Full text of William McChesney Martin, Jr., Papers : Comments on Staff Report on Employment, Growth, and Price Levels (Douglas Hearings) : 1959, Box 25, Folder 3

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

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READING GUIDE
AND

PRELIMINARY COMMENT

*

THE MONETARY PORTION ONLY

OF
THE JOINT ECONOMIC COMMITTEE'S
REPORT
ON

"EMPLOYMENT, GROWTH AND PRICE LEVELS"


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156 pages - about 78,000 words
Published - January 26, I960
86th Congress - 2nd Session
Joint Economic Committee:
Paul H. Douglas- Chairman
Wright Patman - Vice Chairman

sje

>'f

Prepared solely for personal
desk reference.
Wednesday, January 27, I960
James L. Knipe

MONETARY POLICY

General Comment
General monetary policy has tried to do an impossible job and has,
therefore, done a poor job in recent years, it is contended.
"In fact, the general tightening of money and credit
had its main impact in limited areas. . . and not in those
areas where the price rises were largely taking place. "

p. 30

The Federal Reserve System is said to be out of touch with the modern
needs of the economy.
". . .its approach to monetary policies has become
increasingly more classical. . .its policies have been reshaped in the image of the 1 9 2 0 f s . "

p. 31

The Committee will recommend against the removal of the 4-1/4per cent ceiling on long-term Government bonds until changes have been
made.
"It is our recommendation that the 4-1/4-per cent
ceiling on long-term Government bonds. . .not be removed
until major reforms in fiscal, monetary, and debt management policies are instituted. " . . .

f-

"It may well be that only by refusing to remove the
ceiling can these major reforms be brought about. "

p. 47

;7to

The minority makes a strong r e t o r t to this position taken by the
majority, with respect to the 4-1/4-per cent ceiling.
"This is nothing but political blackmail--with the
public the main loser. "
~

p. 86

Otherwise, the minority commends the temperance of the monetary
position taken by the majority.


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"In view of the extreme positions taken in the staff
report on monetary policy, we are somewhat relieved at
the moderation, and even diffidence, with which the majority toys with the idea of cheap money. It asks only a moderate increase in the rate of growth of the money supply,
a modest lowering of interest rates, and only occasional
Federal Reserve intervention in the long-term Treasury
bond market. "

p. 84

-2-

General Comment (continued)
Yvrithin the Democratic majority, Mr. Patman breaks completely with
his colleagues. He submits his own, personal report, filled with criticism
and denunciation of the Federal Reserve. Some typical quotations will illustrate his attitude.
"In periods when interest rates are being raised, these
spokesmen are given to making such statements as the Federal Reserve is 'simply following the market' and otherwise
suggesting that the events of the day are natural phenomena
over which the Federal Reserve has no influence or control.
Only in recession periods, when interest rates are being
lowered, do these spokesmen take credit for actions which
reveal that credit availability and interest rates are, after
all, products of their decisions." . . .
p. 65
"The Federal Reserve System should be brought back
into the Government from whence it has seceded. . . " . . .

p. 65

"It is my view that until these fundamental reforms
are made, Congress should, at the beginning of each year,
pass legislation specifying the rate at which the Nation's
money supply shall be increased during the year. "

p. 65

Senator Butler, of the minority, pays several graceful tributes to
the System, welcome to the reader who had just finished going over
Mr. Patman's remarks.
" . . . the fact of the matter is that an unusually fine job
was done during the past 6 years by those who maintained
the delicate balance between ample credit to meet the
Nation's proper needs and yet avoided stoking the fires of
inflation. "
I
V
The "Bills-Only" Doctrine

p. 124

As might have been anticipated, the "Bills-Only" doctrine receives its
usual manhandling by the majority. But, very interestingly, the tone of the
statements is moderate. Only Mr. Patman, in his separate report, states
the extreme view. The calm attitude of the majority appears at a number of
places.


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". . . It would appear that an important power was given
up for no appreciable gain.
"It may be that after a long period of pegged interest
rates something like 'bills only1 was required to impress
upon investors the fact that the Federal Reserve was no
longer going to peg them. " . . .

p. 32

-3-

The "Bills -Only" Doctrine (continued)
"We are not advocating that the Federal Reserve peg
the long-term bond market. We are advocating that the
Federal Reserve System assume responsibility for the
orderly behavior of our credit markets. "

p. 42

It is true that the majority goes on, in the very next paragraph, to a
position far beyond the one just stated above, but even this is not anywhere
nearly as extreme as the views expressed by many critics in recent years.
"A method by which the interest rate s t r u c t u r e can
be improved and the long-term bond market strengthened
as a consequence, without, in any way, expanding the
money supply or pegging the bond market or producing
inflationary effects, is by changing the mix in the holdings
of the Federal Reserve portfolio.
"In 1951, the Federal Reserve held about $5 billion
in long-term bonds which was 21. 5 per cent of its total
portfolio holdings of $22. 7 billion. As of the end of
October 1959, the Federal Reserve held only $1.5 billion
in long-term bonds which was only 5. 7 per cent of its
total portfolio of $26. 3 billion. There is no reason why
the present ratio should not be improved. "

p. 42

What the Committee seems to overlook is that, once the •&&£&&*&. ratio
had been reached, the bullish influence on the long-term bond market would
no longer be felt. As a matter of f a c t , there might be a depressant in the
overhanging effect of a mass of $6 billion or so of long-term bonds. Does
the Committee anticipate substantial sales of longs at some future date?
The Committee is not clear in its exposition on these points, but it
would appear that the position taken is sufficiently reasonable that a clarification of the meaning of "Bills Only" as a doctrine, and perhaps a slight
modification of Reserve operating practices, would produce a- situation
wherein the Committee would not be excessively critical.
Mr. Patman, of course, goes far beyond the majority position:


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"It should maintain a ceiling of 2-1/2 per cent on
long-term Government bonds now. It should--to use a
dirty w o r d - - ' p e g ( Government bonds ."

p. 67

-4-

Consumer Credit Controls
The Committee agrees with its Staff Report's attitude that consumer
credit control is a tool which the Federal Reserve System should have and
should use.
"More monetary tools rather than less are necessary. . .
Credit for consumers and the supply of funds for most business investment are very little affected by monetary policy, . .
"We recommend that legislation for standby regulation
of the downpayment and of the maturity terms of consumer
loans be enacted. . . sudden surges of consumer credit have
from time to time been an important source of instability. . .
the rapid rate of expansion of consumer loans in some p e r iods has contributed to inflation through its effect both on
prices and w a g e s . "

p. 33

Mr. Patman, again, is in opposition to his own Party's majority
view. He objects to the authorization of standby consumer credit controls
on a number of grounds.
". . .but selective controls first and foremost over
business credit--both for inventory speculations and
expansions of productive capacity. ". . .
"If we eliminate competition in these services, then
elimination of competition in interest rates is almost sure
to follows. " . . .
" . . . it provides no means for stimulating consumer
demand when it is too low, which is the more usual state
of a f f a i r s . "

pp. 67-8

R edis c ounting
The Committee takes a very definite stand on the question of rediscounting: it should be abolished.


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"R edis counting should be eliminated as a general
practice. It should be allowed only when a member bank
encounters potentially serious difficulties not of its own
making. " . . .
"If rediscounting is not eliminated entirely, at least
the use of the rediscount rate as an influence on interest
rates should be. The discount rate should be made a
penalty rate, and only adjusted for the purpose of keeping
it so. "

p. 32

-5-

Rediscounting (continued)
Mr. Patman, once more, is in disagreement, on the ground of
regional needs, and on the additional ground of difficulties which the
country banks might encounter in buying and selling on the open market.

p. 68

The Reserve Requirement Tool
The Committee contends that the Federal Reserve System is at fault
in not having raised reserve requirements since 1951.
"The Federal Reserve, in extensive hearings and
questioning, has been unable to provide us with an
economic or monetary justification for preferring lower
reserve requirements instead of the open-market method
of expanding the money supply when necessary. "

p. 44

It is implied that the Federal Reserve is guided by the banks' profit
motives and that this is pushing the System to an ill-chosen goal.
"It appears to be aiming at a general reserve requirement level of about 10 per cent which, in the opinion of this
committee is not necessary nor in the public interest. " . . .

p. 43

"In f a c t , if instead of the policy of lowering reserve
requirements, the expansion of credit which was created
by this means since 1953 had instead been created by openmarket operations, the net increase of revenue to the T r e a s ury at the bond rate would have amounted to a total of almost
$500 million and at a present annual rate of some $112.7
million. "
p. 44
and table
p.45
M r . Patman agrees in this case, but would like to go a great deal
further.


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"It would not restore to the public the Government
securities which the Federal Reserve System has given away
from the vaults of the Federal Reserve banks in the course
of its successive reductions in reserve requirements since
1951. There should be a restoration of reserve requirements
and a return of these assets to the Federal Reserve System. " p. 72

-6The Money Supply, and the "Bills Only" Doctrine
The Committee considers the problem of the long-run growth in the
money supply and comes up with the thought that the way to increase the
money supply would be for the Federal Reserve to purchase about $750
million per year (at the beginning) of Government securities.
"If such secular expansion were to take place under
present conditions, it would appear that the purchase of
long-term securities for this purpose would be warranted.
This would help to lengthen the debt structure, increase the
price of bonds, and have the effect of lowering the longterm interest rate. "
It is not made clear whether or not this proposed purchase program
for long-term bonds is or is not in addition to the suggestion that the System
work back toward a figure of around 21% in long-term issues in its portfolio.


