View original document

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

Tuesday, May 14, 1968
Approximately 1 P.M. EDT


Remarks of

Board of Governors
of the
Federal Reserve System

at the

"When Peace Comes"
Sponsored by the
New York Society of Security Analysts
New York City
May 14, 1968


This is a most pleasant occasion.

The topic "When Peace Comes"

is both hopeful and exciting in its promise for the future.

I found it

relaxing to stop worrying about day-to-day events in order to examine
some basic problems that may have to be faced in the future.

As I

understand the purpose of today's seminar, it is to look beyond immedi­
ate worries in order to develop analytical concepts useful in projecting
economic promises and performance in the period well beyond the next
six months or year.
A bonus in peering ahead was my sudden recognition that some­
time in the year 1970, less than two years from now, the U.S. economy
will be turning out goods and services at an annual rate of over one
trillion dollars.
I want to discuss only two of the many welcome questions
raised by this seminar's topic, "When Peace Comes":

What sort of monetary policy--or, as a corollary,
what type of interest rates--might appear useful
for the first postpeace year?


Is a desirable policy achievable? Or, what basic
domestic and international forces might make it
difficult to achieve?

The briefest answer is that more credit than is now available
and lower interest rates should be both useful and efficient for the
immediate postwar type of economy.

The achievement of such policy

objectives will depend on the path that prices, wages, and monetary and



fisea1 policy take between now and then.

The important fact though is

there appear to be no insurmountable barriers to the adoption of such a
policy goal.
As an aside, I have assumed that this conference is primarily
concerned with the underlying relationships expected in some Year P,
the first postpeace year.

What year that will be is uncertain because

we don't know how long negotiations will take nor what the resulting
speed and degree of demobilization will be.
thought of Year P as 1970.

For convenience I have

However, the analysis would still apply if

the first postpeace year were either earlier or later.
Similarly I have not attempted to forecast interim policy.
I have thought of Year P as one in which most of the war's impact on
the economy will have faded away.

I assume our current problems--too

large a budget deficit, too rapid rises in prices, too much Federal
demand for financing will have been solved.

If they have not been,

major adjustments in the analysis might be necessary to account for any
remaining disequi1ibria.
Private Investment
My projection for 1970 as Year P shows large and growing re­
quirements for both domestic gross private investment and net exports.
Their dollar total should be at least 25 per cent higher than either the
latest quarter or the average of the past two years.

Perhaps more



significantly, gross private investment may be expected to rise from
the current rate of 14-3/4 per cent of the GNP to a rate of 16 per cent.
Each of the three basic sectors of private domestic investment
should partake in this expansion.
Many have been concerned with the viability of recent rates
of investment in plant and equipment.

Certainly they have been ex­

tremely high--at record-breaking levels--for the past three years.


the other hand, with an expanding economy, continued rapid improvements
in technology, and growing wage costs, demand appears adequate for these
expenditures to continue to run in the neighborhood of 10.5 per cent of
the GNP.
The value of residential construction (given adequate financing)
should rise by more than 50 per cent compared to 1966-67.

I say this

even though I believe that most observers overestimate the number of new
housing starts required in the next three to four years.
Since investment in business inventories in normal periods is
primarily related to growth in the economy, I would expect inventories
to expand in the vicinity of $8 billion a year.
A fourth sector of the investment sphere is the transfer of
resources abroad through net exports of goods and services.
ledge and ability to project in this sphere is minimal.

Our know­

The amount of

required investment will be directly related to the role the U.S. wants


to play internationally.

With our military commitments, the world need

for aid, plus that for direct private investment abroad, a net non­
military export goal of $10 to $12 billion a year would seem small
rather than large.

My later remarks are pertinent to the question of

whether such a level is possible.
Public Investment
Because it depends on thousands of political decisions, fore­
casting public investment is far more difficult.
that this demand will decline.

I see no indication

On the contrary, I guess that it will

grow even more rapidly than private demand.

Certainly the needs for

investment brought about by the increasing pollution of our air and
water, the continued deterioration of our cities, our growing needs for
recreation, as well as the rapid expansion of higher education, medical
care, and similar community activities all point to greater, not lower,
needs for public investment.
Monetary Policy
Most economists would probably agree that these large invest­
ment requirements could be met more easily and efficiently in an economy
characterized by comparative monetary ease and with considerably lower
interest rates than we are now experiencing.

At lower interest rates,

individuals, firms, and local governments could finance more of their
needs directly in private financial markets.

More decisions would be




The achievement of those needs which seem to be rising

in our national scale of values--housing, slum clearance, transportation,
hospitals, schools, col leges--would be enhanced if there were lower
interest rates with funds more easily available.
Granted the desirability of such a monetary policy, are there
any obvious factors standing in the way of its fulfillment?
domestic side the answer seems clearly to be n£.

