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Remarks of

Board of Governors
of the
Federal Reserve System

at the
22nd Annual Conference
of the
Financial Analysts Federation
St. Louis. Missouri
May 12, 1969


I imagine I was invited today because of the problems that most
of you face in formulating an analytical concept with which to treat
monetary policy. The type of questions you probably have in mind are
those I am asked daily. Why are prices rising so fast when interest
rates are so high? Do the high interest rates cause the high prices?
Is gradualism in fighting inflation possible, or logical? How does the
Federal Reserve expect to halt the price rise? Is monetary policy frus­
trated by bank innovations of new ways of raising money that avoid reserve
requirements? Must stock prices and output be depressed to end infla­
In the words of the famous bishop, "Those are real questions."
Unfortunately, I don't plan to answer them for you. While I have my own
views on each question,, on some and perhaps many they would not be at
the consensus of Federal Reserve opinion (if there is such a thing!).
Instead, I thought it would be more useful to you simply to outline some
of the concepts useful in judging these and similar problems.
I have picked the title, "Tasks of Monetary Policy," because
it seemed to me simplest to organize analytical concepts by first out­
lining the divergent views of many as to what logical tasks or limits
exist for the Federal Reserve and then to show some of the factors lead­
ing to these varying views.
Note that I have used the term, "task," rather than, "goal."
Everyone can agree with the general goals of national economic policy,
namely, full employment, maximum sustainable economic growth, relative
stability in prices, and a viable equilibrium in international financial
relationships. These are the objectives of the entire Government, includ­
ing the Federal Reserve. But controversy arises when it comes to imple­
menting policies to serve these ends. Debates continue with respect to
the channels and timing of monetary policy, the appropriate mix of mone­
tary and fiscal policy, and to the relative priorities to be assigned to
the different objectives in differing economic environments.
There are at least three contrasting views as to the task mone­
tary policy should attempt to achieve. I speak of the choice of a task
as the choice of a specific target which is used to guide the rate of
expansion in money or credit.
One view is that monetary policy should aim at achieving a
more or less constant rate of growth in the monetary aggregates. The
aggregate chosen may differ among proponents--some take total reserves,
or the monetary base, or the narrow money supply, or money in a broader


definition, or total bank credit--but the objective in any case is to
establish a neutrality in monetary policy by allowing the demand and sup­
ply for goods to adjust themselves through interest rates, velocity,
prices, and employment without being influenced by any shifts in monetary
A second view of monetary policy--the one traditionally held by
policy-makers and the financial community--is that monetary policy should
be contra-cyclical, i.e., monetary expansion should be controlled so as
to add to or subtract from the demand for goods and services when they
are below or above some normal growth line. It is argued that the non­
monetary factors in the economy, such as demand from military, inter­
national, fiscal, and private sources cause large fluctuations in spending.
The task of monetary policy is to work against these factors in a manner
calculated to produce the proper equilibrium of aggregate supply and
demand. If these other factors are inflating the economy, monetary policy
should be deflationary and vice versa.
A third view is that monetary policy has a special obligation
to defend the value of the dollar, both at home and abroad. Although the
multiple objectives of national economic policy are recognized and ac­
cepted, this view holds that prices and the balance of payments are firstorder priorities for monetary policy. Thus, so long as prices are rising
significantly, or if prices are rising faster than is occurring generally
abroad, monetary expansion should be restrictive even if this requires a
slowing up in the growth rate for the economy as a whole and an increase
in unemployment.
To many the idea that there are differing views as to even what
task monetary policy is to perform may seem strange. Daily I read stories
and look at cartoons picturing the Federal Reserve's battle against in­
flation. Most seem to imply a direct relationship between monetary pol­
icy and prices. They jump the tremendous gap which actually exists be­
tween these two. A great deal of confusion seems to surround the ques­
tion of how monetary policy works. Partly this arises because the opera­
tional techniques employed in monetary policy are complex. Partly it
arises from the central banking tradition that objectives can be achieved
more easily if they are left ill-defined instead of being spelled out.
Partly it arises because of lack of knowledge or agreement as to how mone­
tary policy does work.
In fact, however, how and when monetary policy affects prices
remain the subject of great debates. People's ideas as to what a logical
task is for monetary policy depend upon their judgment as to how changes
in policy influence the economy, how long it takes for a change to be
effective, and also on value judgments as to who gains and who loses if


