the

rate objective is avoidance of instability and

one hand, they are more closely related to real

not pegging. It still permits some fluctuations in

economic developments than money market con

rates and other money market terms to occur

ditions, the day-to-day operating guides to Fed

and through them hopes to detect significant

eral Reserve policy, and, on the other hand,

changes in the demands for and supplies of

they are more closely subject to Federal Re

short-term funds.

serve influence than the ultimate objectives of

It is also true that in striving to avoid day-

policy like employment, production and pur

to-day instability in money market interest rates

chasing power, which I shall come to a bit

and other terms the Federal Reserve allows

later.

short-run changes in the public’s desires for

Having said that these intermediate objectives

money and bank credit to be accommodated.

were of major importance in the determination

This is as it should be. The demands for money

of monetary policy, let me say that most of us

and bank credit have much short-run volatility

in the Federal Reserve probably consider them

and reflect changes of a seasonal, temporary and

important as a group and not in isolation. This

random nature. They should be accommodated.

is essentially because we have not yet found a

Hence we look to relatively stable money market

simple or unchanging set of transmission proc

conditions as a proximate short-run guide to

esses among financial variables themselves or

policy because we know of nothing better. The

among financial variables and economic activity.

supply of bank credit and money comes to be

Earlier, I noted briefly the connections between

adjusted in conformity with the longer-run ob

Federal Reserve action and money market de

jectives of Federal Reserve policy.

velopments, bank credit and money. The con
nections from there on out to other financial

M o n e y su pply, b a n k credit, a n d interest

variables and then on to real economic develop

rates

ments are much more complex. In addition,

Let me turn now to a discussion of a set of

problems of feedbacks and interactions among

more basic financial variables on which some

the various variables begin to become more im

Federal Reserve critics suggest that the System

portant.

should put major, if not exclusive, emphasis

In essence, though, the most common view

in determining monetary policy. These would

within the System is that changes in the money

include such variables as the money supply,

supply, in the cost and availability of bank

variously defined, bank credit and longer-term

credit and in money market conditions do, after

interest rates.

a time lag, affect the capital markets, and the

These variables are often termed “ intermedi

ability and desires of consumers and businesses

ate” in character, not because they are inter

to finance expenditures and to acquire financial

mediate in importance but rather because they

and real assets. These effects occur as a result of,

are intermediate in the over-all transmission
process between Federal Reserve action and

first, changes in the availability and cost of bank

economic activity. In terms of importance and

of various marketable financial assets, relative

relevance to current monetary policy formation,

both to each other and to the prices of goods

credit and then changes in the prices and yields

business review

and services. The flow of funds to and from

major sectors of the economy considerably more

nonbank financial institutions are also soon af

rapid than that in the real GNP. Such rates of

fected by these changing yield, price and avail

increase could probably be sustained for a very

ability relationships among various types of

long time, theoretically indefinitely, if interest

loans and investments. It is in these changing

rates tended downward more or less continu

relationships among all types of assets, both fi

ously, but there are practical limitations to such

nancial and real, and from money to the most

a downward drift of interest rates in a key cur

illiquid of fixed investments, that we feel that

rency country like the United States. Monetary

monetary policy has its impact on the real

policy cannot do the entire job of ensuring full

economy;

utilization of the economy’s resources. This is

At the risk of gross oversimplification, I have

particularly true if the economy is plagued by

tried my hand at a simple diagram of these

more basic, structural problems, for example, a

transmission processes. It sketches the main in

cost and price structure that is incompatible

fluences and feedbacks among major categories

with full resource utilization or a distribution

of financing and the real economic world.

of income that is not conducive to sustained high-

Perhaps the ma
jor question econo
mists

would

raise

about this diagram

MAJOR REMAINING STEPS IN THE MONETARY
PROCESS— WITH SOME OF THE MAIN
INTERACTIONS NOTED
MONEY MARKET CONDITIONS,
INCLUDING SHORT-TERM INTEREST RATES

CAPITAL MARKET CONDITIONS,
► INCLUDING LONG-TERM
INTEREST RATES

level consumption.
In

recent

years

this country has also
experienced a fairly

concerns the inclu
sion of an element

rapid rate of rise
in liquid assets, to

entitled, “ the rate
and quality of mon

terpart of the debt

etary and credit ex

expansion. This rise

pansion.”

