View original document

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

For Release on Delivery
Friday, May 17, 1968
10*00 a.m.,E,D.T.




NEW HORIZONS IN MONETARY AND FISCAL POLICY

Remarks by

Andrew F .
Board of Governors of the
Federal Reserve System

Before the

48th

1 Conf€

of the
National Association of Mutual Savings Banks

Washington Hilton Hotel
Washington, D. C.

May 17, 1968

NEW HORIZONS IN MONETARY AND FISCAL POLICY
By
Andrew F. Brimmer*
Long before we reached the present stage of the current
inflation in the United States, a vigorous program of fiscal restraint
was clearly required.

Such a program is a desperate need today.

And

while I (along with virtually all other observers) have learned over
the last few years not to be particularly optimistic about Congressiona
response to the need for fiscal restraint, there is still reason to
expect that some combination of higher income taxes and reduced Federal
expenditures will be adopted to apply to fiscal year 1969.

The combi-

nation with the strongest Congressional backing to date involves a 10
per cent income surtax, a $6 billion reduction in expenditures and
cutbacks in past and future appropriations.
The adoption of this set of fiscal measures would enhance -not lessen -- the need for flexibility in monetary management.

On

numerous occasions, I (and many others in the Federal Reserve System)
have advocated more assistance from fiscal policy partly as a means of
reducing the burden of restraint carried almost entirely by monetary
policy.

Once more fiscal restraint is actually in force, it will be

vital to mesh the two sources of restraint to ensure that the pace of
the economy is moderated in an orderly way in the months ahead -particularly in light of the unfolding effects of the monetary actions
already taken.
^Member, Board of Governors of the Federal Reserve System.




-2In my own view, to date we have not achieved enough restraint
on aggregate demand to check inflation in the United States within a
reasonable period of time.

Thus, we need more total restraint.

This

goal can be achieved by either a somewhat firmer monetary policy,
by a vigorously restrictive fiscal policy or by some combination of
the two approaches.

Personally, I would clearly prefer the third

alternative, calling for more fiscal -- and less monetary -- restraint.
However, just how much of a constraint would be imposed on such a
choice by the pervasiveness of domestic inflationary pressures and
the serious deficit in our balance of payments is obviously one of
the most critical questions the monetary authorities will have to face
once the proposed fiscal measures have been actually adopted.

I shall

return to this question later in these comments.
In the meantime, the central theme of these remarks can be
summarized briefly:




-

Since the shift to a policy of restraint last November,
the Federal Reserve System has brought the rate of growth
of member bank deposits to less than half that recorded
last year. Moreover, restraint has been brought about
much more rapidly (and to date much more smoothly) than
was the case in 1966.
The effects of monetary restraint (delayed and partly
masked by a web of institutional relationships) are

becoming increasingly evident. Flows to savings institutions have
slowed substantially. The number of new housing starts,
until a sharp jump in April, had been on a plateau for
several months. As these effects permeate to other
sectors, the degree of'monetary restraint achieved so
far would lead to some moderation in the pace of domestic
economic activity in the closing months of 1968 and in
the first half of 1969.

-3-

Fiscal restraint of the magnitude now being considered
in Congress, even taken alone, would also have a sizable
impact on the economy in the first half of 1969. Previously approved -- but delayed -- Social Security taxes
will also become effective early next year. Thus, if
the surtax and expenditure reduction proposals are
adopted in the near future, fiscal policy will — finally -become a significant means of checking inflation.

-

On the other hand, the cumulative impact of the present
degree of monetary restraint plus the restraint to be
generated by the new fiscal measures may turn out to be
more than the economy requires as the year 1959 progresses.
Consequently, a high premium must be placed on the sensitivity and flexibility of monetary management in the months
ahead.

Recent Trends in Monetary Policy
The principal actions taken by the Federal Reserve since a
policy of restraint was adopted last November have been commented on
rather widely.




However, it may be helpful to summarize them here:

-

The discount rate has been raised three times: from 4 to
4-1/2 per cent in mid-November; to 5 per cent in midMarch, and to 5-1/2 per cent effective /pril 19. The
first increase was made in the context of adjustment
following the devaluation of sterling, and the second
move was part of a package of coordinated measures
designed to cope with speculation against the official
price of gold. The last increase represented a further
step to bring about greater restraint to help counter
domestic inflation and to contribute to improvement in
our balance of payments.

