Regional President Speech

TIMING AND TOOLS OF FEDERAL RESERVE POLICY An address by Karl R. Bopp Before the 73rd Annual Convention of the Pennsylvania Bankers Association held in Atlantic City, New Jersey on Monday, May 22, 19^7 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Timing and Tools of Federal Reserve Policy ... In the 1960’s the Federal Reserve tried to improve the timing of policy changes and experimented with new uses of the tools of monetary control. The Paper Industry is Like That . . . . . . There are easier ways of making money but perhaps none so diverse and fascinating as papermaking. BUSINESS REVIEW is produced in the Department of Research. Evan B. Alderfer is Editorial Consultant. Donald R. Hulmes prepared the layout and artwork. The authors will be glad to receive comments on their articles. Requests for additional copies should be addressed to Bank and Public Relations, Federal Reserve Bank of Philadelphia, Philadelphia, Pennsylvania 19101. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis TIMING AND TOOLS OF FEDERAL RESERVE POLICY by Karl R. Bopp* As bankers, you are fully aware that we have TIMING OF FEDERAL RESERVE POLICY had some rapid-fire and rather novel changes in Wesley Mitchell wrote his pioneering book on monetary policy during the past year. During the business cycles over 50 years ago. Among the first ten months of 1966, in the face of an ex­ factors to which he drew attention as being ini­ cessively rapid economic expansion that was gen­ mical to achievement of steady advances in pro­ erating strong upward pressures on prices, oper­ duction and employment were the financial panics ations were conducted with a view toward mod­ that had at times severely disrupted the economy. erating the growth of money and credit which One of the main reasons the Federal Reserve Sys­ resulted in the high interest rates and scarce tem was established was to help avoid the sharp credit mentioned by President Bracken. Then in monetary contractions and liquidity freezes that November 1966, when the pace of the expansion had precipitated or accentuated economic down­ moderated and inflationary pressures began to re­ turns in the past. cede, monetary policy shifted promptly toward Soon after its inception, however, the Federal encouraging flows of money and credit. Reserve saw that it had a responsibility to do These sharp movements in monetary policy more than serve passively as a lender of last re­ within a short time demonstrate how quickly it sort in order to prevent financial crises. It began can respond to changing economic conditions. to foster monetary conditions that would stimu­ They also show that as we increased our knowl­ late the pace of business activity when it was de­ edge of the workings of the economy and of mone­ pressed and moderate it when the economy was tary policy, we have tried to improve the timing expanding. That is, it began early to use the of policy changes and have experimented with business cycle as the general framework to guide new uses of the tools of monetary control. it in its conduct of monetary policy. Since events of the past year highlight these The rationale, and I am greatly over simplify­ changes in the conduct of monetary policy, I ing, went something like this. When business take this opportunity to point out some of them to activity declines, unemployment rises and income you. I shall first discuss some of the factors that falls. Consequently, monetary policy should be ex­ have influenced the timing of changes in general pansive in order to stimulate production, em­ monetary policy and then turn to some of the ployment and income. But as economic activity modifications we have made in the use of specific expands and prices tend to rise, monetary policy tools. should become restrictive. Peaks in economic activity were signals indi­ * Mr. Bopp, President of the Federal Reserve Bank of Philadelphia, gave this talk at the 73rd Annual Conven­ cating that monetary policy should begin to move tion of the Pennsylvania Bankers Association, Atlantic City, May 22, 1967. toward ease, and troughs were signals indicating 3 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis business review that monetary policy should begin to move toward moved toward ease. restriction. The trough was reached in April 1958, just Now, as I say, this is an oversimplification. The nine months after the previous peak. The Federal problem of determining policy has always been Reserve was again able to recognize the turning much more complicated than this. All signals point with a lag of only three months and, as be­ seldom point in the same direction. Often the fore, immediately decided to reverse the direction Federal Reserve can achieve one objective only of monetary policy. at the expense of another. For example, massive It is clear from this brief overview of the 1950’s international gold flows in the 1930’s and the that the business cycle did exert a large influence huge Government financing needs in the 1940’s on the timing of policy changes. The peak in led the Federal Reserve to pursue policies at times 1953 was the main exception, and in that case that were not what they would have been if it had disruption of Government securities markets been trying solely to moderate cyclical fluctua­ played a large part in the early move toward tions in the economy. Nevertheless, with due re­ ease. More generally the pattern was that as soon gard to these qualifications, changes in the phase as the Federal Reserve recognized a cyclical turn­ of the business cycle—peaks and troughs—ob­ ing point, it reversed the direction of policy in viously have been important considerations in­ order to stimulate the economy during recessions fluencing the timing of policy changes. and moderate the pace of advance during ex­ Let me apply this principle