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Remarks Prepared by
Darryl R. Francis, President
Federal Reserve Bank of St. Louis
for Presentation to the
Argus Economic Conference
Phoenix, Arizona
November 22, 1969
It is good to have this opportunity to keynote these
seminars you will be attending for the next few days. Before
proceeding to what I have to say about "The New, New Economics
and Monetary Policy," let me place the two uses of the term
"New" in their proper perspective.
The expression "New Economics" has been applied to
the body of economic theory popularly called "Keynesian
Economics." This theory was set forth by John Maynard Keynes
in 1936 and has been in vogue among economists since the
1940's. Economic policy-makers in the 1960's have made great
use of the "New Economics" as guidance for their actions.
The early followers of Keynes stressed the view that
chronic unemployment is a characteristic of our economy.
This view was consistent with the mass unemployment of the
1930's. The business fluctuations which continued in the
late 1940's and 1950's led many followers of the New Economics
to conclude that our economy is basically unstable — subject to


-2shifts between periods of recession and inflation. These two
conclusions — that unemployment is a chronic problem and
that our economy is basically unstable — resulted in the
proposition that vigorous Government actions are necessary
to promote high level employment, economic growth, and
relatively stable prices. This proposition is embodied in the
spirit of the Employment Act of 1946.
This view was accepted by the President's Council
of Economic Advisers from I960 to 1968. The tax cut of 1964
and the tax increase of 1968 are the hallmark of the "New
Economics." The "New Economics" is a combination of
depression-oriented theories and expansionist objectives.
Such a combination contains an inherent inflationary bias
which should be carefully considered when it is applied to
national economic policy.
Let us now examine the other use of the word "New."
The body of economic theory which we will study in these
seminars is not something new tacked on to the basic
analytical framework of the "New Economics." Instead, it is
an up-dated version of the economic theory which was dominant
for many decades prior to what has been labeled the "Keynesian
Revolution." The older economics held that our economic
system is inherently stable; hence, there was little need for
vigorous stabilization actions on the part of Government.



-3fact, Government was viewed as a major source of economic
instability. The expression "New, New Economics" refers
to a revival and elaboration of this pre-Keynesian body of
economic theory.

This development has been accelerating

during the past few years because of the failures of
stabilization policy based on the major premises of the New
I now turn to my main topic, "The New, New Economics
and Monetary Policy." My remarks will be built around three
points.- First, the two competing views of monetary and fiscal
actions in economic stabilization are outlined, and evidence
is presented which, I believe, has led most of the economists
who will deliver presentations at these seminars to assign
great importance to monetary actions. Next, there is an
examination of the slow response of inflation to recent monetary
restraint. Finally, the problem of reducing the rate of inflation
without a great reduction in output of goods and services and a
marked increase in unemployment is considered.
Two Views of Monetary and Fiscal Actions
I will now contrast the two views of monetary and fiscal
actions. The basic premise of the "New, New Economics" is
that the Federal Reserve System, through its control of the money


-4stock, exercises a pervasive influence on the course of
total spending, that is, gross national product, and thereby
on prices. On the other hand, Federal Government spending
and taxing actions, alone, are held to exert little net influence
on movements in GNP and prices.
For example, an increase in the rate of Government
spending at a time when the money stock remains unchanged
requires either of two methods of financing — taxing or
borrowing from the public. In either case, spending by the
private sector is reduced by an amount approximately equal
to the rise in Federal Government expenditures, resulting
in little, if any, change in the rate of over-all spending in
the economy. However, if the Federal Reserve System makes
it possible for the banking system to acquire sufficient
Government debt to permit financing a rise in Government
expenditures without taxing or borrowing from the public,
total spending will increase. In this case, the money stock
increases and is more properly considered the cause of
increased spending.
These observations regarding fiscal policy have been
recognized by both Keynesians and proponents of the "New,
New View," except that Keynesians have not assigned as
important role to money. Unfortunately, however, this point


-5regarding fiscal actions has received little recognition in the
formulation of stabilization policies or in recently constructed
econometric models of our economy from which many policymakers obtain information. Instead, Government spending
and taxing have been considered extremely powerful tools
of economic stabilization, regardless of the source of funds
to finance a deficit or of the disposition of a budget surplus.
As a result, fiscal policy, in my opinion, has been given
too great an emphasis and has had a misguiding influence
in monetary policy formulation.
I now come to monetary actions — the point at which the
New, New Economics differs greatly from the school of economic
thought prevailing since the mid-1930's. Early Keynesians
held that changes in the money stock, unless accompanied
by appropriate changes in Government spending, have little
influence on GNP. Monetary policy was assigned only a
passive, supporting role to fiscal policy. This view that
there is little independent influence of monetary actions on
total spending was widely accepted up to the mid-1960's and has
played a dominant role in the formulation of economic stabilization
policies, even up to now.
The New, New Economics directly challenges the validity
of this proposition. Historical evidence strongly supports
this challenge! Whenever growth of the money stock indicates