-

/bout $550 million of bank reserves were absorbed in
mid-January by an increase of 1/2 percentage point in
reserve requirements on demand deposits above $5 million
at each member bank.

-

Open market operations, on balance, have been used to
absorb (rather than supply) reserves, so that the net
growth in reserves since last November has come about

-4entirely through member banks borrowing from Federal
Reserve Banks. At the same time, a considerable
volume of Treasury financing has been accommodated.
-

The maximum rates of interest payable on largedenomination time deposits were raised slightly
effective April 19. This move was intended to
moderate the rate of attrition in such deposits —
and not to ease credit conditions generally. Ceiling
rates on savings and other time deposits were not
changed.

I would like to stress that policy actions during the present
period of monetary restraint have been undertaken in a deliberate and
moderate manner.

All the major policy instruments have been employed

in a coordinated way, and excessive reliance has not been placed on
any particular measure.

Throughout, the basic aim has been to restrain

the growth of bank credit and the money supply without creating excessive
strains on the nation's financial fabric and without disrupting the
basic functioning of the economy.

Impact of Monetary Restraint
The above policy actions have had a noticeable effect on
money and credit flows.

This is clear from the statistical measures

summarized in Table 1.

Several general conclusions can be drawn from

these figures.

It is evident that the impact of credit restraint in

the current period has been registered on monetary, flows much more
rapidly than was the case two years ago.

It will be recalled that the

previous period of monetary restraint got underway early in December,
1965, while the current effort began in mid-November, 1967.




Thus, the

-5Table 1.

Series Seasonally Adjusted

/nnual Percentage Rates of Change
in Monetary Indicators for Selected
Periods

Year
1965

Dec.65-. Year
A p r . 66-i' 1966

Year
1967

Dec. 6 7 - . Dec.67- .
Mar.68±' Apr.6fti'

Total Reserves

5.2

7.7

1.2

9.8

6.5

3.5

Nonborrowed Reserves

4.2

4.9

0.8

11.5

-0.4

-2.3

Total member bank
deposits

9.1

7.6

3.7

11.6

5.5

3.5

Time deposits

16.0

10.4

8.8

15.8

6.7

5.6

Money supply

4.7

7.0

2.2

6.5

3.6

4.6

1/

Dates are inclusive

impact of restraint during the last five months can be compared with
the experience in the same months two years ago.

At the same time,

however, one should remember that the really severe effects of
restraint in 1966 were not registered until after mid-year.
In reviewing the current experience, one should note that
the growth of bank reserves, deposits and the money supply has been
reduced sharply -- with growth rates ranging from roughly one-third
to one-half those recorded in 1967 as a whole.

One should note parti-

cularly that the Federal Reserve has made no net contribution to bank
reserves on its own initiative during the last five months.

In fact,

on balance, it has absorbed reserves, and all the net- growth in reserves
since November has come about by member banks borrowing from Federal Reserve




-6Banks.

Total reserves have expanded at an annual rate of about 3.5

per cent, but nonborrowed reserves have actually declined at an
annual rate of 2.3 per cent.

This result has been achieved despite

the fact that the System found it necessary to purchase over $2
billion of Government securities to cushion the reserve impact on
the domestic banking system of the substantial outflow of gold.

In

contrast, total reserves expanded at an annual rate of nearly 8 per
cent in the first five months of credit restraint two years ago, and
the System supplied nearly two-thirds of the net growth.
Since the end of last November, total member bank deposits
have increased at an annual rate of 3.5 per cent; this i s just over onequarter the rate registered last year and less than one-half the rate
of growth during the first five months of credit restraint in 1966.
Treasury financing patterns have resulted in month-to-month fluctuations in the pace of expansion, but the trend has been distinctly
downward.

Between the end of November and the end of March, the

money supply expanded at an annual rate of 3.6 per cent.

This rate

of growth was about half that recorded in both 1967 and in the first
five months of restraint in 1966.

However, the money supply took a

sharp jump in April raising the growth since November to an annual rate
of 4.8 per cent.

This temporary bulge (which was concentrated around

mid-month) reflected in large part both rapid growth of currency in
circulation and large net transfers from U . S . Government to private
demand deposits.

Between mid-April and mid-May, currency in

circulation grew at a much more moderate pace, but shifts from




-7-

^overnment to private checking accaunts remained relatively
large.