to the 1950’s to pansions. show what I mean. Timing in the 1960’s Timing in the 1950's The timing of policy changes in the 1960’s has In the 1950’s this country had two distinct cycles been different. Policy has been eased before cyc­ in economic activity. lical peaks and was not tightened until long after Economic activity reached a peak in July 1953. the only trough we have had. In June 1953, partly in response to unsettled The Federal Reserve began to ease in March conditions in the Government securities markets, 1960, two months before the peak in the business the Federal Reserve changed monetary policy cycle. At the time, no recession was expected. In­ and began to move toward ease. stead, this policy change was made primarily to This downswing in economic activity con­ reverse a declining trend in the money supply in tinued until August 1954. Because of lags in col­ order to accommodate and stimulate economic lection of data and difficulties of interpreting growth. them, the Federal Reserve did not recognize the The economy reached a trough in February trough until November, or three months later. As 1961. This time the Federal Reserve was able to soon as it did, however, it reversed direction and recognize it with a lag of only two months, but began to move toward restriction. did not regard it as a signal to begin to tighten The next peak occurred in July 1957. Again it monetary policy. The Federal Reserve waited un­ took the Federal Reserve three months to recog­ til October 1961, six months after it recognized nize that the turning point had been reached; but the trough, before making policy slightly less ex­ once it did, it reversed monetary policy and pansive and it was not until 1965 that it really 4 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis business review began to be restrictive. timing is an increased alertness to the dynamics Following extreme restraint in most of 1966, of the business cycle. the Federal Reserve shifted direction again in Wesley Mitchell made clear that what we call November. So far as we know now, we have no the business cycle is really an average of many cyclical peak with which to compare the timing different economic events, each of which follows of this move. But we do know that policy was its own pattern over time. shifted in response to a decline in the rate of eco­ Each firm, industry, and sector in the economy nomic growth with no suggestion that a recession is faced with different forces of demand. At any was imminent. given time, some products and services will be in great demand; others will be subject to declining Reasons for change demand. While one sector of the economy is ex­ Two factors account for differences in the timing panding, another may be contracting. During the of policy in the 1950’s and 1960’s. expansion phase of the business cycle more sec­ First, the economic environment was substan­ tors are expanding than are contracting; during tially different in the two periods. Prices rose the contraction phase more sectors are contract­ persistently and rapidly throughout most of the ing than are expanding. 1950’s. In order to combat this, the Federal Re­ In a dynamic economy, some firms are hiring serve began to tighten policy as soon as it recog­ additional workers while other firms are laying nized the onset of an economic expansion, and off. Similarily, some firms are increasing prices, continued to do so until a peak had been reached. while other firms are lowering them. The levels of Price increases cause personal hardships and aggregate employment and average prices will de­ inequities, and are a major stumbling block in the pend on the net effect of all these labor and price way of achieving sustained economic growth and adjustments. a suitable balance-of-payments position. Mone­ This concept, of course, is not new. But it takes tary policy, therefore, had to do all it could to on added significance as we constantly raise the moderate the upward price pressures that charac­ standards of performance demanded of the eco­ terized this period. nomy. I am very skeptical of statements that the In contrast, until 1965 and 1966 the period business cycle is dead, but I do believe we have since 1960 was characterized by unusual price become increasingly intolerant of it. If the cycle stability at both the wholesale and retail levels. is ever to be vanquished, therefore, public policy And unlike experience in the 1950’s when un­ must be increasingly alert to the dynamics of the employment tended to fall rapidly as the pace of cycle. It must, as economists say, disaggregate economic activity picked up, in the 1960’s it overall movements in the economy. moved much more sluggishly. Lack of price pres­ The Federal Reserve has, I think, come closer sures permitted monetary policy to ease before to doing this in the 1960’s than it did in the peaks in economic activity in order to stimulate 1950’s. The signals to ease have become, not the economic growth. It also permitted policy to re­ peak in the business cycle, but unacceptable in­ main easy well after the trough in order to com­ creases in unemployment and declines in the rate bat excessively high rates of unemployment. of growth. The signals to begin to tighten mone­ A second factor accounting for the different tary policy, rather than simply the trough in the 5 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis business review Sectoral flows in 1966 business cycle, have become unsustainable rates of growth, increases in the price level, and It became clear as monetary conditions tightened so on. in 1966 that markets for mortgages and munici­ While these signals do not always point in the pal securities had to carry a disproportionate same direction at the same time and trade-offs share of the burden of restriction while business have to be made, the