the path to achieving a particular task requires greater sacrifices in
certain fields, and among particular individuals, than for the average
The Channels of Monetary Policy
At the most general level, there is agreement as to how mone­
tary policy works. To fight inflation, monetary policy must lower demand
for goods and services. If the ability of the economy to produce rises
faster than demand, excess capacity will appear in both plant and labor.
Such excess capacity should lead to smaller increases or to actual decreases
in profits, wages, and prices.
The tools of monetary policy, however, do not have a direct
impact on demand. There are missing links and unknown factors. The
Federal Reserve affects the cost and availability of bank reserves.
Changes in reserves influence money and credit. Money and credit influ­
ence demand. Demand influences output, employment, and prices. On this
path, the Federal Reserve's actions have a unique and known result only
with respect to reserves. In each of the other steps, the impact of mone­
tary policy is diffused. It is just one among many forces active in the
economy. The channels, the degree of influence, as well as the time path
by which monetary policy affects prices remain subject to much debate.
The Federal Reserve does influence the cost and availability
of money and credit. We need not delay by detailing the ways in which
this influence is exerted nor need we discuss the offsetting or re­
inforcing pressures from other sources. The question is how are the
movements in money and credit transmitted into changes in demand. How
do higher interest rates and smaller increases in money and credit create
deflationary pressures?
The literature lists five possible methods of transmission from
money and credit to spending. After the change in money and credit has
influenced the amount of spending, different estimates also exist of the
way in which spending changes are divided between real output and prices
and in the time it takes each to be effective.
The stock of money. The simplest and most direct view is
that changes in the amount of money are directly transmitted into changes
in spending. Questions do arise in this sphere as to what constitutes
money, whether the changes in money and spending are or are not propor­
tional, what time lags exist, and as to the impact of interest rate move­
ments. On the whole, however, people are expected to spend less when
they hold less money. A decrease in the rate of money creation will be
followed by a fall in the rate of new spending.


2. The cost of capital. The level of interest rates is an
important factor determining the amount purchasers will spend on real
estate and other long-lived goods. If interest rates rise, abstracting
from the effect of other forces, less should be spent on plant and equip­
ment, housing, consumer durables, and governmental investment. When
financial interest rates rise, a fixed unit of physical capital is a less
desirable purchase.
3. The wealth effect. Consumers' spending is influenced by
their net worth. Consumers will demand less when their net worth falls.
Monetary policy has a deflationary impact insofar as it tends to lower
the prices of stocks and bonds. The fall in stock prices may result either
from lower earnings or from the fact that earnings are capitalized at
higher interest rates.
4. The availability of credit. The decrease in reserves implied
by monetary restraint means funds for lending by institutions are likely
to become less readily available. Some potential borrowers will find that
they cannot obtain loans from their normal suppliers. Nonprice rationing
will prevail. Either because of changes in down payments, terms, require­
ments for balances, or simple refusals, less will be borrowed. Less will
be spent. The clearest example is in housing where because of limited
funds, usury laws, or liquidity factors, institutions may sharply curtail
lending. Those desiring to buy a house may find funds available only at
prohibitive rates if at all.
5. Psychology or expectations. Some argue that people will buy
less because of lower expectations of future income or of future ability
to borrow. Others point out that psychology may influence lenders'will­
ingness to make loans. A perverse effect is, of course, also possible
with people rushing to buy or get available credit if they believe it
will be less available in the future. While much of the impact of ex­
pectations may primarily influence the timing of expenditures, if the
shifts in timing are great enough they can affect the level of demand—
clearly so in short periods--but also over a longer run.
The Timing of Monetary Policy
Estimates of the time it takes a change in monetary policy to
influence spending, and then prices, vary. Most studies of past history,
however, agree that movements occur slowly. There is a considerable lag
between an action and its results. What the final time path looks like
will, of course, depend on how great a change occurs in monetary reserves
(with the related movements in money and credit); on how long the changed
levels are maintained; and probably on the intensity of the force against
which monetary policy is acting.


