Full text of Review (Federal Reserve Bank of St. Louis) : December 1970

View original document

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

FEDERAL RESERVE BANK
OF ST. LOUIS
DECEMBER 1970

1970 — Economy in Transition.. ................ 2
VILLE

Observations on Stabilization
Management ...................................... 14
Federal Reserve System Actions
During 1 9 7 0 ........................................ 19
Review Index —

1970.......................... ....20

1970 —Economy in Transition
by NORMAN N. BOWSHER

slowly. Inflation has become imbedded in thinking,
expectations, policies, contracts, and regulations. This
article: 1 ) points out some of the effects of inflation;
2 ) reviews the period during the inflation build-up;
3) examines actions taken to resist inflation before
1970; 4) discusses alternative courses of monetary
action for 1970; 5) traces the monetary actions
taken; 6 ) analyzes spending, production and price
developments in 1970; and 7) presents three courses
of monetary action for 1971.

NFLATION gradually intensified in this country
from late 1964 to early 1970, and expectations of
future inflation were progressively revised upward.
The interruptions to output and the inequities caused
by redistributions of wealth and income resulting from
the inflation and inflationary expectations became a
serious domestic economic problem.
During 1970 inflation remained strong and per
vasive, but the rate of price advance began receding

Effects of Inflation
General Price Index*
Ratio S cale

Ratio Scale

1958=100
150

145

140

140
+4 3 }\3 5

135

+ 5 .3 % X

130

130
/

125

120

120
+ 3 .1 % ,

115

115
+1.7 % /
+14%

110

105

105
1stqtr.

100

4th

........

1962

1963

1964

tr.

4 th c tr.

....

1965

2 n d qtr.

t
1966

Page 2

.........

1967

* A s u se d in N a t io n a l In c o m e A c c o u n t s
P e r c e n t a g e s a r e a n n u a l rates o f c h a n g e fo r p e r io d s in d ic a t e d .
Latest d a t a plotted: 3 r d q u a r t e r

4th

1968

q f.

1 t qtr. 3 r d qtr

1969

t t

1970

So urce: U.S. De p artm en t of C o m m e rc e

100

Inflation is a rise in the average
level of prices or, stated in another
way, a decline in the purchasing
power of money.1 Because of the key
roles money and money-denominated
assets play, an unanticipated de
cline in the value of money has
many effects on production and dis
tribution. It affects holders of money
adversely, reduces the relative value
of outstanding bonds, mortgages,
savings accounts, and other dollardenominated assets, while giving
windfall gains to debtors. Those on
pensions and others having relatively
fixed incomes have less real buying
power with inflation.
XA11 price increases are not inflationary. In
a dynamic growing economy with overall
price stability, some prices rise while others
decline. Factors affecting individual prices
include advances in technology, changes
in resource availability, amounts of capi
tal invested, and changing consumer
tastes and preferences. Movements of in
dividual prices serve the very useful func
tions of equating supply and demand for
individual products and services and of
allocating the nation’s resources. Attack
ing inflation by controlling individual
prices does not get at the crux of the
problem. Such a policy usually creates
inequities and shortages and tends to stifle
growth and progress.

F E D E R A L R E S E R V E B A N K O F ST. LOUIS

DECEMBER 1970

Just as there are costs and inequities of adjusting
to a higher rate of inflation, there are costs and
inequities involved in adjusting to a rate of inflation
lower than anticipated. Contracts and other commit
ments made on the expectation of continued inflation
become more burdensome to fulfill if inflation is less
than anticipated. When excessive spending is damp
ened, many prices continue to move upward as an
adjustment to past excesses and inequities, causing
declines in production and unemployment.
The current inflation is likely to have pervasive
effects on redistributing income and wealth for a long
time. Costs of adjusting to inflation can be minimized
if the rate of inflation is stabilized for a prolonged
period. If inflation were stabilized at a zero rate, no
adjustments would be required to protect against a
changing purchasing power of money.

Accelerating Inflation
Total spending on goods and services rose at an
average 8 per cent annual rate from late 1964 to the
fall of 1969. Since there was little available excess
capacity, increases in real output were constrained by
the growth in the nation’s capacity to produce. The
rise in spending was roughly double the estimated
rate of real growth, and prices were gradually bid up
until, in 1969, overall prices rose more than 5 per cent.
The economy received many expansive shocks be
ginning in 1964. Expenditures of the Federal Govern
ment rose progressively relative to receipts until
mid-1968. Income tax rates were reduced in early
1964 to eliminate a “fiscal drag” and get the economy
moving. Reflecting the war in Vietnam, defense out
lays of the Government, which had risen at a 1.3 per
cent annual rate from 1957 to 1964 (national income
accounts basis), increased at a 14 per cent rate from
1964 to mid-1968. Growth in nondefense oudays of the
Federal Government was also stepped up from the
9.6 per cent rate from 1957 to 1964 to a 12 per cent
rate from 1964 to mid-1968.2
Studies at this Bank indicate that these fiscal actions
alone were not sufficient to accomplish the rapid
growth in total spending and the acceleration of infla
tion. Such Government actions may reallocate income
and resources and may effect the trend growth in
2A summary measure of the Government’s budgetary influ
ence on the economy is provided by the high-employment
budget (a concept which eliminates the effect of changing
levels of business activity on the budget). This measure
shifted dramatically from a $13 billion surplus in 1963 to a
$14 billion annual rate of deficit in the first half of 1968.

capacity. Initially they also have some influence on
total spending. However, the aggregate influence of
the Government budget on total spending is relatively
small if the resulting deficits or surpluses are financed
by the public out of planned saving rather than ac
companied by changes in the money stock.3
Monetary actions were also very expansive begin
ning in late 1964. By supplying more money than
the public desired to hold, given current levels of
income, wealth, and interest rates, the public’s de
mand for other financial assets and for goods and
services was stimulated. From late 1964 to early
1969 money rose at a 5.3 per cent average rate, up
from a 3 per cent rate earlier in the decade and a
2 per cent rate in the Fifties. Except for the ninemonth period of restraint from the spring of 1966 to
early 1967, monetary expansion was at a very rapid
7 per cent average rate.

Actions Taken Before 1970 to Resist Inflation
As the inflation problem built up, the Government
became concerned and took a number of actions de
signed to restrain it. Unfortunately, many of the
actions were insufficient in magnitude, were based on
3“ Monetary and Fiscal Actions: A Test of Their Relative
Importance in Economic Stabilization,” this Review (Novem
ber 1968), pp. 11-24, and “ Monetary and Fiscal Influences
on Economic Activity — The Historical Evidence,” this Re
view (November 1969), pp. 5-24.
Effects of changes in Government activities tend to be
crowded out by opposite movements in private spending
when the Government finances its deficits with increased
debt to the public. See “The Crowding Out of Private Ex
penditures by Fiscal Actions,” this Review (October 1970),
pp. 12-24.
Page 3

F E D E R A L R E S E R V E B A N K O F ST. LOUIS

poor economic analysis, or had only delayed effects.
Thus they proved to be largely ineffective before
1970. Chief actions presumed and intended to be
anti-inflationary were using moral suasion to moderate
wage and price increases, permitting higher interest
rates, regulating credit, raising tax rates, reducing the
rate of growth of Government spending, and finally,
slowing the growth in money.
Moral Suasion — Before the acceleration of inflation
began in the mid-Sixties, the President’s Council of
Economic Advisers had presented a set of guideposts
for labor and management.4 The guideposts and other
appeals to the public were not effective in holding
down wages or prices when pressures became strong.
Workers and businessmen would not forgo returns
which were available to them. Even if they had, the
economy would have become less efficient, incentives
would have been reduced, shortages would have
developed, and resources would not have been at
tracted into areas of greatest demand.
Interest Rates — Market interest rates increased
greatly from 1964 through 1969. Yields on highest-

