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May 10, 1963
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A. £ > J W .




Introduction - Seventh son of a seventh substitute
Subject given as "a critique of monetary policy".

A Dictionary of Contemporary American Usage defines "critique" as "a pretty
highfalutin word for a critical examination or review, especially of a literary
or artistic work".

Technically it does not mean fault finding, but rather the

exercise of critical (discrimination or discussion of character and quality)

Certainly this is the sense in which you should regard "critique"

as I am forced to use the term.
What we had hoped to present to you today was a "critique" by an
outsider rather than by an insider.

That would not necessarily mean that an

outsider would be more objective, but he almost certainly would have been more
refreshing and you would have regarded him as more objective.
My reference to the seventh substitute is reasonably accurate.


telling you in what order we invited these gentlemen, most of whom have had
previous appearances on our workshop programs, let me list our invitees, all
of whom had irreconcilable conflicts and could not appear today.

They send

you their regrets, but theirs are nothing compared to mine.
Heller - Business Advisory Council (command performance)
Shaw and Wallich - out of the country
Samuelson in California, McCracken in New York
Chandler and Ritter otherwise occupied.
That makes seven.

I'm the substitute.

What I want to do today is present some perspective on Federal Reserve
policy over a relatively long period of time.
with these charts which you see.

To do this I am going to work

Presently I will try to explain the format

of the charts and vhat I think they show.

But before doing that I want to

refer back to some points I tried to make in a paper presented to you last
year on the objectives of central banking.
There are a number of theories of interest rate determination which
center on different, though not necessarily mutually exclusive, aspects of
the process through which rates are set.

Some theories stress supply and

demand for loanable funds, some stress cash balances and liquidity demands,
some stress the savings-investment process.

What I want to stress is that

elements of all these theories seem to account for interest rate movements
at particular circumstances of time and place and under particular institutional
characteristics of the economy.
Monetary policy therefore has to be made on a pragmatic basis and cannot
be tied to a particular theory.

This should not be taken to mean that there is

no conceptual framework for monetary policy but it should be taken to mean that
central bankers cannot be guided exclusively by any one or an unchanging mixture
of such factors as:

the state of liquidity, the level of cash balances, the

money supply, the volume of savings, the amount of investment, or the demand for

Central banking thus remains more art than science.
The fact that precise determination of the effects of credit cost versus

credit availability, of changes in the money supply versus changes in liquidity
and velocity, is not possible does not mean that the general linkage between
monetary policy action and economic response is impossible to discern.


obviously, central banking action affects bank reserves; such reserves form
the basis of the money supply and underpin commercial bank loans and invest*
ments; changes in these affect spending and saving.

Questions of "how much",

"how fast" and so on can be answered reasonably well at a particular point in
time - they merely are not, yet at least, susceptible to formula treatment.




Just to leave this point on a more positive note, I should give you in
broad outline a central banking approach to monetary theory.

Over the long

pull, the demand for real investment must be matched by the supply of real
savings if we are to have high employment and a growing economy operating at
or about at its current capacity.

This is true because economic resources are

scarce and in a capacity operation resources going for investment purposes have
to be taken from consumption purposes and saving represents withholding of
spending from consumption.
Created money or credit, then, can be no more than a relatively shortrun substitute for savings in financing investment.

It can bridge temporarily

gaps between the flow of current savings and needed investment when real re­
sources are available because the economy is operating below capacity.


can aid in smoothing the resource allocation process even under an economy
operating at capacity.

And since a growing economy needs an expanding supply

of credit, the supply of credit and the supply of money need to grow also.
Central banking objectives fall into three broad classes - ultimate,
intermediate, and proximate.
of central banking.

Let us consider first the ultimate objectives

In one form or another, these have been given in official

Federal Reserve publications about as follows:

The Federal Reserve System

attempts to operate so as to promote or contribute to high employment and
production, a rising standard of living, and stable prices.

In a paper sub­

mitted to the Commission on Money and Credit, the goal of monetary policy was
given as "to provide maximum assistance toward promoting long-term growth and
containing cyclical swings in economic activity within reasonable bounds, while
permitting adjustments which are required to preserve the dynamic character of
our economy."




Three comments might be made about these ultimate objectives.


is the fact that monetary policy formulation and execution is a continuous
process, and continuous review of developments provides the basis for continuous
consideration of policy.

The processes and procedures through which policy is

executed in the short run are and have to be far more definite and precise than
the broad goals but always have to be associated with them.
Second is the question of direct linkage between specific policy action
and ultimate economic response.

No one can say with certainty that specific

central banking action leads to ultimate economic response in precisely such
a way or such an amount.

