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Speech by Darryl R. Francis, President
Federal Reserve Bank of St. Louis, to the
Annual Meeting of Stockholders
of the Federal Home Loan Bank
of Des Moines
Chase Park Plaza Hotel
St. Louis, Missouri
May 22, 1969
It is indeed a pleasure to be invited to address the stockholders
of the Federal Home Loan Bank of Des Moines. I -propose to use this opportunity to discuss government policies and actions designed for economic
For almost half a century our government has moved toward
greater participation in economic stabilization programs. The pressures
for such actions were accelerated with passage of the Full Employment Act
in 1946. Today there is little question of the desirability for government
actions to achieve our goals of high employment, stable prices and rising
output per worker. The argument centers around methods and procedures
for achieving these objectives.
Recent Experience
The recent record of national economic stabilization policy has
left much to be desired. For almost five years we have had an accelerating
inflation which we have not arrested either for lack of will or lack of knowledge
as to how to do it. Uncertainty about the role of the Federal budget and about
monetary policy has prevailed. Did the inflation come from the Federal spending,

-2the budget deficit, monetary expansion or from some combination? Is the
cure for the inflation to be found primarily in budget policy or in monetary
A recent experience with overt stabilization actions occurred last
summer when taxes were raised and the growth rate of Federal spending was
slowed. Some believed that these actions would bring the excessive growth
of total spending quickly under control and would soon limit the rate of
inflation. Yet, prices have continued to rise.
Fiscal Views
A/lore generally, we have heard a great deal in the 1960's about the
tremendous success of various fiscal policies, and particularly deficit spending,
in keeping the economy growing. Not too long ago, the financial press made
frequent reference to the number of months since the last recession.


implication was that the economy - at long last - could be "fine tuned."
However, as inflation has accelerated, we have heard fewer references
to successes. Rather, attention has been focused on the need to dampen the
excessive total spending.
With respect to fiscal actions, we are often reminded that the Federal
Government cut taxes in early 1964, and that the economy has grown rapidly
ever since. This observation generally implies a cause and effect relation,
namely, that the growth we have experienced since the early 60's has been
chiefly a result of that 1964 tax cut.
Also, the total national debt has increased every year in this decade.
It is widely believed that these deficits have kept the economy growing and,

-3therefore, have been desirable. Then, last year, this great fiscal force
was reversed in order to cool an overheating economy. Yet, so far the only
thing that has cooled is the talk about the beneficial powers of fiscal action.
Monetary Views
In addition to fiscal policy, it is generally thought that monetary
developments can influence economic activity. There are several monetary
approaches. One focuses on interest rates and other money market conditions
and another concentrates on credit. According to still another version,
the growth rate of money provides the best measure of the influence of
stabilization actions on total spending. Money is defined as demand deposits
plus currency. The Federal Reserve can manage the growth of money through
controlling Federal Reserve credit. According to this view, the level or
movement of interest rates or the growth of credit are frequently misleading.
I will approach the monetary view to economic stabilization by
discussing the following points: First, why have budget measures recently
failed? Second, more generally, how reliable have such measures been?
Third, what are the merits of "money market conditions" compared with
monetary aggregates as measures of monetary influence? Fourth, what
may we conclude about desirable monetary actions in the near future and
the probable course of the economy?
Failure of the Fiscal Plan

Both before and after Congress passed the budget package last

-4summer we heard many different ways in which the impact of such actions
would reach the economy. Let's talk about a few of these. One approach was
to argue that since taxpayers would have $13 billion less purchasing power
as a result of the tax increase and the Federal Government would spend
$6 billion less than otherwise, a total of $19 billion would be "taken out of
the spending stream." It was further argued that, after the initial $19 billion
reduction in total demand, incomes would grow less than otherwise and
increases in other spending would also be moderated. Because of this
"multiplier" effect, the ultimate reduction in total spending would be several
times the initial $19 billion.
A second method of assessing the influence of the budget package
was to note that the Federal cash deficit in fiscal 1968 was over $25 billion,
compared with only a $5 billion deficit projected for fiscal 1969. Hence, it was
said that total spending in the economy would be at least $20 billion less.
If there were a multiplier effect, the ultimate reduction in total spending
would have been much greater. Arguments along these lines ignore the
way the deficit is financed, a point we will return to in a few minutes.
A third way of assessing the influence of the budget package on
the economy was with reference to the change it would cause in a cyclically
adjusted budget, commonly called the "high employment" budget.


the early 1960's, this budget had been in large surplus, but the amount of
this surplus began to shrink rapidly in 1964, and toward the latter part of
1965 moved into deficit. From about 1966 to mid-1968 the deficit increased

