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Darryl R. Francis
President, Federal Reserve Bank of St. Louis
The Money Marketeers
New York City, New York
Wednesday, October 30, 1968

Anyone who is seriously interested in economic stabilization
policy may oe very much in a quandary at the present time. There
is general acceptance of the goals of stabilization policy which include
high employment, rising output, and relatively stable prices. However, there is much debate regarding methods and procedures for
achieving these goals.
A case in point is the fiscal package adopted this past summer.
There was widespread belief at the time of its adoption that the surtax
and the curbs on Government expenditures provided a massive dose
of fiscal restraint. Some believed that this action offered an immediate
and strong restraint on the rate of increase in total spending, leading
thereby to a reduction in inflationary pressures. In fact, some
analysts argued that there was need for relaxation of monetary restraint,
such as there was, to avoid a recession in late 1968 or early 1969.
Such consequences of last summer's action have not as yet
materialized. Gross national product rose at an excessive 9 per cent
rate from the second to the third quarter, only a little less than the
inflationary 11 per cent rate of increase from the first to the second
quarter. The over-all price index rose at about a 4 per cent rate in
the third quarter, continuing the trend of the past year and a half.
These unexpected developments have produced considerable concern
among monetary and fiscal authorities, as well as among interested

-2segments of the public in general. Questions are now being raised
about the validity of some generally accepted propositions underlying
monetary and fiscal management.
Tonight I will discuss an approach to monetary and fiscal
management which I believe may provide a basis for more rational
economic stabilization policy. I will identify this approach as the
"Monetary View." It is my opinion that the usual division of fiscal
and monetary actions into separate entities with differing relative
importance has frequently led to inappropriate and unexpected
developments. Price stability and high employment achievements
have often been less satisfactory than would have been practical.
Before moving on to the main body of my remarks, I want
to clarify briefly my use of the term "Monetary View." Most economists
today believe that monetary actions have an important role in economic
stabilization, but there is lack of agreement on what constitutes such
actions or their relative importance. Many economists stress the
influence of monetary authorities in terms of market interest rates.
Others measure this influence in terms of member bank reserves,
the monetary base, the money stock, or similar aggregates. Still
others consider changes in various measures of credit to be important.
The view I discuss tonight holds that for economic stabilization
purposes monetary actions are best measured by changes in the
money stock and that such changes are a major factor determining
total spending, that is, gross national product.

-3I will develop this view in a sequence of three topics:
first, some basic premises underlying this approach to economic
stabilization; second, some specific principles regarding monetary
management which follow from these premises; finally an appraisal
of the current economic situation in terms of these principles.
Four Basic Premises
In discussing a proposed approach to monetary and fiscal
management, one must set forth at an early stage its basic premises.
Failure to do so often leads to misunderstandings. Of course, there
is a hazard — explicit assertion of underlying premises may lead to
challenge and possible doubt being cast on the recommended course
of action. Yet, the desire to improve monetary and fiscal management necessarily involves a willingness to subject all recommendations
to close examination by others. Development of proper procedures
for economic stabilization will evolve only through a process of offering
propositions which may be subjected to repeated examination and
Accordingly, I advance the following four premises underlying
my version of the Monetary View. First, a predominantly market
orientation is most appropriate for monetary and fiscal analysis.
Second, quantification is essential if economic stabilization is to
become more of a science than a guessing game. Third, our economic
system is more stable than was believed a few years ago. Fourth,

-4monetary management is more properly directed toward influencing
changes in total spending than toward concern for its impact on
selected markets. Let us now examine each in more detail.
Premise One - market orientation - holds a foremost
position in current economic thinking. A basic principle of economics
is that free markets are the most efficient allocator of both real and
financial assets. Free interplay of market forces results in an
efficient allocation of scarce resources and in production directed
by the public's preferences.
Contemporary theories of monetary and fiscal management,
as distinguished from traditional Keynesian economics stemming
from the 1930's, stress the role of individual markets. These current
theories have gained growing emphasis since the early 1950's. They
are based on an examination of the factors determining consumers'
or businessmen's choices among a wide variety of real and financial
assets. Decisions of these and other economic units are studied
as they are manifested through the operations of markets. At a
fundamental level there is little basic difference between the "portfolio"
extension of traditional Keynesian economics and the "broader portfolio"
approach to economic theory sometimes called the "Modern Quantity
Theory." Some noted economists identified with the modified Keynesian
or "portfolio" view are James Tobin, Paul Samuelson, and James
Duesenberry. Leading advocates of the Modern Quantity Theory include

