PAGENO="0001" LEGISLATION FOR ALTERNATIVE TARGETS FOR MONETA~ POLICY a~'~o~ ~ R HEARINGS r ~ARY BEFORE THE STIBCOMIMI[TTEE ON DOMIESTIC MONETARY POLICY OF THE COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS HOUSE OF REPRESENTATIVES NINETY-EIGHTH CONGRESS FIRST SESSION APRIL 26, MAY 11, AND AUGUST 3, 1983 Serial No. 98-40 Printed for the use of the Committee on Banking, Finance and Urban Affairs U.S. GOVERNMENT PRINTING OFFICE 21-7460 WASHINGTON : 1983 PAGENO="0002" HOUSE COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS FERNAND J. ST GERMAIN, Rhode Island, Chairman HENRY B. GONZALEZ, Texas JOSEPH G. MINISH, New Jersey FRANK ANNUNZIO, Illinois PARREN J. MITCHELL, Maryland WALTER E. FAUNTROY, District of Columbia STEPHEN L. NEAL, North Carolina J TFERSON, California CA BBARD, JR., Kentucky JOHN J. LAFALCE, New York NORMAN E. D'AMOURS, New Hampshire STAN LUNDINE, New York MARY ROSE OAKAR, Ohio BRUCE F. VENTO, Minnesota DOUG BARNARD, JR., Georgia ROBERT GARCIA, New York MIKE LOWRY, Washington CHARLES E. SCHUMER, New York BARNEY FRANK, Massachusetts BILL PATMAN, Texas WILLIAM J. COYNE, Pennsylvania BUDDY ROEMER, Louisiana RICHARD H. LEHMAN, California BRUCE A. MORRISON, Connecticut JIM COOPER, Tennessee MARCY KAPTUR, Ohio BEN ERDREICH, Alabama SANDER M. LEVIN, Michigan THOMAS R. CARPER, Delaware ESTEBAN E. TORRES, California CHALMERS P. WYLIE, Ohio STEWART B. McKJNNEY, Connecticut GEORGE HANSEN, Idaho JIM LEACH, Iowa RON PAUL, Texas ED BETHUNE, Arkansas NORMAN D. SHUMWAY, California STAN PARRIS, Virginia BILL McCOLLUM, Florida GEORGE C. WORTLEY, New York MARGE ROUKEMA, New Jersey BILL LOWERY, California DOUG BEREUTER, Nebraska DAVID DREIER, California JOHN HILER, Indiana THOMAS J. RIDGE, Pennsylvania STEVE BARTLETT, Texas SUBCOMMIrrEE ON DOMESTIC MONETARY POLICY WALTER E. FAUNTROY, District of Columbia, Chairman STEPHEN L. NEAL, North Carolina GEORGE HANSEN, Idaho DOUG BARNARD, JR., Georgia RON PAUL, Texas CARROLL HUBBARD, JR., Kentucky BILL McCOLLUM, Florida BILL PATMAN, Texas BILL LOWERY, California BUDDY ROEMER, Louisiana JOHN HILER, Indiana BRUCE A. MORRISON, Connecticut JIM COOPER, Tennessee THOMAS R. CARPER, Delaware HOWARD LEE, Staff Director (II) PAGENO="0003" CONTENTS Hearings held on: Page April 26, 1983 1 May 11, 1983 81 August 3, 1983 175 STATEMENTS Bryant, Dr. Ralph C., senior fellow, the Brookings Institution 84 Feliner, Dr. William, resident scholar, American Enterprise Institute 110 Goldfeld, Dr. Stephen M., professor of economics, Princeton University, and former member of the Council of Economic Advisers under President Carter 118 Gordon, Dr. Robert J., professor of economics, Northwestern University 128 Hester, Dr. Donald D., professor of economics, University of Wisconsin 27 McKinney, Dr. George W., Jr., Virginia Bankers Professor of Bank Manage- ment, Mclntire School of Commerce, University of Virginia 12 Saulnier, Dr. Raymond J., professor of economics, Barnard College of Colum- bia University 23 Volcker, Hon. Paul A., Chairman, Board of Governors, Federal Reserve System 180 ADDITIONAL MATERIAL SUBMIrrED FOR INCLUSION IN THE RECORD Bryant, Dr. Ralph C., prepared statement 91 Fauntroy, Chairman Walter E.: H.R. 1569, text of introduced bill 3 Pertinent backup material 6 Opening statement, hearing of May 11, 1983 83 Regarding April 26, 1983, hearing: Notice of subcommittee hearing, dated April 8, 1983 68 Press release, dated April 12, 1983 69 Regarding May 11, 1983, hearing: Notice of subcommittee hearing, dated May 5, 1983 171 Press release, dated May 5, 1983 172 Regarding May 3, 1983, hearing: Letter from Congressman Bill Patman, dated July 25, 1983, with his introduced bill, H.R. 1432 275 Chairman Fauntroy's response, dated July 28, 1983 280 Letters to Hon. Paul A. Volcker: Dated July 21, 1983 272 Dated July 25, 1983 273 Response of Chairman Volcker, dated August 2, 1983 274 Dated July 28, 1983 281 Memorandum regarding background report reviewing the use of money aggregates as targets for the conduct of monetary policy, with attached report 259 Notice of subcommittee hearing, dated July 26, 1983 282 Press release, dated July 26, 1983 289 Proposed Federal Reserve Act changes 283 Sample letter sent to witnesses containing list of issues to be addressed, dated April 12, 1983 70 Fellner, Dr. William, prepared statement 114 Goldfeld, Dr. Stephen M., prepared statement 124 Gordon, Dr. Robert J., prepared statement "New Targets for the Federal Reserve" 135 (III) PAGENO="0004" Iv Hansen, Hon. George, opening statement, hearing of: Page April 26, 1983 11 August 3, 1983 178 Hester, Dr. Donald D., prepared statement 34 McKinney, Dr. George W., Jr., prepared statement 16 Saulnier, Dr. Raymond J., prepared statement 25 Voicker, Hon. Paul A.: Letter to Congressman Bill Patman, dated August 11, 1983 255 Working Group on Exchange Market Intervention, report of 208 Statement made by the Summit Finance Ministers, Central Bank Governors, and representatives of the European Community on release of above report 206 Wylie, Hon. Chalmers P.: Memorandum to minority members regarding hearings, dated April 21, 1983 72 Memorandum from Dr. Godfrey Briefs, minority staff economist, dated April 21, 1983, with attachments 73 APPENDIX COMMENTS OF PROMINENT ECONOMISTS AND OTHERS ON H.R. 1569 Ackley, Gardner, Ann Arbor, Mich., with attached articles from Dun's Review 306 Blinder, Alan S., professor of economics, Princeton University, Princeton, N.J. 329 Coidwell, P.E., Coldwell Financial Consulting Services, Washington, D.C 294 Eads, George, University of Maryland School of Public Affairs, College Park, Md 317 Eckstein, Otto, Paul M. Warburg professor of economics, Harvard University Department of Economics, Cambridge, Mass 312 Friedman, Benjamin M., professor of economics, Harvard University, Cam- bridge, Mass 327 Greenspan, Alan, New York, N.Y 316 Holland, Robert C., president, Committee for Economic Development, Wash- ington, D.C 300 Houthakker, Hendrik S., Henry Lee professor of economics, Harvard Univer- sity, Cambridge, Mass 320 Jordan, Jerry L.,~ Robert 0. Anderson Graduate School of Management, Uni- versity of New Mexico, Albuquerque, N. Mex 305 Laub, P. Michael, director, economic advisory committee, American Bankers Association, Washington, D.C 333 McCracken, Paul W., Edmund Ezra Day university professor of business administration, University of Michigan Graduate School of Business Ad- ministration, Ann Arbor, Mich 310 Maisel, Sherman J., professor, University of California, Berkeley 298 Malkiel, Burton G., dean, William S. Beinecke professor of management studies, professor of economics, Yale School of Organization and Manage- ment, New Haven, Coan 311 Meltzer, Allan H., John M. Olin professor of political economy and public policy, Carnegie-Mellon University Graduate School of Industrial Adminis- tration, Pittsburgh, Pa., with attached paper 347 Peck, Merton J., department of economics, Yale University, New Haven, Conn 313 Rahn, Richard W., vice president and chief economist, Chamber of Commerce of the United States of America, Washington, D.C 332 Roberts, Steven M., director, Government affairs, American Express Co., Washington, D.C 334 Saulnier, Raymond J., chairman, CEA, 1956-60, Barnard College, Columbia University, New York, N.Y 314 Schechter, Henry B., director, office of housing and monetary policy, Ameri- can Federation of Labor and Congress of Industrial Organizations, Wash- ington, D.C 370 Schott, Francis H., senior vice president and chief economist, Equitable Life Assurance Society of the United States, New York, N.Y 331 Sinai, Allen, senior vice president, Data Resources, Inc., Lexington, Mass 325 Taub, Leon, vice president and chief economist, Chase Econometrics/Interac- tive Data Corp., Washington, D.C 323 Weidenbaum, Murray L., director, Washington University, St. Louis, Mo 303 Wright, Hon. Jim, majority leader, U.S. Congress 322 PAGENO="0005" LEGISLATION FOR ALTERNATIVE TARGETS FOR MONETARY POLICY TUESDAY, APRIL 26, 1983 HOUSE OF REPRESENTATIVES, SUBCOMMITTEE ON DOMESTIC MONETARY POLICY, COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS, Washington, D.C. The subcommittee met, pursuant to call, at 10:10 a.m., in room 2222, Rayburn House Office Building, Hon. Walter E. Fauntroy (chairman of the subcommittee) presiding. Present: Representatives Fauntroy, Patman, Roemer, Hansen, and Hiler. Chairman FAUNTROY. The subcommittee will come to order. Few issues in monetary policy are more crucial than the targets or goals that monetary policy should seek to achieve, the indicators that should be used to ascertain whether the policy is on course, and the plans which monetary authorities propose to use to achieve the goals. Over the past year, this subcommittee and I have devoted a sub- stantial amount of time and energy toward understanding this most fundamental issue. As a result of that effort, I have intro- duced H.R. 1569, a bill that would have the Federal Reserve report to Congress its objectives for the gross national product, real growth-to which determines employment-and inflation. This bill would also direct the Federal Reserve to give us its plans for inter- est rate levels as well as the growth or diminution of money and credit which are necessary for the achievement of these objectives. I have introduced this bill because I believe that the present monetary and credit targets are often misleading and may in fact be dangerous. The original idea for using monetary targets was that the growth in. the monetary and credit aggregates would have predictable results for economic growth. However, there is now strong evidence that this assumption is, at best, shaky, and at worst, wrong. Whether or not there ever was a reliable relationship between monetary growth and the economy, the pace of financial innovation has so fundamentally blUrred distinctions between transactions balances and savings balances that it is doubtful if any predictable relationship now exists between the M1 or M2 ag- gregate and economic growth. The result has been that monetary targets have either been per- verse in their effects or meaningless. Because the Fed's credibility and accountability have rested on achieving targets for these ag- gregates, the Fed has at times tried to do so even in the face ~of a (1) PAGENO="0006" 2 crumbling economy. At other times such as last fall, the Fed has correctly but belatedly ignored the targets to avoid economic disas- ter. These actions have then left Congress and the public complete- ly in the dark about what the Fed was trying to do. If monetary and credit aggregates are no longer useful or reli- able targets, what should be used as targets? I believe that we should have the Federal Reserve report to us on what it believes to be appropriate economic growth, inflation, and real growth for the coming year. In that way, we in Congress could then judge and de- termine whether these objectives were indeed appropriate. In that way, the public in general and fmancial markets in particular would have a clearer idea of what monetary policy was trying to do, of what the Fed considered insufficiently stimulative or exces- sively inflationary monetary and credit growth. H.R. 1569 would mark a major change from the present report- ing requirements set forth in the Humphrey-Hawkins Full Employ- ment Balanced Growth Act. I have, therefore, scheduled a series of hearings so that we can carefully evaluate what should be done, and build a thorough record which could be used to guide the Fed~ eral Reserve and the Congress in interpreting our intentions. There are a number of issues which we must consider. They in- clude: First, do we need targets that the Fed would provide for congres- sional review and then follow, or should there be some other means of keeping the Fed both independent and accountable to Congress? Second, has the usefulness of monetary and credit aggregates as guides to the Fed's economic objectives been fundamentally eroded by financial innovations, or are the distortions transitory? Can we find existing or new aggregates that would h~tve a stable enough relationship to the economy that we could use these as targets for what monetary policy should do? Third, what problems would there be with the use of explicit Fed objectives for GNP, real GNP and inflation? If targets for monetary policy should be factors over which the Fed has some control, does the Fed have enough influence over economic growth, real growth and inflation that it's objectives would be meaningful? Fourth, how would Fed objectives for these factors be coordinated with the President's objectives, and with what Congress would want? Could we in Congress use the Fed's explicit objectives for economic activity in a responsible and constructive fashion, or would we engage simply in unrealistic demands and scapegoating? Fifth, would the public and financial markets benefit from this kind of information, or would it foster false expectations? These issues require careful consideration, which the witnesses at our hearings today and in the future can help us explore. [The text of Chairman Fauntroy's introduced bill, H.R. 1569, and pertinent backup material follow:] PAGENO="0007" 3 98TH CONGRESS 1ST SEssioN * * To amend the Federal Reserve Act to require the Board of Governors of the Federal Reserve System and the Federal Open Market Committee to imple- ment a monetary policy which will achieve balanced full growth in the economy. IN TItlE HOUSE OF REPRESENTATIVES FEBRUARY 22, 1983 Mr. FAUNTROY introduced the following bill; which was referred to the Committee on Banking, Finance and Urban Affairs A BILL To amend the Federal Reserve Act to require the Board of Governors of the Federal Reserve System and the Federal Open Market Committee to implement a monetary policy which will achieve balanced full growth in the economy. 1 Be it enacted by the Senate and House of Representa- 2 tives of the United States of America in Congress assembled, 3 SHORT TITLE 4 S~c'rio~ 1. This Act may be cited as the "Balanced 5 Full Growth Monetary Policy Act of 1983". 6 BALANCED FULL GROWTH MONETARY POLICY 7 SEC. 2. Section 2A of the Federal Reserve Act (12 8 U.S.C. 225a) is amended- PAGENO="0008" 4 2 1 (1) in the first sentence, by striking out "long 2 run"; 3 (2) in the second sentence- 4 (A) by striking out "and plans"; 5 (B) by striking out "monetary and credit ag- 6 gregates" and inserting in lieu thereof "gross na- 7 tional product, real growth, and inflation"; 8 (0) by inserting "interest and exchange 9 rates," after "international trade and payments,"; 10 (B) by inserting after "and prices;" the fol- 11 lowing: "(3) the plans of the Board of Governors 12 and the Federal Open Market Committee with re- 13 spect to appropriate monetary and credit aggre- 14 gates and interest rates in order to obtain the re- 15 ported objectives for growth of diminution of the 16 gross national product, real growth, and infla- 17 tion;"; and 18 CE) by striking out "(3)" and inserting in lieu 19 thereof "(4)"; 20 (3) in the third sentence- 21 (A) by striking out "and plans"; and 22 (B) by striking out "monetary and credit ag- 23 gregates" and inserting in lieu thereof "gross na- 24 tional product, real growth, and inflation, and its 25 plans for the growth or diminution of monetary PAGENO="0009" 5 3 1 and credit aggregates and for interest rates in 2 order to achieve such objectives"; 3 (4) in the sixth sentence- 4 (A) by striking out "and plans with respect 5 to the ranges of growth or diminution of the mon- 6 etary and credit aggregates" and inserting in lieu 7 thereof "with respect to the gross national prod- 8 uct, real growth, and inflation and its plans with 9 respect to the growth or diminution of the mone- 10 tary and credit aggregates and levels of interest 11 rates"; and 12 (B) by striking out "and plans" before the 13 period at the end thereof; and 14 (5) by adding at the end thereof the following: 15 "Any such revision to, or deviation from, such objec- 16 tives shall be reported to the aforesaid committees of 17 the Congress within forty-five days after such revision 18 or deviation takes effect.". PAGENO="0010" Cl) z C.) 0 z ~T1~ ~0 0 ~o. ci ci ~C) .1 00 ~ d 0 ~`1 Oo~Q PAGENO="0011" 7 Those who are interested in the specific hearings which the Subcommittee held are referred to the following hearing dates and titles: t* July 28, 1981 -- Hearings to Analyze Federal Reserve Policies as They Affect Interest Rates and Credit Markets Witnesses who testified included Dr. Alan Blinder, Professor of Economics at Princeton University; Dr. Benjamin Friedman, Professor of Economics at Harvard University; Leif Olsen, Chairman of the Economic Policy Committee of Citibank; and Francis Schott, Chief Economist of Equitable Life Assurance Soci ety. *t March 3 and 4. 1982 -- Hearings on the impact of Money Substitutes on Monetary Control as It Affects Interest Rates and Economic Activity Witnesses at these hearings included the Hon. Lyle Gramley, Board of Governors of the Federal Reserve System, the Hon. Beryl Sprinkel, Undersecretary for Monetary Affairs, the Department of the Treasury; H. Erich Heinemann, Vice- President, Morgan Stanley and Co., Inc.; and Donald Hester, Professor of Economics at the University of Wisconsin at Madison. 4* July 14, 1902 -- Hearings on Alternative Targets for Monetary Policy Witnesses at this hearing included Dr. George Mcl 225-2831 ~tongt~ Of t~ic ~ntteb ~`ti1tc~ ~ou~c of 3&cpre~entatibe~ &la~bin~ton, ~ 20515 July 25, 1983 The Honorable Walter E. Fauntroy Chairman, Subcommittee on Domestic Monetary Policy 2135 Rayburn House Office Building Washington, D.C. Dear Walter: Thank you for the good information you recently sent. Enclosed with this letter are several copies of my bill, H.R. 1432, requiring a monetary early warning report submitted to Congress by the Federal Reserve Board when it plans to implement a change in existing monetary policy. I would appreciate your setting a hearing date for this bill as soon as possible, to be considered along with other bills. Co-sponsors for H.R. 1432, as of July 22, include Congressmen Annunzio, Dannemeyer, Dorgan, Dwyer, Dymally, S. Hall, Kemp, Leath, Mitchell, Morrison (WA), Murphy, Nowak, Perkins, Sabo, Seiberling, Smith (IA), Stenholm and Stokes. With kind regards. Sincerely, WNP/ac PAGENO="0280" 276 98TH CONGRESS 1ST SEssioN To amend the Federal Reserve Act to require the Board of Governors of the Federal Reserve System to transmit to the Congress a monetary early warning report whenever the Board or the Federal Open Market Committee takes any action to implement a change in existing monetary policy. IN TIlE HOUSE OF REPRESENTATIVES FEBRUARY 15, 1983 Mr. PATMAN introduced the following bill; which was referred to the Committee on Banking, Finance and Urban Affairs A BILL To amend the Federal Reserve Act to require the Board of Governors of the Federal Reserve System to transmit to the Congress a monetary early warning report whenever the Board or the Federal Open Market Committee takes any action to implement a change in existing monetary policy. 1 Be it enacted by the Senate and House of Representa- 2 tires of the United States of America in Congress assembled, 3 That section 2A of the Federal Reserve Act (12 U.S.C. 4 255a) is amended by inserting "(a)" after "SEC. 2A." and by 5 adding at the end thereof the following: PAGENO="0281" 277 C) 1 ``(h)(il) As soon as possible but not later han so van cal- 2 endar days after the Federal Open Mn ikat Committee takes 3 any aetioii which will elnmgc the existing trend iatc of 4 growth of any of the monetary aggregates, erod~t sggvegai es, 5 or any other of its economic targets, the Board of C evoroors (3 of the Federal Reserve System shall tiomsrnit a monetary 7 earl warning report to both muses of the Congress. 8 ``(2) Each simh report shall state the initial here , end 9 the estimated change in such level which is likely to result 10 from such action within three months, six tnou~ ho, nine ii months, and one veer after the date on ~vhkil~ such a etiun 12 occurs, of-- 1 3 `hA) the Consumer Ihier Ii idee, as pablmhcd 14 montldv by the Bores u of Labor hkahsties; I ~) "(13) (OflplOVmeflt texpiessed in terms of the I utah 10 number of ~ob~) and the rate of inieniplovmont, us mb- 17 lished monthly by the Bureau of Labor Statisties; is ``(C) the nominal ~rass notions ~ so I 9 ~ 0" `1 i( fl 20 "(E) the g~oss no lions I inndu~t implicit price do- 21 flator; 22 `(iS) hoiiowing cooLs of ind.ividusls, hinvehulds 23 corporations, pai'tncrs1~~ps, :iiid sole proprmt utolups: 24 ``(G) interest rates, including--- 25 `(i) the Federal funds rate; 21-740 0-03--IS PAGENO="0282" 278 3 1 "(ii) the rate for three-month and six-month 2 Treasury bills; 3 "(iii) the rate for securities with a maturity 4 of twenty years which are offered by the Treas- 5 ury; 6 "(iv) the rate for bonds issued by corpora- 7 tions whose bond rating is AAA or the equivalent 8 of such rating; and 9 "(v) the rate for bonds issued by corporations 10 whose bond rating is Baa or the equivalent of 11 such rating; 12 "(H) the rate of business and household bankrupt- 13 cies; and 14 "(I) such other measures of economic performance 15 as are necessary to indicate the full effect of such 16 action on the economy. 17 "(c)(1) Not later than thirty days and again ninety days 18 after the implementation of an action described in subsection 19 (b)(1), the Board shall transmit to both Houses of the Con- 20 gress a revised monetary early warning report regarding such 21 action. 22 "(2) Every ninety days thereafter, the Board shall 23 transmit to both Houses of the Congress a revised monetary 24 early warning report regarding such action. PAGENO="0283" 279 4 1 "(3) Each such report shall revise and correct, to the 2 extent necessary to reflect changing economic conditions, the 3 immediately preceding monetary early warning report re- 4 garding such action which was transmitted by the Board to 5 both Houses of the Oongress. 6 "(4) At such time as the Board subsequently takes any 7 action requiring a new monetary early warning report under 8 subsection (b), the Board shall no longer be required to 9 submit revised monetary early warning reports under para- 10 graph (2) regarding any previous action.". PAGENO="0284" U.S. HOUSE OF REF RESENTATIVES JoIn 2-I, 1933 The Honorable Bill iatper- 1403- Lc:1900'tlc H~vne Gofici Euildie9 Hsshir.eteco, H. C. Fear Bill: r o -~r i bill to seer t1-e tpfccc-.ol teserve lot to rncc:jire the Board of Gc,'snrcorn of the Federal For-rove Sc-she: to trarar-it to the 9cr-cress ocosetarv early s-arcing repc-rt -:he:sever the Foerd or the Federal C9en tUrbot Cconittee totes soy action Ce ir-picocot chso~e in esiotie3 acorectacy poll cy - Based titer tIc- cc-sr-eats so: bee e-ids to 05 dariicq the Lest Boner-ens, i sir cieso'cd to s1:~ so you that I hove ci rea3y incorporated the thrust nt OOc;r- till into 12. 