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Statement by
0. Charles Partee
Member, Board of Governors of the Federal Reserve System
before the
Subcommittee on Domestic Monetary Policy
of the
Committee on Banking, Finance and Urban Affairs
U.S. House of Representatives
March 30, 1977

I am happy to appear on behalf of the Board of Governors
of the Federal Reserve System to discuss the Implications of U. S.
Treasury financing requirements for monetary policy. Your Chairman has
asked me to comment, 1n particular, on whether the Increased Federal
deficit financing needs soon to be created by the Administration's
proposed fiscal package are likely to complicate the management of
monetary policy.
At the outset, I should emphasize that under the insti­
tutional arrangements 1n the United States, decisions on monetary
policy and Treasury debt management are kept relatively independent
from one another. When the Treasury seeks to Issue new debt, It
generally does so in the securities market, paying rates that are
competitive with those available on debt securities of other borrowers.
This market-oriented approach permits the Treasury to cover Its
financing requirements without special support from the central bank.
The Federal Reserve Is then left free to pursue its monetary policy
objectives, which are set with reference to what we believe con­
sistent with the emerging needs of the overall economy.
In some other countries, new public debt is financed
initially at the central bank, often at rates below the cost of
borrowing from market sources. When this approach 1s followed, the
central bank in effect creates money to pay the government's bills,
at least until such time as 1t can successfully resell the securities
to the private Investment community. Monetary policy 1s thus subor­
dinated to the immediate requirements of financing the public debt,


and in the process the central bank may sometimes lose control of
the nation's supplies of money and credit. Sooner or later, this
lack of control 1s likely to bring escalating rates of domestic
Inflation, along with the economic distortions and Instabilities
that rapid Inflation breeds.
The fact that our governmental structural separates
responsibility for debt management from that for monetary policy,
however, does not mean that the Federal Reserve Is not vitally
interested In successful Treasury debt management. A failure by
the Treasury to cover Its financing requirements, in addition to
precipitating a crisis in public credit, would disrupt financial
markets and create serious problems for other borrowers as well.
Such a development would doubtless make it necessary for the Federal
Reserve to divert open market operations for a time from more fundamen­
tal objectives to the task of coping with the Immediate financial market
To help minimize the possibility of Treasury financing
failures, the Federal Reserve during the 1950's and 1960's followed
the practice of maintaining an "even-keel" posture 1n monetary policy
at the time of major debt management operations. Basically, this
commitment meant that during the critical days of Important Treasury
financings 1n the coupon market, the Federal Reserve would not take
overt monetary actions— such as a change in the Federal Reserve
discount rate or a significant shift 1n the thrust of open market


operations— which might be construed by participants In the U. S.
Government securities market as a basic adjustment in monetary policy.
In more recent years there has been a gradual relaxation 1n the
constraints on monetary actions Imposed by this "even-keel" commitment.
This relaxation has been possible mainly because the Treasury has
Introduced debt management Innovations that have made its
financings less vulnerable to sudden variations In market Interest
Perhaps the most significant of these Innovations has been
the Increased emphasis on the auctioning of new debt offerings.
In the 1950's and 1960's, when the Treasury sold new notes and bonds
1t generally announced fixed Interest rates on the new Issues 5 or 6
days 1n advance of taking subscriptions. Under this procedure the
financing could be jeopardized by any sizable, unexpected Increase 1n
market Interest rates that developed between the announcement and
actual offering of the new Issues. When yields on outstanding
market securities rose just before the offering date, the terms of
the new Issues naturally looked less attractive to Investors. If
this erosion of Investor Interest went too far, the Treasury ran
the risk of falling to sell enough of Its new debt and thus of being
temporarily embarrassed for lack of funds. Under the auction procedure
now used this risk 1s reduced, because the yields and prices of new
issues are determined through bidding on the date of the financing
Itself, rather than some days before.



A second Innovation in debt management that has diminished
the constraint of "even-keel" considerations on the conduct of
monetary policy has been the restructuring of much of the marketable
debt Into regularized cycles of debt offerings that can be handled
on a rather routine basis. Financings are split Into moderate-sized
auctions that occur on a definite schedule» which encourages Investors
to accumulate funds for regular placement In Treasury Issues.
It Is fortunate that the Treasury has been able to channel
much of Its recent borrowing Into these relatively routine debt
offering cycles, because the heavy Federal deficits of the past few
years have greatly expanded both the aggregate volume of Government
financing and the frequency of new Issues. Last year, for example,
the Treasury sold 1n the market $93 billion 1n new notes and bonds
to refund maturing debt and to raise new cash, far above the $25
billion average annual volume that had prevailed during the decade
from 1965 to 1974. Moreover, last year's financings Included 30
separate Issues of new marketable debt other than Treasury bills,
compared with an average of 12 per year from 1965 to 1974.
Against this background, 1f a rigorous "even-keel" approach
to Treasury financings were required, the greater frequency of
operations could often delay needed Federal Reserve actions, and
to that extent reduce the flexibility of monetary policy. Of course,
there 1s always a free and full exchange of Information on such
matters as financial market conditions and Federal financing