-5rather rapidly, reaching an annual rate of $15 billion in the second quarter
last year. Thus, this measure of the budget moved from a $15 billion
surplus at the end of 1963 to a $15 billion deficit in mid-1968. Then, in
mid-1968 it was planned by means of the surtax and the cut in the growth
of Federal spending to swing the budget back from the $15 billion deficit a
year ago to a $10 billion surplus in the present quarter. According to
popular analysis, this swing in one year was to provide a "massive dose of
fiscal restraint."
In our judgment the spending stream view, the deficit view, and
the high employment budget view of assessing the influence of the fiscal
package of June 1968 on total spending in the economy overlooked several
key points. One question is whether the surtax would really reduce total
spending or merely redistribute it. When the Federal Government obtains
funds by taxing rather than by borrowing from the public, taxpayers have
less to spend, but real investors have more. Total demand for the goods
and services in the economy is not necessarily changed. Similarly, if the
government decision to spend less means only that less taxes will be collected
and/or the government will borrow less from the public, then total
spending - Government plus private - may not be affected.
A key point in evaluating the effects of such iincreasedtaxes is
the question of what the government would have done as an alternative, and
what would have been the source of its command over resources if taxes
had not been increased?
When the Federal Government operates at a deficit it means that
the Government spends more than it takes in through taxation. But this

-6does not mean that the Government really spends more than it takes in,
since it borrows an amount equivalent to the deficit. Total demand is only
increased if the deficit is financed by newly created money, as it has been
for much of this decade and especially in 1967 and 1968. If, as the Federal
government runs a deficit, and increases its sales of bonds, the Federal
Reserve adds to the total reserves of the banking system by purchasing
securities on the open market, then total purchasing power is increased.
The source of this increase in total purchasinq Dower and demands for
goods and services flows from the newly created money, not from the deficit
per se.
Key Fiscal Measures Unreliable
An analysis which uses the budget as a measure of the influence
of stabilization policies on the economy is incomplete. I am not familiar with
any theory, nor any empirical evidence, which supports the use of this
measure alone. The high employment budget moved sharply into deficit
during 1966 and 1967 indicating a high and accelerating degree of fiscal stimulus.
The economy was expected as a result to remain very strong. According to
any commonly used measure of fiscal influence, the pause in the growth
of total spending in early 1967 was unexpected and, in retrospect, unexplainable.
Similarly, the sharp swing in the high employment budget from large
deficits to large surplus after mid-1968 supposedly indicated a massive dose
of fiscal restraint. However, we have yet to see the results of this fiscal
action. Furthermore, recent research at the Federal Reserve Bank of St.
Louis has cast considerable doubt on the use of changes in the high

-7employment budget as a measure of either fiscal or overall stabilization
influence on the economy.
In short, the way the deficit is financed makes a crucial difference
in determining how much stimulus is indicated by a budget deficit or how
restrictive an influence results from a surplus.
We have no reason to believe that large deficits such as we have
had in the 1960's are in themselves any more stimulative to total spending
than the relatively small deficits in the 1950's after the Korean War. What
matters is how much monetary creation accompanies the deficit. Therefore,
when actions were taken last year to substantially reduce the deficit, the
relevant questions for assessing the restraining influence of such action
should have been: What will be the change in the rate of money creation?
And, how long will it take before any slowing in the rate of monetary
creation begins to slow total spending? Since the rate of monetary growth
has since slowed only gradually, it is not surprising that there has been
no reduction in the rate of inflation in the first three quarters following
the tax increase.
Interest Rates Also Poor Guideposts
Since it appears increasingly clear that monetary actions are
the prime stabilization influences in the economy, I would like now to
consider the choice between the growth of a monetary aggregate such as the
money supply and "money market conditions" or movements in interest
rates as the primary indicator of monetary actions. One criterion for
choosing an indicator of the influence of monetary actions from among the
various available monetary variables is that movements in the indicator be

-8attributable to policy actions. The policymakers must be able to know what
they have done.
Financial and business publications make frequent reference
to tight and easy money, and we all know what these words generally imply
in terms of interest rates. High or rising levels of interest rates are often
misjudged as tight money and low or falling rates are often thought to be
a sign of easy money .

But what is really meant is tight or easy credit,

and it throws no light on what influence is being exercised by the monetary
The Brazilian economy has typically experienced a very rapid
rate of inflation and simultaneously interest rates of about 40 per cent.
These high interest rates were a result of very easy or inflationary monetary
policies rather than a sign of monetary restraint. On the other hand, if we
examine the experience in the Swiss economy, we find that interest
rates have typically been the lowest in the world, averaging around 2 or 3
per cent. Once again, I think that we could agree that these low interest
rates in Switzerland have, in large part, been a result of public policies
of restraint.
Why is it then that high or rising interest rates, coupled with
accelerating inflation, really represent expansionary policies and that if
interest rates decline this would indicate monetary restraint? This is not
a new paradox. It was recognized many years ago that actual market interest
rates are equivalent to the expected rate of productivity of real capital plus the
rate of anticipated price increase over the term of the loan. For instance, if