DECEMBER 197 0

the higher rates would restrain the expansion of in
vestment and other spending while stimulating saving.
The rise in interest rates was in response to a great
demand for loan funds by both the Government and
private sectors. The private sector demand derived
from the rapid growth in total spending and anticipa
tions of inflation. With expected inflation, borrowers
were willing to pay higher rates to buy plants and
equipment because these items were likely to cost
more later.5 Rapid monetary expansion resulted, in
part, from the central bank attempting to moderate
interest rate increases in the short run. But the rapid
monetary expansion, by stimulating total spending
and thereby increasing inflation, led to still greater de
mands for credit and higher interest rates than would
have occurred without such monetary expansion.
Credit Regulation — Regulation Q was administered
on the basis of a belief that it would help limit infla
tion. This Regulation, which originated in 1935 under
quite different circumstances, was used to keep the
rates that banks were permitted to pay on time de
posits below market rates during most of 1969. As a
result time deposits in commercial banks fell 5 per
cent in the year, after rising at a 14 per cent annual
rate in 1967 and 1968. Largely as a result, total credit
extended by commercial banks rose only 3 per cent
during 1969, following an 11 per cent rate in the two
previous years.
The total supply of funds, however, was not di
minished; they flowed from supplier to ultimate
user through other channels, such as direct loans,
commercial paper, and the Eurodollar market.6 Regu
lation Q probably had little or no effect on either
total credit extended or total spending. Yet, by di
verting funds through alternative routes, inefficiencies
and inequities developed. Homebuyers, small busi
nesses, and consumers, who must rely on local finan
cial institutions to obtain credit, were at a disadvan
tage. Large businesses which could obtain funds in
central money markets received more funds and prob
ably at lower rates than in the absence of the disin
termediation. Small savers were penalized by the
low regulated rates received, while larger lenders
who have more alternatives received higher returns.

up dramatically from 4.5 per cent in the early Sixties
to nearly 8 per cent in late 1969. It was thought that
4Wages were to be raised no faster than the national trend
of productivity growth ( estimated at about 3 per cent a
year), and prices were to be established so as not to raise
profit margins.
Page 4

B“Interest flates and Price Level Changes, 1952-69,” this
Review (December 1969), pp. 18-38.
6In suspending the ceiling on 30- to 89-day large certificates
of deposit the Board of Governors noted on June 23, 1970
that an expected increase
. . in bank loans would not
constitute an increase in total credit flows, to the extent that
they simply represented a transfer of borrowings from other
financial avenues, . .
Federal Reserve Bulletin (July
1970), p. 605.

F E D E R A L R E S E R V E B A N K O F ST. LOUIS

Fiscal Actions — The Revenue and Expenditure
Control Act was signed into law on June 28, 1968.
The major features of the Act were a 10 per cent
surtax designed to reduce the amount of disposable
income and thereby slow private spending, and a re
quirement that the growth of Government spending
be restricted. Federal outlays in the national income
accounts budget rose at a 6 per cent annual rate in
the last half of 1968 and in 1969, compared with a
13 per cent trend rate from late 1964 to mid-1968.
As a result of these actions, growth in total spending
was expected to slow by some multiple, placing im
mediate downward pressure on prices.
These fiscal actions of mid-1968 did not produce
the results expected by their sponsors. Excessive
growth in total spending continued at only a slightly
reduced rate. Slower growth in spending by the Fed
eral Government was largely offset by greater outlays
of those who were able to attract the funds formerly
flowing to the Government to finance its deficits.
Monetary Actions —Growth in the nation’s money
stock was slowed markedly in early 1969 in another
attempt to reduce the inflationary surge. Following a
rapid 7.6 per cent annual rate of money growth during
1967 and 1968, growth in money slowed in the first
seven months of 1969 to a 5.1 per cent rate, and to
a 1.2 per cent rate from July to February 1970. With
the money stock growing at a slower rate than the
M oney Stock

Perce ntage ! ore annual rates of change for p erio d s indicated.
Revised series • N ovem b er 1970.

DECEMBER 197 0

demand for money, spending was expected to slow as
businesses and consumers attempted to conserve cash
balances.
As usually occurs after a change in the growth
trend of money, spending continued to be influenced
primarily by the previous trend of money growth for
about six months. Hence, spending continued to rise
excessively until the early fall of 1969, and inflationary
pressures intensified despite the monetary restraint.
Later in the year, total spending slowed, but prices
continued to rise in delayed response to the previous
excessive spending. Despite the actions taken, the
upward surge of prices continued to accelerate
through 1969.

Policy Alternatives at the Beginning of 1970
As 1970 began, the economic situation was suffering
greatiy from the fiscal and monetary actions of 1965
through 1968. The rate of overall price increase was
about 5.5 per cent a year at the end of 1969, after
accelerating for five years. Real production was not
expanding, unemployment was rising slightly, and
corporate profits were declining. Both bond and stock
prices were lower than a year earlier. On the favorable
side, the battle against inflation had begun to show
the first signs of success. The excess demand, which
was the major causal link to inflation, had been
moderated.
The crucial consideration for the nation in the com
ing year was to determine how rapidly the price
effect of the past excesses could and should be extin
guished. If restrictive monetary actions were aggres
sively pursued, the rise in total demand for goods
and services might slow rapidly, and inflationary
pressures might be extinguished sooner than other
wise. However, the transitional costs in terms of lower
production, employment, and incomes would be se
vere, and the temptation would be strong to restimulate the economy before the task was completed, as
had been done in 1967.
On the other hand, if demand grew so rapidly as
to permit growth in production, employment, and real
incomes to continue at near their long-run optimal
trends, moderation of inflation might never be
achieved. In such a case, the country would continue
for a prolonged period to suffer inefficiencies and in
equities caused by a continuous erosion of the value
of the dollar. Some middle course seemed more ad
visable than either a quick vigorous correction or the
toleration of endless, and possibly increasing, inflation.
Page 5

F E D E R A L R E S E R V E B A N K O F ST. L O U IS

DECEMBER 1 97 0

Table 1

* 'L & iiM i' *

Sim ulation o f Alternative Rates of M o n e ta ry E xp an sion A t the B e g in n in g o f 1 9 7 0 *
1969

1 97 0

III

Actual

Estimated

1971
III

III

Projections

Assum ed Rates of Change
in M o n e y Stock
0 Per Cent
A n n u al Rate of C h an ge in:
N om inal G N P

8.0

4.6

3.1

1.8

1.3

1.6

1.2

Real G N P

2.2

-0 .7

— 1.9

-3 .0

-3 .2

— 2.9

-2.9

— 2.5

— 1.9

— 1.3

G N P Price Deflator

5.4

5.2

5.1

4.9

4.7

4.6

4.3

3.8

3.2

Unemployment Rate

3.7

4.1

4.5

5.0

6.1

7.2

7.3

7.1
7.2

2.5
8.0

7.1

6.6
7.4

7.6

Corporate A a a

5.5
7.4

7.0

6.7

4.6

0.3
4.4

0.6

1.1
3.5

6.2

4.0
6.5

6.7

7.3

7.1

6.8

Rate

7.5

3 Per Cent
A n n u al Rate of C h an ge in:
Nom inal G N P

8.0

4.6

3.9

5.0

2.2
5.4

— 0.7
5.2

— 1.2

3.7
— 1.2

4.2

Real G N P

-0 .6

0.1

4.7
-0 —

5.1

4.9

4.8

4.7

Unemployment Rate

3.7

4.1

4.5

4.9

7.1

7.2

7.1

7.2

5.3
7.4

5.6

Corporate A a a Rate

5.9
7.4

G N P Price Deflator

7.5

6 Per Cent
A nnual Rate of C h an ge in:
Nom inal G N P

8.0

4.6

5.5

7.1

8.4

8.1

8.0

7.9

Real G N P

2.2

— 0.7

— 0.5

0.5

2.0

3.2

2.9

3.0

3.1
4.7

3.4
4.4

5.4

7.2

7.0

5.4

5.2

5.0

5.1

3.7

4.1

5.1
4.4

5.0

Unemployment Rate

G N P Price Deflator

4.8

5.1

5.1
5.2

Corporate A a a Rate

7.1

7.2

7.0

7.2

5.0
7.4

7.5

4.9
5.3
7.4

*The projections were based on equations estimated in December 1969, using actual data through III/1969. Money stock and high-employment Federal expenditures were estimated for IV/1969 by this Bank. Thereafter expenditures were assumed to grow at a 6 per cent
rate. Alternative assumed rates o f change in money stock began in 1/1970.

This Bank at the beginning of the year simulated
the effects on the economy of three alternative courses
of monetary action. These simulations were prepared
using the Bank’s model, and assuming Federal Gov
ernment expenditures would grow 6 per cent in the
year.7
One test assumed a slight tightening of the restric
tive monetary actions which had been followed since
mid-1969, that is, holding the money stock unchanged.
The model indicated that this would cause a signifi
cant recession in 1970 and 1971 (see table). Total
spending would rise only slightly, output would de
cline at a 2 or 3 per cent annual rate, and unemploy
ment would move up to over 6 per cent by the end
of 1970 and to about 8 per cent by the end of 1971.
Because the imbedded inflation was strong, the rate
of price increase would slow only gradually. The
model indicated that prices might still be going up
at about a 4.5 per cent rate in late 1970 and at a 2.5
7For a discussion of the model see “A Monetarist Model For
Economic Stabilization,” this Review (April 1970), pp. 7-25.
Current projections based on this model are presented in
the “ Quarterly Economic Trends” release which is available
on request from this Bank.
Page 6

per cent rate in late 1971. With the continued rapid
rate of price increase, long-term interest rates were
projected to re m a in h ig h d u rin g 1970.