1559 and into tie Crciir,naa's .hlch I -ci: to cnLcn9 Lectern to ores 1:-c chortle. ide layislat tee in clcjsctivccs c-arose-i sy the Fr-b LIE dc'os cr- o~s.C, to i:::i'cr-eot sect f1:5?IPI. tense teat tsr-s cr-ar-c cc-i- too ci recesses ;e1c at vet better to or-corporate tics 1 rl cc-i- the release of F-Let P3i~C~ lircocios: than no 0019590 101 00 010501 aiscays cIcero the tire - ly. sieve cc root c--icy rev lntir-c:cdj-ute terycte of i-ore-v and credit icd cc e sector-. -eoc;~c-cv-u the Fsdsrei Reserve to announce its otjectivc-icittc rcsc-sct to toe -sooss oP g-cc-cth for the Gross ha ticonA Prods-ct. cii th forscssts ~or ore I cjrc-cth. unecir-lopoceot and infiatio-~, the rerert to Cen9reea of slip! chc-cecs it thou objective coRd aute-caticell- sccI~rsc:e tIcs erooc:tc icciic.ctoro oceccie are ir-Pereated iii cci o 1 e are riot technically coysole of buir-o c-oh. as co-Ac as Re:c-cl Poser's To-rd Cisirceur BetA toicicen ~-ili to cecentv of ~o-,piO cisc: c-i ho p-scorns to c000usc cr-tn ye: -ccci roe- cave -itt rccc-ect Ce the ct-riot `ce-' bill - I c-il- ic- -0~0 hr rSlei:19 vi trio r:ac-;re. `ieer 1ccei-seclpetieO curo r ~ 1 e ci r iii e I 1 1 n -1 i hoc: it plans to dc it, arid ho-.-: it rcr.v chance 01:5 d.coinic-e ire: tOss to ticce to reflect crcsnnirc-c Csr000cstsr.0c5. lien lincost pcce~rsal reaardc, I so PAGENO="0285" LLS. NOLISO FFFI000NTABIVES ILL ON DUtIES (IC tONE, 01(0 `110101' COMII `IRE ON 001(111(0, FINANCE AND URBAN 0110155 s,005EINGTON. D.C. 20(1 dIlly 21o lurO)ieblL: P1151 0. \oictor Choi reels Board of Govorsors Federal P.eSel'1'0 SYSSOB 20th and tosoti tot 05 Genes Washington, B. C. 2(1551 tour Foul I lOVE: ecei `ced the oncl 115cC! C tter 11001 my coil eageo and a hooter of the Subooscoittee, lb. Patent oii HR. 1432, a bill to 3005a the Federal Reserve Act to require the Board of Governors of the Pederol Reserve System to transmit to the Congress (I monetory eorly morning report whenaver the Board or tue fOWC to Los any 10 tics to iOi~i event ii. change on cvi aton~l monetary pot icy. I have `osposdee to two as shoes to the ~ucl USed letter wio aiconu other i tools , steteo (flat I ioul d chore ibis looter 1,1! Lb yes to hot you and he cool C! di ecess tile thrust of the bill at the presently cc bode! cC! 11001'! rig Elf thi s Subccscsi t tee on Aogest 3 9dB B . P. 1 432 is not a part of tile hear! ng for that day; nonot ml esu, I n RO once to there i S (I roqu i riS1flt in both I P. 1 569 01111 the tim 110(111 v Mo r for reporting changes in ohj ect'vc s , I thouqht it weal C! ho useFul for us to be able to pursue s colloquy if tile opportuno ty presioitei itself. Ste you then! Wi th Li ridoit `el1iitd5 , I am 11_tlC Cheii~ses EIJCI.051 lIE PAGENO="0286" 282 U.S. HOUSE OF REPRESENTATIVES SUBCOMMITTEE ON DOMESTIC MONETARY POLICY COMMITTEE ON BANKING. FINANCE AND URBAN AFFAIRS NINETY-EIGHTH CONGRESS WASHINGTON D.C. 20515 July 26, 1983 NOTICE OF SUBCOMMITTEE HEARING AND WITNESS EIST TO: Members, Subcommittee on Domestic Monetary Policy Members, Committee on Banking, Finance and Urban Affairs FROM: Walter E. Fauntroy, Subcorrcnittee Chairman RE: Continued Hearings on Alternative Targets for Monetary Policy: Directing the Federal Reserve to target nominal GNP instead of Monetary and Credit Aggregates On Wednesday, August 3, 1983, the Subcommittee on Domestic Monetary Policy will meet at 10:00 A.M., in WEDNESDAY Room 1310 of the Longworth House Office Building to take testimony from the Honorable Paul Volcker, AUGUST 3, 1983 Chairman of the Board of Governors of the Federal Reserve System on legislation which would direct the Federal Reserve to report to Congress objectives 10:00 A.M. on the ranges of growth of the gross national product and the plans with respect to appropriate monetary and credit aggregates, interest rates, or other policy 1310 LONGWORTH instruments in order to obtain the reported objectives for growth of the gross national product. The Subcommittee has previously held several clays of hearings to explore the need to make changes in the present monetary and credit targets used by the Federal Reserve, the chantms that might be appropriate, and the relationships that various types of objectives and plans ought to he-- with respect to the economic goals of the country as they are expressed in the Economic ~p~.Ct of the President and the P.H.~9E~ Resolutions of the Mouse and Senate. The Subcommittee has requested that Chairman Voicker focus on the advantages and disadvantages of the proposed economic growth targets contained in a newly - revised Chairman's Mark and to suggest any modifications which would be necessary for the successful administration of such a policy. WITNESS: The Honorable Paul Volcker, Chairman Board of Governors of the Federal Reserve System PAGENO="0287" 283 CHANGES IN THE FEDERAL RESERVE ACT AS PROPOSED BY THE HONORABLE WALTER E. FAUNTROY CHAIRMAN, SUBCOMMITTEE ON DOMESTIC MONETARY POLICY COMMITTEE ON BANKiNG, FINANCE AND URBAN AFFAIF:S IN THE CHAIRMAN'S MARK OF THE MONETARY FOLICY ACT OF 1983 SECTION 2A -- Monetary and Credit Aggregates 1. General Policy: Congressional Review The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall md~t~i-~ )-~ng re~ seek~ tbCpPg~ ~ growth of th~ monetary and credit aggregates and ot~q~ U~ ~CUSROtS~ ~ EPPOPGLE ~ commensurate with the economy's long run potential to increase production. so as to promote effectively the goals of maximum employments op~ stable pricess ~r~d m~d~rm~e i~ng-~erm tn~ermm~ rm~m. in furtherance of the purposes of the Full Employment and Growth Act of 1978, the Board of Governors of the Federal Reserve System shall transmit to the Congress, not later than February 20 and July 20 of each year. independent written reports setting forth (1) a review and analysis of recent developments affecting economic trends in the Nation: (2) the objectives m~d pF~~ of the Board of Governors and the Federal Open Market Committee with respect to the ranges of growth or di-mreti-or' of the motry mod ermdi* gregm~em gros~ OO1IPD01 PCEt1UP~ tttb 1PCBPGB~G IGC CEG~ gCPFL~fl5 UOES2kQYfiEOt~- ~ Lo1~G~Po for the calendar year during which the report is transmitted, taking account of past and prospective developments in employnient, unemployment, production, investment, real income. productivity, international trade and payments, kP~ECES~ dfl~ ~?iPb~OQE CGLFR~ and prices: 1~! ~flE 21405 p1 tb~ ~P4C~ 21 ~iP~ECOPC9 ~oi~ lbs EP~ECo1 ~2ED ~4C~EI ~B1tIEB MIIb CESPEPI 12 OPPCPPCIGIE FJPOPIOCY 4O~ CCE~1t PC?G41F5~ IOISCEGI C4lss~ PC PIbEC 1lc~ IDSICH 015 10 PCbEC tp Pbl~io lbs CBPPCIEb pbiBPllYPB 1PC lbs CGOPES p1 PCPBIb 21 lbs PCPSS 04112041 PCP `Eli and *G* (4~ the relationship of the aforesaid objectives and plans to the short-term goals set forth in the most recent Economic Report of the President pursuant to section 3(a) (2) (A) of the Employment Act of 1946 and to any short-term goals approved by the Congress and PPCSUGOI Ip lfls ~cisl ~oc~ 1s~p~obssot cP0~CPl Act. In addition, as a part of its report on July 20 of each year, the Board of Governors shall include a statement of its objectives and plans with respect to the ranges of growth or me~ori of the morie~mry mod ~rmdr~ gr~mm QCPSS 04112041 OCP~2E1 BIIb lpCscGsls IPC C541 PCPMlb.~ U0ESP12Y8501~ ~ob toLLoltPo for the e tmridmr ymmr thre5 cdlsObdC Y5GCG following the year in which the report is submitted. The reports required under the two preceding sentences shall be transmitted to the Congress and shall be referred in the Senate to the Committee on Banking, Housing, and urban Affairs, and in the House of Representatives to the Committee on Banking. Finance and Urban Affairs. The Board shall consult. with each such Committee on the reports and, thereafter, each such Committee shall submit to its respective body a report containing its views and recommendations with respect to the Federal Reserve~s intended policies. Nothing in this Act shall be interpreted to require that the objectives and plans with respect to the ranges of go~st1i or d±-m et±-ori of th~ moomtmry mod ormdi~ mggrmgm~mm tbs PCPMIb P1 lbs PCPSS OG1LPOG~ P~CPbVEt disclosed in the reports submitted under this section be achieved if the Board of Governors and the Federal Open Market Committee determine that they cannot or should not be achieved because of changing conditions: Provided. That in the subsequent consultations with, and reports to, the aforesaid Committees of the Congress pursuant to this section, the Board of Governors shall include an explanation of the reasons for any revisions to or deviations from such objectives mod p1-mom. Any socb C5YISIPOB l~ s~icb pbiscl~~ss sbGll bs CEPPCIEb IP lbs GIPCESGIb ~PS511155S p1 lbs ~P0PC5BS MIlbID ~ ~s~s G1lsC s~b E5YIGIPO 14i~s5 s1±sol~ (Incorporating amendments that would be made by the Chairman's Mark of the Monetary Policy Act of 1983. Additions are shown by UQb5CLLDE deletions are shown by ~romm-~hroogI~.) cite: 12 USC 225a. As added by act of November 16, 1977 (91 Stat. 1387) and amended by act of October 27, 1978 (92 Stat. 1897). rev: 8-1 PAGENO="0288" SUCCO;T'TTEE PRINT REPL[CTILG T01T CIIATRI'IAII'S BARk] TI BILL To emend cc f',irersl eerie Ac; to requt re the Po~"ii ol Ge'imrners of 1 "n tr c `lp lilt to it;cie;snr eonsts;', pci ic which ciii] achieve Balanced full to it er'acceh 1,' the Sane me ens louse of Representatives of Ste i~,itt01 States of A;wini~ ice Tcir,1I'ess csse;bied. 311021 TiTLE SECTCI'1 1. This Act 5i5,' ha cited as the "tlcnoterv `01 ic' Act ci 1283". CL Tilt (]~1'1' 11 Bi'NLIARV POt ICY 102 2. Sect on 20 of the Federal Reserve Act (12 USC. 225a) -- (1) c she first sentence -- B' nErd tins Oct "tat nsa I one run" end diner tiflO in lieu Sc,' st ri tine ccc "tt~e" if trw' `ercocli of" I I r ±~ c I ts t ostn c ic growth" after "monetary and ciedi t angmeec Los" striking out ".` and inserting "end" after "goals of mC:'isluO es ci omsent" asic (C) he' stri icing out " end endarste long term enterest rates' (2) ci the secend sertec Cc -- by stiw Li nci out "and plans" (B) k'' ttrc ne oct `or' diminution" IC) d~' striking cut `menatars and credit agnroeates" and inserting en 10,; thereof "cross nntfenai prsdi;ct with forecasts for reel siroeth, unerpic~'rcenl end infiatic'r~ (11) B',' irserting rtorest ccci exchange rates" after "international tratt cr3 (C) iIII `wlS'ic'Llc;C aster `end prices;" the feliewine: "(3) the plan: the Fleece of ,os'arnc'rs and the Fecera] Open RacheL Coceittes ress'e'cc so a:'orseri ale monetary and credit angregates, interest rates. or c'tner siolici instrunants in orcer to obtain the repcrtoe ot~,~cc S see for sirs' rangr,s of growth of the gross national product;" et00, 000 ``(3)" ane inserting in lieu thereof "(4)" and (A) By lnsoct~ng "and pursuant to the Budget and Impoundment Centre Act,' after "approvcd by Coneress" (3] in the third sentrrce -- `i st 1 killi 0115 `Cc 0 mnutCer; (F) I',' stcitine out "ccinos,ary and credit acgreouces" ard insert tog icc:: thu:eoi `cross ieStiOS5l product site forecasts con real growth, uoc~m1e,rens, sod inflation' tC) st:'~2irwi c~t `calendar ,c'ear' lenO Innertens in lieu thereof cci e~ar ear's' (4) the sixth; seottiece -- (A) by scrikir~c e';t "erowth or durcunitic'n of the monetary ansi cried it a~cicey Sec art inserting in lieu ttioreor "the growth of the gro~ soc 1, I owsi product'' a rid (1) tv s tr'i tint out "and planS" L'ai'ore the period at the end thereof; on (5) L'c' ade inn at tic end tneraoi t he, to] `0111 ni: "An', such revi s I otis to sod otto Lies snail he `aoerted to tl~c aforesaid ccrelittees of the Cone roes mienin 45 class ,,fter such ros'is ion or deviation totos effect." PAGENO="0289" 285 Secticn-~byct1orr Orlysls (Srchcoiflmi ttec? Fri it Pie-f I ecti nq the Ch~ri rice Mcrr c 0 Bill to emend the Fedr'rrcl hies~rvo Oct to require the fru:rrd c-f hrc,o~ rnor of the Federel Pieser-"e Syst:em rind the Federal Open Merf.rct. Pencil t tine ci i ripI ~rnent o monetary policy echich ccii) ochie-ve bolorcced (ccli qrorci:ic ccc :1cc -ccccrcimy Section 1. Provides or s-tort title so thort the Oct rioy he ci tot) on the `M~otd.:c y Fe] icy Oct of 1982. Sectcon 2. Omends Section 2(1 c-f the Federrcl llncoerve Oct (12 Ut)): 22t,nI by: (1) in the first sentence -- (Pc) stri ccc no out "rnosntotn loop run' mb c noert inq n 1: on icr co-f "seeb~ throuqic toe" This o:rrendmccnt. in cOnjLtrccticrc `cith (1) (Pi) arc) If) till directs Ihu board of Bovernors and the FOlIO to focus monc?t cry pci1 r cy on -root cr up groccth of the econom" c:orncrcercsurn'te cc: th the `c:onocey' Ion cc --r uic potent 1 oil -for product i on I rist end oP slop I y S si ot cc nc no I en o-~r ccc cicot `-y u cci growth et implied I occ and stable rates The urrr:'ndsc-ccf cc cl I r'ctc v~I ~ ehi Pt the god of crrr:cncn tory pci] i c y rr,say -f r oct (or: irs: up upo ncc,trrir'c ccc ci ru-b oqprcng oct05. (B) by stri fri nq out "the' of tsr "proc-cUr of- Fri eerily stylistic thi sore endcrrr'nt Ic n(cu': ci eocr os-ct rccrcccct or c-nc.1 rrsdc aqqrcqocteo need not be the oncc-c- prccarccc ti y tic coo icc p' ccc `or nrc 15 to be reed in con uncti on ccc th I I F (C) (C) by inserting "end other pair cy 1 rr-otr rccrrcntcc (cc I crc:. run onrccmcc groc'cth" after "coconetorry end cr edt t oqqr ecjort'o" - This amendrrrent estorbi i sires the prr or:: pie tho~, tire hc:lrtr ci 1-o-nur','cn may ccti lice ether I rcstrurnccnts in adds t: crc to c--ronet:orv tori c rc-dc F ,cJclccnrfncteEc to -foster echi evesent cc-f its rcunerrrr c. object: `,cns. 8) by str if-i re out " - " trod 1 r, err t :c or: " ocr ci" ri-f icr "p cccl cc- cc I rot i mccci sep 1 oymerc L ihin r::Irnrnoe in- 5t'/ll'Iic. - (F) by str if. jog cccct " . end moderote lone trrcrc r rrtr rc:c. t r ntis In es much as i ntccrest rater- arc o crc-cnn to ochr cvi- nc ~-S~O-L )~ vr.' trri s amendment. together cii th (2) (8) ci arc 1: us t)cat (:1cc cr) ti mccii:- etc r0-r:i. 1 ``crc of cr'onetary policy nccao c rrrcccrc ncrcr crop I oycrcncrt ncr) cc- iLl e icr 1 cut:. PAGENO="0290" 286 (21 in the second sentence -- (A) by striking out and plans This change distinguishes between the objecti ies end the means (p1 ens) used to achieve them. (B) by striking out `or diminution The phrase present) y reads "growth or diminution' - Removing the term "diminution" suggest only growth which better conceptuli:es the concept o~ a gross national product objective that is enunciated in (2) (C). (Ci by striking out monetary and credit aggregates' and inserting in lieu thereof gross nati cnal product with forecasts for real growth. unemplvment~ and inflation. This change which is the heart o~ the bill, establishes that the objective which the Federal Reserve should report upon to Congress are the ranges of growth of the gross nati onal product with attendant forecasts for real growth, unemployment and inflation instead of monetary and credit aggregates which are subsequently treated in fol lowing sections of the bill as instruments, of policy used to achieve the object I ye. (0) by inserting "interest and eschange rates after international trade and payments. This change adds these components to the factors of `employment. unemployment~ production, investment, real income, productivity, international trade and payments whose past performance the Federal Reserve is supposed to take account in setting the ranges of growth p4 the gross national product, (E) by inserting after "and prices:" the following: "(3) the plans of the Board of Governors and the Federal Open Market Committee with respect to appropriate monetary and credit aggregates, interest rates or other policy instruments in order to obtain the reported objectives for the ranges of growth of the gross national product: This change indicates the variables which the Federal Reserve may use and directs that the Federal Reserve to show how it plans to use monetary and credit aggregates, interest rates or other policy i nstruments in order to obtain the objective it has set for the ranges of growth of the gross natinal product. (F) by striking out "13)' and inserting in lieu thereof "(4)" Renumbers the e~:i sting phrase presently numbered "131" to the new numL'er "(4)", PAGENO="0291" 287 (B) by inserting "and pursuant to the Budget and Impoundment Control Act." after `approved by Congress" This provisions provides that the Federal heserve report upon the relationship of the objectives and plans to the goals approved by Congess pursuant to the Budget and Impoundment Act, the Economic Report of the Fresident, and other short term goals, if any, which are also approved by Congress. (3) in the third sentence -- (A) by striking our "or diminution" This provides conformity with the other parts of the bill which removes the term "diminution" from the phrase "growth or diminution". B) by striking out "monetary and credit aggregates" and inserting in lieu thereof "gross national product with its forecasts for real growth, unemployment, and inflation" Establishes the statutory basis which directs the Federal Reserve to state as a part of its July 20 Report on the Conduct of Monetary Folicy, first, its objectives for the ranges of growth of the gross national product and, secondly. its forecasts for real growth, unemployment and inflation for three calendar years following the year in which the report is submitted. F'resently. the Federal Reserve projects forward only one year. (C) by strking out "calendar year" and inserting in lieu thereof "three calendar years" Makes the change to the multi-year projection discussed in (31(C). Three years was selected as being in conformity with the present projections used by the Budget and ImpoLndment Control Act. (4) in the sixth sentence -- (A) by striking out "growth or diminution of the monetary and credit aggregates" and inserting in lieu thereof "the growth of the gross national product" This provision provides conformity with changes made elsewhere in the b i:(l. (B) by striking out "and plans" before the period at the end thereof; This provision continues the differentiation between objectives and means (plans) used to achieve the objectives and would require that changes in objecti `des be expl ai ned in subsequent reports to Congress . PAGENO="0292" (5. ~- ~c(1 ;nc~ i(n'~u~h ~~(25~ ~pcjt~i tr~ PAGENO="0293" HC~JSE oF 11111 FOIl - - --o':'-r~) on: 0 i: it ?041-,_ Ac' 040 00:44.: ii :~:i_c coo 4-444 040001 VJAHNG1OftOC. 0040 Till SF1-i. lILY 36, 1°03 ty;VACI: beard I 00 I ILD1A1E I~[L[A0L fndrc~i bert be 0?-23E-1315 EL) CiiIiIRl-tAN VOLCKLi) `ILl [H 1EV OIl 1/itO) OR bell AOl 30~ iCY euntr sy Subcoo.iii sloe to L: 1 ore lii ecH no bed to vet toni no) FlIP Into_tao OT 110503' and Cr-do I T,ourcr'-ien (10511 beLlS D.c.) Foderc1 105CC' Veto d OVa rio ic ii "cO'l:'; `11) intl f3 on 1 c-ni ii ~t ion oh i ch --au di ri-c he lb-h a re~ort ti Con: ron objo `ti -os c's ho rosnon oi p cots of the root notional ~rod'icL cod ito olano beth :`~spc'ct 10 s~~: 01 lobe i- anotary' usd trodi 0 o1u:':'gate., :nnereot ratot, or othtr nol icy i notruicefli il 01 tier to r'ht' in tic 10 porOto object; in S I or liP crowt:. onolincinC the oaring, Con:4: e'trtn loiter C. Eeuntroy (0-1:0), CV.) i--n of bOo Suitor-i 01(0 on Elcmesti c 1-0: `ta~ y lol Icy of the iloute [ni. nq Con i tt:-e, said tl;c root-ni i only -qu iron the Cod to r -1:urL on variouS ioonoy cad croci t oeyrr[a Los that do not rocots:riiY rofioc t ttusoeiC activity. TOo [shot nit tee 0- :1 aye, 1:) ch ii Ii ii-: I: 1 at 10:1)0 [.1). , on iled:-rsdc-y, f:tguc 3, i beT, in [:00 l3)~) *-~ Lie 1 :~eyocth lioutc Off1 cc 11011 ding in Vt) o~' on D.C. , ore : contiflu ,t ion on In: c.4 lOOt triaL 1: on cxplr:roiI the er-d for thong-s in the prc"-uat onney and crud it :15410090 tot system, thu .1005 of chcnyes :be oh mi git be appropi i at: 0111: the t-t l uonhi be i hot sari sun types of c:hjecti sen asd plant ought to h:so wi th res4:ect to thu :-tu50:t 1 [0010 01 I ci I i 4 1 1 ran' I tc:( : ro the P01010 [~tc:l ii ion:: cI LV-.- ISsue :41111 [conini:: -al I ty :-nstr~ 11 y, : n-i e:sst- to 0 101 : p i a p - r I -cl at , :1:001 5Cc 0 11:01 cHi:l of thu r sal ur 1 U in oh 1 oh Pop Vt--s tc lid jobc, st)'~ ort pi ri 111)1 Itiurot, 0,0 04000 O~hiOtoSSi LOtS Di üI hurt, Fdsrtroy Sn `lion orlura only, ti:a nor:ay and crud it ton guts 001 ci: i iso Leer: list to conduci :101' ry C--il Cy have- i vnIc-d to obocuru, if nut contrcdi ct, econ001 goalS In st-thing tO 0110 10 OCt00 :rl)lti'ct'y lurGaL Or 1_li :r 1-12, 01410': dictl lot :-td Oven 010000 r:'vultt 01 ron I :e-irlu of jstt abe I:uben"ns ~tti'-ity 1000 000010' in')' -d. ,uLn tho Cud, it it lid lots Ic-c 050 Ii tOO it abs too, :e:p:niiod or 10/10041 its 00501' 1-: urn t' , it Vt-t ci i-cl H on `-:-bei nty 0hoot so_at ito bej--co ion worn. ll: so) atioc , at: o':i mr to I auntroy, ":s to have tho led- ri [c-sorer I all o_at lint) :1 cr010: :10 gut-tV thu, are trying te los' or I hooeql lions - to'~' 0th :01-', and Who t lOrd 0' 1 :0flij ond cit-hr t jr/ti: and in to roS I rot:: S too',' t-r:: ph noisy to hoyt 5~ Sri n~ -bent thot b-dora I Con-trot Eio: ro Ci::): Ion Paul Vcd: bell n: ~1.i fy - 0 01115 ii: on E.g 0:: 100 `4eS' 001 Iss°° 01 4)05 tul ~O1t c, Il 1ot-; cr1 0:1 a , -v iso i-ill. ic-gir-lot co )-I5iCS ``ill he tons:uored in tho heorinq on Aoynt 3 ton -t-i-n deer-) opor1 h1: Cht-i ri01O Fount: 03' 00 tIe b-nH of hi: i c-~ic-ssiy' i r:trooucc'd 1) gil ation (11. 11. istO) directing the lid to roport its count-soc oHctt von and ito plant for nancy and crocil t grootO and I no_rot a Li-s , nid on liv of II. 1-1. 3346, whion woulo add -or I in tt-ri's 1 aLes i tht corn tnt eui:ita'y and c r:-di t t:. rg-tu. Foes troy Ln:ioves that t1-:ngt-5 l 0 tic- pr-rcv~t tcrt~-t nyste toist be :ado, part I cul or l1~' in light of Lion I co-rube in tie louse Cudqot Revel uti en that `sight I ha Ft-d' s ut-jOt civ's `or SiP qron'th, ron 1 yr o:~0-r, in Itt- IHIl, ::r:d sntWplO3'0 eeL, led is i I::- C::n Ci cr00 2:-port we: cii also ttll I'd [or i :1 ott-be ion to be provi dod lay iso cii on ibe "105000)0 C 05 05: pt'i unC end gOals'. PAGENO="0294" PAGENO="0295" APPENDIX COMMENTS OF PROMINENT ECONOMISTS AND OTHERS ON H.R. 1569 (291) PAGENO="0296" PAGENO="0297" U.S. HUUSR Oh PPFtAS LldT/\TIVES rrtt on cc rrrc raruwinne ccLrcv cois~~ n~u en 00, ecu uriceus aivOca VC/SdiNGTO~, tiC. 505553 dare 24, 1983 [lear On Tuesday, February 22, 1505, 1 introdocad 8.2. i0~b, ate balanced Frill Growth Planetary Policy Act of 1903, which woild make chusyca is the monetary policy targets that the hoard of Governors of ten Federal Reserve System are presently directed to callow and report upon twice each year in their report on the Conduct of lonetary Policy. - Specifically, ray bill would diucoct tee Foaeral Reaerva to transmit to Coagresa on the sane scsi-annual basis their objic ales tar the growth or niicei satins of the gross national product, real growth and inflation. It ilao directs the Board to report its plans for achiaaimg those objectives through the growth or diminution sF monetary end credit aggregates and interest rates. A copy or cnn bill is enclosed. V V I am sure that you, as a former number of the Board of Governors of the Federal Reserve System, rave thcsgirt utout and Formed seas opinions on what target:. iF airy, the Federal Reserve board thould be following in its condact of nonatary policy. I would like to ask you to reviser this bill, which I have enclosed, cry to proeidt: roe sith your thoughts on it. The Subcommittee has bees holding he.srings on tliia icace and your coaceusts would be of greet help in our deliherrtionrc arid mark-up. In the aicantioru, if you have soy queabiovc stout this bill please ccntact [award Lee or Anerew Sartelu oF the ~r:bcuveitcue who way be reeched at 202/2267315. 