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FEDERAL RESERVE POLICY AND INFLATION AND
HIGH INTEREST RATES
HEARINGS
BEFORE THE
COMMITTEE ON BANKING AND CURRENCY
HOUSE OE REPRESENTATIVES
NINETY-THIKD CONGKESS
SECOND SESSION
JULY 16, 17, 18, 30; AUGUST 7, AND 8, 1974
Printed for the use of the
Committee on Banking and Currency
U.S. GOVERNMENT PRINTING OFFICE
36-714
WASHINGTON : 1974
COMMITTEE ON BANKING A N D CUKRENCY
WRIGHT PATMAN, Texas, Chairman
WILLIAM B. WIDNALL, New Jersey
WILLIAM A. BARRETT, Pennsylvania
LEONOR K. (MRS. J l H N B . ) SULLIVAN, ALBERT W. JOHNSON, Pennsylvania
J. WILLIAM STANTON, Ohio
Missouri
BEN B. BLACKBURN, Georgia
HENRY S. REXJSS, Wisconsin
GARRY BROWN, Michigan
THOMAS L. ASHLEY, Ohio
LAWRENCE G. WILLIAMS, Pennsylvania
WILLIAM S. MOORHEAD, Pennsylvania
CHALMERS P. WYLIE, Ohio
ROBERT G. STEPHENS, JR., Georgia
FERNAND J. ST GERMAIN, Rhode Island MARGARET M. HECKLER, Massachusetts
PHILIP M. CRANE, Illinois
HENRY B. GONZALEZ, Texas
JOHN H. ROUSSELOT, California
JOSEPH G. MINISH, New Jersey
STEWART B. McKINNEY, Connecticut
RICHARD T. HANNA, California
BILL FRENZEL, Minnesota
TOM S. GETTYS. South Carolina
ANGELO D. RONCALLO, New York
FRANK ANNUNZIO, Illinois
JOHN B. CONLAN, Arizona
THOMAS M. REES, California
CLAIR W. BURGENER, California
JAMES M. HANLEY, New York
MATTHEW J. RINALDO, New Jersey
FRANK J. BRASCO, New York
EDWARD I. KOCH, New York
WILLIAM R. COTTER, Connecticut
PARREN J. MITCHELL, Maryland
WALTER E. FAUNTROY,
District of Columbia
ANDREW YOUNG, Georgia
JOHN JOSEPH MOAKLEY, Massachusetts
FORTNEY H. (PETE) STARK, JR.,
California
LINDY (MRS. HALE) BOGGS, Louisiana
PAUL NELSON, Clerk and Staff Director
CURTIS A. PRINS, Chief Investigator
BENET D. GELLMAN, Counsel
JOSEPH C. LEWIS, Professional Staff Member
DAVIS COUCH, Counsel
ORMAN S. FINK, Minority Staff Director
(ii)
CONTENTS
Hearings held on—
July 16, 1974
July 17, 1974
July 18, 1974
July 30, 1974
August 7, 1974
August 8, 1974
"Report on Federal Reserve Policy and Inflation and High Interest Rates,"
submitted to the House Banking and Currency Committee by Dr. Robert
Weintraub, staff economist, July 12, 1974
Page
1
77
165
249
489
289
31
STATEMENTS
Balles, John J., president, Federal Reserve Bank of San Francisco
97
Burns, Hon. Arthur F., Chairman, Board of Governors of the Federal
Reserve System
251, 289
Eastburn, David P., president, Federal Reserve Bank of Philadelphia
121
Francis, Darryl R., president, Federal Reserve Bank of St. Louis
166
Hayes, Alfred, president, Federal Reserve Bank of New York
78
Mayo, Robert P., president, Federal Reserve Bank of Chicago
194
Meiselman, David L, professor of economics, Virginia Polytechnic Institute
and State University
337
Morris, Frank E., president, Federal Reserve Bank of Boston
209
Weintraub, Dr. Robert, staff economist of the House Banking and Currency Committee
5
Wright, John Winthrop, president, Wright Investors' Service, Bridgeport,
Conn
516
ADDITIONAL QUESTIONS
Questions Submitted by the Chairman and Members of the Committee
to the Federal Reserve Witnesses Along With Their Replies
I. Chairman Wright Patman, concerning the Federal Reserve's Securities
Portfolio
II. Hon. Leonor K. Sullivan, requesting comments on the staff recommendations made by Dr. Robert Weintraub, staff economist of the House Banking and Currency Committee on July 16, 1974
First recommendation
Second recommendation
Third recommendation
III. Hon. John H. Rousselot, concerning possible efforts to influence and
coordinate testimony of the Federal Reserve bank presidents
IV. Hon. John H. Rousselot, concerning effect of the action taken by the
Federal Reserve to supply the Franklin National Bank with $1.2 billion
in emergency reserves
V. Hon. Fernand J. St Germain, concerning the viability of thrift institutions and housing in periods of inflation and high interest rates; and
Hon. John H. Rousselot, on miscellaneous matters
(in)
349
361
361
367
370
373
399
409
IV
ADDITIONAL INFORMATION SUBMITTED FOR THE RECORD
Balles, John J.:
Page
Prepared statement
101
Response to questions of :
Chairman Wright Patman
354
Hon. Edward I. Koch
163
Hon. John H. Rousselot
376,401
Hon. Fernand J. St Germain
411
Hon. Leonor K. Sullivan
363, 368, 370
Brimmer, Hon. Andrew F., member, Board of Governors of the Federal
Reserve System, letter to Hon. Henry S. Reuss, dated August 5, 1974,
commenting on legislation designed to empower the Federal Reserve
Board to influence explicitly the sectoral distribution of bank credit
274
Brown, Hon. Garry, article entitled, "Burns Urges White House To Push
Drive On Inflation, but Sees Long Battle Ahead," from the Wall Street
Journal of August 7, 1974
334
Burns, Hon. Arthur F . :
Letters t o :
Chairman Wright Patman regarding questions about the Federal
Reserve Board's responsibilities under the Bank Holding Company Act as they relate to the Franklin New York Corporation,
the parent of the Franklin National Bank, and the acquisition
of voting shares by Fasco International Holding, S.A.
("Fasco"), dated:
June 5, 1974
295
August 2, 1972
296
Hon. Henry S. Reuss, commenting on H.R. 15709, legislation
amending the Federal Reserve Act to permit the Federal Reserve Board to allocate credit so as to serve national priority
needs, dated July 29, 1974
271
Response to questions of:
Hon. William A. Barrett
261
Hon. Ben B. Blackburn
279, 281, 285
Hon. Margaret M. Heckler
307, 310
Hon. Matthew J. Rinaldo
326
Hon. John H. Rousselot
396, 401, 407
Hon. Fernand J. St Germain
269, 414
Hon. Leonor K. Sullivan
264, 265, 366, 369, 372
"Ways To Moderate Fluctuations in the Construction of Housing,"
summary report from the Federal Reserve Bulletin for March
1972
477
Eastburn, David P . :
Papers submitted from the "Business Review" of the Philadelphia
Federal Reserve Bank:
"Can Credit Controls Be Controlled," January 1972
447
"Federal Regulation of Stock Market Credit: A Need for Reconsideration," July-August 1974
465
"Federal Reserve Policy and Social Priorities," November 1970
425
"Interest Ban on Demand Deposits: Victim of the Profit Motive?",
August 1972
455
"Should Housing Be Sheltered From Tight Credit," November
1970
433
Prepared statement
125
Response to questions of:
Chairman Wright Patman
356
Hon. John H. Rousselot
378
Hon. Fernand J. St Germain
412
Hon. Leonor K. Sullivan
364, 368, 371
Federal Reserve banks represented at hearings:
Boston
209
Chicago
194
New York
78
Philadelphia
121
St. Louis___
166
San Francisco
97
Francis, Darryl R.:
Prepared statement
170
Francis, Darryl R.—Continued
Response to questions of :
Chairman Wright Patman
357
Hon. Ben B. Blackburn
247
Hon. Lindy (Mrs. Hale) Boggs
245
Hon. Bill Frenzel
242
Hon. James M. Hanley
240
Hon. John H. Rousselot
379, 402
Hon. Fernand J. St Germain
413
Hon. Leonor K. Sullivan
364,368,371
Hon. William B. Widnall
247
Hayes, Alfred:
Prepared statement
83
Response to questions of:
Chairman Wright Patman
349
Hon. Henry S. Reuss
144
Hon. Matthew J. Rinaldo
153
Hon. John H. Rousselot
375, 399
Hon. Fernand J. St Germain
409
Hon. Leonor K. Sullivan
361, 367, 370
Mayo, Robert P.:
Prepared statement
200
Response to questions of:
Chairman Wright Patman
358
Hon. Ben B. Blackburn
247
Hon. Lindy (Mrs. Hale) Boggs
245
Hon. Bill Frenzel
241
Hon. James M. Hanley
240
Hon. John H. Rousselot
394, 405
Hon. Fernand J. St Germain
236, 413
Hon. Leonor K. Sullivan
365, 368, 372
Hon. William B. Widnall
246
Morris, Frank E.:
Prepared statement
213
Response to questions of:
Chairman Wright Patman
359
Hon. Ben B. Blackburn
248
Hon. Lindy (Mrs. Hale) Boggs
245
Hon. Bill Frenzel
243
Hon. James M. Hanley
240
Hon. John H. Rousselot
394, 405
Hon. Fernand J. St Germain
236,414
Hon. Leonor K. Sullivan
365,369,372
Hon. William B. Widnall
246
Patman, Hon. Wright:
"Arthur Burns: In a Tight Money Squeeze," article from the Washington Post of August 8, 1974
300
"Bank Dominos," article from the Wall Street Journal of August 8,
1974
298
"Federal Reserve Readies Emergency Loan Plan," article from the
Washington Post of August 8, 1974
299
"Internal Revenue Collections of Individual and Corporate Taxes,
Selected Years, 1945-73" (table)
234
Letters to Chairman Arthur F. Burns :
Concerning the Federal Reserve Board's responsibilities regarding
the Franklin National Bank and its holding company operations
and the entry of foreign investment in the U.S. banking system,
dated:
May 14, 1974
293
July 19, 1972
295
Regarding the Chicago Federal Reserve Bank's refusal to the
committee's chief investigator to review various expenditures
of the Federal Reserve Club of the Chicago bank, dated August 1,
1974
297
VI
Reuss, Hon. Henry S., letters from the Federal Reserve Board commenting
on H.R. 15709, legislation which would amend the Federal Reserve Act
to permit the Federal Reserve Board to allocate credit so as to serve
national priority needs:
Chairman Arthur F. Burns, dated July 29, 1974
Gov. Andrew F. Brimmer, dated August 5, 1974
Weintraub, Dr. Robert, response to question of Hon. William S. Moorhead
on "Why are Federal Reserve policymakers for the most part wary of
Cagan's
findings?"
Wright, John Winthrop, prepared statement
271
274
29
491
FEDERAL RESERVE POLICY AND INFLATION AND
HIGH INTEREST RATES
TUESDAY, JULY 16, 1974
HOUSE OF REPRESENTATIVES,
COMMITTEE ON BANKING AND CURRENCY,
Washington, D.O.
The committee met, pursuant to notice, at 10:20 a.m., in room 2128
Rayburn House Office Building, Hon. Wright Patman [chairman],
presiding.
Present: Representatives Patman, Barrett, Sullivan, Reuss, Moorhead, Stephens, St Germain, Gonzalez, Minish, Annunzio, Rees, Koch,
Cotter, Mitchell, Moakley, Boggs, Widnall, Stanton, Brown, Williams, Wylie, Heckler, Crane, Frenzel, and Rinaldo.
Also present: Dr. Robert Weintraub, staff economist of the House
Banking and Currency Committee.
The CHAIRMAN. This morning we open hearings on monetary policy
with particular emphasis on how that policy affects inflation and interest rates. These can be some of the most important hearings this
committee has ever conducted, and they come at a time when the
American public is deeply concerned about the mismanagement of the
economy and is demanding action by its officials. Without question, we
are in one of the worst periods in the economic history of this Nation,
and the signs for the future are not encouraging. Raging inflation, the
highest interest rates in history by far, and mounting unemployment,
and yet we have no real plan to attack the problems.
The Federal Reserve System, with its vast powers, provides much
of the key to our economic successes or failures. The Federal Reserve
as a monetary manager must accept responsibility for economic conditions, and it is the responsibility of this committee, and for that
matter the Congress, to hold this agency responsible.
But the Federal Reserve has been a master of the bureaucratic snow
job. It operates behind years of carefully developed mythology, and
today too many newsmen and columnists and too many Congressmen
accept the pipe-puffing generalities as gospel.
In my opinion, and it will be supported by data that will be brought
out during these hearings, the Federal Reserve has been the engine of
our current inflation, and not the number one fighter against inflation,
as some financial columnists have informed us in recent weeks. In this
hearing, as in all previous hearings, the Federal Reserve Chairman,
Dr. Arthur Burns, will pass the buck, blaming the Congress, blaming
everyone but his own agency, which unfortunately has been allowed a
free hand to operate as it pleases.
(D
This time I hope the members will press in and ask the critical
questions, and not allow the personalities to stand in our way and to
let the outlandish buckpassing go by us as the truth. This is our
responsibility and the public expects action during this critical period
of our economy.
Dr. Robert Weintraub, who joined the staff last year from the University of California, has interviewed all 12 Federal Reserve bank
presidents and 5 of the 7 Governors of the Federal Reserve Board.
These are the most extensive interviews of Federal Reserve officials
ever conducted for a congressional committee.
Dr. Weintraub will be our first witness and will be followed by six
presidents of the Federal Reserve banks and Dr. Arthur Burns, Chairma]! of the Federal Reserve Board. I think it is valuable to have their
presence before the committee because we need more than just the
mimeographed statements of Dr. Burns. I cannot believe in this farflung Nation that all people are of the same voice in the Federal
Reserve System, and that there are not differences of opinion.
It is essential that the Congress have this knowledge. Therefore, I
hope that each of these Federal Reserve bank presidents are straightforward, and that they do not pull any punches, even if their testimony might upset the careful facade constructed by Dr. Burns through
previous congressional testimony and the endless backgrounders.
Dr. Robert Weintraub received his Ph. D. in economics at the University of Chicago, and has written extensively in the area of monetary
policy. He has assisted this committee over a period of several years.
I think he is one of the most highly qualified people we could have, and
the committee is fortunate to have him on board to conduct these
interviews.
Dr. Weintraub, you are recognized, sir. Are you ready to start ?
Dr. WEINTRAUB. Yes, I am, Mr. Chairman.
Mr. BROWN. Mr. Chairman ?
The CHAIRMAN. Yes ?
Mr. BROWN. I would like to be heard just briefly.
The CHAIRMAN. All right, go ahead.
Mr. BROWN. It is certainly convenient for any Member
of Congress,
especially the chairman of this committee, to pass the buck and to
pass the blame, as the chairman has suggested Dr. Burns has done, to
pass the blame to an agency. But there is not any question that the
authority lies within the Congress not only to do what it wants to
with respect to the Federal Reserve Board, but to eliminate it and to
eliminate the Federal Reserve System.
The law can be repealed, and yet in the course of the 8 years I have
been here, I have listened to this "Patmania" and I have yet to see the
chairman of this committee come forward with a restructuring of our
financial system, come forward with a proposal that would accomplish
that, to correct that which he now criticizes. I think until that time it
ought to bo the function of this committee and the function of the Congress to attempt to work with the members of the Federal Reserve
Board and the Federal Reserve System to try to get us out of the
problem, rather than further contribute to it by criticism of it.
The CHAIRMAN. I thank the gentleman for those critical words, and
I do not object to them at all. I am proud of them. I think that members should criticize anyone, even the chairman. But may I invite your
attention to the fact that I have had a bill, H.E. 11, in several Congresses, not just one. It takes time to pass laws that are not administration proposals. One of the most important laws ever passed in this
Congress, a bill to pay 3.5 million veterans of World War I $3.7
billion, H.E. 1, was before a number of Congresses before it finally
became a law and the veterans got their money.
Now, H.E. 11 is to restructure the Federal Eeserve. We not only
have had it pending in several Congresses, but we have had hearings on
it, and a lot has been done in that direction. I will state to the gentleman, and we may yet get it passed in time. It is possible the time will
come when liquidation would be desirable, and the Federal Eeserve
Act provides for liquidation, and all of the assets go to the U.S.
Treasury if the Federal Eeserve is liquidated. But I am not advocating
it at this time.
But we will wait to see if we can get any improvements in the Federal Eeserve where it will not be justified. The liquidation value would
be $100 billion, and the Federal Reserve has $80 billion in U.S. Government securities in its portfolio. The bonds were bought, but with
Government money. The Federal Eeserve did not pay a penny of that
money. The U.S. Government paid for them, and those bonds are now
in the portfolio of the Federal Eeserve in the Federal Eeserve Bank
of New York, and they are still collecting interest on those bonds.
They are collecting between $4 and $5 billion a year, although those
have been paid for once when they took Government money and paid
for Government bonds.
As every academic professor in economics will tell you, they are
always proudly saying that when the obligor and the obligee become
the same person the debt is paid, and this is that case.
Mr. KOCH. Mr. Chairman, may I be recognized for a moment ?
The CHAIRMAN. Wait just a moment. I will yield to Mr. Widnall.
He is senior minority member. We have got to get started.
Mr. KOCH. Mr. Chairman, I do not mind your yielding to Mr. Widnall. But I want to be recognized before we hear the first witness. I
just think that common courtesy and the rules of the committee would
provide that where a member asks to be recognized that he be recognized. Since you have already recognized two members, I would ask
for at least equal time.
The CHAIRMAN. I will recognize Mr. Widnall first.
All right, Mr. Widnall.
Mr. WIDNALL. Mr. Chairman, I just have to make this comment.
After many years of serving on this committee, and it has been a great
committee to serve on—we have had a chairman who has a history of
activity and performance in many ways that have been a credit to him
and to the country. But I am a little bit sick and tired of the opening
statements that have been made from time to time in which unsupported accusations are made in that statement and characterizations
are made of people and their activities in a way that is, I think, unwholesome and completely unfair and something that never gets
proven later on in connection with a case.
I have been here when we have had a Chairman of the Federal
Eeserve coming before us, and you, Mr. Chairman, have said in welcoming him that you knew he was a fine and honorable man and a
man of good character, and he has been a good Chairman. But at the
same time, if anybody else had done the things that he was doing, he
would be in jail today. There has never been any followup on that, and
I think things like that are extremely unfair characterizations, and I
for one—and I know Congressman Brown feels very much the same
way that I do—am a little bit tired of those accusatory statements that
are at the beginning of a meeting, which sets up sort of an unfair
background for the consideration of legislation, important legislation that we must consider on this committee. I just urge that you
preside with as much fairness as you can, and we will do a much better
job.
The CHAIRMAN. Well, the fairest thing I have always done, I have
always yielded to you immediately 'after I made those statements.
[Laughter.]
Mr. KOCH. Mr. Chairman ?
The CHAIRMAN. Shall we yield ? If we yield to one we should yield
to all.
Mr. KOCH. YOU have yielded to two members, Mr. Chairman.
The CHAIRMAN. HOW much time do you want?
Mr. KOCH. Four minutes or less.
The CHAIRMAN. Without objection, the gentleman is recognized.
Mr. KOCH. The reason that I asked for recognition was that I did
not want to sit here and permit my silence to be deemed an assent to
your comments with respect to Dr. Burns, and I am glad that two
other members have spoken out so forcefully, because you may disagree
The CHAIRMAN. Dr. Burns will be here next Tuesday to speak for
himself.
Mr. KOCH. Mr. Chairman, please permit me to continue.
We may disagree, you may disagree with me and I with you, and
the two of us on occasion with Dr. Burns. But the fact is, he is a very
honorable man whose reputation cannot be blemished by the comments that the Chair makes and has made on many occasions. I agree
with the ranking member on the Republican side here that it has come
to a point where it has got to stop. You just simply cannot tarnish the
reputations of people who come before us and then blithely go on and
let the testimony be taken, and then the comments that the Chair makes
go unsupported. That is number one; so I want to make that clear. I
have >a Jiigh regard for Chairman Burns.
The CHAIRMAN. I have not attacked him personally ever.
Mr. KOCH. The second point I want to make is this. I think it is
extremely important that this committee evaluate the agenda items.
I mean, it seems to me that a committee, made up of as distinguished
members as this committee ,has, should have some input into the
agenda, have some input into the witnesses that are called. I noticed,
just looking at the ranks of those who have not come or those who have
left, that that may be some indication of their upset at the way this
agenda is put together. I just offer the chairman, for whom I have a
very high regard, this comment that he ought to consider the opinions
and judgments of members of this committee in making up the agenda
and in the items that this committee will consider.
The CHAIRMAN. The gentleman should keep in mind that I ihaye
never made any personal attack on Dr. Burns. I have criticized his
policies and will continue to do so, regardless of what the gentleman
says, and that is where they are justified.
Mr. BROWN. Mr. Chairman, when you talk about pipe-puffing generalities, there is not much question in anyone's mind in this room who
you are talking about.
Mr. ANNUNZIO. I congratulate the chairman on the pipe-puffing,
and I hope he drops his pipe one of these days. I am tired of watching
the guy smoke while the depositors of this country and the small
people of this country iand the housing industry is suffering. It is too
damned bad when the chairman cannot express himself.
The CHAIRMAN. All right.
Dr. Weintraub, you are recognized. Do you have a prepared statement?
Dr. WEINTRAUB. Yes, I do.
The CHAIRMAN. All right, you go ahead with your prepared
statement.
STATEMENT OP DR. ROBERT WEINTRAUB, STAFF ECONOMIST
OP THE HOUSE BANKING AND CURRENCY COMMITTEE
Dr. WEINTRAUB. The members have before them two statements, a
long one and a condensed version, and what I am going to do is summarize from the condensed version, if that would be all right.
Let me begin by taking up what the Governors and presidents said
about the part that the Federal Keserve has played in the episode of
inflation, and high and still rising interest rates which have afflicted
our economy since 1964.
Nearly all recognize some and many an important degree of responsibility. There is wide agreement that accelerated money supply
growth stemming from stepped-up open market purchases, acts
sooner or later to accelerate inflation. This is the fundamental proposition of monetary theory. President Eastburn of Philadelphia used
it to synthesize monetary and other explanations of price developments in the 1965-73 period. He said:
In longer run periods, I think that it cannot be denied that the rate of growth
of money affects prices. Over this longer run period, that relationship has
existed.
He continued:
You have had rises in money growth and rises in prices, and I think the two
are related. Now, when you get to subparts of that and you narrow down the
time frame, then you get other elements affecting inflation. For example, fiscal
policy, special factors such as crop failures, worldwide demands for goods, shortages of materials and energy and so on.
To recapitulate this important statement, while fiscal policy and
special factors may account for changes in the rate of inflation for
short periods, in the context of a period as long as 1965 to 1973, inflation is a monetary phenomenon, and its rate depends on the rate of
growth of new money. In the 1965-73 period, the average annual increase in the Consumer Price Index or CPI was 3.2 percent faster than
in the 1959-64 period. It is no coincidence that between 1959-64 and
1965-73 the average annual growth rate of the conventionally defined
money stock, M-l, which consists of publicly held currency and demand deposits, jumped by 3.3 percent.
Moreover, responses by the Governors and presidents to questions
on specific policy actions and trends in monetary policy during the
6
1965-73 period also reveal that even in fairly shortrun contexts, there
was a close lagged relationship between money supply changes and
changes in economic activity, including the rate of inflation.
Inflation did not happen all at once, nor did it occur in a uniform
continuous wave. It began in 1965, slowed in the fall and winter of
1966-67, then reaccelerated and reached 6.3 percent per year in the
first 7 months of 1969. Referring to this subperiod, President Hayes
of New York said:
We did apply the pressure in 1966 and when we did see business slowing down
we reacted in early 1967. Perhaps we reacted a little too much in our fear of a
recessionary development which turned out to be very temporary and not very
serious. Then, in 1968, when we finally did get the fiscal support, monetary policy
was fearful that the fiscal move maybe was too strong. That turned out to be a
failure in judgment.
President Morris of Boston said: "The last half of 1968 was clearly
a misjudgment."
M-l growth was slowed beginning in the winter of 1969 and the
deceleration continued until February 1970. In the year ending February 1969, M-l growth was 8.1 percent. The next year it was 2.9
percent.
From August 1969 to January 1972, inflation tapered off. The
annual rate of rise of the CPI dropped from 6.3 percent in the first 7
months of 1969 to 3.9 percent in the first 7 months of 1971 just before
President Nixon's new economics program was put into effect, and to
2.9 percent from August 1971 to January 1972.
On this period, President Francis of St. Louis said:
In 1969 the Fed slowed down the rate of money creation and held it down to a
degree through 1970. We saw during that period, I would say, some wrenching in
the economy. We had some small influence, I think, also on the inflation rate—
it began to taper off.
From January 1972 to the summer of 1973, M-l growth was very
rapid. Year-to-year growth was 9 percent between January 1972 and
January 1973, and 8 percent in the year ending July 1973. The interviews reveal considerable dissatisfaction among Federal Reserve
policymakers with what happened during this period.
Governor Holland:
With hindsight, I am sure we would have followed a less expansive monetary
policy.
President MacLaury of Minneapolis:
Beginning mid-1972, I left the bandwagon, saying that we should be pursuing
a more restrictive policy in terms of monetary growth than we were in fact
pursuing.
Governor Brimmer:
In my view, many policy actions taken during much of 1972 were improper,
and rather than fighting inflation they were adding to it.
THE NEXT QUESTION
Questioning President Black of Richmond, I said:
I would come to the conclusion that money supply is very important for
understanding prices. Would you agree with that?
He answered:
I would agree completely. But so far as saying that that is the sole cause,
that is another question. You have got to go behind why the money supply did
what it did.
One reason that was given to explain inflationary M-l growth wras
an information problem. The Federal Eeserve does not itself track
demand deposits in nonmember banks. The FDIC does this through
its periodic call reports. Until last month, the FDIC called and received only four reports each year, and the Fed's between-reports
estimates of nonmember bank deposits and hence of M-l were low.
This information gap has largely been corrected. The FDIC is now
assembling large nonmember banks' deposits weekly and passing on
the aggregates to the Fed. The information problems aside, the Federal Reserve policymakers agree that they have ample powers to control money supply.
Most important, money supply cannot grow unless the Fed wants
it to. Questioning President MacLaury of Minneapolis I said:
Well, let me ask you: How could money supply, the nominal money supply,
have grown? How could it grow just because the economy wants it to grow unless
the Federal Reserve supplies the base for it?
President MacLaury of Minneapolis:
The way you put that, it could not. It could not. We have the ultimate control,
and the question is of the growth of the monetary base. I agree with you on that.
WHY MONET SUPPLY GREW AS IT DID
Why did it happen ?
At times during the 1965-73 period, M-l growth was stepped up
deliberately to reverse developing recessions and/or to reduce unemployment, each one over the near term. Most recently this was done
to reduce unemployment in 1972. Referring to the fact that unemployment was above 5i/£ percent until late that year, President Balles of
San Francisco said:
You would have had to conclude that we needed to stimulate the economy more
to get the unemployment rate down. Now, admittedly that was going to have some
unfortunate effect on prices, and I think it probably did.
Another reason why M-l grew as rapidly as it did since 1964 is that
the Federal Eeserve, since 1964, has tended to accommodate inflation
by validating price increases which originate in special events. And
many would now extend this policy to accommodate increased prices
of oil and also past pervasive inflation as well.
Governor Mitchell:
If you said that the original price rise was due, say to the Vietnam war, and
then you get a higher price level built into your system, then I think that monetary policy would tend to accommodate the price level rather than to roll it back.
President Black of Richmond:
With these extraneously imposed pressures on prices, you either had to create
unemployment or validate those price increases.
Governor Holland :
Our monetary aggregates need to be averaging a little higher than would be
true in the absence of the energy crisis or the food crisis that took place last
summer.
Governor Brimmer:
If the rate of growth in the money stock falls substantially short of a built-in
rate of inflation, you end up with very depressing effects on the real economy.
Others disputed the preceding lines of argument, some very
vigorously.
President Francis of St. Louis said:
I don't know why, if the level of production of goods and services in this country is forced down by an outside influence like energy, why we'd want to put
more dollars in the economy to chase those goods and services. I can see only
one outcome, and that would be further inflation.
President Balles of San Francisco: "It would be economic madness
to keep stepping up the rate of money supply to keep up with
inflation."
Excessively rapid M-l growth also was explained as the predictable
byproduct of the Federal Reserve trying to do other things. One such
reason cited was choosing to monetize large parts of fiscal deficits.
President Mayo of Chicago:
Fiscal policy was the basic culprit in forcing up, if you please, the increases in
the money supply.
Weintraub:
But what I'm puzzled about is the connection—the nexus. What is it that
compels the Federal Reserve to act to increase money supply and to increase the
rate of increase in money supply when the budget is in substantial deficit?
President Mayo:
Well, this is a direct result of the fact that the Treasury obviously has to
borrow when there's a deficit.
Weintraub:
That's right.
President Mayo:
The Treasury has to borrow in a real market. The Federal Reserve, I think has
a responsibility to see that a Treasury offering when properly priced in the given
market environment is not thwarted by tightening up on monetary policy. That is
why we have what is called even keel. The fact that the Treasury was, say
doubling its demands on the market would be a constraint that we couldn't
ignore, we couldn't say that the demand had to come out of somebody else's
hide.
A different view on this question was expressed by President
Francis of St. Louis. He said:
It is not necessary for the Federal Reserve to come to the support, say, of the
Treasury, to the degree it has. I would much prefer to see the Federal Reserve
try to determine the level of money that is consistent with full employment and
stability, and I don't think these are inconsistent objectives. I think it can be
accomplished by letting the Treasury cut its excessive needs out of the market.
Many indicated also that M-l growth strayed from the optimal
longrun path because the Fed let it do so while concentrating on fighting fires and keeping order in money markets.
President Cold well of Dallas:
Is the Federal Reserve to have its eye only on a target 18 months out, or is it
to respond to shortrun fire fights.
President Winn of Cleveland:
You know, I would agree that if you set controlling money supply as a single
objective, and you were not concerned about the behavior of any of the other
9
variables, you probably could control it much closer than you are able to do at
the moment. But I think what happens is, is to your willingness to let some of
the other elements fluctuate.
Weintraub: "There seems to be a set of targets that sometimes
"
Winn: "Are self-defeating in terms of
"
Weintraub: "Can be self-defeating certainly of a moderate money
supply."
Winn: "This is correct."
Governor Sheehan:
Money is growing faster than you want it to grow, so you turn to the staff and
say, "Staff, if we move against this high growth, what do you think the Federal
funds rate is going to do?" The staff says. "If you want to get it down within
your proposed limits, during that 3-month period, you have to be willing to
accept a Federal funds rate in the range of 20 to 25 percent for 8 to 10 weeks."
Others saw dangers from neglecting money supply while trying to
smooth shortrun fluctuations in the Federal funds rate and other
money market rates.
President Eastburn of Philadelphia:
You can forget what happens to money. I think that's the problem.
President Eastburn also said:
If you agree that it's desirable to get growth in money down sometime, one of
the problems that one incurs is finding the appropriate time, and there never
seems to be a good time.
THE FEDERAL RESERVE AND INTEREST RATES
Let me turn now to the relationship between Federal Reserve actions and interest rates. I t is commonly believed that the Federal
Reserve can decrease interest rates by increasing M-l growth. But it
cannot. Initially it is true that open market purchases increase reserves which impels banks to increase their lending, and money supply
expands and interest rates tend to fall in the process. But the fall in
interest rates does not last. Together, money supply growth and lower
interest rates impel increased spending. As a result, production and
prices advance, and there is feedback to credit markets from the increases in production and prices and such anticipated inflation as is
generated.
Questioning President MacLaury of Minneapolis, I asked:
Now, is there any feedback from the price increases and the output increases
on any of these variables that you have talked about? Interest rates in particular.
MACLAURY. "Definitely so. Yes."
WEINTRAUB. "OK, what happens to interest rates as a result? The
feedback?35
MACLAURY. "And now you are leading me to say, and I don't resist
saying, that interest rates are going to rise."
WEINTRAUB. "There is some tendency for interest rates to rise now?"
MACLAURY. "Surely."
WEINTRAUB. "And the greater, presumably, the rate of inflation,
would you go along with that theory, the greater the tendency for interest rates to rise?"
MACLAURY. "Yes, I would go along with that."
President CLAY of Kansas City. "Inflation causes high interest rates.
I believe that high interest rates result from inflation."
10
Questioning Governor Holland, I asked:
So a curious thing emerges here which is that insofar as monetary policy was
responsible for the expansion and the buoyancy and the inflationary tendencies,
it is responsible for the high interest rates.
Governor Holland:
Yes, I put a lot of weight on the "insofar as responsible," because I think there
are a lot of factors at work here. But the more monetary stimulus that's pressed
into the economy, the more response you get in terms first of real output, and
then as you get close to capacity, the more that expansion spills out in prices;
and the more the latter happens, the more there tends to develop subsequently a
lift in interest rates.
Referring to recent years, in questioning President Morris of Boston I asked:
Given the choice that was made which was for higher money supply growth
and higher, therefore, inflation in order to achieve lower unemployment, what
about nominal interest rates? Did this produce higher or lower interest rates?
President Morris of Boston: "Higher."
SUBSTANTIVE ISSUES
Four major substantive questions about Federal Reserve policies
and operating procedures emerge from the interviews. Resolving these
issues is crucial for the formulation and implementation of monetary
policy now and in the future.
One, major differences exist on the practice of stepping up M-l
growth to accommodate special inflationary developments. The burden
of proof is on those who would have M-l growth move with and not
into the winds of inflation. These hearings would appear an appropriate place to ask how inflation will decelerate under this policy and
why this policy would not generate continually accelerating inflation.
In addition, it would be useful to clarify why we should be concerned
because prices have lately increased more than M-l, inasmuch as M-l
increased more than prices in years past. Perhaps prices are just catching up. Finally, it is important to question the underlying assumption
of this policy that prices with rare exception do not fall. It is very
important to question that assumption.
Two, Government must pay for the goods it buys and the services it
hires. In real terms, and in a full or nearly full employment economy,
this requires transferring resources from the private to the Government
sector. To the extent that taxes fail to provide the needed buying
power, the Federal Eeserye decides whether it shall be obtained by
the Treasury selling securities and bidding away saving from private
investors, or by the Federal Reserve issuing currency and book entries
in Reserve banks, that is, essentially by printing the money. The Fed's
decision has important implications for the economy. Requiring Government to raise the buying power it needs by bidding away saving
from the private sector could "crush out of the private economy an
equal amount of spending," as President Black of .Richmond said, and
raise interest rates "to astronomical levels," as President Balles of San
Francisco said.
On the other hand, President Francis of St. Louis warned: "Treasury borrowing alone would be more of a transfer of money from the
private sector to the public, but when you interpose new money on top
11
of that, or too rapid increase in the rate of monetary expansion, I think
this is the kicker on inflation." And I would add, on high interest
rates, too.
Moreover, to the extent that inflation results from the Federal Reserve's decisions, appropriated expenditures will fall short of achieving the transfer of resources required to accomplish the spending goals.
Thus, monetizing deficits either results in underfunded programs or
requires supplemental or deficiency appropriations to cover cost overruns. It also later generates larger tax receipts which tends also to
increase future spending.
This is a critical issue, a very critical issue. Are the arguments of
Presidents Black and Balles valid, or is President Francis right?
Incidentally, right now I have the impression that President Balles'
use of the word "astronomical" was only a way of adorning a point. He
wanted, I think, to make sure that I understood that he would not
dodge the fact that for a while, at least, interest rates would tend to
rise if the Fed required the Treasury to finance deficits by selling
securities to the public rather than to the Fed after first selling it to
the public. You can question him on this, of course.
In any case, these hearings present a timely opportunity to fully
air opinions on how high and for how long interest rates would rise if
the Fed makes no special effort to monetize deficits, and to air also
other aspects of this question.
Three, many Federal Reserve policymakers favor resisting sudden
extraneously caused money market pressures even at the cost of temporarily allowing M-l to grow faster than desired as a longrun matter. But others believe that money markets are inherently orderly.
They suggest that, left alone, these markets would absorb exogenous
shocks with minimal trouble, and hence need little protection. They
also warn that fighting fires and keeping order in money markets can
require the Fed to supply new money much faster than the desired
longrun rate for an extended period of time, and with disastrous longrun consequences.
The argument of those who would protect the money market assumes that a small increase in money supply induces a large fall in
money market rates and that these rates stay down for a period which
is long enough to permit the extraneous pressures to decay, and it is
presumed that they will decay, yet somehow the time involved is also
supposed to be short enough to allow the Fed to achieve desired longrun M-l growth. The assumption is not only complicated, it is heroic
and it is without strong statistical foundation. On the contrary, there
is considerable evidence that it takes large increases in money supply
to induce a significant fall in interest rates and that the fall does not
last very long, especially in periods of buoyant credit demands and
inflation, and soon becomes a rise.
During the interviews, considerable attention was given to the findings of Phillip Cagan on the central tendency in our economy, over the
years, of interest rate changes that have occurred in the wake of
step-ups in money supply growth. Cagan found that following a
a step-up in M-l growth of 1 percentage point per year, the commercial paper rate at first falls and later rises. The initial decline lasts
less than one-quarter and reaches only seven basis points. In the third
36-714—74
2
12
quarter the commercial j>aper rate is higher than initially and after
2y2 years, it is 40 basis points higher.
Federal Reserve policymakers for the most part were chary of
Cagan's findings. They did not accept that the average size and
duration of the initial effect could be as small and short as Cagan
found it to be. In addition, nearly all pointed out that the size and
duration of the response of interest rates following a change in money
supply depends upon initial conditions^ as surely is correct and
Cagan surely would agree. Thus the historical central tendency can be
misleading. But many also felt that in periods of buoyant credit demands and inflation, the size and duration of the initial effect was
likely to be smaller and shorter than in other economic conditions.
President MacLaury of Minneapolis:
I would expect that you could have a year, a year and a half, 2 years of declining interest rates.
The question was discussed further at Minneapolis.
John Karaken, an economic adviser to President MacLaury:
To the extent that initial conditions matter, you can give an average which
may not, however, have a tremendous amount of meaning.
Weintraub:
Right, there may be great variation around the central tendency. But, in a
period of relatively full employment, you would expect it, the turnaround, that
is, to be faster than a period of, you know, unemployment, relatively high
unemployment. Do you agree with that?
President MacLaury: "I certainly do."
President Morris of Boston: "The higher the level of resource
utilization, the shorter the time in which the rates react."
Questioning President Balles of San Francisco I asked:
Would you expect in an expansionary, buoyant, inflationary period the effect
to be greater and shorter or smaller and longer than in a period of recession?
President Balles: "Smaller and shorter."
Governor Bucher:
And 111 tell you, the more and more the financial community and even the
public become aggregate watchers, if you will, I think the more this will be
exacerbated. I think this tendency will be to shorten it and shorten it, as people
in their own minds, compare growth in money supply with future inflation.
Cagen's results are not conclusive. But, particularly during
periods of buoyant credit demands and inflation, it appears that resisting extraneous pressures requires large increases in M-l growth, and
because feedback is rapid, the initial decline in interest rates is small
and very short-lived, and unless the policy is quickly reversed, all too
soon the result is faster inflation, higher interest rates, and graver
money market crises. It would be appalling if this happened for no
good reason because as President Eastburn of Philadelphia said: "The
market could be more self-reliant with respect to changes in interest
rates than it has been permitted in the past."
The relationship between money supply and money market developments has, of course, also positive implications for how to use mone-
13
tary policy to fight both inflation and high interest rates. On this
theme, President Francis of St. Louis said:
I don't like to say or I don't like to hear people say, that the way the central
bank goes about slowing up inflation is to raise interest rates. I think the thing
we can do, the tools with which we work, dictate that we get the rate of monetary
expansion under control.
The fourth substantive issue that emerges from the interviews concerns the tradeoff between inflation and unemployment. Many of those
interviewed believe that we can check the current inflation only if we
are willing to significantly underachieve with respect to employment.
They question, as President Morris of Boston did:
I don't know what the maximum level of unemployment the Congress would
accept in the interest of dampening inflation.
Congressional guidance could be useful. In specific, it would be useful to set forth a desired time path for decelerating inflation. Experience, mid-1969 to mid-1971 indicates that by braking M-l growth,
substantial progress can be made in checking inflation in what appears
to be a relatively short time. But unemployment increased unacceptably in that episode. Slowing down the process by reducing the deceleration of M-l growth could hold unemployment increases to acceptable levels.
Attempts to formulate a soft landing time path must, of course,
take into account that the trade off between Unemployment and inflation is a slippery one. Federal Reserve policymakers are not unaware
of the problem. But despite this problem, we can achieve price level
stability and full employment simultaneously if appropriate policy
is developed.
President Francis of St. Louis said:
Dr. Weintraub, I honestly believe that if we would get busy searching out the
longrun level of monetary growth that would facilitate what many economists
refer to as the growth potential in this country, that we could indeed have an
economy growing at its, what should we say, normal potential, with full
employment.
Is the approach recommended by President Francis the right approach ? Perhaps not. But at the least, it would appear to be worth
ventilating. Many believe this approach is essential if the tide in our
long battle with inflation and high interest rates is finally to be
changed.
Concentrating on M-l growth will require focusing the Open Market Committee's instructions on M-l growth. At present the instructions are focused on money market targets as well as M-l growth, and
these can be incompatible. Often this results in confusion about what
to do, ias the following remarks by Governor Sheehan show.
We use both aggregates and interest rate tolerances for targets. So we take an
eclectic approach.
Weintraub:
When you take this eclectic approach and look at two or more variables, up
to five at the same time, it's only a happy accident when they're all behaving in
the appropriate way or in the expected way.
Governor Sheehan, at a different point in the interview.
There have been periods since I've been here where we didn't feel that the
desk manager was doing what we told him to do. Therefore we met and recon-
14
sidered, and had vigorous discussions as to "Is that really what we told him to
do, and is he interpreting our instructions correctly."
Focusing the OMC's instructions on M-l growth would put an end
to such confusion. It would permit the desk manager to achieve desired M-l growth.
RECOMMEND ATIOXS
It is not easy to be sanguine about the Federal Reserve's focus being
changed through internal debate alone. I say this notwithstanding that
among the Federal Reserve policymakers interviewed, more than a
handful are men of special candor and knowledge and courage. I say
this because the entrenched intellectual traditions of established institutions are seldom if ever changed from within. For 60 years Federal
Reserve policy has been dominated by the themes of the banking school.
To wit:
(a) Vary the money supply so as to smooth shortrun fluctuations
in money rates; prevent, as Paul M. Warburg put it long ago, "too low
money rates in times of abundance as well as too high rates in times of
scarcity."
(h) Furnish money to accommodate the "real needs" of Government and business. Thus President Kimbrel of Atlanta posed the question : "Well, I wonder from you, how do we anticipate, how do we wonder that we're going to accommodate an honest contract ? At a period
of time when interest rates are already high, we're trying to change
the reserves, trying to slow the things down, already in a period—
but these banks are actually committed to make further loans of substantial numbers."
Weintraub:
Isn't there the possibility, at least, that if, in a period like today, if the Federal Reserve supplies banks with reserves to make these additional loans that
they have committed themselves to do, that this will lead to still more inflation?
Kimbrel:
Yes, I think the answer would be that obviously, you'd be contributing more
and more to inflation.
The monetarist warning that policies based on banking school
themes exacerbate longrun economic instability and cause too high,
not too low interest rates in times of monetary abundance has not yet
been heeded. What is needed is to bring the substantive issues involved
out into the open to be debated fully and regularly.
Accordingly, it is recommended that Congress treat monetary policy
in the same way as it is now about to treat fiscal policy. First, let the
Federal Eeserve annually request from the Congress permission to
operate within specified M-l growth guidelines, which, to retain limited flexibility to deal with shortrun problems, could be expressed in
terms of the behavior of year-to-year growth for the next 12 months.
Targets would be set for each of the next 12 months in terms of percentage changes from the same month a year ago. For example, 5 percent for the year ending next October, plus or minus 1 percent.
Let Congress hold hearings on the Federal Reserve's recommendations. The Federal Eeserve should spell out the implications: of alternative target M-l growth paths on unemployment, inflation, interest
15
rates, and such priority concerns as housing. Congress can then approve or modify the recommendations as desired.
Second, let Federal Reserve policymakers be responsible as individuals for reviewing last year's money supply behavior, explaining
its consequences and specifying what changes they now would make
in that behavior if they could go back and change their past decisions.
A single review could be submitted to the Congress it there was no
disagreement. But all presidents and Governors should be required
to explicitly state their concurrence.
Third, let the full minutes of the Open Market Committee meetings
be made public immediately or at most 6 months after they are held,
deleting until another 6 months has elapsed all so-called sensitive
discussions.
These recommendations can be viewed singly or as a package. The
first recommendation to establish a target money supply growth path
for the coming year in open forum would provide everyone with the
same knowledge about long term monetary policy. Wage and other
contracts could be negotiated more rationally as a result, that is, with
full understanding of the extent to which monetary policy would or
would not validate inflationary contracts. Households and business
could plan their budgets with knowledge of the extent to which their
plans would or would not be propped up by monetary policy. Those
who buy and sell securities could also use this information. But there
is no reason to think that buyers or sellers could obtain a net advantage
from knowledge of the Federal Reserve's money supply target growth
path. Moreover, as President Mayo of .Chicago pointed out, as things
now are, money market transactors know all they need to know about
the Fed's intentions. He said
The market indeed does have a fairly full understanding as to what the factors
are in monetary policy that are going to lead to specific steps by the Federal
Reserve. This happens to be a product in part of the fact that many of these
people who are in the market, and in the position of making markets, have at
one time either worked in the Treasury or in the Federal Reserve. Indeed, there
is also crossfertilization the other way. So it is no great secret as to how you
interpret what the Fed is doing and indeed, is trying to do. A number of the leading writers in New York, the Lehman Letter, Lanston's Letter, and so forth, are
written by former Treasury, former Federal Reserve people, and they're very
good in interpreting these things.
Incidentally, the italic there is not my own. The emphasis is from
the transcript of the Chicago Bank.
The latter two recommendations would permit Congress and the
public to better utilize the candor, knowledge, and courage of individual Federal Reserve policymakers. These recommendations moreover are in the tradition of the Federal Reserve Act, as initially enacted. Congress rejected the Aldrich bill which would have established
a single central bank with dispersed operating branches. T,he Federal
Reserve Act rather set up a system of 12 regional central banks supervised by a Board of Governors. Of course, the System has to act as a
single unit in implementing monetary policy. But it is neither necessary nor desirable to submerge the views of individual policymakers in
formulating policy or to relegate them to voices in the wilderness in
overseeing it.
Finally, the thrust of all three recommendations is that those who
are responsible for monetary policy will do a better job if, one, their
16
parts as individuals in decisionmaking are made public while the decisions are still of vital interest to the public; two, they are compelled
to regularly publicly review the consequences of past decisions in a
format which permits airing dissenting views rather than only setting
forth the consensus view; and three, they must annually arrive at and
seek (approval for their consensus money supply growth path.
In closing, it should be recognized that proper monetary policy is
not a panacea. It can save us only from the consequences of inadequate
monetary policy. In particular, no financial system, no matter how
well structured and regulated, can function smoothly in a disruptive
monetary environment. Our financial system has been in a stateof
irregular but recurring turmoil since 1966, the year after the inflation
began, accommodated and fueled by rapid money supply growth. A
year 'ago, the turmoil centered on so-called wild card deposits. Now
it is focused on Citicorp's proposed variable interest redeemable note.
issue. It is, in the final analysis, futile to stop these innovations in
mobilizing saving on the ground that stopping them will remove the
threat to the growth and development of housing oriented thrift institutions. These innovations are not the cause of the malaise which now
threatens thrift institutions. They are its manifestations. Stop one,
and another soon emerges. If we want a financial system in which
housing oriented (thrift institutions can grow and function smoothly,
we must first get a proper monetary policy. Only after money supply
growth is controlled so that it is neither accommodative nor generative
of either inflation or recession, can we hope to succeed in assuring the
viability of thrift institutions; the allocation of credit for low- and
moderate-incdlne housing, and other priorities as Congress may establish ; and the equitable treatment of small savers in the mobilization
of saying. Being able to explore ways of improving our financial system in a noncrisis atmosphere would be one beneficial byproduct of
achieving a monetary policy which is not destabilizing. The direct
benefits, once again, I believe, would be greater economic stability,
minimal unemployment and minimal inflation, and reasonable interest rates.
Mr. Chairman, may I have the long document inserted in the record ?
The CHAIRMAN. Without objection, so ordered.
[The "Report on Federal Reserve Policy and Inflation and High
Interest Rates," submitted to the House Banking and Currency Committee by Dr. Weintraub appears at the end of today's hearing and may
be found on page 31.]
The CHAIRMAN. May I suggest, Dr. Weintraub—are these two statements reconciled to where they do not unnecessarily duplicate ?
Dr. WEINTRAUB. Well, the shorter paper is a condensed version of
the long one, so it might be all right just to put the long one in the
record.
The CHAIRMAN. And leave the other one out of the record?
Dr. WEINTRATTB. Yes.
The CHAIRMAN. I want
to ask you—you interrogated five members
of the Board, is that right?
Dr. WEINTRAUB. All except Chairman Burns; and I did not interrogate Governor Daane either because he was at the time leaving the
Board; and I did not interrogate Governor Wallich, who took Governor Daane's place.
17
The CHAIRMAN. Yes, he just came in. Why did you not interrogate
the Chairman?
Dr. WEINTRAUB. He did not want to be interrogated by me. We requested it, but he declined the request. You, I believe, did request it.
The CHAIRMAN. Concerning President Hayes, of New York, whois
president of the New York Federal Reserve Bank, he occupies a different position from the other presidents. Congress passed a law in
1942 or 1943, I remember it, making him eligible to attend the secret
sessions of the Board at all times and to participate just like a member—ask questions, present motions or anything else. In other words,
he had all the power that a member of the Board had; is that not
correct ?
Dr. WEINTRAUB. I would have to accept what you are saying as
correct. I did not ask him about that. I do know that the presidents
are not all equal and he has more powers, privileges,.and duties.
The CHAIRMAN. Did you interrogate Mr. Hayes ?
Dr. WEINTRAUB. Yes, I did, but I did not ask him about that, sir. I
do know that he is the vice chairman of the Open Market Committee,
and as such he is a perpetual voting member of the Open Market
Committee.
The CHAIRMAN. Does he attend—of course, he attends all of the
Federal Open Market Committee meetings.
Dr. WEINTRAUB. Yes, but whether he attends some Board meetings
or not, I am not certain. But all of the Open Market Committee meetings, clearly he does.
The CHAIRMAN. Mr. Hayes is the most highly paid member of the
Federal Reserve System, is he not?
Dr. WEINTRAUB. Yes, I believe he is.
The CHAIRMAN. HOW much is his pay?
Dr. WEINTRAUB. I believe it is $90,000 a year at the present time.
The CHAIRMAN. And international expenses.
Dr. WEINTRAUB. He is going to be here tomorrow, and I think he
could answer those questions himself, better than I can.
The CHAIRMAN. Anyway, he is the highest paid one. All of them
cooperated with you, except the Chairman did not want to participate ?
Dr. WEINTRAUB. That is correct.
The CHAIRMAN. What about the others who did participate ? Were
they of a one mind and school of thought ?
Dr. WEINTRAUB. There were differences among them in my opinion,
and some are superior to others.
The CHAIRMAN. Did you get all of the presidents of the Federal
Reserve Board—I mean of the regional banks ?
Dr. WEINTRAUB. Yes, I did. I got all 12 presidents.
The CHAIRMAN. Did you get any of the directors of the regional
banks ?
Dr. WEINTRAUB. NO, I did not get any of the directors.
The CHAIRMAN. I think it would be well to consider asking you to get
the directors, because the directors run the regional banks and the
Federal Reserve Board gets money to operate from the regional banks.
Of course, the Federal Reserve Board does not use much money. But,
in fact, the members of the Board would not even get their expenses
and their salaries if the regional banks did not appropriate the money
for that purpose; it that not correct ?
18
Dr. WEINTRAUB. That is correct, yes. The Board gets its expenses
by assessing the regional banks.
The CHAIRMAN. By assessing the regional banks ? Then it is up to
the regional banks as to whether or not they pay it? These regional
banks, they have nine directors. Six of those directors are selected by
the banks themselves, are they not ?
Dr. WEINTRAUB. That is correct.
The CHAIRMAN. In the region? Like the New York or the San
Francisco region ?
Dr. WEINTRAUB. Eight.
The CHAIRMAN. The six members that are selected, of the nine, are
selected by the banks themselves. Did you ever see those ballots that
they use?
Dr. WEINTRAUB. NO, sir.
The CHAIRMAN. I have. We
got them one time, and they are just like
the Democrats or Republicans will use to select their nominees or select
their officers. They select the first six directors, and then the Federal
Reserve Board, of course—that is, a majority; that is, two-thirds of
them, they can run the show—and then, you see, the Federal Reserve
Board selects the other three. But the Chairman must be of tested
banking experience.
Dr. WEINTRAUB. The Chairman must be.
The CHAIRMAN. The Chairman
Dr. WEINTRAUB. I did ask about that, Mr. Chairman. I asked some
of the presidents about the fact that the Chairman of the Board of
Directors had to be a man of tested banking experience, and what drew
me to that was, the first bank that I interviewed, whose president I
interviewed, was the Boston bank. The Chairman of the Board of
Directors there is one James Duesenberry, who is an economist of some
note. I asked President Morris, you know, what sort of tested banking
experience Professor Duesenberry had. He kind of indicated that this
was a very loosely interpreted law, and we probably would be better
off without it. I asked President Hayes the same question, and he said
he thinks that if this were removed from the law, this requirement,
there would be nothing lost and probably a lot gained.
The CHAIRMAN. They do not need it because they have six bankers
on there, six selected by the bankers: three of them must be bankers,
and the other three do not necessarily have to be bankers. But we
polled all of them one time and about 90 percent of them were bankers.
Dr. WEINTRAUB. Right.
The CHAIRMAN. They have no problem about the other three, because the six directors selected by member banks determine the direction of the bank.
Dr. WEINTRAUB. I think there is no question but that the banking
industry is overly represented on the Boards of Directors.
The CHAIRMAN. DO they not run the show? Is it not run by the
bankers ?
Mr. BROWN. Mr. Chairman, I think this is all very interesting, but
the gentleman has gone to a great amount of work in interviewing
peor>le about monetary policy, and that is what his report relates to.
I think we ought to have an opportunity to go over it. I know I have
questions I would like to ask Dr. Weintraub.
19
The CHAIRMAN. We are going to let each member
Mr. BROWN. I think the discussion up to this point has not had anything to do with his report, but rather the niceties of the individuals
and personalities of the people involved.
The CHAIRMAN. May I suggest to the gentleman that I do not try to
substitute my judgment for his judgment in asking questions that are
relevant and material, and these are relevant and material.
Mr. BROWN. Mr. Chairman, I do not have time to sit here while—
if you want to have this discussion with Dr. Weintraub, I think that
is fine. If we have time later on—but we have got so many things to
do and we are taking time right now when we should be in Housing
and Community Development Conference, things that are very pertinent to this Nation. I think we are wasting the committee's time by
going into this kind of discussion when we have before us for consideration a very important and significant report by the gentleman
who is the witness.
The CHAIRMAN. Certainly; I would agree with you 100 percent, but
I think each member will, without dictation from the gentleman from
Michigan or the gentleman from Texas, ask questions that he wants to
that are relevant and material. In fact, I was just about finished.
Mr. BROWN. I S this the chairman's time for questioning ?
The CHAIRMAN. Yes.
Mr. BROWN. When does your time terminate ?
The CHAIRMAN. I consider it up now, because
I want all of the members to have an opportunity to interrogate. In fact, I am proud of the
fact that we started this in our committee, and when I was chairman.
Now nearly all of the committees of the Congress have adopted it.
They give each member an opportunity to interrogate the witness.
I will yield to Mr. Widwall for the purposes of interrogating the
witness.
Mr. WIDNALL. Thank you, Mr. Chairman.
In section 4 of your statement, you contend that our attempts at resisting short term extraneous money market pressures are selfdefeating and produce even worse pressures in a fairly short time. I
was intrigued by this, and I would appreciate it if you* would explain
the ways we have been attempting to deal with the short term pressures, and elaborate the reasons why these attempts have been selfdefeating.
Dr. WEINTRAUB. I will try to do that, Mr. Widnall.
What I have in mind here is, let us suppose that there is a sudden
pressure from any source you might want to assume, which would, if
left to itself, drive interest rates up somewhat, and that the Federal
Eeserve decides to resist this pressure. They try to keep interest rates
from rising, at least very much, in the next week or 2 weeks. The way
they do this is to increase their purchases of securities on the open market and supply banks with additional reserves. Their hope is that a
small increase in reserves and a small increase in the money supply
emanating from that increase in reserves is all that will be required to
keep interest rates from rising.
However, that is an heroic assumption, and it is an heroic assumption for the following reasons:
20
Suppose that you wanted to step up the money supply growth from
4 percent a year to 8 percent a year. You have to think in terms of a
year. In today's terms, we have about a $280 billion money supply—
let me round that up to $300 billion, just for the sake of argument.
That would mean stepping up the money supply from 4 to 8 percent
would require an increase of $12 billion above what it otherwise would
have been in a year. But in a month, it is only $1 billion, and $1 billion
is just not enough to swing interest rates very much one way or
another. If you try to go beyond that, you are going to increase the
money supply much too rapidly. What you will be doing is setting in
motion these feedback forces—that is, the money will be used to buy
goods and services which will make credit demands still more buoyant,
and before you know it, interest rates will be even higher than they
were initially. You will have fed the process, rather than resisted it.
This is the point I was trying to make.
Mr. WIDNALL. The country went along for a rather lengthy period
with a 2 to 3 percent annual inflation rate, which did not seem to be too
disruptive; do you agree?
Dr. WEINTRAUB. I would agree that somewhere around 1 to 2 percent
is probably tolerable in the sense that it may reflect close to zero inflation, because there is some improvement in the quality of goods each
year and in the range of goods.
Mr. WIDNALL. So, I take it you would condone further inflation at
this rate.
Dr. WEINTRAUB. I am sorry, sir?
Mr. WIDNALL. Then I take it you would condone further inflation
at this rate.
Dr. WEINTRATTB. At 1 to 2 percent?
Mr. WIDNALL. Two to 3 percent.
Dr. WEINTRATTB. I modified your 2 to 3 down to 1 to 2, and I do not
think I would like to see it above 1 or 2 percent.
Mr. WIDNALL. In addition, we have a growing population and a
growing base of commerce. It has resulted m the growth of real GNP
in the neighborhood of 4 percent per year over the years.
What level of increase would you condone in the money supply to
accommodate this inflation and this growth ?
Dr. WEHSTTRAUB. I would not accommodate the inflation, I would
just simply have the money supply growing to accommodate the expected long-term growth of the economy at full employment, which
would be about 4 percent a year; and I would aim for 4 percent. That
would be my own preference, 4 percent a year.
Mr. WIDNALL. In August of 1973, the staff of the Subcommittee on
Domestic Finance of this committee presented several proposals for
consideration by the committee. Among these was a suggestion that the
number of members of the Open Market Committee be reduced from
12 to 5. This is felt to be a possible solution to the problem that so many
persons are involved in deciding what to do that minimizing internal
disputes and frictions becomes an end in itself. I did not notice any
reference to this problem in your condensed report. Nor did I notice
any recommendation that would reduce the membership of the committee. What are your feelings on this matter?
Dr. WEINTRAUB. Let me say^ that in August of 1973, had you asked
that question, I would have said, absolutely, let us reduce the member-
21
ship to five—the number of Governors from seven down to five, and
eliminate the role of the presidents. I truthfully no longer think this
way. I think that the proper way of handling the problem is the way I
have suggested now: to bring everything out into the open and to
utilize the candor and the knowledge of some of the presidents. I think
you should give them even greater opportunity to express their views,
and this is the way that things could get changed.
Mr. WIDNALL. Thank you. I regret my time is up.
The CHAIRMAN. All right, Mrs. Sullivan.
Mrs. SULLIVAN. Thank you, Mr. Chairman.
Your statement is very enlightening, Dr. Weintraub. A lot of it is
completely over my head, but I do have three questions that I would
like to ask you, referring to your discussions on pages 20 to 24 of your
long statement, and 39 and 50. t
Your argument is that resisting money market pressures is both
futile and self-defeating. Would you go over it again; why is it futile,
why is it self-defeating?
Dr. WEINTRAUB. Yes.
It is futile because we really do not get much of a bang from changing the money supply insofar as the interest rates are concerned.
Economists measure something called the elasticity of the money
demand with respect to interest rates. All this means is the percentage
change in money demand with respect to a percentage change in interest rates, holding everything else constant, if we turn that upside
down, we get the percentage change in interest rates with respect to a
percentage change in money demand or money supply.
Let us suppose that this is a very low number, like 10—that is, minus
one-tenth, and then invert it: 10. This would mean that in order to get
a change in interest rates of 10 percent, you would require a change in
the money supply of 1 percent.
A change in money supply of 1 percent in a 1-month period of time
is a step-up in the annualrate of growth of 12 percent you see. What
is a change of 10 percent in interest rates? It is really not very much,
especially if it is going to be short lived. That 12 percent per annum
change in money supply is going to quickly cause interest rates to rise
again because, as it feeds into the economy, as people now begin to buy
goods with it, inventories will go higher, inventory prices will go
higher, people who carry inventories will demand more credit and bid
up the price of credit, which is the rate of interest. It becomes very
quickly self-defeating, and this is why I say that.
Mrs. SULLIVAN. Can we stop inflation by raising the interest rates ?
Dr. WEINTRAUB. NO. I believe if we try to do it that way we are going to be misled. This, I think, has been the problem in the last couple
of years, that we have tried to stop inflation by raising interest rates—
and in fact, interest rates have been driven up by inflation. We have
confused cause and effect.
I would agree, myself, with President Francis that the Federal Reserve ought to do what it can do, which is to control the money supply.
This would not only control inflation, it would bring interest rates
down, as well. Letting money supply grow too rapidly, on the other
hand, raises the Federal funds and other rates, and in fairly short
time.
22
Mrs. SULLIVAN. Of course, the raising of the Federal funds rate is
going to affect the interest rates on every other credit transaction, is
it not?
Dr. WEINTRAUB. It certainly has a rippling effect.
Mrs. SULLIVAN. It costs the banks more money, so that they have to
ask for more.
Why is the Federal Reserve fearful of concentrating on money supply control ? What would happen if we slowly dropped M-l growth to
4 percent per year ? Would this not raise the interest rates ?
Dr. WEINTRAUB. NO, it really would not, in my opinion, for any time
or in any amount that would be worth talking about. I think the Federal Reserve is fearful because, they would argue, it would raise the
interest rates. But I think the evidence points in another direction.
The evidence points to the fact that, by reducing the rate of growth of
the money supply gradually, from, the rate we have had the past few
years of around 7 percent per year to 4 percent per year—which could
be done over a 6-year period, frankly; a half a percent a }^ear—would
not have any effect on interest rates as far as their going up is concerned. Rather, it would bring them down. I do not think you would
observe interest rates to go up significantly or for long from this effect.
Any roller coaster ride, as some have put it, would be a kiddie-car ride.
Mrs. SULLIVAN. I just have one more question.
President Eastburn's lament is that "there never seems to be a good
time" to get money supply growth down. When do you think would
be a good time, or have you 'any opinion on that?
Dr. WEINTRAUB. I do; and I think starting today would be the best
time, I would think. I would simply start to bring it down. I think it
is important to bring it down slowly, and not to move rapidly. That is
the mistake that the Federal Reserve has made in the past so often, to
cut the rate of growth sharply, like last summer, from an annual rate
of roughly 8 percent to zero. That is a wrenching that the financial
system cannot take. But to cut it from 7 percent to 6.5 percent in 1
year, and down to 6, and then 5.5 and 5, over a period of time, is exactly what it will take to purge the economy of inflation and to reduce
interest rates at the same time, without disrupting labor markets, also.
Mrs. SULLIVAN. Thank you; my time is up. I would just like to
throw this out: Do you think we see and can see a lowering of interest
rates soon ?
Dr. WEINTRAUB. Only if the Federal Reserve lowers the rate of
growth of the money supply.
The CHAIRMAN*. Mr. Brown is recognized.
Mr. BROWN. Thank you, Mr. Chairman.
Dr. Weintraub, I have enjoyed very much hearing your testimony,
and having an opportunity to review your report. I think I tend to
concur with you, if I understand you correctly, that you feel the system has reacted to acute situations rather than chronic problems and
the policy has been to soften the ripples, rather than prevent big waves;
and that it should deal with big waves, not with ripples.
I am not sure, though, that I follow how—your recommendation
that the Congress become involved in hearings, because if you get the
Congress involved, I think all you do is focus attention on the ripples
rather than the basic problems. That has been my experience, at least
in the Congress.
23
Dr. WEINTRAUB. Could I comment on that ?
Mr. BROWN. Certainly.
Dr. WEINTRAUB. I would say I do not really believe it. I think that
probably I have more trust in you, maybe, than you have in yourself,
and more trust in the Congress. I think that Congress will react to
long-run problems, will focus on long-run problems, if it is done in this
open sort of annual, regularized hearing program that I have suggested. I believe that if you do not, the public will force you to. I
really believe
Mr. BROWN. Let me say in that regard, that if you want a broader
input, would it not be better to have this broader input, as you have
suggested in your report, from those in all of the banks ? The economists of the several banks and all this, who really have greater expertise ? If we are looking at monetary policy in somewhat of a rarified, a
puristic way, and not let it get engaged in these other things that are
extraneous to our basic policy, would it not be better to have those who
have greater expertise to be the ones that have greater input than
people who are relatively unfamiliar with the problems, the purpose,
and, really, the functions of monetary policy? Just let me throw that
out.
You have said that you feel that, in developing this system, that it
really should match the long-term increase in the gross national product 4 percent, I think you said—something of that nature—population,
gross national product and so on. But what about severe distortions in
the GNP ? For instance, a Vietnam war at the same time as a bread
and butter domestic program that was massive compared to what we
had. When you have that kind of situation, you have substantial distortion by decisions made on the fiscal side—political side—political
and fiscal. You have severe distortions which cause a severe distortion
in the GNP for a relatively short period; what do you do in that
situation ?
Dr. WEINTRAUB. I would still increase the money supply at an annual rate of 4 percent a year. Let me try and go over this interaction
between fiscal and monetary policy, if I can, once again.
If we have a very large fiscal deficit which is the result of a new
program or a Vietnam war or something of this nature, it is clear that
it has got to be paid for, and the payment in the real sense requires
the transfer of resources from other uses to that use. Now, if taxes are
uct 4 percent, I think you said—something of that nature—population,
then the Federal Reserve makes the decision as to whether the Government will raise its funds by selling bonds on the open market, and
bills, or by essentially printing the money—which the Federal Reserve
would do by first having the Government sell the bonds to you and me,
and the Federal Reserve would buy them from us.
Let us just take step one. Supposing the Treasury sells the bonds
to you and me. All that would happen is that the Government would
step up its spending on its new programs and the war, and you and I
would lower our spending elsewhere and there would be roughly a
balance. In the case of the Vietnam war, I think that maybe, of the,
oh, say, 20 percent rise in the Consumer Price Index that occurred
from 1965 to 1970, possibly 2, maybe 3, percent could be accounted for
by simply the fact that we were using resources in nonconsumption
uses—that is, to produce guns, rather than butter, as the old saying
24
goes. But the remainder was monetary. What happened was that we
were not allowed not to spend on beer and ice cream and so forth. The
Federal Reserve decided, after you and I bought those bonds, that
they would buy them back from us. They induced us to do so by bidding
up the prices a little bit, and that expanded the money supply and gave
us the money to go ahead and start bidding up prices of the usual goods
that we buy in the consumption sector. So, we had inflation, and that
resulted, incidentally, in requiring the Congress to pass supplemental
and deficiency appropriations, because we thought we were getting so
many planes for the money, and we found out we were not.
Mr. BROWN. I would like to pursue this further, but my time has
expired. But before concluding, I have one question.
I notice in your report that you indicate some opposition to the
legislation that is presently pending before this committee, dealing
with the variable notes issued by Citicorp.
Dr. WEINTRATTB. NO, I did not relate my discussion to that legislation. What I said was that if you stop this particular note issue from
going ahead right now, it is not going to solve the problem. I think
you have to face up to that. You still might want to stop it for certain
shortrun reasons—that is, there is no question that what inflation
does is it distorts the allocation of saving and credit; that is one of
its most perverse effects. You have to expect those who are hurt by it
to fight back, and I think that is what you find.
Mr. BROWN. YOU are saying you are not opposed to it, but you think
would be ineffectual ?
Dr. WEINTRAUB. Yes.
The CHAIRMAN. The time of the gentleman has expired.
Mr. Eeuss?
Mr. RETJSS. Thank you, Mr. Chairman.
I want to express my gratitude, Dr. Weintraub, for your encyclopedic report and all the effort that went into it.
You say 4 percent is your preferred rate of growth for the money
supply, narrowly defined. Most of the monetarists put it in terms of
an upper limit of 6 percent. Do you reject that ?
Dr. WEINTRAUB. NO. Four percent would be my target. I would have
a range around the target of 3 to 6 percent.
Mr. REUSS. Looking at your table 2, Dr. Burns and his Federal Reserve Board seem to have attained an M-l growth in the year ending
April of 7.2 percent, in May of 6.4 percent, and in June of 5.6 percent.
Putting those 3 months together, that comes out at about the upper
limit which you just described. Would you say that, pipe or no pipe,
Dr. Burns has done a reasonably good job m the last 3 months—
drawing a veil of charity over earlier aberrations ?
Dr. WEINTRAUB. Certainly the facts are on that side but I think
I would put in a caveat here; I think we have to be very cautions.
I would like to see this in October, and then in December. I think you
will see the year-to-year figures higher then than they now are, and
one reason is that the currency component of the money stock has
been growing very rapidly, and it just is unusual that the public
should be deciding to take more currency and less demand deposits
right now, and yet that is what the figures seem to show. My guess
is that the tracking problem, which I mentioned in the report, was
25
still with us up until June—that is, the FDIC decided only in the
end of June to solve this problem, by assembling data from all large
member banks.
Mr. EEUSS. Why all this itch for cash, as opposed to checking
accounts ?
Dr. WEINTRAUB. Well, I am suspicious, and I do not believe it,
really, is what I am saying. Normally, people go for cash rather than
demand deposits when they are fearful the banks are not going to
survive. Maybe that is true today; I hope not.
Mr. EEUSS. In your paper occur some comments and controversy
between various Federal Reserve bank presidents on the matter of
banks making commitments to give a certain amount of credit to a certain prospective borrower. The apologists for that tend to say these
are contracts, and therefore the Fed has to accommodate these sacred
contracts.
Actually, the idea of letting banks make whatever so-called credit
commitments, good, bad, or outrageous they want to and then validating them is a sure-fire prescription for inflation, is it not ?
Dr. WEINTRAUB. Yes, it is.
Mr. REUSS. What ought the Fed or anybody else to do about it ?
Dr. WEINTRAUB. Well, I think
Mr. REUSS. This practice is highly respectable but highly dangerous,
it seems to me.
Dr. WEINTRAUB. I think this is one of the dangers of focusing on a
money market rate like the Federal funds rate, and it is combined with
another practice that the Federal Reserve has had in the past 6 years,
I think it is, which is that banks are required to put up reserves behind
their deposit liabilities of 2 weeks ago.
Look and see what this results in. Banks have these commitments,
these advance loan commitments that they make. Now suddenly those
who are on the other side of that contract come in and say, we want
the loan. The bank says, fine, and they make the loan. The result is
that deposits go up and the money supply goes up. Now 2 weeks later,
the banks have to find the reserves to cover the deposits that arise from
increasing these loans.
How do they do that? The answer is, they bid for Federal funds,
and that drives up the Federal funds rate. The Federal Reserve sees
the Federal funds rate up and says, oh, my goodness, this is terrible.
We had better give the banks the reserves that they need to keep the
Federal funds rate in line, and they just feed the process.
I would say that two things should be done. One is that you ought to
make reserves and deposit liabilities concurrent. That is that banks
ought to be required to put up reserves on today's deposits, even
though the information problem is a little bit severe.
The second thing is they ought to stop concentrating on the Federal
funds rate and look at the money supply. This is really the major
thing.
Mr. REUSS. I have just one more question.
Faced with the aggregate money supply theory, which means that
money gets tight and interest rates get very high across the board, a
number of conservatives—Governor Brimmer of the Federal Reserve,
Chairman Bunting of the First Pennsylvania Bank, the editors of
Business Week, as well as myself—have suggested that a system of
26
differential reserve requirements according* to the type of loans by the
bank might be one way of channeling credit where it is needed, away
from inflation-producing causes and toward useful causes. What is
your view on the validity of such a proposal ?
Dr. WEINTRAUB. I think it is probably a good proposal. I think we
ought to understand that most of the distortions in credit allocation,
or a good part of them, that we. are now disturbed about come from
inflation. But even if we had no inflation, there would remain certain
problems.
These are particularly acute in housing, especially for low-income
people. There are other priorities that could be mentioned, of course. I
think that if we used the sort of sniper's approach to handle credit
allocation in these areas, that would probably be very useful.
Mr. RETTSS. Thank you. My time has expired.
The CHAIRMAN. Ail right.
Mr. Williams.
Mr. WILLIAMS. Thank you, Mr. Chairman.
Dr. Weintraub, von have put together an excellent report. Do I
understand your thinking to be that if we could control the increase
of monev supply with a 4-percent increase annually, that we could then
control inflation?
Dr. WEIOTRAUB. Yes, absolutely. There is no question in my mind
about it. Let me comment on that a little bit further.
Since the time of Queen Elizabeth I, the world has never had an
inflation without haying money supply growing more rapidly than
4 percent a year. It is just a fact. Furthermore, whenever the money
supply has grown faster than this rate, we have had an inflation.
Mr. WILLIAMS. The Fed has the power to control the money supply,
and, apparently, they have been permitting the money supply to grow
at a faster rate than 4 percent?
Dr. WETNTRATTB. Yes, absolutely correct. They have done this for a
variety of reasons that I have spelled out, none of which I think is
particularly valid.
Mr. WILLIAMS. Last year they cut the money growth back to zero
from 8 percent, virtually overnight.
Dr. WETTNTTRAUB. They certainly did during the summer. I would
never recommend that sort of a sharp turnaround. T think that
creates all sorts of problems for thrift institutions and housing, in
particular.
Mr. WILLIAMS. What happens if the Fed would hold the increase of
money supply to 4 percent, and the Federal Government continues
borrowing on the open money market billions of dollars? Then there
is not truly an increase of 4 percent available for the American public,
is there?
Dr. WEINTRAUB. I think—there's also another problem—supposing
the Congress passes the law enacting a new program. Presumably,
what Congress wants is this program to be properly funded and the
goods that it's supposed to buy to, in fact, be bought.
This requires that real resources, labor and capital, be transferred
from other uses to these uses that Congress has now specified it wants.
If the Federal Reserve increases the money supply more than 4 percent per year in such a case, the real resources simply will not get
transferred there, because what will happen is inflation will develop.
27
and Congress will think, well, we had a program that was going to buy
us 100 widgets for $1,000, but now we find out with the $1,000 that we
appropriated, we can only buy 60 widgets, and they have to come
through with a supplemental appropriation.
Mr. WILLIAMS. What if the Federal Government, in order to meet
its spending requirements, raises taxes rather than borrowing from
the private sector?
Dr. WEINTRAUB. I think that in some cases that would be absolutely
preferable if that "were done that way. I am certainly not against
balancing the budget.
Mr. WILLIAMS. Actually, on page 16 of your report, you sajr, "Requiring Government to raise the buying power it needs by bidding
away savings from the private sector could crush out of the economy
an amount equal to spending." In other words, what you are really
saying is that the more that the Federal Government borrows, the
more buying power or spending power they are crushing out of the
private sector.
Dr. WEINTRAUB. There is no question that you can only enlarge the
Government sector by—I would not use the word "crushing out," that
was President Black's word—by taking the resources away from some
other use.
Mr. WILLIAMS. But then you say that President Balles states that
this would raise interest rates to astronomical levels. I believe you took
some issue with the word "astronomical."
Dr. WEINTRATJB. Yes, and I think he too would not now use it. I
think you might ask him that when he is here tomorrow. But I would
say I have looked at this question carefully since going over the transcript of my interview with President Balles.
There is one experience that we have had in recent years that throws
some light on it. It is 1968. In 1968 there was a swing in the Government's budget deficit of about $20 billion primarily as a result of a
surtax that was enacted in June of that year. It went from a $25 billion deficit down to a $5 billion deficit.
You would have expected, if you held the view that interest rates
would change astronomically, that this would result in a very large
fall in interest rates at that time. But what in fact did happen—and I
went and I looked it up and the Treasury bill rate in June of that year
was 5.54 percent. In August it had reached 5.10 percent; it fell 44 basis
points and by December, it was back to 5.92 percent. It was higher than
initially.
The result is that I would conclude that there is no evidence that a
swing in the Government's deficit of even $20 billion is going to have
very much effect on interest rates, certainly not in any longrun sense,
not longer than 2 months.
Mr. WILLIAMS. Not unless the elimination of deficits became part of
our long-range plan and we then had no deficits.
Dr. WEINTRATJB. I think that over a 1,000-year period or a 100-year
period, I would prefer to see the Government's budget balanced. There
are particular years when it would go out of balance because of a variety of events over which no one has any control.
Mr. WILLIAMS. Dr. Weintraub, thanks very much. Again, let me
commend you for an excellent job.
36-714—74-
28
Mr, BARRETT [presiding]. Mr. Moorhead.
Mr. MOORHEAD. Thank you, Mr. Chairman.
Thank you, Dr. Weintraub. If and to the extent that there are price
increases in commodities, particularly imported commodities—and
naturally, you think of oil being the prime example—how can we control that kind of inflation by our money supply ?
Dr. WEINTRAUB. I am glad you asked that question. I really am,
because I think it is a terribly important one.
I think we have to distinguish between a risen price and rising
prices. There is no doubt in my mind that if the anchovies flee from the
coast of Peru as they did a couple of years ago this is going to drive up
the price of anchovy meal, and then competing substitute products
like soybean meal and all derivative products from that, like cattle
and so forth. This will cause by itself, at most, a once-for-all increase
in the price level. In fact, it is not likely to be a permanent increase.
That is, prices might go up one year from 100 to 104, let us say, on an
index, but it would not go up to 108 the following year. The anchovies
can flee from the Peruvian coast only once. Indeed, if they return, or
if we begin to plant more soybeans throughout the world, you are going to drive that price and the index as well back down.
The only way you will get inflation built into the system as a result
of this event is if the monetary authority and the Federal Reserve
reacts in the first instance and says, oh, my goodness, the price of
anchovies went up, and now we see this reflected in the consumer
prices being higher; and pour in money to validate that. That assures
that you are going to get not only a risen price but a rising price, when
in fact what you could have gotten was a risen price for a snort period
of time, and then it decayed back to where it was initially.
Mr. MOORHEAD. I see. Why do you use the narrow definition of
money supply, the M-l ?
Dr. WEINTRAUB. I suppose that is just an old bias of mine, but I
could have used M-2 and the results really would not be particularly
different than they were with M-l. You know that Milton Friedman,
under whom I studied, does use M-2.
I use M-l, I think, really because I look upon money as being something which is a medium of exchange, and the only things that qualify
for that are checking accounts and currency.
Mr. MOORHEAD. On page 5 of your oral testimony, you talk about
the FDIC giving information to the Fed on large nonmember banks.
Would it not be better, and workable, to have it on all banks, not
just the large ones in their system ?
Dr. WEINTRAUB. It certainly would. I think the reason they did not
is because there is a cost of a bank filling out these forms, and the costs
can be burdensome to a small bank. So if the results prove good just
assembling the data from the large banks, well and good, and they will
continue with this. If they do not, I think they would go to the small
banks as well.
Mr. MOORHEAD. Suppose the figures on your table 1 indicate—and I
grant you that it is only an indication—that the Fed has brought the
increase in money supply down in recent months. Suppose they did
hold to this 4 to 5 percent increase.
What would you expect interest rates to do in the short term, in the
1 month, 2-month period, 6 months, 1 year, 2 years, if they held it
there?
29
Dr. WEINTRAUB. If they held it right now, I would expect interest
rates, starting from now, really, to go down.
Mr. MOORHEAD. It would not be a short term up ?
Dr. WEINTRAUB. I think any upturn that we would have in them has
already taken place. I think it is all over with, and we might just as
well hold to where we are right now, and we can now expect things to
start going down. I would think that if you dropped down, say to
3 percent, from this level, you might have a rise of 20 basis points in
the Treasury bill rate over a 2-month period, and then things would
again begin to come down, and by 6 or 7 months, it would be falling.
Mr. MOORHEAD. I see. Because I thought there would be an up-kick.
But I guess you are saying that it is your testimony that you would
have to go below 4 percent before you would have a short term
upswing ?
Dr. WEINTRAUB. I am not disagreeing with you on what you are
saying. What I am saying is that the money supply deceleration that
occurred in May and June may already have given us whatever upkick we were going to have. In other words, from a slowdown in the
rate of growth of money supply, we can expect a very small temporary rise in interest rates.
We have had the slowdown in money supply, if we can believe these
figures, in May and June. We have had a small rise in interest rates.
You may say it is not a small rise, but it is from May. In fact, Treasury
bill rates are down from May. You know, in the middle of May they
were 9 percent, and they are now below 8 percent. Commercial paper
rates and the prime rate, of course, are up.
In other words, I think whatever roller coaster ride was going to
happen from following this policy, the upside of it has already
happened.
Mr. MOORHEAD. Because my time has expired, I will ask you a question, and could you submit your answer for the record ?
On the bottom of page 17, you say, "Federal Eeserve policymakers
for the most part were wary of Cagan's findings."
My question to you for the record will be, "Why ?"
Thank you very much, Mr. Chairman.
[In response to the request of Mr. Moorhead, the following information was submitted for the record by Dr. Weintraub:]
REPLY RECEIVED FROM DR. WEINTRAUB
Federal Reserve policymakers do not accept that the average size of the fall
in interest rates from increasing money supply is as small as Cagan found or that
it reverses as quickly as Cagan found. Moreover, they stress that the size and
duration of the fall will depend on the conditions that prevail when money supply
is increased and that therefore looking at the central tendency can be misleading.
But, they offer no evidence which contradicts Cagan's results on the centra!
tendency, and furthermore themselves stress that in inflationary periods (e.g.,
now) the size and duration of the fall are likely to be "smaller and shorter" than
on the average. I would add that, even disallowing any and all feedback, which
is unrealistic, to decrease the commercial paper rate, which is now about 12%,
say to 10% in a three months period, would require a step up in M-l growth of
17 percentage points per year if the interest elasticity of money demand is as low
as —.25. It should be obvious that it is difficult to get back to a 4 percent per year
growth track if you move up to 21 percent for three months. It is a little like the
dieter who goes off the diet for "just" a few months never being able to lose
weight. Finally, because feedback starts immediately, in this case going off the
diet is unlikely to be as tasty a "binge" as contemplated, that is, stepping up M-l
30
growth from 4 to 21 percent per year won't actually reduce the commercial paper
rate from 12 to 10% (with elasticity = —.25) because feedback from the step-up
In money «upply starts immediately to pull up with interest rates.
Mr. BARRETT. Dr. Weintraub, you are a very fine witness. You have
heard it from both sides. They are very much pleased with your report.
One short question I want to ask you, in your interviews with these
various presidents. Did any of them indicate that any of them knew
anything about Citicorp before it was announced?
Dr. WEINTRATTB. None of them knew, and certainly, I was not aware
of this and did not ask about it.
Mr. BARRETT. In other words, the whole country knew on the same
day?
Dr. WEINTRAUB. Yes. Of course, these interviews took place quite
some time ago. I think you might want to ask that question of the
presidents, whether they had information, say, 6 weeks ago.
Mr. BARRETT. We asked that question yesterday to all of those who
were here. They paid no, they learned of it only about the first few days
of July, indicating nobody had heard anything or learned anything
about the plan being in the works until it was announced publicly.
Everybody knew, the public and the bankers alike, at the same time.
Dr. WEINTRAUB. It was a well-kept secret.
Mr. BARRETT. Thank you very much for being here as a witness this
morning.
The committee now will stand in recess until 11 a.m. tomorrow morning, at which time we will have Federal Reserve bank presidents,
Balles of San Francisco, Eastburn of Philadelphia, and Hayes of
New York.
[Whereupon, at 12:10 p.m., the committee was recessed, to reconvene
at 11 a.m., Wednesday, July 17,1974.]
[The "Beport on Federal Reserve Policy and Inflation and High
Interest Rates," submitted by Dr. Robert Weintraub, follows:]
REPORT ON FEDERAL RESERVE POLICY AND INFLATION AND HIGH INTEREST RATES, SUBMITTED TO
THE HOUSE COMMITTEE ON BANKING AND CURRENCY BY DR. ROBERT WEINTRAUB, STAFF ECONOMIST, JULY 12, 1974
This "Report on Federal Reserve Policy and Inflation, and High
Interest Rates" is a preliminary and boiled-down version of a larger
Eeport now being prepared on this and related questions. Like the
larger Report, it is based on interviews with the twelve Eeserve Bank
Presidents -and five members of the Board of Governors. The interviews were conducted last December, January, and February. The
larger Eeport will utilize also testimony from these hearings.
Part I of today's Eeport excerpts explanations of the proximate
causes of the waves of inflation which have hit our economy since
1964. Special attention is given to the part played by the Federal
Eeserve, in either contributing to it or holding it back. Part I I probes
behind the policies which were pursued that contributed to inflation.
It gives Federal Eeserve policymakers' views on the reasons why these
policies, especially the monetary policies, were followed. Part I I I presents views on interest rates. Current substantive issues, as revealed
by the interviews, are taken up in Part IV. Some recommendations
are made in Part V.
I. INFLATION, THE PROXIMATE CAUSES
From 1965 to 1973, the Consumers' Price Index or CPI and the
M-l money supply (publicly held currency and demand deposits)
grew 3.2 and 3.3 percentage points, respectively, faster per year than
in the 1959-1965 period. In the earlier period, M-l growth measured
2.5 percent per year and inflation, 1.3 percent. In the 1965-1973 period,
M-l growth jumped to 5.8 percent per year and inflation to 4.5
percent.1
But, with some exception, Federal Eeserve officials did not assign
monetary policy the dominant role in the inflation which has afflicted
our economy since 1964. With respect to the 1965-1973 period as a
whole, the following quotes are representative of the majority view.
MacLaury (Minneapolis) :
I would ascribe this much more to the difference in the
economy and public policy in its broader sense of war, nonwar periods.
1
M-2 growth jumped 3.1 points between 1959-64 and 1965-73, from 5.3 to 8.4 percent
per year. (All calculations are December to December.)
(31)
32
Morris (Boston):
I think the primary causal force has been an excessively
expansionary fiscal policy, beginning in late '65 and continuing to the present date.
Hayes (New York):
We came quite decisively into a demand-pull inflation in
about 1965. We have the feeling that demand was ample, if
not perhaps getting close to excessive, in '65, before the Vietnam speedup, and when that speedup took place, it just was
the decisive thing that broke the back of the previous relatively stable record, and from then on, the tendency was to
have too much demand in the economy.
From January 1972 to July 1973, M-l growth (seasonally adjusted)
was 8.6 percent per year compound, more than twice as fast as the 4
percent per year norm corresponding to our long term output growth
potential, and moreover, nearly 50 percent faster than the upper
guideline of the Joint Economic Committees' 2-6 percent per year
range for M-l growth which allows for reasonable deviations around
the norm.* Nonetheless, the sharp jump in inflation in 1973 often was
explained as due primarily to special factors. These quotes are
representative.
Hayes (New York):
And, of course, the extent of the inflation in 1973,1 think,
went far beyond what you'd expect from those demand-pull
influences because you had suddenly thrown in along with
that influence all these special factors, like the world food
shortage and the fuel shortage. And the effects on our own
economy of devaluation; and the simultaneous boom conditions in most of the major industrial countries, having an impact all at once on commodity prices. I think all these special
factors were primarily responsible for the very drastic
speedup we've had in 1973.
Governor Sheehan:
Let me talk about what I think the causes of inflation have
been for the last 12 to 18 months. We've had a devaluation
during that period which has been inflationary . . . Farm
products were in short supply around the world. Another factor is that we had all the major economies of the world moving up at the same time and closely in phase. The European
and Japanese economies are much larger and more industrialized now relative to the U.S. than in the past and competed more strongly with us for some raw materials at a time
of shortages.
So you've got a food shortage, raw material shortage; and
then you had the Arabs throttle the oil supply. Now, what
did the Central Bank have to do with that? Nothing. And it
has had very little to do with the devaluation except to advise the Treasury from the sidelines on its actions. So you
have surging prices.
anding (rfttfsejirodjfUtOn
F r i e d m a n a n d C l a r k Warb
» r ton *>r sharpening my under-
33
But some assigned substantial part of the 1973 inflation to monetary and fiscal policy.
Morris (Boston) :
I asked my research staff to run the St. Louis model, which
is the only way I could think of to quantify these things, and
to tell me in the past year—that is, the fourth quarter of '72
through the third quarter of '73—how much inflation the St.
Louis model would have projected on the basis of the monetary growth rate and the Federal government fiscal policy.
The model indicated, on the basis of these monetary and fiscal
factors, that we should have had an increase in the GNP
deflator of 3.8 percent. The actual figure was 6.8 percent. The
other 3 percent came from the shortage of food, the impact of
the devaluation which was a major factor, and now the energy
crisis.
The contrast in views was most marked in assessing the relative
contributions to inflation of fiscal and monetary policy. For example:
Governor Mitchell:
Now as far as the last half of thefeO'sare concerned, and
early 70's, I think that the major problem was the war in
Vietnam, and I think that, more than any other single factor,
conditioned the results that we got on the price front. I would
say that monetary policy in this period had spurts of restraint
and spurts of ease.
Mayo (Chicago):
I feel that fiscal policy is still the biggest contributor to inflation and, at the same time, the number one instrument for
inflation control.
But President Francis (St. Louis) did not agree. In his view:
When a change in government spending that creates deficit
in the government accounts occurs, there may be some small
impact on the real economy but not too much. I think the key
factor is when the central bank moves in to support the borrowing, and injects what I call "new money" into the economic system. Treasury borrowing alone would be more of a
transfer of money from the private sector to the public, you
get that I think with any period of Treasury borrowing, but
when you interpose new money on top of that, or too rapid
increase in the rate of monetary expansion, I think this is the
kicker on inflation.
The chain of events that links inflation to Federal Reserve policy
usually starts with open market purchases. Open market transactions
are the principal instrument of Federal Reserve policy. The following
excerpts from the interviews describe what happens:
Black (Richmond) :
Well, to generalize, very simply, which I gather is all you
want at this point, if you start supplying reserves at a more
34
rapid rate, this means that the banks are going to be in a position to begin their lending and investing activities at still a
higher rate. And this is going to be reflected in a growth in
their liabilities, either in the form of time or demand deposits
and probably there will also be an increase in the supply of
currency held by the public. And all of these factors are going
to work towards increasing spending . . .
Weintraub:
All right. Now, just to flush this out just a little bit more,
the increase in spending would, of course, impact on both output and prices, and the partitioning between them would depend critically I suppose on how close we were to full employment or how much slack there was in the economy.
Black:
Eight. Hopefully you have physical output growing at the
same rate as your spending. But sadly that seldom happens.
Governor Holland:
Other things being- equal, the more monetary stimulus
that's pressed into the economy, the more response you get in
terms first of real output, and then as you get close to capacity, the more that expansion spills out in prices . . .
As indicated by President Black and Governor Holland, accelerated money supply growth stemming from stepped-up open market
purchases, acts to accelerate inflation. This is the fundamental proposition of monetary theory. There is wide agreement on its validity at
least as a long-run matter. President Eastburn (Philadelphia) used
it to synthesize monetary and other explanations of price developments in the 1965-1973 period.
Eastburn (Philadelphia) :
First of all, I think that it should be said that over the
whole period, not dividing into these subperiods and consistent with the position that I stated earlier, that in longer
run periods, I think that it can't be denied that the rate of
growth of money affects prices. Over this longer run period,
that relationship has existed. You might be interested in this
chart [Chart A]. It plots percentage changes in the GNP
price deflator and a three-year moving average of the percentage changes in the narrowly defined money stock.
35
CHART A
flftoney Supply Growth and inflation
Percent
Money Supply C3-Year Moving Average)
AGNP Fric* Deflator
Weintraub:
Yes, beginning in 1962, the money supply growth begins to
rise and it proceeds rapidly in 1965, and the deflator begins its
move up at that time.
Eastburn:
Well, looking at the whole period, that's been the case. You
have had rises in money growth and rises in prices, and I
think the two are related. Now, when you get to subparts of
that and you narrow down the time frame, then you get other
elements affecting inflation. For example, in the middle and
late 60's, that part of the failure to contain prices can be
attributed to lack of an appropriate fiscal policy which the
President and Congress failed to put through. During more
recent periods, I think it can be attributed to special factors
such as crop failures, world-wide demands for goods, shortages of materials and energy and so on, which we're seeing
now. So, that in the shorter periods, you get these special
36
tactors which either are superimposed on the money phenomenon or override it, and these can be used to explain specific developments in those shorter periods.
To recapitulate President Eastburn's synthesis, while fiscal policy
and special factors may account for changes in the rate of inflation
for short periods, in the context of a period as long as 1965-1973, inflation is a monetary phenomenon, and its rate depends on the rate
of growth of new money. But, moreover, response by the Governors
and Presidents to questions on specific policy actions and trends in
monetary policy during the 1965-1973 period reveal that even in
fairly short run contexts, there was a close-lagged relationship between money supply changes and changes in economic activity including the rate of inflation.
1965-mid-1969 :
Inflation did not happen all at once nor did it occur in a uniform
continuous wave. In the year ending December 1965, the CPI rose 3.4
percent. Then, after rising 3.9 percent per year in the first nine months
of 1966, the rate of rise of the CPI slowed to 1.4 percent per year in
the fall and winter of 1966-67. It then re-accelerated and reached 6.3
percent per year in the first seven months of 1969. As shown in Tables
1 and 2, during these years, M-l growth was accelerated until April
1966, slowed from then until January 1967, sharply re-accelerated
for two years, reaching 6.1 percent in the year ending October 1967,
7.1 percent in the year ending January 1968, and 8.1 percent in the
year ending February 1969, and then slowed to an average of 4.2
percent per year until July 1969.
Referring to this period, President MacLaury (Minneapolis) said:
Certainly in retrospect, looking back on that period . . .
monetary policy during the period should have been tighter
than it was. I certainly go that far.
Hayes (New York) :
We always have to walk this fine line between combating
inflation and taking undue risks of setting in motion recessionary forces. And we did apply the pressure in 1966, and
you recall the famous credit crunch which to some extent
reflected that effort. Obviously, in the absence of fiscal support, monetary policy has a harder burden and can't be
expected to do the job by itself
effectively; and when we did
see business slowing down, wTe reacted in early '67. Perhaps
we reacted a little too much in our fear of a recessionary
development which turned out to be very temporary and not
very serious. Then, in 1968, when we finally did get the fiscaJ
support, monetary policy was fearful that the fiscal move
maybe was too strong. That turned out to be a failure in
judgment. I can come back to that later because there were
differences of opinion within the System at that time, but
the majority view was that we should slacken up, and we
did slacken up somewhat.
37
TABLE I.—MONTHLY PER ANNUM M-l GROWTH RATES, 1959-1964 AND 1965-1974
1959
1960
1961
1962
1963
1964
1965
January
February...
March
April
May
June
July
August
September.
October
November..
December..
1966
9.1
4.2
4.9
14.6
.7
1.4
(4.1)
(1.4)
6.9
(4.1)
k
1967
0.7
12.3
8.8
(4.1)
12.1
10.0
9.3
6.6
7.2
6.5
3.9
J
2.1 4.5
1968 1969
1970 1971
5.1 7.1 10.4 3.3
6.4 7.7 (5.7) 13.0
5.1 4.1 9.7 10.2
5.7 4.7 9.1 9.0
12.0 4.1 5.6 13.2
10.6 4.1 3.9 9.9
7.4 4.1 5.6 7.2
5.5 (2.9) 6.7 1.0
7.3 2.3 10.5 1.5
7.3 3 5 5 5 4.1
10.9 3.5 4.4 ( 5)
7.2 ( .6) 3.3 2.0
1972
1973
1.5
13.8
8.5
7.5
4.0
6.9
11.8
6.3
7.7
8.7
6.2
14.7
4.7
5.6
.9
6.0
13.9
14.2
4.1
( .5)
(3.6)
5.0
11.7
9.8
1974
(2.7)
12.9
11.0
8.7
5.2
4.7
i Denotes negative growth.
TABLE 2.—YEAR-TO-YEAR M-l PERCENTAGE GROWTH, 1965-74
1965
1966
1967
1968
1969
1970
1971
1972
1973
January
February
March
April
May
June
July..
August
September.._
October
November
December
4.7
4.5
4.5
4.6
4 2
4.4
4.1
3 7
3.9
4 2
4 2
4.6
5.1
5.4
5 5
6.1
5 8
5.3
4.6
43
4.2
3 1
2.8
2.4
1.6
2.3
2.6
1.4
2 5
3.7
4.4
5.1
5.1
6 1
6.3
6.6
7.1
6.6
6.2
7.1
7 1
7.1
7.0
6.9
6.9
7.0
7.6
7.8
8.0
8.1
8.0
7.9
7.2
6.6
6.3
5.6
5.2
4.8
4.2
3.5
3.8
2.9
3.4
3.8
3.9
3.9
4.0
4.9
5.6
5.6
5.7
6.0
5.4
6.8
6.8
6.8
7.5
8.0
8.1
7.6
6.8
6.9
6.4
6.3
6.2
6.2
6.4
6.2
5.4
5.2
5.6
6.0
6.6
7.0
7.6
8.7
9.0
8.3
7.3
7.2
8.1
8.7
8.0
7.4
6.4
6.1
6.6
6.1
Yearly1
4.3
4.5
3.7
7.0
6.3
4.5
7.0
6.4
7.4
1974
5 H
6.1
7.0
7.2
6.4
5.6
..
..
..
..
..
..
Average of monthly M-l stocks this year divided by preceding year's average.
Morris (Boston) :
The last half of '68 was clearly a misjudgement.
Coldwell (Dallas) :
As I recall that period you're citing in there, up through
'69, there was a considerable uncertainty as you may remember on the surtax question of Congress that was delayed for
about 18 months. When it finally was passed in July of 1968,
there was a lot of talk about overkill and putting the economy
into a severe restraint. There were those of us who were on
* the Committee at that time who did not see it that way,
but the overall total was a move toward ease. Then, of course,
we reversed within a six-month period.
August 1969-January 1972:
From August 1969, to January 1972, inflation tapered off. The
annual rate of rise of the CPI dropped from 6.3 percent in the first
seven months of 1969, to 5.9 percent in the remainder of 1969, to 5.5
percent in 1970, to 3.9 percent in the first seven months of 1971 just
before President Nixon's New Economics Program was put into
effect, and to 2.9 percent from August 1971 to January 1972. M-l
growth was slowed beginning in the winter of 1969 and the deceleration continued until February 1970. In the year ending February
38
1969, M-l growth was 8.1 percent. The next year, it was 2.9 percent.
After February 1970, M-l growth was again stepped up; rapidly'
until early 1971 and very sharply until July. From July 1971 to
January 1972, there was little growth in M-l. This subperiod provides clues on the policy pressures, time dimension and tolerances
required in unwinding from inflation.
TVeintraub:
Let me show you a chart that I think is very interesting,
that I also have drawn up. This one uses year-to-year price
> changes in the Consumer Price Index, and it runs from September 1968 to July 1971, a period of thirty-four months.
You'll notice it's almost a bell-shaped curve, peaking in
February 1970. That is the month that marks the highest
year-to-year
change in consumer prices in this period. All
right? 2
MacLaury (Minneapolis) : "Yes."
entage
the
'Ending
iev 1963
To July 1971
I II
I M I I M
U
| « l . ) | I l - M I I I I j . i I Li i
Weintraub:
It takes seventeen months for the Consumer Price Index
to go from a rate of increase of 4 percent per year up to 6.4
percent, and seventeen months to get it back down, which
is an interesting
thing. Now I use 7-71 because of an obvious
reason, wThich is that it is the last month before the freeze.
So it strikes me perhaps we had inflation licked, at that time,
2
C h a r t I replicates the c h a r t referred to.