So, while the growth of the money supply has declined from

the high April rate, it has not receded to that registered from
November through March.
The inflow of time deposits at commercial banks has slowed
noticeably.

During the five months ending in April, the annual rate

of expansion was 5.6 per cent.

This was about one-third that recorded

for 1967 and just over one-half the rate of increase in the DecemberApril months of 1965-66.

Moreover, most of the increase in time

deposits during the current period of credit restraint occurred before
the end of March.

In April alone, the annual rate of growth was down

to 1.3 per cent; and for the period November 29-May 15, the annual rate
was 4.6 per cent.

While May as a whole may show inflows of time

deposits at commercial banks somewhat greater at an annual rate than
were registered last month, the growth probably will be well below
that for the December-April months.

Both the rate of growth and composition of bank credit have
varied significantly in the last few months. As shown in Table 2,
total loans and investments at commercial banks rose at an annual rate
of 7.2 per cent during the five months ending in April.

This increase

was just over three-fifths of the gain in 1967 as a whole and also
somewhat below the pace of expansion in the early months of credit
restraint two years ago. As one would expect during a period of
heavy Treasury borrowing, the behavior of total bank credit has been




-8Table 2.

Annual Percentage Rates of
Change in Bank Credit for
Selected Periods

Series Seasonally Adjusted

Year
1965

Dec.65Apr.66^

Bank loans and
investments

10.2

8.3

5.7

11.5

7.2

U.S. G o v . securities

-5.6

-7.6

-6.3

11.0

-10.1

Other securities

15.8

10.9

6.5

26.1

12.3

Total loans

14.7

12.5

9.1

8.2

10.6

18.8

16.1

13.3

9.8

12.7

Business loans
JL/

Year
1966

Year
1967

Dec.67Apr.68±'

Dates are inclusive

greatly influenced by changes in banks' holdings of U.S. Government
securities.

In February, the banks substantially enlarged their

Government portfolios, but sizable liquidation of such securities
occurred in March.

The result was a rapid rise in total loans and

investments in January-February followed by a moderate decline in
March.
In April and in the first half of M a y , the growth of bank
credit has centered in loans rather than in investments.

The expan-

sion in business loans was especially rapid in April as a whole, but
some weakening has been evident since the mid-April tax date.

Loans

to business increased at an annual rate of 12.7 per cent during the
December-April months of 1967-68, or roughly four-fifths of the




-9expansion recorded in the same months of 1965-66.

The rise in business

loans in April alone this year was at an annual rate of almost 20 per
cent; in the first quarter, such loans climbed at an annual rate of
7 per cent compared with 10 per cent in the full year 1967.

While

direct tax borrowing by corporations (particularly outside New York
City banks) accounted for a substantial share of the April rise in
total bank loans, apparently a number of finance companies also borrowed
heavily from banks to replace an unusually large volume of open market
paper which corporations allowed to run off in order to meet their own
tax payments.

There was also a noticeable quickening in demand for

loans by industrial and mining firms -- aside from borrowing for tax
purposes.
In the last few weeks, however, there appears to have been
some weakening in demand for business loans.

This tapering off is

evident in several areas, including primary metals, machinery and other
fabricated metal products, textiles, chemicals and rubber, and mining.
Available information is not yet sufficient to explain this moderation
in loan demand.

However, a few observations are possible.

The heavy

tax period borrowing in April would normally be followed by substantial
loan repayments by some firms in early M a y .
recently by a chemical company.

A large term loan was repaid

In the mining area (where a number of

banks joined in April to supply funds for a large acquisition), there
was also a large volume of repayments in early May.

Holdings of bankers

acceptances (which are included in the business loan statistics) have
also declined rapidly in recent weeks.




-10-

But one should interpret these latest moderating trends in
business loans with caution. Looking ahead over the next few months,
it seems that the demand for business loans is likely to be strong
rather than weak.

The expected acceleration in inventory building

certainly suggests that this will be the case. Moreover, if the surtax
proposal is enacted in early June, corporations may borrow heavily around
the middle of that month not only to pay current taxes but also partly to
catch up on liabilities arising from both the retroactive feature of the bill
and the provision requiring further acceleration in payment of corporate
taxes generally.
The Dimensions of the Current Inflation
The inflation which monetary policy has been attempting to
check actually has been present for nearly three years, although the
pace has accelerated since mid-1967. .