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p. 46

I


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READING GUIDE
AND

PRELIMINARY COMMENT

*
THE STAFF REPORT ON
"EMPLOYMENT, GROWTH AND PRICE LEVELS"

1|85> pages - about 21^0,000 words
Published - December 2k, 19^9
86th Congress - 1st Session
Joint Economic Committee:
Paul H. Douglas - Chairman
Wright Patman - Vice Chairman
Authors
Otto Eckstein
James W, Knowles
Warren L. Smith
Norman B» Ture*
Harold M. Levirtson
and many others

Prepared solely for personal
desk reference.
Wednesday, January 20, I960.
James L. Knipe

"

INTRODUCTORY COMMENT

This is not a partisan report in any obvious sense. It goes out
of its way from time to time to direct some small criticism at earlier
Democratic administrations. It is partisan and disingenuous, though, in a
much subtler, wider, and more important sense. This is repeatedly illustrated in the way it skims over the self-interested actions of the great,
voting groups, and concentrates instead on the alleged faults or weaknesses
of elected or appointed officials, such as the Federal Reserve or the Treasury or the Budget Bureau0
Any report on the inflationary processes of recent years which
claims to be non-partisan, "scientific," must constantly emphasize that the
main forces behind the price rise are:
the organized power of labor,
the market power of manufacturing, and
the political power of agriculture.
It is these groups, promoting their self-interest with skill and unrelenting
tenacity, which wreak the damage on
preachers,
teachers,
Government employees,
career members of the Armed Forces,
holders of insurance policies,
bondholders,
retired people,
annuitants, and
pensioners.
Regardless of how courageously any elected or appointed group may wish to
protect the dollar, as a matter of justice, the effort is of£en thwarted by
the three great power groups,,
Perhaps this is the way it should be in a democracy. If the three
great power groups represent, say 80$ of the people, and those harmed by inflation amount to only 20%, then perhaps the moral principle of an. honest
currency should be ignored. Shocking as this may seem, perhaps the selfinterest of those who have learned to ride the whirlwind of inflation should
be the determining factor. It has certainly been so in recent years. Of
course, some of the elected or appointed leaders who are trying to safeguard
the currency make every effort to convince the inflation-promoters that it
is not truly in their self-interest to chip away at the dollar, if regard
is paid to the longer pull. These warnings have, so far in the last fourteen years, fallen largely on deaf ears.


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-2-

The Report treats the activities of these large power groups
quite casually, especially in the cases of labor and agriculture. One
would almost think that a few officials in Washington might, if they only
possessed a bit more intelligence and courage, enact laws and establish procedures which would reconcile the irreconcilable and thwart the will of the
80$ or so who are enjoying the inflationary years so thoroughly.
The evasiveness in this Report may be irritating, but it is not
much worse than the same characteristic in the writings of some of those who
are endeavoring to protect the currency. The real inflationary culprits are
never named arrithe writings are filled with economic double-talk which
serves to remove a large percentage of the meaning for many readers.
The Report is stimulating and interesting, lucidly written in
some of its most difficult sections. ¥ithin the limitations imposed by this
reluctance to offend the large groups of inflation-promoters, it gives the
appearance of intellectual honesty and of imaginative analysis, along with
many traces of the rankest amateurishness.
There is an impression here and there of brashness and overstatement. This is inevitable when bright young men are trying to jar their
elders out of their intellectual ruts. In so far as the apparent brashness
stems from disregard of facts, it should properly be criticized, but in so
far as it stems from a cheerful disregard for unsupported, and unsupportable,
theories of academicians who, to these young authors, seem to be out of touch
with the world, it might be applauded.
A more important question is whether or not the Report is realistic,
Will all, or most, of the things be done which are recommended as needed to
reconcile full employment, growth, and dollar stability? The answer is, of
course, negative. At most, a few things will be done. Therefore, the
Federal Reserve will, a few years hence, probably still be struggling along
as the loyal defender of the dollar, with few allies and beleaguered on all
sides by critics. Holding a beach-head of economic integrity may, however,
in the long run, lead to winning the war for a stable unit of' currency in
the United States.
Coming down to the Report's comments on the detailed operations of
the Federal Reserve System, are the suggestions and criticisms logical and
helpful? These questions are taken up in the body of a preliminary outline
of the Report, which is attached, following a one-page summary.


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ONE PAGE SUMMARY

Almost constant full employment, strictly defined, together with
rapid growth, optimistically defined, are twin policy goals which far outweigh the honest dollar goal. Policies should be geared, first, to these
two objectives, with purchasing power stability an important, but definitely
secondary, goal.
General monetary policies have not been very effective in the
postwar years and this is just as well, because if they had been as effective
as their proponents expected the results would have been disastrous.
Inflation has arisen primarily out of the unrestrained use of
market power by labor and management, especially in the steel and automobile
industries. Management's market power should be restrained. There is not
much that can, or should, be done about labor's market power. The enormous
corporate profits of postwar years may be the most important factor in the
process of inflation„
Federal fiscal policy has been so thoroughly inept, at least since
19^2, that it has accentuated cyclical tendencies, instead of exerting the
proper contracyclical pressures. Many reforms are recommended.
All of this has left the Federal Reserve with an extremely difficult job, which it has not performed with any particular skill or imagination.
The System needs to think through a number of its basic philosophical attitudes, as well as some of its procedures.


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The big questions are:
(1) Why not use a selective control on consumer
credit?
(2) ¥ould a selective control for inventory be
possible?
\
(3) Is there a way to devise a selective control
for plant and equipment?
The small questions are:
( ) Is the discount rate policy properly thought out
1
and administered?
(2) Why have reserve requirement raises not been
used in recent years?
(3) What is the policy now generally called "bills only"?
(U) Can policy administration be streamlined?

HISTORY AND THEORIES OF INFLATION
Burden and Danger
In a large Report, prepared by a number of writers in a
short time, it is to be expected that inconsistencies will be found
here and there. Comments with regard to the burden of inflation
afford a good example of this sort of thing. Inflation is spoken of
as though it were dangerous and unjust at times, and at other times
as though it were not really very important:
"Stable prices are a desirable attribute of the
American economy. When inflation occurs, some groups
gain and others lose in a pattern which is unjust."

p.

7

ft

The hazard of a creeping inflation turning
into a gallop is truly perennial, and requires constant anti-inflation efforts/1

p. 11

And yet the Report makes this
remark, in connection with the
hypothetical imposition of price and
wage controls:
"The imposition of price and wage controls . . .
would be wholly unjustified by the small increases
in the price level which have occurred."

p. 29

In another place, it is implied
that escape from the burdens of inflation is not particularly difficult
or unusual. Discussing the rise in
common stock prices since 1939
( 5 $ , and of real estate ( 0 ^
30)
20250^), the Report says:
"On the other hand, the cost of living has
advanced only by approximately 110^ ... a household
that had divided all its assets between real estate
and common stock and had at the beginning of the
period financed one-half of its total assets by
borrowing, would at the end of the 20-year period not
only have preserved intact the purchasing power of
its net worth, but would actually have increased it
by 60 per cent."
It is not easy to generalize as to the basic attitude of
the Report toward the burdens and dangers of inflation, but it
certainly seems fair to say that the authors are a great deal less


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p. 113

-2-

concerned about the damage and injustice brought on by inflation than,
say, officials of the Treasury, or of the Federal Reserve System.
History of Post-World War II Inflation in the United States
The fourteen-year period, 1946-1959 (September) inclusive,
showed three main periods of rising price levels. These were:
Consumer Price
Index
(1) 1946-48 (3 years)
1949

(1 year)

Up
Down

2 . points
49
2.1 points

(2) 1950-51 (2 years)
(Korean War)

Up

12.5 points

1952-55 (4 years)

Up

1.5 points

Up
Up

(3) 1956-59 (Sept.)
(about 4 years)

Wholesale Price
Index
Up
Down
Up

33.2 points
5.1 points
1 . points
53

Down

1.1 points

1 . points
06

Up

7.8 points

47.4 points

Up

50.1 points

From
table
p. 104

Referring to the Consumer Price Index, this upward movement in prices amounted to 61$, with a little more than one-half of
the increase occurring in those three disastrous years, 1 4 - 7 4 ,
964-8
a little less than one-quarter during the two-year peak period of
the Korean War, 1950-51, and about one-quarter in the last four
years, 1956-59, of so-called creeping inflation.
The Report fails to emphasize at this point that iUt was
only the drop in such things as agriculture and textile prices that
kept the so-called creeping inflation from showing up in the Indexes
as early as 1952. The creeping inflation, if one looks at some
important component series in the Indexes, is really a phenomenon
of the last eight years, 1952-59, rather than of just the last four
years, 1956-59.
It is not easy to understand how the Report can refer to a
rise in the Consumer Price Index as ". . . the small increases
in the price level which have occurred."
In looking at the Consumer Price Index, it is seen that
the "All Services," with a weight of 3 . , and a rise of 50.7$ from
21
1947 to 1958 (compared with an increase of 29.3^ for the entire
Index in those twelve years), made a huge contribution to the inflationary process. A similar effect of "Services" shows up in the
GNP Deflator.

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29

From
table
p. 105

History of Post-World War II Inflation in the United States (coutinued)
Another sector which gave a strong push to the price level
was "Construction." As shown in the GNP Deflator for 1947-1958,
"New private construction" has a weight of 8.5 and went up 4&«4^
as compared with 33.4^ for the GNP Deflator as a whole.
As measured in the Wholesale Price Index, for these same
years, "Machinery and Motive Products," with a weight of 19.3,
pushed upward 6 . per cenu, compared with 23.7^ for the Index as
19
a whole, and contrasting with declines of 6 6 in "Textile Products"
.^
(weight of 7.5) and 5.1$ in "Farm Products" (weight of 1 . )
07.
Also in the "Wholesale Price Index for these years, "Metals
and Metal Products," weighted 13.5> rose 6 . $ The report stresses
47.
the significance of these two groups, "Machinery and Motive Products,"
and "Metals and Metal Products.":
"The two latter groups not only account for
almost one-third of the direct weights in the WPI, but
also have a very considerable immediate impact on the
prices of other goods which use steel and other metal
or metal parts, and a longer run impact on other
prices through their effects on costs of machinery
and equipment. These two sectors also account for a
large part of the 55 per cent increase in the
'producers' durable equipment1 index in the GNP
deflator."
" "

p. 105

The Report takes a more detailed look at each one of these
industries mentioned as playing a meaningful role in the climb of
the price indexes. First, some remarks about "The Service Industries,"
which gave powerful aid in the rise of the Consumer Price Index and
the GNP Deflator.
*
It is pointed out that "Services" have not only sh6wn large
price increases but have also moved upward in every year since 1945*
p. 130
during recessions as well as booms. In view of this relentless price
rise, it is significant that:


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"... the services industries provided the most
important sources of employment expansion after the
war. After one year of no net increase from 1947 to
1948, employment in services has risen annually.
From 1953 to 1957, the average annual rate of increase
in services employment has been 3.4 per cent. This
contrasts sharply with a drop of approximately 1 per
cent per year in manufacturing, mining, and 'transportation and public utilities,1 and to a rise of only

-4-

History of Post-World War II Inflation in the United States (continued)
1.7 per cent per year in construction and 1.8 per
cent in trade. Put another way, the very great bulk
of the expansion of employment in the economy as a
whole after 1953 can be traced to the services
industries."
Additionally, services have claimed an increasingly
important share of total consumer expenditures, growing from about
to 38^ of the consumer's budget, from 1947 to 195&.

