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Office Correspondence

Mr. ^>T»Hn

Mr. Currie




Dt jm w


Subject:Would a Further Expansion of
Money be "Injurious"?

I am enclosing a memorandum expanding my remarks at the Board
meeting last Tuesday for distribution to Board members and others
who may be interested.

Lauchlin Currie
January 25, 1937.

The Problem
In the past three years the volume of circulating deposits
(adjusted demand deposits) plus currency outside banks has expanded
by over $11 billion or 55 percent.
excess of the figure in 1929.

It is approaching $5 billion in

Excess reserves are well over $2

The Board has the power to raise reserve requirements

further "to prevent injurious credit expansion".

The problem is to

determine whether the present volume of money is deficient, adequate
or excessive.

Another way of statins the saiae thing is to determine

whether any further expansion is justified and if so how much, or
whether and at what point further expansion will be "injurious"*
An attempt at the solution of the problem entails a discussion
of what criterion can be used to determine the adequacy or excessiveness of the volume of money and what the prospects are for further
expansion if no action is taken.
Elements of the Problem
It is obvious that the present supply is not excessive in the
sense of promoting too much spending at the present time.

The ques-

tion, however, is whether it is excessive for conditions of relatively full employment; whether, in other wordst the present supply is
such as to facilitate too great an expansion of incomes and prices
in the future,
An expansion of incomes (or the value of output) may be excessive on two counts,

It may come about because of too rapid a rise


of prices in general, or it may come about because of too large a
volume of production resulting from widespread night work, over
time, and employment of people not usually employed in industry.
Usually these two factors go together.

An adequate amount of

money would be such as to corresjjond with full production without
undue strain and with only a moderate and unavoidable rise of prices.
In other words, the value of output and the national income should
increase by little more than the increase in the physical production of goods and services.
The elements in the problem, then, are as follows:

The increase in physical production that can be achieved

without strain.
This depends on such things as man power, physical equipment,
and technical knowledge.
2. The cost (including profits), or value of total production.
This depends, in turn, on the increase in production and the
price level of production.

This, in turn, equals the total money

cost, including profits, of production.

The total money cost (including profits) of production or

the national money income may be further broken down into the amount
of money and the rate of income velocity of money.
If we know the amount of money and we can estimate the probable income velocity of money, we can estimate the probable total
money cost of production, or the national income.

We may then


compare this with an estimate of tlie total value of production which
we think the community could produce without strain and at a price
level which would not invite commodity speculation, etc.

If our

estimated probable national income is in excess of this figure it
means that prices will rise more than we think advisable.

In these

circumstances the supply of money will be excessive and any further
expansion would be injurious.
The Probable Increase in the Rate of Turnover of Money
It is generally believed that the turnover of money is subject
to such wide swings that it is useless even to speculate on the
probable turnover in the event of full recovery.

This belief is

reinforced by inspection of the variations in the crude or transactions velocity of money, that is, the rate of turnover of money
for every purpose.

The concept of velocity which is relevant here,

however, is not crude velocity, but income, or as some people prefer
to call it, circular velocity.

Crude velocity includes the turnover

of money for all purposes, most of them of little economic significance. An increase of $10 billion in speculative transactions —
swapping stocks for example — while it may be important from the
point of view of the technical position of the market, has nowhere
near the same economic significance as an increase of $10 billion in
incomes or consumers' purchases.

In 1929 consumers1 expenditures

amounted to less than five per cent of total bank debits.
The concept o£ velocity that is more significant for our purposes,
therefore, is that known as the income velocity of money.

It is


obtained by dividing the annual national income by the average
amount of money, and represents the nuxaber of times on the
average the total stock of money is turned over to income
receivers in the course of the year.

It is true that this is

a simple arithmetical ratio, but it has the merit of permitting
a shorthand expression of the net resultant of the myriad of
forces that enter into the determination of the national income.
The interesting thing for our purposes about this type of
velocity is that it does not show such wide fluctuations as
crude velocity.

The income velocity of money remained very

steady from 1923 to 1929 at around 3. The new money created did
not result in any change in the rate at which the total stock of
money was being turned over to income receivers.

The nation as

a whole held a stock of money equal to about the value of four
months* production of goods and services.