A second test assumed a less restrictive 3 per cent
annual growth of money (similar to the trend since
1953). The simulation indicated that the economic
adjustment would be less severe but also less progress
against inflation could be expected. Under such a
policy, total spending was projected to rise at a 4 to
5 per cent rate during 1970 and 1971. Over the two
year span, price increases might slow to a 3.5 per cent
rate while unemployment might rise to about 6.7 per
cent of the labor force.
A third test assumed a still more expansive policy

(6 per cent annual rate of increase in money). This
indicated a more expansive economy but with only
slight downward pressure on inflation. The rise in
total spending was projected to accelerate during
1970 to about an 8 per cent rate and continue at that
rate during 1971. Production would quickly begin
expanding, reaching about a 3 per cent rate of
growth in late 1970 and a slightly higher pace a year
later. Unemployment would rise to just over 5 per

F E D E R A L R E S E R V E B A N K O F ST. LOUIS

cent in late 1970 and to about 5.5 per cent in late
1971. After two years of such a policy, the simulation
indicated the rise in prices would slow only gradually
from the 5.3 per cent rate in late 1969 to about a
5 per cent rate in late 1970 and to about a 4.5 per
cent rate in late 1971.
The choice was difficult. No policy alternative
promised a quick, painless elimination of inflation.
Fewer real goods and services would be available
because of lost production and unemployment, and
pain caused by inequities and inefficiencies of infla
tion would continue. One lesson from the experience
was obvious; more care should be taken in the future
to avoid such mistakes as those of 1965 through 1968
which generated the strong inflationary momentum.

Monetary Actions During 1970
Early in 1970 the Federal Reserve System adopted
a more expansive policy and began placing more
emphasis on monetary aggregates in policy formula
tion and implementation. Late in 1969 the System’s
Open Market Committee (the chief policymaking
group) had directed the operating manager to main
tain the prevailing firm conditions in money markets.8
This was a continuation of the policy which had re
sulted in the slow growth of the money supply be
ginning in July 1969.
At the January 1970 meeting a slight easing of
policy was adopted, and the manager was requested,
among other things, to seek a modest growth in money
and bank credit.9 At the February meeting (and
most subsequent meetings for which directives have
been made public, after about a three-month lag) the
manager was requested to seek a moderate growth in
money and bank credit.11' The word “moderate” pre
sumably implied more expansion than “modest.”
The word “moderate” in the directive was inter
preted to mean different rates of expansion from one
meeting to another. In general, policy in terms of
money was initially to seek about a 3 per cent annual
rate of increase; at the May 5 meeting, the target was
raised to 4 per cent.11 During the late Spring and
early Summer when fears of financial panic arose
with the declines in security prices, the Committee
temporarily agreed that operations should be adjusted
as necessary to moderate unusual pressures in finan
cial markets, should they develop. The money mar
8Federal Reserve Bulletin, March 1970, pp. 273 and 278.
9Federal Reserve Bulletin, April 1970, p. 339.
10Federal Reserve Bulletin, May 1970, p. 442.
n Federal Reserve Bulletin, August 1970, p. 631.

DECEMBER 197 0

ket conditions specified in the meeting of May 26
were thought to be consistent with a 7 per cent rate
of money expansion from March to June.12 At the
meeting of June 23, the Committee adopted a target
rate of about a 5 per cent growth rate in the money
supply from June to September.13 This target was
reaffirmed at meetings of July 21 and August 18 (the
last released record ).14
The directives, however, were not without ambigu
ity. Money was not the only aggregate to be con
trolled; the Manager was also directed to obtain a
moderate growth in bank credit. Because of the re
intermediation of time deposits following relaxations
of Regulation Q in January and in June and declines
in market interest rates, bank credit rose very rapidly.
It became clear that the System could not count on
obtaining the specific objectives with respect to both
money and bank credit. The primary emphasis was
placed on the money objective in the directive of
August 18. The bank credit effects of the reintermedia
tion were viewed as a substitution of bank credit for
other credit.
Even though the Committee sought a given rate
of growth in money, it was not intended that the
manager was to seek this trend rate each day, each
week, or even each month. The reason for not rigidly
applying the aggregate guide in the short run was to
avoid the gyrations in interest rates that was thought
might be produced by a strict adherence to the ag
gregates. In these shorter periods the manager was
to operate, as previously, with an eye to money
market conditions. The conditions selected were those
thought to be consistent with a growth in the ag
gregates at the desired rate over a period of about
three months. Whenever the aggregates appeared to
be deviating significantly from the desired path, the
manager was to permit changes in the money market
conditions to develop with an objective of getting the
aggregates on course. This procedure was not precise,
but largely a trial and error approach. Also, money
market conditions were not always used merely as a
means to obtain the desired growth rate in money;
at times money market conditions became an end in
themselves to be considered along with the aggregate
targets.
From December 1969 to the four weeks ending
December 4, 1970 the money stock rose at a 5.5 per
■^Federal Reserve Bulletin, September 1970, pp. 711-13.
mhid., pp. 717-19.
14Federal Reserve Bulletins, October 1970, pp. 762-3 and
November 1970, p. 820.
Page 7

F E D E R A L R E S E R V E B A N K O F ST. LOUIS

DECEMBER 197 0

Money Stock
Ratio Scale

Ratio Scale
M o n t h ly A v e r a g e s o f D a i l y F ig u r e s

230

225

220

215

215
2

210

+0.6%
+.5 1% w —

205

— /

200

195

/ s
's '

190

„

185

190
185

180

170

180

s ?
V

175
170
o;

165

210

205

200

175

3 .8

•0

O'
^

c
-s

160

165
160

1967

1968

1969

1970

P e r c e n t a g e s a r e a n n u a l ra t e s o f c h a n g e f o r p e r i o d s i n d ic a t e d .
R e v i s e d s e r ie s - N o v e m b e r 1 9 7 0 .
L a te st d a t a p lo tte d : N o v e m b e r

cent annual rate. This rate of increase was calculated
on the basis of the revised series (November 1970)
and was slightly faster than the rate calculated using
the old series. Even though money grew on average
at about the desired rate, the performance may have
been accidental. From February to the four weeks
ending June 17, a period when there was an inten
sification of money market pressures and some inter
est rates rose, money expanded at a rapid 9 per cent
annual rate. From the four weeks ending June 17 to
the four weeks ending November 25, when money
market conditions eased markedly and interest rates
fell, money rose at a 3.7 per cent rate. This was
similar to the previous pro-cyclical tendency of the
System to inject money rapidly at times of huge
credit demands (usually accompanying stronger
business conditions), and to withdraw money or in
ject it slowly at times of weak credit demands (usu
ally accompanying contractions in business activity).
The pro-cyclical tendency of System actions when
formulated in money market conditions terms was
one reason for the System to shift to monetary aggre
gates in the formulation and implementation of
monetary policy.
Studies at this bank indicate that temporary varia
tions from trend, of the magnitude and duration of
those experienced during 1970, have no significant
effect on total spending, prices, production, or em
ployment. If the deviations were larger or were al
lowed to persist longer, they would have undesirable
results.
Page 8