Its seeds were planted in mid-

1965 when the expansion of military activity in Vietnam put additional
burdens on an economy already on the eve of full employment.

With the

rapid growth in demand for goods and services for military purposes
(unmatched by higher taxes to pay for the war), the Federal Government
became a principal source of inflation in the United States.
The magnitude of the current inflation has been commented on
quite widely, but it might be helpful to put the matter in perspective
again.

Perhaps the best way to grasp the dimensions of the inflation

problem is to examine the composition of changes in gross national
product (GNP) over the last few years.




This is done in Table 3,

-11Table 3.

Composition of Changes in
Gross National Product, 1964-1968

(Billions of dollars- seasonally adjusted annual rates)
Source of change
in GNP
Net
Domestic
Exports
Demand

Composition of change
in GNP (per cent change)
Prices
Real
GNP
Output
(Current
dollars)

GNP
(Current
dollars)

Change in
GNP
(Current
dollars)

Year 1964

632.4

41.9

39.3

2.6

7.1

5.5

1.5

Year 1967

785.0

41.7

42.0

-0.3

5.5

2.5

3.0

First Quarter,
1968

825.7

19.4

20.7

-1.3

9.5

5.9

3.7

Period




-12showing changes in GNP traceable to the growth of domestic demand v s .
net sales abroad and changes in real output v s . changes in prices
since 1964.
It will be noted that in both 1964 and 1967 the production
of goods and services in the economy (as measured by GNP) expanded by
about $42 billion.

However, in the later year, over half of the

apparent gain actually reflected nothing more than the general rise
in prices rather than an increase in real output.

In contrast,

although some inflation was also evident in 1964, almost four-fifths
of the rise in GNP in that year represented an increase in real output.

The expansion of GNP during the first quarter of this year

contained a

larger shaire of real growth than was the case

for 1967 as a whole, but the inflation component was still nearly
twice as large as in 1964.
Looked at from the perspective of the U.S. balance of
payments, the domestic inflation has also been costly.

In 1964, U.S.

exports of goods and services rose by $2.6 billion more than the
increase in imports.

This rise in net exports represented over 6 per

cent of the increase in GNP and was clearly of substantial benefit to
our balance of payments.
completely.

By 1967, the situation had swung around

Last year, net exports of goods and services dropped by

$300 million compared with the year before, and there was a further
relative decline during the first quarter of this year.

Thus, the

recent growth in domestic demand has outstripped the rise in domestic




-13-

output, with imports making up the difference.

In other words,

domestic inflation has had a major adverse impact on the U.S. trade
account and on the balance of payments as a whole.
The spreading effects of inflation can also be traced in
the more familiar measures of price changes.

For example, in 1964

the consumer price index (CPI) rose by 1.3 per cent.

In the first

quarter of this year, the CPI rose at an annual rate of about 3.6 per
cent.

Wholesale prices, which registered little change during the

years 1958-64, rose by over 5-1/2 per cent in the three years ending
in 1967.

The rise in durable manufactures (reflecting both military

demand and a strong investment boom) was particularly large.

The GNP

deflator (perhaps the broadest measure of price changes we have) rose
at an annual rate of over 3-1/2 per cent in the first quarter of this year,
compared with 3 per cent in the full year 1967 and 2.7 per cent in
1966 as a whole
Until mid-1966, the rise in prices outstripped the increase
in wages, so real income of wage earners actually declined.

However,

in the last two years, wages have risen rapidly -- partly in an effort
to compensate for the previous increases in consumer prices and partly
in response to the strong demand for labor generated by an economy
operating close to the full employment ceiling.

Fringe benefits and

employment taxes are also significantly higher.

A t the same time,

productivity has fallen considerably below the long-term annual increase
of 3.5 per cent.




The result is that, between the first quarter of 1966

-14and the first quarter of 1968, labor cost per unit of output in
manufacturing climbed by almost 10 per cent.
Moreover, in the absence of further restraint on aggregate
demand, there is no real prospect of checking inflation in the United
States over any reasonable period in the future.

The near-term out-

look is for continued large increases in personal income and in
consumer spending, the latter being augmented by a further decline in
the savings rate.

Outlays on plant and equipment by business firms

also seem destined to register modest

gains in the months ahead, and

inventory accumulation may also quicken.

With the Federal budget

continuing to run an enormous deficit, it seems obvious that the total
demand for goods and services will continue to exceed the capacity of
the economy to meet it without adding further to inflationary pressures.
In the face of this prospect, the need for more restraint also seems
obvious.




