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January 11, 19h9

Background of Regulation W
The role of consumer credit controls must be evaluated in terms
of the unusually strong inflationary forces of the past three years.
Demand for consumer durables has been at record levels as a consequence
of the wartime years of sharply reduced production coupled with large
holdings of liquid assets and high current incomes. At the same time,
production of many major consumer durables has been restricted because of
the equal urgency of demand for durable producer goods and the limited
amount of steel available to satisfy the unprecedented total demand.
Under these circumstances, restrictions on the use of consumer
credit have served to lessen the intensity of demand for scarce consumer
durables and thereby to temper somewhat the consequent price increases.
Nevertheless, the instalment credit controls exercised by the Board became
inoperative after November 1, 19U7, in accordance with the resolution of
Congress approved on August 8, 19^7 •
After a sharp decline in prices of farm products and foods in
February of 19U8, inflationary pressures were again reasserted and by
mid-summer appeared to be clearly dominant for the near future, particularly since average prices at both wholesale and retail had been rising
sharply in the preceding months. Enlarged defense expenditures arising
out of the tense international situation, the adoption of the European
Recovery Program, and a substantial reduction in personal income taxes
combined with previously existing factors of strength to give a strong
upward lift to the economy in the second and third quarters.
During the middle months of the year, personal income rose
very sharply, in part because of higher employment and in part because
of higher wages resulting from wage contracts negotiated in the mass
production industries. Gross national product increased at an annual
rate of 11 billion dollars from the first to the third quarters reflecting increases in both prices and output. Corporate profits both
before and after tax reached new peaks in the third quarter. During
this period, the most important apparent anti-^inflationary factor was
the bumper harvest of 19U8, as a result of uthich prices of important
crops declined to about support levelst

# Prepared by Mr. Williams and the staff of the National Income, Money
Flows, and Labor Section.

- 2 In the light of strongly inflationary developments in both the
postwar period as a whole and in the immediately preceding months, the
Board of Governors on August 19, 19^8 issued Regulation 1t to become effective
on September 20, thereby reinstituting consumer credit regulation. This
action was taken under Public Law 905 which the President signed on August l6#
Recent economic developments
More reoently a less inflationary pattern of economic tendencies
has begun to emerge* (Contributing somewhat to this tempering of inflationary
pressures were the reimposition of Regulation W and the raising of member
bank reserve requirements in September.) Signs have recently appeared that
in an increasing number of areas supplies had caught up with or even
exceeded demand at current prices.
Average wholesale and consumer prices have receded from their
August peaks. In fact, at the end of December, average wholesale prices
were just below those of December 1947, while average consumer prices were
moderately higher* These broad averages, however, obscure the fact that
changing cost, demand and supply situations in various markets have been
reflected in an increasing divergency in price movements, with wholesale
prices of many commodities, particularly nondurables, lower at the end of
the year than at the beginning. Of the ten major groups in the wholesale
prioe index, only metals an4 metal products, fuels and lighting materials,
housefurnishings and building materials are at higher levels than a year
ago. Prices of metals and metal products, however, increased almost 15
per cent in I9I4.8--»a larger increase than in 19^4-7—*and such prices are still
moving up.
V<hile wholesale price declines since August are mainly the result
of lower prices for farm products and foods, it is significant that prices
of all other commodities have been virtually unchanged on the average since
mid-August, although they are still moderately higher than at the end of 191+7*
Prices of nonmetallic raw materials have been drifting down, while metals
have continued to edge up.
Following an increase in reserve requirements at member banks,
expansion of loans at commercial banks, which had been at about the same
rate in the July-September period as in the same months of last year,
slackened considerably in the fourth quarter. Bank lending to businesses,
real estate buyers, and consumers was generally curtailed and showed little
growth in the last quarter of the year compared with a very large expansion
during the same period in 19^7 • In part, slackening of business demand for
bank loans is the result of the increased volume of funds obtained from
other sources, including retained earnings out of record profits and funds
from nonbank sources, including insurance companies. Reduced expansion in
total consumer instalment credit in October and iMovember reflected in part
the reimposition by the Board of Governors of controls on the terms of such
loans, effective September 20.

