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CONFIDENTIAL
Notes on meeting o f May 18, 1936
Led by Mr. C u r r i e

SOME MONETARY ASPECTS OF THE EXCESS RESERVE PROBLEM

Excess reserves c o n s t i t u t e a problem because they may lead t o on
excessive expansion of d e p o s i t s .

Adjusted demand d e p o s i t s have increased

some $8,000,000,000 since 1955 and are l a r g e r than i n 1929.

I t would

be g e n e r a l l y agreed t h a t an a d d i t i o n a l expansion o f |30,000,000,000 o f
d e p o s i t s would be excessive i n terms o f our o b j e c t i v e , which i s l o n g term p r o s p e r i t y , o r , more p r e c i s e l y , as f u l l a u t i l i z a t i o n of our p r o d u c t i v e resources as can be continuously sustained.
i s whether any f u r t h e r expansion ?/ould be a d v i s a b l e .

The problem, however,
T h i s problem i s

e a s i e r t o s t a t e than t o answer, b u t an e f f o r t must be made t o solve
even though much o f the e s s e n t i a l i n f o r m a t i o n i s

it

lacking.

For the country as a whole, unused capacity i s measured by unused
mim power.

On the b a s i s o f past experience, what f i g u r e o f n a t i o n a l

income might correspond w i t h r e l a t i v e l y f u l l employment?

During the

p e r i o d 1923-1929, a l t h o u g h complete s t a t i s t i c s o f unemployment a t t h a t
t i m e are n o t a v a i l a b l e , the general impression i s t h a t i t was n o t excessive.

For March 1929 Mr. Lubin estimates unemployment a t 2,250,000, or

about 5 percent o f t h e g a i n f u l l y employed.

I t i s d o u b t f u l whether the

s l a c k i n t h e system represented by 5 percent unemployed could have been
s u b s t a n t i a l l y reduced w i t h o u t i n c u r r i n g the r i s k o f a boom.

The general

p r i c e l e v e l was d e c l i n i n g g e n t l y and the q u a l i t y o f goods was improving.




-2-

I t may be j u s t i f i a b l e , t h e r e f o r e , t o t r i e the t r e n d o f n a t i o n a l income
from 1925 t o 1929 as corresponding w i t h r e l a t i v e l y f u l l employment.

In

t h a t p e r i o d the estimated n a t i o n a l income p a i d out increased from $63,000,000,000 t o $79,000,000,000, or by 5.8 percent per annum.

In arriving st

some approximation o f the f i g u r e of n a t i o n a l income t h a t would correspond
w i t h c o n d i t i o n s o f r e l a t i v e l y f u l l employment i n the n e x t few y e a r s ,
t h e r e f o r e , the t r e n d of n a t i o n a l income from 1925 t o 1929 may be taken as
a starting point.

A rough approximation of the f i g u r e o f "proper" n a t i o n a l

income now or i n t h e near f u t u r e may be a r r i v e d a t simply by p r o j e c t i n g
the t r e n d o f n a t i o n a l income from 1925 t o 1929 on t o d a t e , i f we assume
t h a t t h e number o f workers, a d d i t i o n s t o c a p i t a l equipment,

efficiency,

and p r i c e s had maintained the trends e v i d e n t from 1925 t o 1929.

These

f a c t o r s should be considered s e p a r a t e l y .
The number o f a v a i l a b l e workers has continued t o increase since
1929 a t a r a t e n o t markedly d i f f e r e n t from t h a t which p r e v a i l e d from
3.925 t o 1929.

Mr. Lubin estimates t h e a d d i t i o n t o the l a b o r market since

1929 a t 5 1 / 2 t o 4 m i l l i o n .