1 1 oak Forward to rev i cud no your ccmacrta and lops to near from you shortly. Sincerely yours, ~ ~ ~ 3 . Pd tee C. Fauctroy Chainveri (2~/3) 21_7iG O~tl. -20 PAGENO="0298" 294 COLDWELL FINANCIAL CONSULTING SERVICES 1833 K STREET N.W. SUITE 600 WAShINGTON DC. 20008 202-8870177 July 7, 1983 Congressman Walter E. Fauntroy Committee on Banking, Finance and Urban Affairs U.S. House of Representatives Washington, D.C. 20515 Dear Congressman Fauntroy: In response to your letter of June 24, requesting my comments on your proposed legislation concerning Congressional reports on Federal Reserve objectives in the development of monetary policy, I have the following observations: First, I am sympathetic to the problems of Congress, and indeed the nation, in trying to understand the workings and plans for monetary policy. it is a subjective, sometimes confusing, and mysterious procedure for most Americans. Thus I approach your program in an accomodative mood and hope that my comments can - direct you toward a reasonable, beneficial, and effective system which will enable the Congress to understand the objectives of monetary policy and provide guidelines for monitoring the performance of the central bank. Second, I am also sympathetic to the plight of the Federal Reserve in being second-guessed, after the fact, on both the results of economic stabilization policy (of which monetary policy is only one part), and the problems of forecasting when variables beyond the central bank's control are introduced into the equation. This does not relieve the Federal Reserve from providing the best advice it can to the Congress, nor eliminate the need for periodic reports on the developing situation. Therefore, the problem to be addressed by your Subcommittee seems to resolve itself into requesting the right information to provide a clear idea of the Federal Reserve's intentions and such: quantitative data as to be useful in monitoring the performance of the central bank. I think that the current reporting arrangements need extensive revision to remove the emphasis upon monetary aggregate targeting. The volatile money supply and interest rate trends of the past three years clearly point to the deficiencies of such. a PAGENO="0299" 295 Congressman Walter E. Fauntroy July 7, 1983 Page Two monetarist approach. At the very least, Congressional review of monetary policy should focus on the broader picture of the general economic and financial situation rather than upon the specific targets on the various money supply measures. Furthermore, in my opinion, the targeting of the M's should be placed in a two year context where the Federal Reserve can be asked to provide, on an annual basis, the growth rates it considers most important without reference to weekly, monthly, or quarterly data. It seems to me that Congress should be centering its attention upon the general economic stabilization program of the Government with the Federal Reserve providing the monetary policy element by means of a clear description of its. objectives concerning the changes and balance between the demand for and supply of credit and the expected results in terms of changes in nominal Gross National Product, the rate of inflation, the range of interest rates anticipated, and the factors which could significantly alter the results such as adverse international developments and changes in the budget deficit. The Federal Reserve can only control the reserves which it supplies the banking system. It cannot control the expectational market reaction to the whole spectrum of changes developing during a year nor the fiscal policy of *the Administration and Congress. These and a host of other influences bear upon the growth rate of the economy and the result to be expected. For most of these, the Federal Reserve has no control and in many has no influence and thus, should not be held accountable. For example, to require the Federal Reserve to target or project the expected rate of growth in real GNP and be held responsible for the results would be to say that the Federal Reserve can determine the share of GNP which goes into real growth versus inflation and the degree to which individuals save or spend their disposable income, similarly, to require the central bank to be accountable for estimates on unemployment would mean that monetary policy is somehow responsible for such unemployment whereas the degree of efficient capacity utilization, the hiring practices of large corporations, the degree of labor force participation and the rate of profits being generated are much more important factors in such a calculation. In essence then, I am asking the Congress to set measures which have a direct bearing on monetary policy and which can be used to test whether or not the central bank has done its job. Measures which cannot be directly related to monetary policy either in its development or resulting from its application should not be considered. I suggest that Congress require the Federal Reserve to supply its annual objectives for the current year and the following yearfor the measures reflected below: PAGENO="0300" Congressmen Ta3-ter E. Fauntrov July 7, 1933 Page Three 1. The rate of ON? in nominal terms that can be exoected from the monetary policies to be adopted. Of course, the full result at the end c-f the focecast pericd should be judged by both the monetary policy imp~erzented and the other policies of government, futernational shifts,- and the chances unforeseen at the time of the forecast. 2. Rate of inflation measured by ON? fined weight deflator. 3. The rate of credit utilization by both public and private borrowers. 4. The expected rate of Federal Reserve provision of reserves to the banking systom measured by the changes in total Federal Reserve credit and non borrowed reserves after adjustment for changes in institutional requirements). 5, The general range of average interest rates expected by the Federal Reserve as a result of its operations in implementing monetary policy as measured by the Federal Funds rate and the one year Treasury bill rate, 6. Noasures of broad money supply change in the coming two years, reflecting the gross of all transactions and savings liquidity in the economy and the change in transaction money, It seems reasonable to me that the Congress could require the Federal Reserve to provide a clear and concise description of the economy it anticipates over the coming two years both in business cycle terms and in the overall changes toward which Government policy should be dedicated. I would hope that the Congress would spend its hearing time on such broad policy objectives and the degree to which monetary policy can be expected to contribute to the desired results. I hope that the Congressional committees will not spend their hearing time on the specific money supply measures of short term consideration. I recognize the normal human trait to seek quick fixes and to he able to almost instantly measure the effectiveness of a particular policy but our economy is a huge and complex affair taking time to adjust and time for new policies to take bold, Thus, the semi-annual schedule for hearings is quite frequent enough~ In summary, I hope that you will reconsider some of the specifics in your bill and direct your efforts toward requiring measures which truly reflect the impact of monetary policy and which can be monitored over the appropriate time period. Please do not ask the Federal Reserve to project measures over whicn they have no direct influence or which are so diffuse that responsibility cannot be assigned. I recognize the temptation to PAGENO="0301" 297 Congressman Wal ter E Faun troy July 7, 1983 Png~ Four direct. or fine tune rolicies by agencies or the MministratiOn but, at least for monetary po1icy~ I hope that Congress will resist that temptation~ The direction and implementation of monetary policy is a comple;~ and intricate job which requires professional judgements and day-to-day consideration on the whole tones of interrelated factors. I appreciated the opportunity to comment on this important matter. Sincere 1~v, P,E~ Coldwell PAGENO="0302" 298 UNIVERSITY OF CALIFORNIA. BERKELEY EEBXELEY ELViS . iRVINE. LOS ANGELES RIVERSIDE SAN DIEGO SAN FR.ASCISCO School of Booio,ss Administration 350 Borroms Hall Borkeley, California 94720 ~Mt. jj July 5, 1983 The Honorable Walter E. Fauntroy, Chairman Subcommittee on Domestic Monetary Policy U.S. House of Representatives H2-109, Annex No. 2 Washington, D.C. 20515 Dear Chairman Fauntroy: This is in reply to your letter of June 24, 1983, requesting my comments on HR 1569. My general conclusions are that your proposed amendments would probably do more good than harm, but that the Act would remain contradictory and unlikely to achieve the objectives desired. It could be improved if more consideration were given to the true objectives of the Act and what could actually be achieved by Federal Reserve reporting. The first inconsistency arises in the initial sentence of the Act. The Federal Reserve is instructed to maintain long-run growth of money and credit commensurate with long-run potential. Yet the interest of Congress and the country are in intermediate-run monetary policy and its effects on one- or two-year movements in the gross national product, output, employment, and prices. The Act requires reports on short-run actions and prospects with no attempt to relate the short- and long-run. A second problem arises because we have little or no knowledge of the trade-offs between changes in the GMP and real growth and inflation. The Federal Reserve can attempt to alter money and credit to bring about certain changes in the GNP with a set of assumptions as to how these will translate into output and prices. However, the Fed has no way of influencing the trade-off. Therefore, it can only pick the GNP, output or prices as its objective, not all three. The Act should make clear that its target should be nominal spending (GNP) whichthe Fed can influence. A third problem arises with respect to the last sentence requiring reports when deviations take place. Unless it is made clear that objectives are to be stated in fairly broad ranges, this is really a requirement for constant reporting. Our statistical system and random events make it likely that deviations from any set of point PAGENO="0303" 299 Walter E. Fauntroy Page 2 July 5, 1983 estimates will occur constantly. The measures of money, GNP, prices, and output are subject to major errors and revisions. The Act should recognize this fact. Most deviations are artificial statistical artifacts. Requiring explanations of them would raise their importance way above their real significance. Interaction between Congress and the Federal Reserve can be extremely valuable, if it has the proper objectives. The reporting Act should be drawn recognizing the numerous problems of economic and monetary policy. It should aim at increasing the public's knowledge of the difficulties of picking proper policies and at maximizing congressional input in the determination of policy goals and objectives. This can only be accomplished if the Act recognizes how great is the lack of knowledge in the monetary sphere. Congress can be extremely useful in its oversight functions if it attempts to aid in the proper choice among conflicting goals and in making certain the Federal Reserve explains its actions. It will do more harm than good if it concentrates on spreading blame for the failure to achieve impossible conflicting goals. Sincerely, Sherman . Maisel Professor SJN/rlw PAGENO="0304" Coc £ r a r cc- *-1 Wai~n~-. 0 0 (202~ 2T. September 2, 1903 Pobsrt C Y~ar.~ The Honorable tfalter F. rmtro- Chairmen Subcommittee on Domestic Nonetaro Policy of the Committee on Sth~fmo, Finance and Urban Affairs U.S HO COO of Papses unto times Washington, D.C. 20515 Some time coo you wrote me inviting my comments on 5 5 0 i_i ~o .zc- a -`c-a~ em a -~ on which tOte Pafisral P emma memorba to the Concreer. I em co longer c5cmee crouch to the monetery process to knew 111 the detailed irsolhcotions of the bill's language and all the effects that might OJow therefrom. I do, however, have a general view on Lbs subject which I am glad to report to you. I do rot fever rerruizine the Fee to set specific targets for gross national oroduct, reel growth end i'btla Lion. three measures are ~li imoorlent to the walJ--beire of our citizens and worthy of efforts to mows them in optiral directions. dot the Fed hoe no 0 ~rect or eroxir-mte control of any of there The linirocas between there magnitudes end what the Fed does control aze cc~a~les, enS many otter factors, 1SC!UfJlflC fiscal actions hr the Conoress, also have an important bearing on the eventual course of c-o~ prices and interest Deck in the farm corerttrv where I came from, we usually ask a farmer in the spring hoc: much core he In clanting rather ~ riCO nv bushel a ho is going to harvest or hoe much his cram will sell for. tie may have hopes or erpcctatlccns fur the latter:, but those are nut bankable o~ think the relationshime of rose-eves one irnrieosrv atorsTatec Os oN? one prices woo:-: in much she PAGENO="0305" The Honorable Walter E. Ye ~roy September 2~ l9~3 Page 2 co::danaly1 I regard tnt urosero: form of lee reo:W~11g to the CongresS 55 about raht~ dosorlOlug antondec. target ronges far what the Fed can control rarsorwibly well and tee- cribing its expactOtlOnS for the bay overall measureS such us CN1? and unemployment that moneta:r:v conditions can influence but not ueterffllfle. .1t Scents to me such raoortirtg provides a basis for UCeIrJ.L discussion of the relevant poiic~ and gives the Congress appropriate grounds for judging the stewarat3hll) o:: the Fed i hope these thoughts may ha of some help to you and your eubcommittCe~ 1 /1 / ~ ~ 1/ -- RCH :51: PAGENO="0306" 302 U.S. HOUSE OF REPRESENTATIVES SUBCOMMITTEE ON DOMESTiC MONETARY POUCY OF THE ~`~r' COMMITTEE ON BANKING. FINANCE AND URBAN AFFAIRS NINETY-EIGHTH CONGRESS WASHINGTON, D.C. 20515 On Tuesday, February 22, 1983, I introduced H.R. 1569, the Balanced Full Growth Monetary Policy Act of 1983, which would make changes in the monetary policy targets that the Board of Governors of the Federal Reserve System are presently directed to follow and report upon twice - each year in their report on the Conduct of Monetary Policy. Specifically, my bill would direct the Federal Reserve to transmit to Congress on the same semiannual basis their objectives for the growth or diminution of the gross national product, real growth and inflation. It also directs the Board to report its plans for achieving those objectives through the growth or diminution of monetary and credit aggregates and interest rates. I am sure that you as a former member of the Council of Economic Advisors have thought about, researched, and formed some opinions on what targets, if any, the Federal Reserve Board should be following in its conduct of monetary policy. I would like to ask you to review this bill, which I have enclosed, and to provide me with your thoughts on it. The Subcommittee will hold hearings on this issue in late March or April and your comments would be of great help in our deliberations and mark- up. If you would be interested in testifying at these hearings, please let me know and I will make every effort to try and accommodate you. In the meantime, if you have any questions about this bill, please contact Howard Lee or Andrew Bartels of the Subcommittee who may be reached at 202/225-7315. I look forward to reviewing your comments and hope to hear from you shortly. Sincerely yours, Walter E. Fauntroy Subcommittee Chairman PAGENO="0307" 303 ~ March 11, 1983 [ ~-J4 L i (1 CENTER FOR THE STUDY OF AMERICAN BUSINESS Honorable Walter E. Fauntroy, Chairman Subcommittee on Domestic Monetary Policy Committee on Banking, Finance and Urban Affairs U.S. House of Representatives H2-109, Annex No. 2 Washington, DC 20515 Dear Mr. Fauntroy: This is in response to your letter of March 8, 1983, requesting my views on HR 1569, the Balanced Full Growth Monetary Policy Act of 1983. As you indicate in your letter, this is a subject to which I have given very considerable time and study both in government and as a private economist. Under the circumstances, I must state that, in my view, the bill imposes on the Federal Reserve System a collection of tasks which no central bank and no monetary policy can perform. To con- trol simultaneously nominal GNP, real growth, and inflation is a responsibility which the ~ed cannot carry out except by sheer luck. And to mandate that, in setting its objectives for these three economic goals, the Fed must take account of employment, unemployment, production, investment, real income, productivity, international trade and payments, and interest and exchange rates is an exercise in wishful thinking. Frankly, I would sooner give this set of tasks to the Congress and hold the Congress accountable. Not that I really believe that the Congress can or should control the economy to that extent, but that body surely possesses more power over the economy than the Federal Reserve System. You may appreciate the pleasure it is for me to speak my mind once again as a private citizen, knowing that my views cannot be attributed to anyone else. Thus, I respond to your request with a sense of sadness. It is sad to contemplate that the Congress might even consider the type of buck passing that is implicit in HR 1569. After all, it was not the Federal Reserve System but the Congress that passed the spending and tax laws that are generating~ $200 billion deficits that help to keep real interest rates so PAGENO="0308" Honorable veithar 0. Fauntrcy Page 2 Harch 11, 1903 hicth. It was net the Federal Reserve but the Conaress that pasSed the regulatory lava that reduced productivity and the ccmoeti Live- ness of American industry, at hose end abroad. It was not the Federal Reserve System but the Congress that enacted the host of credit proorams that deplete the pool of savinc availeblo for econo- mic growth. And then to turn to the Fed to scroighten out the shcrtcomtngs in cbs economy without a single reference to the responsibility of the Concress and the Executive Branch is, in my iudement, not a constructive aporcech. I regret that these conunents are so negative, but I feel obliged to respond to your letter with complete condor and I hope that you consider it in that light. / / ector ELF/mw PAGENO="0309" 305 THE ROBEflT 0. ANDEE1SON c t DUATF CHOOL OF 1~ I !AL."H ~J TI U I JFI 0 V I ICC ,~LnUQUEP.QUE. UEW E~XICO r1~1 March 11, 1983 The Honorable Walter 5. Fauntroy Chairman, Subcommittee on Domestic Monetary Policy of the Committee on Banking, Finance and Urban fe'fairs U.S. House ~ Rerresentetives Washinoton, DC 20515 Dear Congressman Fauntroy: I am resoonding to your letter of March 8~ 1983 regarding 1.0. 1569. 1 am stronq~y opposed to Uns proposed ieqisleticn. My vie~is on the issues are set forth as clearly as I can make thor, in Chapter 3 of the Annuri Ronort of the Council of Economic Advisers February 1982; op. Al-/i. kespectUuily subrdtt~d, ( ç7~ ~ - ~~/~`Z -~2~ Je~4 L. 7/ - / JL3/ps PAGENO="0310" 306 GARDNER ACKLEY 907 Berkshjr'e Road Ann Arbor, Michigan 48104 313-665-8770 March 15, 1983 Honorable Walter E. Fauntroy Chairman, Subcommittee on Domestic Monetary Policy Cornrriittee on Banking, Finance, and Urban Affairs U.S. House of Representatives Washington, D.C. 20515 Dear Mr. Chairman: This is in response to your recent letter asking my views on your Bill, HR 1569, the "Balanced Full Growth Monetary Policy Act of 1983". I believe that the changes you propose in the Federal Reserve Act are entirely appropriate and potentially useful. To be sure, there is probably no feasible way in which a Federal Reserve Board that did not share the goals and objectives that you and I and a large portion of the American public hold for economic policy could be required fully to pursue those objectives. But such a requirement as you propose would at least clarify the discussion and sharpen the issues. That is always useful. I wish that I were able to participate in your Hearings, but my travel plans do not appear to permit it. For your information, i enclose a summary statement of my back- ground in such matters as these. I also enclose copies of some at least partially related things that I have written on mone- tary policy. Gardner Ackley GA/hi PAGENO="0311" 307 ~Gardner Ackley On the Economy ~. Monetarism Doesn't Work. It Never Has, And It Never Wifi The Federal Reserve has, at least for now, formally abandoned its commit- ment to stabilize the growth of Ml at a low, steady rate. Thus, the central bank has ended its recent commitment to a monetarist ideology. I, for one, am pleased with this development, which I hope will be permanent. The Fed abandoned its money-sup- ply-growth target, it said, because recent structural changes in financial institutions, laws and business ar- rangements had altered~-st leastfor a time-the assumed stable "velocity" of money: the ratio between money supply and `nominal GNP" (Gross National Product valued in current prices). Because velocity is supposed to be stable, control of Ml is supposed to produce a slow, steady growth of nominal GNP. However, the fact is that velocity has rarely been stable for any substan- tial period of time. Instead, it varies systematically, in relation to changes in interest rates (and perhaps to changes in other economic variables). And it varies unsystematically, as the result of institutional changes and in- novations, including new kinds of fi- nancial institutions; new kinds of finan- Former Chaipnan of The Council of Economic Advisers, Gordner Ackley is Henrj Carter Adams University professor of political economy of the University of Michigan. He is president of theAmericon EconomicsAssocistion. cial accounts and new ways of settling them (often based upon new computa- tional, information-storage, and trans- portation facilities); changes in federal legislation goveming banks and other financial institutions; changes in ex- pectations; and many similar factors. Pretending that velocity is stable is the great fiction of monetarist ideology. This fiction was-once again- effectively demolished in recent testi- mony by Professor Robert J. Gordon of Northwestern University and the National Bureau of Economic Re. search, before a subcommittee of the House Banking Committee. Gordon pointed out that, during the four quar- ters ending in the third quarter of 1981, Ml was caused (or allowed) by the Fed to grow by 6.2%. Over the next4our quarters, the Fed caused (or allowed) Ml to grow by 5.7%. That's Steady growth of Ml about as steady an Ml growth as any- one-even a monetarist-could ask for. Consequently, nominal GNP should have grown steadily, at a rate close to 6% a year. Unfortunately, however, during the first four-quarter period, velocity also increased-by 5.9%. Then, during the next four quarters, velocityfell- by 2%. Another way of putting this is to say that, in the first year, nominal GNP rose by 12.1%, consisting of 6.2% for Ml growth, plus 5.9% for growth of velocity; in the second year, nominal GNP grew by 3.7%, consist- ing of 5.7% for Ml minus 3% for velocity. What this means is that 94% of the decline between these two years in nominal GNP growth was associated with a sharp and unpredictable drop in RI velocity. Gordon's calculations further showed that comparable slowdowns in velocity-and not primarily changes in rates of monetary growth-have oc- curred in every p~stwar recession, except one, since 1958. Indeed, as Gordon summarizes the story, the typical pattern over these years has been that in the late stages of each cyclical expansion, interest rates rise sharply because of a combi- nation of (1) growth of real GNP and employment; (2) inflation, caused in part by the GNP expansion or, at other times, by exogenous farm-price or energy shocks; and (3) a relatively slow growth. of the money supply. This rise in interest rates, in Sum, speeds the growth of velocity, allow- ing the boom to continue for a while. Then, as high interest rates finally halt the expansion of real output, the con- sequent and subsequent drop in real GNP shows up as a sharp decline in velocity, sometimes exaggerated by the effects of a fall in interest rates. It is a complex but plausible story-and one more reason why monetarist ideas are so dangerously wrong. Gordon strongly supports a quite different monetary rule. It is to man- age the growth of the money supply so as to stabilize the growth of nominal GNP, deliberately varying money sup- ply growth soas to offset the effects of changes in velocity, whether those changes are systematic or irregular. This will place a dragon growth of real GNP when velocity increases or when prices rise more rapidly, and will stim- ulate growth of real GNP in the opposite cases. A number of economists have re- cently proposed a similar rule. It is time for the Federal Reserve to con- aider it most seriously. 