-5Karl Brunner, Allan Meltzer, and Milton Friedman. Despite some
differences, both views are market orientated.
Premise Two - quantification of both actions and results is required for development and implementation of rational procedures
for stabilization policy. Those responsible for carrying out stabilization responsibilities require considerable knowledge of the probable
results of any particular course of action. Such knowledge includes
identification of strategic variables and specification of operational
hypotheses about the end results expected from alternative courses
of action. Development of this knowledge requires empirical verification of various economic theories.
Not only the results, but also the actions, must be measurable.
Rational economic stabilization policy requires that its operations be
conducted in terms of specified and measurable changes in strategic
variables. Vague concepts such as "easier," "tighter," or "more
restrictive" carry little operational content for monetary management.
If the FOMC directive contained truly quantified instructions, those
responsible for its implementation would receive definite rather than
impressionistic instructions. Under these conditions monetary
managers at all levels could be held accountable for the success or
failure of their actions.
This ideal of quantification is not out of reach. Since World
War II much research has pointed to the possibility of improving the

-6precision of economic stabilization. Statistical analyses and
econometric procedures have been applied to a wide variety of
economic problems. Quantitative methods for making decisions
in the face of uncertainty have been successfully applied to many
problems of business management. It is time that scientific
methodology and modern quantitative analysis be used to a greater
extent in developing appropriate procedures for monetary and
fiscal management.
Premise Three - inherent economic stability - is beginning
to play a more important role in thinking about economic stabilization
policy. Until recently there was quite general acceptance of the
view that there is basic instability in the economy which produces
wide fluctuations in output and employment. Some recent studies
have cast considerable doubt upon this view. In its place is proposed
the proposition that there is a high degree of inherent stability in
our economic system. According to this proposition, population,
natural resources, capital formation, and technology determine
growth in output of goods and services. Since these factors change
slowly and exert a powerful influence, they provide great underlying
stability to the trend growth of output and employment. Variations
in total spending can be induced by monetary and fiscal actions, but
they have only a short-run effect on output and employment. In
the longer run they mainly affect the price level.

-7Premise Four - focus on total spending rather than on
conditions in individual markets - is based on the generally accepted
proposition that economic stabilization actions should be concerned
primarily with prevention of inflation or deflation. Such price
movements are viewed as detrimental to the well-being of our citizens.
At times actions are required to match growth in total spending to
growth permitted by increases in our economy's productive potential.
Such actions may be viewed by some as impinging unduly on certain
sectors of our economy. But when free markets are allowed to
channel the influence of monetary and fiscal actions throughout
the multitude of individual markets for goods, services, and financial
assets, over-all economic efficiency and individual freedom will be
less affected. Of course, many markets do not meet completely the
criterion of "free"; but nevertheless, the allocation of resources
through imperfect markets is to be preferred over allocations made
by administrative fiat. Furthermore, markets could be made more
free if various price and interest rate controls were relaxed.
Propositions for Monetary and Fiscal Management
Application of these four basic premises leads to a number
of specific propositions regarding the conduct of monetary and
fiscal management. Let me now discuss these propositions as they
apply to the monetary aspects of economic stabilization policy.

-8Monetary management is properly directed, in the main,
toward influencing movements in total spending for goods and
services. Such movements should be consistent with price level
and employment goals and with fulfillment of our economy's
productive potential. Incidentally, the inherent stability I mentioned
previously still leaves room for discretionary monetary management.
Monetary forces must be managed if they themselves are not to be a
source of economic instability. Also, the impact of Government
deficits and surpluses on total spending depends greatly on the extent
to which monetary authorities monetize changes in the national debt.
Recent theoretical and empirical research has raised doubts
regarding the validity of some widely held concepts of monetary
management. The use of such vague concepts as "tone and feel"
of the money market have been found to carry little useful information. Measures of money market conditions such as market interest
rates and free reserves have been shown to be poor indicators of
the influence of monetary actions. These two measures are affected
greatly by forces other than actions of monetary authorities; hence,
interpretation of their movements for economic stabilization purposes
is problematic. Likewise, "tight money," as measured by money
market indicators (in other words, high interest rates) does not
necessarily indicate restrictive monetary actions in terms of their

-9influence on growth In total spending. Instead, high or rising
interest rates are frequently the result of excessive monetary
stimulus in the past rather than of present restraint.
Primary and consistent use of monetary aggregates, a
practice which has not prevailed heretofore, would seem to be
essential for sound monetary policy. Certain aggregates such as
Federal Reserve credit, member bank reserves, the monetary base,
and the money stock have been shown on theoretical and empirical
grounds to be useful and important tools of monetary management.
All of these aggregates can be rather precisely controlled by
monetary authorities. Much of contemporary monetary theory
and related research has assigned an important role in economic
stabilization to some of these or closely related measures. In
many recent studies changes in the outstanding volume of these
aggregates are viewed as influencing total spending through changes
in market-determined prices and interest rates. But I want to point
out that it is changes in monetary aggregates which initiate changes
in total spending; interest rates and prices only constitute the
transmission mechanism. For stabilization purposes, movements
in interest rates should be viewed no differently than movements in
commodity prices.

