Conference Series No. 1 SAMUELSON MEISELMAN TOBIN MELTZER WALLICH ANDERSON ANDERSEN KAREKEN HOLMES DUESENBERRY SMITH PIERCE MAISEL PROCEEDINGS OF A CONFERENCE HELD IN JUNE, 1969 FEDERAL RESERVE BANK OF BOSTON Controlling MONETARY AGGREGATES Proceedings of the MONETARY CONFERENCE Held on Nantucket Island JUNE 8-10, 1969 Sponsored by THE FEDFRAL RESERVE BANK OF BOSTON FOREWORD Controlling Monetary Aggregates is the proceedings of a conference on that topic, sponsored by the Federal Reserve Bank of Boston in June of this year. The conference-the first of a proposed series, covering a wide range of financial and monetary problems- brought together a distinguished group of men from the uni- versities, government, and finance to exchange ideas on one of the most pressing of current policy issues-the roIe of money in economic activity. We hope that the distribution of these proceedings will make a useful contribution toward increased public under- standing of these issues-and to evolving policy decisions. Frank E. Morris President Boston, Massachusetts September, 1969 THE FEDERAL RESERVE BANK OF BOSTON CONFERENCE SERIES NO. CONTROLLING MONETARY AGGREGATES JUNE, 1969 NO. 2 THE INTERNATIONAL ADJUSTMENT MECHANISM OCTOBER, 1969 NO. FINANCING STATE and LOCAL GOVERNMENTS in the SEVENTIES JUNE, 1970 4 HOUSING and MONETARY POLICY OCTOBER,1970 5 CONSUMER SPENDING and MONETARY POLICY: THE LINKAGES JUNE, 1971 NO. 6 CANADIAN--UNITED STATES FINANCIAL RELATIONSHIPS SEPTEMBER,1971 NO. 7 FINANCING PUBLIC SCHOOLS JANUARY, 1972 NO. 8 POLICIES for a MORE COMPETITIVE FINANCIAL SYSTEM JUNE, 1972 NO. 9 CONTROLLING MONETARY AGGREGATES II: THE IMPLEMENTATION SEPTEMBER, 1972 NO. 10 ISSUES IN FEDERAL DEBT MANAGEMENT JUNE, 1973 NO. ll CREDIT ALLOCATION TECHNIQUES and MONETARY POLICY SEPTEMBER, 1973 NO. 12 INTERNATIONAL ASPECTS of STABILIZATION POLICIES JUNE, 1974 NO. 13 THE ECONOMICS of a NATIONAL ELECTRONIC FUNDS TRANSFER SYSTEM OCTOBER, 1974 Third Printing, 7- 70-10M Fourth Printing, 11-71-5M Fifth Printing, 8- 73-5M Sixth Printing, 11-75-5M CONTENTS Controlling MONETARY AGGREGATES FOREWORD FRANK E. MORRIS PANEL The Role of Money in National Economic Policy PAUL A. SAMUELSON 7 DAVID MEISE’LMAN 15 JAMES TOBIN 21 ALLAN H. MELTZER 25 HENRY C. WALLICH 31 Monetary Velocity in Empirical Analysis PAUL S. ANDERSON 37 Discussion LEO’NALL C. ANDERSEN 52 The Federal Reserve’s Modus Operandi JOHN H. KAREKEN 57 Operational Constraints on the Stabilization of Money Supply Growth ALAN R. HOLMES 65 Discussion JAMES TOBIN 78 Tactics and Targets of Monetary Policy JAMES S. DUESENBERRY 83 Discussion ALLAN H. MELTZER 96 A Neo-Keynesian View of Monetary Policy WARREN L. SMITH 105 Discussion HENRY C. WALLICH 127 Some Rules for the Conduct of Monetary Policy JAMES L. PIERCE 133 Discussion DAVID MEISELMAN 147 Controlling Monetary Aggregates SHERMAN J. MAISEL 152 PANEL The Role of Money in National Economic Policy PAUL SAMUELSON The central issue that is debated these days in connection with macro-economics is the doctrine of monetarism. Let me define monetarism. It’s not my particular title. Monetarism is the belief that the primary determinant of the state of macro- economic aggregate demand-whether there will be unemployment, whether there will be inflation-is money, M1 or M2, and more specifically, perhaps, its various rates of change. I’m going to borrow a method of exposition that I understand Jim Tobin used at an ABA meeting some years ago, when A Monetary History of the United States of Mrs. Schwartz and Mr. Friedman was being discussed. I wasn’t present, but I was told that Jim wro’te three sentences on the blackboard: "Money doesn’t matter," "Money matters," and "Money alone matters." And he then said that Professor Friedman, having established to everybody’s satisfaction the untruth of the first statement, went on as if it were a sequitur to think that he had established the third statement. Well now, I wasn’t provided with a blackboard, and I can’t lapse into my academic mannerisms, but I have written down a spectrum of remarks from "Money doesn’t matter," to "Money matters," to "Money matters much," to "Money matters most," and to "Money alone matters." Now, monetarism is certainly at the right of this spectrum. There is nobody, I think, worth our notice on the American scene who is at the left end of that spectrum, although there still do exist in England men whose minds were formed in 1939, and who haven’t changed a thought since that time, and who do belong at the left of that spectrum and say money doesn’t matter. They’ve embalmed their views in the Radcliffe Committee, one of the most sterile operations of all time. And so, monetarism, which is a correction to that extreme view-and, I think, an excess on the Mr. Samuelson is Institute Professor and Professor of Economics at the Massachusetts Institute of Technology, Cambridge, Massachusetts. 