41 PAGENO="0312" F' -f-i-~'? tot, 0-roe:: ocoods- rocot p"edi:cobtc nod cc-er the c--nc. (c:c-otc lot `-c of this oc'er- p iron of in r-oO crc-c-, 1-'; to coy, c-n' donnst"oblv `T'' c:'p -°r-i cion' n.-nc- tic- c--nc-n: ) Tie': c--c- o:.::'--c':, 0 IOOSt, ci `c-_n ` `:, or- `on' -c lion tie' tc-:~ 1- lie-c-: n-con c-not Cutout to :rob;iicc- I:-: re.oo 7 c-cc-rico: ot icc-c: ccii:: "fe-cc-c-ion- `:f O'er. `no-.--.- .`_O tie' oh'': "cent" cocci, p n. ic-g P `c-i--' o'er ieee c'-1-ciicnfccowi1-l:':fcinti'c- ":r::gi'l':fcncoo..doe'dooivi:y, d-ooe-oo tr,r "-c- (i.e., in ti-c "nc-Ic'-- ned ii:,rtunot-n c-ri'. c-c eith'r ci hoe' cc ron:'). too decree's r,h::nr,ns. Jul rent output, r It ii nFo~-run no occv-rop'otn gro.'th, tint. mon-v :-ir~-ly cc frie: tncc~. (in to coo: c-' 1 -ii) v cot fe':n or, `n- The:, if niocicy c-rot r:'ol r:utpcct cite -.rc-i cot- c-i 0.3'P- to: 100 etocl-er t'c'c9 to I o:h ::cntrofly coonc'oot in ire short - in "10' 000:, ic'c -coo up to 17.90 c-cc, don-c or' -:cOo". cpf;:iy (they rev) c-:moi-oc-. 0-n c-ic- :t:. cit 1:' :hro lion croon ot'y tic- -roe.: In-nt, Scoot ccc are -~n ci' ~`n' -7 -0 :"m.c'ld i-c-": r.'eç'c-.ri'-ccrin7 irdr,:ic'n, `-`n cc:'t ste's ``-0", `` nn°rn coo- .otc' `-i intone-I ci-o",n, to go:-':': of n::nno- And if, in `c "c-."° c-c-: ci': :, ` c~'~( /,-,. 0: -.- :`~`i'7rr:' 0,- c' I I I I I ccc. -ic--c-n, C "-`c `c-c-i ic:,- ret Foot p:ct con tie: ii:: Gre-n Foci' nc-I t'c-:ciccct pnic: do' -- 7 cc--F- t':'i i-n Po' ~v_r tH p:nt c--fFt go- :0:1- `ci n' en- `, `- -::i cc tm-il -u II t cc--c,dy :o:ie: cc'.: (oct `-:chrr 10',- cc - :1-:,::: ... .n':ncri:t cc-id-c- cc :,~ ceo r, tonoc cc: t:,c c-c c-' to to' c:-y, coccI -: ri.,': ,,,~ iF,,, cc- ,Jc',r,'-r,,,'c cc-coo cc: c'c-ic'c-9y, ho no :ccIc-':cU crr.:lic'auiy. And `0', i c-c-i- , ``I.: `nd c-c: c-cOon:, cc-ct G 01' Ic- ``c:mCiv c::O 1:0cc stalIn ci- :r,' :`h-. 0 "u foii'L',-,,-'i q:c::: f'.c-- `cc-,. fl:: Pod, iu ~hoc't, It: 1-nc-n strep- i.o:.c:t cod tIc-c- -. cit `."iId cc-ri-icr'::: is velac-it:: 0:10 into - -n-c-boo `c-c:': totcc0b~: to ~c-ntt , nc:,, - `n co q:corr- t'n, tryinc- (1:0cc-c-:-.: P tIc to Imp 07 rnc-:. hr ic-c- `c--too gm c-in `ci' nc-nc-c,' ~rC0: nrc-do " ` ` mt1-f-' 1'." - (I c- `p mc- c-nrc--c- : ri)' ti-c mccc": rat: f-rot-c-n - "' `P `c-- - in, `I :oo'dc' tin oncon of ii.O .:d c"" -- .,Oc-. I' thry ore :1 cn" F" °P `"1 0' . "c'- mc- cony L'~s Save the Federe] Ree~'ve From. vc-ne~arr~'s "H sc,c:---'d, in',noro:! :0cc - `n- -`c I::, tin no" dccv:-, :0cc: ore" -of "c-i: 1979 to coot: c-ftc-mo' in i-c- o- or. ic-: tc- to- `at end :;e:-:c-1--r, ire ``-`cc-c-cd :cp to 2i'7' in D'c-c-rnni-'r. Oho rote' nc-int-ioo:I :1-c-oct 1I,'ir `-`cl toPic shion to `i-n `ftc ce-r,'eu,uecmn nt ti-crc ire'.'. ork~ ic-cbt:dcd n:rp-p:-::o:' ic "c-n- ic-n cc-cm- clr-,crzi"cs, s'.y:m'ot.ctir,: ti:n r"::' oP building; odes, c:contccro, a:" roe-ct praIclr:'no: in ro:sc:rc-e: bond c::,!.c-, : -, - o rn or,-, I: r,:t p.. nFcPc-.-. 0 `c' 0: :-: ci--. c': j: :~}:~ ic) `(tO: `I,c;: cO..~: I ``c-F' `.:,(`-,:: :1 i'c'0t;:t0000l',', c-cOn" `c':c'o i-_nc- r:'O:-: `c:,':' ,acccicc c-f P,t:::oicF I:' icc:- I ::c~c-":c :~c-,; -I.' i"- -`` -`-~`ic-~ :~i C:':. "``c- cc-rn', IF "cc-:: ocr- rncccl~ of nutty 9,c-bcaciot~ .0 c-or:': c-ill bc-c-a c.i-o',cicdo-i.::t :cc: r::c-" ~. n-ic `.`:ill "c-ely v'ec-,no ,o'a_ -`n coon.-' to c',: oc-c'nt'oc- r:nFy c'o "n-nd " c--c .`:ccy'oc: tlot `cc- : `-c-~cc"dn cf -:c:yc---I''c-':P 1': `.:""occ': `: ,v'lcF,-t'-:cc:c-:','- `0:"C',: oct PAGENO="0313" 309 The Economy The last year has seen an almost un- precedented volatility of interest rates and some striking innovations in the conduct of monetary policy by the Federal Reserve System. The innova- tions appeared to respond to long- standing criticisms by a particutar schoctt of economic theorists-the "monetarists." However, the Feds new methods have not fully satisfied either the monetarists or the Fed's anti- monetarist critics. Last October, the Fed scented to orcept basic nsonetarist principles when it announced a major change in its techniques of conducting "open-mar- ket-operations" in U.S. government securities, through which it supplies or withdraws "reserves" to the banking sysletn. Before October, its operating method involved maintaining interest- rate fluctuations within a narrow band-for example, keeping the rate on "federal funds" (overnight loans, mainly among banks) between 7% and 7'/~%. The Fed had no trouble achieving such interest-rate targets; and the targets were frequently changed,. Beginning October 9, its operations were instead directed tosvard supplying the right growth of reserves to support slosv, steady growth of defined "money stocks." Tltcse money-growth targets were to be pursued almost regardless of what happened to interest rates; the rate on federal funds might fluctuate be. tuvcen 10% and 18% uvithin a single week. * However, the Fed had always ex- plained that it selected-and varied-its interest-rate targets precisely in order to acltieve steady growth of the money stock at explicit target rates, to which it formally committed itself. Nevertheless, it hod not been meeting its money. grosvth targets through its interest-rate technique. Far example, its money- growth ta~getn between tIre fourtlt quar. tern of l978.and 1979 were 3% for M-t F,cnt,'r Chainnan oft/re Council of Economic Advisers, Gardner Ark/c1 is I/corp Car/er Adams University professor of politico! eros- 005). 01 the University of Michigon. and 6.5% for M-2. Yet between October 1978 and October 1979, H-I actually grew 5.2% and M-2 8.3%. And between April and October 1979, H-I grew at an annual rate of 8.5% and M-2 at 11.2%. Tire central bank has never provided a fully satisfactory explanation for this failure. 1-las the Fed come close to its money- growth targets under the new syurena? Using neuv definitions of money, the Fed set grosvth targets for the new M-1A, M-lB, and M-2 at 4.75%, 5.25%, and 7.50% between the fourth quarters of 1979 and 1980. But actual growth, front October 1979 to May 1980, was only at annual rates of 1.21%, 1.88%, and 6.03%. M-tA and M-1l3 actually declined for several months in the spring. Lastyear, mottetarists hod berated the Fed for greatly fxcceding nsoney- grouvth targets that they agreed were reasonable (at least in the short-ran); now they berate the Fed for falling short of its new targets, also considered rea- sonable, Too Much Fine-TunIng? Some monetarists say the problem is that the Fed tries to line-tune its opera- tions to supply just the right amount of reserves each week and month in order to keep mane)' growth stable in the short run, despite short-rust fluctuations in the demand for money. For example, in trying to get M-lA, M-lB, and M-2 to grow smoothly, tlte Fed caused (or permitted) "Unbor- rosved Member-flank Reserves"- svhiclt its open-market operations di- rectly affect-to grow at rates of 28.5% in Deccntber 1979, 7.1% itt January 1980. - 14.1% in February, -21.4% in March and 56.5% in April. The "mone- tary base," which open.nuarket opera- tions can even more easily control, grew at annual rates of 12.5%, 7.2%, 9.7%, 7.1% and 3.1% during the osme months. Many monetarists argue that suds at- lenspted fine.tuning is wrong and mis- chievous. Instead, they say, the Fed - should churn out monetary base at a steady rate each week and month; and Gardner Ackley \. ~ this will insure that money grosvth will conform to the targets, at least when averaged over periods ax long as a year. Yet Iltere is no doubt that such a prac- tice would produce highly unstable rates of short.run moor) grosvth. TIns svould surety frighten the avid `money.uvatch. em," whom the monetarists have taught to watch not merely ntonth!y mosey- growth rates but even the almost mean- ingless weekly numbers. Monetarists have screamed about such short-run in- stability in the past. However, it seems unlikely that the recent slowdown in money grosvrh was due entirety to the unreliability of the new procedures in the face of a shrink- ing demand for money in a recessionary economy. Rather, the Fed may have deliberately let money growth slip belouv its targets, because to achieve such targets would have pushed U.S. interest rates eves further belosv interest rates in other currencies. Wealthhotders would then have sold more dollar- denominated assets (or borrowed snore dollars) in order to buy ossets denomi- nated in foreign currencies. And this would have severely depressed the dol- lar exchange rate. While a cheaper dollar might strengthen our trade balance in the short run, the increased dollar cost of nsost things we buy abroad svottld add to domestic inflation. This might soon - wipe out any trade advantage, leaving only a permanently higher price level and lower exchange rate. There clearly are dangers in pursuing moneiarj grouvth whatever its conse- quences for interest rates-dangers that a simple-minded monetarism ignores. On the other hand, stable mosey grosvth at a moderate rate helps contribute to a more stable economy; louver domestic interest rates should nosy stimulate busi- ness and housing investment, aiding re- - covery from recession. In order to achieve our multiple goals for the economy, monetary policy can- not be rigidly hitched to a money- growth target; and discretionary fiscal policy and exchange market interven- lion nsay also have to be used. DR t.'4.eJ~t (92~ DUNS REVI6W The Fed's Turn to Monetarism: Too Rigid A Policy to Achieve Multiple Goals 10 21-746 O-83---21 PAGENO="0314" 310 THE UNIVERSITY OF MICHIGAN GRADUATE SCHOOL OF BUSINESS ADMINISTRATION ANN ARBOR, MICHIGAN 48109 Paul W. McCracken March 15, 1983 Edmund Eaa Day Uninersity Professor of Rosiness Administration Mr. Walter E. Fauntroy Subcommittee Chairman U.S.- Houae of Representatives Subcommittee on Domestic Monetary Policy of the Committee on Banking, Finance and Urban Affairs 112-109, Annex No. 2 Washington, D.C. 20515 Dear Mr. Fauntroy: This is in response to your letter enclosing a copy of H.R. 1569. I have generally been rather sympathetic with the idea of targets, going back to supporting the view that the Federal Reserve should follow the lead of the Deutsche Bundesbank on monetary targets a decade or more ago. I supported this view because i~t seemed to me it sharpened and disciplined thinking both within government and outside. Generally I would support having the Federal Reserve extend this explicitness to a statement about their objectives for nominal GNP and their evaluation of how it might divide between real output gains and inflation. There is this one important caveat. It would be easy for this to degenerate from encouraging more disciplined thinking to a kind of Monday morning quarterbacking. Inevitably what the Federal Reserve lays out in advance is going to be missed a good deal of the time. There is no reason to think that the organization there will be any more successful in translating monetary changes into nominal GNP, and again into real gains and inflation, than those on the outside. Since by and large according central banks some degree of remoteness from gales which blow through the immediate political arena has been justified by history, I would not want this to degenerate into some sort of political "I told you so" exercise. Regards, ~ PWM: dj PAGENO="0315" 311 Yale School of Organization andManagement Box 1A New Haven Connecticut 06520 Burton G. Malkiel Dean WilliamS. Beinecke Profestor of Management Studies Professor of Economics March 15, 1983 The Honorable Walter E. Fauntroy U.S. House of Representatives H2-109, Annex No. 2 Washington, D.C. 20515 Dear Representative Fauntroy: Thanks very much for your letter of March 8. While I am indeed very interested in the issues raised in your `Balanced Full Growth Monetary Poli~y Act of 1983," I am terribly sorry that my time schedule during the remainder of this academic term simply precludes my making either written comments or testifying at your hearings. I regret having to decline your kind invitation and hope that I may be able to be of some help sometime in the future. Sincerely, (~LL~ BGM/ ktg PAGENO="0316" 312 HARVARD UNIVERSITY - DEPARTMENT OF ECONOMICS Orro ECKSTEIN 231 Lrn2001 Cooit~ P~oI 30. JV,bo,g P,of~o~o~ ~J E~,~i: Couo,rnco, Mossocna~oi-n 02138 March 17, 1983 Congressman Walter E. Fauntroy Chairman, Subcommittee on Domestic Monetary Policy Committee on Banking, Finance and Urban Affairs H2-109, Annex No. 2 Washington, D.C. 20515 Dear Congressman Fauntroy: Thank you for the opportunity to comment on H.R. 1569, the Balanced Full Growth Monetary Policy Act of 1983. As I interpret it, the proposed act would instruct the Federal Reserve to set targets and submit reports to the Congress about real growth and inflation, rather than the monetary aggregates. The aggregates would be treated as instruments, not as goals. The Humphrey-Hawkins Act was, I believe, designed to accomplish thIs same general purpose, to make both the Administration and the Federal Reserve commit themselves to paths to fuil employment consistent with the anti-inflation goals, and to set forth measures that would accomplish these goals. As I read the responses by the Federal Reserve and by the Administration through its economic report to the Humphrey- Hawkins requirements, it is my feeling that the responses are pretty flimsy. Neither the Administration nor the Federal Reserve seems to be taking the Humphrey-Hawkins targets seriously, and while the original targets may be unattainable, I think it is still the responsibility of both groups to face these questions in a more substantive and intellectual way and to report to the Congress on them. Whether it is wise to substitute targets for general economic conditions for the monetary aggregates is a more technical issue. There is no doubt that the Federal Reserve does not control the GNP or the inflation rate, and given the limits of economic forecasting, finds it impossible to treat such targets as imperatives that simply must be met. In the bill passed late last year, the Federal Reserve was instructed to report about interest rates, and I thought that was a reasonable Congressional instruction. I think these reporting requirements could be broadened to include the Federal Reserve's expectations and goals for real GNP and inflation performance, and then to relate the instruments of the monetary targets to those goals. I believe this is a doable procedure, though the Congress will have to understand that the Federal Reserve will never achieve those targets exactly, given the uncertainties created by private actions at home and abroad and federal budget policies. Indeed, to a degree, the Federal Reserve already meets these requests. It now reports the expectations of the individual members of the Open Market Committee for growth and inflation, and presumably, by publishing them in its minutes, indicates that it finds them satisfactory under actual conditions. I do not believe the Federal Reserve's independence would be impaired by formalizing this procedure. Whether it is worth a major struggle in the Congress to pass this legislation is another question. Even if adopted, I do not believe it would make much substantive difference to what the Federal Reserve actually does nor would we want the Congress to become too specific in its instructions to the Federal Reserve, since long historical experience has demonstrated that an independent Federal Reserve is a useful counterweight to the numerous inflationary forces found both in the private sector and in the political process. I hope you find these reactions useful. With best wishes, Sincerely yours, PAGENO="0317" 313 Yale University New Haven, Connecticut 06520 DEPARTMENT OF ECONOMICS 28 Hilhouse Avenue Box 1972 Yale Station March 28, 1983 The Honorable Walter E. Fauntroy Subcarrnitte Chairman Subcar,kittee on Dat~stic Monetary Policy Caimittee on Banking, Finance and Urban Affairs U.S. House of Representatives Washington, D.C. 20515 Dear Mr. Fauntroy, Thank you very much for your inquiry of March 8. You will recall that letter asked ma to corrmant on H.R. 1569, the Balanced Full Growth Monetary Policy Act of 1983. Since I served on the Council, I have turned ruj research interests away fran macroeconomics. Furthenrore, I will be just about to depart for Europne when you will be holding your hearings Ithis I~pri1. Accordingly, I am not really in a position to carmant on your bill or to testify at related hearings. I do appreciate very much your thinking of ma. Sincerely, Merton J. Pe& PAGENO="0318" 314 RAYMOND J. SAULNIER LEHMAN HALL BARNARD COLLEGE, COLUMBIA UNIVERSITY NEW YORK, NEW YORK 10027 March 27, 1983 Walter E. Fauntroy, D.C., Chairman Subcãmmittee on Domestic Monetary Policy H2-.109, Annex No.2 Washington, D.C. 20515 Dear Mr. Fauntroys I appreciate very much your invitation to comment on the bill you have introduced (HR 1569) to change the re- porting requirements of the Federal Reserve System. It could well be that there are changes in present arrangements that would improve the chances of achieving national economic policies that are appropriately shaped and adequately coordinated, but I must tell you, regret- fully, that I do not believe HR 1569 would advance that cause, which is a vitally important one. The principal faults in the approach which it takes are, as I see it, the followings (1) It seems to me inevitable that the emphasis placed by the bill on targeting real GNP and interest rates will at some point subordinate and overcome the targeting of the monetary and credit aggregates, and that sooner or later this will lead to money supply increases that will cause the inflation rate to accelerate and defeat the objectives of the bill, which are to achieve low interest rates and a high growth rate. In short, in my view the bill has the objectives of national economic policy upside down. (2) The monetary authorities must, of course, have interest rate ob~ectives in mind á~ they shape the policies which they administer, but to require that they state these pub- licly will create pressures to set targets at levels below what woul& be appropriate for the achievement of stable prices. The monetary expansion this will invite will in the end cause inflation to accelerate. It will also in the end de- feat the objective of keeping interest rates low. PAGENO="0319" 315 (2) (3) Whether low interest rates are justified or not by the realities of financial markets, the conflict between a pop- ular demand for rates that are low and market conditions (including the need to finance the public debt in a non- inflationary way) that call for rates that many will regard as unduly high is such that a statute that requires the mone- tary auth~ties to target rates publicly will almost inev- itably put the authorities at some point in conflict with Congress,and/or th'è White House in ways that will threaten the contiuiation of the non-political conduct of monetary policy. (~) Deviations of what happens in the real world from what planners plan are so numerous that to have the monetary author- ities reporting as frequently as would be required by the li~5-day rule under HR 1569, and especially where they are reporting on interest rates, would keep financial markets, and thus the economy generally, in a more or less constant state of turmoil, either in suspense and guessing what the next Federal Reserve move is going to be, or making hasty adjustments to what it proved to be. I see no benefit in this except to so-called Fed-watchers, of which we have a sur- feit, and potentially a good deal of harm. (5) This is obviously something on whibh Federal Reserve officials themselves are best situated to comment ~, but it does seem to me that the bill would put unnesessary and potentially injurious reporting burdens on the System, and especially on the Chairman, who must bear the principal if not the exclusive responsibility for reporting persoma'IIy to Congress. There must be a point at which the ability of top Federal Reserve officials to function effectively and respon- sibly will be dangerously impaired by the piling up of report- ing requirements. and it could well be that HR 1569 pushes the requirements past that point. (6) Finally, and without meaning in the least to sugge~ st that money policy can do no harm and never has, I believe that one unintended but nonetheless real effect of a bill such as HR 1569 would be to put the onus on money policy for a poor performance of the economy when the blame should be laid at the door of fiscal policy, in its taxing or spend-. ing aspects, and to invite the belief that money policy not only can correct mistakes that are essentially fiscal hut should somehow be "required" todo so. All in all, I strongly advise that the bill not be en~cted, and if there are public hearings on it I would apprecia- ate an opportunity to testify to thai effect. - ,`~4~9,~u1nier, Chr. CEA, 1956-60 PAGENO="0320" 316 ALAN C3REENBpAN ONE NEW YORK PLAZA NEW YORK. N. Y. 10004 March 25, 1983 The l-bnorable Walter E. Fauntroy Chairman Subcommittee on Domestic Monetary Policy Committee on Banking, Finance and Urban Affairs U.S. House of Representatives Washington, D.C. 20515 Dear Mr. Chairman: Thank you very much for sending me on a copy of H.R. 1569. While understand your concerns with Congressional oversight of monetary policy, I do not believe that H.R. 1569 will be he p fu I. Federal Reserve policy is inevitably confronted w i th conflicting and at times, contradictory evidence on the status of the economy. While economic trends are clear in retrospect, at the time policy initiative~ must be made, the outlook is too often clouded. I believe to confront the Federal Reserve with requirements to project defined goals for GNP, real growth and inflation would subject them to undo, after the fact, "second guessing.'t I fear that this could very well tend to bias Fed policy in ways which would not be helpful for the nation. Thank you very much for giving me the opportunity to comment on this legislation. AG:an PAGENO="0321" 317 UNIVERSITY OF MARYLAND School of Public Affairs COLLEGE PARK. MARYLAND 20742 Suite 1218 March 22, 1983 Lefrak HaU (301) 454-6193 Hon. Walter E. Fauntroy Subcommittee Chairman Subcommittee on Domestic