-10The monetary view I am espousing includes the
following points. Changes in Federal Reserve credit are under
direct Federal Reserve control and have been found to be the
main determinant of the monetary base. Since the monetary
base is subject to rather precise Federal Reserve control, it is a
very useful indicator of Federal Reserve actions. This statement
holds regardless of what indicator is used by the Federal Reserve,
because the result of System actions is reflected in the monetary
base. A very stable empirical relationship has been found to
exist between the monetary base and the money stock. Consequently, the money stock is viewed as a good measure of over-all
monetary influence. It reflects primary actions of the Federal
Reserve System, taking account of decisions of others involved
in the monetary process, specifically, commercial banks, the
nonbank public, and the Treasury.
This brings me to the most important aspect of my
suggested approach to economic stabilization — the proposition
that monetary actions are a major determinant of short-run
movements in total spending. This is in contrast with much
of the current economic stabilization theory and practice. It
has been fashionable to ascribe to fiscal actions a large and

-IIimmediate effect on total spending and to monetary actions a
small and long delayed effect. Consequently, taxing and
Government spending actions have been assigned the major
role in economic stabilization. Monetary actions, according
to some proponents of this dominant view, are of small consequence,
with little effect on total spending, output, and prices. These
same proponents argue, however, that monetary actions have a
potential for doing great harm to specific sectors of the economy,
for example, thrift institutions and the housing industry. They
conclude that actions of monetary authorities are more properly
directed toward the well-being of these sectors than toward influencing
total spending.
Much research has recently been devoted to testing
the proposition that monetary actions are a major determinant
of total spending, but the issue is far from settled. Friedman
in the early 1950's advanced on empirical and theoretical grounds
the proposition that money is the most important determinant of
economic activity. In extensive tests conducted a few years ago
in collaboration with Meiselman, he concluded that money rather
than autonomous expenditures, which include fiscal actions, is
the major determinant of consumption expenditures. This

-12proposition was immediately challenged by several economists.
Modigliani and Ando, major figures in this debate, reported
tests which showed that money was an important, but not
the most important, determinant of consumption spending.
Mayer, one of the original challengers of the Friedman
position, concluded in a recent book that much recent evidence
supports the view that the money stock, and therefore monetary
policy, has a substantial effect on income. He points out,
however, that there is not general acceptance of the view that
the money stock has a dominant effect.
All this research did not test directly the relative
importance of monetary and fiscal actions in economic stabilization. At the Federal Reserve Bank of St. Louis we have recently
made an attempt to test their relative importance. I summarize
the results of this research as an example of one attempt to provide a more scientific underpinning to stabilization policies.
The time period examined was from 1947 to mid-1968.
Monetary actions, measured by changes in the narrowly defined
money stock, accounted for about 40 per cent of the variation of
quarter-to-quarter changes in GNP. Changes in tax rates were

-13found to have little, if any, direct influence on changes in
GNP. Changes in Government expenditures explained a
comparatively small per cent of changes in GNP. This evidence
does not support the conventional view that fiscal actions evoke
a larger and faster response in total spending than do monetary
The influence of monetary actions on GNP is quite
large in the quarter in which they occur, larger yet in the
next quarter, and is fully manifested by two quarters after
action is taken. The influence of changes in Government
spending, on the other hand is relatively small, and its impact
is not fully manifested until three quarters after a change.
Once again, the conventional view is not supported.
These results suggest that the following hypotheses for
economic stabilization are more appropriate than the conventional
ones used at the present time. The response of total spending to
changes in the money stock is relatively large and fast. By
contrast, the response to changes in Government taxing provisions
is negligible. Furthermore, the response of total spending to
changes in Government expenditure programs is much smaller
than its response to changes in money, and the ultimate effect
takes a longer time interval.