- 3 New residential units started have declined steadily from the
peak reached in May, in contrast to experience in 19h7 when they rose
steadily to October. In recent months, the volume of such starts has
been well below the levels of the corresponding months of l a s t year.
Expectations of deflationary developments have been supported
by the widespread reporting of pre-Christmas sales and by a host of reports on layoffs and shortened hours in maiy industries, including con*sumer durables. Quantitatively, these layoffs have not yet added up to
much, but as indications of slackening demand they have been disquieting.
Contrary to the usual pre-holiday seasonal advance between October and
November, employment in nonagricultural establishments declined by 170,000
this year, according to estimates of the Bureau of Labor S t a t i s t i c s . Total
nonfarm employment, at U$,700,000 persons in November, was 780,000 above
the same month of l a s t year. However, this was the f i r s t time in 19U8 that
the year-over-year differential has fallen below a million.
The curtailment of operations in t e x t i l e , leather, and apparel
groups, along with scattered layoffs in some other industries, resulted
in some increases in unemployment. In December, according to the Census
Bureau estimates, unemployment rose to 1»9 million persons, about 300,000
more than at the lowpoint reached in October and also about 300,000 more
than in December 19U7* Furthermore, sharp reductions in the work week
have taken place in those soft goods industries which have been curtailing
A trend of small increases in unemployment is also indicated by
the number of persons filing claims for unemployment compensation under
the State programs (exclusive of the veterans program). The number of
i n i t i a l claims filed increased from about 160,030 a week at the end of
September to 280,000 a week in late December, and claims filed for continued unemployment rose in the same period from a level of about 800,000
to 1,2 million. By contrast, there was virtually no change in the number
of claims filed during the same period l a s t year. For the week ending
December 25, 19U8, about 130,030 more i n i t i a l claims were filed and there
were about UU0,000 more continued claims than in the same week last year.
Consumers have been exercising a surprising amount of caution
in making r e t a i l purchases, in view of the record levels of personal income and the large and fairly well distributed volume of outstanding
liquid assets. Throughout November and early December, department store
sales were below those of the corresponding months of 19li?• Sales in December, however, are now estimated to have been about 1 per cent higher than
in December 19U7* For November and December combined, such sales did not
quite equal those of l a s t year. Particularly hard h i t in department stores
were sales of msgor household appliances. To some extent, however, this
may represent a loss of such business to other types of r e t a i l outlet, but
this TOuld generally reflect a sharp intensifying of competitive activity
in this merchandising area. Sales of a l l r e t a i l stores dropped slightly

-kin October, and by November they
on a seasonally adjusted basis*
group showed a decline of almost
and a decline of k per cent from

were 2 per cent below those of September
Sales of stores in the housefurnishings
12 per cent fron* September to November
November l

After sharp rises in the middle months of 19i+8, personal income
has been fairly constant at record levels since August in contrast to
experience in 19U6 and 19ii7# when it increased sharply in the closing months
of the year* In part* this is due to the fact that wage and salary income
has leveled off in recent months*
The ratio of personal saving to disposable income has shown a
tendency to increase moderately since the second quarter of 19U7* In
part, this upward drift has represented a relative shift in the disposition
of personal incomes from consumption type objects toward nonconsumption
categories, such as noncorporate business investment, farm inventories, and
purchases of new homes which are included in saving rather than in
consumption expenditures* ftevertheless, insofar as the rise reflects
increased consumer savings in liquid form and an increased volume of debt
repayments, it has served to relax inflationary pressures generally in the
economy* Available data through the end of 19*4.8 are not adequate to
evaluate properly the relative importance in aggregate consumer demand of
these two factors* In view of the slackening becoming evident in purchases
of new homes and in retail sales generally and the declines in prices of
farm products, however, increases in the rate of personal savings at this
time suggest growing weakness rather than continuing strength in such demand*
On the basis of the limited data now available, it is probable
that the median liquid asset holding and the proportion of units with some
liquid assets declined sligjrtly during 19^8* Total individuals1 holdings
of liquid assets remain about as large as at the end of 19<U7 and fairly
widely distributed.
The outlook for the first half of 19ii9
There have been several occasions in the postwar years when it
appeared that inflationary pressures were receding* Although major factors
of strength remain in the economy, there are several reasons for believing
that the current period actually is at least a temporary period of change
from a condition of generally rising prices to one of relative price
stability at generally high levels of production and employment*
Three years of high-level production of houses and consumer and
producer durables have succeeded in reducing the intensity of demand for
many commodities at current prices* This situation has been reflected in
the divergence of price movements this year, in the moderate slackening in
the rate of investment in producers1 goods and inventories, in the reduced
rate at which new housing units are being started, and in increasing consumer