important point is that loans were expanding at an unsustainable pace. policy changes are more directly related to the The problem in the mortgage market was due policy goals themselves rather than to the peaks in part to the difficulty savings and loan associa­ and troughs in the business cycle. tions and mutual savings banks had in attracting Stabilization of the business cycle, after all, is and holding deposit and share accounts. They are not a goal by itself. We are concerned with limited in their ability to increase the rates they achieving full as well as stable employment, and pay to savers because the bulk of their assets are rising as well as stable rates of production. Con­ of fixed yield and turn over slowly. Consequently, sequently, shifts in monetary policy should be as market rates rose, savers channeled an in­ geared directly to the degree of achievement of creasing proportion of their funds directly into each policy goal—that is, to changes in the rate market instruments rather than into these finan­ of unemployment, the level of prices, the rate of cial institutions. At the same time, commercial economic growth, and the degree of disequili­ banks raised the rates they were willing to pay brium in the balance of payments. on time deposits and some funds that might otherwise have gone to nonbank financial inter­ NEW USES OF OLD TOOLS mediaries went instead to commercial banks. Along with changes in the timing of policy ac­ These two factors sharply curtailed the ability of tions, there have been changes in the use of the savings and loan associations and mutual savings tools of monetary policy. banks to invest in new mortgages. Since they are You are familiar with the way the Federal Re­ typically heavy suppliers of funds to this market, serve has traditionally used open market opera­ the availability of mortgage funds was severely tions and changes in reserve requirements and the reduced. Home builders were forced to bear a discount rate either individually or in combina­ relatively large part of the burden of monetary tion to achieve a given degree of restraint or ease. restriction. To restrain, securities have been sold, reserve The problem in the market for municipals was requirements raised, or the discount rate in­ different. While commercial banks were better creased. To ease, the System has purchased able to compete for the saver’s dollar than were securities, lowered reserve requirements, or drop­ most nonbank financial institutions, they still ped the discount rate. experienced demands for their funds that greatly Different emphasis has been placed on each of outpaced their ability to attract deposits. Requests these tools at different times, but until recently for business loans were particularly heavy. In an they were generally used only to influence total attempt to satisfy some of these burgeoning de­ flows of money and credit through the economy. mands for credit, banks liquidated large amounts Last year, a new dimension was added and they of municipals. Since they are ordinarily heavy were used to influence sectoral flows as well. purchasers of these securities, this liquidation re­ 6 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis business review suited in the steep run-up in interest rates on these The second thing the Federal Reserve did to issues. Either because of legal constraints, the help even out the burden of its restrictive mone­ forces of custom, or the exercise of judgment, some tary policy was to give real bite to Regulation Q. state and local governments were unable or unwill­ Always in the past when interest rates on time and ing to borrow at these high rates. In addition, savings deposits bumped against the ceilings es­ there was some question as to whether or not some tablished under Regulation Q, the ceilings had issues could have been sold even if the borrowers been increased. This was not true in 1966. In had been willing to incur high interest costs. July the maximum rate on multiple-maturity time deposits of 90 days or more was reduced Federal Reserve response from 5Y2 to 5 per cent and for maturities of less than 90 days the ceiling was reduced to 4 per The Federal Reserve was concerned that moves to cent. In September the Federal Reserve used its restrict the overall flows of money and credit were newly acquired power to flexibly regulate maxi­ impinging heavily on the markets for mortgages mum rates on time and savings deposits to drop and municipal securities while business loans the rate ceiling for time deposits other than sav­ continued to advance too rapidly. Yet inflationary ings deposits of under $100,000 from 51/? to 5 conditions in the economy and large deficits in per cent. the balance of payments clearly warranted a policy of general monetary restraint during most Meanwhile, the Federal Reserve maintained the of 1966. The Federal Reserve, therefore, decided ceiling on other time deposits even though many to use its ability to alter reserve requirements and banks were paying rates near or at that rate and set maximum rates on time deposits to try to market rates had risen even higher. correct some of these sectoral imbalances. These adjustments under Regulation Q were In response to the difficulties in the mortgage intended to help maintain competitive balance market, the Federal Reserve first refined its use among financial institutions and thereby prevent of changes in reserve requirements. Instead of in­ excessive and disruptive rate competition and creasing the requirements against a whole class help take some of the pressure off the mortgage of deposits as it had done in the past, differential market. The result was a big net decline in large reserve requirements were introduced against denomination certificates of deposit after August specific types of time deposits. In June and again 1966, a