Monetary Policy Committee on Banking, Finance and Urban Affairs U.S. House of Representatives Washington, D.C. 20515 Dear Mr. Fauntroy: This is in reply to your letter of March 8 in which you ask for my views on H.R. 1569, a bill you have introduced that would change the targets that the Federal Reserve Board is directed to aim for *as it seeks to put the economy on a balanced growth path. Contrary to your assumption, I have not made any special study of the precise instruments or ranges that the Fed should employ. As you know, the Council of Economic Advisers is composed of three Presidential Appointees - the Chairman and two Members. While the Chairman is expected to be familiar with all field of economics, the members are chosen for their expertise in one of two major areas - macroeconomic policy or microeconomic policy. My field is the latter, and it was that which I specialized in while at the Cou~ci1. Nevertheless, one cannot serve on the Council without becoming involved, at least tangentially, in macroeconomic questions. As a result of my service on the Council, plus my efforts to follow important macroeconomic policy issues since I left the Council, I have developed a few thoughts on the matters addressed by your-bill that I will be happy to share with you. I just want you to understand that they do not come from someone who specializes in macroeconomic policy. The issue of how the Federal Reserve should set its targets - and, indeed, what it should attempt to target in the first place - has been greatly complicaT~by recent changes in financial markets. An article in the January 1983 issue of the Survey of Current Business reviews what has happened to the various components of the standard monetary aggregates over the last twenty years - and especially over the last five. With these changes, and the accompanying sharp changes in velocity that we have recently been experiencing, it is little wonder that macroecononists - and indeed the Fed itself - would be seeking more reliable target variables. A number of economists have proposed that the Fed target not money but broader indicators of economic performance. Your bill would make that mandatory by substituting GNP, real growth, and inflation for the current target variables, the monetary and credit aggregates. PAGENO="0322" 318 2 While I understand the concern over the unreliability of current definitions of money, I cannot see why such a change in focus would accomplish much that is useful. Presently, the Board operates off a forecast of the economy that its staff develops and this forecast, when translated through the relationships the staff assumes to exist between such things as the rate of GNP growth and the rate of growth of the money supply or the supply of the bank credit, determines the targets that the Fed presently reports to Congress. If the change your legislation contemplates were made, the Fed would still have to translate its goals into specific policies that it can carry out, given the range of its authority. These policies would involve control over such things as the rate of growth of certain money aggregates and/or the supply of bank credit. Nothing in any legislation I have seen would change the basic policy tools that the Fed has at its disposal. All they would change is the focus of their use, and I'm not sure what good that by itself would accomplish. Prior to October 1979, the indicator the Fed watched was nominal interest rates. After that date, it changed its emphasis to the rate of growth of certain money aggregates - principally M1A, M1B, and M2. More recently, because of difficulties in keeping track of these aggregates, it has been shifting its target emphasis to the total volume of bank credit. In each case, the objective of the Fed has been the same - a particular rate of growth of money GNP. By controlling this rate relative to the rate of growth potential Gi~P~The Fed has sought to stimulate economic growth without at the same tinii stimulating inflation. Needless to say, its success in achieving this goal has been mixed. But you can say that about fiscal policy as well. - Efforts to shift the Fed's focus to a still broader set of targets are intended, I understand, to return us to a time when the Fed paid greater attention to the interest rate and less to the various monetary and credit aggregates. This is stimulated by the belief that the high interest rates that have resulted from the Fed's post-October 1979 policy have helped produce the current prolonged recession. I do not like high interest rates any more than you do, but absent success in efforts to get fiscal policy to shoulder its share of the economic policy load, directing the Fed to pursue an easy money policy in the name of stimulating growth would be to court an economic disaster even worse than we now are in. For this reason, I cannot support proposals to get the Fed to ease up as long as the underlying imbalance in fiscal policy has not been remedied. And once it has, pressure on the Fed will become unnecessary. In the past few years, we probably have relied much too much on high interest rates to wring inflation out of the economy. The cost in terms of foregone output, and unemployment have indeed been huge. It may be true that we could have performed the task more slowly, rather than pursue the `cold PAGENO="0323" 319 3 turkey' strategy of the last few years. Certainly a few downward supply shocks such as the break in oil prices we now seem to be facing would have helped. But, given what we have gone through, and given the current shift of fiscal policy as created by the Reagan Administration's irresponsible fiscal actions, I don't see what could be gained from directing the Fed to abandon its efforts. As our traditional monetary aggregates become less reliable as links to money GNP, it is indeed appropriate for the Fed to redefine its target instruments in order that they reflect these changes. And, considering the present state of the economy, a little more monetary ease might be risked. But given the long term fiscal picture, it would be madness to direct the Fed to abandon its attempt to break the back of inflation for, despite Administration claims and the current CPI numbers, the underlying problem is still very much with us. I hope these comments prove helpful to you. Please excuse my delay in replying; the University was on vacation last week and I was unable to connect with my secretary. Please let me know if I can be of further assistance. Sincerely, George Eads GE/bnc PAGENO="0324" 320 HARVARD UNIVERSITY HENDRIK S. HOUTHAKKER M-8 LITTAUER CENTER HENRY LEE PROFESSOR o~ ECONOMICS CAMBRIDGE, MASSACHUSETTS 02138 (617) 495-2111 March 21, 1983 The Honorable Walter E. Fauntroy Chairman, Subscornrnjttee on Domestic Monetary Policy of the Committee on Banking, Finance & Urban Affairs U.S. House of Representatives Washington DC 20515 Dear Congressman Fauntroy: Thank you for your letter of March 8 transmitting HR1569 for my comments. i believe that this bill if enacted could improve the conduct of monetary policy and the public understanding thereof. The distinction made in the bill between "objectives" and "plans" is particularly useful. As I read the bill, it recognizes that the Federal Reserve is only one of several policy makers who affect growth and inflation. The bill does not hold the Federal Reserve or the FOMC responsible for attaining a certain level of real GNP and price change, but it may lead to closer consistency between the actions of the different policy makers, including the Congress. The inclusion of interest and exchange rates in the variables that the Federal Reserve should con- sider is also appropriate. I support the independence of the Federal Reserve and I do not see any threat to its independence in the enactment of this bill. If you consider it useful I shall be pleased to testify before your subcommittee. Yours sincerely, HSH: j S PAGENO="0325" 321 ~co~ U.S. HOUSE OF REPRESENTATIVES ~C*~?(&Ofl- - SUBCOMMITTEE ON DOMESTIC MONETARY POLICY COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS NINETY-EIGHTH CONGRESS WASHINGTON. D.C. 20515 March 22, 1983 On Tuesday, February 22, 1983, I introduced H.R. 1569, the Balanced Full Growth Monetary Policy Act of 1983, which would make changes in the monetary policy targets that the Board of Governors of the Federal Reserve System are presently directed to follow and report upon twice each year in their report on the Conduct of Monetary Policy. Specifically, my bill would direct the Federal Reserve to transmit to Congress on the same semi-annual basis their objectives for the growth or diminution of the gross national product, real growth and inflation. It also directs the Board to report its plans for achieving those objectives through the growth or diminution of monetary and credit aggregates and interest rates. A copy of the bill is enclosed. I am sure that you have thought about, researched, and formed some opinions on what targets, if any, the Federal Reserve Board should be following in its conduct of-monetary policy. I would like to ask you to review this bill, which I have enclosed, and to provide me with your thoughts on it. The Subcommittee will hold hearings on this issue in April and your comments would be of great help in our deliberations and mark-up. If you would be interested in testifying at these hearings on behalf of your organization, please let ma know and I will make every - effort to try and accommodate you. In the meantime, if you have any questions about this bill, please contact Howard Lee or Andrew Bartels of the Subcommittee who may be reached at 202/225-7315. I look forward to reviewing your comments and hope to hear from you shortly. Sincerely yours, Walter E. Fauntroy Subcommittee Chai rman /J PAGENO="0326" 322 JIM WRIGHT ~on~rc~ of tt,e ~Jniteb ~`tate~ H;ou~t of ~tprrSrntatibee Qfficc of tIjt £~lajoritp ~Ltabcr Wae~ington. ~.C. 20515 April 14, 1983 Hon. Walter E. Fauntroy U.S. House of Representatives Washington, D.C. 20515 Dear Walter: Thank you for your letter extending an invitation to testify on the goal of changing the way the Federal Reserve is conducting monetary policy. Also, I appreciate your thoughtfulness in asking for my recommendation of economists. Assuredly it would be a pleasure to have the opportunity to testify before your subcommittee on the importance of the goals you outlined. I look forward to hearing from you as to the date and time hearings are to be held and hope that I can participate. With regard to economists, I have always respected the work of Walter Heller and Lester C. Thurow. Perhaps they could offer some insights regarding the implementation and effects of this type of legislation. Certainly look forward to working with you in the coming months on a method to end the use of strict monetarism as the sole determinant of economic policy. Just this week, I reintroduced legislation from the last Congress on the need for a balanced monetary policy. Very best wishes. ncer y, Jim Wr~ght PAGENO="0327" 323 CHASE ECONOMETRICS/interactive Data Corporation 1110 Vermont Avenue, N.W., Suite 1100, Washington, D.C. 20005 (202) 775-0610 May 6, 1983 Honorable Walter E. Fauntroy Chairman, Subcommittee on Domestic Monetary Policy U.S. House of Representatives Washington, D.C. 20515 Dear Mr. Fauntroy: Thank you very much for the opportunity to comment on your proposal, H.R. 1569. I believe that requiring the Board of Governors of the Federal Reserve System to report twice a year on their objectives for the real growth and inflation would make a major contribution toward improving the conduct of economic policy in the United States. The reason a nation follows a specific monetary policy is that it wishes to affect the rates of change of real economic activity and prices. Any impact which monetary policies have on the monetary aggregates is important only to the extent that it is expected to affect aspects of these cruicial economic indicators. It is of the utmost importance that the Fed specify to the Congress its true goals rather than merely benchmark targets. Furthermore, the presentation of monetary growth targets, without specifying real income and inflation targets, is of quite limited usefulness. Indeed, since the measurement of the monetary aggregates is at best problematical, and their impacts upon the economy uncertain, a detailed presentation of the expected growth rates of these aggregates without a presentation of real growth and inflation *objectives may even be counter-productive. In the United States the Congress is responsible for determining the ideal growth path of the economy, and the preferred trade-off between real growth and inflation. To the extent that the Congress allows the Fed to make this trade-off implicitly the Congress has abdicated its responsibilities. PAGENO="0328" 324 CHABE ECONOMETR)CB/J~t,r,ctty, Data Corporation An example of the problem in allowing the Fed to avoid specifying real growth and inflation targets occurred during the first half of 1982. During that period the Fed clearly placed more stress on reducing inflation and less stress on fighting employment than the Congress would have preferred. The culmination of this process occurred in August when the Fed dramatically eased its grip on the money supply. However, the lost of economic performance as a result of overly tight policy during the first half of the year was quite substantial, amounting to billions of dollars; the human cost was uncountable. With respect to the conduct of monetary policy, I believe that the Board of Governors of the Fed should function as the management of an institution, with the Congress serving as the Board of Directors. As with any institution, it is the responsibility of the management of the institution to perform the day-to-day activities (in this case deciding what levels of money supply growth best meet the economic objectives of the nation). However, senior management is always required to present to the directors, on a regular basis: (1) their perception of the goals of the institution; (2) their best estimate of their likely success of meeting those goals; and (3) the major impediments toward meeting those goals. It is then the responsibility of the trustees (in this case the Congress) to determine if the statement of goals is correct. In the same manner, I believe the Fed should be required to present to the Congress: (1) a set of realistic real growth and inflation goals which it intends to pursue; (2) its belief as to whether or not it can meet these goals, and, if not, how far the economy is likely to stray from each of these goals; (3) its understanding of the impediments to reaching these goals; and (1~) the monetary policies the Fed intends to pursue to meet these goals. This final point should include (as the Fed presently does) a statement of expected monetary growth rates; it should also include a statement of the Fed's estimate of theinterest rate consequences. Sincerely, Leon Taub Vice President and Chief Economist, Washington LT:wvt PAGENO="0329" 325 `~JjJ~ Data Resources, Inc. 29 Hartwell Avenue Lexington, Massachusetts 02173 Telephone 617/861-0165 Allen Sinai 5enior 5/ice President May 2, 1983 Walter E. Fauntroy Chairman Subcommittee on Domestic Monetary Policy U. S. House of Representatives H2-109, Annex No.2 Washington, DC 20515 Dear Chairman Fauntroy. Thankyou for your letter of April 19, inquiring as to my opinions on a bill introduced by you this past February, H.R. 1569, the Balanced Full Growth Policy Act of 1983. I am happy to provide some views on the proposal. I think it would be an excellent idea for the Federal Reserve to indicate its objectives for growth in nominal gross national product and the split between the real and inflation components in each report on the conduct of monetary policy. To an extent, the central bank has already been providing some indication on its expectations for the range of possibilities for outcomes on nominal GNP, real economic growth, and inflation. One can infer a more specific target for nominal GNP working backward from the target ranges for the monetary aggregates and assumptions on the growth in velocity, but no idea of the split in nominal GNP between the real and inflation components can be obtained in this way. Many observers take the range of possibilities indicated by the Federal Reserve and the induction on nominal GNP implied by the monetary growth targets and velodty growth as the objective in the coming year for the central bank. But this really is insufficient, since ambiguity is left by the refraining of the central bank from indicating objectives. Clearly indicating objectives would, I believe, help stabilize financial markets by minimizing the amount of guessing that goes on with regard to Federal Reserve policy. Much of the volatility and gyrations in the financial markets may well be a direct consequence of uncertainty over monetary policy and the objectives of the Federal Reserve. A second reason for being more explicit about these objectives is that when actual results deviate from what is desired, a clear understanding, perhaps well in advance, would exist that changes in policy are necessary. A third benefit is the clarity of understanding about national economic goals that would arise between the different policy-making bodies of our government. One of the major difficulties in past years has been an inadequate coordination of monetary and fiscal policies with respect to agreed upon objectives by the administration and Federal Reserve. A clash of monetary with fiscal policy was most counterproductive to U. S. economic performance in the first half of 1982. With more explicit goals set by the major policy-making bodies, the kind of conflict that arose at that time would be less likely to occur. 21-746 0-83-22 PAGENO="0330" 326 Although I am sympathetic and supportive of the part of your bill that directs the Federal Reserve Board to report its plans for achieving the objectives on the economy and inflation through the growth of monetary and credit aggregates and interest rates, I think this would be extremely difficult to achieve in practice. The Federal Reserve could be more explicit about how the targets for growth in the monetary and credit aggregates will bring achievement of the objectives on U. S. economic performance, but in practicality, there are too many factors impacting on the growth of money and credit to justify any realistic expectation that the plans will be consistently achieved. We have seen an example of this during the past year or so with the new depository instruments, MMDA and Super-Now accounts, distorting greatly the pattern of growth for Ml and M2. At various times, other factors besides real GNP and inflation can materially affect the pattern of growth in the Ms. The relation between the demand for money, real GNP, inflation, and interest rates has broken down numerous times since 1976. Thus, it probably would be a mistake to expect that the Federal Reserve could ~ its plans on how growth in money and credit might achieve the desired objectives on the economy, let alone manipulate these aggregates to make it happen. It is even more difficult with respect to interest rates, since their relationship to real GNP and inflation is even less predictable and is more wide-ranged. One possibility would be to request directional or range indications from the Federal Reserve, in effect recognizing the great uncertainty that attaches to these kind of deliberations and projections, something between your bill and nothing at all on this subject. I hope these comments are helpful to you. If you wish, I certainly might be able to testify. on this topic. Sincerely, PAGENO="0331" 327 k~. HARVARD UNIVERSITY BENJAMIN M. FRIF.DMAN LITrATJER CENTER 127 Professor of Economics C~ERmcn, MASSACHIJSETTI 02138 (617) 495-4246 April 28, 1983 The Honorable Walter E. Fauntroy Chairman Subcommittee on Domestic Monetary Policy Committee on Banking, Finance and Urban Affairs U.S. House of Representatives Washington, D.C. 20515 Dear Congressman Fauntroy: Thank you for your letter of April 19 asking for my views on the Balanced Full Growth Policy Act of 1983 which you have submitted. I am pleased to respond. I support the basic thrust of this bill. It is essential that the Federal Reserve System, in carrying out monetary policy, pursue overall macroeconomic objectives that are ôonsistent with those of the nation's fiscal policy as determined by the Congress and the Executive. In this context the targets for the growth of monetary and credit aggregates, which the Federal Open Market Comrnittes has set in recent years, and which the Chairman of the Federal Reser~e System regularly reports to the Congress, are not ends in themselves but merely means of achieving nonfinancial economic objectives. In the interest of further enhancing the coordination of monetary policy with the other important elements of the nation's macroeconomic policy, therefore, I support the proposal that the Federal Reserve include in its regular reports to the Congress, along with the targeted growth rates for money and credit as at present, a statement of its nonfinancial economic objectives including the growth of gross national product, of real gross national product, and of price inflation as measured by the gross national product price deflator. I do, however, have reservations about one aspect of the bill. For several reasons, it probably would be counterproductive for the Federal Reserve System to include interest rates (or exchange rates) among the broadened gro~ of economic activity measures which it adds to its reports. First, although experience shows that the level of interest rates that is appropriate for monetary policy purposes is subject to frequent and sometimes sharp change, an institutional mechanism like that proposed in the bill would probably constrain the Federal Reserve to be overly reluctant to vary interest rates as necessary in the pursuit of the more fundamental objectives that constitute the proper focus of. monetary policy. Second, because of the pronounced interest sensitivity of many important sectors of our economy, announding in advance the interest rates likely to be consistent with the Federal Reserve's other objectives would probably attract even more attention than at present to the interest rate aspects of monetary policy, instead of PAGENO="0332" 328 The Honorable Walter E. Fauntroy April 28, 1983 page 2 monetary policy's more fundamental dimensions. Third, it is possible that unsophisticated investors may be misled unintentionally to be sure, but unfairly nonetheless - by statements by the nation' s central bank regarding the future of interest rates. In sum, I support the basic thrust of the bill you have proposed, including in particular its attempt to achieve greater consistency between the nonfinancial economic objectives respectively pursued by monetary policy and by fiscal policy; but I oppose the inclusion of interest rates among the objectives and targets to be reported in advance by the Federal Reserve System. Thank you for giving me an opportunity to express my views on this proposed legislation. I hope that they will be of some use to you and your colleagues on the Committee. If I can be of any further assistance in this regard, please do not hesitate to let me know. With best personal regards, Sincerely yours, BMF/cln PAGENO="0333" 