Technological improvements i n the form o f

b e t t e r o r g a n i s a t i o n and new i n v e n t i o n s have continued since 1929, though
one cannot be sure whether they were a c c e l e r a t e d or r e t a r d e d by the
depression*
The i n d e x o f commodity p r i c e s i s somewhat lower than the trend of
1925 t o 1929 p r o j e c t e d t o date*

For t h e present purpose, however, the

discrepancy i s l e s s than appears a t f i r s t s i g h t .

For one t h i n g , the

index does n o t g i v e proper weight t o the i n f l e x i b l e p r i c e s o f




finished

-3-

manufactures, nor t o f r e i g h t or power r a t e s .

Moreover, some f u r t h e r

rise

o f p r i c e s may be a n t i c i p a t e d as one i n d u s t r y a f t e r another approaches
capacity production.

The present lower l e v e l o f p r i c e s does n o t , t h e r e -

f o r e , c a l l f o r much of a downward adjustment o f t h e p r o j e c t e d f i g u r e s of
n a t i o n a l income.
The f a c t o r t h a t does c a l l f o r a d r a s t i c downward adjustment i s the
t r e n d o f c a p i t a l equipment.

A s u b s t a n t i a l p a r t o f the i n c r e a s e i n p h y s i -

c a l p r o d u c t i o n , which p e r m i t t e d i n c r e a s i n g income t o correspond w i t h
g e n t l y f a l l i n g p r i c e s from 1923 to 1929, was due t o the annual increment
i n our stock o f c a p i t a l goods.

Since 1929 c a p i t a l equipment has probably

d i m i n i s h e d r a t h e r than increased.

New c o n s t r u c t i o n has been confined

l a r g e l y t o p u b l i c works and i n d u s t r y has n o t f u l l y maintained i t s p l a n t .
I f the s t o c k o f c a p i t a l equipment i s n o t g r e a t e r then i n 1929, production
could be g r e a t e r only because of increased man power and e f f i c i e n c y
a r i s i n g f r o m t e c h n o l o g i c a l improvements.

Making a rough allowance f o r

the f a i l u r e o f c a p i t a l equipment t o increase and assuming s l i g h t l y
h i g h e r p r i c e s , we may hazard the guess t h a t t h e d o l l a r value o f output
under c o n d i t i o n s o f r e l a t i v e l y f u l l employment t o dry would l i e somewhere
i n the rsngq o f #85,000,000,000 to #95,000,000,000.

The l o n g e r i t takes

t o g e t f u l l recovery or the more p r i c e s r i s e , the higher would the f i g u r e
become.
Whether t h e present stock o f money i s l i k e l y t o be compatible w i t h
a n a t i o n a l income of t h i s s i z e depends on t h e probable t u r n o v e r of money.
I t i s g e n e r a l l y b e l i e v e d t h a t the turnover o f money i s s u b j e c t t o such




-4-

vdde swings t h a t i t i s useless even t o speculate on the probable turnover
i n the event o f f u l l recovery.

This b e l i e f i s r e i n f o r c e d by i n s p e c t i o n

o f t h e v a r i a t i o n s i n the "crude" v e l o c i t y o f money, t h a t i s , the r a t e of
t u r n o v e r o f money f o r every purpose.

The concept o f v e l o c i t y which i s

more p e r t i n e n t h e r e , however, i s "income" v e l o c i t y .

"Crude" v e l o c i t y

i n c l u d e s the t u r n o v e r o f money f o r a l l purposes, i n c l u d i n g numerous
d u p l i c a t i o n s , and i s g r e a t l y a f f e c t e d by s p e c u l a t i o n .

I n 1929 consumers1

purchases amounted t o l e s s than f i v e percent of t o t a l bank d e b i t s .
Income v e l o c i t y i s obtained by d i v i d i n g t h e annual n a t i o n a l income
by the average amount of money, as measured by currency o u t s i d e banks
p l u s demand d e p o s i t s , and represents the number o f times on the average
the stock o f money i s turned over t o income r e c e i v e r s i n the course of
the y e a r .

