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Speech by Darryl It. Francis,, President
Federal Reserve Bank of St. Louis, to the
Tennessee Association of Realtors
At Its 50th Annual State Convention
NAREB Regional Convention
Rivermont-Holiday Inn
June 13, 1969

It is good to have this opportunity to discuss some important
policy issues with Tennessee Realtors. The issues which I propose to
discuss revolve around government policies and actions designed for economic stabilisation.
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.
considerable doubt upon this view.

Some recent studies have cast

In its place is the proposed view

that there is a high degree of inherent stability in our economic system.
According to this view, 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.
However, it is also increasingly recognized that fiscal and monetary
actions of the government can be a source of short-run instability since,
if improperly used, such actions can force the economy off of our highemployment stable-price growth path. One of the most important
controversies presently facing those of us concerned with stabilization
policies is the choice of reliable indicators or summary measures of the
ways fiscal and monetary actions of the government influence the economy,
I would like to discuss this problem with you.

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Recent Experience
The recent record of national economic stabilization policy has
left much to be desired.

For almost five years we have had an accelerat-

ing 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, the budget deficit, monetary expansion or
from some combination?

Is the cure for the inflation to be found primarily

in budget policy or in monetary policy?
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 under control quickly and would soon limit the
rate of inflation. Yet, prices have continued to rise.

Fiscal Views
More 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. The 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

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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

It is widely believed that these deficits have kept the economy

growing and, therefore, 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
approach, the growth rate of the stock of money provides the best measure
of the influence of stabilisation 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 and the
monetary base. According to this view, the level or movement of interest
rates or the growth of bank credit are frequently misleading.
I will approach the monetary view of economic stabilization by
discussing the following points: First, why have budget measures recently

Second, more generally, how reliable have such measures been?

Third, what are the merits of "money market conditions11 compared with

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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
summer 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
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

~ 5_

adjusted budget, commonly called the "high employment" budget. Throughout
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 rather 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 private 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 increased taxes is
the question of what the Government would have done as an alternative, and

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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

does 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 purchasing power 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.
As a result, the economy was expected 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

- 7-

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
employment budget as a measure of either fiscal or overall stabilization
influence on the economyIn 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

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

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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 attributable 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 that credit is tight

or easy, and it throws no light on what influence on total spending is
being exercised by the monetary authority.
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

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
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

- 9 -

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 the 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
demands 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 the "tightness" or "ease" 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?

- 10 -

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

To support this theory there is substantial empirical evidence

indicating that marked and sustained changes in the rate of growth of the
money supply have always been followed by changes in the growth of totalspending 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 the influence of
monetary policy actions.
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

- 11 that inflation would he with us for quite a while longer.
interest rates a year ago indicated

If the rising

a substantial degree of monetary

restraint," then when will this economy feel the effects of that restraint?
In 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
this past December indicates that a substantial degree of monetary res
has been achieved, but the ultimate impact of this restraint on total
spending will depend on its duration.
The money stock increased at less than a 2 per cent annual rate
from last December to March

which our research shows was a sufficient

degree of monetary restraint to eventually bring an end to the inflation.
However, in April some special factors caused money to jump sharply, and the
level of money remained fairly high in May.

Indications now are that the

growth ,of money from the first to second quarter will be about the same as
the fourth quarter last year to the first quarter.

I think we have made

substantial, although not yet sufficient, progress towards attaining the
necessary monetary restraint.

- 12 -

The available data, combined with statements of policymakers,
indicate that sufficient monetary restraint probably will be achieved,
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, and a temporary rise in unemployment. On
the more favorable side, such conditions would start reducing inflation,
and as inflationary expectations recede, market interest rates will
probably decline.
Let me summarize in a few words the message I hope gets through
from all I have 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

The record of the recent past has been sufficiently overt to convince

thoughtful people that further fine tuning budget experimentation can lead
only to the injection of unnecessary instability into an otherwise inherently
stable economic system.