has been desirable,

This

some extent a coun

an aspect of the fi

as it has meant a

nancial system that

channeling of more

people in central banking, and in the financial
world in general, seem to emphasize more than

funds from savings, as well as from the banking
system, into investment and consumption of dur

academic economists. I identified it separately

able goods. But the resultant large volume of

in the diagram not so much because of its inde

liquid asset holdings outstanding does pose a

pendent importance, but rather because of the

potential inflationary threat if the holders of

limitation some people in the System feel that

such assets would decide to spend them in large

it puts on the use of monetary policy as an in

volume. Of course liquid assets have to be con

strument of economic stabilization.

verted into money before they are spent and the

It is felt that it has a limiting nature for two

Federal Reserve has some control over this con

reasons. In the first place, rates of credit and

version process. But the exercise of such control

monetary expansion can be unsustainable. For

could pose serious practical difficulties.

example, for some years now we have had rates

Secondly, there is the question of the risk

of credit or debt expansion in several of the

character of lending and investing activities.

business review

Available evidence suggests the terms of many

late policy.

types of loans and investment have been pro

simple quantitative guide to policy nor any in

gressively relaxed in recent years. Actual de

variate model of the functioning of the econ

fault

also

omy, but it does have in mind both a set of

risen in some lines. There is also the potential

objectives and a set of transmission processes

additional loss problem in case of economic re

through which policy takes effect.

and

foreclosure

experience

have

cession.

Admittedly, the System has no

In this connection, it is relevant to note that

Another aspect of this credit question that
has concerned some in the System in recent

the Federal Reserve has not had the benefit of
any analytical framework of monetary policy

years has been the growing practice of borrow

that is generally accepted by monetary econo

ing short and lending long. This process is, of

mists; for there is none. Moreover, there are

course, in a sense the heart of banking and it

also varying degrees of importance attached to

has been with us since at least the beginning of

monetary policy as compared with fiscal policy

banking. When widespread, however, and in

as an instrument of economic stabilization.

volving both large holders of volatile funds and

Most monetary economists, both in this coun

many small individual savers, it poses the pos

try and abroad, probably fall into one of two

sible restrictive effects of sudden and large with

schools of thought as to the principal ways in

drawals of funds on long-term interest rates, the

which policy affects the economy. The first

capital markets and investment generally. This

school stresses the causal importance of li

could also mean financial failures, on the one

quidity, including but not necessarily confined

hand, or inflation, on the other hand, if the de

to the money supply, variously defined. The

mands for liquidity were met by the Federal

second stresses the cost and availability of fi

Reserve.

nancing, mainly of longer-term borrowed funds,

Many economists argue that credit quality
should not be a concern of central bankers, but

including but not exclusively those supplied by
commercial banks.

rather should be left to the judgment of indi

The more vocal school— which stresses a sim

vidual lenders and borrowers acting in the

ple, elegant and, on its face, most appealing

market place. But history shows that lenders and

theory— at the moment appears to be the li

borrowers can be sheep, and that a central bank

quidity school. In this country, stress is put

that completely disregards credit quality does

mainly on the strategic importance of the money

so at great risk.

supply, but not consistently defined. In England,

The foregoing discussion of what many of us

on the other hand, many economists tend to

in the Federal Reserve consider to be the main

downgrade the importance of the money supply

relationships, linkages or transmission processes

per se and stress rather the total liquidity of the

between monetary action and economic activity

economy, rarely, however, very specifically de

is the basic answer to the second major criti

fined. In this country, we also have numerous

cism of the System that has been raised in recent

economists who stress credit and capital market

years, namely, that it has no acceptable theo

conditions generally and the level of longer-term

retical or analytical framework and, therefore,

interest rates rather than the money supply as

that it has no real basis upon which to formu

the set of variables most related to real economic

Digitized for8 FRASER

business review

developments and, therefore, the most pertinent

saying something about the problem of defining

guides to the formulation of monetary policy.

terms, because I think it is more than just a

However strong the differences in view of

matter of semantics. It is important mainly be

economists are as to the strategic factors in

cause if a monetary theorist has a problem in

monetary policy formation, I find the most re

defining his terms, he is also likely to have a

cent views of the various proponents as to the

problem with his basic theory.

transmission processes between policy and eco

Let me illustrate my thought with the word

nomic activity fairly similar, and, for that mat

“ money.” Friedman now defines money, for ex

ter, quite similar to the transmission processes

ample, to include time and savings deposits at

I traced out a bit earlier. This is a step forward.