- 5resistance and selectivity with respect to consumer durable goods as well
as nondurable goods and services* To^a minor extent, this relative weakening
of demand is being reflected in declines in employment and output as well
as in prices•
The bumper crops of I9I4.8--in contrast to short crops in 1 9 h 7 "
coupled with improvement in the agricultural situation abroad have resulted
in marked price declines of such commodities, and serve to relax upward
price pressures on foods and other finished commodities and to moderate
pressure on wages arising from high living costs. furthermore, industrial
recovery in Western Europe has served to reduce demands for such commodities
as coal and textiles which are normally not imported in large quantities
from the United States, thereby considerably easing the supply position
here for these commodities* In other areas, such as petroleum products,
the large scale investment of recent years is resulting in increased domestic
Tinder these circumstances, it appears that further inflation is
not likely to develop in the first half of 1949* if it is assumed that
actual and prospective defense spending is not increased substantially
more than the rise indicated by present schedules based upon the fiscal
19^9 budget* A defense budget of well over 15 billion dollars for fiscal
1950 is not likely to affect materially developments in the first half of
19i+9* in view of the fact that appropriations are not ordinarily passed
upon much before the adjournment of Congress although anticipatory effects
upon consumer and business expenditure policies might be of some importance*
The major uncertainly, then, for the first half of 19^9 relates
not to whether there will be further inflation tut rather whether there
will be sharp price deflation with accompanying widespread reductions in
output and employment or whether moderate downward price adjustments can
be effected with generally high levels of employment. The cumulative
evidence of slackening of demand in many markets at current prices must
be considered in the light of the remaining factors of strength in the
economy, including record levels of personal income, large and fairly widely
distributed holdings of liquid assets, still rising State and local expenditures on greatly needed public works, large and still rising Federal
expenditures particularly for defense and foreign aid*
The limitation placed on the money supply by a large Federal cash
surplus in fiscal 19I48 has been substantially reduced this year as a result
of increasing expenditures and the reduction of personal income tax rates
last spring* Thus, in the first half of calendar I9I4.8* the Federal cash
surplus was 7»6 billion dollars; in the same period of 19^9 it is estimated
at 2*1 billion* A further reduction in the cash surplus or even a deficit
is likely in fiscal 1950 in view of the probably large increase in
expenditures, unless tax rates are increased. Meanwhile, state and local

- 6 governments, which showed a cash surplus of 1 billion dollars in 19U7,
have shown an increasing cash deficit throughout 19U8. In view of increasing demands placed on such governments for education, construction
of public buildings and roads, it is likely that this d eficit will be
larger in calendar 19h9 tod that borrowing by these governmental units
will continue to expand*
Large programs of private investment in plant and equipment,
especially on the part of public utilities and railroads, are still a
long way from completion. In this connection, the most recent CommerceSEC Survey of Plant and Equipment Expenditures (conducted after the
election) indicates that planned expenditures in the first quarter of
19U9 are about 5 per cent above actual expenditures in the first quarter
of 19U8. In view of price increases for capital goods since early 19^8,
this probably represents a small decline in the physical volume of such
investment, but the planned level of investment is nonetheless high.
Another favorable factor in the economy is the fairly cautious
policy of inventory accumulation which business has followed since the
end of the war* There is no evidence in recent months of any shift to
speculative accumulation. While excessive inventories have been accumulated in some lines—in some cases involuntarily^-there is no statistical
evidence that the over-all holdings of business inventories are seriously
excessive in relation to business in the second half of 19i*8. It should
be pointed out, however, that declining levels of business aLways make it
appear that pre-existing inventories have been too high.
Another source of strength in the first part of 19li9 arises out
of the fact that Federal refunds on personal income taxes are likely to
be about 1 billion dollars larger than in the first part of I9I48 because
of the fact that reduced withholdings did not go into effect until May 1,