p. 130

p. 130

While the term "services" is often spoken of as some sort
of a homogeneous mass of labor, it is really no such thing, as the
Report makes clear. It consists of such diverse elements as
utilities and transportation (regulated by Government), medical care
(highly skilled in many phases), barbers, repairmen (medium skilled),
and laundry workers, domestic service, etc. (low skills), Comments
or analyses must necessarily take up such differing categories as
separate subjects for discussion.
p. 133
In discussing the unskilled occupations, the Report affords
a good example of reticence and understatement, together with what
certainly looks like naivete. One needs only to have observed
unskilled workers at their jobs in recent years to realize that their
productivity must have dropped sharply as compared with men and
women on factory production lines. It is perfectly clear why it is
often cheaper to throw away a piece of household equipment, and buy
a new one, than to attempt to have it repaired. But, the Report
treats this situation with great delicacy:
"The final variable which may explain the price
movements in services is productivity. Here no
reliable data are available. The nature of the
occupations involved, however, is such that i^ is
quite probable that productivity increases have been
considerably lower in these sectors than in the
goods-producing industries. . ."

p. 135

Similarly, the spreading effects of union power are
shrugged off as of little importance:


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"Except in so far as the wages in services have
been increased more than otherwise by the indirect
influence of union pressures elsewhere— a possibility
not generally supported by the data available —the
higher prices in the unskilled services appear to
be the result of normal competitive market forces."

p. 135

-5History of Post-World War II Inflation in the United States (continued)
The authors1 conclusion would seem to be that there is no
very accurate way to generalize about the price rise, since the
skilled workers appeared to have been affected largely by "pure demand p. 136
and supply," while the unskilled workers presumably allowed their
productivity to decline, and also may have been affected by other
factors. No attempt is made to point up the obvious fact that the
supply and demand situation during almost constant full employment has
exerted a great influence toward lower productivity on most unskilled
workers who are not subject to the discipline of a factory production
line.
Turning to the construction industry, the analysis is so
contradictory and inconclusive as to be thoroughly confusing. This
is especially true with respect to the market power of labor unions.
At one point it is asserted that


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l!

An examination of the trends in real output in
the industry suggests that at least a good part of the
explanation nay be found on the demand side of the
market . . . Under these conditions, it is most
difficult to believe that demand did not constitute
the major underlying cause of the inflation which
occurred during this period."
p. 120
But twenty-two pages later:
"Average hourly earnings in the construction
industry also rose by considerably more than those
in manufacturing from 194? to 1953 and by an amount
about equal to those in manufacturing from 1954 to
1958. The nature of the construction industry is
such as to create conditions which are very favorable to the exercise of market power by unions.
First, the industry is strongly organized by
several unions representing highly skilled craftsmen, who are limited in supply. Second, the competitive area of the product market is almost completely
local, so that no problem of outside competitive
pressures or of 'runaway* shops exists. Third,
bargaining is conducted very largely by autonomous
local unions, subject to considerable interlocal
rivalries. And, finally, the settlements negotiated
in the residential sector of the industry are often
determined by the terms established by the same local
unions in the industrial and commercial sectors, where
the economic environment is generally more favorable

-6Historj of Post-World War II Inflation in the United States (continued)
to relatively liberal wage-fringe adjustments. Taken
together, all these considerations would suggest that
union power has been a factor underlying the relatively high wage increases in the industry.
n

On the other hand, however, there was considerable evidence presented in the previous section of
this chapter that output and employment trends were
extremely favorable, at least until 195 5 > and that
they continued to be quite favorable in nonresidential
construction through 1956 and 1957. Under these
conditions, it is difficult to assert that demand
considerations did not also play an important role in
the rising wages and prices in this industry. On the
basis of the available data, it is impossible to pass
judgment on the relative importance of demand versus
market power in the determination of wages in the
construction industry."
p. 150
What the Report is attempting to do in these industry
analyses is, of course, nearly impossible, in that the effect exerted
by demand for labor can seldom be clearly separated from the effect
exerted by supply of labor as controlled by the market power of labor
unions. A constant situation of full, or nearly full, employment
(high demand) affects not only the demand side of the market but,
also, indirectly, the supply side, in encouraging more aggressive
actions by unions and in discouraging productivity improvements.
Therefore, while these brief analyses are of some interest, they do
not throw too much additional light on the processes of inflation.
The authors never quit trying, though, and they do not hesitate to make a sweeping generalization with regard to the machinery
industry:
\
"The most important finding of the machinery
study, however, was that demand pressures rather than
market power played an important role in the 1955-57
inflation."

p. 124

Here they are referring to the market power of industry, rather than
to the market power of labor. In this case, as in all others in which
they are treating the market power of either industry or labor, they
can come nearer to making a case, one way or the other, when they are
dealing with industry, because a lengthening of profit margins carries
more specific meaning to most analysts than does an increase in wage
rates. The extraordinary growth in profit margins in the machinery
industry, together with the strong pressure on productive capacity,
p. 124
would seem to lend considerable validity to their contention

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History of Post-¥orld War II Inflation in the United States (continued)
that the machinery case represented a good example of demand pressure
in the major role, rather than market power, either of industry or of
labor.
With respect to steel, the Report comes to nearly the opposite
conclusion as to the reason for the price increases. Presumably the
argument as to the way in which the steel industry differed from the
machinery industry is based on the fact that steel production did not
press hard on capacity, although that is not made clear. So, although
the reasoning is not fully revealed, an explicit conclusion is drawn:
tf

ln effect, these two factors reflected a situation in which two strong groups attempted to bring
about a redistribution of income, each in its own
favor, with the result that the rest of the economy
suffered,...
"Neither the increase in steel wages nor the increase in steel prices can satisfactorily be explained
by demand factors alone* The wage and price behavior
of the steel industry represents an important instance
of inflation caused to a substantial degree by the
exercise of market power. This type of inflation cannot be controlled by policies aimed^solely at restricting total deiag-fld*" (Underlining supplied.)

p» 12ij,

Thus, the implication is that the authors believe general
credit restriction might be of some help in holding down the prices of
(1) services, and (2) machinery, but it -would have little effect on (3)
construction, and it would be likely to have practically no effect on
(U) steel.
¥hile the reasoning may not be wholly clear, and the documentation inadequate, these sections of the Report are useful, as an attempt
to be a bit iK>re specific than the usual generalization, which might run
something like this, "General credit policies are handicapped by the
fact that in certain industries, such as steel, the market power of both
industry and labor are so great as to generate inflationary price rises
almost without regard to the state of overall demand in the economy.1*
Mages and Profits
In a section devoted to more general discussion of what has
been happening to wages, profits, and prices, and to aii attempt to separate out the effects of demand as contrasted with the effects of market
power, the Report is similarly interesting but by no means entirely


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-§*
Wages and Profits (continued)
convincing:
"It is by now almost -universally agreed that the
sharp rise in prices immediately after "World War II
and the second wave of manufacturing price increases
during 1950-51**ecan be attributed primarily to demand forces**,

p* 119

"After 1955* however, the increase in output continued at a very low rate... By this point in time,
there can be little doubt that pressure on productive
capacity can no longer be considered a reasonable explanation of the continuing rise in manufacturing
prices."

p. 120

-»

Moving on to the question of just how this market power functioned, it is not necessary to pay any particular regard to the Reportfs
thesis that market power was especially important only from 1955 onward.
Their reasoning is of interest, whether it applies only to 1955-59 or
to, say, the entire thirteen years from 19hi through 1959•
Ho relationship was found between changes in hourly earnings
and employment in each industry, nor between changes in hourly earnings
and output, nor between changes in hourly earnings and productivity.
p, lit?
What was found was that wage changes in nineteen manufacturing
industries were related to (l) the level of corporate profits in the
industry, and (2) the degree of competition in the product market, as p. 1|
]7
measured by 1951* concentration ratios. The study also attempted to
check the relationship between changes in hourly earnings and "estimated
union strength." The conclusion was:
*
M
There was no generally applicable relationship
p* Ik9
evident between union strength and wage changes, however.ft
"Phis last conclusion is a challenge to onefs common sense.
It would seen to be impossible to measure "estimated union strength,tt
and it would seem much more likely that union strength, if properly estimated, would simply be added to corporate profits and corporate market
dominance (concentration) as the third principal determinant of changes
in hourly earnings. It is not necessary to argue this point with the
authors while considering the principal result of their study«-**the
shocking fact that changes in hourly earnings are not related to output
or productivity or employment. If they have really established this as
a fact, as they contend, then they have struck a great blow at an the
traditional ideas about how to control inflation.


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Wages and Profits (continued)

*9*

"Whether or not most other analysts agree with them, there
can be no doubt that this general view is widely held today among
economists and financial analysts, and it is back of the contention
that traditional control methods are not always as useful as in the
past.
Continuing their survey of the wage trends of recent years,
especially as influenced by corporate profits and corporate competitive position, they describe the development of wage "patterns," based
on "key" settlements.
p. 150
et seq,
M

3h the summer of 1955, the 'key1 bargain was
negotiated in the automobile industry, which was
enjoying its second most profitable postwar year, with
sales of over 7 million cars*..profits after taxes were
21 per cent.. Shortly thereafter, the steel industry
negotiated a wage increase.«e Output in steel had also
risen sharply from the 195k recession...1955 profits.*,
after taxes, 13.5 per cent... Before the year was out,
the leading firms in several other major industries..,,
had negotiated similar contracts, many on a 3-year
basis.
p. I i .
5|
"The results of these tuo 'patterns,1 negotiated
during periods of high output and profits, continued
to be felt throughout the declining years of 1957 and
1958.
~
'

p. 155

"It was, then, a combination of market power in
both the product and labor marketa, initiated by rising
demand and high profits, nhich accounted for the developments in these industries."
p. 158
There is no reason to question the broad statement^of the
last paragraph above. If market power (of industry and of labor) is
as strong as implied here and elsei*here in the Report, then the challenge to unquestioning acceptance of the entire body of traditional
monetary control doctrine is very real.
Theories of Inflation
The Report lists first the traditional "pure demand -pullfl type
of inflation, and points out that it can be controlled in the traditional
fashions


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"The policy implications of a demand pull inflation
are likewise quite clear. Since the basic cause is an
excess of aggregate purchasing power, policy must be