On the

Easier money and lower

interest rates should be possible in the first postpeace year.


the correct policy mix needed to obtain it will be selected is, of course,
an entirely different matter.
Examining the possible flow of funds needed to finance the
large investment of Year P, we find no need for significant deviations
from relationships experienced in recent years.

The amounts needed for

each market can be reached through a continuation of recent trends.


mortgage requirements are above recent levels as would be expected from
the sharp expected spurt in housing, the general distribution of funds
would come close to that of many postwar periods.
Differences from the past are well within ranges that could be
offset rather easily by minor shifts in fiscal policy.

The war's end

will see a sizable peace dividend available for government programs.
As Vietnam expenditures are phased out, revenue surpluses should develop
sufficient to expand current programs, add new ones, or alter the deficit.


Because the projected financial flows are close to balance,
rather minor shifts in Federal borrowing should bring about an equilib­
rium at considerably lower interest rates.

In addition, if the Federal

Government increases its grants and direct lending it will reduce the
burden on the financial markets by lowering the amount of funds recipients
would otherwise have to borrow in the market.
In the first postwar year, as in recent ones, fiscal policy
will be a major determinant of the height of interest rates and the
general availability of credit.
International Monetary Policy
The idea that there are no obvious domestic impediments to
easier money now visible for the postwar year and that an easier money
policy could result from a proper fiscal package is understandable, ex­
plainable, and probably acceptable to most of you.
be made on the international side?

Can the same statement

Is there something basic in inter­

national financial relationships which would make it difficult to achieve
the type of monetary policy we would choose for domestic reasons?
Again my general answer is no.

International financial forces

should not require higher interest rates than are desirable for domes­
tic reasons.

I must admit though that the analysis in this sphere is

far more complex.

We lack the data, the concepts, and the models that

are the equivalent of those available for the domestic economy.




addition, traditions, emotions, conflicting aims, and misunderstandings
tremendously complicate analysis.
Since international questions are so important and since the
lack of understanding is great, I will spend the rest of my time on it.
I will take a single abstract hypothetical problem and try to show its
various policy possibilities as simply as I can.
First let me point out that the required analysis has little
or nothing to do with gold.

Most discussion and much analysis intermingles

and confuses two rather separate problems:

that of confidence and

stability in our international exchanges with the much more difficult
problem of balance of payments adjustment.
one of confidence and reserve stability.

The gold problem is mainly
It may but need not be related

to the problem of how a country adjusts its balance of payments when
they are in either deficit or surplus.

I intend to talk only of the

second or adjustment problem.
Good discussions of the adjustment problem are fewer than they
should be because so many concerned with the balance of payments have
spent so much of their time in the past 10 years fighting the brush fires
associated with the problems of stability and gold.

Perhaps as a result

of the Washington-Stockholm conferences in March, gold will more and more
assume the role of comparative unimportance to which most modern
economists have wanted to relegate it.


As I see it, these two conferences were extremely important
because, among other things, they make it possible to separate the prob­
lem of stability from that of adjustment.

Each of these problems may

now be faced up to logically and separately.

The two-tier gold system

and its semi-demonetization of gold is a recognition of and a solution
to one of the problems that arises naturally in an exchange system
based on several types of reserves.

Such difficulties are exacerbated

when a reserve serves multiple purposes as does gold by being both a
commodity and a monetary reserve.
More importantly the conferences seem to me a public recognition
by the major countries of what many economists have preached for years-that there is no necessary relationship between the price of gold and
the world's balance of payments problems.

The conferences may also be

interpreted as a significant reaffirmation of the determination of the
major countries not to allow fear or market speculators to dominate
logical unified international financial policies.
Interest Rates and
International Adjustment
For our discussion of balance of payments adjustment, let's
pick as simple a problem as possible.

Let's assume that in Year P, the

United States successfully adopts the best possible mixture of policies
to meet our domestic goals.
commodities is constant.

The index of wholesale prices of industrial

Growth of real GNP is close to 4.5 per cent a

Unemployment is at its structural minimum.


What would happen?

What would be gained; and what lost if

monetary policy were now used in an attempt to adjust the balance of
First one might ask how there could be a balance of payments
problem when the domestic economy was in ideal balance.

The answer is

that there is no necessary relationship between the post-Vietnam situ­
ation which will exist in the domestic economy and the resulting inter­
national balance.

Our Year P balance of payments will depend on where

our domestic prices stabilize relative to those in foreign countries.
It will be influenced by accumulated deficits, longer term liabilities,
and backlogs resulting from current policies.