-15Differential Impact of Monetary and Fiscal Restraint
In the judgment of a really remarkable consensus of
economists, bankers, businessmen and public officials, the best way
to achieve the required moderation in domestic demand is through a
policy of vigorous fiscal restraint.

I fully share this view.

Because of a number of vital considerations, it makes a great deal of
difference x*hether the additional restraint comes through fiscal policy
rather than through monetary policy.

The main characteristics of the

differences in the impact on the economy of the two policy approaches
are generally known.

However, it might be helpful to sketch the broad

outlines here.
It will be recalled that last January, the Council of Economic
Advisers (CEA) estimated that GNP in 1968 would approximate $846 billion
if the President's fiscal program were enacted early in the year.

This

would represent a gain of about $61 billion, with real output increasing
somewhat more than 4 per cent and prices advancing somewhat more than
3 per cent.

With the civilian labor force expected to grow by 1-3/4

per cent, the anticipated rise in output would be sufficient to maintain
the unemployment rate in the neighborhood of 3.7 per cent.
The economic outlook for this year as CEA foresaw it becomes
clearer when viewed in terms of the principal expenditure sectors

—

again on the assumption that the 10 per cent surtax would be adopted
early in the year.

Perhaps the most important area is homebuilding.

Private nonfarm housing starts were expected to exceed 1% million units




—

-16in 1968, compared with 1.29 million in 1967 and 1.17 million in 1966.
Expenditures on residential construction (which amounted to $24.4
billion last year) were expected to increase by $5 to $6 billion.
T h u s , it was anticipated that homebuilding would continue to show a
substantial recovery from the low level of activity registered in 1966.
The Council recognized that this expected outcome would depend heavily
on the avoidance of severe monetary restraint during 1968.

Consumer

outlays for goods and services other than housing were expected to rise
about $33 billion during the current year.

The Council thought that

—

even after taking account of both existing income taxes and the proposed
surtax —

disposable personal income would increase by approximately

$35 billion, and the savings rate (which rose from 5.9 per cent in 1966
to 7.1 per cent in 1967) would remain essentially unchanged.
In the business sector, CEA foresaw a moderate expansion of
about $4 or $5 billion in fixed investment during 1968.
would be about double that recorded last year.
which

expanded

Such a gain

Business inventories,

by $5.2 billion in 1967, were expected to rise by several

billion dollars faster during the current year.
State and local governments, CEA thought, would probably
increase their purchases of goods and services by $8 or $9 billion in
1968.

In this area, also, the Council recognized that the ability of

these governmental units to raise their expenditures would depend on
the existence of financial conditions which would allow them to proceed
with their planned construction projects.




-17For present purposes, the really critical assumptions in
CEA's outlook applied to the Federal Government.

In calendar year

1968, it was estimated that Federal expenditures would rise by around
$15 billion, compared with a gain of $21 billion last year.

Purchases

for national defense (including military pay increases) were scheduled
to rise by $4 billion, in contrast to $12 billion in 1967.

An increase

of $3 billion in social security benefits was set for the spring of 1968,
which would be partly offset by a $2 billion rise in payroll taxes
effective next January 1.

Aside from the scheduled changes in social

security benefits, the other projected increases in Federal expenditures
would be about matched by the normal yearly rise in Federal revenues at
existing tax rates.

Consequently, in the absence of tax rate increases,

the Federal budget deficit (on a national income basis) in 1968 would
be about the same or slightly higher than the $12% billion recorded in
1967.
Because such a deficit would continue to provide more
stimulus to aggregate demand than the economy could absorb readily
without adding further to inflationary pressures, the President recommended the enactment of the temporary 10 per cent surcharge on personal
and corporate income taxes, effective January 1 for corporations and
April 1 for individuals.

The surtax was expected to yield about $8

billion of additional revenue in 1968.

The extension of several excise

taxes (scheduled to lapse in April) would maintain another $2 billion of
revenue which otherwise would be lost.

The combined impact of these

revenue measures would reduce the Federal deficit to approximately




-18$5 billion in calendar year 1968.
Federal budget —

While still expansionary, the

with the tax increase -- would be a substantially

smaller source of inflationary pressures in the current year.
So much for the economic outlook on the assumption that a
major share of the needed restraint on aggregate demand in 1968 would
come through fiscal policy.