39
due to the fiscal and monetary policies that were being followed, although there was something of a recession. Would
you agree that there at least was this very strong tapering
off?
MacLaury:
The numbers speak for themselves in that respect.
A caveat is in order before proceeding. Wholesale prices behaved
differently during this period. The annual rate of rise of the WPI
decelerated from 5.5 percent in the first seven months of 1969, to 4.0
percent in the remainder of 1969, and to 2.3 percent in 1970. But in
the first seven months of 1971, it accelerated back to 5:6 percent.
On this period, President Hayes (New York) said:
And we did see some progress, as you've indicated, in the
following years in the slackening rate of inflation. But it
wasn't enough progress—it was rather discouraging, in fact,,
and it seems to us that we had a cost-push inflation which
had been generated by the previous inflationary experience . . . As the real economy began to slow down, we were
much more loath to apply the pressure.
Francis (St. Louis) :
. . . In '69 the Fed slowed down the rate of money creation and held it down to a degree through 1970. We saw during that period, I would say, some wrenching in the economy . . . we had some small influence, I think, also on the
inflation rate—it began to taper off.
From January 1972 on:
From January 1972 to the summer of 1973, M-l growth was very
rapid. Year-to-year growth was 9.0 percent between January 1972
and January 1973 and 8.0 percent in the year ending July 1973. Some
felt, nonetheless, that monetary policy was not a strong inflationary
factor during this period—though not endorsing it as sufficiently restraining especially in retrospect.
President Hayes, recognizing that the strength of demand-pull
forces turned out to be stronger than expected, stated that:
This happened in the face of strong efforts by monetary
policy to fight inflation, commencing back in '72 and getting
stronger through the first half of ' 7 3 . . .
Weintraub (in a question put to Governor Bucher) :
We seem to have embarked on a path in the last few years
which has taken us away from this long-run growth of the
money supply which is consistent with minimal inflation and
full employment with absorption of labor force growth and
productivity. At least I think that that is what has happened
in the last few years.
Governor Bucher:
I wouldn't agree with that. There have been some circumstances that have caused some problems. There have been
other factors in the economy that have made us adjust our
40
thinking a bit at certain times. At least as long as I have been
here, I have felt the objectives have not been inconsistent
with the type of program you have in mind.
Weintraub:
I think the objectives may be there, but the results I'm not
so sure about, as far as the money supply is concerned anyway I know that . . .
Governor Bucher:
I think generally we've done a pretty good job, money
supply wise. That is, of course, my opinion.
Governor Sheehan:
If you measure real growth in narrowly defined money, it
was about the same as the real growth in the economy. So by
this measure, at least policy was not stimulative. In one recent period we measured, we had something like 7.4 percent
real economic growth and 7.6 percent growth in money—M-l.
So we weren't flooding the economy with liquidity, just as Art
Okun has said.
Mayo (Chicago) :
The expansion of the money supply, I believe, can be fairly
stated as being consistent with the expansion of real growth
that took place in the calendar year 1972, on the rough order
of 7!/2 percent in each case, if I remember my figures correctly.
Others interviewed had different opinions:
MacLaury (Minneapolis) :
I think that the—certainly my reading of Fed policy intentions, starting with mid-'71, which is when I came into this
slot, we did look upon the price freeze and subsequent incomes
policies, price and incomes policies, as permitting us some
leeway to have an expansive policy in that period of high unemployment than we could have without those policies. I think
that's a fact, as I understand it.
d a y (Kansas City) :
I think you can explain that pretty easily—may not like it,
but I think you can explain it on the basis that overly optimistic expectations as to the effectiveness of Incomes Policies that resulted in less cautious fiscal and monetary actions
after you get into your Incomes Policy.
Governor Holland:
With hindsight, had we been sure in the summer of '72,
that so strong an upsurge in private demand was due to happen through the fall months and the winter of 1972 and 1973,
I am sure we would have followed a less expansive monetary
policy.
MacLaury (Minneapolis) :
Beginning mid-'72, some of us, myself included, became increasingly concerned by the rate of growth in the money sup-
41
ply and other things that we saw going on in the economy, and
I can't remember what month it was that I succeeded in casting at least one negative vote in that committee, saying that I
felt our policies were overly expansive. So that, I left the
bandwagon about mid-'72, saying that we should be pursuing
a more restrictive policy, in terms of monetary growth, than
we were in fact pursuing. I have felt that was true; well, I
think in retrospect, that has been vindicated.
Governor Brimmer:
I am on the published record for all of this. Beginning on
September 1, 1972, I indicated my view of what I thought
the Federal Keserve was doing and started voting "no." The
issue came up in connection with the Board's consideration of
the proposed discount rate. The Board disapproved increases
in the rate some eight times between September 1 and December 18,1972. That was a real debate. There was some debating
in meetings of the Federal Open Market Committee but the
real issue, the cutting edge in 1972, was over the discount
rate. . . . In my view many policy actions taken during much
of 1972 were improper, and rather than fighting inflation they
were adding to it.
1967 Until Now, the Monetarist View :
Francis (St. Louis) :
Then we did go through the two-year period of 1967 and
1968 at rates of money expansion somewhere around seven
percent, as I remember. And we saw the economy grow I
guess at pretty rapid rates, and we saw the rate of inflation
pick up constantly through that period. In mid-'68 the Congress finally acted to increase taxes as one means of trying
to fight the inflation that was developing, and there were
many I think who believed that a balancing of the budget
alone at that time through a shift to higher taxes might set
off an instant recession in the economy. Some of us who look
more closely at money argued that unless the rate of monetary
expansion slowed with the fiscal action probably nothing
really was going to happen. And I think history proved that
point. The rate of inflation continued to grow throughout
1968, and then we went into the next period you mentioned
when in '69 the Fed slowed down the rate of money creation
and held it down to a degree through 1970. We saw during
that period, I would say, some wrenching in the economy,
not as bad as we have in some other times during history, but
dropped the rate of real production down into the zero area
for a quarter, or two, or three. But we had some small influence, I think, also on the inflation rate—it began to taper
off. But there again, following 1970 and beginning in 1971
and running right up to the present time, we have seen a
monetary expansion somewhere in the area of seven percent
annual rate on M-l, and we have seen inflation, while slowed,
temporarily, come right back into the picture and reach the
highest level we have seen in a great period of time.
42
T H E NEXT QUESTION
Eeferring to data showing a strong association between money
supply growth and rates of inflation both among different countries
in the same time period and over time in the United States, I said
to President Black that, "I would come to the conclusion that money
supply is very important for understanding prices. Would you agree
with that?"
Black (Richmond) :
I would agree completely. But so far as saying that that
is the sole cause, that's another question. You've got to go
behind why the money supply did what it did.
II. W H Y MONEY SUPPLY GREW AS I T DID
Why did M-l grow as rapidly as it did from early 1967 to early
1969, from early 1970 to mid-1971 and from January 1972 to mid1973? Many stressed, as the preceding excerpts show, that mistakes
were made in predicting that fiscal overkill would develop rapidly
from the surtax of mid-1968, and in failing to recognize the strength
of the economic expansion that was developing in 1972. Some also
pointed out that a mistake was made in believing that Incomes Policy
would effectively check price hikes in 1972 and 1973. These errors
appear to be the proximate causes of inflationary M-l growth in the
second half of 1968 and again in 1972. But we have to dig deeper. As
shown in Tables 1 and 2, money supply also grew rapidly enough to
cause inflationary problems (faster than 6 percent per year) both
before the bad forecast of mid-1968 and before and after the misreading of the economic winds in 1972-73.
Why did it happen ? Broadly speaking, there are three possible
reasons:
(1) M-l growth was deliberately stepped up to reverse developing
recessions and achieve "full" employment, and to accommodate inflationary developments—startling though this may seem to some.
(2) Inflationary money supply growth emerged as the predictable
byproduct of monetizing Government deficits and fighting fires and
keeping order in money markets.
(3) It happened because of inability to control money supply
growth.
Excerpted now are quotes from the interviews articulating the
positions of Reserve Board Governors and Eeserve Bank Presidents
on these explanations of what happened.
A Deliberate Choice:
To REVERSE DEVELOPING RECESSIONS AND TO ACHIEVE " F U L L "
EMPLOYMENT
m Frequently it was said that inflationary policies, including excessively rapid M-l growth, had been and continued to be followed,
basically, because the Nation prefers inflation to unemployment and
43
depression. In specific, M-l growth was stepped up to reverse developing recessions and to achieve "full" employment.3
Governor Bucher:
I'm also, I think, quite pragmatic in my awareness of how
Congress reflects public opinion, and I feel this is a real
restraint. Here I'm referring to such things as the extent to
which unemployment is allowed to increase. Thus things
which we might be able to do in a vacuum and which would
probably make the most economic sense cannot be fully implemented because of possible Congressional reaction.
Clay (Kansas City) :
Well, fundamentally, I think the reason that we have inflation—and probably the reason we'll continue to have inflation to some degree—is that the people of the United States
have experienced a Great Depression within their time, or at
least within the memories of their fathers and mothers. As a
result of that, every political person, every person that has
gone through that sort of thing, says, "Let's never let that
happen again." So the natural tendency of our political system at the present time is to make any mistakes on the side of
greater ease, rather than greater tightness.
As we go along and begin to recognize that the Government
is spending too much money—or that the Federal Reserve is
producing too much money—we are slower to make the correction to slow down these rates of Government spending or
the rates of the increase of the money supply or credit, than
we are to turn the other way on the other side of the picture.
Politically it is unacceptable to take any penalties from recession—and certainly from depression.
Morris (Boston) :
I think when we talk about inflation control, we ought to
consider it in the context within which we have to operate.
The Federal Reserve System is not empowered by the Congress to pursue in a single-minded fashion the goal of controlling inflation. The Congress expects us to do the best job we
can in coming up with a mix of unemployment and inflation
which is going to be acceptable to the American people. I don't
know what the maximum level of unemployment the Congress would accept in the interest of dampening inflation.
Balles (San Francisco) :
I can look back even to 1972 and recall that it wasn't until
late in the year that the unemployment rate got below 5%
3
In the 1965-73 period, unemployment averaged 4.5 percent compared to 5.7 percent
in 1959-64, but the difference is at least partly attributable to differences prevailing
when the two periods began. In 1958 unemployment averaged 6.8 percent compared to
5.2 percent in 1964. (In December 1958 it was 6.1 percent as compared to 5.0 percent
in December 1964.) Moreover, during the earlier period, unemployment fell steadily after
the 1960-61 recession. The 5.0 percent rate in December 1965 was just two-tenths of a
percent below the December 1973 rate.
36-714—74-
44
percent. Well, given what has emerged as something of a consensus goal on an acceptable long-term unemployment rate of
4 percent, that clearly meant that if you looked at the unemployment rate as an indicator of whether policy ought to be
less expansive or more expansive, you would have had to conclude that we needed to stimulate the economy more to get
the unemployment rate down. Now admittedly, that was going to have some unfortunate effect on prices, and I think it
probably did, so how are we going to resolve those conflicts
in national goals ?
ACCOMMODATING SPECIAL AND GENERAL INFLATION
In addition, because of the desire to avoid unemployment, the Federal Reserve since 1964 has tended to validate price increases which
originate in events other than accelerations of money supply growth
and also to accommodate past pervasive inflation. Such accommodations of inflation are based on the following (simplified) perceptions
of the economy and economic processes. To wit: that price increases
increase the demand for money as the public seeks to finance the
higher cost of transactions. If additional money is not supplied, the
public reduces spending and because prices are rigid-downside, the
spending cuts cause production and employment cuts. Not all Federal
Reserve policymakers agree that such accommodations should be made,
however.
Governor Holland:
We are experiencing a sharp rise in energy costs, just as we
experienced a sharp rise in food costs last summer . . . Now,
I believe the evidence in the modern American economy suggests that it is very hard to drive prices down very far in any
sectors. Indeed, if you try to do so by any general policy, you
produce a lot of disruption—a lot of unemployment, a lot of
unutilized resources. Therefore, I wouldn^t regard it as an appropriate target for monetary policy to drive down other
prices enough to average out the rise in prices of food and energy. I think that means that our monetary aggregates need
to be averaging a little higher than would be true in the absence of the energy crisis or the food crisis that took place
last summer.
Governor Mitchell:
If you said that the original price rise was due, say to the
Vietnam war, and then you get a higher price level built
into your system, then I think that monetary policy would
tend to accommodate the price level rather than to roll it
back . . .
Weintraub:
So what you're saying is that somehow or other, let me see
if I understand this, that we get a series of events in the last
8 or D years, starting with the Vietnam war, which essentially
boosted prices and that because we are unwilling to wring the
price boost out, we validate this with a monetary expansion.
45
Governor Mitchell:
I think this is easiest to observe in the Vietnam war.
Black (Eichmond) :
And you have these extraneous factors that work from the
outside. You had the devaluation, worldwide inflation, shortages of raw materials and other products that were driving
up prices and so on to some extent, and I think probably to
a large degree because of our wage and price controls. And
with these extraneously imposed pressures on prices you
either had to create unemployment or validate those price
increases.
MacLaury (Minneapolis) :
As a legitimate reason—explanation if you want to—for
exceeding 6 percent at the current moment, let us say, I would
see it as a legitimate explanation mainly that we are in an
environment of 8 percent price increases, part of which is
exogeneously determined, and whereas I would certainly not
want to validate the whole of the price increase, it seems to me
quite reasonable that we should be validating, if you want to
put it that way, I don't like that phrase in this context, but
taking account of some part of that annual rate of increase
in prices, so that for example, take 8 percent. If that was your
price increase, maybe we should take a 4 percent rate of
growth in prices and only validate half of what is happening
at the moment, and I don't see that myself as building in problems for us for the future.
Governor Brimmer:
. . . If the rate of growth in the money stock falls substantially short of a built-in rate of inflation, you end up with
very depressing effects on the real economy.
Coldwell (Dallas) :
We're looking at a pretty sizable change in the inflation
rate. And if that's the case, and if our prices are going up so
much higher then there is a major upsurge in transaction
demand because of this higher price level, maybe there has
to be some bow in this direction. I would be reluctant, however, in a theoretical position^ to say that we must validate
all the rates of inflation coming down the pike because we
then get into this racheting problem.
Governor Bucher:
I think that your central banks feel a responsibility to provide funds, at the minimum, adequate enough to fund the real
growth of the economy; and probably more than that—probably enough to fund a major portion of the nominal growth
of GNP.
*
Others disputed the preceding lines of argument. Their disagreement is represented next.
46
Referring to a recommendation that M-l growth be kept at 7-9*
percent per year to override the oil shortage and compensate for past
price increases, President Mayo (Chicago) said:
I feel that's entirely too accommodative . . . our major
concern should still be fighting the battle against inflation.
Francis (St. Louis) :
I don't view the energy crisis as a great complication in thi&
process. Now, I know that there are different views, and there
are many who have spoken out, that if indeed the energy crisis
should develop to the point where it influences our rate of
production downward, you need to raise the money supply r
and that I completely cannot understand. I don't know why,
if the level of production of goods and services in this country is forced down by an outside influence like energy, why
we'd want to put more dollars in the economy to chase those
goods and services. I can see only one outcome, and that would
be further inflation.
Hayes (New York) :
But I don't think we should be too quick to try to do anything on the monetary side to meet the immediate failure of
supply
Balles (San Francisco):
It would be economic madness to keep stepping up the rate
of money supply to keep up with inflation.
PREDICTABLE BYPRODUCT
MONETIZING DEFICITS
Excessively rapid M-l growth also was attributed to accidental
reasons. One such reason cited was that rapid growth was a byproduct
of the Federal Eeserve choosing to monetize large parts of fiscal
deficits.
Coldwell (Dallas) :
The Federal Eeserve has normally taken a position that it
should support the credit of the United States in its issuance
of any securities . . . And we monetized the Government's
efforts to spend for the Vietnam war.
Mayo (Chicago) :
Let me go back again to my basic philosophy as it applies to
this particular period. I feel very strongly that taking the
whole period together, fiscal policy in the '66 through '68
period was the basic culprit in forcing up, if you please, the
increases in the money supply.
Weintraub:
But what I'm puzzled about is the connection—the nexus.
What is it that compels the Federal Eeserve to act to increase
47
money supply and to increase the rate of increase in money
supply when the budget is in substantial deficit?
Mayo:
Well, this is a direct result of the fact that the Treasury
obviously has to borrow when there's a deficit.
Weintraub:
That's right.
IMayo:
The Treasury has to borrow in a real market. The Federal
Reserve, I think has a responsibility—I wouldn't call it a compulsion—to see that a Treasury offering when properly priced
in the given market environment is not thwarted by tightening
up on monetary policy . . . That is why we have what is called
even keel, which is I think much more reasonably handled
nowadays than when I was in Treasury . . . the fact that the
Treasury was, say doubling its demands on the market, would
be a constraint that we couldn't ignore . . . we couldn't say that
the demand had to come out of somebody else's hide . . .
Ulack (Richmond) :
You can find that there were reasons, institutional reasons,
why we erred on the easy side when we did, for example,
back in the period we were talking about earlier when we
had the heavy deficits. You know you pretty well have to
underwrite those deficits unless you are going to crush out
of the private economy an equal amount of spending. And
that's not feasible sometimes, so you're kind of stuck with
that.
Weintraub:
Is there any reason why money supply has to grow because
of a large federal deficit?
Balles:
Well, it's awfully hard to prove this one way or another.
But my impression from years of study of monetary policy
has been that when you're right down at the firing line,
the Federal Government does have to get financed. It would
simply be unthinkable for the central bank to refuse to provide the financing the Federal government needs, based on
the existing facts of expenditures, revenues and the deficit.
To refuse to do so would probably be to create chaotic conditions in money markets and probably very severe deflationary effects on the economy. You can postulate a constant rate
of growth of the money supply in the face of large private
demands augmented by the Federal government demands in
a period of budget deficit. If we simply refuse to expand
the money supply, then what happens is fairly clear. Namely,
private demands for credit would somehow get squeezed out,
and interest rates would rise to astronomical levels.
48
A different view of this question was expressed by President Francis
(St. Louis). He said:
Of course, I believe and I've said this literally hundreds
of times in speeches, that I think it is not necessary for the
Federal Reserve to come to the support say, of the Treasury,
to the degree it has. I think it is more a matter of a tradition
of central banking that has done that, and we continue to
follow that tradition. I would much prefer to see the Federal
Reserve try to determine the level of money that is consistent
with full employment and stability, and I don't think these
are inconsistent objectives. I think it can be accomplished by
letting the Treasury cut its excessive needs out of the market.
This would have been my preference, but it's not the way it
worked during the early period.
FIGHTING FIRES AND KEEPING ORDER IN MONEY MARKETS
The Federal Reserve's frequent absorption with money-market
problems also was given as a reason for excessively rapid M-l growth.
Many indicated that M-l growth strayed from the optimal long run
path because the Fed let it do so while concentrating on fighting fires
and keeping order in money markets.
Coldwell (Dallas):
Well, I think we need to look at what are to be the actions
of the Federal Reserve. Is the Federal Reserve to have its eye
only on a target 18 months out, or is it to respond to short-run
fire fights and other things which develop in the economy and
internationally ?
Governor Bucher:
I also think there are times when we have to vary from
paths. There are circumstances, such as the Penn-Central situation, and others, which are beyond our control. In these
cases, we have to leave what would normally be a desirable
path as far as money growth and other conditions are concerned.
Winn (Cleveland):
You know, I would agree that if you set controlling money
supply as a single objective, and you were not concerned
about the behavior of any of the other variables, you probably
could control it much closer than you are able to do at the
moment. But I think what happens is, is to your willingness
to let some of the other elements fluctuate.
Weintraub:
This I get is—one of the findings that I'm getting as I interviewed the Presidents and some of the Governors in the
Federal Reserve System, is precisely that there seems to be a
set of targets that sometimes . . .
Winn:
Are self-defeating in terms of . . .
49
Weintraub:
Can be self-defeating certainly of a moderate money
supply . . .
Winn:
This is correct.
Later, returning to this theme, President Winn indicated that holding a steady monetary growth course could bring substantial money
market rate changes. In specific, Winn said:
I'm contrasting this now in terms of the policy you're proposing^ And you know, I know what we got in this period
with what we did—what would have been the results if this
had been different. And you know, what would 15 or 20 percent Federal funds rate mean ?
Weintraub:
Well, we're not a bit sure that we would have had 15 or 20
percent.
Winn:
No. No. No. I mean this is—you can't rule it out.
Weintraub:
No, I understand. I've been told that there was a period
recently—it may have been one hour when it hit 50 percent.
Winn:
We had that one day. That's right. We had a couple of
transactions reported on that kind of a rate.
Weintraub:
I really find it hard to believe that with steady money
supply growth, that you'd get anything like this sort of
aberration and gyration in interest rates.
Winn:
Well, you're assuming with constant growth that you don't
have these fluctuations I mentioned as a result of other forces,
which are really quite a surprise
We're shooting to achieve
a multiplicity of targets and you want to shoot at a single
one—but the result of that is that you get even greater extremes on some of these other trends.
Governor Sheehan:
During the first quarter of 1973 the money supply as defined by M-l grew very modestly, it shrank in January, and
grew just a little in February and March. Then, in the second
quarter it grew at a rate of between 10 percent and 11 percent.
We got it back down again in the third quarter. Well, you sit
in the Open Market Committee Meeting debating this, and
you are in the middle of the second quarter and money is
growing faster than you want it to grow, so you turn to the
staff and say, "Staff, if we move against this high growth,*
50
what do you think the Federal funds rate is going to do?" The
staff says, "If you want to get it down to within our proposed limits, during that three-month period, you have to be
willing to accept a Federal funds rate in the range of 20 to 25
percent for 8 to 10 weeks." And then you say, "Well, is that
all right with Friedman, just control the money stock, to
hell with the interest rate. Can we ignore the stress this puts
on S&L's all over the country and the financial system as a
whole ? It's just impracticable to completely neglect interest
rates."
Weintraub:
. . . I would have reduced the growth to around 5*/£.
Governor Mitchell:
But Bob, you are saying that without saying what goes
with it. That's why I come back to this question right at the
beginning: "Would you go for a 10 percent mortgage rate?"
Hayes (New York):
There were times in '72 when I would have wanted to slow
the rate of growth of money somewhat more than the System
did. But . . . I suspect that a 4 percent growth in the mon^y
supply would have brought some awfully sharp market reactions because of wild interest rate moves.
Governor Brimmer:
Would I just aim for some growth rate in the money
stock? The answer is no. There would be a great risk in
setting our policy target in terms of the narrowly defined
money supply and then sticking to that target. You mentioned the need to avoid disruptions in labor markets and so
on. In fact, that is not where you would first see the disruptions. You would see them first in the financial markets long
before you got to the real economy. You have already seen
what will happen to the savings and loan associations. Many
people do not realize it, but there has also been an impact on
the brokerage business. There is no doubt that a good bit of
financial turmoil that we see is simply indicative of what
would happen more generally to the real economy. Financial
institutions carry their assets rather substantially in the form
of fixed values. Wide fluctuations in interest rates have a
sharp impact on the prices of such assets. Certainly, if we
were to adopt a policy track designed to get the rate of inflation down to—let us say to 3 percent from 8 or 9 percent over
too short a period of time—that would mean restraining the
rate of growth in money and credit to rates so small that we
would end up with substantial capital losses for financial
institutions and others. The counterpart of those effects, of
course, is bankruptcy. I stress that because many people,
especially many of the monetarists, do not pause to survey the
debris that would be built up along the way.
51
Others saw dangers from neglecting money supply while trying to
smooth short-run fluctuations in the Federal Funds rate and other
money market rates.
Balles (San Francisco) :
To keep the money supply growing at a constant rate, and
to do this by controlling our operating target, I don't think
we can or should ignore big shifts that can and do occur in
the demand for money. If we were to try to keep the M-l
growing at a rigidly controlled rate, I think we would probably see some pretty wide and counter-productive fluctuations
in the level of interest rates in the short run. I think that we •
can allow variations in the rate of monetary growth to occur
over short spans of time with a view to preventing undue instability in the behavior of interest rates. Longer run, however, I am very much of the view that interest rates as a target
are going to get us into trouble.
Eastburn (Philadelphia) :
Well, let me say one thing. As you confront this task, if
you agree that it's desirable to get growth in money down
sometime, one of the problems that one incurs is finding the
appropriate time, and there never seems to be a good time..
Eastburn (at another point in the interview) :
I do feel that the Open Market Committee has to watch
interest rates, and I don't want to leave the impression that
money is the sole indicator.
Weintraub:
Let me ask you why that's true then ?
Eastburn:
There are a number of factors. One factor has to do, of
course, with the effect of instability in the markets. If you
take the view that the Fed has a key responsibility for some
degree of stability in financial markets, I think that as a
lender of last resort, the Fed has the responsibility to prevent panics, and this to some extent, is an interest-rate phenomenon. Also, there is some question as to less extreme
fluctuation of interest rates. The Open Market Committee,,
as you know, has not been prepared to take the money supply
as the be-all and end-all policy target. It also looks at interest
rates, especially short-term rates. My view is that the market
probably could be more self-reliant with respect to changes
in interest rates than it has been permitted in the past. And
therefore, perhaps, we would have to focus less than before
on short-run fluctuations in interest rates. Nevertheless, I
think there may be times when disorderly markets result and
disrupt the rest of the economy, and that must be watched
. . . The difficulty is not so much which one is the better
indicator, but what happens when you use money market.
52
conditions and rates as a short-term guide. I think using
money market rates can get you into difficulties in the longer
run. And this was what we were talking about earlier. You
may look at them from meeting to meeting or week to week
or day to day and they can be a good guide. But when you
rely on interest rates, you can forget what happens to money.
I think that's the problem.
Control Problems
Federal Reserve policymakers do not deny that they have ample
powers to control money supply growth from year to year. However,
nearly all Governors and Presidents mentioned an information problem as a reason why M-l growth had been faster than it appears, at
least in retrospect, was desired in 1972 and 1973. M-l consists of currency and coin and demand deposits held by the public. The Federal
Reserve does not itself track demand deposits in non-member banks.
The FDIC does this through its periodic call reports. During this
period the FDIC called and received only four reports each year—
one each quarter—from non-member banks on these deposits. During the 1972-73 period, the Fed's between-reports estimates were low.
Moreover, because there was only one report each calendar quarter,
the reliabilty of the information received from the FDIC on nonmember bank deposits was less than perfect.
As a result, sometimes the estimate of non-member bank deposits for
a given month had to be revised upwards more than once. The first
revision was made on the basis of the FDIC reports for the immediate
quarter and later revisions on the basis of later reports.
Ample Powers
Weintraub :
There would be, as I understand it, no difficulty in the Federal Reserve's controlling the growth of the money supply
from year to year, or controlling the 12-month moving
average of it, if it so desired.
Governor Holland:
If we were giving that top priority. If we decided that the
goal of hitting that target overrides everything else we could
do, I think we could probably come fairly close from one year
to the next in achieving the M-l growth that we decided we
wanted to create in the economy.
Weintraub:
First off, a year is long enough to control the money stock
if that were what the Federal Reserve was trying to do.
Francis (St. Louis) :
Well, certainly a year, and of course, I believe we can do
it effectively on a quarterly basis.
Weintraub:
Well, let me ask you. How could money supply, the nominal money supply, have grown—how could it grow just be-
53
cause the economy wants it to grow, unless the Federal Reserve supplies the base for it ?
MacLaury (Minneapolis) :
The way you put that, it could not. It could not. We have
the ultimate control and the question is, of the growth of the
monetary base. I agree with you on that.
Inadequate Information
Governor Mitchell:
The only information we have on 25 percent of the money
supply is four observations through the year. On the remainder we have an observation every single day. Fluctuations
in those deposits can be very substantial.
Weintraub:
Now, could the Federal Reserve, if it were instructed, or
if it desired of its own volition, keep this 12 months' average . . .
Morris (Boston) :
Yes, with the single provision that I mentioned at lunch,
that the money stock is subject to annual revisions based on
the non-member bank data. It could be that an annual revision
will be sufficiently large to throw us out of the range.
Governor Sheehan:
We were surprised 2 years in a row about the growth rate
of that part of the money supply which is in non-member
banks and that we do not collect data on ourselves.
III.
THE FEDERAL EESERVE AND INTEREST RATES
The relationship between Federal Reserve actions and interest rates
is one of the least understood and perhaps the most misunderstood
questions in monetary economics. There is wide recognition that open
market purchases increase reserves and tend also to decrease the federal funds rate and Treasury bill rates, and that, in turn, the increase
in reserves impels banks to lower loan rates and increase their lending,
with money supply expanding in the process. This is the feed-in from
open market purchases to money supply and interest rates. There also
is feedback. Often this is overlooked.
Together, money supply growth and lower interest rates impel increased spending. As a result, production and prices advance. Feedback derives from the increases in production and prices and such anticipated inflation as is generated. It causes credit demand to increase
and hence interest rates to be bid up. Also to the extent that inflationary expectations are stimulated, saving is discouraged and interest
rates are thereby propelled upwards even more.
The Outline
Governor Brimmer:
The Federal Reserve does not control interest rates. The
Federal Reserve controls bank reserves in this country . . .
54
If you really want to judge the efficiency of monetary policy, then you should look at the behavior of bank reserves and
the timing—the quantitative change in bank reserves and the
timing.
There is, however, a link between bank reserves (the control variable) and interest rates. As developed in a discussion with Governor
Brimmer,
. . . the observed interest rates today—leaving aside their
behavior and talking about their structure and content—contain some payment for the use of money in the traditional
sense. But they also contain a substantial discount for future
inflation and expectations of future inflation.
Weintraub:
I would like to ask you to focus if you would on this oneelement which is common to both you and Fisher, called the
allowance for expected inflation. If I were to say that the
Federal Eeserve influences, or can influence, interest rates
through this element, would you agree with that ?
Brimmer:
The Federal Eeserve can certainly influence market perception and behavior through its actions such as those affecting
bank reserves and the money supply. It may induce the public
to expect more or less inflation . . . If an economy is operating close to capacity . . . so an increase in the supply of
money or credit might induce the public to believe that the
demand for real goods and services will increase and thus the
rate of inflation. In this situation, the public would want to
hedge. If they are lending money, they might want to demand
a higher premium.
Weintraub:
Now, is there any feedback from the price increases and the*
output increases on any of these variables that you've talked
about ? Interest rates in particular.
MacLaury (Minneapolis) :
Definitely so. Yes.
Weintraub:
Okay, what happens to interest rates as a result ? The feedback?
MacLaury (Minneapolis) :
And now you are leading me to say (and I don't resist
saying) that interest rates are going to rise, and that one can
make the argument in time sequence that one ends up exactly
no better off than he was before by this kind of a variant of
money supply policy.
Weintraub:
There is some tendency for interest rates to rise now ?
55
MacLaury:
Surely.
Weintraub:
And the greater, presumably, the rate of inflation, would
you go along with that theory, the greater the tendency for
interest rates to rise?
MacLaury:
Yes, I would go along with that.
Olay (Kansas City) :
When the supply of money is in excess of the demand for
money, we would expect interest rates to fall: money would
be worth less. So, we would expect it to fall—in that kind of
situation. And I think that on a short-run basis, this would
generally be true.
Weintraub:
Now, then, because this also induces increased spending by
consumers and investors and acts to expand both output and,
as we approach full employment, the rate of inflation also
goes up. Then there is a feedback as I understand it or, as I
understand the theory, there is a feedback that causes interest rates to rise, so we can explain . . .
Clay:
I think that what you're saying—and I believe it is so^-is
that inflation causes high interest rates. I believe that high
interest rates result from inflation.
Weintraub:
Now, so that we really have to—in a sense—if we wanted
to explain high interest rates, then we have to ask ourselves
what is causing the current inflation... let's say open market
purchases, a snift upward in the rate of purchases, would
immediately do what to interest rates ? It would reduce them
is that . . .
Governor Holland:
It would make interest rates immediately lower than they
otherwise would be.
Weintraub:
And simultaneously add to bank reserves and to currency
held by the public to . . .
Governor Holland:
And to some monetary aggregates.
Weintraub:
Eight. Okay. And the decreases in interest rates and the increases in the monetary aggregates together will expand consumption and investment spending.
56
Governor Holland:
Yes, that's right. It stimulates some kind of response in
spending. . . . I think the effect you get on real output expansion, on the one hand, and on price on the other, will
vary. I'll put it in a more simplistic kind of way: the closer we
are to full employment, the more the effect of that monetary
stimulus tends to be diverted into price advances and the less
is utilized in financing an expansion of real output. But
there's always some effect on both fronts. . . .
Weintraub:
Now, we come to this last element and factor you mentioned, mainly some sort of feedback. And in particular, I'm
interested in the feedback on interest rates from the increase
in output and the increase in the rate of increase in prices.
There is a feedback on interest rates ?
Governor Holland:
I believe there's a strong tendency in this direction.
Recent Experience
Weintraub:
You believe. Okay, now. So that in a sense one might say,
looking at the past few years, that we have high interest rates
today m part,1because the economy has been so buoyant and
we've had rapid expansion both of output and of prices in
recent years. The high interest rates today would reflect this
buoyancy and expansion ?
Governor Holland:
Yes, I think it's one of the ingredients that has contributed.
Hayes (New York) :
I think that obviously if you get too much of a boom effect
from the increase in money supply and that turns into accelerated inflation, the very fact of the inflation is going to tend
to make people want to get higher interest rates as a trade-off
against that inflation. Is that what you're talking about ?
Weintraub:
Essentially. Let's see if I understand that—you're saying
that the inflation feeds back and causes the interest rates to
rise then.
Hayes:
Yes.
Weintraub:
So, a curious thing emerges here which is that insofar as
monetary policy was responsible for the expansion and the
buoyancy and the inflationary tendencies, it is responsible for
the high interest rates.
57
Governor Holland:
Yes, I put a lot of weight on the "insofar as responsible,"
because I think there are a lot of factors at work here. But
there's no question in my mind but that we're dealing with
an interacting mechanism. Other things being equal, the more
monetary stimulus that's pressed into the economy, the more
response you get in terms first of real output, and then as you
get close to capacity, the more that expansion spills out in
prices; and the more the latter happens, the more there tends
to develop subsequently a lift in interest rates, due partly to
the increase in credit demands you've created and due partly
to the tendency for an inflationary discount to be built into
interest rates.
Weintraub, referring to recent years,
. . . given the choice that was made which was for higher
money supply growth and higher, therefore, inflation in order
to achieve lower unemployment—what about nominal interest rates? Did this produce higher or lower interest rates?
Morris (Boston) :
Higher.
Kimbrel (Atlanta) :
Interest rates certainly were influenced by a buoyant economy. But had you wanted to hold the interest rates down, then
what would you have chosen as a measure to try to restrain
them?
Weintraub:
My own would have been to have kept the rate of growth
of the money supply below the six percent guideline. I think
that this would have produced, as I think I said before, a less
steep rise in interest rates during both of these periods, and
we would have had lower rates now than we have.
Kimbrel:
But I assume, though, that you would have had this lower
growth much earlier than the period that you point out.
Weintraub:
Well, I said the year ending June 1973. Less than six percent rather than 7*/2 percent. (Revised data now show that
M-l grew 8.7 percent in the year ending June 1973.)
Kimbrel:
Well, I think that if all other things had been the same
as they were, and you had started earlier and had provided
less reserves, yes. I think that is exactly right.
President Mayo (Chicago) had a partly different view:
I think we would have higher interest rates . . . We would
have had higher especially in the short area . . .
58
This becomes a rather delicate value judgment if you are
talking about long-term rates because of the inflation factor,
an expectational inflation factor.
Weintraub:
Would it have made inflation higher, 5*/£> (percent M-l
growth) as compared to the 7 ?
Mayo:
Inflation may have been inhibited by going to 5y2 percent
instead of 7 percent. On the other hand, we might very well
be in a recession today.
Weintraub:
Well, quite apart from that because I don't know whether
the 5y2 percent would have created a recession or not. This is
an "iffy" question, but if inflation would have been inhibited
then clearly the inflationary additive in interest rates would
have been less than it now is.
Mayo:
Oh yes; that's why I made the point.
President Black (Richmond) stressed inflation's impact on longterm rates, but because of arbitrage possibilities, indicated his belief
that short rates also would rise in periods of expansion and inflation:
I think in retrospect when we look back on that period, although it was a period of very rapid physical growth in the
economy, real GNP was increasing at maybe a 7 percent rate
during 1972 or something like that. That in retrospect and,
again, let me say in retrospect, I think we let the money supply
grow too fast during that period of time. And my feeling
would definitely be that if we'd kept it at a slower rate of
growth that we probably would have ended up with lower
interest rates than we did because we would not have unleashed some of the inflation and inflationary expectations
thait did in fact occur . . . you would have had less of an inflation premium in interest rates than you in fact did.
Parthemos (Senior Vice President and Director of Research, Richmond) :
Talking about long-term interests only, Bob ?
Black:
Yes.
Weintraub:
Well, the effect
Black:
I was thinking primarily of long ones really.
Weintraub:
To the extent that there is arbitrage here which
59
Black:
What I'm saying really is if we had curbed demand better
in 1972 we wouldn't have had as much pressure on interest
rates across the board later on as we did, I believe.
Weintraub:
Let me begin by asking a question about why interest rates
are high today—nominal interest rates.
Francis (St. Louis) :
Well, my view of the high interest rates is one that involves
the rate of monetary expansion, and while as I remember the
elementary course I had in money and banking said something
like easy money or fast monetary expansion means low interest rates and tight monetary policy means high interest
rates, I think the books had to be rewritten and something
added that while those statements may be true over a very
short-run, that given high rates of monetary expansion, over
long periods of time, two things usually happen: you get inflation in prices and you get high interest rates. I think there's
a relationship there.
Weintraub:
So essentially, we might say the relationship between money
supply growth and interest rates is one that, initially interest
rates fall when money supply growth is increased, but this
effect is transient, a temporary effect, and there is a feedback
that comes from the increases in output and prices that accompany monetary expansion.
Francis:
I think this is a direct result of the influence of a change, a
more rapid growth rate in money supply having what I believe to be an impact on the demand for goods and services;
and as that demand for goods and services goes up, the demand for credit increases. I think it's purely a matter of a
market relationship, as the demand goes up against the given
supply, and even though that supply must be increasing, the
demand may go up faster and interest rates go up also.
Balles (San Francisco) :
My overall impression of what happened in the latter half
of the 1960s and to some extent in the early half of the 1970s
was that efforts to keep interest rates down led to a rate of
monetary expansion which eventually was inflationary and
caused interest rates to go up. I think you've got that kind of
a dilemma. In a short run the central bank can keep interest
rates down, even in the face of rising demands. But in the long
run it cannot do it because inflation itself will cause interest
rates to go up. Investors will demand a premium for investing
in long bonds, and I think we now see a large inflation premium in long term interest rates.
36-714—74
5
60
Referring to 1972-1973, President Balles continued :
If you want to try to pinpoint the thing a little more, I
would think that within a say a three to six month span, we
could have seen (1972-1973) interest rates higher had the
money supply growth been lower. Now I don't think that
would have persisted over a much longer period than that.
IV.
SUBSTANTIVE ISSUES
(i) Relationship of Money Supply to Inflation and Interest Rates
(a) Federal Reserve policymakers have diverse opinions about the
role that monetary policy has played in the several waves of inflation
which have hit the U.S. economy since 1964. Nearly all recognize
some and many an important degree of responsibility. To synthesize,
for short periods, the pace of inflation since 1964 was dominated by
sporadic non-monetary events such as fiscal excesses, extraordinary
demand increases for medical care, wage push, protein feed shortfalls
and the oil embargo. But taking the long view, the 4rate of inflation
was linked to the rate of growth of M-l money supply.
The 3.2 percentage point jump in the annual rate of rise in the CPI
in the 1965-1973 period, from the 1959-1964 rate, as was earlier observed, corresponds very closely to the 3.3 percentage point jump in
M-l growth between these periods. This striking statistical association is supportive of the synthesis proposition linking the long run
rate of inflation to M-l growth during the 1965-1973 period. Many
Federal Reserve Policymakers stress additionally, that the timing of
the several waves of inflation which we experienced after 1964 conforms closely to the patterns of M-l growth that occurred.
(b) Interest rates also depend strategically on M-l growth. Trends
to higher interest rates develop from accelerating M-l growth. Federal Reserve officials nearly all recognize the feedback forces which
generate higher interest rates from stepped up M-l growth. Initially
stepping up M-l growth decreases interest rates and increases spending, and with this, output and prices rise. As a result, credit demands
increase and saving tends to fall. As a further result, interest rates
rise. We haf e high interest rates today because past M-l growth was
too fast.
{2) Controllability of Money Supply
The Federal Reserve has ample powers to control M-l growth from
year to year and even from quarter to quarter if it desires to do so.5
(3) Policy and Procedure Roots of Rapid M-l Groioth in the 19651973 Period
M-l growth was accelerated because of bad forecasts in the second
half of 1968 and in 1972. The interviews also reveal:
* Discussions during the interviews centered on M-l. The relationships of the economy's
performance to the growth of other monetary aggregates correspond closely to the relationship
to M-l growth.
5
From a purely technical standpoint, the major constraint on close control in the
recent past was informational. The Federal Reserve did not receive an adequate flow of
reliable information on demand deposits in non-member banks. This situation was recently
substantially corrected when the FDIC agreed to sample weekly deposits of non-member
banks and pass the aggregated statistics on to the Federal Reserve.
61
(a) M-l growth was deliberately stepped up to reverse developing
recessions early in 1967 and early in 1970, and to achieve fuller
employment throughout 1972.
(b) M-l growth was deliberately stepped up at times to accommodate special inflationary developments. This was done in order to
avoid putting downward pressure on sales in immediately unaffected
sectors.6
(c) M-l growth increased at times as a byproduct of monetizing
Government budget deficits.
(d) M-l growth often accelerated as a byproduct of the Federal
Eeserve focusing on fighting fires and keeping order in money markets.
(It) Substantive Questions To Be Resolved
Four major substantive unsettled questions about Federal Reserve
policies and operating procedures thus emerge from the interviews.
Resolving these issues is crucial for the formulation and implementation of monetary policy to decelerate inflation and reduce interest
rates.
(i) Major differences exists on the practice of stepping up M-l
growth to accommodate special inflationary developments. The interviews reveal this being done in the past. Moreover, the interviews
indicate substantial support for now accommodating pervasive inflation on the ground that spending fell off last winter because the
rate of rise of the CPI now exceeds M-l growth. Possible benefits
and risks involved in accommodating M-l to inflation, whatever
the source, are revealed by the following exchanges with President
MacLaury (Minneapolis) and Governor Sheehan:
Weintraub:
In view of the lags in the economy from the money supply,
does the policy prescription—how would you interpret it?
How sensible is it? We're already in the first half of the
year in which we . . .
MacLaury:
Yes, I see your point entirely.
My point, as President MacLaury saw, was that increasing current M-l growth would spur a recovery which is in the cards anyway, and hence only add to future inflation. Governor Sheehan at
first disagreed, saying:
Is it the function of the Fed to squeeze that resulting inflation out? If it does, which prices will fall so that all prices
can be stable, and how much unemployment are we going to
suffer as a result ? We all must recognize that the cost in terms
of unemployment might not be acceptable.
Later, however, Governor Sheehan recognized that there is a danger
of accelerating inflation from stepping-up money supply growth.
6
That the Federal Reserve accommodates inflationary developments blurs causality in
monetary economics. Ordinarily we think of a causal event as one that precedes the
result. But given this accommodating behavior, accelerated M-l growth will not precede
accelerated inflation. Yet, in a deeper sense it is nonetheless the cause; for without it,
the step-up in inflation would not endure.
62
Weintraub:
I think it's fairly clear, to me at least, that the higher the
rate of growth of the money supply, the more inflation we're
going to have. And that rates of 20 percent as Japan has had
are going to produce 20 percent inflation, sooner or later.
Governor Sheehan:
The Japanese are a very good example. The Japanese have
had a severe problem with inflation in the last 12 to 18 months.
The burden of proof is on those who would have M-l growth move
with and not into the winds of inflation. These hearings would appear
an appropriate place to ask how inflation will decelerate under this
policy. Also, inasmuch as today's increases in M-l have effects on
future spending, why this policy would not generate continually accelerating inflation. In addition, it would be useful to clarify why we
should be concerned because prices have lately increased more than
M-l, inasmuch as M-l increased more than prices in years past.
Perhaps prices are just catching up. Finally, it is important to question the assumption that prices (with rare exception) do not fall.
There is a considerable body of evidence which shows that many goods
prices fall as well as rise. They fall even in periods of pervasive inflation. Witness what has happened recently to prices of harvested com*
modities, livestock, and derivative products, and many industrial
commodities. Many other prices surely would fall if the underpinning
of a monetary policy which accommodates and validates and often
leads inflation were removed. Witness what happened to new and used
car prices, fuel oil, and coal and many other prices in the mid 1960s.
Also, interest rates would fall, and they are an important cost element
especially in housing.
(ii) Government must pay for the goods it buys and the services it
hires. In real terms, in a full or nearly full employment economy, this
requires transferring resources from the private to the Government
sector. The transfer can be accomplished by taxing the private sector.
If this is not done, Government runs a deficit. It can finance the deficit
either by selling interest-bearing securities or issuing noninterest bearing currency and Federal Reserve book entries. If the former method
is used, Government obtains the buying power it needs by bidding
away financial resources (ultimately savings) from private investors.
If currency and member bank Federal Eeserve book entries are issued,
Government, in effect, prints the buying power it needs.
In our economy, Congress and the Executive decide whether to use
Government's taxing powers to achieve a desired transfer of resources
from the private to the Government sector. To the extent that this decision fails to provide the needed buying powder, the Federal Eeserve
decides whether it shall be obtained by bidding aw^ay saving from private investors or printing the money. The Fed's decision has important
implications for the economy. During the interviews it was argued that
requiring Government to raise the buying power it needs by bidding
63
away saving from the private sector would "crush out of the private
economy an equal amount of spending," as President Black (Richmond) said, and raise interest rates "to astronomical levels", as President Balles (San Francisco) said.
On the other hand President Francis (St. Louis) warned:
I think the key factor is when the central bank moves in to
support the borrowing, and injects what I call "new money"
into the economic system. Treasury borrowing alone would be
more of a transfer of money from the private sector to the
public, you get that I think wdth any period of Treasury
borrowing, but when you interpose new money on top of that,
or too rapid increase in the rate of monetary expansion, I
think this is the kicker on inflation.
Moreover, to the extent that inflation results from the Federal
Reserve's decisions, appropriated expenditures will fall short of
achieving the transfer of resources required to accomplish the spending goals. In this way, monetizing deficits, will either result in underfunded programs or require supplemental or deficiency appropriations.
This is a critical issue. Are the arguments of Presidents Black and
Balles valid, or is President Francis right ? These hearings present a
timely opportunity to fully air both sides of the question.
Whatever decisions the Federal Reserve makes in deciding each
year, as it now does whether consciously or not, how much of Government's deficit is to be monetized, are ones that Congress should closely
follow. The Federal Reserve should be asked to set forth annually how
and why it made the choice it made and whether in retrospect the decision was wise or in what way it should have been modified.
(iii) Many Federal Reserve policymakers fear that, unless the Federal Reserve keeps order in money markets, there will be financial
chaos, including money market rates so high that today's rates will
seem low, disintermediation on a still unimagined scale and widespread bankruptcies, plus a full fledged depression, at least in housing.
They favor resisting sudden extraneously caused money market pressures even at the cost of temporarily allowing M-l to grow faster
than desired as a long run matter. But others believe that money
markets are inherently orderly. They suggest that, left alone, these
markets would absorb exogenous shocks with minimal trouble, and
hence need little protection. They also warn that fighting fires and
keeping order in money markets can require the Fed to supply new
money much faster than the desired long run rate for an extended
period of time, and with disasterous long run consequences.
The argument of those who would protect money markets rests on
two unproven assumptions. First, it assumes that all or a large part
of an unresisted exogenous increase in interest rates would last long
enough to cause disintermediation and other financial disruptions and
depress housing and inventory and other investments. If the exogenous change did not endure long enough, it could be ignored.
On this point a comment made by Governor Mitchell on a related
question indicates that "long enough" may not be very long at all;
it would happen very quickly.
64
He said:
Well, I think some actions wouldn't involve any lag at all
and other actions do. We were talking earlier about a 10
percent mortgage rate. If the market should today perceive
that the Federal Keserve is going to tighten up, and we got
bill rates up to say about 8V2 or 9 percent; we got disintermediation in thrift institutions; and we got 10 percent mortgages—that could all happen in 30 days.
Governor Mitchell nonetheless had doubts about focusing on money
market developments. He continued:
But I think the easiest effects to perceive, and maybe the
effects that we are over-influenced by, are the ones that you
see immediately. And I think these are the effects that Congress perceives, too. Sometimes it's difficult to get Congress'
attention away from these short-run effects to the longer-run
effects which may, in fact, be more important.
Further testimony on this matter would appear useful. Experience
this year could throw light on the lag before disintermediation begins,
or at least becomes substantial, in the wake of rising money market
rates. Also, Governor Mitchell's comment suggests exploring how the
Federal Reserve's focus can be shifted from the short to the long
run. Are the Federal Reserve's perceptions of Congress' concern
correct ?
Second, the argument additionally assumes that a small increase in
money supply induces a large fall in money market rates for a period
which is long enough to permit the extraneous pressures to decay, and
yet short enough to allow the Fed to achieve desired long run M-l
growth. Figure I may help in understanding what is involved. The
figure plots the target interest rate vertically and M-l horizontally.
The inner demand line prevails at the start, and initially we are where
we want to be, which is at point A. Extraneous forces then pull demand
up. If M-l doesn't change we go to point B which gives us a much
higher interest rate. We needn't stay there, however, as we can be
anywhere along the new (outer) demand line. We choose to go to
point C, involving a small increase in M-l and preventing a large
rise in the interest rate. The extraneous pressures decay quickly and
we return to the desired neighborhood at point A.
65
Figure I
Illustration
(Not scaled.)
Target
Interest
Rate
Inner
Initial
Demand
Line
\
Outer Demand
Line
Initial
M-l
Stepped
Up M-l
3 Months
Later
Mr I
In evaluating this scenario several points should be kept in mind.
First, Federal Reserve actions to change the rate of M-l growth a
small amount, say 2 percent per year will, after a month produce only
two-twelfths of one percent change in M-l from what it would have
grown to under the previous policy. After three months, the change
will be one-half of one percent. After six months it will be only one
percent. This means per annum M-l growth must be increased substantially to bring about modest increases in M-l in a few months.
Second, because the interest rate elasticity of money demand increases
as time passes (reflecting that market responses to interest rate changes
66
are not instantaneous) the resulting opposite change m interest rates
which develops from a given money supply change with other factors
held equal, is larger the shorter the period. In terms of Figure I, the
outer demand line flattens, using point B as the pivot, as time passes.
Third, feedback to interest rates from the production and price effects
of increasing M-l starts almost immediately. In terms of Figure I,
this pulls out the demand line and thus provides long run upward
impetus to interest rates.
The following questions are pertinent. What are the time elasticities
of money demand with respect to changes in interest rates ? Put otherwise, how much would various interest rates (short and long term)
change in response to given M-l changes after one month, three
months, etc. ? Keep in mind that, for a one-half of one percent change
in M-l which results after three months of accelerating M-l growth
by 2 percent per year, for example, a given interest rate will change
only 2 percent even if the three months money demand elasticity is
as low as — ^ For an interest rate initially at 8 percent, the three
months response is thus only 16 basis points, a snow flurry some would
say. Unless it can be shown that money demand interest rate elasticities
are extraordinarily low in the appropriate period, resisting money
market pressures could succeed only by generating excessive and probably irreversible M-l growth, and also, there would be little to fear
from gradually moderating M-l growth regardless of money market
pressures. Moreover, even if such elasticities prevail, we can't be sure
that getting off the desired long-run M-l growth track would be a net
benefit because feedback from any money supply increase reduces the
Fed's power to resist interest rate changes in the short run, thus requiring more and more money creation to do the job, and operating thereby
to defeat Ijhe original purpose in the long run.
Second, how long does it take before the direction of the initial
change in interest rates which develops from changing M-l growth
reverses ? If the lag is short, there again would appear to be no reason
to fear keeping M-l on the desired long run growth track, and considerable risk in leaving this path inasmuch as this would cause money
market pressures to build up cumulatively over time because of the
feedback.
During the interviews considerable attention was given to the findings of Phillip Cagan on the central tendency in our economy, overthe years, of interest rate changes that have occurred in the wake of
step-ups in money supply growth. Cagan's results cover both the feedin and feedback from money supply changes and ignore extraneous
influences. They thus shed light on the size and duration of the initial
interest rate "bang" which we can expect from changing money
growth, and on the long run effects as well. Cagan's findings on the
M-l, commercial paper rate nexus in the 1953-1965 period are plotted
in Chart II. Following a step up in M-l growth of one percentage
point per year, the commercial paper rate at first falls and later rises,
just as the discussions in Part I I I of this report indicate will happen.
The initial decline lasts less than one quarter and reaches only 7 basis
points. In the third quarter the commercial paper rate is higher than
initially and after 2y2 years it is 40 basis points higher.
67
Cmmili.cive
Change In The
Commercial Paper
Rate
~
i
>
o
••
.
'
•
/
'
Chart II
' '
•
Cumulation Change in the Commercial Pap«
*»» Response to a Step-up in M-l Growth c
-
^
'
MONTHS FROM THE STEP-UP IN M - l GROWTH
:
•
" '
"
Federal Reserve policymakers for the most part were chary of
Cagan's findings. They did not accept that the average size and duration of the initial effect could be as small and short as Cagan found it to
be. In addition, nearly all pointed out that the size and duration of
the response of interest rates following a change in money supply depends upon initial conditions, as surely is correct and Cagan surely
would agree. Thus the historical central tendency can be misleading.
But many also felt that, in periods of buoyant credit demands and inflation, the size and duration of the initial effect was likely to be smaller
and shorter than under other economic conditions.
Eastburn (Philadelphia) :
My understanding of the literature is that the findings on
this are diverse. What I know of the MPS model, for example, suggests to me that its estimates would be considerably longer. The model of the Federal Reserve Bank of St.
Louis has relatively short lags, and you say the Cagan model
has relatively short lags. My feeling is that the judgments
aren't all in. When you have so many experts disagreeing on
this, we're still stuck with the position that lags are variable
uncertain.
Hayes (New York) :
It may be that you probably ought to ask one of these
associates.
Weintraub:
Well, perhaps, let me ask Richard Davis what he thinks.
68
Davis (Vice President) :
Well, the estimate of lags is awfully tricky, and Cagan's
lags sound very short to me.
MacLaury (Minneapolis) :
I suppose I would say that, as a rule of thumb—and you
can check me because I don't have this in front of me—but
I would expect that you could have a year, a year and a half,
two years, of declining interest rates by this kind of phenomenon or logic that we've talked about, and then, probably a
couple of years of rising interest rates. That could be, in some
sense, a typical cycle.
The question was discussed further at Minneapolis.
Kareken (Economic Adviser) :
It's a little bit tricky. I think that it's a very hard question
to answer because if you believe, as Anderson of the St. Louis
Bank and others have found, that the response of the economy depends upon initial conditions, for example, you might
expect what happens to interest rates when you start this
experiment could depend upon how close you are to full employment, or something like that. So, I think that to the
extent that initial conditions matter, you can't give—you can
get an average which may not, however, have a tremendous
amount of meaning.
Weintraub:
Eight, there may be great variation around the central
tendency. But, in a period of relatively full employment,
you would expect that some—someone said they expected it
to be faster than a period of, you know, unemployment, relatively high unemployment. Do you agree with that ?
President MacLaury:
I certainly do.
Weintraub:
How about you, John?
Kareken:
Well, that is certainly the conventional wisdom, and I'm
not prepared at this point to toss it out, but it's a tricky
question.
Francis (St. Louis) :
I've never felt too sure about specific timing of lags. I'm
quite sure there are time lags. To be specific, and say in every
instance it's going to be three months one way and nine another, I'd be a little fearful of that. The lags are there and
it may be three months, it may be less or more. I think that
differing economic situations might vary time lags. . . .
Morris (Boston):
I don't think you can generalize. It depends on the state of
the economy at the time the money supply increase was in-
69
jected. I think the higher the level of resource utilization, the
slower, the lag, or the shorter the time in which the rates
react. . . .
Weintraub:
Would you expect in an expansionary buoyant inflationary
period the effect to be greater and shorter or smaller and
longer than in a period of recession ?
Balles (SanFrancisco) :
Smaller and shorter.
Weintraub:
Ail right. I think I'm back on now. The question I had
raised when the tape ran out was whether or not the initial
effect, this so-called reverse effect of the change in the money
supply, would be shorter or longer in an inflationary period
than in a period of recession or depression.
Coldwell (Dallas) :
My instinctive reaction to this is that you're likely to get a
shorter period of time in an inflation than you do in a deep
recessionary period, just partly because you get this inflationary impact on interest rates and interest rates reflecting the
inflationary period.
Governor Bucher:
Now, I think when you have an increase, particularly a significant increase, in the money supply, although it does temporarily reduce short-term rates, . . . an excess supply of
money is going to have a long-range effect on prices and,
therefore, on interest rates through anticipation of inflation.
Weintraub:
Suppose we now were in a period, though, in which we
have had price increases, and the public has become accustomed to experiencing inflation, and now we again stepped
up the rate of growth of the money supply. In this sort of a
period would you expect the time before interest rates began
to rise again, following their initial fall, to be shorter?
Governor Bucher:
Yes, I would.
Weintraub:
Okay, fine. I agree with that entirely. I wpuld expect the
longer we lived in inflation the shorter this period could
become.
Governor Bucher:
And I'll tell you, the more and more the financial community and even the public become aggregate watchers, if you
will, I think the more this will be exacerbated. I think this
tendency will be to shorten it and shorten it, as people, in
70
their own minds, compare growth in money supply with
future inflation.
Cagan's results are not conclusive. But they present a formidable
empirical challenge to those who would use monetary policy to resist
money market pressures and who fear the money market effects of
gradually moderating M-l growth. The challenge, as the interviews
reveal, is especially persuasive during periods of buoyant credit demands and inflation. We are now in such a period. Those who would
ignore Cagan's findings in formulating and implementing monetary
policy should be asked to provide strong contradictory evidence. If
fighting money market fires and resisting extraneous pressures requires M-l growth to shoot-up well above the desired long run growth
path (as may well have happened in 1974 and certainly has happened
before), then, unless it is quickly brought back down, all too soon the
result will be still faster inflation, even higher interest rates, and
graver money market prices. It would be appalling if this happened
for no good reason because the expected initial response of interest
rates was either trivial or ephemeral; and in today's conditions it may
be both.
As President Eastburn (Philadelphia) said, in an earlier quoted
discussion:
. . . the market could be more self-reliant with respect to
changes in interest rates than it has been permitted in the
past.
The relationship between money supply and money market developments has of course also positive implications for how to use monetary
policy to fight both inflation and high interest rates. On this theme
President Francis (St. Louis) said:
Well, Dr. Weintraub, I have always taken a little different
approach. I don't like to say, or I don't like to hear people say,
that the way the central bank goes about slowing up inflation
is to raise interest rates. I think the thing we can do, the tools
with which w^e work, dictate that we get the rate of monetary
expansion under control. Now if this should cause interest
rates to kick up momentarily, I wouldn't be upset about that,
but I think that if we were doing the right thing on the aggregates, say M-l for example, or the base, any kick-up in
interest rates would be very short lived and over the longer
pull you would see interest rates come down. So, I prefer for
the Federal Keserve System to focus in on the monetary aggregates, or maybe better put, the rate of monetary expansion.
(iv) Many of those interviewed believe that we can check the current inflation only if we are willing to significally under-achieve with
respect to employment. They question, as President Morris (Boston)
did, as quoted earlier:
I don't know what the maximum level of unemployment
the Congress would accept in the interest of dampening
inflation.
Congressional guidance could be useful. In specific, it would be useful to set forth a desired time path for decelerating inflation. Expe-
71
rience (mid 1969-mid 1971) indicates that by braking M-l growth
substantial progress can be made in checking inflation in what now
appears to be a relatively short time. But unemployment increased unacceptably in that episode. Slowing down the process by reducing the
deceleration of M-l growth would hold unemployment increases to
acceptable levels.
Attempts to formulate a soft landing timepath, whether made by
the Congress in carrying out its oversight responsibilities or the Federal Reserve alone or together with the Executive Branch, must take
into account that the trade off between unemployment and inflation is
a slippery one. Federal Reserve policymakers are not unaware of the
problem.
MacLaury (Minneapolis) :
I think the first point I would make is that on the unemployment level, there is a debate and I think a serious one,
on what is a—whether there is a new trade-off on the Phillip's
curve between unemployment and inflation, and I think I subscribe to the George Perry kind of argument that in fact
what used to be thought of as the trade-off at 4 percent is now
5 percent or something like that . . .
Weintraub:
I think so, but I want to press you a little bit more on it.
Perry has said, and you apparently agree with this, that the
trade-off terms have changed.
MacLaury:
Adversely.
Weintraub:
. . . So that the—and against us, and the Phillip's curve
is a slippery device at best, isn't it?
MacLaury:
Correct.
This does not make it impossible to achieve price level stability and
full employment simultaneously.
Weintraub (questioning President Francis of St. Louis) :
You have indicated, in answering one of the questions, that
we could achieve both, reasonably full employment and reasonable price stability, simultaneously.
Now there was, a few years ago at least, a hypothesis
abroad that we couldn^t; there was a trade-off between the
two. And I guess (looking at the 1960's), one could say there
may have been a trade-off, but the terms (at least) have
changed (but still exist). But your notion would be that over
a longer period of time the so-called trade-off simply is too
slippery to be a useful policy tool.
Francis:
I have never seen monetary policy, and I guess substantially because of this lag thing that we talked about, as being
72
a very useful instrument to offset short-run happenings in
the economy. And I think that over history we can see too
many periods of time when it would appear that in attempting to use monetary policy for that purpose we have gotten
perhaps opposite results than were intended . . .
Dr. Weintraub, I honestly believe that if we would get
busy searching out the long-run level of monetary growth
that would facilitate what many economists refer to as the
"growth potential" in this country, that we could indeed have
an economy growing at its, what should we say, normal potential, with full employment.
Is the approach recommended by President Francis the right approach? Perhaps not. But at the least, it would appear to be worth
ventilating.
The interviews show that the Francis approach would involve
major changes in the Federal Reserve's current (and traditional)
policies and operating procedures. In essence, the Federal Reserve
would have to focus less (much less) on solving perceived short run
problems and concentrate its efforts on achieving long run goals. In
specific, the following changes would be required.
(i) The Federal Reserve would have to refrain from accommodating special events and developments. Such restraint could be a large
plus. Accommodating behavior, which is reminiscent of "real bills"
behavior, lends itself to magnifying economic cycles. Monetary policy
is no more stabilizing in years that are marked by rapid M-l growth
and inflation even though there is rapid economic growth, than in
years when low M-l growth is matched by low economic growth even
though prices are stable. Accelerated inflation conies with and after
the former; recession with and after the latter. Recommendations to
match M-l growth to predicted or past inflation appear especially
counterproductive. Those who urge this, as was earlier discussed,
should be asked how inflation is to be decelerated and related questions. Refraining from such short run accommodating or matching
behavior could eliminate a major cause of past cycles.
(ii) The Federal Reserve must determine on a continuing basis
exactly how much debt (old and new) it has to monetize for M-l to
grow along the desired long run track. It must refrain from monetizing more than is required in years when the deficit is large and less
than is required when the deficit is small or the budget in surplus.
(iii) Perhaps most importantly, the Federal Reserve must be chary
of resisting money market pressures, lest, as has often happened in the
past, money supply is forgotten and grows at a destabilizing rate as the
byproduct of the actions taken to fight fires and keep order in money
markets. As discussed earlier, there is no evidence that resisting money
market pressures achieves its purposes. Rather, the evidence indicates
that desired interest rate effects are small and short-lived and that the
permanent effect is to pull interest rates up significantly. Thus little
if anything will be lost by concentrating on M-l growth, and there
is much that can be gained.
Last, concentrating on M-l growth will require focusing the Open
Market Committee's instructions on M-l growth. At present the instructions are focused on money market targets as well as M-l growth,
73
and these can be incompatible. Often this results in confusion about
what to do, as the following remarks by Governor Sheehan show.
We use both aggregate and interest rate tolerances for
targets. We do look at the aggregate and set targets for
them. We do look at a variety of interest rates and set targets
for them in ranges. We try to balance our activity between
4 or 5 selected targets. Over time we may find that exogenous
factors may affect one and we'll disregard it for a short period
of time. Currently M-l is depressed, or there's a percentage
of change on the upside because certain things are happening,
we'll tend to disregard that for the next 4 to 6 weeks and
see what happens while we focus on 3 or 4 others: M-2, the
Federal funds rate, and other rates.
Weintraub:
All right.
Governor Sheehan:
So we take an electric approach.
Weintraub:
This can be dangerous, of course. I think it was Lee Bach
who said many years ago at the 1964 anniversary hearings
on the Federal Reserve that when you take this eclectic
approach and look at two or more variables, up to five, at the
same time, it's only a happy accident when they're all behaving in the appropriate way or in the expected way. So that
sometimes they're inconsistent and then you have to make a
choice.
Governor Sheehan (At another point) :
It's very difficult to find out really what the Fed is doing
if you're not on the inside.
Weintraub:
Well, all right.
Governor Sheehan:
There have been periods since I've been here where we
didn't feel that the Desk Manager was doing what we told
him to do. Therefore, we met and reconsidered, and had
vigorous discussions as to, is that really what we told him
to do, and is he interpreting our instructions correctly?
Focusing the OMC's instructions on M-l growth would put an
end to such confusion. It would thereby permit the Desk Manager to
achieve desired M-l growth. This, many believe is absolutely essential
if the tide in our long battle with inflation and high interest rates is
finally to be changed.
V. RECOMMENDATIONS
It is not easy to be sanguine about the Federal Reserve's focus being
changed through internal debate alone. I say this notwithstanding
74
that among the Federal Reserve policymakers interviewed more than
a handful are men of special candor and knowledge and courage. I
say this because the entrenched intellectual traditions of established
institutions are seldom if ever changed from within. For 60 years
Federal Reserve policy has been dominated by the themes of the
Banking School. To wit:
(a) Vary the money supply so as to smooth short run fluctuations
in money rates; prevent, as Paul M. Warburg put it long ago, "too
low money rates in times of abundance, as well as too high rates in
times of scarcity."
(b) Furnish money to accommodate the "real needs of Government and business. Thus President Kimbrel (Atlanta) posed the
question :
. . . We were trying to police bank credit and yet in the
real world, the banks had extraordinary commitments that
they had made in earlier periods. They had sought accounts
with the attraction that we'll have commitments for lending
available, not thinking that these at some future time would
be utilized. Well, I wonder from you, how do we anticipate,
how do we wonder that we're going to accommodate an honest contract? At a period of time when interest rates are
already high, we're trying to change the reserves, trying to
slow the things down, already in a period—but these banks
are actually committed to make further loans of substantial
numbers.
Weintraub:
Isn't there the possibility, at least, that if, in a period like
today, if the Federal Reserve supplies banks with reserves to
make these additional loans that they have committed themselves to do, that this will lead to still more inflation?
Kimbrel:
That was certainly our thought at the time, and with the
same set of circumstances existing today, yes—I think the
answer would be that obviously, you'd be contributing more
and more to inflation.
And with inflation, to higher and higher interest rates.
The monetarist warning that policies based on Banking School
themes exacerbate long-run economic instability, and cause too high,
not too low interest rates in times of monetary abundance has not yet
been heeded. What is needed is to bring the substantive issues involved
out and into the open to be debated fully and regularly.
Accordingly, it is recommended that Congress treat monetary policy in the same way as it is now about to treat fiscal policy. First, let
the Federal Reserve annually request from the Congress permission
to operate within specified M-l growth guidelines, which, to retain
limited flexibility to deal with short-run problems, could be expressed
in terms of the behavior of year-to-year growth for the next 12
months. (Targets would be set for each of the next 12 months in terms
of percentage changes from the same month a year ago, for example,
75
for the year ending October 1974, 5 percent plus iy2 o r minus 1
percent.)
Let Congress hold hearings on the Federal Reserve's recommendations. The Federal Keserve should spell out the implications of
alternative target M-l growth paths on unemployment, inflation, interest rates, and such priority concerns as housing. Congress can then
approve or modify the recommendations as desired. If within the next
12 months the Federal Eeserve wants to operate outside the established guidelines, it can request that special hearings be held for the
purpose of relaxing the guidelines. Congress has demonstrated capacity to act promptly in other connections and presumably could do so
in this connection if such action was really needed. Moreover, in monetary policy as in all affairs, haste often leads to unwanted results.
Second, let Federal Reserve policymakers, be responsible as individuals for reviewing last year's money supply behavior, explaining
its consequences and specifying what changes they now would make
in that behavior if they could go back and change their past decisions.
(A single review could be submitted if there was no disagreement.
But all Presidents and Governors should be required to explicitly
state their concurrence.)
Third, let the full minutes of the Open Market Committee meetings
be made public immediately or at most six months after they are
held, deleting until another six months has elapsed all so-called sensitive discussions.
These recommendations can be viewed singly or as a package. The
first recommendation to establish a target money supply growth path
for the coming year in open forum would provide everyone with
the same knowledge about long term monetary policy. Wage and
other contracts could be negotiated more rationally as a result, that
is, with full understanding of the extent to which monetary policy
would or would not validate inflationary contracts. Households and
business could plan their budgets with knowledge of the extent to
which their plans would or would not be propped-up by monetary
policy. Those who buy and sell securities could also use this information. But there is no reason to think that buyers (or sellers) could
obtain a net advantage from knowledge of the Federal Reserve's
money supply target growth path. Moreover, as President Mayo of
Chicago pointed out, as things now are:
. . . the market indeed does have a fairly full understanding as to what the factors are in monetary policy that are
going to lead to specific steps by the Federal Reserve. This
happens to be a product, in part, of the fact that many of
these people who are in the market, and in the position of
making markets, have at one time either worked in the
Treasury or in the Federal Reserve. Indeed there is also
cross-fertilization the other way. So it is no great secret as
to how you interpret what the Fed is doing and indeed is
trying to do. A number of the leading writers in New York—
the Lehman Letter, Lanston's Letter and so forth—are written by former Treasury, former Federal Reserve people, and
they're very good in interpreting these things.
36-714 O—74-
76
There would appear to be much to be gained and nothing substantially to be lost in setting the money supply target openly in
public forum.
The latter two recommendations would permit Congress and the
public to better utilize the candor, knowledge, and courage of individual Federal Reserve policymakers. These recommendations moreover are in the tradition of the Federal Reserve Act. Congress rejected
the Aldrich Bill which would have established a single central bank
with dispersed operating branches. The Federal Reserve Act rather
set up a system of 12 regional central banks supervised by a Board of
Governors. Of course the System has to act as a single unit in implementing monetary policy. But it is neither necessary or desirable to
submerge the views of individual policymakers in formulating policy
or to relegate them to voices in the wilderness in overseeing it.
Finally, the thrust of all three recommendations is that those who
are responsible for monetary policy will do a better job if (1) their
parts as individuals in decisionmaking are made public while the
decisions are still of vital interest to the public, (2) they are compelled to regularly publicly review the consequences of past decisions
in a format which permits airing dissenting views rather than only
setting forth the consensus view, and (3) they must annually arrive
at and seek approval for their consensus money supply growth path.
In closing, it should be recognized that proper monetary policy is not
a panacea. It can save us only from the consequences of inadequate
monetary policy. No financial system, no matter how well structured
and regulated, can function smoothly in a disruptive monetary environment. Our financial system has been in a state of irregular but
recurring turmoil since 1966, the year after the inflation began, accommodated and fueled by rapid money supply growth. A year ago,
the turmoil centered on so-called "wild card" deposits. Now it is
focused on Citicorp's proposed variable interest redeemable note issue.
It is, in the final analysis, futile to stop these innovations in mobilizing
saving on the ground that stopping them will remove the threat to the
growth and development of housing oriented thrift institutions. These
innovations are not the cause of the malaise which now threatens thrift
institutions. They are its manifestations. Stop one, and another soon
emerges. If we want a financial system in which housing oriented thrift
institutions can grow and function smoothly, we must first get a
proper monetary policy. Only after money supply growth is controlled so that it is neither accommodative or generative of either inflation or recession, can we hope to succeed in assuring the viability of
thrift institutions; the allocation of credit for low and moderate income housing, and other priorities as Congress may establish; and the
equitable treatment of small savers in the mobilization of saving. Being
able to explore ways of improving our financial system in a non-crisis
atmosphere would be one beneficial byproduct of achieving a monetary
policy which is not destabilizing. The direct benefits, once again, are
greater economic stability—minimal unemployment and minimal inflation—and reasonable interest rates.
FEDERAL RESERVE POLICY AND INFLATION AND
HIGH INTEREST RATES
WEDNESDAY, JULY 17, 1974
HOUSE OF REPRESENTATIVES,
COMMITTEE ON BANKING AND CURRENCY,
Washington, D.C.
The committee met, pursuant to recess, at 4:05 p.m., in room 2128,
Rayburn House Office Building, Hon. Wright Patman [chairman],
presiding.
Present: Representatives Patman, Barrett, Sullivan, Reuss, Moorhead, Stephens, Hanna, Gettys, Rees, Koch, Widnall, Johnson, Brown,
Wylie, Burgener, and Rinaldo.
Also present: Dr. Robert Weintraub, staff economist of the House
Banking and Currency Committee.
The CHAIRMAN. If you gentlemen will get seated and put the microphone in front of you, we'll get started pretty soon.
We want to apologize for being late, but we were tied up all day,
in caucus or on the floor of the House, or before the joint meeting
of the conferees.
Today we are going to hear testimony from three Federal Reserve
bank presidents: John J. Balles of the San Francisco bank, David
P. Eastburn of the Philadelphia bank, and Alfred Hayes of the New
York bank. President Hayes also is vice chairman and a permanent
voting member of the Open Market Committee. Presidents Balles
and Eastburn serve as voting members of the committee only once
every 3 years.
Some members of this committee took exception yesterday to my
charging in my opening statement that "the Federal Reserve has
been the engine of our current inflation." Let me assure the gentlemen
that I would welcome a debate on the substance of this issue. Let the
gentlemen be mindful that no light is cast on the issue by their
attacking me. I stipulate that Dr. Burns is an honorable man, and
a fine fellow, for that he is as I have said on numerous occasions
including when he was appointed. Defense of the Federal Reserve
and its various chairmen is nothing new in this committee.
But in this critical period I would hope that the members will
direct their attention to the substantive issue of the Federal Reserve's
performance. Let us abandon knee-jerk defenses of agencies which
we are charged with overseeing and start talking about the consequences of their policies.
Yesterday we heard very persuasive testimony from Dr. Robert
Weintraub, a member of our staff, that Federal Reserve Open Market
Committee money supply policies have caused and accommodated the
raging inflation and high interest rates which afflict our economy.
(77)
78
The witness yesterday called attention to four critical issues in monetary policy, which in recent years appears to have been persistently
resolved by deciding to take action which accommodates and generates
inflation and high interest rates. In his interviews he found a substantive difference of opinion about the wisdom of accelerating money supply growth, as the Federal Reserve has been doing, to accommodate
and validate transient and even self-reversing inflationary developments such as bad harvests. He found also differences of opinion about
the Federal Reserve's normal practices of monetizing Government
deficits and fighting fires and keeping order in money markets, even
though the predictable byproduct of these practices are inflationary
money supply growth and in short order, higher interest rates. Finally,
he found concern about the possible employment effects of moderating
money supply growth to check inflation.
The witnesses we will hear from today should be able to enlighten us
about these critical issues. It also is my hope that Presidents Balles,
Eastburn, and Hayes will comment on the staff's recommendations to
improve all aspects of monetary policy: Formulation, implementation,
and oversight evaluation.
The staff recommended that the Federal Reserve annually provide
Congress with analyses of the implications of alternative money supply
policies and that the Congress select the policy to be implemented. It
was recommended also that all Federal Reserve policymakers annually
review and evaluate last year's money supply behavior and that the
minutes of the Open Market Committee be made public immediately.
Gentlemen, your comments on these issues and recommendations
could be of great value to the committee. Let me welcome you and
express the hope that you will be straightforward and not pull any
punches in your testimony.
You may proceed by summarizing your testimonies, starting with
President Hayes, as he is the vice chairman of the Open Market Committee. After President Hayes, we will then hear from President
Balles and then President Eastburn.
Gentlemen, you are recognized in that order, and I say again, we
are delighted to have you, you are welcome; and we will certainly
give careful consideration to everything you tell us because we know
that you have expertise in this line that we do not have, and we welcome
your testimony. Mr. Hayes, you may commence your testimony.
STATEMENT OF ALFRED HAYES, PRESIDENT, FEDERAL
RESERVE BANK OF NEW YORK
Mr. HAYES. Thank you. Mr. Chairman and members of the committee, I am happy to have this opportunity to express my views on some
of our current economic problems, especially as they relate to monetary policy and the Federal Reserve System.
I will shorten my statement, which I will submit in full for the
record.
I would like at the outset to add my voice to those who believe that
our most serious current economic problem is inflation. Indeed, the
solution to many of our other difficulties, including high interest rates,
the slump in housing, the liquidity problems of business and financial
institutions, as well as many of our problems in the international
79
financial sphere, depends importantly on our ability to get inflation
under control. I believe that control of inflation clearly should be the
main objective of monetary policy for the present and probably for
quite some time to come.
I won't go into the whole history of the reasons for our inflation,
it has had a long evolution, leading back to the late 1960's. The demand
inflation, which it was at first, led in due course to cost pressures and
steadily mounting inflationary expectations.
Over a long period of nearly 10 years, we have paid an increasingly
heavy price, in terms of irregularly accelerating inflation, for giving
insufficient attention to the limits on our capacity to meet evergrowing
demands at stable prices. Over most of this period, the Federal budget
has been in significant deficit and fiscal policies have certainly been
too expansionary during the period as a whole. Nor would I argue
that monetary policy has been immune over this long period to the
national tendency to try to expand demand at a rate in excess of what
can be produced at stable prices. Indeed, I think there have clearly
been times, particularly in 1968 and in 1972, when monetary policy
has been rather 'too expansionary.
In any case, I think we have learned that the virus of inflation becomes progressively more difficult to cure as its treatment is postponed
or neglected. The prospect of an ever-accelerating inflation is truly
frightening in its implications for the stability of our economic and
social system. The point has now been reached where we must direct
our attention to solving this problem even though the cure may have
painful side effects in the short run. As I will later indicate in more
detail, I do not believe that our present inflationary problems stem
solely from demand conditions. Nor do I believe that monetary and
fiscal policies, which are the main tools of demand management, are
the only ones we should use in bringing inflation under control. But
I think that prudent moderation in aggregate demand is an absolute
precondition to the restoration of price stability.
Against this general background, I would like to address myself
now to some issues in which the chairman indicated a particular
interest in his letter inviting me to testify.
One of those is the so-called tradeoff between inflation and unemployment and its implications for formulating monetary policy. In
my view the notion that unemployment can be permanently reduced
below some specified minimum simply by pumping up aggregate demand—and without any improvement in the structural characteristics
of our labor markets—is quite misleading. Indeed, the notion that
low levels of unemployment can be achieved by monetary policy alone
has probably caused a good deal of mischief.
To be sure, if unemployment is abnormally high, the judicious
application of monetary stimulus can help reduce unemployment to
more moderate levels with little adverse effects on inflation. Beyond a
certain point, however, one that seems to be dictated largely by the
structural characteristics of labor markets, attempts to reduce unemployment in this way require progressively larger doses of stimulus. Thus, a progressively more rapid inflation is required to achieve
given effects on unemployment. Certainly, our present situation of unemployment in excess of 5 percent, coupled with the escalation of
inflation rates that we have witnessed, strongly suggests that this
process has been at work over the past decade.
80
At the same time, I do not want to suggest that an unemployment
rate such as 5 percent needs to be accepted for all time as the best we
can do. What I think has to be recognized is that the only way permanently to reduce the levels of unemployment compatible with price
stability lies in measures that will increase the qualifications of the
labor force that are in demand and that will produce a more efficient
and speedy matching of willing workers and available jobs. Any attempt to solve the problem by pumping up aggregate demand can,
in the end, have only devastating inflationary consequences with the
accompanying risk of leading ultimately to really serious slumps in
the economy and heavy unemployment.
I would like to turn to the relationship between monetary and fiscal
policies, and the problems posed to monetary policy by fiscal stimulus in the inflationary environment. Monetary and fiscal policies work
best in tandem, not when they are working at cross-purposes. While
monetary policy can offset some of the effects of an excessively expansive Federal budget, it cannot compensate for all of the shortcomings of fiscal policy.
When productive facilities are strained by excessive demands for
goods and services, Federal deficits tend to exert upward pressure on
prices. At the same time, deficit financing also puts upward pressure
on interest rates as the Government bids for credit to cover its deficits. This situation creates a dilemma for monetary policy. To underwrite the deficit by monetizing the Federal debt would of course tend
to be inflationary. Inflation tends in the longer run to become embedded in the credit markets in the form of higher interest rates, as
I shall indicate more fully in a moment.
On the other hand, preventing credit from expanding to accommodate a Federal deficit would tend to put immediate upward market
pressures on interest rates. Such developments are, of course, unpopular, and it's all too easy without realizing it, almost, to accommodate the pressures generated by fiscal deficits.
Reliance on monetary policy alone to restrain inflation in the face
of overly expansive fiscal policy therefore does entail risks. Rising
market rates of interest induce savers to withdraw funds from thrift
institutions, thereby drying up the major source of private financing
of residential construction. Extremely tight money, moreover, can
imperil the liquidity and even the solvency of credit-dependent firms.
The Federal Reserve cannot be oblivious to the risk of pushing
monetary restraint too far. We must bear in mind our essential role
as lender of last resort to the economy. If liquidity pressures mounted
to the point that a breakdown of the credit system appeared to be a
serious threat, the Federal Reserve would have to take steps to forestall it. This might entail some temporary deviation from the monetary
growth rates that would be consistent with long-run price stability.
I would like to comment also on the relationship among the monetary aggregates, inflation and interest rates. Certainly, historically,
there has been a broad long-run relationship between trends in monetary expansion and the behavior of prices. Over a long period of time,
price stability depends upon a rate of money and credit growth commensurate with the economy's capacity to produce. Ultimately, therefore, the return to an era of price stability will require the restoration
of the monetary aggregates to moderate rates of growth. I should perhaps add that some of our current notions of what constitutes moder-
81
ate growth would have seemed rather rapid in an earlier period of
relative price stability.
I think it would be an oversimplification, though, to attribute all
fluctuations in the pattern of inflation to the behavior of the monetary
aggregates. There may be many nonmonetary developments which can
have a powerful influence on the behavior of prices for a period of
1 year, or 2, or even longer; I need only mention the recent case of
fuel and food supply shortages as an example.
There are other factors that may have an important influence over
prices, quite independent of the behavior of the monetary aggregates.
One of the most conspicuous of these in recent years has been the behavior of foreign exchange rates. I think there is little question that
the overall depreciation of the dollar since early 1971 has been a
significant inflationary force in this country.
With regard to the relationship between inflation and interest rates,
the trend to higher levels of interest rates that has developed over the
past several years has clearly reflected in major part the behavior of
prices. In a situation where rising prices have steadily eroded the real
value over time of debt instruments, lenders have come to demand an
inflationary rate premium, and borrowers have felt justified in paying
such a premium. It is hard to persuade savers to lend their savings
at interest rates lower than the rate of inflation, especially when real
estate and other commodity investment exist as alternatives to fixed
dollar instruments. In this setting an attempt to bring down interest
rates by rapid expansion in money and credit would be self-defeating,
except perhaps in the very short run. I am convinced that the only
way to restore more normal levels of interest rates is to restore stability—and this will require restraint in monetary expansion, not
extravagance.
The problem for monetary policy in bringing inflation under control and interest rates down to more normal levels is indeed essentially
a single problem. The solution requires a degree of monetary restraint
over a period sufficiently long to wring inflation out of the economy.
On a number of occasions in recent years during periods of monetary
restraint, tight money conditions have resulted in sharp liquidity
pressures on particular institutions, or particular segments of the
markets. In some instances these have been so acute, or threatened to
become so acute as to create risks for the financial system as a whole. In
such instances the Federal Eeserve has recognized and accepted its
responsibilities, particularly in its role as lender of last resort, and
has taken action designed to cushion the impact of such pressures.
There are a number of things that could be done to make the task of
monetary policy easier. I mentioned fiscal restraint, programs to aid
housing, such as those recently announced by the administration; a
third would be efforts to improve the functioning of our labor markets,
perhaps including, if needed, Federal job programs for the unemployed.
One important factor that gives me hope that our job may be a little
easier this time is the widespread conviction on the part of the American people, at least as I observe it personally, that inflation is public
enemy No. 1.1 am hopeful that this will be reflected in a healthy measure of self-restraint in our common fight against inflation, including
82
restraints by labor in wage settlements, and by industry in the setting
of prices.
In any case, I think a patch of prudent monetary restraint for however long is needed to restore price stability is the only responsible
course of action. A premature easing would lead to a resurgence of
demand pressures, and a renewed and even more virulent acceleration
of inflation. This would, I am convinced, pose serious dangers for our
economic and social fabric. Price stability, as I said, is the key to many
things, to low interest rates, to a smoothly functioning financial system, to a healthy housing industry, to a strengthened international
economy, and to the opportunity for sustainable economic growth.
All of these things can be achieved through responsible policies,
including monetary policy, not without temporary costs, to be sure,
but at costs that will be far outweighed by the accrued benefits.
Thank you, Mr. Chairman.
The CHAIRMAN. Thank you, Mr. Hayes. We have a policy here for
the panel, that each one make his statement, comments; and then we
will interrogate all three of you at the same time, each member will be
allowed a limited time to do the interrogating.
In order to shorten it, sometimes we ask the witnesses if they are
willing to answer in writing questions that members may submit to
them, and if that's agreeable—we have that policy, and if that's agreeable, we'll do that in many instances rather than asking the questions.
Would that be satisfactory to you gentlemen ?
Mr. HAYES. Fine.
[Testimony resumes on p. 97.]
[The prepared statement of Mr. Hayes follows:]
83
Statement by
Alfred Hayes
President, Federal Reserve Bank of New York
before the
Committee on Banking and Currency
of the
House of Representatives
July 17, 1974
Mr. Chairman and members of the Committee, I am happy to
have this opportunity to express my views on some of our current economic
problems, especially as they relate to monetary policy and the Federal
Reserve System.
I would like at the outset to add my voice to those who believe
that our most serious current economic problem is inflation.
Indeed,
the solution to many of our other difficulties, including high interest
rates, the slump in housing, the liquidity problems of business and
financial institutions, as well as many of our problems in the international financial sphere, depends importantly on our ability to get
inflation under control.
I believe that control of inflation clearly
should be the main objective of monetary policy for the present' and
probably for quite some time to come.
Our current inflationary situation has had a long evolution,
dating back to the mid-1960s.
It began with our unwillingness, for a
long period, to provide increased taxes to finance the Vietnam war and
expanded social programs.
The result was an excessively stimulative
fiscal policy and pressures on aggregate demand.
The ensuing demand
inflation led, in due course, to cost pressures and to steadily mounting
84
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inflationary expectations.
These secondary, but apparently inevitable,
consequences of prolonged demand pressures made inflation progressively
more deep-rooted and difficult to cure.
The recession of 1970 removed
demand pressures for a time. While it went too far in generating idle
resources, the rate of inflation did begin to come down.
Unfortunately,
the gains in this respect were disappointingly slow and modest to an
understandably frustrated public.
I believe the program of price and
wage controls begun in mid-1971 made a significant contribution to
reducing inflation as long as demand pressures remained under control.
By late 1972, however, the economy was again expanding too rapidly.
Demand pressures reasserted themselves, making controls of little use
and even counterproductive over the last portion of their life.
Over a long period of nearly 10 years, we have paid an
increasingly heavy price, in terms of irregularly accelerating inflation,
for giving insufficient attention to the limits on our capacity to
meet ever growing demands at stable prices.
Over most of this period,
the Federal budget has been in significant deficit and fiscal policies
have certainly been too expansionary during the period as a whole.
Nor would I argue that monetary policy has been immune over this long
period to the national tendency to try to expand demand at a rate in
excess of what can be produced at stable prices.
Indeed, I think there
have clearly been times, particularly in 1968 and in 1972, when monetary
policy has been rather too expansionary.
85
- 3 -
In any case, I think we have learned that the virus of inflation
becomes progressively more difficult to cure as its treatment is postponed or neglected.
The prospect of an ever accelerating inflation is
truly frightening in its implications for the stability of our economic
and social system.
The point has now been reached where we must direct
our attention to solving this problem even though the cure may have painful side effects in the short run. As I will later indicate in more
detail, I do not believe that our present inflationary problems stem
solely from demand conditions.
Nor do I necessarily believe that monetary
and fiscal policies, our main tools of demand management, are the only
ones we should use in bringing inflation under control. Nevertheless,
I think it is clear that prudent moderation in aggregate demand is an
absolute precondition to the restoration of price stability.
And monetary
policy certainly has a very large role to play in this development.
Against this general background, I would like to address
myself now to come issues in which the Chairman indicated a particular
interest in his letter inviting me to testify.
One of these issues is
the so-called "trade-off" between inflation and unemployment and its
implications for formulating monetary policy.
In my view, the notion
that unemployment can be permanently reduced below some specified
minimum simply by pumping up aggregate demand—and without any improvement in the structural characteristics of our labor markets—is quite
misleading.
Indeed, the notion that low levels of unemployment can be
86
- 4 -
achieved by monetary policy alone--provided only that a little more
inflation be tolerated—has probably caused a good deal of mischief.
To be sure, if unemployment is abnormally high, the judicious
application of monetary stimulus can help reduce unemployment to more
moderate levels with little adverse effects on inflation.
Beyond a
certain point, however, one that seems to be dictated largely by the
structural characteristics of labor markets, attempts to reduce unemployment in this way require progressively larger doses of stimulus.
The resulting inflation, which may be moderate at first, tends to
accelerate progressively.
In time, inflation comes to be built into
the structure of costs and expectations and its stimulative effects
wear out.
Thus, a progressively more rapid inflation is required to
achieve given effects on unemployment.
Certainly, our present situa-
tion of unemployment in excess of 5 per cent, coupled with the escalation of inflation rates that we have witnessed, strongly suggests
that this process has been at work over the past decade.
I do not pretend to know just what rate of unemployment
might be a sustainable minimum for price stability under the conditions of the 1970s.
I do feel sure, however, that it is something
materially above the 4 per cent figure that was often cited in the
past as an appropriate full employment goal.
At the same time, I do not want to suggest that an unemployment rate such as 5 per cent need be accepted for all time as the best
87
- 5 -
we can do under conditions of sustained price stability.. What I
think has to be recognized is that the only way permanently to reduce
the levels of unemployment compatible with price stability lies in
measures that will increase the qualifications of the labor force
that are in demand and that will produce a more efficient and speedy
matching of willing workers and available jobs.
Attempts to solve
the problem by pumping up aggregate demand can, in the end, have only
devastating inflationary consequences with the accompanying risk of
leading ultimately to really serious slumps in the economy and in
employment.
Even if we could be sure we could trade a higher level of
employment for an additional measure of inflation, this would seem to
be a very bad bargain for the American people under the present circumstances.
The longer inflation is allowed to run unchecked, the larger
will be the distortions built into the economy and the more difficult
and painful will it be to bring inflation under control.
Thus, even
though unemployment is not as low at present as most of us would like
to see it, I think we have no real alternative to a policy of moderate
but continuing monetary restraint.
The short-term costs of restraint
at this juncture will be less than would ultimately have to be paid if
we were to allow inflation to gain even further headway before acting
decisively to bring it under control.
A somewhat special problem for monetary policy in combating
inflation can arise, as the Chairman suggested in
his letter, when
- 6 -
non-recurring price increases stemming from supply shortfalls arise.
The increase in petroleum prices associated with the Middle Eastern
oil boycott last winter is the most conspicuous recent example.
I
think it is difficult to generalize about the possible implications
for monetary policy of such developments. Much depends upon circumstances.
In some cases, I would think such developments need not
require any change in the thrust of monetary policy.
In principle,
the rise in prices in one sector of the economy may set in motion
compensating price changes in other sectors as available funds are
diverted to the sectors where prices have risen.
Thus there may be,
especially, in the longer run, little net change in inflationary
pressures and no reason to change the thrust of policy.
In particu-
lar instances, however, much depends upon the flexible and timely
reaction of prices in the sectors not directly affected by the special
development.
In the shorter run, such developments clearly can add
to the overall rate of inflation.
Of course, shortages of oil or other essential commodities
can have a magnified depressing effect on total real output since
they are needed to produce other goods and services.
This was a
matter of considerable concern during the recent oil embargo.
While
we in the Federal Reserve were under no illusions that we could increase
the supply of oil by increasing the supply of money, we were also alert
to the danger that the shortage-induced downturn in the economy could
89
- 7 -
cumulate into a general recession. We were prepared to ease monetary
policy if such a process seemed to be getting under way.
This did
not develop, however, and policy was not changed in any major way
in response to the effects of the embargo.
I would now like to turn to the relationship between monetary and fiscal policies and the problems posed for monetary policy
by fiscal stimulus in an inflationary environment. Monetary and
fiscal policies are most effective when they are used in tandem,
rather than working at cross purposes. While monetary policy can
offset some of the effects of an excessively expansive Federal budget,
it cannot compensate for all of the shortcomings of fiscal policy.
Our experience over the past several years bears testimony to this
truth. While a combination of factors has exacerbated our inflationary problem, Federal budgetary deficits have played a significant
underlying role.
When productive facilities are strained by excessive demands
for goods and services, Federal deficits tend to exert upward pressure
on prices, as the Government competes with the private sector for
scarce resources. At the same time, deficit financing also puts upward
pressure on interest rates as the Government bids for credit to cover
its deficits.
This situation creates a dilemma for monetary policy.
To underwrite the deficit by monetizing the Federal debt would of
course tend to be inflationary.
And inflation tends in the longer
run to become imbedded in the credit markets in the form of higher
90
- 8 -
interest rates, as I shall indicate more fully in a moment.
On the
other hand, preventing credit from expanding to accommodate a Federal deficit would tend to put immediate upward market pressures on
interest rates.
Such developments are, of course, unpopular and it
is all too easy, almost without realizing it, to accommodate the
pressures generated by fiscal deficits.
Reliance on monetary policy alone to restrain inflation in
the face of overly expansive fiscal policy therefore does entail risks.
Rising market rates of interest induce savers to withdraw funds from
thrift institutions, thereby drying up the major source of private
financing of residential construction.
Extremely tight money, more-
over, can imperil the liquidity and even the solvency of credit-dependent
firms.
The Federal Reserve cannot be oblivious to the risks of pushing
monetary restraint too far. We must bear in mind our essential role
as lender of last resort to the economy.
If liquidity pressures
mounted to the point that a breakdown of the credit system appeared
to be a serious threat, the Federal Reserve would have to take steps
to forestall it. This might entail some temporary deviation from the
monetary growth rates that would be consistent with long-run price
stability.
In practice, monetary policy must weigh the dangers of
accommodation against those of resistance to excessive fiscal stimulus.
The results are unlikely to be entirely satisfactory as long
as excessively expansive fiscal policy is tolerated.
I am encouraged
91
- 9 -
by Congressional steps to gain better control over fiscal policy.
I hope a more active and concerted role by the Congress in framing
fiscal policy will significantly diminish the risk that monetary
policy will have to select among bad choices in the face of inappropriate fiscal policy.
In commenting on the role of fiscal policy, I do not want
to imply that monetary policy has not played a role in the evolution
of our present situation.
Indeed, as I indicated earlier, I think
monetary policy has clearly been somewhat too expansionist at times
over the past decade.
I would now like to turn to the relationships among the
monetary aggregates, inflation and interest rates.
Certainly, there
has been, historically, a broad long-run relationship between trends
in monetary expansion and the behavior of prices.
Over long periods
of time, price stability depends upon a rate of money and credit growth
commensurate with the economy's capacity to produce.
Ultimately,
therefore, the return to an era of price stability will require the
restoration of the monetary aggregates to moderate rates of growth.
And I should perhaps add that some of our current notions of what
constitutes "moderate" growth would have seemed rather rapid in an
earlier period of relative price stability.
It would, however, be a gross oversimplification to
attribute all fluctuations in the pattern of inflation to the
behavior of the monetary aggregates.
6-714 O - 74 - 7
There may be many non-monetary
92
- IO developments that can have powerful influences on the behavior of
prices for periods as long as one, two, or more years.
The special
case of supply shortages, as in the recent fuel and food cases, has
already been touched on. As I noted earlier, such supply developments need influence only relative prices in the longer run, with
spending being diverted from other sectors whose prices should in
principle fall, or at least rise less rapidly, leaving the overall
rate of inflation unaffected.
But in the shorter run, the prices of
goods in sectors not directly affected by such special developments
may be rather unresponsive to demand conditions.
Under these circum-
stances, there may be, and I believe have been, significant, if
temporary, effects on the overall price level.
There are, moreover, many other factors that may have an
important influence over prices quite independent of the behavior
of the monetary aggregates.
One of the most conspicuous of these in
recent years has been behavior of foreign exchange rates.
I think
there is little question that the overall depreciation of the dollar
since early 1971 has been a significant inflationary force in this
country.
The depreciation of the dollar has raised the dollar prices
of goods we import.
It has also tended to raise the prices of goods
produced in the United States and sold in both domestic and foreign
markets.
Among other influences on inflation apart from the behavior
of the monetary aggregates, I have already noted the role of excessively
93
-nstimulative fiscal policy.
More broadly, I think the rough long-run
statistical parallelism between price and monetary behavior conceals
important social and political factors that partly account for this
statistical relationship.
The well-known association between wars
and inflation, for example, has often reflected the unwillingness
of governments to finance military spending through adequate taxation.
This has often led to pressures on central banks to accommodate government borrowing through excessive monetary and credit expansion. And
wars have not provided the only instances of governmental failure to
face up to the costs of spending programs with consequent pressures,
direct or indirect, on central banks to make up the difference by
monetary expansion.
With regard to the relationship between inflation and
interest rates, the trend to high levels of interest rates that has
developed over the past several years has clearly reflected in major
part the behavior of prices.
In a situation where rising prices
have steadily eroded the real value over time of debt instruments,
lenders have come to demand an inflationary rate premium and borrowers
have felt justified in providing it.
It is hard to persuade savers
to lend their savings at interest rates lower than the rate of inflation, especially when real estate and other commodity investments
exist as alternatives to fixed dollar instruments.
In this setting,
an attempt to bring down interest rates by rapid expansion in money
and credit would be self-defeating, except perhaps in the short run.
94
- 12 I am convinced that the only way to restore more normal levels of
interest rates is to restore price stability--and this will require
restraint in monetary expansion, not extravagance.
The problem for monetary policy in bringing inflation under
control and interest rates down to more normal levels is indeed
essentially a single problem.
The solution requires a degree of
monetary restraint over a period sufficiently long to wring inflation out of the economy.
This will mean gradually reducing the growth
of the monetary aggregates to a trend compatible with long-run price
stability.
The task of restoring price stability is likely to be
protracted.
The experience of recent years indicates that our price
system reacts only gradually to changes in demand conditions owing
to the long-lasting secondary effects of demand pressures on costs
and expectations.
In view of these factors, I do not expect price
behavior to react quickly to monetary restraint.
The length of time
that will be required to bring the long-run trend of monetary expansion, aggregate demand, and price behavior to a satisfactory point
will depend upon a number of factors.
The ability of our financial
markets to withstand restraint, the impact of restraint on unemployment and on particularly sensitive areas of the economy such as the
savings institutions and the housing industry, will affect the feasible
path of monetary policy.
On a number of occasions in recent years during periods of
monetary restraint, tight money conditions have resulted in sharp
95
- 13 -
liquidity pressures on particular institutions or particular segments
of the markets.
In some instances these have been so acute, or
threatened to become so acute as to create risks for the financial
system as a whole.
In such instances, the Federal Reserve has recog-
nized and accepted its responsibilities, particularly in its role as
lender of last resort, -and has taken action designed to cushion the
impact of such pressures.
There are a number of things that might be done to make
the task of monetary policy easier.
Fiscal restraint is certainly
one of these. A budget surplus would be very helpful in relieving
strains on financial markets.
Programs to aid housing, such as
these recently announced by the Administration are another example.
A third would be efforts to improve the functioning of our labor
markets, perhaps including, if needed, Federal job programs for the
unemployed.
An important factor that I hope will make our job easier
this time is the widespread conviction on the part of the American
public that inflation is public enemy number one.
