View original document

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

For release at 7 p.m.,
Eastern Standard Time
Tuesday, December 11, 1962

Econosnr'.c Knowledge and Government Reiyonsibillty
Remarks of George W. Mitchell
Member, Board of Governors of the Fs&eral Reserve System
Carroll College
Waukesha, Wisconsin
December 11, 1962

Economic Knowledge and Government Pespousibility
I welcome the opportunity to spend an hour in an academic
atmosphere where it is fitting and proper to éngage in abstraction
and to turn thé world upside down without regard for what comes unstuck.
It is hot often that I have an opportunity to shed mere, practical
affairs and to speculate.

And, of course, I assume that what I will

have to say will be understood as speculation prompted by the ancient
and generous spirit of' academia and not as a program of immediate
You have invited my-observations on "Economic Knowledge and
Government Responsibility."

I must immediately confess my inability

to present you'with a thoroughly articulated and carefully reasoned
statement— a statement uhich would at once give unassailable content
to these concepts, and which would spell out -their linkage.


older among you will, perhaps, be-inclined to forgiveness: from the
younger among you who expect- (as you should) on-target performance,
I ask indulgence«
Let me indicate to you the way in which I have organized my

My intention is fitst to discuss the most .controversial

component of the theme— Government Responsibility.

I have taken this

to mean Government responsibility in the economic sphere.

I will

discuss this component of the theme under what seems to me to be.
three convenient headings.
Knowledge and attempt, as

I will then turn to some notes on Economic
am able, to treat what relevance

economic knowledge could/.{ifr.ffibül-d, have to Government responsibility.


The issue of "Government Responsibility” in the economic
sphere belongs to a very durable debate; durable both in terms of
the toughness of the issues and in terms of the length
which it has taken place.

of time over

The contestants in this debate are currently

the Liberals and the liberals.

I do not intend this as a puzzle*


am just not able to speak out the fact, since I do not share Victor
Borge's talents for vocal punctuation, that I mean one liberal to be
capitalized and the other not.

To introduce vocal notation, I will

speak of the nnew liberal" and the :old liberal/’ This is a matter
of notation only and is not an assessment of their relative content:
the terms "old" and "new" are not intended to convey my feelings about
the relative freshness or mustiness of these positions.
The arguments of the "new liberal" on Government Responsi­
bility in the economic sphere axe topical.

Essentially, they deplore

what they see as a great disparity between publicly and privately
rendered services.

That is, they deplore "Conventional Wisdom 1 s"

seeming inability to be distressed about the public preference for
orchid Cadillacs rather than public schools.

They propose a

Redressing of Balance" between the public and private sectors through
an increase in governmental activity.

I think I can be fair (and

safe) in having you think of these arguments as being summarized in
Professor/Ambassador Galbraith's book, The Affluent Society.


The arguments of the "old liberal" are less topical; at
least less topical in their traditional form»

(It is rather amusing

to note here, parenthetically, that Classical Marxism is not the only
politico-economic statement to suffer "revision").
a few moments of our time to recall the

It will be worth

old liberal" position on

Government Responsibility in the economic sphere.

The best source of

this position seems to me to be contained in Adam Smith.
Many interpreters of Smith equate his argument for laissez
faire with his theory of "the invisible hand," that the individual
intends only his own gain, and he is in this.... led by an
invisible hand to promote an end which was no part of his intention."
But Smith’ argument for laissez faire and a 'social harmony" resulting
from the guidance of the invisible hand of self-interest was an
exercise in "conjectural history."

That is, it was an exercise in

what would have been in the context of ideal institutions.


practical plea for laissez faire--if you will, the operational content
of his plea--was quite simple.

It was dictated by his extreme

skepticism of the beneficence of strong government.

Under laissez

faire there would be an absence of conditions under which the Govern­
ment could impose, under the auspices of powerful special interest
groups, "mean and malignant expedients" on the community in the guise
of the public good.

Laissez faire, in short, would make the power of

government unavailable as a means to buttress monopoly.
Smith’ reading of "actual history," his look at the pre­
vailing economic organization of England and the Continent under the


imean and malignant expedients'* of government-supported mercantilistic
policy, convinced him that bending the power of government for human
good, and reforming it to this end, was a very po 6 r bet.