Theories of Inflation (continued)
directed toward reducing that purchasing power by
aggregate fiscal and monetary policies* And since
markets are competitive and wages and prices flexible,
this result can be achieved without developing any
serious unemployment.11

p. 115

!Eien there is the "cost-push," or "administered price," or
"sellers11 or, the term preferred in the Report, "market power11 inflation. Toward a "market power" inflation, there are obviously two major
policy approaches. The first is the traditional monetary and fiscal
approach, because unless aggregate demand keeps rising the two great
power groups, industry and labor, cannot exercise their market power.
p. 116
The third type is called "structural," and refers to a type
of inflation wherein aggregate demand in the economy is not excessive
but upward price thrusts occur"«.«in particular sectors of the economy
because of substantial and rapid shifts in demand toward those sectors.11
Continuing,
p. 116
"A net inflationary movement can result, however,
partly because of the immobility of factors of production—which prevents supply from adjusting quickly
to shifts in deamnd—-but more importantly, because of
the lack of downward flexibility of prices and wages
in those sectors in which demand has declined.11

p. 1 6
1

Conceptually, this is merely a sort of special case of "market power11 inflation, in that it is the exercise of market power which
prevents the normal, downward, counter-balancing wags and price adjustments in the sector from which demand has moved. It seems unlikely that
tf
structural" inflation can very often be identified. The inflationary
movements in the United States during recent years have embodied all
three types, and so it follows**...therefore, that any publid, policy
designed to deal with the problem must itself be diverse and flexible." p. 16*0
But these public policies are often so politically impracticable, it is suggested, that there is not much point to giving them
serious consideration. For exainpl®, in the exercise of traditional
monetary and fiscal controls, the restriction must be strong enough to p. Ik3
reduce market power. That is the only way it can work. Then comes the
question of whether or not a level of unemployment high enough to produce an effect will be socially "acceptable," or "tolerable." It was
only eight short years ago (1952) that Senator Douglas defined full
employment as 6% unemployed. Now the staff for the Committee of which
he is Chairman writes:


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-11Theories of Inflation (continued)
"Past evidence suggests, therefore, that
unemployment would have to average at least 6 per
cent to Iseep the rate of wage advance no greater
than the rate of increase in productivity. Clearly,
monetary and fiscal policies that yielded this result
would be socially unacceptable.'1
If that statement were literally true, then the proponents
of the virtues of monetary and fiscal controls would surely be on
the horns of a dilemma, and they would be there even if everyone
were suddenly to proclaim that monetary and fiscal policies represented the best possible way to fight inflations. It is certainly
possible that the quoted statement above is true, that the American
public is so interested in full employment that even small deviations from it, in order to protect people from the injustices of
inflation, will not be countenanced.


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-12CQNTRQL OF INFLATION, NON-MOMETARY
Antitrust Action
The principal thesis of the Report, that public policies
must be diverse and flexible to deal with the modern forms of inflation, leads to the consideration of market power and how to deal p. 160
•with it. Antitrust action comes to mind, and it seems to the authors
to have some obvious usefulness when applied to business firmsj
"This approach has the immense advantage of not
only reducing this source of inflationary pressure,
but also raising the effectiveness of the economy
for growth, for reducing undesirable concentrations
of power in private hands, and accomplishing all
this without increasing the amount of government
intervention in the private economy.«

p» it-32

So, a recommendation is made*
ft

¥e recommend that the basic approach toward
the problem of market power should be through a
considerably expanded antitrust program.*

p. 1 3
|3

This includes a word to the
Federal Reserves
W

A similar 0valuation of the effects of the
Federal Reserve Board's policies toward bank
mergers would be desirable.n
The suggestion made by many people that stepped-up antitrust activity might be a good thing, also, in the case of the
labor unions, leads the authors to discover several reasons why the
suggestion has no value. They say that the application of antitrust laws to the labor market would « . . . strike at the very
existence of unionism and collective bargaining itself.* I\
might be «. . . tantamount to stating that unions per se will be
unlawful."

p. k33

p. k3k

Dismissing this first suggestion as to how union power
might be curbed, the authors turn to two other ideas which have been
advanced, (1) the outlawing of industry-wide bargaining, and (2)
the outlawing of national union participation in bargaining. After p. 1*35
a brief discussion, these two harsh thoughts are also discarded.
They quickly wash their hands of all such ideas, and go back to
p. U36
contemplation of how useful it would be to turn antitrust forces
loose on business:


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-13Antitrust Action (continued)
"We believe, therefore, that the antitrust approach
to the problem of market power in the labor market is
neither feasible nor desirable, and would create many
more problems than it would solve. It may well be,
nevertheless, that stricter antitrust enforcement in
the product market . . . would have favorable indirect
effects on wage pressures as well.n
p. Ii36
Other possibilities
Moral suasion, the Report has to admit, is not likely to
accomplish very much, if anything. In a competitive economy, busip. 1±37
ness executives and labor leaders do not construe their jobs to be
to work for the common good, but for the immediate and direct
interests of those who hire them. One proposal, though, might
p. k37
have some slight value, " . . . an annual conference of business,
labor, and Government leaders.n But it might " . . . become a
mere public forum for presenting the viewpoints of special interests.11
About the only other thing left along these lines would be
an increased Government participation in the price-wage-setting
process. In considering this course of action, the Report suggests "no," then suggests ttyes,B and, finally, tosses it back to
the public. Apparently this problem was too hot for even the
confident authors to pass judgment on:


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"There is always the danger that Government
participation in the determination of wages and prices
will interfere with the proper allocation of resources
among industries, will have an adverse effect on the
incentive of labor and capital in the industry, and
will particularly in the long run, create more
serious problems than it solves.**
^
p. 1^3?
V
But:
^Nevertheless, society also has the right to
impose limitations on the exercise of private market
power, if it is felt that market power is being used
in a manner detrimental to the basic interests of
society. Our studies suggest that market power has,
in fact, contributed to the inflation of recent years." p. 1*38
So, although they are very willing to
pass grave judgments in other places in the Report,
here they walk away from the problem;

Other Possibilities (continued) • *
2*
"The problem of balancing these divergent considerations is, of course, a judgment only society
can make."
In quite another area of action, but one which is also
closely tied in with the market power of business, the Report
suggests that w ... we should steadily continue to reduce
tariffs." Apparently it is realized that this recommendation is
not very likely to be acted on, or produce any effects at all,
because it is dismissed in one paragraph.
Control Through Fiscal Policy
During the*last twenty years it has become accepted doctrine among most economists that a reasonable use of Federal budgetary surpluses and deficits in a counter-cyclical pattern might be of
considerable assistance in damping the fluctuations of the business
cycle. At the top of the cycle, surpluses would tend to reduce the
money supply and, perhaps, the velocity of spending. At the bottom
of the cycle, deficits would tend to expand the money supply and,
possibly, step up the spending velocity. This neat theory is based
on the tacit assumption that the fiscal actions will have no unexpected, additional effects of some sort on business confidence,
beyond these conventional effects which have been postulated.
As an additional refinement to the theory, planners would
hope that the restrictions at the top of the cycle and the stimuli
at the bottom of the cycle might have particular effect on industries which are in need of restriction or stimulation, i.e., that
Federal spending increases and decreases would be directed to where
they would do the most good, counter-cyclically.
This Report surveys the Federal budgetary record of the
postwar years, finds it falling most of the time far short of what
the theory demands, and suggests improvements. Even in the cases
where a reader agrees with the line of reasoning, some of the suggestions for improvement seem naive. They either cannot be carried
out, or will not be carried out. Even a man like Treasury Secretary
Anderson, eager to make every possible use of budgetary policy as an
economic control tool, points out the practical barriers on the road
to accomplishment of some of the widely-accepted theoretical goals.


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First, it is pointed outt
"Changes in the volume and character of Federal Government demands, particularly for defense
purposes, have been an important source of economic

p. 1*38
^.
.*
p. k3k

-15Gontrol Through Fiscal Policy (continued)
"instability. The postwar period has seen several
rising and falling waves of defense procurement
activity, in connection with the Marshall Plan,
the Korean War, the post-Korean defense program,
and most recently the post-sputnik defense

*"*

program." ...

p. 215

"The postwar record strongly suggests that
relatively moderate changes in defense orders
for hard goods are closely associated with
relatively large fluctuations in total demand
for durable goods and in plant and equipment
expenditures."

p. 262

These shifts in both volume and character of Federal
spending seemed to have unfortunate effects at various times, with
the sequence of events in 1956-57 as a good example. In early 1956s
"Increases in Federal demands, therefore, were
concentrated in the very sectors in which total
demand was rising and in which strong upward price
pressures were developing, and at the very time at
which private demand was at a peak.11

p. 2lj.8

This changed rapidlyt
"From mid-1956 through the third quarter of
1957, defense orders for hard goods declined substantially, after a sharp rise in the preceding year. . .
"Total new orders, civilian as well as military,
in this industry were $6.5 billion in the second
half of 1956 but fell to $3-7 billion in the first
half of 1957 . . .
"These simple magnitudes do not convey the full
significance of this cutback. Because of the rapidly
changing technology in military hard goods, any
given change in the volume of orders for such equipment is likely to result in a substantially magnified
change in total new orders for durable goods."
The Report takes the stand that nothing much can. be done
about these swift and largely unpredictable zigzags in defense
spending. After all, defense does come first. The recommendation,


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p. 250-1

-16Control Through Fiscal Policy (continued)
therefore, is to learn to live with them and to try to make compensatory
adjustments in taxes—an unrealistic proposal for a solution to this
rough problem. If any counteracting adjustments are to be made, it
would certainly appear that they will have to be made in expenditures, *•-*
not in taxes. Even there, the lag problem is in itself almost insuperable, or so it would seem at this time. However, here is their
conclusion and recommendation:
w

Decisions with respect to the volume and
character of defense procurement should be made on the
basis of judgments about the Nation's long-term
military posture. They should be divorced from shortrun budgetary considerations and prospects concerning
the level of economic activity. On the other hand, these
decisions should be a major consideration in formulating
stabilization policies" . . .
" . . . Public policy should be prepared to make
compensatory adjustments, primarily in taxes, on a
timely basis in response to these disturbances originating in changes in defense demands."

p. 26?