The drive shaft between central banking action and

ultimate goal is too long and is linked to too many gears of indeterminate

Nor can anyone state with precision what would have happened absent

the central bank action or with a different action.

But here again the indicated

direction of central bank action is fairly clear, and the continuous review
process makes it possible to change the speed and pressure of such action as
the course of developments in the ultimate goals is observed.
Third is the point that the ultimate goals may not always be compatible.
In one sense, this is true; in another sense it is completely misleading.


strength of a dynamic and democratic system lies in its ability to make adjust­
ments that permit optimum attainment of the goals of a free society.

So to

say that the ultimate goals of central banking are not compatible is to state
the obvious but without any understanding of our society.
From consideration of ultimate objectives, let us move all the way back
to proximate objectives before discussing the intermediate class.

These proxi­

mate objectives are those most directly controlled or influenced by central
banking policy actions.

In this group I put nonborrowed reserves, total

reserves, and net free reserves (both positive and negative).

While many

people would disagree, I also put here short-term interest rates and the
general level and configuration of the interest rate curve.




We can now move back, more or less halfway toward the ultimate objectives,
to consider the intermediate class.

These have to do with spending and con­

sumption, saving and investment, and thus include the volume of credit, the
liquidity of the banking system and the economy as a whole, and the money supply.
My comments on the intermediate objectives can be quite brief.


linkage between Federal Reserve policy actions, the response of those factors
in the proximate objective area, and the secondary response of the factors J n
the intermediate objective area are seen with reasonable clarity, as I observed

Strictly speaking, Federal Reserve control over intermediate objectives

does not exist, but practically Federal Reserve influence does, even though the
degree of influence varies with time, place, and circumstance and is not precise
nor definite.
While the linkage between proximate and intermediate objectives is not
precise and definite, it is far more so than the linkage between intermediate
and ultimate.

Federal Reserve policy strongly influences total bank deposits

and bank loans and investments.

Its influence is somewhat less definite on

money supply and general liquidity but is apparent.

When funds flow into ulti­

mate particular uses, however, they are beyond central bank control - which I
believe is as it should be.
Notice the several references to central banking as an art and refer
back to the definition of "critique" - "a review of an artistic work".


word thus suits particularly what I propose to do now as we consider the charts.
These charts attempt to present the proximate, intermediate and ultimate
objectives of credit policy against the background of policy action.


(the charts) are complex and need explanation of format before explanation of
what they vhow.
Fundamentally what I am attempting to do here is to present something
like a 6 dimensional view of credit policy and its results.
ground of each chart is identical.

The colored back­

The three shades of red indicate restrictive

credit policy periods with degree of restriction varying with color intensity.
The three shades of green indicate easy policy with degree of ease varying
with color intensity.

Actually, of course, neither restriction nor ease has

only three degrees - in real terms there should be a spectrum of reds and

Obviously this cannot be done from a practical standpoint so I have

had to be satisfied with the three intensities - which you may think of as
light, medium or heavy restraint, or small, moderate or substantial ease.
It is important that you understand how I arrived at these color

And I should begin this part of the explanation by underlining

two points about the art of central banking.

First, is the fact that credit

policy ordinarily shifts gradually; it is a rare occasion when there is an
abrupt or drastic change in policy direction.

The question that faces the

central banker constantly is a simple one although the process in deriving
the answer is far from simple.

Should policy he easier, tighter, or stay the

At every open market committee meeting this is the question to answer.
Second, is the fact that the policy record as published provides a

clear description of that answer.

The Open Market Committee has often been

criticized for using ambiguous language in its directives.

To a degree that

charge is justified simply because words often mean different things to dif­
ferent readers.

Certainly any given directive of the FGMC to the desk might

be read in several different ways.

But a reasonably careful reading of the

policy record as a continuum produces reasonably clear indications as to
whether policy is designed to tighten, ease, or stay the same relative to the
current and immediate past period.
Each policy change over the 1951-62 period is shown on this chart as
a shift in color intensity, including as shifts changes from green to red, as
well as changes in one color intensity.

These policy changes are taken directly

from the published policy record, either shown as a change in a directive or




as a (in my terminology) shaded instruction given within the framework of an
existing directive.
Let me illustrate.

On March 27, 1956, the directive (the pertinent

economic clause) read "restrain inflationary developments in the interest of
sustainable economic growth".

By itself that sounds restrictive and it was.

It also sounds highly general and it was.

On May 23, 1956, the directive read

"restrain inflationary developments in the interest of sustainable economic
growth and take into account any deflationary tendencies in the economy".
Again this is highly general language but clearly indicates a shift to an
easier policy position relative to the former position.
"easier" and not "easy".