Money rose roughly 5 per cent in 1970, based on
quarterly averages of daily figures, increasing at an
nual rates of 4 per cent from the fourth quarter of
1969 to the first quarter of 1970, 7.2 per cent from
the first to the second quarter, 5.3 per cent from the
second to the third, and an estimated 4 per cent
from the third to the fourth. During the Fifties and
early Sixties, a 5 per cent growth of money was
extraordinarily high and, if long maintained, tended
to cause accelerating inflation. With the strongly im
bedded inflation in 1970, however, spending could be
permitted to expand faster than the growth of produc
tive capacity and still place some downward pressure
on prices. By permitting a growth in spending at a
rate faster than in previous attacks on inflation, costs
in terms of lost production and unemployment may
be expected to be kept at relatively low levels.
Short-term interest rates declined sharply during
1970. There was a slowing in the demand for funds,
reflecting a moderated growth in spending following
from the monetary restraint of 1969. Also, there were
increasing supplies of short-term funds resulting from
the more rapid injection of money during 1970 and
from the temporary use of proceeds of long-term
financing. Yields on prime 4- to 6-month commercial
paper averaged 5% per cent in early December, down
from 9 per cent in early January. The three-month
Treasury bill rate was below 5 per cent in early
December, compared with nearly 8 per cent at the
beginning of the year. Reflecting the same forces, the
rate charged prime business customers by commer
cial banks was lowered from 8V2 per cent early in
the year to 8 per cent in March, to 7% per cent in
September and to 7 per cent in November. The dis
count rate (the interest rate charged member banks
by Reserve Banks) was out of touch with market
rates early in the year, but as market rates declined
markedly, the discount rate was reduced from 6 per
cent to 5% per cent in November and early December
to keep it in line with other rates.
Long-term interest rates remained relatively high
during 1970; mortgage rates changed little on bal
ance while yields on municipal and Government secu
rities declined from peak levels. Yields on highestgrade seasoned corporate bonds averaged about 7.8
per cent in early December, about the same as a
year earlier. The continued high rates, despite some
slowing in the growth of spending and presumably in
overall credit demands, reflected in considerable
measure the strongly imbedded inflationary expecta
tions. With great inflationary expectations, incentives

F E D E R A L R E S E R V E B A N K O F ST. LO U IS

to borrow long are increased while incentives to lend
at long term are reduced. Demands for long-term
funds may also have been bolstered by an attempt to
improve liquidity.

Economic Developments in 1970
Total spending on goods and services rose at a 4.6
per cent annual rate during the four quarters ending
with the third quarter of 1970, despite some large
cutbacks in production of war goods. This was ap
proximately the growth in spending the St. Louis
model had simulated given the monetary expansion
which occurred. In the fourth quarter spending was
interrupted by the major automobile strike, but much
of the loss is expected to be made up within a few
months after resumption of full production. By com
parison spending rose at an excessive 8 per cent
average rate from late 1964 to late 1969.

D em and an d Production
R a tio S c a le
T rillio n s o f

Quarterly Totals at A n n u a l Rotes
S e a so n a lly Adjusted

R a tio S c a le
T rillio n s o f D o lla r s

DECEMBER 197 0

and in the fall of the year signs became widespread
that inflation was receding moderately. Prices of the
sensitive thirteen raw industrial commodities have
declined since early 1970. Overall prices rose at a 4.4
per cent annual rate from die first to third quarter
and probably continued to rise at approximately that
pace in the fourth quarter. By comparison, these
prices went up at a 5.3 per cent rate from late 1968
to early 1970. Consumer prices have risen at a 5 per
cent rate since April, after increasing 6 per cent in
the previous twelve months.
Hourly earnings in manufacturing, adjusted to ex
clude effects of overtime and interindustry shifts,
have risen 6.6 per cent in the last twelve months.
Adjusted for price increases, these earnings have in
creased about 1 per cent. When the value of fringe
benefits is added, real earnings have probably in
creased more than estimated output per man hour.
Nevertheless, these figures raise some doubt about
the belief that the recent inflation has been the result
primarily of a wage-push situation.
With prices rising about as fast as total spending,
production was changed little on balance during the
first three quarters of 1970. There was a small net
decline in the first quarter largely offset by slight
rises in the second and third quarters. Production
probably fell again in the final quarter of the year,
but this was mainly the result of the automobile strike
and probably did not reflect cyclical influences.

Real Produ ct 2

Q G N P in current dollars
1 2 G N P in 1958 dollars.
Perce ntage s are an nu a l ri

S ou rce: U.S. Department of Com merce
is of change for p erio d s indicated.

Latest d a ta plotted: 3rd quarter

During 1970 the labor force grew, capital was in
vested, and there were advances in technology. As
a result, productive capacity was rising while total
output changed little on balance. Accordingly, re
sources not utilized or underutilized increased. Com
petition from these resources was the main force
which tended to reduce the upward momentum of
prices.

Government spending rose more rapidly than pri
vate spending in 1970. Federal Government expendi
tures rose at a 7.4 per cent annual rate in the first
three quarters of the year, state and local government
outlays expanded at an 11.1 per cent rate, and private
spending increased at a 4.4 per cent rate. Defense
outlays were reduced at a 5 per cent rate, while
spending on all other programs of the Federal Gov
ernment rose at a rapid 16 per cent rate.

One indication of the utilization of capacity is pro
vided by the employment rate. Employment declined
from 95.8 per cent of the labor force in the first
quarter of 1970 to about 94.5 per cent in the early
Fall. Later in the year employment drifted a little
lower in response to the interruption caused by the
auto strike. In terms of married men, employment
declined from 98 per cent early in the year to 97.1
per cent in the Fall.

Prices continued to rise in 1970 as a result of pre
vious expansionary fiscal and monetary actions and
consequent excessive total spending. However the ac
celeration of price increases was stopped early in 1970,

All unemployment does not represent excess capac
ity. Workers leave jobs in search of better opportuni
ties; some activities are seasonal; some people have
but marginal production capacity; and some become

Page 9

F E D E R A L R E S E R V E B A N K O F ST. LO U IS

DECEMBER 1 97 0

Unemployment Rates

Sources: U.S. Deportment ot Labor ond U.S. Department of Commerce

unemployed temporarily when bus
inesses are forced to cut back or
close because they are no longer
competitive. Comparisons with pre
vious periods may be helpful in
evaluating the present unemploy
ment rates. The recent 5.8 per cent
rate of unemployment (including
strike effects) compares with a 5.2
per cent rate in 1964, the last year
of pronounced economic expansion
without accelerating inflation. In
1962 and 1963 unemployment re
mained in the 5% to 6 per cent

Page 10

range. In the economic expansion
between the 1958 and 1960 reces
sions, unemployment reached a
low of 5 per cent. In 1958 and again
in 1960 when downward pressure
was applied to inflationary pres
sures, unemployment rose tempo
rarily to 7 per cent and above. When
unemployment remained below a
5 per cent rate in 1965 through 1969,
inflationary pressures intensified.
Given minimum wage laws and
other features of American labor
markets, it may be that 5 per cent
rather than 4 per cent or less unem
ployment is about the practical
non-inflationary minimum. Attempts
to maintain the unemployment rate
at some artificially low level may
succeed temporarily but ultimately
will only assure accelerating inflation.

Average Duration of Unemployment *

• Duration ot unemployment represents the overage length ol time lorithmetic meon| during which those classified os unemployed have been continuously looking tor work
Latest data planed: November
Source: U.S. Department ot lobor

Total Civilian Employment
P e r C e n t o f T o ta l P o p u la t io n o f W o r k i n g F o r c e A g e (16 -6 4)

F E D E R A L R E S E R V E B A N K O F ST. LOUIS

Another measure of the utilization of labor is the
number of people actually working relative to the
civilian population of working force age. The Novem
ber level of 63.7 per cent is down from the peak,
but still higher than anytime in the Fifities or Sixties
before late 1966. Another indication of the magnitude
of the employment situation is the duration of un
employment. This past fall the average length of
unemployment was about 9 weeks, up from about 8
weeks in 1969, but still substantially below the 12
weeks or longer from 1958 to early 1965.
Corporate profits, after taxes, declined from a peak
of $49.7 billion in the second quarter of 1969 to $45.4
billion in the third quarter of 1970. Since the inflation
began increasing in 1965, corporate profits have de
clined from 6.8 per cent of gross national product to
4.6 per cent.