-6one direction of movement for GNP and the Government's budget
another, the subsequent course of GNP in virtually every case
follows that indicated by money. There are two important
pieces of recent evidence supporting this monetary view. One
is the mini-recession experience following the monetary
restraint of 1966 — when money remained unchanged and
the budget moved into greater deficits. The other one is the
failure of fiscal restraint which began in mid-1968 — a time
when money continued to increase at an excessive rate.
Another piece of evidence is provided by the Great Depression
of the I930's, when economic activity followed more closely
the course indicated by movements in the money stock than
the one indicated by the Government's budget.
This evidence, along with that provided by many
detailed studies, in my opinion, demonstrates that monetary
actions measured by changes in the money stock should
receive the main emphasis in economic stabilization. To
ignore the influence of monetary actions is to insure disruption
of our normal, orderly economic processes. History demonstrates
that most of our recessions and periods of inflation can be
attributed to perverse movements in the money stock. For
example, the Great Depression was marked by an 8 per cent
annual rate of decrease in money during the four years after


-7Slow Response to Recent Monetary Restraint
I now turn to my second main point, the apparently
slow response of inflation to recent monetary restraint. We
have had an avowed policy of monetary restraint for nearly a
year, but there is only scattered evidence at present that the
over-all pace of inflation has begun to recede. Some have
started to question whether monetary restraint will prove
to be as ineffective in curbing the current inflation as
did fiscal restraint in the past year and a half. Two things
can account for the slow response of inflation to the
restrictive monetary policy adopted last December.
First, only in the past six months has there been
what may be characterized as substantial monetary restraint.
The rate of monetary expansion was reduced in two stages from
the excessive 7 per cent annual rate of 1967 and 1968. The
rate of growth in the money stock was reduced to about
5 per cent for the first five months of this year, and since
then money has not increased. This latter development
is one which I would call substantial monetary restraint.
Second, there is a considerable lag in the response
of the economy to a change in the rate of monetary expansion.
At the St. Louis Federal Reserve Sank our staff has conducted
an extensive investigation to uncover the nature of this
lag, using the New, New Economies' frame of reference.
Although this research is not quite finished, I would like


-8to share with you our findings up to now.
This research indicates that, following a marked
decrease in the rate of growth in money, at least two
quarters are required for a noticeable reduction in GNP
growth. When total spending does finally slow, growth
of output of goods and services slows simultaneously, but
at least an additional three quarters are generally required
for a marked reduction in the rate of inflation to appear.
We estimate that the entire process of curbing inflation
would normally require about three years. Our research
further indicates that the process of fully curbing inflation
is delayed still longer when monetary restraint is
implemented after a period of prolonged and accelerating
price advances.
This is the situation which currently confronts
efforts to reduce the rate of price increases. We have now
had an obvious and accelerating inflation for about five
years. As a result, many economic decisions are based on
expectations of continued inflation. For example, union
leaders seek higher wages in part to protect workers' earnings
from continued inflation, and business firms expect to be
able to pay the higher wages by being able to increase their
prices. Also, contracts to borrow funds take into consideration


-9expectations of future inflation, thereby adding an inflation
premium to market interest rates. Our research indicates
that on the average it may take about five years of decelerating
price increases to eliminate most of the expectations of
continued inflation.
Given the normal response of the economy to slower
growth in money, the entrenched expectations of continued
inflation, and the beginning of really firm monetary
restraint only six months ago, I am not disturbed that we
have not yet seen a slowdown in the rate of price increases.
There is some evidence of the slowing of growth of total
spending and real product in recent monthly statistics.
Personal income in September and October grew at only
half the rate of the previous year. Industrial production
in the last three months has declined at a 3 per cent annual
rate after increasing at a 5 per cent rate in the previous year.
Retail sales have been about unchanged since last spring,
and in real terms have of course declined.
What has been accomplished thus far has been
setting of the stage for a reduction in the rate of inflation.
Consequently, at least the next three years will be required
to eliminate a significant portion of this inflation. In response
to recent monetary restraint, assuming it is continued or


- l0relaxed only moderately, we believe that gross national
product and real output have begun to grow at a slower pace.
We believe that there will be further marked slowing in
1970, and that the rate of inflation will have been moderated
significantly by late 1971. But even at that point, additional
time will be required before we will have reduced inflation
below a two per cent rate. With continuation of inflation
for some time to come, interest rates, because of the
inflation premium mentioned earlier, are not likely
to decrease much in the near future.
If the results of this research into the nature of
the response of output and prices to monetary actions are
nearly correct, I have just outlined the extreme problem
that lies ahead. A high degree of moral, economic, and
political fortitude will be required if we are to overcome the
increasingly painful results of the New Economies' guidance
of policy during the last several years.
Curbing Inflation Without a Recession
I now come to my last main point, the problem of
curbing inflation without causing a recession. I believe
most economists will agree with the proposition I have just
advanced - - t h a t whenever the rate of growth in total spending
decreases for several quarters, real output of goods and


