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Speech by Darryl R. Francis
at the
Federal Reserve Bank of St. Louis Seminar
December 12, 1969

There has been a great revival of interest in the
use of monetary tools for stabilization purposes in recent
years. How great this move from obscurity to renown has
been can be observed from an examination of both textbooks
and financial papers. Most economic textbooks now contain
chapters on monetary theory, whereas two decades ago
this topic was largely ignored in classroom discussion.
Similarly, the financial press gives much more space
to monetary affairs than formerly. Monetary discussions
have permeated both the economics profession and the
political arena.
We need only go back to the early post-World War II
years to find monetary policy objectives limited to the
maintenance of low interest rates. In 1945, E. A. Goldenweiser,
Director, Division of Research and Statistics of the Federal
Reserve Board, stated, "In the monetary field we must in
the first place maintain the value of Government bonds. . .
This country will have to adjust itself to a 2 1/2 per cent
interest rate as the return on safe, long-time money. . ."—
]/_ E. A. Goldenweiser, "Postwar Problems and Policies",
Federal Reserve Bulletin, Feb. 1945, p. 117.


-2Throughout the 1940's and 1950's monetary and credit policy
took a back seat to fiscal policy in stabilization plans. In
1948 Arthur Smithies, in A Survey of Contemporary
Economics, wrote, "In the field of compensatory action,
I believe fiscal policy must shoulder most of the load. Its
chief rival, monetary policy, seems to be disqualified on
institutional grounds. This country appears to be committed
to something like the present low level of interest rates on
a long-term basis".—
In contrast to the policy of low interest rate
maintenance of the 1940's, the pendulum has swung back
much closer to the 1920's when great potency was attributed
to monetary actions. The nation experienced a number of
visible demonstrations of the power of monetary actions
in this period. Monetary restraint in early 1923 was
followed closely by a downturn in business activity. An
easier monetary policy in late 1923 and early 1924 was followed
by a business upturn in mid-1924. Some monetary restraint
in the third quarter of 1926 was followed by an October
downturn in business. These changes in economic activity,
following the announced policy changes, produced great
confidence both within and outside the System as to the
effectiveness of monetary actions. This confidence went
2/_ H. S. Ellis, ed., A Survey of Contemporary Economics,
(Philadelphia: Blakiston Co., 1948), p. 208.


-3far beyond our current ideas as to what can and should be
controlled by the monetary authorities. It was generally
believed that numerous economic and social objectives could
be achieved simultaneously through monetary actions.
In a discussion of monetary objectives during the
1920's, Benjamin Strong, Governor of the Federal Reserve
Bank of New York and one of the leading architects of
System policy noted "some people think that prices should
be the guide, which comes close indeed to thinking that
the Reserve System can and should fix prices".— He
further points out, however, that there are influences other
than prices which affect monetary policy including the following:
"Is labor fully employed?
Are stocks of goods increasing or decreasing?
Is production up to the country's capacity?
Are transportation facilities fully taxed?
Is speculation creeping into the productive and
distributive processes?
Are orders and repeat orders being booked much ahead?
Are bills being promptly paid?
Are people spending wastefully?
Is credit expanding?
Are market rates above or below Reserve Bank rates?"
3/_ W. Randolph Burgess, ed., Interpretations of Federal
Reserve Policy in the Speeches and Writings of Benjamin
Strong. (New York: Harper & Brothers, 1930) pp. 233-234.


-4These questions indicate the great concern of the
monetary authorities for factors having little to do with
economic stabilization. For example, deciding how the
System should react to wasteful spending, speculation,
and tardy bill paying would tax the imagination of authorities
even in a nation that attempted to morally upgrade its
citizens with Prohibition. This confusion in the Twenties
as to appropriate objectives led to attempts to induce Congress
to require the Reserve System to make price stabilization
its primary objective.-^-- It was largely the Federal Reserve
System that opposed the stabilization bills in Congress.
Governor Strong feared that the public would be unable
to distinguish between stabilization of the general price
level and prices of individual commodities.
With this wide range of moral and economic criteria
for determining monetary policy, it was inevitable that
conflicts would develop between the various discretionary
objectives. Further complicating monetary thought at the
time was the traditional "real bills or needs of trade" doctrine.
In effect, it implied an expansive monetary policy as business
was expanding and a contractive policy while business was
contracting, rather than action in the opposite direction to
4/ Lloyd W. Mints, A History of Banking Theory (Chicago;
University of Chicago Press, 1945) p. 272.
5/_ Burgess, p. 272.