Now we can ask the question:

if the

surtax proposal or a sizable reduction in Federal expenditures is not
adopted by Congress, what would be the effects on the economy of
attempting to moderate inflationary pressures through monetary policy?
This question cannot be answered with precision, but the differential
impact of the two policy approaches can be outlined.

At the same time,

it is necessary to keep in mind that the effects of monetary policy
actions are normally delayed, and autonomous developments (unrelated
to policy moves) also frequently influence the actual behavior of the
economy.
In general, against the background of the monetary restraint
introduced since last November, and on the basis of projections recently
made by the U . S . Department of Commerce, it seems that GNP might
amount to about $850 billion in 1968.

At this level, GNP would show

a rise some $4 billion above that anticipated under conditions of
additional fiscal restraint.
output

The share of the gain representing real

xrould be somewhat less and that representing price increases

somewhat larger.

The unemployment rate (in the neighborhood of 3.7

per cent) might be about the same, or slightly higher, but the civilian
labor force would probably expand by less than it would with a more




-19balanced increase

in output.

In the homebuilding area, the level of private nonfarm
housing starts will undoubtedly fall short of the

million or

more units anticipated by the CEA for 1968 as a whole.

In the first

quarter of this y e a r , housing starts averaged 1.49 million, at a
seasonally adjusted annual rate, with March alone registering a slightly
higher figure.

In April, the annual rate jumped to 1.62 million units.

However, because of the volatility of this series, one must always
interpret changes in a single month with considerable caution.

In

view of the slowing in mortgage commitments which began to appear
before the end of last year, the annual rate may ease off considerably
in the months ahead.

By just how much homebuilding will actually be

moderated during the rest of this year will depend substantially on the
course of market interest rates and the inflow of funds to savings
and loan associations and mutual savings banks —
of home finance.

the principal sources

B u t , on balance, it appears most unlikely that the

increase of nearly 300 thousand in new housing starts which CEA foresaw
for 1968 would be realized if further monetary restraint is required.
Consequently

the expected gain of $5 to $6 billion in expenditures for

residential construction in 1958 most likely would also not be idealized •
with the short-fall perhaps amounting to as much as $3 billion.
On the other hand, disposable personal income would rise by
some $5 to $6 billion more in 1968 than it would if the surtax were in
force.




With some further decline in the savings rate, consumer

-20expenditures would probably climb by an additional several billion
dollars, with a particular stress on increased purchases of durable
goods.
Outlays for business fixed equipment, which CEA thought
might rise by $4 to $5 billion with the surtax on the books, might
expand somewhat more rapidly.
would also be somewhat faster —

The rate of inventory accumulation
without the tax increase.

Thus,

while monetary restraint could be expected to have a moderating effect
on investment expenditures in the business sector, it would be less
than that exerted by fiscal restraint.

In contrast, State and local

governments might expand their purchases by $200-$300 million less
than they would if more general restraint came about through fiscal
rather than monetary policy.
Again, of course, the really big difference (almost by
definition) between the two policy approaches to restraint would be
registered in the impact of the Federal Government on the economy.
As mentioned above, on a national income basis, in the absence of a
tax increase, the Federal deficit in 1968 would be well above the
$12-1/2 billion recorded for 1967.
$13 billion.

In fact, it may well exceed

Under these circumstances, there would continue to be

a sizable transfer of resources from the private to the public sector
but without a matching transfer of revenue to pay for them.

Instead,

the Federal Government would have to continue its massive borrowings
in the capital market (adding to the pressure on interest rates)
while expanding aggregate demand which is already excessive.




—

-21All of us should find this prospect unacceptable.

The proper

remedy for it is the early adoption of a vigorous policy of fiscal
restraint.

Coordination of Monetary and Fiscal Policy
Having argued that the outlook for the economy is far from
comfortable in the absence of additional fiscal restraint, let me stress
again that the task for monetary policy also remains critical.

Clearly,

the continued failure to adopt the proper fiscal measures would mean
that monetary policy would remain virtually the only active force in
the campaign against inflation.

None of us should have any illusions

whatsoever about the implications of following such a course.

The

expansion of bank reserves (whether provided by the System or borrowed
by member banks) would have to be kept quite modest.

The growth of

bank credit and the money supply would have to remain under considerable
restraint.