329 ~qjp *:~ Princeton University DEPARTMENT OF ECONOMICS PRINCETON, NEW JERSEY 08544 April 27, 1983 Congressman Walter E. Fauntroy 2350 Rayburn House Office Building Washington, D.C. 20036 Dear Congressman Fauntroy: In general, I support your proposed bill that would change the Congress' instructions to the Federal Reserve. The various M's have been for some time, and continue to be, badly out of touch with reality. Consequently, the Fed is playing with fire (and the economy has been badly burned) when it bases its policy decisions on inflexible targets for the M's. I thought, however, that I might call your attention to two objections to the bill. I, personally, find neither one compelling, but other economists do. - The first objection is technical/scientific. Some would argue that there is so much professional dispute among economists about how any given change in nominal GNP will be divided between gains in real GNP and inóreases in prices that it is unwise to post separate targets for real GNP and prices. Instead, they argue, it is best to target on nominal GNP (which is the product of real GNP times the GNP deflator). No doubt, there is professional disagreement on how nominal GNP changes get apportioned. But, I think, it is easily exaggerated by paying too much attention to those who do not marshal statistical evidence, but simply counter statistical evidence with a priori assertions based on unrealistic theories. In the end, it is a judgment call whether the degree of uncertainty is or is not "too much!' My judgment still prefers separate targets for real growth and inflation, but the opposing argument cannot be dismissed. The second objection is political. The Fed, it is argued, would never have the political will to declare that it was trying to engineer a slowdown in economic activity in order to fight inflation. Hence, the PAGENO="0334" 330 Congressman Walter E. Fauritroy -2- April 27, 1983 argument continues, it is better to let them hide behind a target growth rate for nominal GM? without saying how they imagine that nominal GM? growth will be divided between real growth and inflation. Again, I am not persuaded. What happened in 1980-82 suggests to me that, when a political consensus in favor of fighting inflation emerges, the Fed can take a very stern stance indeed. Furthermore, I do not particularly like the implication that the right thing to do is to con the public into thinking, e.g., that the Fed is shooting for positive real growth when, in fact, it is trying to cause a recession. Honesty in government sometimes produces undesirable results, but it is better than the alternative. I hope these brief remarks are helpful to you. Yours truly, Alan S. Blinder Gordon S. Rentschler Memorial Professor of Economics ASB/pld PAGENO="0335" 331 THE EQUITABLE LIFE ASSURANCE SOCIETY OF NE UNITED STATES 1285 Avenue of the Americas. New York. N.Y. 10019 FRANCIS H. SCHOTT Senior Vice President and Chief Economist April 26, 1983 The Honorable Walter H. Fauntroy Chairman, Subcommittee on Domestic Monetary Policy U.S. House of Representatives H2-l09, Annex No. 2 Washington, D.C. 20515 Dear Rep. Fauntroy, Thank you very much for your letter of April 19 and for your interest in my views on H.R. 1569. I sympathize strongly with your desire to reduce the role of monetary aggregates in the discussion and conduct of monetary policy. I agree that real growth and inflation control (plus employment targets) are the true objectives of monetary policy. I also agree that the monetary aggregates have at times obfuscated the effects of Federal Reserve policy on the true goals. I do, however, also wish to make the following three points -- 1. The goals you state may be in conflict with each other. It is clear - cer- tainly in retrospect, but most likely also in a prospective appraisal - that sharply reduced inflation since 1980 was achievable only by sacrificing growth objectives temporarily. 2. The linkage between any Federal Reserve policy step and the true goals we seek is not as tight as most of us might wish. The Federal Reserve cannot be assumed to be capable of achieving the goals Congress or the Fed itself might set. Improvements in techniques are conceivable, but some price must be paid for having a "free" economy. (The price of course should be weighed in light of. the fact that plenty of deviations from plan also occur in "controlled" economies.) 3. The Federal Reserve is laboring under severe odds if there is no coordination between monetary and fiscal policy. I am convinced that interest rates would never have risen to as high a level in 1980-82 as they did had we not tolerated large budget deficits. The same observation still holds true for the future. A ~200 billion federal deficit is incompatible with the interest rate targets you (or I) might wish to set for the Federal Reserve in the abstract. Therefore, it is also quite possible that real growth goala and inflation goals will again cone into conflict as recovery~5pro ceeds. Sincerely, PAGENO="0336" 332 CHAMBER oF COMMERCE OF ThE UNITED STATES OF AMERICA Rtc~~is W. R.AI*4 1815 H Ssoo~rN~W ~CE PRESIDENT April 25, 1983 WASWNGTON.D. C. 20062 CHIEF ECONOMIST (202) 483-5020/23 The Honorable Walter E. Fauntroy Chairman, Subcomittee on Domestic Monetary Policy House Comittee on Banking, Finance and Urban Affairs U.S. House of Representatives Washington, D.C. 20515 Dear Congressman Fauntroy: Thank you for offering us an opportunity to provide you with testimony on H.R. 1569, the Balanced Full Growth Monetary Policy Act of 1983. Regrettably, we will not be able to accept your invitation because the Chamber does not have explicit policy on the issues addressed in the proposed legislation. We do, however, intend to raise this issue at our next meeting of the appropriate Chamber policy coninittee. I will make sure that the position taken by the comittee will be conveyed to you at the earliest possible date. Our organization appreciates your willingness to consult with us on matters which may affect our member Sie Richard . Rahn RWR:lsh PAGENO="0337" 333 AMERICAN 12.0 Connecticut Avenue. NW. BANKERS Washington. D.C. ASSOCIATION 20036 ECONOMIC CHAIRMAN ADVISORY Robert 1. Parry COMMITTEE Euecutive Vice President 1. Chief Economist Security Pacific National Bank April 19, 1983 P.O. Boo 2097, TermInal Annex Los Angeles, California 90051 213/613-5372 DIRECTOR P. Mkhaei Laub. Ph.D. The }bnorable Welter E. ~auntroy 202/467-4021 thai rman, Subcommittee on Ecinestic ~ ftnetary Policy 2o2~/467:40t4 82-109, Annex No. 2 Washington, DC 20515 Fear thairman Fauntroy: I am writing to convey to you the views of our Economic Advisory Cbmmittee on H.R. 1569, which you introduced February 22, 1983. The Economic Advisory Coriinittee consists of 16 leading economists from commercial banks across the country. A list of the members of the corrmittee is enclosed. C*Ie of this committee's prime responsibilities is to advise our association on economic policy matters. The Federal Reserve is a creature of Congress and it is certainly the duty - of Congress to provide adequate input and oversight to the administration of monetary policy. There are twa ways of accomplishing this. Qie is through specific legislation that wauld 4nandate the way in which monetary policy is conducted and what its objecCives are to be. The second is throtgh the dialogue that takes place throuh the process that is already established for the congressional oversight of monetary policy. We believe the current institutional structure of the Federal Reserve system is adequate for monetary policy purposes and that the complexities and uncertainties of monetary policy st.sggest that it is more prudent to take the second approach. Thus, we are opposed to any legislative changes that wauld specify in law the way the Federal Reserve is to conduct monetary policy. Congress already has the needed authority to oversee the operations of the Federal Reserve. We do feel that a better dialogue is needed between the Federal I~serve and Congress. Since there is a link between the money supply and Q~P, the Federal Reserve should provide more explicit answers to questions about what the aggregate targets mean for achieving GNP objectives. This could be accomplished by more direct questioning of the Federal ~serve when it comes before congressional committees for monetary policy oversight hearings. The questions should explore the effect on the economy, including gross national product, real growth in the economy, and inflation, of achieving the Federal Reserve targets and the expected results, if the targets are not achieved. Included in this should be questions on the underlying assuoptions used by the Federal Reserve to derive its expected results. We feel this approach is more warthwhile than that presented in }I.R. 1569. Sincerely, P. Michael Lath PAGENO="0338" 334 AMERICAN EXPRESS COMPANY. 1700 K STREET NW. WASHINGTON. DC 20006 STEVE N M. ROBERTS May 23, 1983 The Honorable Walter E. Fauntroy Chairman, Subcommittee on Domestic Monetary Policy Committee on Banking, Finance, and Urban Affairs U.S. House of Representatives Washington, D.C. 20515 Dear Chairman Fauntroy: Several weeks ago I spoke with Howard Lee, the Staff Director of your Subcommittee, considering H.R. 1569, The Balanced Full Growth Monetary Policy Act of 1983, which you have introduced. I am enclosing my comments on the legislation so that they may be included as part of your hearing record. I am also willing to appear before the Subcommittee to answer any questions you may have about my statement on Congressional review of monetary policy set by the Federal Reserve System. I am spurred to do this by the article in the Washington Post about your hearings last week and my generil concern about monetary policy and the state of the economy. You may recall that from 1972 to 1980 1 was Chief Economist for the Committee on Banking~ Housing and Urban Affairs of the U.S. Senate. Prio~ to that I was a senior economist with the Board of Governors of the Federal Reserve System. I hope that my views are helpful to you and the Subcommittee. Sincerely, /~tp~ ~* Steven M. Roberts SMR:fb PAGENO="0339" 335 Comments on H.R. 1569 Submitted to the Subcommittee on Domestic Monetary Policy Committee on Banking, Finance and Urban Affairs U. S. House of Representatives by Steven M. Roberts* Director - Government Affairs American Express Company Mr. Chairman, and members of the Subcommittee, I appreciate the opportunity to comment on H.R. 1569, The Balanced Full Growth Monetary Policy Act of 1983. As an *observer and former participant in the Congressional process of oversight of the conduct of monetary policy by the* Federal Reserve System, I believe that the legislation before you provides a useful focal point for modification of the dialogue between the Congress and the Federal Reserve on monetary policy. The current reporting requirements contained in Section 2k of the Federal Reserve Act need to be examined from time to time as monetary policy changes and as its relationship to the economy changes. During the past eight years since H.Con.Res. *Former Chief Economist, Committee on Banking, Housing and Urban Affairs, United States Senate PAGENO="0340" 336 -2- 133 was passed, the reporting requirements have been modified twice, most recently by the Full Employment and Balanced Growth Act of 1978. We live in a dynamic, changing environment. Recent experience with the monetary aggregates and the change in their relationship to GNP suggest to me that the time has arrived to once again review the types of information, objectives and targets that the Federal Reserve uses in determining policy and how they are to be communicated to the Congress. i commend you for your efforts for such a review. H.R. 1569 As I understand this legislation, it would ~irect the Board of Governors of the Federal Reserve System to transmit to Congress their objectives for growth or diminution of nominal gross national product, reaI~ gthwth, ~ánd inflation on a semi-annual basis. The legislation would also have the Federal Reserve outline their plans with respect to the various monetary and credit aggregates and interest rates that are necessary to obtain the reported objectives. Further, the Board of Governors would be required to report to Congress whenever it determines that changing economic conditions require a revision or deviation frOm the previously rep'or~ed objectives and plans within 45 days of such revisions. PAGENO="0341" 337 -3- Background The approach taken by this legislation gives clear recognition to the `ultimate targets' of monetary policy and, I would add with emphasis, fiscal policy -- GNP, real grOwth, and inflation. It also recognizes that the Federal Reserve uses `intermediate target' objectives to explain its policies and their effect on the ultimate targets. Those intermediate targets identified in the legislation. are growth in monetary and credit aggregates ~nd interest rates. The Federal Reserve's policy instruments, although not identified in H.R. 1569, are changes in required reserves, changes in actual reserves available i~n - the banking system, and reserve requirements, as well as changes in the discount *rate. The policy instruments are important because they are the tools of monetary policy. They have an initial impact on the Federal Funds rate, which is the rate banks charge each other for interbank lending of reserves, and that impact is then transmitted to other interest rates, the availability of credit, the money supply, etc. The transmission of monetary policy -- from instruments to intermediate targets to ultimate. targets -- is well known to monetary economists and has been for some time. However, it must be clearly recognized that the linkages between PAGENO="0342" 338 -4- instruments and intermediate targets, and between intermediate targets and ultimate targets are both inexact and variable. This means that the Federal Reserve Board and the Open Market Committee must (1) be flexible in their deliberations about policy and how it is to be implemented, (2) take into account all available information about changes in the u.s. and international economies, including `fiscal policy' impacts, and (3) recognize, to the extent possible, shifts in relationship between its policies and the economy; that is, the ultimate policy targets. The Federal Reserve has a responsibility to communicate to the Congress and the public at large its policy objectives. How this is done is critically important~ Congress has an obligation to ensure that its oversight responsibilities are carried out to the fullest extent possible. The dialogue between the Congress and the Federal Reserve conveys information that is needed for fiscal policy as well. Monetary and fiscal policy are both important and should not be considered in total isolation. There is no doubt that monetary policy actions influence the economy as a whole. They also influence individual and business financial decisions. While monetary policy is very complex, it is better understood today than it was a decade ago. Unfortunately, however, the focus in recent years on PAGENO="0343" 339 -5- changes in growth of the monetary aggregates has resulted in misunderstanding and a tremendous amount of volatility in interest rates which makes economic policy and individual decisions more difficult. Even now, when the Federal Reserve is on record as paying little or no attention to the narrowly defined money supply (M-l), financial markets still churn after the Friday announcement of M-l growth for the week. Weekly M-l changes impact both interest rates and exchange rate relationships. M-l has been elevated to a height it no longer deserves. This is amazing since even the Federal Reserve acknowledges that it cannot interpret or forecast M-l changes. I have advocated the elimination of the weekly release of M-l numbers for some time. The Federal Reserve knows very little~ about the meaning of M-l numbers because of the new money market deposit accounts and Super Now accounts. In this environment of deregulation and innovation, the weekly* publication is even more alarming. The intermediate target strategy used by the Federal Reserve System, although not necessary in theory (the Federal Reserve could have a strategy which goes from its instruments directly to ultimate targets), is probably useful in explaining to the public at large information about monetary policy. However, the monetary and credit aggregates are not the only indicators of monetary policy that night be considered as PAGENO="0344" 340 -6- intermediate targets. The Federal Reserve could be given greater flexibility in determining which intermediate targets it wishes to convey to Congress. The only problem that I can conceive of if this were to be done, would be that of preserving consistency. At the same time many observers believe that the monetary aggregates are less useful today as intermediate targets, or indicators of policy, than they were several years ago. Indeed, as I indicated above, N-I is probably not of much use at all and continued attention to it could be harmful. The most obvious problem is definitional. We don't really know what ~moneyR is and therefore cannot know its relationship to GNP. In recent years deregulation and financial innovation have added new categories of deposits and other near monies to our vocabulary -- NOW accounts, ATS, money market funds, CMA's, Super-NOWs, MMDA5, etc. Some of these bear interest at market rates. This removes or reduces the incentives to minimize cash balances to the level needed for transactions purposes. Also, some of the new near-monies are most certainly investment vehicles, not transactions accounts. This makes it even more difficult to accurately define money. This problem of new types of *momeyw is not one that will stop anytime soon. Certainly if you can't define money neither can you measure it nor know how its growth will impact the economy. PAGENO="0345" 341 -7- The more broadly defined monetary aggregates, 14-2 and 14-3, share the same types of problems inherent in 14-1, although of lesser magnitude. These aggregates add to M-l time and savings deposits, money market fund assets, and several other components. The problems with these aggregates are less severe because some of the new types of near-monies have characteristics of both transactions and savings accounts. Therefore, they are subject to less statistical noise. The broader aggregates are also released only once each month with a several week lag: hence, the market jitters caused by weekly release are removed. These broader aggregates might still be useful as intermediate targets. The Federal Reserve's control of 14-2 and 14-3 is, however, weakened by the fact that a large portion of deposit liabilities in those aggregates are not covered by reserve requirements. The Federal Reserve has recently added ~total domestic nonfinancial debts to its arsenal of intermediate targets. It is a welcome addition. This past February, Chairman Voicker indicated to the Congress that wtotal domestic nonfinancial debtw is an experiment without full status as a (intermediate) target. The variations of this variable have been relatively modest, and its relationship to GNP is relatively stable. 21-746 O-83---23 PAGENO="0346" 342 -8- H.R. 1569 specifies `interest rates' as an intermediate target for policy. I think that this is a mistake for several reasons. First, the Federal Reserve to the extent that it can influence interest rates can only do so for a limited period of time. Second, even the Federal Reserve cannot know what level of interest rates is required in the future to meet its objectives for either nominal GNP or the monetary and credit aggregates. Third, inflationary expectations have in the past several years affected interest rates. Any attempt by the Federal Reserve to reduce interest rates during a period of increased inflationary expectations would prove to be counterproductive. Fourth, as a general rule, I do not believe that the central bank should give its projections, thoughts, or comments about interest rates. To do so on a regular basis might cause serious problems in financial markets, both domestic and international. My bottom lane on the question of intermediate targets is that the Federal ~eserve should be given fairly wide latitude as to which intermediate targets they should provide to Congress, with the provisos: (1) there be no requirement in the law specifying int~rest rates as an intermediate target, (2) that M-l should be discarded as an intermediate target, and (3) there needs to be consistency over tine so that judgments can be made as to how good or bad monetary policy has been. PAGENO="0347" 343 -9.- Ultimate Objectives of Po~4qy It is important for fiscal and monetary policy purposes to have a clear idea both where the economy is heading and how quickly, and where policy-makers would like it to be going. Short and medium term policy variables are designated in the Full Employment and Balanced Growth Act of 1978 (FEBGA). That Act also specifies a process for setting those targets annually which involves the President through his Annual Economic Report and the Congress through the budget process. A major question raised by B.R. 1569, as opposed to the FEBGA, is whether the Federal Reserve should independently set its own targets for nominal GNP, real GNP, and Inflation, or whether the Federal Reserve as an independent agency should accept the policy targets selected by the Congress and the President. In my view, the independence of the Federal Reserve System is critically important to the well-being of the economy. That independence could be threatened if the Federal Reserve was required to make decisions about economy policy (set targets for nominal GNP, real growth and inflation), when in fact, the responsibility to do so rests elsewhere in the government. That is, I believe that economic policy objectives should be set by the Congress through the budget process in conjunction with the President. The Federal Reserve is a creature of the Congress, not a fourth arm of government. PAGENO="0348" 344 -10- However, I do agree with the thrust of H.R. 1569 -- that the Federal Reserve should have as its objective some ultimate economic targets. My preference would be to limit the target variable that the Federal Reserve is to direct its policy toward to nominal GNP. The Federal Reserve cannot influence the mix as betweem real growth and inflation, at least in the short-run. The Federal Reserve also has a responsibility for containing inflation. ~Over a multi-year period monetary policy affects inflationary expectations, and therefore, inflation. But at any point in time the Federal Reserve's influence is on nominal GNP. Recommendations H.R. 1569 contains some important ideas for modifying the Federal Reserve's monetary policy reports to Congress. Its thrust is to turn attention away from intermediate monetary targets to the ultimate aim of policy, which I take to mean growth in nominal GNP. This is critically important. I am concerned, however, that the Federal Reserve not be forced to carry the entire weight of macro-economic policy. In order to avoid that burden I would make the following recommendations: 1) The legislation should direct the Federal Reserve, in its semi-annual reports to the Congress, to comment on PAGENO="0349" 345 -11- the growth of nominal GNP as projected in the Congressional Budget Resolution for the current fiscal year and the resolution being discussed for the upcoming fiscal year. The Federal Reserve should, and can, have its own thoughts about the pace of nominal GNP, but they must be broadly consistent with the Budget. Thus, in its semi-annual reports to Congress held in February and July the Federal Reserve should comment on nominal GNP in both the current fiscal year and in the fiscal year beginning in October and ending a year later. 