I am hopeful that
this will be reflected in a healthy measure of self-restraint by all
of us in our common fight against inflation--including restraint by
labor in wage settlements, and by industry in the setting of prices.
In any case, I think a path of prudent monetary restraint
for however long is needed to restore price stability is the only
responsible course of action.
A premature easing would lead to a
90
- 14 -
resurgence of demand pressures, and a renewed and even more virulent
acceleration of inflation.
This would, I am convinced, pose serious
dangers for our economic and social fabric.
Price stability is the
key to many things, to low interest rates, to a smoothly functioning
financial system, to a healthy housing industry, a strengthened international economy, and to the opportunity for sustainable economic
growth.
All of these things can be achieved through responsible
policies, including monetary policy—not without temporary costs, to
be sure, but at costs that will be far outweighed by the benefits
accrued.
97
The CHAIRMAN. The next witness is John J. Balles, president of the
Federal Reserve Bank of San Francisco. I believe you are next, Mr.
Balles.
STATEMENT OF JOHN J. BALLES, PRESIDENT, FEDERAL
RESERVE BANK OF SAN FRANCISCO
Mr. BALLES. Thank you, Mr. Chairman, I appreciate this opportunity to share my thoughts with this committee on the problems raised
in your letter. I have submitted a longer statement for the record.
The CHAIRMAN. It may be inserted in the record.
Mr. BALLES. In the interest of brevity, sir, I will try to capsulize
in about 10 minutes the essence of my views.
The CHAIRMAN. All right; yes, sir.
Mr. BALLES. AS you pointed out in calling this hearing, certainly
two of the most serious problems in this country today are rampant
inflation and sky-high interest rates. The present inflation is especially
pernicious because it has hit hard at the poor, that is where the greatest
price increases have been, in food, fuel, and the necessities of life.
There is no doubt that the high level of interest rates has had a very
serious dislocation effect in numerous areas in our economy that I
spell out in my detailed statement for the record.
As you all know, this problem is not confined to the United States.
It's a worldwide phenomenon, high interest rates, high inflation—in
most countries worse than in our own. How did this happen ? I don't
believe that governments and central banks operate out of blind ignorance, or perverse motives; thus I have tried to identify some deepseated causes around the world that have brought this result about.
Two things have been very important. One is the increasing pressure we seem to have on the world's available resources that has oeen
created by a growing, more affluent population around the world by
people and in country after country that have rising aspirations for
a higher standard of living.
Another key factor seems to have been that, as a result of the greatest
depression that we all suffered from around the world in the 1930's,
government after government after World War I I adopted a conscious full-employment policy, giving very high priority to rapid
growth, to reaching capacity output, and keeping unemployment down
to what we consider acceptable levels. Given that priority, governments have committed themselves to ongoing expansionary domestic
policies to prevent these unacceptable levels of unemployment. At
the same time there has been created in this country, and most others,
an underlying policy bias toward inflation.
You might well ask, why hasn't monetary policy been more effective
in first heading off, or later combating inflation when it does develop ?
I would like to identify what I think are the three key things that
have prevented that from happening. The first key factor, I think, that
inhibited the effective use of monetary policy is the long succession of
Federal budget deficits that we have had 14 of the last 15 fiscal years,
$193 billion increase in debt, or about 67 percent since 1959. In theory *
it can be argued that a tighter monetary policy ought to be able to
offset this. In practice, Mr. Chairman, I find the opposite tends to
take place. I think the reason is along the following lines:
Large-scale deficit financing, first of all, does add greatly to credit
demand in the market; and the initial effect is to have a rise in interest
rates. Since many sectors of the economy are adversely affected by
interest rates, some more than others, especially housing and municipal
finance, you soon get pressures, to keep interest rates from rising to
what are considered to be unreasonable levels, or even dangerous
levels.
For example, in the spring of 1973, you recall there was a serious
effort made by some Members of the Congress to freeze interest rates,
or even roll them back to the level of January 1. The central bank
in this country, or any other, cannot and should not be independent
of government. The central bank, in this country and others, must
respond to what it perceives to be the order of priorities as determined
by the national administration and the national legislature. Unfortunately the only way that mounting credit demands can be satisfied—
in the short run at least—without an increase in interest rates, is
for the Fed to accelerate the growth of money and credit, and in the
process we generate inflationary pressures that show up a year, or 2
later.
It has been my observation, in short, that excessive deficit financing
has been the main thing pulling monetary policy off course toward
excessive monetary expansion which creates inflation in the long run.
The second major fact, in my view, that has been adversely affected the use of monetary policy as an anti-inflation tool is the
conflict that sometimes arises between policy goals of full employment
and stable prices. Since the early 1960's it has been my understanding
that the full employment goal of this country has generally been
expressed as an unemployment rate of not more than 4 percent.
There are some good studies, including one made by Brookings
Institution and one by Professors Eckstein and Brimmer for the Joint
Economic Committee, that suggest that a 4-percent unemployment rate
today represents a much tighter labor market than it did, say 10 years
ago, or 20 years ago, principally because of an increased participation
in the labor market by teenagers, by part-time women workers, and
by others who may lack marketable skills. As a result monetary and
fiscal policy design today to reduce the jobless rate to 4 percent tends
to create inflationary pressures.
I would suggest that rather than imposing inflation on everyone by
attempting to reach our laudable employment goals by expansionary
fiscal monetary measures, our aim should be a much more vigorous
use of selective measures to deal with the structural unemployment
problems, steps to facilitate worker mobility, or low-interest education
loans to youth, minority workers, or retraining programs for workers
directed toward jobs where vacancies are abundant. I'm not for unemployment ; I'm for a different mix of programs, sir, to deal with it.
The third factor that I think has tended to inhibit the effective use
of monetary policy is a rather complicated technical one, and that is
the lag impact we get on the economy from a change in monetary
policy. We don't know as much about this as I would like to, our
knowledge of lag is imperfect; but it's pretty clear that the lag in the
effect of a policy change is much shorter for production, employment,
and profit than it is for prices.
99
In an easy money situation the good news appears first, that is the
stimulating effect on jobs, output and profit, you may see that, let's say,
in 6 to 12 months; but, the bad news comes later. The inflation doesn't
appear until 1 or 2 years later as a lagged impact of the easy money.
Conversely, in a tight money situation the process is reversed, so that
the bad news comes first, that is the dampening of economic activity;
and the good news is delayed, of diminished rate of inflation. Given
this, it's not difficult to predict what type of policy is the more popular,
that is easy money in the short run, which is, I'm afraid the type of
horizon most of our people would look at.
I think we've got to recognize that the very sharp escalation of interest rates we have seen in the first half of 1974 has occurred despite a
rise in the money supply, that some of our critics fear it is still too large
to be noninflationary. In short, the money supply has gone up at something over a 7-percent annual rate in the first half of this year, and yet
interest rates have escalated.
Thus, the extremely high level of interest rates in my view has
stemmed mainly from the forces set in motion by inflation itself, which
is the inflation premium which you find in interest rates that is, lenders demanding a premium because the purchasing power of their assets
is going to be reduced and by the fact that inflation magnifies credit
needs because the prices of goods and services go up.
High and rising interest rates have certainly taken their toll on the
economy and on financial markets. Again, as I spelled out in more
detail in my prepared statement.
One may certainly ask whether we must put up with such severe
dislocations, with all that it implies for disruption in our economy.
Unfortunately, I don't see any way out of it, short run, because a
policy specifically aimed now at reducing interest rates would require
us in the Fed to provide a massive injection of loanable funds into the
banking system, and an acceleration in the growth of money and
credit.
The result might be, in the short run, some stabilization or possibly
a decline in interest rates; but in the longer run that policy would
surely cause an even sharper rise in prices as we got the delayed impact
of too many dollars chasing too few goods, and with that higher rate
of inflation down the road, interest rates would soar even higher.
I conclude with the question, what can we do to extricate the
economy from the present situation of surging inflation and sky-high
interest rates?
I have four specific recommendations, Mr. Chairman, realizing with
some spirit of humility that we don't know all the answers, I certainly
don't know them all; but at least this represents my best judgment.
First of all, I think it would be very beneficial for the Congress, the
administration, and the Fed itself to take a longer view of things in
its policy planning measures, to adopt the longer term policy horizon
because we do have lag impact of things that we do in the fiscal policy
area, lagged effects of what we do today in the monetary policy area.
I'm afraid all too often we tended to do shortrun good, but have produced longrun harm.
Second, budget reform. I applaud the Congress for the moves taken
this year in moving toward budget reform. For the first time, Congress
will be able to vote on fiscal policy, and that is a major leap forward.
100
But, beyond that, I think it is vital to push for actual budgets which
are restrictive in periods of severe inflation, such as we have today.
Specifically, I think the best fiscal policy for the current fiscal year
would be at least a balanced budget, or preferably a surplus, instead
of the $11.5 billion deficit that is presently projected. In my judgment
that is the most important single step that the Congress itself could
take to relieve pressures on the credit market, to relieve inflationary
pressures, to get the level of interest rates down. Up to this time we
nave tried to lean too heavily on monetary restraints to do the job
with the result that we have a rather narrow focus to our anti-inflation efforts, that is, credit controls, and resulting high interest rates.
The third recommendation I would make would be an amendment
to the Employment Act of 1946, assuming that the Congress agrees
with this pnilosophy, stating explicitly that price stability is a coequal
goal of economic policy along with those famous triple goals of the
Employment Act of 1946, maximum employment, production, and
purchasing power. I think in the past our laudable emphasis on maximum employment, production, and purchasing power has caused us
to down play the importance of price stability with the results we see
today.
My final recommendation has to do with monetary policy itself. If
we are to overcome inflation, we need to have congressional and administration support in pursuing a noninflationary growth target for
money and credit, even if high-interest rates, and possibly some increase in unemployment are necessary in the short run, as we wring
inflationary forces out of the economy.
In conclusion, I think it's particularly vital that we in the Fed are
not pulled off course toward excesses, that is inflationary credit ease,
by two major forces that have done so in the past; first, the necessity
to finance large-scale budget deficits, and the tendency to call for easy
money to solve structural unemployment problems that could be better
handled through selective measures of the type that I have described.
In conclusion, Mr. Chairman, your letter of June 19 set forth six
specific areas in which there are disputes in monetary economics. My
prepared statement does contain a summary of my views point by
point on each of those, but in the interest of brevity I will not read it
at this time.
The CHAIRMAN. Thank you kindly, sir.
[Testimony resumes on p. 121.]
[The prepared statement of Mr. Balles follows:]
101
Statement o f John J. Balles, President
Federal Reserve Bank of San Francisco
to
House Committee on Banking and Currency
Washington, D. C.
July 17, 1974
102
PROBLEMS OF INFLATION AND HIGH INTEREST RATES
Mr. Chairman, I appreciate this opportunity to share my thoughts
on basic monetary problems with this Committee.
I will attempt to
set forth and analyze what I believe are the major issues and the
appropriate policies to deal with them.
In that context, I will deal
with the questions you raised in your letter of June 19.
As you pointed out in calling these hearings, two of the most
serious problems currently facing the U.S. economy are an unprecedented
rate of peace-time inflation and a record high level of interest rates.
The present inflation is especially pernicious because many of the
largest price increases have been for necessities such as food, housing
and fuels, so that the poor and those living on reduced retirement income have been hardest hit.
Such perverse effects of inflation tend
to negate the attempts of the government in recent years to assist
such groups with direct government programs.
Similarly, it is clear
that the current high level of interest rates has created serious dislocations and strains in our economy.
These include the adverse
impact on the housing market, the large capital losses to those persons
in all walks of life who have put their savings into stocks and bonds,
directly or through mutual funds and pension trusts, and the threat to
the liquidity of financial institutions.
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Page 2
World-Wide Problem
As you are aware, the problems of rampant inflation and extremely
high interest rates are not restricted to the United States.
All of
the major industrial countries are experiencing similar, or even
higher rates c£ inflation, and the high interest rates which go with
these rates of inflation.
A significant share of our current inflation
results from the fact that the prices of many basic goods —
oil, wheat, cotton, and lumber —
such as
are determined in the international
market place, rather than in the U.S. market alone.
Thus, worldwide
inflation acts to exacerbate and complicate our domestic inflation
problem.
For similar reasons, the resolution of our current inflation
and high interest rate problems does not lie completely within our
hands, but rather requires the cooperation of the major industrial
countries of the world.
ITiat has led to this unprecedented worldwide inflation?
Some
observers would cite excessive monetary and fiscal expansion as the
major immediate cause.
But since I do not believe that governments
and central banks act out of blind ignorance or perverse motives,
we must consider the social and political climate which tends to
produce a bias toward inflationary policies.
One major factor appears
to be the increasing pressure on the world's available resources
which has been created by a growing and more affluent population with
ever-rising expectations for a higher standard of living.
Another key
factor appears to be the increased priority that governments have
assigned to achieving a fully employed economy, both here and abroad,
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Page 3
since World War II.
Given this priority, governments have committed
themselves to ongoing, expansionary domestic policies to prevent
"unacceptable" levels of unemployment from developing.
These secular
developments have tended to create an underlying inflationary bias in
government policies throughout the world.
The cultural and economic forces generated over the past three
decades have provided the basis for our present inflationary experience,
but they do not explain why serious worldwide inflation occurred in the
first half of the 1970 f s, rather than the second half of the 1960 f s, or at
some other period.
complex.
The reasons for the timing of our problems are
However, one element which has not received as much attention
as it deserves is the breakdown of the Bretton Woods System, and the decline in recent years in foreign confidence in the U.S. dollar.
In the
1
years from the end of World War II until the mid-1960 s, the world looked
on the U.S. as the strongest and most stable country, and the dollar
as the strongest and most stable currency.
As a result, both foreign
governments and private persons tended to accumulate dollar assets.
But as the U.S. suffered an almost unbroken string of deficits in our
balance of payments, and as the U.S. inflation rate gradually accelerated
in the late 1960fs towards 6 percent, confidence in the dollar weakened,
and there was an incentive to switch out of dollars into other currencies.
This movement out of dollars accelerated in the period after the
U.S. suspended convertibility of the dollar into gold in August, 1971.
The movement only came to a halt in March 1973, when most industrial countries floated their exchange rates, and thereby rang down the curtain on the
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Page 4
Bretton Woods system of fixed-exchange rates.—
In the period up to March
1973, foreign governments resisted an appreciation in value of their
own currencies vis-a-vis the dollar because they believed that it
would hurt their export industries, slow their growth, and create
domestic unemployment.
The consequent intervention in foreign-exchange
markets by other governments substantially increased the domestic
money supply in these countries as they bought dollars by issuing .
their own money through central bank operations.
Thus the well-
publicized dollar overhang was matched by foreign monetary expansion.
Simultaneous monetary expansion in all major industrial countries
helped to foster a simultaneous business-cycle boom around the world,
which aggravated the inflation from which we all now are suffering.
Having noted the worldwide inflationary climate, I would now like
to turn to a more specific analysis of the underlying factors that
have produced rampant inflation in the United States, even in the face
of a softening in economic activity.
It may be helpful to put this
problem in historical perspective, before attempting to assess possible
cures.
Effect of Budget Deficits
Our domestic inflation problem owes much to the fact that the
Federal Government in the United States has run deficits in 14 of
JL/
"How Well Are Fluctuating Exchange Rates Working," Report of the
Subcommittee on International Economics of the Joint Economic Committee, 93rd Congress, 1st Session (Washington, D.C.: U.S.
Government Printing Office), August 14, 1972.
106
Page 5
the last 15 fiscal years.
These deficits, which have occurred in
all phases of the business cycle, have expanded the Federal debt by
$193 billion, or 67 percent since 1959.
Federal deficits became an
especially critical problem with the major escalation of the Vietnam
war in mid-1965.
The size of these deficits increased at an alarming
rate during the, Vietnam build-up period between 1966 and 1968 when
the economy was at, or near, full employment.
The fiscal situation
was temporarily relieved by the belated income-tax surcharge in mid-1968,
and by a leveling off in military expenditures at about the same time.
However, the situation deteriorated further in 1969-70 when outlays
for civilian programs outstripped recession-reduced revenues, and
became still worse in the 1971-73 period when a full-blown expansion
got underway.
It can be argued that a tighter monetary policy ought to have
been able to offset the inflationary effects of this large, sustained
deficit financing.
In theory this may be true, but in practice the
opposite has tended to occur.
When huge Federal credit demands are
added to those of a fully-employed private sector, interest rates
tend to rise sharply.
There are some sectors of the economy, such as
housing construction, and programs financed with municipal bonds, that
are especially sensitive to such a development because they depend
heavily upon long-term credit.
Because high interest rates have an
uneven impact on the economy, demands for relief are quickly heard.
example, in the spring of 1973, there was a serious effort made by
some members of Congress to freeze interest rates, or even roll them
back to the level of January 1, 1973.
For
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Page 6
In short, large-scale deficit financing by the Government tends
to bring great pressures on the central bank to keep interest rates
from rising to "unreasonable," "unacceptable," or "dangerous" levels.
Unfortunately, the only way that mounting credit demands can be
satisfied without an increase in interest rates in the short run is
for the Federal Reserve to accelerate the growth of money and credit.
But if done for too long, or to an excessive degree, such action can
generate inflationary pressures which may persist for a long period
of time and result in even higher interest rates in the long run.
It has been my observation that large and persistent Federal
deficits are a major factor in pulling monetary policy off course,
in the direction of excessive monetary expansion, as the central bank
attempts to cope with the conflicting pressures that develop.
Too
often in practice, therefore, an expansionary fiscal policy tends to
generate excessive expansion in money and credit.
Priority of Employment Goal
The second major factor tending to inhibit the use of monetary
policy in combatting inflation is the conflict in national goals that
often occurs as between "full employment" and stable prices.
Since
the early 1960's, the "full employment" goal in the U.S. generally
has contemplated an unemployment rate of 4 percent or less.
Such a
rate was regarded by many as a practical minimum, in view of the normal
shifting of workers between jobs and the lack of marketable skills of
some job-seekers.
Whenever the conventional or aggregate unemployment
rate has exceeded A percent, pressures have developed for expansionary
36-714 O - 74 - 1
108
Page 7
monetary and fiscal policies.
For example, recently there have been
demands for a tax cut to take up slack in the economy and to reduce
our conventional or aggregate unemployment rate from the 5.2 percent
level that prevailed last month.
Were such policies to be undertaken,
I greatly fear that they would simply accelerate the already extremely
high inflation rate in the U.S.
In my view, there has not been enough policy use of a refined analysis
of the employment and unemployment data, concentrating on the "hard core"
of our labor force —
i.e., heads of households or "breadwinners" —
for
whom the social and economic costs of unemployment are the highest.
Among this group, the unemployment rate last month was only 3.1
percent, in contrast to the conventional or aggregate unemployment
rate of 5.2 percent.
The significance of a 4 percent aggregate unemployment rate has
gradually changed over time because of shifts in the composition of the
labor force.
An earlier study by George Perry of the Brookings
2/
Institution— , and a more recent study by Eckstein and Brimmer for
the Joint Economic Committee—
suggest that a 4 percent unemploy-
ment rate today represents a much tighter labor market than it did
2/
George L. Perry, "Changing Labor Markets and Inflation", Brookings
Papers on Economic Activities, No. 3, 1970
2/
"The Inflation Process in the United States." Study prepared for
the use of the Joint Economic Committee by Otto Eckstein and Roger
Brimmer, (Washington, D.C.: U.S. Government Printing Office),
February 22, 1972.
109
Page 8
twenty years ago, in view of the increased participation in the labor
market by teenagers and other new entrants who also lack marketable
skills.
Generally, it now seems to take a higher rate of inflation to
achieve a 4 percent unemployment rate than it did some years ago
because of those factors.
Thus if we should now attempt to follow a
monetary policy aimed at reducing unemployment to 4 percent, the
likely consequence would be to exacerbate present inflationary pressures,
which have already reached dangerous levels.
This, of course, is not to imply that monetary and fiscal policy
should never be used to help deal with unemployment.
What it does mean is
that, because of shifts in structure of the labor force, there may be
a change over time in the practical minimum unemployment target that
can be achieved through expansionary monetary and fiscal policies without creating an unacceptable rate of inflation.
Thus, some knowledgeable
observers would hold that, because of the shift in the composition of the
labor force already noted, the practical miniumum target today might be about
4*5-5 percent as far as measures to stimulate aggregate demand through
monetary and fiscal policy are concerned.
In these circumstances, a very useful way to fight unemployment is
to attack the structural source of the problem by helping to increase
the marketable skills of those groups who lack experience.
Such
measures as low-interest education loans to youth and minority groups,
retraining programs directed toward skills where job vacancies are
high, and steps to facilitate worker mobility are all important in this
context.
Rather than imposing inflation on everyone by attempting to
reach our employment goals through expansionary monetary and fiscal
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Page 9
policies, our aim should be a much more vigorous use of selective means
to deal with these specific problems.
We need a high-powered rifle shot
approach, rather than the shotgun approach of monetary and fiscal policy.
For whatever reason, there has been a tendency for the goal of "full
employment" to take priority over stable prices, in view of actions in
recent years by the Administration and Congress —
determine national priorities.
paid to the trade-off —
whose job it is to
Not enough attention seems to have been
i.e., the additional inflation that must be
accepted to get a lower unemployment rate.
In essence, my argument is
that we have had both a faulty diagnosis, and in part the wrong medicine,
for the unemployment goal.
First we need a more meaningful "target rate"
for unemployment, as I have explained.
Secondly, we need new perceptions
and new remedies for structural unemployment, particularly among teenagers,
minority groups and part-time women workers.
Lags in Monetary Policy Impact
A third major factor which tends to inhibit the use of monetary policy
in combatting inflation, and which results in calls for its use to provide
short-term stimulus to the economy, is a complicated
technical one.
Namely, the lags in the effects of a change in monetary policy seem to be
shorter for production, employment and profits than for prices.
Ad-
mittedly, our knowledge about the length of those lags is imperfect.
But it is reasonably clear that the "good news" from easy money appears
first, with production, employment, and profits expanding within, perhaps,
6 to 12 months.
However, the "bad news" comes later, in the form of
increased inflation with a lag of perhaps 1 to 3 years.
Conversely,
if a tight money policy is adopted, the bad news of a dampening of
Ill
Page 10
economic activity comes first, whereas the good news of a diminished
rate of inflation is delayed.
In these circumstances, it is not sur-
prising that elected officials who must face the voters at regular
intervals tend to prefer an easy money policy.
Has Monetary Policy Been Too Expansive?
Thus, it may be asked, has monetary policy been a principal cause
of our inflation problem, with the accompanying high level of interest
rates, and could this have been avoided if monetary policy had been
tighter in recent years?
In testimony earlier this year before the
Congress, Chairman Burns acknowledged that, with the benefit of hindsight,
monetary policy may have been overly expansive in 1972.
Some of our
critics, such as Professor Milton Friedman, would go much further
—
alleging that the money supply has grown too fast since about 1970,
and that this played a major role in producing the current inflation.
Such criticism, whether or not fully justified, is easy enough to
make, based both on monetary theory and statistical studies, but it
seems to me to ignore real problems in the real world.
can be or should be wholly independent of government.
No central bank
The elected
representatives of the people of the United States, both the Congress
and the Administration, must have the ultimate responsibility for
economic policy.
The Federal Reserve System must take account of the high
priority which the Congress and the Administration have assigned to full
employment and economic growth, which has often conflicted with stable prices.
Central banks cannot completely ignore such imperatives —
their better judgment.
even against
It is vital that this matter be thoroughly appreciated,
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Page 13
yielding market instruments, and the consequence has been a major curtailment of funds to the housing industry. To the man on Wall Street, the
dangers have been just as ominous. For example, public utilities have
experienced serious difficulties in raising money in the capital market,
and the commercial banks have had increasing problems in raising funds to
meet heavy loan demands.
The market disruptions caused by high interest rates, in turn,
have seriously affected the real economy. Those who have invested in
stocks and bonds, directly or through mutual funds and pension trusts,
have suffered substantial capital losses, and have become poor sales
prospects for new homes, new cars and other big-ticket items. And
higher borrowing costs generally have contributed to higher prices of
most goods and services.
One may certainly ask whether we must put up with such severe dislocations in the financial markets and the overall economy. Unfortunately,
the answer to this question appears to be yes. A policy specifically aimed
at reducing interest rates now would require massive injections of reserves
into the banking system by the Federal Reserve and an acceleration in the
growth of money and credit. The result might be a temporary levelling off
or decline in interest rates, and a short-run rise in output. But in the
longer run, this policy would cause an even sharper rise in prices, which
in turn would cause interest rates to rise even higher.
Since high interest rates have had such painful consequences, it is
pertinent to ask whether they have done any good in moving toward a
solution to the inflation problem. I see mounting indications that
the high cost of credit is having the desired rationing effect, both
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Page 14
from the standpoint of borrowers and lenders, in "cooling off" the
economy.
This is a necessary first step in purging the economy of
inflationary excesses and starting on the long road back toward stable
and non-inflationary growth.
Policy Recommendations
What can policymakers do to extricate the economy from the
present situation of surging inflation and high interest rates?
I
believe that several major lessons are implicit in what I have already
said about the dangers of inflation and of unbalanced policy responses.
However, these lessons can be summarized in the following four
specific policy recommendations.
1. Longer-term policy horizons. Both with regard to monetary
and fiscal policy, I suggest that we explicitly recognize the lagged
effects of policy measures, and work within somewhat longer time
horizons than has been the custom in the past. In our present uphill
battle against inflation, we should expand our policy-planning
horizon to at least three years to measure the effect of policy actions
being taken currently.
A planning horizon which does not capture the
full consequences of current policy actions, especially with regard to
prices, necessarily has an inflationary basis.
2. Budget reform. I applaud Congress* efforts this year in
moving toward budget reform. By setting up new machinery that will
deal with the budget as a singl entity, you are in effect creating a
vested interest devoted to the cause of economic stabilization. For
the first time, Congress will be able to vote on fiscal policy. But
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Page 15
beyond that, it seems essential to push for actual budgets Which are
restrictive in periods of severe inflation.
The best fiscal policy
for fiscal 1975 would be at least a balanced budget, or preferably a
surplus, instead of the $11.4 billion deficit currently projected.
In
my judgment, this is the most important single step that the Congress
could take to relieve inflationary pressures and to reduce the level of
interest rates.
Up to the present, far too great a burden has been
placed on monetary policy, with the anti-inflation effort centered around
credit controls and the resulting high price of credit.
3.
Economic priorities.
I would recommend an amendment to the
Employment Act of 1946, stating explicitly that price stability is a
co-equal goal of economic policy, along with "maximum employment, production, and purchasing power."
Further, I would suggest making explicit
in policy decisions the implicit trade-off between full employment and stable
prices whenever a conflict arises between these two goals.
In the past,
our laudable emphasis on the full-employment goal has caused us to
downplay other necessary objectives, with the results we see today.
4.
Monetary policy.
If we are to overcome inflation, the Federal
Reserve System must have Congressional and Administration support in
pursuing a non-inflationary growth target for money and credit —
even
if high interest rates and some increase in unemployment are necessary
in the short run, as inflationary forces are wrung out of the
economy.
It is particularly vital that we not be pulled off course
toward excessive credit ease by the two major forces that have done
so in the past —
i.e., the necessity to finance large-scale budget
deficits, and the tendency to call for easy money to solve structural
117
Page 16
unemployment problems that could be handled better through selective
measures of the type I f ve described.
Concluding Comments
My testimony, Mr. Chairman, has attempted to deal with the broad
problems raised in your letter of June 19.
Now I would like to conclude
with a brief recapitulation directed specifically towards the six issues
noted in that letter that involve some dispute in monetary economics.
While recognizing that there are differences of opinion on these matters,
both within and without the Federal Reserve System, my own views are
summarized below.
1.
The reliability of the trafe-off between inflation and
unemployment as a guide for monetary policy.
The trade-off between inflation and unemployment seems
to be unstable and subject to change.
In recent years, it
appears that the trade-off has worsened —
i.e., it now takes
more inflation to produce a given decline in unemployment.
Even with the recent 11.5 percent inflation rate, the unemployment rate last month was 5.2 percent.
Moreover, the trade-off
appears to be a short-run phenomenon.
In the long run, say, three
years or more, a higher inflation rate will not "buy" a lower
unemployment rate.
Only in the short run of one to two years
will we possibly observe a higher rate of inflation leading
to a temporary decline in unemployment.
follows from the widely-accepted doctrine
This observation
that in the long
run the growth in the money supply affects only the general price
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Page 17
level, while in the short run the principal effects are on
production and employment.
2.
Benefits and risks involved in the Federal Reserve accommodating non-recurring price increases originating in supply
shortfalls and other special events.
It is my view that the Federal Reserve should seldom,
if ever, accommodate price increases originating from
supply shortfalls and other transitory events.
This will do
nothing to ease the supply problem, and by facilitating
higher prices, it will contribute to a higher permanent
rate of inflation.
As Chairman Burns said last winter, we
recently have had a shortage of oil, not a shortage of money,
and we cannot increase the supply of the former by increasing
the supply of the latter.
3.
The benefits and risks involved in monetizing deficit spending.
As I indicated earlier, it is undesirable for the Federal
Reserve to monetize the deficits of the Federal Government in
periods of full or nearly-full utilization of resources.
At such times, the monetization of Federal deficits tends to
pull monetary policy off course toward excessive monetary expansion, and thus contributes to inflation.
In periods of recession,
on the other hand, it is appropriate and beneficial to monetize
Federal deficits as part of a program aimed at recovery.
Unfor-
tunately, Federal budget deficits (as measured by the unified budget)
have occurred in 14 of the last 15 years, irrespective of the
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Page 18
state of the business cycle.
There have been a number of
Important technical reforms in recent years, such as the auctioning of Treasury securities, which have reduced the Federal
Reserve's role in support of the debt management area.
However,
the fundamental solution to the problem lies in keeping spending
in line with receipts, thereby eliminating the deficits when
they are not needed to bolster a sagging economy.
4.
The benefits and risks involved in the Federal Reserve
fighting money market fires.
A primary function of any central bank is to act as the
lender of last resort to protect the institutional integrity
of the financial system.
In this sense the Federal Reserve
must "fight money market fires."
Many scholars believe that a
serious aggravating factor in the Great Depression was the Federal
Reserve's failure to perform this function in an aggressive way.
In my opinion, the Fed has done a creditable job in protecting
the institutional integrity of financial markets in recent
decades during periods of liquidity crises, without letting
the money supply get out of control on the upside.
5.
Relationships between money supply, inflation and
interest rates.
The rate of growth in the money supply is a major influence
determining the level of interest rates in both the short run
of a few months, and in the long run of a few years.
However, the
nature of this influence is quite different in these two time
periods, because of the role of inflation in these relationships.
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In the short run, accelerated money growth can force interest rates
down, and restricted money growth can force interest rates up, by
altering the short-run supply of funds relative to demand for
these funds.
However, short-run changes in money growth have little
if any direct effects on the overall rate of inflation.
In the
long run, sustained changes in the rate of growth in the money
supply are a major determinant of the rate of inflation, and expectations of future inflation rates.
Since current rates of
inflation and inflation expectations are major determinants of the
current level of interest rates, sustained changes in the rate of
money growth will have a major effect on the level of interest
rates.
The lesson here is that efforts to reduce interest rates by
accelerating money growth in the short run will be self-defeating
in the long run.
Thus, excessive easy money over a period of
several years leads to inflation, which is a major factor producing
high interest rates.
6.
How to use monetary policy to check inflation and to bring
interest rates back down to reasonable levels.
Monetary policy can check inflation and bring interest rates
back down to reasonable levels through a gradual but steady policy
of reducing the rate of monetary expansion to a non-inflationary
growth track.
But to make this a viable approach, we will need
a powerful assist from a policy of fiscal restraint, along with
support for making stable prices a goal of equal importance with
economic growth and full employment.
121
The CHAIRMAN. Our next witness is David P. Eastburn, president
of the Federal Reserve Bank of Philadelphia. Mr. Eastburn, you
may proceed in your own way.
STATEMENT OF DAVID P. EASTBURN, PRESIDENT, FEDERAL
RESERVE BANK OF PHILADELPHIA
Mr. EASTBURN. Thank you, Mr. Chairman, it is a pleasure to be here.
I would like to talk about four points; first, is the causes of inflation ; two, is what to do about inflation; three, is the role of interest
rates; and four, is the question of evening out the burdens of inflation.
First, on the causes of inflation, I think without minimizing any
of the difficulties we face, that inflation is our major economic problem. It has many causes, but I think it's helpful to divide the causes
into two aspects. One aspect involves extraordinary events, such as
crop failures, oil embargoes, dollar devaluations. These come and go
and often not much can be done about them. We have beef prices
skyrocketing, and then tapering off; wheat prices diminish, then expand ; anchovies disappear from the coast of Peru, and then reappear.
If we are lucky these phenomena occur at different times. Unfortunately, in the last couple of years we have been unlucky; many of these
have occurred together. This is one aspect, these extraordinary causes
of inflation.
The second aspect is monetary. Whatever immediate events may
cause prices to rise, including shortages and higher wage costs, a
higher price level cannot be maintained without sufficient money. In
retrospect it would have been better if money had not grown so rapidly
over the past decade. The reasons for this growth go to a large extent
to considerations other than inflation, which the Federal Reserve has
believed to be important.
Throughout much of the period there was primary concern about
the disadvantaged, those unemployed living in dilapidated housing
and attending crowded schools. Ample growth in money was necessary
to meet these economic and social problems.
In more recent periods the Federal Reserve, partly reflecting views
of Congress, has been concerned about the effects of high and rising
interest rates. Still more recently concerns for the stability of financial
institutions have come to the fore. Whatever the reasons, the consequence of this history is that we found ourselves with rapid increases
of both prices and money, and the question is how to deal with them.
This brings me to my second point, what to do about inflation.
Inflation has taken nearly a decade to build up, and it will take considerable time and discipline to unwind. There are, I believe, four
essential requirements to dampen the inflation.
First, we have to become more realistic about our capacity to fulfill our wants. There has been a tendency in recent years to pass over
a hard fact of life, and that is the scarcity of resources. We simply
cannot fulfill all desires for all people all at once, although we may
earnestly wish to do so. Scarcity is still with us, even in an affluent
society.
The second requirement for fighting inflation is a firm handle on
fiscal policy. In this regard I would like to join in the comments made
122
by the other participants that Congress is to be congratulated for passing the recent budget reform bill; this legislation can give Congress
the kind of control that is long overdue.
Third, I believe there is a limited role for an income policy. We
have just been through 32 months and four phases of controls, and
the economv has just plain had it with controls for awhile. But, there
could still be a useful role for monitoring and publicizing key wage
and price decisions.
Finally, we need to keep a firm grip on money and credit. History
teaches us two lessons about the impact of monetary policy. One is
that inflation cannot continue without the money to finance it; therefore, if inflation is to be moderated, growth in money must also be
moderated.
The second lesson is that growth in money must be moderated slowly to avoid sending the economy into a serious recession. Translated
into current policy, these lessons mean that the recent 7-percent growth
in money must be moderated over a period of time, and this time
could be quite long. I believe it's important, therefore, for the Federal Open Market Committee to set longrun targets for moderating
growth, and then diligently pursue hitting these targets. The FOMC
has in fact been attempting such a procedure for over 2 years now, and
I am hopeful that with experience and resolve we will be able to improve the accuracy of our aim.
This brings me to the third point, what is the role of interest rates?
What would this policy of a gradual restriction on money mean for
interest rates ?
I'm uncomfortable with high interest rates, especially with the record levels we are currently experiencing. We should be clear aibout two
things: One is what is necessary to bring interest rates down; the other
is the role which interest rates play in combating inflation.
The Federal Reserve could try to lower interest rates by supplying
money and credit more generously than it has. A faster growth rate
for money would likely lower short-term interest rates temporarily,
but only temporarily. Opening the money spigot further would add
still more fuel to the fires of inflation. This in turn would add to inflationary expectations and interest rates would rise as lenders protect
themselves by building in larger inflation premiums. A looser monetary policy aimed at lowering interest rates now would eventually
lead to higher rates.
The surer way to lower interest rates is by reducing inflation. In
order to do this, the Federal Reserve has to be less generous in supplying money and credit. Cutting back on the flow of money and credit
into the economy itself will push up interest rates temporarily. In
time, however, lower monetary growth will lead to less inflation and
lower interest rates. A restrictive monetary policy will lead in time
to lower interest rates, not higher ones.
In the meantime, we should recognize that interest rates are playing an important role in combating inflation; and I say this despite
the fact tnat I know that there is a good deal of debate about the
effects of interest rates on the economy. I believe, however, that rising
interest rates do choke off some demand for credit, and therefore do
help to bring total demand for goods and services into better balance
with the ability of the economy to meet these demands.
123
A final question remains, however, and that is, what is the impact
of credit restraint and high interest rates on various sectors of our
economy and society ?
That brings me to my fourth point, and that has to do with evening
out the burdens of fighting inflation.
One of the burdens of combating inflation will be a higher unemployment rate than we would like. I believe the benefits of moderating
inflation will be widely distributed and therefore the burden of fighting inflation should be as widely distributed as possible. Liberalized
unemployment benefits, public service jobs, welfare reform, training
and education programs are all ways of dealing with problems of
those hit hardest by slack in the job market.
The financial burdens of a restrictive monetary policy are also not
distributed evenly across the economy. High interest rates, for example, impact heavily on housing and some public projects. A logical
question, therefore, is whether we could allocate credit in such a way
as to smooth out the burden or even favor some high priority sectors
at the expense of lower priority ones. In other wonis, should the
Federal Reserve allocate credit as well as create credit ?
I happen to approach this question with considerable sympathy
because I think the forces at work in our society, especially over the
past decade, confront us with aspects of the distribution of burdens
and benefits in a way that we have never had before, with an urgency
we have never felt before. They will not go away, and there is good
reason, therefore, for the Fed to consider the matter of the allocation
of credit with great care and concern.
As a matter of fact, a few years ago I explored this question as
thoroughly as I knew how in a paper which I should be happy, Mr.
Chairman, to submit for the record.
The CHAIRMAN. Without objection it will be inserted in the record. [See page 425.]
Mr. EASTBURN. Thank you very much. In addition to that I asked
our research staff to undertake further studies of selective credit
controls, involving their history and their efficacy. We will be putting
out the first volume in this series of studies shortly after the turn
of the year.
Let me just make five points in summary on this question of allocating credit.
First, selective credit controls are less necessary when markets are
working well. One reason credit does not flow into markets such as
housing is that artificial limitations are placed on interest rates and
lenders. The point is that action to eliminate usury ceilings and other
such restraints would make selective credit controls less necessary.
Second, the Fed's experience in attempting to direct credit into
"productive" and away from "nonproductive" uses has not been good.
The reason is that it becomes virtually impossible in practice to determine which uses are really productive and which are nonproductive.
I agree with those who believe a basic solution to inflation is to enlarge
the economy's ability to produce. My point is that selective credit
controls offer little practical promise of directing funds in ways that
will accomplish that. In fact, if it should be part of policy to direct
funds into capital investment, this is being done quite effectively by
today's tight capital market.
36-714 O—74
124
Third, the idea that positive incentives might be helpful in directing
funds in certain ways has a great deal of appeal. We have, in Philadelphia, researched this in some depth, particularly the proposal that
variable reserve requirements be placed on various kinds of bank
assets. For example, you could place a lower reserve requirement on a
high-priority loan, and higher requirements on lower priority loans.
Our research reveals there may be a problem, and that is that credit
is extremely mobile, and people are ingenious in substituting one kind
of credit for another. If, for example, reserve requirements were to
favor home mortgages over business loans, it seems inevitable that
businessmen would simply bypass banks to go to other lenders or
the open market. An effective program of credit allocation would
have to apply across the board; and the workability of such a program
seems questionable, to say the least. The costs would be enormous.
Fourth, if, in spite of these difficulties, Congress were to decide that
credit should be controlled in accordance with social priorities, I
believe that the determination of these priorities is properly a matter
for Congress, not the Federal Reserve.
Fifth, the goal of stimulating certain sectors of the economy and
restraining others might in some cases better be approached through
fiscal rather than credit action. The variable investment tax credit is
one possibility. Direct provision of funds for the mortgage market
is already being employed; and other possibilities should be explored.
I conclude from this, Mr. Chairman, that over time the question
of allocating credit should be studied further. Our analysis today,
however, suggests serious problems. Perhaps the most important point
is that if we can avoid inflation through general monetary and fiscal
policy, we have less reason to be concerned with the allocation of
credit. A program of credit allocation is no substitute for responsible
policy in dealing with the overall supply of money and credit.
Thank you, sir.
[Testimony resumes on p. 133.]
[The prepared statement of Mr. Eastburn follows:]
125
STATEMENT
BY
DAVID P. EASTBURN, PRESIDENT
FEDERAL RESERVE BANK OF PHILADELPHIA
BEFORE
COMMITTEE ON BANKING AND CURRENCY
U.S. HOUSE OF REPRESENTATIVES
WASHINGTON, D.C.
July 17, 1974
126
I welcome the opportunity to be with you today.
When Congress created
the Federal Reserve System over 60 years ago, it was fearful of too much
power concentrated in too few hands.
Thus, it wisely established a decen-
tralized central bank with powers shared by a seven-man Board of Governors
in Washington and 12 regional Banks throughout the country, all outside the
executive branch.
But this organizational arrangement in no way was in-
tended to reduce the accountability of the Federal Reserve to Congress.
are a creature of Congress and accountable to it.
We
I think it is most ap-
propriate, therefore, that Federal Reserve officials testify frequently before the various Committees of the Congress and also that from time to time
you hear from the Presidents of the various Reserve Banks.
I should like to talk briefly about four closely related problems:
1) causes of inflation; 2) what to do about inflation; 3) the role of interest rates; and 4) evening out the burdens of fighting inflation.
1)
Causes of Inflation
If we could somehow create an economic discomfort index the way weathermen combine temperature and humidity, I suspect we would find ourselves about
as uncomfortable as at any time in recent years.
Prices are soaring, the un-
employment rate is creeping up and interest rates are at record levels.
Without minimizing any of the difficulties we face, I believe the major
problem is inflation.
our history.
We are in perhaps the worst peace time inflation in
Unless we begin to unwind inflation, I am fearful of the con-
sequences not only for the economy but for our entire social fabric.
Our current inflation has many causes, but it is helpful to divide them
into two main aspects.
One aspect involves extraordinary events such as
crop failures, oil embargoes, and dollar devaluations.
They come and go and
127
-2-
often not much can be done about them.
Beef prices skyrocket then taper
off; wheat supplies diminish then expand; anchovies disappear from the
coast of Peru and then reappear.
at different times.
If we are lucky, these phenomena occur
In the last couple of years we have been unlucky;
many extraordinary events have occurred together.
A second aspect is monetary.
Whatever immediate events may cause
prices to rise—including shortages and higher wage costs—a higher price
level cannot be sustained without sufficient money.
In retrospect it would
have been better if money had not grown so rapidly over much of the past
decade.
The reasons for this growth go to a large extent to considerations
other than inflation which the Federal Reserve has believed to be important.
Throughout much of the period there was primary concern about the disadvantaged—those unemployed, living in dilapidated housing and attending crowded
schools.
Ample growth in money was necessary to meet these economic and
social problems.
In more recent periods, the Federal Reserve, partly re-
flecting views of Congress, has been concerned about the effects of high and
rising interest rates.
Still more recently, concerns for the stability of
financial institutions have come to the fore.
Whatever the reasons, the consequence of this history is that we find
ourselves with rapid increases in both prices and money.
The question is
how to deal with them.
2)
What to do about Inflation
There are no quick or painless answers.
Inflation has taken nearly a
decade to build up and will take considerable time and discipline to unwind.
There are, I believe, four essential requirements for dampening inflation:
First, we have to become more realistic about our capacity to fulfill
128
-3our wants. There has been a tendency in recent years to pass over a hard
fact of life—scarcity of resources. We simply cannot fulfill all desires,
for all people, all at once, although we may earnestly wish to do so.
Scarcity is still with us even in an affluent society.
A second requirement for fighting inflation is a firm handle on fiscal
policy.
In this regard, Congress is to be congratulated in passing the
recent budget reform bill. This legislation can give Congress the kind of
control that is long overdue.
Third, I believe there is a limited role for an incomes policy. We've
just been through 32 months and four phases of controls and the economy has
just plain had it,with controls for awhile. But there could still be a useful role for monitoring and publicizing key wage and price decisions.
Finally, we need to keep a firm grip on money and credit. History
teaches two lessons about the impact of monetary policy. One is that inflation cannot continue without the money to finance it. Therefore, if
inflation is to be moderated, growth in money must also be moderated. A
'
second lesson is that growth in money must be moderated slowly to avoid
sending the economy into a serious recession.
Translated into current policy, these lessons mean that the recent
seven percent growth in money (the narrow money supply or M^) must be moderated over a period of time, and the time could be quite long.
I believe
it is important, therefore, for the Federal Open Market Committee to set
long-run targets for moderating growth and then diligently pursue hitting
these targets. In fact, the FOMC has been attempting such a procedure for
over two years now.
I'm hopeful that with experience and resolve we'll be
able to improve the accuracy of our aim.
129
-4-
3)
Role of Interest Rates
What would such a policy mean for interest rates?
I am uncomfortable
with high interest rates, especially with the record levels we are currently
experiencing.
But we should be clear about two things:
one is what is
necessary to bring interest rates down; the other is the role which interest
rates play in combatting inflation.
The Federal Reserve could try to lower interest rates by supplying money
and credit more generously than it has.
A faster growth rate for money would
likely lower short-term interest rates temporarily, but only temporarily.
Opening the money spigot further would add still more fuel to the fires of
inflation.
This in turn would add to inflationary expectations and interest
rates would rise as lenders protect themselves by building in larger inflation
premiums.
So, a looser monetary policy aimed at lowering interest rates now
would eventually lead to higher rates.
The surer way to lower interest rates is by reducing inflation.
In order
to do this, the Federal Reserve has to be less generous in supplying money
and credit.
Cutting back on the flow of money and credit into the economy
itself will push up interest rates temporarily.
In time, however, slower
monetary growth will lead to less inflation and lower interest rates.
So, a
restrictive monetary policy now aimed at slowing the rate of inflation will
lead in time to lower interest rates, not higher ones.
In the meantime, we should recognize that interest rates are playing an
important role in combatting inflation.
I say this despite the fact that
the effect of interest rates has long been debated.
I believe, however, that
rising interest rates do choke off some demand for credit and therefore do
help to bring total demand for goods and services into better balance with the
130
-5ability of the economy to meet these demands.
A final question remains, however: what Is the Impact of credit restraint and high Interest rates on various sectors of our economy and society?
4) Evening Out the Burdens of Fighting Inflation
One of the burdens of combatting Inflation will be a higher unemployment
rate than we would like. I believe the benefits of moderating inflation will
be widely distributed and therefore the burden of fighting inflation should
be as widely distributed as possible. Liberalized unemployment benefits,
public service jobs, welfare reform, training and education programs are all
ways of dealing with problems of those hit hardest by slack in the job market.
The financial burdens of a restrictive monetary policy are also not distributed evenly across the economy.
High interest rates, for example, impact
heavily on housing and some public projects. A logical question, therefore,
is whether we could allocate credit in such a way as to smooth out the burdens
or even favor some high-priority sectors at the expense of lower-priority ones.
In other words, should the Federal Reserve allocate credit as well as create
credit?
I approach this question with considerable sympathy.
Forces at work in
our society, especially over the past decade, confront us with aspects of the
distribution of burdens and benefits with an urgency that we have never felt
before. They will not go away. There is good reason for the Fed to consider
the matter of the allocation of credit with great care and concern.
A few years ago I explored the question as thoroughly as I knew how in
a paper which I should be happy to submit for the record.*
I asked our research
staff to undertake further studies of selective credit controls, their
* "Federal Reserve Policy and Social Priorities," BUSINESS REVIEW, November 1970
131
-6-
history and their efficacy.
The first volume of these studies will appear
shortly after the turn of the year.
I should like now simply to make five
points in summary.
First, selective credit controls are less necessary when markets are
working well.
One reason credit does not flow into markets such as housing
is that artificial limitations are placed on interest rates and lenders.
The point is that action to eliminate usury ceilings and other such restraints
would make selective credit controls less necessary.
Second, the Fed's experience in attempting to direct credit into "productive" and away from "nonproductive" uses has not been good.
The reason
is that it becomes virtually impossible in practice to determine which uses
are really productive and which are nonproductive.
I agree with those who
believe that a basic solution to inflation is to enlarge the economy's ability
to produce.
My point is that selective credit controls offer little practical
promise of directing funds in ways that will accomplish this.
If, in fact,
it should be part of policy to direct funds into capital investment, this is
being done quite effectively by today's tight capital market.
Third, the idea that positive incentives might be helpful in directing
funds in certain ways has a great deal of appeal.
We in Philadelphia have
done considerable analysis, for example, of the proposal that variable
reserve requirements be placed on various kinds of bank assets.
A lower
requirement could be placed on high-priority loans and a higher requirement
on lower-priority loans.
Our research indicates a major problem:
credit is
extremely mobile and people are ingenious in substituting one kind of credit
for another.
If, for example, reserve requirements were to favor home
mortgages over business loans, it seems inevitable that businessmen would simply
bypass banks to go to other lenders or the open market.
An effective program
132
-7-
of credit allocation would have to apply across the board.
of such a program seems questionable, to say the least.
The workability
The costs could be
enormous.
Fourth, if, in spite of these difficulties, Congress were to decide
that credit should be controlled in accordance with certain social priorities,
I believe that determination of these priorities is properly a matter for
Congress, not the Federal Reserve.
Fifth, the goal of stimulating certain sectors of the economy and restraining others might in some cases better be approached through fiscal
rather than credit action.
bility.
employed.
The variable investment tax credit is one possi-
Direct provision of funds for the mortgage market is already being
Other possibilities should be explored.
1 conclude from all this that, over time, the question of allocating
credit should be studied further.
serious problems.
Our analysis to date, however, suggests
Perhaps the most important point is that if we can avoid
inflation through general monetary and fiscal policy, we have less reason to
be concerned with the allocation of credit.
A program of credit allocation
is no substitute for responsible policy in dealing with the overall supply of
money and credit.
133
The CHAIRMAN. I don't intend to be blunt, but it will sound almost
blunt, the questions I ask, as I try to reduce the length of the questions, to cover the maximum number of subjects that I would like
to. But, I will take advantage of the opportunity to ask some of them
in writing and send them to you gentlemen, send them to the clerk,
and he will convey them to you. I would appreciate a frank answer.
Of course I would expect to, I have no reason to believe that I wouldn't
get a frank answer.
First is, the biggest thing about the Federal Reserve right now is
the $80 billion portfolio in the Federal Reserve Bank of New York.
The portfolio bonds were purchased by the Government's credit, you
took the Government's money and bought the bonds, and you didnt
cancel the bonds.
But, you know, academic professors, almost invariably say in dealing with credit instruments and things of that nature, they use,
usually, this phrase: "That when the obligor and the obligee become
the same person or entity, the debt is canceled."
Have you heard that phrase, Mr. Hayes?
Mr. HAYES. Not in so many words.
The CHAIRMAN. Not in so many words?
Mr. HAYES. But I understand what you mean.
The CHAIRMAN. But, this $80 billion was not paid for by any other
money but the Government's money.
Now, then, the debt is not being canceled; the taxpayers are still
being compelled to pay between $4 and $5 billion on that money every
year. That looks to me like it's clearly wrong, and a bad policy for
Any agency of the Government, to abuse credit in the way it is being
abused in this case. That means, when these bonds become due—they
have already been paid for once—William McChesney Martin in answer to my question, right here where you are sitting, said they have
been paid for once.
So, now, then, if they are not canceled, they will have to be paid
for again when they become due and payable, nobody questions that.
You don't question that, do you, Mr. Hayes ?
Mr. HAYES. Yes, sir; I do.
The CHAIRMAN. YOU do?
Mr. HAYES. Yes.
The CHAIRMAN. I will ask
you to explain it. Go right ahead, Mr.
Hayes.
Mr. HAYES. I would say very briefly
The CHAIRMAN. Be as brief as I was.
Mr. HAYES. I would say the bonds you are speaking of were initially
sold by the Government to various investors all around the country,
institutions primarily, and persons; and those institutions and persons paid the Government money for those bonds. We, then, bought
those bonds on the open market, and we paid for those bonds. Naturally, the person who had bought them from the Government had to be
paid.
The CHAIRMAN. With Government credit.
Mr. HAYES. He would have been out of an asset, which he had bought
with his legitimate funds.
The CHAIRMAN. But you paid with Government credit.
134
Mr. HAYES. NO, we paid them—let's say we buy from a bank, we pay
by crediting the bank's reserve account on our books.
The CHAIRMAN. That's right.
Mr. HAYES. There is no skulduggery here, it's a very straight transaction. Then we hold these bonds as security for the obligations, our
obligations, security for our note obligations which are the currency
we all carry with us; or as an offsetting asset to our reserve account
for these various banks. It's a perfectly clean-cut bookkeeping operation, and I don't understand the double-payment theory.
The CHAIRMAN. Well, the double payment is when you reach over
into the Government's money, and pay for these bonds that were sold
in the open market. If you had canceled the bonds right there, it
wouldn't have been near as bad. But, having kept the bonds you have
both this $80 billion reserves or book entry outstanding, and the Government bonds outstanding, that's $160 billion.
And, since you are carrying them, they will have to be paid for
or "rolled over" when they become due. The Federal Reserve claims
to be fighting inflation, and accumulating this portfolio causes it in
the very worst way. That's just like trying to put out a fire by using
gasoline instead of water; you just can't do it that way.
The last few years the interest rates have gone up, up, up, commencing with June 9,1969, that was the highest prime rate in the whole history at that time, Sy2 percent. Today interest rates are even higher and
are still going up, up, up, the Federal Reserve telling us that, now, we
ought to put them up further in order to put them down. But, they
don't go down except just a little bit for a short time; but they keep
on going up, and now the prime is 12 percent. I think that is an
immoral rate. I think you gentlemen ought to consider that an immoral
rate and do something about it, stop it.
The Federal Reserve can make interest rates go up, interest rates
go down, make interest rates remain low; they have done that 14
years one time in our history. For 14 years they kept them there, the
Federal Reserve can do it.
Now, then, I think if that $80 billion were canceled like the churches
do sometimes, when the obligation is paid they have a big bond burning right out in front of the church, they can see it at the end of the
year, or 20 years. So, if we had an $80 billion bond burning out here
in front of the Capitol. They have been paid for once, why not burn
them ? Why make the people pay $4 or $5 billion a year interest on
bonds that have already been paid for? Why, that's almost—not a
crime
No; I can't yield. Let's not ask members to yield their 5 minutes,
now. No; it hasn't been 5 minutes yet.
Mr. STEPHENS. Did you yield a minute in the last 25 minutes?
The CHAIRMAN. Just half a minute, and I'll be finished. But, why
should we leave those bonds outstanding. I think that is a terrible
thing, and I ask you, Mr. Hayes, and you gentlemen there, to give
serious consideration to that; you are doing this country a great
disservice.
The small businessman spends 1 6 ^ percent interest, now. That never
happened before in the history of this country, and you gentlemen can
do something to stop it; and I will ask you now to do something to
stop it.
135
Now I'll yield to Mr. Widnall.
Mr. WIDNALL. Thank you Mr. Chairman.
Mr. Hayes, did you want to say something in answer to that ?
Mr. HAYES. I just wanted to make a couple of comments. In the first
place, the chairman urges us to get interest rates down. I thought we
had made it pretty clear in our testimony that in our judgment perhaps
inflation is the main reason why interest rates are where they are; and
getting inflation down in order to get interest rates down is something
we very much agree with, but it will take a lot of time.
With respect to those bonds I would point out, although there is
interest of $4 or $5 billion on the bonds, virtually all of that is repaid
into the Treasury by us anyway because all of our profit over and above
a relatively small part which goes to meet expenses, automatically goes
back to the Treasury.
Finally, I would point out, if these bonds were canceled, the Federal
Reserve System would be left without any assets against a very large
liability to the member banks' reserve accounts, and also the liability
on our notes which we all carry in our pockets.
Mr. WIDNALL. Thank you, Mr. Hayes.
First, I want to thank all three of you appearing here as witnesses
today for extraordinarily fine, and thoughtful statements, and constructive approach to the most serious problem we have.
Mr. Hayes, in your statement you call for a long-run period of monetary restraint in order to slow the rate of inflation and bring down
interest rates.
Yesterday, while testifying before this committee, Dr. Weintraub,
our staff economist has told us that a 4 percent per annum increase in
the money supply would clamp sufficient restraints on the economy to
reduce and keep down inflation and interest rates. Do you believe the
4-percent figure is an appropriate one ?
Mr. HAYES. Mr. Widnall, I don't believe that there is any exact
formula for finding out just what is the right number over an extended
period, whether it's 4 percent, or any other percent.
I think that's a gross oversimplification of the task of monetary policy. Under certain circumstances 4 percent might be fine for a while;
under other circumstances it might be much too low. I suspect that
right at the present moment it might be much too low.
I believe the amount of money that we allow to increase—that we
create in the economy—is only one of the factors that we ought to look
at in determining our total policy. That is, I am not one of those that
believe that the rate of increase in the money supply is the sole determinant of prices and costs in the economy. I think that interest rates
themselves have very great effects, can have very great effects on various industries, on the liquidity of institutions, on their willingness to
lend, and so forth. I think that we have to follow a rather flexible policy as to the growth rate we would like to see in the money stock; that's
always a very important part of our deliberations, that is, we do look
ahead and say, well, we would like to see it growing at a certain rate.
I'm precluded from saying what we think the rate ought to be within
the next few months, and you will understand that. But, in any case,
I don't believe you can name one specific figure and say, for a long
period of time, that this is the right number.
136
Mr. WIDNALL. Mr. Balles, I was surprised by your—what I took to
be a pessimistic statement concerning the future of prices and interest
rates. You said, "It will probably require several years to reduce the
rate of inflation, and hence interest rates to more reasonable levels."
You suggest the only way to solve our difficulties is through sustained monetary and fiscal restraint. To me that is a rather ominous
suggestion. Could this sustained restraint cause a sustained recession;
or is a recession the only way to insure price levels and interest rates ?
Mr. BALLES. That is a very good question, sir, and I wish I had an
answer that I was completely confident of. The reason I took the view
that you think is pessimistic, and perhaps it is, that it will require
several years, that if we were to attempt to suddenly get down to a 3or 4-percent rate of expansion of the money supply, versus the 7 percent that we had in the first half of this year, annual rate; I think the
shock effect on the economy would tip us into a serious recession.
Broadly speaking, I think all the students of money and credit that
I'm aware of, and in whose judgment I would place confidence, who
have looked at this question, caution that even though we must get the
rate of monetary expansion down from what it has teen in recent years
to be a noninflationary growth path, that they caution not to do it
too rapidly, to do it in small stages because we are not concerned in
this country, as you well know, only about the price level, as bad as
that is right now, and as serious as that question is right now.
We simply, in my view, sir, should not take steps that have a shock
effect on the economy, and that would upset the applecart badly in
terms of current production, orders, jobs, and that sort of thing.
In short, it todk us a number of years to get into this inflationary
situation, and I don't know of any magic to get us out of it quickly. I
hope that we can avoid a recession, we are certainly going to try as far
as monetary policy is concerned. But, I'm not promising that it's going
to happen. There is a risk there.
Mr. WIDNALL. Thank you.
Mr. Eastburn, in your statement you mention that there are two
major aspects to the causes of our current round of inflation: extraordinary events and monetary mismanagement.
I think it's important to define these aspects, as you have done. But
we must not stop there because if we do the answer to the cause of
inflation is incomplete. It is vital that we determine the weight of each
aspect in the creation of inflation; only then can we begin to solve our
problems.
What is your feeling about the proportional contribution of these
two aspects to the current inflationary trends ?
Mr. EASTBURN. That is a very difficult question to answer. I have
given some thought to this; we investigated that in our research department, our staff; and there are various estimates that are given about
the relative proportion of what you might call these extraordinary
causes, and what you might call monetary causes.
As nearlv as we can tell in recent periods, it comes out about half
and half. About half of the price increases have been caused by these
peculiar, special conditions; and about half have been caused by the
basic underlying monetary aspect which you referred to. This is a very
rough rule of thumb.
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Mr. WIDNALL. Would you consider a recent unfortunate experience,
wage and price controls, an extraordinary phenomenon, as opposed
to the monetary aspect of inflation; or do other conscious policy decisions and programs constitute a third facet of inflation?
Mr. EASTBURN. Well, that's a very good question. I divided that into
two parts, two aspects because I think the monetary one underlies all
the others. I would consider that despite whatever controls we might
have that apply to prices and wages, that if you have an ill-considered
monetary policy, that those controls will not be effective.
That is, if you try to put ceilings on prices and wages and you continue to expand the money supply rapidly, too rapidly, these controls
will give way.
Putting this in another frame, therefore, when you have prices going
up with removal of the controls, these I would consider part of the
extraordinary forces, rather than the basic underlying factor; they
reflect an effect, a catchup effect of the basic underlying forces, but
they are in the same category as these extraordinary forces that I
mentioned.
Mr. WIDNALL. Thank you, I believe my time is up.
The CHAIRMAN. All right. Mr. Barrett ?
Mr. BARRETT. Mr. Chairman, I just want to welcome Mr. Eastburn
here, a Philadelphian, coming from the "City of Brotherly Love," and
also Mr. Balles and Mr. Hayes; three very, very fine witnesses.
I'm maybe a little bit prejudiced, but I think Mr. Eastburn has indicated in some way how we can bring inflation under control. I would
like to ask the three of you the same question I asked several who were
before us the other day.
When did you learn about Citicorp's plan being in the works ?
Mr. HAYES. My answer to that is very easy as I just returned
Mr. BARRETT. Pardon, me; I can't hear you.
Mr. HAYES. My answer is very easy as I just returned from a European trip last weekend, and I read about it in the paper over in Europe.
Mr. EASTBURN. My answer is, I read it in the paper when it appeared
in the press.
Mr. BALLES. Same answer.
Mr. BARRETT. In other words, all the Federal Reserve banks and all
the banks in this country learned about it the same way. As long as I
have been on this committee, I have always believed that a Chase
Manhattan, or the First National Bank of New York would invariably go in and see the Federal Reserve people, and say, "This is what
wei are contemplating, what do you think about it ?"
On this occasion I think Citicorp just did solely what they wanted
to do in spite of what harm it would do to the mortgage market and
the monetary policies of this country.
I can't see any answer for that, and I want to ask the three of you
the same question as I did the other day; is the inflation out of control?
Mr. HAYES. N O ; I would hope that the inflation is not out of control.
I think the inflation is in a very dangerous—at a very dangerous level;
but I'm rather optimistic that on balance, with the kinds of policies
we have been talking about, with a reasonably cooperative fiscal policv
and a moderate monetary policy persisting over considerable time, I
think there is a very good chance that we will see the inflation rate
abating within the next year; but I think there is some big question
mark there.
138
Obviously the rate of increase in prices should slow noticeably in
food and fuel, and some other areas but we may not have seen the
worst in some of the industrial price increases and we are facing the
question of the wage-price spiral.
Mr. BARRETT. DO you think it's uncontrollable at this point ?
Mr. EASTBURN. I would agree with Mr. Hayes, that it is not out of
control; but I do think it's vital to understand that if it is to become
controlled, it requires a great deal of sacrifice.
Mr. BALLES. I would agree also, Mr. Barrett. I would refer, I think,
to the findings of the famous Douglas subcommittee and the Patman
subcommittee on this subject in the early 1950's. My recollection of
both of those committees is that they proposed that vigorous coordinated and timely use of monetary credit and fiscal policy be the main
means that we use to achieve the aims of the employment act of 1946.
I think the testimony of the three of us today has called for that sort
of vigorous and coordinated use of monetary and fiscal restraints to
lick inflation. If we do that, I think we can get things under control,
although not quickly.
Mr. BARRETT. I think you made three very fine statements here, but I
do say the gentleman from the "City of Brotherly Love" hit more toward the target than you two. We heard testimony here yesterday
about ways to check inflation and bring the interest rates down—
and Mr. Hayes talked about this. I was wondering if the interest rate
can be brought down by controlling the growth of money supply to
less than 4 percent, or a rate of, say, 6 percent a year.
Would either of you agree on that, and if all of you agree on that,
how do you think tnis control can be used to bring down the inflation
to a normal level ?
I would like to hurry up here, before my 5 minutes terminates.
Would you agree that this is the job that the Federal Reserve should
have. If you do agree on that, why aren't they making more strenuous
efforts to control the money supplies ?
Mr. HAYES. Could I just
Mr. BARRETT. Yes, Mr. Hayes, I think I would like to hear from you.
Mr. HAYES. I would say that our efforts are rather strenuous. First
I would like to say that the 6 percent figure that you mentioned does
happen to be the rate at which money grew in 1970, and 1971, and 1972.
Mr. BARRETT. May I just interpose here. This is the reason I asked
you this question because you said in your statement there two or
three times, that this goes back a decade, and you are going back to
that, practically. Why wasn't it controlled when it started skyrocketing.
Mr. HAYES. Well, originally, I think, the failing was largely fiscal,
the unwillingness to tax in the middle 1960's, when our expenditures
were going up very rapidly, was the origin, in my judgment, of the
acute form of inflation.
I admit that our own policies may not have been perfect, either,
sometimes I believe thev were too liberal, in retrospect.
But I think now, when you say why aren't we making strenuous
efforts, we are trying to limit the growth of credit and money at a
time when public demands are enormous; and the resulting signal
of that, the common thermometer of what's happening, is the fact
that for instance the Federal funds rate is around 12 percent, it has
139
even been around 13 percent. Some people consider that a measure of
quite strenuous effort on the part of the Federal Reserve.
The CHAIRMAN. The gentleman's time is up. Mr. Johnson ?
Mr. JOHNSON. Thank you, Mr. Chairman.
I, too, want to welcome you three gentlemen here. I think we are
highly honored to have the presidents of three of the great Federal
Reserve banks of the United States here. I guess it may be a "first"
for this committee; and we are certainly glad that you are here.
Mr. Eastburn may be from Philadelphia, but I want you to also
know that Mr. Balles is late of the city of Pittsburgh, from the Mellon
bank in Pittsburgh. So, we have two Pennsylvanians here. I don't
know whether you are from Pennsylvania or not, Mr. Hayes, but we
wish you were.
Mr. HAYES. My father was.
Mr. JOHNSON. That's fine. Recently I read an article in one of the
financial magazines, and the headline was, "High Interest Rates Are
Here To Stay"; and in reading the article carefully, the thrust of the
article seemed to be about what you have said on page 11, Mr. Balles,
that interest rates and the price of money are determined by the
supply and demand for funds which in turn are critically influenced
by inflation expectation.
This article went on to say the reason for high interest rates is that
anybody loaning out money will want to hedge, so that when he gets
that money back 2 years from now, instead of being able to buy 10
Cadillacs, he will only be able to buy 8 Cadillacs; and therefore his
way of compensating is to get a high interest rate which is, as I say,
a hedge.
Mr. Balles, we understand as long as inflation continues the way it
does, that theory is correct; and you seem to expound it here, interest
rates are really going to be high, and for an indefinite period ?
Mr. BALLES. I certainly agree with the thrust of your remarks, Mr.
Johnson; and unless we can convince the people in this country that
their Government, the Congress, the administration and the Fed are
working together, are going to take effective steps to get the rate of inflation down, unless we can do that, then I think you are quite right,
interest rates will stay high, and for the very reason that you mentioned, that lenders will expect and demand a premium above a real
rate of return to protect the value of their assets.
That's why I think it's so terribly important as to our credibility in
an anti-inflation program. If we can get this credibility established,
and the people realize that the Congress is going to take effective steps,
say through fiscal policy; and that the administration is going to take
effective steps; and that the Fed is going to diminish the rate of monetary growth, and that we get this expectation established that prices
are going to come down, then I believe that interests will come down;
and again for the reasons you cited, quoting that article.
Mr. JOHNSON. Mr. Eastburn, I want to pin some more laurels on you
because you say on page 3, which probably is the most significant thing
that you have said in your statement, and that is: "Inflation cannot
continue without the money to finance it."
I think that is a pretty fair summation of inflation today. Is that
one of the reasons for, say, the high interest rate policy of the Fed, to
make money harder to get, so that we don't have so much money around
to finance these inflationary pressures ?
36-714 O - 74 - 10
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Mr. EASTBURN. Yes, sir. This explains why the Federal Reserve is
trying to exercise monetary restraint, to combat inflation. The initial
impact of that monetary restraint is our interest rates, in the interest
of getting interest rates down in the longer run.
In response to the question you asked John Balles, an interesting
statistic is that if you look at—long term—interest rates over a period
of time, and you see that they are now running 9, 10, 12 percent, and
you adjust them for what has happened to prices; and if you do that
over a period of time, you will see then what might be called the real
interest rate is remarkably constant at something like 3 percent, which
indicates that underlying the economy is a real interest rate of 3 percent, and the rest is all inflation.
Mr. JOHNSON. Would you like to comment on that, Mr. Hayes?
Mr. HAYES. I just want to add one note, which in a way I would
regard as a hopeful note, that the interest rate really reflects not the
present or the past rate of inflation, but expectations as to the future
rate of inflation.
So, it's quite conceivable that if we can establish credibility and real
belief that we are going to lick the problem, you could get a downward trend in interest rates before you have achieved very much in
actual dampening of the inflation.
Mr. JOHNSON. If we could say that high interest rates are really the
result of inflation, then this abuse, let's say, that is being heaped on
Dr. Arthur Burns for being a high interest rate man, and being the
cause of it, that particular abuse is not warranted; isn't that so?
Mr. HAYES. Yes, sir. I would say that none of us central bankers love
high interest rates. We accept high interest rates as an unfortunate
sign and thermometer that the fever is high.
Mr. JOHNSON. Thank you. My time is up.
The CHAIRMAN. Mrs. Sullivan ?
Mrs. SULLIVAN. Thank you, Mr. Chairman.
All three statements that you gentlemen made are very helpful and
very enlightening. The statement that you made on page 5, Mr. Eastburn, where you say that liberalized unemployment benefits, public
service jobs, welfare reform, training, education programs are all ways
of dealing with problems of those hit hardest by a slack in the job
market, we have passed legislation on every one of these issues, I believe, except welfare reform. Many times we had to attempt to pass
legislation over a Presidential veto, or come back another year to pass
it again because we too, feel that we must keep unemployment down as
much as we can.
I would like to ask several things. No. 1,1 think that you gentlemen
are all familiar with the staff recommendations that were made to us
yesterday; and I would like to have your comments on these recommendations, but not right now because there are too many. If you
could give us a brief comment when the transcript is sent to you for
correction.
[The replies requested by Mrs. Sullivan from the witnesses on the
recommendations presented by Dr. Robert Weintraub, staff economist
of the House Banking and Currency Committee, may be found on
page 361.]
Mrs. SULLIVAN. President Eastburn, you stated, as I understand it,
that the market could be more self-reliant with respect to changes in
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interest rates than it has been permitted to be. I wonder if you could
amplify on that; what are you getting at?
Mr. EASTBURN. There has been a term used in the past called money
market myopia, which has to do with concern with the minute changes
in the financial markets in New York, and a desire to try to "fine
tune" the market, if you will, to keep interest rates stable over a very
short period of time.
What I am saying, essentially, is that as you look at the tradeoff
between trying to get money under control, and trying to stabilize interest rates, there is some benefit in letting interest rates fluctuate more
in order to accomplish that greater stability, or greater control over
the money supply.
Mrs. SULLIVAN. I see. Do you really believe that we can stop inflation by raising the interest rates ?
Mr. EASTBURN. I believe we will probably continue to have some
degree of price increase, even with the best of policies; and that doesn't
greatly concern me if it's fairly moderate and fairly constant, and
predictable.
What does concern me is the very rapid and unpredictable kinds
of changes in prices. I believe that unless we have a responsible monetary policy, and monetary restraint over a sustained period of time,
which in turn will mean high interest rates, we will not get inflation
under control; and we will not, in turn, have lower interest rates in the
longer run.
Mrs. SuiiLivAN. Well, I have been saying—I don't know if I'm right
or wrong—that the higher the prime rate goes, the more the product of
the business—usually the large business concern can get money and
can pay the high interest rates because whatever he has to pay he is
going to charge back in the service he produces, or the product. So, he
is getting this money, and raising the prime rate hasn't stopped big
business from getting these loans.
The reason I say this is because some of the bankers who have
come before us—not just at this time, but prior to this—have said,
well, they have made commitments to their customers long before,
and they just must have that money or they lose their customers; and
they get it, regardless of what rate they have to pay.
It's the small businessman that suffers, does he not ? Because he can't
afford to pay these rates. Am I wrong when I say that most businesses
have to do their daily work based on credit, they don't work out of cash
on hand; they work through credit; am I right or wrong?
Mr. HAYES. I think you are right that by and large, that large business firms have better, more access to credit and more optional ways
of raising money than the small company. That's one way that it is
quite true that a period of tight money, high interest rates, does tend
to have differential effects, there isn't any doubt about it, I think.
Mrs. SULLIVAN. Big business is getting the loans, isn't it?
Mr. HAYES. I would say I believe, as one of my associates has
brought out in his paper, there is a marginal effect wnen rates become
as high as this, that does begin to freeze out certain transactions that
otherwise would have taken place, even among big companies. When
they find they have to pay 10 or 12 percent, they may think a little
longer about doing a given piece of business.
Mrs. SULLIVAN. Thank you, I'd like to pursue it
142
Mr. HAYES. I also would like to say the prime rate is not set by the
Federal Reserve; it's set by the commercial Banks.
The CHAIRMAN. Your time is up.
Mrs. SULLIVAN. Thank you.
The CHAIRMAN. Mr. Brown ?
Mr. BROWN. Thank you, Mr. Chairman; and thank you gentlemen
for being with us today.
The chairman of tnis committee on many occasions has said that
high interest rates are a cause of inflation, rather than a result of inflation ; but I think it's the position of you gentlemen that it's the other
way around. Is that not correct ?
Mr. EASTBURN. Yes. I think to be completely objective about this,
that there are both effects. I think that there is a cost effect interest
rates that is built into cost of business and operation, and so on.
I think it would be our feelings that costs, more than offsetting that
effect, is the effect in reducing demand for credit and the demand for
goods and services. So, they are both working, but one is more effective than the other.
Mr. BROWN. Oh, of course, the increased interest rates then add to
inflation.
Mr. EASTBURN. Yes. It's a relatively minor aspect, I think.
Mr. BROWN. Secretary Simon has said recently that the Federal
Government, either in its direct borrowings, or in its contingent borrowings of its different programs, FHA, or anything else, has preempted 60 percent of the capital and credit markets of this country.
Do you agree with that ?
Mr. HAYES. I couldn't give you the figure, Mr. Brown. It sounds
a little high.
Mr. BROWN. That's what Paul Volcker said.
Mr. HAYES. IS this including State and local governments ?
Mr. BROWN. NO, he said, as I recall—and it seems high to me and
that's why I questioned it—his statement was, I believe, and it was
in U.S. News and World Report, one of the interviews, he was saying
that the Federal liability, direct and contingent, amounts to 60 percent of the domestic markets.
The only reason I ask this is that it seems to me whenever we run
into these problems of not getting credit into housing when we want
it, we always think of some way to—we talk about either allocation
of credit; we talk about in some way coming up with special gimmicks
to get money into it through extra borrowings by the Federal Reserve
Board, the Treasury and all; and we always talk in some way about
advantaging the disadvantaged sector.
Why don't we ever look at it the other way, you accomplish the
same result if you disadvantage the advantaged sector, don't you ?
Mr. HAYES. Yes. I think, as a matter of fact, Chairman Burns'
suggestion of the tax, the variable tax, would do just that.
Mr. BROWN. I thought that would probably be your rebuttal. However, if you then look at the fiscal side of things, the investment tax
basically ends up with a budgetary negative because to the extent
that you provide investment tax credit, variable investment tax credit,
you are taking away from revenues, rather than adding to them.
Why not a borrowing surcharge? There is no question that corporate borrowings today since, corporations are roughly in the 50
143
percent bracket have an effective rate different from the apparent rate.
If they are paying 14 percent, they have an effective rate of 7. The
home buyer, the homeowner, the mortgagor, in turn being in a different bracket, when he has to pay 14 percent, his effective rate is probably 12.
So, now, why not restrict the deductibility of interest? Historically,
I think, that 7 percent has been a rate that has been about as high as
interest rates have gotten except in tight money times, and so why
not restrict the deductibility interest above that figure.
Then, what you would be doing, you would be disadvantaging the
advantaged sector, and it will result in a budgetary plus, yet be
consistent with an economic policy of restraint.
Mr. EASTBURN. I think that is a very intriguing idea.
Mr. HAYES. I think, as you recognize, there are times when you
want to encourage investments.
Mr. BROWN. I would say you can tie on your variable investment
tax credits, if you want to, you are getting it then on both sides.
But at least you are saying that we have established a norm, and we
are not going to advantage the advantaged sector any time we want
that sector disadvantaged.
Mr. EASTBURN. Could I respond to the first part of your question,
sir?
Mr. BROWN. Yes.
Mr. EASTBURN. I think as a general principle the country is better
served by using incentives, rather than disincentives, if I can make
that distinction.
Mr. BROWN. Well, that's a little bit—aren't you laboring under the
same basic problem that we have, and that is that we have always
wanted an expanding economy. It's a little bit like having a farm
policy that was always trying to handle surpluses; we don't know
how to react in an economy when we have to work on the other side
of the ledger, instead of stressing expansion, we should concern ourselves with contraction ?
Mr. EASTBURN. We do have an economy based on a profit motive,
and it seems to me the extent to which you can use the profit motive
and push something the way you want it, rather that prohibiting it
from going the way you don't want it, then you are better served.
Mr. BROWN. My time has expired. Oh, excuse me, Mr. Balles.
Mr. BALLES. I just wanted to make a brief comment, Mr. Brown. I
think in our remarks so far we have possibly failed to touch on one
very important way of helping to solve inflation in the longer ran,
and that is the increased supplies. We have been talking about restraining demand, which is the big problem now.
But certainly, anything that can be done through public policy to
generate strong rates of increase in productive capacity will help solve
inflation over a period of 2 to 5 years ahead. We have a capacity
crunch in this country, I'm sure you know, in many industries.
Mr. BROWN. The only trouble is, it seems to me, and I think you
will agree, it has been much easier to increase the supply of credit
than it has the supply of eggs.
Mr. BALLES. Unfortunately.
Mr. BROWN. Thank you very much, gentlemen.
The CHAIRMAN. Mr. Reuss.
144
Mr. REUSS. Thank you very much, Mr. Chairman.
Mr. Hayes, not long ago the Federal Reserve Bank of New York
came to the rescue of the Franklin National Bank to the tune of more
than $1 billion. Can you tell us—and if you prefer to make this answer
in the record, rather than offhand, that's entirely up to you—where
Congress set forth by statute the power of the Federal Reserve bank
to engage in that kind of operation ?
Mr. HAYES. I'd rather look that up because I can't quote the authorization.
Mr. REUSS. That will be entirely satisfactory, when you correct
your testimony.
Mr. HAYES. I would like to say this, that it's my belief that a basic
function of any central bank is to provide, try to provide, a certain
stability in financial markets. The reason for stepping in here, essentially, was not any love of Franklin, or any love of its management,
or any great regard for the way the bank had been run, quite to the
contrary.
Our reason was fear that a failure of a bank of that size could lead
to very serious financial
Mr. REUSS. I appreciate the reasons that motivated you all, I wanted
to see the grant of authority by the legislature.
Mr. HAYES. I'll be glad to write that for you.
[In response to the request of Mr. Reuss, the following information
was submitted for the record by Mr. Hayes:]
STATEMENT REGARDING STATUTORY AUTHORITY FOR LENDING BY FEDERAL RESERVE
BANK OF NEW YORK TO FRANKLIN NATIONAL BANK
The statutory authority for lending by the Federal Reserve. Bank of New York
to Franklin National Bank, a member of the Federal Reserve System, is found
in the eighth paragraph of Section 13 and in Section 10(b) of the Federal Reserve
Act, 12 U.S.C. § 347 (1970) provides in relevant part that:
"Any Federal reserve bank may make advances for periods not exceeding
fifteen days to its member banks on their promissory notes secured by the
deposit or pledge of bonds, notes, certificates of indebtedness, or Treasury bills
of the United States, or by the deposit or pledge of debentures or other such
obligations of Federal intermediate credit banks which are eligible for purchase
by Federal reserve banks under section 13(a) of this Act, or by the deposit or
pledge of bonds issued under the provisions of subsection (c) of section 4 of the
Home Owners' Loan Act of 1933, as amended; and any Federal reserve bank
may make advances for periods not exceeding ninety days to its member banks
on their promissory notes secured by such notes, drafts, bills of exchange, or
bankers' acceptances as are eligible for rediscount or for purchase by Federal
reserve banks under the provisions of this Act, or secured by such obligations
as are eligible for purchase under section 14 (b) of this Act."
Section 10(b) of the Federal Reserve Act, 12 U.S.C. § 347b (1970), provides
in relevant part that:
"Any Federal Reserve bank, under rules and regulations prescribed by the
Board of Governors of the Federal Reserve System, may make advances to any
member bank on its time or demand notes having maturities of not more than
four months and which are secured to the satisfaction of such Federal Reserve
bank."
Pursuant to Section 13 and other provisions of the Federal Reserve Act, the
Board of Governors of the Federal Reserve System has issued its Regulation A,
entitled "Extensions of credit by Federal Reserve banks" (12 C.F.R. 201). Reserve Bank extensions of credit, including loans by this Bank to Franklin, are
made in accordance with the provisions of that regulation.
Mr. REUSS. Mr. Eastburn, first let me congratulate you on that
November 1970, article in Business Review which has been put into
the record; I think it's a splendid job and ought to be widely read,
as I hope it will be.
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As I look over the financial situation in this country with particular regard to inflation, I'm not terribly encouraged. I see utility
after utility failing in its attempt to get loans to expand vitally
needed energy resources; I see State and local governments, including the largest local government in our country failing to secure funds
which are desperately needed; I see that greatest source of capital
investment and ingenuity in this country, the small- and mediumsized corporation, failing to secure either from the banking system,
or outside the banking system, the money for new plants and equipment so desperately needed to combat inflation.
On the other side I see the great money market banks, the big Wall
Street banks, for instance, increasing their loans by some 20 percent
over a year ago, reaching out for new sources of funds at home and
abroad in the most ingenious manner. I see a large part of those loans
going for bidding up the price of inventories, bidding up the price
of scarce supplies, bidding up the price of real estate.
Just as you have been generous enough to congratulate Congress
on reforming fiscal policy—and we accept that with pleasure—isn't
it time to reform monetary policy and see if there isn't a way whereby the Federal Keserve could allocate credit, as well as create credit?
In short, isn't that the goal that you have been pursuing, in your
thinking at least, for the last 4 or 5 years ?
Mr. EASTBURN. Yes, Mr. Eeuss. I must say, I have a great deal of
sympathy with what you are saying, and I have for a long time;
that's why I am struggling with the problem. What disappoints me
is the realities of working it out, of making it work.
Mr. RETTSS. One of the things that disappointed you a little bit, I
think—and you stated it in your testimony today—is that if there
are to be priorities, then establishing these priorities is clearly a matter
for Congress, not the Federal Reserve.
Have you had a chance to look at the material on this which I had
in the record several weeks ago?
Mr. EASTBURN. Yes; I have. I have read your bill, and I think you
have done this in your bill, except for item E. Item E, as I remember,
leaves it to the Federal Reserve to determine other areas.
Mr. REUSS. With the right of Congress to veto it.
Mr. EASTBURN. That's right.
Mr. REUSS. This is neither the time nor the place, and certainly
my time doesn't permit to ask you for a full answer, but do you
think the approach I suggested is worth exploring ?
Mr. EASTBURN. I have felt that—I thought that this approach is
worth exploring for some time, and that is the reason we have done
the research that we have done on it. But, I must say, the further
we look at it, the more difficulties I see in making it work. The main
reason is that applying it solely to banks can't be the solution because
it spills out of banks into the marketplace; and that means that you
have to make it applicable across the board. That, I think, is quite
a different proposition than the kind of bill that you propose, which
applies just to banks. The costs and the burdens are much greater.
Mr. REUSS. Thank you.
The CHAIRMAN. Mr. Wylie ?
146
Mr. WYLIE. Mr. Chairman, thank you.
There is no question that the subject most on Mr. and Mrs. John
Q. Public's mind is inflation and interest rates. I happen to think
inflation comes first, and if we can place inflation under control, interest
rates will come down.
Mr. Reuss, the gentleman from Wisconsin asked about his bill. I'll
ask about mine. I have introduced a bill, H.R. 15375, which would
reduce Federal spending below income, and call for a reduction of
the Federal debt on a graduated basis.
I would like to have your comment on H.R. 15375 from each of
you. Do you think passage of H.R. 15375 would effectively control
inflation?
Mr. HAYES. I'm sorry to say, I'm not familiar with the details of
the bill, so, I'm just
Mr. WYLIE. Let's assume that the bill would require Federal spending
below income, and that it would reduce the Federal debt by 2 percent
for fiscal 1975 if followed.
Mr. HAYES. I would think that in the present setting something
along those lines could be very useful, yes. If it's a matter of doing
this year in and year out, all the time, I'm not so sure because I think
there may be times when a Federal deficit could be actually not harmful, but positively useful. But certainly not in an overheated atmosphere like now.
Mr. WYLIE. But on a short-term basis you think it might be helpful,
and might in fact be desirable.
Mr. BALLES. I would strongly endorse it, Mr. Wylie. In my prepared statement I indicated, and I would like to reiterate, the most
useful single step that Congress could take in this current fiscal year
is to have at least a balanced budget, and preferably a surplus, rather
than the $11.5 billion deficit.
If that is the thrust of your bill, I would certainly have to endorse
it very strongly.
Mr. WYLIE. That is indeed the thrust of my bill. Mr. Eastburn ?
Mr. EASTBURN. I agree with that.
Mr. WYLIE. Thank you.
The gentleman from Wisconsin, Mr. Reuss, touched on the allocation of credit rather—I think he used the words "pursuing credit,"
I'm not real certain what he meant—but I know that Governor Brimmer has advanced the theory for some time, that the Federal Reserve
Board ought to allocate credit.
Now, is that workable? I say that because allocation of credit is
difficult at best because it extends well beyond the banking system.
For example, corporations can go to insurance companies and get
credit; or they can issue their own commercial paper.
Would you care to comment on that, Mr. Hayes ?
Mr. HAYES. Could I comment—I don't want to seem like a backsliding reactionary, and I certainly welcome the kind of study that
my colleague, Mr. Eastburn, has been doing on this subject. I must
admit I start with a more negative view on the likelihood of finding
a workable way of allocating credit, than perhaps he does.
In fact, I think that in the Federal Reserve System as a whole, there
is still a great reluctance to get into this area of credit control, or
allocation; and I think with good reason because I think it's such an
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overwhelming problem. As you say, the banks are only a part of the
problem. But, once you got started on that, I don't know where it
would end. I think it would be too much of a task for the Federal
Reserve.
Mr. WYLIE. Mr. Eastburn ?
Mr. EASTBURN. Yes, sir. Governor Brimmer's proposition is essentially the same as Mr. Reuss' bill, which would provide differential
reserve requirements on different kinds of assets, to encourage, or
discourage, the direction of flow of funds.
I think the same thing would apply to Governor Brimmer's proposal as I have applied to the Reuss bill, and that is the difficulty
of applying the allocation of credit simply to banks; and the point
that you have made about the corporations and the marketplace
underscores the difficulty of allocating credit.
Mr. WYLIE. Thank you. My time has already expired, and I have
only just begun. Thank you, Mr. Chairman.
The CHAIRMAN. Mr. Moorhead?
Mr. MOORHEAD. Thank you, Mr. Chairman; and I also want to
thank you, Mr. Hanna, for not asking to go on.
I want to welcome, of course, my old friends and my new friend
from Pennsylvania to this panel. The first question was touched on
by all of you, but I would like to direct it, at least at first, to Mr.
Balles; and this is the question whether, if we have perfect fiscal
and monetary policies, and if inflation is really worldwide—can we
solve the problem ?
Mr. BALLES. Mr. Moorhead, I think that we can solve a large part
of the problem, but not necessarily all of it. To the extent this is a
worldwide inflation, the solution to it doesn't lie entirely within our
own grasp, and that bothers me.
It will take some cooperative efforts by other governments, and by
that I mean cooperating with us in the sense of trying to calm down
inflation because if they don't, we are likely to import some of their
inflation through prices of imports. So, that the problem is not entirely
of our own choosing in terms of how we go about solving it.
But as the biggest, most powerful country in the world, we should
exert some leadership in the area; and I think if we did that we could
get some cooperation of other countries, I hope. I'm fairly optimistic
on that.
Mr. MOORHEAD. I wish I shared your optimism. I see not just the
disappearance of the anchovies off Peru, but I see the developing
nations insisting on higher and higher prices for their raw materials.
I have introduced legislation to anticipate where we are going to have
troubles, and whether we can't plan offsets, alternative sources, offer
ways of reducing demand.
Mr. Eastburn, you said we could not have inflation without money to
finance it, and yet all of you seem to shy away from moving as rapidly, as safely as possible toward getting the ideal growth rate of
money.
It would seem to me—and maybe I should direct this to Mr. Hayes
as the permanent member of the Open Market Committee^-that you
could move toward a decreased growth and test the wind, and if it's all
right take another step. Couldn't we get to whatever is the optimum
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growth rate more rapidly than I get the feeling from the testimony of
all three of you ?
Mr. HAYES. I think, Mr. Moorhead, in a sense we are doing that all
the time. We are trying to find out what the interrelationships are
between growth of money and growth of other credit measures, and
levels of interest rates; and we are measuring what effects these interest rates are having on markets, or having on financial institutions.
At the same time, as has been pointed out, we recognize that there are
risks on the economic side that we dont want to exceed. We certainly
intend to have in mind the danger of having such an unfavorable influence on the economy that we begin to tip it over into recession, which
is the last thing we want to do.
I think we really are doing what you say, we are treading a very
narrow tightrope, really, and trying to slow down the expansion as
rapidly as we can without creating various difficulties for ourselves,
either financially, or economically.
Mr. EASTBURJST. Might I say something?
Mr, MOORHEAD. Yes, certainly.
Mr. EASTBURN. I might just say, we are not talking about theory
here, we are talking about something based on experience. If you go
back and look at what happened in the 1950's and 1960's with respect
to the growth of the money supply, you will see a very clear relationship between when you have a drastic reduction in the rate of growth
of money supply, you have following that, after a certain lag period,
you have a recession. I think this is experience which stands us in good
stead now.
Mr. MOORHEAD. I want to be sure that the record doesn't leave the
inference that I'm in favor of a drastic cutback in the growth; I
meant, can we do it a little more quickly and test the wind? This is
the question and the proposition I was urging.
Mr. BALLES. It sounds like a promising idea, and perhaps we should
try it.
Mr. MOORHEAD. Thank you.
Mr. Eastburn, in your study of selective credit controls, do you
include consumer credit controls?
Mr. EASTBURN. Yes, sir.
Mr. MOORHEAD. DO you advocate them at this time ?
Mr. EASTBURN. NO, sir; I do not advocate them at this
time for two
main reasons. One is that excess consumption is not our problem, and
I don't think we need control of the consumer credit.
The second reason is that I think it remains to be determined how
effective consumer credit controls are; and I think this also needs a
good deal of study.
The CHAIRMAN. Mr. Burgener ?
Mr. BURGENER. Thank you, Mr. Chairman.
Gentlemen, it's a privilege to have you here. Would you outline for
me a few of the various instruments of Federal debt, like savings
bonds, Treasury notes; would you recite the various instruments,
examples, I mean.
Mr. HAYES. Well, you mean Treasury bills and Treasury certificates?
Mr. BURGENER. Yes. What's the typical maturity of those?
Mr. HAYES. The Treasury has maturities running all the way from
90 days to 25 years, or 30 years.
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Mr. BURGENER. The savings bond would be one that's a long term,
what is the typical interest rate on those ?
Mr. HAYES. Savings bonds are now 6
Mr. BURGENER. Just roughly.
Mr. HAYES. Roughly 6 percent, but I'm not sura
Mr. BURGENER. What's the highest yield instrument put out by the
Federal Government?
Mr. HAYES. By the Federal Government, I suppose the highest
yield is on some of the recent, some of the newest issues which have
been in the neighborhood of something like 9 percent.
Mr. BURGENER. All of these documents collectively assembled are
the national debt, are they not ?
Mr. HAYES. Right.
Mr. BURGENER. I have here a Federal Reserve note
Mr. HAYES. Yes, sir.
Mr. BURGENER. That one has instant maturity, I take it.
Mr. HAYES. That is money.
Mr. BURGENER. Right. If these wear out, they make new ones.
They
burn them up and make new ones, right ?
Mr. HAYES. Right.
Mr. BURGENER. But you also add new ones when they are not worn
out, right ?
Mr. HAYES. There is a certain increment, yes.
Mr. BURGENER. What I'm getting at, just quickly the mechanics of
creating new money in the economy. Could you just give me about 1
minute on that, quickly ?
Mr. HAYES. I am not an economist, but I will give you just a kind of
layman's view. Money really is created, all basic money is created by
the Federal Reserve when through open market operations, or the discount window, but primarily through open market operations, we create reserves in the hands of member banks.
Those member banks can use those reserves to get money like that
from us, so that they will have it for their customers; or if they don't
need it for that purpose, they will use those reserves as the base for deposits on the books of the member banks, whether demand deposits, or
time deposits.
Mr. BURGENER. Each year more and more of these cash things get
into circulation, right ?
Mr. HAYES. Right.
Mr. BURGENER. What act, or what authority causes them to be
printed? They are backed by the general credit of our Government,
right; they are not backed by gold or silver.
Mr. HAYES. They are collateralized. When we issue those, we have
to have acceptable forms of collateral, primarily U.S. Government
securities, behind them.
Mr. BUHGENER. All right. So, you have a bond, or a note, or a bill,
which has replaced the old gold standard back in the 1930's, right?
Mr. HAYES. Yes.
Mr. BURGENER. I
was just trying to get the mechanics. If you issue
a bond for $1 million, and somebody pays you cash for it, you got a
credit and a debit; you've got the cash in your hand, and you owe somebody $1 million, plus interest. So, you don't think you are creating
something for nothing. I couldn't follow the chairman's earlier
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Mr. HAYES. That bill constitutes an obligation. It's an obligation of
the Federal Reserve bank that issued it; it's also an obligation of the
U.S. Government.
Mr. BURGENER. The other day on the House floor about 200 Members voted to add $300 million to an HEW bill, probably a very worthwhile cause; 92 of those people also voted against increasing the debt
ceiling. What's your reaction to that, do you have a reaction ?
Mr. HAYES. They voted—excuse me.
Mr. BURGENER. They voted to add $300 million to an HEW spending bill, probably for a very worthwhile cause; 92 of those same people
voted against increasing the debt ceiling.
Mr. HAYES. My own personal feeling is that limitation on the debt
ceiling is a sort of indirect and inefficient way of trying to limit public
spending. The approach, in my judgment, toward public spending
should be direct, you decide whether you want to spend it, or don't
spend it. The debt ceiling is just a way of financing it. If you decide
to spend it, you have to
Mr. BURGENER. It's already spent, I realize that. But, what I am
really trying to get at is that we are doing a little doxibletalking
around this place.
Every witness that has been here in the last 18 months, almost without exception, has asked for a reduction in Federal expenditures as a
means of combating inflation; and almost every member on both rows
has agreed with all these witnesses; and then voted for billions of
dollars that we can't pay for, that's my point.
The CHAIRMAN. The gentleman's time has expired. Mr. Stephens?
Mr. STEPHENS. Thank you, Mr. Chairman.
I appreciate the fact that our chairman has scheduled these hearings; and I think it's about time for us to have you gentlemen here,
as well as others that have been scheduled, and will be scheduled.
Here is something that worries me, and I don't know whether there
is an answer to it, or not; but, we have been talking about, and everybody is talking about high interest rates. In 1954 I bought a home in
Athens, Ga., and I bought it for $30,000. The loan from the Federal
Savings and Loan that I had on it was at 4 percent.
In 1974, the same property that has had 20 years of depreciation,
has been estimated to be worth $60,000, and the loan that I could get on
it from the same savings and loan would be at least 8 percent. So, I
haven't gained anything, or lost anything. When we are talking about
high interest rates and real money, we haven't changed in 20 years.
I'm not as concerned, maybe, about interest rates when you are
talking about real dollars. So many people seem to be, in respect to
the real dollar. I remember when I got married in 1938, we were paying 11 cents for a can of Vienna sausage. Now it's about 43 cents. But,
I was just making $108 a month when we got married, I was teaching
at the University of Georgia.
The thing that worries me and concerns me is this: Are we still
talking—when we are talking about real high interest rates—about
the high cost of everything in relationship to real money ? Or, are we
talking about the fact that in 1938 and 1954 these prices were paid
then, and that we are comparing those prices then to those prices
now ? We also, it seems to me, must take into consideration that everybody has got a high wage, and a high rate; and we haven't changed
the real value of money.
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I guess the only time the bank interest rates will go down is when
my banker calls me up and says, "I've got some money here, and I
want to lend it to you." Those are some observations, but I have been
wondering how practical those are, the high interest rates a,nd the high
cost of everything, unless we put it on a comparative basis.
I've got more money now than when I was making $108 a month,
except I owe a few more people.
Mr. HAYES. I think a lot of us face the same situation, Mr. Stephens.
Mr. STEPHENS. I don't know whether it's necessary to comment on
that, I was just curious about it.
Mr. EASTBTIRN. If I might react, Congressman, I think that the problem about inflation is, all people aren't affected equally by what happens over this period. Some people are debtors, for example, and some
people are creditors, and people who are debtors tend to benefit by
inflation, and people who are creditors tend to lose. This is the thing
about inflation that some people benefit, and some people do not.
Mr. STEPHENS. Excuse me, let me get that straight, people who are
creditors tend to
Mr. EASTBURN. Tend to lose by inflation; people who are debtors
tend to gain by inflation, and therefore you have unequal effects, in
retrospect.
Mr. STEPHENS. What I should do, then is to sell my house now for
$60,000, and just wait until the $60,000 are worth $120,000, based upon
the real value of money. I never have been a creditor so I'm not
Mr. BURGENER. If the gentleman would yield.
Mr. STEPHENS. I don't know if I've said anything.
Mr. BURGENER. Yes, you have. If you could borrow a million dollars
today and pay it back with cheaper dollars, you would greatly benefit
by inflation. There is some gamble as to what might happen in the next
couple of years, so, there is some risk involved.
Mr. STEPHENS. Thank you very much. My time is up, maybe I
shouldn't have used it at all.
The CHAIRMAN. Mr. Rinaldo.
Mr. RINALDO. Thank you very much, Mr. Chairman. I certainly
want to thank the distinguished panel of witnesses for their testimony.
I would like to direct my first question to Mr. Eastburn. I gather
from reading and listening to your testimony that you favor longterm monetary and fiscal restraints as a means of combating inflation
and high interest rates. Certainly, in proposing this, you have agreed
with many other economists who have appeared before us, and with
others with whom I have discussed this problem.
But, it's vital, as I see it, that we thoroughly investigate the effects
of this policy of restraint on unemployment. I didn't notice, for example, in your testimony much mention of the present or future levels
of unemployment. What do you consider to be the effects on unemployment of a restrictive monetary and fiscal policy such as you
outlined ?
Mr. EASTBURN. That's a very difficult question to answer. Let me
make a stab at it. First of all, I think that it is a very astute observation that one of the prices that we pay for getting inflation under control is higher unemployment. It's likely that unemployment will be
rising this year to 6 percent, and possibly even higher in 1975, as the
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economy continues to be sluggish, and as monetary restraints continue.
So, that this is the price we do pay for trying to combat inflation.
I'm not sure what level of unemployment is tolerable from the point
of view of the American people in order to accomplish price stability.
I think that the degree of acceptance of higher unemployment is now
greater than it would have been a few years ago. I think that people
are more concerned about inflation than they were before, and are
more willing to pay the price in terms of higher unemployment.
How high they would be willing to see it go, I really don't know;
but I think it will probably have to be higher than it is now.
The point of my remarks in my statement was that I think we need
a two-pronged policy to deal with this problem. One is that you need
monetary restraint to deal with inflation. You need social policies to
deal with the unemployment impacts. And I think the two have to go
hand in hand.
Mr. RINALDO. This is all well and good, and I understand exactly
what you are driving at. However, take a look, for example, at the
district I represent, Union County, N. J., and particularly at the unemployment level. The monetary policy that Mr. Balles discussed is
aimed at reducing unemployment to 4 percent. He says the likely
consequence would be to exacerbate present inflationary pressures. I
agree with him there.
