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Speech by Darryl R. Francis, President
Federal Reserve Bank of St. Louis, to the
Program for Management Development Group at
Harvard Business School, April 1, 1968
In the brief span of one hour, we could barely list, let
alone discuss, the problems of the management of our economic
stabilization tools, and it is my understanding you have had considerable comment on the quantity theory. As a result, I shall focus
attention on some of the more prominent problems encountered
in monetary management during 1967 and early 1968.
In recent years, much has been said concerning the
art of "fine tuning" the economy through the use of fiscal and monetary tools. Yet, it seems that those entrusted with these tools are
probably as far from "fine tuning" the economy today as I am when
adjusting the picture on my television set. Generally, by trial
and error 1 find a usable picture, but seldom is it the sharp, clear
Image that the ads promise.
Much of the enthusiasm for "fine tuning" the economy
developed following the tax cut of 1964. Although the economy had
been expanding for several years, a significant volume of resources
remained unemployed. It was widely felt that additional stimulation

-2vvas desirable. After much persuasion, Congress cut taxes at a
time when substantial budget deficits already existed (an almost
unheard of experiment). Shortly thereafter, increases in spending,
production, employment and income began to accelerate about as
the advocates had predicted.
The degree to which the tax cut in mid-1964 was responsible for the quickening in economic activity will not be examined
here. Suffice it to say that about a month after the tax cut was enacted
the Tonkin Gulf affair occurred and a major build-up for Vietnam followed to put heavy claims on our productive resources. Also, monetary
actions had turned more stimulative about mid-1964.
The enthusiasts for controlling the economy within narrow
limits would not admit other explanations. They had advocated a
policy; it was adopted, and the expected results followed. For them
a new era had, indeed, dawned. It was overlooked that although
this action was initially advocated in the "Economic Report of the
President" in January 1962, and would have been even more aporopriate at that time, it was not made effective until two and one-half
years later in mid-1964.

-3Some advocates of "fine tuning" by fiscal actions are
becoming disillusioned on this timing issue. It was a slow and
tedious process to get Congress to enact the tax cut, but it seems
even more of a task to obtain a tax increase. Since late 1965 the
economy has obviously needed fiscal restraint (a tax increase or
less Government spending), but Congress has not acted. It is now
becoming evident that military, welfare, and political considerations
prevent measures desirable for overall economic stabilization from
being adopted to the proper extent and at the appropriate time.
As a result of this recent experience, more reliance is
being placed on the role of monetary policy in "fine tuning" the
economy. Here, it is alleged, is a tool whose managers are experts
in stabilization. They meet almost continuously and are able to
adjust their actions very finely. It is believed that they have few
other responsibilities to distract their attention. There has also
been a revival in confidence in the power of the monetary mechanism
after its virtual demise in the 'thirties and 'forties. Did not the
economy slow in early 1967 following a period of monetary restraint
despite a very stimulative Federal budget? Let us now examine the
problems encountered in "fine tuning" the economy by the monetary
mechanism during 1967 and early 1968.

-4Monetary growth during 1967 was very rapid, the largest
in over two decades. From January 1967 to January 1968 total
reserves of member banks increased-10 per cent. By comparison,
reserves rose at an average 3 per cent annual rate from 1957 to 1966.
The money supply of the country — demand deposits plus
currency — went up 7 per cent in the twelve months ending this
January. From 1957 to 1966 money rose at an average annual rate
of 2.4 per cent.
Total commercial bank credit outstanding increased 11
per cent from January last year to January this year. By comparison,
bank credit grew at 7 per cent per year from 1957 to 1966.
By most aggregate measures this country experienced
monetary conditions that were extremely expansionary from early
last year until early this year. In evaluating the contribution of
these conditions to economic stability, one must also examine other
forces acting on the economy during this period, such as fiscal
measures. Then, too, the performance of the economy itself
must be reviewed.
Fiscal actions of the Government were extremely expansionary in 1967 and early 1968. Spending rose for both the

-5v/ar and welfare programs,- while tax. rates remained essentially
unchanged. The high employment budget, which separates the
effect of discretionary Governmental actions on the economy from
the effects of the economy on the budget, was at its most stimulative
level since World War III—over $11 billion in deficit. Preliminary
data indicate that the deficit continued near this level in early 1968.
This is about $10 billion more stimulative than in the 1966 period,
and over $20 billion more expansionary than the average of the
1960 through 1965 period.
At the beginning of 1967, following nine months of
monetary restraint, economic activity was on a plateau. Total
spending for goods and services rose at a 2.2 per cent annual rate
from the fourth quarter of 1966 to the first quarter of 1967, the
slowest rate for a quarter since the last recession in 1960. Real
production of goods and services actually declined very slightly
during this same quarter.
In the late spring of 1967, economic activity began
expanding, as expected when both monetary and fiscal developments
are very expansionary. At first, the upturn was slow and hesitant,
but as the year progressed it gained momentum.

