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1980 Annual Report / FEDERAL R ESER V E BA N K OF RICHMOND










I S S N 0164-0798

L I B R A R Y OK C O N G R E S S C A T A L O G C A R D N U M B E R :

16-72o4

Additional <•
• <;t tin.' Aunual Report may :,r- ootained withe;:! clru ^ c u om thf
Bank and Public Relation.-; Department. Feck-raI Reserve Rank o f Richmond,
P. O. B ox 27(>22, Richmond, Virginia
2.3261.




T o Our Member B an k s:

W e a r e p le a s e d t o p r e s e n t t h e 1 9 8 0 A n n u a l R e p o r t o f t h e F e d e r a l R e s e r v e
B a n k o f R ic h m o n d .

T h e R e p o r t ’ s f e a t u r e a r t ic le a t t e m p t s t o d is p e l s o m e p o p u la r

m is c o n c e p t io n s r e g a r d in g t h e v ie w s o f J o h n M a y n a r d K e y n e s , t h e f a m o u s E n g lis h
e c o n o m is t , o n i n f la t io n a n d it s c o n t r o l.

T h e R e p o r t a ls o in c lu d e s h ig h lig h t s o f t h e

y e a r , a s u m m a r y o f o p e r a t io n s , c o m p a r a t iv e f in a n c ia l s t a te m e n ts , a n d c u r r e n t lis t s
o f d ir e c t o r s

and

o f f ic e r s

of our

R ic h m o n d ,

B a lt im o r e ,

C h a r lo t t e ,

C h a r le s t o n ,

C o lu m b ia , a n d C u lp e p e r O ff ic e s .

O n b e h a lf o f o u r d ir e c t o r s a n d s t a f f , w e w is h t o t h a n k y o u f o r t h e c o o p e r a t io n
a n d s u p p o r t y o u h a v e e x te n d e d t o u s t h r o u g h o u t t h e p a s t y e a r .




S in c e r e ly y o u r s ,

President




KEYNES ON INFLATION
Thomas M . Hum phrey

Not the least of inflation’s consequences is the
damage done to the reputations of certain prominent
economists. A case in point is John Maynard Keynes
(1883-1946). Once highly regarded for his brilliant
pathbreaking analysis of the causes of mass unem­
ployment in the Great Depression of the 1930s, he is
now given low marks for his views on inflation.
Popular folklore has it that he was largely uncon­
cerned with inflation from the start, that his subse­
quent preoccupation with unemployment led him to
ignore it altogether, and that, as a result, he favored
expansionary measures to eliminate unemployment
regardless of their inflationary consequences. Since
his death in 1946 his name (or at least the label
“ Keynesian” ) has been linked to such inflationist
slogans as “ full employment at any cost” and “ money
doesn’t matter.” It has also found an association
with the discredited concept of a stable enduring
trade-off between inflation and unemployment as well
as with the equally discredited notion that the au­
thorities can peg interest rates and real economic
activity at any desired level simply by manipulating
the policy instruments they command. On the policy
front his name is now popularly identified with ex­
cessive government spending, mounting budget defi­
cits, inflationary money growth, and, in Britain at
least, with the idea that inflation can be contained
with incomes policies and wage-price controls. In the
textbooks, his views are caricatured in the stylized
“ Keynes versus the monetarists” manner as the
opposite of the anti-inflationary views of the mone­
tarists. Small wonder that he has been widely per­
ceived as an inflationist and that our present inflation
is often described as the legacy of Keynes.1

1 For a recent expression of this view see Buchanan and
Wagner [1] who assert that “Lord Keynes himself” must
“bear substantial responsibility” for our “apparently per­
manent and perhaps increasing inflation” [1; p. 4].
“Without Keynes,” they write, “inflation would not be
the clear and present danger to the free society that it
has surely now become. The legacy or heritage of Lord
Keynes is the . . . intellectual legitimacy provided to . . .
deficit spending, inflation, and the growth of govern­
ment” [1; p. 24].