commercial banks as well as currency and de

If we can agree on the transmission processes,

mand deposits. But when he defines money to

we may be able to affect those processes by in

include an item other than that which can be

fluencing not necessarily one but a number of

used as a medium of exchange, it seems to me

its elements. For example, the Federal Reserve

that he opens up a Pandora’s box. Why not, for

puts considerable stress on the course of aggre

example, include as part of the money concept,

gate bank reserves in policy formulation, in

savings and loan shareholdings which you and

large part because it is reserves, more specifi

I hold as close substitutes for demand deposits,

cally, nonborrowed reserves, that the System

and Treasury bills which corporations hold for

affects most immediately and most directly. A

similar purposes? It is not satisfactory to an

given level of reserves is not sought in and of

swer this question simply by saying that the

itself but because through it the System can

observed past relationship between changes in

achieve certain effects on such factors as bank

the money supply defined in a particular way

credit, the money supply and interest rates,

and changes in economic activity is closest. A

effects which, it should be noted, are neither

more convincing rationale is needed.

precise nor unvarying.
If one accepts essentially the transmission

U ltim ate objectives

processes I mentioned earlier, the question of

Thus far I have talked solely of the role of

whether one should focus on money supply and

financial variables in the formulation of mone

liquidity, or on the cost and availability of

tary policy, starting with a discussion of day-

credit as the key intermediate objectives for

to-day money market guides to action and then

monetary policy also becomes less significant.

going on to discuss the relationships of these

This is because in this view of the transmission

very short-run developments to changes in what

processes money and liquidity affect spending in

I have called “ intermediate” factors like bank

large part through their effects on interest rates

credit, money and interest rates. But, as I noted

and on credit availability, although they are in

earlier, these intermediate financial variables

turn, of course, affected by the cost and avail

are only steps in the process of influencing the

ability of credit as well as by such other factors

ultimate economic objectives of policy. Now

as transactions, precautionary and speculative

what are these ultimate objectives?

needs for cash balances.
I do not want to leave this subject before

Basically, the ultimate objectives of monetary
(Continued on Page 12)

THE CASE OF THE VANISHING METALS
S IL V E R

GOLD
BILLIONS OF DOLLARS

BILLIONS OF DOLLARS

0
-2
-4

-6

Since 1958, the United States has been experiencing sub
stantial deficits in its regular balance of international
payments.

PER CENT

, <
*
For some time, while the gold stock has been dropping, the <
dollar volume of Federal Reserve note and deposit liabili
ties has been rising. Consequently, there has been an
increase in the gold certificate reserve required to back
them.

Not only has new production of silver in the United States
. . been stable for years, but our Nation was a net exporter of
the metal in 1964 for the first time since World War II.
t

MILLIONS OF OUNCES

140 -

The Government has taken steps in recent years to make
available for coinage the silver held in the silver certificate
reserve account. Retirement of $5 and $10 silver certifi
cates was ordered in 1961. In addition, the Treasury is now
retiring $1 silver certificates and Federal Reserve notes
in $1 denomination are being issued in their place.
BILLIONS OF OUNCES

BILLIONS OF DOLLARS

At the same time, industrial consumption has risen and
outstripped new production. Further increases in non
monetary demand appear certain because of the continued
* growth of users such as the electronics, photography and
missile industries.

The deficits have been settled in both gold and dollars.
Although the percentages of gold to the deficit have been
declining, gold sales to foreigners continue and will in
crease this year.

BILLIONS OF DOLLARS

December 31

With the gold certificate required reserves going up and
gold certificates actually held by Federal Reserve Banks <
going down, the amount of "free" gold certificates (that not
held as reserves) has declined steadily.
<<

To fill the ever-widening gap between supply and demand,
the Treasury has been drawing on its silver stock. Although
its holdings are still large, the growing rate of depletion in
recent years and prospects for continuation have stimu
lated thinking as to what might be done.

MILLIONS OF OUNCES

CENTS PER OUNCE

PER CENT

* Includes paym ent o f $344 m illio n to I.M.F.

As a result of the gold sales, the gold stock of the Treasury
has declined and promises to continue to fall.

As a result, the ratio of gold certificates to Federal Reserve
note and deposit liabilities has approached the 25 per cent .
legal minimum, thus calling for measures to relieve the
situation.
.

Along with increased industrial demand, the use of silver
for coinage zoomed as the Treasury sought to satisfy what
seem to be the insatiable demands of the economy, espe
c ia lly vending machines, numismatists and hoarders.

The release of Treasury silver stocks to help meet the
shortfall of production relative to consumption in the
United States as well as the world has had a stabilizing
effect on silver prices. Quotations for prompt delivery in
New York have been at 129.3 cents per troy ounce since
the fall of 1963.