The best

course was to limit its scope.
If governmental systems of preference and constraint were
removed, Smith argued in one of the finest passages in the Wealth of
Nations, then
The obvious and simple system of natural liberty
establishes itself of its own accord.

Every man,

as long as he does not violate the laws of justice,
is left perfectly free to pursue his own interest
his own way, and to bring both his industry and
capital into competition with those of any other
man, or order of men.

The sovereign is completely

discharged from a duty, in the attempting to perform
which he must always be exposed to innumerable
delusions, and for the’
proper performance of which
no human wisdom or knowledge could ever be sufficient;
the duty of superintending the industry of private
people, and of directing it towards the employments
most suitable to the interest of the society.
Adam Smith*s "obvious and simple system of natural liberty"
can hardly be described as being in effect in any modern-day country.
People are not perfectly free to pursue their own interests and the
sovereign has certainly not been discharged from the duty of


"superintending the industry of private people . 11

Sc, we are currently

in the position of being rebuked by both sets of liberals--by the Mold
liberal" for going too far and by the "new liberal" for not going far

It is a case of being twice damned.
There is little prospect for repentance from either the "old"

or the "new liberal" and only a very small chance that we could convince
either that they are indulging in grievous error,

I suggest, then, that

instead of resolving the points of difference between these two, we
examine the role government has evolved--devolved may be a better term-in the economy of the modern state.
We can think of government's economic role as it exists in
our country as being, roughly, a tripartite one:

Government enters

the market place as a "demander" of goods and services; Government
acts as an "equilibrator" of the system of markets which make up the
economy; Government acts as a "regulator ’ markets.

These functions

are, of course, not distinct since Government purchases can act to
equilibrate or disequilibrate a system of markets.

But with a mental

footnote to the effect that these functions are linked up, let us
examine them as if they were distinct.

. Government is a Idemander" of goods and services because

we as citizens exhibit both public and private wants.

As textbooks

of economic principles are given to putting it, we are entitled to
think of private and "social" consumption.

Private wants and private

consumption can be satisfied in the framework of the market.


consumer*s bid for a good or service is an index of its. value to him,

and a clue to the producer who would undertake to assume the costs
of producing the good or service.

'Public wants and social consumption

cannot be so attended to.
There is, for example, no way of privately producing and
selling units of national defense, nor is there a way of marketing
law-making and enforcing services, to name two Government functions
no one would suggest as appropriate for private enterprise.


fact that our Government passes defense work on to the private economy
in the form of contracts does not change the fact that the scope and
character of defense expenditure does not grow out of the private
market system).
In the case of health, welfare, and education, on the other
hand, it is technically possible, using insurance schemes and family
units, to have the market determine how much we shall consume,
individually and in the aggregate.

But social feasibility is another

Partly on the grounds that the benefits from these services

spread beyond immediate users and partly on a purely humanitarian
basis, government participation reshapes the scope and, in some degree,
the character of health, education and welfare services.

This is done

by using tax revenue to cover transfer payments to recipients of
such programs and to produce free or heavily subsidized health and
education facilities.

By and large it is the difficulty of financing

that draws government deeply and importantly into such functions.
There are still other government services where fees,
tolls, or quasi-prices are or can be used to simulate the effects

of a market system.

The charge made is intended to be roughly

proportional to the amount and character of the service provided.
Streets and highways, water and waste disposal are huge items in
over-all government spending that fit into this category.
Government responsibility can be said, therefore, to extend
to functions for which the market system (1 ) cannot define an
appropriate scope or character, or (2 ) does not have the distributional
characteristics that appease our social conscience, or (3) can be
replaced with a simulated market system based on fees and public
The problem, of course, is to determine just where to draw
the line and to decide in precisely which areas the market mechanism
fails to reflect preferences accurately and should be dispossessed.
We have gone well beyond providing only those goods and services through
government whose justification on grounds of the incapacity of private
markets is indisputable.

There is no way, at least until one of you

delivers us a "General Theory of Economic Welfare," to isolate
individuals’true preferences for social consumption.

Until then,

there is no way to determine how much of our scarce resources should
be diverted to production of social goods except by the voting mechanism.
Aside from problems on the theoretical level--what voting process is
best in some sense--the voting process has the undesirable property
of forcing the outcome of majority rule on all.