-6Total demand for goods and services has been rising at
about a 9 per cent annual rate since early last summer. Sharpest
increases have been in outlays by businesses and Governments,
but consumer spending has also climbed despite much talk of a
higher saving rate.
Real output of goods and services has gone up at about a
5 per cent annual rate. Since productive capacity has risen at a
rate of about 4 per cent, unemployment has been reduced. Women
have been attracted into the labor force, and idle plants have been
put into operation. Many firms are operating at near effective capacity.
The sharper rise in spending than in productive capacity
has placed upward pressures on prices, caused a worsening in the
nation's balance of payments and encouraged international speculation
against the dollar. Since the second quarter of last year, the overall
price index, the GNP deflator, has risen at a 4 per cent annual rate.
Most economists agree that total spending on goods and
services has been excessive since last fall. Why, we might ask,
was monetary action continued at such a stimulative pace while
the eeonomy was overheating and developing excesses and imbalances?
The answer to this question may provide some insight into the
ability to "fine tune" the economy by monetary action. To respond

-7to this crucial question, let us examine several subperiods of the
past 15 months.
The first period might cover January through June of
1967. In retrospect, it appears that expansionary monetary
actions were entirely appropriate in this period, contributing to
optimum utilization of our resources. As noted previously, the
economy paused in early 1967. Production declined, and many
thought the country was on the threshold of recession. In the
April 1967 issue of the St. Louis Bank Review the question of "Economic
Plateau or Downtown?" was examined with the conclusion that "this
question cannot be conclusively settled at this time (early April)."
In view of the slack in the economy and the widespread fear of a
recession, historians will no doubt conclude that the stimulative
monetary actions during early 1967 were appropriate.
A second period might run from sometime in June to
late November of 1967. During this period spending accelerated
rapidly. Even though there v/as a major auto strike, output rose,
unemployment declined, and inflationary pressures intensified.
Most analysts concluded that the economy was developing excesses.
Nevertheless, monetary actions continued to be very expansionary.

-8As early as the May 23 meeting of the Federal Open
Market Committee, the published record quotes me as having
"expressed the view that monetary policy had been highly stimulative
thus far in 196?, that fiscal policy was providing an increasing
stimulus, and the economy was responding relatively quickly.
On the ground that a marked increase in demands for goods
and services was likely later in the year and that monetary actions
had their main effects after some time lag, I thought some firming
in the money market should be sought now to guard against the
development later of excessive demands and associated inflationary
Why, then, did money developments continue to be
stimulative in the summer and fall last year? In short, the
monetary managers faced a large number of other issues which
placed constraints on their actions.
The first constraint was one of knowledge. During the
summer months, analysts could not agree on whether or not economic
activity was quickening. Data are available only after a one or two
month lag, and since most economic time series contain irregular

-9fluctuations, it is dangerous to rely on figures for only one or two
months as a signal for the beginning of a new trend. My statement
in May was based chiefly on past relationships of expansionary
monetary and fiscal actions to changes in the growth rates in
spending. There were few solid business statistics to support the
belief of an economic upturn during the early summer. Therefore,
1 cannot criticize others who had honest differences of opinion
on the course of the economy for retaining the policy of continued
monetary expansion in the early summer. This lack of ability to
determine the strength of economic activity promptly is a serious
limitation on our capacity to "fine tune" the economy.
Sometime in late summer when it became abundantly
obvious that the economy was strengthening, another knowledge
constraint emerged. In the initial months of the upturn, there
was great uncertainty over how much monetary restraint, or more
properly how much withdrawal of stimulation, the economy could
withstand without reverting to less than acceptable rates of growth.
Even after activity began expanding at a fairly rapid rate, some
felt that it was preferable to continue the stimulation and run a
risk of excessive demands than to tighten and run the risk of
inadequate demand. This lack of knowledge of the effects of alternative monetary actions on the economy was another limitation on the
central bank's ability to adapt promptly.

-10A third uncertainty developed in the summer and fall of
1967 because various financial indicators gave contradictory readings
regarding monetary developments. Member bank reserves, bank
credit, and money were expanding rapidly, an indication of
monetary ease to those who believe that monetary aggregates are
the proper guide to monetary influence. On the other hand, most
market interest rates rose during the summer and fall, many
reaching their highest levels in about 40 years, indicating monetary
restraint to analysts who believe that money market conditions are
the most reliable guide to monetary influence. The lack of agreement on how to measure the effect of monetary actions caused honest
differences of opinion to develop among those responsible for
monetary policy determination. Such differences tend to prevent
the central bank from responding quickly to changes in economic
Another constraint on monetary managers in the late
summer and fall of 1957 was the fear of a financial panic. Recalling
the so-called financial "crunch" in the early fall of 1966, there was
a-considerable school of belief that such conditions should be avoided
at virtually all costs, The problem arises because there are many
rigidities in our financial system—usury laws, institutional
practices, and other limitations on Interest rates. Hence, when