Source: H andy & Harman.

business review

(Continued from Page 9)

With this view of the close relationship in the

policy are no different from those of other Gov

achievement of all of the various ultimate objec

ernmental economic policies. Essentially, they

tives of monetary policy, the trade-offs among

are those embodied in the Employment Act of

possible conflicting objectives become somewhat

1946, that is to say, monetary policy is to con

less of a problem. While fully recognizing that

tribute to the fullest to the achievement of maxi

the ultimate of objectives of monetary and all

mum employment, production and purchasing

other Governmental economic policies is a con

power. Most interpreters of the Employment

tented and full life for all the people, which in

Act, including most of us in the System, have

cludes the ability to find work as well as to fi

come to define purchasing power as involving

nance and enjoy leisure, we have not yet found

the need to maintain reasonable price stability.

it practicable either to assign weights to the

Two additional basic objectives have become

various objectives noted earlier or to measure

accepted parts of Governmental economic pol

their interrelationships. More research is badly

icy, including monetary policy, since the enact

needed on this subject. In the meantime, it is

ment of the Employment Act, namely, maximum

probably fair to say that when actual conditions

economic

get far out of line with any one of the broad ob

growth

and balanced

international

payments.

jectives, it tends to get priority attention.

On this general question of the ultimate ob

Nor do we find we can go directly to one or

jective of monetary policy, however, there re

all of these ultimate objectives as a guide to

main some fundamental points of disagreement.

day-to-day monetary policy formulation. Let me

Among the most important of these I would

illustrate this point. An academic friend of mine

put (1) the ranking of objectives in case of con

dropped into the office some time ago to com

flict, and (2) the question as to whether mone

plain that current monetary policy was too re

tary policy can most effectively be used contra-

strictive. I asked him why he thought this was

cyclically or only to achieve longer-run growth.

so. His answer was direct and simple— the un

As for possible conflicts among the ultimate

employment rate was too high. Granted, I said,

goals, many of us in the System feel that most,

but what does that mean as to how many Gov

if not all, of the goals are inextricably inter

ernment securities the Federal Reserve should

twined. This means that some progress must be

buy or how many bank reserves it should supply

made toward achieving all of them in order to

today. His second and following answers were

achieve any one of them. For example, we feel

just as direct and simple as his first. Buy more

that reasonable price stability and balanced in

Governments and provide more bank reserves

ternational payments are essential if maximum

today than was done yesterday, and if the un

employment and production are to be achieved.

employment rate continues too high, buy more,

There is also the argument, but one to which

the day after tomorrow than tomorrow, and

most of us in the System would not subscribe,

keep doing this until the unemployment rate
drops to the desired level.

namely, that monetary policy can appropriately
pay more attention to prices and the balance of

When I questioned my friend as to the possi

payments, while fiscal policy concerns itself
more with employment and economic growth.

ble effects of this course of action on such as

pects of economic and financial life as the bal

business review

ance of payments, the gold outflow, interest

monetary policy is best used as a counter-cycli

rates,

prices,

cal economic instrument or one better designed

wages and the like, he also had ready answers.

to achieve longer-run objectives. The answer to

But these answers did not seem adequate to me

this question hinges essentially on one’s view as

stability

financial

markets,

because they failed to assess properly the sig

to the lags involved in the monetary process.

nificance of economic developments other than

The most important lag concerns the time be

the unemployment rate.

tween the taking of a monetary policy action

Those of us on the firing line do not feel that

and spending, whether it be for consumer or

we can accept with equanimity, for example,

capital goods. There are other lags, for example,

substantial price increases, wage settlements in

between the need for a policy action and its

excess of productivity gains, disorderly financial

recognition, and between recognition and action

markets, and large gold outflows. Therefore, we

by the Federal Reserve, but most observers feel

do not feel we can use a measure like the un

that these lags are quite short now or could be

employment rate as a single, simple guide to

made so.

monetary policy formulation.