-9the marginal productivity of capital is currently estimated to be about 3 per cent
a year, and most lenders and borrowers expect inflation for the indefinite
future at about 3 or 4 per cent per year, one would expect market rates
of interest of 6 to 7 per cent. Is there one of us here today who would be
willing to lend our money for the indefinite future at a 4 per cent rate if
we expected the rate of price increases to be 4 per cent per year more or
less indefinitely?
My point is that market rates of interest are directly responsive to
supplies and demands of funds in the capital markets. Any changes in
the demand for or in the supplies of credit by the private sector of the
economy cause changes in market interest rates. In addition, any change
in the flow of funds from Treasury operations,changes in international
liquidity flows, expectations about future events, international crises, etc.,
call for fluctuations of interest rates. Acceptance of the effect of all of
these factors on interest rates makes it only slightly less than amazing that we
still frequently hear references to movements in interest rates or-changes
in "money market conditions" as a measure of monetary policies. Can
stabilization policymakers in this country use interest rates as their indicators
if they cannot assess the influence of their own actions on interest rates?
Money Stock Best Indicator
On the other hand, we have a theory which says that changes in
the growth rate of the money supply cause changes in total spending in the
same direction. To support this theory there is substantial empirical evidence

-10indicating that marked and sustained changes in the rate of growth of the
money supply have usually been followed by changes in the growth of total
spending in the same direction. Research indicates that changes in the
growth of money have been fully manifested on total spending within a few
The Federal Reserve System, through its power to create and
destroy bank reserves, can control the money supply. Since there are
close causal links between changes in Federal Reserve actions and in the
money supply and between changes in the money supply and changes in
spending, I submit that the money supply gives us the best overall measure
of monetary policy action.
An example of the difference between the use of interest rates and
the growth of money as indicators of the thrust of monetary actions is
found in early 1968. Throughout the first half of 1968 the Federal Open
Market Committee agreed that a restrictive monetary policy was appropriate.
However, at several of the Committee meetings, the proceedings of which
have been published, some participants argued that a substantial degree
of monetary restraint had already been achieved, as indicated by the high
and rising market interest rates. Now it is true that interest rates rose
rapidly through the first five months of last year, but these rising prices
of funds were the result of very strong demands for credit enlarged by the
anticipation that inflation would be with us for quite a while longer. If
the rising interest rates a year ago indicated "a substantial degree of
monetary restraint," then when will this economy feel the effects of that

-IIIn contrast to the unreliable signposts provided by interest
rates, the money stock indicator pointed in the direction that the economy
actually moved. The money stock grew at a very rapid 7 per cent annual
rate in the first half of last year, about as rapid as in any six-month
period in the past twenty years. This rapid monetary growth in early 1968
has since been stimulating the economy. It was not surprising to those
who observe the economy from the monetary point of view that there was
little slowing in total spending in late 1968 and early 1969, and no improvement
in the inflation problem.
Most recently a monetary interpretation of the developments since
this past December indicates that considerable monetary restraint has been
achieved, but the ultimate impact of this restraint on total spending will
depend on its duration. Weekly data show that the level of the money stock
jumped sharply in early April, but by the end of the month had fallen to
the March level. The average level of money in the last four weeks was
up at only a 2 per cent rate from December.
Monetary analysis indicates that the growth of money in May
and June will have a very important bearing on total spending the remainder
of this year. If the level of money in May and June averages higher than
in early April, the growth of money this spring would be sufficiently rapid
as to offset any restraining influence otherwise resulting from the relatively
slow monetary growth from December to March. On the other hand, if the
money stock in May and June averages about the same as the lower March

-12 figure, a substantial slowing in the growth of total spending is likely to
be observed in the second half of this year.
The available data, combined with statements of policymakers,
indicate that effective monetary restraint will probably be maintained, and if
so, in the second half of this year smaller increases in total spending
can be expected. Slowing in the growth of total spending will be accompanied
at first by a slowing in the growth of real output, a decline in business
profits, arid a temporary rise in unemployment. On the more favorable
side, such conditions would start reducing inflation, and as inflationary
expectations recede, market interest rates wiil probably decline.
Let me summarize in a few words the message I hope gets
through from all I've said this morning.

It is my confident belief that the

long-run best interest of all the people in this country is best served by a
federal budget that is in balance or even moderate surplus. Within the
framework of a balanced budget monetary policy can create and maintain
an economic atmosphere that is conducive to optimum economic growth,
effective full employment, and a constantly improving standard of living
for all. The record of the recent past has been sufficiently overt to convince
thoughtful people that further fine tuning budget experimentation can
only lead to the injection of unnecessary instability into an otherwise
inherently stable economic system.