T h i s i s a simple a r i t h m e t i c a l r a t i o t h a t permits a shorthand

expression of t h e n e t r e s u l t a n t of the myriad o f f o r c e s t h a t e n t e r i n t o
the d e t e r m i n a t i o n o f the n a t i o n a l income.
Income v e l o c i t y remained comparatively steady from 1923 t o 1929 a t
s l i g h t l y under 5.

Professor A n g e l l obtains s u b s t a n t i a l l y the same r e s u l t

w i t h somewhat d i f f e r e n t s e r i e s of money and income, extending back t o 1910.
The new money c r e a t e d d i d n o t appear t o a f f e c t s i g n i f i c a n t l y the r a t e a t
which t h e s t o c k o f money was being turned over t o income r e c e i v e r s .

The

community on t h e average h e l d a stock o f money equal t o s l i g h t l y l e s s than
f o u r months 1 p r o d u c t i o n o f goods and s e r v i c e s throughout the p e r i o d .

The

reason f o r the steadiness was doubtless because consumers on the average
k e p t a more or l e s s d e f i n i t e r a t i o o f t h e i r balances t o t h e i r incomes mid




-5-

business k e p t a more or l e s s d e f i n i t e r a t i o of i t s balances t o the value
of i t s

output.

From 1929 t o 1933 the supply o f money and i t s income v e l o c i t y both
d e c l i n e d by about 25 percent.
but l i t t l e .
duction.

From 1933 t o 1934 t h e income v e l o c i t y changed

The stock of money e q u a l l e d the value of 5 1 / 2 months 1 p r o -

The c r u c i a l question i s whether income v e l o c i t y 7d.ll i n c r e a s e ,

i n t h e event o f f u l l r e c o v e i y , t o i t s 1923-1929 range.

I f i t does, the

p r e s e n t stock o f money plus the probable increase i n the immediate f u t u r e
could support a n a t i o n a l income of about | 9 0 , 0 0 0 , 0 0 0 , 0 0 0 .
I n e s t i m a t i n g probable income v e l o c i t y i n t h e f u t u r e i t i s important
t o consider whether new c o n d i t i o n s have a r i s e n which w i l l lead i n d i v i d u a l s
and businesses t o keep l a r g e r or smaller balances r e l a t i v e t o t h e i r incomes
and o u t p u t .
One f a c t o r o f undetermined importance t h a t may cause consumers t o
m a i n t a i n l a r g e r balances i n r e l a t i o n t o t h e i r incomes i s the widespread
i n i t i a t i o n o f s e r v i c e charges since 1929.

I n the Large Deposit Study,

however, evidence was c i t e d t o the e f f e c t t h a t consumers 1 balances are
n o t very i m p o r t a n t q u a n t i t a t i v e l y .

A moderate i n c r e a s e i n t h e r a t i o of

consumers 1 balances t o incomes would n o t , t h e r e f o r e , a l t e r income
velocity

significantly.

Of much more importance i s the r e l a t i o n between business and f i n a n c i a l d e p o s i t s and t h e value o f o u t p u t .

The Large Deposit Study i n d i c a t e d

t h a t t h e b u l k o f demand deposits i n 1933 appeared t o belong t o business,
p u b l i c b o d i e s , .and f i n a n c i a l h o l d e r s , and t h a t business deposits increased




-6-

as r a p i d l y as those o f other groups.

I t i s f a i r l y safe t o say t h a t

business demand d e p o s i t s are now as l a r g e as i n 1929 and t h a t business
c o u l d e a s i l y i n c r e a s e i t s disbursements and o u t p u t w i t h o u t i n c r e a s i n g
i t s balances f u r t h e r .