Admiration of the authors for compensatory adjustments in
taxes is not entirely clear in the matter of how much affection
they have for tax raises. As to tax decreases, there is no question
about their enthusiasm. As one reads along through these sections,
he has no trouble in finding specific reference to the usefulness of
tax cuts, but references to the worthwhileness of tax increases are
couched in the vaguest and most general terms. As an example, they
like the reductions of 19i*8 and 19£U, despite the paradoxical background of the reductions. They say nothing at all about the disastrous effects in 195>5-5>7 of the reductions of 195U.
"Discretionary tax changes have not been employed even in the face of strong recessionary and
inflationary developments throughout the economy.
Reductions in tax rates in 19U8 and 195U certainly
contributed to moderating the recessions of 19U9 and
195>3-£U respectively. In the former case, however,
the reductions were enacted despite the general
assumption that inflationary, rather than recessionary, influences dominated the economy. In the latter
case, the reductions were automatic, pursuant to the
Revenue Act of 1951.w
Commenting on the 19^7-58 period, when the President so
staunchly resisted tax-cut demands from every quarter, the Report
dismisses the political courage and economic good sense of President
Eisenhower with this curt remark:


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?• 216

-17Control Through Fiscal Policy (continued)
"Tax cuts were proposed and explicitly rejected
as an antirecessionary policy instrument in the
recession of 1957-28."
Consideration of this subject of compensatory tax adjustments is terminated with the recommendations
"In short, more vigorous fiscal policy for
economic stability calls for principal emphasis on
tax rate changes and minimum reliance on expenditure
changes . . ."

p. 265
«-*"

p. 266

There is some doubt as to (1) whether or not this recommendation really embraces the tax increase side as well as the tax
decrease side, and (2) whether or not this proposal is politically
realistic enough to have any meaning at all.
The only slightly encouraging factor which can be seen in
the Federal budgetary picture is something which is mentioned in
several places in the Report, that is, the small stabilizing effect
automatically exerted by the tax "take." The authors suggest
strengthening these automatic fiscal stabilizers?
"Automatic fiscal stabilizers should be
strengthened, particularly with a view toward increasing their sensitivity to changes in employment.
«... The automatic stabilizers, however, have
only a limited function to perform? they can damp
down fluctuations but they cannot prevent them . . .
". . .Of the built-in responses, that of the
corporation income tax is by far the most pronounced.
Its effect in stabilizing corporate outlays, however,
does not appear to be particularly great. Changes in
individual income tax liabilities, on the other hand,
seem to be associated with relatively substantial
changes in consumption outlays."

p. 266

While the Report provides some stimulating reading on the subject
of fiscal history and policy, and their relationship to control of inflationary tendencies, it does not bring to the reader a sense of nearby assistance
in the handling of inflation. As in the case of the other non-monetary
controls, antitrust action, moral suasion, government wage-price intervention,
and tariff reduction, the discussion is interesting but the proposed
"solutions" are either so weak as to have limited meaning, or so unrealistic
as to make certain that they will not be followed. The responsibility,
therefore, for controlling inflation will continue, it would seem, for the
foreseeable future to be in the hands of the monetary authorities. If they
are to do the job, they must have added public understanding and cooperation.
The Report next takes up -foese matters in the chapter entitled, "Monetary
Policy and Debt Management."

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-18GENERAL MONETARY POLICY
The Alleged Price
In this section of the Report, mainly Chapter IX (Pages
315-428), the two principal themes are:

~-*

(1) control of inflation solely by general monetary
policy involves too great a price, and
(2) general monetary policy is often a crude and
clumsy tool, or, to change the metaphor, a shotgun instead of a rifle.
Looking first at what the Report has to say about the price paid for
stabilization of price levels via general monetary and credit policy,
these quotations are typical:
fl

lt is doubtful that a secular upward trend in
wages and prices can be avoided with an average level
of unemployment which is considered socially acceptable, given our present types of anti-inflation
p. 144

"Under some circumstances, public policy may
have to choose between the price level and the rate
of employment as the stabilization objective. In
such circumstances, greater emphasis should be
placed on stabilizing the rate of employment."

p. 264

With respect to growth:
"A considerable amount of growth was sacrificed
in order to prevent inflation; and the policy tools
that were employed were not capable of containing
inflation."
These quotations are, of course, simply expressions of opinion.
The Contentions as to Impact
If a line of argument can be sustained that the differences
of impact of general monetary policy on various sectors of the
economy are so meaningful and so unfair that they more than counterbalance whatever price-level stabilization ensues, then the case for


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p. 95

-19-

The Contentions as to Impact (continued)
more extensive use of supplementary or alternative selective control
devices might be sustained. This is the line of reasoning pursued
by the authors.
First sector explored is residential construction. Here it
is initially implied that the impact has been too great. The
evidence adduced points out something different, at least as to future
possibilities. Is/hat develops out of this study is that the sharp,
countercyclical effect of recent years has been due almost entirely
to the interest ceilings on FHA and VA mortgages. Instead of too
pp. 363great an impact, the more important likelihood is that, if the ceiling
368
were removed, the impact would be so small as to be almost useless.
This directly opposite likelihood is stated at the end of the
section:
"But instead of behaving in a contracyclical
fashion, as has been the case in the last few years,
it seems likely that the income effect would dominate
and the fluctuations would be procyclical, thus
contributing to overall instability."

p. 368

Based on this theorizing, but with the available historical
evidence indicating the opposite situation, the authors go on to
propose a selective control for residential construction. They
suggest that it might be advisable to retain the present interest
rate ceilings rather than to try to develop a new control:
"The question is whether it would be better to
keep the present interest rate limitations, recognizing them frankly as a selective credit control,
and manipulating them accordingly, or to adopt
another kind of selective regulation in the form of
variable controls over downpayments and maturities
of mortgages.11

pp. 400-1

None of this is very convincing and the case against general monetary controls in the field of residential construction cannot be
sustained with this kind of "evidence.11 It is merely an expression
of an opinion. The treatment of the interest ceilings as a selective control device, though, is a thought-provoking approach.
In connection with the financing of state and local
projects, such as schools, hospitals, and water systems, the available yearly dollar totals which are cited seem to indicate that
general monetary policy of recent years has had relatively little
effect on this financing. If anything, the desired cyclical counter- pp. 381-85
action effect gives the appearance of being too small, rather than


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-20The Contentions as to Impact (continued)
too large. However, the authors apparently are convinced that the
effects have been too large, and they cite an unfinished study as
indicating this. In addition, they express the opinion that the
p. 363
increasing school-age population may be pressing too hard on existing ^-*
school facilities. If this is meant to suggest that certain public
facilities, such as schools, ought to be exempted in some way from
the effects of countercyclical monetary control efforts, then this
should be frankly stated. Neither the figures nor the prose in this
section of the Report are convincing as an argument either for or
against general monetary controls. If a social problem like this one
is in need of special treatment, and the need can be clearly established, that is a problem quite separate from that of the effectiveness or lack of effectiveness of traditional countercyclical money
and credit efforts.
The financing of small businesses, in contrast to larger
ones, has often been suggested as being somewhat more affected by
general monetary policies. One's common sense would lead to
acceptance of this thought as containing at least a kernel of truth.
After all, marginal firms are presumably affected first when available
credit is bid for in ever-increasing amounts at the top of an inflationary boom. Marginality is surely associated, in some cases, with
smallness. And yet, the Report says:
"However, as to whether there has in fact been
such discrimination in the last few years, the
evidence is mixed, difficult to interpret and highly
unsatisfactory."

p. 378

Quoting similarly indeterminate findings of a Federal Reserve study
the authors are left with no tangible evidence on which to rely and
so, once more, they theorize:
"That is, if monetary policy works chiefly through
availability and if availability is not a problem for
large firms, it follows that when monetary policy is
effective in curtailing business spending, its impact
must fall mainly on small business."
p. 381
No matter how charitably one would like to regard such
theorizing, all that can be said for it is that it obviously harbors
a small amount of logic. The unprovably strong statement in the
last few words of the quotation is not justified.
Glancing back at the three areas examined to here, the results are not too reassuring as to whether the authors are really
eager to work with facts or to air their favorite theories. In the
case of residential construction, the evidence indicates a large
countercyclical response to policy in recent years. However, they
quite properly point out that this is largely because of the existence of interest rate ceilings, and then go on to theorize that the

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.
-21The Contentions as to Impact (continued)
industry otherwise would not respond properly to general monetary controls and so needs a selective regulation. As to state and local
projects, the evidence does not back up the thought that general
monetary policy has been too effective, i.e., has evoked too strong
a countercyclical response. The same thing is true in the case of
~-*
small businesses. So, in both of these cases, they are left with
their own value judgments as the only basis for criticism of general
monetary policy. Therefore, a strong statement like the one quoted
below represents nothing more than an opinion, unsupported by any
substantial evidence. If the opinion were not expressed in such exaggerated terms, one would pay more heed to it as an opinion:
"General controls are a mirage and a delusion.
It is perhaps just as well that monetary controls
have not been very effective; if they had been,
they might have been disastrous.tt

p. 401

Next areas to look at are the three great originators of
imbalance in the American economy, the three great "causes" of
cyclical swings. These are ( ) inventories, (2) expenditures on
l
plant and equipment, and, less important to many analysts, (3) consumer credit. Whatever control method, or methods, will produce a
strong countercyclical response in these three areas will be the
one which is truly effective. Evaluation of any method hinges on
how well it performs in restraining the sheep-like movements of
the business and financial world, in the first two cases, and
similar movements of consumers in the third case.
The Report does not agree that changes in the rate of
business inventory investment and disinvestment have been a serious
factor in producing instability during the postwar period. It is
not necessary to debate this point, because the problem of inventory
control is treated in the Report as seriously as though the authors
thought inventories had been originators of imbalances,.

p. 399

It is the contention of the authors that general monetary
controls do not exert a strong influence on inventory investment:

p. 391

"In any case, there is certainly no evidence
that monetary policy has had any appreciable effect
on inventory investment and its fluctuations in the
last few years."
Nor, it should be added, is there any evidence that it has not had
an effect. The relative moderation of inventory swings of the last
nine years, years of actively-practiced general monetary policy,


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p. 392

-22-

The Contentions as to Impact (continued)
might at least suggest the usefulness of the countercyclical efforts.
Having rendered their judgment that general monetary policy
is not effective in the control of inventories, the authors go on to
lay out proposals for how to go about the job. They mention the
possibility of a variable secondary reserve requirement as a way to
control bank credit—an old idea, possibly a good one, used in some
p. 399
countries, but with some dangers, especially with relation to Federal finance. Another possibility mentioned is the basing of reserve
requirements of commercial banks on types of assets, rather than on
liabilities.
All of their discussion on inventory swings, and how to
restrain their amplitude, is useful, even though the initial statement of the problem may not be adequately backed by facts. The
Federal Reserve System should, it is often said, have under way at
all times studies leading to the determination of how effective
monetary policy has been in various areas of the economy, and as to
how it might be improved. All specialized treatments, such as various
forms of secondary reserve requirement plans, need to be re-studied
frequently in the light of changing conditions.
When the authors turn their attention to plant and equipment
expenditures, probably the greatest single de-stabilizing influence in
the economy, they find themselves unable to obtain facts in satisfactory
form, and unable to come to any very firm conclusions as to what they
think ought to be done. It seems clear to them that they cannot find p. 368
solid evidence as to how much the rate of investment is restrained
et,seq.
by rising interest costs. They recognize that internal financing
often decreases the sensitivity of corporations to changes in the
interest rate structure. After considering the different aspects of
how corporations set their capital budgets, they conclude:
M