The time at which results can be expected will depend upon the
channels through which monetary policy transmits its force. Thus, those
who believe expectations are important would not be surprised if a change
in monetary policy were followed by a sudden and dramatic shift in spend­
ing. At the other extreme, those who assume monetary policy primarily
affects business spending on plant and equipment would expect to see lit­
tle if any impact during the first year or two of a changed policy.
While the estimates from history of the time relationships in­
volved are extremely crude and subject to all types of analytical and
statistical questions, they are worth examining. They give some idea of
the kinds of delays and lags which may exist, although it is important to
recall that the variations around the estimates are great and that the
forecasting record is not too good. In order to compare various estimates,
let us assume that a change in monetary policy is maintained for a year.
How long will it take before the new monetary policy begins to change
spending significantly? How long into the future will this year's change
in policy still be cutting into the expansion in demand?
Those studies based upon a direct relationship between changes
in the amount of money (however defined) and movements in spending show
the most rapid impacts. However, because measures of even past relation­
ships are sensitive to specific assumptions, they vary considerably among
themselves. As an example, some studies show that from 15 to 25 per cent
of the expected total decrease in spending rates will occur in the first
six months after a deflationary policy is enacted. From 55 to 60 per
cent of the decrease can be expected in the first year. The remaining
impact on the economy's growth rate should be felt during the year after
the policy has ended. (As an aside, I might note that two of three major
monetary aggregates show no growth over the past five to six months.)
In contrast, the models which assume monetary policy is effective
through other channels show much slower impacts. Several econometric
studies I have seen, for example, show that if monetary growth is re­
tarded for an interval of one year, the first six months of the period
will witness less than 5 per cent of the total decrease expected in spend­
ing's growth. For the whole first year, the share of the total decrease
is less than 20 per cent, and for the first two years it is about 60 per
cent. Three years after monetary policy returns to its original state,
a depressing effect is still being exerted on the growth of spending.
These same models estimate that a balanced fiscal program
(half tax increase/half expenditure cut) will have more than three times
as great an effect on the economy's first-year spending as will a mone­
tary change with the same ultimate impact. Those who follow monetary
effects through the spending channels believe that fiscal policy has a


comparative advantage over monetary policy in timing as well as in equity
and certainty. This is why such stress is placed on having a large sur­
plus in inflationary periods such as the present.
All of these studies show additional lags between the time
when spending is curtailed and the time when prices come under measur­
able pressure. For example, the large-scale models with a slow reaction
to monetary change show very little price impact in the first year. It
is not until the third year after a monetary policy change occurs that
even half of the estimated pressure on prices is felt. Of course, a
faster reaction of spending to monetary changes speeds up the pressure
on prices.
Still, except for purely psychological theories, most analysts
probably would not expect any appreciable price impact until at least a
year after monetary policy alters. Even a more direct channel between
monetary policy, spending, and prices would still probably show that the
peak of price reactions would not be reached until the third year after
monetary policy changes.
Relationship to the Choice of Tasks
An understanding of the diverse ways in which monetary policy
may influence spending, output, and prices is one of the factors leading
to people's choice of the task for policy. However, different valuations
of risks, of the ability to forecast, and of particular goals also create
separate choices.
Those who choose the simple rule of a constant growth in the
monetary aggregates believe that the time lag before monetary policy
takes effect is relatively long and policy-makers--influenced inordi­
nately by current developments--are very likely to make the wrong deci­
sions. Therefore, the results of policy will be maximized if the longrun monetary needs of the economy are determined and then provided month
by month and year by year. Other factors may influence the short-run
performance of the economy, but in the long run steady growth in the
monetary aggregates will prevail and the best over-all performance of the
economy--in terms of all of our major objectives--will be achieved.
There would be little debate over the tasks of monetary policy
if everyone agreed that this golden result would follow from a simple
rule. Unfortunately, doubters exist. Interestingly enough they hold
that the rule may be either too restrictive or not sufficiently restric­
tive depending on particular circumstances.