The reason for the

steadiness was probably that consumers kept a more or less definite ratio of their balances to their incomes and business kept
a more or less definite ratio of its balances to its output.
There were, of course, random fluctuations but over the whole
of the economy definite and comparatively steady ratios obtained.
From 1929 to 1932 the income velocity of money declined from
over 3 to less than 2.

In other words, a considerably decreased

supply of money became equal not to the value of four months1
production, but to the value of over six months1 production.


From 1932 to 1936 the income velocity of money has apparently
remained fairly stable around 2, slightly above its low point in
1932. The large addition to the supply of money did not, in other
words, bring about a significant change in the rate in which the
total stock was being turned over.
In the event of full recovery, may we expect the income velocity
of money to increase, and if so, by how much?

An alternative way

of stating this question is: What reasons are there for thinking
that the relationship between money and income prevailing from
1923 to 1929 will not be restored in the event of full recovery?
Are public bodies, financial institutions, business men and private
individuals likely to hold larger or smaller balances in relation
to income f n the volume of their operations in the event of full
recovery than they held from 1923 to 1929?
We may first consider the possible behavior of consumers in
this regard.

One factor that may cause consumers to maintain larger

balances in relation to their incomes is the widespread initiation
of service charges since 1929. Another factor is the increased
emphasis on liquidity, although this is probably of minor significance in the case of the bulk of consumers.

In any case, there is

considerable evidence that consumers1 checking accounts are not
very important quantitatively, amounting to possibly only 15 percent
of the total. A moderate increase in the ratio of consumers1 balances to incomes in comparison with the ratio prevailing before the

deflation would not, therefore, alter the income velocity of money
Let us now turn to a consideration of whether there are any
new elements in the situation that might cause business to maintain
larger holdings of demand deposits in relation to output than in
1923-29 in the event of full recovery.

There appear to be several.

In the first place, one effect of the depression that will
probably persist for some time is an increased emphasis on liquidity.
It is quite true that a desire for liquidity can be satisfied in
other ways than by holding demand deposits.

The important thing for

our purposes, however, is not only that there may be a greater desire
for liquidity but in addition relatively less desire and ability to
secure liquidity through the holding of assets other than demand

For one thing, there are increased restrictions on time

deposits and so long as low interest rates persist, bankers are
reluctant to accept large time deposits. Again, one source of liquidity in 1929, call loans of businesses to brokers, is no longer available.

So long as the yields on Treasury notes and bills remain so

low, business hardly finds it worthwhile to hold Governments in place
of demand deposits.

If, as seems likely, the Treasury should retire

and refund a substantial portion of the short term debt, the rates
on the remaining short term debt outstanding would remain very low.
There are indications that financial institutions, wealthy individuals and public bodies hold very much larger balances than they
did in the 20* s. There appear to be no very good reasons for believing

-7that when favorable opportunities for investment reappear
balances held by financial institutions and wealthy individuals
will not return to levels more comparable with those that prevailed before the depression.

The Federal Government,. on the

other hand, is likely to hold large balances.
On the whole it would appear that while we may expect a
considerable expansion in the income velocity of money the
probabilities appear to be against its going above 3.
The Supply of Money
The latest figures available for adjusted demand deposits
of all banks are for June 30, 1936.

On that date the total

adjusted demand deposits plus outside currency amounted to approximately #30 billion.

Judging from the increase in adjusted demand

deposits that has since occurred in reporting member banks, it
appears safe to say that the total volume of money now amounts
to at least #31 billion.
The Desirable National Income
We now come to the hazardous task of estimating the figure
of national income that would correspond with relatively full
employment under conditions that we might hope to maintain.
This is both a question of physical output of goods and services
and of the price of that output. We may first dispose of the
price aspect.
While a case could bo made out for the. desirability of
maintaining the present level of prices, this does not appear


to be possible.

The recovery movement does not proceed evenly

in all industries.

Owing to relative changes in demand since

1929, some industries may be working at capacity, while others
may be relatively slack.

It would be very difficult to absorb

the unemployed in the laggard industries while preventing a rise
of prices in the industries which are being pushed to capacity.
Hence, as one industry after another approaches full capacity we
may expect price advances which will raise the general average.
The more gradual the recovery movement, the more opportunity
there will be for building up capacity where it is deficient and
for moving and training labor and, hence, the more moderate will
be the rise in prices.