-11interest rates rise above certain levels, some activities cannot be
•financed at any price. When dramatic increases occur in interest
rates, most financial intermediaries by borrowing short and lending
long, incur sharp losses. Then, too, rapid increases in interest
rates usually have a marked effect on residential building and
other activities where interest cost is a large portion of total costs.
Conversely, others are much less concerned by the
problems of the "crunch." Even in 1956, when ! think all agree that
monetary actions became unduly restrictive, the financial system
continued to operate moderately well. Those problems that did
arise were probably caused by the excessively expansionary monetary
actions taken earlier which brought about higher interest rates.
Other problems were caused by the legal and traditional limitations
on interest rates, which should be removed rather than permitting
them to hamper overall monetary action. !n essence, the problem
faced in such periods is one of excessive total demands. Proper
monetary actions cause some of these demands to be postponed
or withdrawn. In the past this adjustment has been accomplished
fairly well. Perhaps, the adjustment might be made more equitable
between the various sectors of the economy if there were fewer

-12interferences to the free market, but until the unrealistic limitations are removed, should the benefits of overall stabilization be
sacrificed in deference to a particular segment of our economic life?
Honest differences on the possibility of a financial panic
undoubtedly ied to further procrastination in adopting monetary
action to cope with the excessive demands. My own preference
would have been to probe a little more aggressively toward monetary
restraint last fall. But, others were genuinely concerned that the
costs to particular sectors would outweigh any supposed benefits
to the overall economy and might even have brought about a downturn
in overall activity. Until this issue of the effects of a marked tightening
in money markets is settled, a truly "fine tuning" of the economy will
be severely limited.
Another constraint on monetary action last fall arose
because of a desire for a coordinated application of the various
stabilization weapons in curtailing the excessive demands. Even
after it became widely believed that aggregate demand was unduly excessive, it was equally widely believed that a chief cause was the stimulative
fiscal actions. It was felt that a tax increase (or less Government
spending) was urgently needed. Such an action would both remove

-13a powerful stimulant to the economy and by relieving the strong
budgetary pressure on capital markets would eliminate a strong
upward force on interest rales, making control of monetary expansion easier. Because of the strong belief in the desirability of
a tax increase, these advocates favored taking a calculated risk of
postponing monetary action in the belief that such a course would
be the most likely to encourage Congress to pass a tax increase. Our
own view was that the overall public interest lies in the best possible
monetary action regardless of what other agencies do or fail to do,
but until this question of proper mix of the various stabilization
measures and their interim roles is settled, another serious limitation is placed on quick, decisive, monetary response.
Because the Government operated at a large cash deficit,
and has a huge Government debt with a relatively short average
maturity, there was an almost continuous flow of Government
security offerings last fall. These offerings placed another constraint on monetary actions. There is a doctrine called "even keel"
which usually prevents any changes in monetary policy in the period
from a few days before the Treasury's announcement to a few days
after the securities are distributed. The practice has a long tradition
in both this country and abroad. At the St. Louis Bank we believe

-14that even keel has been a serious impediment to System action,
we fail to understand its advantages to the Treasury, and we urge
that the academic community invesilgate the advantages and disadvantages of this practice. Our studies indicate that as long as
the practice of even keel continues, "fine tuning" of the economy
by monetary actions will be limited.
Another constraint on monetary action late last fall was
the deteriorating British balance of payments. The situation in
Britain wasserious, and it was felt that any action by this country
causing interest rates to rise further might precipitate an additional
outflow of funds from Britain. In short, until the world adopts a
viable international payments mechanism, another periodic limitation
is placed in the way of a quick response of the monetary authorities
to solve domestic economic problems.
This is not an attempt to list all constraints on monetary
actions, but only to outline some of the major factors which actually
caused monetary action last fall to be more expansionary than many
of us in the Central Bank would have desired. Until these issues
are squarely faced and solved, a rapid adjustment of the monetary
mechanism is not likely to occur.