. . . that while changes in interest rates and
credit availability brought about by monetary policy
have some marginal influence over business investment
expenditures, these effects are so weak that they are
commonly swamped by the dynamic forces of innovation,
surging business activity, and rising profits which
almost invariably underlie a rapid growth of investment. For example, it is very doubtful whether
restrictive monetary policy did more than touch the
fringes of the private investment boom of 1955-57."

p. 375

The authors proceed to contemplate possible actions to
improve on the countercyclical responses to general monetary policy.
They mention the prewar experiment, a tax on undistributed profits,

p. 397


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-23-

The Contentions as to Impact (continued)
as one way to increase the influence of the interest rate. Means of
controlling at the source the flow of funds into fixed investment are p» 398
considered. But their conclusion expresses the uncertainty which must *"*
plague any analyst who studies this most difficult of all cyclical
(and secular) problems:
tt

¥e may conclude that, while the proposals referred
to above and others as well are worthy of study, it is
by no means clear that it would be either desirable or
feasible to apply selective controls to business expenditures on plant and equipment* Some instability
may be the price we have to pay for a generally high
rate of capital development; moreover, it is by no
means certain that controls would be effective in preventing instability."
A realistic conclusion, and one tAiieh at least implies that general
monetary policy is now doing all that could be expected in this volatile sector, tiiile preserving a system of economic freedom in the
United States.
Moving to the behavior of consumers in the purchase of consumer durable goods, based to an important degree on consumer credit,
the Report cites the sheep-like behavior of both lenders and borrowers, p* 389
which heightens the necessity for stronger countercyclical action,
as well as the occasional eccentricities which produce other odd effects, as in 1955*56-57 > mentioned in the quotation below:
w

lt seems reasonable to conclude that, while general controls almost certainly have some effects on
consumer credit, these effects are probably not very
great. Moreover, there is another problem that arises
when the movements in durable goods get out of phase
with the economy as a whole—as in 1956-57 when the
automobile industry was depressed at the same time that
general business conditions were reasonably good. In
such a situation, it may be desirable to tighten credit
generally without having an effect on the depressed
sector."
p. 390
The case for selective controls on consumer credit is summed
up quite impressively?


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W

A boom in consumer durable goods, especially automobiles, powered by a rapid growth of consumer credit,
in 1955> seems clearly to have been a factor in the inflationary expansion of 1956 and 1957, both through its
effect on profits and on the three-year wage settlement

-2U-

The Contentions as to Impact (continued)
negotiated on the basis of them, and through its effects
on other industries. Moreover, the excessive expansion ^.*.
in the automobile industry in that year set the stage
for the unemployment and stagnation in that industry in
the ensuing years, »• And, finally, the automobile expansion of 1955 undoubtedly helped to power the boom in
planet and equipment in 1956 and 1957> which eventually
resulted in overcapacity and unemployment**. A similar
burst of growth 11 occurred in 1959.»«and.»«is a mathas
ter for concern*
p. 399
When the Report states that the Federal Reserve System has
shown a wclear antipathy^ toward selective controls, the adjective may p. 3hk
be inapplicable and the re&o&n may be unfair, bat, nevertheless, many
people would agree. It might have been wiser for the System, years ago
(1) to have described the kind of a statute which would work, ( ) to
2
have expressed its reluctant willingness to tatos on a difficult task,
and (3) to have asked for carefully-drafted standby legislative authority. Not having done this, and having permitted the growth of this
feeling of "clear antipathy,w the System should reassess the situation
and reformulate its attitude toward the use of consumer credit control
devices.
The treatment of these three imbalance-generators is, on the
whole, stimulating. On inventories, they point out the need for different kinds of approaches in order to produce stronger effects. With
regard to plant and equipment expenditures, they do the same thing, but
they are realistic in recognition of the virtual impossibility of ever
reaching a full solution. Stated another way, it might be said that
the authors have the common sense to realize that in a system of highly*capitalized production techniques one cannot expect perfect long-range
forecasting of final markets. Then in the field of consumer credit they
expose the problem so clearly that the Federal Reserve will undoubtedly
have to take a new look at an old attitude, or, if the public has misunderstood the Federal Reserve position, explain the position with
greater clarity.
Monetary Policy Since World War II
A sketchy, unsatisfactory, and sometimes inaccurate account
of the monetary policy of recent years is found between pages 315 and
3h3« When one sees a statement like the one quoted below, it tends to
lessen interest in the rest of the narrative. Referring to the firming
ordered by the Federal Open Market Committee in early 1955* it is saids


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tt

This was the first move toward the application
of a restrictive monetary policy which was to be

-25-

Monetary Policy Since World War II (continued)
applied continuously and with generally increasing
intensity, until late in 1957.*

p. 332
*r~'

For the authors to have missed the controversial policy zigzags of
1956 is not conducive to eager readership and it is not understandable
because they mention these 1956 uncertainties twenty-eight pages later, p. 360
Their conclusions are improvable, somewhat inconsistent, and contribute
nothing to an understanding of the flow of events. For example, what
should one understand from these two generalizations, only a few lines
apart:
^Monetary policy has been more restrictive thus far
in the 1958-59 (sic) than in the same phase in 195^-55•" p* 3kk
Only a few lines before:
""When restrictive policies have been applied, their
general effectiveness does not appear to have been great,
due to the fact that the slowing down of the growth of
the money supply has been accompanied "by induced increases
in velocity.tt
p. 3l*3
Following this unsatisfactory, little, historical narrative,
there are a few pages on "some limitations on the overall effectiveness pp. 3hl
of monetary policy." The shifts of bank assets from loans to securities 362
and back again throughout the course of the business cycle are briefly
discussed, as are ihe cyclical adjustments in corporate liquidity, the
activities of financial intermediaries, and the cyclically-varying investment policies of investing groups.
These phenomena, which they call "slippages," soften the ef- p. 359
feet of restrictive Federal Reserve policies. It is not clear, in this
summary, whether they think this is useful or not. What seems to come p. 362
out of the discussion is that the general monetary policies are weakened
by these institutional escape hatches but that the restrictive effects
could not safely be any harsher anyway. This leads them, finally, to:
n

..oin light of the structure of the economy and
the nature of present-day problems, renders exclusive
reliance on general monetary controls an unsatisfactory
way of achieving sound stabilization objectives.11
p. 362
Another matter which is touched on very briefly as a further
limitation on general monetary policy is the time lag. Here again the p. 393
analysis is superficial, seeming to ignore, for example, the meaning
of all of the preliminary stimulative or restrictive signals which are
hoisted before a quantitative change in the money supply appears.


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-26-

Monetary Policy Since World War II (continued)
Certain of the techniques of Federal Reserve policy require re-thinking and overhauling, the authors feel:
"Apart from the matter of selective controls,
there is some question whether the Federal Reserve
System has made optijnal use of the general credit
control weapons now at its disposal.*. In addition,
some changes in the administrative organization of
the System are worthy of consideration."

p. i;05

The discount rate philosophy, a mystery to so many students of the System, is brought up first:
"It is not always clear when a change in the
rate is meant to be a signal and when it merely
represents a passive adjustment to the market."

p«, U05>

Pending further enlightenment by the Federal Reserve as to what the
discount rate philosophy really is, two alternative suggestions are
tossed into the pot, (1) the Bank of Canada1s link to Treasury bills,
and (2) the elimination of rediscounting altogether.
Alternative use of the reserve requirement weapon and the
open-market weapon is discussed. Explanations offered to date by
the System, as to why reserve requirements have not been raised during
recent cyclical upturns have seemingly not been entirely convincing
to the authors, as they have not been to some other analysts:
"Reserve requirement adjustments are a rather
cumbersome tool of short-run monetary policy, and
there is very little that they can accomplish that
cannot be done with more finesse by means of openmarket operations. However, it is not clear why the
System has been adjusting reserve requirements downward secularly nor where it thinks they should
eventually come to rest. Lower reserve requirements
«...improve the profit position of the banking
system..."

pp. ij.23Ifik

p. 1^06

Next technique to be questioned is "bills only." The Report calls for a clarification and takes a stand in favor of extended
System responsibility in the market:
"The policy should clearly be abandoned in its
present rather doctrinaire form... The Federal Reserve should certainly take some responsibility for the
structure of interest rates."
Here is the astonishing situation wherein these authors, and other
analysts, are critical of the System on the grounds of what it says

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p. i;06

-27-

Monetary Policy Since World War II (continued)
it does, whereas what it actually does is probably more or less in line
with what the constructive critics want it to do—a remarkable communi- ^-*
cations lapse.
Turning to administrative arrangements, two big questions are
raised, (1) would it not be better to have all of the credit control
weapons in the hands of the same agency, and, referring to the Open
Market Committee, (2) "...some streamlining of this complex machinery...'1
Getting more specific:
p. ij.07
"some streamlining of this complex machinery would seem to be in order... Perhaps a reduction of the size of the Board of Governors and
the concentration of authority with respect to all of
the policy weapons in the hands of this group.. .would
be desirable. Some reform along these lines is vitally
necessary if a more complex policy involving the use
of selective controls is to be put into operation."

p. 1407

However one may feel about such improvable dicta as those in the last
sentence above, it is true that many basic changes have been proposed
by responsible people in recent years. It would seem that the System
should at least have its own thoughts well organized on such questions,
as perhaps it has. The public should be told about them at an appropriate time«,
A little further along in the Report, the techniques whereby
the Federal Reserve System occasionally aids the Treasury in debt
management are under discussion. The authors nonchalantly come out
with one of those sweeping proposals which make the Report look
amateurish in certain places:
"There is something to be said for emphasizing
debt lengthening operations in periods when interest
rates are low in order to keep down the Treasury interest costs. If operations timed in this way should
interfere with economic stability, the Federal Reserve System should be prepared to offset these
effects by appropriate action. In this connection, it
would be desirable for the Federal Reserve to abandon
the bills-only policy and be prepared to offset in the
most effective way possible any undesirable effects
which might be produced by Treasury debt management
operations following the suggested pattern."
Have they thought out the meaning and after-effects of "appropriate
action?"