2) The Federal Reserve should not be required to have explicit objectives for real GNP or inflation as presently written in R.R. 1569. The Federal Reserve should be free to comment on this mix and on the role of fiscal policy. 3) The Federal Reserve should be required to explain their plans with respect to Rintermediate monetary and credit targets, or indicatorSw, that are necessary to obtain the objectives for nominal GNP. The broader monetary and credit aggregates would be appropriate intermediate targets, but the Federal Reserve should not be asked to specify interest rate objectives. PAGENO="0350" 346 -12- 4) This Committee may wish to consider whether in this period of deregulation and financial innovation it is useful and appropriate for the Federal Reserve to publish weekly M-l data. If you conclude that this practice should be * stopped, which is ny clear preference, you nay wish to provide the Federal Reserve with a waiver from the Freedom of Information Act that would accomplish this end. 5) I see no reason for the Federal Reserve to be required by law to report to Congress Rwhenever it determines that changing economic conditions require a revision or deviation from the previously reported plans and objectives within 45 days of such revisionsN. In practice the appropriate Committees or Subcommittees of the Congress can call the Federal Reserve to testify on changing economic conditions at anytime. I commend this Committee for its constructive approach to a difficult and complex area, and thank you for the opportunity to present my views. PAGENO="0351" 347 Carnegie -IViello n University Graduate School of Industrial Administration William larimer MellonFounder Schenley Park Pittsburgh, Pennsylvania 15213 [412] 578-2283 Allan H. Meltzer JohnM. OlinProfessorof Political Economy and Public Policy May 10, 1983 Congressman Walter E. Fauntroy, Chairman Subcommittee on Domestic Monetary Policy Committee on Banking, Finance and Urban Affairs H2-109 Annex No. 2 Washington, D. C. 20515 Dear Congressman Fauntroy: I am responding to your letter of April 19 and your request for comment on H.R. 1569. I do not believe that the proposals in the legislation are consistent with the title of the Act -- Balanced Full Growth Policy. Our economy does not suffer from the Fed's failure to control interest rates. The Federal Reserve devotes far too much attention to controlling interest rates. A great many of the problems with monetary policy are direct consequence of the mistaken belief that the Federal Reserve can set and achieve interest rate targets that are consistent with long-tern growth, price stabilj~ty, and a stable economy. - Further, I believe it is a mistake to give additional targets to the Federal Reserve. The greater the number of targets, the less likely that they will achieve any target on a consistent basis. The larger the number of targets, the greater is the uncertainty about the aim of Federal Reserve policy and the more difficult it becomes for consumers, businessmen, workers, and everyone else to make the type of consistent plan that is required for a return to stability. I strongly urge a very different approach. The Federal Reserve has an excess of authority and limited accountability. Federal Reserve errors cause severe difficulties for the economy. Instead of imposing additional tasks, targets, and goals on the Federal Reserve, the Congress must require the Federal Reserve to achieve the limited goals that it announces. 1~hen it shows itself capable of achieving what it has set out and announced that it intends to do, it may be possible to find additional tasks. For the present, we are in need of a few goals consistently achieved. These should begin with adequate control of the monetary aggregates. I am sending under separate cover a recent paper, "Present and Future in an Uncertain World." On pages 11 to 18 of that paper I have set out some other objectives that must be achieved if we are to return to stability, high growth with low inflation. I hope you will find my statement useful. I regret that I cannot accept your invitation to appear before your subcommittee. I will be out of the country for the next 5 to 6 weeks. Sincerely, AIIM! jep N PAGENO="0352" 348 Revised Draft Feb. 1983 Present and Future in an Uncertain World by Allan H. Meltzer In the two decades that followed World War II, real per capita income probably increased at a higher rate, in more countries and for more people than at any other time in recorded history. The achievement is not dfminished by the qualifications. There are, of course, more people, and the recorded history for much of the world is relatively brief. It remains true, however, that in these two decades, there was considerable material progress for much of the world's population. The progress of the fifties and the sixties continued in the seventies. Estimates by the World Bank show that between 1970 and 1977, nearly 5O~ of the world's population lived in countries that experienced growth of real per capita incomes of 47. or more. Many of these gains are real gains in s~andard of living that do not vanish when we mentally make the more obvious adjustments for erroneous and imprecise reports, effects of the oil cartel on the reported income in oil producing countries, and differences between consumption and average per capita income reported or produced. Much of the world may remain poor on some absolute standard, but most of the world is less poor than a generation ago. And progress appears to have been more rapid and widespread than in earlier periods of comparable length. By the end of the seventies, however, growth and development slowed in many countries. Reduced growth in several of the major developed countries necessarily slowed the growth in other, less developed, countries that rely See World Bank Atlas 1979. 2 Persistent declines in output for both the periods 1960-70 and 1970-77 are found in only five countries reported by the World Bank. The five are: Cuba, Ghana, Niger, Sonelia and Kuwait. Data are from World Bank Atlas 1972 and 1979. PAGENO="0353" 349 -2- on the growth of their exports to maintain or increase growth of domestic output and income. Growth rates remained below the level of the sixties in many countries during the first two years of the eighties. Although the world economy has grown more slowly and many countries have experienced temporary recessions or stagnation, there is no general decline that is in any way comparable to the decline from 1929 to 1933 or even the decline of 1920-2 1. It is common, now to assign major responsibility for slower growth to some recent political personalities or their policies. Reaganomics and Thatcheritis are often described as causes of slower growth, stagnation or even depression in the world economy. Such statements are imprecise and inaccurate. Slower growth did not begin in 1980 or 1981. The growth rate of output for 1977-80 had fallen below the rates achieved earlier in the decade. A substantial decline in reported growth for 1977-80 relative to 1970-77 occurred in many countries, including the U.S. and the U.K., but also including Canada, Spain, New Zealand, Belgium, Brazil, Korea, France and the Netherlands. - Growth occurs when people sacrifice current consumption in anticipation of increased future consumption. Output and consumption increase if the resources released from current consumption are invested in productive assets, in useful training, or in improvements of technology. Properly calculated measures of the ~eturn on these investments deper~d on the rate of interest. See Appendix, Table 1 for the reported growth rates in these and other countries. A few countries on the list -- Mexico, Italy, Switzerland, Germany and Sweden -- reported substantially higher growth in the later period. For 8 of the 23 countries, the relative growth rates do not differ by more than 107. up or down in the two periods. The list includes most of the market economies of North America, Europe and Asia but excludes the Comecon countries and others for which comparable data is not available in the sources used. PAGENO="0354" 350 -3- The higher the rate of interest, the smaller is the present value of returns received in future years; the lower the rate of interest, the larger the present value of returns received in future years. Projects with a given current cost become more profitable as the rate of interest falls. A rise in the rate of interest reduces investment, the accumulation of capital and the level of future of output. The rate of interest relevant for these comparisons is the so-called real rate of interest. This rate differs from quoted market rates by the rate of inflation that borrowers and lenders anticipate. The higher the anticipated rate of inflation, the higher is the market rate that is required to maintain a given real rate of interest. The critical role of the real rate of interest in allocating resources between present and future suggests that we look to the present level of real rates to explain the slower growth of output experienced in many countries during recent years. All computations of the real rate of interest -- whether by subtracting the past average rate of inflation, the current rate of inflation or some measure of expected future inflation -- show a marked rise in the computed real rate in recent years. I believe that increased risk or uncertainty is a principal reason that interest rates, after adjusting for inflation, have remained above their postwar norms in recent years. One principal cause of the increased uncertainty is the greater variability of money growth that we have experienced in recent years. Although the Federal Reserve announces targets for money growth, the targets bear little relation to the actual rates of money growth. No one can guess whether monetary policy will produce another round of inflation, a severe deflation,or a period of disinflation. Interest rates and exchange rates reflect this uncertainty. PAGENO="0355" 351 -4- Unstable U.S. monetary policy is not the only source of increased uncertainty. Trade policy and fiscal policy are difficult to forecast also. Countries repeatedly use and threaten to use tariffs, quotas, subsidies and regulations to protect or support domestic industry or to retaliate against real or alleged harm done by others. Recent tax cuts in the United States did not increase certainty about fiscal policy or make future tax rates more predictable. Future tax rates are no more certain. Increased uncertainty about the future discourages investment in real assets and encourages people to hold relatively safe assets such as currency, insured bank deposits and short-term debt. The attempt to shift from long-term debt, land, common stocks and other real assets to these safer assets raises the real rate of interest on long-term debt and on real assets. In principle, the increased demand for money and short-term securities may raise or lower the real rate of interest on short-term securities. If long-term debt is a closer substitute for short-term debt than for money, real rates on short-term debt rise with long-term rates. This is the pattern observed in recent years. -~ The mismanagement of monetary control by the Federal Reserve increased the variability of both money growth and interest rates after 1979. Instead of trading increased variability of interest rates for greater certainty about money growth and inflatioi~, Federal Reserve policy added to the risks in the economy. The increased risk is reflected by the higher levels of short- and long-term rates and by the failure of rates to respond fully to the substantial decline in current and expected future rates of inflation. ~ Technical details of this argument and estimates of the increased risk premium are in Angelo Mascaro and Allan H. Meltzer, "Long- and Short-term Interest Rates in a Risky World," unpublished December, 1982. This study suggests that the risk premiums in short- and long-term rates increased by 3-1/2 and 1-1/2 percentage points during the period 1979-81. PAGENO="0356" 352 -5- The increase in risk premitras helps to explain several features of recent experience other than interest rates and the increased demand for "safe" financial assets. The increased demand for money lowered the increase of the price level and contributed to the decline in inflation. The reduced demand for real capital contributed to the persistent stagnation of real output from 1979 through 1982. The rise in real rates of interest attracted foreign capital and contributed to the higher exchange value of the dollar. Technical economic analysis contributes to an understanding of our past and current position and the effect of policy procedures on risk. It does not explain why destabilizing and inefficient procedures are adopted and maintained or why policyrnakers do not adopt more stable policies. To explain the choice of policy procedures, we must join the political to the economic aspects of policy. Why Government Policies Are Often Variable and Unpredictable Every predictable policy is a policy rule. Policy rules may be complex or sfriple. They may call for predictable changes in response to observable events. Or, they may specify a constant level, a constant ratio or a constant rate of change. The essential feature of a policy is that action is predictable. The alternative to a policy rule is random, haphazard, unpredictable action. No one chooses to defend haphazard or unpredictable policies, so the case for unpredictable policy is presented instead as a defense of discretionary action by a policymaker. The traditional argianent for discretion presupposes This section is partly based on Alex Cukierman and Allan H. Meltzer, "A Positive Theory of Credibility and Monetary Inflation," unpublished November, 1982. PAGENO="0357" 353 -6- that the central bank or government can predict future changes well enough to offset then and reduce variability. The traditional case against discretionary policy is that, in practice, discretionary policy increases variability and reduces stability. At issue, is the degree to which dis- cretionary changes in policy can be used to offset unforseen changes arising from other sources. A rule that requires policies to remain predictable denies to governments the opportunity of responding to unforseen events but also prevents governments from making errors. There are probably specific examples of discretionary policy that reduced variability and, on the other side, some mistakes that increased variability. A recent very approximate calculation, for the period 1953-80, suggests that, on balance, discretionary monetary policy in the United States si~ghtly increased the variability of the economy. In the more recent period,. 1969-80, a monetary rule that held the growth of the monetary base constant would have eliminated 607. of the variability in growth of nominal GNP. 21 Computations of this kind, or more exact computations that give broadly similar results, are not likely to persuade central bank or governments to adopt a monetary rule. The experience with monetary targets shows that legislation requiring the Federal Reserve to announce money growth rates has not been followed by tighter control of money growth. Deviations from announced targets are large and variability of quarterly growth rates has increased. Studies completed by the staff of the Federal Reserve show that 6 See Milton Friedman, "The Effects of a Full Employment Policy on Economic Stability: A Formal Analysis," in Friedman (ad.) ~ in Positive Economics Chicago: University of Chicago Press, 1973, pp. 117-33. See Karl Brunner and Allan H. Meltzer, "Strategies and Tactics for Monetary Control," ~ ic-Rochester Conference Series on Public Poj4qy~, 18, Spring 1983, Table 1. PAGENO="0358" 354 -7- many of the errors, and much of the variability, is avoidable if improved control procedures are adopted. Most of the required changes have not been made. Experience in several other countries that have announced monetary targets has not been studied in as much detail. In many of these countries, however, there are substantial differences between the announced and actual growth rates. The Bank of Canada announced monetary targets for several years but often pursued exchange rate policies that were inconsistent with the announced monetary targets. The Bank of England publicly accepted the monetary policy of the government but strongly resisted any effort to adopt procedures that would improve monetary control. None of these experiences is inconsistent with the propositions that governments, and their central banks, resist policy rules, fail to adopt procedures that would make rules work effectively and prefer discretionary policies even if these policies increase variability and uncertainty. The problem is to explain why governments often resist policies that reduce uncertainty and favor discretionary policies that increase uncertainty. The reason, I suggest, is that government policynakers gain from discretionary policies. The gains arise from the effects that unanticipated policy changes have on employment and output. Unanticipated increases in money increase spending, output and employment. Fully anticipated changes in money increase prices but have no effect on output and employment, 8 Errors of 17. per year, or less are attainable according to Federal Reserve estimates. See Board of Governors, New Monetary Control Procedures vols. I and II. Washington 1981 and also .3. Johannes and R. H. Rasche, "Predicting the Money Multiplier," Journal of Monetary Economics 5, (July 1979) pp. 301-25. There is simply no factual basis for James Tobin's claim that the "central bank fraternity embraced monetarism," and Tobin offers none. See James Tobin "The Monetarist Counter-Revolution Today -- An Appraisal," Economic Journal 91 (March 1981) p. 30. PAGENO="0359" 355 -8- Anticipated and unanticipated changes in tax rates have different effects on the timing of spending. Discretionary policies give policymakers the opportunity to respond to shifts in voter preferences and to make exaggerated claims about the short-run effects of their actions. Public opinion polls that ask people about their "priorities" show positive association with current problems. When unemployment is high, the polls report that the public gives higher priority to reducing unemployment than to reducing inflation. When the rate of inflation rises, the reported "priorities" change. Public opinion polls do not inquire about the public's long-term preferences or ask whether the public is willing to increase the maintained average rate of inflation or the size of govertmtent to speed the reduction in unemployment. Economists recognize that there is no permanent trade-off between unemployment and inflation. Increases in the growth rate of money increase the rate of inflation but have no lasting effect on employment or the growth of output. Increases in the budget to stimulate spending often become permanent programs and lead to higher tax rates. We can only guess at the extent to which public opinion polls reflect these long-term effects or the public's preferences for stable long-term policies instead of shifting priorities. Suppose policymakers respond to the poll results. If they respond ixnmediately,changes in policy are predictable. The polls would be an accurate index of the timing (but not the magnitude) of policy changes. People would learn to anticipate a shift to inflationary or disinflationary policy or a change in tax rates or government spending and cquld take action to PAGENO="0360" 356 -9- protect themselves. To increase the effectiveness of discretionary policy, there must be a very loose relation between reported changes in opinion and policy changes. People must remain uncertain about the timing and magnitude of policy changes and the duration of policies. Although uncertainty increases the effectiveness of policy changes, it has a cost to the policynaker as well as to the public, Large, frequent differences between announced and actual policy reduce the credibility of announced policies. Low credibility means that the public puts low weight on policy announcements * The public remains skeptical about commitments to reduce inflation or to keep inflation from rising or to reduce taxes. Widespread skepticism about policy announcements raise the cost of slowing inflation and the cost of shifting resources from constznption to investment. Skepticism reduces the gains to the policymaker from announce- ments or campaign promises. The greater is the skepticism, the slower is the response by the public to policy announcements. People take a wait and see approach. They delay increases in investment and are hesitant to make long-term commitments based on the belief that the announced policies will continue. We have seen some recent examples of the high social costs of skepticism and the low credibility about the degree to which tax rates and inflation will remain low in the future, These social costs differ from the costs borne by the policymaker, but the two are related, The public blames the policyrnaker for the persistence of "high" interest rates, unemployment, slow growth and falling real income that areconsequences of the low credibility, skepticism, and disbelief about the announced policies or about commitments to "stay the course" which leave "the course" uncertain, PAGENO="0361" 357 -10-* The policymaker has no lasing interest in perfecting policy operations to eliminate control errors. The reason is that, at times, control errors have a function for the policymaker. If control is poor, the policymaker can attribute his mistakes to errors in the control process. Since the public cannot separate control errors from unannounced changes in policy, they learn, gradually, that actual policy differs from the announced policy. They observe the deviation but cannot be sure whether they have observed a control error that will be corrected or an unannounced policy change that will persist. When policies change, some are fooled into believing that policy has not changed. The policymaker who chooses to increase current output and employment by choosing more expansive policies than he announces raises the cost of slowing inflation that he, or his successor, bears in the future. Abstract arguments about credibility and control errors may seem far removed from practical affairs, but they are not. Currency devaluations are almost always preceded by commitments to maintain the exchange rate. Control errors make it difficult to separate the thrust of actual policy from random fluctuations. President Johnson chose to hide the increase in expenditures for the Vietnam war in the monthly budget variances. The Federal Reserve, the Bank of England and other central banks resist changes that can reduce the errors in monetary control and the variability of money growth to a fraction of