-5excessive business gyrations. This doctrine was built
into the System and, through its policy of contractive
actions, the System was a major contributor to the Great
Depression as the economy contracted in the late 1920's
and early 1930's. Economic stabilization objectives during
this period were secondary to the maintenance of the gold
standard, the stability of exchanges, and other monetary
In a discussion of the objectives of monetary policy
in 1937, after the economy had been depressed for a number
of years, the Federal Reserve Board continued to give low
priority to price stabilization as an adequate monetary
objective. It stated that "price stability should not be
the sole or principal objective of monetary p o l i c y . . . .
Proposals of price stability necessarily refer to some index
or average of prices. There is no general agreement on the
question of what constitutes a satisfactory price index for
this purpose . . . Correspondence between price stability
and economic stability is not sufficiently close, therefore,
to make it desirable to restrict the objective of monetary
policy to price stability. 2L with a multiplicity of objectives
and an absence of priorities, the System was never in a
position of having to accept responsibility for economic
6/ Federal Reserve Bulletin, September 1937, pp. 827-28.


-6events. It could always fall back on the historians'
type of analysis that all major events were the inevitable
result of a prolonged buildup of causal factors and little
could be done to alter this course.
The preoccupation of the monetary authorities
with factors that have little or nothing to do with economic
stabilization has carried over into the 1960's. The current
concern for the level of interest rates, the balance of
payments, Government debt financing problems, stock
market credit, loan liquidity, viability of financial agencies,
and flows of credit into specific sectors of the economy
is strikingly similar to the concern for non-stabilization
objectives in the 1920's.
The extent that non-stabilization objectives have
been incorporated into monetary policy since 1953 can be
demonstrated by statistical analysis. Research at this
Bank indicates that only about one-fifth of Federal Reserve
behavior with respect to monetary actions during the period
1953-1968 can be explained by economic stabilization objectives.
The remainder are explained either by "even-keel" or
financial objectives.— Financial objectives, other than
even-keel operations, in this analysis include all behavior

7/ Michael W. Keran and Christopher T. Babb, "An
Explanation of Federal Reserve Actions (1933-68)",
Review, Federal Reserve Bank of St. Louis, July 1969,
p. 14.


-7designed to protect financial markets. The signals for those
actions are deviations from "normal" interest rates. Higher
than normal rates indicate to the System that its actions
should become more expansive by supplying additional funds
to the credit markets. This action is believed to relieve
financial institutions of stress and provide more funds to
the savings and loan associations and the residential housing
industry. On the other hand, lower than normal interest
rates cause concern for "sloppy" financial markets and
future inflations.
The even-keel objective discussed by Norman Bows her
is a carryover from the World War II and early postwar
practice of supporting Government bond prices at low rates
in an attempt to reduce the burden of the debt on taxpayers
and to prevent bondholders from sustaining losses on their
bonds. More recently, the objective of "even-keeling" has been
to reduce the financial risk to Government bond dealers who
make the initial purchases. Apparently, it is assumed
that this favorable policy with respect to dealers in contrast
to that of investors will provide lower cost Government debt
financing. I believe, however, that the link from dealer
to ultimate investor is just as important as the Governmentdealer link. If investors are faced with rising rates
immediately after purchasing Government securities from


-8dealers, they can be expected to discount the expected
interest rate movements during future offerings. Also,
corporate financing can be expected to occur more frequently
during these more favorable rate periods. An auction of
all Government debt in orderly quantities would relieve
the Treasury of concern for under-subscribed issues and
the Federal Reserve of "even-keeling", which is a consequence
of the Treasury's reliance on fixed price issues.
The current preoccupation of the monetary
authorities with factors having little relation to stabilization
is also reflected in the concern of the System for speculative
actions and credit quality. Similar to the supposed danger
of the growth of speculative loans in 1928-29, we are
currently witnessing a major effort to prevent further
speculation in stock purchases by including in the regulations
the coverage of numerous unlisted firms. Reasons for these
actions are obscure. Current measures to prevent speculation
may have resulted from the original idea that such activities
would absorb funds to the prejudice of "productive commercial
interests". Borrowing for speculative purposes could cause
higher rates to commercial borrowers. This line of reasoning,
however, does not prove fruitful if one pursues it to its
ultimate impact on national output. General welfare may
be enhanced just as much by stock market credit as by


-9any other type of credit.
There is also an ethical question as to whether
individual purchases of stock with credit are basically
different from other capital purchases with the use of bank
credit. In my view one can "speculate" with credit by
purchasing anything of value.
Furthermore, there is a basic question as to the
appropriateness of restricting credit for speculating or
investing in a free society. In addition to the problem of
deciding whether or not an act is one of speculation or
investment, there is a question as to whether speculation
should be restricted as long as the general public interest
is not affected adversely. Personal freedom is maximized
when we permit each person all the liberty desired so long
as no other person is damaged. When both borrower and
lender are satisfied with a credit arrangement, we are not
sure that credit for common stock purchase is more harmful
to social welfare than credit for the purchase of any other
As I close out this brief review of Federal Reserve
objectives during the past half-century, I will quote an
item from Theodore Morgan's excellent paper entitled,