Policy Choices for 1971
As the new year begins, the critical question still
remains, “How rapidly should the nation proceed in
reducing inflation?” Prices are rising more slowly
now than a year ago, and some further downward
pressure has been accumulated that may be expected
to reduce the inflation further in 1971. Even so, prices
are likely to continue rising at a rather fast pace. At
the same time, production is below capacity, some
are unemployed, and the economy is sluggish.
The choice for the nation, as a year ago, is one
of the lesser of evils. It serves no purpose to pretend
there is an easy, costless, quick cure to inflation. The
adverse consequences of the mistakes of 1965-68 con
tinue to bear heavily on the nation. To focus solely
on either the inflation or the capacity utilization prob
lem is apt to intensify the pain and suffering from
the other. Some compromise has to be made. This
Bank has again made simulations of prospective eco
nomic conditions, assuming various courses of mone
tary action. For the model simulations, Federal
Government expenditures through second quarter of
1971 have been estimated by this Bank and have
been projected thereafter to grow at an 8 per cent
annual rate. The calculated figures were smoothed
judgementally in the lower half of the table on page
12 to remove irregular fluctuations.
One course of action which might be followed
would be to continue to seek a 5 per cent growth
rate of money, the rate planned in the last-released
record of policy actions. With such a growth of money,
total spending growth might accelerate from the 4.5

DECEMBER 1 9 7 0

per cent rate of the past year to about a 6.5 per cent
rate in late 1971. If such a growth of money were
maintained, spending might be expected to continue
to grow at about the 6.5 per cent rate in the first half
of 1972. Real output, which declined slightly in the
past year, would probably be growing at about a
2.5 per cent rate a year from now. These simulations
are designed only to project most probable cyclical
and trend influences of money and the Federal budget
on the economy. They do not purport to project
erratic short-term developments, such as a bulge in
spending and production after the auto strike and
any dip in case of a steel strike.
The model indicates that with the 5 per cent growth
of money, inflation would most likely still remain
strong at the end of next year, with overall prices
rising at about a 4 per cent annual rate. Recently,
prices have been rising at about a 4.5 per cent pace.
Unemployment would most likely move up from the
recent 5.5 per cent of the labor force (excluding
strike effects) to around a 6 per cent level.
If the nation desired a quicker approach to reduc
ing inflation, a 2 per cent growth rate of money
might be undertaken. The simulation indicates that
spending under this policy might be down to about
a 3.7 per cent growth rate a year from now. In
flation would be reduced slightly faster than with
the 5 per cent rate of growth of money, dropping to
about a 3.5 per cent rate a year from now and to
about a 2.8 per cent rate by mid-1972. Production,
however, would be very sluggish, and unemployment
might rise to about 6.5 per cent of the labor force in
late 1971 and to over 7 per cent by mid-1972. With
unemployment at such a level, the temptation to
restimulate the economy would become great re
gardless of inflationary consequences.
If it is desired to attempt to hold the adjustment
costs in terms of lost production as low as possible
in 1971 and early 1972 while placing some down
ward pressure on prices, a faster 8 per cent rate of
money growth might be selected. In this case, model
simulations indicate that spending might rise to about
a 9.5 per cent growth rate in the Fall of next year and
remain at that pace in the first half of 1972. Produc
tion would be rising at faster than an assumed 4 per
cent long-term trend in late 1971 and in early 1972,
and unemployment would probably not reach 6 per
cent and would be declining in late 1971 and in early
1972. Prices, however, would continue to rise for a
long, long time, since the rate of increase would be
inching down very slowly. The total cost in lost proPage 11

DECEMBER 1970

F E D E R A L R E S E R V E B A N K O F ST. LOUIS

Table II

Current Projections, o f Total Spending, , Rea! Product, Prices, Unem ploym ent, an d

III

IV_

Actual

Estimated

1972

1971

1970

Assum ed Rates of C hange
in M o n e y Stock

Interest Rates*

G EN ER A T ED

III

2 .7 %

3 .5 %

Projection s

DIRECTLY BY THE ST. L O U IS M O D E L

2 Per Cent
A n n u a l Rate of C h an ge in:
N om inal G N P

6 .1 %

6.3 %

5.5 %

4 .3 %

6 .2 %

Real G N P

1.4

1.6

1.0

0.1

2.1

— 0.6

3 .1 %

-0 .6

0.6

G N P Price Deflator

4.6

4.5

4.2

4.0

3.7

3.3

2.9

Unemployment Rate

5.2

5.4

5.6

5.9

6.2

6.3

6.7

7.0

Corporate A a a Rate

8.2

7.9

8.0

7.9

7.7

7.5

7.3

Nom inal G N P

6.1

6.3

6.1

9.0

6.4

5.8

6.5

Real G N P
G N P Price Deflator

1.4

1.6

1.7

2.3

2.0

3.0

4.6

4.5

4.3

4.7
4.2

4.0

3.8

3.5

Unemployment Rate

5.2

5.4

5.6

5.8

6.0

6.1

6.3

Corporate A a a Rate

8.2

7.9

7.7

7.6

7.4

N om inal G N P

6.1

6.3

6.8

7.8

11.9

9.6

8.9

9.6

Real G N P
G N P Price Deflator

1.4

1.6

2.2

3.4

7.3

5.2

4.6

4.6
5.4

4.5

4.4

4.3

4.2

5.3
4.1

Unemployment Rate

4.6
5.2

5.6

5.7

5.8

5.6

5.5

Corporate A a a Rate

8.2

7.9

7.7

7.8

7.7

7.6

7.5

5 Per Cent
A n n u al Rate of C h an ge in:

8 Per Cent
A n n u a l Rate of C h an ge in:

S M O O T H E D T O R E M O V E IRREGULAR F LU C T U A T IO N S

2 Per Cent
A n n u al Rate of C h an ge in:
5 .6 %

6.0 %

5 .7 %

4 .8 %

4.1 %

3 .6 %

3.5 %

Real G N P
G N P Price Deflator
Unemployment Rate

0.9

1.4

1.2

0.6

0.1

— 0—

0.3

0.7

4.7
5.2

4.6
5.4

3.3

2.8
7.0

Corporate A a a Rate

8.2

Nom inal G N P
Real G N P
G N P Price Deflator

Nom inal G N P

3.7 %

4.5

4.2

4.0

5.9

6.2

3.7
6.3

7.9

5.6
8.0

8.0

7.9

7.7

6.7
7.5

5.6

6.0

6.3

6.4

6.5

0.9

1.4

1.8

2.1

2.3

2.5

2.7

3.0

4.7

4.6

4.5

4.3

4.2

4.0

3.8

3.5

5.2

5.4

5.6

5.8

5.9

6.0

6.1

6.2

7.9

7.8

7.7

7.6

7.4

7.3

5 Per Cent
A nn u al Rate of C han ge in:

Unemployment Rate

8.2

7.9

Nom inal G N P

5.6

6.0

7.2

8.5

9.5

9.6

Real G N P
G N P Price Deflator

0.9

1.4

2.7

4.1

5.2

5.3

5.5

4.7

4.6

4.5

4.4

4.3

4.2

4.1

Unemployment Rate

5.2

5.4

5.6

5.7

5.8

5.6

5.5

5.4

Corporate A a a Rate

8.2

7.9

7.7

7.8

7.7

7.6

7.5

Corporate A a a Rate
8 Per Cent
A n n u al Rate of C h an ge in:

actual data through III/1970. Money
♦The projections are based oi[1 Miuuiaitions as described in the April 19 7() issue of thi:3 Review using 71.
High-employment Federal Governn
f n /Ci lK
r If O
am
p t ii u
t i imi ds ii hpd
0CU hv
Uj tl’
u 11s B an k; alteruative assumed rate;s of change 1>egin with 1/19
S tO
r IT VV / /1
i yQ( 7UA la w
tures
are
assumed
to grow at an 8 per cent rate.
ment expenditures are estinrlated thr ough 11/1971 by 1;his Bank. There‘after, expendi

Page 12

F E D E R A L R E S E R V E B A N K O F ST. LO U IS

DECEMBER 197 0

duction might be as great or greater under this course,
if price stability is ever to be achieved, as it would be
under a more aggressive approach, since actions to
dampen inflation would have to be continued much
longer.

illusion, lack of knowledge of costs, public opinion
and Government regulation. As these wages and prices
now move toward equilibrium levels, the increased
production costs place upward pressure on other
prices.

Conclusions

Some believe that prices and wages could be held
stable with much less cost by merely “controlling”
them. It seems so simple to just have the Government
outlaw inflation. Suggestions have taken a variety of
forms from a broadscale rigid control of all prices,
with severe penalties for violations, to a temporary
freeze, to a control of certain key prices, and even to
using persuasive tactics called “jawboning.” Yet, past
attempts to control prices both here and abroad in
dicate that such controls have been largely ineffective.
Controls are frequently circumverted through blackmarkets, quality deterioration, clever pricing, or other
devices. Controls are costly to adminster, impinge on
freedom, create shortages (usually requiring ration
ing), misallocate resources, and frequently slow the
rate of economic growth.