I f t h i s happened, the p r o p o r t i o n o f balances t o

o u t p u t would d e c l i n e , o r , i n other words, income v e l o c i t y would i n c r e a s e .
I n s o f a r as l a r g e r balances represent funds accumulated i n d e f e r r e d maintenance and d e p r e c i a t i o n accounts, or funds earmarked f o r other

specific

purposes, they are l i k e l y t o be u t i l i z e d as recovery proceeds.
F i n a n c i a l d e p o s i t s have increased r a p i d l y since 1933 and are i n
excess o f normal requirements.

The same i s t r u e o f balances o f p u b l i c

b o d i e s . Even w i t h o u t f u r t h e r expansion of money, t h e r e f o r e , business and
p e r s o n a l d e p o s i t s could be increased s u b s t a n t i a l l y by a t r a n s f e r of
balances f r o m f i n a n c i a l and p u b l i c bodies.

Hence, even should business

m a i n t a i n the same r a t i o between output end balances as p r e v a i l s now, an
i n c r e a s e i n income v e l o c i t y could occur.
There are s e v e r a l new elements i n the s i t u a t i o n t h a t might cause
b u s i n e s s , i n the event of f u l l r e c o v e r y , t o m a i n t a i n l a r g e r h o l d i n g s of
demand d e p o s i t s i n r e l a t i o n t o output than i n 1923 t o 1929.

One e f f e c t

o f t h e depression t h a t w i l l probably p e r s i s t i n some degree i s an i n creased emphasis on l i q u i d i t y .

Not only may t h e r e be a g r e a t e r d e s i r e f o r

l i q u i d i t y , b u t t h i s d e s i r e may be s a t i s f i e d more by h o l d i n g demand
d e p o s i t s than by h o l d i n g other a s s e t s .

For one t h i n g , t h e r e are increased

r e s t r i c t i o n s on time deposits and so l o n g as low i n t e r e s t r a t e s p e r s i s t ,
bankers are r e l u c t a n t t o accept l a r g e time d e p o s i t s .




Again, c a l l loons

-7-

o f businesses t o brokers are no longer a v a i l a b l e as i n 1929, and so l o n g
as t h e y i e l d on s h o r t - t e r m governments remains so l o w , business does n o t
f i n d i t w o r t h i t s w h i l e t o h o l d governments i n place o f demand d e p o s i t s .
Too much weight should n o t be attached t o these c o n s i d e r a t i o n s ,

since

they depend i n l a r g e p a r t on the continuance o f very low s h o r t - t e r m
interest rates.
On t h e whole, i t would appear t h a t some increase i n the income
v e l o c i t y can be expected, though whether the v e l o c i t y w i l l increase t o
3 or higher i s uncertain.

I t would, however, be dangerous t o r e l y upon

t h e continuance o f the present v e l o c i t y and t o increase the supply o f
money s u f f i c i e n t l y t o get an income o f $90,000,000,000 w i t h the present
velocity.

As an a i d i n i n t e r p r e t i n g business developments and f o r m u l a t i n g

p o l i c y , i t i s 6 f t h e h i g h e s t importance t h a t the Board have c u r r e n t
i n f o r m a t i o n on t h e h o l d i n g s o f demand deposits o f d i f f e r e n t groups and on
t h e n a t i o n a l income.
The t e n t a t i v e conclusion i s t h a t t h e e x i s t i n g supply o f money, p l u s
the expansion which w i l l take place i n the immediate f u t u r e , may very w e l l
prove adequate f o r c o n d i t i o n s of r e l a t i v e l y f u l l employment and t h a t
f u r t h e r expansion i n v o l v e s some r i s k .

still

I f f u r t h e r expansion were v i t a l f o r

r e c o v e r y , t h e r e m i g h t be some j u s t i f i c a t i o n i n assuming the r i s k .

If

little

a d d i t i o n a l h e l p t o recovery w i l l be a f f o r d e d by f u r t h e r expansion, however,
i t appears p r u d e n t , u n t i l we can see t h e way more c l e a r l y , t o discourage
f u r t h e r expansion by r a i s i n g reserve requirements i n the near f u t u r e .