All right, let's say we raise that level to 5 percent. It still would not
satisfy the present problem because the unemployment rate in my
district, and in many other districts is well above the 5.2 percent
national rate. It is pretty difficult to go back and tell the unemployed
individual that this is the policy that the Government proposes, the
policy that we in Congress are going to go along with; this is the policy that at some future date will curb inflation; but in the meantime
this policy is going to make it more difficult for you to get a job and
it is going to cause other people to become unemployed. Certainly people do not—and I can easily understand why they don't—accept such
an answer.
Perhaps what we should be discussing, in addition to restraint,
which I agree is vitally needed; in addition to perhaps a debt ceiling;
in addition to curbing Federal expenditures, are some concrete methods of curbing unemployment.
Mr. HAYES. I think we all agree 100 percent with what you are saying, and I think that I certainly stressed in my statement, and I think
the others did, too, that we believe it's vital and very urgent that
measures be taken to deal with unemployment, specific measures. The
unemployed people should not regard general credit policy of the
Federal Reserve as the means to solve their problem, that's really
our
Mr. RINALDO. They shouldn't, you know, and I sympathize with
everything that has been said not only by each of you, but by other
witnesses, and by other economists, and in the literature that I have
read, and the arguments pro and con. It all boils down to one thing:
cut Federal spending.
Mr. Hayes, you said that we must utilize "measures that will increase
the qualifications of the labor force that are in demand, and that will
produce a more efficient and speedy matching of willing workers and
available jobs."
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My time has expired, Mr. Chairman, but perhaps for the record,
could you elaborate upon this by specifying the types of measures to
which you referred in your statement ?
Mr. HAYES. I would be glad to try, I'm not an expert on that.
The CHAIRMAN. He can submit that in writing.
Mr. RINALDO. That's what I asked for, Mr. Chairman.
[In response to the request of Mr. Rinaldo, the following information was submitted for the record by Mr. Hayes:]
REPLY RECEIVED FROM MR. HAYES
DISCUSSION OF MEASURES WHICH MIGHT BE UNDERTAKEN TO RAISE LEVELS OF EMPLOYMENT COMPATIBLE WITH PRICE STABILITY
Over the past two decades, the United States has consistently experienced
higher rates of unemployment than have other industrialized nations. The comparatively high rate of unemployment in the United States is essentially a
structural problem, one that is rooted in the relatively frequent spells and
high incidence of joblessness among particular age-sex-race groups in the
work force. A permanent reduction in the level of unemployment compatible with
price stability will require structural improvements in the labor market. At
the Federal Reserve Bank of New York, our concentration is of course on monetary and financial matters rather than labor market economics. After considerable thought and experience over the years, we have concluded that the solution to the problem of structural unemployment does not lie in stimulative
monetary and fiscal policies. After a certain point, at least, such policies can at
best achieve only temporary reductions in unemployment in the absence of ever
larger and more inflationary doses of stimulus. Nevertheless, there are a number
of measures that have been suggested from time to time to improve the structural
characteristics of the labor market that appear to us worthy of serious consideration by the Congress. Before discussing some of these measures, however,
it might be useful to discuss in greater detail some salient features of the
unemployment problem.
The burden of unemployment in this country has not been distributed equally
among the various groups of workers. Women, teenagers, and members of
minority groups bear a disproportionately large share of total unemployment,
in periods of excessive aggregate demand as well as in periods of slack overall
economic activity. The high rates of joblessness in these groups appear not to
represent a large core of permanently unemployed but, rather, a constantly
shifting incidence of unemployment among individuals. In fact, the average
duration of unemployment is usually quite short. Typically, about two-thirds of
the people who become unemployed are out of work for five weeks or less. Among
adults aged 25 and above, while the unemployment rate for women has been
consistently higher than for men, the average duration per spell of unemployment has been lower for women. Workers who have either (1) quit their previous
jobs, (2) are new entrants looking for their first job, or (3) are reentrants into
the labor force typically account for between one-half and two-thirds of total
unemployment.
These characteristics of the labor force suggest that the major unemployment
problem in the United States has to do with the instability of individual employment. Workers in those age-sex-race groups of the labor force with high rates of
unemployment tend to change jobs frequently, often being unemployed for
fairly brief periods in the interim. To a considerable extent, this experience
reflects the unavailability of many of these workers of jobs offering high wages,
good working conditions, job security, and opportunities for advancement (sometimes referred to as "primary" jobs). Because of the relatively unattractive nature of the jobs available to these workers ("secondary" jobs), their job attachment is often weak. For them, the time spent between jobs may be as much a
relief from the drudgery of unpleasant unrewarding work as it is an opportunity
to search for a new job. The bleak prospects facing many of these workers reflect
both artificial barriers to entry into primary jobs and lack of skills needed for
more rewarding work.
Permanent decreases in the unemployment rate can be brought about by
measures that would reduce either the frequency of job changes or the average
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length of individual periods of unemployment. Among the remedial measures
that would seem likely to be effective are a modification of the minimum wage
laws as they apply to young workers, public employment programs, improved
and better funded manpower training programs, more efficient fitting of available workers to available jobs, modification of the unemployment compensation
program, and the elimination of the barriers against entry into certain professions. Each of these proposals will be considered in turn.
1. Revised Minimum Wage Laws for Teenaged Workers
Teenaged workers tend to quit their jobs or are laid off more often, exit from
and then reenter the labor force more frequently, and spend more time in search
of a job than do adult workers. This pattern of behavior underlies not only the
very high rate of unemployment among teenagers but also their low and volatile
labor force participation rate. It should be noted, however, that the high unemployment rates for teenaged workers tend to overstate the seriousness of
the problem to some extent. First, a high proportion of unemployed teenagers
is comprised of full-time students looking for either part-time or summer
jobs. Second, throughout the year, a large number of unemployed teenagers are
new entrants into the labor force. Since these new entrants lack work experience
and well defined career goals, it takes them somewhat longer to find a job than
it takes older, experienced workers. Third, with few commitments and responsibilities, some teenaged workers may respond to increases in wages by electing to
work shorter hours or for shorter stretches since higher wages can enable them
to maintain an acceptable high money income even as they devote more time
to leisure activities.
The fundamental problem connected with—but overstated by—the high unemployment rates of teenaged workers would seem to be the unavailability of
jobs offering either the opportunity of advancement within the firm or training
and experience that would enhance the marketability of these young workers.
It seems to us that the consequences of this dearth of good jobs may be far-reaching and long-lasting. We may be putting an excessive reliance on formal education
so that young workers who have less than the average amount of education and
few marketable skills—the "underprivileged"—tend to become enmeshed in the
secondary labor market, with only "dead-end" jobs ever opening up to them.
As a general rule, firms will provide young workers with job opportunities
affording them on-the-job training or learning through experience only if their
value to the firm while they are being trained at least equals the sum of their
wage costs and the cost of providing the training. The unavailability of good
jobs to teenaged workers is attributable in part to the minimum wage laws, as
well as to discrimination on the part of employers, seniority systems that
block them out of good jobs, and the high quit rate of young workers as they
explore career possibilities.
Some modification of the minimum wage laws that apply to young workers
would seem to be in order. For as these laws presently stand, they make it uneconomical for firms to offer jobs with a low immediate productivity but a high
degree of general on-the-job training. At least a partial solution to the unemployment problem faced by young workers is to exclude them from coverage
under the minimum wage laws. Conceivably some consideration might be given
to subsidies either in the form of income supplements to young full-time workers
to ensure them a livable income, or to firms to encourage them to hire and train
young workers. Furthermore, additional vocational training and guidance in
high schools would no doubt also be beneficial.
2. Public Employment Programs
Public employment programs can serve as a useful means for tiding workers
over temporary spells of slack demand in the private sector as well as for providing the work experience and on-the-job training required for successful private placement. The concept of public employment encompasses both public works
and public service jobs. Public works usually involve long-term capital projects
while public service generally covers such community-service jobs as school
and medical aids.
In the last recession, stepped-up Federal government subsidization of state
and local public employment was used to mitigate the impact of slack labor
demand in the private sector. In 1971, Federal funds were provided for 128,000
positions. The countercyclical advantage of public service employment is that
it can be more rapidly instituted and later terminated than public works programs which might hold skilled labor out of the private sector during an upswing. To the extent that both types of programs absorb unskilled labor, however,
155
they do not seriously aggravate labor supply bottlenecks and associated labor
cost pressures in the private sector.
It is important to note that any public employment program should be supported by taxation. To finance such programs through increased deficits would
tend to be inflationary. Another possible drawback of public employment programs in combating residual unemployment in periods of strong demand is that
the programs may not consist of jobs providing training and experience which
will result in advancement. To the extent that the public jobs are "dead-end"
jobs, then the type of workers filling these slots may well experience the same
rapid turnover and consequent unemployment that occur in similar private sector
job categories.
3. Manpower Training Programs
Manpower training programs are designed to provide training and upgrade the
skills of disadvantaged workers, enabling them to move up from the secondary
to the primary work force. In the past, the manpower training programs have
evidently not been terribly successful in providing Mgood" jobs to disadvantaged
workers. Perhaps what is needed are programs which make it in an employer's
own interest to extend career opportunities to secondary workers. Policies along
these lines might include contractual employment programs whereby the Federal government underwrites the private cost of hiring and training disadvantaged workers and tax credits covering employers' investments in human capital.
4. Employment Services
In recent years, unemployed workers have had to spend between one and one
and a half months on average searching for a new job. Most of this time is spent
in scanning the want-ads in newspapers, contacting friends and acquaintances,
and canvassing potential employers. Expanded government employment services
might greatly facilitate the matching up of available jobs and workers, even
within the present institutional framework. There may be enormous potential
benefits to be gained from having a centralized computer data bank listing the
available jobs and employees over wide geographic areas. Indeed, a 25 percent
reduction in the average duration per completed spell of unemployment, if it
could be achieved, would translate roughly into a 25 percent reduction in the
overall rate of unemployment.
5. Unemployment Compensation Reform
Work disincentives built into the system of unemployment compensation appear to have increased the average rate of unemployment in the United States.
While the specifics evidently vary widely among states, a worker's unemployment compensation benefits have been estimated to be on average about 50 percent of his gross weekly earnings. However, because these benefits, unlike the
income earned from working, are exempt from Federal, state and local income
taxes, the percentage differences between the average worker's take-home pay
and the benefits he can collect are much smaller than the differences between his
gross pay and these benefits. Indeed, the cost to the individual worker of becoming unemployed or of remaining unemployed for additional weeks—up until
the time his eligibility to receive benefits expires—may be quite low in many
cases. Such workers may thus have little incentive to avoid being laid off, or to
return to work very soon after becoming unemployed. The unemployment compensation system should be reexamined with a view to reducing the disincentives
to work while at the same time insuring workers against a total loss of income
on account of involuntary unemployment. Meanwhile, the work disincentive
effect could be reduced materially if unemployment compensation benefits were
taxed at the same rate as workers' normal income.
6. Breakdown of Artificial Barriers to Entry
Economists and others have long recognized the deleterious and self-perpetuating employment impacts resulting from artificial barriers to entry into
certain occupations. One common denominator behind such diverse barriers to
entry as occupational licensing, educational requirements, and union membership
is the discrimination that it permits along age-sex-race lines. Without attempting to disentangle cause and effect, it remains true that such discrimination,
for whatever reason, acts to maintain the segmentation of the workforce into
primary and secondary subsectors.
The cause of productive efficiency, as well as the cause of justice, dictates the
elimination of unnecessary barriers to entry into the primary subsector of the
labor market. To a large extent, the ways in which this can be brought about
36-714
O - 7 4 - 1 1
196
are those that have already been discussed: employment service, manpower
training programs, public employment programs, and elimination of the minimum wage laws for young workers. Hence, inasmuch as these proposals would
also mitigate the de facto discrimination and segregation within the labor market,
it would seem all the more urgent that some such measures be implemented.
7. Concluding Comment
A,s was indicated earlier, the various proposals that have been outlined here
are merely suggestions that appear promising as a means of reducing the structural component of our unemployment problem. Upon closer examination, some
may well appear more appropriate than others. The basic point, however, is
that structural measures along these general lines are the only means through
which we can expect the level of employment compatible with reasonable price
stability to be increased. In the absence of such measures, attempts to reduce
unemployment through aggregate demand policies alone quickly run into the
problem that ever more inflationary amounts of demand stimulus are needed to
maintain the higher levels of employment. Our current situation of unprecedently rapid peace time inflation, an inflation that has accelerated, with interruptions, for nearly a decade, coupled with unemployment rates in excess of 5
percent, shows the ultimately self-defeating nature of attempts to solve the unemployment problem without the needed structural reforms.
The CHAIRMAN. Mr. Hanna.
Mr. HANNA. I'm as pleased as the others to have you here, and
especially you, Mr. Balles, coming from the State of California.
Mr. BALLES. Thank you.
Mr. HANNA. I am struck by the humility that I read in your presentations, and I find that highly laudable; it reminds me of a statement that Mr. Churchill was supposed to have said to somebody. He
said, "It's fine to find you humble for you have so much to be humble
about."
[Laughter.]
Mr. HANNA. I think that humility ought to spread. I really believe
that we are looking too strongly at you, and at inflation, and at interest
rates; and not strongly enough at the real problems, some of which you
have indicated.
I think we are looking at a patient that has boils and a ferar, and a
broken leg. We are treating the fever and the boils, but are not doing
anything about the broken leg; and the leg marrow is what produces
the agent that reduces infection and fever. So, now we are putting in
artificialities and nobody is treating the broken leg.
y _
some of the suggestions you made, together with suggestions I'm going
to indicate, I think is the way we ought to be going.
I think that what the Congress and the administration both need—
and since the administration isn't going to get it, I think the Congress
ought to pursue it—is a model, an economic model of the international
economy because we are going to have to look what is happening internationally as well as domestically. As you have indicated, Mr. Balles,
many of these things are coming at us not because of the aggregate
demand economy; Mr. Hayes, forget it, this is not the problem of the
aggregate supply and demand economy. This is the broken leg that
comes when you have a severe shortage of fuel for the activities of
industry, and therefore a high rising price under these conditions for
products; when raw materials that industry uses in its activity are
going up and up; and when there is a fast growing policy on the basis
157
of everybody that puts the pressure on; high population growth, which
puts additional pressure on. All of these things are occurring outside
to a great degree of our own economy, but we ought to have some better understanding how that is ultimately going to impact the inside.
Here is where I think you, as the good doctors, ought to come in
and say, look, don't ask me to do the bone work, I'm not the bone
specialist; I can continue to do something about the boils and the
fever.
What I suggest is that we have got to learn to live with some of
that fever because there isn't enough artificial medicine to keep it
down; but what we could do is to strike out for this kind of a policy:
A very subdued growth rate in the economy.
No. 2, an inflation that's probably going to go to at least somewhere between 6 and 8 percent, at least for a while.
Interest rates that are going to be between 8 and 9 percent, for a
pretty substantial period of time. Unemployment that is going to be
somewhere between 4 and 5 percent, or in that range.
Then, taxes, taxes which will allow you to make the redistribution
of wealth that you are talking about, that will offset the benefits and
burdens of the era that we are in, so that we ca,n come online with
some of these programs, not to lessen our spending, but to spend it
intelligently and to tax for it, not borrow for it; and to tax the
elements that are still benefited by what the engine of the economy is
actually doing.
That kind of a program would seem to me to make good sense;
and we could bring into this thing the bone specialist to help you fellows that are dealing with the boils and the fever. I would like to have
you react to those kind of suggestions on the record, if you would.
Mr. HAYES. Without endorsing all the specific figures, I think the
basic idea is an excellent one, that is that Congress and the Government in general, should be directing its thoughts to where they want
to go on all these things. This goes certainly far beyond wnat the
Federal Reserve can do.
Mr. HANNA. Exactly, you can only do so much. I think that allocation of credit is absolutely imperative. If we don't do some of these
things within 9 months from now, gentlemen, you guys are going to
be doctors for a terrible patient.
I see in about between 9 and 18 months, that's all the time we've
got to start moving this thing from where it is now. When you increase the interest, you don't decrease inflation, not under the circumstances that I have been talking about. You are going to decrease
jobs; you are going to decrease evolutions of the economic machine;
you will reduce consumption because there will be reduced production. But, you will not decrease prices, I guarantee it, you will not
decrease prices because the price of fuel is not coming down; the price
of metals and minerals is not coming down; and the price of food is
not coming down. It has nothing to do with what the interest rates
are, in the main. It has to do with population growth, with the higher
aspirations, with the attitudes of the people who have these basic raw
materials.
The CHAIRMAN. Mr. Eees ?
Mr. REES. Thank you, Mr. Chairman; I de/fer to Mr. Gettys.
158
Mr. GETTYS. Thank you, Mr. Chairman, thank you Mr. Eees, I am
sitting out of order. I'm not sitting as chairman of the lower row
today.
The CHAIRMAN. YOU are sitting in the wrong place.
Mr. GETTYS. Mr. Chairman, the hour is late, and I won't take but
a few minutes. I would like to say to Mr. Hayes, and Mr. Eastman, and
Mr. Balles, I wish my friend from Atlanta was here because, you know,
it seems like we are always forgetting about the great Southern States.
But, we are delighted to have you from New York, and San Francisco,
and from Philadelphia, these distinguished gentlemen.
The immediate problems, of course, of inflation are critical. The
Congress and the President have the problems of fiscal policy; you
gentlemen in the Federal Eeserve have the monetary policy.
Is there some area where we can get more cooperation and coordination between these objectives, the purely economic views that you have,
and the political situation; and at the same time answer the question
of whether the independence of the Federal Reserve Board should be
eliminated and the Board be responsive to the political situation.
Would you comment, each of you, very briefly on that?
Mr. BALLES. I might try to start, Mr. Gettys. With respect to getting
better cooperation, I couldn't agree more that that is absolutely vital,
and I am hopeful that we will make a strong start on this with the
new congressional approach to the budget.
As I said in my opening statement, I think for thefirsttime Congress
is going to have a chance to vote on fiscal jx>licy. That has not been
done heretofore, as you know, the appropriations bill being considered
more or less independently of each other, and not in relation to the
total revenue, and hence
Mr. GETTYS. I agree with you wholeheartedly. I participated in it
and supported that thing. But I'm afraid we are relying too much on
these budget matters. Aren't we looking for too much from that
law?
Mr. BALLES. Well, I hope not. It's yet untested, perhaps your guess
as to how it will come out will be better than mine; but I'm going to
be very disappointed for the sake of the country if it doesn't work
well.
Mr. GETTYS. NO question, it is moving in the right direction, but I
think we are expecting too much. I don't think it is going to be something that solves all problems in the field.
Mr. BALLES. AS far as the second half of your question is concerned,
should the independence of the Federal Reserve be eliminated, or retained ; that, of course, will have to rely on the ultimate judgment of
the Congress, as to how the country will best be served. The Federal
Reserve System is the agent of the Congress, we are independent only
within the Government to the extent that you delegate authority and
responsibility to us.
I would hope you would continue to believe that trust is well placed.
But, that will have to be your decision, not ours.
Mr. GETTYS. That I understand. But, what is your opinion on the
continuation of the present structure; and I think you would like the
independence, as it is interpreted in today's words, to continue; is that
correct?
Mr. BALLES. Yes, sir, I would.
Mr. GETTYS. Would you gentlemen
159
Mr. EASTBURN. Yes, may I say a word. I would endorse what Mr.
Balles says about fiscal policy. Could I say a word about your second
question on independence ?
I think this is a term which is very loosely used and not very
often understood, or explored. As indicated, the Federal Eeserve considers that this word "independence" applies to its independence from
the executive branch; and there is long historical reason for this independence that goes back through our history, and has been demonstrated time and again that the sovereign, or the executive, has abused
the privilege of money control for his own benefit.
Therefore the founders of the Federal Eeserve System carefully insulated the Federal Reserve from control by the executive branch, and
made it responsible to Congress.
There is a more subtle question, having to do with its independence
with relationship to Congress. As Mr. Balles indicated, we are a
creature of Congress, and we are subject to Congress. On the other
hand, I think that it is necessary for Congress to consider the proper
relationship with respect to the Federal Reserve with respect to conducting its day-to-day business; and a certain degree of——
Mr. GETTYS. I thank you, Mr. Eastburn, my time has expired, but
with the indulgence of the chairman and the members, could Mr. Hayes
comment, maybe, 1 minute ?
The CHAIRMAN. With unanimous consent, so ordered.
Mr. HAYES. I would agree entirely with my colleagues on this point,
and I would point out that a certain degree of independence of the
central bank from the administrative executive of the country is
something that has been tested around the world, and by and large
has been adhered to. Not entirely, but still believed to be a worthwhile thing. I believe it's not worthwhile. The Federal Reserve, I
would add that we have an advantage over certain other central banks
in having a regional system, where the regions of this very large country are given some degree of semiautonomy within the system. That
also adds strength to the Federal Reserve System.
Mr. GETTYS. Thank you, Mr. Hayes, and thank you, Mr. Chairman.
I would like to pursue that subject another time, and I appreciate the
indulgence.
The CHAIRMAN. Mr. Rees ?
Mr. REES. Thank you, Mr. Chairman.
Mr. Eastburn, I was very impressed with your testimony. I would
like to request that the material you offered us on page 5 of your
prepared statement—especially your paper on "Federal Reserve Policy and Social Priorities" be submitted for the record. I would also
like to have other papers you have been developing in the field of credit
allocations inserted in the record. [See page 425.]
I want to talk about two points: The first is that the Federal budget
is always the whipping boy because everyone wants to cut the Federal
budget. I consistently vote against the defense budget, so I guess I
have one of the best economy votes in the House, but I usually vote
for all the domestic proposals, as well as the national debt increase.
Dr. Burns wants to cut the budget $10 billion. I have here a list of
the new Federal Reserve buildings that are going to be constructed
around the country. The one in Philadelphia is going to be completed
in the very interesting year of 1976; it will cost $53 million. The Boston
Bank Building will be completed the same year, for $75 million. And
160
there are plans to build new buildings in Richmond and San Francisco in addition to the Dallas Bank Building and subsidiary offices
of the New York Federal Reserve Bank.
164
The CHAIRMAN. The gentleman's time has expired.
Thank you, gentlemen, very much for your testimony. You have
been very fine witnesses, and we appreciate your testimony; and what
you have said will really receive consideration of all the members of
the committee.
We have, some of us, questions to submit to you in writing, if you
would answer them when you correct the transcript. Thank you very
much.
Mr. HAYES. Thank you, Mr. Chairman.
Mr. EASTBURN. Thank, you.
Mr. BALLES. Thank you, Mr. Chairman.
The CHAIRMAN. The hearing is recessed, subject to the call of the
Chair.
[Whereupon, at 6:30 p.m., the hearing was recessed, subject to the
call of the Chair.]
FEDERAL RESERVE POLICY AND INFLATION AND
HIGH INTEREST RATES
THUKSDAY, JULY 18, 1974
HOUSE OF REPRESENTATIVES,
COMMITTEE ON BANKING AND CURRENCY,
Washington, D.C.
The committee met, pursuant to recess, at 10:15 a.m., in room 2128
Rayburn House Office Building, Hon. Wright Patman [chairman],
presiding.
Present: Representatives Patman, Barrett, Sullivan, Reuss, Moorhead, Stephens St Germain, Gonzalez, Minish, Gettys, Annunzio,
Rees, Hanley, Koch, Fauntroy, Young, Moakley, Stark, Boggs, Widnall, Johnson, Stanton, Blackburn, Brown, Williams, Heckler, Rousselot, McKinney, Frenzel, Roncallo, Burgener, and Rinaldo.
The CHAIRMAN. Today we are going to hear testimony from three
Federal Reserve bank presidents, Darryl R. Francis of the St. Louis
bank, Robert P. Mayo of the Chicago bank, and Francis E. Morris of
the Boston bank. All three serve as rotating members of the Open
Market Committee, President Mayo once every 2 years and Presidents
Francis and Morris once every 3 years. We have heard testimony for
2 days now substantiating that the Federal Reserve, by accelerating
open market purchases and the money supply growth, has been an
engine of our raging inflation and high interest rates.
In particular years other factors have played a role, but over the
long run, special factors, decay and reverse, and it is the Federal Reserve's money supply policies that dominate. Yesterday President
Balles of the San Francisco Federal Reserve Bank testified :
In the long run, sustained changes in the rate of growth of the money supply
are a major determinant of the rate of inflation and expectations of future inflation rates.
President Hayes of New York said:
I think there have clearly been times, particularly in 1968 and 1972, when
monetary policy has been rather too expansionary.
President Eastburn of Philadelphia told us:
Whatever immediate events may cause prices to rise . . . a higher price level
cannot be sustained without sufficient money. In retrospect, it would have been
better if money had not grown so rapidly over much of the past decade. . . . Inflation cannot continue without the money to finance it. Therefore, if inflation is
to be moderated, growth in money must also be moderated. A second lesson
is that growth in money must be moderated slowly to avoid sending the economy
into a serious recession.
Your opinions on the effects that the Federal Reserve's money
supply policies have on prices and interest rates will be of great bene-
(165)
166
fit to the committee. It is my hope that you will comment also on the
issues in monetary policy which the staff report called attention to
on Tuesday relating to the employment effects of moderating monetary growth; the Federal Eeserve's policy of accommodating and
validating transient and even self-reversing inflationary developments, monetizing deficits, and keeping order in money markets.
I also want to ask you to comment for the record, you gentlemen,
after you receive your transcripts, on the staff recommendations.
You may proceed by summarizing your testimonies, and if it is all
right with you gentlemen, the members only have 5 minutes each to
interrogate you and we usually have an understanding that each
member reserves the right to submit written questions to you, and that
the witnesses will reply when they examine their transcript for approval or correction.
Will that be satisfactory with you gentlemen ?
[A chorus of "yes, sirs."]
The CHAIRMAN. YOU may proceed by summarizing your testimony,
starting with President Francis and proceeding in alphabetical order
with President Mayo and then President Morris. All right, Mr. Francis, you are recognized.
STATEMENT OP DARRYL R. FRANCIS, PRESIDENT, FEDERAL
RESERVE BANK OF ST. LOUIS
Mr. FRANCIS. Mr. Chairman and members of the committee, it is
good to have this opportunity to meet with this committee and present
my views regarding our country's inflation and high interest rates
and the role of monetary policy in dealing with these and other
economic problems.
I have submitted to the committee a full statement of my views,
so what I present now is a brief summary of them.
The CHAIRMAN. With your approval, we will submit the whole
statement for the record.
Mr. FRANCIS. Thank you.
My position regarding the cause of current inflation and high
market interest rates is that they both stem from the same source—
an excessive trend rate of expansion of the Nation's money stock since
the early 1960's. Monetary policy, therefore, can contribute to solving
both of these problems over a period of a few years by fostering a
noninflationary rate of growth of the money supply.
My view is that growth of a concept called the monetary base is
a prime determinant of growth of the money stock. The major source
of growth in the base is changes in the volume of Federal Government
debt purchased by the Federal Reserve System on the open market.
The relationship between the narrowly defined money stock and the
monetary base is very close, and where differences occur the cause can
be clearly identified. Thus, control of the monetary base gives the system the ability to closely control the money stock.
In my opinion, the actions that led to the acceleration in growth of
the monetary base and money supply since the early 1960's occurred
as a result of three things:
First, excessive preoccupation with the prevailing level of market
interest rates;
167
Second, the occurrence of large deficits in the Federal Government
budget; and
Third, shifting emphasis of policy actions because of an apparent
shortrun tradeoff between inflation and unemployment.
Throughout most of the 1960's, and to some extent in the 1970's,
the conduct of open market transactions was influenced, in considerable
measure, by a desire to prevent unduly high market interest rates from
choking off growth of output and employment. The System purchased
Government securities in increasing quantities in an attempt to hold
interest rates at the then prevailing levels.
Past experience, in my opinion, indicates quite conclusively that the
Federal Reserve has little ability to control the level of market interest rates for any extended period of time. Experience also indicates,
for both this and other countries, that growth of total spending has
been retarded very little by high interest rates. On the other hand,
attempts to resist upward movements in market interest rates have
resulted in faster growth of money.
The Federal Reserve, at various times over the past 10 years, has
been concerned about dislocations in flows of funds to financial intermediaries and their customers. Attempts to maintain nominal interest
rates below their free-market level have resulted in accelerating money
growth, an acceleration in inflation, and still higher interest rates.
Another concern regarding market interest rates relates to the Federal Reserve's role in the orderly marketing of U.S. Government debt.
Since changes in interest rates traditionally have been viewed as interfering with the orderly process of marketing new issues, fluctuations
of market rates during the financing period have been limited by purchases of securities on the open market which in turn, add to the monetary base. Furthermore, System purchases of securities during such
periods were not fully offset by subsequent sales and, as a result, money
growth accelerated.
This process, in effect, has resulted in at least partial financing of
Government deficits through the creation of money rather than borrowing from the private sector. When the Federal Reserve buys outstanding securities from the public, a part of the Government debt is
ultimately being financed by the creation of new money. The ultimate
effect of this indirect debt monetization is manifested in an increase
in the price level—inflation—and higher interest rates after a substantial lag.
Since the early 1960's emphasis of monetary policy actions has, at
various times, shifted between reducing inflation and reducing the
unemployment rate.
On balance, the actions taken to achieve these shifting goals resulted in periods of rapid monetary growth which were longer than
those of slower growth, and the result was a rising average growth
rate of the money stock.
My analysis of the unemployment-inflation tradeoff leads me to
conclude that it is nonexistent, except possibly for very short intervals
of time. Therefore, with relatively stable monetary growth over a long
period, I believe it would be possible to have an essentially stable average level of prices, and this could be accomplished without accepting a
permanently higher unemployment rate. The desire to reduce the average level of unemployment should be approached through programs
180
-nwith this method of financing, I believe, that has contributed to
the process of inflation. Once the inflation has been generated,
a substantial period of time is required to reverse it, and unfortunately this can be accomplished only by incurring costs of
lost output and higher unemployment.
Thus, over short periods of time it has appeared that debt
monetization gives society something for nothing.
And although
this alternative may not have been chosen consciously and the
actions which monetized the debt may not have been taken for
that purpose, the excessive concern over market interest rates and
the occurrence of large Government deficits led to this course of action.
I can find no benefits accruing to the whole of society from,
debt monetization, but the risks are very serious and can be
expressed in one word - - inflation.
In the way that I have described
above, to a considerable extent since the mid - 1960's deficit spending
financed indirectly by Federal Reserve purchases of securities on
the open market has meant an increase in money which has exceeded
the growth in our output potential, and therefore has been inflationary.
Turning to another issue, it is my belief that shifting emphasis
of monetary actions because of a presumed trade-off between inflation and unemployment has contributed to the rapid monetary
expansion.
The idea of a trade-off between unemployment and in-
flation typically assumes that high rates of unemployment are
181
- 12 -
associated with low inflation, and low rates of unemployment
are associated with high rates of inflation.
This view has led
some analysts to argue that policy actions can assist the economy
in achieving an acceptable combination of unemployment and inflation.
However, experience indicates that the unemploymentinflation trade-off, if it exists at all, is purely a short-run
phenomenon.
Chart 4 demonstrates that there exists no long-run
relationship between the unemployment rate and the level of inflation.
The only striking features I find are that since 1952 the
yearly average unemployment rate has clustered around its
average (4. 9 percent) for the whole period, and the rate of inflation, regardless of the level of the unemployment rate, has
moved progressively higher since the mid- 1960's.
In the past, emphasis of monetary policy actions has, at
various times, shifted between reducing inflation and reducing
the unemployment rate.
For example, according to the published
policy Record, since the early-1960's (except 1966 and 1969) a
primary goal was lower unemployment, and expansionary monetary policies were adopted to achieve it.
In 1966 and 1969
emphasis was on achieving lower rates of inflation, and restrictive
monetary policies were accordingly adopted.
However, on balance
182
- 13-
the actions taken in the past decade resulted in periods of
rapid monetary growth which were longer than those of slower
growth, and the result was a rising average growth rate of the
money stock.
More recently the emphasis of the adopted
policies again has been to reduce inflation, but the actions
taken thus far have not resulted in a reduction in the average
growth rate of the money supply.
It is my view that there will always be some normal rate
of unemployment as new workers enter the labor market, as
relative demands and supplies for labor services change, and
as workers simply leave present jobs to find more rewarding
ones elsewhere.
Such a level is not necessarily desirable, but
rather it is a level determined by the normal functioning of our
product and labor markets, given existing institutional and social
conditions.
Monetary actions cannot influence this normal level of
unemployment; other policies are necessary to attack that problem.
As a matter of fact, monetary actions taken in an effort to reduce
unemployment have contributed to increased inflationary pressures.
Subsequent attempts to arrest inilation have temporarily
fostered increased unemployment in addition to the normal
amount consistent with existing Labor market Conditions.
183
- 14 -
My analysis of the unemployment-inflation trade-off
leads me to conclude that it is non-existent, except possibly
for very short intervals of time.
Therefore, with relatively
stable monetary growth over a long period, I believe it would
be possible to have an essentially stable average level of
prices, and this could be accomplished without accepting a
permanently higher unemployment rate.
The desire to reduce
the average level of unemployment should be approached through
programs which reduce or eliminate institutional rigidities and
barriers to entry in labor markets, which provide job training,
and which improve information regarding job availability.
In recent months a new proposal has been advanced
which, if adopted, would most likely lead to further acceleration in the rate of monetary expansion, thereby adding to
inflationary pressures.
It has been suggested that it is ap-
propriate for monetary and fiscal authorities to stimulate
aggregate demand during periods when domestic production
is curtailed by some special event, such as the oil boycott,
or when foreign demand for a specific product, like wheat,
increases suddenly.
The argument is that the resulting price
pressure from such non-recurring events is inevitable and
that an expansionary aggregate demand program is required
184
-15 to protect employment in the case of a decrease in domestic
production, and to protect consumer buying power in the case
of an increase in foreign demand.
Unfortunately, the probability
of achieving either of these goals with stimulative monetary
actions is very small and the costs in terms of accelerated inflation are certain.
The main point to keep in mind is that the forces
that
cause prices to rise in a specific market are very different from
those which cause inflation - a persistent rise in the average
price of all items traded in the economy.
The prices of indi-
vidual items rise and fall continuously, and an increase in a
particular price, even if it is the price of an important budget
item like food, is not necessarily an indication of general inflationary pressures.
In the absence of additional monetary
stimulus to aggregate demand, price increases in specific markets are a signal that either the demand or supply conditions, or
both, have changed; not that total demand for all goods and services has increased.
Such price increases serve a very useful
function of allocating scarce resources according to consumer
preferences.
An increase in foreign demand for American products
is not inflationary per se.
It represents a shift in the composition
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- 16 -
of demand for our output, but not an inflationary increase in
aggregate demand.
Inflation would occur if monetary actions
were taken in order to accommodate the price pressure in
individual commodity markets.
In the case of some unfore-
seen event, such as a domestic crop failure or an embargo on
imports of raw materials, the productive capacity of the
economy is reduced.
Most of the time the effect is temporary,
but, as in the case of the oil embargo, the effect can be longlasting.
There is little that: an increase in aggregate demand
can do to stimulate more production in such a situation.
In my opinion, a monetary policy which results in an
increased growth of the money stock has no role to play in accommodating the relative price effects of autonomous changes
in demand or supply in specific markets.
Such monetary
actions would only raise the overall rate of inflation.
Temp-
orary gains in output and employment might be achieved, but
the ultimate effect would be only on the rate of change of prices
in general.
I now turn to my final topic - the contribution that
monetary policy can make to reducing the rate of inflation and
lowering market interest rates.
My views on this topic should
by now be very obvious; monetary actions can, and must, make
186
- 17 a positive contribution.
The iiterests of the whole economy
would be best served if the trend growth rate of the money stock
were to be gradually, but persistently, reduced from the high
rates experienced in the recent past.
I believe that, once we
achieved and maintained a 2 to 3 percent rate of money growth,
both the rate of inflation and the level of interest rates would
ultimately decline to their levels of the early 1960's.
I believe such a policy of gradual, rather than abrupt,
reduction in the rate of monetary expansion from the high average
rate so far in the 1970's, would not have severely adverse effects
on the growth of output and employment.
Such a gradual policy
would probably mean, however, that the period of combatting
inflation and high interest rates would extend through the balance
of the 1970's.
Some analysts believe that_if_the Federal Reserve sought
to control the rate of growth of the money supply within a fairly
narrow range, unacceptable short-run fluctuations in short-term
interest rates would be generated.
I do not believe that it is
necessary for the Federal Reserve to intervene systematically
in financial markets in order to maintain orderly conditions.
It seems to me that there are three basic parts to this
argument regarding the desirability of actions to smooth short-run
187
- 18 interest rate fluctuations.
First, the argument assumes that
Federal Reserve actions in the past have in fact reduced shortrun fluctuations in short-term interest rates compared to what
-they otherwise would have been.
As far as I am aware, there
is no substantial body of empirical evidence supporting this
claim.
There is, however, a large and growing body of evidence
suggesting that highly organized financial markets by themselves
do not generate excessive and unwarranted short-run interest
rate fluctuations.
Second, this argument assumes that by stabilizing shortterm rates the System can, in the short-run, stabilize intermediate and long-term interest rates.
Again, I am not aware
of any empirical evidence in support of this proposition.
Third, this position assumes that short-run fluctuations
in interest rates have a significant impact on the ultimate goals
of stabilization policy - namely, price stability, a high level
of employment, and economic growth.
I know of no reason to
believe that moderating short-run fluctuations in short-term
interest rates has any significant stabilizing influence on prices,
output, or employment.
Even within the context of the well-
known econometric forecasting models, stabilization of short-term
36-714 O - 74 - 13
188
-19interest rates has almost no stabilizing influence on prices,
output, or employment.
Some would oppose my recommended course of monetary
policy on the grounds that it would not allow the Federal Reserve
to perform its responsibility of a lender of last resort; so I want
to make my views clear on this point. I believe it is possible
that the failure of a major bank or other corporation can, at
times, disrupt the smooth functioning of our financial markets.
In my opinion, the Federal Reserve has an obligation to prevent
the temporary problems of a major institution from affecting
financial markets and perhaps even affecting the economy.
At the same time, however, I do not think that the System
should subsidize inefficient management by making funds available at interest rates well below market rates, or be concerned
about the losses that stockholders of a basically unsound institution might saffer.
In the long-run, such actions can only
weaken, rather than strengthen, the financial system, as well
as the business community at large.
Any temporary assistance to a basically sound institution
should be unwound in a relatively short period of time. At the
same time, the provision of funds through the Federal Reserve
discount window should be matched by a sale of securities from
189
- 20 the System's portfolio in order to prevent an expansion in the
monetary base and the money stock.
Carrying out the monetary policy actions that I recommend could be greatly facilitated by complimentary actions on
the part of others. A balanced Government budget would eliminate much of the pressure on interest rates, thereby removing
one cause of accelerating money growth in the past.
Legislation
removing impediments to the free functioning of our product,
labor, and financial markets would allow these markets to adjust
to monetary restraint more rapidly, and without the severe dislocations of the past.
It would also be helpful if all segments of our society
would realize that rapid monetary growth, inflation, and high
market interest rates go hand-in-hand; that, once initiated, inflation cannot be eliminated without some temporary costs in
terms of slower growth of output and employment; and that
considerable time will be required to reduce substantially both
the rate of inflation and the level of interest rates.
Such realiz-
ations would tend to mitigate the short-run pressures that in the
past have resulted in postponements of efforts to curb inflation.
Darryl R. Francis
190
19S2
958=100
1953 1954
1955
|
110 General Price Index
Seasonally Adjusted
RATIO SCAIE OF YIELDS
j
|
[
Corporate Aaa Bonds
1952 1953 1954 1955 1956 1957 195S 1959 1960 1961 1962 1963 1964 1965 1966 1967 196S 1969 1970 1971 1972 1973 1974
Shaded area represents Phases I and II of the price-wage control progra
lowest data plotted: GPl-ist quarter,- Others-2nd quarter estimated
191
Chart 2
Influence of Federal Government Debt on Monetary Expansion
1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974
irVi/-'V.V
'
— '
'
1
1
1
1
Federal Government Debt*
1
1
1
1
1
—I
1
1
1
/VMMSJ,.
I
1
1
1
r
'Federal Government Debt istotalgrots public debt less debt held by
.S. Government agencies and trust funds. The o.iginol data may be found "
ble entitled "Ownership of Public Debt
in the Federal Reserve Bulletin
Federal Government Debt
Held by the Federal Reserve System
14 Percent of Federal Government Debt
Held by the Federal Reserve System
RATIO
BILLIONS OF DOLLARS
Monetary Base
Seosonolly Adjusted
1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974
Shaded areas represent periods of business recessions as defined by the Notional Bureau ol Economic Research.
Latest d a t a plotted: Monetary Base ond Money Slock. 2nd quarter estimated; Orherslst quarter
1
192
Chart 3
Growth of Government Debt and Money
Billions of Dollars
55
Billions of Dollars
55
1
| CHANGE IN DEBT HELD BY THE FEDERAL RESERVE SYSTEM
CHANGE IN DEBT HELD BY THE PUBLIC
CHANGE IN MONETARY BASE
m CHANGE IN MONEY STOCK
I/53-IV/56
I/57-1Y/60
I/6MV/64
I/65-IV/68
I/69-IV/72
-5
Note: The debt held by the Federal Reserve System plus debt held by the domestic public and
foreigners is net government debt, which is equal to total gross public debt minus debt
held by Government agencies and trusts. The monetary base is net monetary liabilities of
the Government. The money stock (M]} is defined as demand deposits plus currency held
by the public. Each of the five groups of bars depict level changes from the beginning to
the end of the period indicated. All data are seasonally adjusted.
Prepared by Federal Reserve Bank of St. Louis
193
Chart 4
Consumer Prices
Percent
Prices and Unemployment
1953-1973
(Annual Data)
Consumer Prices
Percent
A V E R A G E 4.9%
!
1973
197C
1969 •
1971 •
1968 •
1957
•
1}
•197:
1967*
1966
• 1 >58
# 1965
1960
•
194 4 » 1963
1962*
1956 •
j
1953*
19 61
1959
• 195.
l
i
1955
!
3
4
5
Unemployment Rate
6
7
ii
Source-. U.S. Department of Labor
Prepared by Federal Reserve Bank of St. Louis
194
The CHAIRMAN. Thank you, President Francis.
We will next have Robert P. Mayo of the Chicago bank. Mr. Mayo,
you are recognized, sir.
STATEMENT OF ROBERT P. MAYO, PRESIDENT, FEDERAL
RESERVE BANE OF CHICAGO
Mr. MAYO. Thank you, Mr. Chairman, members of the committee.
I am pleased to be with you today to do whatever I can to help in
this important inquiry into the problem of inflation and its effects on
our economy and alternative cures. I think you will find as you listen
to my testimony today, ladies and gentlemen, that I take a slightly
different approach to the problems of monetary policy than my associate, who has just spoken. I respect his judgment very much and I
consider it carefully, even though I must say in my own deliberations
I come to somewhat different policy prescriptions. Yet I must add in
the same sentence that his and my prescriptions are both within identical broad economic goals, and we share those fully. Each of us making
his monetary policy recommendations within the Open Market Committee must, of course, in all candor, use his own experiences, his own
observations of the world, his own framework for sorting things out,
for organizing these observations and doing his own weighing of the
information available. That is what we are supposed to do in carrying
out these responsibilities.
These differences in approach are appropriate and useful to monetary policy formulations. No individual that I know of has perfect
knowledge and foresight. I certainly do not. There are no perfect,
unchanging relationships among either the real or the financial variables of our economy. There are no mechanistic certainties in the responses of our economy to meet our monetary policy actions. There are
only indicators, and I think we all have to keep that in mind.
These differences, ladies and gentlemen, are fully examined in the
uninhibited forum of the Open Market Committee. They interact and
they add to each other and they modify each other, and they form, in
my opinion, a more complete fabric for policy construction than any
individual could possibly produce singlehandedly. That is the beauty
to me, and the strength, of the open market system.
Indeed, it is the strength, in my opinion, of the whole Federal Reserve System—an institutional wisdom that Congress has created and
has strengthened over the years.
We have learned much in recent years about the consequences of our
actions, but we still have even more to learn as we face the challenge
of an even more complex domestic and international economy. We just
do not know all of the answers, particularly when the questions keep
changing.
I might just say that the role of finance in my mind is to grease the
wheels of production, distribution, and consumption—to make those
wheels more efficient. Finance—not just monetary policy, but finance
as a whole—is therefore a means to an end, not to an end in itself, and
that is why I put so much weight on the analysis of the production,
distribution, and consumption functions in our economy as I look at
the problems of monetary policy.
195
I think we all agree that inflation and its effects on interest rates, on
asset values, on real incomes and on the general welfare of our citizens
are serious indeed, particularly today.
Those of us in the Fed share with the Congress and the administration the desire and the responsibility for achieving our national goals
of high employment, relatively stable prices, sound economic growth,
and a reasonable balance in our international payments.
I think it is crystal clear that the Fed is not only fully aware of the
dangers and costs of continuing inflation, but is making what I think
is every reasonable effort to resist and contain the current rising trend
in the general price level. The public is fed up with inflation; that is
perhaps one thing that all of us in this room can agree on today. The
public has finally decided that price rises have gone beyond a tolerable
level. They are willing, I think, to support effective efforts to control
inflation, recognizing that there are substantial costs involved in so
doing.
The current inflation has developed over a long time. It is worldwide, not just a U.S. phenomenon. As leaders of the free world, we
cannot take too much satisfaction in that since we are sharing a disease, if you please, that is worldwide. We have some inflation control
responsibilities that extend far beyond our own borders.
But for all of us—whether we be German, Italian, British, Japanese,
or Americans—it will take time, determination, and patience to resolve
these problems.
As we choose the course to follow in combating inflation wisely, we
must keep in mind that the U.S. economy responds only gradually over
time to the majority of the actions that we take. There is no such thing
as instant policy in the monetary field, and indeed, its lag is variable
and is not precisely predictable.
No one will deny that inflation is directly concerned with the relationship between the quantity of goods and the quantity of money.
That relationship, in turn, has many facets. The great perspective of
20-20 hindsight tells me, for instance, that the growth of the money
supplied during 1972 and the first part of 1973 was somewhat higher
than many of us wished in view of the way the underlying economic
situation turned out, and thus added in some degree to inflationary
pressures.
I say this candidly, even though a review of the decisions in the
perspective of the environment at the time that those decisions were
made, suggest to me no substantive disagreement with each decision
that we made. We can always do our quarterbacking a little better
on Monday morning. But even more importantly, I cannot ignore
the fact that many other factors outside of the influence of the Federal Eeserve played a very important role in the unprecedented inflation of 1973 and 1974. Those factors include the coincident strong expansion of all of the industrialized nations of the world, crop failures
abroad, successive devaluations of the dollar, and the termination of
wage-price program, which was necessary, at least in its early stages,
to help mitigate the effects of our deficit-riddled fiscal policy of 1967
and 1968.
All of these events together produced 1973 export demand far exceeding expectations, and added price pressures to a domestic economy
already operating at full capacity. Then, of course, the oil embargo
and oil price increase added to the problem.
196
In addition to these special factors, hopefully, each of them nonrecurring, fiscal policy did become too expansionary in 1971 and 1972
as the Federal Government worried more about large potential increases in unemployment, which did not develop, than about large
increases in inflation, which did.
The Federal Reserve has an independent charge from the Congress
to act as a prudent manager of monetary policy. But the Fed is also
charged with the responsibility for maintaining an effective, viable
financial system for the reasons I indicated in my introduction, not
just fighting inflation blindly, regardless of what the consequences
might be. When the administration recommends and Congress authorizes expenditures far in excess of revenues, the Treasury has no alternative but to issue more securities to pay for its spending. The Federal
Reserve, of course, has the responsibility to see that each Treasury
issue is reasonably priced, and that the Treasury is successful in the
acquisition of the necessary funds to finance the U.S. Government.
The net result of assisting deficit financing in an economy which is
already generating sufficient momentum to achieve very high employment levels, is, of course, inflationary. The Congress has not, of course,
intentionally placed this burden on the Treasury or the Fed. It is a
residual burden, even though it is a heavy one. Rather, my experience
as a Treasury debt management official for many years, as Director of
the Bureau of the Budget in 1969 and 1970, and then as a Federal
Reserve bank president, indicates to me that this situation arises from
a fundamental flaw in governmental coordination of economic policy
and public finance up until the present time.
I testified a year ago in my own behalf, not for the Fed, before the
congressional budget reform committee as a strong proponent of the
proposal that, in effect, the Congress has now enacted to have a Joint
Committee on the Budget fully staffed to provide the Congress with an
independent view of the whole budgetary picture.
I think it will work. I certainly hope it will. Again, we are all human
beings and work in an institutional environment that does not work
perfectly. But, I think it will work well enough to make a positive
contribution to control the fiscal policy actions by the Congress.
Let me turn then just for a moment to the question which is a very
important one. Where we have the economy operating close to full
capacity, monetary growth in excess of the growth of the capacity to
produce goods and services, obviously, tends to sustain general price
inflation and will result in higher interest rates, as ongoing rates of
inflation are built into those rates.
In such a situation we must ask why the rate of inflation and interest
rates cannot be decreased simply by reducing the rate of monetary
growth. I think the answer lies, ladies and gentlemen, in the fact that
we as a nation have more than one economic goal. In addition to our
desire and need to reduce the rate of increase in the general price level,
we must consider the effects of any contemplated restrictive actions
on unemployment and on overall economic growth. We must be cognizant of the sectoral ramifications of various degrees of constraint—
the housing sector being the most obvious example today, as it was in
1966 and 1969. Nor can we neglect the needs of small businesses and
local governments. Finally, we must always remember that our actions
do not have their principal effects today, but some months hence, and
197
we do not even know precisely how many months hence; they are
diluted; they vary.
We cannot expect immediate price restraint from restrictive actions,
but we also must take great care we do not overstay our welcome and
precipitate a serious economic downturn.
I do not think we are overstaying our welcome today. The tradeoff relationship that exists between the rate of general price increase
and the rate of unemployment is unstable, and is therefore, in my
opinion, of limited usefulness as a guiding principle of economic
policy. Nevertheless, we cannot ignore this relationship as we assess
the alternatives open to us at any time. A restrictive monetary policy
can result in increased unemployment far more quickly than it can
result in decreased inflation. We know that the expectations of consumers, businessmen, Government officials, and financial market participants play a critical role in a situation of persistent inflation. Tnese
expectations are affected primarily by performance, not by promises,
and even then very slowly.
A reduction in the rate of inflation and in price level expectations
will eventually produce a decline in interest rates. This result will
ocscur only after an appreciable delay. When economic activity is
stimulated to a point where output in dollars exceeds real capacity
output, the initial response of interest rates to the adoption of a restrictive monetary policy is increased, not decreased interest rate.
Given our reliance on general fiscal monetary restraint, declining
interest rates will occur only after aggregate demand is reduced, thus
reducing demands for money and credit.
As prices respond, the rate of inflation will then subside and expectations of inflation will be reduced. It is only then, not before, that
the inflation premium built into interest rates today will be eroded.
We have seen a good example of the shorter-run relationship between restraint and monetary growth and interest rates during the
past 6 months.
During this period the U.S. economy suffered from inflation stemming from one, past fiscal and monetary stimulus, two, relaxation, and
then termination of a wage-price control program that, in my opinion,
had overstayed its welcome and its usefulness, three, the effect of
shortages in energy and agricultural products, and four, international developments.
When it became clear to everyone that the Fed was indeed moving
further to restrain these inflationary forces, interest rates, as you
also well know, increased rapidly. Demands for money and credit far
exceeded expectations which reflected in part the sharper than anticipated rate of general price increases. We were all disappointed
in this.
I must add, Mr. Chairman, that everything else being equal, I share
the feeling that is common in this country, that we are better off when
interest rates are low than when they are high. But we cannot always
afford that luxury of low rates. We get closer to it than most countries of the world. We, again, cannot do it as perfectly as we would
like because of our other economic goals.
Market interest rates have increased so far and so fast this year
in response to our efforts to restrict availability of funds to banks
that new questions have arisen in the minds of many people about
198
the operation of our Nation's financial markets. The economy has
been subjected to a highly unusual shock by the arbitrary and very
sudden increase in petroleum prices. Underwriting these price increases fully by monetary expansion is, as my predecessor in the testimony this morning indicated, self-defeating if the monetary expansion simply results in further price increases.
I think there is a little more to it than that. Increases in energy
prices of the magnitude we have witnessed require reallocation of
real consumer and business spending throughout our economy. Spending patterns will either shift toward more dollars spent on energy at
the expense of other things, or there will be a reduction in energy use,
or some combination of the two will occur. In the textbook economy
that adjusts instantaneously to rapid and large changes in relative
prices, such a reorientation could take place without undue strain. The
economy of this country does not adapt that quickly to changes of such
magnitude. Thus, insistence that increases in energy prices be treated
as relative price changes that should not be permitted to increase the
general price level at all runs, in my opinion, the serious risk of precipitating an economic downturn. It seems preferable to me, then,
ladies and gentlemen, to permit a portion, but as little as is reasonable,
of these nonrecurring price increases to be reflected in increases in the
general price level in order to provide additional time for adjustment
to what is really a new environment. On both of these grounds, then,
minimizing financial market adjustment problems and adapting carefully to the sudden change in energy prices, and, if you wish, the aftermath of the 1973 upsurge in agricultural prices as well, I believe monetary aggregate growth in recent months modestly in excess of what
might be considered "normal" guidelines is entirely appropriate.
Under these circumstances, an overly protective or timid appraisal of
the ability of financial markets to withstand strain, or an excessive
accommodation of highly unusual price increases, would have the effect
of worsening inflation. Throughout our discussion, we must bear in
mind that the sharp increases we have seen in key prices are only
beginning to appear in their secondary effects on prices of other
products, and in wa^es.
Our own analysis of economic developments during the second
quarter of 1974 indicates we have passed through the critical period
of serious petroleum shortage reasonably well, all things considered.
Unemployment did not increase significantly and our economic decline
seems to have leveled off. Yet we are just now facing what in many
ways is the more serious phase of our problem. Inflation continues
and will accelerate in some areas in response to earlier price increases
in key commodities. Financial markets remain unsettled. Uncertainty
is still a major factor.
While the current situation may seem to present only limited
grounds for optimism, I am inherently an incurable optimist and I
believe that we now have the opportunity to reduce our inflationary
problems without imposing unacceptable high social costs and human
misery and foregone output. The downturn in the first auarter was not
accompanied by a large increase in unemployment. Pressure to be
fiscally expansive in order to reduce unemployment has not been
strong. There is some promise of relief from price pressures in the
agricultural area in the coming months.
199
We probably will have our best crops in history, even though the
weather has perhaps lessened some of those estimates a bit. Petroleum
products are at least available once again, even though prices are
Finally, viewed against the background of recent price performance,
monetary policy has already set in place strong restraining forces that
will act as a brake on inflation and on interest rates in the months
[Testimony resumes on p. 209.]
[Mr. Mayo's prepared statement follows:]
200
Statement by Mr. Robert P. Mayo, President,
Federal Reserve Bank of Chicago
to the Committee on Banking and Currency,
U. S. House of Representatives, Washington, D. C ,
July 18, 1974
I am pleased to have the opportunity to meet with you today to
do whatever I can to assist your Committee's inquiry into the problem
of inflation in our national economy.
We all agree that inflation and
its attendant effects on interest rates, asset values, real incomes, and
the general welfare of our citizens are Indeed serious.
Those of us in
the Federal Reserve System share with the Congress and the Administration
the desire and the responsibility to achieve our national goals of high
employment, relatively stable prices, sound economic growth, and a reasonable balance in international payments.
1 think it is crystal clear that
the Federal Reserve System is not only fully aware of the dangers and
costs of continuing inflation, but is making every reasonable effort to
resist and contain the current rising trend in the general price level.
In our present unusual economic environment, this is not an easy
task.
But the task would be even more difficult if the Federal Reserve
System, as the manager of the nation's monetary system, did not possess a
strong regional orientation and structure.
Since I assumed my position as
President of the Federal Reserve Bank of Chicago almost four years ago, I
have found the economic input from the members of my Board of Directors
most helpful as I have attempted to evaluate policy alternatives in an
environment in which our national economic intelligence—even though the
best in the world—is still inadequate.
The existence of this strong
regional structure, in my view, permits the Federal Reserve to be more
flexible and responsive to a rapidly-changing economic environment that
201
is only reflected in more formalized data with a significant time lag.
I can also report to you that the degree of public support in the
Seventh Federal Reserve District for current Federal Reserve monetary
policies is very strong, judging by the comments I have received wherever
I go.
The encouragement for continued monetary restraint comes not only
from the banks but also from institutions and individuals whose own financial
condition often has been and will continue to be adversely affected by continued market pressures.
The public is fed up with inflation.
They have
finally decided that price rises have gone beyond the tolerable level.
They
are willing, I believe, to support effective efforts to control inflation—
recognizing that there will be substantial costs involved in so doing.
I am gratified by this support.
Without it we might become less
confident in our resolution to accomplish the difficult task that lies
ahead.
Yet we must always remember that excessive zeal in combatting in-
flation could lead to even more serious economic difficulties than those
that now confront us.
The current inflation has developed over a lonp time.
It is worldwide—not just a U. S. phenomenon.
But as leaders of the free
world we have inflation control responsibilities that extend far beyond our
own borders.
It will take time, determination, and patience to resolve
these problems.
As we choose the course to follow in combatting inflation wisely,
we must keep two important factors in mind—the sequence of events that
has led us to our current situation and, exactly where we stand at this
juncture.
A brief review of the past provides us with a better understanding
of earlier misjudgments that should be avoided ,in future actions.
Knowledge
of the current situation is essential because the U. S. economy responds
only gradually over time to the majority of forces leading to change.
202
Therefore, we must take into account forces already set in motion that
are not as yet evident.
There is no such thing as instant monetary policy.
Its lag is variable and not precisely predictable.
No one will deny that inflation is concerned with the relationship
between the quantity of goods and the quantity of money.
ship in turn has many facets.
But that relation-
The great perspective of 2020 hindsight
tells me that, the growth of the money supply during 1972 and the first
part of 1973 was somewhat higher than many of us wished in view of the
way the underlying economic situation turned out, thus adding to some degree
to inflationary pressures.
But even more importantly, we cannot Ignore the fact that many
other factors outside the influence of the Federal Reserve played a very
important role in the unprecedented inflation of 1973-74,
Those factors
include the coincident strong expansion of all of the industrialized
nations of the world, crop failures abroad, successive devaluations of the
dollar,- and the termination of the wage-price control program which was
necessary, at least in its early stages, to help mitigate the effects of
our deficit-riddled fiscal policy of 1967 and 1968.
All of these events
together produced 1973 export demand far exceeding expectations, and added
price pressures to a domestic economy already operating at full capacity
or beyond.
Finally, of course, the oil embargo was an obvious unanticipated
shock, and the substantial price impact domestically was equally unnerving.
In addition to these special factors, hopefully non-recurring—
fiscal policy, in terms of budget deficits, became too expansionary in
1971 and 1972 as the federal government worried more about large potential
increases in unemployment (which did not develop) than about large increases
in inflation (which did). The Federal Reserve has an independent charge
from the Congress to act as a prudent manager of monetary policy.
But the
203
Fed is also charged with responsibility for maintaining an effective, viable
financial system—not just fighting inflation blindly regardless of the consequences.
When the Administration recommends—and the Congress authorizes—
expenditures far in excess of revenues , the Treasury has no alternative
but to issue more securities to pay for its spending.
The Federal Reserve
has, of course, a responsibility to see that the Treasury is successful in
acquiring the necessary funds without significant distortion and disruption
in financial markets.
When excess capacity exists in the economy, and the money and
capital markets are quiet, the Treasury can handle deficit financing and
refund maturing issues fairly easily.
But, as the economy approaches
capacity output and the deficits persist because of fiscal policy lags, the
Treasury must compete with other market participants for increasingly scarce
financial resources.
Under these circumstances, continued large Treasury
financings, particularly with an ever shortening debt maturity structure,
can have significant impacts on market interest rates.
In order to avoid
serious disruptions in private capital markets, then, the Federal Reserve
is under pressure to allow more rapid increases in monetary aggregates than
would be the case in the absence of debt management pressures.
The net
result of assisting deficit financing in an economy which has already
generated sufficient momentum to achieve very high employment levels is,
of course, inflation.
The Congress has not, of course, intentionally placed this burden
on the Treasury and the Federal Reserve.
a heavy one.
It is a residual burden—albeit
Rather, my experience as a Treasury debt management official,
as Director of the Bureau of the Budget, and as a Federal Reserve Bank
president, indicates to me that this situation arises from a fundamental
flaw in governmental coordination of economic policy and public finance
36-714 O - 74 - 14
204
up until the present time.
There is great need for a system to review all
of the authorizations of the Congress and their spending implications in
totality, taking into account the impacts of these actions not only in
specific areas but also on financial markets and the growth of economic
activity in general.
I testified a year ago before the Congressional budget reform
committee as a strong proponent of the proposal that the Congress establish
a Joint Committee on the Budget to provide the Congress with an independent
view of the whole budgetary picture, and with an analytical staff capability of its own to lessen its factual dependence on the Executive Branch.
I am most enthusiastic about your recent approval of such overall fiscal
control.
The cynics say it won't work because of the deep-seated jealoui es
of Congressional committees.
I disagree.
It can work and I believe Con-
gressional leaders will see to it that it does.
I now turn my attention to a few key issues in our current environment.
We know that once the economy is operating close to full capacity,
monetary growth in excess of the growth of the capacity to produce goods
and services will sustain general price Inflation and will result In higher
interest rates as ongoing rates of Inflation are built into those rates.
In
such a situation, we must ask why the rate of inflation, and Interest rates,
cannot be decreased simply by reducing the rate of monetary growth.
The answer lies in the fact that, as a nation, we have more than
one economic goal.
In addition to our desire and need to reduce the rate
of increase of the general price level, we must consider the effects of any
contemplated restrictive actions on unemployment and on overall economic
growth.
And, we must be cognizant of the sectoral ramifications of various
degrees of constraint—the housing sector being the most obvious example
currently, as it was in 1966 and 1969.
Nor can we neglect the needs of
205
small businesses and our local governments.
Finally, we must always remind
ourselves that any actions we do take will have their principal effects not
today, but some months hence.
from restrictive actions.
We should not expect immediate price restraint
We also must take great care that we do not over-
stay whatever restriction is adopted and precipitate a serious economic
downturn.
The problem is made even more difficult by the limited ability
to forecast future economic developments.
The tradeoff relationship that exists between the rate of general
price increase and the rate of unemployment is unstable and is therefore
of limited usefulness as a guiding principle of economic policy.
Nevertheless,
the relationship cannot be ignored as we assess the alternatives open to us
at any time.
A restrictive monetary policy can result in increased unemploy-
ment far more quickly than it can result in decreased inflation.
And we know
that the expectations of consumers, businessmen, government officials, and
financial market participants play a critical role in a situation of persistent inflation.
These expectations are affected primarily by performance—
not by promises—and even then very slowly.
We must move cautiously yet
firmly with our restrictive actions and be prepared to adhere to those
policies long enough for the effects to be felt.
A reduction in the rate of inflation—and in price level expectations—
will eventually produce a decline in interest rates.
occur only after an appreciable lag.
But this result will
When economic activity is stimulated
to a point where the rate of output in dollars exceeds real capacity output,
the initial response of interest rates to the adoption of a restrictive,
monetary policy will be increased rather than decreased interest rates.
This is true because real money balances tend to be reduced below desired
levels within our existing income and price structure.
Given our reliance
on general monetary and fiscal restraint, declining interest rates will occur
206
only after aggregate demand is reduced, thereby reducing demands for money
and credit. As prices respond, the rate of inflation will then subside and
expectations of inflation will be reduced. It is only then that the inflation
premium in interest rates will be eroded—not before.
We have seen a good example of the shorter-run relationship between
restraint in monetary growth and market interest rates during the past six
months or so. During this period, the U. S. economy suffered from inflation stemming from (1) past fiscal and monetary stimulus, (2) relaxation—
and then termination—of a wage-price control program that had overstayed
its welcome and its usefulness, (3) the effects of shortages in energy and
agricultural products, and (4) international developments. When it became
clear that the Federal Reserve was moving further to restrain these inflationary forces, interest rates, as you all know so well, Increased
rapidly. Demands for money and credit far exceeded expectations which
reflected in part the sharper than anticipated rate of general price
increases.
Market interest rates have increased so far and so fast this year
in response to our efforts to restrict availability of funds to banks that
new questions have arisen about the operations of our nation's financial
markets. The economy has been subjected to a highly unusual shock by
the arbitrary and very sudden increases in petroleum prices. Underwriting
these price increases fully by monetary expansion is, of course, self-defeating if the monetary expansion simply results in further price increases. But
there is much more to it than that.
Increases in energy prices of the magnitude we have witnessed require
reallocation of real consumer and business spending throughout our economy.
Spending patterns will either shift toward more dollars spent on enerpy,
away from other areas or there will be a reduction of energy use—or some
combination of the two will occur. In a textbook economy that adjusts
207
8
instantaneously to rapid and large changes in relative prices, such a reorientation could take place without undue strain.
But the economy of this
country does not adapt that quickly to changes of such magnitude.
Thus, in-
sistence that increases in energy prices be treated as relative price changes
that should not be permitted to increase the general price level at all
runs the serious risk of an economic downturn.
It seems preferable to me to
permit a portion (but as little as is reasonable) of these non-recurring
price increases to be reflected in increases in the general price level in
order to provide additional time for adjustment to the new environment.
On
both of these grounds—minimizing financial market adjustment problems and
adapting carefully to the sudden changes in energy prices—and the aftermath
of the 1973 upsurge in agricultural prices as w e l l — I believe monetary
aggregate growth modestly in excess of what might be considered "normal"
guidelines in recent months is appropriate.
We are sailing on uncharted seas.
Our 1974 economic environment is
a new experience in terms of supply constraints.
Reliance on past patterns and
relationships as a guide to policy making and policy execution has been less
than adequate.
Therefore, we are still operating in a highly unpredictable
environment, one in which the broad outlines of an unfolding situation are
only now becoming a little clearer.
Here again I am thankful for the role
that our regional Federal Reserve bank board of directors play in helping
us clear away some of the clouds of uncertainty.
Under these circumstances, an overly protective or timid appraisal
of the ability of financial markets to withstand strain, or an excessive
accommodation of highly unusual price increases, would have the effect of
worsening inflation.
And, throughout our discussion, we must bear in mind
that the sharp increases we have seen in key prices are only beginning to
appear in their secondary effects on prices of other products—and in wages.
208
We do not have the ability to perform miracles.
wands to wave.
We have no magic
Our own analysis of economic developments during the second
quarter of 1974 indicates that we have passed through the_critical period of
serious petroleum shortage reasonably well, all things considered.
Unem-
ployment did not increase significantly and our economic decline seems to
have leveled off.
Yet we are just now facing what in many ways is the more
serious phase of the problem.
Inflation continues and will'accelerate in
many areas in response to earlier price increases in key commodities.
kets remain unsettled.
Mar-
Uncertainty is still a major factor.
While the current situation may seem to present only limited grounds
for optimism, I believe we now have the opportunity to reduce our inflationary
problem without imposing unacceptably high social costs in human misery and
foregone output.
The downturn in the first quarter was not accompanied by a
large increase in unemployment, and pressure to be fiscally expansive in
order to reduce unemployment has not been strong.
There is some promise of
relief from price pressures in the agricultural area in the coming months.
Petroleum products are at least available once again even though prices are
high.
Finally, viewed against the background of recent price performance,
monetary policy has already set in place restraining forces that will act
as a brake on inflation and interest rates over the months ahead.
In conclusion, I want to remind all of us that we as a nation cannot
reasonably expect to eradicate inflation during the next two or three years.
If our policies are successful, they will be successful only in reducing
the rate of inflation gradually.
Nor should we as a nation ask monetary
policy to carry the entire burden of inflation control.
The social costs
and adverse sectoral impacts of relying on a single general type of policy
are simply excessive.
It is absolutely essential that both specific and
general fiscal policy measures be coordinated with monetary policy during
the coming period if we are to truly dampen inflation.
209
The CHAIRMAN. Thank you, sir, and we now have Mr. Morris of the
Boston bank, and Mr. Morris, if you will please summarize your statement by emphasizing your principal points, it will give the member?
more time to ask you questions, and very likely, all the more will be
brought out that way.
STATEMENT OF PRANK E. MORRIS, PRESIDENT, FEDERAL
RESERVE BANK OF BOSTON
Mr. MORRIS. My prepared statement is quite brief, Mr. Chairman,
but I will try to shorten it.
I welcome the opportunity to testify before this committee. In your
letter, Mr. Chairman, inviting me to testify, six specific issues were
raised. I think it is best to approach these issues by placing them in a
broad framework emphasizing two things. First, that policy must always be judged in the light of the information available at the time the
decisions were made. Second, that we in the Federal Reserve have
learned a great deal from the events of the past decade and we are determined to benefit from this knowledge.
With these two things in mind, I would like to first talk about the
problems of the Federal Reserve's basic longrun policy, and second, to
talk about the day-to-day problems of implementing policy.
In evaluating the Federal Reserve performance, the central question
must be whether the trend rate of growth of the money supply, over
which the Federal Reserve has reasonably effective control, was properly given reasonable forecasts of the money-to-GNP relationship,
which the Federal Reserve does not control. Evaluation of past policy
must proceed in the light of the information on the economic relationships available at the time the decisions were made.
Following the experience of late 1968, when monetary policy was
clearly too expansionary, the Federal Reserve moved to reconsider its
policy procedures. In early 1969, Chairman Martin appointed a subcommittee of the Open Market Committee, of which I was a member.
The subcommittee recommended that the FOMC place greater emphasis on the growth of monetary aggregates and less emphasis on interest rates in future policy terminations.
Beginning in January of 1970, this recommendation was implemented in a clause in the directive defining basic monetary policy in
terms of monetary growth targets.
This 1970 shift in the way policy is formulated will, I think, appear
in the historical accounts of economic policy as a milestone of importance comparable to the Treasury-Federal Reserve Accord of 1951.
The form of the directive we are now using reflects the Federal Reserve acceptance of the proposition that, other things being equal,
significant and sustained changes in money growth produce significant
changes in the course of the economy.
This important proposition, however, simply alters the starting
point for our analysis. Because other things are not constant, the relationship between money growth and GNT growth is not constant.
I have in my prepared text an illustration of the policy problem of
1972 and 1973, pointing out that in those years the velocity of circulation of money, which had been increasing prior to this time at about 1
percent a year, jumped to 4 percent a year, and as a consequence, we
210
had a bigger growth in money GNP in the years 1972 and 1973 than
our earlier relationships would have forecast on the basis of the rate
of growth in the money supply.
Unfortunately, this extra growth in GNP was reflected to a large
extent in a higher rate of inflation than could have been anticipated
on the basis of earlier relationships. Obviously, if we had known that
GNP would grow by 11 percent in these 2 years, we would have
planned for a less rapid monetary expansion. A GNP growth rate
in the neighborhood of 8 percent would have been better than 11 percent. However, if we look at the problem from the vantage point of
1971, suppose we had held money growth to 4 percent and suppose
velocity, instead of growing at 4 percent a year, had grown at 1 percent a year—then GNP would have grown at an annual rate of 5
percent instead of the 8 percent we were shooting for. In that event,
the central topic of this meeting would be how to deal with unemployment rather than how to deal with inflation.
My views on the appropriate stance of policy have been affected
by this experience. Advocates of discretionary policy—and I am one
oi those—have always recognized that policy should become neutral
once the economy has reached the neighborhood of full employment,
unless it is possible to identify a clear disturbance that ought to be
offset. I am now of the view that the neighborhood around full employment calling for a neutral policy is wider than I had previously
thought, and I am less optimistic than I used to be in a world which is
growing increasingly interdependent, that policymakers can always
identify and offset disturbances.
If this view is correct, it means that all of us must be more patient.
We must be willing to ride out surprises in the expectation that most
such surprises are self-correcting. There is nothing that monetary
policy can do to offset the inflationary effects of a worldwide food
shortage or oil embargoes; in terms of general monetary and fiscal
policy, we must be patient and wait for increased food and oil production to level off or to reverse these price disturbances.
There is clear evidence, I think, that in the long run, a lower trend
rate of money growth will be needed if the rate of inflation and the
level of interest rates are to be reduced. It would not be wise, however,
to think about this problem in terms of setting now a schedule for
reducing money growth over the next few years.
We certainly should seize any opportunities to move more quickly
than any schedule might suggest, but we must be aware of the possibility that we will be forced to move more slowly should unemployment climb higher than expected.
The only clear guideline we have at the moment is that we should
be very careful not to permit the trend rate of growth in money to
rise significantly above the growth rates of recent years. We should be
completely honest about the possibility that the American people may
have to grit their teeth and endure a period of moderate unemployment. If every small increase in unemployment is met by demands for
accelerated money growth while declines in unemployment are not
met by reduced growth, then inflation is certain to accelerate in the
long run.
In pursuing a longrun policy to reduce inflation, it would be extremely helpful if continuous fiscal restraint could be maintained. By
21.1
reducing the upward pressures on interest rates caused by the Federal
deficit financing, it would be possible to maintain a policy of moderate
monetary expansion while at the same time making clear progress
toward the goal of lower interest rates.
One of the lessons of the past decade, it seems to me, is that the
American public is not going to be satisfied with the Government's
stabilization program until such time as we can develop a better mix
of fiscal and monetary policy.
Looking over the past 10 years I find only one period—late 1968
through 1969—during which fiscal policy could be described as substantially restrictive. During the rest of the 10-year period fiscal
policy ranged from neutral to strongly stimulative, and the aggregate
Federal budget deficit for the period amounted to substantially more
than $100 billion.
Beginning in 1964, we proceeded to reduce individual income tax
rates, corporate income tax rates, and excise tax rates substantially
below the levels prevailing in 1960. With the exception of the temporary surcharge, which lasted only 18 months, the only major tax rate
we have seen fit to raise during this inflationary era has been the social
security tax. All the other tax rates are lower.
This is not to say, with the benefit of hindsight, that monetary
policy should not have done more to offset expansionary fiscal policies
than it did. However, it does emphasize the handicap under which
monetary policy has had to operate during most of the past decade.
If fiscal policy is not to carry its fair share of the stabilization burden, monetary policy will have to be applied more severely than would
otherwise be necessary. The social and economic problems occasioned
by a severely restrictive monetary policy stem in large part from the
fact that its impact is not evenly distributed throughout the economy.
It hits especially hard on those units most vulnerable to a sharp rise
in short-term money rates, such as the thrift institutions. It inevitably
means a sharp contraction in residential construction. It impacts
severely on securities markets and the holders of outstanding stocks
and bonds, and it bears heavily on the small businessman whose access
to money is limited to the commercial banks.
We need in this country an anti-inflationary program which distributes the burden of restraint more evenly among the various sectors
of the economy. This, in my opinion, can only be achieved by a balanced application of fiscal and monetary policy. I will comment very
briefly on some of the issues surrounding short-term policy
implementation.
I think the major problem for the Federal Reserve in implementing
policy, a policy designed to control the rate of growth in the money
stock, is to distinguish between short-term fluctuations in interest rates
which serve an equilibrating function and those that are a consequence
of disequilibrating disturbances. There is no question in my mind that
it is absolutely essential for the Federal Reserve to intervene to stabilize financial markets following events such as the Penn-Central
bankruptcy and the subsequent disturbance in the commercial paper
market in 1970. Events of this kind are characterized by irrational
market reactions affecting institutions other than those directly involved. It is obvious from the pre-Federal Reserve experience and the
experience of the early 1930's that snowballing financial failures can
212
create enormous difficulties. We cannot risk the generation of such a
snowball.
However, I am inclined to believe that one of the lessons of recent
years is that we have been too ready to cushion interest rate movements
with the result that we have experienced more variable money growth
in the short run than is necessary or desirable. While very shortrun
variations in the rate of growth of the money supply have little economic significance in themselves, smaller variations will help us to keep
closer to the desired longrun growth path in the future.
Some of these issues are currently being explored by a new Committee on the Directive, which Chairman Burns recently appointed, and
of which I am a member. We have extensive staff work now underway
and I am optimistic that we will soon be able to come up with improvements in our present operating procedures which I think will give us
a better way of controlling the rate of growing in the money stock.
In summary, Mr. Chairman, it seems to me that we have learned a
great deal from the experience of the last decade, and what we have
learned is that a change toward a more stable monetary and fiscal
policy in the neighborhood of full employment is critically needed.
But in viewing our recent experience we should be careful not to learn
lessons that are not true. I am told that lawyers have the saying that
tough cases make bad law, and it may well be that abnormal economic
developments teach bad lessons.
Our inflationary, shortage-ridden economy of the past year has been
abnormal and we must be very careful not to overreact. By placing
recent events in a longer historical context, let us hope that we can
learn the right lessons.
[Testimony resumes on p, 225.]
[Mr. Morris' prepared statement follows:]
213
Statement of
Frank E. Morris
President, Federal Reserve Bank of Boston
before the
House Committee on Banking and Currency
July 18, 1974
I welcome the opportunity to testify before
this Committee on the fundamental issues of monetary
policy.
In Mr, Patman's letter of June 19 inviting
me to testify, six specific issues were raised.
I
believe it is best to approach these issues by placing
them in a broad framework emphasizing two themes.
The first theme is that policy must always be judged
in the light of the information available at the'time
the policy decisions were made.
The second theme is
that we have learned much from the events of the past
decade.
With these two themes in mind, I would like
to discuss, first, the issues connected with the
Federal Reserve's basic long-run policy and, second,
the issues connected with the day-to-day problems
of implementing the basic policy.
Long-Run Policy Issues
In evaluating Federal Reserve performance the
central question must always be whether the trend
214
-2rate of monetary growth, over which the Federal Reserve
has reasonably effective control, was proper given reasonable forecasts of the money-to~GNP relationship, which
the Federal Reserve does not control.
Evaluation of past
policy must proceed in the light of the information on
economic relationships available at the time the policy
decisions were made.
I am not going to attempt an evaluation of past
monetary policy decisions; judgments of this kind are
perhaps best left to independent and unbiased observers
rather than to policy-makers in positions such as mine.
What I do want to do is to discuss some of the considerations underlying monetary policy decisions and to examine
what I believe to be the major lessons of recent experience.
Following the experience of late 1968, when
monetary policy was clearly too expansionary, the
Federal Reserve moved promptly to reconsider its
policy procedures.
In early 1969 an FOMC subcom-
mittee on the Directive was formed.
The Directive
Committee, of which I was a member, recommended
that the FOMC place greater emphasis' on the growth
of monetary aggregates, and less on interest rates,
as explicit policy targets.
Starting in January, 1970,
this recommendation was implemented in the form of a
215
-3clause in the FOMC Directive defining basic monetary
policy in terms of monetary growth targets.
The 1970 shift in the way monetary policy is
formulated will, I believe, appear in historical
accounts of economic policy as being a milestone
of importance comparable to the Treasury-Federal
Reserve Accord of 1951.
The form of the Directive
since 1970 reflects, in my opinion, Federal Reserve
acceptance of the proposition that, other things
equal, significant and sustained changes in money
growth produce significant changes in the course of
the economy.
This important proposition, however, simply
alters the starting point for policy analysis.
Because other things are not constant, the relationship between money growth and GNP growth is not
constant.
To illustrate the problems caused by
changes in economic relationships, consider the
situation faced by policy-makers in the fourth
quarter of 1971, at the beginning of the experiment with wage-price controls.
In planning the appropriate monetary policy
at that time it was necessary to take account of
the likely effects of the wage-price controls,
fiscal policy, and other factors affecting the
216
-4economy.
However, it was also necessary to take
account of the changed historical relationship
between GNP and money, or what is called the
income velocity of money.
Whereas velocity grew
at a 3 percent trend rate before 1966, after 1966
it grew about 1 percent per year and so it was not
unreasonable in 1971 to anticipate a continuation
of this new velocity trend.
Between the fourth quarters of 1971 and 1973
the annual rate of money growth averaged about 7
percent.
If the recent historical relationships
had prevailed, GNP would have grown at a rate of
about 8 percent per year.
In fact, over this
period GNP grew at an 11 percent rate, and unfortunately much of the extra growth reflected a
higher rate of inflation than was anticipated.
The recent change in velocity is by no means
unprecedented; changes of a similar order of magnitude were not uncommon in the early 1950s and
early 1960s.
But the recent behavior of velocity--
a 4 percent rate of increase over the last two years-is a surprise given the marked slowing of the trend
rate of change in velocity between 1966 and 1971.
If we had known that the GNP would grow by 11 percent
per year we obviously would have planned for less
rapid monetary expansion.
A growth rate for the GNP
217
-5in the neighborhood of 8 percent would have been better
and, as a matter of arithmetic, if velocity were completely independent of the rate of growth of money,
then a 4 percent money growth rate would have been
appropriate.
However, looking at the problem from a
1971 vantage point, suppose we had held money growth
at 4 percent but suppose velocity had continued to grow
at the 1 percent trend characteristic of the late 1960s.
Then GNP would have grown at an annual rate of only
5 percent and unemployment would almost certainly
have risen above the already elevated levels of
1971.
In that event, the central topic of these
hearings would have been unemployment rather than
inflation.
My views on the appropriate stance of monetary
policy have been affected by this experience.
Ad-
vocates of discretionary policy--and I certainly
include myself in this group--have always recognized
that policy should become neutral once the economy
has reached the neighborhood of full employment
unless it is possible to identify a clear disturbance
that ought to be offset.
I am now of the view that
the neighborhood around full employment calling for
neutral policy is wider than I had previously thought,
and I am less optimistic* than I used to be that in
a world which is increasingly interdependent policymakers can identify and offset disturbances.
What
218
-6this means in practice is that in the absence of a
clear and present danger to economic stability
policy-makers should be more aware of the need to
set a stable policy setting.
If this view is correct, however, it means that
all of us must be more patient.
We must be willing
to ride out surprises in the expectation that most
such surprises are self-correcting.
There is nothing
that monetary policy can do, for example, to offset
the inflationary effects of a world-wide food shortage
or oil embargoes; in terms of general monetary and
fiscal policy we must be patient and simply wait for
increased food and oil production to reverse these
price disturbances.
There is ample evidence, I believe, that in
the long run a lower trend rate of money growth
will be needed if the rate of inflation and the
level of interest rates are to be reduced.
It
would not be wise, however, to think about this
problem in terms of setting now a schedule for
reducing money growth over the next few years.
We certainly should seize any opportunities to
move more quickly than a schedule might suggest,
and we must be aware" of the possibility that we
will be forced to move more slowly should unemployment climb higher than expected.
219
-7The only clear guideline that I can offer is
that we should be very careful not to permit the
trend rate of money growth to rise significantly
above the growth rates of recent years.
We should
be completely honest about the possibility that
the American people may have to grit their teeth
and endure a period of moderate unemployment.
If every small increase in unemployment is met by
demands for accelerated money growth while declines
in unemployment are not met by reduced growth, then
inflation is certain to accelerate in the long run.
In pursuing a long-run policy to reduce inflation
it would be extremely helpful if continuous fiscal
restraint could be maintained.
By reducing the up-
ward pressures on interest rates caused by Federal
deficit financing, it should be possible to maintain
a policy of moderate monetary expansion while at the
same time making clear progress toward the goal of
lower interest rates.
One of the lessons of the past decade is that
the American public is not likely to be satisfied
with our stabilization program until such time as
we can develop a better mix of fiscal and monetary
policies.
In only one period during the past ten
years--late 1968 through 1969--Can fiscal policy by any
measure be described as substantially restrictive.
Fis-
cal policy in the other nine years ranged from neutral
36-714 O - 74 - 15
220
-8to strongly stimulative, and the aggregate Federal
Government deficit for the period amounted to substantially more than $100 billion.
Beginning in 1964 we
proceeded to reduce individual income tax rates,
corporate income tax rates and excise tax rates
substantially below the levels prevailing in 1960.
With the exception of the temporary surcharge, which
lasted only 18 months, the only major tax rate we
have seen fit to raise during this inflationary era
has been the Social Security tax.
This is not to say, with the benefit of hindsight, that monetary policy should not have done
more to offset expansionary fiscal policies than
it did.
However, it does emphasize the handicap
under which monetary policy had to operate during
most of the past decade.
If fiscal policy is not to carry its fair
share of the stabilization burden, monetary policy
will have to be applied more severely than would
otherwise be necessary.
The social and economic
problems occasioned by a severely restrictive
monetary policy stem in large part from the fact
that its impact is not evenly distributed throughout the economy.
It hits especially hard on those
units most vulnerable ta a sharp rise in shortterm money rates, such*as the thrift institutions.
221
-9It inevitably means a sharp contraction in residential construction.
It impacts severely on securities
markets and the holders of outstanding stocks and
bonds.
It bears heavily on the small businessman
whose access to money is limited to the commercial banks.
We need an anti-inflationary program which
distributes the burden of restraint more evenly
among the various sectors of the economy.
This
can only be achieved by the balanced application
of fiscal and monetary policy.
Short-Run Policy Issues
My discussion of the issues surrounding
short-run policy implementation can be fairly
brief.
My most important point is that the more
stable long-run policies discussed above frequently will require active short-run intervention.
A stable policy should not be confused with a handsoff policy.
We cannot permit stones in the road to
throw us off course.
Just as the stable tax policy
of 1966-67 produced an inappropriate fiscal policy
when Vietnam expenditures rose sharply, so also
could Federal Reserve inaction permit events to
push monetary policy off course.
222
-10In this regard the major problem for the
Federal Reserve is to distinguish between shortrun fluctuations in interest rates that serve an
equilibrating function and those that are a consequence of disequilibrating disturbances.
There
is no question in my mind that it is absolutely
essential for the Federal Reserve to intervene
to stabilize financial markets following events
such as the Penn-Central bankruptcy and the subsequent disturbance in the commercial paper market.
Events of this kind are characterized by irrational
market reactions affecting institutions other than
those directly involved.
It is obvious from pre-
Federal Reserve experience and the experience of the
early 1930s that snowballing financial failures
create enormous difficulties.
The way to stop an avalanche is to stop the
snowball when it is small.
are harmless.
But some snowballs
For the Federal Reserve this issue
of judgment arises frequently, for it is often
necessary to decide when interest rate shocks
ought to be cushioned and when not.
I am inclined to believe that one of the
lessons of recent years is that we have been too
ready to cushion interest rate movements with the
result that we have experienced more variable
223
-11money growth in the short-run than is necessary
or desirable.
While very short-run variations
in the rate of growth of the money supply have
little economic significance in themselves, smaller
variations will help us to keep closer to the
desired long-run path.
It may well be that in the
absence of identifiable money markets disturbances
we should intervene less often to smooth interest
rate-fluctuations.
In recent years the markets
have learned to cope with larger interest rate
fluctuations and while the Federal Reserve's
criteria for defining "undue" fluctuations have
changed, we have perhaps lagged somewhat behind
the market.
Some of these issues are currently being
explored by a new Committee on the Directive,
of which I am a member.
Extensive staff work
is now under way and I am optimistic that we
will soon have a clearer picture of how our
operating procedures can be improved.
Concluding Comment
In summary, it seems to me that what we have
learned from the experience of the last decade is
that a change toward more stable monetary and
224
-12fiscal policies in the neighborhood of full employment is needed.
In viewing our recent experience,
however, we must be careful not to learn lessons
that aren't true.
Lawyers have a saying that tough
cases make bad law, and it may well be that abnormal
economic developments teach bad lessons.
Our in-
flationary, shortage-ridden economy of the past year
has been abnormal and we must be very careful not
to over-react.
By placing recent events in a
longer historical context, let us hope that we can
learn the right lessons.
225
The CHAIRMAN. Thank you, sir.
President Francis, is it your testimony that Federal Reserve policies have caused both inflation and high interest rates?
Mr. FRANCIS. My testimony is that a long run, what I would term
excessive, rate of monetary expansion causes both inflation and high
interest rates, in that order.
The CHAIRMAN. There are those that say that we can stop inflation
by raising interest rates. Let me ask you if interest rates rise, as we
all know they have been doing for the past few years, whether this
means that the Federal Reserve is fighting inflation?
Mr. FRANCIS. Mr. Chairman, I guess to answer that question I put
myself in a little different view than some of my colleagues. But nonetheless, I hold the view, given my original statement, that a high
trend rate of monetary expansion is the cause of high interest rates
following the development of inflation. I think the cure lies in the
reversal. As I see the high interest rates in the market today, I do
not interpret those high interest rates as being the result of restrictive
monetary actions. Rather, I interpret them as being the result of a
long period of rapid monetary expansion.
The CHAIRMAN. DO you not think it is terrible that people who have
to buy a home now, say costing $20,000 or $25,000, that they have to
obligate themselves to pay twice as much for their home in interest
on what they borrow. In other words, they pay for three homes in
order to get a title for one.
Mr. FRANCIS. Mr. Chairman, I think that situation is doublebarreled.
No. 1, it would be a bit difficult, as a result of the inflation
we have had in building costs, to buy that $25,000 home in my area
right now, and so I think the home buyer perhaps suffers just as
much or more from the inflation in the original cost as he does from
the high interest rates.
One thing is true. When he buys the house at a given price, he is
obligated for that inflated price. If he takes care in his mortgage,
he could, assuming lower interest rates later on, adjust his interest
rate cost. It is an unhappy situation for a home buyer.
The CHAIRMAN. DO you believe that interest costs should be considered in the cost of living index ?
Mr. FRANCIS. I do not even know if they are.
The CHAIRMAN. They are not.
Mr. MORRIS. Mr. Chairman, I believe that mortgage interest costs
are in the Consumer Price Index.
The CHAIRMAN. That is considered, but interest rates, generally,
are not considered, and it occurs to me that when interest rates are
so high, like when we are paying $29 billion a year in interest rates
on the national debt alone, that should certainly be an item that should
be considered. I do not know but I am just offering that as a suggestion, that it should be considered.
President Mayo, you said something that I, of course, agree with.
I have been considered a low interest man a long time and you stated,
as between the two, the country would be better off with low interest
than high interest. Is that right ?
Mr. MAYO. I thought that would appeal to you, Mr. Chairman.
226
The CHAIRMAN. We have not had any thrift campaigns going on.
I think people have been a little negligent there in not having thrift
campaigns going on at all times to advise people about the burdens
and responsibilities, and the inability to pay sometime enormous debts
that they are accumulating, which makes it hard on themselves and
their families for a long time to come.
Do you not think we could well afford to give a little bit more attention to thrift campaigns ?
Mr. MAYO. I think this is an important aspect of the problem, Mr.
Chairman.
The American people have turned out to be a surprisingly thrifty
people over the years. They have done this at low interest rates as
well as at high interest rates. This is going to be a very important
key to the solution of the future problem that we have, Mr. Chairman, in satisfaction of capital demands that are going to be absolutely
fantastic, even by today's standards, in their volume.
I happened to work for the Treasury for many years and maybe
that is why I made my earlier statement. We always tried to borrow
as cheaply as we could. I learned some lessons from that, Mr. Chairman, though, in that there were times when we were making false
savings, and we had to go to higher rates to borrow in a real market
in competition with the rest of the world. I have changed my
philosophy quite a bit in the last 30 years in that respect even though
I still have a liking for lower interest rates.
The CHAIRMAN. President Morris, you made the statement about
taxes being reduced in the last decade, or even longer. I just wonder
if those reductions have been in proportion or proportionately between
the corporations and individuals.
What has been your observation and recollection on that ? In other
words, has the burden gone up for individuals on taxes and up for
corporations, or have they been disproportionately going up or down?
Mr. MORRIS. Well, sir, I happen to have some estimates by the Brookings Institution of 1975 tax revenues on the basis of the present tax
rate structure, and the structure in effect in 1960. I think the numbers
are rather interesting. If we had the 1960 tax rate structure in effect,
we would expect individuals to pay in 1975, $157 billion as against
$134 billion under the present tax structure. The comparable figures
for the corporate tax rate are $66 billion under the 1960 structure, as
against $57 billion under the current structure.
So proportionately the corporate rate has been reduced somewhat
more. The biggest reduction, however, has been in the excise tax take,
which would have been $35 billion under the 1960 rates, and is now
estimated at $17 billion. It is about cut in half.
The CHAIRMAN. Mr. Johnson.
Mr. JOHNSON. Thank you, Mr. Chairman.
I want to welcome you three gentlemen here today. Yesterday we
were honored by the presence of the presidents of the banks of New
York, Philadelphia, and San Francisco, and we are equally honored
today to have you men here. I think it is fine of you to leave your busy
schedule to come here and give us the benefit of some very serious
testimony.
I would like to put in perspective here how you increase the money
supply and so forth. One of my staff said, Mr. Johnson, on television
the other night it showed how inflation occurs, and the culprit was the
227
Federal Reserve System. You were displayed as cranking out Federal
Reserve notes indiscriminately and whenever we needed money around,
all you did was print some paper money.
I have been connected with a bank all my life in one capacity or
another. However, I have not in the last 10 years since I have been on
this committee, but when we in that country bank wanted $5,000
worth of currency, we contacted the Federal Reserve Bank of Philadelphia. They sent us $5,000 worth of currency but they charged our
account for it. There was a debit on our account for $5,000, and we
received $5,000 in currency.
You people do not deliberately issue currency willy-nilly unless the
banks around the country need currency for purposes of their day-today operations with business and customers; is that not true?
Mr. MAYO. That is correct.
Mr. JOHNSON. IS there any change in the way you are issuing currency today than, let's say, 15 years ago when I was working with it ?
Mr. MAYO. NO change.
Mr. JOHNSON. Also, mutilated currency—is it not true that member banks, when they send in mutilated currency to you, you destroy
it and then you either give them credit on their accounts or you issue
new currency and send it to them? You do not inflate the currency
over and above that mutilated ?
Mr. MAYO. That is correct.
Mr. JOHNSON. This television show really was a false portrayal. I
did not see it, but I think the American people should realize that you
do not just deliberately crank out money without getting quid pro quo.
Is that not right ?
Mr. MAYO. Correct.
Mr. JOHNSON. NOW, the other statement here by Mr. Francis.
In your statement, when the Federal Reserve System buys outstanding securities from the public, a part of the Government debt is ultimately being financed by the creation of new money, the Fed pays
for the securities purchased on open market by giving member banks
credit, which increases the monetary base.
What you are trying to say is that if a country bank wants to sell
$100,000 worth of Government bonds, you will buy them up and you
will give them credit for the bonds on their members' reserve account,
and of course, you will thereby be creating new money, but you will
be satisfying a need engendered by that community back home, will
you not?
Mr. Francis?
Mr. FRANCIS. I take a little different approach to that. What I am
referring to is the purchase and sale of Government securities through
the operating desk of the Open Market Committee in the New York
bank. The process would be like this. May I take a minute ?
Mr. JOHNSON. Yes.
Mr. FRANCIS. I think there is widespread misunderstanding about
this business of money creation, and it comes about because of a little
different type of accounting system that we in the Federal Reserve
enjoy as compared to what most other institutions could do. It is
given to us by the Congress through the authority to issue money.
If it were the desire of the Federal Open Market Committee to
add to the money supply, it would ask the operating desk in New
228
York to go into the market and buy securities. They could be, I suppose, from literally anybody, whoever sold those securities. Let's say
there was $1 million involved. Whoever sold those securities would receive a check from the Federal Reserve drawn on itself in payment for
the securities. The seller, I would think, would very shortly deposit
that $1 million in his account with his commercial bank. The commercial bank with whom he deposited his $1 million, in turn, upon
having given him credit in his deposit account for the $1 million, would
send a check to us for collection. We would pay the check by a credit
to that bank's reserve account. Therein lies the accounting difference.
Both sides of our ledger rise simultaneously.
We would have $1 million more in assets as a result of the acquisition of the new securities. We would have $1 million more in liabilities
because we gave a $1 million credit in reserves to that member bank.
Any other institution or individual that I know of making that purchase could not run up both sides of his ledger. He would have to
have an asset somewhere to transfer to the purchaser.
Mr. BURGENER. Will the gentleman yield for a question on that ?
Mr. JOHNSON. Yes.
Mr. BURGENER. The
one link I did not quite understand—the operating desk buys securities. What kind of securities ?
Mr. FRANCIS. Governmental securities.
Mr. JOHNSON. I am sorry, my time is up.
The CHAIRMAN. Mrs. Sullivan.
Mrs. SULLIVAN. Thank you, Mr. Chairman.
I am very happy to have my fellow St. Louisan come before us.
Your statement, Mr. Francis, and that of the others, have been excellent. I do not pretend to understand them all, but I have some
questions to ask.
I presume that you gentlemen are familiar with the recommendations that Dr. Weintraub made the day before yesterday ? When you
get your transcripts, I wish you would let us have a comment on the
recommendations so that we are privy to that.
[In response to the request of Mrs. Sullivan, the replies on the recommendations of Dr. Robert Wemtraub, staff economist of the House
Banking and Currency Committee, may be found on page 361.]
Mrs. SULLIVAN. I wanted to ask you again, Mr. Francis, you were
asked—interest rates have been rising—but I did not quite get your
answer. Does this mean that you have been fighting inflation by these
rising interest rates ?
Mr. FRANCIS. Mrs. Sullivan, there are two schools of thought on that
subject. I must respect both, but I will have to give you my belief. I
think the rising interest rates are an indication of a long-term, expansion in the money supply—excessive monetary expansion, if you please.
In my judgment, the high rates that exist today, and that many write
about as representing tight Federal Reserve policy, just does not
square. I think the high rates represent a tight credit market. But in
my view, the continued rapid rate of monetary expansion, which continues right up to now, would not indicate a tight series of monetary
actions. On the contrary, my feeling is that we are continuing to now,
in terms of monetary actions, on an even course.
Mrs. SULLIVAN. I think that answers the question I was going to put
to you: Should the Fed fight inflation by raising interest rates or
decelerating money growth ?
229
Mr. FRANCIS. Mrs. Sullivan, I might respond very quickly to that.
I think the only way that the Fed can really lower interest rates over
the longer run—now, they might really for a momentary period lower
interest rates—but over the longer run, the only way the Federal
Reserve can reduce interest rates is to slow up the rate of monetary
expansion. This in turn, with some lag, should begin to ease the raite
of inflation. In that process, there might be a short while when interest
rates go even higher because of the slowup in the rate of monetary
expansion. But over time, they will turn and work their way down if
we persist in the lower rate of monetary growth.
Mrs. SULLIVAN. In some of your statements that I think you made to
the staff, when you say that the tradeoff between unemployment and
inflation is a slippery one, what do you mean, more precisely?
Mr. FRANCIS. I mean, as I look at the history of the last 20 or so
years, and I plot the levels of unemployment against the levels of inflation that exist at <a given time—and there is a chart in my statement
which I hope you will look at—you find that maybe for a short run you
can almost trace out the so-called Phillip's curve; but over the long
run it disappears and there seems to be no direct relation between the
rate of inflation and the rate of unemployment. Indeed, if you look
at two or three periods of time, you will find it interesting, with different levels of economic policy stimulus, how the unemployment level
has tended toward an average in each period, of approximately 4.9
percent.
Mrs. SULLIVAN. What sort of a glide down to minimal inflation, with
minimal disruptions in labor markets, do you envision ? What protections must we keep for housing and other sensitive sectors during
this glide ?
Mr. FRANCIS. Of course, if I had my choice, the wind down from the
high levels of monetary expansion that we have now would be a
gradual one, because we have been through periods in recent history
when we have made rather abrupt and substantial moves, which tends
to shake the economy in terms of production and in terms of unemployment.
Given the fact that we have a long history of inflation buildup, and
that we have had sort of an escalating trend rate in monetary expansion, I would not want to try to bring this thing under control too
quickly, because I think the cost would be too high in terms of lost
production and unemployment. If we could gradually wind down
over the remainder of the 1970's and I think we can do so—maybe with
not the optimal level of real production in this country, but at least
with a positive level—we would observe an unemployment rate which
is perhaps above what we would like, but not above what we can stand
or take care of.
Mrs. SULLIVAN. Thank you very much; my time is up.
Thank you, Mr. Chairman.
The CHAIRMAN. All right.
Mr. Williams.
Mr. WILLIAMS. Thank you, Mr. Chairman.
I certainly want to thank you three gentlemen for appearing here
this morning. Your testimony and that of all of the presidents of
the various Federal Reserve banks has been outstanding, and it has
been quite an education.
230
As I understand it, under monetary policy we can reduce the increase in the money suj>ply, so that it onl^ increases at a rate of about
4 percent annually; this would stop fueling the fires of inflation by
making too much money available. Then, under fiscal responsibility,
if we can accomplish what seems to be the impossible task of stopping
Federal borrowing to cover Federal deficit spending, and do this by
either raising taxes or reducing spending, then this would be a major
step toward the control of inflation, which eventually would bring
down interest rates.
