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For release at
1 p.m. , EST
Friday, Nov. 11, 1966

Some Current Problems of Monetary Policy
Remarks of George W. Mitchell
Member, Board of Governors of the Federal Reserve System
at the
Joint Luncheon Meeting
of the
Southern Economic Association
Southern Finance Association
Atlanta, Georgia
November 11, 1966

Some Current Problems of Monetary Policy
When 1 accepted your Program Chairman's invitation to be in
Atlanta today it seemed desirable to have a fail-safe title for my remarks-neither too confining nor too demanding on my resources, neither too dull
nor too exciting to your expectations.

We came up with "Some Current

Problems of Monetary Policy.” It covers everything and promises nothing-the latter is perhaps more important to me as no one likes to find himself
in a state of obvious "flunkedness."

I once heard Jimmy Ernst say "It is

far easier to compose a stimulating, provocative speech title than it is
to compose the speech that lives up to it"--an aphorism which he proceeded
to demonstrate.

I obviously am not under that constraint today.

However, as the time for delivery of this speech drew near the
more obvious facets of my wide-ranging topic seemed less and less worth
our time and attention.

What more is there for me to say than one can read

in the daily newspaper about the problems of monetary policy that are implicit
in unfolding economic and financial trends?

Is there an unseasonal chill descending on the private economy?
Have interest rates reached and passed their cyclical highs?
Will Vietnam spending escalate further?
Have banks, prodded by the Federal Reserve, brought business
loan growth to a standstill, or are faltering business loans
bringing bank growth to a standstill?

Or is it that bank growth

is the victim of necessitous disintermediation brought pn by
interest rate ceilings on time deposits which disadvantage banks
because the yields on marketable securities and ceiling rates on
savings and loan association shares are higher?


Is the balance of payments getting worse because our trading
position is deteriorating, or is it getting better because of
the large short-term money inflow that has been taking place?
Was the little spurt in money supply growth back in May-October,
1964, associated with the surge in GNP in the fourth quarter of
1965 and first quarter of 1966--about 16 months later; and did
the let-down, in money supply growth early in 1965 presage the
falling off in GNP in the second quarter of 1966--again, nearly
16 months later?
If the relationship between these phenomena is more than co­
incidental, what should we be expecting of GNP late in 1967
and early in 1968 in light of the fact that money supply has
shown no growth in the past six months?
In time we may well have the answers to all of these and like
questions--as of now I could, for the record, only speculate about them,
as can anyone else.

But, unlike most economists, I have a special handicap,

not too widely shared, of possibly having something to do with the answers
to some of these questions.

The inhibiting effect of responsibility does

not make for free-flowing prognostication.
Under my protean speech title I had thought I could also discuss
the pros and cons of moderating economic expansion by using Federal fiscal
action to supplement or supplant monetary action, as the case may be.


that the selective impact of general monetary restraint has been so widely
observed, if not shared, there is a certain yearning for some anonymity in
the linkage between policy actions and economic consequences.

How nice it

-3would be to have a gentle diffusion of policy effects--felt by none, but
influential on all.

It is too much to expect, however, that restraint will

go either unnoticed or unchallenged.

Quite naturally we from the Federal

Reserve who have had our finger— and perhaps even more of our anatomy--in the
dike for a year or so would welcome fiscal action, either as a replacement or
an ally in the task to be done.
But a speech along this line would be "old hat" for you and, in a
way, self-serving for me.

I concluded, therefore, that for this audience it

would be most appropriate to unveil some of the monetary planning now going
on at the Federal Reserve--planning which we hope will make our future
monetary actions more timely, more precise and more certain and, hence, less
unnecessarily disruptive to our financial framework and institutions.


it comes as a surprise to you to know that the Federal Reserve plans ahead,
just as do those who build cars, space vehicles, or cities.

We are now

researching the guidelines for monetary policy in future periods of ease
and restraint, and how tools of monetary policy can be adapted or invented
to best serve the needs of the economy of tomorrow.
The most far-reaching basic research currently underway is an
organized attempt to fill the gaps in our knowledge about the processes
through which monetary policy influences the general economy.

For short,

we call this "linkage" research.
The influence of financial factors on the demands for goods and
services is doubted by few economists, but there is either uncertainty or
disagreement as to which financial variables are the most influential,
through what channels--financial and real--they exert their influence on

-4spending and saving decisions, the magnitude of their

influence, how long

it takes for this influence to be effective, and how their magnitude and
timing varies at different stages of the business cycle.

Nor is there an

entirely satisfactory understanding as to the processes by which the monetary
policy actions of the Federal Reserve itself affect the financial variables
which, in turn, act on the real economy.
Our research in this area is based on the belief, or at least the
assumption, that an adequate model of the quantifiable monetary influences
on the economy must deal with both the balance sheet and income accounts of
consumers, businesses and financial institutions.

