advocates admit that a budget deficit, for example, is more expansive when the resulting increase in Government securities can indirectly increase the monetary base through purchase by the Fed, than when the same securities must be sold to the public and drive up interest rates. And I would say this administration is a concession to monetary policy. The principal real issue between monetary and fiscal policy arises at the margin of a little more of one versus a little more of the other. It arises because monetary expansion and fiscal contraction both tend to lower interest rates, and vice versa. People like Chairman Patman, for example, want interest rates low at all times, to encourage investment and economic growth. And such people should, therefore, be more "monetarist" in recessions than they sometimes are, and also more "fiscalist" in inflationary booms. My second positive point is about rules versus discretion. Discretion implies activism in policy, a considerable assumption of responsibility. It should be distinguished from leaving the economy to the free market, or, at the other extreme, leaving the economy to whatever controls may be established by somebody else. But the implication of a rule is not at all certain. Some rules are purely passive, or laissezfaire. Some rules are long-run active, and they leave the short-term "fine tuning" to the market, or to other peoples' controls. And finally, some rules are as active and as interventionist as you please. The pure or pre-1914 gold standard, like the fiscal balanced budget, is passive. The 5-percent growth rule for the monetary stock, I would call longrun active. The rule for price-level stabilization would be as active. as most forms of discretion. Now, to something more controversial: my own thinking has tended toward rules as against authorities, and therefore, also toward monetary rather than fiscal policy as requiring considerably less discretion. This preference for rules, as against authorities, flies in the face of the obvious principle that God needs no rule to guide His actions. Optimal discretion can never be worse than the optimal rule, and can be better. My preference therefore expresses willingness to settle for a kind of "second best" in the form of a rule, simply as a matter of "risk aversion." A good policy rule is a kind of insurance against the corruption, incompetence, or malevolence of some few administrators and politicians. More important, it is also insurance against the tendency of a good many more administrators and politicians to put off hard or unpopular decisions until after the next election. This sort of thing can lead to Louis XV's "after me, the deluge." At present, I am not sure which deluge I fear most, for this country may get a mixture of two of them at once, the economic equivalent of freezing rain. One deluge, of course, is open hyperinflation-Latin America, here we come. The other deluge is a set of well-intentioned direct controls like the recent wage-price guideposts or the present restrictions on capital movments, or a permanent straitjacket economy on some wartime model. Unless you gentlemen convince me that I am really just "Caspar Milquetoast" or "Nervous Nellie." or can provide some insurance policy better than a monetary rule, I shall have to remain heretical for awhile longer. Of course, there are rules and rules. Some rules would be recipes for disaster, and I shall not regale you with these. The particular rule I favor is monetary, and is a minor extension of the steady growth rule advocated most prominently by Profs. Milton Friedman of Chicago and Edward S. Shaw of Stanford. I think that our econometric fine tuners have reached the point where we can let the monetary growth rate rise when they anticipate a rise in the labor force growth rate, or in the growth rate of man-hour labor productivity, or a fall in the velocity of circulation of money. And vice versa, of course-perhaps I should add that I'm least enamored of the velocity adjustment. Velocity may be sensitive to interest-rate fluctuations, which are themselves sensitive to both monetary and fiscal policies. If my extra fanciness does not seem worth bothering with, as I gather, it does not to most policy "monetarists," I should welcome the Friedman-Shaw alternative to the status quo, in any of its several evolving forms. Many respected monetarists, including my Carnegie colleague. Allan Meltzer, focus their attention on the growth of the monetary base-which is "outside" currency plus bank reservesinstead of the entire monetary stock. The base is more easy to control than the stock is, but I'm still not sure any "monetary base" rule is adequate to prevent "pushing on a string" in case a major deflation would set in the base expanded, for example, during the great depression, but the total stock did not follow. Nevertheless, I should consider a "monetary base" rule preferable to the status quo. Chairman Proxmire has proposed a range of monetary stock growth rates, with the Fed required to explain why it has permitted the rate to stray outside the range-in case it does so. This strikes me as an admirable compromise between rules and discretion or perhaps an entering wedge to a stronger rule this is probably why the Fed opposes it. A similar policy would, of course, be applied to the monetary base as well as to the monetary stock. Passing to the fiscal side of the "great policy divide,” I should like to draw the Joint Economic Committee's attention to the possibility of a double, or percentage