As for the lags between policy action and

Moreover, we have only a limited number of

spending, much useful research on this subject

general policy tools to deal with these varying

has been done in recent years but much more

economic and financial problems, and there are

remains to be done. Friedman, for example,

interrelationships among the responses that keep

finds the lags long and variable and, therefore,

us from solving the problems in strict econo
metric style. Most of us in the System are not

concludes that monetary policy has little to con
tribute as a contra-cyclical economic policy in

very sanguine about the effectiveness over any

strument. Kareken, Solow, Brown, Ando and

extended period of time of trying to achieve any

most other economists who have studied this

significant part of our objectives by selective or

problem find the lags shorter and, contrary to

direct controls. Of course, the Federal Reserve

Friedman, feel that monetary policy can profit

has regulated stock market credit for many years

ably be used to moderate cyclical fluctuations.

and an interest equalization tax on foreign se

Probably most of us in the Federal Reserve

curity issues is now in existence, but these are
the only selective credit controls now in effect

share this latter view. Quantitative studies un
derplay the psychological and expectational ef

and they only deal with a relatively small part

fects of a change in monetary policy on spend

of total credit flows.

ing in general. Moreover, the effects of changes

This lack of reliance on selective credit con

in policy on such factors as spending plans, new

trols is another reason why the formulation of

ordering and the like are probably quite prompt.

general monetary policy has to take into con

Thus, we feel that monetary policy does have

sideration all, and not just one, of the objectives

an important role to play in evening out the

of such policy. There is, of course, the possibil

cycle.

ity of varying to some extent the composition of

As for the appropriate place of economic

our available limited set of general tools, for ex

growth in the set of ultimate objectives of mone

ample, the monetary policy-fiscal policy mix.

tary policy, many of us in the System have con

Let me turn now to the question as to whether

cluded that it is probably not very fruitful to

business review

think of it as an independent objective of policy.

conditions, and, second, that it has no accept

That is, we feel that maximum, sustainable eco

able framework or model as to how monetary

nomic growth can probably be most likely
achieved if the Federal Reserve concentrates on

policy affects the general economy, that is, that

helping to achieve maximum employment, pro

is most appropriate at any given time.

duction

and purchasing power,

it has no basis for knowing what kind of policy

implying as

In addressing myself to these criticisms, I

these objectives do, a moderation of cyclical

have tried to be constructive rather than de

fluctuations.

structive. In stating why I feel these criticisms

It would take me about as long to support this

represent a false view of Federal Reserve thought

proposition as I have talked already— and I

and action, I hope I have spelled out some of the

have already talked too long. Essentially though,
it boils down to the fact that we think that the

dimensions of a framework for policy that the
System does have in mind.

rate of economic growth depends much more

This framework, unfortunately, is neither sim

on nonmonetary than monetary factors, factors

ple nor precise. This is no doubt due in part

like the allocation of income between spending

to inadequate information and to limited ana

and saving, and the rate of development of new

lytical powers, but I think it is also due to the

human skills and technical processes. Monetary

very nature of the problem with which we are

policy does affect to some extent, of course, the

dealing. We live not only in a very complex,

formation of capital. But the importance of the

relatively free market economy but also in one

differential effects of monetary policy on various

that is very dynamic in its nature.

types of spending and debt— for example, on

Having said this, let me reaffirm the fact that

consumption versus investment or on housing

the Federal Reserve does have a set of objec

versus business debt— are not clear.

tives for monetary policy constantly in view, as

Thus, I am by no means certain about the

well as some ideas about the transmission proc

practical importance of the commonly expressed

esses through which System action seeks to

dichotomy that suggests that easy monetary pol

achieve, or at least helps to achieve, these ob

icy favors investment over consumption and

jectives. However, our knowledge of these proc

easy fiscal policy consumption over investment.

esses, changeable as they may be, is extremely

Moreover, this line of thinking abstracts com

poor. We very much need a stepped-up program

pletely from possible problems raised by con

of empirical work to study and assess the many

tinuing easy money on the international finan

processes, linkages and relationships involved in

cial area.

the vast areas between Federal Reserve action
and over-all economic activity. We are eagerly

Concluding com m ents

seeking “ models” of

In conclusion, let me try to summarize what I

observed

have tried to say today. I have taken as my

text two frequently expressed criticisms of the

given

the economy

relationships

decide

that

appropriate

times and

can

monetary

under

given

based

help

policy

circumstances

Federal Reserve, first, that it has “ money mar

and to assess the results of policy

ket myopia,” that is, that it is unduly concerned

once

with day-to-day fluctuations in money market

as well as you in the universities, have done

14FRASER
Digitized for

taken.

the

Federal

actions
Reserve,

business review

far too little of this type of work in the past.

statistical techniques, and closer observed rela

But, finally, let me express a word of caution

tionships will help us formulate a better mone

about work in this field. Let us be extremely

tary policy in the future, but I suspect they will

careful about trying to fit a complex world into

never completely eliminate the need for con

an oversimplified mold, and let us be modest

siderable doses of judgment— both value and

about implying immutability to past relation

empirical judgment— on the part of our mone

ships we may discover. More data, improved

tary policy makers.