Given the strong demand for funds which undoubtedly would

exist during the rest of this year, interest rates and market yields
would obviously remain under pressure.
In such an environment, inflows of funds to financial
institutions -- to commercial banks as well as to savings intermediaries -would undoubtedly shrink considerably.

In fact, actual outflows into

market instruments might occur on a noticeable scale.

But, unlike the

case in 1966 when strong competition of commercial banks for savings
and time deposits created serious problems for S&L's and mutual savings
banks, the difficulties this year might arise primarily from the pull




-22of market yields.

It should be recalled that since September, 1966,

the bank supervisory agencies have had authority to set maximum rates
of interest payable on deposits and savings capital in such a way as
to dampen competition among the different types of institutions.

On

the other hand, the inflow of funds to all three types of depositaries
has slackened considerably in recent months.

In fact, commercial banks

experienced sizable attrition in their passbook savings in April, while
between mid-March and mid-April their negotiable CD's outstanding in
denominations of $100,000 and over declined by $1.5 billion -- partly
reflecting the liquidation of such paper by corporations in order to
pay taxes.

Although the banks as a group have been about holding the

level of CD's nearly constant since the rate ceiling was raised in
April, there is little prospect that they will register any appreciable
gain in the months ahead.

f

There is also little likelihood that S & L s

and mutual savings banks will make any headway in competing for funds
against market securities offering particularly attractive rates of
return.
In my personal judgment, if such financial conditions actually
develop, the present structure of interest rate ceilings on consumer
savings deposits and accounts may well have to be adjusted, :nd aven so
thrift institutions would still find it hard to compete against the rates
available on market instruments.
restraint




In the absence of additional fiscal

I am convinced that the issue will become pressing.

-23B u t , I am certain everyone is asking, what is the role of
monetary policy if a vigorous program of fiscal restraint is adopted
in the near future?

Obviously, I cannot forecast what course the

monetary authorities will pursue.

As mentioned at the outset, the

serious deficit in the balance of payments as well as the dimensions
of the domestic inflation will clearly impose a constraint on the
options available to the managers of monetary policy.
On the other hand, I am personally persuaded that a
sufficiently strong program of fiscal restraint —
soon —

adopted relatively

would open the way for a better mixture of stabilization policies.

Such a mixture would contain a lessened degree of monetary
restraint.

Exactly how much relaxation might be possible is clearly

the critical point.

One would normally anticipate that passage of

a tax bill would have a favorable effect on market expectations,
resulting in some improvement in securities prices and some decline in
market yields.

The extent to which bank reserves could be expanded

to help validate such changed expectations is a matter which we will
clearly have to weigh carefully.
Looking ahead through the rest of this year and into 1969,
we must keep in mind that the combined impact of the proposed fiscal
actions and monetary restraint would have a progressively dampening
impact on the economy.

This will be reinforced by the rise

security taxes effective next January.
exactly what the economy needs.

in social

Such a progressive dampening is

At the same time, however, we must

also remain alert to see fchct the rate at which excess demand is




-24brought under control is kept ;orderly.

Without attempting to

assign the blame for it, I think it must be admitted that inflation
has progressed a considerable distance.
time before it is brought under control.

T h u s , it will require some
It is vital that we achieve

this objective without creating rates of growth in output so low
and unemployment rates so high «

—

that the cost of checking inflation

would be unacceptable to the vast majority of the nation's population.
B u t , precisely because it will take some time to bring price increases
back to a more tolerable pace, it is imperative that we get on with the
task through the early adoption of more fiscal restraint.
Given the constraints imposed on policy actions by the
necessity to see that the financial system (including our seriously
deficient arrangements for home financing) is kept in reasonably
good working order and to see that fluctuations in output and employment
are kept moderate, I think we really canndt avoid a flexible approach
to the management of monetary and fiscal policy.
is far preferable that public policy instruments —
have to be changed from time to time —

In my judgment, it
although they may

be required to r espond to

changing circumstances than that the economy itself be allowed

to swing

widely under the impact of autonomous shifts in the composition and
rate of growth of private demand.

In this approach to national

stabilization policies, neither monetary nor fiscal policy can remain
frozen.

S o , as the situation requires, I am perfectly willing to

support a change in monetary policy toward greater restraint or greater
ease.




-25I would personally welcome an opportunity to confront
such an option in the context of more fiscal restraint brought about
by the early passage of the President's 10 per cent surtax proposal.