This means that you

and I may be forced to accept certain goods and services in quantities
and at taxes which may not be satisfactory to us.
other hand, fractionalizes issues of this sort.

The market, on the
The market enables

each of us to choose or to refrain from choosing as pleases us.

-8 -

These questions are very large, and I am sure involve inter­
disciplinary exercise in definition, much less in groping for something
passable as answers.

Here I plead guilty to the charge of only

raising commonplace questions in an area in which there appears to be
a community of confusion and historical accident.

There is some reason

for good cheer, however, in faint rumblings of a joint effort on the
part of political and economic scientists to arrive at some theory of
optimal voting procedures.
Before I go on, let me add a footnote and a conclusion.
the footnote.


If it is necessary to point out that we are a good way

off from providing only those goods and services through government
which the market is incapable of providing, it is also necessary to
point out that we are also a good way off from socialism as it has
been traditionally understood.
the means of production.

Socialism is government ownership of

Provision for public wants in our country

is not typically undertaken by government acquisition of the means of
producing them.

Rather it is done by an exercise of effective demand

in the market place.

Goods and services which have come to be defined

as public wants are, for the most part, produced by the private sector.
It is sometimes inferred that government demand for goods
and services is "socialistic . 11

This is a difficult definition to

A definition of "socialism" as government demand for goods

and services requires the person making it have in mind how much the
government must buy from private producers in order to mnke the purchase

The person using this definition must also have in mind

how larg;e a government subsidy to a private undertaking makes that under­
taking :s o c i a l i s t i c . W e sometimes hear a cry of "socialism" raised when
the government taxes and transfers the receipts to a welfare recipient
who spends the money for private goods and services; we rarely hear the
cry of "socialism'* raised when the government levies taxes and uses the
receipts to purchase, say, 1 00 per cent of the output of a defense
Now let me conclude our discussion of government as a demander
of goods and services.

Markets allocate our scarce resources among

competing uses through the intermediation of the price system.


prices are indices of relative scarcities and act to coordinate a
multitude of decisions to produce and consume.

Firms contemplating

undertaking the production of a good or service will be guided by the
selling price of the good or service it expects to prevail and the
prices of the factor services necessary to produce the good or service.
Persons attempting to satisfy their needs will be guided through the
maze of comr^*;:ir.£ ^oods and services by selling prices.
M.irksts may fail to perform their function in the case of
social consumption where decisions to produce and consume have more
than private impact.

Just where the market fails in this sense is

arguable, as I have pointed out, and constitutes part of the debate
between the 1i
old,,and 1 new liberals.1
The fact that questions of how much or how often the govern­
ment should displace the market are extraordinarily difficult questions
should not disguise the fact that once the level of government activity
is given, the activity it undertakes is most often through the market



The government in taxing you and me and transferring part of

our income to a widow, does not tell the widow what to buy.

The govern­

ment does not give the widow stamps redeemable only at a government
store; it gives her a check to spend as she chooses for goods and
services produced privately.

The government in providing a new

defense facility or a grain storage depot contracts the services of
private firms who decide how to mix the services of labor and the
services of drill presses.

In short, government provision of social

goods does not circumvent and weaken the enterprise system but
rather utilizes and strengthens it.

We shall now turn to the rationale of government as

"'equilibrator.i Government’ role as equilibrator of the economy
may be separated into two main branches: one is a fiscal branch, and
the other is a monetary branch.

Let us discuss each branch in turn.

We have already observed that government supplies services
to us as citizens by purchasing and using the output of private firms
and by directly employing private individuals so as to make their
services available to the public.

Government levies taxes in order

to finance the purchase of these goods and services.

Or, to put it

differently, we, the public, pay for services supplied by government
through the tax system, while we pay for privately supplied goods and
services through the price system.
In the process of spending and taxing, government inevitably
has direct effects on private economic activity.
flow along several channels.

These effects

Government purchases of defense equipment,

which are privately produced as we have noted, create employment and


incomes in defense industries.

And as those who earn their livelihood

in these industries spend their incomes, still others feel the impact
of government purchases.
of goods and services.

So it is with all direct government purchase
Government also affects private incomes through

what we call transfer payments--welfare benefits, unemployment com­
pensation, social security.
On the other hand, Government extracts income from the
private economy in the form of taxes.