Inflation in recent years has been one of the
nation’s most serious domestic economic problems. It
causes inequities and inefficiencies, and prejudices
the future viability of the economic system. The
process of its elimination is inevitably causing an
underutilization of labor and other resources. The
first effective steps in eliminating the inflationary mis
takes of 1965-68 were taken by the monetary authori
ties in 1969, yet price increases continued unabated
throughout that year. Monetary actions were relaxed
in early 1970 but have continued to be anti-inflationary. During 1970 the rate of inflation began ebbing,
with overall prices rising at an estimated 4.5 per cent
rate now, compared with a 5.5 per cent rate a year
ago.
The transition to a lower rate of inflation has been
painful for many. Real product has increased little, if
at all, and contracts based on expected continued
rapid inflation are costiy to fulfill. Yet, given the
strongly imbedded inflation, the costs of reducing it
have not been so great as one might have anticipated
from previous attempts at arresting inflation in this
country. Studies at this Bank indicate that the cut
backs in production and employment in the 1969-70
battle against inflation were smaller because the na
tion’s money stock was not permitted to decline, as
it did in previous periods of correction. Since early
1969 money has expanded at an average 4 per cent
annual rate.
Simulations using the Bank’s model indicate that if
money continues to rise moderately, further progress
will be made in 1971 in reducing the pace of price
increases. However, the battle will not be won easily
and without cost. Expectations of rising prices are
still strong. Some prices, such as those in term con
tracts and union wages, were relatively inflexible
during the excessive spending of the late 1960’s. Other
prices were temporarily held back by inertia, a money

A contribution can be made to a more rapid solu
tion of the problems of inflation and underutilization
of capacity by improving the market system. Such ac
tions might include reducing subsidies, tariffs and
import quotas, widening the scope of the anti-trust
laws to cover more monopolistic practices, increas
ing the skills of workers, eliminating outdated build
ing codes and other barriers to greater productivity,
and modifying the minimum wage laws in the inter
est of improving job opportunities for teenagers and
the handicapped.
Progress h a s been made on the inflation problem.
Costs have occurred in reducing it, but so far they
have been less than in any previous attempt. Con
tinued perseverance along the general course charted
in the past two years would seem to be appropriate
in 1971. As long as total spending continues to grow
at a moderated rate, both the inflation and the capac
ity utilization problems will be gradually solved as
the effects of past maladjustments atrophy. Experi
ence demonstrates that Government actions designed
to shock the economy into a quicker adjustment
have usually had net adverse consequences.

Page 13

Observations on Stabilization Management
A Speech by HOMER JONES, Senior Vice President,
Federal Reserve Rank of St. Louis, to the Joint Luncheon,
Southern Economic Association and Southern Finance
Association, Atlanta, Georgia, November 13, 1970

JL HERE IS a prevalent idea that dynamic govern
ment action is necessary to effectively restrain prices
and promote employment. This has been the pre
vailing view during the past twenty-five years.
I wish to pose two questions: First, is there evidence
that active stabilization management has, on the
whole, been desirably effective in the last twentyfive years? Second, does that quarter century of ex
perience suggest that active stabilization manage
ment can be desirably effective in the future?
We may list five classes of stabilization tools which
are most commonly considered as means of achieving
more stable high-level non-inflationary growth,
namely, fiscal, monetary, investment funds flow con
trol, changes of economic structure, and price and
wage controls. I would like to look at each of these
tools in turn.

Fiscal Management
Let us first look at fiscal management. In undertak
ing to judge the record of fiscal management, we are
faced with a problem of measurement. There are a
variety of possible measures of fiscal action: among
these are Federal Government expenditures, high-employment tax receipts, national income accounts tax
receipts, high-employment surplus or deficit, and
national income accounts surplus or deficit. Scholars
are far from agreement as to which of these measures
best indicates the influence of fiscal management on
total demand, or how they could be amalgamated as
a single indicator of fiscal influence. In view of such a
confused situation regarding the measurement of fis
cal management, it is no wonder that fiscal manage
Page 14

ment has been less than successful in the past twentyfive years.
In any case, no matter how one measures fiscal
management, I find no evidence that these magni
tudes have followed courses which, in any plausible
way, have been related to a desirable course for total
spending, for real product, or for prices. In my read
ing of economic history, I do not find a consistent and
predictable relation convincingly demonstrated be
tween any fiscal measure and economic activity. In
deed, I would suggest it is more likely that the fiscal
management which we have had has contributed to
instability and to limitations on average growth, either
directly or indirectly, through its influence on mone
tary management.
Let me turn to the question of what we now know
about whether fiscal management may in the future
be able to contribute to stabilization, high employ
ment and growth. That fiscal variations have not on
the whole contributed to a successful course of the
economy in the past does not necessarily mean that
they have not had an effect, or that they could not
conceivably have a desirable effect in the future.
Whether fiscal manipulation might be capable of
promoting desired economic ends in the future de
pends on two considerations, the economic and the
political. With respect to the economic, we have not
been lacking in theories about fiscal influence during
the past forty years. Where we stand now about the
theories, I shall not attempt to comment. But I shall
comment on what research seems to show about a re
lation of fiscal developments to economic activity. My
chief point is that research has not found consistent

F E D E R A L R E S E R V E B A N K O F ST. LOUIS

relations, independent of monetary action, between
any of the standard measures of fiscal action and
simultaneous or subsequent changes in aggregate eco
nomic events. The large models which have dealt
with this matter have not successfully disentangled
the influence of fiscal from the influence of monetary
factors. Casual empiricism of observing the course of
fiscal management, together with total spending, real
production, and prices, does not yield positive con
clusions. Our econometric studies at the St. Louis Fed
eral Reserve Bank have not yielded positive relations
between high-employment taxes or the high-employment surplus-deficit, when the monetary fac
tors have been held constant. These studies have
yielded some positive results with respect to the in
fluence of Federal expenditures, but they are not very
impressive.
Some observers may not be impressed with our re
sults. In response, I can only say that we await either
suggestions as to how we can make better tests, or
the results of the work of others which find, from
experience, plausible useful independent relations
between fiscal a c t i o n s and crucial economic
developments.
But, if we were to find significant and stable rela
tions between fiscal actions and economic develop
ments, could we put them to practical use? Success
ful application of the knowledge would depend
upon useful forecasting of other economic variables
which would need to be offset or supplemented.
Given the general record, I think we cannot be op
timistic about the imminent practicality of such
forecasting.
Finally, experience with respect to the political
implementation of fiscal management is not impres
sive. I am not sure that the political problem has
made past experience any more adverse than it other
wise would have been; but even if economists did
know how to actually manage a budget beneficially,
the application might very likely be adverse after
political manhandling. It may be that the less it is
suggested that the budget is something to be manipu
lated, the less likely politically we are to get adverse
budget results.

Monetary Management
Let me now turn to our monetary experience. On
the whole, it is similar to the fiscal. As in the case of
fiscal management, we are plagued by lack of agree
ment as to proper magnitudes of measurement. But

DECEMBER 197 0

using any of the common measures, examination of
the experience of the past twenty-five, fifteen, or ten
years, does not indicate that active monetary man
agement has in fact contributed beneficially to sta
bility and optimum levels of employment, prices,
and growth. Here again it seems possible that fluctua
tions in strategic monetary variables may have con
tributed more to failure to achieve these objectives.
But, even though active monetary management may
not in actuality have contributed desirably, experi
ence suggests that monetary developments have had
reasonably predictable effects on total spending, real
product, employment and prices. Casual empiricism,
the research of others which is persuasive to me, and
our own econometric studies at St. Louis, have long
indicated strong, roughly predictable, relations be
tween monetary action, intentional or unintentional,
and the course of the economy. Here, as with our own
studies of fiscal management, I realize that many
students of these matters may not be fully impressed,
if at all. But, here again, we are open to suggestions
as to better means of studying past relations between
monetary actions and total spending, real product
and prices.
Assuming that we have found relations between
monetary actions and the course of strategic economic
variables, does this mean that we can expect to en
gage usefully in active monetary management in the
future? Here again, we may question whether active
monetary manipulation, any more than fiscal, can be
expected to eliminate short-run fluctuations as en
visaged by the proponents of fine tuning. Because of
lags in the effect of monetary actions, we would have
to forecast successfully, many months in advance,
the course of other factors to be offset or supple
mented, and the forecasting record is very poor. And,
while I believe that we have positive results regard
ing monetary effects, we cannot claim that the tim
ing of results is a very exact matter. I therefore con
clude that we cannot in the near future engage
intelligently in short-run manipulative monetary
management.