RETURN TO THE C ITY FACT OR FANCY?
It was a big day for the Scotts. The clothes were

development. Rising incomes and the availability

packed, telephone disconnected, furniture and

of long-term mortgages enabled suburbia to fit

rugs all ready for the movers. The Scotts were

into more and more family budgets. The wide

leaving their ten-year-old ranch-type house, their

spread ownership of cars made commuting prac

uphill struggle with the lawn, and the hours

tical; no longer were residential areas circum

spent getting to and from work, shopping cen

scribed by bus routes or railroad tracks.
Along with the people came shopping centers

ters, and Boy Scout meetings to hardier pio
neers with more patience and greener thumbs.

The Scotts were moving back to the city.

branches of well-known department stores, va

all sizes

and descriptions complete with

riety stores, and specialty shops. The city was
O ff to the su burbs
Ten or fifteen years ago the Scotts’ type of move

not only losing its population, but its hold on

was unheard of. Mass exodus from the cities

As if this were not enough, industry, too, began

to the promised land of suburbia was then in

to harken to the call of the suburbs. Land was

full swing. During the 1950’s, over a quarter of

cheaper and more readily available;

a million more people moved out of the City of
Philadelphia than into it while the outlying

housing developments could provide the labor
and in some cases the market for production;

counties experienced phenomenal growth. All

.firms were able to combine utility and beauty in

over the nation, city dwellers by the millions

architecturally attractive, one-story plants.

the shopping dollar was seriously threatened.

nearby

advertisements.

The city was rapidly disintegrating. Natural

Sunshine and fresh, clean air; trees and grass;

processes of decentralization were not the only

open space for the children; and the pride of

problems. Many neighborhoods were deteriorat

owning a home were all possible in a suburban

ing into slum or semi-slum conditions; over

eagerly

answered

real

estate

business review

crowding was an unpleasant fact; community

in the expansion of hospitals and universities,

facilities were outdated. These conditions did

industrial development, and the preservation of

nothing to curb the suburban stampede; in fact,

good neighborhoods.

they persuaded many on the fringe of blighted
areas to get out while they could.
Some of those who were left behind stayed

In 1965 a Philadelphia Rip Van Winkle would
have difficulty recognizing his old city. Even
ten years ago there was no Penn Center, no

not by choice but of necessity. Moving requires

Independence Hall Mall, no Park Towne, and no

money. Even with low down payments and easy
credit terms, numbers of unskilled workers were

modern Food Distribution Center. Over 35,000
new housing units were authorized by building

tied to the city by lack of funds. Older families

permits since 1960. Playgrounds, parks, malls,

faced with the prospect of decreased earnings

office buildings, apartment houses, and modern

were often unwilling to take on new financial

housing developments are all part of the face

burdens. It is not surprising, therefore, that city

lifting.

residents tend to be older, have less education
and lower incomes than suburbanites.

Back to the city?
Recent population estimates do not suggest im

The c h a n gin g city

proved growth in most large cities, but they

The city of the past was rapidly becoming obso

do indicate a change for the better in Phila

lete. Where deterioration and overcrowding were

delphia. The population of Philadelphia County

present, solutions were obvious but expensive.

decreased by 3 per cent between 1950 and 1960;

Decentralization posed a different problem, for

from 1960 to 1963, it increased by 2 per cent.

to some extent it was natural and unavoidable.

The central counties of the fifteen largest met

The city had to adjust to the inevitable by ac

ropolitan areas, however, had the same rate of

tively developing its assets as a center for mar

population increase after 1960 as in the 1950’s—

kets, administrative and head offices, theaters,

1 per cent per year.1 As the chart shows, the

and all sorts of cultural and recreational facili

suburbs continued to out-gain the central coun

ties. With these services, the city should be able

ties in population. Between 1950 and 1960, sub

to attract and hold a substantial resident popu

urban counties grew about four times as fast as

lation, and bring in nonresidents to buy and sell,

central counties. From 1960 to 1963, this growth

to coordinate business activity, and to enjoy

differential was reduced to two-and-a-half to

more fully their leisure time. The city would
become an indispensable service center for a

one in favor of the suburban counties.

widely diffused urban area.