I think it is fair to say

that, within the existing range of uncertainty, a majority of monetary
economists have arrived at a roughly similar working consensus as to how
monetary instruments influence aggregate demands for goods and services
and, through them, such ultimate policy variables as employment, production
and growth. ' This is commonly referred to as the "portfolio" approach to
monetary influence.
Views of Professor Friedman and others that concentrate on money

supply influence on GNP are, it seems to me, less widely credited.

Nor are

the pure Keynesian macro-models generally accepted, since they deal almost
entirely with the income accounts of participants in the economic processes,
treating balance sheets only in a very fragmentary way.

The spending

behavior of consumers and businesses in these models reflects monetary
variables only by including in their equations some interest rates and
perhaps a few liquidity variables.

It is our feeling that monetary policy

works its effect on the economy partly through disturbing balance sheet


equilibria, and that these disturbances are adjusted in complex ways that
include, but are not confined to, changes in the flows of funds reflected
in the income accounts.
Let me hasten to say that our current emphasis on work in this area
does not imply that the research staffs in the Federal Reserve System have
just awakened to the need for a better understanding of monetary processes.
In a sense, the Fed has been doing linkage research all its life, just as
Moliere'aM. Jourdain discovered that he had been writing prose for 40 years.
But Federal Reserve research into the linkages between monetary action and
ultimate economic effects is now being organized more systematically and
pursued with more modern techniques.

In particular, the current effort

represents the System's first big entry into the wonderful world of
econometric-model building and large-scale use of the computer in such
model building.
Our initial approach to "linkage" research was in the best of
Federal Reserve System tradition--we appointed a committee.
by Dave Eastburn of the Philadelphia Reserve Bank.

It was chaired

This group brought forth

a charter for our research efforts at understanding monetary processes
entitled, "Linkages Between Monetary Policy and the General Economy: A
Framework for Research."
With this charter at hand, we tapped three sources of analytical

One group, comprised of economists from both the Board's staff

and the staffs of the Federal Reserve Banks, went to work on severable
and manageable segments of the monetary processes as described in the charter.
Another group was brought into being by beefing up our in-house staff at the


Board of Governors to develop an econometric model of the economy that was
oriented very closely to what we considered to be the needs of a monetary

And a third approach to the problem was organized by financing,

through the Social Science Research Council, work by academic monetary
economists in the area of the impact of financial variables on various
sectors of the real economy.
A few words about each of these approaches.
efforts have involved five working forces.

Our System-wide

One group, initially chaired

by John Kareken of the Minneapolis Reserve Bank and the University of
Minnesota, and now by Richard Davis of the New York Reserve Bank, currently
on leave at Princeton, was given the job of developing a model or framework
for the entire linkage process all the way from a specific Federal Reserve
action to the ultimate goals of monetary policy.
Now, ideally, we should have stopped right there and waited for
the model to be constructed before we started testing its many relationships.
But since we knew this would be a long and difficult job and since we also
felt pretty sure that we could identify some of the relationships that would
no doubt turn up in any model, we set up four additional working groups,
each of which was deliberately charged with taking a partial rather than an
over-all approach, at the same time the over-all model was being constructed.
One of these task forces is concerned with linkages among money
market variables.

It is headed by Robert Holland of the Board's staff.

More specifically, this group is seeking to establish the relationships
among Federal Reserve open market operations in Government securities,
various short-term interest rates, and other indexes of money market
conditions and reserve utilization by the banking system.



Another group is concerned with links between money market variables
and more basic financial variables.

This group, headed by Maurice Mann of

the Cleveland Reserve Bank, is studying the links between changes in bank
reserves and such other financial variables as demand deposits, currency in
circulation, time deposits, bank credit and longer-term interest rates.
Still another group is concerning itself with the relationships
among the real variables in the economy.'

Wilbur Billington of the Kansas

City Reserve Bank is heading this group and it is focusing on the relation­
ships among such ultimate goals of monetary policy as high employment,
production, sustainable economic growth and reasonable price stability.
A final group, which is just getting off the ground and which is
headed by Robert Solomon of the Board's staff, is concerned with the relation­
ships between domestic financial conditions and -international capital movements.
The work of the in-house staff of the Board and that of the academic
economists .associated with the SSRC is gradually converging.

Both are now

involved in the construction and testing of a 50 to 60 equation quarterly
model of the U.S. economy.

The main purposes of such a model are to aid in

short-term forecasting and to establish the likely effects of alternate
monetary policies on major economic aggregates.

