A Fed chief urges keeping eye on long-term policy
Lawrence K. Roos, president of the Federal Reserve Bank of St. Louis, said he was speaking from "a sense of deep frustration." For nearly two days, Mr. Roos had been listening to economists at a conference in New Hampshire argue on the theme "Controlling Monetary Aggregates." Their papers were full of incredible detail, complexity, and disagreement.
It all adds up, he said, "to a hopeless maze of impediments which would stand in the way of policymaking."
That debate over monetary policy continues today in Washington. President Carter and Secretary of the Treasury G. William Miller have injected it into the presidential campaign with criticism of the Federal Reserve System and commercial banks for hiking interest rates again.
"It's in everyone's interest to avoid a run-up in rates that will abort the recovery," Mr. Miller maintained at a breakfast meeting with reporters Tuesday. "I believe that the Federal Reserve System has a policy responsibility that's broader than a mechanistic adherence to regulating the money supply."
A similar argument was made at the New Hampshire conference earlier this month sponsored by the Federal Reserve Bank of Boston in which Mr. Roos participated. Mr. Roos is currently a member of the Fed's Open Market Committee (FOMC) which sets the nation's monetary policy. That policy is crucial to the nation's future economic growth and level of inflation as well as to interest rates.
It met later Tuesday after Mr. Miller made his comments. If remarks by Mr. Roos Wednesday are indicative of the views of the majority of the FOMC, then the administration has no reason to hope for lower interest rates at once.
"The evidence of the past underscores the futility of trying to expedite recovery from a recession by expansive measures," said Mr. Roos in a telephone interview. He argued that expanding the money supply in an effort to keep interest rates low under present conditions would have little lasting effect in either speeding the recovery or strengthening the expansion phase.
Rather, he added, it would merely increase inflation.
"Recognizing the top priority facing our nation is inflation, to repeat the mistakes of the past by an expansive policy at the present would be the height of folly," Mr. Roos said.
Treasury Secretary Miller argued that the Fed should be more tolerant of fluctuations in the money supply on a week-to- week basis, though he admitted it should stick to its monetary targets over a longer period.
When the money supply was dropping below target last spring as the economy sunk sharply, the Fed tolerated this, he noted. "If they hesitated to do it in one direction when economic conditions don't require further action, why can't they hesitate for a week or two on the up side?"
However, with the money supply growing rapidly in recent months, the Fed has raised interest rates in an effort to restrain this above-target growth.
Mr. Roos countered that any short-term boost in economic activity from lowering interest rates would merely compound the nation's problem with inflation over the long run. Rather, he said, the Fed should follow a "policy of consistency," permitting only gradual growth in the money supply -- the amount of cash and credit that feeds the nation's economic machine.
In each previous recovery, he recalled, there have been many doubts expressed about the vitality of that economic expansion. As a result, the Fed and the administration have stimulated the recovery with easier monetary policy and looser fiscal policy (federal tax and spending decisions).
However, he notes, research indicates that accelerated growth of the money supply during a period of expansion has little effect on the strength or the length of the expansion.
Short-term changes in money growth above or below trend have little impact on inflation, he adds. But "the core rate of inflation at any particular time is approximately equal to the trend rate of growth in money over some extended time period -- typically over the past three to five years." So, any long-term boost in the creation of money, will eventually shove up the inflation rate; and vice versa.
If short-term changes in money growth occur for six months or more, they can have sizable, albeit temporary, effects on economic activity and output, Mr. Roos went on in a recent speech. In other words, six months or more of reduced money growth cause recessions; six months or more of expansion in money growth provide a temporary stimulus to the economy.
"In the long run, however, changes in money growth have virtually no lasting effect on output. Lasting growth of output can be achieved only through expanded productivity and growth in factors of production. The only legacy of monetary expansion is inflation."
With such views, Mr. Roos is not inclined to play short-term games with monetary policy to accommodate what could be merely the political convenience of the administration.
At the conference, Mr. Roos noted that the economists were arguing over the technical details of money supply and so on when the "missile" of inflation was "headed our way." Common sense, he said, dictates that policymakers stick to their long-term goal of restraining monetary growth.