Purchasing power which we would

have exercised directly or indirectly is absorbed by government and
used either to finance its purchases of goods and services or to trans­
fer purchasing power to others.
There are times when government tax collections do not pre­
cisely match outlays.

In other words, there may be a deficit in the

And as the government borrows to finance that portion of

expenditures not covered by tax receipts, it has effects on money and
capital markets.

These effects, in turn, have an impact on the ability

of private borrowers to finance their projects.

At other times--less

frequent in recent history--the budget is in surplus and the manner
in which the government disposes of the excess of tax receipts over
expenditures also affects private capital markets.
In these ways, which I have sketched very roughly, govern­
ment budgets have an impact on economic activity--that is, on total
demand, on output, on incomes, and, at times, on prices.

It is also

true, incidentally, that changes in economic activity have an impact
on the budget.

Because tax revenues are linked so closely to incomes,

anything that causes a change in private incomes automatically affects


tax receipts.

Thus, there is a reciprocal relationship between the

budget and private economic activity.
It has come to be generally accepted in almost all countries
that government should shape and time its budgetary activities and tax
policies in a way that encourages the economy to perform at its best;
that is, to perform so as to provide employment for a growing labor
force, and to produce a steadily expanding volume of goods and services
at relatively stable prices.

In the United States, passage of the Employ­

ment Act of 1946 symbolized acceptance of these responsibilities by the
government--not only in the case of fiscal policy but also monetary and
other policies that affect economic activity.
The fiscal branch of government's role as an ’
equilibrator , 11
then, is concerned with the interaction of government budgets and private
incomes and expenditures.

The monetary branch of government's role as

an equilibrator, on the other hand, is concerned with the terms upon
which economic activity is financed.
and availability of credit.

It is concerned with the cost

The government could, of course, organize

its budget and monetary affairs without regard to their impact on the

Although this would certainly qualify as a monetary and

fiscal policy, it is not one we would be prepared to live with.


is usually meant is that the government organize and implement its
budget and monetary affairs in such a way as to stimulate an optimum
performance of the private economy.
We have discussed some of the mechanics of fiscal policy in
the last few minutes.

The mechanics of monetary policy are quite

complex and deserve much more in the way of detail than we have time
for, but let me see if I can suggest their operation.

-13To illustrate-, the Federal Reserve can implement an
expansionary monetary policy by purchasing government securities on
the open market.

This purchase will drive up the prices of these

securities and-drive their yields down.

Lenders who had not been

contemplating making loans to businesses or consumers will be encouraged
to do so instead of holding government securities.
be able to sell their securities at a profit.

Many lenders will

The enlarged competition

of lenders means that some applicants for loans will now find credit less
expensive and will activate decisions to borrow and to spend.
the cost of credit component of monetary policy.

This is

Furthermore, commercial

banks, having gained reserves from open market operations, now have more
to lend or invest.

Or looking at it differently, the Federal Reserve

has created new money to pay for the Government securities it purchased.
All lenders are now aware that the total resources for meeting loan
and investment demands have been enlarged so measures to bring resources
and demands together are put into effect.

Lenders are less selective,

tenas are eased, and interest rates fall.

In the process some who

would otherwise have been unable to get financing come into the market.
It is often said that monetary easing is like pushing on a
string unless eager borrowers are in evidence. •What is forgotten is
that there are always eager borrowers if the price is right and the
terms are favorable.

Khat is often overlooked is that monetary action

by imposing an investment decision on the most sensitive and versatile
financial nerve--toe money market bank--is certain of initiating a
succession of investment: ncfions that wi l l ultin?Ately lead to spending.



In fulfilling its responsibilities to encourage economic
growth and stability through the use of fiscal and monetary policies,
government is, as I have said, attempting to act as an equilibrator.
This means that it has recognized the fact that private economic
activity proceeds unevenly in a free market economy.
auto years and "poor5 auto years.

We have "good

We have years in which many businesses

decide that prospects justify large additions to their productive capacity
and to their inventories and years in which these prospects are less
In addition to the inherent tendencies toward fluctuation-the business cycle is as ola as the free market system--there is another
consideration that invites governmental policies to equilibrate the

Not only is the economy subject to fluctuations, but also

there is no reason to believe that the economy has a normal and natural
tendency to gravitate toward full


Deviations from this

ideal condition should not be interpreted as indicating that the
economy is suffering pathologically from some malady, which, if we
could only identify and eliminate it, would permit a return to prosperity
and stability.

