The Political Economy of Money: Evolution and Impact of Monetarism in the Federal Reserve System

Abstract

For almost a generation a vigorous debate has been underway over the conduct of monetary policy. The central questions in this controversy are widely known. What are the appropriate goals of monetary policy? What are the linkages between actions to influence the cost and availability of money and credit and the behavior of real output, employment, and prices? What are the best means-in terms of targets and central bank operating techniques-to accomplish the objectives of monetary policy? The divergent answers which economists of different intellectual persuasion give to these questions have generated a sharp schism in the body of monetary theory. On the one side are the Keynesian and postKeynesian economists who have stressed the efficacy of fiscal policy for the purpose of economic stabilization. On the other side are the members of the monetarist school 'who assign great weight to the role of monetary policy. The aim of this paper is to sketch the evolution of monetarist thought inside the Federal Reserve System. In this appraisal, I have viewed the evidence from the vantage point of a member of the Federal Reserve Board and of the Federal Open Market Committee (FOMC). I concluded that a particularly promising approach was to observe the FOMC at work in those rare instances when it set out especially to make substantive revisions in the form of the directive through which it gives instructions to the manager of the System Open Market Account (SOMA). In the last decade, there have been at least four such effortsin the years, 1961, 1964-65, 1966, and 1970. While the focus was on the proposed changes in the directive language, it is clear from the record that the debates were actually over the objectives and conduct of monetary policy. Thus, the directive revision episodes present a unique opportunity to observe the impact on FOMC members of competing ideas about monetary management. I have relied primarily on the public record available in the Minutes of the FOMC for the years 1936-1965 and on the FOMC Record of Policy Actions through the meeting of September 21, 1971 (the last one in the public domain at this writ* Member, Board of Governors of the Federal Reserve System. This paper is a condensation of a more comprehensive version presented at the 84th Annual Meeting of the American Economic Association. Copies of the original paper may be obtained from the Board, Washington, D. C. 20551. I am indebted to a number of persons in the Federal Reserve System for assistance in the preparation of the original paper. Foremost among those are several of my fellow board members (especially Governors J. Dewey Daane, Sherman J. Maisel, George W. Mitchell, and J. L. Robertson) who responded readily to my numerous questions and shared with me some of their recollections regarding internal debates in the Federal Open Market Committee (FOMC) and at the Board on the appropriate techniques of monetary management. Of course, they bear no responsibility for the use or interpretation I have made of the information provided. Several members of the Board's staff (identified in the original version) also helped in the preparation of the paper. Again, I must stress that the views expressed here are my own and should not be attributed to my colleagues either on the Board or among its staff.