Darryl Francis and the Making of Monetary Policy, 1966-1975

Abstract

oday, it is widely acknowledged that thefundamental mission of monetary policy isto maintain the long-run stability of theprice level. Economists and policymakers generallyagree that persistent changes in the price level(inflation and deflation) are, in the long run, causedby growth of the money stock in excess of thegrowth of total output. It is thought, moreover, thatmonetary policy can best promote high employ-ment and maximum sustainable economic growthby maintaining reasonable stability of the pricelevel. The charter of the European Central Bank, aswell as legislation governing the behavior of centralbanks in several countries, specifies price stabilityas the sole objective for monetary policy. TheFederal Reserve, by contrast, is assigned multiplepolicy objectives—“maximum employment, stableprices, and moderate long-term interest rates”(Federal Reserve Reform Act of 1977). Nevertheless,in recent years U.S. monetary policy has been con-sistent with a gradual reduction in the rate of infla-tion to the point where many economists believethat price level stability, for practical purposes, hasbeen achieved.The consensus about the importance of pricelevel stability and the role of monetary policy is afairly recent development. The macroeconomicparadigm that emerged from the Great Depressionand dominated from the 1940s to about 1980 heldthat full employment should be the primary objec-tive of monetary and fiscal policy. Stabilizationpolicy was viewed as choosing from among a menuof unemployment and inflation rates along a stablePhillips curve. Many economists and policymakersviewed moderate inflation as an acceptable cost ofmaintaining full employment. During the 1950sthe Federal Reserve frequently was criticized forpaying “excessive” attention to inflation, to thedetriment of employment and output growth.Perhaps in part a response to such criticism, inthe early 1960s the Fed’s monetary policy generallybecame more expansionary. Inflation began to risein 1965 and continued to increase through the1970s. Unemployment fell at first, but during the1970s the average rate of unemployment was higherthan it had been during the preceding two decades.Moreover, inflation, unemployment, and real outputgrowth all became more variable as the average rateof inflation increased.Not surprisingly, the poor performance of themacroeconomy during the 1970s brought theFederal Reserve much criticism. Among profes sionaleconomists, once-dominant views about the roles ofmonetary and fiscal policy began to shift. Experiencedemonstrated the folly of those policies designedto exploit a tradeoff between unemployment andinflation and showed that expansionary monetarypolicy could not permanently lower the unemploy-ment rate or increase the growth rate of real output.By October 1979, when Federal Reserve officialsfinally resolved to bring inflation under control, thecosts of disinflating were substantially higher thanthey would have been earlier in the decade wheninflation was lower and less entrenched. This paper examines alternative views aboutmonetary policy within the Federal Reserve Systemfrom the mid-1960s to the mid-1970s. We highlightthe views of Darryl Francis, president of the FederalReserve Bank of St. Louis from 1966 to 1975. Incontrast to most of his Fed colleagues, Francis arguedthat monetary policy should concentrate on haltinginflation. He believed that the influence of monetarypolicy on the unemployment rate was unpre dictableand at best temporary. He was an early proponentof the view that the unemployment rate (and realoutput growth) tends toward a “natural” rate deter-mined by factors outside the control of monetarypolicymakers. Francis argued that the Fed shouldmaintain a steady growth rate of the money stockand blamed the Fed’s targeting of interest rates andmoney market conditions for producing destabilizingswings in money stock growth.