Rather, in an economy in which decisions to invest and

save are taken by millions of individual units, it is a remarkable
coincidence if these decisions result in just the correct amount of
aggregate demand to utilize fully, but not excessively, the economy’
productive capacity.

For this reason, too, a degree of guidance from

fiscal and monetary policy is necessary and desirable.

-15By emphasizing fiscal and monetary policies I would not want
to create the impression that these tools are sufficient to cope with
structural unemployment, the balance of payment deficit, the agricul­
tural surplus, or any one of many aggravations to our economy.


broken leg is not cured with a good diet nor will a ruptured balloon
soar in a gale.

It is just as evident that if we obscure the necessity

for specific remedies with e general euphoria the specific problems
will be with us for a long time.

want to emphasize that the use by government of fiscal,

monetary, and other economic pcl'*'ies can and should be consistent
with the maintenance of economic freedom.

Government spends, taxes,

and carries out central banking operations, and these actions affect
the environment in whicn individual consumers and businesses make
their own decisions to spend, to save, to Invest, to lend, and to

But these individual decisions remain within the discretion

and authority of individual economic units.
As I have said, government will in any case be influencing
the private economy by its budgetary and money-creating activities.
Uhat fiscal and monetary policies attempt to do is to time and
direct these governmental activities so as to provide an environ­
ment conducive to opHnurr» performance by the economy.



The rationale of government as a "regulator" in the

economic sphere is largely a matter of protecting citizens from abusive
exercise of economic power.

The concentration of economic power which

makes such abuse a matter of public concern may come about because the
profit motive incites profane as well as acceptable conduct.
also come about for technical reasons.

It can

The technical conditions

surrounding the production of a good or service may be such as to lead
to the survival of only one producer; in other words, to what has been
called a "natural monopoly."

Decisions of consumers and businessmen

are restrained when they are made in monopolistic markets.

The only

exercise of consumer sovereignty available to them is to decide whether
or not to do without.

This is a significant reduction in economic

freedom which should be redressed.
Attack on monopoly may occur through government acquisition
or purchase of its means.

Buying out the monopolist in this manner is

in effect a directly socialistic expedient.

Regulation of the price and

output decision of the monopolist is another expedient.

The inter­

vention of government through the expedients of socialization and
regulation are aimed at circumventing or amending the "non-optimal" price
and output decisions a private monopolist would make.
There is a third expedient we should mention.

This expedient

consists simply of allowing the private monopolist enough rope to hang

The theory here is that the monopolist cannot exist in a dynamic


If it is possible to ignore him--i.e., if he does not

possess title to some vital facility--he will, in time, through the



deficiencies induced by his own noncompetitive behavior, overlook the
forces that will undercut him.

In time, new techniques and new products

will enable consumers to substitute against him and break his grip.
Will the ultimate distress of a broken-down monopolist be
compensation to a long exploited consumer?

Some "old liberals 11 think

so because there are no monopolists in the long run.

But the consumer

who has been waiting for a streetcar all the years it took to develop
the family car and the air-conditioned bus would likely object to this
timeless interpretation of his welfare.
It is unlikely that the long run over which the monopolist
can have his way will become so short that there would not be time
enough to establish and staff a government regulatory body to super­
intend his actions. There is, however, a lesson for regulation in the
thought that a manufacturer of a peanut-sized electron tube may find his
product replaced in five years by one the size of a pea.

I will want to

speculate some more about this in a different context in a moment or two.
But for now, I think that any proposal by "old liberals '1 to simply forget
whole areas of extant regulation--if indeed such would be offered
seriously--is utopian.

It is an exercise of "conjectural history."

Government is very much in the business of "superintending the industry
of private people."

Our concern would seem to me to be to make this

government superintendence as enlightened as it is possible to make it;
as free from "meanness and malignancy" as it is possible to make it.
The instances in which the government acts as a regulator are
very numerous.

They range from very detailed regulation of public

utilities to the simple regulation involved in licensing a restaurant and


inspecting its kitchen.


Although these acts of regulation share some

common properties and are (or should be) based on some common principles,
each is essentially sui generis.
The fact that individual instances of regulation are stories
in themselves is what makes the study of regulation interesting and

I cannot, of course, duplicate the efforts of those who

have written treatises on the subject of regulation.