There is a third factor, and that is, today credit is readily available through credit cards, and so forth, and very little downpayment
is demanded on anything any more. What would you think about a
modified regulation W, which was used during the 1950's, at a time
when we were having inflation and increased interest rates. I would
like an answer from all three of you.
Mr. MAYO. Mr. Williams, if I may start, it seems to me that your
suggestion has merit in terms of the general idea of trying to get
into more specific credit controls as, again, a general proposition.
In other words, do we have to just have the one big, general approach
in terms of a broad monetary policy ?
Mr. WILLIAMS. Regulation W, as it was finally prepared by the
Federal Reserve Board, was pretty detailed.
Mr. MAYO. Yes, I am coming to that.
Of course, regulation W related to consumer particulars. I do not
see any real danger at this point, if I may put it that way, in the way
in which credit is going ahead in the consumer area, at a time when
we have a basic sluggishness in terms of consumer spending. The statistics over the last year on retail sales—in particular, if you adjust
them for price increases—indicate a pretty flat performance of the
consumer. Interestingly enough, the consumer is saving more money
than you might have guessed, knowing what we know now. So, I am
saying that I do not think in this instance a selective credit control,
related to consumer purchases—either on installment or through
credit cards—would help us much in the battle against inflation.
Mr. WILLIAMS. YOU see, you have touched upon one of the things
that really concerns me. You have money flowing out of all of our
financial institutions, whether it is S. & L.'s, mutual savings banks, or
commercial banks. Apparently there is some question about where it
is going, because there is no apparent place that it is going.
During the depression, when people lost confidence in the banks,
people had money in safe-deposit boxes, hidden around the houses,
and that sort of thing. If you are going to say to somebody who is buying an article, you have got to place 25 percent down, is that not going
to help to slow down inflation and to bring down interest rates? The
funny part of it was, regulation W was feared in many circles as
destined to be the complete break in our economy. It was not; it caused
very little disruption in our economy, if any.
Mr. MAYO. It is, as you realize, a very difficult sort of thing to administer. It can be done as you suggest; it has been done. But I guess
I go back again to the idea that it was done, both during World War
I I and during the Korean conflict again, to mitigate a peculiarly consumer-oriented asDect of the inflation problem—an aspect which does
not exist in quite the same way today.
231
One of the peculiar phenomenon, of course, growing out of this inflation is that your wife and mine have to spend more money on food and
on gas for the car, just to get the same number of physical units. That,
in itself, provides a restraint on our purchases—meals out, or movie
tickets, whatever it may be—and there is sort of a built-in restraint
here. So I feel that, at least as far as it applies to the consumer, I would
not recommend it at this point.
Mr. WIUJAMS. Thank you very much.
The CHAIRMAN. Mr. Reuss.
Mr. KETTSS. Thank you, Mr. Chairman.
I congratulate each of our three witnesses on a very helpful statement, and I particularly want to welcome my own leader, Mr. Mayo.
Mr. Francis, you had a number of interesting things to say, toward
the end of your paper, concerning the Fed's role in bailing out a major
bank. You pointed out that you do not believe the System ought to
subsidize inefficient management by making funds available at interest
rates well below market rates. In the case of the recent Franklin National Bank in New York—where the Fed, I believe, put in $1.2 billion—the fact is, is it not, that these funds were made available through
the discount window at about 8 percent, as opposed to the commercial
rate which, for CD's, was about 11.75 percent ?
Mr. FRANCIS. It would be my understanding that the advances
through the New York bank were probably part at the 8-percent rate
and part at 8.5 percent.
Mr. REUSS. YOU would, as you frequently do, dissent from that kind
of a subsidy, would you not ?
Mr. FRANCIS. I am not sure I understand your question. I would
prefer not to have that in there—that subsidy in the discount rate—
but I would not dissent, given the level of the discount rate, whatever
it may be, from temporary assistance to save an institution that is
said to have sufficient sound assets to become again a viable institution—which was said in that instance.
Mr. REUSS. Were not the main persons being protected, by the Fed
making these discount window advances, the holders of large denomination certificates of deposit? Was not this action, in effect, giving
them a deposit insurance which, of course, the FDIC does not give?
Mr. FRANCIS. I would view it as an effort on the part of the Fed,
given the fact that the Comptroller of the Currency had said that there
were sufficient sound assets in the bank to liquidate its obligations, that
the Fed, in supplying funds through the discount window, would enable the bank to pay off some CD's and perhaps other obligations; but
to also stay afloat, which it might not have been able to do otherwise.
Mr. REUSS. Have you read in the press, as I have, accounts to the
effect that the Fed or the FDIC is going to be asked, in the event that
the Franklin National—or what is left of it—is taken over by some
other bank, to write off part of the debt ?
Mr. FRANCIS. I have not been familiar with any suggestion that the
Fed would be in a position that it would have to write off a part of the
debt, no.
Mr. REUSS. If that is the way it would end up, that would not be a
very good way of exercising the Fed's last resort powers, would it ?
Mr. FRANCIS. I think if that is the way it ends up, it would end up
in the category I think that I covered in my testimony: that I do not
232
favor moving in and attempting to save an institution that is past
redemption.
Mr. REUSS. One more question on this subject.
You go on to say, and I quote:
The provision of funds through the Federal Reserve discount window should
be matched by a sale of securities from the System's portfolio in order to prevent an expansion in the monetary base and in the money stock.
When the Fed put in $1.2 billion to come to the Franklin's rescue,
there was not a corresponding sale of securities, was there ?
Mr. FRANCIS. Probably not.
Mr. REUSS. There you would note a similar dissent, would you not ?
Mr. FRANCIS. I would feel very strongly that where the Fed is justified in going into a situation of that kind, in that amount, and particularly during a period of excessive expansion of the monetary
variables, I think that, yes, the offset should be made.
Mr. REUSS. One other question, Mr. Francis.
You dissent, I take it, from the current Federal Reserve practice
of so-called even keeling a Treasury issue ? You think it is not good
policy to increase the money supply in order that the Treasury, when
it needs to have recourse to the market, should have an easier time
than it otherwise would have ?
Mr. FRANCIS. Congressman Reuss, I am on record for a long period
of time as not being in favor of the so-called even keeling operation.
Mr. REUSS. YOU convinced me. Have you convinced any of the other
11 Federal Reserve Board presidents or any of the 7 members of the
Federal Reserve Board ?
Mr. FRANCIS. I could not say, sir.
Mr. MORRIS. Mr. Reuss.
Mr. REUSS. Yes, Mr. Morris.
Mr. MORRIS. I share the same feeling on even keel; that we have
done too much of it. I was Treasury Debt Manager in the Kennedy
administration and I know we could get along if we priced our
securities properly.
Mr. Mayo and I would like to correct one statement by our colleague. It is our impression that the money put in through the discount window to the Franklin National has been offset in open market
operations.
Mr. MAYO. Not on a 1-for-l basis, Congressman Reuss, so you could
identify it; but in terms of a daily revision of the open market desk's
appraisal of the situation on bank reserve requirements. The moment that $1 billion, or whatever the exact figure is, enters the picture, it is in that equation and is worked out through other reserve
providing or reserve retracting activities. So, I think it is fair to say
it has been offset.
Mr. REUSS. It was completely washed out ?
Mr. ROUSSELOT. Will the gentleman yield at that point?
Mr. REUSS. My time is up; I cannot yield my time.
The CHAIRMAN. The time of the gentleman has expired.
Mrs. Heckler.
Mrs. HECKLER. Thank you, Mr. Chairman.
I would like to welcome our distinguished witnesses. Mr. Mayo, it
is a pleasure to see you wearing a new hat. I especially welcome Mr.
Morris, from Boston.
233
Of course, your testimony raises a very broad gamut of issues that
could be addressed fruitfully.
I particularly welcomed your statement, Mr. Mayo, relating to the
significance of the congressional budget reform legislation. I think
that it is far more significant than the Gulf of Tonkin resolution.
It would be much more beneficial for the country, and I also hoj>e
that the Congress will have the will to implement it. I expect that it
will, because I think the people are going to demand that.
The question that I would like to raise is one that perhaps relates
to the area of most acute distress that I sense in Massachusetts and
in my own district.
As you have said in your statement, Mr. Morris, the impact of the
high interest rates, tight money, and so forth, is not evenly distributed.
Unfortunately, while we should not learn bad lessons from bad law,
it seems that we should have learned that the disproportionate burden which the thrift institutions and the housing industry have borne
during similar periods of high interest rates and tight money, should
have perhaps made us or made the Federal Reserve or made the
country aware of the need for some strategy to prevent a recurrence.
We have not developed that strategy, and now we are in a worse
position than we were before. I am concerned about the viability of
some of the thrift institutions.
Of course, some of the bankers, quite logically and understandably,
complain about the disintermediation that they are suffering; and the
potential home buyers and real estate brokers are making their complaints quite evident, as well.
One leading banker, whom I greatly respect, the president of a
thrift institution in Massachusetts, has made a suggestion which I
would like to have each of you gentlemen comment upon. His proposal
would be the creation of a new class of deposit with interest exempt
from Federal taxes which would bear an interest rate of about 6 percent ; the funds from which would be mandated to go into the field of
housing—the offering to be granted only by thrift institutions.
I wonder if any of you would be receptive to this idea. I wonder
exactly how you would respond to it. Do you see the creation of a
certificate of housing under such a mandate as possibly the answer to
this great disintermediation and the competition for funds?
Mr. MORRIS. Mrs. Heckler, I do not. I would personally be opposed
to any further proliferation of tax-exempt instruments because it
does great damage to the equity of our tax structure.
I think there are two viable strategies; both have difficulties. I think
in the past we have been trying to deal with the housing problem
through various sorts of financial gimmicks which simply do not
have the potential for meeting the problem. One necessary element
in the strategy is to have a more even balance between monetary and
fiscal policy. If we had at this period in time, say, a $10 or $15 billion
surplus in the Federal budget, the current rate of monetary growth
would be associated with a lower level of interest rates. I think the
fact that we have relied almost exclusively on monetary pjolicy as a
restrictive instrument has put an undue burden on the housing industry and the thrift institutions.
The other strategy would be to restructure the institutions themselves. This will take time, but I think it is something that the Congress
234
ought to give a lot of attention to. To restructure the character of the
assets and the liabilities of the thrift institutions so that they are more
viable in periods of sharp changes in short-term money rates. I think
these are the only two strategies that are really going to work.
Mrs. HECKLER. HOW would you counsel the president of a thrift
institution to compete under the present conditions today, tomorrow,
or next week, with the disintermediation that is occurring?
Mr. MORRIS. He cannot restructure his institution overnight, but I
think we have to give attention to diversifying both the assets and
the liabilities of these institutions so that they can be more viable. But
it is nothing that can be done overnight.
I think in periods such as this, we are going to have to depend on
assistance to the thrift institutions in the event that they are pushed to
the wall. I can assure you, Mrs. Heckler, that I have met with the savings bankers of Massachusetts and I have assured them that the Federal
Reserve System is not going to stand by and let the thrift institutions
suffer in this period.
Mrs. HECKLER. I thank the gentleman; my time has expired.
The CHAIRMAN. I am going to have to be on the floor when the
House meets at 12 o'clock, and I will ask Mrs. Sullivan to preside.
In the meantime, I will ask unanimous consent to place in the record
at this point the internal revenue collections of individual and corporate taxes from 1945 down to date.
[The information referred to by Chairman Patman follows:]
INTERNAL REVENUE COLLECTIONS OF INDIVIDUAL AND CORPORATE TAXES, SELECTED YEARS, 1945-73
[Billions of dollars]
Total individual income taxes
Year
1945..
1950.
1955
1960...
1965
1970....
1971
1972
1973
Corporate profits taxes
Amount
Percent of
total
Amount
Percent of
total
Total
$19.0
17.2
31.7
44.9
53.7
103.7
100.8
108.9
125.1
54
61
63
67
67
75
77
76
76
$16.0
10.9
18.3
22.2
26.1
35.0
30.4
34.9
39.0
46
39
37
33
33
25
23
24
24
$35.0
28.0
49.9
67.1
79.8
138.7
131.3
143.8
164.1
Source: Official Treasury statistics.
The CHAIRMAN. I just want to ask you one simple little question.
Do you agree with the few economists who are saying that the
people are responsible for the present inflation ?
Mr. MAYO. In one sense, Mr. Chairman, the people are responsible
for everything—what else is there ? We, as the people, elect the representatives that are sitting before us here. We elect the President
of the United States. We make our decisions as to what we buy and
what we sell. We make business decisions. We all like a higher standard of living. That is my interpretation of what Chairman Stein was
trying to say.
The CHAIRMAN. Thank you.
Mrs. SULLIVAN [presiding]. Mr. St Germain.
235
Mr. ST GERMAIN. Before the chairman leaves, I would like to make
this observation: people do not elect the members of the Federal Reserve Board, so the people are not responsible for that.
Mr. Morris, you mentioned restructuring of the thrift institutions,
as far as the assets and liabilities are concerned. We are all familiar
with the financial institutions reform legislation that has been proposed which by trying to achieve lowest common denominator agreement, became quite controversial since many of the Hunt Commission
suggestions were disregarded. I believe the Fed itself was not too
happy with the eventual recommendations. It is a package which appears to give the commercials a little bit and the S. & L.'s a little. A
few carrots here and a few carrots there. What concerns me is that,
traditionally, the thrift institutions have provided the funding for
home purchases. Restructuring of the assets and liabilities and conferring of additional powers, seems to add up in the long run to
across-the-board commercial banks.
Do you not agree that we have to be very cautious in the way we
proceed, to insure that we preserve the primary function of the thrift
institutions; to wit, to take care of the moderate-income home
purchaser ?
Mr. MORRIS. Yes, sir; but I also have confidence in the marketplace.
To the extent that the participation of thrift institutions in the mortgage market bill be diminished, if mortgage rates are competitive with
other rates, we are going to see an enlargement in the participation
of other institutions in the mortgage market.
One example is the insurance companies. Twenty or thirty years ago,
the insurance companies participated on a large scale in the mortgage
market. They withdrew from it because they found other instruments
gave them a better return. I think that the market will respond. I am
confident the market will respond and maintain an adequate supply of
mortgage funds.
Mr. S T GERMAIN. That is a very simple solution, I must agree. But
looking at the practicalities and realities of life; we were told during
the testimony on the Citicorp notes a few days ago that S. & L.'s should
be allowed to proceed in the same way as Citicorp. If they were given
these
powers we would end up with an effective mortgage rate of
ll 1 /^ to 12 percent, given today's market. As a practical'matter, what
are you going to go for ? A 75-year mortgage, or something of this sort ?
I mean, how can the man making $10,000 a year afford an 11- or 12percent mortgage rate, on top of the fact that the price of housing
has gone up at a figure approximately 6 percent per year for the past
5 or 6 years ? These are things we have to face.
Mr. MORRIS. The most critical thing for the housing industry is to
reduce the rate of inflation, because this will, in one stroke, slow down
the rising cost of construction and reduce the mortgage rate at the
same time; and both of these factors are important—it is not only the
interest cost, but the rising cost of construction that I fear is going
to drive our young generation coming into the labor force, out of any
opportunity to buy a home in the United States.
Mr. ST GERMAIN. They will all be mobile homes.
Mr. MORRIS. SO I think the thing the housing industry needs, the
thing the thrift industry needs most is success in slowing down the
rate of inflation.
36-714—74
16
236
Mr. S T GERMAIN. YOU gentlemen have testified that it is not the
consumer who is purchasing that much more—and I have seen the
same studies. The number of units have been pretty much a constant.
So that one wonders about the consequently increasing interest rate.
Your consumers are not directly responsible, except they are paying
more for energy, and more for food, and so forth. Essentially, it is
the large corporate borrowings that are creating the shortage of
money, and I find it difficult to understand why we have such large
corporate demands on money, when the demand for additional units is
not there. Is it for research and development? I mean, where is this
demand coming from ?
Mr. FRANCIS. I would like to respond to that question. I think that
this relates to the excessive growth of aggregate demand that we have
discussed here. With the long range, what I call excessive, rate of
growth in the money supply, we have bad in this country growth of
demand for goods and services at rates greater than our ability to produce. When such a situation develops I would expect corporations to
attempt to put into place new productive facilities in order to supply
the goods that are sought by consumers.
At the same time we have gone through a special situation where
various constraints have temporarily limited the ability of businesses
to meet growing demand. The result has been that the prices of the
available goods are bid up. Dollar sales rise while the amount of goods
sold change little. Thus the large corporate borrowing, accelerating
consumer prices, and the relatively unchanging rate of real consumption go hand in hand.
Mr. S T GERMAIN. Would the other gentlemen answer for the record
when they get their transcripts ?
[In response to the request of Mr. St Germain, the following replies
were received for the record from Mr. Mayo and Mr. Morris:]
REPLY RECEIVED FROM MB. MAYO
The shortage of money or credit that you suggest is not caused by corporate
borrowing. Rather, it results from inflation and the efforts of monetary policy
to restrict the total supply of money and credit in order to reduce the inflationary
pressures in the economy.
In an inflationary environment, the demands for credit from all sectors of the
economy are strong. For businesses in particular, rising prices increase the demands for credit to finance necessary inventories and current operations and also
to expand productive capacity to meet the expanded needs for goods and services.
REPLY RECEIVED FROM MR. MORRIS
While inflation generally increases business profits substantially, it increases
the needs for business funds even more. For example, in 1973, corporate profits
before taxes were $115 billion, a rise of $21 billion from 1972. Federal income
taxes absorbed half of this rise, so that profits after taxes were up over $13 billion, a rise of over 25 percent, a large rise indeed.
But business need for funds to finance the added costs of inflation rose much
more. The cost of inventories, as measured by the inventory valuation adjustment, rose $18 billion. Similar data on the impact of inflation on plant and equipment expenditures are not available, but the inflationary cost increase must have
been at least $10 billion. Thus, profits after taxes increased by $13 billion, but
inflation requirements absorbed about $28 billion more, leaving a net deficit of
about $15 billion. So despite their handsome rise in profits, corporations were in
a cash squeeze and they had to rely heavily on external funds to finance their
operations.
237
At times like this, corporations, like everyone else, have difficulties in acquiring external funds. Borrowing is cheaper, as a general rule, than selling capital
stock. But as businesses rush in to borrow, interest rates rise tremendously, as we
have seen, so borrowing became very expensive. Naturally corporations then
consider selling stock. But the rise in interest rates tends to reduce the market
prices of stock, and, as a result, those sources of funds become almost prohibitively expensive. Price/earnings ratios of even the blue chips have fallen to
levels of eight or so which represents a cost of funds before taxes of almost 25
percent; lesser known corporations have to pay much more. In this situation,
corporations must rely on bank loans and, if they are large enough, on commercial paper which is also expensive but does not involve a long-term cost
burden.
If inflation could be halted, all these factors would swing the other way. Profits
would be reduced, but not as much as the saving in inventory and capital outlay
costs. Corporations could reduce their reliance on external funds; interest rates
would fall and stock prices would rise. If they wished, corporations could then
use these lower-cost external sources of funds to pay off bank loans and generally
to strengthen their liquidity positions.
To summarize, inflation brings on the paradoxical situation where businesses
make more money at the same time that they are being squeezed for money.
Mrs. SULLIVAN. Mr. Rousselot ?
Mr. ROUSSELOT. Thank you, Madam Chairman.
Mr. Morris, you and your colleague, when Mr. Reuss' time was cut
off, you were discussing the Open Market Committee. You thought
it did respond on the Franklin Bank. Could you, for the record, comment as to how that was achieved ? I mean, I do not want to cut into
other things, but I think we would be interested in knowing how that
was done. Could you each respond to that ?
Mr. MORRIS. Certainly.
[In response to the request of Mr. Rousselot, replies received from
the witnesses for inclusion in the record may be found on page 399.]
Mr. ROUSSELOT. Thank you.
First of all, I want to compliment each of you gentlemen on your
testimony and your analysis of the problem of inflation and high
interest rates, and I did have a chance to glance at each of your statements prior to coming today, and appreciate the chance to review
them. I would like an answer from any one of the three of you. Did
the Federal Reserve Board here in Washington make any effort to
influence or coordinate your testimony before this committee?
Mr. MORRIS. NO, sir. We did ask the research staff of the Federal
Reserve Board to look over our comments, check any inaccuracies, but
there was no censorship.
Mr. ROUSSELOT. ISTO ; I am not suggesting censorship. I am just suggesting guidance.
Mr. MORRIS. In my case, I can assure you there was no guidance, nor
were there any significant changes in the text I originally drew up.
Mr. ROUSSELOT. Mr. Mayo?
Mr. MAYO. Mine were only editorial changes.
Mr. ROUSSELOT. Editorial changes? What does that mean?
Mr. MAYO. I should say suggested changes in words—semantics—
just in a few cases. There was nothing substantive changed, and the
suggestions were only by the Board staff. To my knowledge, no Governor has ever seen my statement.
Mr. MORRIS. I might also add, sir, that we are completely free to
reject any suggestions the Board staff puts forth.
Mr. ROUSSELOT. Mr. Francis ?
238
Mr. FRANCIS. The Board staff did ask to see the statement. Mine was
transmitted to them. There were some suggestions, but I have a sort
of a country person feeling about the principles of appearing before
a congressional group, and I think that when I am invited to do so, I
am obligated to give you my views, and mine alone; and the statement
you have is my original statement, without one word having been
changed.
Mr. KoussELOT. Good. I appreciate that.
Mr. MAYO. That is true in my case, for all intents and purposes, too.
Mr. ROUSSELOT. My understanding is that there was a special meeting of the Board held this past Monday, July 15. Did any of the Governors discuss potential testimony before this committee ? Was there
any discussion about it ?
Mr. MAYO. May I ask what you mean by potential testimony ?
Mr. ROUSSELOT. Well, your potential testimony.
Mr. MAYO. Well, again, as we discussed here, there was a recognition
<of the fact in the meeting that you refer to that we are indeed part of
a system, and that there is an inherent strength of what you might call
joint decisionmaking, and the way that the Federal" Open Market
Committee is working on it, and that is the most important ingredient,
and there is no disagreement among any of us on that. That is far more
important than the differences that each of us may have with each
other on detail.
, Mr. ROUSSELOT. Then, is your answer that it was discussed in the
meeting—your joint ideas ?
Mr. MAYO. In a broad way.
Mr. ROUSSELOT. In a broad way it was discussed ?
Mr. MORRIS. We did discuss Dr. Weintraub's proposals. We talked
them back and forth over dinner. We are all going to make our independent statements for the record on his proposals, and I suspect
that probably you will find a difference in my response and my colleague's, Mr. Francis.
Mr. ROUSSELOT. Yes, I noticed that. Then your statement is that,
even though it was discussed on a joint basis in the meeting on Monday, July 15, this is just for the edification of each other? There was
no attempt by any of the Governors to say, well, this is what we have
been saying, and hopefully you will say the same thing, or what ?
Mr. MORRIS. NO, sir.
Mr. MAYO. NO, sir.
Mr. ROUSSELOT. YOU
actually, then, are independent operators, as it
comes to your own statements ?
Mr. MAYO. That is correct.
Mr. ROUSSELOT. Thank you, Madam Chairman.
[Congressman Rousselot submitted written interrogatories on this
question to the witnesses. Their replies may be found on page 373.]
Mrs. SULLIVAN. Mr. Hanley?
Mr. HANLEY. Thank you, Madam Chairman.
Gentlemen, I too want to express my appreciation for your interest and your presentation this morning. I have always been puzzled
at the general reluctance on the part of most money experts to associate inflation with the rate of interest, so I am delighted to note that
apparently you three are tuned in on the same frequency, and observe
a ralationship there.
239
Mr. Francis, I was delighted to hear you say that low rates of
interest are desirable for the economy. I have always concurred with
this, and I think if we look back down the road to around 1946, it is
fair to say that the low rate of interest that prevailed, mandated in essence by the GI bill of rights, which as you know created the great
homebuilding boom and the opportunity for business and industrial
development; I believe that that act alone contributed so greatly to
the economy that our Nation has enjoyed for better than two decades,
up until the initiation of the inflationary cycle in the mid-1960's.
As I observe what is happening, I find it very disheartening, and I
cannot be at all optimistic about the future of this economy. This,
for instance, is evidenced by the most recent Commerce Department
report with regard to the status of the gross national product, which,
as you know, for two consecutive quarters—the first 3 months and the
second 3 months of this year—has dipped. The professionals tell us
that this is a true sign of recession. I think of the homebuilding industry in my particular community, and there has been some colloquy
about the cost of homes, and I represent central New York, and in that
particular area, over the course of the past 2 years, the cost of building a house has increased by 40 percent. To that, you add, if you can
get a mortgage at the rate of interest prevalent today; the fact being,
however, that mortgages are just about no longer available in that
rather large area of central New York. In fact, the savings bank industry and the savings and loans have transmitted messages to me during
the course of the last week or two that the overture on the part of the
Citicorp is really the straw that is breaking their backs. The major
bank in the area advised that due to it, they were no longer accepting
mortgage applications, subsequent to the end of this month.
This produces a very difficult problem, and for these reasons, I am
greatly concerned about the future of this economy, and our ability to
avoid a depression.
My friend Mr. Mayo said that the ability to finance greases the
wheels of our economy, and I am in complete agreement with you
there. However, on the basis of the feedback that I get, this grease
is no longer on the wheel, and I have talked with industries and
businesses, and in particular those that have been affected by the
energy crisis through no fault of their own. They go to the traditional
lending institutions, and money is not available, or is available at a
rate of interest which is impossible for them to digest. So they have
to walk away from that lending institution, and perhaps proceed to
file chapter 11 bankruptcy. We are hearing this virtually every day.
With that thought in mind—and I think of the colloquy back during
the course of our deliberations on price and wage controls, and the
possibility of a ceiling on interest rates—may I ask of each of you what
your attitude on that possibility is ?
Mr. FRANCIS. Congressman, I think that an attempt to institute a
ceiling on interest rates would probably go the way of other ceilings
that have been attempted in this economy when it was under very expansionary pressures. I would go back to my original contention that
there is one way to pull these interest rates down, and that is to slow
up this inflation and to bring it under control.
Mr. HANLEY. If you will yield at that point, I am reminded of
another inconsistency. We talked about Secretary Simon, and his
240
recent overture with regard to the reduction of Federal expenditures
to bring about a halt in this inflationary cycle. On the other side of
the spectrum, we hear the proposal of the President, whereas if enacted, the program would pump $10.8 billion into the troubled home
mortgage market. Like me, I think you would observe quite an inconsistency here, because of the fact that number one, we do not have
this $10.8 billion; and if enacted, we would have to take the borrowing
route. As you know, we operate with a rather large deficit. So, to pick
up this $10.8 billion, it appears to me it would be necessary for the
U.S. Government to go to the well again, and sell U.S. Treasury bonds
at the rate of interest currently appropriate.
So how, then, are we assisting the inflationary spiral? So we are
talking out of both sides of our mouth. The Secretary of the Treasury
versus the President; the Secretary embracing the conservative concept, and on the other hand, the President moving in this direction.
I am sorry that apparently time has about ended. I would like very
much if, in writing, you would provide me with your comment on the
inconsistency that I have related to you. I would appreciate that.
[In response to the request of Mr. Hanley, the following replies
were received from the witnesses for inclusion in the record:]
REPLY RECEIVED FROM MR. MAYO
As I noted in my statement I believe that the deficit financing burden placed
on the Federal Reserve has been a heavy one. My experience in various positions
has led me to conclude that it occurs because of a fundamental flaw in governmental coordination of economic policy and public finance. The need to review
all authorizations and proposals and their spending implications in totality, in
terms of their effects on specific areas and on economic stabilization, is great.
It is for this reason that I applaud Congress for establishing a Joint Committee
on the Budget to provide the Congress with an independent view of the whole
budgetary picture and with its own analytical staff to lessen Congress' factual
dependence on the Executive Branch.
The $10.8 billion you referred to, Mr. Hanley, does not represent an increase
in borrowing of that amount by the Federal Government. The measure was primarily designed to subsidize below market rates on loans for, potentially, more
than 300,000 units rather than to provide outright new credit extensions. This
type of sectoral relief is an appropriate role of fiscal policy.
REPLY RECEIVED FROM MR. FRANCIS
In analyzing the inflationary impact of Federal budget activities, it is essential
to examine the extent to which the Federal Reserve indirectly finances such
activities. Reducing Federal expenditures tends to reduce deficits, thereby removing upward pressure on interest rates and, according to past experience,
tending to produce slower money growth. Federal lending programs, such as
borrowing in national credit markets by the FNMA and relending these funds
to the housing market, need not be inflationary, provided the Federal Reserve
does not purchase the agency issues or attempt to resist any associated upward
pressures on interest rates.
REPLY RECEIVED FROM MR. MORRIS
While the President's program to aid the housing markets may have a slightly
expansionary impact, I do not believe the program should be described as "inconsistent" with the goal of curbing inflation. The difficulty is that while curtailing inflation is our current major objective, we have an additional objective
of maintaining reasonable stability in the housing sector of the economy. Multiple
objectives generally require multiple policies. When the Federal Reserve holds a
tight rein on money and credit in order to reduce inflationary pressures, a dis-
241
proportionate amount of the burden falls on the housing industry. This burden
can be mitigated, although not eliminated, by programs designed to direct funds
to the mortgage markets. So long as the Federal Reserve maintains moderate
growth of total money and credit, the rechanneling of funds to housing need not
have an inflationary impact.
Mrs. SULLIVAN. Mr. Frenzel ?
Mr. FRENZEL. Madam Chairman, I would ask unanimous consent
to ask four questions to which the panel might respond in writing,
since the time is short.
Mrs. SULLIVAN. Because of the time factor—if you would just ask
them.
Mr. FRENZEL. The first relates to the fact that we are always attacking our problems here in a piecemeal fashion. Today we could not
complete the attack on a problem that vexed us, but I would like to
have your opinion as to whether we would not be better advised
to consider something like the Hunt Commission report, which looks
at our entire financial system, rather than attacks on demand whenever one segment of our financial community is hurting, or one section
of our economy is hurting.
The second question would relate to the possibility of a band-aidtype treatment that has been suggested; and that is the possibility
of offering a tax credit for those people who invest in the thrifts.
Hopefully, it would present some kind of basis against disintermediation, and assist us in the difficult housing areas.
Third, I would like to ask you, what are the kinds of interest rate
increases that we have observed in the last couple of years ? We know
it happens to the big corporations, because they get the prime rate.
But what happens to the small businessmen? My impression is that
rather than a high rate, he does not get any money. Installment loans,
I presume, or consumer-type loans, bank loans, revolving credit, small
loans, and so on, probably do not change very much. Of course the
home buyer most likely gets frozen out, rather than having his rate increased. I wonder if you would lay those out for me in order.
The final question relates to the open market operations and the
control of the monetary supply by the Board. It seems to me that our
ability to control is a lot less than many of us in Congress seem to believe. I wondered if you would comment on how tightly we can
control, or how easy it is to achieve a target of increase or decrease
in the money supply.
Madam Chairman, I thank you.
[In response to the questions above of Mr. Frenzel, the following
replies were received from the witnesses for inclusion in the record: j
REPLY RECEIVED FROM MR. MAYO TO QUESTIONS OF MR. FRENZEL
Question 1, Should we consider a general rather than a piecemeal solution to
the sectoral problems generated by anti-inflationary actions?
Answer. My view would be similar to that presented earlier by my colleague,
Mr. Morris. Basically, the problem of differential sectoral impacts results from
the necessity of waging an active war against inflation. With greater coordination
between monetary and fiscal policy the dangers of developing inflationary situations would be lessened. Further, less reliance would have to be placed on monetary policies which in fighting inflation do result in short term increases in
interest rates. And it is this increase in rates which causes more difficulties for
some sectors of our economy than it does for others.
I also concur, however, with Mr. Morris' view that a full review—perhaps
resulting in a restructuring of financial institutions—would be desirable. Such
242
a review will take time but is far preferable to the use of piecemeal approaches
which have the tendency in this complex and interrelated economy of ours to
have unforeseen and frequently harmful impacts elsewhere in the economic
system.
Question 2. Should a tax credit be given to those investing in thrift institutions?
Answer. I do not think that this would be the appropriate course to take. Not
only does the use of tax exempt obligations damage the equity of our tax structure, but it also would distort the pattern of savings and financial flows to the
detriment of the efficient working of our economy.
Question 8. What has been the pattern of interest rate increases by type of
borrower?
Answer. On the basis of the information I have seen, smaller business firms
have not been frozen out of the credit markets. They have had difficulties, of
course, but so have many other borrowers.
It appears that the so-called "two-tier" rate structure under the Committee
on Interest and Dividends was effective with rates rising less rapidly in bank
financing for small borrowers than for large borrowers. We must remember,
however, that rates vary greatly within any size group of borrowers on the basis
of the risk to the lender. Consequently, the rates for "good" credit risk small
borrowers and the availability of credit for small borrowers may actually be
more favorable than it is for some large borrowers.
As to sectoral problems, such as housing, the problems of high rates and limited
availability of credit, these are the result of many institutional factors. State
usury ceilings have, for example, reduced the participation of lenders in some
housing markets. It is because of these institutional factors that I suggested
support earlier for the more extended review of institutional arrangements.
Question 4. How closely can we control the money supply ?
Answer. As I indicated in my testimony and in responses to earlier questions,
I am unwilling to support the use of a single target such as Mi as a guide to
monetary policy. In part, this position is based on my experience that close control of this aggregate for very short periods is difficult if not impossible. The
longer the period over which control is to be exercised the greater are our chances
of achieving a given Ma growth. I would hasten to add, however, that agreement
that control might be possible over a long period is not tantamount to accepting
an immutable long-term path, fixed long before the period to which it applies,
as a sole guide for monetary policy.
REPLY RECEIVED FROM ME. FRANCIS
RESPONSE TO THE FIRST QUESTION OF MR. FRENZEL
I agree that much of our nation's financial problem lies in the structure and
the restrictions imposed on our financial system. Rather than controlling money
each time that the nation has experienced a crisis, a new flurry of controls have
been placed on financial institutions, especially banks. These controls limit the
viability and competitiveness of these institutions. We now control the activities
in which they can participate, their office locations, their type of investments,
rates paid on funds, and often the rates that borrowers can be charged is limited.
The Hunt Commission's proposal is consistent with the goal of freeing up our
financial system and increasing competition among financial firms. It would reduce rigidities and provide for tax equality and greater uniformity of operating
rules. It would provide for relatively free entry and exit. Such system would improve the services provided by our financial sector. We might experience an occasional failure; however, the maintenance of a set of anti-competitive regulations so strict that the weakest firms can survive is not consistent with provision
of economically efficient financial services to the community.
RESPONSE TO THE SECOND QUESTION OF MR. FRENZEL
Rather than offering tax credits to savers at thrift institutions, I would
suggest the removal of rate controls as indicated in the answer to Mr. Frenzel's
first question, and loans by the Federal Home Loan Bank to those sound institutions which may face temporary liquidity problems. Some means providing
relief from state usury laws would be also helpful.
243'
RESPONSE TO THE THIRD QUESTION OF MR. FRENZEL
Interest rates have generally increased to all users during the past two years.
However, the state usury laws have no doubt been detrimental to the small
businessman's access to credit markets. When such laws set a maximum rate
that financial firms can charge, they will lend their funds to the safest borrowers and this is often the larger firms. In some states (for example, Missouri)
corporations are exempt from the usury laws and financial firms may charge
them the market rate. Since financial firms can make more profit by lending
to corporations at the higher market rate, corporations will likely get the
major portion of the available credit.
Another impediment to the small firm's access to credit is the restrictions on
rates that financial firms can pay savers. Such restrictions reduce the amount
of funds that people save through those agencies. Rather than placing savings
at low rates with banks and savings and loan associations, many people will
invest their funds directly in the capital markets, mortgages of friends, or real
property. As a result, the total amount of loanable funds through those firms
is limited. Larger corporations with their better credit worthiness may, however,
go directly to the capital markets and sell debt instruments.
RESPONSE TO THE FOURTH QUESTION OF MR. FRENZEL
The degree to which the Federal Reserve can control the growth of the money
stock is related to the length of time over which this control is to occur. Under
present institutional conditions, I would expect to observe fairly large errors
on a weekly or even monthly basis. However, extending the control period to
a quarter or longer sharply reduces the expected errors. The Federal Reserve
should be able to quite accurately determine the average growth path of money
over a period as long as a year. The relevant comparison for a year would be
the average level of money in the fourth quarter of one year compared to the
average level of money in the fourth quarter of the following year.
The growth of money is very closely related to the growth of the monetary
base. Unambiguously, the Federal Reserve can closely control the average growth
of the monetary base over periods of a month or more.
One additional point. The Federal Reserve cannot control both interest rates
and money growth at the same time. If the Federal Reserve seeks to restrict
interest rate movements within a very narrow band, then at certain times a
conflict would emerge with the desire to closely control the growth of the money
stock.
REPLY RECEIVED FROM MR. MORRIS TO QUESTIONS OF MR. FRENZEL
ANSWER TO FIRST QUESTION
The integrated approach to the restructuring of our financial system espoused
by the Hunt Commission is desirable for three reasons. First, such a general
approach helps avoid the inequities which often result from "piecemeal" solutions. Second, a general approach should increase the efficiency of the entire financial system, thus encouraging saving, lending, and investing. Third, the Hunt
Commission's integrated approach to financial problems insures an internal consistency to the overall solution such that one financial sector's remedies does not
become another sector's disruptions.
ANSWER TO SECOND QUESTION
A tax credit for investments in thrift institutions is not advisable because it
would open another loophole in our tax laws, running counter to the trend
toward tax reform which I endorse. In addition, I am skeptical that such a tax
credit would be effective in supporting the thrifts at the times it would be needed
most. The situation is similar to that of the tax exemptions for state and local securities. When funds are easily available commercial banks buy large quantities
of these securities to take advantage of the tax exemption. When funds are scarce
the commercial banks reduce their participation in the tax-exempt market in
order to meet loan demands, exacerbating the financing problems of state and
local governments. I am on record as favoring a direct interest subsidy to state
and local governments. If additional support is deemed necessary for the thrifts,
I believe this direct approach would be more efficient and more fair.
244
ANSWER TO THIBD QUESTION
Interest rates have increased for every class of borrower over the past two
years. But, as you note, the interest rate on business loans under $10,000 rose
from 7.3 to 10.5 percent between August 1972 and May 1974, while the rate on
loans over $1,000,000 rose from 5.6 to 11.1 percent. At the same time banks have
become more stringent in their non-interest requirements according to the Federal
Reserve System's Survey of Lending Practices.
While the rate on small business loans was rising more slowly, the volume of
new lending to small businesses decreased by 15 percent over the 1972 to 1974
period, while that going to large businesses increased by 91 percent. These
observations are consistent with your suggestion that small business loans are
more difficult to obtain, although other influences could also account for part of
the results. As you suggest, the interest rate on consumer loans since 1972 has
remained relatively stable, with the rate on credit card plans remaining right
at 17.25 percent while the average rate on automobile credit rose little, from
10.0 to 10.6 percent. From all indications, consumer credit has been readily
available in this period. The volume outstanding rose substantially in 1973 but
has been pretty much on a plateau since, as auto sales have plummeted.
ANSWER TO FOURTH QUESTION
In the very short run, the rate of growth in the money supply is often dominated
by random events. In a one-month time span, for example, there is no close
relationship between a given input in reserves and the resulting output of Mi.
However, these random short-term influences on the money supply do not cumulate. Therefore, while it is impossible to control the growth of the money stock
in a one-month period, and while it is very difficult to control the growth of
the money supply within reasonable tolerances over a period as short as three
months, it is possible to do so over time spans of six months or longer.
Short-term variations in the rate of growth in the money stock do not have
any great economic significance in themselves. However, to the extent that the
short-term variations can be reduced in amplitude, our ability to hit longer
term targets will be enhanced. The cost of greater short term stability in monetary growth will be increased instability in short-term money rates. This is a
cost which I think the public and the Congress ought to accept in the interest
of achieving more stable monetary growth rates.
Mrs. SULLIVAN. Mrs. Boggs ?
Mrs. BOGGS. Thank you, Madam Chairman.
I want to thank all of you for being here, and for your wonderful
testimony. I am smiling, because for several days, since I am the last
one who has an opportunity of asking a question, I missed asking
questions, and I thought I was going to be felled by the bell again. But
one of the questions that I have been wanting to ask the last several
days has been answered by Mr. Mayo, and that is because monetary
policy alone has not been able to cure inflation, and because we must
have the tandem of monetary and fiscal policy in order to accomplish
the ends that we all seek, I do feel that the new Budget Committee is
going to go a long ways in providing this dual monetary and fiscal
policy; and I was very grateful that you did bring it out again in your
testimony today, as you had earlier, when we were considering setting
up an overall Budget Committee.
As we have said, we are elected, and the people are the cause of
inflation, if they elect us; and we will indeed, I think, in cooperation
with the Federal Reserve, be able to represent the people in a more
effective fashion by having our own Budget Committee with the
proper statistical help, and the proper staffing.
There is one question that I should not really be addressing to you,
but since I have not had the opportunity of asking it earlier, I would
like to ask, and if you would not mind writing your answer, about
245
devaluation and its effect upon inflation. In earlier testimony this was
mentioned over and over again in the various presentations, and I
noticed in the Weintraub presentation, that one of the Governors had
suggested that the Federal Keserve really had only a sideline role in
any kind of input into the devaluation decision. I would like to know
what advice was given, even in that sideline position.
Thank you very much.
[In response to the questions above of Mrs. Boggs, the following
replies were received from the witnesses for inclusion in the record:j
REPLY RECEIVED FROM MR. MAYO
Question 1. What is the effect of devaluation on inflation?
Answer. As I indicated in my statement, one of the factors outside the influence
of the Federal Reserve that played a role in our inflation of 1973-74 was successive devaluations of the dollar. The objective of devaluation is, of course, to improve a country's balance of trade. The initial impact is inflationary since it increases the prices of goods imported. In addition, if the economy is fully employed, the increase in foreign demand for the relatively cheaper goods here leads
to additional pressures on the price of these goods and the resources which produce them.
Question 2. What input did the Federal Reserve have in the decisions concerning devaluations ?
Answer. While international considerations are an important element in the
domestic monetary policy decisions which I must make as a member of the FOMC,
I would not because of the nature of my responsibilities be directly involved in
providing input for this type of decision.
REPLY RECEIVED FROM MR. FRANCIS
The discussion between the Treasury and the Federal Reserve System about
devaluation was carried on between the Board of Governors and the Treasury.
I have no information about what specific recommendations were made.
While the Federal Reserve System may have had only a sideline role with
respect to the decision about when and by how much to devalue, I believe monetary actions played an important role in setting the stage for the necessity to
devalue. In my opinion, the breakdown in fixed exchange rates and devaluation
of the dollar were directly related to inflation here and abroad. As I have stated
elsewhere in my testimony, I believe excessive monetary growth was the dominant
cause of the inflation, thereby creating the conditions that ultimately forced the
decision to devalue the dollar.
REPLY RECEIVED FROM MR. MORRIS
Concerning the role of the Federal Reserve, I did not personally participate
in any way in the decision to devalue the dollar. The Federal Reserve had taken
no official position on devaluation and its official acceptance was not needed,
so devaluation was accomplished without any action by the Federal Reserve.
As to .any sideline role which the Federal Reserve may have played, that question would have to be addressed to Chairman Burns.
With respect to the impact of devaluation on inflation, I do not believe we have
a definite answer. With the dollar in an overvalued position, the dollar prices of
imported products were kept below their true economic level. Therefore, when
exchange rates were cut loose to vary flexibly, the first impact was a rise in the
cost of most imports. It also lowered the foreign prices of our exports which
increased exports and added to demand pressures thereby tending to raise
domestic prices.
Various estimates have been made that devaluation has accounted for about
one-fifth to one-sixth of the total rise in the consumer price index of about
25 percentage points or 20 percent, between August 1971 and June 1974. Even
though devaluation caused additional inflation, some adjustment in exchange
rates or in foreign trade was necessary. Foreign countries became increasingly
246
reluctant to absorb over-valued dollars and the only alternatives were to devalue
or to institute trade and other restrictions. In my opinion, devaluation was
the lesser evil by far.
Mrs. SULLIVAN. Thank you, gentlemen. We are just about deserted,
but we are going to have to go over to the Housefloorbecause the bells
have rung. We appreciate your testimony. It has been very helpful.
I do not think you have the answer, but neither do we, so let us just
be hopeful.
We have some questions from other members which we would appreciate your answering for the record.
[The following are written questions submitted by Mr. Widnall to
the witnesses, along with their answers:]
WRITTEN QUESTIONS SUBMITTED BY MB. WIDNALL TO WITNESSES
Mr. Mayo, on page 7 of your submitted statement, you state that our economy's
inflation over the past.6 months has been caused by fiscal and monetary stimulus,
the end of wage-price controls, shortages, and international developments. What
I am especially interested about is the monetary stimulus you mentioned. I knowthat you think that the growth of the money supply during 1972 and the first
part of 1973 was too rapid—it was, in fact, inflationary. I do not believe in looking back merely to criticize, but only to better understand what must be done in
the future. What portion of the increase in the inflation rate was caused by
the relatively easy monetary policy of the Federal Reserve?
REPLY RECEIVED FROM MB. MAYO
I do not believe that the proportional effects of various policies can be quantified. As I indicated in my statement, I do feel that there is a significant association between fiscal deficits and monetary policy actions. In the absence of deficits and thus a lessened burden on the Fed to see that the Treasury is successful
in securing additional funds, there would in my view have been less monetary
stimulus. I am sure I could not accurately or usefully reconstruct the decision
I would have made in the absence of the deficit. Nor could I obviously do this for
all of the others participating in the policy decisions.
In addition, I do not know how to untangle effectively all of the other special
factors that influenced our decisions. Even our econometricians, as capable as they
are, cannot unambiguously interpret the contribution of each factor.
Mr. Morris, on pages 8 and 9 of your submitted statement, you talk about the
uneven impact of severe monetary restraint on the economy. You argue that a
sharp rise in short-term money rates adversely affects thrift institutions, residential construction, security markets, and small businessmen. This, of course, is not
news to me. What I am interested about is the way to make this impact less damaging to these sectors of our economy. You say that this goal can only be achieved
by the balanced application of fiscal and monetary policy. This is an extremely
general statement, and I would appreciate it if you could elaborate upon it.
REPLY RECEIVED FBOM MB. MOBBIS
Restrictive monetary policy affects primarily the credit markets and investment activity. Restrictive fiscal policy affects primarily the government sector
through reduced government expenditures and the consumer sector through increased taxes. Given a targeted reduction in aggregate demand, the greater the
amount of this reduction being effected through fiscal policy, the less the burden
on restrictive monetary policy and the credit sensitive investment sector. Tighter
fiscal policy means a smaller government deficit, less deficit financing, less pressure on credit markets, and more funds left over for private investment needs.
247
Mr. Francis, on April 29th of this year, in a speech before the Steel Plate Fabricators Association, you said, and I quote: "Those of us who see aggregate demand as being very strong and inflation as the most serious problem would argue
that the trend rate of money growth should be reduced immediately to about a 5
percent rate for the balance of the year." Today, less than 3 months after that
speech, you have stressed the importance of a gradual reduction in the money
supply growth rate. It seems to me that you have changed your mind in these
last several weeks. Would you like to comment on this?
REPLY RECEIVED FROM ME. FRANCIS
My recommended course of money growth for the balance of the year in my
address presented to the Steel Plate Fabricators Association on April 29, 1974,,
was based on information available at that time. From the first quarter of 1973.
to the first quarter of 1974, M, had increased 5.7 percent, and weekly data for
early April indicated that money growth was continuing at a somewhat more
rapid rate. Therefore, I viewed my recommendation of a 5 percent growth of
money to the end of the year as a gradual deceleration.
In the interval between the preparation of those remarks and the preparation!
of my testimony, two things occurred which would influence my recommendation at this time. First, there was a major upward revision to the money stock
data and, second, approximately three months of additional data are available.
So, at the time of preparing my testimony, indications were that the money stock
had grown at a 6.7 percent annual rate from the first quarter of 1973 to the second quarter of 1974, and weekly data for June and early July suggested that
ijts growth had continued to be rapid. Therefore, when I recommended a gradual
deceleration, I had in mind approximately a one percent reduction in the rate of
money growth for the balance of this year. This is the same magnitude of reduction as I had mentioned in my earlier address.
[The following are written questions submitted by Mr. Blackburn
to the witnesses, along with their answers:]
WRITTEN QUESTIONS SUBMITTED BY MR. BLACKBURN TO WITNESSES
Question. Should the Fed limit the growth of money created by the expanded
use of credit cards?
REPLY RECEIVED FROM MR. MAYO
No particular form of credit granting activity, which credit cards are, can
be singled out as a reason for the expansion in the growth of money created. The
extent to which the money supply expands depends on the reserve supplying
activities of the Federal Reserve System. Restrictions on credit cards would
be simply another type of credit allocation device.
REPLY RECEIVED FROM MR. FRANCIS
In analyzing the effect on monetary policy actions on output, prices and
employment, it is important to make a distinction between money and credit. An
increased use of credit cards involves an increase in the extension of credit, or
at least a rechanneling of credit through this instrument; however, there is no
evidence of a causal link leading from a change in one form of credit to the
pace of economic activity. Credit extended through non-bank credit cards, such
as American Express, Diners, Carte Blanche, and those issued by oil companies,
simply represents loans by these companies to their customers and does not
result in an increase in money creation. Use of bank credit cards, such as
Master Charge and Bankamericard, increases loans by banks to their customers.
On the other hand, the amount of money in the economy—checking account
deposits plus currency held by the public—is dominantly influenced by central
bank policy actions. Furthermore, there is substantial empirical evidence demonstrating that growth in the nation's money stock has a significant influence on
the rate of inflation, and, in the short-run, on the rate of output growth, and the
level of employment. Since the increased use of credit cards represents a rechanneling of loanable funds to small consumers, the Federal Reserve should not,
in my opinion, seek to limit the increased use of this means of credit extension.
248
REPLY RECEIVED FBOM MR. MORRIS
My answer is no. Credit cards presently account for less than 5 percent of
all consumer credit and even this amount is partly a substitution for other types
of consumer credit, so they pose no monetary control problem. While credit cards
are extremely convenient, their impact on the monetary system is no different
from that of other forms of consumer credit.
Question. When we speak of neutral monetary policy when we reach full
-employment: (1) How would you define full employment and neutral monetary
policy? (2) Should not full employment be treated as 5 to 5.5 percent unemployment, in view of the floor of comfort now provided for the unemployed?
REPLY RECEIVED FROM MR. MORRIS
1. I would define full employment as the level of employment which is consistent with price stability or, at most, with a gentle rise in prices. A neutral
monetary policy under these conditions would neither try to stimulate or restrain growth in the economy. Instead, monetary policy would keep the growth
of the monetary aggregates at a rate consistent with our long-term real growth
path.
2. Full employment should be treated at 4^-5% unemployment, but not
because it is so comfortable to be unemployed. The changed age-sex composition of the labor force since the early 1960s has raised the level of unemployment consistent with full employment because those groups with the highest
turnover rates have increased as a proportion of the labor force. In addition,
capacity bottlenecks in a few basic industries have meant that a higher level,
of unemployment is required for price stability until investment increases
the economy's capital stock in these fundamental areas.
Mrs. SuiiLiVAN. The committee stands in recess.
[Whereupon, at 12:20 p.m., the committee recessed, subject to the
call of the Chair.]
FEDERAL RESERVE POLICY AND INFLATION AND
HIGH INTEREST RATES
TUESDAY, JULY 30, 1974
HOUSE OF REPRESENTATIVES,
COMMITTEE ON BANKING AND CURRENCY,
Washington, D.C.
The committee met, pursuant to notice, at 10:05 a.m., in room 2128
Eayburn House Office Building, Hon. Wright Patman [chairman]
presiding.
Present: Representatives Patman, Barrett, Sullivan, Eeuss, Ashley, Stephens, St Germain, Gonzalez, Minish, Hanna, Annunzio, Eees,
Hanley, Koch, Mitchell, Fauntroy, Young, Moakley, Boggs, Widnall,
Johnson, Stanton, Blackburn, Brown, Williams, Wylie, Heckler, Eousselot, McKinney, Frenzel, Conlan, and Einaldo.
The CHAIRMAN. The committee will please come to order.
We have quite a program today. In fact, we have Dr. Burns at 10
o'clock, and we have a markup of the Eximbank and the EisenhowerEayburn coin legislation. After the markup session we have a housing
conference. We have been meeting on housing the last week or 10 days.
We spent several hours a day some days. We have hopes that we will
get that conference through probably tomorrow. We expect to work
on it some today. It is a very important bill, the housing bill.
Dr. Burns, I wish you would give consideration to your statement.
I have read it over. I t is very good. From your viewpoint it is fine,
and I do not object to that at all. I do not know of anyone who does
not present things from their own viewpoint, and I am not criticizing
you for that.
But it will be necessary for you to reduce the length of it, please,
because we would not have time to end before 12 o'clock.
How much time could you reasonably get along with and present
the questions you would like to present in the fashion you would like
to present them? Would it be asking too much to say 30 minutes?
Dr. BURNS. I could not hear you, Mr. Chairman.
The CHAIRMAN. Would it be asking too much to ask you to see if
you could not reduce your speech to 30 minutes ?
Dr. BURNS. I could reduce it to any length.
The CHAIRMAN. The reason I say that is you will be interrogated
by all members of the committee and you will have an opportunity
to bring in most anything, I think, that you would care to bring in
anyway.
Dr. BURNS. I would prefer to read my full statement, because it is
addressed with some care to the questions that you, Mr. Chairman,
have put to me. These questions, I must say, as I have told Dr. Weintraub, are very well put; that is, they go to the heart of monetary
(240)
250
policy. Therefore, I would prefer to read my whole statement. I do
not think it will take more than 30 minutes. But I can cut my time
down to 30,15,10,5, or zero.
The CHAIRMAN. We will accede to your request, and you can reauri
it, but I want to read this statement first.
This morning we continue our hearings on monetary policy. We
have before us Dr. Arthur Burns, Chairman of the Federal Reserve
Board and one of the chief economic policymakers in this administration.
Four and one-half years ago, when Dr. Burns was appointed by
President Nixon, I urged in various -speeches that he be given the
benefit of the doubt and that he be judged on his performance.
As Dr. Burns knows, I gave him personal assurance as chairman of
this committee that I would do everything possible to make sure he
had a chance to prove himself in the job before we started making
judgments.
We have differences, Dr. Burns; we have had many differences. But
I assure you that so far as I am concerned, I believe it is the same
way for other members of the committee, these differences were on
policies and not personal in any respect. Never has it been our intention to make any personal attack on you or any other member of
the administration, because we are seeking information from you
in the interest of the entire country. But we are now well into the
fifth year of your performance, Dr. Burns, and as a committee of
Congress with specific oversight functions over your agency, it is our
responsibility to start making some evaluations.
Certainly, you have had a free hand, an independent hand, as the
people at the Federal Eeserve like to call it, to set the policies and to
administer them.
It is to state the obvious to note, first, we have the highest interest
rates in the history of the Nation with the housing industry in a near
depression. In fact, most people claim it is in a depression right now,
and millions of Americans priced out of opportunities for decent
shelter.
Two, we have raging inflation. The current figures indicate something on the order of 12 percent on an annual basis.
Three, we have these storm clouds of recession and open talk of
depression. We have serious disintermediation and liquidity problems in the financial community. In fact, it is difficult to find a good
economic indicator. When we have conditions like this, it is incumbent upon the Congress to probe, to seek answers, to find out why. The
policymakers who enjoy their glories when policies go well must bear
under the responsibility without excessive buckpassing when the
policies go sour.
It does not serve the reputation of Congress well when it continues
to praise, to commend and congratulate in the face of economic realities of today. The people expect the Congress to hold the bureaucrats accountable when it has oversite functions, and carrying out
this responsibility is not always pleasant. But we are operating a
committee of the Congress with specific responsibility.
Frankly, Dr. Burns, I hope you will address your remarks here this
morning to what your agency has done, is doing, and will do, and
especially, what you expect to do about housing, unemployment, inflation, and high interest rates.
251
We have other competent witnesses available to tell us about other
branches and other departments and agencies. This morning-we are
interested in discussing the performance of your agency and the Federal Reserve Board and the-Federal Reserve System as a whole.
In correspondence received by the committee and from individuals,
we are often reminded we do not want our monetary policies run like
the Penn Central Railroad policies are run.
Now, of course, that does not refer to any particular person or any
particular policy. It just shows unrest in the country about monetary
policies, especially when interest rates are about twice, almost twice
as high as they have normally been in the history of the Nation.
So, Dr. Burns, we are delighted to have you, sir. As Chairman of
the Federal Reserve Board, you have more to do with the monetary
policy than anyone else in the United States, and we welcome your
testimony and after, I will not ask you questions at first, as normally
I do, but I would yield to different members of the committee from
side to side. To give everyone a chance, we will go around under the
5-minute rule first, and then we will start over again. If we do not
get through this morning, we will arrange for a time to continue. We
apologize for not being able to get to you earlier as planned.
This is the third meeting that you have honored us with your presence. The other two you were unable to be heard because we had other
things that we just had to get through—caucuses and bills
on the floor
we had to get passed; and we had some important lawTs that were expiring, and we had to go ahead and have hearings on them and get
them through as quickly as possible, which we tried to do.
So we welcome you and look forward to your testimony, and you
may proceed in your own way, sir.
Mr. WIDNALL. Will the gentleman yield ?
The CHAIRMAN. I will yield.
Mr. WIDNALL. Thank you, Mr. Chairman.
Dr. Burns, I want to join in welcoming you before the committee.
You have always been most cooperative in coming up here and you
have been a straight shooter. We expect you to do the same this
morning. Thank you for coming.
STATEMENT OF HON. ARTHUR F. BURNS, CHAIRMAN, BOARD OF
GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Dr. BURNS. I want to thank you, Mr. Chairman, for giving me this
opportunity and in welcoming me here this morning.
I want to thank you, Mr. Widnall, and I want to thank you, Mr.
Barrett, for your kindness in permitting me to go ahead with my statement. In due course I shall do what I can to deal with your questions.
I am pleased to appear before this committee today to discuss the
six questions posed by Chairman Patman's letter of June 19,1974. The
several areas addressed by these questions are of great interest, particularly to professional economists. My comments on them convey
the basic thinking of the Board of Governors, and will—I believe—
be responsive to the committee's needs.
I must, however, go beyond a narrow or technical interpretation of
these questions. Rapidly rising prices, rapidly rising wages, rapidly
36-714—74
17
252
rising interest rates—these are the burning economic issues of our
time. My testimony today will seek to identify the sources of this
menacing inflationary problem and to outline the course that public
policy must take to restore price stability.
The first question raised by Chairman Patman concerns the reliability of the tradeoff between inflation and unemployment—the socalled Phillips curve—as a guide for monetary policy. The discovery
some years ago of a statistical correlation between the rate of inflation
and the rate of unemployment seemed to offer a straightforward choice
to policymakers. These early studies—using data first for the British
economy, later for the United States and other economies—suggested
that unemployment could be reduced if a nation were willing to put up
with more inflation, and that advances in the general price level could
be slowed down if a higher rate of unemployment were tolerated.
Further research and subsequent developments have indicated, however, that simple statistical correlations of this kind are misleading.
The forces affecting economic activity and prices in a modern economy
are far too complex to be described by a simple mathematical equation.
We found in 1970 and early 1971, for example, that increases in
wage rates and prices may continue and even accelerate—in the face
of rising unemployment and declining real output. The experience of
the United States m this regard was not unique; similar developments
occurred at about the same time in Canada and the United Kingdom.
We have also come to recognize that public policies that create excess
aggregate demand, and thereby drive up wage rates and prices, will
not result in any lasting reduction in unemployment. On the contrary,
such policies—if long continued—lead ultimately to galloping inflation, to loss of confidence in the future, and to economic stagnation.
The central objective of monetary and fiscal policies should be to
foster lasting prosperity—a prosperity in which men and women looking for work are able to find work; a prosperity in which incomes and
savings are protected against inflation; a prosperity that can be enjoyed by all. Of late, such a prosperity has eluded us, because we have
not yet found a way to bring an end to inflation.
Let me turn to your second question, concerning the benefits and
risks involved in the Federal Reserve accommodating increases of the
general price level that originate in supply shortfalls and other special
events.
Prices in the United States have been affected heavily in the past
several years by a variety of special factors. Disappointing harvests
in 1972—both nere and abroad—caused a sharp runup of food prices
in 1973. Beginning in the fall of last year, the manipulation of petroleum shipments and prices by oil exporting countries led to huge increases in the price of gasoline, heating oil, and related products.
Furthermore, a worldwide boom in economic activitv during 1972
and 1973 led to a bidding up of prices everywhere. In the United
States, larger foreign orders for industrial materials, component parts,
and capital equipment added to growing domestic demands. Pressures
became particularly intense in the major materials industries—such as
steel, aluminum, cement, paper—in which expansion of capacity had
been limited in earlier years by low profits and environmental controls.
The impact of worldwide inflation was especially severe in the
United States because of the decline in the exchange value of the dollar relative to other currencies. Besides stimulating our export trade,
253
and thereby reinforcing the pressures of domestic demand on available resources, devaluation raised the dollar prices of imported products, and these effects spread through our markets.
More recently, the removal of controls over wages and prices has
led to sharp upward adjustments in both our labor and commodity
markets.
It has at times been suggested that monetary policy could have
prevented these special factors from affecting significantly the average level of wholesale and consumer prices. That may well be true,
but the cost of such a policy should not be underestimated. Last year,
about 60 percent of the rise in consumer prices was accounted for by
food and fuel; for wholesale prices, the proportion was even higher.
To achieve stability in the average price level, it would therefore have
been necessary to bring down very sharply the prices of other goods
and services.
Prices of many commodities—particularly farm products and industrial raw materials—are established in highly competitive markets
and are therefore capable of declining as well as rising. The prices of
many other commodities and services that make up the gross national
product, however, are nowadays rather inflexible in a downward direction, in large part because of the persistent upward push of labor
costs and imperfect business competition. For these commodities, significant price declines could be achieved only by drastically restrictive
policies—policies that would lead to widespread bankruptcies and
mass unemployment. A monetary policy that sought to offset completely the effects on the average price level of the rising cost of food,
petroleum products, and other commodities whose prices were so
heavily influenced during the past 2 years by special factors, would
clearly have been undesirable.
Nevertheless, monetary policy must not permit sufficient growth in
money and credit supplies to accommodate all of the price increases
that are directly or indirectly attributable to special factors. The rise in
the price of petroleum, for example, has increased the costs of energy,
plastics, petroleum-based chemicals, and other materials. Business
firms will endeavor to pass these higher costs through to consumers.
Workers, too, will bargain for larger wage increases, in order to compensate for declines in their real incomes. To the extent that wage
increases outrun gains in productivity, business costs—and ultimately
consumer prices—are driven up. Thus, in addition to their direct effects
on prices, special factors may have large widespread secondary effects
on the price level.
A monetary policy that accommodates all of these price increases
could result in an endless cost-price spiral and a serious worsening of
an already grave inflationary problem. The appropriate course for
monetary policy is the middle ground. The price rigidities characteristic of modern industrialized economies must be recognized, but a full
passthrough of all the price effects stemming from special factors must
not be permitted.
The middle course of policy we have adopted has resulted in a
growth rate of the narrowly defined money supply—currency and
demand deposits—of about 6 percent during the past 12 months. This
rate of growth is still too high for stability of average prices over the
longer term. But moderation in the growth rate of money and credit
354
supplies must be achieved gradually to avoid upsetting effects on the
real economy. This is particularly true now, when price-cost relations
are seriously distorted.
I turn now to Chairman Patman's third question, which relates to
the positive elements and the risks involved in monetizing deficit
spending. The simple fact is that financing Federal deficits hy printing money involves risks, and the risks are grave.
Fortunately, since 1951, monetary policy in this country has not
been conducted with an eye to providing a ready market for Treasury
securities, or for financing Federal deficits. Considerations, of this kind
were an objective of Federal Reserve policy during World War II,.,
when Treasury borrowing proceeded on an unprecedented scale in
relation to the size of our economy. I doubt if such a policy was warranted eve$ under wartime circumstances, and its continuation in the
years immediately after the war was a very serious mistake. It led toexcessive increases in borrowing by private firms, consumers, and State
and local governments, and thus fueled the subsequent inflation.
The dangers inherent in this situation became acutely evident during the Korean war, when Federal deficits once again threatened.
With the aid of prodding by the Congress, particularly by Senator
Douglas, the Federal Reserve and the Treasury resolved their disagreements, and monetary policy returned to its traditional role of
regulating the supply of money and credit in the interest of economic
stability. Since then, the Treasury has financed its deficits at prevailing market interest rates in competition with other borrowers.
During periods of large Treasury financings, the Federal Reserve
follows the practice of maintaining "even keel" in the money market—
that is, we refrain from taking overt actions that market participants
might interpret as a change in monetary policy. On some occasions,
therefore, the maintenance of "even keel" has delayed the timing of
changes in monetary policy. Treasury financing operations thus pose
problems for monetary policy, particularly when they are large and
frequent.
Federal deficit financing becomes a major source of economic and
financial instability when it occurs during periods of high economic
activity, as it has in recent years. The huge Federal deficits of the past
decade have added enormously to aggregate demand for goods and
services, and have thus been directly responsible for upward pressures on the price level. Heavy borrowing by the Federal sector has
also been an important contributing factor to the persistent rise in
interest rates, and to the strains that have at times developed in money
and capital markets. Worse still, continuation of budget deficits has
tended to undermine the confidence of the public in the capacity of
our Government to deal with inflation.
If the present inflationary problem is to be solved, and interest
rates brought down to reasonable levels, the Federal budget must be
brought into better balance. This is the most important single step
that could be taken to restore the confidence of people in their own and
our Nation's economic future.
Let me turn, next, to the committee's fourth question, dealing with
the benefits and risks of the Federal Reserve's fighting money market
fires.
256
As this committee well knows, the cardinal aim of monetary policy
is maintenance of a financial environment in which our national objectives of full employment and price stability can be realized; For
the most part, this responsibility is best achieved by striving for appropriate growth rates of the monetary aggregates, and letting financial markets take care of themselves.
The appropriate monetary growth rates will vary with economic
conditions. They are apt to be higher during periods of economic
weakness, when aggregate spending is in need of stimulus, than when
the economy is booming and inflationary tendencies threaten economic
stability. Special circumstances may, however, call for monetary
growth rates that deviate from this general rule. For example, as
noted in my response to the second question, the special factors giving
rise to extraordinary price pressures during the past year or two have
required toleration of a monetary growth rate that has been relatively
high by historical standards.
There are times when responsibility for maintaining financial and
economic stability requires the Federal Eeserve to focus attention
primarily on factors other than growth in the money supply or bank
credit. The oldest and most traditional function of a central bank is
to act'as a lender of last resort—that is, to provide liquidity when
dislocation of financial markets threatens serious damage to the economy. Acting in this capacity, the Federal Reserve, in the summer of
1970, warded off a developing liquidity crisis in the commercial paper
market. This year, difficulties encountered by a large commercial
l>ank led to rumors of widespread illiquidity of the commercial banking system. These concerns were reduced by timely Federal Eeserve
action at the discount window.
I t so happens that in neither of these instances did the Federal Reserve's intervention result in a significant deviation of the monetary
aggregates from desired growth rates. But let there be no mistake
about our determination to deal with financial troubles. In the future,
as in the past, we will surely not stand aloof and permit a crisis to
develop out of devotion to this or that preconceived growth rate of
the money supply.
The responsibility of the Federal Reserve for conditions in the
money and capital markets goes beyond its historic function to act as
lender of last resort. Monetary policies need to be implemented, I
believe, in ways that avoid large and erratic fluctuations in interest
rates and money market conditions.
From one month to the next, the public's demand for money is subject to variations that are usually of a shortrun nature. For example,
a large tax refund, a retroactive increase in social security benefit
payments, or a sizable disbursement by the Treasury of revenuesharing funds may produce a temporary bulge in the demand for cash
balances. If the Federal Reserve tried to maintain a rigid monetary
growth rate in the face of such developments, interest rates could
fluctuate widely, and to no good end. The costs of financial intermediation would be increased, and the course of monetary policy might
be misinterpreted. To avoid these harmful effects, the Federal Reserve seeks to achieve desired growth rates of money and credit over
relatively long periods. Experience over the past two decades suggests that even an abnormally large or abnormally small rate of
256
growth of the money stock over a period of 6 months or so has a negligible effect on the course of the economy—provided it is subsequently
offset.
We recognize, of course, that too much attention to preventing shortrun fluctuations in interest rates could inadvertently cause the growth
rate of money or credit to drift away from what is appropriate for the
longer run. To guard against this possibility, the Federal Reserve, in
early 1972, introduced a new set of procedures for implementing monetary policy. These procedures focus more attention on provision of
bank reserves through open market operations at a pace consistent
with desired growth rates of monetary and banking aggregates.
The new procedures have been helpful, but numerous problems of
monetary control still remain. For example, a substantial part of the
money supply is in the form of deposits at nonmember banks. As a
consequence of this and other factors, there is considerable slippage
between the supply of bank reserves controlled by the Federal Reserve
and the Nation's money supply. Monetary control is therefore less precise than it could or should be, I would once again urge the Congress
to correct this defect by extending the Federal Reserve's power oven
reserve requirements to all commercial banks.
Let me turn next to Chairman Patman's fifth question, which deals
with the relationship that interest rates, the money supply, and the
rate of inflation bear to one another.
Most interest rates in the United States are now at the highest levels
in our history. There are some who believe that restrictive monetary
and credit policies are responsible for this state of affairs. This view is
erroneous. The basic reason why interest rates have risen to their present level is the accelerating pace of price advances over the past decade, so that we now find ourselves in the midst of a two-digit inflation.
Historical evidence—from other countries as well as our own—indicates beyond any doubt that inflation and high interest rates go together. The reasons are not hard to understand. In most countries
throughout the Western World, inflationary expectations have become
deeply imbedded in the calculations of lenders and borrowers. Lenders
now reckon that loans will probably be repaid in dollars of lesser value,,
and they therefore hold out for nominal rates of interest high enough
to assure them a reasonable real rate of return. Borrowers, on their
part, are less resistant to rising costs of credit when they anticipate
repayment in cheaper dollars.
Interest rates at anything like present levels are deplorable. They
cause hardships to individuals and pose a threat to the viability of
some of our industries and financial institutions. But we cannot realistically expect any lasting decline in the level of interest rates until
inflation is brought under control.
History also indicates that high rates of inflation are typically accompanied by high growth rates in supplies of money and credit. But
inflationary tendencies and monetary expansion are not as closely related as is sometimes imagined. For example, the econometric model
of the St. Louis Federal Reserve Bank, which assigns a major role to
growth of the money stock in movements of the general price level, has
seriously underestimated the rate of inflation since the beginning of
1973. Simulations of the model, using the actual growth rates of the
money supply since the first quarter of 1972, suggest that the rate of
257
inflation during the past two quarters should have been a mere %
percent. Apparently, special factors—such as I mentioned previously—have been at work.
Inflationary processes are characterized by rising turnover rates of
the existing stock of money as well as by relatively high rates of
monetary expansion. Recent experience in the United States illustrates
this fact. Over the past 10 years, the average annual increase in the
money stock has been about 6 percent>—a higher rate than in the previous decade. Since 1964, however, the income velocity of money—that
is, the ratio of gross national product to the money stock—has risen
at an average annual rate of about 2i/£ percent, thus contributing
importantly to the inflationary problem.
The role of more rapid monetary turnover rates in inflationary
processes warns against assuming any simple casual relation between
monetary expansion and the rate of inflation either during long or
short periods. Excessive increases in money and credit can be an
initiating source of excess demand and a soaring price level. But the
initiating force may primarily lie elsewhere, as has been the case in
the inflation from which this country is now suffering.
The current inflationary problem emerged in the middle 1960's
when our Government was pursuing a dangerously expansive fiscal
policy. Massive tax reductions occurred in 1964 and the first half of
1965, and they were immediately followed by an explosion of Federal
spending. The propensity of Federal expenditures to outrun the
growth of revenue has continued into the 1970's. In the last 5 fiscal
years, total Federal debt—including the obligations of the Federal
credit agencies—has risen by more than $100 billion, a larger increase
than in the previous 24fiscalyears.
Our underlying inflationary problem, I believe, stems in very large
part from loose fiscal policies, but it has been greatly aggravated
during the past year or two by the special factors mentioned earlier.
From a purely theoretical point of view, it would have been possible
for monetary policy to offset the influence that lax fiscal policies and
the special factors have exerted on the general level of prices. One
may, therefore, argue that relatively high rates of monetary expansion have been a permissive factor in the accelerated pace of inflation. I have no quarrel with this view. But an effort to use harsh
policies of monetary restraint to offset the exceptionally powerful
inflationary forces of recent years would have caused serious financial
disorder and economic dislocation. That would not have been a sensible
course for monetary policy.
The last question put to me deals with how monetary policy should
be used to check inflation and bring interest rates down to reasonable
levels.
The principal objective of monetary policy since late 1972 has been
to combat the inflationary forces threatening our economy. To this
end, supplies of money and credit have been restricted at a time when
credit demands were booming. Inevitably, therefore, interest rates
have risen. This unhappy consequence has led some observers to conclude that restrictive monetary policies are counterproductive—because rising interest rates are an added cost to businesses and thus
may result in still higher prices.
258
There is a grain of truth in this argument, but no more than that.
For most businesses, interest costs are only a small fraction of total
operating expenses. The direct effects of a restrictive monetary policy
on costs and prices are therefore small. The indirect effects of a restrictive monetary policy on prices are far more important. When growth
in supplies of money and credit is restrained, some business firms
and consumers are discouraged by the high cost of credit from
carrying through their plans to spend; others find it more difficult
to obtain credit and therefore trim their spending; still others, reckoning that monetary restraint will cool off aggregate demand, curtail
their outlays for goods and services even though they do not depend on
the credit markets for spendable funds. In all these ways, a restrictive
monetary policy helps to moderate aggregate spending and thus to
reduce inflationary pressures.
In order to bring interest rates down to reasonable levels, we shall
need to stay with a moderately restrictive monetary policy long
enough to let the fires of inflation burn themselves out.
Progress can still be made this year in slowing the rate of price
increase, and it is urgent that we do so. Inflation has been having
debilitating effects on the purchasing power of consumers, on the
efficiency of business enterprises, and on the condition of financial
markets. The patience of the American people is wearing thin. Our
social and political institutions cannot indefinitely withstand a continuation of the current inflationary spiral.
We must face squarely the magnitude of the task that lies ahead.
A return to price stability will require a national commitment to fight
inflation this year and in the years to come. Monetary policy must play
a, key role in this endeavor, and we, in the Federal Reserve, recognize
that fact. We are determined to reduce, over time, the rate of monetary
and credit expansion to a pace consistent with a stable price level.
Monetary policy, however, should not be relied upon exclusively
in the fight against inflation. Fiscal restraint is also urgently needed.
Strenuous efforts should be made to pare Federal budget expenditures,
thus eliminating the deficit that seems likely in fiscal 1975. The Congress should resist any temptation to stimulate economic activity by
n general tax cut or a new public works program. There may be justification for assistance to particular industries—such as housing—that
are especially hard hit by a policy of monetary restraint. An expanded
public service employment program may also be needed if unemployment rises further. But Government should not try to compensate fully
for all the inconvenience or actual hardship that may ensue from its
struggle against inflation. Public policy must not negate with one
hand what it is doing with the other.
There are other actions that may be of some help in speeding the
return to general price stability. For example, limited intervention in
wage and price developments in pacesetting industries may result in
considerable improvement of wage and price performance. I would
urge the Congress to re-establish the Cost of Living Council and to
empower it, as the need arises, to appoint ad hoc review boards that
could delay wage and price increases in key industries, hold hearings,
make recommendations, monitor results, issue reports, and thus bring
259
the force of public opinion to bear on wage and price changes that
appear to involve an abuse of economic power. Encouragement to
capital investment by revising the structure of tax revenues may also
be helpful, as would other efforts to enlarge our supply potential. For
example, minimum wage laws could be modified to increase job opportunities for teenagers, and reforms are still needed to eliminate
restrictive policies in the private sector—such as featherbedding and
outdated building codes.
A national effort to end inflation requires explicit recognition of
general price stability as a primary objective of public policy. This
might best be done promptly through a concurrent resolution by the
Congress, to be followed later by an appropriate amendment to the
Employment Act of 1946. Such actions would heighten the resolve of
the Congress and the Executive to weigh carefully the inflationary implications of all new programs and policies, including those that add
to private costs as well as those that raise Federal expenditures. They
would signal to our people, and to nations around the world, that
the United States firmly intends to restore the conditions essential
to a stable and lasting prosperity.
I want to thank you for the privilege, Mr. Chairman, of reading my
whole statement.
The CHAIRMAN. Thank you, Dr. Burns, Your statement is very interesting. We will certainly give careful consideration to what you
have said in this statement.
We will not start around the table under the 5-minute rule, and if
the members will assist in maintaining that 5 minutes, so that all members may have a chance, it will be appreciated.
Mr. Barrett, since I am not asking any questions first, I will yield
to you first.
Mr. BARRETT. Thank you, Mr: Chairman.
Dr. Burns, I listened to your testimony very carefully, and I thought
it contained some differences with your economic adviser colleagues.
The chief economic adviser to the President, Dr. Herbert Stein, has
made a statement to the effect that the inflationary situation in the
economy has been caused by the American people who did not seek or
did not insist on a tax increase.
Do you agree with that kind of a statement %
Dr. BURNS. Well, I think that statement is much too brief. I do
not know what the full thought of the man who made that statement
might have been. Certainty, the American people have not been
clamoring for a tax increase. On the other hand, I am not aware that
governmental leaders have been urging that Federal revenues be
sufficient to meet the steadily and sharply rising rate of governmental
expenditures. I find it a little difficult, really, to place the blame for
the inflation that we have been having on this group or that. As I
survey the scene, I cannot help but feel that the Congress has been
to blame, the President and the entire executive establishment has
been to blame, business corporations have been to blame, and we at
the Federal Reserve Board have also not been blameless. Therefore,
my answer to your question is, the statement that you have quoted is
much too simple an explanation.
Mr. BARRETT. Dr. Burns, I assume you know the concerns that the
members of the committee have about the present mortgage money
260
market. The recent issue of the Citicorp floating rate notes and the
announced intention of other bank holding companies to issue similar
instruments are going to further drain the available mortgage funds
from the thrift institutions.
In your letter to me of July 22, and the statement from a member
of the securities industry that there may be $10 to $15 billion of such
instruments issued in the near future, it raises, I think, two questions:
First, do you not now believe that the Congress should act so <as
to give the regulatory agencies the necessary authority to exercise discretion in this area of the money market ?
May I ask you the next question, and put them together? The
second one:
Would you not agree to give the Federal Keserve the necessary
discretionary authority to section 19(a) of the Federal Reserve Act,
which should be amended ?
I have offered a substitute to the bill here offered by the committee
to give the three regulatory agencies some power to control the issuance of floating interests, and I would like to get your reaction on it.
Dr. BURNS. Thank you very much.
Let me answer your two questions as best I can. The position of
the Federal Reserve Board at present is that the Congress would be
well advised to wait a little while and see what our experience with
issues such as Citicorp may be. This is the position of the Federal
Reserve Board. We also recognize the great concern of the Congress
that money may be drained in large amounts from thrift institutions
and, therefore, the mortgage market, which is badly depressed at present, would suffer further shrinkage.
The CHAIRMAN. The time of the gentleman has expired.
Mr. BARRETT. Mr. Chairman, I ask unanimous consent to let the
gentleman answer.
Dr. BURNS. I would love to finish my thought.
Mr. ROUSSELOT. Mr. Chairman, reserving the right to object, and
I will not object—my onlv statement is, if you will allow other people
to finish their questions the same as you are doing for Mr. Barrett, I
will not object. Will you do that ?
The CHAIRMAN. NO, we cannot do that.
Mr. ROUSSELOT. Then I will object, then, if the chairman will allow
other people the same courtesy that he is giving Mr. Barrett.
The CHAIRMAN. I congratulate the gentleman on assuming that
attitude.
Mr. REES. Mr. Chairman, I ask unanimous consent that Dr. Burns
be allowed to complete his statement, his answer to Mr. Barrett's question.
The CHAIRMAN. I hope you do not insist on that. We will have to do
it for others. We will ^et back to you on the next round.
Mr. MITCHELL. Mr. Chairman?
The CHAIRMAN. We will never get through on a matter like this.
Mr. MITCHELL. Could we not establish a policy now that when a
member has put a question and Dr. Burns is responding to that question, that he be allowed to finish the answer to that question ? I think
that is only fair.
Mr. ROUSSELOT. That is my point.
The CHAIRMAN. Should we have a limitation on it?
261
Mr. MITCHELL. I am convinced that Dr. Burns will not protract his
answers so that all the time will be taken up of the committee.
The CHAIRMAN. Mr. Mitchell makes a unanimous consent request.
Is there objection ?
Mr. STEPHENS. Reserving the right to object, and I would not object. I came today to hear Dr. Burns. I wish you would let Dr. Burns
answer the question to a conclusion. I withdraw my objection.
The CHAIRMAN. The members will, of course, have another chance
to ask him questions.
Is there objection ? The Chair hears none. Go ahead, Dr. Burns.
Dr. BURNS. Out of respect for the wishes of the committee, I am
going to try to be as brief as I can.
The CHAIRMAN. YOU may elaborate on your statement when you
examine the transcript for your approval.
Dr. BURNS. Mr. Barrett asked whether I would agree to have the
Congress give the Federal Eeserve additional authority to deal with
issues such as Citicorp. If it is the wish of the Congress to move along
legislative lines, then I believe that amending section 19 (a) would do
It. A simpler way, perhaps, of achieving the same purpose would be
to accede to the Senate Concurrent Resolution 103, which clarifies
the
legislative history of the current Federal Reserve Act in such a
w7ay as to give the Federal Reserve the power to regulate issues of the
Citicorp type. I think that would be the simplest way of doing it,
through that concurrent resolution. But amending section 19 (a) would
perform the same function. If you are going to legislate, I think that
ivould be the best way to proceed.
Mr. BARRETT. Dr. Burns, would you please answer this question for
the record.
The homebuilding industry and mortgage money market is like a
sponge in our economy; when there is rampant inflation, interest rates
climb and money gets tight. The homebuilding industry and mortgage
money market are the first to feel the effects of such constraints and
the last to recover when the situation slackens.
In the past, these cycles have run about a year. At the present, however, indications are that the cycle may last 4r years.
What are you, the Federal Reserve, and the Open Market Committee going to do to relieve the problems of housing during these 4
years ?
[In response to the request of Mr. Barrett, the following information was submitted for the record by Dr. Burns:]
!
REPLY RECEIVED FROM DE. BURNS
The Federal Reserve will, as in the past, maintain an active interest in housing and residential finance during the years ahead. The Board believes that
the most important single contribution that could be made in this period toward
relieving problems associated with the stability of the housing industry would be
to obtain better control over the forces of inflation. That is now the principal
objective of monetary policy.
The basic goals of monetary policy, of course, are more general—to contribute
to achieving high employment with sustainable growth, a stable dollar at home,
and over-all balance in our financial transactions with other nations. In contrast
to these goals, the Federal Reserve has no specific authority insofar as housing or
other individual branches of the economy are concerned. Nevertheless, several
aspects of the System's general responsibilities will undoubtedly have a direct
bearing on housing and residentialfinancein the future.
262
For example, the Federal Reserve purchases securities of Federal credit agencies, as well as direct Treasury debt, in the conduct of its open-market operations.
Net purchases of FNMA, FHLBank, and Farmers Home Administration securities by the System totaled more than $1.3 billion in the first seven months of
1974, compared with $200 million in the same period of 1973. Further transactions in such securities will probably occur in the years ahead under carefully
defined guidelines, designed to add breadth to this market without running the
risk of dominating it.
Regulation of ceiling rates of interest on time and savings deposits of member
banks also influences the state of housing finance. Gradual easing of Regulation
Q ceilings on consumer time and savings deposits at member commercial banks,
and similar action on rates paid by savings banks and S&Ls, may be possible in
coming years, once a number of fundamental steps have been taken to strengthen
our depositary institutions. Any such easing would, of course, increase the flow
of savings to thrift institutions, and expand the potential supply of mortgage
credit. In this connection, the Board continues to endorse the basic principles
of the Report of the President's Commission on Financial Structure and Regulation (the Hunt Commission) and the general provisions of the Financial Institutions Act of 1973, many of which are of substantial significance for housing
finance. Once appropriate broadened lending and investment powers have been
secured for depositary institutions, it should then be feasible to gradually withdraw restrictions on interest rates paid on their deposit accounts, and to replace
the statutory controls with standby powers to reimpose the ceilings in the event
of unforeseen contingencies.
Additionally, the Federal Reserve continues to stand ready to provide emergency credit facilities, if needed, for financial institutions other than banks.
Assurance that this backstop exists encourages lending institutions to make
commitments of funds to the mortgage market.
Beyond these specific responsibilities, the Federal Reserve will continue, as the
need may arise over the years ahead, to support appropriate policy actions
through HUD, the Federal Home Loan Bank System, and the federal housing
credit agencies to mitigate any undue burden on housing of generally restrictive credit conditions. The Federal Reserve, for example, actively encouraged
the Administration's special housing policy actions announced May 10, 1974,
making some $10.3 billion of additional funds available through the Government
National Mortgage Association, the Federal Home Loan Mortgage Corporation,
and the Federal Home Loan Banks.
In addition, the Board may itself, from time to time, call the attention of the
Congress to other measures that should be considered for strengthening housing
finance or for stabilizing the housing market. As recently as March 1972, the
Board transmitted to the Congress a comprehensive report on "Ways to Mod*
erate Fluctuations in the Construction of Housing." and testimony on the report
was later presented before the Subcommittee on Priorities and Economy in
Government of the Joint Economic Committee.
While several proposals contained in the Board's 1972 report have since been
adopted in some form, numerous others—such as the removal of legal and regulatory obstacles to flows of mortgage credit—remain to be implemented in whole
or in part. Two high-priority Board recommendations yet to be adopted are the
flexible use of a tax credit on business fixed investment in machinery and equip*
ment, and provisions for wider use of variable-rate home mortgages under
terms which would be fair to both the borrower and the lender.
The CHAIRMAN. All right.
Mr. Widnall?
Mr. WTDNALL. Dr. Burns, your statement is a curious combination
of optimism and pessimism concerning our economic future. Perhaps
this is the only realistic way to view the situation. However, there is
one sentence in your testimony that causes me special concern. On
page 19 you said, and I quote:
Our social and political institutions cannot indefinitely withstand a continuation of the current inflationary spiral.
Because I respect and admire your abilities, not only as an economist, but also—and this is important—as a man of great social
263
insight, I would appreciate it if you would elaborate on that statement.
Dr. BURNS. I will try to be brief.
If you turn to European countries that have practiced inflation,
you find that inflation has had very injurious and disturbing consequences for the social and economic systems and the political system.
The CHAIRMAN. Let us have order, please.
Dr. BURNS. The collapse of Russia in 1917 was in part due to the
huge inflation experienced by that country at that time. What happened in Nazi Germany during a most unhappy period for all of us
is in large part traceable to the galloping inflation experienced in
that country after World War I.
When you turn to Latin America, you find one revolution after
another caused to a significant degree by the social upheaval, the
misery, generated by inflation. Once inflation takes root in a country, and if government does not deal properly with it the road is
wide open for demagogs to exploit the sense of frustration, the sense
of misery, that is felt by many. These are some of the thoughts that
ran through my mind when I wrote that sentence.
Mr. WIDNALL. Last week while testifying before this committee,
Dr. David Eastburn, president of the Federal Reserve Bank of Philadelphia, expressed skepticism of a credit allocation scheme because of
the problems of the workability and the enormous costs it might
engender. What is your feeling on that subject?
Dr. BURNS. I share Dr. Eastburn's concern. I have just written Congressman Reuss a long letter dealing with the problem which I am
sure he would be glad to share with members of this committeie. I
should say in fairness that in that letter, where I expressed the basic
thinking of the Board on credit allocation, I also indicate that one
of my colleagues on the Board, Governor Brimmer, has a different
view, and Governor Brimmer will be writing to Congressman Reuss
separately.
The concept of credit allocation implies a degree of knowledge of
social priorities that I for one am quite certain that we at the Federal
Reserve Board do not have. I think the Congress would not be well
advised to give us a power that we simply do not know how to exercise properly. If we are to have credit allocation in this country, then
I think credit allocation should proceed according to rules devised
by the Congress. But there again, I must say, in all humility, that I
am not at all sure that Congress has the wisdom to substitute its rules
for the workings of the marketplace.
The CHAIRMAN. The time of the gentleman has expired.
Mr. WIDNALL. Thank you very much.
The CHAIRMAN. Mrs. Sullivan ?
Mrs. SULLIVAN. Thank you, Mr. Chairman.
Dr. Burns, I have a series of questions for you. But should my time
run out, I will submit them, the unasked questions, to the reporter at
that point, so that you may complete your answers in your copy of the
transcript.
Dr. Burns, in your opinion is any form of credit today being extended in the United States in an excessive volume ?
Dr. BURNS. Let me say this, that I have felt unhappy over the
extremely rapid growth of loans by our commercial banks to busi-
264
ness firms, that is, the rapid growth of business loans by commercial
banks this year. This year during the first quarter, the rate of growth
in business loans proceeded at an annual rate, I believe, of 22 percent,
and during the second quarter at an annual rate of 23 percent. These
are enormous increases. I think I can explain them up to a point.
But I have been disturbed by the rapid advance in that sector.
Mrs. SULLIVAN. Well certainly, mortgage credit is not being extended in excessive volume, and I guess it is safe to say that securities
credit, at least on common stocks, is not being extended in an excessive
volume.
But how about the other specific areas that you mentioned—business, business loans? What about consumer credit?
Dr. BURNS. The rate of growth of consumer credit has tapered off
rather sharply, and I am not concerned about that.
Mrs. SULLIVAN. Well, what about credit for speculating in commodity futures? Are any of these being extended in an excessive
volume?
Dr. BURNS. I do not have any data. Whether they exist or not, I am
not sure. I doubt it. In any event, I do not have any data on the amount
of credit extended for that purpose.
Mrs. SULLIVAN. For commodity markets ?
Dr. BURNS. I will look into that specifically. But I doubt if statistics on the subject are available.
[In response to the request of Mrs. Sullivan, the following information was submitted for the record by Dr. Burns:]
REPLY RECEIVED FROM DR. BURNS
I doubt that any appreciable volume of credit is being extended for the purpose of speculating in commodity futures. Banks would be extremely wary
about making loans for that purpose. However, my response must remain conjectural, since no data are available on the amount of credit extended for that
purpose.
The only information that we have relating specifically to the financing of
commodity markets appears in the breakdown of business loans by industry of
borrower that is reported weekly by about 160 of the largest banks in the country. This report includes a category for outstanding loans to "commodity dealers."
The credit extended to these borrowers is used mainly to finance working inventories ; little of it would be used for speculative acquisitions. Over the past
year, loans to commodity dealers have expanded by about 15 per cent, or less
than the increase in prices of raw commodities during that period.
Mrs. SULLIVAN. Would you say that at any time in the past Sy2
years any form of credit was being extended in an excessive volume,
and if so, in which areas or at which times ?
You mentioned the commercial banks loaning to business. Is there
anything else in the past 3^2 years ?
Dr. BURNS. I would say that consumer credit rose much too sharply
during 1972 and part of 1973, but not now. Yet, I keep on being urged
to do something about consumer credit at the present time. In the first
place, we do not have the power under the law to do that on our own
initiative. In the second place, if we had the power, this is not the
time to use it. However, had we had the power, we probably should
have used it in 1972 and early 1973.
Mrs. SULLIVAN. Well, Dr. Burns, I am sure you know why I am asking these questions.
Dr. BURNS. Yes, I think I do.
265
Mrs. SULLIVAN. They refer to the specific language in the Credit
Control Act of 1969.
Dr. BURNS. Yes.
Mrs. SULLIVAN. The
Economic Stabilization Act of 1971, providing
unprecedented powers to the President to control interest rates and
the terms and conditions of any form of credit in the United States,
and that authority has never been used. But under the Credit Control
Act, the President could have the Federal Keserve Board regulate
and control any or all extensions of credit.
Dr. BURNS. That is correct.
Mrs. SULLIVAN. Whenever he determines that such action is necessary or appropriate. I believe you told us early in 1970, after you took
over as Chairman of the Federal Keserve, that you were mighty glad
that law, the Credit Control Act of 1969, was on the books. I believe
you testified on that before this committee, and this was shortly after
President Mxon had denounced us for passing that law and attaching
it to a bill that he could not veto. But nothing has been done under it.
Now, what I would like to ask, have you ever suggested to the President that he implement this law, or have you been convinced for the
past 3y2 years that no form of credit has been extended in an excessive
volume contributing to the generation of inflation ?
Dr. BURNS. At no time since the passage of the Credit Control Act of
1969 has the Federal Reserve Board petitioned the President to implement that legislation for any specific purpose.
Mrs. SULLIVAN. Thank you. My time has expired. I would love to explore that with you, but I will put it in the record.
[The following are written questions submitted by Mrs. Sullivan,
along with Dr. Burns' answers:]
Question 1, Dr. Burns, under the Credit Control Act of 1969, when you felt
consumer credit was excessive, could not the Fed have set a payment level or a
percentage of credit allowed on the consumer item ?
REPLY RECEIVED FEOM DR. BURNS TO QUESTION 1 SUBMITTED BY MRS. SULLIVAN
Sec. 205 of the Credit Control Act provides that, under a specified set of circumstances, the President may authorize the Board of Governors "to regulate
and control any or all extensions of credit". Sec. 206 of the Act further provides
that the Board—if given this general authority by the President—may by regulation prescribe limits on a wide variety of the terms on which credit is extended,
including interest rate, maturity, repayment schedule, and the amount of the
initial loan.
The Federal Reserve could have set limits on the extension of consumer credit,
if the President had been willing and able to give the Federal Reserve the authority, and if the Board had felt that consumer credit was being extended in excessive volume. The President could have gracnted that authority only under one
specific condition: "that such action is necessary or appropriate for the purpose
of preventing or controlling inflation generated by the extension of credit in an
excessive volume".
Question 2. At the administration's request, we wrote different language into
the Economic Stabilization Act of 1971 allowing the President, rather than the
Fed, to regulate interest rates consistent with orderly economic growth, and
President Nixon put you in charge of that. But again, nothing was done to regulate a single interest rate in any part of the economy.
Do you feel we had no choice in all of these past 3 or more years than to let
interest rates drive us to the brink of disaster?
No President in our history had such powers—not even in wartime.
266
REPLY RECEIVED FROM DR. BURNS TO QUESTION 2 SUBMITTED BY MRS. SULLIVAN
The deplorably high interest rates that have developed in recent years are
fundamentally a reflection of the rapid inflation that has prevailed in the United
States and other key countries of the world. When lenders foresee a period of
persistent and substantial inflation ahead, in which the purchasing power of
interest and principal payments is likely to be depreciating, they naturally try to
protect against this risk by increasing their interest charges. Borrowers, on the
other hand, are deterred less by high interest rates because the outlays financed
on credit today may look inexpensive when compared with the much higher
total costs expected for the same items in the future.
While the over-all interest rate level rose during the past three years as a
result of inflation, certain measures were taken to alleviate the difficulties caused
by rising market interest rates. As a result of an executive order issued pursuant
to the Economic Stabilization Act, the Committee on Interest and Dividends
undertook a voluntary program of interest restraint. The Committee concentrated on interest rates charged by banks and other financial institutions to small
businesses, consumers, home buyers, and farmers—that is, to borrowers without
significant access to alternative sources of funds. The Committee's program protected such borrowers against burdensome increases in interest costs in a period
of rising open market rates.
The Committee recognized that open market rates are determined under highly
competitive conditions and reflect daily changes in the supply of and demand
for funds. Any attempt to control such rates would have distorted the flow of
funds in the economy and would have interfered with monetary policies designed to deal with changing economic conditions. For example, efforts by the
Committee to interfere with the market process by attempting to hold down
market rates in an inflationary environment would have vitiated the restrictive
effect of rising market interest rates on credit demands, would thereby have
worsened inflationary pressures, and would, in the end, have caused interest
rates to rise even more as inflation worsened.
As part of its activities, the Committee pioneered by recommending a dual
prime rate to banks—one applicable to large businesses and one to small businesses. The interest rate on loans to small businesses and also the rates on loans
to the other small borrowers who were of principal concern to the Committee
were subject to special restraint, while movements in the large business prime
rate were permitted to be more reflective of market interest rates. The interest
rate criteria issued by the Committee specified that interest rate increases on
smaller loans could be made only if fully justified by increases in costs of lendable
funds to the extent that such increased costs were not offset by higher earnings
on other loans and investments.
Interest rate data indicate that the interest rates subject to special restraint
by the Committee rose decidedly less than open market rates or the large business prime rate during the two year period of strong upward interest rate pressures from the spring of 1972 to the spring of 1974. While the large business
prime rate rose about 5*4 percentage points, rates charged by banks on small
short-term business loans rose only about 2y2 percentage points, on farm loans
around 2 percentage points, on consumer loans less than y2 of a percentage
point, and on home mortgages about 1% percentage points. Thus, small borrowers were to some degree protected in a difficult period, characterized by strong inflationary pressures and large credit demands.
But there are clear limitations on the extent to which particular interest rates
can be regulated. If some rates are arbitrarily kept unduly low, lenders will shift
their funds to other uses in a period of rising market interest rates, when the
lenders, themselves have to bear an increasingly high interest cost in order to
raise funds in the market. Moreover, it would be counter-productive to attempt
to supply through monetary policy additional credit in an effort to lower interest
rates generally in an inflationary environment. Such a policy would only make
the inflation worse, and lenders would become even more unwilling to commit
funds except at increasingly high interest rates while borrowers would accelerate
credit demands for fear of higher costs later.
The solution to the problems of high interest rates is to control the basic cause
of the high rates—that is, to control inflation. A number of specific factors—such
as poor crop harvests in many key producing countries, and the decisions of oilexporting nations to boost petroleum prices—have contributed to the rapid inflation of recent years. These factors have clearly been beyond our control. But
267
the inflation from which we are suffering is also a result of inadequate economic
stabilization policies. In recent years, Federal spending has risen swiftly, deficits
have been chronic, and the public debt has mounted. While our present grave
problem of inflation stems from many causes, inadequate fiscal discipline is
prominent among them. Fiscal restraint would, in the past, hare reduced Governmental demands on credit markets and thereby lessened interest rate pressures, and, if practiced, will do so in the future.
Question S. Do you agree with the view expressed by some Reserve bank presidents that over an 8 or 9-year period the rate of inflation is closely tied to money
supply growth?
REPLY RECEIVED FROM DR. BUBNS TO QUESTION 3 SUBMITTED BY MRS. SULLIVAN
Most economists would agree that over long time periods changes in the
money supply and changes in prices are related to one another. There is disagreement, however, on the length of the time period over which this relationship
holds, and on how close a relation exists between money and prices. Professor
Friedman, commenting on the relationship between money growth and prices in
a recent letter to Senator Proxmire, noted that "this is an average relationship,
not a precise relationship that can be expected to hold in exactly the same way
in every month or year or even decade." The imprecision of this relationship is
one reason why monetary policy does not seek to achieve a fixed growth rate in
the money stock.
The CHAIRMAN. Mr. Johnson ?
Mr. JOHNSON. Thank you, Dr. Burns.
As I have said, it is very refreshing to have you here today, and
your statement certainly is a powerful statement. You have made some
very strong statements, such as, in commenting on the fact that you
helped save a large bank recently, that:
"In the future, as in the past, we will surely not stand aloof and permit a crisis to develop out of emotion to this or that preconceived
growth rate of money supply."
What I want to ask is: Over the weekend somebody came to me
and said, well, what are you fellows down there in Congress going
to do to stop inflation, which is the stock question that we get wherever
we go. In your statement I was looking to see what you think Congress can do—first of all, you say we must exercise fiscal restraint;
second, not indulge in any tax cut, expand public service employment
if we deem it necessary.
But I think the most significant statement that we should reestablish the Cost of Living Council. This spring I went along with those
who did not want to reestablish the Cost of Living Council, thinking
that this committee would exercise oversight and that we would watch
raises in wages and prices and would act quickly. But I can see that we
just do not simply seem to be equipped to do it.
You feel that we should reestablish the Cost of Living Council,
and I notice what you have said does not give them any particular
power, but you suggest to give them broad investigatory powers and
that of making recommendations, and then making their findings
public, which is a powerful weapon. Is that about what you have in
mind?
