The Choice of Monetary Instruments and the Theory of Bureaucracy(1)

Abstract

Increasingly economists have reached agreement on the requirements for effective monetary control. In theory, control of the price level can be achieved through control of one nominal magnitude and an interest rate.(2) In practice, the requirements as Harry G. Johnson argues, are identical: ‘the central bank can control the price level if it fixes the yield on its liabilities and controls the quantity thereof through open market operations’ (pp. 977–78). Acceptance of this view ranges over a wide spectrum of economists from Milton Friedman (1960, pp. 50–51), an adviser to the Republican party, to Warren L. Smith, a member of the Council of Economic Advisers under the Johnson administration. Smith for example states:

I would favor placing complete reliance on open market operations, under ordinary circumstances, as the means of conducting general monetary policy… It is difficult to see that adjustments in reserve requirements and the discount rate give the authorities any ability to change the structure of interest rates and the total credit supply that could not equally well be accomplished by sufficiently flexible use of Federal Reserve open markets and Treasury debt management operations. (p. 281)

As Johnson observes, ‘… In the actual practice of central banking, however, reliance is placed on additional instruments and techniques of control over the commercial banks. From the point of view of the theory of monetary control, these additional controls are unnecessary’ (pp. 977–78).