Other Stabilization Tools
I now turn briefly to three other social controls
which are frequendy offered as stabilization tools,
though sometimes only as supplements to general
fiscal and monetary controls: namely, administrative
allocations of the flow of investment funds; structural
changes in economic institutions, such as changes in
the labor market; and wage and price controls.
Page 15

F E D E R A L R E S E R V E B A N K O F ST. LOUIS

Proposed and actual investment fund allocation
management really has nothing to do with stabiliza
tion management, but rather with providing a general
alternative or supplement to allocation by means of
market forces. It is frequently said that tight money
squeezes especially and unjustly particular fields of
real investment. This matter has entered into ration
alizations of Regulation Q management. Actually,
adverse effects on certain sectors, such as housing,
arise not from tight money policy but from great
monetary expansion as in the 1965-68 period. A
steadier monetary expansion, which would probably
be desirable on all counts, would remove much of
the alleged need for administrative allocation of in
vestment funds. But if there were still a call for alloca
tion different from that provided by the market, this
would have nothing to do with stabilization manage
ment but with continuous noncyclical economic
policy.
With respect to structural changes such as reducing
unemployment through improvements in the labor
market, these stand on their own merits and have
nothing to do with cyclical stabilization policy.
With respect to labor power and corporation power,
and their contributions to inflation, I am inclined to
say that possible improvements here have little to do
with cyclical stabilization. But I suppose there are
two ways in which wage-price controls or guidelines
may be brought in. First, proponents suggest that
wage-price controls are an instrument that should al
ways be available and would come into play in the
boom phase of a cycle and then could be held in
abeyance at other times. A second, closely related,
suggestion is that wage and price controls will be
used continually. In this latter instance fiscal and mone
tary policy would foster a total demand so high that
production, employment, and growth would be
maximized while demand would not be dissipated in
higher prices.
Experience with wage-price guidelines has not
been propitious. The guidelines were instituted at a
time when we were not having an inflation problem
in 1962-64. Then, as they obviously failed in 1965 and
1966, they were quietly dropped. Now, in a time of
recession (I do not consider this an evil word, or that
it is evil for anything ever to recede, ever so slightly),
those who inaugurated the guidelines in recession and
abandoned them in inflationary boom propose their
reinauguration as a price panacea. It would appear
that wage-price controls, rather than being an instru
ment to be always in effective operation or to be
Page 16

DECEMBER 197 0

used in boom and laid aside otherwise, are instead to
be abandoned during inflationary boom and at all
other times to be actively used. On the contrary, I
believe, as Paul Samuelson has recently written, “No
mixed economy has been able yet to find a satisfac
tory incomes policy.” (New York Times, October 30.)
I personally conclude that experience shows wageprice controls have no semblance of beneficial prac
ticality in any economy which retains any pretence
of market determination of the allocation of resources.
And we have no evidence that a chronic policy,
pressing up inordinately on total spending, will give
a higher or steadier employment or production than
otherwise, without chronically accelerating inflation.
The apparently widespread popular call for adminis
tered prices and wages indicates that we have done
a poor job teaching economic history and of teaching
the role of prices in allocating resources and product.

Historical Background
It may be useful to try to reconstruct why and how
we developed the dogma that active fiscal manage
ment was necessary and practical to avoid stagnation
at and about a low level of activity. I suggest that out
of desperation in the 1930’s we had to find something
that we could do. The desperate and largely wrong
panaceas of the Keynes of 1936 resulted because the
prescriptions of the Keynes of thirteen years earlier
were ignored.
Possibly we now have again an opportunity to profit
from the Keynes of the Tract on Monetary Reform of
1923. Then, Keynes was fighting to achieve monetary
management for sound domestic economic stability,
freed from the shackles of fixed exchange rates. But
Keynes lost, and so occurred one of the great tragedies
of modem economic and political history. England
returned to the shibboleth of the fixed exchange rate,
and this, in turn, led to the suicidal world monetary
policies of 1925-33. Then, in desperation, were created
all the elaborate theories that fiscal management
could substantially solve the problems of economic
instability, and along with this the theory that in the
absence of finely-tuned fiscal policy an economy might
most likely stabilize at or fluctuate far below optimum
employment and production.
Now we should put ourselves back with the Keynes
of 1923. We should abandon the chimera that it is
either necessary or practical to actively manage a
fiscal policy in the interest of stable high-level eco
nomic activity. Our experience indicates that, even
as in 1923, the main key to a satisfactory operation of

F E D E R A L R E S E R V E B A N K O F ST. LOUIS

the economic system is not to permit a fixed exchange
rate system to dictate disastrous monetary contrac
tion, as in 1925-33. The other side of the coin is that,
given this freedom, we should equally avoid inor
dinate monetary expansion.
It may be instructive to consider how much happier
we might have been in the last forty years if Keynes
had been successful in 1923-25 —if Britain had not
hung about her neck the albatross of a $4.87 pound,
and the other leading nations of the world had not
subsequently been preoccupied with defending their
currencies. We would have had a good chance of
avoiding 1929-33 and all the troubles which that pe
riod brought in train economically, politically, and
militarily.
If we have had reasonably good economic perform
ance during the past twenty-five years in this coun
try, and in most other countries, we cannot ascribe it
to the success of active manipulation of fiscal and
monetary management. Rather, it is due to the in
herent strength of what are still, on the whole, free
market economies. It has depended upon avoiding,
on the whole, shocking monetary and fiscal misman
agement such as in England in 1925, and in the United
States in 1929-33 and 1936-37.
Having said so many negative things, let me make a
few positive remarks. In the field of fiscal manage
ment we should avoid gyrations of the high-employment surplus or deficit. For purposes of promoting
national saving, investment and growth, I would pre
fer a substantial high-employment surplus. But this
is less crucial than budget stability. Similarly, in the
monetary field, the most important objective for pol
icy is to avoid gyrations. Until we can get better in
formation upon which to base our actions, I believe
a steady growth of money gives a better chance of
getting a steady growth of total spending, real pro
duct and employment, and a tolerable price trend
than does any other procedure. In such a fiscal and
monetary setting, the market economy has a better
chance of following the high stable growth trend
which we desire than does any alternative procedure
apparent to us at present. But this is not easy. We
know from experience that avoiding unintended gyra
tions in strategic fiscal and monetary variables re
quires eternal vigilance.

Conclusions
In conclusion, I have two points, one concerning
what economists should be teaching, and the other
dealing with the problem of current policy.

DECEMBER 1 9 7 0

Economists have spent a generation teaching that
there are some magic tools of fiscal policy, and more
recently of monetary policy, which, if managed ac
cording to some scientific principles, supposed to be
well known to the experts, can be used and must be
used incessantly and with finesse to give us satisfac
tory operation of the economy. Will the profession
now have enough fortitude to face and teach the
facts? We should now, while saving as much face as
possible, tell the public that we do not know how to
finely manage the economy, and that, the way the
fiscal and monetary tools have been used in the last
twenty-five years, manipulation has probably done
more harm than good. We should inform the public
that the best we can do — and it will be a major im
provement —is, on the one hand, to avoid mistakes
such as the monetary and fiscal excesses of 1965-68
and, on the other hand, to avoid letting monetary
expansion be led around by fixed exchange rates and
by money market conditions.
Finally, where are we just now and what course
shall we follow? Despite my negative remarks about
active, positive fiscal and monetary management, bad
management can give us massive trend disturbances,
as did the monetary collapse of 1929-33, the war in
flations, and the inflation of 1965-69.
Such massive disturbances, which could and should
have been avoided, not only have their immediate
social evils, but they create the problem of what, if
anything, fiscal or monetary management can do to
restore stability. It is this last problem we have now
been struggling with for the past two years.
Let me emphasize that our present not too happy
situation derives from gross fiscal and monetary mis
management in 1965-68, when with shocking sudden
ness, we accelerated Federal expenditures, turned a
high-employment surplus into a great deficit, and
accelerated monetary expansion. Having made these
grave errors, which brought inflation and expecta
tions of inflation, what to do has been a great
problem.
It is sometimes said that we are experiencing the
worst of all possible worlds — we continue to have
inflation and real product is not growing. But I be
lieve that this situation is the inevitable result of the
best possible choice among the three alternatives
which were available to us. First, we could have fos
tered a total spending which would have temporarily
better maintained production and employment, but
which would have provided accelerating inflation.
Page 17

FEDERAL. R E S E R V E B A N K O F ST. LOUIS

Second, we could have achieved a faster reduction
of inflation, but that would have involved less real
product and more unemployment than we have
achieved. Third, we could choose a course between
these alternatives, and this we have done.
The course we chose has meant, is meaning, and,
if pursued, will continue to mean, only slowly de
clining inflation, retarded growth of real product, and
rising unemployment. If we had not made the gross
errors of 1965-68, we would not subsequendy have
had the painful choice between accelerating infla
tion and the restricted production and employment
which we are now experiencing.
Given our decisions and our present situation, we
can now expect that, if we avoid erratic fiscal and
monetary action, real product and employment
growth will accelerate gradually over the next few
years, and the upward trend of prices will end or
become nominal. In time we can obviate the results
of the 1965-68 mistakes and can achieve a practical

DECEMBER 1 97 0

optimum of employment, real growth and price
trends.
In my judgment, given the errors of 1965-68, subse
quent developments have been as good as could be
expected. One trouble has been that the economics
profession has led the public to believe that there
could be miraculous correction of the price trends
without pain. That was not possible in 1969-70 and it
is not now possible in the immediate future.
We should not pretend to the public that there is
some “game plan” which will magically and pain
lessly avoid the results of the errors of 1965-68 along
some time-path of short duration. It is sometimes said
that the fiscal and monetary actions since June 1968
or since January 1969 have grossly failed. I do not
think they have failed. They have done what was in
the nature of the economic universe that they could
accomplish. And I cannot see, on a basis of hind
sight, that we could have made another choice that
would have given us a better pattern of results.