Dr. BURNS. That is correct. The only thing that I would add is that
I would also reestablish the Construction Industry Stabilization Committee, which was a powerful force in keeping the rate of increase in
construction wages within moderate bounds. You may recall that in
1969 and 1970 construction wages began skyrocketing—increases of 10,
15,20, and 25 percent became rather commonplace, and these increases
36-714 0—74
18
268
in the construction industry soon spread to manufacturing industries.
We are in danger at the present time of going through, once again,
that kind of experience. Therefore, reestablishment of the Construction Industry Stabilization Committee would, I think, be a salutary
step.
Mr. JOHNSON. It is generally felt that one of the important reasons
for the high rate of inflation in the United States is existence of even
higher rates of inflation in most of the other countries in the world,
and that is the reason we had so many foreign governments fall in
the last 6 months. I notice their inflation rate was anywhere from 12
to 24 percent.
Can we realistically expect to retard our inflation rate at home
when the rest of the world is experiencing rapid price increases?
Dr. BURNS. I would answer that question in the affirmative. For one
thing, our example would be followed in very large part by the rest
of the world. The world looks to us for leadership. Once we begin
bringing our rate of inflation down through a policy of monetary and
fiscal prudence, other countries will follow, I think, quite promptly.
Second, we must also bear in mind that foreign trade is a rather
small factor in our economy. Though inflationary forces may come
from the outside, they will ordinarily be a small factor in our total
economic picture.
Mr. JOHNSON. What do you think of the statement by one of the
presidents of your banks where he, in answer to another question, said,
well, we, the Fed, are not the ones that are raising interest rates.
Do you have a comment on that statement ?
Dr. BURNS. Well, I think that is basically true. Interest rates are
established in our highly competitive money and capital markets. The
Federal Reserve has not been starving this economy for money and
credit. If anything, the rate of growth of money and credit has been
a little too rapid. What has happened is that the demand has grown
much more rapidly than the supply, and therefore, interest rates have
shot up.
Mr. JOHNSON. Thank you. My time has expired.
The CHAIRMAN. Mr. Reuss ?
Mr. REUSS, Thank you, Mr. Chairman.
I will yield briefly to Mr. St Germain, who must be elsewhere in a
moment.
Mr. S T GERMAIN. I thank the gentleman for yielding.
Chairman Burns, what would the attitude of the Federal Reserve
Board be toward regulation of commercial paper, traditional commercial paper as defined in section 3(a) (3) of the Securities Act of
1933, under the Senate bill and under the proposed legislation in the
House?
Dr. BURNS. Regulation of commercial paper ?
Mr. S T GERMAIN. What is your attitude toward the regulation of
commercial paper, as opposed to the regulation of notes like the Citicorp notes ?
Dr. BURNS. The Board has not taken any position on the regulation
of the commercial paper market as a whole. The Board has taken a
certain position and has communicated with your chairman and Mr.
Barrett on regulation of issues such as those by Citicorp and now proposed by Chase Manhattan Bank.
269
Mr. ST GERMAIN. If you would, for the record—I do not want to
impinge any further on Mr. Reuss' time—would you tell us what your
attitude would be if the Senate resolution is adopted or if the legislation before the House committee is adopted ?
Thank you.
[In response to the request of Mr. St Germain, the following information was submitted for the record by Dr. Burns:]
REPLY RECEIVED FROM DB. BURNS
The Board understands that the principal purpose of the legislation under
consideration is to authorize the Board to regulate bank holding company note
issues which are clearly directed to the individual saver-investor. Commercial
paper has, however, historically only been sold in large denominations to sophisticated institutional investors. The legislative history of the 1969 amendment
to section 19 makes clear that the Board was to have the authority to classify
obligations of a bank holding company as deposits if the proceeds of the obligations were channeled by the parent holding company to a subsidiary bank. To the
extent that proceeds from the sale of commercial paper by bank holding companies are so used, they are presently subject to reserve requirements applicable
to member banks. The Board does not, however, understand the present amendment as being directed toward commercial paper issues and would not view its
enactment as conferring any additional authority to regulate commercial paper
issues by bank holding companies.
Mr. REUSS. Chairman Burns, a couple of months ago, before our International Finance Subcommittee, you educated me to good effect on
budgetary matters. You pointed out that over the last 5 years the
regular budget deficits have come to $68 billion, and now I quote you:
Troublesome enough, but when one takes into account outlays of Federal
agencies not included in the budget, such as the Export-Import Bank, the total
deficit for those 5 years comes to a staggering $109 billion.
I took in good heart your observation, and I am pleased to report
that though Congress, as you know, for some reason back in 1971 took
the Eximbank out of the budget where it had always been, the other
day the committee, in marking up the bill, specifically provided that
the Export-Import Bank should be back in the budget.
I think this is a good provision because, for example, in fiscal 1973
Exim disbursed $1.9 billion, but only got back in interest and principal
$1.3 billion. So there was $600 million that really was a stimulus to the
economy.
Do you share my feeling that we are making some progress in putting that back into the budget just like any other expenditure?
Dr. BURNS. I have testified on this question previously. I was opposed to taking the Export-Import Bank out of the Federal budget,
and my view philosophically on that question has not changed.
The only hesitation that I would have at the present time is this:
According to my understanding, Congress must act quickly on the
Export-Import Bank legislation. I think action must be taken this
month. If action is not taken, the Export-Import Bank would have to
shut down. Whether you can carry through this reform, which I endorse, in such a short time, I would not know. But sooner or later,
it ought to be done.
Mr. REUSS. I think we can provide it by supplemental appropriation
funds to keep the Bank operating if it needs to be done.
Let me now turn to the very interesting discussion you had with
Mr. Widnall and Mrs. Sullivan about credit allocation. I thank you for
270
your letter, which has not reached me yet, but I certainly will share
it with all my colleagues here. [See page 271.] You point out—and
I think you are rights—that the Fed does not feel up to being told
that it must make these great social priority decisions.
I have, in the legislation I have submitted, tried to delineate what
they ought to be. As you know, I have specifically said productive
capital investment, low- and moderate-income housing, small business,
and State and local governments should be preferred objects of credit
allocation, which means that all the other things, like this 33-percent
increase in inventory loans to business, would have less credit. The
interest rate on these business loans would go up and that would serve
an allocating function. I am pleased at your answer because it indicates
to me that there is an area for discussion here, and we do intend to go
into it at greater length.
I like too, and agree with, your urging on page 20 of your paper,
where you say:
I would urge the Congress to reestablish the Cost of Living Council and to empower it as the need arises to appoint a review board that could delay wage and
price increases, monitor results, and so forth.
I like that recommendation. I would be disposed to take steps to do
something about it tomorrow were it not for the fact that the President, last Thursday, came down very strongly against what he called
"the discredited patent medicine of wage and price controls", which
turns back or delays wage or price increases. A price-review board is,
of course, a control. I think we need it.
I just want to share with you the fact that it is not easy for Congress
to respond if it feels that at the end of the road what we do will not
be welcome.
Dr. BURNS. I am not at all sure that my suggestion is inconsistent
with the President's statement. Perhaps it is. I am not sure of that,
though.
Mr. REUSS. Well, we will have to find out. If it is not inconsistent,
let us get on with carrying out these things.
Thank you, Mr. Chairman.
[Mr. Reuss submitted the following letters for inclusion in the
record from Chairman Burns and Governor Andrew F. Brimmer of
the Federal Reserve Board. The letters comment on H.R. 15709, legislation which would amend the Federal Reserve Act to permit the Federal Reserve Board to allocate credit so as to serve national priority
needs:]
271
CHAIRMAN OF THE BOARD OF GOVERNORS
FEDERAL RESERVE SYSTEM
WASHINGTON, D. C. 20551
July 29, 1974
The Honorable Henry S. Reuss
House of Representatives
Washington, D. C. 20515
Dear Mr. Reuss:
The Board welcomes the opportunity to comment on H. R. 15709,
a bill which would amend the Federal Reserve Act to permit the Federal
Reserve Board to allocate credit so as to serve national priority needs.
We recognize that monetary policy can have a differential
impact on particular types of credit flows and, accordingly, tftat there
is a continuing need to explore ways to minimize unwanted selective
effects of general monetary restraint. The Board believes, however,
that it would be inappropriate to grant the central bank discretionary
power to allocate credit according to its judgment of national priority
needs. The determination of national priority needs—that is, whether
more or less credit should flow to housing, small business, agriculture,
and so o n — i s highly important in a democracy, but it is unwise for a
central bank to become involved in such questions. This responsibility
may conflict with the critically important responsibility of providing
the money and credit needed to promote economic growth with a minimum
of inflation. We believe that the discretion of the central bank
should be confined, in the main, to such matters*of general monetary
policy.
H. R. 15709, which would allow the Board to impose supplemental
reserves and credits on member bank assets, would pose serious problems
for monetary policy. These problems are analyzed in detail in several
papers by the Board's staff in our publication Federal Reserve Staff
Study: Ways to Moderate Fluctuations in Housing Construction, a copy
of which we have enclosed for your convenience. A particularly
troublesome problem would be that the imposition of reserve requirements and credits such as you have proposed would reduce the precision
of Federal Reserve control over the stock of money and bank credit,
since shifts in the level of required reserves would result from
changes in the composition of bank asset portfolios.
Furthermore, the restructuring of member bank portfolios
induced by these differential requirements would probably have only
minimal effects on the flow of funds among the various sectors of the
economy. To the extent that member banks sought more of any asset
272
The Honorable Henry S. Reuss
Page Two
that qualified for a reserve credit, the yield on that asset would
tend to decline and other lenders would tend to withdraw from that
market. For those assets on which supplemental reserve requirements
were applied, the costs of funds to borrowers at member banks would
rise--and these borrowers would try to satisfy their credit needs
from other sources. Thus, shifts in bank credit demands and supplies
would tend to offset the effects that supplemental reserves and credits
would have in changing member bank asset preferences.
Supplemental reserve requirements and credits on assets would
also cause serious administrative problems for the Federal Reserve
System, Member banks would have to devote large amounts of additional
resources in order to supply detailed asset data. If reserve require- ,
ments on assets were to be calculated on a comparable basis with those
on liabilities, such data would betneeded on a daily basis. If the
reserve credit-or supplement were to apply over the entire life of an
asset, as might be necessary, records would have to be kept for each
and every asset on a bank's books over the life of those assets.
There would also be enormous problems encountered in translating
phrases such as "useful capital investment" into defensible operational categories of bank loans.
Finally, since the added costs implied by the reserve
requirements on various assets and the need for additional detailed
data WQuld-apply only to member banks, the competitive disadvantage
of membership in the Federal Reserve System would be increased, thus
aggravating an already serious problem. Even if,the bill were extended
to all commercial banks, these banks would be placed at a competitive
disadvantage vis-a-vis other financial institutions. To avoid such
effects, nonmember banks and nonbank institutions would need to be
subjected to comparable incentives and disincentives.
In light of these considerations, the Board opposes the
enactment of H. R. 15709. However, we recognize that our financial
markets may not provide adequate supplies of credit for high priority
uses, as judged by Congress. There are a number of Federal agencies
that already exist for this purpose whose activities have proven
constructive. For example, agencies such as the Federal Home Loan
Bank System, FNMA, and GNMA, have provided massive assistance to the
housing industry in times of need. Further consideration should be
given to encouraging additional lending to the mortgage market from
private sources through a tax credit for interest income on residential mortgages. There are other Federal credit agencies that
furnish credit to farmers and to small businesses, and still others
273
The Honorable Henry S, Reuss
Page Three
that make loans to students. These agencies have performed a vital
service in rechanneling credit flows to high priority uses.
If the Congress should conclude that certain national
priority needs deserve more ready access to sources of credit than
now exist, we believe that the most direct, and probably also the
best, means of accomplishing this objective would be to expand the
scope of operations of existing Federal credit agencies in those
areas, and to create new entities where they are needed. In the
special area of housing and mortgage credit, the Board would suggest
consideration of the several recommendations it made in its report
to Congress in March 1972.
I hope that these comments, which represent the thinking
of the Board, will be helpful to y$u and the House Committee on
Banking and Currency. Governor Brimmer, however, has arrived at
different conclusions, and I have suggested that he write you
directly.
Sincerely yours,
Arthur F. Burns
274
BOARD OF GOVERNORS
FEDERAL RESERVE SYSTEM
WASHINGTON. O. C. 2 O 5 5 I
ANDREW F. BRIMMER
August 5, 1974
The Honorable Henry S. Reuss
House of Representatives
Washington, D. C. 20515
Dear Congressman Reuss:
I am responding to your letter of July 10, 1974. You"asked
me (along with other Board Members) to comment on the legislation
which you have introduced designed to tmpower the Federal Reserve
Board to influence ""explicitly the sectoral distribution of bank credit.
In a letter of July 29, 1974, Chairman Burns responded on behalf of
the other Board Members. It was indicated that I would respond separately
since I did not share the position adopted by the majority of the Board.
First of all, I wish to applaud your effort to provide the
Federal Reserve with additional instruments which would enable the
Board to cope more effectively with the distortion in the sectoral
distribution of bank credit which typically occurs during periods of
monetary restraint. I have also been troubled by the-same range of
difficulties which have concerned you. In fact, as>long ago as April,
1970, I suggested that the Board be given authority -to establish supplemental reserve requirements on bank assets. Such supplemental reserves
would have been set on a differential basis — thus allowing the Board
to encourage banks to channel funds into areas of high national priority
and to discourage bank credit lending in areas of lesser importance.
In the Spring of 1971, the Subcommittee on*Financial Institutions of the
Committee on Banking, Housing, and Urban Affairs of the U. S. Senate
held hearings on a bill containing many of the features of the proposal
which I advanced. At that time, the majority of the Board also objected
to being granted sueh authority. In appearing before the Subcommittee,
I favored the idea; I still favor a similar attack on the problem.
Your proposed legislation is- superior to the earlier approach
because it would provide for the establishment of a system of both
supplementary reserves and credits. This provision would endow the
Board with a great deal of flexibility, and it would also deal with
some reservations raised with respect to the earlier proposal.
275
The Honorable Henry S. Reuss
Page two
August 5, 1974
The general nature of the problem on which you focus is
widely understood. As you know, in a number of papers, I have documented the adverse effects of monetary restraint on sectoral credit
flows. One of these was presented at the Annual Meeting of the American
Finance Association in December, 1972. Another was presented at the
American Economic Association Annual Meeting last December. I have
enclosed copies of these papers for your information.
In essence, during a period of substantial monetary restraint,
the resulting higher costs and lesser availability of bank credit strike
different sectors of the economy most unevenly. In general, banks show
a strong preference for lending to long-standing business customers
(particularly large corporations) whi^e other potential borrowers
receive a reduced ^share of the available funds. At the same time,
there is typically a sharp shift in the flow of funds away from housing,
State and local governments, small business, finance companies, and
farmers. In contrast, business borrowers are affected to a much lesser
extent -- although the cost of funds to them does rise substantially.
Operating under your proposal, the Federal Reserve could
provide a genuine incentive fcfr banks to concentrate on socially
desirable lending. It is true that, within the framework established
by the bill, the Board would have a great deal of discretion to vary
supplemental reserve requirements. However, no central bank credit
would flow into particular sectors. Instead, by varying the structure
of supplemental reserves or credits, the Board could induce banks to
respond more explicitly to the hi-gh priority financing needs of the
economy.
Over the last four years, during which I have been calling
attention to the need for authority similar to that which you propose
to give the Federal Reserve, I have encountered a number of reservations.
These have been raised within the Federal Reserve System as well as by
observers on the outside. Some of these were expressed by the majority
of the Board in Chairman Burns' letter of July 29. I see no need to
respond in detail to those reservations at this time. I would simply
say that they do raise a number of issues on which you and your Committee ought to focus. For my part, while I recognize the basis of
the reservations, I personally think that the benefits which would
accrue from implementing the proposal outweigh the types of costs
which others have identified. In a paper I gave in April, 1970, I did
address myself to some of the(similar) objections which had been
276
The Honorable Henry S. Reuss
Page three
August 5, 1974
expressed at that time. Many of these reservations involve mainly
technical issues. Consequently, the application of a reasonable amount
of first-rate staff talent should result in their resolution. I also
enclose a copy of that paper for your information.
In passing, I should note that the use of differential
reserve requirements to influence sectoral credit flows is quite
common among some foreign central banks. This is especially so among
banks in developing countries. I summarized the experience of some
of those foreign institutions in a paper which I delivered in Jamaica
in 1970. I have also enclosed a copy of that paper.
Again, I applaud your efforts to have the Federal Reserve
given additional instruments to deal more effectively with the adverse
shifts in credit flows associated with monetary restraint.
Sincerely yours*,
277
The CHAIRMAN. Mr. Stanton.
Mr. STANTON. Thank you, Mr. Chairman.
Dr. Burns, on page 9 of your statement you point out that if the
present inflationary problems are to be solved, and interest rates
brought down to reasonable levels, the Federal budget must be brought
into better balance. You go on to say this is the most single important
step that could be taken to restore the confidence of people in their
economic future.
The Secretary of the Treasury, it seems to me he went a step further
than you do in urging upon Congress not a better balance, but a totally
balanced budget, and if possible, a surplus, and I wondered if you
agree with that view.
By saying "better balance" have you stayed away from the possibilities of a balanced budget ?
Would you comment on that, please ?
Dr. BURNS. I used the phrase "better balance." It is a vague phrase
but I am glad to have the opportunity to clarify my thought, I would
certainly favor, at a time like this, a budgetary surplus. We should
have been running a budgetary surplus. 1 would favor thiat. However,
I would be quite content if we could have a strict budget balance, neither a surplus nor a deficit; eliminating the deficit that is now projected would, I think, be an enormous step forward.
You refer to Secretary Simon. He is fully qualified to speak for himself and I do not want to speak for him, but I do think, that in the
interest of the truth, I should say that the newspaper reports about
Secretary Simon's views on the budget have not been correct. To the
best of my knowledge—and I am quite sure I am well informed on
this—Secretary Simon has not recommended a cut of $20 or $25 billion
in this fiscal year's expenditure, nor has he recommended that the cuts
be made in welfare programs.
This report, apparently, is based on a very tentative set of questions
that Secretary Simon wrote out in a memorandum. That must be the
source. But Secretary Simon is back in the country and he will speak
for himself.
Mr. STANTON. Thank you.
Another question. On the bottom of page 19 you make your position on the general tax cut very clear and you say that the Congress
should resist any temptations to stimulate economic activity by general tax cuts or new public works programs. I wonder, Doctor, on the
next page over, you go on to say that this is not to say that we should
not perhaps consider an expanded public service employment program.
It may also be needed if unemployment rises further.
I would just be interested in your own differentiation between the
two thoughts; one between an expanded public service employment
program to curb unemployment, and your outright position against
new public works programs ?
Dr. BURNS. A public works program, if legislated today, would not
produce any results for months. Ultimately, expenditures would rise
in response to that legislation, and the great bulk of the expenditures
under that legislation might well come at a time when the economy
is again expanding vigorously. Therefore, the public works programs
could add to our difficulties at later times. Public works, by and large,
are costly. A long period must elapse before sites could be established,
278
before contracts could be written. Then the construction period itself
tends to be quite long. So, public works are a very clumsy tool. A public works program would be the right economic tool to stimulate the
economy if we faced a long, drawn-out depression. But very few, if
any, of us anticipate any such problem in this country. Therefore, I
think we ought to get public works programs out of our minds.
By way of contrast, a public service employment program could
be expanded rather promptly and cut back rather promptly. Not only
would the timing be better, but the cost, in the end, would be very
much smaller.
Mr. STANTON. Thank you very much.
The CHAIRMAN. Mr. Stephens.
Mr. STEPHENS. Thank you, Mr. Chairman.
Dr. Burns, in your statement, as has been repeated, you said you
will oppose a tax cut; and we were just discussing the effect of an
increased public works program.
What would be the effect on an income tax increase on the inflation
and the economy?
Dr. BURNS. An income tax increase ?
Mr. STEPHENS. Yes.
Dr. BURNS. Well, we have
a sluggish economy: the confidence of the
people is low. We have ah unhappy country. To raise taxes at the
present time could cause an increase in unemployment. It could choke
off new investment plans bv business firms. It could hurt consumer
markets which are not flourishing at the present time. I would not do
it.
Mr. STEPHENS. Several years ago, when Secretary Fowler was the
Secretary of the Treasurv, the administration advocated a tax reduction, and Congress went along with the idea of an income tax reduction.
In testifying before our committee in respect to that general program, Secretary Fowler pointed out that every time, historically, in
the United States, that we had had a tax reduction, that the revenue
of the United States had increased.
Would that have any effect if we should, say, reduce taxes a little
further? Do you think that it would be true at this time that such a
result might come about ?
Dr. BURNS. Such a result might come about several years from now,
but I would be greatly concerned about the intermediate period and
the short-run effects, because this would mean at once a larger governmental deficit; therefore, more borrowing by the Federal Government ; therefore, more pressure upon interest rates. I do not think we
ought to take risks of that sort at the present time.
Mr. STEPHENS. YOU do not think it would result in an increase in the
Federal income ? Not mavbe for the immediate tax future
Dr. BURNS. It might if, let us say, we had a cut in taxes and if that
cut in taxes were accompanied bv a cut in expenditures. The effect
might then be salutary immediately, but that is most unlikely to happen. I do think that our Federal deficits have been a major cause of
the inflation that we have had, and it is high time that we got out of
279
the habit. A tax cut at the present time would simply perpetuate the
long series of deficits, so that people in our own country and people
abroad, who have now greatly diminished confidence in our ability
to manage our finances, would interpret such a tax cut to mean that
we are going down the road of inflation at a still faster pace. I would
not take that risk.
Mr. STEPHENS. Thank you very much. I yield back the balance of
my time.
The CHAIRMAN. All right.
Mr. Blackburn.
Mr. BLACKBURN. Thank you, Mr. Chairman.
Dr. Burns, it is always a pleasure to have you before our committee.
I would like to pose two questions to you at this time, not that they
be answered, but when you prepare your answers to the total questioning, that you address yourself to these questions.
First of all, with the operation of inflation, combined with the
graduated income tax, the result is that an ever greater share of GNP
is going to be funneled through government.
I would like for you, in your prepared answers, to give me some
suggestions as to how the Congress might deal with this problem—
particularly those of us who feel that government should not dominate our whole economic structure. With the combination of these
two factors as they now operate, we are heading in the direction toward
more and more Government control of the economy.
Second, I would like for you to give us what you would consider to
be a good definition of a balanced budget.
It seems to me that the unified budget as we now have it is not really
a good reflection of the relationship between gross revenues and the
cost of operation of the Government, when we take in trust accounts
and income and then we do not have all the outlays. In fact, in my
opinion, we should distinguish between expenditures for capital improvements and amortize them over a period of years, and the cost of
operation of government, such as salaries and so forth.
[In response to the request of Mr. Blackburn, the following information was submitted for the record by Dr. Burns:]
REPLY RECEIVED FROM DR. BURNS
Answer to question 1. Inflation, in combination with the progressive income
tax, causes an upward drift in income tax rates that increases the share of income going to government. It has been estimated that for every one per cent
increase in taxable individual income, Federal income tax revenues increase by
approximately 1.3 per cent. This characteristic of the income tax does have some
desirable aspects because it reduces purchasing power in the hands of the public
during periods of excess demand inflation. In fact, this "automatic stabilizing"
property of the income tax has generally been viewed by economists as highly
desirable. On the negative side, however, the increase in prices and consequent
increase in real tax burdens tends to be permanent and, thus, can dull incentives
to work and to invest, as well as cause individual hardships. In addition, the
progressive income tax may encourage profligacy in government spending if tax
rates are not reduced periodically. When inflation continues for a number of
years, these defects in the progressive income tax can become quite burdensome.
Answer to question 2. No single budget concept is appropriate for all purposes.
For analyzing the effect on the economy, I generally prefer more inclusive budget
concepts that incorporate all those government spending programs that have an
impact on private economic activity.
280
When the unified budget was adopted, the spending of nearly all Federally
owned agencies—including the trust funds—was included so that the true scope
of the government activities could be seen. Since that time, however, some government-owned agencies, such as the Export-Import Bank and the Postal Service,
have been largely excluded from the unified budget In general, I am opposed
to this concept of "off budget" agencies because it may lead to expenditures that
are not carefully scrutinized, besides understanding the economic impact of the
budget—especially on financial markets.
Also, "government sponsored agencies" are now being excluded from the unified
budget because they are privately owned. Nevertheless, it is useful to include
their activity in any assessment of the economic impact of the Federal sector
because they, too, compete with private borrowers for financial resources, and
their activities add to aggregate demand for goods and services.
In recent years, the Federal trust funds have generally experienced substantial
surpluses on current account. As a result, the conversion from the old administrative budget that excluded the trust funds to the unified budget that incorporated them has reduced reported budget deficits substantially. While this inclusion of trust funds may be appropriate in assessing overall budget activity,
it may have encouraged excessive growth of other outlays that are no longer
balanced solely against non-trust funds receipts. A conversion to a capital budget
would further reduce reported budget deficits and further understate the impact
of the Federal sector of the economy. For this reason I oppose the suggestion
that it be adopted as the official budget. In this period of rapid inflation, particularly, it would be unwise to employ an official budget concept that understates the impact of Federal spending on economic activity and prices.
Mr. BLACKBURN. NOW, as I recall your testimony, your testimony
was that the effective growth of money supply—that is, the narrow
definition of money—has increased over the past year at the rate of
about 6 percent. The Federal Reserve Board of St. Louis came up with
an opinion that it was about 8 percent.
I do not want to get into a quibble about the differences in your
respective opinions, but the gross national product for the last 6 months
has actually decreased by one-half of 1 percent. So, any increase in
money supply over the last 6 months is bound to have an inflationary
effect, is it not?
Dr. BURNS. I do not think, as I have tried to indicate in my testimony, that there is a very close linkage in the short run between the
rate of growth in the money supply and the rate of inflation.
Mr. BLACKBURN. YOU feel 6 months is a short term ?
Dr. BURNS. Oh,
yes.
Even over longer periods of time, the relationship is quite loose.
I think that many economists have gotten into the habit of looking
at the money supply and ignoring another factor, that certainly in
the short run is far more important, and that is the rate of turnover
of the existing stock of money. Thefluctuationsin the rate of turnover
of money are simply enormous. I made brief reference to that in my
testimony, and I will supply detailed data on that, because this is something that the committee should become thoroughly acquainted with.
We are all paying too much attention to the money supply and too
little attention to the willingness of people to use the money that they
have, in other words, the rate of turnover of the existing stock of
money.
281
[The following information subsequently was furnished by Dr.
Burns:]
TABLE 1.—DATES WHEN THE GROWTH OF VELOCITY (RATIO OF GNP TO Mi) AT A COMPOUND ANNUAL
RATE FELL WITHIN SELECTED RANGES, 1947:1 TO 1974:2
Less than
—5 percent
49:1
49:2
53:4
58:1
- 4 . 9 to
—3 percent
49:4
52:2
59:3
60:3
70:4
71:2
....
*4
*6
""Total number of observations.
- 2 . 9 to
0 percent
0.1 to
2.9 percent
3 to
5 percent
5.1 to
10 percent
51:4
52:1
53:3
54:1
54:2
57:4
58:2
60:4
61:1
63:1
64:4
67:1
67:2
67:3
68:3
68:4
70:1
70:2
71:3
74:1
74:2
47:2
53:2
54:3
56:1
57:2
59:1
60:2
62:4
63:2
64:2
64:3
66:2
67:4
69:1
69:2
69:4
70:3
72:2
72:3
73:2
47:3
48:4
49:3
51:3
52:3
56:2
56:3
63:3
63:4
65:2
65:3
65:4
66:1
68:1
68:2
72:4
73:3
50:2
51:2
53:1
54:4
55:1
55:2
55:3
55:4
56:4
57:1
57:3
58:3
58:4
59:2
59:4
61:2
61:3
61:4
62:1
62:2
62:3
*21
•20
*17
*31
64:1
65:1
66:3
66:4
69:3
71:1
71:4
72:1
73:1
73:4
10.1 percent
and greater
47:4
48:1
48:2
48:3
50:1
50:3
50:4
51:1
52:4
60:1
•10
TABLE 2.—DURATION OF VELOCITY (RATIO OF GNP TO Mi) GROWTH RATES, 1947:1 TO 1974:2
Less than - 5 percent
- 4 . 9 to - 3 percent
—2.9 to 0 percent
0.1 to 2.9 percent
Beg.
qtr.
Duration
(qtrs.)
Beg.
qtr.
Duration
(qtrs.)
Beg.
qtr.
Duration
(qtrs.)
Beg.
qtr.
49:1
53:4
58:1
2
1
1
49:4
52:2
59:3
60:3
70:4
71:2
1
1
1
1
1
1
51:4
53:3
54:1
57:4
58:2
60:4
63:1
64:4
67:1
68:3
70:1
71:3
74:1
2
1
2
1
47:2
53:2
54:3
56:1
57:2
59:1
60:2
62:4
63:2
64:2
66:2
67:4
69:1
69:4
70:3
72:2
73:2
2
1
1
3
2
1
2
Duration
(qtrs.)
2
1
1
2
1
3 to 5 percent
5.1 to 10 percent
10.1 percent and over
Beg.
qtr.
Duration
(qtrs.)
Beg.
qtr.
Duration
(qtrs.)
Beg.
qtr.
Duration
(qtrs.)
47:3
48:4
49:3
51:3
52:3
56:2
63:3
65:2
68:1
72:4
73:3
1
1
1
1
50:2
51:2
53:1
54:4
56:4
57:3
58:3
59:2
59:4
61:2
64:1
65:1
66:3
69:3
71:1
71:4
73:1
73:4
1
1
47:4
50:1
50:3
52:4
60:1
4
1
3
1
2
2
4
2
1
1
5
2
1
2
1
6
1
2
1
1
2
1
1
1
Oo
to
283
TABLE 3.-CYCLICAL PEAKS AND TROUGHS CHOSEN FROM CHART OF PERCENT CHANGE IN VELOCITY (RATIO OF
GNP TO Mi) 1947:1 TO 1974:2
Peak
Troughs
Percent
Percent
change in
change in
velocity, A.R. Date
Date
47:4..
50:3..
52:4..
55:1..
56:4..
58:3..
60:161:4..
64:165:169:371:1_.
73:1..
16.9
22.7
10.2
9.3
6.7
8.1
12.6
6.5
5.5
8.5
5.6
8.3
7.9
49:1
52:2
53 4
56:1
58:1
59:3
60:3
63:1
64:4
67:1
70:4
71:2
74:1
velocity, A.R.
.--.
.
.
._.
___
-5.9
-3.7
-5 7
.4
-5.6
-4.3
-3.5
.5
-1.0
-2.1
-3.8
-3.1
-2.2
NBER PEAKS AND TROUGHS WITH CORRESPONDING PERCENT CHANGES IN VELOCITY (RATIO OF GNP OVER M,)
1947:1 TO 1974:2
3.7
-2.4
5.8
2.0
1.0
48:4..
53:3..
57:3..
60:2.
69:4..
36-714 0 — 7 4 -
-19
49:4
54:3
58:2....
61:1
70:4
-3.2
1.0
-1.3
-1.4
-3.8
285
Mr. BLACKBURN. I certainly agree with you, and I think that we
are going to have to help to draw a more sophisticated definition of
money supply.
It seems to me that many times we tend to oversimplify things in
the Government, and we get so narrowly concerned with symptoms
that we fail to really stand back <and look at the causes of some of our
problems. The President says we have got to encourage people to
save more money. I think it is generally agreed that we need more
capital to meet our capital needs in this country, but our present
policies are discouraging savings. Because of the operation of regulation Q, the small depositor cannot receive enough earnings on his savings to offset the diminution in capital which is occurring by reason of
inflation. Then, to add insult to injury, we tax him on the interest that
he draws, as though he had earnings.
At the very least, it seems that if the Government allows inflation
to occur at a rate of 7 percent, if the depositor gets only 7 percent on
his money, we should not tax him on earnings, because he has not earned
any money, he is just holding his own.
To me, the real problem is the operation of regulation Q. It seems
to me that we ought to allow the small investor to obtain an economic
rate on his money. By the operation of regulation Q, we are really discouraging the small depositor from accumulating any savings.
Do you have any comments on that ?
Dr. BTJKNS. Well ; I agree with you philosophically, and yet I find
myself in the position of supporting regulation Q at a time like this.
Suppose the regulation Q were done away with entirely. I would
then have fears about the continued viability of our savings and loan
associations and our savings banks if that happened.
Mr. BLACKBURN. Suppose we gave them additional tax incentives?
My time has expired. Would you address yourself to that in your
prepared answers ? Because I do want to give some special attention
to the housing industry.
[In response to the request of Mr. Blackburn, the following information was submitted for the record by Dr. Burns:]
REPLY RECEIVED FROM DR. BUBNS
As a general principle, tax incentives can serve as a useful instrument of
economic policy. They must be used carefully, however, because they tend to
erode the nation's tax base and, in the absence of higher tax rates, to reduce
the overall level of income tax receipts. In view of our present need for fiscal discipline to control inflation, an erosion of the tax base would be a step in the
wrong direction. I would therefore be opposed at this time to the use of tax incentives to increase the yields that savers receive on deposits in banks and thrift
institutions.
The best long-run solution to low interest returns on small thrift accounts is
to raise Regulation Q ceilings. At the present time, however, thrift institutions
could not afford a sharp upward adjustment in their interest costs, though there
may be some steps that could usefully be taken even now to improve the ability
of depositary institutions to compete for the savings of individuals.
The difficulties presently encountered by the depositary institutions in attracting and holding savings funds arise because of a mismatch of maturities between
their assets and their liabilities. Public policy actions along the lines of those
proposed in the Board's 1972 recommendations to Congress for moderating shortterm fluctuations in the availability of housing finance (a copy of which is attached) would help to improve the ability of thrift institutions to function in a
climate of fluctuating interest rates.
286
Mr. BLACKBURN. Thank you, Mr. Chairman.
The CHAIRMAN. Mr. St Germain.
Mr. S T GERMAIN. Thank you, Mr. Chairman. I thought I was going
to have to be away.
I have two questions relating to a couple of statements on page 5.
My first question focuses on your statement that: "the price of commodities, particularly farm products and raw materials, are established
in highly competitive markets."
Dr. BURNS. I am sorry, I did not hear you.
Mr. S T GERMAIN. Page 5, your first sentence, where you refer to the
price of commodities, foods.
I would ask you this: You know the producers, the farmers and the
breeders, have continually stated to me during this period of increased
costs, that they were not, in reality, getting a profit. Now we see
a judgment of a substantial amount awarded against the A. & P. chain
in California for their practices in this area, particularly with respect
to the price of meat.
If this were followed through—and I understand it is going to be
followed through—against other chainstores, would this not be an
important factor to determine whether or not, in truth, the moneys
or profit in the increased prices have filtered through not to the producer, the farmer, but rather to the middleman and the processor?
Dr. BURNS. I see your question. Let me just say two things quickly.
First, farm income rose dramatically last year. It rose far more
sharply than the income of any other group of any size in our country.
Second, last year, for a time, retail margins became, under our system of controls, very narrow. Since the lifting of controls, retail
margins have widened.
There undoubtedly are pockets of monopoly in our country. Your
reference to a discovery of one such pocket is, I think, important. But
while I would grant that we may have a problem in that area, I am
not kid each other—a very terrible decline? In other words, the contrary, farm incomes have been flourishing. I say that in spite of the
fact that in some branches of the farming industry, particularly cattle
raising, things have not gone well at all this year.
Mr. S T GERMAIN. Then a few sentences further, you refer to imperfect business competition. I wonder if you would elaborate on that.
Dr. BURNS. YOU, yourself, have done that very well, Mr. Congressman. You have given a dramatic example—and of course there are
numerous examples like that, no doubt. I think we need very strict
enforcement, probably much stricter enforcement than we are getting,
of our antitrust laws.
Mr. S T GERMAIN. However, the trend has been the other way, in the
past 4 or 5 years, as far as the antitrust laws are concerned. The trend
has been to sort of lay off.
Dr. BURNS. I think this is something that requires the attention of
the Congress. Our antitrust laws must be enforced strictly, and if they
are not strict enough, it is the duty of the Congress, I think, to make
them stricter.
For example, I myself have long thought that violations of antitrust laws should be punished more heavily than they are, according
to statutes at the present time. I would have more severe penalties than
are written into the law at present.
287
Mr. S T GERMAIN. Thank you. One last question: If there were to
be other issues to follow Citicorp, of a similar nature, what, in your
opinion, would be the effect on the stock market already in—let us
not kid each other—a very terrible decline % In other words, the confidence of the investor hasdiminished tremendously. They are already
having problems with new issues; and the income from investments
has declined sharply. Would not the average investor, who has a certain amount of sophistication, prefer to go into an issue like Citicorp,
or subsequent issues of that type, rather than to go into the stock
market—considering what has been happening in the market over the
past 12 or 14 months?
Dr. BURNS. I think that if issues of the Citicorp type were followed
up by other bank holding companies, or for that matter, other institutions in the financial area or otherwise, undoubtedly, many small investors would turn to those issues rather than to the stock market. But
I do not think that the weakness of the stock market can be dealt with
by suppressing issues of the Citicorp type. If we want a stronger
stock market, I think we will need, fundamentally, to have improved
profits in your corporations. I think we will need to revise our capital
gains tax legislation. I think that we will need to bring inflation under
control so that interest rates, which have been serving to depress the
stock market, may come down.
Mr. ST GERMAIN. Thank you, Mr. Chairman.
The CHAIRMAN. The time of the gentleman has expired.
Mr. Brown.
Mr. BROWN. Thank you, Mr. Chairman.
Thank you, Dr. Burns, for being with us this morning. Following
up on Mr. St Germain's questions regarding the Citicorp question,
regardless of whether we go the Patman legislation route, the Barrett
substitute route, or the Senate concurrent resolution route, it is not
your desire or your intention, is it, to attempt to regulate usual commercial paper issued to finance normal business operations, is it? You
are not seeking that authority, are you ?
Dr. BURNS. NO, we definitely are not.
Mr. BROWN. In other words, you would want that authority
restricted basically to Citicorp type issues ?
Dr. BURNS. If Congress is to legislate in that area, I think that is
what the Congress should seek to accomplish.
Mr. BROWN. Even if it were left open, so that conceivably the language would permit you to regulate normal commercial paper, you
would not intend to exercise that authority, is that right?
Dr. BURNS. We certainly would have no intention of doing that
at the present time, no.
Mr. BROWN. Under what conditions do you see that you might want
to?
Dr. BURNS. I do not know that I can visualize them; I am just being
cautious in answering the question.
Mr. BROWN. Dr. Burns, I cannot remember the data, but there was
an article by Milton Friedman, I believe, in one of the weekly magazines, in which he was somewhat critical of the way in which the Fed
has exercised its lender of last resort authoritv. I believe it was his
position that as such a lender, banks should have a basic right of
access to you, rather than it being a privilege granted at the discre-
288
tion of the Fed; and that it should not be, the borrowing should not
be, at a discounted rate, but should be at market rates.
Would you care to comment on that ?
Dr. BURNS. If I may, let me try and state Professor Friedman's
position as I understand it—I think I do understand it.
Professor Friedman would do away with the discount window at
the Federal Eeserve banks entirely. Second, he believes that if,
contrary to his own judgment, the discount window was kept open, we,
at the Federal Reserve, should place the discount rate at a level that is
close to the market level of interest rates. Since, in recent months, the
discount rates has been well below short-term market interest rates
generally, Professor Friedman argues that we, at the Federal Reserve,
have been subsidizing those who have come to the discount window to
borrow. That is his position, I believe.
Mr. BROWN. That is his position. What is your position with respect
to his position ?
Dr. BURNS. On the matter of subsidy, let me say only that we charge
our borrowing banks, 8 or 8.5 percent—depending upon the kind
of paper they submit—at the discount window. If, instead of lending
on that paper, we invested in Treasury bills, the rate of return to the
Federal Reserve would now be lower. So that in no sense can one
argue that the taxpayer, through the Federal Reserve, has been subsidizing banks that borrow at the discount window. There has been
no subsidy in that sense.
It has certainly been true that the discount rate has been below the
market rate; it has been below the market rate by a wider margin than
any that I can recall in our Nation's history. The reason has been
that we, of the Federal Reserve, have been reluctant to push up the
discount rate, and in the process become an active force in raising
interest rates. To us, the rise in interest rates is a side effect, you see.
It is something that we do not want to accomplish actively. It is not
something that we seek.
Looking back, if you were to ask me, whether it would not have been
somewhat better if we had raised the discount rate previously, I would
probably answer the question in the affirmative. But at each point, we
have been a little reluctant to push up the discount rate and thereby
release market forces that may work in the direction of still higher
interest rates.
Mr. BROWN. My time has expired, Dr. Burns.
The CHAIRMAN. The committee will stand in recess subject to the
call of the Chair.
[Whereupon, at 12 noon, the committee recessed, to reconvene subject to the call of the Chair.]
FEDERAL RESERVE POLICY, INFLATION, AND HIGH
INTEREST RATES
THURSDAY, AUGUST 8, 1974
HOUSE OF REPRESENTATIVES,
COMMITTEE ON BANKING AND CURRENCY,
Washington, D.C.
The committee met, pursuant to notice, at 9:40 a.m., in room 2128,
Rayburn House Office Building, Hon. Wright Patman [chairman]
presiding.
Present: Representatives Patman, Barrett, Sullivan, Stephens, Minish, Gettys, Koch, Cotter, Fauntroy, Young, Moakley, Stark} Boggs,
Widnall, Johnson, Blackburn, Brown, Wylie, Heckler, Crane, Rousselot, Frenzel, Burgener, and Rinaldo.
QUESTIONING OF HON. ARTHUR F. BURNS, CHAIRMAN, BOARD OF
GOVERNORS, FEDERAL RESERVE SYSTEM—Resumed
The CHAIRMAN. The hearing will come to order.
Dr. Burns, I wrote you a letter last Friday or Saturday about an
incident at the Chicago Reserve Bank. We had been advised by you
that we could send our investigator to any Reserve bank and that we
would be furnished information promptly. We had sent our investigator to Chicago to see all the vouchers and he almost got thrown out.
You did not cooperate with us at all, the president of your bank, and
we did not get information we desired. Of course, we will pursue
now the information that you told us we can get from the gentleman
who is your executive director, and if we do not get it, why, of course,
we will take it up directly with you.
There is certain information that we want and we do not want to
have to bother you with it every time.
Another thing—about the money that was furnished to the Franklin
National Bank. How much was that, Dr. Burns, when they were
about to go under, when they thought they were, when they had trouble
with the solvency of the bank in May, I believe ?
Dr. BURNS. I think the first loan was made on May 8. That is my
recollection. That amount has changed from day to day, but the trend
has been upward, though it has stabilized recently.
The CHAIRMAN. I understood you to say in conversation—if this
should not be repeated, of course, you have a right to say so—that you
furnished them $1,300 million.
Dr. BURNS. I have at no time disclosed the figure of our actual loan.
If this is something that the committee would like to know, I would be
pleased to answer that question in executive session.
(280)
290
The CHAIRMAN. All right, sir. I will get in touch with you then, Dr.
Burns.
Of course, that is just a typical question we will ask you. Another
question will concern whether, with this bank in very bad condition,
what the Federal Reserve did, gave the big CID holders the $100,000 or
more notice, and they rushed in and cashed their CD's, and they came
out whole on this.
Now then, when you furnished the money, it would appear that
that money was really used to "bail out" the big fellows. They got
their money.
Dr. BURNS. I think in due course you will want a thorough investigation of what happened in connection with Franklin National Bank.
The CHAIRMAN. We will.
Dr. BURNS. I and others of the Federal Reserve will testify and
testify fully. I think that you, Mr. Chairman, and the members of your
committee will be pleased with the performance of the Federal Reserve and its handling of this very sad episode.
The CHAIRMAN. I think I wrote you a letter on May 14 and sought
information about the holding company and other things in connection
with the Franklin National Bank. You wrote me back, I think, and
said that you had furnished that. But we have never received that, Dr.
Burns. I give that as typical of things that we will have to take up
with this gentleman who you tell us will furnish the detailed information. Will he furnish all of the information that you would
furnish us?
Dr. BURNS. Will who furnish ?
The CHAIRMAN. The man that you said was your executive director
for the Federal Reserve.
Dr. BURNS. I cannot say what he will furnish. Certainly, on administrative matters, he will not even come to me. He will furnish that.
But if you ask questions of a policy nature, he will come to me.
The CHAIRMAN. This probably would be of a policy nature, and then
we would take it up with you. That would be proper for us to do that,
I assume.
Dr. BURNS. I cannot think of you, Mr. Chairman, doing anything
improper.
The CHAIRMAN. Yes, sir. Now then, last year. You know you have
insisted all along that these expenses—you have thousands of associations and chambers of commerce and clubs and tens of thousands of
them that you contribute to over the years, and I know that you do that
for the purpose of gaining goodwillDr. BURNS. NO. I must interrupt that. We do not do that for the
purpose of gaining goodwill. The only goodwill that we need is your
goodwill and that of your colleagues in the House of Representatives
and in the Congress. We serve the public, Mr. Chairman.
The CHAIRMAN. You say you serve the public.
Dr. BURNS. Of course we do. Whom do you think we serve ?
The CHAIRMAN. Well, why would you not just depend on us then if
you serve the public ?
Dr. BURNS. Why do I not just depend on you ?
The CHAIRMAN. Why are you appealing to the public through all of
these organizations like ladies' clubs and everything else you make
291
contributions, and it runs in the millions of dollars. I see no reason for
that at all.
Dr. BURNS. Mr. Chairman, if you want to discuss contributions,
please let me know and I will come prepared to discuss contributions
in detail.
The CHAIRMAN. Well, that is exactly what I want to know.
Dr. BURNS. Most of them, I am sure, are defensible. We have 28,000
employees. There is some carelessness now and then. It is painful to
me when I discover it. I work hard at it. But when you want to examine me on questions like that, please let me know and I will come
prepared.
The CHAIRMAN. Well, I am asking you now who to deal with when I
do not want to bother you with triiiing things, although they are important to us. So I will get in touch with this director that you told
me to, and if it is a policy matter, of course, I will expect him to say it
is a policy matter and if he cannot do it, then I will take it up with
you. But we have not had a good line of communication with you, Dr.
Burns. It has been kind of irritating to you, I know, for us to take all
of these things up with you.
Dr. BURNS. NO. I do not find it irritating. I do find that it takes a
good deal of my time, but that is my job.
The CHAIRMAN. YOU know in the debate on the audit bill many
Members said, "Now, Dr. Burns, he will furnish any Member of the
House any information he may want to know about the Federal Reserve." You have a lot of friends like that. But, of course, I had not
had that good luck myself and that is the reason I took note of it.
Dr. BURNS. Mr. Chairman, I wish you would ask me sometime how
much time is devoted by my staff in answering your questions. I wish
you would ask me that. I will furnish you with the answer promptly.
The CHAIRMAN. Since you brought that up, why would not the man
in Chicago let my investigator have information? You told me he
would.
Dr. BURNS. Well, I cannot answer that.
The CHAIRMAN. I wrote you a letter about it.
Dr. BURNS. Yes, you did, and I am looking into it. I have had a report from Chicago and I do not take it at face value. I have been told
that a young man from your staff appeared and that he used language
that could not possibly appear in print. Some ladies on our staff there
were embarrassed and shocked.
I take all that with "a grain of salt." Possibly, these ladies needed
some enrichment of their vocabulary. I do not know these facts. I will
look into them in due course. I hope not to bother you with details like
that.
The CHAIRMAN. Well, anyway, those are typical questions that we
would ask you and we hope we get adequate consideration in the future,
better consideration in the future, than our investigator got at the
Chicago bank. We have never had any complaints about him.
Dr. BURNS. Mr. Chairman, if anyone from the Federal Reserve family was ungracious to any member of your staff or any member of your
committee, this is something that I deplore and I am very sorry about.
The CHAIRMAN. We are not going to start out investigating these
rabbit trails, I would consider that a rabbit trail. We will not investigate it further, but that is the way it was. Getting back to the
292
Franklin, this $1.3 billion, you will not say publicly whether that is
correct or not. You state that you are going to bail out other banks
and that infers to me that you are adopting on your own a sort of
an RFC, Reconstruction Finance Corporation, to bail out all the banks
that get in trouble. I think personally that you need to have the
authority of Congress to do that.
Dr. BURNS. Mr. Chairman, I do not think I have ever said that
the Federal Reserve will bail out any and every bank.
The CHAIRMAN. I thought it was in the newspapers, I thought you
did. Maybe I am wrong. I would just put these newspaper articles
in the record.
This morning there is one, "The Federal Reserve Readies Emergency Loan Plan." Under this plan, you can get part of the money
for Franklin National, from the $80 billion that you have in your
portfolio in the New York Federal Reserve Bank.
Dr. BURNS. Mr. Chairman, we operate a bank. Every commercial
bank, and ours is run on identical principles, has the power to lend
money. In the process of lending money, it normally gives a deposit
credit to the borrower. That deposit credit is not linked mechanically
at all with the particular assets that it happens to have on hand.
The CHAIRMAN. Well, you would have to offset the loans by selling
securities to keep from inflating the money supply. I can shorten this,
Dr. Burns, by putting these articles in the record, and then you will
know that we are going to interrogate you about it in the future. If
we do not get the information from the Executive Director whose
name you gave me—and I will ask the other members to use that name
when they want information from the Federal Reserve, we will get
in touch with you.
I have an article from this morning's edition of the Wall Street
Journal, "Bank Dominos." That is the heading. I also have an article,
"Arthur Burns: In a Tight Money Squeeze," in this morning's Washington Post. Also, another one in the Washington Post, "Federal
Reserve Readies Emergency Loan Plan."
Without objection, I will place those in the record at this point,
and you will see them and vou will know the information that we
will be asking you about in the future when we agree upon some time
that is mutually satisfactory.
Mr. JOHNSON. Reserving the right to object, Mr. Chairman, and I
will not object. But I personally cannot see any reason for cluttering
up the record with a lot of newspaper stories by a number of writers
who may or may not know what they are writing about and are just
speculating on this, that, or the other thing. All those articles do is
tend to inflame the Nation. At a time when we are at a critical economic
crisis, I do not think we should be talking about a lot of banks going
to fail.
I think we ought to be fortunate and glad that we have got the
Federal Reserve System, that we have a Fed Chairman of it who has
the courage to step forward when the need arises and do the job that
is necessary in order to keep this country on a stable economic basis.
The CHAIRMAN. Without objection, they will be placed in the record.
293
[Testimony resumes on p. 301.]
[The letters and articles referred to by Chairman Patman follow:]
U.S. HOUSE OF REPRESENTATIVES,
COMMITTEE ON BANKING AND CURRENCY,
Washington, B.C., May U, 1974Hon.
ARTHUR F. BURNS,
Chairman, Board of Governors,
Federal Reserve Board, Washington, D.C.
DEAR DR. BURNS : As you are aware, I am deeply concerned about the various
aspects of the Franklin National Bank case and the role of your agency in
regulating this holding company. This bank and its holding company involve
some of the basic problems attendant to holding company operations and the
entry of foreign investments in the United States banking system.
As you should recall, I expressed my concern over the Franklin National
Bank in a letter to you on July 19,1972—approximately 22 months ago. This was
at a time when a huge block of the outstanding common stock had just been
acquired by a Liechtenstein-based corporation, Fasco International Holdings.
My letter, a copy of which I am attaching, pointed out that this raised serious
questions about the application of the Bank Holding Company Act in view of
the fact that Fasco International controlled several big U.S. Corporations—
corporations clearly outside the scope of permissible non-banking activities for
a holding company. My letter asked for specific actions on the part of the Federal
Reserve in connection with this Franklin National Bank case and I quote from
the July 19,1972 correspondence :
". . . since the Federal Reserve Board has the authority to administer this
Act, it would be appreciated if you would inform me as to whether the Board
feels that if present law is adequate, what it intends to do in the situation outlined above, and if the present law is not adequate, what legislative recommendations you would make."
In an answer to this letter dated August 2, 1972, you dodged the issue of
"control" of the bank holding company by Fasco but promised an investigation
into the matter. At that time, you informed me that the Fasco representatives
"have promised to cooperate fully in providing such information as the Board
may request."
That, Dr. Burns, was nearly two years ago and my files do not reflect the
results of this investigation- Judging from your letter of August, 1972, your
agency has apparently had access to all of the necessary data from Fasco and
I assume that you have been on top of the situation throughout these many
months.
Frankly, I must state that this appears to me to be an unusually long time to
complete an investigation and this delay is particularly regrettable in view of
the current troubles of Franklin National. While the Federal Reserve has delayed its findings and reports, there have been reports in the news media of
attempts by Michele Sindona to restructure his control of Fasco International
and other business interests. In fact, the Wall Street Journal of December 27,
1973 reported that these actions were being taken by Mr. Sindona for the purpose
of escaping the strictures of the Bank Holding Company Act. A disinterested
observer might conclude that the Federal Reserve was indeed holding up its
decisions to allow Mr. Sindona to find the necessary loopholes. Perhaps there
are other explanations and if so I hope that you will be kind enough to forward
them to me at the earliest possible time.
In fact, Dr. Burns, I would like answers to these specific questions:
1. Why has the Federal Reserve delayed since my inquiry of July, 1972 to this
date in making a determination of the application of the Bank Holding Company
Act to Fasco and Franklin National?
2. In carrying out its investigation and in reviewing the information which
your letter of August, 1972 said was being made available, did your agency discover any problems associated with the management and <tihe operation of Franklin National and the holding company and if so what remedial steps were taken
and what other banking agencies were informed?
3. Has the Federal Reserve determined what relationships may exist between
Franklin National and any corporation owned and controlled by Fasco Inter-
294
national and/or Mr. Sindona? In particular, are there any loans outstanding
from Franklin International to Oxford Electric Corporation, Argus, Inc., Interphoto Corporation, the Canadian Seaway Hotel chain, or any other enterprises
owned or controlled by Fasco International or Mr. Sindona ? If the Federal Reserve has obtained such information I would appreciate it being forwarded to me.
As I stated earlier, this case covers two areas—holding companies and foreign
investments in the United States banking system—which have concerned this
Committee for some time. I have written you on numerous occasions about problems in both of these areas as your files reflect. In fact, in this particular case I
wrote you in July of 1972 asking that the Bank Holding Company Act be applied as fully as possible to control the situation and I further asked you if there
were additional legislative remedies which you might require in this case.
In conclusion, this appears to be another classic case of foot-dragging by a
bank regulatory agency. While the record is certainly not complete at this point,
it is a strong possibility that prompt and vigorous action by the Federal Reserve
in applying the bank holding company regulations might have diminished some
of the banking problems which have emerged.
Sincerely,
WRIGHT PATMAN, Chairman.
CHAIRMAN OF THE BOARD OP GOVERNORS,
FEDERAL RESERVE SYSTEM,
Washington, D.C., June 5,197/h
Hon. WRIGHT PATMAN,
Chairman, Committee on Banking and Currency,
House of Representatives, Washington, D.C.
DEAR MR. CHAIRMAN : Your letter of May 14 raises questions about the Board's
responsibilities under the Bank Holding Company Act as they relate to Franklin
New York Corporation, the parent of Franklin National Bank, and Fasco International Holding S. A.
Your concern about any undue delay is understandable, but the question to be
resolved, namely, whether one company is exercising a controlling influence over
the management policies of another organisation, is highly complex when, as in
this case, there is less than 25 per cent stock ownership. When there is control of
less than 25 per cent of any voting shares, the Act provides that control can still
exist either (1) when a company controls in any manner the election of a majority of the directors or trustees of the bank or company or (2) when the Board
determines, after notice and opportunity for a hearing, that a company, directly
or indirectly, exercises a controlling influence over the management or policies
of the bank or company. In the latter case, as I indicated in my earlier letter,
"simple, objective criteria for measuring the exercise of control" are lacking.
Since actions suggesting control must be evidenced, considerable time often
elapses before sufficient information is accumulated to allow the Board to determine whether commencement of a proceeding to determine control is justified.
The facts are that Fasco International Holding acquired about 21 per cent of
the shares of Franklin New York Corporation in July 1972. In order to determine
whether control existed despite the fact that less than 25 per cent of the voting
shares were acquired, the Federal Reserve's staff then initiated a review of the
actions of the corporations and their representatives which might indicate that
control was being exercised over Franklin New York Corporation and, if so,
whether such control was being exercised by a corporation and thus fell within
the purview of the Act. While this assessment was in process, Franklin New
York Corporation filed an application in August 1973 to acquire Talcott National
Corporation from Fasco. Since this proposal raised new questions, and promised
to yield new information, concerning the relationship between Franklin New
York Corporation and Fasco, it was most appropriate for the Board to consider
the control question at the same time it considered the Franklin application.
In connection with an amendment to the Franklin-Talcott proposal, Fasco
applied in March 1974 to become a bank holding company. This filing by Fasco
provided further information and gave the Board an opportunity to rule on the
appropriateness of Fasco's becoming a bank holding company. It also obviated
the need for separate consideration of the control question while the FranklinTalcott application was pending. On May 1, 1974, the Board denied the latter
a|>plication, thereby making Fasco's companion application moot.
295
With the Franklin-Talcott application out of the way, the Board is continuing to devote attention to the question of the possible control relationship between
Franklin and Faseo in the light of more recent events. In this connection, we are
prepared to initiate a proceeding to determine if control is being exercised over
Franklin by any corporation if such action appears warranted.
Thus throughout the period since July 1972, the Federal Reserve has explored
the complex questions of control, and has carefully evaluated the voluminous
material associated with the Franklin-Talcott and Fasco applications. The matter has been, and remaining matters will continue to be, under active considera*
tion.
With respect to your second question, the Board's information concerning the
financial problems of Franklin National Bank and its parent was derived from
the Board's processing of the Franklin-Talcott application, not from the control
investigation. Questions concerning control relate primarily to structural characteristics bearing on identification of the group that is making management
decisions. They do not relate directly to the day-to-day financial condition of
the organizations in question.
The information which the Board acquired in processing the Franklin-Talcott
application came from the application itself, discussions with senior officers of
the bank and holding company, together with examination reports of the Comptroller of the Currency, and related primarily to the financial condition of Franklin National Bank. Our overall findings led the Board to take specific action designed to strengthen the bank. On May 1, 1974, the Board denied the FranklinTalcott application. The Board's denial order conveyed the view that the management of Franklin New York Corporation should devote its attention to its subsidiary bank and that "the acquisition of Talcott would be a complicating and diversionary factor."
With respect to your third question, information relative to outstanding loans
by Franklin National Bank to enterprises owned or controlled by Fasco, or by
any individual, comes from the Comptroller of the Currency, who, as primary
supervisor, examines the bank directly. Information such as you seek, as well
as information concerning the financial condition of the bank, should properly toe
sought from the Comptroller's office.
Sincerely yours,
ABTHUR F. BURNS.
JULY 19,
Hon.
ARTHUR F. BURNS,
1972.
Chairman, Federal Reserve Board,
Federal Reserve System, Washington, B.C.
DEAR DR. BURNS : A recent report in the newspaper indicates that one of the
largest bank holding companies in the State of New York, the Franklin New
York Corporation, has had one million of its common shares, representing around
20 percent of its outstanding common stock, acquired by a Liechtenstein-based
corporation, Fasco International Holdings. It has also been reported that Fasco
International controls several UJS. corporations, including Oxford Electric Corp.,
Argus, Inc., Interphoto Corp. and the Canadian Seaway Hotel chain.
It seems to me that this acquisition raises some very serious questions related
to the application of the Bank Holding Company Act as amended in 1970. It
permitted to go unchallenged, it seems to me that control of American banks
through a foreign holding company which also controls substantial nonbanking
interests in the United States would tend to defeat the clear purpose of the holding company act to separate banking from nonbanking activities.
My feeling is that the 1970 amendments would enable the Federal Reserve to
deal with the serious problems raised by such an acquisition as outlined above.
However, since the Federal Reserve Board has the authority to administer this
Act, it would be appreciated if you would inform me as to whether the Board feels
that if present law is adequate, what it intends to do in the situation outlined
above, and if the present law is not adequate, what legislative recommendations
you would make.
Your attention to this matter is appreciated.
Sincerely yours,
WRIGHT PATMAN, Chairman.
296
AUGUST 2,
1972.
Hon. WBIGHT PATMAN,
Chairman, Committee on Banking and Currency,
House of Representatives, Washington, D.C.
DEAR MR. CHAIRMAN : I am writing in reply to your letter of July 19 concerning
the newspaper report of the acquisition of 21.6 per cent of the outstanding common shares and 18.37 per cent of the outstanding voting shares of a large New
York bank holding company, Franklin New York Corp., by a foreign company,
Fasco International Holding, S.A. ("Faseo").
You have questioned whether Fasco has become a bank holding company
through the reported acquisition and, if so, whether it is engaged in nonbanking
activities in the United States that are not permissible to bank holding companies
under section 4 of the Bank Holding Company Act.
It appears that Fasco has certain affiliates in the United States that engage
in the manufacture or sale of goods, an activity that is not permissible for bank
holding companies. Under the Board's regulations, subsidiaries of foreign bank
holding companies enjoy a limited exemption to engage in activities in the United
States such as may be "incidental to their international or foreign business", but
these "incidental" activities may not include the sale of goods or commodities.
It is not clear, however, whether Fasco has become a bank holding company
through the reported acquisition. Under section 2(a) (1) of the Bank Holding
Company Act, a company is a bank holding company if:
(A) the company directly or indirectly or acting through one or more other
persons owns, controls, or has power to vote 25 per centum or more of any class
of voting securities of a bank or a bank holding company;
(B) the company controls in any manner the election of a majority of the directors or trustees of a bank or a bank holding company; or
(C) the Board determines, after notice and opportunity for hearing, that the
company directly or indirectly exercises a controlling influence over the management or policies of a bank or bank holding company.
From the information presently available to the Board, it appears that Fasco
is a personal holding company of an Italian financier, Mr. Michele Sindona, and
that its acquisition of shares of Franklin New York Corp. was undertaken on behalf of Mr. Sindona alone. The Board has no information suggesting that Fasco
directly or indirectly owns, controls or has power to vote more than 25 per cent
of any class of voting securities of FrankUn New York Corp. or Franklin National
Bank or controls in any manner the election of a majority of the directors of such
bank holding company or bank. The question whether Fasco has control over
Franklin New York Corp. or Franklin National Bank depends upon the Board's
determination as to whether Fasco directly or indirectly exercises a controlling
influence over the management or policies of such bank holding company or bank.
The fact that Fasco has acquired what may be the largest single block of
voting shares of Franklin New York Corp. at a price substantially above market
value is not sufficient by itself to show that Fasco exercises a controlling influence over the management or policies of the company or its subsidiary bank.
However, the Board intends to obtain the information needed to exercise an
informed judgment on the question of control. The rebuttable presumptions of
control established in section 225.2 (b) of the Board's Regulation Y and the
guidelines issued to the Federal Reserve Banks at the time when such regulations were promulgated (3fi Federal Register 18945. September 24, 1971) indicate the line of inquiry that the Board may be expected to take in investigating
this matter.
The Board has already been in touch with representatives of Fasco through
the Federal Reserve Bank of New York. The Fasco representatives have promised to cooperate fully in providing such information as the-Board may request.
The Board's task of making individual factual findings on the issue whether
a company is exercising a controlling influence over the management or policies
of another company or bank is difficult in the absence of simple objective criteria for measuring the exercise of control. Nevertheless, until the Board has
had more experience in administering the existing standard under the Bank
Holding Company Act Amendments of 1970, it would seem premature to draw
any conclusion regarding the adequacy of the present law in this respect.
Sincerely yours,
ARTHUR F. BURNS.
297
U.S. HOUSE OF REPRESENTATIVES,
COMMITTEE ON BANKING AND CURRENCY,
Washington, D.C., August 1, 1974.
Hon. ARTHUR F. BURNS,
Chairman, Board of Governors, Federal Reserve System,
Federal Reserve Building, Washington, D.G.
DEAR MR. CHAIRMAN : On numerous occasions you and members of the Federal Reserve Board have stated that the Federal Reserve System always makes
available to Congress complete information about the expenditures of the Federal Reserve Banks and their branches.
For instance, when Governor Mitchell appeared before the Banking and
Currency Committee in October of last year in connection with the Federal Reserve Audit bill he stated, "the Board reports promptly and fully to special congressional inquiries, particularly those inquiries from congressional committees
involving the systems, policies, operations and expenditures." Governor Mitchell
further stated, "the Board reports directly to Congress and always stands ready
to provide any information Congress seeks about expenditures of the System."
Such statements are indeed questionable in light of the Banking and Currency Committee's attempt to determine the types of expenditures which are
involved in the various Federal Reserve Clubs throughout the System.
Just this week a Committee attempt to determine these expenditures was
completely rebuffed by the Chicago Federal Reserve Bank in a manner which
raises grave questions about the creditability of the Federal Reserve System.
On July 30 the Committee's Chief Investigator, Mr. Curtis Prins, at my direction visited the Federal Reserve Bank of Chicago to review various expenditures
of that bank and its branches. He asked the bank's chief auditor for copies of
vouchers of expenditures made by the Federal Reserve Club of the Chicago bank.
He was told that such information would be provided the following morning.
The following morning, however, he was told by the bank's chief auditor that
"upon instructions from the Federal Reserve Board I cannot let you see the
expenditures." Mr. Prins then asked the auditor, Mr. Fred Dons, to provide him
with a statement in writing stating that the bank would not provide the Committee with the information. Mr. Dons first agreed to sign such a statement, but
when Mr. Prins presented him with a statement for signature, Mr. Dons stated
he would not sign any statement until he had conferred with the bank's counsel.
Later at a meeting between Mr. Dons, Mr. Prins and the bank's counsel, Mr.
William Gram, Mr. Prins again tried to obtain a written statement from either
Mr. Gram or Mr. Dons stating that they would not make the information
available.
The fact that Mr. Dons stated that he was withholding the information upon
advice of the Federal Reserve Board is shocking since you have many times
stated that the 12 Federal Reserve Banks are set up to operate autonomously but
apparently that is not the case. In fact, it appears the Board is keeping a rather
tight reign on the operations of the banks.
The withholding of information about Federal Reserve Clubs and their expenditures is extremely significant in light of Committee disclosures about how the
system spends taxpayers' money. In recent years the Committee has found that
Federal Reserve banks have spent thousands of dollars for art teachers, music
teachers, bingo parties, card parties, theater parties, cocktail parties, picnics and
other social activities for Federal Reserve employees. There has never been a
clear justification of any of these expenses and it now appears that the Federal
Reserve banks are moving to hide these expenditures rather than curtail such
misuse of taxpayers' funds.
In 1972 only six Federal Reserve banks and fifteen branches provided funds
for Federal Reserve Clubs. However, in 1973 ten of the twelve Federal Reserve
banks had established Federal Reserve Club payments and twenty of twenty-four
branches had also initiated club payments. In 1972 total payments to the Federal
Reserve Clubs amounted to $85,032. In 1973 that figure had jumped to $159,579.
It is interesting to note that one of the banks that began a Federal Reserve Club
in 1973 was the Federal Reserve Bank of Chicago.
Since the publicly disclosed expenditures of the Federal Reserve System
included thousands of dollars of highly questionable items, I can only wonder
what type of expenditures are included in the Federal Reserve Club area.
298
And the Federal Reserve Board's Watergate type tactic of "stonewalling" the
Committee's attempt to audit these expenditures serves only to increase my belief
that the Federal Reserve Club expenditures must indeed be of the most questionable nature.
Let me also point out another aspect of the Chicago Federal Reserve Bank's
operation that troubles me. During President Mayo's appearance before the
Committee I submitted a question to him concerning whether or not the Federal
Reserve System was "an agency of the government, and in specific, of the Congress." President Mayo responded that the Federal Reserve was indeed an
agency of the government. However, when the Committee's chief investigator
questioned the Chicago Federal Reserve Bank's counsel about his refusal to
turn over Federal Reserve Club expenditures he wanted to know why an
employee of the United States Government would not cooperate with another
employee of the United States Government. The bank counsel replied, "I don't
work for the U.S. Government, I work for the Federal Reserve Bank of Chicago."
This attitude is shocking and causes me to wonder if the bank's counsel is not
an employee of the U.S. Government or at least feels he is not then with whom
do his loyalties rest. The attitude by the bank's counsel, if shared by even a small
segment of the bank's employees, could cause disastrous effects in the Federal
Reserve's role in both regulating its member banks and handling monetary policy.
In light of the Board's stated policy of making all Federal Reserve expenditure records open to the Committee, may I request that you immediately make
the expenditures of all Federal Reserve Clubs available to the Committee and
that the Committee staff be given complete access to these records during their
field investigations.
Sincerely,
WRIGHT PATMAN, Chairman.
[From the Wall Street Journal, Aug. 8,1974]
B A N K DOMINOS
In May, when the Franklin National Bank was on the verge of collapse, the
Federal Reserve rushed into action with a $1.£ billion rescue operation. In June,
when the largest private bank in West Germany—Herstatt—was on the verge
of collapse, the Bundesbank considered a rescue operation and turned thumbs
down.
The difference between the Fed and the Bundesbank, when faced with the
same problem, gets down to the question of "confidence." The Fed, and the Bank
of England for that matter, belong to the school that believes a bank, at least a
big bank, shouldn't be allowed to go under or the public's confidence in banks
generally will be undermined. The Bundesbank, on the other hand, believes that
the public will have confidence in banks when banking is sound, and that banking diverges from "soundness" when those who run banks know there is a net
under them.
Isn't it strange that the Socialists who run the West German economy insist
that their banks meet the test of the marketplace, and the free enterprisers at
the Fed want their banks, at least the big ones, kept out of harm's way in the
market?
The banking community, here and abroad, would now be in a more promising
condition if the Fed had followed the lead of those West German Socialista The
Franklin National should have been permitted to sink, victim of its excesses in
"unauthorized currency trading." Its loan portfolio would have been peddled
and its depositors paid off, and if there were anything left over, the shareholders
would have divided that up. While we always dislike seeing shareholders damaged, the market system cannot function without downside risk to discipline
managers.
There is a prevailing view that bankruptcy at Franklin National might have
started a chlain reaction, a falling of dominos, because of a public loss of confidence. Such things have happened in the past, of course, and a central bank
should come to the rescue if otherwise sound banks start to fold from mass
psychology rather than their own mistakes. But if this danger is overestimated
and the panic button pushed at every sneeze, market discipline goes out the
window.
299
In fact, panic psychology would be likely to develop only if the Fed failed to
facilitate liquidation of Franklin National to keep depositors from being squeezed.
The most positive and beneficial economic act taken by any Western government these past six months was the Bundesbank's decision to allow Herstatt to
collapse. From that moment, bankers throughout the world became more interested in banking, and cut their cocktail h)ours accordingly. If it has previously
taken a 2nd vice president to approve a $5 million loan, with a bonus triggered
by his loan volume, it suddenly required a senior vice president to approve a $1
million loan, with no rewards for new business. Suddenly, nobody on that banking high wire could be quite sure there was a net below, a "lender of last resort/*
The Fed fixed that up by taking care of Franklin National. The Bank of England put a net under the London banks. And Treasury Secretary Simon, while in
London, heroically announced that the United States would supply liquidity in
the event of falling dominos in the Eurodollar market.
The net effect of all these assurances has been unfortunate. On the assumption
that central banks will bail out big blanks, depositors are pulling out of small
banks and regional banks and going with the big fellows. Eurodollar lending to
any but the 40 largest banks in the West is almost nonexistent. All the distortions are perverse. A risky bank that is "big" is to be preferred to a sound bank
that is small. The small, sound bank thus loses out in the competition for funds
and, at best, becomes smaller. The big bank gets funds easier and becomes riskier.
What can be done to correct this condition? There are only two alternatives.
The Bundesbank can announce, along with the Bank of England and the Fed,
that all banks, big and small, will be rescued when parlous conditions occur. Of
course, this would invite longer cocktail hours, decision-making by the 3rd vice
presidents, and in no time at all a string of Franklin Nationals.
The other alternative is for the other central banks to join the Bundesbank in
pulling the net from under all the banks, big and small, inviting lenders to search
out not big banks, but sound ones. If there is going to be a shake-out in the banking industry, it would grieve us enormously if it took place after governments
ensured that the first to go would be small in size and not necessarily small in
quality. A shake-out should start with the imprudent and ill-managed, whether
big or small.
[From the Washington Post, Aug. 8, 1974]
FEDERAL RESERVE READIES EMERGENCY LOAN PLAN
(By Joseph R. Slevin)
The Federal Reserve System is tuning up a multibillion-dollar emergency loan
program to assure that the U.S. will not be hit by a wave of bank and business
failures.
It has the legal authority, the responsibility and the money and has been checking out its operating machinery so it will be ready if the need arises.
No one at the Federal Reserve is expecting a major failure but the markets are
jittery and have been close to panic in recent weeks and the emergency lights
could begin flashing at any time.
There have been speculative excesses. Money is tight. The great fear is that
lenders suddenly will decide that a major bank or industrial corporation no longer
is safe and will pull out their money.
Federal Reserve Board Chairman Arthur Burns insists that the chances that
the Fed will have to activate its emergency plans are "most remote" but he declares that its resources will be "fully adequate" if an emergency comes.
The Fed demonstrated its muscle when it began pumping more than a billion
dollars of emergency loans into the collapsing Franklin National Bank last May.
Franklin had been the 20th biggest bank in the country but big corporations
pulled out hundreds of thousands of dollars after it became known that it had
suffered large foreign exchange losses.
Fed officials are quick to stress that it won't save any bank or business but only
a solvent one that is hit by a liquidity squeeze. The modern-day run on Franklin
is said to be a classic illustration of their point.
Franklin has many excellent loans and substantial amounts of high-grade collateral but there was no way it could have raised new deposits from wary private
lenders to replace the money the corporations withdrew.
36-714—74
20
300
A Fed decision to allow Franklin to go under would have had a devastating
impact both here and abroad.
Franklin is a major borrower from banks and business firms. If it had closed its
doors, vast sums would have been frozen. Banks throughout the world suddenly
would have found their sources of funds drying up because lenders no longer
would have been willing to put their money at risk.
The Fed is prepared to do as much for other solvent banks as it did for
Franklin.
It also has considered how it can assist a suddenly squeezed savings and loan
association or mutual savings bank. Officials believe it would help a savings and
loan through a regional Federal Home Loan Bank while aid to a savings bank
would be channeled through a commercial bank.
Emergency assistance to a business corporation would be provided under little
known and never used Sec. 18 of the Federal Reserve Act.
Action could Tbe taken reasonably quickly but not easily. Fed officials hope they
will hear about any emergency problem in time.
Assistance will have to be recommended by directors of a regional Federal
Reserve Bank. In addition, live of the seven Federal Reserve Board governors
will have to find that the firm is credit-worthy, has acceptable collateral and cannot obtain credit from private sources and that its collapse would create a crisis
for its industry or the national economy.
The Fed is the U.S. lender of last resort. The tests for helping a stricken company aren't easy. The power is there, however, and that is good reason for a
strained, jittery financial system to breathe a bit easier.
[From the Washington Post, Aug. 8,1074]
ARTHUR BURNS : I N A TIGHT MONEY SQUEEZE
(By Hobart Rowen)
The name you hear most frequently in Wall Street is not Richard Nixon's or
that of the next President, Gerald Ford. It is Arthur F. Burns, the white-haired
chairman of the Federal Reserve Board, who simultaneously is blamed for the
present critical shape of financial markets and looked to as the ultimate restorer
of the nation's economic health. As the man who doles out the money, he is the
devil and the savior rolled into one.
Every word that Burns says is parsed and analyzed for its meaning. Did thepowerful chairman of the central bank say money policy would continue to be
tight, or tighter? Is his latest warning on the evils of inflation more serious in
tone than the last?
Will the Fed ride to the rescue of banks or corporations short of liquid reserves,,
but technically solvent, as it did in the case of the Franklin National Bank?
Bankers and financial men don't hate Burns with the passion of a George
Meany, who says Burns hasn't had a single new economic idea in the past five
years.
But there is a widespread view among them that the Federal Reserve Board
sadly missed its timing in 1972. "Arthur got the anti-inflation fervor too late,'^
says one critic who, nevertheless, is a great admirer of Burns. His theory—quitethe opposite of Meany's—is that Burns continued a liberal money policy too long.
"Burns should have told the banks to slow down their loans, to quit advertising the availability of consumer credit—in other words, to be more prudent,"
says one Burns critic.
"Instead, he became too oriented to the money supply. In effect, he said 'We'll
supply the money, and let the market ration credit.'"
Burns agrees with Chase Manhattan Bank chairman David Rockefeller that
some banks have now gotten themselves out on a limb with loans that may be
of dubious quality. This week, in testimony before the Joint Economic Committee,
Burns said that "some carelessness crept into our financial system," and that some
banks had indulged in "financial adventuring."
On Capitol Hill, Burns is shown the greatest deference by senators and representatives who normally are jealous of their prerogatives. They are polite and
rarely criticize him, although many agree with economist Walter Heller (and
George Meany) that the Burns money policy is too stringent and threatens*
recession.
301
Canny politician that he is, Burns takes pains to stroke the congressional egof
testifying patiently and for long hours, willingly repeating himself to a committee member wandering to a hearing (or who didn't get the drift first time around).
Only Arthur Burns could have deftly sidetracked as determined an inquisitor as
Sen. William Proxmire, who wondered this week whether Alan Greenspan was
worthy to be designated chairman of the Council of Economic Advisers inasmuch
as he is a vigorous opponent of the antitrust laws.
"Senator," Burns responded benignly, "Alan Greenspan was one of my students
and I never criticize any of my former students—I love them all."
The message that Burns is imparting to the Congress and to financial markets
is a mixture of a sober—almost gloomy—analysis of prospective economic
troubles, coupled with a pledge that the Federal Reserve—as a "lender of last
resort"—will not allow things to get so bad that there will be a money drought,
that is to say, a policy so tight that it creates an absolute shortage of money to
grease the nation's financial machinery.
But Burns, in contrast to the Nixon party line, is not optimistic that serious
price inflation will abate in the second half of this year. He thinks it "plausible"
that the rate of real economic growth for the next six months could be as little as
zero to 2 per cent—a range which implies that 1974 as a whole will show a drop
in activity from 1978.
Burns readily concedes that a change of leadership in the White House will
provide a psychological thrust forward. A new administration under Ford would
not be overwhelmed—as Nixon was—with Watergate, the cover-up, the legal
defense. As far back as June 23, 1972, as the fateful tape of that day's conversation with Haldeman shows, President Nixon couldn't be concerned with the float
of the British pound and didn't give an (expletive deleted) about the Italian
lira.
A President Ford, however, could concentrate on the economy. He could even
declare a National Economic Emergency with no suspicion that he is trying
to distract attention from Watergate. Broadened in perspective and coverage,
an economic summit might yield a balanced approach to economic problems, and
take Arthur Burns off the tight money hook.
The CHAIRMAN. I assure the gentleman that these are constructive
statements and I call them to your attention.
Anyway, Dr. Burns, I will yield to the other members here and let
them interrogate you at this point. We did not get through the other
day and that is the reason we asked you to come back.
The first one, I think, on our side is Mr. Minish, and on this side I
think it is Mr. Wylie and then Mrs. Heckler. She just came in. She
would be next after you.
All right, Mr. Minish.
Mr. MINISH. Thank you, Mr. Chairman.
Dr. Burns, correct me if I am wrong, but I believe that you indicated
or made a statement that the energy crisis has contributed to our
inflation.
Is that correct, sir ?
Dr. BURNS. That is correct, yes.
Mr. MINISH. The oil companies are making profits that are astronomical and I think we can agree on that. Then we have the problem
of Mr. Sawhill, who suffers from a disease that whenever he gets on
TV he just has to say that the price of oil and gasoline will go up,
notwithstanding the profits of the oil companies.
I was just wondering whether you can bring any influence on this
individual or someone in the administration to be more concerned with
the rising cost of gasoline, fuel oil, and heading oil and to work toward
getting tnese corporations to cut their prices in view of their astronomical profits. I would like your opinion on that, sir.
Dr. BURNS. I am concerned about the excessive profits of the oil
companies. I am very much concerned about that. However, as far as
302
[ and petroleum products generally
are concerned, I feel that in the absence of rationing—and we do not
have a rationing system—price has to perform a rationing function,
and that a high price leads to conservation in the use of petroleum
products. This, I think, is important.
Actually, if you look around the world you will find that the price
of petroleum products, gasoline, heating oil, et cetera, is a good deal
lower in our country than practically anywhere in the world. In fact,
I cannot think of any country where the price is lower.
You will also find that after the oil-exporting countries began
manipulating the price of oil, which resulted in a close to quadrupling
of the price of crude oil, that the leading industrial countries around
the world increased their taxes on gasoline.
Why did they do that ? They did that in the interest of reducing
consumption. They did that in the interest of reducing their imports
of oil products and thereby helping to protect their balance of
payments.
So what concerns me, to come back to your question, is first, the
level of profits in that industry. I share your concern about that, but I
do not share your concern under present circumstances about the high
price of gasoline, and other petroleum products. The high price serves
a function of reducing demand. The only other way of doing it would
be to introduce formal rationing through coupons, et cetera.
Mr. MINISH. Do you not think that when a company like Exxon
reported $750 million in the first quarter and then was found to have
set aside $400 million in profits, do you not think they ought to reduce
the price rather than increase it ?
There are people who use gasoline, not for enjoyment or joy riding—
they need the car for work.
Dr. BURNS. I realize that. I am not being very successful in conveying my thought to you.
I see great difficulties around the world because of the unconscionable and extortionate increase in the price of crude oil. The world has
to adjust to it if our monetary system is not to break down. How can
we do it ?
First, I think, by conserving oil products, using less. That will put
certain pressure on the market and the oil-exporting countries may
find that they will have to lower the price.
Second, I think we have to push ahead with Project Independence.
That has been going much too slowly.
And third, I feel that it is the business of the world's oil-consuming
nations to get together. Just as the oil-exporting countries have formed
a cartel to raise the price of oil, so the oil-consuming countries need to
get together.
In addressing myself to your question, I was concerned solely with
the conservation problem. We began conserving gasoline pretty well,
you see, through various devices. We are doing it solely through the
market, and doing it through the market means that the price has to
be high. That is the way the rationing takes place, through the marketplace.
Mr. MINISH. Thank you, Dr. Burns.
That is all, Mr. Chairman.
The CHAIRMAN. All right then. Mr. Wylie.
303
Mr. WXLIE. Thank you, Mr. Chairman.
Chairman Burns, I was pleased to see your picture on the front
page of Business Week recently and to have you characterized as the
man who has emerged as perhaps the only authentic expert in the
economic policy arena. I might add that I spoke to a group of Ohio
bankers yesterday and many of them feel the same way. So they are
looking to you for guidance during this time of economic crisis, Mr.
Chairman.
The thrust of these hearings has been that the so-called money
supply problem in the United States is directly responsible for many
of our economic ills. Now even the most dyed-in-the-wool monetarists
agree that there are other factors influencing our economy, such as
fiscal excesses, although some would claim that this effect is the result
of monetarizing the debt.
It seems to me that the Fed is the closest thing we have to a central
bank and can have a strong but not absolute influence on the economy
by influencing our money supply. Now just as the Fed cannot control
the money supply absolutely, the Fed cannot take all the blame or
credit, it seems to me, for failures or successes. I, for one, would
oppose total and complete control of money supply in any single place.
Would you comment on the manner and guidelines for the Federal
Eeserve decisionmaking process and actions in pursuing money supply
goals? In other words, what process do you go through when you
decide you are going to have' an expansionary monetary policy or a
moderate monetary policy or a restricted monetary policy? I am
asking the question because it came to me yesterday at our meeting, as
I say, out in Ohio. Bankers are interested in knowing what your
guidelines might be. There is a shortage of money at the present tim*
as far as commercial banks are concerned and yet there are moit
pressures for credit than ever before. Would you please commenl
Dr. Burns?
Dr. BURNS. Well, we have been passing through a period when th(
demand for credit is enormous. The demand has been particularly
strong for business loans. The Federal Eeserve has continued to use
its power to expand the money supply. We have, however, sought to
moderate the rate of growth of the money supply so that the rate of
growth of the money supply would be below the rate of growth of
the gross national product but still somewhat above the rate of growth
that would be needed for a time of general price stability.
In other words, we try to pursue a middle course. If we kept on the
present track and permitted the money supply to grow year in and
year out at something like 5% or 6 percent, we would be virtually
guaranteeing a continuance of inflation for this country, not in any
particular month or year or two but over the long run.
Our objective, therefore, is to bring the rate of growth down, but to
do it gradually because we are well aware of the fact that the demand
for credit is very strong. It will take time to unwind the inflationary
process that is underway.
Some price increases in our economy are unavoidable. Take the
case of public utilities, for example. The price of fuel has gone up
sharply. Other costs have gone up very sharply. Interest rates have
gone up sharply. These public utilities are subject now to a very
strong cost-price squeeze. Actually, utilities over the country of late
304
have been cutting back on their investment plans, and that does not
bode well for this country's future. Utility rates simply have to go
up, not in every part of the country but in many parts of the country.
This is one example of many where price increases must take place
^because of earlier cost increases and the cost increases still going on.
So the short answer to your question is, to repeat, that we are seeking
a rate of monetary growth that, on the one hand, is well below the rate
of growth in the dollar value of the gross national product, but on the
other hand, well above the rate of growth that would be needed over
the long run to maintain a stable price level in the country.
Mr. WYLIB. Thank you. Earlier in your testimony you said that
over the past 12 months the money supply has grown at an annual rate
of approximately 6 percent, and this was a decrease from 8 percent the
previous year, and yet, credit demands were stronger this year than
they were last year with less money being available.
There have been several recent newspaper articles that indicate that
many commercial banks are way overextended and our chairman, Mr.
Patman, got into this a little earlier this morning with reference to
the Franklin National Bank situation. There are indications from
newspaper articles that a number of American banks lost heavily when
the Germans' Bankhaus Herstatt, failed.
Would you care to comment on thefinancialhealth of the domestic
financial banking system in the United States ?
The CHAIRMAN. The time of the gentleman has expired, but you may
go ahead, Dr. Burns, and answer his questions.
Dr. BURNS. I think that, by and large, our banking system is entirely
sound, but we have had some carelessness creep into a number of our
banking institutions, which have allowed their capital positions to
erode and which have permitted themselves to rely excessively on
borrowed funds such as Eurodollars and certificates of deposits and
overnight Federal funds. This condition will need to be corrected, and
there are defects in our regulatory system that will need to be corrected.
In due course I am going to come before this committee and present
some significant legislation on banking reform.
Mr. WYLIB. I thank the Chairman.
The CHAIRMAN. Mr. Gettys*
Mr. GETTTS. Thank you, Mr. Chairman.
^ Dr. Burns, we all appreciate your appearance here this morning,
sir. We have been discussing for years whether high interest rates are
a cause of or a result of inflation. Would you give your concurrent
views on that question, sir ?
Dr. BURNS. Well, I dealt with that question in the statement that
I gave to the committee at the last hearing. The short answer is that
interest rates, to a very small degree, intensify inflation. There is a
grain of truth in the allegation that is so frequently made that when
interest rates rise, the costs of business enterprise also rise and prices
follow suit.
There is some truth in that, but only a grain of truth. Preponderantly, the effect of higher interest rates is to reduce the demand for
credit and thereby to reduce the demand for goods and services. High
interest rates are simply a symptom of reduced availability of credit.
With borrowing tapering off, the demand for goods and services tends
to taper off and, therefore, the pressure on resources is reduced. Funda-
305
mentally, therefore, high interest rates serve to reduce the rate of
inflation rather than to raise it.
Let me make one other statement. Interest rates are a cost of doing
business. Of course they are. Wages are a cost of doing business. Of
course they are. On the average in our country, for every dollar paid
by business firms in interest, $20, $25, or $30 are paid in wages. I find it
very curious that so much emphasis is placed by many on interest rates
as a price-raising factor, and that the role of wages as a price-raising
factor is slighted.
Mr. GKTTYS. DO you consider, Dr. Burns, that the present high interest rates are effectively reducing inflationary pressures?
Dr. BURNS. Yes, they are. I gave some testimony on that 2 days ago
before the Joint Economic Committee. If I may, let me read a sentence
or two from that statement.
Evidence is accumulating that the restrictive policy pursued by the Federal
Reserve is helping to moderate aggregate demand by reducing the availability
of credit to potential borrowers and disciplining inflationary psychology. In the
first half of last year, the credit extended to private domestic borrowers increased at an annual rate of $165 billion and amounted to about 14% percent
of the private component of the gross national product. Estimates for the first
•half of this year suggest that the rate of aggregate private credit expansion has
fallen to about $145 billion or liy2 percent of private GNP.
Mr. GETTYS. Thank you, sir. One other brief question: Would the
allocation of credit serve a useful purpose at this time, sir ?
Dr. BURNS. Well, if we knew how to do it, it might, but I think
when we speak of allocation of credit, we are speaking of an enormously difficult undertaking and one that might easily make things
worse rather than better.
Mr. GIHTYS. Thank you.
If I have time left, Mr. Chairman, I would yield to my good friend
from Ohio, Mr. Wylie.
Mr. W Y U B . I thank the gentleman for yielding.
The CHAIRMAN. He has 30 seconds.
Mr. WYLIE. Dr. Burns, you indicated earlier that monetary policy
oannot do it alone, that the fight against inflation cannot be won
through a monetary policy alone. Further you said that fiscal policy
must be changed.
I have introduced H.R. 15375 which, simply stated, would say that
the Federal Government through Congress could not spend more than
it takes in and would reduce the Federal debt by 2 percent for this
fiscal year.
What do you think of my bill, Dr. Burns ?
The CHAIRMAN. The time of the gentleman has expired.
Mr. WYLIE. Could he answer the question, Mr. Chairman ?
The CHAIRMAN. All right. The time has expired, but go ahead and
answer it.
Dr. BURNS. I like the direction of your thinking, Congressman
Wylie. As to the specific proposal, I would like to reflect on that before
I would comment.
The CHAIRMAN. All right, sir.
Mrs. Heckler.
Mrs. HECKLER. Thank you, Mr. Chairman.
Thank you, Dr. Burns. It is always worthwhile to listen to your
point of view. I would say that your spearheading the fight against
306
inflation is positively what the current situation requires. I certainly
join you in the effort.
However, my particular concern about the inflationary spiral relates
to one sector of the economy. People in my district are generally in
support of a fight against inflation. I think the recognition on the
grassroots level has increased substantially. While we are told we must
all bite the bullet, it is quite apparent that the housing industry is
supposed to swallow the bullet. As a member of the Housing Subcommittee, I have to express my deep concern over what I consider to be
the disproportionate share of the burden which the housing industry
is bearing.
I have talked to home buyers who cannot purchase a home, realtors
out of work, carpenters, construction workers at the low-income level.
We hear about the high salaries and wages which some construction
workers enjoy, but not all of them have that same benefit; there are
many who just scrape by or earn at most a very meager income.
Mortgage lenders are concerned that, in general, builders and everyone else associated, with housing are in a desperate situation.
I think part of the problem is that not only the current policy bears
down excessively heavily on the housing industry, but also that in the
policymaking structure housing is not represented. They are merely
the scapegoats of a decision and not participants in the decisionmaking. It seems to me that there are questions about how far we can
go. Is there any way to redress the inequities of this situation ?
If the housing industry had not always been the shock troops of
tight money, we might find ourselves understandably bewildered. But
this has been a pattern that has repeated itself many times in recent
years.
Why is it that the brilliant minds, at the Federal Reserve and elsewhere, have not developed a strategy to create equity in terms of bearing the brunt of the tight money policy?
I question how far we are going to let the whole thing go. In
Massachusetts, housing starts dropped in 1 month 10 percent from
May to June; residential construction is down 44 percent below a
year ago; commercial construction, down 48 percent; mortgage money
outflow from S. & L.'s in Massachusetts in June was $6.8 million;
that was the poorest month since 1969. S. & L. new receipts for the
first 6 months of 1974 in Massachusetts are 24 percent below a year ago.
I do not know what the specific figures on unemployment in the construction industry are, but we are seeing nationwide concern with the
rising unemployment levels. I would like to see the figures on unemployment in construction-related jobs. I think it would be really
shocking.
The question is, how far will we allow housing to slide? How much
unemployment in the construction industry can we tolerate ?
How high can the mortgage rates go and still have any housing at
all, and how much disintermediation will the thrift institutions be
expected to bear?
Is there a trigger point? Is there any point at which we can say,
enough, or too much, and do something for housing? Is there any
way out of this quandary ?
Dr. BURNS. Mrs. Heckler, you have made an excellent statement
about the condition of the homebuilding industry and the condition
307
of our thrift institutions. I can only commend you for everything
you have said.
As you have noted, the problem of the housing industry is one of
very long standing. It has been a prince and pauper industry throughout modern times. The fluctuations in homebuilding have been large.
This has been true not only of our country; it has been true of every
country of the world, including, interestingly enough, socialist economies which engage in planning and scheduling. Presumably, one
might think, they could stabilize the industry. They have not succeeded.
What I am trying to say is merely that this is a problem of long
standing that many men have studied, and tried to deal with. The success that we have had so far has been quite limited.
You may recall that at the time of my confirmation hearing in the
Senate for the post that I now hold, I was asked a question about housing. It so happens that I began studying the homebuilding industry
and its financial problems some 50 years ago. In that time, I have
learned a little about its problems. I indicated to the Senate Banking
Committee it was my fervent hope, while I am in this post, to make
some contribution to the solution of this problem.
One of the first things I did was to organize a rather comprehensive
study of home mortgage financing, its instability and how it might be
dealt with. I drew not only on my own sizable and very competent staff,
but we brought in some 20 specialists, as I recall, to work on this
problem.
By March 1972, we had completed our inquiries and submitted a
report to the Congress. We made various recommendations for dealing with this problem before we reached another crisis in the homebuilding industry.
Whether that report was good or not is something that others can
judge better, certainly more objectively, than I can. But I had hoped,
and I still hope very much, that the Congress would take that report
seriously, so that it would serve as a point of departure for a thorough
critical examination of the problems of that industry; and if the proposals brought forward by the Federal Reserve Board were deemed
inadequate or defective, that in the process of holding hearings and
deliberating on the problem, better thoughts would come to the surface.
Unfortunately, this report has received very little attention. I still
think it deserves a better fate than it has received.
I am only at the beginning of answering your question. The chairman is exercising his authority very properly; I would only ask the
privilege of expanding these inadequate comments so that I come to
grips with your question.
The CHAIRMAN. Without objection, so ordered.
[In response to the request of Mrs. Heckler, the following information was submitted for the record by Dr. Burns:]
REPLY RECEIVED FROM DR. BURNS
The Federal Reserve Board's recommendations for moderating fluctuations in
housing construction were sent to Congress in March of 1972, along with an extensive study by the Federal Reserve Staff on this subject. These recommendations included a number of institutional changes that would have helped to avoid
the present dire shortage of mortgage credit.
308
As developments this year have made clear, steps are still needed to strengthen
the ability of depositary institutions to attract and hold consumer savings when
yields are rising on market securities. The thrift institutions are particularly
vulnerable at such times because of the maturity imbalance between their assets,
which consist essentially of long-term loans with fixed yields, and their liabilities,
which are short-term. While some progress has been made in correcting this disparity, more might be accomplished by relaxing deposit rate ceilings in ways
that would allow greater incentives for savers to deposit funds for longer periods.
Some benefit would also accrue from shortening the average life of the earning
assets of thrift institutions, although any sizable move in this direction should
come only after careful consideration of the potential impact on the long-run
supply of mortgage credit. Some benefits along this line would be gained by authorizing the thrift institutions to place a somewhat greater share of their earning
assets in short-term consumer loans. Their earnings would then respond better
to changes in market interest rates, and they would be in a better position to
adjust the rates they pay on deposits so as to maintain their savings flows.
Another useful step would be to enable all depositary institutions to offer home
mortgages with variable interest rates and attendant consumer safeguards, side
by side with the traditional fixed-rate mortgage. Since the variable rate mortgage
would result in more flexible average earnings rates, the institutions could compete more effectively for deposits. Greater stability of deposit flows would yield
greater cyclical stability in the availability of mortgage credit without affecting
adversely the long-run supply of mortgage funds. It would probably take a decade
or more for variable rate mortgages to become a subtantial factor in the portfolios of depositary institutions. But over time such loans have the potential for
helping to smooth out flow of funds into home loans, and their encouragement
deserves careful consideration.
By making greater use of fiscal tools, sectors of the economy that are now
relatively immune to monetary policies would come to bear a more equitable share*
of restraint during periods of excess aggregate demand. For this reason, the Federal Reserve Board would once again recommend flexible use of an investment
tax credit as a means of promoting greater stability in outlays by business firms
for machinery and equipment. Such expenditures are large, cyclically volatile,
and—unlike housing—relatively insensitive to monetary policy.
Further steps could also be taken to remove legislative and regulatory constraints that at times discourage mortgage investment. For example, interest
rate ceilings on FHA-insured and VA-guaranteed mortgage loans—intended as
protection for home buyers—have meant that in practice such financing periodically dries up, or becomes available only if the seller is willing to pay several
"points" as a loan fee. In recent years, administrative adjustments in the ceilingrates have been more frequent, so that these ceilings have less often given rise
to a blockage of mortgage funds. However, if Congress abolished the ceilings
altogether, or tied them directly to market interest rates, the States might be
encouraged to take similar action with respect to their usury laws, which still
serve to blockflowsof funds into mortgages when over-all demands for credit are
high.
Other changes in Federal legislation that would also be of some help include
the granting of authority to the Federal Reserve to lend to member commercial
banks on the basis of mortgage collateral at the regular discount rate, permitting
national bank investment in real estate loans based solely on considerations of
safety and soundness; and relaxation of geographical restrictions on conventional
mortgage loans of Federal savings and loan associations, which could lead tosimilar liberalization of state laws.
The CHAIRMAN. YOU see, we are trying to divide time between all the
members.
Dr. BURNS. I understand your position perfectly, Mr. Chairman.
Mr. COTTER. Mr. Chairman, I am very much interested in this.
The CHAIRMAN. Mr. Koch is next.
Mrs. HECKLER. Mr. Chairman, may I be recognized for a unanimousconsent request?
The CHAIRMAN. Certainly.
Mrs. HECKLER. I would ask unanimous consent that this study which?
Dr. Burns has alluded to will be a part of the record so that we will
have the opportunity to consider it in depth.
309
The CHAIRMAN. Without objection, so ordered.
[In response to the request of Mrs. Heckler, the study referred to by
Dr. Burns, "Ways to Moderate Fluctuations in the Construction of
Housing", published in December 1972, is retained in the committee's
file. A summary report from the Federal Reserve Bulletin for March
1972, may be found on page 477.]
Mr. COTTER. Mr. Chairman, I am very much interested in the line
of questioning by Mrs. Heckler. As a matter of fact, I was going ta
pursue it, and I would yield my 5 minutes to allow Dr. Burns to
continue.
The CHAIRMAN. Mr. Koch is next.
Mr. KOCH. Well, I would defer for this.
The CHAIRMAN. If you want your time, you had better take it.
Mr. KOCH. Mr. Chairman, I am trying to oblige Mr. Cotter and Mrs.
Heckler. Could the chairman not come back to me by unanimous
consent ?
The CHAIRMAN. All right. Without objection, it will be done this
time, but we cannot make a habit of it, because we are trying to divide
the time so each member will have at least 5 minutes. All right, go
ahead, Mr. Cotter.
Mr. COTTER. Dr. Burns, if you could, please summarize some of the
proposals you made in your report of March 1972, as relating to the
housing industry.
Dr. BURNS. The two most important proposals in that report were,
first, that we change the investment tax credit from the fixed rate to
a variable rate and thereby release funds at certain times to homebuilding, funds that now go into business investment.
The second major proposal was to permit and encourage variable
rate mortgages. There were a dozen proposals of lesser importance, and
I will not take time to summarize those. The entire report will be put
in the record. I would like to deal with Mrs. Heckler's questions more
specifically now.
I think we have to ask ourselves the question, What is wrong with
our homebuilding industry at the present time ? Why is it in such a bad
slump? The depression that you pictured we recognize; it is more
severe in some States than in others, and it is particularly severe in
your State, Mrs. Heckler. Why is the industry in difficulty ?
First, I would say the industry is in difficulty because the purchasing power of the average workingman of this country has eroded during the past year as a result of the inflation. His purchasing power,
the ability to buy goods and services, is 5 percent lower now than it
was a year ago. This has caused a reduction in the demand for housing, just as it has caused a reduction in the demand for automobiles,
the demand for appliances, and big-ticket items generally. That is one
cause.
Second, the price of land and construction costs generally have been
rising sharply. The high price of homes is simply pricing many even
of our middle-income families out of the market.