slower growth in bank credit from Sep­ in August, requirements against time deposits tember to November, and hopefully a more bal­ other than savings accounts in excess of $5 mil­ anced distribution of the effects of monetary lion were increased, first to 5 and then to 6 per restriction among the various financial institu­ cent. It was hoped that this would better enable tions and sectors of the economy. savings and loan associations, mutual savings In direct response to the excessive expansion banks, and smaller commercial banks to attract of business loans and difficulties in the market deposits. With the higher propensity of these in­ for municipal securities, the presidents of the stitutions to invest in mortgages and other types Federal Reserve Banks sent a letter to all member of nonbusiness loans, this would ease conditions banks on September 1 requesting that they mod­ in the mortgage market and moderate the pace of erate their expansion of business loans and re­ business spending. frain from further liquidation of municipal se- 7 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis business review curities. The promise of adequate accommodation IMPLICATIONS at the discount window was held out to those I have noted some highlights of recent modifica­ complying banks which needed such help to tions in the timing of changes in monetary poli­ smooth over the period of adjustment. At the cy and in the Federal Reserve’s use of the tools of same time, the discount officers at each Reserve monetary control. What do they imply about fu­ Bank began to hold regular telephone conferences ture changes in monetary policy? There are four to ensure uniform administration of the discount main conclusions I should like to draw. window throughout the country. These efforts First, the Federal Reserve will continue when marked a milestone in the Federal Reserve’s use possible to ease monetary policy when the econo­ of moral suasion and discount policy to influence my slows down rather than waiting for a reces-^ flows of money and credit. sion. Such easing should not be interpreted as indicating that we are forecasting a recession. Reason for sectoral approach The business cycle may not be dead, but there The Federal Reserve is concerned about flows of may be times when the rate of growth will slow funds to different sectors of the economy as well down without being followed by large declines in as about the total volume of money and credit production and employment. That happened in because it is concerned about the specific effects 1962 and also may describe what has happened of monetary policy. Just as there is need to dis­ recently. Under such circumstances, if you inter­ aggregate broad economic movements and look pret an easing of monetary policy as a sign that at each policy goal individually in deciding a recession is close at hand, you might well adopt when to change monetary policy, there is need to policies yourselves and recommend to your bor­ disaggregate the effects of monetary policy to rowers that they adopt policies that are not in see how it should be changed. Because of institu­ your best interest or theirs. tional, legal or other market rigidities, the stimu­ Second, when production and employment are lus or restriction resulting from monetary policy at depressed levels, even though business activity may at times produce sectoral imbalances that is increasing, you can expect monetary policy to threaten sustained growth of the economy. The follow a stimulative policy as long as possible. Federal Reserve has a duty to try to prevent such Business cycle troughs will not themselves signal imbalances from damaging the general health of a shift in policy. the economy. Third, we will continue to be alert to the sec­ Experience last year demonstrated that there toral as well as the total flows of money and cred­ may be times when growth and stability of the it. Hopefully, the market will function effectively overall economy call for particular attention to so that there will be few occasions when sectoral developments in parts of the economy. In such imbalances will develop that will require us to conditions, it may be necessary to employ the deviate from our usual practice of making only tools of policy differently than usual. In most general changes in monetary policy. circumstances, however, use of general instru­ Fourth, with respect to both the timing and ments can be directed toward the total flow of tools of monetary policy, it is clear that we still money and credit without trying to influence di­ have a lot to learn about the economy and the ef­ rectly where these funds go or how they are used. fects of monetary policy on it. We are trying to 8 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis business review learn more. We currently have studies under way cute policy. Consequently, the changes in the appraising the discount mechanism, studying the procedures I have described here are not the Government securities market, and investigating end of the story. They are simply part of a the linkages between monetary policy and real continuing effort on our part to see that economic activity. As these and other studies monetary policy makes its maximum contribu­ are completed, they will likely lead to further tion to the achievement of the nation’s economic modifications in the way we formulate and exe­ objectives. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Karl R. Bopp (1967, May 21). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_19670522_karl_r_bopp

@misc{wtfs_regional_speeche_19670522_karl_r_bopp,
  author = {Karl R. Bopp},
  title = {Regional President Speech},
  year = {1967},
  month = {May},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/regional_speeche_19670522_karl_r_bopp},
  note = {Retrieved via When the Fed Speaks corpus}
}