expenditure budget. A percentage budget is not exactly a fiscal rule, but, like a fiscal rule, it might be designed as a check on logrolling in our present situation a check on inflationary expenditures. Let me explain what I mean by a double budget on the expenditure side. The primary budget is the present form, and the total appropriations add to a certain total, which we may call a dollars. The secondary, or percentage, budget is in percentage terms with the total percentages adding to 100. The Congress must then vote on both an overall total and a percentage discretion. And the hooker is that a single overall vote for a total budget of y dollars will give individual Congressmen a chance to express their "economy" or "taxpayer" views and make y substantially less than the a which has been appropriated as the sum of the agency dollar budgets. So that in one vote the Congress can approve a series of departmental budgets, and in another hand they can vote a total budget for something substantially less or greater as the case may be. Dealing with any particular activity, like post offices in Paducah, in a double budget system, the administration may have two mandates within which to allocate its funds. One limit is a specific appro priation, and the total of these appropriations is a dollars. The other limit, which I would expect usually to be lower, is a percentage pay of an overall total y. Normally, I would expect a times y to be less than the specific appropriation if only because y is less than a. The leeway accorded by this system can give the administration elbow room to maneuver, and to squeeze the fat out of appropriations which are voted by the Congress. Like Professor Bach, I should also like to express myself in favor of the CED's recent proposal to permit limited administrative positive and negative personal and corporation income surtaxes, subsequent to congressional veto. Perhaps changes, particularly those attractive tax rate cuts, might be banned in the 2-, 3-, or 4-month period preceding the first Tuesday after the first Monday in November of each even-numbered year. This would reduce, but not eliminate, the danger of the surtax becoming a political football rather than an economic tuning fork. Rather than developing either of these proposals in any detail, I have presented copies of two relevant essays before the committee for possible inclusion in the record of these hearings, and I should like to end my direct testimony at this point. Senator PROXMIRE. We welcome these essays, Professor Bronfenbrenner. Thank you very much. They will certainly be put in the record. (See appendix I, p. 578, and p. 583.) Senator PROXMIRE. Our next witness is Professor Culbertson. You may proceed, sir. STATEMENT OF JOHN M. CULBERTSON, PROFESSOR OF ECONOMICS, UNIVERSITY OF WISCONSIN Mr. CULBERTSON. Thank you, Mr. Chairman. Monetary and fiscal policy in 1968 produced two striking events. First, monetary policy caused an unwanted inflation, thus illustrating both its potency and its uncontrolled status. Second, a very large change in fiscal policy has so far had no discernable effect, adding to the growing evidence that fiscal policy in usual dosages has surprisingly little influence upon economic developments. The task now facing policy is promptly to slow the rate of growth of total demand, to dampen inflation without causing a recession or a large rise in unemployment. This calls for carefully controlled use of monetary and fiscal policies. Unfortunately, the record of recent years argues that fiscal policy is virtually impossible to control closely with the existing policy machinery, and that monetary policy as conducted by the Federal reserve continues to be erratic, unpredictable, and a threat to the stability of the economy. To those who follow the hearings and reports of this committee, these lessons will not be strange, but the reader of reports of the Council of Economic Advisers and the Federal Reserve may have a quite different picture of the lessons of recent history. The Council of Economic Advisers Report represented recent fiscal policy as an unparalleled achievement. Such a picture was developed through a biased choice of the actions taken as measuring fiscal policy and of the time periods over which comparisons were made. In truth, when consistent ly measured by the high-employment surplus, fiscal policy in the past decade was unusually erratic and much of the time unsuited to the economic situation. Similarly, a favorable picture of recent monetary policy has been painted by the Federal Reserve and the Council by referring to alleged policies of "credit restraint" or "credit ease." These are taken to be evidenced by changes in the level of interest rates. But the error in thinking that interest rates measure monetary policy has been pointed out countless times. The increase in interest rates last year could not have reflected a Federal Reserve policy of monetary restraint, for the Federal Reserve was pumping bank reserves and money into the economy at an unusually rapid rate. On the contrary, the rising interest rates reflected very strong credit demands associated with inflationary expectations. Thus they indirectly reflected the fact that Federal Reserve policy was so expansionist as to be inflationary. In the present state of knowledge, the most convenient measure of the independent or casual role in the economy of Federal Reserve monetary policy is the behavior of the money supply, or of the Nation's medium of exchange. Each year the