-10'The Theory of Error in Centrally Directed Economic Systems",

published in the August 1964 Quarterly Journal of Economics.—
Professor Morgan stated that 'The first general rule is that
central direction in economic affairs leads to fewer but
bigger errors...The self-interest of any administrative group
lies in its reputation for good performance. Hence the
group is sensitive to the tests of performance that can be
applied to It". He further notes that one reason for this
tendency for big organizations to make big errors is that
"the expression of a point of view by the chief puts blinders
on the staff of an office or department".
Because of the possibility of major errors by large
organizations, great freedom of expression is desirable for
each Federal Reserve Bank and the Board. Such freedom is
taken in making the following proposals for conducting
monetary policy in the years ahead.
First, I propose the total elimination or relegation
to a low priority of the following factors involved in past
monetary deliberations, namely, interest rate levels, balance
of payments, viability of financial intermediaries, even-keeling
and other Government debt financing, control of credit for
so-called speculative purposes, and all qualitative credit considerations. In my view, if the Federal Reserve does an adequate job of
8/_ Theodore Morgan, 'The Theory of Error in CentrallyDirected Economic Systems", The Quarterly Journal of
Economics, August 1964, pp. 395-419.


-IIeconomic stabilization, market forces will take care of
these factors in a satisfactory manner. Nominal interest
rates are not an appropriate monetary target, since Central
Bank action may cause perverse movements in rates. In
other words, Central Bank expansive actions designed to
lower rates may cause them to decline initially but to rise
over the longer-run.
S ince we cannot readily separate day to day from
longer-run forces it is apparent to me that day to day
money market rate movements should be ignored in Central
Bank actions. I believe that market forces can do a better
job of smoothing out daily fluctuations in interest rates
than can be done by the Federal Reserve System.
Control of speculation is not an appropriate
objective for monetary action. The influence of speculators
on economic activity has been greatly overemphasized.
Rather than speculators causing the boom and bust of
the late 1920's and early 1930's, I suggest a close look
at the course of the stock of money. Speculators may
have some short-run impact on common stock prices, but
the main line of causation is not from stock prices to
economic activity; it is rather from economic activity to
expected corporate earnings to stock prices.


-12Similarly, monetary policy should be made
independent of most balance of payments considerations.
Our domestic economy is too important to impair its
functioning in any way in order to achieve some specified
balance of payments level or to maintain some specified exchange
rate. Other means are available by which the balance can be
altered with no damage to the domestic economy.

I suggest

some type of flexibility in exchange rates as the appropriate
answer when relative values of national currencies change.
Other factors in monetary considerations of recent
years, such as viability of financial agencies and credit
for specific sectors, can likewise be determined by the market
place, provided useless interest rate restrictions are removed.
Ability to compete and willingness to pay should be of prime
concern to those who are in financial business and to those
who obtain credit. In this market-determined manner welfare
will be maximized.
In my view the economy is basically stable and
resilient. Most instability is caused by Government actions;
thus a prime concern of policy makers is to avoid unsettling
actions rather than attempts to correct assumed imbalances
in specific sectors or to achieve ideal conditions.
The Federal Reserve is eminently qualified to
control monetary aggregates. There is little doubt of its

-13ability to do this job and by doing so it can prevent major
recessions and major inflations. I have doubts concerning
the ability of the Federal Reserve to fine tune the economy.
It can offset major and longer-run swings caused by
exogenous factors, but perhaps we should be content with
the smaller economic recessions and expansions. I believe
that the monetary authorities can do this modest job of

economic stabilization by controlling the stock of money.
If it is determined after an earnest effort is made that the
stock of money cannot be controlled within an acceptable
range, I suggest either the monetary base or bank credit
(absent Regulation Q) as an acceptable substitute.
Furthermore, I suggest that all secrecy be
eliminated and psychological reactions of the public be
ignored in conducting monetary affairs. The so-called
"hidden hand view" holds that Central Bank actions can
only be effective if the public is ignorant of them. It may
be assumed that formulating monetary policy in secrecy is
desirable from the monetary authorities1 viewpoint on the
ground that the public would be unable to question the
wisdom of the action. In my view, however, the proceedings
of each FOMC meeting should be released to the public as
soon as possible after each meeting. The release should


-14be concise and in language that the public can understand.
If this is accomplished, the actions to be taken will influence
expectations rather than the reverse. These proposals will
provide the public with a means for testing stabilization
policies and actions while they are being formulated. They
conform to the democratic axiom that monetary business is
Government business and Government business is the
public's business.