-14An additional point raised is that the manner of financing
Government expenditures provides the main avenue by which
fiscal actions influence total spending. Financing expenditures
by borrowing from the public is not much different in its impact
on total spending from taxing. Government expenditures financed
by monetary expansion, however, will be expansionary. Most
studies, until recently, using traditional Keynesian analysis
ignore this consideration.
Another result of our research on the determinants of
total spending is that forces other than monetary and fiscal actions
exert a significant influence, but that this influence is less than
that of money. These other forces have not been examined in
detail, but it is believed that they include changes in consumer
and investor preferences, outbreak of war, and strikes in major
industries. There is considerable doubt in my mind whether any
stabilization actions could provide effective offsets to such forces
as these.
The hypotheses advanced by this research should, of
course, be subjected to repeated testing. As I said earlier, only
by advancing propositions, testing them, and having them challenged
by others will progress be made toward developing rational procedures
for economic stabilization.

-15Finally, the evidence pointing to the strength and speed
of the influence of monetary actions on total spending leads to the
conclusion that attempts by monetary authorities to control
developments in specific markets are undesirable on both allocation
and stabilization grounds. Regulation of interest rates paid by
commercial banks and thrift institutions unduly disrupts the
allocation function of markets. Furthermore, excessive concern
for the well-being of these institutions and the housing industry
have caused monetary authorities to expand the money stock at a
rapid rate during much of the current inflationary period.
Undue concern for the well-being of the Government
securities market and the concept of "even keel" during Treasury
financing are other impediments to rational monetary management.
These considerations have greatly hampered the carrying out of
monetary actions designed to influence or to maintain an appropriate
rate of expansion in total spending. For example, during the last
nine months of 1967 the FOMC imposed the even-keel constraint
more than half the time. In those periods the money stock grew at
a 12 per cent rate during Treasury financings and at a 4 per cent
rate the remainder of the periods. The result was an over-all
increase in money at a 7 per cent rate, an excessive rate of increase
in view of the mounting inflationary pressures.

-16In summary, the monetary approach to economic stabilization I have just presented incorporates the following points:
(1) Public stabilization policies should focus on
total spending, allowing markets to filter their
influence throughout the economy.
(2) Monetary actions are a very important
influence on changes in total spending.
(3) The money stock is the best measure of
the influence of monetary actions on
total spending, given the current state
of knowledge.
(4) Growth in total spending at a rate consistent
with price level and employment objectives
is more important to the over-all well-being
of our citizens than are monetary actions
directed toward the welfare of special sectors.
Monetary Interpretation of the Current Economic Situation
I now turn to a monetary interpretation of recent economic
developments. As a result of the fiscal actions of last June, it is
estimated that the high employment budget will swing from a $16
billion deficit (annual rate) in the second quarter of 1968 to a $15
billion rate of surplus a year later. This $31 billion turnaround

-17within a year has been cited as a massive dose of fiscal restraint.
The money stock continued to rise rapidly up to mid-summer
followed by a more moderate rate of growth in the last three months.
For purposes of this analysis, I will use the propositions
advanced by the study I reported earlier.

It concluded that the

response of total spending to monetary actions is much larger than
the response to fiscal actions and that the monetary response
occurs within a shorter time period. Applying this proposition,
little slowdown in GNP growth should have been expected in the
recent third quarter. GNP was under the influence of rapid
monetary expansion in the previous two quarters. One factor
tending to offset partially the influence of the rapid monetary
expansion to July on GNP was the rundown in steel inventories
built up in expectation of a strike. This factor, however, was not
related to stabilization actions.
What does the results of this research imply for the
influence of the fiscal package? The impact would come from
sources other than those cited last summer. The increase in
tax rates by itself, according to our study, would have virtually
no influence on total spending, and a reduced rate of increase in
Government spending, if implemented, would have only a small
direct effect. The main restraining influence of the fiscal package

-18would result from the Government having to finance a smaller
deficit, thereby relieving upward pressures on interest rates.
Attempts to offset such pressures in the past have induced excessively
rapid monetary expansion during inflationary periods.
Growth of GNP during the next three quarters, according
to this monetary view, as supplemented by our research, depends
largely on the rate of increase in the money stock. If money should
rise rapidly, there will be little reduction in the rate of expansion
in total spending. Only if the recent slower rate of monetary expansion
is continued will there be appropriately slower growth in total spending
and a reduction in inflationary pressures.
In conclusion, I want to point out two important implications
of this monetary view for the conduct of economic stabilization
policies. First, the proposition that monetary actions, measured
by movements in the money stock, have a large and immediate effect
on total spending implies that the monetary authorities should not
engage in activities which cause large swings in growth of money.
Second, the proposition that the influence of fiscal actions is
comparatively small and longer delayed implies that if we are to
have appropriate results from stabilization policies, monetary
authorities should not wait for fiscal measures to be undertaken
before changing the thrust of their own actions.