requirements between the Treasury and the Federal Reserve. But
If we are to be successful 1n maintaining effective control over
longer-run growth 1n the monetary aggregates, sufficient leeway
to make timely adjustments in the supply of bank reserves 1s an
essential prerequisite.
This brings me to the more Immediate question of whether
the Administration's proposed tax rebate and social security payment
package 1s likely to create any special difficulties for Federal
Reserve policy during the months just ahead. Two possible sources
of difficulty have been Identified.
First, some analysts have speculated that the sheer weight
on financial markets of Treasury borrowing to finance this package
might Inhibit the flexibility of Federal Reserve actions. I do not
think that this 1s a realistic possibility. Although the $10 billion
or so expected to be distributed as tax rebates and associated
payments during the next few months 1s a very large sum, 1t 1s not
likely to create a major financing problem for the Treasury. Not
only will the bulk of the payments be occurring during a part of the
year when regular Income tax receipts would otherwise be creating a
seasonal surplus, but the persistent shortfall 1n Federal spending
below budget estimates thus far 1n the current fiscal year has held
aggregate deficit financing requirements somewhat below market
In a broader sense, the addition of another $10 billion to
the Treasury's borrowing needs extends the period of exceptionally



heavy deficit financing and Increases the risk that adverse
financial market effects could begin to accumulate. The Federal
deficit In the current calendar year— Including the deficits of
off-budget agencies— now seems likely to approach $80 billion, up
$17 billion from last year and only moderately less than In calendar
1975. If these large deficit financing needs persist Into the time
when private credit demands are rising strongly In response to con­
tinued economic recovery, substantial pressures on both the cost
and availability of credit might very well develop. But this 1s a
longer-run and more generalized concern.
The second aspect of the fiscal package that poses a
potential problem for the Federal Reserve 1s the likelihood that
the rebates will produce temporary— but difficult to Interpret—
distortions In the monetary aggregates. To the extent these temporary
rebate effects disguise the more fundamental Influences on monetary
growth, it will be difficult for a time to determine the near-term
course 1n money growth and Interest rates that is most likely to be
consistent with the developing financial requirements of the economy.
To help understand why the Impact of the tax rebates on
monetary growth Is so difficult to predict, let me briefly discuss
the relationship of U. S. Treasury cash balances to the money supply.
First, it should be noted tha't although the Treasury holds Its cash
balances as demand deposits,'partly with commercial banks and partly
with Federal Reserve Banks, Neither type of deposit is included in
statistics on the money supply. Deposits held by other key types


of spending units— households, businesses, and State and local
governments— do, of course, all appear 1n the monetary aggregates.
The rationale for excluding Treasury deposits from the
various measures of money has traditionally been that spending
decisions by the Federal government are not at all Influenced by
the size of Its cash position. Federal spending programs are
legislated by Congress and supported by tax revenues or borrowed
funds. Thus, the level of the Treasury's bank balance at any given
point simply reflects different flow patterns of outlays and receipts.
The spending decisions of other economic units, on the other
hand, do appear to be influenced significantly by the size of their
liquid balances. Since this relationship 1s a critical link 1n
understanding the probable Impact of monetary developments on
aggregate spending 1n the econon\y, it 1s Important to have statistics
on the monetary aggregates that provide the most meaningful analytic
measures of these variables.
The exclusion of Treasury balances from the published money
supply statistics, however, may occasionally present difficulties 1n
Interpreting short-run movements In these data. Whenever taxpayers
or Investors make net payments to the Federal government, their
deposit balances tend to be drawn down and those of the Treasury
rise. Similarly, when the Treasury spends more than 1t receives,
Its balances are drawn down and those of other units 1n the economy
tend to rise. But most of these shifts 1n cash position between the
public and the Treasury are regularly recurring events related, for
example, to the timing of tax payment dates and periodic Treasury


financlngs. Therefore, they tend to wash out 1n the seasonally
adjusted measures of the money supply that are used as guides to
monetary policy.
Even after taking out the seasonal, our statistical studies
have not shown a predictable, consistent relationship between
variations 1n the Treasury's balance and changes 1n money growth
rates. This 1s probably because of the myriad of transactions that
go through deposit accounts each day, and also because most large
depositors typically adjust their demand balances promptly to
desired levels.