-7 -

It would not be restrictive enough if the economy simply in­
creased the velocity with which money is used. These critics hold that
if real demands are sufficiently inflationary, total demand will continue
to grow and prices will continue to rise even if the rate at which the
monetary aggregates expand is quite slow. While there may be a final
limit on the speed at which money turns over, velocity has increased in
all except one of the past 20 years for the narrowly defined money sup­
ply and in 60 per cent of the years for the broader aggregate which in­
cludes bank time deposits. In any case, year-to-year changes in velocity
frequently have been great. Thus, the simple rule if applied automatically
could still lead to price increases in many years.
The problem at the other extreme is related to the one that
faces the use of monetary policy when it attempts to deflate demand.
Should major consideration be given to the possibly uneven impacts of a
deflationary monetary policy in specific markets? This is in part a
question of how much consideration in over-all policy should be given to
the possibility of a financial crunch--by which I assume is meant a i
inability of credit markets to function in an orderly and continuous
manner. It is alleged that if a crunch occurs in markets for municipal
or corporate securities, or for mortgages, the result will be greater
long-run damage to the operations of the economy than would be justified
by any short-run policy goals. Indeed, if the market reaction is severe
enough, an inability to sell financial assets combined with a marked
slowing in flows of funds to banks and other financial institutions could
lead to a liquidity crisis and possibly the failure of some of these
A second kind of market consequence that some would say repre­
sents too high a price to pay for the short-run goals of monetary policy
would be a "crunch" in particular markets for goods. Thus, if credit
flows are sufficiently restrained, some goods markets heavily dependent
on credit may be severely constrained. The traditional victim is housing,
but State and local capital spending and the orderly financing of small
business may also be candidates for such a fate. Involved are not only
questions of national priority, but also the possibility that the squeeze
could be so severe that resources permanently disappear from the market,
thus jeopardizing its ability to recover production potential at a later
date. Again, the question is whether there is a point beyond which
product market adjustments to tight money are too drastic to warrant the
end objectives being sought.
In contrast to the above, many believe that monetary policy
will not be performing its proper task unless there is some form of crunch
probably in both financial markets and in the markets of particular indus­
tries. They believe that in an inflationary period, monetary policy will
not have a sufficient impact unless it is definitely hurting many poten­
tial borrowers and spenders.

-8 -

For those who can tolerate a good deal of discomfort in indi­
vidual credit and product markets, the point marking the outer boundary
of monetary restraint may be that where the effects of restraint on the
over-all economy begin to bite substantially. Thus, a sharp drop in
business profits, or a significant rise in unemployment or a stalling
in the real growth of the economy may be judged too drastic a medicine,
even though, for example, prices are continuing to rise and the balance
of payments continues in an unsatisfactory condition. The longer run
effects of these developments--on the nation's investment potential,
material welfare and social fabric, respectively--may be regarded as too
great for the benefits to be gained. Moreover, it is pointed out that
by the time these conditions become evident, it will already be too late
to halt them through a reversal in policy, in view of the time lag before
such policy change will take effect.
Those who pick the third task--that of using monetary policy
primarily with the aim of halting price increases--clearly believe either
that no legitimate constraints on policy exist or that they will not be
breached. A deflationary monetary stance should be maintained, accord­
ing to this view, even if particular markets get into difficulty and the
unemployment rate is rising significantly. This, in essence, is the old
gold standard view of forced internal adjustment; though not often labeled
as such in modern parlance. It still represents the position of a sig­
nificant number of financiers and economists.
While I have merely attempted to sketch some of the diverse
views of the tasks of monetary policy, I hope I have given you some feel
for the complexities surrounding current debates both as to where we are
and where we should go.
It would be nice if all that had to happen to stop prices from
rising was to set monetary policy at a given level particularly if such
a setting contained no risks of undesirable effects. Unfortunately, this
is not the case. Which task is selected depends upon individuals' and
institutions' beliefs in how monetary policy works, the period within
which its influence will be felt, and the risks of failure from too much
or too little action.
The choice of tasks is never static. Views change with surround­
ing circumstances. Many people, I believe, are now prepared to run higher
risks of undesired consequences from a restrictive monetary policy than
was the case two or three years ago. This reflects dissatisfaction with
the higher rates of inflation we have been experiencing.