It will be used to supplement,

and in conjunction with, the judgmental models we currently use in our policy
Our in-house work on an over-all model is mainly under the
direction of Frank de Leeuw.

Incidentally, let me work in a recruiting plug

We are in the market for several good, young econometricians.

If you-

know of any such people who would be interested in getting involved in our


exciting linkage work, Daniel Brill, Director of our Division of Research
and Statistics, would be most pleased to know about them.
Our Social Science Research Council work was originally under a
committee headed by James Duesenberry of Harvard, now at the Council of
Economic Advisers, and Franco Modigliani of MIT.

This committee contracted

several studies on the influence of financial variables on various types of

This work is still going on and, more recently, we are also

sponsoring a larger research project led jointly by Modigliani and Albert Ando
of the University of Pennsylvania on the construction of the model to which I
have referred earlier.
It is still too early to say anything about the over-all results
to date of our work.

Some time next year we hope to have constructed a

model and to have begun to fit the pieces involving the various observed
relationships among specific variables into the over-all framework.
In.the meantime, though, several individual pieces of the work
have been completed.

Some of these have been summarized in the Federal

Reserve Bulletin and are available in full in mimeographed form on request.
Other papers will follow from time to time as they are completed.
In the System-wide work, research to date has focused on what
someone has termed the "inside links," that is, those connecting variables
over which the Federal Reserve has most direct influence and other financial

To cite just one example, George Kaufman of the Chicago Federal

Reserve Bank sought to identify variables most closely related to past
changes in the public's holdings of currency.

Among all the variables he

tested, he found that only changes in income and/or aggregate expenditures
were consistently and significantly related to changes in currency.

-9An example of System work on relationships among the real economic
variables is a study by Addison Cutler of the Cleveland Reserve Bank, which
concerned itself with the relative roles of "demand-pull" and "cost-push"
in commodity price movements in the late 1950's and early 1960's.

He con­

cluded, based on an analysis of data on prices and output of 188 product
lines, that cost-push was relatively more important in the 1953-57 period
than in the 1957-63 period, although even in the latter period the role of
cost-push seemed to be far from negligible.
We have also done some work on the linkages between finance and
the real economy.

One paper by Jimmie Monhollon of the Richmond Federal

Reserve Bank, for example, on manufacturers' inventory investment and
monetary policy, has been summarized in the Bulletin. Another by Professor
Sesek of the University of Illinois on the effects of financial variables
on investment in plant and equipment— one of several financed under our Social
Science Research Council contract— is scheduled to be published shortly in the
Review of Economic Statistics.

The Monhollon paper found no significant

direct relationship between the cost and availability of credit and inventory
investment in the postwar period.

The paper suggested, however, that the

indirect effects of monetary policy through sales, unfilled orders and prices
may be quite important to such investment.

The Resek paper, on the other hand,

.produced some surprisingly strong evidence on the influence of financial
factors such as interest rates and stock market variables on plant and
equipment spending.

Other work in our project is well advanced on the effects

of financial variables on consumer spending, on durable goods, and on State
and local government spending.

-10One final word about our efforts in this area of the relationship
between monetary policy and. economic activity.
is, I believe, a sizable step forward.

Our current research program

It should provide us with much more

quantitative information as to the many processes, linkages and relationships
involved between specific Federal Reserve actions at one end of the line and
the ultimate goals of economic stabilization at the other end.

We very much

need quantitative measurements to condition and to back up our judgments of
appropriate policy.
The Federal Reserve System is also engaged in a comprehensive study
of the discount mechanism.

This study has sought to evaluate the working of

the present system in periods when monetary posture is stimulative, accommo­
dative or restrictive.

While it is currently absorbing a large amount of

System research effort it, too, is not oriented at present-day problems but
rather at issues likely to be faced in the future.

Thus, it is examining

prospective changes, ranging from small technical improvements to major
revisions in the. discount mechanism and rationale.
The present discount function operates under Regulation A, Which
was last revised in 1955.

The changes in the economic and financial

environment that have taken place in the intervening ten years--such as
the decline in bank holdings of easily marketable assets, the growth of
markets for certificates of deposit and Federal funds, and the evolution
in bank attitudes and practices toward borrowing— were motivating factors
in undertaking the current study.

That the present mechanism is perhaps

not well suited to current conditions has been suggested by criticisms
and questions raised both within and without the System as well as by the
¿mall scale of System lending.

-11Participation in this project has involved staff and officials
from many parts of the System.

The Steering Committee is composed of

representatives from the Board of Governors and Presidents of the Reserve
Banks; the research is being directed by top-level official staff personnel
at the Board and the Banks; staff economists and technicians have been
working with academic consultants as well as the staffs of foreign central

More than 25 separate research studies have been completed or are

in process.
Studies to date have made it clear that for discounting purposes
we cannot regard our banking system as homogeneous.