It would take the

remainder of my time to outline the issues raised in a representative
set of chapters of these treatises on the problem of "fair value1 and
"fair return 11 in public utility regulation alone.

So, if you will

indulge me, I would like to narrow the scope of our discussion of govern­
ment as regulator by examining a part of a regulation in which I have
more than a lay interest.

That is, I would like to examine the special

case of government as a regulator of banks.

But, first, let me spend a

few moments in setting the stage for the discussion.
The banking system has a critical role to play in the attain­
ment of our general economic goals.

We should want a banking system

that is most likely to offer the array of assets and yields to savers
and the level of charges to investors conducive to the high level of
savings and investment necessary for our employment and grox^th goals.


should want a banking system which is most likely to channel savings to
most productive uses.
These performance criteria might be approached in the framework
of collectivist planning, or at a less bureaucratic level, in the frame­
work of deep-going regulation.
alternatives repugnant.

As a society, we have found both

We have chosen rather to restrict ourselves,



wherever it is feasible, to indirect means to the attainment of these

That is, we have chosen to restrict ourselves to the main­

tenance of market forces as regulators.

This in the economic theory

that these forces are sufficient to obtain good performance.

This in

t^ political theory that reliance on the market maximizes the
individual’ opportunity to dissent.
In the absence of indisputable grounds for establishment of a
public utility, the nature of government's "superintending the industry
of private people" would seem clear--enforcing a policy of competition.
Whether there are claims of equal importance on government's super­
intendence of industry--e.g., preventing an economy of shopkeepers from
being transformed into an economy of clerks, or placing upper limits on
a firm's size per se--are, for the most part, policy imponderables.

I do,

however, feel that it is reasonable to assume that an ably implemented
policy of competition will do more toward meeting the economic and
political ends of our society if we will permit it to assume more of the
The high rate of bank merger activity in the past few years
undoubtedly reflects important changes that have occurred in banking's
economic environment.

Outstanding among these changes is the marked trend

toward population concentration and the growth of nonbank financial insti­

These changes were bound to produce adaptive response by the

banking system.

Since the inherent flexibility in the bankfs lending

activity is unmatched by a freedom to change location in response to
deposit opportunities, it is inevitable that banks should consider, along
with other measures, purchasing other banks as a means to achieve adaption.


Adaptation to, changed economic circumstance in banking,
especially as it is manifested in a high rate of merger activity, seems
to me to demand careful scrutiny of regulatory policy.

Merger within

an industry having administered barriers to entry is potentially
hostile to the public interest..

It is potentially hostile to the public

interest because it could foster monopoly by allowing existing banks to

together while established policy forestalled the creation of new

It is in this environment of barriers to entry and of high
merger activity that proposals have been made (and in some cases enacted
into law) that would limit the efforts to expand services by existing
banks to the purchase of established locations.

That is, banks can only

expand into new areas by buying banks already in the area.

This curious

inversion of the public interest, a kind of "Fair Trade Law 11 for bank
growth, not only fails to recognise the direction of economic develop­
ment but also denies expanding banks the opportunity to make their own
judgment about the best way to enter an area.

This is a policy differing

only in- minor details from those attacked by Adam Smith a century and
three-quarters ago.
Banking is an industry where public authority supervises entry.
This means that economic power can be dispensed by those delegated the
responsibility of regulation.

The only reason for the ability to confer

such power resides in the fact that a strict procompetitive policy has not
been considered appropriate in banking.

The primary reasons for this are

(1 ) banks are strategic in the creation of our country's credit;

and (2) banks are caretakers of "other peoples 1 money."

An inescapable


consequence of competition is that only the nimble survive.

Banks, it

is argued, are too important in their dual role as creators of credit
and as caretakers of money to be exposed to the threat of failure.


experience of the 1930's is said to provide the lesson to those who
desire a procompetitive banking regulatory policy.
It is not axiomatic that even in the strongest competitive
atmosphere we would experience widespread bank failure; that competition
would spell catastrophe for our credit mechanism.

The late 1920's and

early 1930's were a complicated bit of political and economic history.
Environment conditions other than the pattern of banking organization
were determining.