In the rebate case, however, the Treasury disburse­

ments will be especially large; they will be concentrated 1n timing
and non-seasonal 1n character; and the payments will be made to
families rather than to business units. There will probably be some
delay as families deliberate on how to use the windfall and, If so,
there will be a sharp temporary upsurge 1n their average cash balances
and a resulting spurt 1n the growth of the monetary aggregates. Later,
as these balances are spent, there should be a reversal of the money
bulge, and a concomitant slowing 1n monetary growth until the
recipients have used the funds and cash balances have been reduced
to normal working levels. This 1s the pattern of response that seemed
to occur 1n the money growth numbers during the prior tax rebate
episode In 1975.
Looking to the months ahead, 1t 1s hard to judge with
any precision how large the distortions In money growth rates
triggered by the 1977 fiscal package may be. We have only one


prlor experience to draw upon, and today's economic setting differs
1n Important respects from that of two years ago. Hence, the Federal
Reserve 1s likely to have considerable difficulty as the period
progresses 1n assessing the more fundamental developments 1n the
underlying trend of money growth.
Most analysts clearly recognize the compHcations In
evaluating money growth rates during and Immediately after the
forthcoming rebate period. But the Intriguing point to me 1s that
different experts commenting on how the Federal Reserve should cope
with this problem are offering us diametrically opposing advice.
Some argue that because the data.on the monetary aggregates
can be expected to behave erratically, the Federal Reserve should dis­
regard them 1n the period during and Immediately after the rebate
period. Instead they recommend that we focus on keeping money market
conditions— Including the Federal funds rate— from tightening. Since
the economy 1s operating at substantially below Its optimum rate,
they see little risk In adopting this policy approach.
Others argue, on the other hand, that even temporary
abandonment of the aggregates as a guide to policy would be risky,
given the long lags with which monetary conditions affect the economy.
If the expansion 1s now gaining momentum, which seems probable,
resorting to a stable Interest rate policy might lead to a substantial
overrun 1n growth of the aggregates— going well beyond the temporary
rebate Influence. If this were to happen, 1t 1s feared that the
Federal Reserve would experience difficulty holding the longer-run



growth rates of the aggregates within the ranges that have been
specified, with probable adverse future consequences for the rate
of Inflation. To avoid the threat of excessive longer-run monetary
growth, this group recommends keeping a close control over the
aggregates, even during the rebate period.
It seems clear that any rigorous effort to hold down
monetary growth rates during the rebate period would bring substantial
and potentially unsettling short-run Interest rate movements— first
upward, and then downward— as the adjustments in money balances are
made. Such fluctuations would seem to serve little purpose and could
be misleading and disadvantageous to both borrowers and lenders. A
total lack of attention to the aggregates, on the other hand, could
permit a sizable lasting expansion In money and credit to get under
way, particularly 1f the economy continues to strengthen generally
over the period ahead.
In my view, there 1s a safer middle course between
these two recommended policy approaches. This course would be to
attempt to estimate, In advance, the deviations from otherwise
expected patterns of money growth that might develop due to the
special Treasury payments. These estimates would allow both for
an Initial period of temporary acceleration 1n monetary growth
and a succeeding period of temporary slowing. A need for possible
Federal Reserve actions to counter unusual developments 1n the
monetary aggregates would then be Indicated only to the extent that
actual growth rates moved well beyond the parameters established by
these allowances.



While this was the general approach followed by the Federal
Reserve during the tax rebate period of 1975, only a single point
projection of the rebate effect was formulated and there was no
prior experience on which to base the estimate. As 1t turned out,
that point estimate was on the low side. Consequently, policymakers
Inferred that the monetary expansion actually observed 1n the spring
of 1975 was greater than could be attributed to the rebate and hence
greater than would be subsequently reversed. Looking back to that
experience, both the rebate Influence and the reversal appear to have
been underestimated.
This time around, I would expect greater recognition to
be given to the uncertainties surrounding estimates of what proportions
of the rebates and other distributions will be retained 1n money form,
and for how long. It may well be that a range of projections will
prove more reliable than a single point estimate 1n order to bracket
the various possibilities. Thus It 1s probable, as Chairman Bums
stated at a Senate Budget Committee hearing last week, that our zone
of tolerance 1n permitting monetary expansion to run at high rates
for a while will be somewhat wider this time. But if we find that
monetary growth does not subsequently moderate 1n the expected
degree, we may then need to act to keep longer-run expansion of
the monetary aggregates within our stated ranges.
While 1t is clear that observed money growth rates are
likely to show sizable fluctuations in the period to come. Federal
Reserve policy will continue to seek longer-run growth rates


appropriate to the requirements of the economy* At the same time,
It 1s undesirable and unnecessary to expose the economy to the
uncertainties and destabilizing effects of movements 1n Interest
rates If these are likely to be reversed shortly* Careful monitoring
of emerging economic and financial developments during and after the
rebate period should permit us to allow for any needed adjustments
In money growth rates and Interest rates on a reasonably timely
basis. This 1s so since a major virtue of monetary policy as an
Instrument of demand management 1s Its operational flexibility.

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