It is, rather, a

collection of 14,000 individual units, of which about 6,000 are members
of the Federal Reserve System, and among whom some 700 of the largest are,
for practical purposes, sui generis.

These latter banks all actively deal

in Federal funds, and about 200 of them are directly and continually in
contact with the Nation's central money market.

All other banks, while

constituting about 95 per cent of the banks in the country, hold only
about 30 per cent of total deposits, and account for an even smaller
proportion of the fluctuations therein.

Discounting is at times vitally

important to the smaller banks, but the total volume of their borrowings
is relatively unimportant for over-all monetary policy.

It is within the

group of larger banks, and especially the money-market banks, that changes
in the aggregate volume of discounting can importantly affect the bite
of national monetary policy.

-12We have found it useful to think of discounting as made up of two
dimensions, which might be described as operational and strategic.


operational includes meeting those needs for reserves which are caused by
such factors as random short-falls from projections, seasonal patterns of
loan demand, and deposit losses.

These needs appear in almost all banks

at some time, and are presumably not created, nor importantly affected, by
changes in monetary policy.

This is the sort of discounting upon which the

1955 Regulation concentrated.
The strategic dimension of discounting includes borrowing which
comes about as the result of monetary pressure and this is the sort of
borrowing that accounts for most of today's aggregates.

In practice, of

course, the two dimensions of discounting often blend together.

The operational

needs increase somewhat during periods of restraint, and, probably more
important, other means of adjustment become less readily available.
It seems reasonable to expect that the discount window will continue
to assist banks in meeting their purely operational needs, a task for which
it is uniquely suited.

However, various improvements in the way it meets

them are under consideration.

Also being examined are possible ways of

easing these needs by mechanisms other than the discount window--for example,
the possibilities for changes in reserve period accounting or the fostering
of secondary markets to ease flows of funds among banks.
Also being discussed is the possibility of the discount window
assuming some of the responsibility for operational reserve adjustments
now performed by open market operations.

These would be somewhat different

from the above in that they would involve offsetting some of the short-term,

reversible movements in reserves which are also largely unrelated to monetary
policy, but which affect the economy as a whole as well as any individual bank.
Another question that has been raised is the possibility of the
window taking a more active part in carrying out the thrust of monetary policy.
As the proportion of reserves supplied through the discount window increases
in periods of restraint, more banks are under pressure to adjust, and thus
the restraint is transmitted throughout the banking system.


for improving and strengthening this mechanism are being discussed.
A question which overrides all considerations of discount window
use is how to control it.

The extent of borrowing is now controlled primarily

by bank reluctance to borrow and, when this is not effective, by administra­
tive counseling.

The discount rate serves only a subsidiary role.


system has been the target of much criticism; various changes have been

The academic experts would have us rely almost exclusively on

Other suggestions are for quantitative limits, such as lines of credit

or possibly an auction of funds, or some more positive variation of adminis­
trative control.

All these possibilities are being considered within the

framework of the study, as are numerous other combinations.

As of now, no

clear consensus has begun to emerge other than the sense, based largely on
our own and foreign experience, that it would be unwise to give up a tool
we have, or to wed ourselves exclusively to any one control mechanism which
may become inappropriate in future circumstances.
These are but a few of the areas of inquiry within the discount
study, but they perhaps give you some idea of its scope and the range of
changes in the mechanism which it may produce.


A final thought which I would like tc leave with you concerns the
relationshi. between the economics profession and the Federal Reserve System.
1 do not think L car. overstress the importance of your understanding of our
problems and our understanding of yout potential contribution to their

It is, of course, true we have always learned from each other,

raided one another's intellectual resources and scoffed at each other's
foibles of fact or theory.

But, I think the time is coming when your

responsibility for contributions to monetary theory and practice should
weigh more heav'.ly on you.

After all, your guild now holds four out of

seven seats on the Beard and we need your supportI should repeat to you that in the past three years the Federal
Reserve has heard a good deal of wise counsel from a series of academic
seminars sponsored by the Board, Held in Washington, and dealing with
current monetary issues and selected economic problems affecting the
future course of monetary policy.

These seminars, held three- or four

times a year, are arranged by professor Lee Bach of Stanford University.
Professor Bach selects the topics with some consultation with us and
arranges on his own responsibility for a dozen or so academic participants
at each meeting.

The response from economists from all over

the country has beer, as close to ICO per cent as busy schedules permit
and the intellectual response to the problems presented has consistently
strengthened our grasp of the difficult issues we must face

This is

the most concrete evidence I can advance that the guild is not letting
us down.