8 Controlling MONETARY AGGREGATES other side--is very much an item for export to the British Isles. For so many years they exported wisdom and knowledge to us, it’s only proper that we requite that past with export. I would argue that the right view, the extreme view, is not the most persuasive view, but monetarism is that. Now, you may think that’s a straw man that I’m setting up-that there is nobody who believes in monetarism as I’ve defined it. But I believe that I’m correct in saying that there is at least one person in this country who does believe in it, and he is a person of no small stature. I’m not referring to John Kenneth Galbraith, in saying this, but to one who has not graced our assembly with his presence here today, and that is Dr. Friedman. I’ve an advantage probably not vouchsafed to all of you. Once a week I am privileged for 28 1/2 minutes to listen to the voice of Dr. Friedman-and his view, as expressed repeatedly in those tapes, is this: that as far as macro-economic aggregate state of demand is concerned, money alone matters. Now, this doesn’t mean that money alone determines everything. It will not cure flat feet, or dandruff, or marital fidelity. It is not true, for example, that fiscal policy has no role: For example, how big the Galbraithian public sector is is very much determined by fiscal policy; and what the composition of any state of aggregate demand is, in terms of consumption goods and capital formation, does depend upon a fiscal policy. But as for the general issues--of whether you are going to have more inflation or deflation, or whether you are going to have unemployment-we know a very little bit about it. About something like half of the squared variation in the state of aggregate demand can be explained by the money factor; the rest is noise. There are no systematic predictable elements. Now, I think that that is an extreme view, and it is not a persuasive view if you look at all of the evidence. There was a great debate at NYU between Professor Friedman and Walter Heller. I wasn’t privileged to be there. I talked to various people in New York who were there and, generally speaking, those who were in favor of one view when they came in, went out thinking that their man had won the debate. I talked to one Wall Street character who alleged to be neutral, and he said, "Well, Heller had the better wisecracks, but Friedman had mountains of evidence. He didn’t have time to give those mountains of evidence there at that time, but, you can’t laugh off the evidence." THE ROL~E OF MONEY . , SAi~IUELSON 9 I have reviewed these mountains of evidence, and I think that there is a great amount of evidence-much of it is due to the efforts of Pi~ofessor Friedman at the National Bureau, much of it is due to workshop students working with him, and much of it to col- leagues-but most of that evidence is not, in the sense of the statistician, a powerful test of monetarism as I’ve defined it. Most of that evidence is conclusive with respect to a Radcliffe Committee stupid view that money doesn’t matter, but as to the view that money matters and that fiscal policy, just to take an example, does not have a systematic influence, there is very little of the mountain of evidence that is germane to that. Types of Evidence Now, since other speakers have to speak, I can’t review all these mountains of evidence, but let me just mention what some of the types of evidence are. First-and I’ve heard several tapes dealing with this-take particular incidents in American history. In 1919, for example, we came out of World War I; there was a much-under- balanced budget; the Federal Reserve was under the thumb of the Treasury; and then, on a certain day, it can be established, just as a diplomatic historian can establish facts, that the Federal Reserve was given its freedom from the Treasury. On that certain day, it took certain acts, so you have almost a controlled experiment in which something happened to the money supply and then-within six months or seven months or nine months, whatever the lag period is--something happened to the business conditions. Now, I think that is good evidence that money matters. That does not tell you what its role is with respect to the iraportance of fiscal policy or other matters. But we have a lot of evidence like that. There is another kind of evidence.