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p. U19

CONFIDENTIAL (F.R, )

January 6> I960.

A COMMENT ON "REPORT ON EMPLOYMENT, GROWTH AND
PRICE LEVELS1' OF JOINT ECONOMIC COMMITTEE STAFF
The "Report on Employment, Growth and Price Levels'" prepared
by the staff of the Joint Economic Committee for the consideration
of that Committee includes, among other contents, a lengthy descriptive analysis and appraisal of postwar monetary and debt management
policies, with a number of critical conclusions as to the conduct of
those policies. The aim of this note is to point out and discuss one
particularly significant fallacy in the premises underlying this appraisal, without attempting to present a thoroughgoing critique of
the entire discussion of the subject.
The descriptive analysis of actual developments is on the
whole competently done, although some significant aspects are neglected and fault may be found with the tone and slant of some of the
treatment. Conclusions as to the effectiveness of monetary policy
and debt management and recommendations as to changes that might be
made appear throughout the Staff Report, are summarized from $ime to
time, and are frequently repeated in the other chapters, as well as
in that dealing specifically with the subject. In many cases —
perhaps most — the conclusions and the recommendations do not follow
logically from the descriptive analysis of the events and are not
adequately supported by facts or reasoning. Nor is it demonstrated
how the changes in procedures recommended would correct the deficiencies mentioned»


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The more significant conclusions are threefold;

-2(1) Monetary controls are generally not effective in contributing to economic stability because of other factors which
affect aggregate demand and which are reflected in the velocity
of money. These include the holding and use of liquid assets
other than money and the operations of various financial intermediaries (although as to the latter the report tends to play
down their significance),
(2) The effects of monetary policies on different sectors
of the economy are irregular, partly because of varying degrees
of sensitivity in their response to interest rate changes0

Ef-

fects of monetary policies appear to be most pronounced in residential building and to some extent in the financing of State and
local governments and of small business, but are weakest with
respect to business fixed capital,, inventories, and consumer
credit, which are alleged to be the greatest contributors to
instability*
(3) In those sectors of the economy characterized by rigidly
administered prices, general monetary controls are likely to
result in curtailment of output and employment.

This is an un-

satisfactory way of controlling inflation.
Specific suggestions in the Staff Report are not precise or
definite. The logic of the analysis indicates a bias toward greater
use of selective controls, rather than general instruments of monetary
regulation^ but there is no specific development of a case for selective controls. Among selective controls mentioned, particular emphasis


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—3—

is given to business fixed investment and inventories, in addition to
consumer credit and mortgages, which are commonly considered as the
appropriate areas for selective regulation.
The Staff Report contains some vague and qualified suggestions for possible changes in System operating techniques with respect
to the discount rate, reserve requirement changes, and "bills only".
It also suggests that the administrative machinery of the System
should be streamlined.

No evidence or analysis is presented to show-

how these suggestions would correct the deficiencies mentioned elsewhere in the report.

One recommendation that may be significant is

that the interest rate ceiling on Treasury bonds should be repealed,
but this suggestion is always accompanied by a proviso that "modification of the policies that led to the present situation is a matter of
much more pressing importance".
Fallacious Underlying Premise •«•
Aside from many deficiencies with respect to details, the
major criticism that may be made of the Report is appraisal o^ the
effectiveness of monetary policy is that it is primarily based on an
incorrect major premise.

This premise, vrfiich is implied throughout

and is specifically stated at times, is that the function of monetary
policy is to control the total volume of or_edit_ — presumably in a
manner that will accomplish desirable social objectives, such as
growth and full employment, A minor premise, that is questionable,
is that monetary policy exercises its controls principally through
interest rates.

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On the basis either of actual developments or of deductive
reasoning, it can be reaolly demonstrated that monetary policies
have not accomplished and could not effectively accomplish the broad
function of ^cont rolling the total volume of credit.

The Staff Re-

port's criticism of monetary policy is largely based on this limitation 0
The Report fails to recognize that the area in which monetary
policy operates is limited to supplying, or enabling the commercial
banking system to supply, the money that the public wants and is willing
to hold as cash balances*

The Report contains a comprehensive analysis

of the functioning of financial intermediaries and the use of money
substitutes and points out the difficulty of controlling these elements
through monetary policy.

There is no recognition of the fact, however,

that it is not a part of the task of monetary policy, strictly speaking, to control these areas.
Bank credit needed to supply the appropriate volume of cash
balances is a relatively small part of the total volume of all credit
that is supplied out of all savings in the course of time.

Annual

rates of increase in the money supply, excluding time deposits, have
averaged about $3 billion in the past decadej they are unlikely to
exceed $6 billion in any one year and annual decreases are rare.
Annual increases in the total of all credit have ranged in the past
decade between $30 billion and somewhat more than f£Q billion, with
an average of nearly '^0 billion.

One of the serious omissions in

the Staff Report is that it does not point out or recognize the significance of these relative magnitudes.

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-5This total of all credit supplied is determined by the amount
of individual and business savings available for lending.

Monetary

policy operations, to be sure, might affect the supply of lendable
funds by permitting &n expansion of bank credit, but if this expansion
provides more money than the public wants to hold as cash, that money
in being put to use can have a multiple effect on the flows of both
money and the demand for goods*

This process can continue until

savings held in cash increase sufficiently.
Changes in rate of monetary turnover can occur independently
of monetary policy actions. Either these changes or those resulting
from attempts to expend money beyond the willingness of the public
to hold cash are not, as alleged in the Staff Report, an evidence of
weakness or ineffectiveness of monetary policiese

They are, instead,

factors that are largely outside the area of monetary policy control
but must be taken into consideration at any given time in determining
monetary policy actions. If velocity of cash holdings increases, then
less money is needed and less should be supplied; if the public wants
*
to hold larger amounts of cash and velocity declines,then tuor-e money
should be made available. Monetary policy in recent years has been
conducted according to this criterion^
Essential for sustained and stable growth of the economy is
an expanding volume of investment and saving — in appropriate balance
with consumption. Monetary creation can contribute only a very small
portion to the total needed. The bulk of the saving must come from
current income in order to maintain a balance between demand and output.


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-6Monetary policies can to some extent influence but cannot control
the volume of saving. Easy money certainly is no inducement to
saving,, Creating additional money and arbitrarily lowering interest
rates would discourage saving.

Inducement to saving can be effected

only by permitting interest rates to reach the level that brings demand and supply into balance.
Many other factors than monetary policy influence and determine the volume of saving and also the allocation of saving among
different channels of lending.

Also many other factors determine the

aggregate volume and composition of borrowing demands. "Tight money"
and rising interest rates are generally not caused by monetary policies
but by the growth of total borrowing demands at a faster pace than
savings available for lending.

For example, of the expansion in the

annual increase in total debt from about 01j.O billion in 1958 to about
055 billion in 1959, very little, if any, could have appropriately
been met by expansion in the money supply — the existing supply,
which was increased greatly in 1958, was being used more actively
in 1959 and was fully adequate to meet current cash needs. What was
required under the circumstances was more saving,

\

Similarly, monetary policies cannot be blamed — as is done
in the Staff Report — for the diminishing availability of residential
mortgage financing.

The principal real reason is the acceleration of

other borrowing demands*

To some extent, monetary expansion in 1958

made more funds available for mortgages, but the decline in other
borrowing demands was perhaps a more important factor, and in any
event the monetary expansion could not be continued at the rapid
1958 rate. For the same reasons monetary policies can have but limited

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-7and indirect effects upon the availability of funds for State and
local government borrowing or for investment in corporate fixed investment. Monetary policies more directly influence availability of
short-term bank credit to business, but cannot determine the amount
of total credit allocated by banks to this purpose«
General monetary instruments cannot determine the proportion
of the total credit supply that goes into consumer credit.

Monetary

policies, together with customary institutional practices and the
pressures of other demands, might to some extent limit the aggregate
volume of funds available for such use. Finally, monetary policies
cannot make credit available for specific purposes without affecting
the total volume of credit and money. This is true because of the
potential multiple expansion of bank reserves and because of the ready
flow of money from one use to another.
Conclusion It might be said that what the Staff Report is groping for,
without realizing it and certainly without recommending it, is a
system of total credit control, which should be distinguished from
monetary control.

The latter necessarily operates in a limited area,

the scope of which is determined by the need for cash balances.

It

can and does influence other types of credit and interest rates, but
cannot be expected to control either the aggregate amount or relative
magnitudes of such credits or the level and structure of interest
rates9

In fact, the influence of monetary policy on over-all credit

is best exercised by permitting interest rates to move flexibly in
response to market forces, not by attempting to maintain any rigid
level or structure of rates.

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-8-

Control of the total _yolume_of_all cre_dit_ and of its

dis-

tribution among different types and uses would be a much more formidable
task.

The possibility of doing it effectively and maintaining a free

enterprise economy is highly questionable.

Whether, if attempted, such

a control should be determined and administered by a single agency or
by separate agencies operating in different areas is an important
question.

There may even be reasonable doubt as to whether such credit

controls, if attempted, should be exercised by the same body that is
responsible for monetary regulation.

In any event this is a subject

that needs much careful study before jumping at conclusions and trying
to set up new machinery.

In the meantime, monetary policy should

not^be expected to accomplish all the purposes that such credit controls might be designed to effect and should not be perverted from
its true function in a vain attempt to correct all deficiencies in
our economic structure or to direct the whole course of economic
events 3


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WOOCLIEF THOMAS


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Margaret:
Gov. Balderston asked that I send a copy
of this letter to the Chairman,
hbw

UNIVERSITY OF NORTH CAROLINA

^H

SCHOOL OF BUSINESS ADMINISTRATION
CHAPEL HILL, NORTH CAROLINA

February 3, I960

Federal Reserve System
Washington, 0. C.
Dear Canbys
In line with your request I hare now gone through the Staff
Report on Employment, Growth, and Price Levels. As I indic a tied, your request came at a time when I was in something of
a time-bind but I have gotten back to the report whenever I
could. You asked me to give you my reactions, whatever they
might be, so here they are. I did go over the entire report
but gather after doing so that your primary interest was in
my reaction to Chapter 9.,
Let me start by saying that I am very much disturbed by the
attack which is currently being launched against monetary
policy and the Federal Reserve. It seems to me to be
gathering momentum and the push, unfortunately, is being
helped by a good many people who are basically friendly to
monetary policy but who are disturbed about some aspects of
the present posture.
I think the general theme-of Chapter 9 is summed up in Smith1s
statement: (1*01) "General controls are a mirage and a
delusion. It is perhaps just as well that monetary controls
have not been very effective; if they had been they might have
been disastrous." I suggest this is very much like the
bystander watching the fire department pour water on an outof-hand four-alarm fire who suggests they turn the water off
for a while since the fire doesn't seem to be going out while
the drenching continues--and besides everything is getting
all weti
Smith's factual sections seem to me to be accurate enough but
like so many other writings today they tell only a part of
the story and leave the impression that monetary policy is
not only inept in such periods, but also futile and,ultimately,


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Mr. C. Canby Balderston

February 3, I960

mischievous in its effects. Smith's presentation is particularly effective because it is made without histrionics for
the most part. The case that I see coming through the text of
Chapter 9 takes the following sequential steps: (for periods
of expansion)
1.
2.
3.