-15The third monetary policy period 1 would like to discuss
runs from late November of last year to late January of this year.
The period can be characterized as one of ineffective action. Monetary
policy actions were taken with regard to all three of our monetary
tools but there was no commitment to pursue real monetary restraint.
In late November, the discount rates were raised 1/2 of
1 percentage point to a level of 4-1/2 per cent. Although this action
had the appearance of monetary restraint, it had virtually no real
effect. Even at 4-1/2 per cent, the discount rate was about 1/2 of
1 percentage point below market rates. Funds at the discount window
continued to be rationed by the same rules of administration as
before; the rate was no deterrent.
In mid-December, the open market committee adopted
a more restrictive policy provided no unusual liquidity pressures
developed. Yet, except for the much criticized "free reserve"
measure, not much change occurred in money market pressures
or in the growth rates of member bank reserves, bank credit and
money until nearly the end of January. In mid-January, reserve
requirements of member banks were increased about $550 million.
However, in order to prevent undue market pressures from

-16developing during the two week period, open market operations
injected a sufficient volume of new funds to more than offset the
effects of the higher requirements.
The November to January period was not unusual. During
most shifts in monetary policy, there have been lags between the
time when policy makers adopted a new policy and the time that it
has been effectively implemented. Because of the aforementioned
constraints which operate to delay the policy action, there is a great
hesitancy to move vigorously once a new course is accepted. Action
is taken siowiy and continuously in a probing manner in order to
attain some monetary restraint but to minimize other problems. Also,
some seem to have naive faith that the announcement effects of the new
policy, alone, will have the needed beneficial effects. I don't believe
that sophisticated money market participants are quite that easily fooled.
A fourth period of monetary developments will be touched
on only briefly. Since late January of this year, it appears that there
has been real restraint. Most aggregate measures of monetary
actions have slowed, and most of those involved in making monetary
policy appear to be convinced that the problems of excessive total

-17demand are so serious that action is desirable despite the risks
discussed. Although this period has been brief and the effects
may not all have emerged, an early evaluation indicates thatmany of the earlier concerns with regard to adopting the policy
shift haye not occurred.
In summary, there were many constraints on a quick
monetary response to the changing economic developments of the
past year. The lack of knowledge about the course of economic
activity and monetary effects was a serious limitation last summer.
We at the St. Louis Bank, and those in other parts of the System,
are conducting many research studies designed to increase our
understanding. This is essential if monetary action is to be
The hesitation to move toward monetary restraint because
the effects may bear heavily and unreasonably on particular sectors,
such as financial intermediaries and home construction, does not impress us
as a valid excuse to fai! to do what is in the overall public interest. Our
studies indicate that most of the problems in these sectors have been
caused by market imperfections, such as rate regulation, and not by
monetary developments. Our studies also show that excessive monetary expansion with the accompanying rises in prices and nominal

-18interest rates are more harmful to the housing market than a
policy designed to provide a more moderate growth in total demand
and fewer inflationary pressures.
The hesitation to adopt appropriate policy in order to improve
the chances of obtaining a desired tax action seems to us unjustified. The central bank's responsibility is monetary policy. 1 do
not have much faith in the System's ability to conduct monetary
policy in such a way as to guarantee the adoption of responsible fiscal
Similarly, we fail to understand the great need to stabilize
the money market during periods of Treasury financings, or to
deviate from sound policy because of the periodic problems arising
from international movements of funds.
In short, monetary authorities, in our opinion, should
determine policy on the basis of maximum contribution to overall
economic stability and growth. It should not subordinate the overall
public interest to the excesses of other public bodies or for the
benefit of particular private interests.
The experience of the past year indicates that a "fine
tuning" of the economy by the monetary mechanism sti!! leaves much

-19to be desired. In addition to the recognized problems of our ability
to forecast and the lags of monetary effect, there are tough problems
of choices monetary managers must make in formulating policy. As
I pointed out there were many real issues presented to the monetary
policy makers during 1967. Differences of opinion existed on how
much weight should be placed on these constraints by the various
participants. Until these constraints are resolved, a quick response
by the monetary authorities to a change in economic conditions is
not likely.
The potential of the monetary system for providing a quick
countervailing force to undesirable economic developments has not
been attained. As a result, perhaps we should forego some of the
claimed benefits of "fine tuning," which have been largely illusory
and at times destabilizing. Alternatively, monetary authorities, might
strive for a steadier rate of growth in bank reserves, bank credit,
and money. Such actions would contribute to economic stability.
They may not achieve the ideal "fine tuning " however, they would
be considerably more stabilizing than our past stop-and-go actions
hindered and slowed by constraints and the lags of effect.

-20Please do not interpret this proposal as being in the
Friedman uniform rate of growth in money school. We at the St. Louis
Bank do not suggest that in periods of severe recession or excessive
boom that varying the rate of monetary growth cannot contribute
to economic stability. We merely suggest that, in an aggressiveness
to seek an optimum level of economic activity at all times combined
with the constraints imposed on reversing these actions, monetary
developments have, many times, been more destabilizing that stabilizing.
Meanwhile, we suggest a strong program of research for
improving the monetary mechanism so that it may become more
adaptable in the future. In this research, the academic community
can be of great help in investigating and analyzing these constraints
to stabilizing actions. Until they are eliminated or greatly reduced,
a true "fine tuning" of the economy by flexible monetary action is
not likely.