Even assuming all controls

and special taxes will be removed, a backlog will remain of potential
investments, lending, and travel held back by prior restrictions.
Equilibrium will also depend on whether foreigners wish to increase or
decrease the dollars they hold for transactions or reserve purposes.
Most important will be decisions as to the Government's post­
war military and aid commitments.

Many people believe that our recent

annual totals of net lending abroad by the U.S. Government, grants for
economic aid, and net military expenditures abroad of $7 billion-under 1 per cent of GNP--should be our minimum target for the future.
Many observers believe that to perform its proper role, given our size,
income, and importance of the dollar, the U.S. nonmilitary net export
balance, which averaged $8 billion in 1966 and 1967, ought to run be­
tween $10 and $12 billion.


Since predicting where we might or should end up is at this
point almost entirely guesswork, I shall not attempt it.
pick an entirely arbitrary example.

Instead, I'll

Let's assume that in our postwar

world with ideal domestic conditions, we decide we want to increase our
net balance on nonmilitary goods and services and private capital move­
ments by $3 billion per year.

It doesn't matter whether this is to give

more aid, reduce a deficit, or keep more troops overseas.
How could monetary or interest rate policy help to bring about
the desired adjustment?

Through what channels would it work?

What sort

of relationships seem to exist between domestic changes and those in the
balance of payments?

What other possibilities of adjustment exist in

addition to domestic monetary or fiscal policies?
Higher Interest Rates
and Tighter Money
There are three separate channels through which higher interest
rates may influence the balance of payments.

The first is through the form and location at
which people hold their assets and liabilities.


The second is through reducing the level of
income and production.


The third is through reducing the price level
below the point it would otherwise reach.

It is clear that higher interest rates may act and react through
each channel simultaneously.
examine each separately.

For ease of exposition, however, let's


The Direct Effect of
Differential Interest Rates
Surprisingly our actual knowledge of impacts is probably
least in the area where the expected effects of changing interest rates
on the balance of payments are most traditional while the controversy
over its effects may be greatest.

It seems obvious that higher interest

rates ought to improve the balance of payments by attracting more money
and reducing U.S. lending abroad.

Liabilities held by foreigners are

shifted from central banks to private banks or individuals.

Assets held

abroad by U.S. banks and investors increase less than they otherwise
would have.

Our reserve position improves.

Depending on definitions,

our balance of payments may also.
Others argue, however, that such an apparent improvement does
not really aid in adjusting the balance of payments.
total liabilities may be unaltered.

The country's

Added deposits of short-term money

that are not simply a transfer of existing outstanding liabilities
would perhaps help.

Even in this case, however, the basic situation may

actually become more unstable if the added liabilities are "hot" and
likely to move at the least provocation.
Along with changes in our assets and liabilities there will
be changes in receipts and payments of investment income.

We may in­

crease our reserve stock temporarily and our debts equally, but we do
not improve our net annual flow of earnings.

In fact, income may

decrease and the future deficit may become worse.

Higher payments will

be made to foreign holders on both the new and pre-existing liabilities.


If the investments that are attracted are longer term or
direct, this is usually considered a more permanent force.
consider this a true basic adjustment.

Many would

A debate does exist, though,

as to whether indirect effects on investments through lower income
would not completely outweigh the direct effects.

If our income growth

fell below the optimum, fewer foreigners would invest here.


more U.S. firms and individuals would also invest abroad is not at all
Changes in Income and Production
Domestic monetary policy can influence the balance of payments
if it successfully alters domestic production, income, and employment.
Balance of payments deficits will decrease if a lower GNP leads to
smaller imports and a greater desire to export.

Some idea of the prob­

able order of magnitudes involved can be obtained from the many avail­
able econometric models.

Specific estimates in this sphere must be

taken with more than the normal grain of salt, but the numbers express
the common sense concepts of experience.
The statistics suggest that for each decrease of $10 billion
annually in the GNP (assuming for the moment no price effects), U.S.
imports of goods and services should drop by $550 to $650 million.
Exports would not gain but would be expected to drop because when
other countries' income decreases as a result of selling less to the


U.S. they will buy less from us.

Depending on how they react, on the

time period under consideration, and the amount by which they can off­
set the fall in income, the net gain in the entire balance of trade
estimated by these models is from $150 to $350 million per $10 billion
drop in the U.S. 6NP.

In other words, if the tighter money were

effective only in lowering income and did not influence prices or the
form of assets, it would require a GNP decline of from $85 to $200 bil­
lion per year below its normal rate to offset a deficit of $3 billion
in the balance of payments.
Price Effects
Tighter money does not affect income alone.
unemployment, prices rise less rapidly.
would fall is not as clear.