It seems clear, at least to me, that "undue" competi­

tion was not at the root of bank failures in that period.
Both bank stockholders and bank depositors have a claim on the
public interest.

But it is not an equal claim.

The stockholder of the

bank does not in logic acquire, with his certificates, claim to
extraordinary public protection from loss.

He has not given up the

major decisions over the direction of the use of his capital that his
colleague owning public utility stocks has.

The bank stockholder is a

"risker of capital" in the same sense as is the stockholder of the local
manufacturing corporation.

As such he deserves no special public

The bank depositor does deserve protection, and in most
instances gets it through a combination of deposit insurance, the cushion
of bank capital, and regulatory rules and supervision of investment and

Providing safety for the depositor is not inconsistent with

competitive behavior of banks.


Some moments ago I mentioned a lesson for regulation inherent
in the fact that ours is a rapidly changing economy.

I have also

mentioned that present bank regulation administers entry of banks, the
creation of itefa banks, in the attempt to prevent what has been called

These barriers to entry are erected to "keep

competition withiri safe levels."

The effectiveness of limiting

competition by limiting entry of banks is, however, waning.
for this lies in the rapid growth of nonbank competition.

The reason
Savings and

loan associations, finance companies, credit unions and the like com­
pete vigorously with banks for savings or in the provision of certain
types of loans.

Broadening capital and money markets are beginning to

impinge on traditional bank "preserves.n

Banking authorities do not

control these institutions and, hence, cannot control the force of their
competition with banks.
The only banking activities where entry restriction may still
limit competition effectively is in the area of services to depositors
and loans to the small business borrower.

Large, well-known businesses

can appeal to highly developed and very competitive markets, and to a
variety of financial institutions for their borrowing needs.


and mortgage credit needs are serviced by several nonbanking financial

But small business borrowers of modest means and modest

reputations, unless fully indentured by trade credit, are likely to be
limited to bank credit, and to banks in their own locale.


competition within safe levels" can mean limiting the alternatives of such

It can mean that the borrower of modest circumstance unsatis­

fied with the terms his bank offers has only the option of doing without.


There are grounds for a more procompetitive policy in bank
regulation, especially

in the form of some relaxation of entry

The adoption of more in the way of procompetitive policy

would do much to reduce the. number of occasions for the banking
authority to decide on what is "adequate 11 for a community or on what
a community "needs."

Competition has a way of determining needs and

providing for adequate facilities.
offered by bureaucratic decisions.

It is a much better way than that


Perhaps a moment spent on a summary of our very wideranging discussion would be worthwhile.

I have attempted to indicate

to you my understanding of Government Responsibility in the economic
sphere by speaking of governments role as a "demander”of goods and
services, as an nequilibratorI of the economy, and as a "regulator ’1
of certain aspects of market behavior.

I have discussed in general,

though hopefully not too vaguely, the rationale for each
artificially separated roles.

of these

At various points in the discussion

we have touched upon political constraints within which government
action takes place*
I imagine it is rather common to leave discussions of this
nature with feelings of dissatisfaction for having raised rather
standard questions and having invoked the standard plea for "more
research" and for ’
better understanding.” But I have promised some
observations on the relevance of Economic Knowledge to Government
It xtfould certainly be trite to remain on the most general
of levels in meeting my responsibility for such a discussion*


then we would end our hour together by concluding that it would be
a good thing if government action were not carried out in total

Let me see if I can avoid being that banal in attempting

to discuss the link between Economic Knowledge and Government
Re s pons ib i1i ty.


We might attempt to give setting to our discussion of this
link by touching on one of the most difficult problems of our time.
Growth in the economy is crucial to the workings of our capitalist

Without expansion, the economy cannot provide the jobs an

increasing population needs*
or less regular and even*

Further, this expansion must be more

We must avoid the inflationary flare-ups

which depreciate peoples 1 past efforts stored in the form of their

At the same time, we must avoid the protracted slumps which

waste human resources and frustrate our potential.

We should not

convey the impression to the world that our freedom is, in the main,
the freedom to be unemployed.
We can begin thinking about the problem of more even and
sustained growth in terms of a set of goals which are to be implemented.
This set of goals is a "policy" and is drawn up in terms of levels or
changes in levels of certain "economic variables."