Third, the gasoline shortage, uncertainty about its price and availability in the future, has caused some decline in the demand for housing. People are less willing today, not knowing what the future may be
in this regard, to buy a home or to build a home 20, 30, or 40 miles
away from the place where they work.
310
Fourth and finally, in some parts of the country, we have had overbuilding. The proof of that is that vacancy rates for the Nation as a
whole are higher than they have been in some 5 or 6 years.
Now, then, I come
Mrs. HECKLER. Would the gentleman from Connecticut yield ?
Mr. COTTER. Certainly.
Mrs. HECKLER. Mr. Chairman, would it be possible for you to list
those areas in which there has been overbuilding ?
Dr. BURNS. Yes, I will do that. The figures are less detailed than I
would like, but we can do it by broad geographic regions.
[In response to the request of Mrs. Heckler, the following information was submitted for the record by Dr. Burns:]
REPLY RECEIVED FROM DR. BURNS
Nationally, rental vacancy rates in the second quarter of this year averaged
6.3 per cent—the highest for any second quarter in the past seven years. Second
quarter home-owner vacancy rates have also risen to 1.1 per cent, as against
0.9 per cent a year earlier. Vacancy rates in most Census regions have risen over
the past year, as the attached table indicates, but the rise has been most marked
in the South.
While recent vacanev rates are still well below the post World War IT peaks
reached during 1965, the over-all number of units (especially apartments) still
under construction has remained very substantial—at a level of about 1.5 million
this summer. Also, merchant builders' inventories of single-family dwellings for
sale at mid-year approximate 10 months supply at prevailing rates of sale. This
compares with about 8 months supply in the second quarter of 1973 and with
fewer than 6 months supply in most other recent years.
RESIDENTIAL VACANCY RATES
[In percentl
Average for the 2d quarter
Rental units.
Northeast
North-central
South
West
Homeowner units._
Northeast.
North-central
South
West
.__
1965
1971
1972
1973
1974
8.2
5.3
7 1
8.5
12.6
1.5
.7
1 0
1.9
1 9
5.3
3.0
5 3
7.2
5.6
.9
.7
.7
1.3
1.0
5.5
3.0
67
6.9
5.7
1.0
.5
1 0
1.1
1.4
5.8
3.7
5.7
7.2
7.0
.9
.6
.9
1.0
1.2
6.3
4.0
6.4
7.9
6.8
1.1
.6
1.0
1.4
1.3
Dr. BURNS. NOW, I come to interest rates and the availability of
mortgage credit. Interest rates, on mortgages for homes are now 9 percent, 9y2 percent. They have risen very materially. This is a further
discouraging factor coming on top of the difficulties from which the
homebuilding industry was already suffering. Then, some States have
usury laws, so that people who are willing to pav the market interest
rate and to build or buy are prevented, in effect, from doing so.
Finally, what can one do about it, and what can the Federal Reserve
do about it, and what has the Federal Reserve been doing about it?
First, let me talk about the Federal Reserve, and then I will talk
about the Government in general. Or I can invert the order, if you
would prefer.
*
Mrs. HEOKLER. NO ; I would like that order.
311
Dr. BURNS. All right. What is the Federal Reserve doing about it?
Well, we have no specific authority, as you know, in the housing area.
I think that in fighting inflation, as we are at the present time, we are
making a major contribution not only to the economy of this country
and the restoration of its strength, but also to the economics of the
homebuilding industry. Unless or until inflation is brought under control, homebuilding, I am convinced, will be in difficulty.
Look at what is happening now to construction wages. Construction wages recently have been going up at an enormous rate, and we
are on the threshold of a repetition of the cycle that we had in 1969 to
1970 when construction wages
The CHAIRMAN. Mr. Cotter's time has expired.
Dr. BURNS. May I finish my sentence? When construction wages
rose in different localities 10, 15, 20, 25, and 30 percent. Before very
long, the enormous increases in the construction industry spread to our
manufacturing plants and across the country.
We are on the threshold of a repetition of that cycle, and it is very
dangerous. The recent closing down of the Construction Industry
Stabilization Committee—and I believe one of your constitutents,
John Dunlop, ran that committee, and he ran it well—I think was a
great mistake.
The CHAIRMAN. All right.
Mr. Crane.
Mr. CRANE. Thank you, Mr. Chairman.
Dr. BURNS. May I just say one more word ? I still have not finished
answering Mrs. Heckler. She deserves an answer, and she will get it
from me in the record.
The CHAIRMAN. We appreciate your suggestion. I wish we could just
give unlimited time.
Dr. BURNS. I appreciate your problem, Mr. Chairman.
The CHAIRMAN. We cannot just turn everyone loose, as much as we
would like to. We would like to hear you all day, but we just cannot
do it.
All right, Mr. Crane.
Mr. CRANE. Thank you, Mr. Chairman.
I want to welcome Dr. Burns back before the committee. I would
like to yield to my distinguished colleague from Massachusetts
initially here for another inquiry.
Mrs.r HECKLER. I thank the gentleman for yielding.
I w ould just like to make public a suggestion that I made to you,
Dr. Burns, privately. I do think the exclusion of the housing sector
from the considerations of the Federal Reserve Board is a glaring
omission, and I feel that since the housing industry does face the prospect of carrying the heaviest burden, as I have suggested to you
privately, I would like to have this record show that I request that consideration be given to having a representative of the housing industry
on the Federal Reserve Board, so that this industry can be represented
while the decisions are made. Perhaps some equity, or greater equity,
can be restored to the system.
I thank the gentleman for yielding.
Mr. CRANE. Dr. Burns, I unfortunately do not have your initial
statement from last week when you were here, and I did not get the
opportunity at that time to question you.
312
A question that was on my mind, and I think is on the minds of
quite a number of people, is about a kind of tangential reference you
made in your statement to the Franklin Bank situation. Then somewhat further on, you did make a comment, as I recall, to the effect that
the Federal Reserve System would not permit any kind of massive dislocation in the banking industry. I am sure that remark was designed
to allay some of the apprehensions that many people had evidently felt
because of Franklin and then Herstatt, plus a great many rumors that
I know you are aware of concerning the condition of banking generally in this country.
The question I have is, what is the capacity of the Federal Eeserve
System to deal with this? I mean, how many banks with problems
similar to Franklin's could the Fed salvage?
Dr. BURNS. I do not know that I could answer that numerically.
Your question is hypothetical. I think our banks by and large are in
sound condition, and I do not expect another Franklin. If we have bad
luck and another Franklin or even two come along, we can deal with
that very easily.
Mr. CRANE. I am glad to hear you say that, because, as you know,
coming from the State of Illinois and the Chicago area, there have
been some rumors that have been injurious, you know, to some of our
banks in Chicago. These rumors have been unsubstantiated, to the best
of my knowledge, by the facts. So I am grateful to have you make that
a part of the record, that with your expertise and knowledge, you know
that most of these rumors are unsubstantiated and unreliable.
One other thing that I want to commend you for, but on the other
hand was a source of concern to all of us, was your commencement talk
at Illinois College in Jacksonville where I think you put your finger on
something. You paraphrased, as I recall, a statement attributed to
John Maynard Keynes, who said that there is no subtler or surer way
to overturn existing society than to debauch its currency. It engages,
Keynes said, all of the hidden forces of economic law on the side of
destruction in a way that not 1 man in 1,000 can diagnose. I presume he was talking about money policies run amok and the threat that
that represents to all other institutions in society.
Would you elaborate just very briefly on some of those comments
you made at Illinois College ? How portentous is the situation in your
eyes right now ?
Dr. BURNS. I think that the history of many nations around the
world demonstrates quite conclusively that when people lose confidence
in their currency, a social and political upheaval tends to follow. You
may recall what happened in Europe after World War I, in Russia,
in Germany, in Austria. These countries went through a rampant
inflation, and the entire social and political system was changed, largely
as a result of the misery and inequities and frustrations brought about
by inflation.
The history of Latin America, most recently the history of Chile,
indicates what happens when inflation begins to gallop in a country.
It is no accident that when China moved over into the Communist
sector, the shift to communism was preceded by a rampant inflation.
We have had several changes in governments in Europe this very year
as a result of the inflation experienced by these countries.
313
There is a great deal of unhappiness in our country over inflation. I
think this is the one problem that concerns the general public more than
any other. People feel frustrated; they feel helpless. They do not
know how to plan their lives as they used to. When people begin thinking about their country in that way, great political uncertainties may
develop, and the outcome may be bad for our future.
These are the thoughts that ran through my mind when I wrote that
address.
Mr. CRANE. My time has expired, Dr. Burns.
I thank you for that.
The CHAIRMAN. All right.
Mr. Koch.
Mr. KOCH. Thank you, Mr. Chairman.
Chairman Burns, as you know, it is a pleasure for me and the members of this committee to welcome you.
I would like to get your comments further on this question of loss
of confidence in currency and all of the ramifications that poses. In
particular, I would like to focus on an area of the economy which
relates to the small saver.
The other day I noticed you proposed a public works project or an
unemployment project—I do not know the exact term—but it provided 800,000 or 900,000 jobs for the unemployed because of the inflationary consequences to employment. I am in support of providing
jobs.
But I want to get to another sector, which relates to the people who
put money in banks, the small saver. I would ask whether or not we
could not apply the index theory concept to the question of small accounts. What I mean by that is, is it not possible, either through the
private banking institutions, to provide that an individual who places
a sum of money in an account—and there might have to be restrictions
as to the size—that when he draws that money out, it will have true
current value, whether it is a year later or 10 years later, plus some
reasonable interest ? We now know that we are discussing what everyone has come to take as an acceptable term, "two-digit inflation," it
is as though by calling it two-digit inflation, it does not have the severe
consequences that it might otherwise have. It is sort of a benign term,
but devastating on the economy.
When someone places money in an account now, two things happen.
One, lie gets about 5% percent interest. Two-digit inflation means that
when he draws that money out a year later, he in fact has suffered a net
loss.
Dr. BURNS. He also has to pay income tax on that.
Mr. KOCH. Exactly, and in addition, pay an income tax on that net
loss, so to speak. That is an outrage. So what I am asking is this: If you
would comment on the feasibility of either a governmental program
or a program through the private banking institutions which would
permit an assured return, so to speak, in the sense that the small saver
would get back true dollars plus some modest interest when he withdraws it.
Is it feasible ? Have other countries done it ?
Dr. BURNS. The only country that I know which has fully developed
and pursued a plan of this sort is Brazil. When you say, is it feasible,
I must respond that it could prove very injurious at the present time.
314
I recognize your quest for justice and it is a thoroughly civilized and
laudable objective. But let us think of what this would mean.
Here you have a savings bank which is paying its depositors 5 or 5y2
percent. You have an inflation rate of 10 or 12 percent. Indexing would
mean that the interest rate paid to depositors would have to be 15 or
17 percent. If the savings bank paid interest of 1*5 to 17 percent, it
would have to charge the borrowers on mortgages not 15 to 17 percent, but 17 to 19 percent.
Mr. KOCH. May I break in ?
Let us get rid of this question of the small saver having to subsidize
mortgages. We need mortgage money and let it come from the Government, either by way of a subsidy or by way of making the money
available. To talk about it in terms that the small saver has to subsidize those people who want to go out and buy houses seems to me
outrageous.
Dr. BURNS. We will put the mortgage market to one side.
Mr. KOCH. Because it is inflammatory.
Dr. BURNS. Yes, we will put it to one side. In some fashion it is
going to be taken care of. Our savings b&nks at the present time, in
addition to investing in mortgages, invest heavily in corporate bonds.
In fact, they have been moving more and more heavily into corporate
financing.
A triple-A bond today will yield something like 10 percent,
and howT is the savings bank going to pay 15 to 17 percent? Let us
look at our savings and loan associations. On any new mortgages—
well, that is going to be taken care of in some fashion. They now have
outstanding mortgages in their portfolio at 4, 5, 6, and 7 percent. How
can they possibly pay such rates of interest ?
Mr. KOCH. Dr. Burns, if we do not provide some assurance to the
small saver that a year hence or 10 years hence his money is not going
to be depleted by virtue of just simply sitting in that account, does
that not in fact create the loss of confidence and should not every
small saver go out and buy something with those moneys—I mean,
something physical that will appreciate with value rather than having
it sit in the account and incur a loss ?
As we have just suggested, he will lose by virtue of the factors you
have discussed.
Dr. BURNS. True, the little saver is in real difficulty. For that matter, the big saver is in difficulty, too.
The CHAIRMAN. The time of the gentleman has expired.
Mr. Rousselot ?
Mr. ROUSSELOT. Mr. Chairman, thank you for your very careful
recognition.
Chairman Burns, I am very appreciative of some of the comments
you have made in your initial statement and wish to commend you for
it, especially your statement that strenuous efforts should be made to
pare the Federal budget expenditures, thus eliminating the deficit
that seems likely in fiscal 1975. I think we can learn a lot on this committee from that statement, on the basis that a housing bill has just
come out of conference that is roughly $2 billion over what it w^as
when it left the House, and maybe we can practice some restraint ourselves. When that comes back to the House, we will see how many are
willing to do it.
*
315
In any regard, I was appreciative of many of your statements about
ways to cope with inflation, and I hope that we as a Congress are willing to abide by some of your suggestions.
Mr. Chairman, I ask unanimous consent to submit for Dr. Burns a
substantial number of questions that I have, and I will try to get
through several of them. Obviously, he cannot answer all of them,
because I have a substantial number.
The CHAIRMAN. Without objection, so ordered. Each member of
the committee shall have that privilege, and each witness will have
the privilege, Dr. Burns, of extending his remarks and inserting unrelated matter in order to make points and clarify the situation.
[The written questions submitted by Congressman Rousselot, and
the response to the questions by Dr. Burns, may be found on page 414.]
Mr. ROUSSELOT. Mr. Chairman, I appreciate your additional comments.
Chairman Burns, on July 17 and 18, as you are well aware, this
committee heard the views of 6 of the 12 Federal Reserve regional
bank presidents concerning the relationship between inflation, high
interest rates, and monetary policies. I have three questions I would
like to briefly discuss with you. I will read all three of them, because
I studied their testimony very carefully, and then we w^ill ask for a
general response, the best you can summarize it:
One, did the Federal Reserve Board of Governors or its staff make
any effort to influence, change, or coordinate the testimony of the
presidents before this committee ?
Two, were any of the presidents required to submit the text of their
testimony to the Board or its staff in advance for review ?
Three, was a special meeting of the Board held on Monday, July 15,
1974, and if so, which Governors and presidents participated, and was
the content of the presidents' testimony before this committee discussed ?
That is a general area of discussion. Do you want to make any comments on that series of questions, and you would certainly have full
rein to respond in detail by letter if you wish.
Dr. BURTSTS. Let me make a general comment, and then I will address
myself, if time permits—it probably w^ill not, unfortunately, the way
things are going—to your questions. I will not be able to answer your
question concerning July 15 until I refresh my memory concerning
precisely what happened on July 15.
Mr. ROUSSELOT. In view of recent events, I think that would probably
be a good idea to refresh your memory. I am speaking of testimony
taken in the Senate.
Dr. BURNS. I think every one of us at all times ought to know
what he is talking about. I have a certain policy. I will tell you what
it is. When I have to make a speech, to make a statement before a
congressional committee not involving the Board—and I do have to
testify as an individual before some congressional committees—what I
do almost invariably is to present my paper to members of my staff, to
my fellow Governors, and I invite their criticisms. I want their suggestions, and I want them to pick up any factual errors that I might
be making.
Mr. ROUSSELOT. If I can interject, that is very understandable. All of
us on this committee, many of us do the same thing with our own staffs.
My question relates to the presidents of the regional banks.
36-714—74
SI
316
Dr. BURNS. I am well aware of your question. Not only do I follow
this practice, but I encourage all of my colleagues to do likewise. We
have no rigid requirements along these lines. I am not a censor; I have
been brought up in a university, and I respect individuals and their
thoughts.
You want to know, did the Federal Reserve make any effort to
change or coordinate testimony. Let me tell you that I, even as of today,
have not read the statements prepared by the Federal Reserve bank
presidents who testified.
Mr. ROUSSELOT. Do you think any of your staff members might
have?
Dr. BURNS. Oh, yes. The Director of Research did do that.
Mr. ROUSSELOT. What is his name ?
Dr. BURNS. His name is Mr. Partee. He did that with a view to
calling factual errors to the attention of the bank presidents, and with
a view to avoiding unnecessary or dubious arguments. Now, what he
did
Mr. ROUSSELOT. At this point, Mr. Chairman, if I could interject, I
would like to provide for the record the statement of Mr. Francis and
the suggestions that Mr. Partee made relating to that statement when
lie appeared before this committee.
The CHAIRMAN. DO you want that included in the record ?
Mr. ROUSSELOT. Absolutely.
The CHAIRMAN. Without objection, so ordered.
[The statement referred to by Mr. Rousselot of Darryl R. Francis,
president of the Federal Reserve Bank of St. Louis, and the mark-up
of this statement as per Mr. Partee's suggestions, may be found on
pages 380 and 389.]
Mr. ROUSSELOT. I clearly want to be fair to the chairman and make
sure that he has adequate and full time to respond to this question,
because I know it is highly detailed and I fully appreciate that the
staff of the Federal Reserve Board clearly helps the regional bank
presidents. I understand that. I do not think that is highly unusual.
The question really relates to the degree of influence, coordination,
et cetera.
Dr. BURNS. Well, the Governors had nothing to do with that. Mr.
Partee looked after that in his own fashion. He is a thoroughly responsible man. He gave suggestions. Now, you had some other
questions.
Mr. ROUSSELOT. I have a question relating to a Wall Street Journal
article that appeared today, entitled "Bank Dominoes," and I ask that
this be submitted in the record, and I would appreciate the chairman's
response to some of the questions raised by the Wall Street Journal.
The CHAIRMAN. Without objection, so ordered.
[The article referred to, "Bank Dominos" from the Wall Street
Journal of August 8, 1974, was submitted earlier in the record by
Chairman Patman and may be found on page 298.]
Dr. BURNS. I would like to answer that question, since it appeared
in this morning's paper, in one sentence, if I may.
The CHAIRMAN. All right, you may do so, Dr. Burns. If you could
be specific without doing violence to your answer, because we are
under pressure.
317
Dr. BURNS. I ask the privilege of answering that question today
since it is in today's paper. That editorial will be discussed widely.
I need one sentence only.
The CHAIRMAN. All right, go ahead, sir. Go ahead and use that
one sentence or any more if you want to.
Dr. BURNS. In the case of Herstatt, the Germans had an insolvent
bank; in the case of Franklin National, we had a solvent bank faced
with a serious liquidity problem. That distinction is not made by the
Wall Street Journal in its editorial. It is a very basic distinction.
Mr. ROUSSELOT. Thank you, Mr. Chairman.
The CHAIRMAN. All right, Mr. Fauntroy ?
Mr. FAUNTROY. Thank you, Mr. Chairman.
Dr. Burns, I simply have two questions on the rising interest rates:
First, to what extent do unsecured lines of credit manifested either
through bank notes or overdraft checking accounts tend to do two
things: first, to maintain high interest rates and acceptance by the
public of those high interest rates;. and second, tend to contribute to
inflationary pressures and a reallocation of resources toward nonproductive sectors of the economy ?
Dr. BURNS. I do not believe that lines of credit as such, whether
secured or unsecured, have any influence in these directions.
Mr. FAUNTROY. I see. I suspect that you would not be prepared to
impose any credit controls in a selective fashion to diminish demands
on the luxury items in the economy.
Dr. BURNS. NO, I would not favor that at the present time; no. Consumer credit is not expanding rapidly at the present time. Consumer
credit did expand very rapidly in 1972 and early 1973. At that time
control over consumer credit might have been justified. I think it would
be very difficult to make out a case for it right now.
Mr. FAUNTROY. Dr. Burns, would you be kind enough to use the remaining 3 minutes of my time to answer Mrs. Heckler's question ?
Dr. BURNS. Answer who?
Mr. FAUNTROY. Answer Mrs. Heckler's question.
Dr. BURNS. Yes. To go back to housing, you are familiar no doubt
with the program that the President announced on May 10. That program called for an expansion of Ginnie Mae's tandem plan; it called
for an equivalent plan to be executed through the Federal Home Loan
Mortgage Corporation in the case of conventional mortgages, and it
also called, third, for subsidized loans by Federal home loan banks to
savings and loan associations.
That was a sizable program, and I think it has made a contribution.
My friends in the homebuilding industry indicate that it has. This is
one thing that was done.
Second, the Federal Housing Administration is processing applications faster than it did, and this has been helpful. Also, in two of our
States, Maryland and Illinois, usury ceilings have been lifted, and this
has helped the housing industry somewhat.
Unfortunately, the housing bill which the Congress has had under
consideration has been held up much too long, and there are several
parts of that housing bill that could be very helpful to the homebuilding industry.
It is regrettable that housing legislation has been delayed so long.
The maximum amount on FHA-insured home loans under existing
318
law is $33,000. That will be raised under the legislation that you are
considering, and it should be raised considerably. If that had been
done months ago, homebuilding activity would be significantly higher
than it is now. That does not help the poor family. I understand that.
I am talking about activity in the homebuilding industry.
Next, take Ginnie Mae's authority. Ginnie Mae's authority to acquire
larger sized FHA or VA loans is expiring in October. That date is
approaching. This is hampering Ginnie Mae's program. That should
have been done long ago, and I hope that time will not be lost further.
There are other features of the housing bill that will be helpful to
the homebuilding industry, and now we come to the question, will that
be enough? Well, it is a difficult question of judgment. The administration has presented a plan for providing an interest tax credit for residential mortgage investment. I think this is a proposal that deserves
very serious consideration by the Congress. That is, since any investor
in a residential mortgage would receive an interest tax credit, that
would tend to stimulate investment in mortgages by all types of financial institutions and individuals.
I think it would be helpful if the Congress gave authority to mortgage lenders to offer variable rate mortgages on FHA and VA loans.
Also, if homebuilding does not revive soon, the Congress might want
to consider legislation under which the home loan banks may be able to
make loans to savings and loan associations on a subsidized basis. They
have been doing it out of their own resources, but an appropriation
might be needed for the purpose. This is not a measure that I would
recommend at the present time, but it is a measure that I would study
at the present time with a view to drawing contingency plans.
It is a depressed industry, and it is not all that clear that the bottom
of that depression has been reached. These are some of the thoughts
that I have about the homebuilding industry.
We at the Federal Reserve have been doing what we can, considering
our authority. Our most important contribution, I think, is to continue
in fighting inflation. That is the fundamental answer to the problem.
We have also been in the market supporting Federal housing agency
issues, and we have been buying them in large amounts. This year
thus far, the Federal Eeserve System has bought housing agency issues
in an amount of $1.3 billion. Last year in the same period, the amount
of purchases came to only $200 million.
We have made plans, contingency plans, to provide backstop lending for the Federal Home Loan Bank System, if it comes to that. I
hope that this will never be necessary. But if it does become necessary,
we will be ready.
I personnally have been quite active. I got Citicorp to modify the
terms of its proposed floating rate in a manner that should be helpful
to the thrift institutions. My Board and the System have been giving
a good deal of attention to the problems of the E E I T industry—that
is, real estate investment trusts.
The CHAIR?.!AX. The time of the gentleman has expired.
AH right, Mr. Frenzel ?
Mr. FKEXZEL. Thank you, Mr. Chairman.
Thank you for your testimony. Dr. Burns.
Do?n your Board foresee any important change in its monetary policy for the short run ?
319
Dr. BURNS. The answer to that question is "N~o."
Mr. FRENZEL. Thank you.
Dr. Burns, you have been identified as the No. 1 inflation fighter in
Washington and you are so saluted by me. More recently, and joined
by Secretary Simon, your advice to us has been that the Federal Reserve cannot do it alone through restrictive monetary policies. Your
advice further has been that unless Congress exercises some willpower
over its spending we could never conquer inflation. I note in the last
couple of months the Congress has passed an Agriculture appropriation of 14 percent over last year; the State, Commerce, and Justice appropriation—no new programs, nothing exciting in there—10 percent
more than last year; our legislative appropriation went over to the Senate with $100 million more. It came back with $100 million more in it.
Our military appropriation must be up $10 billion over last year by
the time we add up all the segments. The HEW bill has got to be a
billion dollars over the budget.
It looks to me like Congress is running a policy which goes exactly
counter to your suggestions and to the
'
The CHAIRMAN. Let us have order, please. Let us have order in the
committee. Will the members please assist the chairman in keeping
order, and also the staff ?
Thank you, sir. Go ahead.
Mr. FRENZEL. It looks to me as though Congress' policies are running
exactly counter to your advice and counter to the policies that you
have set up. It looks to me as though Congress is pursuing a 100 percent proinflation policy. Lately we have passed a Budget Reform Act
for which we all had great hopes. But based on Congress' performance
in the last 2 months, I have become very discouraged. I would like your
opinion as to whether that act is really going to give us any help.
Could you comment on that, please ?
Dr. BURNS. Weil, I am very hopeful that the budget reform bill
will enable the Congress to bring Federal spending finally under decent
control. Whether it will or not will depend, of course, on the willingness of the Members of the Congress to abide by the rather strict rules
prescribed by that legislation.
Also, I believe that it will be about 2 years before that legislation is
truly operative. We have a difficult 2 years ahead, and we have to get
along with such tools as we now have.
Mr. FRENZEL. Could I interrupt there and ask a further question?
I agree for the whole process. But there is a feature within the bill
through which the Chief Executive can return to the Congress individual items for rescission or deferral, which it seems to me might
be a good technique for putting Congress' feet to the fire and a way
that has not been available before.
Do you think that will be helpful ?
Dr. BURNS. It should be. Whether it will be or not, will depend entirely on our willingness as a people, within the Congress, within the
executive, to live by the rules that are so beautifully enunciated in that
legislation. The evidence thus far, as you have suggested, is not entirely
persuasive. I think that we are living with delusions about Federal
finances.
Take fiscal year 1974. I hear it said time and again, that we came
pretty close to having a balanced budget. We had a deficit of merely
320
$3.5 billion. I would say two things about that. First, in view of the
condition of the Nation's economy during that fiscal year taken as a
whole, particularly the high rate of inflation that we were experiencing, we should have had a sizable surplus.
Second, I would say, that the figure of $3.5 billion does not present
the full facts. If you add in, as you should, the off-budget outlays
which are increasing, and if you add in also the outlays of Governmentsponsored corporations, you get a deficit for fiscal 1974 not of $3.5 billion but a deficit of $21 billion.
The CHAIRMAN. The time of the gentleman has expired.
Mr. FRENZEL. I thank the chairman. My 2 minutes seem to be up.
I would like to have the chairman comment in his remarks as to whether
we should preempt State usury rates and whether or not we do have
too much indexation already built into our cost of living agreements
throughout the public and private sector, and particularly in our tax
system.
The CHAIRMAN. GO ahead and answer, Dr. Burns. He asfed you
about the usury rate.
Dr. BURNS. Pardon?
The CHAIRMAN. He asked you about the usury rate. John Wmthrop
Wright, a famous consultant and analyst on the market, testified yesterday that he favored a 10 percent interest rate. It should not be
higher than 10 percent. I think that is what Mr. Frenzel is asking you
about, if you favor that.
Mr. FRENZEL. Mr. Chairman, my question was that if we gave the
S & L's and savings banks all the money in the world they still could
not make loans in my State and many others because of usury rates.
My question was, to Dr. Burns, would it help if a Federal law preempted those usury laws and wiped them off the books ?
Dr. BURNS. I would answer in one word. Yes.
The CHAIRMAN. All right.
Mr. Young?
Mr. YOUNG. Yes, Mr. Chairman. I hardly know where to start. But
picking up on the business of Federal spending, and the concern about
the Federal debt, and our taking the blame in Congress for much of
the inflation; I guess I bolt against that a little bit* because we have
got a private corporate debt of $100 billion plus. We have got significant infusions of foreign capital coming into this country, especially
leaving the Eurodollar market, and coming into American banks
largely because they think you are going to keep American banks
straight, or solvent. With ali of that foreign capital coming into our
economy, and with the tremendous private debt, I wonder if either
your monetary policy or our control of Federal spending really have
any impact upon—I mean, have any possibility of dealing with—the
kind of world inflation situation we find ourselves in.
Dr. BURNS. Well, as far as the inflow of funds from abroad, actually,
this year, we have had an outflow of funds from this country through
our banks that has exceeded the inflow: and the outflow, or the excess,
for the first 5 or 6 months of this year, was about $2 billion. I do not
think this has been a major factor one way or another, so far.
When you speak of corporate debt—and, if you like, corporate debt
financing—it is enormous. You are entirely right about that. But in*
dividual corporations do not have any responsibility for maintaining
321
a stable or prosperous economy. The Congress does, the Federal Reserve doNes, the Executive does. Our Government, as such, does havethat obligation. Government is supposed to provide a balance wheel
To the extent that there are excesses in the private sector, Government
should seek to offset them where it cannot prevent them. Therefore, I
do attach great importance to the state of the Federal budget, and I
do attach great importance to the policies of the Federal Reserve.
Mr. YOUNG. When you use the term, the Government must provide
the balance wheel, I am reminded of my colleague, Mr. Rousselot,
being upset about a housing bill coming up a little high—back from
the Senate, that is—which I would tend to think would help to be a
balance wheel in this economy, versus an enormous defense appropriation which we passed a couple of days ago that meets no particular
consumer need. I see the military complex, basically, as being something we are subsidizing to provide jobs. But while we are providing
a Federal subsidy to provide jobs, we are not really meeting very much
in terms of consumer demand, as we would with a $2 billion housing
bill. I wonder if you would comment on the kinds of spending that we
do, and are there some kinds of spending that contribute more to inflation than others ?
Dr. BURNS. I know very little about the details of the military
budget, but I do not look upon the military budget—and I do not
think any one of us should—as a way of subsidizing or providing jobs.
I look upon the military budget as a way of providing security for this
country in a very dangerous world. I think that we must always remember that the first function of Government, throughout history r
has been to defend the country against foreign aggressors, and to
maintain civil order. That is the first claim on governmental budgets.
Mr. YOUNG. I would agree. But I would contend that the enemies
of this country now are using economic means more than military
means.
Dr. BURNS. TO the extent that that is true, it is the business of the
Congress to search out the facts, and never to permit our national
security considerations to be corrupted by influences of that kind.
There is one element of truth that I am aware of in your statement,
and there may well be others that I do not know anything about. I
am not an expert on military matters. We do have military bases in
this country that are not needed and should be closed down. They have
been maintained because of the pressure from local communities where
those bases are. I think that is unfortunate, and I think we ought to
put an end to it.
Mr. YOUNG. Let me just move on to one other thing, because in your
letter to Mr. Mayo of the Chicago Federal Reserve, you came a little
close to the suggestion that maybe there' should be some social responsibility to the allocation of funds by banks. It says that, "While funds
should normally flow to uses offering greater returns, I believe that it
is important that each banker realize that continued availability of
credit to local activities may well, in the longer run, yield a greater
total return to the economy of his community, and thus to his bank as
well."
Dr. BURNS. This was a letter which I addressed to about four, five,
or six of our bank presidents in cattle-raising areas because of a dif-1
ficulty that was brought to my attention of financing feeder lots and
cattle raising generally
322
Mr. YOUNG. I am suggesting that this is a good thing, and that perhaps, if the Fed is going to be bailing out banks, that there ought to
be some guidelines of social responsibility.
Dr. BURNS. I have got to say a word about that. We are not bailing
out banks. We will lend only to a solvent bank. If a bank is insolvent,
we would not lend it one penny—large or small. If a bank is solvent,
and is faced with a liquidity squeeze, we as a central bank will respect
the most traditional function of a central bank, which is to serve as a
lender of last resort. In that special sense, we help banks.
The CHAIRMAN. The time of the gentleman has expired.
All right, Mr. Burgener.
Mr. BURGENER. Thank you, Mr. Chairman. Dr. Burns, it is a privilege to have you here. I would like to explore with you, for a moment or
two, the Eurodollar situation.
We had a witness here yesterday, a very interesting one. Would you
follow with me, please, a transaction ? I go into a London bank, and I
deposit $100,000 with a check from a New York bank, and I open an
account, and I think I understand that. That is a transfer of money
from here to there.
If I go into the same bank, and I want to open an account in dollars—
I do not have any dollars, but I have collateral—they loan me $100,000,
then I open my account. This witness yesterday alleged that that
money was created then, right then and there, that $100,000. Is that so ?
Or did they have to have $100,000 in the bank of somebody else's, or
theirs, to open my account ?
Do you follow what I am saying ? I am trying to understand wThat
Eurodollars are.
Dr. BURNS. Well, the heart of your question, as I understand it, is
when you go to your bank and borrow $100,000, and the bank credits
your account to that amount, is the bank creating money in the process ?
The answer to that question is yes. But now, can the bank do that?
Whether a bank can do that or not depends on the condition of its
reserves, and depends on its ability—if its reserves are inadequate—
to raise funds in the market.
Mr. BURGENER. The witness, if I may interrupt—the witness alleged
yesterday that these loans, or the dollars credited to my account over
there, were not backed by any reserves of any kind.
Dr. BURNS. All that he would have to do is talk to any banker, who
would tell him how stiff the reserve requirements of the Federal Reserve are.
Mr. BURGENER. I am talking of a foreign bank, Dr. Burns; a foreign
bank, not a domiciled bank, a foreign bank.
Dr. BURNS. If you go to a foreign bank
Mr. BURGENER. Yes.
Dr. BURNS. YOU are going to borrow the money from a foreign bank ?
Mr. BURGENER. That is right, and I am going to open an account;
and I am going to pledge collateral, and they give me $100,000.
Dr. BURNS. The foreign bank has a reserve requirement. It may not
be imposed by law in the given country. Usually it is, but where it is
not imposed by law, it will be imposed by business—banking prudence.
Mr. BURGENER. His point was that there is an immense build-up of
Eurodollars under no control of any kind by us, and that they are
highly inflationary, and contribute to our high cost of living. That is
323
greatly oversimplified, I am sure, but do you consider the Eurodollar
a big problem, or a factor in our inflation ?
Dr. BURNS. I think there are problems connected with the Eurodollar
markets, yes. But when you ask, is this a significant factor in our inflation, I would say no.
Mr. BURGENER. Thank you.
Dr. BURNS. Significant factors in our inflation include various special factors that have hurt us, such as the bad harvests and the foreign
oil. But the basic factors are the state of the Federal budget, and what
we at the Federal Reserve do with regard to money and credit.
Mr. BURGENER. A second question, if I have a moment, is on wages
and the construction industry. In my county, in San Diego, unemployment in that industry is about 30 percent, very high. Carpenters are
getting about $10 an hour. They are striking; they have been striking
a long time for $13 an hour, which they will probably get. I admit,
that sounds like a lot of money. Ten dollars is $400 a week, or $20,000
a year, but we all know they do not work 50 weeks a year. They probably work 50, 60, 70 percent of the year, so we.are losing immense
productivity. Part of that is because of lack of mortgage money, part
of it is because of severe environmental restrictions, some of which are
overdue. What kind of jawboning can we do, what did we do that you
mentioned about Dr. Dunlop, to get the construction industry more
productive, so that the rates will not have to go so high ?
Dr. BURNS. Dr. Dunlop met with the heads of the construction
unions, and with building contractors; he tried to influence their behavior, and he w^as very successful. As I noted before, I think it is a
great pity that the Construction Industry Stabilization Committee is
no longer functioning, and I think it would be highly desirable to
reestablish it.
Mr. BURGENER. Did it go out with the end of price control? Was it
an adjunct?
Dr. BURNS. That is right, and to reestablish it would—I believe—
take legislative action. It perhaps could be done under Presidential authority, without legislative action, but I think having legislative sanction would be the preferable way of doing it.
Mr. BURGENER. What I am trying to get at, I think our carpenters
would rather work 50 weeks a year at $10 an hour than half that number of hours at $13 an hour, and that is productivity. We are losing
it, and we have got to do something.
Thank you.
The CHAIRMAN. Thank you, sir.
Mr. Moakley?
Mr. MOAKLEY. Thank you very much, Mr. Chairman, and thank
you once again, Dr. Burns, for coming back to our committee so many
times to finish your statements.
I noted with interest your testimony before the Joint Economic
Committee the other day, in which I believe you departed from the
stable administration policy, where }^ou were advocating support for
public service employment jobs. Did I detect that ?
Dr. BURNS. Yes. I advocated a contingency plan for expanding public service employment.
Mr. MOAKLEY. I also note that many statements were made that the
Government just cannot spend any more money, because of our inflation. What effect would these public service jobs have on our economy ?
324
Dr. BURNS. The plan that I sketched before the Joint Economic
Committee would be triggered by a 6-percent rate of unemployment
over a period of 3 months. When unemployment reaches that level, it
would become a matter of grave social concern, and I do not think the
Government can stand by and do nothing about it. Public service employment has the desirable feature that it can be triggered in and
triggered out as conditions develop, so the need may be for a very short
period. Also, public service employment has the feature that it can be
expanded in the particular areas where unemployment is largest.
I would hope that if a plan of this sort, or if legislation along these
lines, is adopted, that steps would also be taken to raise a little additional revenue, which we can do, and to cut back on other parts of our
Federal spending program.
Mr. MOAKLEY. Would you consider cleaning up our environment,
or building additional housing units, in the area of public service?
Dr. BURNS. I would not consider building additional housing units
as coming under that category. But I think public service employment could help in cleaning up our environment.
Mr. MOAKLEY. YOU say if the unemployment goes over 6 percent
in some areas, this would be the triggering device ? Did you have any
firm figures on the amount of money that would be spent in certain
areas ? Was there any ceiling ?
Dr. BURNS. This would depend on the Congress. Under the public
service employment legislation that we have on the books, under the
existing legislation, the average wage per year has amounted to $8,000.
I would lower that average wage substantially in the kind of legislation that I am suggesting. In other words, the important thing, as I
see it, is to provide jobs, to enable people to tide over a period of difficulty, rather than to provide a high rate of pay. So I would lower that
figure from $8,000 to $5,000 or $6,000.
Mr. MOAKLEY. Dr. Burns, would this be similar, somewhat, to the
days when I was a youngster, the WPA projects ?
Dr. BURNS. I think it would be similar. I would like to think it could
be administered more wisely, and that these triggering-out devices
would insure that the program did not last any longer than this
abnormal period of unemployment, if we get into that period. We may
not get there. I would have it on the statute books, to take care of a
contingency.
Mr. MOAKLEY. In what kind of area would you be talking about
when you talk about 6-percent unemployment ? Would you be talking
shout a market area, a city, a State? What geographical limitations?
Dr. BURNS. The 6-percent unemployment rate is a national figure,
a national average.
Mr. MOAKLEY. For instance, in the Boston area, I think our unemployment is somewhere between—oh, 6% and 7% percent. You know,
we have had the closing of the naval bases and other industries that
were dependent upon the naval base for their existence. Our unemployment rate is well over 6 percent. But you would say that it would
liave to be a nationwide 6 percent ?
Dr. BURNS. I think that is the way I would do it, yes. However, in
areas where unemployment is particularly heavy, as it is in New England, there I would move in more promptly and on a much larger
325
scale than in other parts of the country, such as the South, where
unemployment is much lower.
Mr. MOAKLEY. Doctor, in your capacity as Chairman of the Board
of Governors, what emergency powers do you have to stabilize
inflation ?
Dr. BURNS. The legislation is not written in that manner. We do
have powers under the law to influence the volume of the growth, the
expansion, of the money supply and bank credit.
The CHAIRMAN. The time of the gentleman has expired.
Mr. MOAKLEY. Mr. Chairman, I would appreciate the complete
answer that Dr. Burns was about to give to my question.
Dr. BURNS. By influencing the rate of growth of the money supply,
and the rate of growth of bank credit, we do release forces that have,
after some lag, an effect on the general price level.
Mr. MOAKLEY. Thank you very much.
The CHAIRMAN. When you examine your transcript for approval,
you may enlarge upon your testimony, if you desire, on this point. It
is a very important point; I realize that.
Dr. BURNS. Thank you.
The CHAIRMAN. Mr. Rinaldo?
Mr. EINALDO. Thank you, Mr. Chairman. I certainly want to extend
my thanks and gratitude to Dr. Burns for so patiently answering these
many questions. But certainly, I think you recognized the importance
of them. To me, this hearing is the most important kind we can hold
In this Congress, providing that effective action does follow the hearings; and the suggestions that you make to combat what I consider
the number one problem facing our country today, at least the number
one problem facing my district, and that is the problem of the economy, the problem of inflation, the problem of paychecks that are being
stretched to the breaking point, and the problem of people that cannot make ends meet. One of the reasons this hearing was called was
to investigate the relationship between unemployment and inflation.
Federal Reserve Board Governor Andrew Brimmer has recently
conducted some studies with the Federal Reserve's econometric models,
and he concluded that, to bring the Consumer Price Index down to
4 percent by December 1975, by using only fiscal and monetary restraint, and not price controls, would mean raising the unemployment
rate substantially above 6 percent.
On page 2 of your testimony, while talking specifically about the
tradeoff on unemployment and inflation, you say, and I quote, "The
forces affecting economic activity and prices in a modern economy
are far too complex to be described by a simple mathematical equation." Does the Brimmer study fit your description of a simple mathematical equation, or can we view the results of his research as an
accurate assessment of the situation ?
Dr. BURNS. I hesitate to answer the question, because I have not
reviewed Governor Brimmer's study with sufficient care to be sure that
my answer will do his study full justice. My impression is that Governor Brimmer's statement, to which you refer, is based on a mathematical model.
Mr. RINALDO. To save time, would you be good enough, or kind
enough, to answer the question for the record, and then maybe in the
.short period of time allotted to me, I can get on to another question ?
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[In response to the request of Mr. Einaldo, the following information was submitted for the record by Dr. Burns:]
REPLY RECEIVED FROM DR. BURNS
Governor Brimmer's comment on the possible effects on unemployment of efforts to reduce the rate of inflation to 4 percent by the end of 1975 was based on
simulations of a large-scale mathematical model. The model contains not just
one equation relating the unemployment rate to the rate of inflation, tout a large
number of equations that describe relationships among many economic and
financial variables. Any mathematical model of this kind is based on average
relationships that have existed in the past, and that may have only limited application to the present or the future. It is my view that the forces affecting
economic activity and prices in a modern economy are far too complex to be
described either by a simple mathematical equation or by a large number of them.
Mr. EINALDO. Last April 30, you and Dr. Dunlop spoke here in re-
sponse to a few questions about wage and price controls. Of course on
April 30 we saw the need of those controls. With the large rise in the
cost of living during the past several months, workers are now trying
to increase their real wages, and in many cases justifiably so. I cannot
completely disagree with them. I understand why they are doing this.
On page 4 of your statement, you said, and I am going to quote you
again, "The removal of controls over wages and prices has led to sharp
upward adjustments in both our labor and commodity markets." Kenneth Rush, testifying before the Joint Economic Committee on July 29,
said that recently negotiated wage settlements have been running well
over 10 percent. Some economists figure that if the 8 percent average
wage increases of 1974 leap to 12 percent next year, inflation may follow suit, and rise at a 1 to 2 percent faster rate than the expected
rate of 7 percent in the fourth quarter of this year.
This type of wage-induced inflation is different from the kind that
follows commodity shortages, to be sure. Wage increases put money in
the bands of people, and with this money, what they in effect do is, as
I understand the economy, is bid up prices by spending more of the
disposable income that is available to each of the individuals in
question.
What, if any, is the type of reaction the Federal Reserve Board has*
and you have in particular, to this type of'Situation, because we are
certainly confronted with it ? •
Dr. BURNS. I have felt for some years that while we must rely primarily on prudent monetary and fiscal policies in our efforts to achieve
some approximation to general price stability, I have talso felt that we
will need to develop an income policy in our country. I see no escape
from the fact that we have in our society some abuses of economic
power by business firms and by trade unions. We have antitrust laws
to deal with business abuses, abuses of business power. I think that the
penalties under our antitrust laws are much too weak, and there is
some question in my mind as to whether the antitrust laws are being
enforced with sufficient vigor. Reforms are needed in that direction,
but, in addition, I think it would be helpful to reestablish at this time
the Cost of Living Council, and to empower that Council to establish,
on an ad hoc basis, review boards to deal with a wage problem or a
price problem in a presetting industry when there is some suggestion
or belief that there may be an abuse of economic power, market power.
327
This could mean that, for a brief period, say 30 to 45 days, the wage
increase that is projected, or the price increase that is projected, would
not go into effect. The ad hoc board would have the authority to conduct hearings, to make recommendations. It would not have any enforcement power. The Cost of Living Council would monitor the results, and determine the degree of compliance with the recommendations. Reliance would be placed on the force of public opinion, which
I think is still a vital force in our society.
Mr. RINALDO. Thank you very much, Dr. Burns,
The CHAIRMAN. The gentleman's time has expired.
Mr. Stark?
Mr. STARK. Welcome back, Doctor; and I am concerned by your
optimistic reaction that the banking, and particularly the savings and
loan industry, do not need bailing out, and I would take exception to
your remarks. Franklin -National, I would submit, was bankrupt by
any standard accounting practice. If you are willing to value their
assets at market value, and not at book, they would have had to be
liquidated. In the banking industry we carry bonds and loans which
you and I both know could not be sold, in some cases, for half of their
carrying value.
The savings and loan industry in this country is technically bankrupt. If they had to sell their mortgages in the marketplace at a price
to yield return that is commensurate with what anybody would invest
today, there is not one of them that would not be 20 or 30 percent in
their capital. They would be wiped out, and as you have aptly pointed
out, the Federal Home Loan Bank Board could very well have some
serious liquidity problems if withdrawals continue. But if you go right
to your own July weekly condition of large commercial banks, there
are $294 billion worth of loans, and $41 billion worth of munis, most
of which will tend to be long-term, and most of which are deeply
discounted, for $335 billion worth of assets. There is only $33 billion
worth of capital in these large banks.
In any State with a 10 percent usury law, on a day when Fed funds
are selling for 12 percent, I would submit there is a very good possibility that the bank is technically insolvent. You and I both know
that it is very unlikely that all this would happen at once. But when
Secretary Simon is overseas telling people that he is going to provide
the liquidity for any Eurodollar crisis, when you have investors lining
up to buy our Government securities at 8 and 9 percent, and they are
taking it out of savings and loans at 7; short of printing money, the
only thing we have left is the confidence that you instill. I am afraid
there is nobody else in the administration who understands economics
that can instill that confidence.
Our confidence is only as good as our ability to control inflation,
and here we have the Hobson's problem. It has got to end, and yet it
is not. Without really strict controls and increased taxes on corporations and higher income for individuals, I just cannot conceive of our
being able to handle a liquidity crisis and control inflation. On this
I would invite your comment, because I am not confident. I would
not want to be the one to start a run on banks and savings and loans,
but on the other hand, I do not like this impression that they are all
that solvent. Technically, I do not think that is true.
328
Dr. BURNS. I think the picture that you have drawn is based on
hypothetical conditions.
Mr. STARK. Not necessarily with the savings and loan industry. I will
grant you that it may be for large commercial banks.
Dr. BURNS. Take the savings and loan industry. The difficulty with
our savings and loan industry is that the inflow of funds is now a
mere trickle. In the month of July, the inflow of funds amounted toy
on an overall basis, an annual rate of growth of 3 percent; in June r
8 percent; in May, 2 percent. When the rate of growth of net inflow
of funds is that low, you will have some savings and loan associations
that are actually losing money; that is, where we have an actual outflow. There are many such savings and loan associations. But they are
not in financial trouble.
The homebuilding industry, however, is in trouble because the net
inflow on an overall basis is so small that many savings and loan associations are experiencing an actual outflow. Financially, these institutions are quite comfortable, but they are not in a position to make
mortgage loans.
Mr. STARK. But they are only comfortable, sir, if you continue to
value their assets at that book figure, which we both know is completely
unrealistic because of this unusual situation and high interest rates.
Therefore they need discounts.
Dr. BURNS. It is an accounting convention. You are asking the
question what would the value of the assets look like if you dropped
that accounting convention. What reason is there for dropping the
accounting convention ?
Mr. STARK. Because we may have to liquidate loans to meet outflow.
Dr. BURNS. Let us look at this.
Mr. EOUSSELOT. Mr. Chairman, I ask unanimous consent that he be
allowed to finish this question.
The CHAIRMAN. GO ahead and answer the question, Dr. Burns.
Dr. BURNS. Let us think of a particular savings and loan association,,
where money is flowing out in large volume. That savings and loan
association will have some liquid assets, but they are small for most
associations, 5, 6, 7 percent, in some instances less than that.
What can that association do? Sell off its mortgages, 4^/2 percent
mortgages, that it has in its portfolio ? It would have to take a huge
loss. That association can turn to the Federal home loan bank, and it
can borrow from the Federal home loan bank. I t will not encounter
any difficulty in doing so.
Assume that the outflow spreads and there are many associations
faced with such a problem. This is making a very extreme assumption.
I do not think we are going to have anything like it. But let us just
assume it happens.
The Federal home loan bank can lend up to a point; it can go into
the market and borrow. But suppose—I am going to follow this to the
limit now. But suppose that the demand on the home loan banks is
large and keeps growing. Then the home loan banks may find that
their ability to borrow in the market is practically at an end.
In that case, they have a line of credit with the Treasury. All right,,
now. The Treasury may be having difficulties of its own at that time.
If we ever reach that position, the Federal Eeserve has a contingency
plan worked out with the Federal home loan bank system that can be
put into operation to handle a crisis problem of that sort.
329
The CHAIRMAN. Mrs, Boggs.
Mrs. BOGGS. Thank you, Mr. Chairman.
Thank you, Dr. Burns, so much for being here. We hate to impose
so much on your time, but all of us are frustrated at trying to rebuild
the confidence in the Government while trying to handle the problems
in our own home districts.
I am very interested in the savings and loan problem, and if Mr.
Stark has any further question, I would be glad to yield some of my
time to him.
Mr. STARK. I thank my colleague very much.
I want to hasten to add that Dr. Burns is right, that these things
tend to be hypothetical. If we are going to try to shore up the Eurodollar in the market at ever-increasing prices, there is an everdecreasing ability on the part of the savings and loan to even pay the
interest. The problem, I am sure we both agree, is inflation. However^
I would still dispute whether Franklin was a solvent organization.
I don't think that bank could have been sold to another bank in the
free market. Its assets could not have realized anywhere near enough
to cover its liabilities.
Dr. BURNS. I looked into that question. We do not regulate that
bank.
Mr. STARK. I understand that.
Dr. BURNS. It is regulated by the Comptroller of the Currency.
We have a definitive statement from the Comptroller on that issue.
I consulted with private bankers who helped me look into this
situation.
Mr. STARK. I appreciate that. Thank you very much.
Mr. BLACKBURN. If the gentlewoman would yield.
Mrs. BOGGS. I would be glad to yield.
Mr. BLACKBURN. I appreciate your yielding; because we talked
about the outflow of capital from the savings and loans, and I think
this is a very easily understood phenomenon when we have inflation
running at 7*4, perhaps 8, percent a year, and we are limiting the
return on deposits to what, 5% percent or something, so that a saver
is not receiving enough earnings to offset the diminution in his principal that is taking place by reason of inflation.
Now we have the Federal Government issuing Treasury notes that
are selling at 7*^ or 8 percent, 9 percent interest. Any rational person
is going to be inclined to take his money out of the savings and
loans and put it in Treasury notes.
It seems to me at the very least regulation Q should be very drastically revised, if not abolished. I am wondering, would it be wise to
provide that there would be no income taxes on interest when interest
is not sufficient to offset the diminution in principal ?
I just wondered if you thought that might be some approach,
because no rational person is going to be happy about seeing his
principal shrink at 7 percent and he receives 5% percent interest, and
then we tax him as though he has earned money and he has lost money.
I think it is a double insult.
What would be your thoughts to some sort of special tax treatment
under such circumstances ?
Dr. BURNS. I am not in favor of tax reductions now, even for very
worthy causes. I think the time will come when we ought to consider
330
your suggestion seriously, Mr. Blackburn. I would not do it now, in
view of the condition of our national economy and the condition of
our national budget.
Earlier I made the comment that we congratulate ourselves, or some
of us do, that the Federal budget deficit last fiscal year was only $3.5
billion. It should have been a sizable surplus. Actually, when you keep
books the way I do, the budget deficit was not $3.5 but $21 billion.
Mr. BLACKBURN. I agree with you.
The CHAIRMAN. The time of the gentlewoman has expired.
It is now time that I may use, but I will ask very few questions.
I will yield then to Mr. Widnall, and then I will yield to Mr. Stephens.
Dr. Burns, you answered Mr. Frenzel that you were opposed to
the usury laws. Is that correct ?
Dr. BURNS. I am sorry, I did not hear you, Mr. Chairman. That I
was opposed to what ?
The CHAIRMAN. TO the usury laws in the States.
Dr. BURNS. Oh, yes.
The CHAIRMAN. And the National Government, too.
Dr. BURNS. Yes.
The CHAIRMAN. DO you mean you are against any usury laws ?
Dr. BURNS. My general thinking runs in that direction, yes.
The CHAIRMAN. I am sorry to hear you say that. That indicates
to
me, in my book, that we could not properly protect the poor and the
poverty-stricken people against these loan sharks, we could not unless
we had some kind of usury law. I am sorry to hear the Chairman of
the Federal Reserve Board take the position that he is against them.
Anyway, I will not pursue that. That is a matter entirely up to you.
The multinational banks in foreign countries, we have lots of them
in every country in the world, big banks have. Lots of money flows
out of the parent banks, say, the Chase Manhattan or First National
City or different ones, to these branch banks in foreign countries.
Is it true that we have no supervisory power over these branch banks
in foreign countries through our regulatory agencies in this country?
Dr. BURNS. N O ; that is not true. We have supervisory power over
the banks of this country and over the branches that they have abroad.
The CHAIRMAN. DO we have supervisory control over the foreign
banks in this country, like in New York and Illinois and a few States
where they have so many ?
Dr. BURNS. There our supervisory power is negligible. We need
legislation, and the Federal Reserve is almost ready to propose legislation.
The CHAIRMAN. I wonder why you do not, Dr. Burns. You know,
the multinational corporations and multinational banks, I think, have
abused their powers all over the world and against the interest of the
United States. Do you not feel that way about it ?
Dr. BURNS. I think there have been abuses. But the reason why we
have not proposed the legislation sooner is that we have tried to work
out legislation in a thorough, professional manner. We have explored
the legislation that we are working on with foreign central banks and
foreign government officials. There is no use coming before the Congress and giving you a bill which is going to cause all kinds of problems, political and economic. We are almost ready with the legislation.
331
The CHAIRMAN. I believe it is the wrong step not to have any legislation at all, and we have suffered many years from these abuses.
I notice you state, Dr. Burns, that on the housing, that the Federal
Reserve has no specific authority in the housing field. I am disappointed in your statement there. Usually I agree with you on most
things, but on that thing and on usury, I just do not do it. I just do
not agree with you.
Why do you not ask for more authority in the housing field ? You
are very familiar with it, and you know that there are all kinds of
abuses. Several times before our committee when we asked you, you
would say you had no specific authority in the housing field. Why do
you not ask for it ? The Congress would be very quick to give it to
you.
Dr. BURNS. We submitted a report to the Congress in March 1972,
that I hope the Congress will consider before too many months
pass.
The CHAIRMAN. I believe that is the first time that specifically has
been brought to my attention. I did not know that you did that. I was
here in 1972.
Dr. BURNS. I assure you, Mr. Chairman, that your office received
more than one copy of that report.
The CHAIRMAN. I wish you would specifically remind us what you
think should be done on that, and also these multinational banks and
the multinational corporations. There are abuses there, I think, that
we could afford to lay aside other things and take up. Anyway, I will
not take up your time on that.
Mr. Widnall, would you like to ask any questions ?
Mr. WIDNALL. Thank you, Mr. Chairman.
Dr. Burns, you have been giving us a very fine group of statements,
on extremely important things with respect to our national economy.
As always, you have been very forthright with us. I, for one, apX>reciate the contributions you have been making.
On page 15 of your testimony, you stated that—and I quote—
"Simulations of the model using the actual growth rate of the money
supply since the first quarter of 1972 suggest that the rate of inflation
during the past two quarters should have been a mere 3% percent."
Furthermore, you said that "special factors" were the major causes
of the inflation rate during the last 6 months.
In view of the fact that a 3%-percent inflation rate would be acceptable to most economists, politicians, and American consumers, are
you contending that our level of money growth in January of 1972
would have been appropriate if these unforeseen special factors had
not emerged?
Dr. BURNS. NO, I would not say that. What I tried to do in that
passage was to call the attention of the members of this committee to
the fact that, while the amount of money is important, the willingness
to use the existing stock of money is also important, and over short
periods much more important.
The money stock is fairly stable in comparison with the rate of
turnover of money balances—which reflects the willingness to use
money. In recent discussions, economists, I believe, have exaggerated
the importance of the rate of growth of money during short periods
and underestimated the importance of the willingness to use such
36-714 O—74
22
332
money as is available. Factors outside the monetary sphere can affect importantly the rate of money use. In my statement, I tried to call
attention to these special factors and also to the role that budget
deficits play in the inflationary process.
We have been trying to achieve a rate of growth of the money
supply that would foster a return to general stability in the price
level. This has required, in view of the special factors presently affecting prices, a middle course for monetary policy. The rate of growth
of the money supply has been below the rate of growth of the dollar
value of the gross national product, but it has been above the rate of
growth of the money supply that would be needed to obtain and maintain a stable price level in the long run. We have been in between those
limits.
Mr. WIDNALL. Do you not really believe that one of the major factors
in our problem today has been the overextension of credit ?
Dr. BURNS. Yes.
Mr. WIDNALL. This has come in in many ways. It has come in
through the abnormal use of credit cards; it has come in through the
extension of activities on the part of many major operations, the thirst
for bigness on the part of corporations, on the part of banks, where the
success of the activity is measured in the millions of assets or hundreds of millions of assets and not on the job that is being done for
the community and the Nation. Is that not partially true ?
Dr. BURNS. Oh, I think that is very—of course it is true. Yes.
Mr. WIDNALL. I am not going to ask you any more questions. A lot
has been covered by our colleagues here, and I think there are some
very important things that you have stated that are in the record right
now. Thank you for coming, Dr. Burns.
The CHAIRMAN. NOW, then, we have just been given notice that we
have this election bill up under the 5-minute rule, and we are going to
have to suspend. But I want to recognize Mr. Stephens, because he
has been here all morning, and he must be recognized.
So go ahead, Mr. Stephens, and when you get through, we will have
to adjourn.
Mr. STEPHENS. Thank you, Mr. Chairman. I appreciate your consideration.
I have not minded at all waiting here and listening, because it has
been to my profit to listen, where sometimes when I talk I do not get
quite as much benefit as I do when I listen.
My concern, at least, because of the importunities that have come
my way in recent weeks, has been on the competition for the savings
dollar. One of the things that has been pointed out is now the small
saver, the little investor, they say is more sophisticated, and he is going
to put his savings at a place where he thinks he is getting a better
return.
I was amazed when I saw the lines last week lined up when the offerings were made by the Treasury Department at a 9 percent rate of
interest.
I happened to be looking at television when one of the reporters
put his microphone in the mouth of this lady, almost in her mouth like
they always do, and asked her where she got the money from. She said,
"Why, from my savings account, because it does not pay as much."
333
I am not sure that there is as much sophistication as there might be.
As I understand it, the Treasury has offered a $1,000 denomination
at 9 percent.
They are offering that on a bid basis. What these people that lined
up may not have understood—at least, I do not think they did—was
that 9 percent interest is not the full return. They, for $1,000, may
have to pay $1,100 on a bid, and that they are not taking into consideration at all the fact that they have a yield, not the interest rate,
but what they are going to actually make. Then, in addition to that,
those obligations are for a longer period of time than 6 months at the
savings and loan at 5y2 percent. Competition for the savings dollar is
partly based upon misapprehension, misunderstanding by the
investors.
I know how you testified before us on the Citicorp issues. But what
has concerned me so much is the fact, the actual fact, that at the withdrawal period which took place as of the 30th of June of this year one
of the two savings and loan associations in my hometown had almost
$i/2 million in withdrawals, net, and they have no ability out of incoming deposits to make a housing loan. The only way that they can
make a housing loan now would be to borrow through the privileges
of the Federal Home Loan Bank Board or wait until their monthly
payments build up their revolving fund so that they can make a housing loan.
So the cost of the house is not so much a problem with them and
with the person who wants to bujr a house. The problem is getting the
money from the lending institution, even on a house that is for the
moderate and a little bit higher income level. That is where I guess I
find myself most concerned, rather than with some of the other things
that you point out are inflationary.
I would like to, if anything that I have said would give you some
comment to make on what we need, really, to do about this competition
for the savings dollar—that is the whole underlying factor, though,
in the Citicorp; that is part of the trouble with the stock market, is the
competition for savings. Of course, regulation Q is a usury law. It is a
usury law that we have enacted.
When we talk about usury laws, in its real analysis, a usury law is
a price control, because it is the price of money. But I do not know
whether I have given anything except the concern as to what you think
we might do to reduce this competition for savings dollars.
Dr. BURNS. We cannot neglect the position of our thrift institutions.
They are in difficulty. Therefore, I would continue with regulation Q
under present conditions. However, I would consider some modification of regulation Q under which savings and loan associations, if
they so chose, could put out issues of the Citicorp type up to a small
fraction of their assets.
Mr. STEPHENS. Would that be with the rate that would vary with the
Federal money?
Dr. BURNS. Yes, some plan like that that would increase their competitive power, but they could do that only to a small degree. They
would need, I believe, statutory authority for it. I think also that our
savings and loan associations should be encouraged to make variable
rate mortgages. However, some safeguards are needed for that.
The CHAIRMAN. TO establish variable interest rates, Doctor?
334
Dr. BURNS. That is right. Where the interest rate paid by the borrower would vary.
Mr. STEPHENS. Mr. Chairman, I know my time has expired, but I
would like to get an explanation or an understanding of what you
mean by a variable rate.
Would that mean that if I borrowed the money from savings and
loan on July 1, on my home, and the contractual interest rate was 8
percent or 9 percent, and then you had a fluctuation in interest rates
2 years from now, that I would either go up or down on the interest
rate ? A new contract would be provided ?
Dr. BURNS. That is right. That could be done, you see, either by
varying the size of the monthly payment or by lengthening the period
over which you make these monthly payments. The second would be
the easier way of doing it for most people.
There are safeguards that are necessary if the variable rate mortgage
is going to spread. Those safeguards should be written into legislation if we are going to move in that direction.
The CHAIRMAN. We will have to recess. The alternative is an afternoon session. I doubt the wisdom of trying it, because we have this
election bill up under the 5-minute rule now, and I do not believe we
could get back here at 2:30 or 3:30 or even 4 p.m. I have no assurance
that we would get out at 6 p.m. because it looks that kind of late.
So our alternative is to recess the committee, and if we need Dr.
Burns back, if there is any real demand for him to come back, we will
get with you, Dr. Burns, and see if we can agree on a time.
Mr. BROWN. Mr. Chairman, before you adjourn the meeting, I
have an article here entitled, "Burns Urges White House to Push
Drive on Inflation, but Sees Long Battle Ahead." I think it would be
good to have it in the record.
I ask unanimous consent that it be put in the committee record.
The CHAIRMAN. All right.
Without objection, so ordered.
[The article referred to by Mr. Brown follows:]
[From the Wall Street Journal, Aug. 7, 1974]
BURNS URGES WHITE HOUSE TO PUSH DRIVE ON INFLATION, BUT SEES LONG
BATTLE AHEAD
Federal Reserve Chairman Arthur Burns urged the White House to take a
"little more energetic action" to slow price boosts. But he also conceded that the
nation's anti-inflation battle will last "two years anyhow, and it may last a
great deal longer."
Asserting he is "an impatient man," the nation's central banker said the Nixon
administration should help curb inflation and deal with other economic ills by
paring the federal budget for the current year as much as $10 billion, by uniting
with other nations to force world oil prices down, and by reestablishing the Cost
of Living Council and permitting it to delay big wage and price increases.
Testifying before the Joint Economic Committee, Mr. Burns emphasized that
he believes the economy "is being attended to" in the White House, but he
indicated the attention to corraling inflationary forces is insufficient. In response to questions, he said the President's Watergate troubles are "adding to
the uncertainty" in financial markets over the administration's ability to fight
inflation. "That's my own impression," he said, adding, however, that he has
found it difficult to document that belief.
The Fed chairman said that during the recent House Judiciary Committee
hearings, he watched with "special care" the foreign exchange market. "It was
remarkably stable, and the dollar actually strengthened," he said, indicating
that the response was surprising.
335
Mr. Burns said the Reserve Board will continue its tight monetary policies
short of causing a credit crunch, and he said "evidence is accumulating" that
the Fed's restrictive policies already are helping to moderate credit demand.
He added that businesses have found it more difficult to obtain bank loans and
that securities markets have been less receptive to their need for funds.
But declaring that the general public "doesn't really understand monetary
policy," Mr. Burns said he favors more budget-cutting measures to slow inflation.
"The public understands that reduction in federal spending will mean a reduction
in aggregate demand for goods and services. They also can understand when the
government has a balanced budget, it doesn't need to enter the (money) market
to borrow," he said.
"For a time, we should be prepared to tolerate a slower rate of economic
growth and a higher rate of unemployment than any of us would like. A period
of slow growth is needed to permit an unwinding of the inflationary processes
that have been built into our economy through years of neglect," Mr. Burns said.
If the nation's jobless rate hits 6% however, Mr. Burns said he favors a
$4 billion public service employment program by the government that would
provide jobs for 800,000 persons.
Mr. Burns voiced a much deeper concern over the effects of sky-high world
oil prices on international financial markets than other government officials
have expressed publicly, including Treasury Secretary William E. Simon. He
said that unless foreign oil prices drop significantly, he "cannot be optimistic"
about the ability of financial markets to manage the recycling of the huge surpluses of oil-producing nations to countries experiencing big international payments deficits.
The Fed chairman urged a stronger fuel-conservation program in the U.S.
and also the formation of an alliance of oil-consuming countries to bring oil
producers "to the path of reason" through common economic policy and through
"political devices." Such an alliance, consisting of the U.S. and 11 other industrialized nations, has already been approved in principle. The agreement calls
for member nations to conserve and share petroleum supplies in the event of a
new energy crisis.
During a 2%-hour question-and-answer period, Mr. Burns made these additional points:
—The administration must move swiftly to aid the troubled utilities industry
by boosting the investment tax credit for utilities to 7% from 4%, by urging
regulators to speed up rate-increase approvals, and by advising bankers to
provide temporary financing to utilities pending their ability to obtain more
permanentfinancingfrom the bond market.
—The Fed staff is drawing up some proposals for "drastic changes" in the
federal bank regulatory structure that he will propose to Congress probably
later this year.
•—He would favor establishment of an advisory council on bank credit policy
but would oppose strongly any bid to force the Fed to allocate credit.
—Prices of industrial raw materials should register declines "of some magnitude" in coming months as world economics continue to slacken.
—The Fed is considering a separate discount rate, which is the fee it charges
on loans to member commercial banks that would apply to long-term loans rather
than to the standard loans of just a few days or so. The new rate, which presumably would be higher than the rate on short-term loans, would be available
for loan situations like that involving troubled Franklin National Bank, which
has borrowed millions of Fed funds to help it stay alive.
Mrs. BOGGS. Mr. Chairman, may I make a comment ?
The CHAIRMAN. Yes.
Mrs. BOGGS. I would
just like to tell Dr. Burns that the interest
shown in the budget committee membership by the Members of the
Democratic caucus, I think, assures him and the other members of
the executive branch and the Federal Reserve that there is very strong
feeling in the Congress for fiscal responsibility, that there are many
people who are anxious to become members of the budget committee,
willing to give up other committee assignments for which they have
worked for many years in order to give full time to the budget
committee.
336
I think that any kind of overspending that results in upping the
average from last year has really been the result of inflation and
devaluation of the dollar. I do think that when you have conditions
where we must solve our problems by a tandem arrangement of monetary and fiscal policies, that you are going to find a great deal of
responsiveness in the Congress for insuring fiscal responsibility.
The CHAIRMAN. Dr. Burns, for myself and the committee, we desire
to thank you for your attendance and your testimony. We have appreciated it very much, and it will be carefully considered in our considerations of any legislation to come before us. Thank you very much,
sir.
Dr. BURNS. Thank you very much for your courtesy, Mr. Chairman.
[Whereupon, at 12:15 p.m., the committee wtas recessed subject to
the call of the Chair.]
STATEMENT OP DAVID I. MEISELMAN, PROFESSOR OF ECONOMICS,
VIRGINIA POLYTECHNIC INSTITUTE AND STATE TJNIVERSTY
[Dr. David I. Meiselman, professor of economics, Virginia Polytechnic Institute and State University was scheduled to testify on
August 7,1974. Time constraints prevented Dr. Meiselman from being
heard. His statement follows:]
I am David Meiselman, and I am a professor of economics at Virginia Polytechnic Institute and State University where I am also
director of its new Northern Virginia Graduate Program in Economics
located in Eeston, Va. I have devoted most of my professional career
to the study of money and its relationship to business and financial
conditions. I appreciate the opportunity to appear before the Banking
and Currency Committee in its hearings on Federal Keserve policy
and inflation and high interest rates.
The Banking and Currency Committee is to be highly commended
for undertaking staff studies and hearings on the role of the Federal
Reserve policy in inflation and high interest rates. I share the general
view that inflation is the country's number one economic problem, that
inappropriate public policy is the major source of inflation, and that
high and rising interest rates have hurt many Americans. It is most
welcome that the committee is now considering these problems and
their relationship to Federal Reserve policy. The problems are serious,
the Congress has unique responsibility in the areas of money and of
Federal Reserve policy, and I believe that inappropriate Federal Reserve policy has played a major role in causing both inflation and high
interest rates. I also believe there is no effective way to reduce inflation
or high interest rates unless there is a marked change in Fed policy.
The Federal Reserve is a creature of Congress and reports to the
Congress. The notion that the Federal Reserve is independent is to
be interpreted only in the sense that under the law the Federal Reserve
is independent of the executive branch of the Government, but not the
legislative branch. In that sense, the Federal Reserve is different from
most Agencies involved in making and carrying out public policy,
especially where economic policy is concerned. This is why I firmly
believe that close accountability to the Congress by the Federal Reserve for their conduct of monetary policy is essential. For if the Federal Reserve is not held accountable by the Congress, then, we must
ask, to whom, this side of Heaven, are they accountable ? By the same
token, we must also ask to whom the Federal Reserve should turn for
guidelines in the use of the vast monetary powers delegated to them
by Congress ?
I have read the staff report on Federal Reserve policy and inflation
and high interest rates and I wish to commend the committee and its
staff for the report's high level of technical skill and objectivity in
preparing an excellent and apt analysis. The findings of the report are
consistent with some of the best research on the role of monetary policy
(337)
338
in determining prices and interest rates which has been done by a large
and growing number of independent scholars, especially in the past 10
or 15 years.
Much of this research has added still more evidence about the central
role of the nominal quantity of money in determining nominal grosp
national product as well as the crucial importance of money in deter •
mining the level of prices, especially secular changes in prices. I believe that the long-period relationship between money and prices is
the single most tested and verified proposition in all of economics,
covering a wider range of economic experience in time, place, and
circumstances than any other, and with essentially the same results.
I have prepared several charts to summarize these relationships, especially for the recent history of the United States. They differ from
historic norms only in that year-to-year changes in GNP and in the
price level are still more closely linked to money than in the past.
The stock of money is controlled by the Federal Reserve. Federal
Reserve actions, primarily open market operations, impact directly
on the monetary base, sometimes called high-powered money, which is
mainly composed of Federal Reserve credit. In turn, changes in the
stock of money closely follow changes in the monetary base, although
on a week-to-week or month-to-month basis it is important to note that
there may be some temporary looseness in this connection. Although
the Federal Reserve has the power and ability to control money it may
not do so, preferring instead to control interest rates, so-called money
market conditions, or perhaps other things. The F,ed cannot effectively
have both money supply and interest rate targets. It has tried to do
both, and in the process has generally achieved neither.
Chart 1 shows the close year-to-year relationship between the narrow
Mi measure of money (currency in the hands of the public plus all
commercial bank demand deposits) and nominal GNP. The result is
virtually a perfect correlation between the two.
Chart 2 shows the same close year-to-year relationship between the
broad M« measure of money (currency in the hands of the public plus
all commercial bank deposits other than large certificates of deposit)
and nominal GNP. Again, the result is close to a perfect correlation.
Both Mi and M2 measures of money yield excellent predictions of
GNP. This is the main reason that many economists believe that the
quantity of money is of crucial significance in determining GNP, that
differences between the effects of the two measures of money are
minor indeed, and that it makes little difference which measure is
used either to predict GNP or to control it.
339
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340
CHART 2
United States
Index Numbers of Money (M )
and GNP, 1960-1973
(1965 = 100)
fro
Nominal gross national product can change when there is either a
change in output or prices, or both. Although there is a dependable
link between money and nominal GNP, there is no simple way to
know how the effect of monetary change will be divided between
changes in prices and changes in output. When we are close to full
employment or capacity, it is clear that increases in money at a faster
rate than the growth of capacity output cannot effectively increase
output and can only lead to price increases. When there is much slack
in the economy, increases in nominal GNP are likely to be composed
of a larger proportion of real output and smaller proportion of price
increases. Unfortunately, there is yet no good theory or evidence to
yield clear-cut general answers on this important question.
341
However, changes in money tend to have output or employment
responses before price responses in many sectors of the economy and
for the economy as a whole. This means that when there is slack in the
economy, monetary expansion leads, first, to the good results of increased output and employment before the later bad results of higher
prices. On the other hand, monetary restriction may correspondingly
lead, first, to the bad results of reduced output and employment before
the later good results of moderating inflation. I believe that this
asymmetry has been a major factor in the inflationary bias of public
policy.
These considerations also argue for moderate and relatively steady
rates of monetary growth, the avoidance of the stop-go actions that
have characterized Federal Reserve policy in the past, and resistance
to the temptation to increase money at a very rapid pace when there is
slack in the economy or to step sharply on the monetary brakes when
there is unacceptable inflation.
There is much evidence that we have inflation when money increases faster than output, that prices fall when money falls relative to output, and that the price level tends to be stable when the
ratio of money to real output is stable. (This relationship follows
mathematically from a stable ratio of money to nominal GNP.) I
know of no important exception in the last 400 years to the rule that
changes in the price level stem primarily from changes in the nominal
stock of money per unit of output.
Chart 3 shows what has happened to these relationships in the
United States since 1960 when M2 is used as a measure of money.
We see a very close relationship between money per unit of output
and prices, here, the Consumer Price Index. Consistent with earlier
norms, the rapid rise in prices in recent years was caused by the sharp
increase in money per unit of output. Since 1971 both the narrow Mt
and the broad M2 measures of money have been rising at the fastest
rate since World War II. Not surprisingly, prices have also been
rising at the fastest rate since 1946.
CHART 3
/So-
United States
Money and Prices, 1960-1973
Index Numbers
(1965 = 100)
Jld -
72.
343
Recent research I have done on worldwide inflation shows essentially the same links between money per unit of output and prices for
foreign countries as in the United States. I cannot go into these details
in my brief presentation except to note that, as in the United States,
the increase in the ratio of money to output that caused the acceleration of inflation since early 1973 stemmed primarily from increases
in money rather than decreases in output resulting from such frequently cited events as the disappearance of anchovies off the coast
of Peru or the operations of the OPEC oil cartel. To be sure, there
was some reduction in the output of petroleum and chickenfeed, which
explains why these prices increased relative to other prices. But aggregate output in the United States and throughout the world tended to
increase, especially through yearend 1973, despite isolated examples
of reductions in supplies of a handful of products. Thus the increase
in the ratio of money to output was largely the result of sharp increases
in money rather than decreases in output.
We have essentially the same relationships if we use the Mx measure of money, provided we take into account the long-period upward
drift in Mi velocity, the ratio of GNP to Mi. Since at least 1960 M2
velocity has been close to a constant. In the 1960's Mi velocity increased
an average of 2.7 percent per year, and the very same long-period
drift continues in the 1970's. Therefore, we would have essentially the
same general relationship between prices and Mi per unit of output
with this simple adjustment. (I have spared you these additional statistical operations but I would be pleased to make them available to
the committee and staff.)
Despite the shocks the economy suffered in the first half of 1974
from the impacts of the OPEC oil cartel and the Arab oil embargo,
the same relationships between money per unit of output and prices
have continued to hold. In the first half of 1974 the monetary base
increased at an annual rate of 8.2 percent, Mi increased 7.1 percent
and M2, 9.0 percent. All of these measures were somewhat higher than
they were for 1973.
Preliminary estimates for real GNP in the first half of 1974 show
output declining at the annual rate of 4.0 percent, mostly associated
with the decline in automobile production in the first quarter of the
year. In combination with M2 increasing at 9.0 percent, the 4.0 percent
decline in output should result in price increases at the rate of roughly
13.0 percent. Prices, of course, have been increasing at about 12.5
percent, which is very close indeed, especially for such short-period
relations using preliminary and seasonably adjusted data. For the
M t increase of 7.1 percent, we must add the 2.7 percent trend rise in
velocity, which also gives us reasonably close predictions of the actual
inflation rate, closer I may add than most of the standard economic
forecasts which depend on other and more complex tools.
I regret to add that despite repeated announcements of intent, there
is yet no clear evidence of any significant shift in the Federal Reserve
actions responsible for this poor record.
In the past year there have been many claims that the major source
of inflation has come from abroad, that inflation has been imported
rather than produced domestically. Since we cut our monetary ties to
gold in 1968, the U.S. money supply has been almost wholly the con-
344
sequence of Fed actions alone. Thus, if U.S. inflation originates abroad
it is necessary to have a corresponding decline in output generated
from outside the United States. This would be reflected in a change
in the terms of trade, import prices relative to export prices, weighted
by the relative share of exports in our GNP. This measure indicates
how much more we have to give up in the way of exports to pay for
our imports. Exporting more to acquire the same goods is the equivalent of a decline in our productivity and output. With a given money
stock, adverse movements in the terms of trade tend to cause a rise in
the price level because of the resulting increase in money per unit of
output.
My colleague, Wilson Schmidt, has made some rough calculations
along these lines and informs me that there are some weaknesses in the
data with respect to coverage and concept. In any event, over the
1971-73 period the U.S. terms of trade declined 5.6 percent. In 1973
exports were 7.9 percent of GNP. Thus, over 2 years prices were less
than half of 1 percent higher than they otherwise would have been in
the absence of the change in the terms of trade, hardly a major factor.
In the first 4 months of 1974 the terms of trade deteriorated sharply
as a result of the oil cartel's increase in the prices of imported petroleum. According to Department of Commerce figures, the terms of
trade deteriorated by 15.5 percent. Exports also increased to 9.6 percent of GNP. Taking the two together we find that real output fell
by 1.5 j>ercent on this account over the period, with prices correspondingly higher. Over this 4-month period the Consumer Prive Index increased 3.9 percent and the wholesale price index 10.2 percent. Although sharply higher prices for imports were more important than
previously, again, the major element in U.S. inflation was domestic.
To be sure, the inflation rate would have moderated had there been
no runup of oil prices, but in the interest of correct labeling, I would
suggest that the speedup of inflation since 1972 be tagged "Made on
Constitution Avenue" rather than "Imported from Saudi Arabia."
I may add that even with current excessively high rates of monetary
expansion that the present rate of inflation is likely to moderate before
the end of the year especially if real GNP declines no further.
I turn now to the question of high interest rates and the relationship of high interest rates to Federal Reserve policy and inflation.
Although there is growing understanding of the connections between
money and interest rates, there is still widespread confusion between
cause and effect. It turns out that an expansionary monetary policy
tends to drive up market interest rates, not lower them, and a
contractionary policy tends to lower market rates, not raise them.
The main reason is that more money leads to more spending. Unless
output also increases to absorb the full expenditures, prices also rise.
Even if interest rates had fallen as the initial impact of the increase
in money, rates will start to rise as people become more eager to borrow
but less willing to lend because of the depreciation in the value of their
money. Interest rates rise to incorporate the inflation, especially as
people come to anticipate future inflation. Thus, rising interest rates
are the consequence of money-induced inflation. The opposite holds
345
for reductions in money-causing deflation. This is why easy money
leads to tight credit, and tight money leads to easy credit. This is why
countries with much inflation have high interest rates and why countries with little inflation have low interest rates. This is why interest
rates were so low in the 1930's following the reduction in the money
supply that was the major cause of the Great Depression and the
associated decline in prices. This is also why interest rates are now
so high.
Chart 4 shows the historic relationship between prices and bond
yields since 1857. The year-to-year association is not always close, but
there is a close connection between long swings of prices (which are
related to long swings of money per unit of output) and long swings
of interest rates. Again, it appears that recent experience on a year-toyear basis is even closer to these norms than before. In addition, the
lag between prices and interest rates have become much shorter.
CHART 4
U.S. PRICES AND BOND YIELDS, 1857-1974
OF WHOLESALE PRICES
(1926*100)
HIGHEST GRADE CORPORATE BONDS
1870
1880
1890
1900
1910
1920
1930
1940
1950
1960
1970
10
347
Several years ago the Joint Economic Committee recommended that
the Federal Eeserve follow monetary policy guidelines that the growth
of the narrow Mi measure of money be kept within the limits of 2 percent to 6 percent. In retrospect, we would have avoided much of our
current problem with inflation and high interest rates if these guidelines had been followed. I may also add that the only extended period
in recent years when Mi growth fell below 2 percent at annual rates
was in the second half of 1969, which was followed closely by the
subsequent recession of November 1969, to November 1970.
We need a slower and steadier growth of money to restrain inflation
and to smooth out the most troublesome business cycle fluctuations
which are the result of erratic and excessively expansionary or contractionary monetary policies.
Wage land price controls, monitors, jawboning, alarms, distress signals, commissions and the like are not the answer. If monetary growth
is not slowed, they cannot succeed. If monetary growth is slowed, they
are superfluous.
To insure that a slower and steadier growth of money be achieved,
I would recommend that this committee and the Congress give consideration to mandating rather than merely recommending appropriate
limits on monetary change, that the narrow Mx measure of money be
increased month by month in the range of 2 percent to 4 percent at
annual rates. I would recommend that these lower rates of monetary
growth be achieved gradually and systematically over at least a 2-year
period in order to moderate the effects of the transition on employment
and output, for experience indicates that a sharp reduction in monetary
growth, even to achieve the desirable end of slowing inflation, is likely
to cause a recession.
Finally, one useful result of this mandated policy would be an
immediate and permanent decline in interest rates, even prior to any
substantial reduction in inflation. Large numbers of investors have
prudently become close Federal Reserve watchers in recent years and
have come to follow the general analysis I have outlined. With the
assurance that the law required a slower and steadier rate of monetary
growth, I have every reason to believe that the inflationary expectations that have caused the current high interest rates will be altered,
causing a sharp reduction in rates, especially on intermediate and longterm loans and securities, including mortgage rates. Bond prices will
rise. For the same reasons, stock prices would also increase.
36-714 O—74
23
ADDITIONAL QUESTIONS
I
THE FEDERAL RESERVE'S SECURITIES PORTFOLIO
[The following are written questions concerning the Federal
Reserve's securities portfolio which were submitted by Chairman
Patman to the Reserve bank presidents, along with their replies:]
1. The Federal Reserve now holds in its portfolio nearly $85 billion of U.S.
Government securities including Federal Agency issues. From year-end 1964 to
year-end 1973 the System's holdings of Government securities more than doubled
(from just over $37 billion to nearly $80 billion).
Question (a). What effects did the enormous and rapid increase in the Federal
Reserve's holdings of Government securities have on Mi growth and the rate of
rise of the CPI since 1964?
Question (&). What obligations did the Federal Reserve issue in building up
its portfolio to the present level? Is it correct to say that the balance sheet liabilities corresponding to the Government securities account are currency in circulation and member bank reserves, with the former being quantitatively more
important by about 7 to 3 ?
Question (c). Is the Federal Reserve an agency of the Government and in
specific of the Congress?
Question (d). In his interview with President Morris, Dr. Weintraub asked
whether "the Federal Reserve might give away this portfolio to the banks?"
President Morris replied: "Give away this portfolio to the banks? That's absolutely absurd. We are not empowered under law to give away anything that's
owned by the United States Government."
Dr. Weintraub then said: "This is in fact owned by the United States Government?" President Morris then said: "This portfolio is owned by the United
States Government through the Federal Reserve System as an instrumentality
of the government."
Do you agree with this view on the ownership of the portfolio?
Question (e). Responding to a question by Congressman Burgener, President
Hayes said of currency issued by the Federal Reserve that "it's also an obligation of the U.S. Government." Do you agree with this view?
Response of President Hayes
Answer to question l ( a ) . Increases in central bank assets—including Federal
Reserve's holdings of Government securities—will tend to be reflected in an
expansion of bank credit and the money supply. The relationship, however, involves a highly complex set of financial and economic interrelations. As a result,
the effect of a given increase in Federal Reserve security holdings on a particular
monetary measure such as Ml is neither immediate, constant, nor precisely predictable, even in the long run. Many fjactors influence the outcome. Over the
period mentioned by Chairman Patman, from the end of 1964 to the end of 1973,
Federal Reserve security holdings rose by about $43 billion, or about 117 percent.
Over the same period, Ml rose about $108 billion, or about 66 percent. (Over
this same period, the consumer price index rose about 48 percent.)
With regard to the relationship between increases in Federal Reserve security
holdings and money supply, it should be noted first that while Federal Reserve
purchases of securities increase member bank reserves, other factors may be
absorbing reserves so that not all of the reserve increase produced by the Federal
Reserve's purchases is lavailable to support money supply growth. Thus, from
the end of 1964 to the end of 1973, Federal Reserve gold holdings declined more
than $3 billion and this absorbed a portion of the reserves provided by the rise
in the Federal Reserve securities portfolio over the period. Moreover, a large
part of the increase in the Federal Reserve securities portfolio was needed to
(349)
350
replace the reserves absorbed through an increase of currency in circuljation—
nearly $33 billion over the nine year period. While the increase in currency
in circulation of course constituted part of the rise in money supply, it may
be noted that money supply increases in the form of currency generate a relatively
greater reserve need than do the money supply increases in the form of deposit
growth; currency expansion absorbs an equal dollar amount of reserves while
bank deposit expansion requires only a fractional reserve increase. The relatively
rapid increase in the currency component of Ml compared with the demand
deposit component from 1964 to 1973 (80 percent compared with 62 percent) helps
to explain the sharper rate of growth in Federal Reserve security holdings
compared with Ml growth. In addition to supporting expansion in Ml, reserve
growth over the period lalso went in part to meet requirements behind time
deposits) in various forms.
Thus, the relationship between Federal Reserve security holdings and Ml
depends on such factors as (1) desires of the public to hold currency; (2) the
extent to which the banks want to use increases in reserves to increase excess
reserves, to repay borrowings from the Federal Reserve, or to increase holdings
of earning assets; (3) the proportions of the various types of bank deposits
the public wants to hold; (4) the levels of reserve requirement ratios imposed
on the various types of deposits; and (5) the proportions of its deposits the
public wishes to hold in small and large, member and nonmember banks. Since
all these factors are capable of considerable variation over time—depending
upon the habits of the banks and the public, the state of general economic conditions, interest rates, and other factors—there is no constant relationship between Federal Reserve security holdings and the level of Ml, even though an
increase in security holdings does tend to generate some increase in the level
of Ml.
With regard to the impact on the consumer price index of the increase in
Federal Reserve holdings of Government securities and its expansionary effect
on the money supply, it Is apparent from past experience that a broad longrun relationship does exist between trends in monetary expansion and the
behavior of prices. As I noted in my statement to the Committee, over long
periods of time, price stability requires a rate of money and credit growth
commensurate with the economy's capacity to produce. Nevertheless, it is an
oversimplification to attribute all fluctuations in prices to the behavior of the
money supply. Among the many nonmonetary developments that can powerfully
influence the behavior of prices for periods as long as one, two, or more years,
are supply shortages—as in the recent fuel and food cases—and the behavior
of foreign exchange rates—as in the case of the overall depreciation of the
dollar since early 1971. This depreciation has acted to raise the dollar prices
of imported goods as well as the prices of goods produced in the United States
and sold in both domestic and foreign markets. Among the several influences
adding to inflation, the role of excessively stimulative fiscal policy has been
one of the most significant.
Answer to question l(b) ( . The Federal Reserve System over the years has
expanded its portfolio of U.S. Government and Agency securities1 through open
market purchases for the System Open Market Account. Payments for such
purchases are made by crediting the account of the seller's bank at the Federal
Reserve, thus immediately
increasing member-bank reserves at the Federal Reserve. These memberjbank reserve accounts are of course a liability of the
Federal Reserve. Further, the banks from time to time exchange part of their
reserve deposits for currency in response to their needs for vault cash. The
demand for vault cash, in turn, is a function of the nonbank public's demand
for coins and currency. The bulk of the public's cash holdings now consists of
Federal Reserve notes, which, like the member-bank reserve accounts, are also
a liability of the Federal Reserve.
As can be seen in the Statement of Condition of the Federal Reserve Banks
(copy attached), they have many asset items other than holdings of Treasury
and Agency securities, and many liabilities other than member-bank reserves
and Federal Reserve notes. But, in general, it is quite correct to say that the
great bulk of Federal Reserve's Government securities account finds its counterpart on the liabilities side in currency in circulation (including banks' vault
cash) and member bank deposits. As of June 30, Federal Reserve holdings of
Treasury and Agency securities totaled about $83.6 billion, or about 78 percent
of total assets. Federal Reserve notes and member bank deposits totaled about
$94.9 billion, or about 88 percent of total liabilities and capital accounts. Federal
351
Reserve notes amounted to about $65.3 billion, while member bank deposits
amounted to about $29.6 billion. Thus, notes were roughly 2.2 times1 the amount
of member bank deposits, or a ratio of approximately 7 to 3.
[The Statement of Condition of the Federal Reserve Banks referred to above
follows: ]
FEDERAL RESERVE BANKS—JULY 1974
CONSOLIDATED STATEMENT OF CONDITION OF ALL FEDERAL RESERVE BANKS
[In millions of dollars]
Wednesday
End of month
1974
Item
1974
1973
June 26
June 19
June 12
June 5
May 29
June 30
May 31
11,460
11,460
11,460
11,460
11,460
11,460
11,460
10,303
400
216
400
216
400
211
400
210
400
215
400
218
400
223
400
305
2,979
2,486
3,157
2,710
4,711
3,209
3,298
1,770
96
95
95
100
66
ASSETS
Gold certificate account
Special drawing rights certificate account
Cash
Loans:
Member bank borrowings._
Other_
Acceptances:
Bought outright
Held under repurchase
agreements
Federal agency obligations:
Bought outright
Held under repurchase
agreements
U.S. Government securities:
Bought outright:
Bills
Certificates:
Special
Other.
Notes
Bonds
Total bought outright. .
Held under repurchase
agreements. __
Total U.S. Government
securities
Total loans and securities
Cash items in process of collection
. .__ _
Bank premises
Other assets:
Denominated in foreign
currencies
. . . ._
Allother
Total assets
. _____
161
2,549
301
2,549
534
2,549
2,621
511
100
97
97
250
207
276
2,621
2,858
2,621
701
270
1,449
642 .
37,089
37,396
35,877
34,700
37,718
37,274
37,818
34,247
39, 533
2, 805
39, 533
2,805
39, 533
2,805
39,533
2,805
39, 365
2,767
39,692
2,822
39,533
2,805
37,111
3,664
79, 427
79,734
2 78, 215
2 77,038
79, 850
79,788
80,156
75,022
2,081
696
1 045
1,714 .
1,239 ..
80, 47?
86, 791
79, 734
84, 864
79,929
86, 542
77,038
82,469
81 931
90,314
80 484
87]125
81 395
88, 329
75,022
78,307
8, 165
238
9,006
238
7,902
236
8,375
237
8,619
236
7,240
239
6,966
236
7,319
204
69
889
71
825
63
791
63
778
16
671
90
935
63
716
4
927
108, 228
107,080
107,605
103,992
111,931
107,707
108, 393
97,769
65,453
65,523
65,701
65,284
65,009
65,295
64,732
59, 807
30,055
27,744
31,257
27,896
33,534
29,623
31,012
24, 818
2,693
282
699
2, 946
753
695
906
359
650
1,340
330
683
2,333
315
642
2, 919
3&4
762
3, 133
429
667
4, 039
334
717
33, 729
32, 138
33, 172
30, 249
36, 824
33, 688
35, 241
29, 908
5,760
278
631
5,528
6,454
5, 405
5, 041
5, 271
1,125
1, 094
1, 149
1,105
1,458
1, 101
1, 160
799
106,067
105,033
105,653
102,166
109,745
105,489
106,174
95,785
LIABILITIES
F.R. notes
Deposits:
Member bank reserves
U.S. Treasury—Genera! account
Foreign
Other: Allother
eferred availability cash
items
Other liabilities and accrued
dividends
Total liabilities
352
FEDERAL RESERVE BANKS—JULY 1974
CONSOLIDATED STATEMENT OF CONDITION OF ALL FEDERAL RESERVE BANKS—Continued
(In millions of dollars]
Wednesday
End of month
1974
Item
June 26
June 19
June 12
1973
1974
June 5
May 29
June 30
May 31
June 30
CAPITAL ACCOUNTS
Capital paid in
Surplus.
Other capital accounts
Total liabilities and
capital accounts.....
Contingent liability on acceptances purchased for
foreign correspondents.....
Marketable U.S. Government
securities held in custody
for foreign and international accounts
876
844
441
876
844
327
875
844
233
873
844
109
873
844
469
878
844
496
874
844
501
820
793
371
108,228
107,080
107,605
103,992
111,931
107,707
108,393
97,769
769
762
724
725
735
795
732
395
29,310
29,164
28,724
28,639
28,104
29,637
28,454
29,278
FEDERAL RESERVE NOTES—FEDERAL RESERVE AGENTS' ACCOUNTS
F.R. notes outstanding (issued
to Bank)
69,698
69,366
69, 215
68,,851
68,622
69,490
68,827
63, 653
Collateral held against notes
outstanding:
Gold certificate account
U.S. Government securities.
2,175
68,295
1,975
68,365
2,175
68,065
2, 135
67, 615
2,235
67, 515
2,175
68, 295
2,235
67, 515
2, 155
62, 645
70, 470
70,340
70, 240
69, 750
69, 750
70,470
69, 750
64, 800
Total collateral
Answer to question l ( c ) . This is, of course, a question that has been raised
more than once, within the Congress and outside it. It would be difficult to improve on the answer given by the Report of the Subcommittee on General Credit
Control and Debt Management of the Joint Committee on the Economic Report,
Congress of the United States (1952).1
The Subcommittee unanimously concluded:
As far as the Board of Governors is concerned, there seems to be no
clearly adjudicated answer to this question. But, while the question itself is an open one, it appears that the practical issues usually debated
under this head have been judicially determined, so that the question
is not really an important one. The Subcommittee was much impressed
in this connection by the testimony of Mr. Wilmerding, who, after stating that "* * * it is impossible to return a clear answer to the question
* * * about the Board's status," continued (Hearings, pp 7753-754) :
Fortunately, from a practical standpoint it is not important that a
clear answer be given. Let it be conceded for purposes of argument
that the Federal Reserve Board, unlike the Federal Trade Commission,
is a part of the executive branch. Would such a status alter in any
practical way the relationship which has been established by statute
between the Board and the President of the United -States? In particular, would it give to the President, under the Constitution, a power to
interfere with, set aside, correct, or revise, the decision of the Board
in any matter which has been committed by Congress to the Board's
exclusive jurisdiction ?
1
The members of the Subcommittee were Representatives Wright Patman (Chairman),
Richard Boiling, and Jesse P. Wolcott, and Senators Paul H. Douglas and Ralph E.
Flanders.
353
This question, I submit, can be answered with a categorical negative.
A long line of opinions by the Attorneys General, acquiesced in by the
Presidents, corroborated by the action of Congress, and the proposition
that, when the execution of a law has been committed by Congress to
the exclusive jurisdiction of a subordinate department or officer of the
Executive, the interference of the President with such execution, either
in the form of direction beforehand or revision and reversal afterward,
so far from being permitted by the Constitution, would be a usurpation
on the part of the President which the subordinate department or officer would not be bound to respect. In such cases the duty of the President to take care that the laws be faithfully executed extends no
further than to see that the officers to whom Congress has given an exclusive jurisdiction perform their duties honestly and capably. If they do
not, he must, under the Constitution, remove them and appoint others
in their stead, but, in the words of one of the Presidents, "he cannot override their decisions and ought not to interfere in their deliberations."
In the light of these considerations it is evident that the question of
the status of the Federal Reserve Board is purely academic. Congress
has committed certain business to the exclusive jurisdiction of that
Board, and this business it must perform under the responsibility of its
trust and not by direction of the President. The case is the same
whether the Board be considered in or out of the executive branch.
The case of the Federal Reserve banks is harder to define. The presidents
of the Federal Reserve banks, in answer to a question whether they considered
the banks to be part of the United States Government or part of the private
economy, said (Compendium, p. 649) :
In our opinion Federal Reserve banks are partially part of the private
economy and are part of the functioning of the Government (although
not technically a part of the Government).
Much evidence was introduced on this subject and appears in the Compendium
and the Hearings. There are many things to be taken into consideration. The
stock of the Federal Reserve banks is owned by their member banks. But the
capital so contributed is a negligible proportion of the assets of the banks and
is limited to a fixed return, however great may be the profits of the Reserve
banks. The Reserve banks are given sweeping exemptions from taxation. But,
Congress can and has given equally sweeping exemptions to private corporations.
The majority of the directors of each Federal Reserve bank is elected by its
member banks. But, the power of the directors to direct is limited; the principal
policy decisions are made or dominated by the Board of Governors, which is
appointed by the President with the consent of the Senate. On the whole, the
Subcommittee sees no objection to this hard-to-define position of the Federal
Reserve banks. The Federal Reserve System has been a helpful institutional
development. Its roots are sunk deeply in the American economy and it has borne
good fruit. This is more important than that each portion of it be subject to
classification by species and genus according to the rules of a textbook on public
administration.
But, one fact with respect to the legal status of the Federal Reserve 'banks
stands out, and it is the only fact of importance. Congress created the Federal
Reserve banks and Congress can dissolve them or can change their constitution
at will. On dissolution the entire surplus of the banks would become by law the
property of the United States. Ultimately they are creatures of Congress.
Answer to question l ( d ) . As a kind of shorthand, general and perhaps simplified response to a technically complex question, I would be willing to concur.
The second paragraph of Section 7 of the Federal Reserve Act provides, in part,
"Should a Federal Reserve Bank be dissolved or go into liquidation, any surplus
remaining, after the payment of all debts, dividend requirements as hereinbefore
provided, and the par value of the stock, shall be paid to and become the property
of the United States...."
The Federal Reservce Act also provides (fourth paragraph of Section 10) that
Federal Reserve notes are "a first and paramount lien on all the assets of such
bank" (i.e., the Federal Reserve Bank of issue).
354
The second paragraph of Section 11 of the Federal Reserve Act states that the
Board of Governors of the Federal Reserve System "shall publish once each week
a statement showing the condition of each Federal Reserve Bank and a consolidated statement for all Federal Reserve Banks. Such statements shall show in
detail the assets and liabilities of the Federal Reserve Banks, single and combined, and shall furnish full information regarding the character of the money
held as reserve and the amount, nature and maturities of the paper and other
investments owned or held by Federal Reserve Banks." In accordance with that
requirement, there is published each week a statement of condition for each
Reserve Bank and a consolidated statement for all 12 Banks; those statements
show Government securities as assets of the Banks, with balances of various
depositors, bank notes, and capital as the major liabilities as offsetting claims
against the assets.
It is undoubtedly true, as President Morris said, that the Federal Reserve
Banks could not give away to the member banks, or anyone else, their portfolio
of Government securities (or any other assets). But, if the so-called "cashless
society" that some people talked about several years ago were to come to pass,
then people and businesses would deposit Federal Reserve notes in their banks,
who would have no desire to hold them in their vaults, and would deposit them
for credit to their reserve accounts. If the Federal Open Market Committee, in
an inflationary period like the present, did not wish to permit a large amount
of excess reserves on which bank credit could be greatly expanded, it would
presumably sell Government securities at the best available price in the open
market. Since payment would be made to the Federal Reserve by a charge to
the reserve accounts of the banks buying the securities, or whose depositors
buy them, the undesired bulge of reserves would be eliminated. But obviously
the securities would not be given away; they would be sold for value, and the
ultimate buyers might or might not be commercial banks.
Answer to question l ( e ) . The first paragraph of Section 16 of the Federal
Reserve Act states unambiguously that Federal Reserve notes "shall be obligations of the United States".