With higher

Whether or how much prices

U.S. wholesale industrial commodity prices

fell minimally in periods after World War II and Korea.

The problem of

how to deflate prices for balance of payments purposes was a major issue
among economists in analyzing the British experience after 1925.
Relative prices do appear to have a considerable balance of
payments impact.

The models estimate that a 1 per cent drop in wholesale

prices relative to those in the rest of the world would be expected to
improve the balance of trade by from $400 to $600 million per year.


these estimates are roughly right, to adjust the balance of payments by
$3 billion, U.S. wholesale prices would have to improve by 5 to 8 per
cent compared to those in the rest of the world.


Adjusting the Balance of Payments
It is against the background of this type of experience and
estimated magnitudes that the debate over how to adjust the balance of
payments, if this proves necessary, will take place.

It is obvious that

in a period of over-full employment and rising prices, there is no con­
flict between desirable action for the domestic economy and that needed
for international balance.

Conflict arises only if the adjustments

required fall outside the limits of desirable domestic policy.

In such

a case four basically different views have been expressed as to what
should take place.

Some believe that domestic policies would have to be

Monetary and fiscal policy ought to shift to higher taxes and

interest rates in order to increase unemployment, cause GNP to expand
below its normal growth rate, and lower prices.

Others disagree either

because they think the price to be paid in lost income is too high, or
because they believe the hoped-for adjustment would not occur.


foreign impacts of a U.S. recession might be such that all trade would

Lower incomes here would be matched by lower incomes abroad.

The deficit would be less in percentage terms but it would not be wiped

Some would simply maintain an optimum domestic policy.

They assume other countries would either accept the added reserves or
would act individually to decrease their own surpluses.

Since whole­

sale prices would be constant here, any increase in prices abroad would


improve the situation.

Any countries which were dissatisfied with the

rate of improvement could halt their own capital imports by direct
action or could move their exchange rates upward.

This group assumes

that most countries would prefer a gradual improvement while gaining
reserves to the threat of a worldwide recession.

A third group emphasizes the strong balance of payments

improvements which the models show arise from comparatively small changes
in relative prices.

They argue that the most logical way of getting

relative price improvements is through more flexible exchange rates.
For example, if the estimates are correct, and if domestic policies
maintain internal price stability, movements in relative exchange rates
of 1 or 2 per cent a year would allow the balance of payments to adjust
by a billion dollars per year.
Some argue that the relatively small changes necessary for
adjustment could be achieved without fear of major destabilizing specu­
lative movements by widening the band of permissible exchange fluctuations,
but they would not allow them to move beyond fixed limits.

Others fear

speculative movements far less and see no advantage to imposing any
limits on the amount the rates could float.

Finally, a further group believes that adjustments should

take place through the type of direct and indirect subsidies, taxes,
and controls now in use.

They feel that if made more flexible and

efficient, the continued use of a package of specific programs aimed


at individual expenditure streams is logical.

The Foreign Investment

Equalization Tax might be extended to all capital and made more flexible.
Across-the-board surcharges on imports have been advocated.

We could

alter the present subsidies on military and economic support and AID.
The proposed travel tax is another measure in this package.
Each of these proposals, of course, affects different groups
in separate ways.

The fact that some of them have been adopted is an

indication thatmanyview them as preferable methods of adjustment to
the previous three.

Others, however, claim that the apparent improve­

ments under these programs are an illusion.

They question whether such

actions have really adjusted the payments mechanisms.

They believe the

apparent effects are only temporary and may cause a later opposite

They also question whether a permanent system based upon specific

adjustments of this type can work because of administrative and control
I recognize that my comments have been far from the specifics
in which you usually deal.

On the other hand, because I am constantly

amazed at the misinformation and misunderstanding which surrounds mone­
tary policy in both the domestic and international spheres, I thought
that you might find some of this analysis useful.

The results of the

projections for the Year P indicate that we should expect a high rate
of private investment.

The demands for money and credit should also be



The funds required, however, appear attainable at lower interest

rates than now exist assuming that fiscal policy results in limiting
Federal demands on the private market.
There is no real way of judging whether or not the balance of
trade will produce a sufficient surplus to enable us to support the type
of foreign policy we will choose in the postwar period.

The needs will

depend on what happens in the interim, on where we would be now if the
market were free, on our ability to choose a proper fiscal-monetary mix
domestically, and on our foreign policy objectives.
We all hope the Year P will soon arrive.

We look forward to

a period when we can spend our income on more productive purposes.


in a trillion-dollar economy, however, we will still have more demands
than resources.

Neither economists nor security analysts need fear
Rather, I fear we will still be suffering under that

ancient Chinese curse:

"May your children live in interesting times"!