-IIservices will also grow at a reduced rate, while the rate of
price increases will respond only with a considerable
lag. Moreover, there is general agreement that, if total
spending slows sufficiently, real output will actually decrease
and a recession develop. It is obvious that in developing a
strategy for curbing inflation, monetary authorities face
the difficult choice of balancing a desire to avoid inordinate
decreases in real output against a desire to curb inflation
in as short an interval of time as possible. This choice is
made more difficult by the long time required to curb inflation,
regardless of whether or not a recession occurs, after such
a long period of inflation as we are currently experiencing.
The present situation bears careful watching that
we not maintain the present degree of monetary restraint
too long. If we continue much longer to hold the money stock
at about its level of early last summer, I am concerned that
the economy will experience an unnecessarily severe decrease
in output next year accompanied by high unemployment before
much progress is achieved in slowing inflation. The recent
research at our bank indicates that there is little difference
in our ability to reduce the rate of inflation over the next three
years if money were to grow at a moderate 3 per cent rate
from now than if it were held unchanged for several months

With a 3 per cent rate of growth in money beginning

soon, we would have a risk of a slight recession, while if


-12money remains unchanged much longer real output is
likely to decrease at about a 3 per cent rate next year. In
either case, unemployment will rise, but the extent and duration
of higher unemployment will be considerably less if a course
of moderate growth in money is now adopted.
If a substantial recession were to show signs of
developing as a result of an excessive duration of the present
level of restraint, I am concerned that there would develop
public pressures to expand money once again at such excessive
rates as have prevailed during much of the past five years.
An examination of the experience of 1967 and 1968 demonstrates
the results of such actions. After the money stock remained
unchanged for the last nine months of 1966, the rate of
total spending slowed during the first two quarters of 1967,
and real output declined slightly in the first quarter of that
year. Hoping to avoid overkill, monetary authorities resumed
money supply growth at an excessive 7 per cent rate and, thus,
stimulated inflation further.
It was entirely proper that money growth should have
been resumed at that time; if it had remained unchanged much
longer, there would have been a significant recession in 1967.
We estimate that if money growth had been resumed at a moderate
3 per cent rate — the rate which in 1961 to 1964 got the economy
out of the previous recession — the rate of inflation would


-13have been about 2 per cent at the present time, instead of
the current rate of 5 to 6 per cent. Moreover, achievement of
price stability would have been virtually assured for next year.
With a slower rate of inflation, long-term interest rates would
have been about 2 percentage points lower today. If we
once again succumb to pressures for excessive rates of
monetary expansion, we will again have lost the battle against
inflation, as in 1967 and 1968.
In conclusion, I am sorry that I cannot present to
you a view which maintains that inflation is fairly easy to
conquer within a year or so. We should remember that our
present inflation was permitted to develop at an accelerating
rate over the past five years. It is rather presumptuous to
assume that this trend can be reversed in a year or so or
that the cooling-off of inflation can be achieved in a
reasonable time without a period of very slow growth in
output and higher unemployment. Overly optimistic pronouncements of our ability to curb the present inflation in
a hurry and with only slight effects on employment are a
disservice to our people and a stumbling block to the working
of orderly corrective processes.
I want to point out that in the 1950's about 7 years of


-14restraint on spending and output were required to eliminate the
inflation which accompanied the Korean War. Three recessions
occurred during this period as the result of stop-and-go
monetary expansion which alternated between periods of rapid
growth and decrease in money. Inflation has now been more
intense than in the 1950's, making the problem even more
difficult. However, if moderate but persistent monetary restraint
is applied, avoiding the stop-and-go policies of previous efforts
to curb inflation, perhaps inflation may be eliminated somewhat
sooner this time without subjecting the economy to wide
variations in output of goods and services and in employment.
This does not mean that monetary actions cannot
produce the desired results. Instead, it means that all
segments of our society must have patience while these actions
are conducted, so as to permit the economy to achieve noninflationary growth in output of goods and services. Such
growth, according to the New, New Economics, will be at a
rate determined by normal growth in the productive capacity
of our economy. Once we have achieved this goal, monetary
actions must be conducted in such a manner as to assure that
they will not be a source of future economic instability.
Many individuals have become impatient at the slow
progress made in curbing inflation and have been urging the


-15imposition of price and wage controls. Recently, there has
been considerable support for selective credit controls. Such
measures, even if cloaked with psuedo-respectability by being
placed on a voluntary basis for a brief period, are not part
of the New, New Economics. Instead, we believe that the
best way to cure our nation's economic ills is to allow
stabilization efforts to work their influence through our
relatively free, competitive market system. Moreover,
experience during World War II and the Korean War has
demonstrated that treating only the symptoms of inflation
is neither effective nor desirable. Also, reliance on such
controls could very well lead to their being substituted for
appropriate over-all stabilization policy. Such was the
experience with the use of price-wage guidelines during the
escalation phase of the Vietnam War.
Finally, experience reinforces the belief held by
many that an inflationary trend should never be permitted to
start because of the great inequities it creates and because
of the long and arduous effort which is required to conquer
it. Some argue that inflation is a small price to pay for a
high level of employment for all segments of our society.
This may be a basic tenet of the New Economics; but it is not


-16a tenet of the economic school of thought represented at these
seminars. The New, New Economics holds that inflation is not
required, and indeed is not a long-run effective means, for
our economy to grow at its productive potential or for the
achievement of a high level of employment.