The purpose of this article, however, it to show
that the foregoing perceptions are wrong: that far
from being an inflationist, Keynes deplored inflation,
warned repeatedly of its evils, and recommended
restrictive demand management policies to prevent
it; that far from being an extreme nonmonetarist,
he shared the monetarists’ antipathy to inflation,
endorsed their policy goal of price stability, and em­
ployed at least five monetarist concepts in his analysis
of inflation; and, finally, that far from advocating
full employment at any cost, he maintained that even
at high unemployment rates expansionary aggregate
demand policy must be curbed to prevent inflation.
More precisely, this article demonstrates (1) that
Keynes was always concerned with inflation, (2)
that this concern motivated his advocacy of antiinflationary aggregate demand management policy on
at least two occasions (including once in the Great
Depression of the 1930s), and (3) that there are
enough monetarist elements in his analysis to qualify
him as at least a partial monetarist as far as inflation
theory is concerned.
These points are documented in the following para­
graphs, which summarize Keynes’ own views on
inflation. As pertinent now as they were when he
first presented them, his views are contained chiefly
in the following works: (1) Indian Currency and
Finance (1913), (2) The Economic Consequences
of the Peace (1919), (3) policy advice given to the
Chancellor of the Exchequer in February 1920, (4)
A Tract on Monetary Reform (1923), (5) the twovolume A Treatise on Money (1930), and (6) a
series of four newspaper articles published in The
Times in early 1937, one year after the publication
of his famous The General Theory of Employment
Interest and Money (1936). Except for the General
Theory, which deals mainly with unemployment and
will not be examined here, these works are largely
concerned with the problem of inflation. They are
examined in the order listed above to show the con­
sistency of Keynes’ anti-inflation attitudes over time.
5

Early Writings
K e y n e s ’ s t r o n g a v e r s io n t o i n f l a t i o n is e v id e n t i n
e v e n h is e a r lie s t w o r k . I t a p p e a r s , f o r e x a m p le , in
h is Indian Currency and Finance ( 1 9 1 3 ) . T h e r e h e
e m p h a t ic a lly r e je c t s t h e a r g u m e n t t h a t “ a d e p r e c i­
a t in g c u r r e n c y is a d v a n t a g e o u s . . . t o t r a d e , ” c o n ­
t e n d in g t h a t a n y a d v a n ta g e s d e r iv e d f r o m i n f la t io n
a r e “ o n ly t e m p o r a r y ” a n d t h a t t h e y “ o c c u r la r g e l y a t
t h e e x p e n s e o f o t h e r m e m b e r s o f t h e c o m m u n it y ”
a n d t h e r e f o r e d o “ n o t p r o f i t t h e c o u n t r y a s a w h o le ”
[ 5 ; p . 2 ] . H e ta k e s a n e v e n t o u g h e r a t t it u d e i n h is
Economic Consequences of the Peace ( 1 9 1 9 ) , c o n ­
d e m n in g in f l a t i o n in t h e h a r s h e s t p o s s ib le t e r m s .
H e says:
Lenin is said to have declared that the best way to
destroy the capitalist system was to debauch the
currency.
By a continuing process of inflation,
governments can confiscate, secretly and unob­
served, an important part of the wealth of their
citizens. By this method they not only confiscate,
but they confiscate arbitrarily; and, while the
process impoverishes many, it actually enriches
some [6 ; pp. 148-9].

H e a g r e e s w i t h L e n in t h a t in f l a t i o n h a s t h e p o t e n t i­
a l i t y o f d e s t r o y in g t h e b a s is o f c a p it a lis t s o c ie ty .
Lenin was certainly right. There is no subtler, no
surer means of overturning the existing basis of
society than to debauch the currency. The process
engages all the hidden forces of economic law on
the side of destruction, and does it in a manner
which not one man in a million is able to diagnose
[6 ; p. 149].