their current values. They choose poorer to better control. Opportunities for discretion are increased, but uncertainty is increased also. 21-746 O-83--24 PAGENO="0362" 358 -11-P Reducing Uncertainty Risk and uncertainty cannot be eliminated. The timing of productive innovations, epidemics, weather conditions, other natural occurrences, wars and political events abroad introduce variability into current prices and output. The future is uncertain because we do not know what will occur or how long the changes we have observed will persist. The institutions, voting and market arrangements that societies adopt can alter the risks and uncertainty that people bear. Insurance is an example of a market arrangement that reduces risk and the cost of risk bearing by pooling risk. The invention of checks, double entry bookkeeping, and credit cards are additional, familiar examples of innovations that reduce risk for the buyer, the seller or both. Many social and political arrangements reduce risk and uncertainty. Others increase risk. Countries with a history of political instability generally have less capital per worker and less durable capital than countries with greater political stability. In countries with a history of instability, the productivity of new capital may be very high, but the return on investment in durable capital is uncertain. Where risk and uncertainty are above the attainable minima, the risk premmuns in interest rates are above the minimum. Interest rates are increased. People hold more of their wealth in assets that earn returns quickly, or they hold a substantial fraction of their wealth in gold, other precious metals, diamonds or foreign assets that are not dependent on domestic political uncertainty. The risk premium for investments in long-term capital reflects the social and political instability. The stock of real capital is PAGENO="0363" 359 -12- reduced to a level at which the after-tax, risk adjusted real return compensates for bearing undertainty. Argentina offers an example of a country where political institutions and a history of monetary and fiscal instability hamper development by increasing uncertainty and reducing capital formation. Bolivia is rich in resources but has a history of coups and revolutions. Per capita income in Bolivia is the lowest in South America. Hong Kong, with few natural resources is one of the richer countries of Asia and one of the most stable. Stable political and economic arrangements are not the only factor determining whether economic development occurs, but the absence of political stability and high uncertainty about tax rates, inflation and other economic policies increase the real rate of interest that projects must yield and, thus, hinder economic development. In countries with a history of political stability, like the United States or Britain, the political system increases variability in a number of ways that are less dramatic and less apparent than the coups and disruptions of Bolivia and Argentina. In Britain a small change in the vote has shifted power from those who favor nationalization of industry or confiscatory taxes on wealth to those who favor denationalization and reduced taxes. Throughout the nineteenth century, the tariff was a major issue in U.S. politics. Small changes in the vote were capable of producing major changes in the real returns to investment in steel and agriculture. Currently in Britain, the United States and other western countries, voters may change their commitment to disinflation or price stability and have done so on a number of occasions. PAGENO="0364" 360 -13- Voters' right to change policy is a principle of democracy. Our choice of policies must always be subject to change as majority opinion changes. within that framework of a political democracy, we can increase stability, lower the real rate of interest and increase real output by removing the instability introduced by unanticipated policy changes and adopting policy rules. To illustrate, I will suggest a set of monetary, fiscal arid trade rules that provide greater certainty than current arrangements. Monetary Arrangements From 1947 to 1964, the United States maintained a relatively stable monetary framework under which many countries developed, recovered and prospered. Inflation remained low in the United States and in many other countries that tied the values of their currencies -- their exchange rates -- to the dollar. The framework and monetary policy procedures were not ideal, but they produced greater stability than the monetary regfmes that preceded or followed. The system of fixed exchange rates based on the dollar, known as the Bretton Woods system, formally ended in 1971 when President Nixon allowed the exchange value of the dollar to be set by market forces. Holders of dollars and dollar securities could, no longer, have any certainty about the long-tern values of the dollar. Long before the Bretton Woods system ended, however, uncertainty about monetary policy, inflation and the future value of the dollar had increased. Inflationary policies after 1964 eroded much of the credibility of the U.S. commitment to a fixed exchange rate system and a PAGENO="0365" 361 -14- non-inflationary monetary policy. The unwillingness of the U.S. to change its policies and the unwillingness of other countries to increase their rates of inflation made certain that the Bretton Woods system would not survive. Only the timing of the breakdown of the system was uncertain. Many people look back on the Bretton Woods system nostalgically. They would like to restore some type of fixed exchange system to recapture some of the stability that enabled countries to achieve the benefits they associate with that system. There are several proposals. Some want to establish a world central bank that would issue a common money to be used as reserves and for settlements between national central banks. Others propose a return to some type of gold standard. These and other proposals for a return to fixed exchange rates misinterpret the experience under Bretton Woods. Fixed exchange rates were not a cause - of increased stability and the relatively high growth of the world economy during those years. They were a result of the relatively stable policies followed in major trading countries and, particularly, the relatively stable monetary and fiscal policies in the United States. In the years 1953-1964, when the Bretton Woods system flourished, deficits remained small on average and the most common measure of the U.S. money stock -- currency and checking deposits -- rose at an average annual rate of less than 2-1/2 percent. In the succeeding seven years, that ended with the breakdown of the system, average U.S. money growth rose to 57. and the variability of money growth increased. To restore monetary stability, I propose a monetary arrangement that builds on past experience. I do not suggest that the proposal would PAGENO="0366" 362 -15- eliminate uncertainty, for I believe that is not possible. I do not claim that the proposal would reduce uncertainty to some theoretical minimum, but I believe there is much to be gained from the reduction of uncertainty that the proposal brings. The proposal calls on the central banks and governments of the leading economies -- the United States, Japan and Germany -- to maintain the growth rate of their monetary liabilities, known as the monetary base -- currency and bank reserves -- in relation to the average rate of growth of domestic output (measured in real terms) during the preceding three years. The relation would be set to maintain a zero average rate of inflation in each of the countries. Other countries that wish to do so could make a similar cotmiitment, or could fix their exchange rates in relation to one of the three currencies, or could remain outside the system. - Price levels would continue to fluctuate in the three countries, and exchange rates between the dollar, the yen and the mark would fluctuate, Fluctuations would remain bounded by the coinnitment of major trading countries to maintain policies that aim at non-inflationary money growth. Each country would gain from its own policy even if other countries did not honor theirs. The gain to participants increases, however, as the number of countries in the agreement rises. The proposal increases stability in five main ways. First, there is a stable fremework for policy that reduces uncertainty about the future price level. Second, exchange rates are free to fluctuate, but long-tern changes are constrained by the commitment to non-inflationary and non-deflationary policies. Third, the system adjusts, gradually, to changes in the growth of output or in the demand for money. Fluctuations in prices or output arising PAGENO="0367" 363 -16- from these sources are not eliminated, but they do not cumulate. Fourth, monitoring is relatively easy, so the credibility problem is reduced. Fifth, central banks are required to control the liabilities on their own balance sheets, a task which is within their capability and can be achieved with precision, They do not forecast or base policies on forecasts by others. Trade and Capital Movements A stable monetary framework encourages people to hold a smaller share of wealth in precautionary balances and to invest a larger share in capital. By reducing present uncertainties, the monetary system contributes to lower real interest rates, a larger capitaistock and increased output. The monetary framework should be supplemented by rules that strengthen trade in capital and reduce the risk of exchange controls. The right to own foreign currencies and invest in foreign assets, like the right to own gold, is a valuable right. The fact that people choose to exercise the right suggests that they perceive risks that can be reduced by the - maintenance of rules that make policies more predictable. Restrictions on capital movements attempt to block the operation of this mechanism. Fear of restrictions encourages people to diversify into short-term foreign assets or into diamonds and precious metals. This reduces investment in long-tern capital and lowers real output. The growth of world trade during the past three decades provided a major stimulus to economic development, the growth of income in many countries and the increase in standards of living. Without rules for trade and agreements (or rules) that reduced tariffs and non-tariff restrictions, growth would have been lower and the increase in standards of living smaller. PAGENO="0368" 3fi4 -17- The Rawley-Smoot tariff of 1930, and the prompt retaliation to the tariff by many countries lowered world real income, Restrictions on trade were an important factor converting the 1929 recession into the period known as the Great Depression and contributing to the avoidable monetary collapse of 1931 to 1933. The well-intentioned policies of fiscal and monetary stimulus contributed to recovery, but did not restore real output to the level reached in 1929 until 1935 for major European countries and until 1939 in the U.S. ~Absent the restrictive trade practices, the recession and the monetary contraction would have been smaller and the depression less severe and long lasting. Governments can contribute to the expansion of the world economy by reaffirming their commitment to the rules guiding trade policies diiring the last three decades and by reducing many of the remaining restrictions on trade and capital movements. Byremoving barriers to trade and capital the principal market economies of the world work to expand output and standards of living. The expansion of world trade is one of the main ways that permanent gains in living standards can be achieved. A Rule for Fiscal Policy Rules for money, trade and capital movements cannot assure that resources are used efficiently. Government tax and spending policies in many countries encourage the transfer of resources from future to current consumption. Variable fiscal policies that increase uncertainty about future tax rates on labor and capital also encourage current consumption and leisure. 10 ~ have discussed this issue in greater detail in `Monetary and Other Explanations of the Start of the Great Depression,' Journal of Monetary Economics, 2, pp. 455-71. See, also, Anna J. Schwartz, `Understanding 1929-1933," in K. Brunner, ed., The Great Depression Revisited. Boston: Martinus Nijhoff, 1981. PAGENO="0369" 365 -18- A monetary rule without a fiscal rule cannot assure stability. The reason is that budget deficits must be financed either by increasing money or by selling debt to savers. When deficits become large relative to saving or output, the saving rate may be too low to finance the deficit and pay the interest on the outstanding debt. Governments typically rely on inflation, under these circumstances, to reduce the real value of outstanding debt and to tax wealth owners. A rule for fiscal policy that fixes the relative size of government, or the relative growth of government, increases certainty about future tax rates. Several years ago, I proposed a rule that ties the growth of government spending to the growth of nominal output and ties tax collections to the average level of government spending. A rule of this type produces a cyclically balanced budget, more predictable average tax rates and limits the growth of government. A common objection to any fiscal rule is that legislatures meet annually and can, if they wish, set an annual limit to spending, taxes, and deficits. Governments have not chosen to limit the growth of spending. In all democratic countries, government spending has grown faster than output for several decades. A main purpose of a fiscal rule is to provide a common understanding of the outcome of collective decisions. A spending rule is an agreement under which everyone agrees to limit the demands he places on government in exchange for a promise by others to limit their demands. A rule that limits the growth of spending affects the demands made by all groups and individuals. In the absence of the rule, no one can be certain whether others will agree to limit the demands they make. The outcome of elections decide how the spending is allocated. The purpose of a spending rule is to provide greater certainty about the demands that others can make and the taxes that everyone pays. PAGENO="0370" 366 -19- Concluding Remarks In recent years, interest rates after adjustment for inflation have remained higher than in the past and growth of the world economy has slowed. A common response to these, related events is to urge a change in the mix of policies in many countries and particularly in the United States. Coordinated monetary expansion in the United States, Germany, Japan and other countries and higher tax rates in the United States are proposed to reduce interest rates and increase output. The recommended change in the policy mix ignores lessons that can be learned from the experience of the past decade and many previous periods. Faster growth of money will be followed either by higher inflation or by another recession. Higher inflation will be the inevitable result of faster m~ney growth; recession is the likely outcome if money growth is reduced at some time in the future. And, both will occur if money growth remains at recent levels then quickly drops to less inflationary levels. No lasting improvement will be achieved if we continue the variable policies of the past two decades. Proposals to adjust the nix of policies ignore learning, anticipations and risk. Years of experience with variable policies has brought higher inflation and higher average unemployment. Many people have learned that periods of monetary stimulus are followed, first, by higher inflation, then by attempts to slow inflation and by higher unemployment. They have learned, also, that the large budget deficits incurred during recessions are usually followed by higher tax rates and by monetary policies that raise tax rates PAGENO="0371" 367 -20- by making an increased share of income subject to higher marginal tax rates. Skepticism about attempts to steer the economy from quarter to quarter or year to year by varying fiscal and monetary policy are a cause of current high interest rates and stagnation. Variable policies increase variability of the prices of assets and output and increase uncertainty. People demand higher risk premiums for investing in durable capital. Investment is lower, so the capital stock is lower, and output is lower. A larger fraction of wealth is held in relatively safe short-term assets or in gold. This paper suggests a very different program to increase output and employment. Emphasis is on long-term stability, on policy rules and on policies that increase information, reduce uncertainty and restore credibility. I argue that acceptance of policy rules that reduced uncertainty about trade, payments and inflation were much more important, and shifts in government policy much less important, than proponents of finely structured mixes of policy recognize or concede when they survey the past or exhort us, currently, to raise taxes, end tax indexation and inflate away the budget deficits that are in large part a result of past efforts to redistribute income. Each of the principal market economies can contribute most effectively to lower interest rates and increase output permanently by adopting rules for monetary, fiscal and trade policy to replace the rules that provided stable growth and relatively low interest rates in the fifties and sixties. The monetary rule that I propose calls for the U.S., Germany and Japan to fix the growth rates of domestic money stocks in relation to the average PAGENO="0372" 368 -21- growth of output so as to maintain price stability on average. Exchange would be permitted to fluctuate, but the range of fluctuation would be reduced by the coasnitment to maintain long-term price stability in each of the countries. A rule of this kind combines the benefit of relatively stable prices that each major country can achieve alone to the benefit of relatively stable exchange rates that countries cannot achieve alone. A monetary agreement of this kind is not a panacea. I propose additional steps to reduce uncertainty about fiscal policy and steps to expand trade by reducing tariffs, other trade restrictions and restrictions on capital movements. Still other steps to provide rules for lenders of last resort can also reduce uncertainty. Opponents of policy rules typically argue that activist policies are required to offset shifts in the rate of use of money, or monetary velocity. This argument is not compelling, as Friedman showed long ago. Discretionary policies conducted with the best of intentions, can increase rather than reduce variability. The fact that there are changes in monetary velocity does not establish that discretionary policies will offset instability. Large or poorly timed policy changes may -- and indeed have -- increased variability during the seventies, in the depression of the thirties, in the recovery of 1937 and in the past five years. The Federal Reserve, and other central banks and goverirnents, make the mistake of identifying most, and perhaps all, instability with changes in the publics willingness to hold money. They want to offset such changes by varying money growth. They fail to recognize that they cannot forecast many of the changes that occur or their duration. They fail to recognize that some of the variability is the result of weather, innovation and other random events. By varying policy, they often increase variability and uncertainty, add to the risk premiums and cause us all, rationally, to discount the future more heavily and to-be poorer as a result. Milton Friedman, ~. S~&~ PAGENO="0373" 369 Appendix Table 1 Growth Rates of Real Output (compound annual rates of growth in percent) 1970-77 1977-80 Ratio of column (2) to (1) (1) (2) (3) Belgium 3.4 2.3 0.68 Brazil 9.6 6.4 0.67 Canada 4,7 2.2 0.47 France 4.0 2.9 0.73 Germany 2.6 3,3 1.27 Italy 2.8 3.8 1.36 Japan 4.8 5.0 1.04 Mexico 5.8 8.6 1.48 Netherlands 3.3 1.8 0.55 Spain 4.8 1.5 0.31 Sweden 1.8 2.3 1,28 Switzerland 0.9 2.4 2.67 United Kingdom 2.2 1.0 0.45 United States 3.4 2.6 0.76 Hong Kong 8.9 9.4 1.06 Indonesia 8.0 7.3 0.91 Korea 10,2 5.5 0.54 Malaysia 8.0 7.6 0.95 New Zealand 2.4 1.2 0.50 Phillipines 6.5 6.0 0.92 Singapore 9.0 9.4 1.04 Taiwan 9.4 9.5 1.01 Thailand 6.8 7.3 1.07 Source: International Economic Conditions, Federal Reserve Bank of St. Louis, June 1982 and Pacific Basin Economic Indicators, Federal Reserve Bank of San Francisco, September 1982. PAGENO="0374" 370 AmericanFederation of Labor and Congress of Industrial Organizations LANE KIRKLAND PRESIDENT THOMAS DONAHUE SECRETARY-TREASURER (202)637.5000 jsho H. Leo: ~ ~ ~ Lloyd MoBUds K*oosth 1. BIsylock AMo E. Hssps ~AO~ E~.I3~ ~g5~" S~ ~ RilOss H. Bycstso MaIN J. BosAs PslIck J. Campbell March 31, 1983 The Honorable Walter E. Fauntroy Chairman Subcommittee on Domestic Monetary Policy Committee on Banking, Finance, and Urban Affairs U. S. House of Representatives Washington, D. C. 20515 Dear Mr. Fauntroy This is in response to your letters of March 22 and 23 addressed to Rudy Oswald, asking for our thoughts on H.R. 1569 and whether we would be interested in testifying in hearings that you plan to hold on the bill. - There is no doubt of a need for a change in monetary policies that would relate more to stable growth of the economy than the monetary policies that have been followed over the past decade and particularly in the last few years. However, I doubt that more stable growth could be achieved by adding targets for GNP, real growth, and inflation. Also, by giving greater consideration to interest and exchange rates, the objectives of greater stability will not necessarily be achieved. My doubts arise from the fact that the basic tools that the Federal Reserve Board would have would still be those of controlilng the money supply and/or influencing the level of interst rates. Both of these processes, in the end, have as a cutting edge of the tool raising or lowering the level of interest rates that, in turn, leacb to a dampening of aggregate demand as a way of fighting inflation, or a rise in purchasing power as a means of stimulating the economy. Past experience has shown us that the need to fight inflation by tight-money, high interest rate policies provides so much harm in the way of business and farm failures through a painful inflationary period, which results in the loss of hundreds of billions of dollars in GNP and tens of billions of dollars in savings and capital formation. Consequently, the economy lags in modernization of plant and equipment and in provision of an adequate housing supply, which lays the foundation for the next round of inflation. A brief experience with credit controls in 1980, and the successful experience of 3apan with that monetary policy tool, indicates that it is a useful tool. It operates to reduce interest rates while fighting inflation. I believe that such a direct approach from time to time is necessary if the various targeting devices are not to prove as weak in the future as they have in the past. I would be glad to appear at a hearing of your committee to spell out this position at greater length if the hearings are held on dates that are open to me. Sincerely, I~9/~7'I/(7 Henry B. Schechter Director Office of Housing and Monetary Policy 0 PAGENO="0375" PAGENO="0376"