This is important.

Note that I said

On June 26, with no change in

the directive a shaded instruction read " resolve doubts on the side of ease".
Once again this is general, but once again it clearly indicates an "easier"
policy position than obtained on May 23, although it was not an "easy" position.
Now my point is clear and I think important.

Anyone with rudimentary

knowledge of economics and monetary affairs can read the published policy record
and tell easily from one FOMC meeting to the next whether policy was to be
tighter, easier, or stay the same.

As noted the record has to be read as a

continuum but it should be read that way anyway.

And I would bet that all of

you in this room would be unanimous in your judgment as to whether policy was
to be easier, tighter, or the same as you read the record.
You would not necessarily agree as to whether the basic policy was easy
or aestrictive, for one man's meat may be another man's poison.

My classification

of policy as restrictive (red) or easy (grean) is based on various factors plus
certain subjective judgment.

You may not agree with that judgment.

My criteria are: positive or negative free reserves, the direction of
movement of free reserves, total reserves, nonborrowed reserves and the bill
rate, the absolute level of the bill rate (above or below 2 per cent) and other




than open market policy actions taken by the System - discount rate, reserve
requirements, and selective controls.

In essence I merely took every month's

record when free reserves were positive and gave that month a green checkmark,
when free reserves were negative a red checkmark.

When free reserves, total

reserves and nonborrowed reserves were rising they got green checks, when they
were falling they got red checks.

When the bill rate was above two per cent

for the month it got a red check, below two per cent it got green.
was rising it got red, falling it got green.

When it

An advance in discount rate was

red, a drop was green and so on.
I arranged these color checks in rows by months chronologically and
inspected them.

Obviously when all or most signs were red or green there was

no problem; when there was a mixture of reds end greens for a month I went
partly by majority but partly by direction of reserve and bill rate change
(free, nonborrowed or total) rather than by absolute level of free reserves
or bills.

The results are as shown.

Now I hope I will not be charged with circular reasoning by using this

Again let me make clear that every shift in color intensity or

from red to green is given solely on the basis of the policy record - either
the directive or a shaded instruction which indicates "tighter", "easier", or
"no change", but not "tight" or "easy".

Only the basic color is derived from

the criteria cited plus the judgment factor.

And while it is true that thi3

methodology generally shows free reserves negative or falling, a bill rate
above 2 per cent or rising, total and nonborrowed reserves falling and upward
movement of discount rate or reserve requirements or margin requirements, etc.,
during a red colored period and the reverse during a green colored period, I
am not using those facts tooprove that policy yields results beyond what
everybody knows - that the proiimate goals are directly affected by policy.




The record of the intermediate and ultimate goals is, insofar as my colors
are concerned, independent.
One final word about the color scheme.
chart is white.

In the early period, 1951, the

This was the period of neutrality following the Accord and

there really were no policy shifts.

In a sense this period might be colored

green since all the criteria show green, except reserve requirements, but I
have left it white just to point up the neutrality under the first year fol­
lowing the Accord.

Also, as is well known, there are periods when the System

attempts to hold an "even keel" when a Treasury financing is in progress.
This is really a policy of no change but for a special reason other than
credit policy.

Probably it would be well to show such periods also as white

but I thought it more useful just to keep the current color going so as to
avoid further confusion.
Now, hoping that the principle of chart background color is adequately
explained, let us pass on to the chart lines.
Chart I - Total reserves - seasonally adjusted and adjusted
for changes in reserve requirements.
(This latter adjustment means that $1 in reserves
supports the same amount of deposits at all times.)
nonborrowed reserves
Free reserves
discount rate - N.Y.
3-month bill rate
Long bond rate

(as published in the Bulletin)

These are the proximate objectives and their movement shows the
direct impact of policy - a fact well known.



Chart II


liquid assets - seasonally adjusted
currency, demand and time deposits - seasonally adjusted
loans and investments - bank credit
gold stock - see right hand scale

These are intermediate goals.
Two points important to note - policy really has not aimed at
direct curtailment but rather changes in rate of growth.
Credit, money and liquidity are affected by policy - at
any rate the slopes of the curves change as policy moves
from restrictive to easy and back.

Chart III

These are ultimate goals and in a sense also guides

to policy.

All series, except prices, are seasonally adjusted.

I think credit policy's concern with unemployment is amply

I think also that these indicate that policy's

timing has been, while not perfect, extremely good on the

And it must be noted that never are the economic

data plotted available at the time of policy decision which
emphasizes the goodness of timing.

Finally, I think the

response of these goals to policy is quite striking.