for two reasons. The classification of a metro

These figures must be interpreted carefully

Responsible citizens sought to hasten this

politan area into central and suburban counties

metamorphosis. Federal and state governments

may conceal almost as much as it reveals. The

provided aid. Planning commissions were es

central county in the majority of areas includes

tablished.

not only the central city but additional land and

Urban

renewal and redevelopment

projects were undertaken. Philadelphia’s pro
gram is a good example; its goals include slum
clearance, the revitalization of center city, aid

Digitized for
16FRASER

1 The fiftee n largest m e trop olita n areas in term s o f the
1960 population are New York, Chicago, Los Angeles-Long
Beach, Philadelphia, D etroit, Boston, San Francisco-Oakland, P ittsburgh, St. Louis, W ashington, D.C., Cleveland,
B altim ore, Newark, Minneapolis-St. Paul, and Buffalo.

business review

URBAN VS. SUBURBAN— POPULATION GROWTH

more people come into an area than leave it. An
increase in population mainly from natural in

PERCENTAGE CHANGE PER YEAR

crease tells us nothing about an area’s relative
attraction as a place to live. To know more about
this, we must look at net migration. Positive net
migration (that is, more people moving into an
area than out) usually is interpreted as a healthy
sign that people favor a particular community
in which to live and raise a family.
All in-migration, however, may not benefit an
area. A community of any size prefers those
persons who possess the skills, educational at
tainments, and economic means to contribute to
the general well-being. In past years, non-whites,
out-of-work coal miners, and farmers came to
people,

big cities such as Philadelphia. Lacking indus

grouped with the suburbs. The extreme example

which

for

our

purposes

should

trial skills, they often could not readily find em

of this is Los Angeles-Long Beach where the
central county and the metropolitan area are one

ployment and become productive members of
the community.

and the same. In cases such as this, it is diffi
cult to know whether the growth in a central

Today this type of migration probably is less
of a factor than formerly in Philadelphia. For

county’s population has occurred in the city

one thing, populations now are smaller in many

portion or in the outlying area of the county.

hard-hit farming and mining areas. Also, the

During the fifties, the outlying portions of cen

worst period of adjustment is over in most such

tral counties gained population faster than did

areas. Furthermore, big cities like Philadelphia

the cities themselves; central counties in nine of

no longer offer many jobs to attract unskilled

the fifteen metropolitan areas gained population

in-migrants. Philadelphia already has a consid

while only one central city did so. If the 1950-

erable surplus of unskilled labor seeking such

1960 growth pattern has not altered greatly in

employment.

the last few years, the outlying areas of the cen

A July, 1962, study by the Pennsylvania

tral counties would once again have been ex

Economy League indicates that non-whites moved

pected to grow faster than the cities. Therefore,

into Philadelphia, largely from the South, at de

the population growth we observed in central

creasing rates as the nineteen fifties progressed.

counties from 1960-1963 may still not be taking

The annual net in-migration during the forties

place downtown.
These population changes are subject to an
other qualification: they reveal little if anything

was approximately 9,000; during the fifties this
dropped to 6,500, and most of this was in the
earlier half of the decade.

about the nature of the growth. An increase in

The latest available estimates of migration are

population occurs for one or both of the follow

for the years 1960-1962. In-migration did ex

ing reasons: more people are born than die, or

ceed out-migration in the central counties of

business review

three areas: New York, Los Angeles-Long Beach,
and San Francisco-Oakland. But, except for
Philadelphia and three other central counties,
the outflow in other areas has not even shown a

URBAN VS. SUBURBAN— NET MIGRATION
AVERAGE YEARLY MIGRATION AS PERCENTAGE OF POPULATION
AT BEGINNING OF PERIOD
15 LARGEST METROPOLITAN AREAS

PHILADELPHIA METROPOLITAN AREA

tendency to slow down since the 1950’s. There
□

fore, although the trend in seven areas indi

1950-1960

■ I 1960-1962

cates some improvement, most suburbs are con

| In-migration
| Out-migration

tinuing to enjoy the benefits of in-migration
while most cities are not.
Once again these figures should be inter
preted carefully. At best, they are only gross ap
proximations of central and suburban move
ments. These statistics include nothing on the

Suburban counties

Central counties

origin of in-migrants or the destination of outCentral county

migrants. It is possible that a large proportion
of migration represents not intra-metropolitan
area movements, but inter-state or even inter

well see a return to the city by many disillu

sectional shifts. For example, over the years,

sioned suburbanites, although population and

California suburbs have had a substantial num

migration data as yet show little evidence of it.