MONEY SUPPLY REVISED
D AT A FOR currency held by the public, demand deposits held by the public, and
time deposits at all commercial banks have been revised by the Federal Reserve Board.
The revision includes a minor adjustment for seasonal factors and for new benchmark
data on nonmember bank deposits. In addition, a major revision of the demand deposit
component of money was made in order to eliminate a measurement error created by a
rising and volatile volume of transactions carried out by certain specialized international
banking institutions.1
The underestimation arose from including items arising from transactions made by
international banking institutions in “cash items in the process of collection” while being
cleared between U.S. banks, and also from including the deposits of these international
banking institutions in interbank deposits by U.S. banks. Since both “cash items” and in
terbank deposits are subtracted from gross demand deposits in computing the measured
money stock, double subtracting resulted. The underestimation was corrected by adding
to gross demand deposits the liabilities of international banking institutions which cor
respond to “cash items” on the books of U.S. commercial banks.
The revision raised the level and the rates of change of the money stock. For example,
money averaged $206 billion in October for the old series, compared with $213 billion for
the new series. The 5.5 per cent rate of change in money from December 1969 to Novem
ber 1970 compares with a 3.8 per cent rate using the old series.2 In the previous eleven
months from January 1969 to December 1969, money grew at a 3 per cent rate accord
ing to the new series and at about a 2 per cent rate according to the old series.
'These institutions are agencies and branches of foreign bonks and subsidiaries of U.S. Banks organ
ized under the Edge Act to engage in international banking.
2November estimated for the old series.

Page 18

F E D E R A L R E S E R V E B A N K O F ST. L O U IS

DECEMBER 197 0

FEDERAL RESERVE SYSTEM ACTIONS DURING 1970
Selected Monetary Aggregates
Per Cent Change
12/68
11/69
to
to
11/70
12/69

Federal Reserve Holdings of Government Securities
Federal Reserve Credit __________________________
Total Reserves of Member Banks
Monetary Base ________________
Money Stock__________________

6.9%
4.6
6.1
5.7
5.1

9.5%
5.2
-0.1
3.1
3.1

Discount Rate
In effect January 1,
November
December
In effect December

1970
11, 1970*
1, 1970* __
15, 1970 ...

6 %

5%
5%
5%

Reserve Requirements**
Percentage Required
Net Demand Deposits
up to $5 Million

In effect Jan. 1, 1970 ________
Oct. 1, 1970 ________
In effect Dec. 15, 1970________

Reserve City
Banks

Other Member Banks

12%

Net Demand Deposits
in Excess of $5 Million
Reserve City
Banks

17%
17%t
17%

Other Mem
ber Banks

Time Deposits
up to $5 Million
& Savings Peps.

Time Deposits
in Excess of
$5 Million

13
13t
13

5t
5

Margin Requirements on Listed Stocks
In effect January 1, 1970 __________________________________
May 6, 1970 _____________________________________
In effect December 15, 1970 _______________________________

80%
65%
65%

Maximum Interest Rates Payable on Time & Savings Deposits
Type o f Deposit

In Effect
Jan. 1, 1970

Savings Deposits __________________________________________
4
Other Time Deposits:
Multiple maturity:
30-89 days ________________________________________
4
90 days to 1 yea r__________________________________
5
1 year to 2 years___________________________________
5
2 years and o v e r ___________________________________
5
Single maturity:
Less than $100,000
30 days to 1 year
_________________________ __ 5
1 year to 2 years
5
2 years and o v e r_________________________________ 5
$100,000 and over:
30-59 days ____________________________________ __ 5%
60-89 days ____________________________________ __ 5%
90-179 days ___________________________________ __ 6
180 days to 1 year
_________________________ __ m
1 year or m ore___
_____________________________ ___6Yi

Jan. 21, 1970

In Effect
Dec. 15, 1970

4%%

4%
5
5%
5%

5
5%
5%

5
5%

6%
7
7%

° Signifies date that first Federal Reserve Bank adjusted discount rate.
00Beginning October 16, 1969, a member bank is required under Regulation M to maintain, against its foreign branch deposits, a reserve
equal to 10 per cent o f the amount by which (1) net balances due to, and certain assets purchased by, such branches from the bank’s
domestic offices, and (2) credit extended by such branches to U.S. residents exceed certain specified base amounts. Regulation D imposes
a similar 10 per cent reserve requirement on borrowings by domestic offices of a member bank from foreign banks, except that only a 3
per cent reserve is required against such borrowings that ao not exceed a specified base amount,
tBeginning October 1, 1970, a member bank is required to maintain reserves against funds received as the result of issuance of obliga
tions by affiliates o f the bank, including obligations commonly described as commercial paper; the requirement on such funds with a
maturity o f (1) less than 30 days is either 17%% or 13%, the same as the requirement on net demand deposits in excess of $5 million
and (2) over 30 days is 5% , the same as the requirement on time deposits in excess of $5 million. See F. R. Bulletin, September 1970,
pp. 721, 722.
ttT he rates in effect beginning January 21, 1970 through June 23, 1970, were 6^4 per cent on maturities of 30-59 davs and 6V2 per
cent on maturities o f 60-89 days. Effective June 24, 1970, maximum interest rates on these maturities were suspended until further notice.
Note: A member bank may not pay a rate in excess o f the maximum rate payable by state banks or trust companies on like deposits under
the laws of the state in which the member bank is located.

Page 19

REVIEW IN D E X — 1970
Month
o f Issue

Tide of Article

Month
of Issue __________Title of Article_________________________

Jan.

Monetary Actions, Total Spending and Prices
The New, New Economics and Monetary Policy
Some Issues in Monetary Economics

July

Inflation and Its Cure
Metropolitan Area Growth: A Test of Export
Base Concepts

Feb.

Real Economic Expansion Pauses
Operations of the Federal Reserve Bank of St.
Louis — 1969
Monetary and Fiscal Influences on Economic
Activity — The Foreign Experience
The Administration of Regulation Q

Aug.

Anti-Inflation Process Continues
The Federal Budget and the Economy
Current Utilization of Labor

Sept.

Economic Slowdown and Stabilization Policy
Selecting a Monetary Indicator — Evidence
From the United States and Other De
veloped Countries

Oct.

Stabilization Policy and Inflation
Some Lessons to be Learned from the Present
Inflation
The "Crowding Out'’ of Private Expenditures
by Fiscal Policy Actions

March Extent of the Slowdown
Money Supply and Time Deposits, 1914-69
More Flexibility in Exchange Rates — And in
Methods
April

Monetary Restraint and Inflationary Momentum
A Monetarist Model for Economic Stabilization
Summary of U.S. Balance of Payments, 1969

May

Transition to Reduced Inflation
Let’s Not Retreat in the Fight Against Inflation
Neutralization of the Money Stock — Comment

June

Downturn Remains Mild
Federal Open Market Committee Decisions in
1969 — Year of Monetary Restraint

N ov.

M onetary and Financial D evelop m en ts

The International Payments System and Farm
Exports
Fiscal Policy for a Period of Transition
Aggregate Price Changes and Price Expectations
Dec.

1970 — Economy in Transition
Observations on Stabilization Management
Federal Reserve System Actions During 1970
Review Index — 1970

Full text of Review (Federal Reserve Bank of St. Louis) : December 1970

FRASER