In view of the prospects for an orderly

recovery and the existence of a wide range of inflexible prices,
we may perhaps posit a ten percent advance in the general level
of prices over the present levei


being the upper limit to

which it is desirable that prices should rise.
We may now attempt to estimate the value of production with
relatively full employment and with prices ten percent higher than
at present.

It is obvious that we cannot expect full employment
For our present purposes we will assume that it will

be reached by 1939.
The method of procedure adopted was to estimate the average
number of unemployed in 1936 at 9.5 million, add 1.8 million workers
as the addition to the labor market in the next three years and
deduct an estimated 3 million workers as constituting the more or less

-9irreducible minimum of unemployed workers, leaving 8.3 million
workers to be absorbed in the next three years.

Assuming that the

average number of workers in 1936 was 43 million, this would represent a 19 percent increase.
Deducting from an estimated national income of $61 billion in
1936 the figure of 1.5 billion as representing the wages of people
on work relief, and then assuming that the national income will be
increased 19 percent by the increase in the number employed,


percent by the increase in output per worker , and 12g- percent from
higher prices (10 percent over present prices eruals 12-J percent
over the average for 1936), wo arrive at a final figure of $84

This figure, which can hardly be classed as more than an

intelligent guess, represents the estimated national income that
would correspond with relatively full employment at prices 10 percent
higher than at present.
Tentative Answer to Question, Would a Further Expansion of Money be
We may now attempt to gather together the various threads of the
argument to this point.

Our first conclusion was that the total

supply of deposits subject to check and currency outside banks is
at present around $31 billion.

There is some reason for believing

that three represents the upper limit to which the income velocity
of money may go.

On the basis of $31 billion of money this would

mean a national income of $93 billion.

If, on the other hand, the

income velocity of money increases only to 2^3/4 this would iiean a
1/ Half of the rate of increase in the past two years projected over
the next three years. This estimate appears adequate in view of the
necessity of resorting to less efficient labor and plant and in view
of the lessened possibility for extending working hours.


national income of $85 billion.

It will be observed that this

latter estimate of the probable national income corresponds quite
closely with our estimate of a desirable national income of $84
billion in throe years* time.
The general conclusion is that the present volume of checking
accounts and outside currency is probably adequate for conditions
of relatively full employment with prices moderately higher than
at present.

Should the volume of money be further increased or

should the income velocity of money regain or exceed the velocity
prevailing throughout the Twenties, the volume of money,might
be excessive in the sense of corresponding with too rapid an
increase in prices and too high a total value of output, A case
can be made out, therefore, for the contention that a further expansion of money might prove to be injurious.
Prospects for a Further Expansion of Money
The most likely ways in which a further expansion of deposits
subject to check may occur are through an expansion of banks* earning
assets or through further inflows of gold.
A previous memorandum discussed the prospects for the demand
for bank loans of various types in the next few years.

It was there

concluded that the demand for security loans would increase only
moderately owing to the relatively high marginal requirements^ that
real estate loans might double their present level of $2 billion;
and that all other loans might expand by some $3 or $4 billion.


Whether the satisfaction of this demand, should it materialize,
would result in an expansion of checking accounts, depends mainly
on the action of the Federal Reserve authorities and of the Treasury.
Should Federal revenues and expenditures be such as to permit the
retirement of a substantial amount of short-term debt, as seems
likely, or should the Treasury decide to refund a substantial
portion of this short-term debt, the contraction of the banks1 holdings of governments might offset the expansion of other earning assets.
Similar uncertainty arises with respect to further inflows of
gold. While we may be fairly confident that the inflow of capital
in the form of gold will continue and will result in the creation
of new deposits if no action is taken, there is a possibility that
action may be taken to discourage further capital inflows.
Assuming that excess reserves are left with, banks, the prospects
for further expansion of demand deposits are uncertain.

It might

conceivably happen that further inflows of gold would be checked and
that the retirement and refunding of short-tena wovernments would
offset the expansion of banks1 other earning assets, so that demand
deposits might remain unchanged.

The balance of probabilities,

however, appears to favor a further expansion of money, particularly
in the next half year or so.
There are grounds for believing that the present volume of money
is adequate to finance a period of full and healthy recovery three
or four years hence.

Any further expansion entails some risk.



balance, the probabilities appear to suggest that further expansion
will occur unless checked.

Adequate monetary grounds exist, there-

fore, for taking action to prevent an injurious expansion of credit.