We can give con­

creteness to these definitions for our growth problem by assuming
that the "policy" is the Employment Act of 1946, and that the "economic
variables" are the levels and movements in prices, total product, and

In addition, the executive and legislative branch of the

government may delegate* and in some instances may retain, control
over what we might call "policy instruments" or tools.

In the case

of the Federal Reserve, the "policy instruments" are the discount
rate at which banks may borrow, member bank reserves, and open market
purchases and sales of Government securities.

Fiscal "policy instruments"

are taxing and spending decisions of government both as to the budget
level and change in that level as well as to kinds of taxes and
programs of expenditure.


How might Economic Knowledge enter here?

It would enter

as knowledge of the relationships that exist among the 'economic
variables” our growth problem specifies--prices, employment, and
total product--and knowledge of the relationship that exists between
the ’
economic variables” and the ’
policy instrumentsn~-monetary and
fiscal topis.

These relationships are studied in general economic

analysis under the title ’
Income Theory.” Income theory suggests that
total product, the consumption behavior of our population in the
aggregate, the investment behavior of business, and the monetary and
fiscal decisions of the Government are related in a particular way.
Income theory, in its most sophisticated dress, appears as a growth

(Really as a set of growth models, since competition is a virtue

economists regard as healthy for themselves as well as others.)


theory as a growth model is suggestive of the way in which the movement
in time of total product, prices, and employment are related.


theory as a growth model is also suggestive of the way in which these
time paths of total product, prices, and employment are affected by
a change in taxes, government expenditures, or the monetary climate.
I say suggestive because these growth models of Income Theory
do not yield these relationships as a quantitative result: They do not
specify a numerical change in the level of employment resulting from
$X billion of riew government expenditures, but only the direction of
the change in employment.

The task of estimating numerical changes in

employment for, say, a cut in taxes of $X billion, or a rise in govern­
ment expenditures of $Y billion is left to a rather exotic branch of
economics called econometrics.


Just as the practicing astronaut came into being with new
scientific knowledge in the form of a space vehicle so the practicing
econometrician came into practical existence with the electronic

This is the instrument which affords him the opportunity

to attempt to predict the future course, of say, employment by his
knowledge of how employment, consumption, investment, and government
expenditures were related in the past.
We need not, of course, restrict our hypothetical econome­
trician to advising government in its role as "equxlibrator . 11


illustrate, let us recall our discussion of government as a "regulator . S
Suppose we narrow this further by imagining that the problem is imple­
menting the Banking Acts conveying Congress 1 intent on mergers and
consolidations of banks.

Economic Knowledge would consist of the

relationships economic theory suggests would exist between the number
of banks doing business in a particular market--the structure of the
market--and the level of interest rates on loans--the performance
of the market.

Our econometrician would then egage himself in

framing and carrying out tests of the relation between the structure
of banking markets and their performance.
This kind of Economic Knowledge--scientific economic
knowledge, if you please--is an ideal.

We see lots of theories but

woefully little in the way of econometric application of these theories.
This is because making econometric applications of theory is a very
difficult job.

Unlike his counterpart in the physical sciences, the

econometrician must be content with changes in his laboratory conditions
which often occur in a most vexing way.


In the absence of a large body

of scientific economic

knowledge, the decision maker is forced to resort to ‘
economics.” "Artistic économies" might be thought of as proceeding
from what the economist derives from his long acquaintance, with a
particular problem.

He is often unable either to state the theoty

upon which he bases his decisions in a systematic form or to attach
numbers to the relationships into which he feels he has considerable
It does not necessarily follow that economic decisions which
are based upon the "art" or the "feel
even suspect.

of economists are wrong or

It does follow, however, that the accumulation of

scientific information in a form readily available to the decision
maker cannot fail to be of assistance to him in the decision-making
It is difficult to say, in general, what portion of economic
decision making may be described as "art ' and what part may be
described as "scientific."

Private businesses have made progress

in recent years in scientific decision making, or "management science."
But in the case of government, with more complex goals and a larger
number of behavioral units and institutions to take into account, the
problem is much more difficult.

In any event, it must not be supposed

that? the complete substitution of scientific for artistic decis-ion
making is possible or even desirable.

At best, a rigorous economic

theory, a set of mathematical equations* and an electronic computer
will aid, not replace, thé economic decision maker, who, it is hoped,
will always have a bit of the artist in him.