The legal status of Federal Reserve notes, however, is far more complicated
than is conveyed by this simple and clear statutory provision. Such notes are
also the obligations of the Federal Reserve Bank of issue, a first and paramount lien on all the assets of the issuing bank (Federal Reserve Act, paragraph 4). As of June 30, 1974, the 12 Federal Reserve Banks had less than
$65.3 billion of notes outstanding and total assets of $107.7 billion. Federal
Reserve notes are fully collateralized by, among other things, the Government
securities pledged by the Federal Reserve Banks in order to obtain such notes
from the Federal Reserve Agent (Federal Reserve Act Section 16, paragraphs
2 and 4). In this connection, the fifth paragraph of Section 16 states that "Any
Federal Reserve bank may at any time reduce its liability for outstanding
Federal Reserve notes by depositing with the Federal Reserve agent its Federal
Reserve notes, gold certificates, Special Drawing Right certificates, or lawful
money of the United States."
Any characterization of Federal Reserve notes must also take cognizance
of their attributes as currency of the United States. Federal Reserve notes,
of course, are "legal tender for all debts, public and private . . ." (31 U.S.C.
§392)
Response of President Balles
Answer to question l ( a ) . Federal Reserve purchases of Government securities
are the principal vehicle by which the System creates new member bank reserves.
These reserves, in turn, can support a multiple expansion of loans and investments by the banking system, creating in the process a multiple expansion of
new deposits. In June 1974 every dollar of member bank reserves supported
approximately $13 of member bank demand, time or savings deposits. This ratio
of reserves to total deposits depends upon a complex set of factors; the difference
between reserve requirements on various types of demand and time deposits,
the size of these deposits, and even the size of the banks in which the deposits
are held. The ratio is further complicated because deposits held outside of
member banks are indirectly supported by member bank reserves.
The ratio of total member bank deposits subject to reserve requirements to
total member bank reserves, has increased at a relatively stable rate since
1960, as is shown in the accompanying table. One major reason for the increase
355
in the ratio is the declining proportion of demand deposits to total time and
savings deposits at member banks; time deposits have a lower required reserve
ratio than do demand deposits. (The former type of deposit includes negotiable
certificates of deposit.) The ratio of demand deposits to total time and savings
fell from about 1.68 in mid-1960, to 0.55 in mid-1973. This shift reflects a number
of competitive innovations, such as expanded use of negotiable certificates ot
deposit, that commercial banks have made since 1960 to attract and hold funds.
Thus, while the principal source of the rise in the money stock (however
defined) since 1964 has been a rise in member bank reserves, this rate of
growth has been increased by a rise in the reserve multipliers related to competitive innovations by commercial banks.
MEMBER BANK RESERVE OF DEPOSITS
SEASONALLY ADJUSTED, JUNE 1960 TO JUNE 1974
[In billions of dollars]
Total member
bank deposits
subject to
reserve
requirements
Ratio of member
bank deposits
subject to reserve
requirements to
total member bank
reserves (2) ^ (1)
(1)
(2)
(3)
18.56
18.41
19.12
20.02
19.84
20.59
21.79
22.66
23.67
25.98
27.94
28.03
30.54
33.03
32.46
36.72
157.8
157.6
168.3
182.5
195.9
210.3
229.5
246.5
262.5
282.8
296.2
294.4
345.3
381.3
428.9
472.8
8.502
8.561
8.802
9.116
9.874
10.214
10.532
10.878
11.090
10.885
10.601
10.503
11.306
11.544
13.213
12.874
Member bank
reserves *
Year
1959...
1960...
1961_.
1962...
1963...
1964...
1965...
1966...
1967...
1968...
1969...
1970...
1971...
1972...
1973...
1974 2.
i Adjusted for reserve requirement changes in order to maintain a consistent series, reflecting latest reserve requirements
21st 6 mo.
The relationship between rates of growth in the money supply and changes in
consumer prices may vary in different time periods. In the short run, movement
in the OPI often is explained by phenomena other than an expansion of Mi.
Wage and price freezes and rapid changes in the supply of raw materials and
finished goods have major effects on the OPI. However, in the long run, general
price increases are primarily a monetary phenomenon. The Consumer Price
Index is but one of many measures of changes in the current level of prices.
Broader based measures, such as the GNP price deflator, are less sensitive to
transitory influences, but even here the short-run relationship between money
growth and changes in the general price level is not constant.
Although the close long-run link between money and prices is well established
in both economic theory and statistical studies, it is not the only factor governing Federal Reserve Policy. The Federal Reserve System must take account of
the high priority which the Congress and the Administration have assigned to
full employment and economic growth objectives, which in some circumstances
has conflicted with the objectives of stable prices. It is vital that this matter
be thoroughly appreciated, not only by the Congress and the Administration, but
also by the business and financial community and the general public. It is only
in this way that we can get support for the belt-tightening measures needed to
overcome the corrosive problem of rampant inflation and sky-high interest rates.
Answer to question l ( b ) . In building up its portfolio of Government securities,
the Federal Reserve issued deposit liabilities, owned principally by member
banks, and Federal Reserve notes (currency). However, it is not entirely correct
to say that the balance sheet liabilities corresponding to the Government securities account are currency in circulation and member bank reserves, because the
356
Federal Reserve has other assets such as gold, special drawing rights and loans
to member banks; one cannot identify specific liabilities that correspond to each
of the Federal Reserve's assets (such as its portfolio of Government securities).
Nevertheless, the largest single asset in the Federal Reserve's portfolio is Government securities, and growth in that asset is roughly proportional to the
growth in the Federal Reserve's liabilities. Currency and member bank reserves
constitute most, but not all, of the Federal Reserve's liabilities. The ratio of
currency to member bank reserves is approximately 7 to 3.
Answer to question l ( c ) . The Federal Reserve was created by an act of Congress with powers and duties specified by Federal law, and in this sense it is an
agent of the Congress and ultimately responsible to the Congress. When established in 1913, the Federal Reserve was deliberately given a status of independence within the Government in order to free it from day-to-day political influence.
Specifically, the System was made independent of the executive branch and responsible to Congress. Congress, in turn, delegated broad powers to the System to
formulate monetary policy in a way that would best contribute to national economic goals. I believe that this arrangement has been a major source of strength
for the Federal Reserve over the years, and has enabled it to formulate and implement monetary policy to serve the nation's best long-run economic interests.
Answer to question l ( d ) . The Federal Reserve System's portfolio of Government securities is an asset of the Federal Reserve Banks. In the event of the dissolution or liquidation of a Federal Reserve Bank, the Federal Reserve Act
stipulates that surplus assets remaining become the property of the U.S.
Government.
Answer to question l ( e ) . In a technical sense, Federal Reserve Notes are a
liability or an obligation of the Federal Reserve Banks. Under the Constitution,
the Congress was given the power "to coin money and determine the value
thereof," but it has delegated much of this power to the Federal Reserve. Through
this delegation, currency issued by the Federal Reserve would become a direct
obligation of the U.S. Government in the event of dissolution of the Federal
Reserve System. Currency, however, is a special form of "obligation"; it serves as
a means of payment for goods and services, and unlike other liabilities of the
Federal Reserve (and the Government) it has an infinite maturity and carries
no interest.
Response of President Eastburn
Answer to question l ( a ) . As a proximate cause, the relatively rapid growth
in Government security holdings largely explains the rapid growth in the money
supply (measured as either Mi or M2) between 1964 and the end of 1973.
That is, the growth in Federal Reserve holdings of its primary assets, Government securities, corresponded essentially with the growth in its primary
liabilities, Federal Reserve notes and member bank reserves. These liabilities
in turn were the primary determinents of the growth in the money supply
over the period of consideration.
As for the impact of the growth in Mi on the CPI, I stated in my testimony
that the increasing rate of inflation over the past ten years could not have
been sustained without the accompanying increase in the rate of monetary
expansion. Over the long term, a sustained increase in the growth of the money
supply is almost certain to produce depreciation in the value of money, that is,
inflation. However, while price stability is an important goal of monetary
policy, I don't intend my conclusion necessarily to be an indictment of Federal
Reserve policy over the past decade. Evaluating monetary policy would necessitate looking at all the objectives of policy as well as taking account of the
social and political environment in which policy must operate.
Answer to question l ( b ) . The issuance of Federal Reserve notes and mem«
ber bank reserve deposits accounted for about 90 percent of the increase in the
Federal Reserve's liabilities over the past decade and, hence, primarily accounts
for the obligations issued in building up its portfolio to the present level.
As to whether the Fed's assets, "Government securities," correspond with its
liabilities, currency and member bank reserves, I must heed the accountant's
warning not to associate particular assets with particular liabilities on any
balance sheet. However, because of the quantitative importance of reserves
357
and currency growth, I think it would be substantially correct to argue that
the rise in Government securities holdings has been largely financed through
issuance of these liabilities. Currency in circulation is about 7/3 as large as
member bank reserves on deposit with the Fed (that is, member bank reserves
other than vault cash).
Answer to question l ( c ) . The Board of Governors is a Federal agency in the
sense that it is a means or agency used by the Federal Government to carry out
fundamental governmental policy. It has final accountability to the Congress
by virtue of the congressional mandate to make a full report annually of its operations to the Speaker of the House of Representatives. Federal Reserve Banks,
on the other hand, are not Federal agencies, but are in a stricter sense Federal
instrumentalities in carrying out fiscal agency functions of the U.S. Government
Answer to question l ( d ) . I agree that the U.S. Government is the beneficial
owner of the portfolio in the sense that it is the recipient of the proceeds of the
portfolio after deduction of expenses and payment of dividends on Federal Reserve Bank stock. It also has the residual right to the portfolio in the event of
dissolution, since all property of the Federal Reserve Banks, after the payments
mentioned above, would become property of the U.S. Government rather than
be distributable to the member banks owning stock of the Federal Reserve Banks.
However, equitable ownership of the portfolio is in the Federal Reserve with
the portfolio managed and controlled by the Open Market Committee.
Answer to question l ( e ) . Yes. The Federal Reserve Banks become primarily
liable for their note issue, even though the notes are collateralized by U.S. Government or agency obligations. Moreover, the Congress has specifically provided
that " . . . the said notes shall be obligations of the United States . . ." (12
U.S.C. 411).
The nature of the Government's obligation is to some extent secondary, as the
Government obligations used to collateralize the notes would be used to make
good the comparable value of notes issued by the Reserve Bank. It is not likely
that the Government would be required to assume any further risk because of
its guarantee of the Federal Reserve notes.
Response of President Francis
Answer to question l ( a ) . From the fourth quarter of 1964 to the second
quarter of 1974, the increase in the Federal Reserve Banks' holdings of Government securities was approximately equal to the increase of the monetary
base. Over this same interval, Federal Reserve Banks' holdings of Government
securities increased $46.6 billion, the monetary base increased $4&6 billion,
and the narrowly-defined money stock (Mi) increased $111.9 billion. On a seasonally adjusted basis, the increase in Mi was at an average 5.8 percent annual
rate, over two and one-half times as fast as the average rate of money growth
in the preceding ten years. As a result, the average annual rate of increase in
the CPI was 4.8 percent from the fourth quarter of 1964 to the second quarter
of 1974, over three times as fast as in the preceding ten years.
Answer to question l ( b ) . When the Federal Reserve System purchases Government securities in the open market it pays for the securities by issuing checks
drawn on itself. When sellers of the securities deposit the checks in member
banks they receive a credit to their demand deposit accounts. Then, when the
member banks send the checks to a Federal Reserve Bank for collection, they
receive a credit to their reserve accounts, which are liabilities of the Federal
Reserve System. The end result of this process is the creation of a Federal
Reserve Bank liability (member bank reserves) much the same as the liability
incurred in issuing Federal Reserve Notes.
It is not correct to say that the balance sheet liabilities corresponding to the
Government securities account are currency in circulation and member bank
reserves. At the present time, the sum of currency in circulation and member
bank reserves is 1.24 times as large as the Federal Reserve holdings of Government securities. It is correct to say that currency in circulation and member
bank reserves corresponds to the monetary base which is a consolidation of the
monetary balance sheets of the U.S. Treasury and the Federal Reserve System.
It is not correct to say that currency in circulation, because it is the larger, is
quantitatively more important than member bank reserves.
358
Answer to question l ( c ) . The Federal Reserve Banks are corporations chartered under an Act of Congress. The corporate structure is unique in that the
power to control, and the beneficial ownership of assets, by the shareholding
banks are limited. Since the structure is unique, it is not possible to give a single
answer for all purposes as to whether the Federal Reserve Banks are agencies
of the Government. Rather, each particular law referring to Government agencies or instrumentalities must be examined to determine whether it was intended to include the Federal Reserve Banks. Under Sec. 15 of the Federal
Reserve Act and the direction of the Secretary of the Treasury, the Federal
Reserve Banks are Fiscal Agents of the United States.
Answer to question l ( d ) . The portfolio of U.S. Government securities is owned
by the twelve corporate Federal Reserve Banks, each having an undivided interest in the portfolio. As long as the corporations exist, no other parties have claim
upon the securities in the portfolio. In the event a Federal Reserve Bank wTere
to be dissolved or go into liquidation, any assets remaining after the payment
of debts, dividend 'requirements and the par value of the stock would become
the property of the United States. To this extent, I agree that the portfolio is
beneficially owned by the United States through the instrumenalities of the
Federal Reserve Banks.
Answer to question l ( e ) . Sec. 16 of the Federal Reserve Act states that Federal Reserve notes "shall be obligations of the United States." I agree with the
statement made by President Hayes.
Response of President Mayo
Answer to question l ( a ) . The Federal Reserve System is charged with the
responsibility by Congress to regulate, in the public interest, the volume and
availability of money. The System, operating through its reserve supplying
activities, has attempted to meet these responsibilities. Since the purchase of
Government securities is the major way of providing reserves, meeting the
economy's expanded needs for money as they have grown has resulted in additions to the System's holding of Government securities. While possible, it would
have been neither practical nor efficient to provide these reserves by other means.
The relationship between the System's holdings of Government securities and
inflation is more complex. Open market operations are only one, albeit important, element in the policy implementation process; a number of instruments
can be used. The significant and relevant issue relates to the more general relationships between monetary policy actions and prices.
I feel, Mr. Chairman, that my views on this more general question have been
indicated in my testimony and my statement which is part of the record.
Answer to question l ( b ) . In purchasing Government securities in the open
market, the Federal Reserve issues an obligation to the seller in the form of a
deposit on our books in the name of the seller's bank. Thus, as a result of this
process, the Federal Reserve obtains an asset (a Government security) offsetting
the liability to the seller. Government securities make up the bulk of the assets
of the Federal Reserve System while Federal Reserve notes and member banks'
deposits account for the majority of the System's liabilities.
Answer to question l ( c ) . Yes, the Federal Reserve was established by Congress
and given responsibility to exercise important functions relating to the supply of
money and credit.
Answer to question l ( d ) . As I indicated in my response to your first question,
Government securities are held as a result of System reserve supplying activities.
They have an important functional role for the Federal Reserve System in meeting
its responsibilities and thus remain until redeemed by the Treasury as an asset
of a Congressional created agency.
Answer to question l ( e ) . Federal Reserve notes are direct liabilities of the
Federal Reserve banks but remain a U.S. Government obligation since their
issuance takes place under the delegation of responsibility given by Congress.
359
Response of President Morris
Answer to question l ( a ) . The increase in Federal Reserve holdings of Government securities has been the main factor leading to the increase in the monetary
base which supports the money supply of the country. As the value of expenditures, as measured by GNP, grows, the money supply and the monetary base grow
more or less in proportion. Gross National Product actually slightly more than
doubled from 1964 to 1973 so it is not surprising that the money supply and
the monetary base rose substantially. Actually the money supply did not double
but rose by only about 65% Tover this period. With the money supply rising less
than GNP the difference w as made up by velocity, of course, which rose by
almost one-quarter.
Unfortunately, part of the increase in total money expenditures in the nation
reflected increases in the CPI. The CPI rose by 43 percent during this period
while GNP in constant prices increased by almost 45%. There is no doubt that
we could have limited the rise in the CPI over this period by limiting growth in
the monetary base. However, additional restraint on growth in the monetary
base and the money supply would have also reduced growth in real GNP and
raised the average level of unemployment. This is a tradeoff we are constantly
facing and we have to make decisions based on our best judgment about it.
Answer to question l ( b ) . It is correct to say that the balance sheet liabilities
of the Federal Reserve System corresponding to the asset, Government securities, are primarily currency in circulation and secondarily member bank reserves. Except for some minor accounts, an increase in the Federal Reserve's
portfolio or in its discounting will be matched by increases in currency in
circulation and member bank reserves. Of the roughly $43 billion increase in
Federal Reserve holdings of Government securities from 1964 to 1973, increases
in currency in circulation represented $32 billion while the remainder went *
increase member bank reserve balances.
Answer to question l ( c ) . The Federal Reserve is an independent
tality of the United States Government. It is not a part of the
Branch of the Government, but is responsible to the Congress.
Answer to question l ( d ) . Yes. Since the Federal Reserve System is an instrumentality of the Federal Government, all of its assets are owned by the U.'S.
Government and all of its liabilities are obligations of the U.S. Government. In
1973 the Federal Reserve System had $4,897 million of income from the interest
it received on its holdings of U.S. Government securities, $109 million of income
from loans to member banks, and $11 million from miscellaneous sources, f^
that year the System had expenditures of $495 million, paid out $49 million
for a 6 percent dividend on member bank holdings of Federal Reserve stock 1*>
accordance with statutory requirements, and transferred another $51 million
to surplus. Eighty-nine percent of the System's income from securities, O'~
$4,341 million, was recycled back to the U.S. Treasury. In effect, therefore, the
U.S. Government received almost nine-tenths of the interest income generated
by the System's portfolio of U.S. Government securities.
Answer to question l ( e ) . Currency issued by the Federal Reserve is, in th*»
first instance, a liability of the Federal Reserve System, secured by the asset*
of the Federal Reserve System. But just as the residual claimant to any asse*>
of the Federal Reserve System is the United States Government, the ultimate
guarantor of the Federal Reserve Notes is also the United States Government.
ADDITIONAL QUESTIONS
II
THE STAFF RECOMMENDATIONS
[The following is a written question concerning the staff recommendations submitted by Mrs. Sullivan to Federal Defense
witnesses, along with their replies:]
I think you gentlemen are familiar with the staff recommendations
that were made by Dr. Robert Weintraub, staff economist of the House
Banking and Currency Committee on July 16, 1974. I would like to
have your comments on those recommendations.
Dr. Weintraub's first recommendation states: ". . . let the Federal
Reserve annually request from the Congress permission to operate
within specified M-l growth guidelines, which, to retain limited flexibility to deal with short-run problems, could be expressed in terms of
the behavior of year-to-year growth for the next 12 months, (Targets
would be set for each of the next 12 months in terms of percentage
changes from the same month a year ago.)"
"Let Congress hold hearings on the Federal Reserve's recommendations. The Federal Reserve should spell out the implications of alternative target M-l growth paths on unemployment, interest rates, and
such priority concerns as housing. Congress can then approve or modify the recommendations as desired. If within the next 12 months the
Federal Reserve wants to operate outside the established guidelines,
it can request that special hearings be held for the purpose of relaxing
the guidelines."
Response of President Hayes
This is a response to the request of Representative Sullivan for comments on
the monetary policy recommendations included in the "Report of Federal Reserve
Policy and Inflation and High Interest Rates", dated July 16, 1974, prepared by
Dr. Robert Weintraub for the House Committee on Banking and Currency.
As I understand it, the broad thrust of Dr. Weintraub's first recommendation
is that Congress undertake periodically to formulate guidelines for monetary
policy. Given Congress' constitutional responsibilities in this area and the highly
important public interest implications of monetary policy, there can be little
doubt that Congress should be somehow better informed about the monetary
policy process. If there is any way that we can be of help we would, of course, be
pleased.
At the same time, however, I have serious reservations about several specific
features of Dr. Weintraub's money-supply growth guidelines, and would urge the
Congress to approach this matter with great caution. There should be no illusions
that procedural changes will automatically result in improved monetary policy
performance. In particular, I feel quite strongly that narrow and rigidly defined
guidelines would prove both unachievable and undesirable in the face of the
constant ebb and flow of economic developments with which monetary policy
must cope.
Perhaps my views in this regard can be best illustrated by discussing those
features of Dr. Weintraub's recommendation about which I have the strongest
reservations. First of all, his recommendation presupposes a knowledge of the
economy, and of the effects of monetary policy on the level of economic activity,
that we simply do not enjoy. There is no question, for example, that the record of
economic forecasters, both governmental and private, has been very unsatisfactory
over the past two years or so. The strength of demand pressures in the economy
(361)
362
in the latter part of 1972 and in early 1973 was seriously underestimated, while
the "slack" of unemployed human and material resources was overestimated, by
most economists. And, over the past year, inflation has been much worse than
almost anyone expected. While no one can be expected to forecast crop failures
and oil embargoes, it is unfortunately true that even in the absence of such unpredictable events our economic foresight is quite limited. Given the difficulty of
forecasting economic developments, it seems clear that monetary policy should be
given ample leeway to adjust to unforeseen and unexpected developments. Such
flexibility has, in fact, always been regarded as one of the principal virtues of
monetary policy.
'Thus, I would suggest that any monetary-policy guidelines that the Congress
might want to develop or approve should be framed in broad general terms with
ample scope for the prompt adjustment of policy to changes in the economic situation. In my opinion, the monthly money-supply growth-rate guidelines recommended by Dr. Weintraub are much too restrictive in this respect. They would
put monetary policy in a straightjacket so tight as to hamper timely and effective
responses to new developments. While Dr. Weintraub suggests that the Federal
Reserve could request special Congressional hearings to change the guidelines,
I fear that under the guidelines he proposes we would have to spend a good deal
of our time, and of the time of the Congress, in special hearings seeking changes
in the guidelines. More liberal and flexible guidelines than those suggested by
Dr. Weintraub would provide for both adequate Congressional oversight of monetary policy goals and for the timely adjustment of policy to unforeseen developments.
In this regard, I should note that Dr. Weintraub's suggestion that the Federal Reserve present Congress with alternative monetary-policy scenarios,
spelling out "the implications of alternative target M-l growth plans on unemployment, interest rates, and such priority concerns as housing," and as an aid
to the Congress in selecting policy guidelines, also suggests a better understanding
of the economy and monetary policy than we in fact possess. My experience on
the Federal Open Market Committee (FOMC), where we often try to follow such
a procedure, is not very encouraging. All too often the economy departs significantly from the scenario expected on the basis of the monetary policy actually
implemented. While such exercises are useful in considering monetary policy
options, they can never be taken too seriously as firm guides to rpolicy.
Second, I also have serious reservations about attempting to frame monetary
policy guidelines in terms of any single variable, such as the narrow money
supply (M-l) recommended for this purpose by Dr. Weintraub. Monetary
economists are divided on the question of whether the narrow money supply is
the best indicator of the thrust of monetary policy. Moreover, most of us in the
Federal Reserve have never believed that we could fulfill our responsibilities
if we confined ourselves to the single-minded pursuit of one target variable, be
it the narrow money supply or any other variable. We believe our financial system
is simply too complex for any single target variable always to provide an adequate measure of the thrust and impact of monetary policy. This is not to deny
the important role of the money supply in the monetary policy process, but only
to point out that it is not unique in this respect. I very much doubt, for example,
that the Congress would want the Federal Reserve to focus on the growth of the
money supply to the extent that it ignores interest-rate developments and their
effects on our financial institutions. Thus, I would suggest that any monetary
policy guidelines considered by the Congress should not be concerned exclusively
with the money supply, but should also take into consideration the behavior of
such important variables as bank reserves, bank credit and interest rates.
Third, the monthly money supply growth rate target proposed by Dr. Weintraub assumes a degree of short-run control of the money supply that the Federal Reserve does not possess. While Dr. Weintraub refers to "year-to-year
growth" in connection with his proposed money-supply target, his proposal seems
to contemplate setting such a target for each month of the year. Since past behavior is of course given at any point in time, this proposal appears to be
equivalent to setting month-by-month growth-rate targets for the money supply.
For example, a target for next month's money stock of 6 percent greater than
the year-earlier level implies a particular monthly growth rate depending
UDon the growth which actually occurred during the preceding eleven months.
If, for instance, the growth of the money stock during those eleven months had
been at an annual rate of 5.8 percent, the 6 percent year-to-year target would
imply a target annual growth rate of 8.2 percent for the coming month. If, on
363
the other hand, the money stock had actually grown at an annual rate of 6.2
percent over the prior eleven months, the 6 percent target would imply a target
of only 3.8 percent for the coming month. Furthermore, with the monthly
targets expressed in terms of constant growth from year-earlier levels, any
random fluctuations in the growth of the money stock in one year would be
built into the targets for the following year.
There is, to my knowledge, no evidence whatsoever that the Federal Reserve
can control the money supply with any precision at all on a monthly basis, even
if it is prepared to pursue this end regardless of the consequences for interest
rates and financial markets. Indeed, there is much evidence that our ability to
control the money supply even on a quarterly basis is subject to a substantial
amount of slippage. However, this lack of short-run control over the money
supply may not be as serious as it might seem. It appears that monthly and
quarterly deviations of the money supply from target growth paths have little,
if any, impact on the economy, provided that they are subsequently offset. In
other words, the growth of the money supply over periods of six to twelve
months, where our control is considerably greater, seems to be of much more
importance for the economy than the short-run fluctuations which Dr. Weintraub would have us attempt to control.
Response of President Balles
When Congress and the Administration established the Federal Reserve in
1913, it deliberately was given a status of independence within the Government,
in order to free it from day-to-day political influence. Specifically, the System
was made independent of the Executive Branch and responsible to Congress. In
turn, Congress delegated broad powers to the System to formulate monetary
policy in a w7ay that would best contribute to national economic goals, by insulating it from short-term political pressures or partisan considerations. Senator
Carter Glass, the architect of the original Federal Reserve Act, hoped that the
System would act as a "Supreme Court of Finance." This hope has been largely
fulfilled over the years, and the measure of independence given to the Federal
Reserve has facilitated the implementation of the System's objectives and afforded
it a considerable degree of success in coping with a variety of serious problems.
There is sound historical basis for insulating the formulation of monetary
policy from short-term political pressures, especially in view of the failure of
fiscal policy in recent years to contribute to economic stabilization efforts.
(Budget deficits in 14 of the last 15 years have been a significant factor contributing to inflation and high interest rates and have rendered the task of
monetary policy far more difficult.) It is my view that it would be premature
at this time, and quite possibly undesirable at any time in the future, to impose
a Congressional mandate on the permissible growth in Mi, the narrowly-defined
money supply.
There are three reasons underlying my view. First, although Mi is of central
importance, it is by no means the only aggregate or consideration of importance
to the Federal Reserve. During the current year, for example, both M2 and M3
have been growing more rapidly than Mi. Mi is currency and demand deposits
in the hands of the nonbank public; M2 adds to Mi the time deposits of commercial
banks exclusive of large CD's; M3 adds to M2 the time and savings deposits of
thrift institutions. Moreover, while Mi has been a valuable indicator of monetary
influences in the past, future developments in our dynamic financial system,
developments partly technological in nature, may be such as to render Mi
less useful. Forces upon Mi as an operating constraint should be predicated upon
a continual and demonstrable test of its usefulness.
Secondly, unless or until there is proven success in the formulation of fiscal
policy by the Congress, under the recently enacted budget reform act of 1974,
it would be unduly risky to expose monetary policy to the same strong inflationary
bias that has characterized fiscal policy. As things now stand, monetary policy
is the only viable instrument of public policy in combatting inflation.
Finally, Congress should consider most carefully whether it wishes to be
exposed to the pressures from constituents for easy money that would inevitably
develop if it were in the position of making detailed decisions on rates of money
growth. The "popular" thing to do would usually be to make credit cheap and
readily available, but over the longer term this could create tremendous inflationary pressures.
30-714—74
24
364
Response of President Eastburn
PROPOSAL NO. 1.—ESTABLISH TARGET Mi GUIDELINES
As I indicated in my prepared remarks, the Federal Reserve is a creature of
Congress and accountable to Congress. How should Congress exercise this accountability? That, I think, is one issue raised by Dr. Weintraub's proposal
to treat monetary policy like fiscal policy in having the Federal Reserve seek
advance permission from the Congress for a specified range of growth for Mi.
History provides ample evidence of the wisdom of granting central banks
some degree of independence within government. One reason is that overly
rapid monetary expansion yields apparent benefits at first but exacts costs later.
I t initially produces low interest rates, low unemployment and a booming
housing sector. Only later does it push interest rates and unemployment up and
housing down. In short, prudent monetary policy requires taking a long view.
In determining monetary policy the Federal Reserve, therefore, should be insulated from the swings and pressures of partisan politics.
Implementation of the proposal would fly in the face of this important lesson
of history and make it impossible for the Federal Reserve to conduct monetary
policy in the long-run interest of the public.
A second disadvantage of the proposal goes to the state of the art of monetary
policy. Desirable as it might be to predict policy in advance and to adhere
closely to the prescribed plan, no one now has the ability to do this. Provision
of ranges makes this scheme more feasible, but the ranges would have to be so
wide as to be virtually meaningless. If it is true that the Federal Reserve lacks
the expertise to devise and carry out the plan, it would also be questionable
whether Congress could exercise the necessary judgment to evaluate the Federal
Reserve's proposals.
Response of President Francis
Dr. Weintraub's three proposals for revising the process of monetary policy
decisions contain much that I can agree with, but they also contain some points
with which I disagree. I fully agree with one central theme of Dr. Weintraub's
recommendations, that the Federal Reserve System should pick a longer-run target for monetary growth (at least one year) and then stick to that target unless
there are extremely important reasons for deviating from the target path. I have
often suggested that the Federal Reserve should use a longer-term planning
horizon. In recent years some progress has been made in that direction, but I
believe the Federal Reserve is still too prone to react to short-term factors such
as interest rate movements, and, hence, move off its longer-run money supply
path.
My main area of disagreement would be with the proposal that guidelines for
monetary policy be specified annually by Congress after open hearings. Although
I have dissented from past policy actions and I have often spoken out against the
course of monetary actions during the time I have served as President of the
Federal Reserve Bank of St. Louis, I am not convinced that this part of Dr.
Weintraub's proposal would improve policy results. I believe that a strong
independent central bank is crucial to limiting inflation. Traditionally, the
central bank is the one institution which has shown primary interest in resisting
inflation. There are always pressures for more spending without the willingness
to pay the price of higher deficit spending. In many foreign countries the independence of the central bank is much more restricted and it is difficult to
separate the central bank from the Treasury, or the central bank has only a minor
voice in actual policy decisions. I do not find that the record of anti-inflation
policy in these countries is any better than in the United States.
I would support a recommendation that members of the FOMC testify about
their outlook for the economy before a Congressional Committee at the start of
each year. The purpose of this testimony would only be to better inform Congress
about the effect of possible policy actions on the economy. If Congress wTould
make it very clear to the Federal Resereve that it was willing to accept the shortrun upward pressures on interest rates and the possible temporary rise in unemployment necessary in a determined fight against inflation, then I would
expect that the Federal Reserve would follow the monetary policy necessary to
achieve the goal of slowing inflation.
365
Response of President Mayo
1. RECOMMENDATION TO ESTABLISH TARGET Mi GUIDELINES
I find this suggestion deceptively simple. It ignores many complications and
restrictions that make it impractical. Mi is only one element in a vast set of
information relevant to the conduct of monetary policy. Specifying only an Mi
guideline presumes a certainty of knowledge on the significance of this measure
for economic stabilization that simply does not exist. As everyone is aware,
there is no unanimous view even among academics as to the appropriateness of
using Mi as the sole target for policy under all circumstances. We are all uphappy
with the current inflation but that does not mean that a monetarist prescription
is called for.
I am particularly disturbed by the implication that monetary policy be assigned
the objective of achieving some measure that is in itself an extremely narrow
concept rather than the objective of assisting in the achievement of our goals
in employment, prices and economic growth. To argue that such an objective as
Mi can be assigned to the Fed because some feel that their experiments show a
relationship between Mi and our national economic goals, seems to me to be asking
that we now proceed to conduct an experiment which would toy playfully with
our economy and indeed with the welfare of our citizens. It is inconceivable to
me that we should do so on the strength of the evidence available so far—
especially when it appears to me that a majority of professional opinion would
clearly reject such a guideline even in theory.
From what we do know about the variability of the relationship between Mi
and our economic goals and the potential for unexpected shifts due to unusual
factors and expectational and attitudinal factors, Federal Reserve responses
must be uninhibited. The Congress has delegated the monetary policy function
to the Federal Reserve. The Fed, in turn, is and should continue to be accountable for its performance relative to national economic goals and not simply to a
statistical measure.
I find the suggestion that Congressional action in the monetary policy area
should be parallel to its newly-formulated budget reform structure rests on rather
tenuous reasoning. Oongressional budget reform is, in my opinion, a laudable
effort to coordinate an existing helter-skelter system of expenditure authorizations. The focus is on control of specific dollars where the Congress has a specific
responsibility which it cannot delegate. Monetary policy, on the other hand, can—
and is—almost fully delegated because of the day-by-day evolution of its goals
and their execution, with Congressional review after the fact to make sure that
the public interest is being appropriately served. I do not believe that the Congress has the time, expertise or willingness to monitor monetary policy, particularly when many goals, not just one, are appropriate. It would make the policy
determination process tortuous and time consuming.
Response of President Morris
The first of Dr. Weintraub's proposals is intended to provide an improved
format for the Congressional oversight of monetary policy. While I sympathize
with the objective. I also recognize a number of operational problems which would
be associated with the implementation of this proposal.
Monetary policy decisions are difficult decisions because they necessarily involve trade-offs between policy objectives which in the short-run are typically
incompatible. My colleague, Mr. Francis, made the point during the hearing,
which I can accept as a theoretical proposition, that in the long run high employment, a low inflation rate and low interest rates are not necessarily incompatible. Unfortunately, in the long run, as Lord Keynes said, "we are all dead."
In the short-run context within which monetary policy decisions must be made,
difficult trade-offs will almost always be required. To the extent that the Weintraub format could provide the Federal Reserve with better Congressional
guidance on these difficult trade-offs, it would be helpful.
However, I foresee a great many problems in attempting to implement the
proposal. First, there are problems arising from the state of the forecasting
art. Presumably, the Federal Reserve, under the proposal, would meet with
the Congressional Committees in January, present its proposed growth path for
36-714—74
25
366
money and its estimates of the growth rate for real GNP, tiie level of unemployment, the inflation rate and the pattern of interest rate behavior associated with
that money growth path. The Committees would then make judgments as to
whether that growth path reflected acceptable trade-offs or whether a higher
or lower path was to be preferred. The difficulty is that we do not have the
capability to generate a reliable set of estimates for the full year ahead.
In recent years our forecasts of real GNP and unemployment have been
fairly good, but our forecasts of inflation and interest rates have usually been
wide of the mark. We often find that we cannot accurately estimate the interest
rate implications of a given money growth path one month ahead, much less
one year ahead. This means that we could not give the Congress, among other
things, an accurate projection of the consequences of the policy path for the
thrift institutions and the housing industry.
Because our forecasting ability is limited, the optimum money growth path
cannot be determined with precision a year in advance. This means that the
bands of acceptability around the growth path would have to be quite wide. For
example if the path were to be 5% for Mi, the acceptable range would have to
be at least as wide as 3% to 8%. Another reason why a wide band would be
essential is that the Federal Reserve must always have complete freedom to
deal with potential financial panics. It would be extremely dangerous for the
country if the Federal Reserve were ever in a position in which it was necessary for it to subordinate its "lender of last resort function" to any other consideration. Time is of the essence in dealing with problems of financial instability, and the Federal Reserve must always be in a position to move within a
matter of hours to counter such instability should it arise.
If the acceptable range of Mi growth were to be as wide as 3% to 8%, which
I think it must be, the Congressional Committees might feel a bit frustrated
in the sense that they would be establishing ranges beyond which the Federal
Reserve would not contemplate moving in any event.
In summary, while I sympathize with the objective of this first proposal, I
simply do not believe it is workable.
Response of Chairman Burns
Adoption of the first recommendation would have the effect of shifting a major
share of the responsibility for deciding current monetary policy from the Federal
Reserve to Congress. While Congress would request the Federal Reserve to recommend a particular growth path for the narrowly-defined money stock, the
ultimate decision on the target path would rest with Congress. Once the path was
established, the Federal Reserve would be expected to achieve it, unless at a subsequent Congressional hearing the Federal Reserve could make a" case for modifying the target.
The Congress might find it possible to manage monetary policy if there were
a simple, fixed, and well understood relation between the growth of the money
supply and economic activity, and between growth in money and the behavior
oi: prices. Unfortunately, this is not the case, spending decisions and prices! are
heavily influenced by the willingness to use money (its rate of turnover), quite
apart from the quantity of money. It is impossible to predict with any confidence
what monetary growth rate would be needed to finance a given increase in the
dollar value of the gross national product for as long as a year in the future.
The particular growth rate of money consistent with the maintenance of economic stability will differ from one set of economic circumstances to another. Not
infrequently, the rate of monetary expansion required to achieve our national
economic objectives changes abruptly, because of unexpected disturbances in
financial markets or anticipated developments in the nonfinancial sectors of the
economy. Such events may stem from any number of circumstances—such a>si the
poor crop harvests of 1972 that sent food prices skyrocketing, or the manipulation of petroleum supplies and prices by oil-exporting nations that began in the
fall of 1973. Or they may arise from cyclical movements in the domestic economy
that are not foreseen.
The ability of the Federal Reserve to respond promptly to* such events contributes importantly to reducing economic and financial instability to manageable
proportions. The loss of flexibility that would ensue if the path of monetary
growth were predetermined for a year would thus seriously weaken our instruments of economic stabilization policy.
367
The first staff recommendation is defective in still other respects. It acknowledges that, in implementing the proposed guidelines for growth in Mi, the Federal Reserve would need "some limited flexibility to deal with short run problems". In fact, however, the proposal hardly meets this test. If growth targets
for Mi in each month of the year were related to levels that prevailed 12 months
before, assurance of achieving the targets would probably require an effort by
the Federal Reserve to fix average growth rates of the money supply not just for
the year as a whole, but for the short run month-to-month periods in between as
well.
Our control of the money stock is, however, very imperfect in the short run.
Inevitably, therefore, actual growth in money balances would deviate from the
targeted path as the year progressed. That fact would be evident to financial
market participants, and it would also be evident to them that our efforts to get
back on target would have major implications for the future behavior of interest
rates. A road map to the course of interest rates would be a rich treasure to
sophisticated market speculators, at the expense of those less able to interpret
the effects of monetary policy on financial markets.
Dr. Weintraub's second recommendation states: ". . . let Federal
Keserve policymakers, be responsible as individuals for reviewing last
year's money supply behavior, explaining its consequences and specifying what changes they now would make in that behavior if they could
go back and change their past decisions. (A single review could be submitted if there was no disagreement. But all Presidents and Governors should be required to explicitly state their concurrence.)"
Response of President Hayes
Dr. Weintraub's second and third recommendations are both designed, in his
words, "to permit Congress and the public to better utilize the candor, knowledge,
and courage of individual Federal Reserve policymakers." In attempting to
achieve this goal, Dr. Weintraub's second recommendation would have individual
Federal Reserve2 policymakers conduct, in effect, an annual postmortem on
monetary policy. As you know, the Federal Reserve Board submits to Congress
a systematic review of monetary policy and its consequences quarterly and the
annual reports of the individual Federal Reserve banks also cover the same
ground. All of us in the Federal Reserve of course seek to benefit from our
experience, including especially our mistakes, but there may be room for improvement in this respect.
Perhaps more attention should be given to the differences in analysis and interpretation among policymakers, differences that naturally tend to be submerged
in the consenses policy in effect at any given moment. I do not mean to suggest,
however, that present procedures stifle public dissent on policy by Federal Reserve officials. As you know, dissenting opinions on monetary policy in the FOMC
become a matter of public record within three months. In addition, Federal
Reserve policymakers have ample opportunity to state their views on policy issues in numerous public statements and speeches as well as in the various publications of the Board of Governors and of the individual Reserve Banks. Thus,
as I see it, the principal advantage of Dr. Weintraub's suggestion would be to
provide a common forum in which differing views on monetary policy might be
explained and discussed.
Two further comments on this recommendation may be in order. First, it should
be clear at this point that I do not agree with Dr. Weintraub's suggestion that a
review of monetary policy during the past year should be confined to the behavior of the money supply. As explained above, I believe that this is too narrow
a focus in which to formulate and evaluate monetary policy. Second, policy decisions can almost always be improved in retrospect, when many of the uncertainties confronting policymakers at the time when a decision has to be made
have been resolved. Thus, I am not convinced that much is to be gained by following Dr. Weintraub's suggestion of having policymakers discuss in retrospect
how they would change their past decisions. It would seem much more useful
and meaningful to apply lessons learned from the past to current and future
monetary policy than to spend time looking back at some hypothetical "might
have been".
368
Response of President Balles
I can see little basis for the present proposal, since I believe that individual
members of the Federal Open Market Committee are presently responsible a&
individuals for the decisions they make in the FOMC.
The policy record, published three months after each FOMC meeting, contains
a compendium of relevant economic information available to the FOMC at the
time of its meetings, a summary of the discussion of this information by members of the Committee, and a report of any policy actions taken, together with
dissenting votes, if any, and the reasons for such dissent. In addition, Reserve
Bank Presidents and members of the Board of Governors frequently give speeches
in which they make public their individual views and differences of opinion on
important economic issues. Finally, individual members of the FOMC are called
to testify before Congressional Committees to analyze the successes and failures
of past monetary policies in the manner of the House Banking and Currency Committee hearings in July of 1974. Questions similar to those posed in the present
staff proposal were put to members of the FOMC in the July 1974 hearings and,
in my opinion, were answered with appropriate "candor, knowledge and courage."
Response of President Eastburn
PROPOSAL NO. 2.—REVIEW LAST YEAR'S Mi BEHAVIOR AND ITS CONSEQUENCES
Dr. Weintraub's suggestion overlooks an essential element of monetary policy.
This is the process of group decision-making. The great strength of the Federal
Reserve lies in the pluralistic nature of its deliberations, the contribution of
diverse viewpoints in solving a common problem. It is appropriate, therefore,
that the policy record of the FOMC states the majority view, but with ample
provision for dissenting opinions.
I believe that Dr. Weintraub's proposal is not well advised in most circumstances. On the other hand, a major principle underlying the organization
of
the System is the dispersion of power and authority. The Boards1 of Directors
and Presidents of Federal Reserve Banks have been given certain powers by
law. It is entirely appropriate for Congress to call on these elements of the
System as often as it believes desirable to obtain a fuller appreciation of diversity
of views within the System.
One further point. I believe a good part of Dr. Weintraub's concern could be
resolved if the Federal Reserve were to put forth at frequent intervals a meaningful, evaluative analysis of policy problems and decisions. At present material
released to the public tends to be either simply descriptive or defensive of actions
taken. A fuller analysis of pros and cons of various alternative actions would
help to bring out the fact that policy is never monolithic in nature and that there
is much more room for differing opinions.
Response of President Francis
!l would support the recommendation for an annual review of Federal Reserve
policy actions involving all members of the Federal Open Market Committee,
All policymakers, including all members of the FOMC, should be subject to
public questioning about their policy decisions. FOMC decisions are committee
decisions and all members of the FOMC share the responsibility for these
decisions.
Response of President Mayo
2. RECOMMENDATION FOR INDIVIDUAL FOMC MEMBER REVIEW OF PRIOR YEAR
DECISIONS
Federal Reserve policy makers are responsible as individuals to provide their
very best in the way of input into the monetary policy formulation. They are,
therefore, responsible for a record of joint accomplishment which is the important end result. Separate records of individual opinion are only of secondary
significance. Under current procedures, those disagreeing with the majority
369
can register a dissenting opinion published as part of the policy record. Thus,
in effect, a review already exists. No purpose is served by asking for specific
comments on money supply behavior since, as I have argued elsewhere, our
objective must be national economic goals and not an intermediate target
measure.
I do not see any reason—nothing to be gained—for individuals to second-guess
past decisions on the basis of subsequent information. The decision must be
considered in the light of the information available at the time. Retrospective
review is and certainly will continue to be made by each policy maker as he
attempts to improve his contribution to the policy decision-making process.
Response of President Morris
The second of Dr. Weintraub's proposals would require individual Federal
Reserve policy makers to review the preceding year's money supply behavior, to
explain its consequences and to specify what changes they would make in that
behavior if they could go back and change their past decisions. While there may
be some merit in the Federal Open Market Committee, as a group, providing
such a document to Congressional Committees annually, I see no purpose to be
served in individual Monday morning quarterbacking by each member of the
Committee. If a FOMC member wishes to dissent from a course of policy action,
the time to do it is at the time the decision is made. In fact, a review of the record
will show that FOMC members have not been reluctant to record their dissents
from policy actions at the time decisions were made. This is the time, and the
only time in my judgment, in which individual dissents serve a constructive
purpose. I would not, therefore, support this proposal.
Response of Chairman Burns
The second staff recommendation is both unnecessary and undesirable. The
record of policy actions of the Federal Open Market Committee is regularly
published in the Federal Reserve Bulletin 90 days following each Committee
meeting. The voting record of every member of the Committee is listed for each
policy action taken, and when an individual member dissents from the action
taken, the reasons underlying the dissent are usually indicated. Similarly, decisions of the Board of Governors that do not become public immediately—such as
action on the discount rate or on reserve requirements—are reported fully in the
Board's Annual Report covering the preceding calendar year. In this case, too,
dissenting votes are permitted to include the specific reasoning of the dissenting
members.
The System also reports extensively on the past performance of monetary
and financial developments in relation to the behavior of the economy. We are
accountable to the Congress and we are available at any time to give our views
on the state of the economy and explain the monetary policy actions taken by the
System. Twice a year, I appear regularly before the Joint Economic Committee,
and I also meet frequently with both the House and Senate Banking Committees
to discuss monetary and economic developments. Also, the Board staff prepares
a quarterly report of monetary and financial developments at the request of the
Joint Economic Committee, and the Board's Annual Report contains a comprehensive review of the economic and financial developments of the previous year,
along with a discussion of the monetary actions that were undertaken.
What is proposed by this second recommendation is a review of the year, after
the fact, by individual policymakers. The practical content of such a review
would, I believe, be unrewarding. All of us would do things somewhat differently
if we could relieve the event with perfect hindsight. No doubt many policymakers
would propose different policies than had in fact been followed, and there would
be points of difference from one policymaker to another. But I doubt that much
would be learned by requiring individual policymakers to air their varied dissents
from the past course of policy, and I am afraid the Congerss and the public would
be confused by all this.
The strength of the policymaking procedures of the Federal Reserve lies not in
the isolated wisdom of individual policymakers, but in the fact that a group of
intelligent men—reasoning together, analyzing evidence, and deliberating together—can reach a judgment that fits the particular circumstances of the economy better than would the decisions of any one or two of three of them. That
370
Valued asset might be destroyed by a system that emphasized the airing of diversity, rather than agreement, in the conduct of monetary policy.
Dr. Weintraub's third and final recommendation states: " . . . let
the full minutes of the Open Market Committee meetings be made public immediately or at most six months after they are held, deleting until
another six months has elapsed all so-called sensitive discussions."
Response of President Hayes
I cannot agree with Dr. Weintraub's final recommendation, which would have
the full minutes of FOMC meetings made public within a time span of no more
than six to twelve months. My objection here reflects my concern that sensitive
discussions with foreign central banks and officials would be precluded if they
could not be assured of complete confidentiality for a substantial period of time.
Moreover, I do not see any real need for the immediate release of the FOMC's
full minutes. The Federal Reserve publishes a rather detailed record of the policy
action taken at each FOMG meeting within approximately 90 days of each meeting. This record includes not only a summary of the economic and financial conditions influencing the FOMC's decisions, but also the short-run targets it has
agreed upon for the money supply, various other monetary aggregates, and money
market interest rates. The record of policy actions, as noted above, also includes
any dissents to the agreed-upon policy along with a summary statement of why
the FOMC member in question dissented from the majority's policy decision.
Thus, I believe that the published record of policy actions sets forth fairly and
adequately differing views among Federal Reserve policymakers. In these circumstances, the benefits of the early publication of the FOMC's full minutes
would seem to be minimal, and to be heavily outweighed by the damage that such
early publication could do to our relations with foreign monetary authorities.
I hope that you will find these comments on Dr. Weintraub's recommendations
helpful. I think that the Committee',s hearings on monetary policy were beneficial to all concerned, and I am pleased that the Congress is taking such a lively
interest in monetary policy. I know that to many people this is an arcane subject
and I welcome such opportunities to try to explain what we in the Federal
Reserve are attempting to accomplish,
Response of President Dalles
As I noted in my response to the second .staff proposal, there presently is a
substantial amount of disclosure with respect to FOMC deliberations three
months after a meeting occurs. The published policy record of the FOMC presents
all questions of fact known to the FOMC as of the meeting date, summarizes the
discussion of the members, and gives the policy recommendation, including a
quantitative statement of the short-run growth rate targets for the monetary
aggregates. This policy record clearly indicates which voting members of the
FOMC approved and which disapproved of the final recommendation, and the
reasons for dissenting votes if any were cast.
The publication of the full and detailed minutes of the FOMC would add relatively little to the substantive understanding of the issues discussed, and would
have two undesirable effects, even with a one-year delay in publication. First,
it could prove embarrassing to other central banks when the discussion turned
to international issues. More importantly, disclosure of such deliberations may
limit the ability of the United States to offer the assurance of strict confidence
in dealings with other central banks, which is absolutely essential to effective
bargaining and to the resolution of many international financial problems. Second, complete candor untempered by considerations of political problems is essential to meaningful and frank deliberations. From time to time it is necessary to
discuss in detail the implications for the economy and for monetary policy of
programs and policies of the Administration and the Congress. If the detailed
minutes were divulged within a shorter time frame than is presently used (i.e.,
5 years), discussion might be inhibited, and the FOMC would be immersed more
deeply in the political arena with undesirable consequences for the effective
formulation and implementation of monetary policy.
371
Response of President Eastburn
PROPOSAL NO. 3 MAKE THE FOMC'S MINUTES PUBLIC IMMEDIATELY OR AT MOST
SIX MONTHS AFTER THE MEETINGS, DELAYING FOR ANOTHER SIX MONTHS
SENSITIVE DISCUSSIONS
I believe Dr. Weintraub's proposal for full disclosure of FOMC memoranda of
discussion within six months goes further than is prudent. It is important that a
balance be struck between full disclosure and the confidentiality necessary to foster honest debate and exchange of information among FOMC members.
The public, in my judgment, likely would benefit from earlier knowledge of
current policy decisions than it now gets.1 This objective could be achieved without immediately revealing in full detail the deliberations within the Committee.
The FOMC could announce its quantitative policy targets with necessary explanatory text with less delay than is now the case. The policy record could continue
to include views of dissenting members.
How soon these quantitative targets and policy text should be released is
debatable. One approach would be to reduce the 90-day delay to 60 days for a
period of six months. If there were no major adverse consequences, then the
delay could be reduced to 30 days.
The FOMC memoranda of discussion should continue to be published with a
five-year lag. In addition, we should continue to delete sensitive material (such
as that involving foreign governments) from the published version. Immediate
release of the full discussion is undesirable because it would inhibit forthright
policy discussion to the detriment of effective policy.
Response of President Francis
I agree with Dr. Weintraub's proposal for release of the FOMC minutes after
a six-month interval. If this policy were followed, the policy positions of each
member of the FOMC would be a matter of public record. Hence, any testimony
by FOMC members before a Congressional Committee could be limited to
responding to specific questions about their published policy positions.
I have long held the view that it would be beneficial to release very shortly
after each FOMC meeting a complete specification of the short-run and long-run
operating targets for Federal Reserve policy. I do not see how this information
would in any way benefit a special class of money market participants. I agree
with the view expressed by President Mayo of the Federal Reserve Bank of
'Chicago during his interview with Dr. Weintraub, namely, that:
. . . The market indeed does have a fairly full understanding as to
what the factors are in monetary policy that are going to lead to
specific steps by the Federal Reserve. This happens to be a product, in
part, of the fact that many of these people who are in the market, and
in the position of making markets, have at one time either worked in the
Treasury or in the Federal Reserve. Indeed there is also cross-fertilisation the other way. So it is no great secret as to how you interpret what
the Fed is doing and indeed is trying to do. A number of the leading
writers in New York—the Lehman Letter, Lanston's Letter and so forth
—are written by former Treasury, former Federal Reserve people, and
they're very good in interpreting these things.
By making complete information about the Federal Reserve's intended policy
actions available to the market, I believe that market participants could structure their portfolio decisions with greater certainty and this would eliminate
pressures that arise in the financial markets as market participants try to
""second guess" monetary policy actions.
1
A summary of FOMC decisions is normally released after a delay of about 90 days.
Memoranda of discussion are released usually after a five-year delay with certain sensitive
material, for example, certain references to foreign governments, deleted.
372
Response of President Mayo
PEOPOSAL NO. 3—RECOMMENDATION ON THE DISCLOSURE OF THE FOMC MINUTES IMMEDIATELY OR SIX MONTHS AFTER THE MEETING
The policy action record is currently published three months after the Federal
Open Market Committee meeting. This record details the bases for the decision,
provides quantitative targets for the period and indicates the dissents, if any, and
the reasons for them. Thus, full disclosure is already made on all relevant policy
elements.
Response of President Morris
The third proposal of Dr. Weintraub is that the full minutes of the FOMC
meetings be made public immediately or at most six months after they are held,
deleting until another six months has elapsed all so-called sensitive discussions.
While I favor the maximum feasible disclosure of Federal Reserve policies and
operations, I do not think that disclosure of the full minutes of the meetings
shortly after the meetings were held would be in the public interest. Such disclosure would greatly inhibit free discussion at meetings and encourage decision
making outside of the meetings. It is necessary to strike a 'balance between the
confidentiality needed to insure adequate internal discussion and the disclosure
needed to insure adequate public understanding of policy and Federal Reserve
accountability. The public's need is met by the Policy Record published for
each FOMC meeting. As you know, the Policy Record for each meeting is released approximately 90 days after the date of the meeting and we have been
expanding the content of this document. Beginning in 1974, the Policy Record
of the FOMC now contains the numerical specifications that guide open market
operations in the period between Committee meetings for Mi, M2, RPD's and the
Federal Funds rate. I believe, personally, that we could safely shorten the time
lag involved in publishing the Policy Record from 90 days to 60 days. However,
for the reasons stated, I would oppose the publication of the minutes.
Response of Chairman Burns
The third staff recommendation—to release the minutes of Federal Open
Market Committee meetings immediately, or within six months time—could
seriously damage the conduct of monetary policy, even if the disclosure of "socalled sensitive discussions" were deferred somewhat longer. Immediate disclosure of the decisions of the FOMC would give an enormous advantage to
sophisticated financial investors, who would realize much more quickly than
would the general public the implications of these decisions for the near-term
course of interest rates and financial asset prices. Based on this knowledge, they
would take action in the securities markets for their own personal gain. Such
personal enrichment would come at the expense of other, less knowledgeable,
individuals who could not react quickly enough to avoid financial losses. Such
inequities could hardly be countenanced.
Withholding publication of the FOMC minutes for 6 months would avoid most
problems of that kind, but a longer lag than 6 months is needed for other reasons.
The FOMC is a deliberative body. Its members must speak frankly to one another
regarding activities of the Administration, of the Congress, of foreign central
banks and foreign governments. If a nearly verbatim record of these remarks
were released in a short period of time, it might produce great embarrassment.
Knowledge of this fact would prohibit the candid and open discussion that is
essential to sound judgments on monetary policy. Some information would
inevitably be withheld, and the positions espoused by individual policymakers
would almost certainly be influenced to a degree by the knowledge that they
would be made public shortly.
Delayed publication of the full minutes of FOMC meetings is not a serious
omission from the standpoint of public understanding of monetary policy. Other
FOMC releases l^eep the public fully informed of Committee actions on a much
more timely basis. The Committee policy record, in particular, provides a full
report—within 90 days of each meeting—explaining the essentials of Committee
actions and the reasons behind them.
ADDITIONAL QUESTIONS
III
POSSIBLE EFFORTS TO INFLUENCE AND COORDINATE THE
TESTIMONY OF THE RESERVE BANK PRESIDENTS
On July 18,1974, Congressman John H. Bousselot explored the question of possible efforts by the Federal Reserve Board to influence and
coordinate the testimony of Eeserve bank presidents before the committee. The pertinent dialogs follow:
Mr. ROUSSELOT. Thank you.
First of all, I want to compliment each of you gentlemen on your testimony
and your analysis of the problem of inflation and high interest rates, and I did
have a chance to glance at each of your statements prior to coming today, and
appreciate the chance to review them. I would like an answer from any one of
the three of you; did the Federal Reserve Board here in Washington make any
effort to influence or coordinate your testimony before this Committee?
Mr. MORRIS. No, sir. We did ask the research staff of the Federal Reserve
Board to look over our comments, check any inaccuracies, but there wtas no
censorship.
Mr. ROUSSELOT. N O ; I am not suggesting censorship. I am just suggesting
guidance.
Mr. MORRIS. In my case, I can assure you there was no guidance, nor were
there any significant changes in the text I originally drew up.
Mr. ROUSSELOT. Mr. Mayo?
Mr. MAYO. Mine were only editorial changes.
Mr. ROUSSELOT. Editorial changes? What does that mean?
Mr. MAYO. I should say changes in words—semantics—just in 'a few cases. There
was nothing substantive changed, and the suggestions were only by the Board
staff. To my knowledge, no Governor has ever seen my statement.
Mr. MORRIS. I might also add, sir; that we are completely free to reject any
suggestions the Board staff put forth.
Mr. ROUSSELOT. Mr. Francis ?
Mr. FRANCIS. The Board staff did ask to see the statement. Mine was transmitted to them. There were some suggestions, but I have a sort of a country
person feeling about the principles of appearing before a Congressional group,
and I think that when I am invited to do so, I am obligated to give you my
views, and mine alone; and the statement you have is my original statement,
without one word having been changed.
Mr. ROUSSELOT. Good. I appreciate that.
Mr. MAYO. That is true in my case, for all intents and purposes, too.
Mr. ROUSSELOT. My understanding is that there was a special meeting of
the Board held this past Monday, July 15. Did any of the Governors discuss potential testimony before this Committee? Was there any discussion about it?
Mr. MAYO. May I ask what you mean by potential testimony ?
Mr. ROUSSELOT. Well, your potential testimony.
Mr. MAYO. Well, again, as we discussed here, there was a recognition of the
fact in the meeting that you refer to that we are indeed part of a system, and
that there is an inherent strength of what you might call joint decision-making,
and the way that the Federal Open Market Committee is working on it, and that is
the most important ingredient, and there is no disagreement among any of us on
that. That is far more important than the differences that each of us may have
with each other on detail.
Mr. ROUSSELOT. Then, is your answer that it was discussed in the meeting—
your joint ideas ?
Mr. MAYO. In a broad way.
Mr. ROUSSELOT. In a broad way it was discussed?
(373)
374
Mr. MORRIS. We did discuss Dr. Weintraub's proposals. We talked them back
and forth over dinner. But we are all going to make our independent statements
for the record on his proposals, and I suspect that probably you will find a difference in my response and my colleague's, Mr. Francis'.
Mr. ROUSSELOT. Yes; I noticed that.
Then your statement is that, even though it was discussed on a joint basis in
the meeting on Monday, July 15, this is just for the edification of each other?
There was no attempt by any of the governors to say, well, this is what we have
been saying, and hopefully you will say the same thing, or what?
Mr. MORRIS. NO, sir.
Mr. MAYO. NO, sir.
Mr. ROUSSELOT. YOU actually, then, are independent operators, as it comes to
your own statements?
Mr. MAYO. That is correct.
Mr. ROUSSELOT. Thank you, Madame Chairman.
There follows now written questions on this matter submitted
by Congressman Rousselot to Presidents Hayes, Balles, Eastburn, Francis, Mayo, and Morris and their replies.
I. During the questioning of Presidents Mayo, Morris, and Francis by the
Committee on Banking and Currency on July 18, 1974, I asked several questions
regarding a possible effort by the Federal Reserve Board to influence or to
coordinate the testimony of regional bank Presidents before the Committee. In
order to explore this issue more thoroughly, I have prepared a series of questions addressed to all six Presidents who testified before the Committee.
The answers to these questions are particularly important in light of the
recommendations which Dr. Robert Weintraub, Staff Economist for the Committee, made at the conclusion of his report that the minutes of the Open Market
Committee be made public and that Federal Reserve policymakers individually
make an annual review of their decisions in order to "permit Congress and the
public to better utilize the candor, knowledge, and courage of individual Federal
Reserve policymakers."
Question 1. With respect to the series of interviews of regional bank Presidents
conducted by Dr. Robert Weintraub, was any effort made by the Governors or
by the staff of the Federal Reserve Board to discourage your participation or to
influence the content of your responses to anticipated questions ?
Question 2. With respect to the testimony which you gave before the Committee
on Banking and Currency, was any effort made by the Governors or by the staff
of the Federal Reserve Board to influence or to coordinate your testimony?
Question S. With respect to any testimony which you may have submitted to
the Governors or to the staff of the Federal Reserve Board for "technical,"
"editorial," or other changes, is there any reason why your own staff was unable
to make whatever changes may have been necessary without consulting the
Governors or staff of the Federal Reserve Board?
Question 4. Do you usually submit advance drafts of your public speeches to the
Governors or to the staff of the Federal Reserve Board for their review?
Question 5. Was a special meeting of the Federal Reserve Board held in Washington on Monday, July 15, the day before the Committee began its hearings on
the relationship between Federal Rserve policy, inflation, and high interest rates ?
(a) If so, which Governors, Presidents, and staff members participated?
(b) Was the content of your testimony discussed?
(c) Was any attempt made to explain the position of the Board of Governors,
its Chairman, or its staff on the substantive issues expected to be raised at the
hearings ?
Question 6. Did you submit any version of your testimony (preliminary or
final) to the Governors or to the staff of the Federal Reserve Board for their
review ?
(a) At whose initiative was it made?
(b) Was a dealine set for such submission, and, if so, what was the date?
(c) Which individuals at the Federal Reserve Board reviewed your testimony?
(d) What changes did they request or suggest that you make?
(e) What actual changes did you make in your testimony before submitting it
to the Committee?
Question 7. At any time prior to your appearance before the Committee, in
connection with your interviews with Dr. Weintraub or with the scheduling,
preparation, or submission of your testimony to the Committee, were you in anjr
375
way threatened with reprisal, including loss of privileges, such as the privilege
of attending meetings of the Open Market Committee (if not a voting member),
removal from office, or reduction in your Bank's budget or research staff?
Question 8. At any time prior to your appearance before the Committee, did you
have any contact with any directors of your Bank concerning your testimony or
concerning any possible problems arising from or relating to it?
Response of President Hayes
Answer to question 1. No effort was made by any Governor or by any of the
staff of the Board to discourage my participation or to influence the content of
my responses.
Answer to question 2. Interpreting this question to apply to the prepared statement I submitted to the Committee, orally in an informal summary and in full
in written form for the record, I can assure you there was no attempt by any
Governor or any of the Board's staff to "coordinate" my views. Several suggestions for changes in wording were made to me, three of which I accepted in part,
and these suggestions are discussed in the response to question 6.
Answer to question 3. Since I was out of the country while arrangements for
my appearance before the Committee were made early in July, and I did not
return until July 13, my staff commenced the preparation of my statement during
my absence. It was, therefore, responsible for the "technical" and "editorial"
content of the statement. However, just as I solicit comments, suggestions, and
criticism from my associates at the Bank on letters and other material I prepare myself, so I am glad to consider comments from the Board and its staff.
(See also response to the next question.)
Answer to question 4. I have made it a practice during my 18 years as> President
of the Federal Reserve Bank of New York to send advance drafts of my public
speeches to the Chairman of the Board of Governors and to the Secretary of the
Treasury, asking for their comments and suggestions. I have given serious consideration to any suggestions they have made, sometimes accepting them, sometimes modifying my wording on the basis of their suggestions, and sometimes
rejecting them.
Answer to question 5. I interpret the question to refer to a meeting at the
Federal Reserve Board and there was such a meeting on the morning of July 15.
Answer to question 5 ( a ) . To the best of my recollection, there were present
Chairman Burns, Governor Wallich, Mr. Partee (Managing Director for Research
and Economic Policy), Mr. Coyne (Assistant to the Board), Mr. Rippey (Assistant to the Board) and several of the Presidents of the Federal Reserve Banks.
Answer to question 5(b). There was a general discussion of the probable lines
of questioning on issues that members of the Committee might be expected to
pursue. Later that day, at dinner, there was a review by Mr. Partee of the recommendations that Dr. Weintraub was making in his report to the Committee. There
was a general discussion of those recommendations, most of it (as you might expect) critical.
Answer to questions 6(a) and (b). Yes, a copy of a preliminary draft version
of my prepared statement for use at the Committee's hearing was submitted to
the Board's staff. On July 8, my office (in my absence) received a wire message
from Mr. David C. Melnicoff, the Board of Governors' Managing Director for
Operations and Supervision, confirming that arrangements had been made with
the House Committee on Banking and Currency for six of the Reserve Bank
Presidents to testify at hearings on July 17 and 18, and adding "we look forward to receiving your draft statement which we hope to return with any comments to seminar on Monday the loth at 9 a.m." An early draft of statement was
sent to the Board on July 10, although my associates continued to work on wording, seeking to clarify the views expressed and to improve expression of the
thoughts.
Answer to question 6(c). To the best of my knowledge, the draft of prepared
statement was reviewed only by J. Charles Partee, Managing Director for
Research and Economic Policy.
Answer to questions 6(d) and (e). To the best of my recollection, Mr. Partee
suggested about half a dozen changes in the draft text; I made three changes in
wording as a result of those suggestions. Although I did not make notes of those
suggestions by Mr. Partee that I rejected, I am attaching a copy of the statement as submitted to the Committee which identifies those changes I did make
376
On the basis of Mr. Partee's suggestions. I should explain that my staff continued to work on the draft sent to the Board on July 10, so that a second draft I
received for review on my return July 13 to the United States reflected more than
a dozen changes made to refine wording and clarify expression of thought. In
my review on July 13 and 14, before the meeting in Washington on July 15, I
made some further revisions. Accordingly, it should be clear that the draft statement I discussed with Mr. Partee contained a number of differences from the
initial draft sent to the Board on July 10.
Answer to question 7. No pressure of any sort was put upon me, nor was I
threatened with any reprisals.
Answer to question 8.1 had no such contact with any directors.
The changes made on the basis of Mr. Partee's suggestions, as identified by President Hayes, are as follows. (Italicized words were added
and bracketed words deleted.)
1. Indeed, I think there have clearly been times, particularly in 1968 and in
1972, when monetary policy has been rather too expansionary.
2. Certainly, our present situation of unemployment in excess of 5 per cent,
coupled with the escalation of inflation rates that we have witnessed, [a peacetime inflation of virtually unprecedented rapidity] strongly suggests that this
process has been at work over the past decade.
3. Indeed, as I indicated earlier, I think monetary policy has clearly been
somevjhat too expansionist at times over the past decade.
Response of President Balles
Answer to question 1. No.
Answer to question 2. No.
Answer to question 3. The Research staff at the Federal Reserve Bank of
San Francisco provided valuable assistance in preparing the testimony I presented to the House Banking and Currency Committee. This staff is perfectly
capable of providing such assistance when and where needed, however they,
like myself, are accustomed to drawing on the resources of the entire Federal
Reserve System when it is convenient and appropriate to do so. Testimony on
subjects as important as the ones addressed at the July 17-18, 1974 Hearings
of the Banking and Currency Committee, in our view, warranted utilization of the
widest range of expertise available to us. The free interchange of ideas among the
Reserve Banks and the Board of Governors is a major source of strength for
the Federal Reserve System as a whole. However, I wish to make it clear that
the ideas contained in the testimony I delivered to the House Banking and
Currency Committee on July 17, 1974 are my own and that I assume personal
responsibility for every word of it.
Answer to question 4. My Research staff generally send drafts of my public
speeches, after review and approval by me, to the staff of the Board of Governors
for comment. Although we do not accept all suggestions received in this process,
many speech drafts are improved by this exchange of ideas.
Answer to question 5. I am not aware that any special meeting of the "Federal
Reserve Board" was held on Monday, July 15 for any purpose. I attended four
meetings that day:
i. At 9:00 a.m. the six Federal Reserve Bank Presidents who were to testify
before the House Banking and Currency Committee met for about an hour to
discuss the Hearing scheduled for July 17-18.
Answer to question 5(a). According to my recollection, Chairman Burns and
Governor Holland attended for a short period, and Governor Wallich attended
the full meeting. Reserve Bank Presidents attending were Messrs. Balles, Eastburn, Francis, Hayes, Morris and Mayo. Staff attending were (Board's staff)
Messrs. Partee, Rippey and Coyne, and (Reserve Banks) Messrs. Sims, Boehne,
Jordan, Rassmick, Eisenmenger, and Scheld.
Answer to question 5(b). I summarized the remarks I planned to make in my
testimony, but there was no discussion of it.
Answer to question 5 (c). I do not recall any such attempt:
377
ii. At 12:00 noon I attended a meeting of the System Steering Committee on
International Banking Regulation, and at 3:00 p.m. I attended a meeting of Reserve Bank Presidents with representatives of the Board's Division of Reserve
Bank Operations to discuss Reserve Bank Budgets. Neither of the meetings had
any relation to the hearing.
iii. At 6:00 p.m. I attended a dinner with Reserve Bank Presidents and members of the Board of Governors, which is done periodically throughout the year.
Following the dinner, there was an extensive discussion of the problems of monetary policy in recent years. Additionally, there was a "roundtable" discussion of
the recommendations made by Dr. Robert Weintraub, staff economist of the
House Committee on Banking and Currency, regarding monetary policy formulations, the scheduled testimony of individual Reserve Bank Presidents was not
discussed, nor was there any effort by the members of the Board of Governors or
its staff to set forth a position on substantive issues likely to be raised in the
hearings.
Answer to question 6. Yes.
Answer to question 6(a). I understand that Chairman Burns initiated the
request, but it was relayed to me by Mr. Partee through Mr. Sims, the Senior
Research officer at the Federal Reserve Bank of San Francisco.
Answer to question 6(b). A draft was requested by July 9, 1974. However, this
date proved inconvenient for me, and so my draft testimony was not sent to* Chairman Burns until July 11.
Answer to question 6(c). To the best of my knowledge, only Mr. Partee, Director of the Board's Division of Research and Statistics.
Answer to question 6 (d). The few suggested changes were of an editorial nature and are indicated in the attached copy of the final version of my testimony,
on which the language of the first draft has been handwritten. I accepted these
suggestions.
Answer to question 6(e). See attached copy of draft sent by wire to the Board
of Governors. I made numerous editorial changes and a few substantive changes
at my own initiative, after sending the first draft. For this reason, I request that
the first draft not be a part of the printed record. (The draft is retained in the
committee's files.)
Answer to question 7. No.
Answer to question 8. No. At our regular Directors' conference call meeting
on July 3, 1974, I mentioned the fact that I would testify before the House Banking and Currency Committee, but there was no discussion of this point.
The changes made on the basis of Mr. Partee's suggestions, as
identified by President Balles, are as follows. (Italicized words were
added and bracketed words deleted.)
1. What has led to this worldwide inflation? Some [many] observers would
cite excessive monetary and fiscal expansion as the major immediate cause.
2. However, one element which has not received as much attention as it
deserves is the breakdown of the Bretton Woods System, and the decline in
recent years in [general loss of] foreign confidence in the U.S. dollar.
3. This movement out of dollars [was] accelerated in the period after [August
1971 when] the U.S. suspended convertibility of the dollar into gold in August
1971.
4. Since the early 1960s, the "full employment" goal in the U.S. generally has
contemplated an unemployment rate of 4 percent or less.
5. This, of course, is not to imply that monetary and fiscal policy should never
be used to help deal with [solve] unemployment.
6. In a very real sense, the double-digit inflation and accompanying high interest rates from which we are now suffering reflect inflationary policies of the
past, the symptom of which were temporarily suppressed during the period
August 1971 to early 1978 [April 1974] by wage and price controls under various
programs.
7. High and rising interest rates have taken their toll on financial markets.
To the man in the street, some of the most obvious results have been the decline
in the stock market and the sharply reduced supply of funds for home loans at
[the disintermediation from] savings institutions.
378
Response of President Eastburn
Answer to question 1. No.
Answer to question 2. Yes. The details of the effort to influence and coordinate
the contents of my testimony are spelled out below in the answer to questtions
5 and 6.
Answer to question 3. I have full confidence in my staff's ability to review
my testimony and to suggest changes. However, I have no objections to receiving comments from the Board of Governors or its staff.
Answer to question 4. I usually forward to the Board of Governors a copy of
my major public speeches about the time of delivery.
Answer to question 5. I know of no special meeting of the full Board. There
was, however, a meeting of some of the Governors, Presidents and staff.
Answer to question 5(a). My best recollection is that Chairman Burns, Governor Wallich, plus Messrs. Partee, Melnicoff, Burke, MeWhirter, Coyne, Rippey
of the Board staff attended. Also, in addition to me, Reserve Bank Presidents
Morris, Hayes, Mayo, Francis and Balles attended, along with staff members Jordan (St. Louis), Scheld (Chicago), and Sims (San Francisco).
Answer to question 5(b). Yes. I summarized the content of my testimony,
but there were no comments from the other participants.
Answer to question 5 (c). No, there was no attempt to explain the substantive
position of the Board, the Chairman, or the staff of issues. However, there was
a discussion of the kinds of questions that might be raised, the style in which
they might be asked, and the style in which they might be answered.
Answer to question 6. Yes.
Answer to question 6(a). Mr. Melnicoff's.
Answer to question 6(b). Yes, July 9, 1974 was set for initial submission date.
Final draft was due July 15,1974.
Answer to question 6(c). To my knowledge, Mr. Partee reviewed my testimony. There may have been others who reviewed my testimony of whom I am
unaware.
Answer to question 6(d).
(i) To clarify the statement in the original draft (p. 2) to the effect that "the
basic cause of inflation is monetary."
(ii) To indicate that the Federal Reserve is concerned with the "effects of
high and rising interest rates" (p. 2).
(iii) To suggest that exploration of possibilities for allocating credit should
proceed over a period of time (p. 7).
Answer to question 6(e). Each of these suggestions was agreeable to me and
so I made the necessary changes.
Answer to question 7. No.
Answer to question 8. No.
The changes made on the basis of Mr. Partee's suggestions, as identified by President Eastburn, are as follows. (Italicized words were
added and bracketed words deleted.)
1. Our current inflation has many causes, but it is helpful to divide them
into two main aspects. One aspect involves extraordinary events such as crop
failures, oil embargoes, and dollar devaluations. They come and go and often not
much can be done about them. Beef prices skyrocket then taper off; wheat supplies diminish then expand; anchovies disappear from the coast of Peru and
then reappear. If we are lucky, these phenomena occur at different times. In
the last couple of years we have been unlucky; many extraordinary events have
occurred together.
A second aspect is monetary. [The basic cause of inflation is monetary.] Whatever immediate events may cause prices to rise—including shortages and higher
wage costs—a higher price level cannot be sustained without sufficient money.
In retrospect it would have been better if money had not grown so rapidly over
much of the past decade.
379
2. In more recent periods, the Federal Reserve partly reflecting views of
Congress has been concerned about the effects of high and rising interest rates.
3. [Sixth, selective credit controls are less necessary if general monetary and
fiscal policies are doing their jobs. Historically, resort has been made to selective
controls usually when general policies have proved deficient. To the extent, therefore, that we can avoid inflation through general monetary and fiscal policy, we
have less reason to be concerned with the allocation of credit.]
I conclude from all this that [possibilities for] over time, the question of allocating credit should be [explored] studied further, Our analysis to date,
however, suggests serious problems. Perhaps the most important point is that
if we can avoid inflation through general monetary and fiscal policy, we have
less reason to be concerned ivith the allocation of credit. A [And in any case, a]
program of credit allocation is no substitute for responsible policy in dealing
with the overall supply of money and credit.
Response of President Francis
Answer to question 1. No.
Answer to question 2. On June 26 there was a conference telephone hookup
between the Presidents scheduled
to testify and Messrs. Melnicoff, Partee, and
Rippey of the Board staff.1 In this call, each President was asked to send a copy
of his prepared testimony to Chairman Burns by July 9, and was told that
within a week thereafter, each would receive such comments and suggestions
for changes as the Board staff might wish to offer. We were also told that there
would be a meeting at the Board on Monday, July 15, to discuss the testimony and
possible questions that might arise during the hearing (See answer to question
No. 5 below). We were told that we would be provided with secretarial and duplicating facilities at the Board to facilitate delivery of our prepared statements
to the Committee in their final form.
Answer to question 3. Our staff is, in my opinion, the finest of its kind, and I
have complete confidence in them. They made many changes as the statement went
through several draft stages. No statement is ever perfect, but in the form in
which it was delivered to the Committee, it came as close as I knew how, to
saying what I wanted to say. Neither the Board nor its staff was consulted.
Answer to question 4. I always send copies of my public speeches to the Board
in their final form. However, they have not been delivered in advance simply
because they normally undergo changes by me or our staff until the day before
delivery. Recently however, I was told that Chairman Burns had taken exception
to some statements contained in one of my speeches and I was instructed to
send the text of future speeches to the Board staff in advance, by wire if necessary, so that they could be examined before delivery. Since I have not given any
public speeches from a prepared text since that time, I have not had occasion
to respond to this request.
Answer to question 5 ( a ) . There was a meeting at 9:00 a.m. on the morning of
July 15, 1974 in the offices of the Board of Governors of the Federal Reserve
System. It is my recollection that in addition to myself the following persons
were present for at least part of the meeting:
Arthur F. Burns, Chairman, Board of Governors, and Federal Open Market
Committee.
Henry C. Wallich, Member, Board of Governors, and Federal Open Market
Committee.
Alfred Hayes, President, Federal Reserve Bank of New York, and Vice Chairman, Federal Open Market Committee.
John J. Balles, President, Federal Reserve Bank of San Francisco.
David P. Eastburn, President, Federal Reserve Bank of Philadelphia.
Robert P. Mayo, President, Federal Reserve Bank of Chicago.
Frank E. Morris, President, Federal Reserve Bank of Boston.
Richard A. Debs, First Vice President, Federal Reserve Bank of New York.
J. Charles Partee, Managing Director for Research and Economic Policy, Board
of Governors.
1
J. Charles Partee, Managing Director for Research and Economic Policy, Board of
Governors ; David C. Melnicoff, Managing Director for Operations and Supervision, Board
of Governors ; and John S. Rippey, Assistant to the Board.
380
David C. Melnicoff, Managing Director for Operations and Supervision, Board
of Governors.
Ronald G. Burke, Director, Division of Federal Reserve Bank Operations, Board
of Governors.
E. Maurice McWhirter, Associate Director, Division of Federal Reserve Bank
Operations, Board of Governors.
Joseph R. Coyne, Assistant to the Board.
John S. Rippey, Assistant to the Board.
Jerry L. Jordan, Vice President, Federal Reserve Bank of St. Louis.
Kent O. Sims, Senior Vice President, Federal Reserve Bank of San Francisco.
Karl A. Scheld, Senior Vice President and Director of Research, Federal Reserve
Bank of Chicago.
There was also a dinner meeting on the evening of July 15 at the Board of
Governors building attended by all members of the Board, and all Reserve Bank
Presidents, as well as a few senior members of the Board staff.
Asnwer to question 5(b). At the morning meeting, remarks were made regarding questions that might arise in the course of the hearings, and each of the Federal Reserve Bank presidents summarized the general thrust of his prepared
testimony. The specific recommendations made by Dr. Robert Weintraub to the
House Banking and Currency Committee were discussed at the evening meeting.
Answer to question 5(c). The views of the Board regarding the special borrowing of the Franklin National Bank were discussed. The views were essentially those stated in a New York Times article by Mr. Ed Dale appearing in the
July 15 issue.
Regarding a possible question as to whether our statements were "cleared", it
was suggested that we say they were sent to the Board staff for comment, some
were taken and some were rejected, and each should emphasize that it was
his own statement and views.
Regarding any possible questions about lobbying activities related to the GAO
audit bill, it was suggested that no lobbying had occurred, that the System was
opposed to such an audit, but, if inevitable, the Ashley Amendment would be
acceptable.
Answer to question 6:
(a) Yes, presumably at Chairman Burns* initiative, since Mr. Partee asked
that I send a draft version to the Chairman.
(b) The date which the testimony was to be received at the Board was July 9.
(c) Mr. Partee and possibly others.
(d) Changes suggested by the Board and staff were transmitted by wire from
Mr. Partee on July 11. A copy is attached.
(e) None.
Answer to question 7. There were no direct or implied threats of any kind
made in specific connection with my appearance before the Committee or in
connection with the interview conducted by Dr. Weintraub.
Answer to question 8. As stated above, my prepared testimony was sent as
requested, to reach the Board by July 9. On July 11, at a regular monthly meeting of our Board of Directors, I briefed the seven directors present on the sequence of events, and read to them verbatim my prepared statement. I told
them that I had no intention of changing anything in the statement, and I asked
whether it contained anything to which they, individually, and as a Board, could
not give an unqualified endorsement. I was assured that, to a man, they stood
behind my statement and supported my decision not to change it.
There follows the testimony of President Francis as it was
submitted to the Federal Reserve Board on July 9,1974, and subsequently given to the committee on July 18, 1974. Immediately
thereafter follows a "mark-up" of this testimony incorporating
the suggestions made by Mr. Partee in his telegram of July 11,
1974:
PREPARED STATEMENT OF DARRYL R. FRANCIS, PRESIDENT, FEDERAL RESERVE BANK
OF ST. LOUIS
Mr. Chairman and members of the committee: I am pleased to have this opportunity to present my views regarding our country's inflation and high interest
381
rates and the role of monetary policy in dealing with these and other economic
problems.
My position regarding the cause of inflation and high market interest rates is
that they both stem from the same source—an excessive trend rate of expansion
of the nation's money stock. Monetary policy, therefore, can contribute to solving
both of these problems over a period of a few years by fostering a non-inflationary
rate of growth of the money supply.
I believe that the historically rapid rate of money growth of the past few
years has caused an excessive rate of expansion of total spending in the economy.
Since rapid money growth has stimulated a growth in demand for goods and
services at rates much faster than our ability to produce, inflation has resulted.
The relationship between expansion of the money stock and the rate of inflation is illustrated in Chart 1. The money stock, defined as demand deposits
and currency held by the nonbank public, increased slowly from early 1952 to
late 1962. Since then, the average rate of money growth has persistently accelerated. As indicated in Chart 1, the general price index, measured by the GNP
deflator, has risen, with a few quarters lag, at rates similar to growth of the
money stock (except during Phases I and II of the price and wage controls when
reported prices were artificially held down).
Chart I
1952
1954
1953
1955
1957
1956
1958- 1959
1960
1961
1962
1963
1964
1965
1968
"1967
1966
1969
1970
1971
1972
1974
1973
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3NSOF DOllAl
BIUK
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300
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Mon e y S toclc
280
Seasonally Adjusted
260
260
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240
220
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382
High and rising market rates of interest go hand-in-hand with a high and
accelerating rate of inflation. This is because lenders and borrowers of funds
take into consideration their expectations with reference to the future rate of
inflation. Lenders desire a market rate of interest which provides them a real
rate of return plus a premium based on their expectations regarding the future
rate of inflation. Also, during inflation borrowers are willing to pay a higher
market rate of interest because they expect the prices of their products to rise,
and they wish to avoid the higher construction and other costs associated with
delaying new projects. Thus, the interaction of demand and supply in the market
for funds during a period of inflation results in market interest rates which
embody an inflation premium.
This response of interest rates to inflation is illustrated in Chart 1. During
the period of a slowly rising general price level in the 1950's, and early 1960's,
the seasoned corporate Aaa bond rate rose slowly until 1959 and subsequently
remained little changed through 1965. Then, with accelerating inflation, this
average of highest quality long-term market interest rates rose steadily for five
years. It was relatively stable in 1971 and 1972, probably reflecting expectations
of less rapid inflation as a result of Phases I and II of the price and wage control
program. During that period the reported rate of inflation decreased to less than
3 percent. However, the renewed acceleration of inflation since early 1973 has
been accompanied by a gradual, but marked, increase in the corporate Aaa bond
rate.
According to my view of the relationships which run from an increase in the
trend growth of money, to a higher rate of inflation, to higher market rates of
interest, present high interest rates do not indicate restrictive monetary actions.
On the contrary, they are the result of excessively expansionary monetary actions
since the early 1960's.
A natural question to be asked at this point is, "What has caused the observed
trend growth of money?" My view is that growth of the monetary base is the
prime determinant of growth of the money stock. The major sources of growth
in the base are changes in the volume of Federal Government debt purchased
by the Federal Reserve System on the open market, and occasional changes in
the quantity or price of gold held by the Treasury. A change in the monetary
base changes the amount of reserves in the banking system, which changes the
amount of deposits created by commercial banks.
Movements in the narrowly defined money stock over extended periods of time
are closely associated with movements in the monetary base, Tiers 4 and 5 of
Chart 2 illustrate this very close relationship, while the top three tiers show
the relation between growth of the outstanding Federal Government debt and
that portion held by the Federal Reserve System.
In my opinion, the actions that led to the acceleration in growth of the monetary base and money supply since the early 1960's occurred as a result of: (1)
excessive preoccupation with the prevailing level of market interest rates;
(2) the occurrence of large deficits in the Federal Government budget; and (3)
shifting emphasis of policy actions because of an apparent short-run trade-off
between inflation and unemployment.
Some people believe that the Federal Reserve System has a high degree of
control over market interest rates. They argue that System open market purchases and sales of Government securities should be so conducted as to assure
that unduly high market interest rates do not choke-off growth of output and
employment. Throughout most of the 1960's, and to some extent in the 1970's,
the published Record of Policy Actions of the Federal Open Market Committee
indicates that the conduct of open market transactions was influenced, in considerable measure, by these two propositions. Once accelerating inflation started
in the mid-1960's, and market interest rates began to rise reflecting an inflation
premium, the System purchased Government securities in increasing quantities
in an attempt to hold interest rates at the then prevailing levels. Such purchases
resulted in rapid growth in both the monetary base and the money stock. In spite
of the efforts to maintain a prevailing level, market interest rates continued
to rise.
383
Chart 2
Influence o
Influence
off FFederal
ederal G
Government
overnment D
Debt
ebt o
on
n M
Monetary
o n e t a r y Expansion
x p a s
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IO SCALE
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1952 1953 1954 1955 1956 1937 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974
I accept neither the proposition that the Federal Reserve can control market
interest rates nor that the high market interest rates have acted to choke-off
economic expansion. Past experience, in my opinion, indicates quite conclusively
that the Federal Reserve has little ability to control the level of market interest
rates for any extended period of time. Experience also indicates, for both this
and other countries, that growth of total spending has been retarded very little
by high interest rates. On the other hand, attempts to resist upward movements
in market interest rates have resulted in faster growth of money.
384
Another concern which has been expressed about market interest rates is that
they should be controlled in order to prevent dislocations in the flows of funds to
savings institutions, the housing industry, and state and local governments. In
addition, there is a commonly-held view that small businesses, farmers, and the
average consumer should not have to pay high interest rates when they borrow.
The published policy Record indicates that the Federal Reserve responded to
such concerns at various times over the past ten years, especially following the
credit crunches of 1966 and 1969-70.
Good though the intentions may have been, I am convinced that monetary actions based on these views have been self-defeating. As explained earlier, such
attempts to maintain nominal interest rates below their free market level in a
period of inflationary upward pressure has resulted in accelerating money
growth, an acceleration in inflation, and still higher interest rates. Thus, those
presumed to be protected by such a course of monetary actions actually turn out
to be worse off—they end up with both more inflation and higher interest rates.
Another concern regarding market interest rates relates to the Federal Reserve's role in the orderly marketing of U.S. Government debt. This refers to the
so-called "even-keel" operations, which have had a long tradition in central banking. When new Government securities are issued, there is additional demand for
credit and temporary upward pressure on market interest rates normally occurs.
Since changes in interest rates traditionally have been viewed as interfering
with the orderly process of marketing new issues, fluctuations of market rates
during the financing period have been limited by purchases of securities on the
open market which, in turn, add to the monetary base.
The published Record indicates that during much of the period of accelerating
inflation System open market operations were constrained by "even-keel" considerations. Furthermore, System purchases of securities during even-keel periods
were not fully offset by subsequent sales and, as a result, money growth
accelerated.
This process, in effect, has resulted in at least partial financing of Government
deficits through the creation of money rather than borrowing from the private
sector. In many other countries the same result has occurred by the simple and
direct expedient of the Government printing the money which is then spent on
goods and services.
Since the direct method of printing money to finance Government expenditures
is prohibited in the U.S., the monetization of Government deficits has occurred
indirectly. Our deficit spending is always financed, at least initially, through
the sale of new Government securities to the public. But when the Federal Reserve System buys outstanding securities from the public, a part of the Government debt is ultimately being financed by the creation of new money. This is because the Federal Reserve System pays for the securities purchased on the open
market by creating a credit to member bank reserve accounts, which increases the
monetary base and money held by the public.
Charts 2 and 3 illustrate the results of the process described above. The increases in Government debt and the amounts of debt that have been purchased
by the public and the Federal Reserve System are shown in the first column of
Chart 3. The proportion of debt bought by the Federal Reserve has been increasing except for the 1971-72 period when substantial amounts were acquired
by
foreigners. The second column for each time period indicates that changes1 in the
monetary base have closely paralleled Federal Reserve purchases of Government
securities. It is this closeness that illustrates monetization of the Government
debt. The resulting increases in the monetary base, of course, lead to the expansion of the money stock, which is illustrated in the third column.
I doubt that monetization of debt has been a conscious act on the part of the
Government or on the part of the Federal Reserve System. Rather, I believe the
reason it has occurred lies in the relative visibility of the three methods of financing Government expenditures—taxes, borrowing from the public, and indirect
debt monetization. Elements of our society have been continually demanding
additional services from the Government, such as more defense, more social
security, more medical security, and so forth. Since these services absorb resources which are limited, someone has to give up resources from other productive uses.
When these additional services are paid for with increased taxes, the real resource cost is clearly visible to all taxpayers since they find their disposable
income reduced. When they are financed by borrowing from the public, the effect
is immediately felt by those competing for funds in capital markets and is visible
in the form of higher interest ratos. But in the case of debt monetization, the
immediate and even the short-run impact is neither an increase in taxes, nor an
385
CHART 3
Growth of Government Debt and Money
Billions of Dollars
Billions of Dollars
55
55
[
1 CHANGE IN DEBT HELD BY THE FEDERAL RESERVE SYSTEM
CHANGE IN DEBT HELD BY THE PUBLIC
CHANGE IN MONETARY BASE
x ^ x } CHANGE IN MONEY STOCK
"5
I/53-IV/56
1/57-IV/6O
r/6WV/64
I/65-IV/68
I/69-IV/72
Note: The debt held by the Federal Reserve System plus debt held by the domestic public and
foreigners is net government debt, which is equal to total gross public debt minus debt
held by Government agencies and trusts. The monetary base is net monetary liabilities of
the Government. The money stock (M]j is defined as demand deposits pius currency held
by the public. Each of the five groups of bars depict level changes from the beginning to
the end of the period indicated. All data are seasonally adjusted.
Prepared by Federal Reserve Bunk of St. louis
Increase in interest rates. And yet, real resources still are being transferred from
private to Government use. The ultimate effect of this method of financing Government expenditures is manifested in an increase in the price level—inflation—
and this occurs only after a substantial lag. It is the lack of immediate visibility
of the costs associated with this method of financing, I believe, that has contributed to the process of inflation. Once the inflation has been generated, a substantial period of time is required to reverse it, and unfortunately this can be
accomplished only by incurring costs of lost output and higher unemployment.
Thus, over short periods of time it has appeared that debt monetization gives
society something for nothing. And although this alternative may not have been
chosen consciously and the actions which monetized the debt may not have been
taken for that purpose, the excessive concern over market interest rates and the
occurrence of large Government deficits led to this course of action.
I can find no benefits accruing to the whole of society from debt monetization,
but the risks are very serious and can be expressed in one word—inflation. In
the way that I have described above, to a considerable extent since the mid-1960's
deficit spending financed indirectly by Federal Reserve purchases of securities on
the open market has meant an increase in money which has exceeded the growth
in our output potential, and therefore has been inflationary.
386
Turning to another issue, it is my belief that shifting emphasis of monetary
actions because of a presumed trade-off between inflation and unemployment has
contributed to the rapid monetary expansion. The idea of a trade-off between unemployment and inflation typically assumes that high rates of unemployment are
associated with low inflation, and low rates of unemployment are associated with
high rates of inflation. This view has led some analysts to argue that policy actions
can assist the economy in achieving an acceptable combination of unemployment
and inflation.
However, experience indicates that the unemployment-inflation trade-off, if it
exists at all, is purely a short-run phenomenon. Chart 4 demonstrates that there
exists no long-run relationship between the unemployment rate and the level of
inflation. The only striking features I find are that since 1952 the yearly average
unemployment rate has clustered around its average (4.9 percent) for the whole
period, and the rate of inflation, regardless of the level of the unemployment
rate, has moved progressively higher since the mid-1960's.
Chart A
Consumer Prices
Percent
7
Prices and Unemployment
1953-1973
(Annual Data)
AVERAC E 4 . 9 %
Consumer Prices
Percent
7
197:
19*7 0
1969*
1971 •
1968 •
1957
•197:
1967 •
1966
• 1 >58
196f
•
1956
•
1960
•
»
1963
64
19 1962*
1953*
19 61
19*59
• 195
1955
3
4
5
6
7
Unemployment Rate
Source: U.S. Department of Labor
Prepared by Federal Reserve Bank of St. Loui.;
387
In the past, emphasis of monetary policy actions has, at various times, shifted
between reducing inflation and reducing the unemployment rate. For example,
according to the published policy Record, since the early-1960's (except 1966 and
1969) a primary goal was lower unemployment, and expansionary monetary
policies were adopted to achieve it. In 1966 and 1969 emphasis was on achieving
lower rates of inflation, and restrictive monetary policies were accordingly
adopted. However, on balance the actions taken in the past decade resulted in
periods of rapid monetary growth which were longer than those of slower
growth, and the result was a rising average growth rate of the money stock.
More recently the emphasis of the adopted policies again has been to reduce inflation, but the actions taken thus far have not resulted in a reduction in the
average growth rate of the money supply.
It is my view that there will always be some normal rate of unemployment as
new workers enter the labor market, as relative demands and supplies for labor
services clrange, and as workers simply leave present jobs to find more rewarding ones elsewhere. Such a level is not necessarily desirable, but rather it is a
level determined by the normal functioning of our product and labor markets,
given existing institutional and social conditions.
Monetary actions cannot influence this normal level of unemployment; other
policies are necessary to attack that problem. As a matter of fact, monetary
actions taken in an effort to reduce unemployment have contributed to increased
inflationary pressures. Subsequent attempts to arrest inflation have temporarily
fostered increased unemployment in addition to the normal amount consistent
with existing labor market conditions.
My analysis of the unemployment-inflation trade-off leads me to conclude
that it is non-existent, except possibly for very short intervals of time. Therefore,
with relatively stable monetary growth over a long period, I believe it would be
possible to have an essentially stable average level of prices, and this could be
accomplished without accepting a permanently higher unemployment rate. The
desire to reduce the average level of unemployment should be approached through
programs which reduce or eliminate institutional rigidities and barriers to entry
in labor markets, which provide job training, and which improve information
regarding job availability.
In recent months a new proposal has been advanced which, if adopted, would
most likely lead to further acceleration in the rate of monetary expansion, thereby
adding to inflationary pressures. It has been suggested that it is appropriate
for monetary and fiscal authorities to stimulate aggregate demand during periods when domestic production is curtailed by some special event, such as the
oil boycott, or when foreign demand for a specific product, like wheat, increases
suddenly. The argument is that the resulting price pressure from such nonrecurring events is inevitable and that an expansionary aggregate demand program is required to protect employment in the case of a decrease in domestic
production, and to protect consumer buying power in the case of an increase
in foreign demand. Unfortunately, the probability of achieving either of these
goals with stimulative monetary actions is very small and the costs in terms
of accelerated inflation are certain.
The main point to keep in mind is that the forces that cause prices to rise
in a specific market are very different from those which cause inflation—a
persistent rise in the average price of all items traded in the economy. The prices
of individual items rise and fall continuously, and an increase in a particular
price, even if it is the price of an important budget item like food, is not
necessarily an indication of general inflationary pressures. In the absence of
additional monetary stimulus to aggregate demand, price increases in specific
markets are a signal that either the demand or supply conditions, or both, have
changed; not that total demand for all goods and services has increased. Such
price increases serve a very useful function of allocating scarce resources according to consumer preferences.
An increase in foreign demand for American products is not inflationary
per se. It represents a shift in the composition of demand for our output, but
not an inflationary increase in aggregate demand. Inflation would occur if
monetary actions were taken in order to accommodate the price pressure in
individual commodity markets. In the case of some unforeseen event, such as a
domestic crop failure or an embargo on imports of raw materials, the productive
capacity of the economy is reduced. Most of the time the effect is temporary,
but, as in the case of the oil embargo, the effect can be long-lasting. There is
little that an increase in aggregate demand can do to stimulate more production
in such a situation.
388
In my opinion, a monetary policy which results in an increased growth of the
money stock has no role to play in accommodating the relative price effects of
autonomous changes in demand or supply in specific markets. Such monetary
actions would only raise the overall rate of inflation. Temporary gains in output and employment might be achieved, but the ultimate effect would be only
on the rate of change of prices in general.
I now turn to my final topic—the contribution that monetary policy can make
to reducing the rate of inflation and lowering market interest rates. My views
on this topic should by now be very obvious; monetary actions can, and must,
make a positive contribution. The interests of the whole economy would be
best served if the trend growth rate of the money stock were to be gradually,
but persistently, reduced from the high rates experienced in the recent past. I
believe that, once we achieved and maintained a 2 to 3 percent rate of money
growth, both the rate of inflation and the level of interest rates would ultimately decline to their levels of the early 1960's.
I believe such a policy of gradual, rather than abrupt, reduction in the rate
of monetary expansion from the high average rate so far in the 1970's, would
not have severely adverse effects on the growth of output and employment. Such
a gradual policy would probably mean, however, that the period of combatting
inflation and high interest rates would extend through the balance of the
1970's.
Some analysts believe that if the Federal Reserve sought to control the rate of
growth of the money supply within a fairly narrow range, unacceptable short-run
fluctuations in short-term interest rates would be generated. I do not believe that
it is necessary for the Federal Reserve to intervene systematically in financial
markets in order to maintain orderly conditions.
It seems to me that there are three basic parts to this argument regarding the
desirability of actions to smooth short-run interest rate fluctuations. First, the
argument assumes that Federal Reserve actions in the past have in fact reduced
short-run fluctuations in short-term interest rates compared to what they otherwise would have been. As far as I am aware, there is no substantial body of
empirical evidence supporting this claim. There is, however, a large and growing
body of evidence suggesting that highly organized financial markets by themselves
do not generate excessive and unwarranted short-run interest rate fluctuations.
Second, this argument assumes that by stabilizing short-term rates the System
can, in the short-run, stabilize intermediate and long-term interest rates. Again,
I am not aware of any empirical evidence in support of this proposition.
Third, this position assumes that short-run fluctuations in interest rates have a
significant impact on the ultimate goals of stabilization policy—namely, price
stability, a high level of employment, and economic growth. I know of no reason
to believe that moderating short-run fluctuations in short-term interest rates has
any significant stabilizing influence on prices, output, or employment. Even within the context of the well-known econometric forecasting models, stabilization
of short-term interest rates has almost no stabilizing influence on prices, output,
or employment.
(Some would oppose my recommended course of monetary policy on the grounds
that it would not allow the Federal Reserve to perform its responsibility of a
lender of last resort; so I want to make my views clear on this point. I believe
it is possible that the failure of a major bank or other corporation can, at times,
disrupt the smooth functioning of our financial markets. In my opinion, the Federal Reserve has an obligation to prevent the temporary problems of a major
institution from affecting financial markets and perhaps even affecting the
economy.
At the same time, however, I do not think that the System should subsidize inefficient management by making funds available at interest rates well below market rates, or be concerned about the losses that stockholders of a basically unsound institution might suffer. In the long-run, such actions can only weaken,
rather than strengthen, the financial system, as well as the business community
at large.
Any temporary assistance to a basically sound institution should be unwound
in a relatively short period of time. At the same time, the provision of funds
through the Federal Reserve discount window should be matched by a sale of
securities from the System's portfolio in order to prevent an expansion in the
monetary base and the money
@FedFRASER