U.
5.
6.

A general tightening of monetary policy by the Fed
A general upward movement of interest rates
A growing pattern of leakages around monetary
policy, e. g., commercial bank switch from
investments to loans; shifts from banks to intermediaries, etc.
Consequent rise in velocity, thus offset-ting
general monetary policy
Further restrictions by the Fed
Higher and higher money costs stifling investment
and output

This step-by-step denouement, as it is done in this chapter,
gives every appearance of a reasoned recital of facts. What
it does not explain is how deficiencies elsewhere than on the
monetary front have compelled the System to take a posture
much more "extreme" than it would have to have taken if these
other policy areas had met their responsibilities. To
illustrate: I don't think there is much doubt but that an
even partially adequate fiscal policy would have taken much of
the steam out of the velocity surge and then a moderate restraint from the side of monetary policy would have been
feasible. To ride my illustration around the track once more:
With those who should have been helping to put out the fire
not only failing to use their own extinguishers but even at
times pouring gasoline on the fire I don't see anything else
monetary policy could have done except continue to drench the
flame with all the tools it had at hand. Those who got
splashed by the spray aren't going to like it and obviously
haven't. But this still seems no reason to withdraw the firemen. J^can_ see toc^fwhqj the fire chief in the midst of his
four-alarm affair might not want to incur the wrath of the
gasoline pourers and run the risk of their dumping a whole
tanklcmd of the stuff onto the structure, but I do think your
own failure to disclaim capacity to do the whole stabilization
job has contributed to the fix you are in now.
The proposals in Chapter 9 for making monetary policy more
effective strike me as largely fantastic. If I read the
author correctly, he is here advocating a package of direct


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Mr. C. Canby Balderston

February 3, I960

controls in the most naive fashion with no comment upon the
complexities inherent in such efforts. I suspect that, as
an old top-drawer price controller I have more than the average distaste for direct controls, but I think also that Smith
is naively simple when he completely passes over the consequences of such a program--particularly in peace time.
a) in re plant and equipment expenditures, does he really
mean to do away with interest costs as a deduction
under the corporate income tax? This seems to be his
thought. If this makes sense, why not eliminate
deduction of other expenses? What connection is there
between cyclical variations in money management problems and interest as a deductible expense?


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Also in connection with plant and equipment expenditures, he apparently thinks well of an undistributed
profits tax. We went through this once before and it
seems to me a much clearer analysis of the effects of .
such a proposal should be proffered by Smith in
rebuttal of our previous experience if he really means
this proposal. Also is it intended to stimulate
investment or deter it? Is it merely intended to
force corporate profits out into distribution where
the corporation must compete for them again? If so,
does he feel these extra dividends would stimulate
consumption? Would they be saved? Would they be kept
in larger idle balances or effectively invested? How
does all this relate to making monetary policy more
.-effective?
In this connection (plant and equipment expenditures)
he introduces the bills only argument. I won't comment
since you have presumably heard all the arguments
already. Why he introduces this in the present connection is not clear unless it is that he wanted you to
know, at some point, that "in its present rather rigid
doctrinaire form" it should be abandoned.
He is more forthright in advocating the removal of
FHA-VA interest ceilings, saying "they probably" should
be removed. But earlier he had noted that the interposition of your general controls and these institutional patterns had produced strong counter-cyclical
effects. Why he now advocates their removal is not
clear, particularly since he seems generally disposed

Mr. C. Canby Balderston

February 3, I960

toward more direct controls and later on advocates,
e. g., direct consumer credit. It seems highly inconsistent of him to advocate selective consumer credit
controls and at the same time oppose the FHA-VA
apparatus which produces selective control for the
construction segment;
I don 1 t know how you feel about his other possibilities
such as the proposal that insurance companies et al. be
required to place reserves on deposit with the~Ted and
then apparently give you power to exercise discretionary
power over the required level of such reserves. Personally, I think the Fed has about all the wash it can
handle without taking on the insurance industry. I'm
intrigued also by his proposal for cyclically varying
depreciation allowances under the corporate income tax.
Presumably he wouldn't have the Fed made these decisions, but with all of his subsequent mistrust concerning discretionary stabilization decisions this proposal, too, seems marvelously inconsistent.
b)

in re consumer durable goods, he clearly wants you
reconciled to direct controls over consumer credit.
My OPA life makes me a biased opponent of such proposals.
I wish he would explain how they can be made enforceable
rather than simply dismiss this aspect by casually
assigning responsibility to you.

c)

inventory investment fluctuations which he also pegs
for special treatment he apparently proposes to treat
by "getting better control over bank loans.11 Just how
this is to be done isn't clear, but he reintroduces the
old discussions so familiar to you concerning variations
in reserves required on loans as distinguished from invest
ment, etc. I believe a careful reading of Abramovitz on
Inventories might suggest that inventory fluctuations
are not entirely the product of bank .loan variations and
"bet.ter control over bank credit" doesn't come just for
the asking.

d)

in the case of residential construction, as I have
indicated above, Smith loses me completely in his proposal for elimination of the FHA-VA ceiling structure.
Apparently great cyclical instability is preferred to
some welfare concept which bothers him having to do


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Mr. C. Canby Balderston

February 3, I960

with who gets housing. He seems to feel the wrong
people are getting it now-~a view he is certainly
entitled to have, but how it relates to his general
heading "making monetary policy more effective" is
not clear to me.
And so the author of Chapter 9 concludes that general controls
are a "mirage and a delusion" and that this is just as Well
because if they were not the result "might have been disastrous." In their place, or in their support (?) we are presumably to have direct controls as above, except where we take
them off, as in the case of housing.
Monetary Policy and inflation--here he is concerned with the
consequences of rigidities in cost and price and suggests that
general monetary policy pressures induce output and employment
reductions. Thus he concludes impact of general tight money
anti-inflation policy will be reduced employment and output in
rigid sectors and price reductions confined largely to nonrigid areas. This, as you folks know even better than I do, is
an issue with largely political (i.e., how much unemployment in
key and influential sectors' can Washington tolerate?) complexion.
An outsider is not much help on this kind of problem and this
outsider is not competent. I wish though some attempt were
being made to try to force to the front more economic assessment
of the issues. On these grounds the case seems to me to be
nowhere near so clear as it is to Smith (who presumably offers
his views as an economist and not a political expert). For one
thing it is economic nonsense to suggest that oligopoly firms
and unions should be bailed out for their excesses by imposing
on all the rest of the society a tax (in the form of a generallypermitted price inflation) in order to prevent curtailments of
profits and jobs by firms and unions which have (presumptively
by the oligopoly definition) been getting excessive prices and
wages in relation to the rest of the economy where greater competition prevails.
Also do we ask the Department of Justice to take action or do
we again make monetary policy carry the load for deficiencies
in anti-trust, etc.? I would think that those who are using
this theme to discredit general monetary policy might be invited
by someone in the administration to give their testimony to the
Department of Justice. In fairness to Smith I think he would
agree with this conclusion, but it is unfortunate that he presents the theme at a point where he is hammering the idea that
general controls are "a mirage and delusion" and this is "perhaps
just as well."


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Mr. C. Canby Balderston

February 3, I960

Alternative proposals for monetary policy—these are presented
as alternatives for those who find the direct controls unpalat- .
able, it is said. And here cones the constant growth of moneysupply thesis a la Friedman and Shaw (with Shaw now witRHrawing
from his Arden House position, I believe). This thesis never
has made any sense to me--all it seems to introduce is an
element of predictability about the money supply, but I don't
believe uncertainty with respect to the money supply has been
demonstrated to be the cause of the business cycle. I suspect
ebbs and surges of investment might still continue to be* somewhat induced by varying expectations of income and other such
things. And none of the inventory models I have seen have
required that their fluctuations be attributed to the money
supply.
The next proposal seems to be that "monetary policy should
avoid the extreme anti-inflationary bias that has characterized
its administration in the past few years.11 This strikes me
again like the case of the bystander watching the fire department.
Techniques and administration--! confess a good deal of sympathy
with Smith's conclusions in re the discount rate. There must be
a whole package of points which can be made here that no one
outside the System understands and I suspect I am walking into
all kinds of obvious (to insiders) reasons why this discount
rate technique must be kept as it is. But anyway--the discount
rate is really twelve rates in spite of your effort in Washington
to coordinate — the discount window seems to be a quite different
thing from one district to another. If you feel that the discount
function is an important service (is it really?) why not one
uniform rate revised weekly to the bill yields on a national
scale? From the little I know of your internal procedures there
must be a tremendous amount of expensive energy spent debating
these rates region by region.

All in all I find this staff paper an incredible performance
and particularly so because of its surface element of sweet
reasonability and dispassionate appraisal. What it seems to me
to condense to is:
.
1. A general indictment of general monetary policy,
without
2. Any balancing introduction of the evidence on inadequacies in other general policy areas which have


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Mr. C. Cnaby Balderston

3»

1*.

5>.

February 3, I960

forced monetary policy to overcompensate for such
deficiencies.
No suggestion that a concerted effort to strengthen
other general tools might, (a) make a moderate
monetary policy effective, and (b) make reliance
upon selective (and probably unenforceable) controls
less necessary.
On the positive side a predilection for selective
action, including;
a) consumer credit control
b) discretionary variation in depreciation allowances
c) removal of interest as a deductible expense for
tax purposes
d) bills only be discarded
e) insurance companies (and other intermediaries?)
be required to place reserves on deposit with
Federal Reserve
f) discretionary power be given Fed to vary required
level of reserves for such deposits
g) differential reserves for loans and for investments, with discretionary modification of required
level for each (or both).
But on the negative side he advocates doing away with
selective VA-FHA interest ceiling which is producing
countercyclical construction pattern.

I hope all this will be of some use to you.
Very truly yours.

Maurice W. Lee
Dean

MWL/ns


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