ber of in-migrants which came not only from

City growth should benefit somewhat by ex

California cities but from all over the country.

pected trends in population. The most rapid ex

Crude as these estimates are, they do provide

pansion is in the young adult group; during the

a clue to central population changes since 1960.

decade of the sixties, this group is expected to

They do not indicate much of a return to the

increase by more than 50 per cent. The popula

city. In both the fifties and the sixties, central

tion over 65 is expected to gain an additional 3

populations increased little. Furthermore, out

million during the same period. These two age

migration from central counties has continued

groups are prime candidates for city life. Popu

unabated in total, although in a few areas it has

lation in central cities has a higher proportion

slowed down or stopped.

in these two groups than it does in the suburbs.
Within central cities, young adults and senior

W h a t of the fu tu re ?

citizens account for one in six of the population.

The suburbs may continue to be favored as

In contrast, these two groups constitute one in

home locations in the sixties, but it is too early

eight of the suburban population.

to be sure. A freshly created supply of good

To attract these potential in-migrants and to

housing in a renewal area may not immediately

keep its present population, the city must accept

generate a group of eager buyers on the door

and promote its role as the metropolitan area’s

step. Location changes are major decisions for

center for business, recreation, and culture. This,

any family, and as such they will be made over

plus its inherent convenience in ease of living,

a period of time. Later in the sixties we may

are its best selling points for the sixties.

Digitized for18
FRASER

F O R THE R E C O R D
INDEX

•

• •

BILLIONS $

MEMBER BANKS, 3RD F.R.D.

B U S IN E S S

DEPARTMENT STORE SALES, DIST.

(1957-1959= 100, SEASONALLY ADJUSTED)

FACTORY PAYRC>LLS, DIST.
(i 57-1959= 100)
.

/
#

-k

FACTORY EMPLOYMENT,’ DIST.
CONSUMER PRICES , PHILA.

(1957 1959 = I00|

2 YEARS
AGO

YEAR
AGO

DEC.
1964

Third Federal
Reserve District

United States

Per cent change

Department
Storef

Factory*
Employ
ment

Payrolls

Sales

Check
Payments

Per cent
change
Dec. 1964
from

SUMMARY
Dec. 1964
from
mo.
ago

year
ago

12
mos.
1964
from
year
ago

mo.
ago

year
ago

12
mos.
1964
from
year
ago

+ 8

+ 6

Dec. 1964
from

LOCAL
CHANGES

mo.
ago

MANUFACTURING
Electric power consumed. . . .
Man-hours, to ta l* ....................
Employment, to ta l......................
W age incom e*..........................

0
+ 2

+ 9
4 *6
+ 9
+ 8

+
+
+

CONSTRUCTION**....................

-5 7

-1 4

+ 13

+ 4

COAL PRODUCTION.................

-2 0

+ 14

+ 3

+ 2

TRADE***
Department store sales.............

+ 4

+ 10

BANKING
(All member banks)
Deposits......................................
Loans...........................................
Investments.................................
U.S. Govt, securities...............
O ther .................................
Check payments ....................

+ 1

+
+
-

2
1
2
3
1
+ I6{

+ 6
+ 8

+
+
+
-

1
3
3

+ 3
+ 3

2
- 5
5
+ 11 + 15
+ 12t + 6 t

0
0
+ 1
+20

+
+
+
-

13
2
2
+ 10
+ 12

+ 12
+ 1
- 6
+ 13
+ 10

PRICES
Consumer....................................
‘ Production workers only.
“ Value of contracts.
‘ “ Adjusted for seasonal variation.

mo.
ago

year
ago

2
0

mo.
ago

year
ago

mo.
ago

year
ago

+ 9

+ 7

+ 5

+ 11

+ 10

+21

6
9

year
ago

ot + l't + 2J

+ 1

f20 Cities
{Philadelphia

Lehigh Valley. . .

+ 2

Harrisburg.........

Lancaster...........

+ 4

+ 11

Philadelphia. . . .

+ 2

+10

+ 18

+ 8

Reading.............

+ 16

+ 13

Scranton............

+ 3

Trenton..............

W ilkes-Barre. . .

W ilm ington. . . .

0
1

York...................

+ 5

+10

+ 9

+ 13

+ 10

+ 2

+ u

+ 12

+ 14

+ 4

+20

+36

+ 19

+ 11

+55

‘ N o t restricted to corporate limits of cities but covers areas of one or more
counties.
{Adjusted fo r seasonal variation.