economy has some rate of increase in total demand that is most consistent with preservation of full employment and price stability. The money supply should grow at a rate consistent with increase in total demand at this prescribed rate. Usually this implies rather steady growth of the money supply at a rate related to the economy's rate of growth in output potential. Many economists and consistently since 1963, I believe, this committee have urged the Federal Reserve to conduct monetary policy in this way. This advice has been rejected. The Federal Reserve continued to take actions leading to erratic growth of the money supply: virtually no net growth from mid-1959 to late 1962, then growth at a rate of about 4 percent a year until spring 1965, then 6 percent until 1966, zero percent until early 1967, and then nearly 7 percent during 1967-68. The question is, looking backward, with the advantage of hindsight, did these ups and downs, or stops and goes, in monetary policy help or hurt the economy? Had the Federal Reserve followed the advice so widely urged upon it and provided steady growth of the money supply, would the economy have performed better or worse than it did? There seems no doubt as to the answer. For this period at least, the position taken by the majority of economists and the Joint Economic Committee was right and the position of the Federal Reserve was wrong. The oscillations in the rate of money growth did not act to offset economic fluctuations, but seem to have been a major cause of economic instability. They contributed to the 1958 and 1960 recessions. the economic slack of 1960-64, the growing inflationary pressures of 1965-66, the subsequent credit crunch and economic softening, and they seemingly were the major cause of the inflationary growth of total demand in 1967-68. That the Federal reserve last year should persist in an obviously inflationary policy during an obviously inflationary period despite the continued pleas of economists, this committee, and an important part of the press-this may seem somewhat surprising. Surprising it may be, but new, unfortunately, it is not. One who reads over the hearings of the Banking and Currency Committees of 1931 and 1932 must be struck by the parallelism. At that time Members of Congress, a stream of eminent economists, representatives of economic groups urged the Federal Reserve to take decisive action to halt the deflation. It rejected their advice. It continued monetary contraction to its bitter end of 1933, when the matter finally was taken out of its hands. What argument did the Federal Reserve offer then for sticking with its deflationary policy? The same kind of argument it offers now. In 1931-32, the Federal Reserve would not take action sufficient to halt deflation because it was afraid it would cause excessively easy credit or would "clog up the banks with excessive reserves." Last year the Federal Reserve would not let off pumping money into the economy to limit inflation because it was afraid this would cause excessively tight credit. The Federal Reserve, it seems, does not learn. In this interpretation of the lessons of the recent past, the control apparatus for monetary and fiscal policies needs reform. Either continued inflation or substantial economic slack in coming years will seriously damage our efforts to meet our domestic and international goals. Existing policymaking institutions do not protect the Nation against such developments. In reforming fiscal policy, first priority, I think, should go to providing machinery to prevent erratic variations in the high-employment surplus. Such an effective discipline over the basic fiscal position seems a prerequisite to any meaningful use of fiscal policy in an anticyclical way. Bringing monetary policy under control seems even more urgent, in view of growing evidence of its greater potency. Because of its erratic nature and the hazard of a really serious error, it does not seem to me excessive to characterize monetary policy as formulated by the Federal Reserve as a threat to the security of the Nation. Given the long record of Federal Reserve intransigence, to wait and hope that institution will see the light does not seem a safe policy. Organizational reform is needed. While more basic reform is sought, perhaps monetary policy can be brought under some degree of control by pressure on the Federal Reserve from the new Council of Economic Advisers-which seems to understand what is needed-and the administration, along with the continued efforts of this committee. New appointments to the Federal Reserve should bring to it men who will apply monetary theory to policy formation rather than men from financial business or those brought up in the Federal Reserve way of doing things. What should be the nature of basic reform of monetary policy? I do not suggest bringing it under the control of the President. In my judgment, if monetary policy during the postwar period had been controlled by the President, it might well have been worse than it was under the control of the Federal Reserve. The most hopeful direction of reform seems to me for Congress to direct the Federal Reserve to make the Nation's money supply behave in a stabilizing manner, and provide it with presumptive guidelines. I also suggest congressional action to centralize the Federal Reserve organizational structure and eliminate its regional aspects, in order to adapt the institution to the functions it should perform. Senator PROXMIRE. Thank you, Professor Culbertson. |