H e t h e n p r o c e e d s t o s p e c if y a t le a s t f o u r w a y s t h a t
r a p id in f l a t i o n w o r k s t o w e a k e n t h e s o c ia l f a b r ic a n d
t o u n d e r m in e t h e f o u n d a t io n s o f t h e c a p it a lis t f r e e m a r k e t s y s te m . F i r s t , u n f o r e s e e n i n f la t io n , h e s a y s ,
r e s u lts in a c a p r ic io u s a n d t o t a l l y “ a r b i t r a r y r e a r ­
r a n g e m e n t o f r ic h e s ” t h a t v io la t e s t h e p r in c ip le s o f
d i s t r ib u t iv e ju s t ic e . B e s id e s it s in e q u it ie s , i n f la t io n
a ls o r e n d e r s b u s in e s s u n d e r t a k in g s r i s k i e r a n d t h e r e b y
t u r n s “ t h e p r o c e s s o f w e a l t h - g e t t in g . . . in t o a g a m b le
a n d a lo t t e r y . ” I n g e n e r a t in g r i s k a n d in ju s t i c e , i n f l a ­
t io n “ s t r ik e s n o t o n ly a t s e c u r it y , b u t a t c o n f id e n c e in
th e e q u it y o f t h e e x is t in g d is t r ib u t io n o f w e a l t h ” [ 6 ;
p . 1 4 9 ] . S e c o n d , i n f la t io n v io la t e s lo n g - t e r m a r r a n g e ­
m e n ts b a s e d o n t h e a s s u m e d s t a b ili t y o f t h e v a lu e o f
m o n e y . I n s o d o in g , i n f la t io n d is t u r b s c o n t r a c t s a n d
u p s e ts “ a ll p e r m a n e n t r e la t io n s b e t w e e n d e b t o r s a n d
c r e d it o r s , w h ic h f o r m th e u lt im a t e f o u n d a t io n o f
c a p it a lis m ” [ 6 ; p . 1 4 9 ] . T h i r d , in f l a t i o n g e n e r a te s
s o c ia l d is c o n t e n t a n d d ir e c t s i t a g a in s t b u s in e s s m e n
w h o s e w i n d f a l l p r o f it s a r e w r o n g l y p e r c e iv e d t o b e

6




t h e c a u s e r a t h e r t h a n t h e c o n s e q u e n c e o f in f la t io n .
T h is d is c o n t e n t is e x p lo it e d b y g o v e r n m e n t s w h ic h
“ b e in g m a n y o f t h e m . . . r e c k le s s . . . a s w e ll a s w e a k ,
s e e k t o d ir e c t o n t o a c la s s k n o w n a s ‘p r o f it e e r s ’ t h e
p o p u la r in d i g n a t io n a g a in s t t h e m o r e o b v io u s c o n s e ­
q u e n c e s o f t h e i r v ic io u s m e t h o d s ” [ 6 ; p . 1 4 9 ] . I n
o t h e r w o r d s , g o v e r n m e n t s a c t u a lly r e s p o n s ib le f o r
c a u s in g in f la t io n s e e k t o s h if t t h e b la m e o n t o b u s i­
n e s s m e n w h o c o n s e q u e n t ly lo s e “ c o n f id e n c e i n t h e i r
p la c e i n s o c ie t y ” a n d b e c o m e “ t h e e a s y v ic t im s o f
in t i m i d a t i o n ” b y “ g o v e r n m e n t s o f t h e i r o w n m a k in g ,
a n d a P r e s s o f w h ic h t h e y a r e t h e p r o p r i e t o r s ” [ 6 ;
p . 1 5 0 ] . B y m a k in g b u s in e s s a s c a p e g o a t a n d t a r g e t
o f v i l i f i c a t i o n a n d c o n t r o l, i n f la t io n r e in f o r c e s a n t i ­
b u s in e s s a t t it u d e s a n d w e a k e n s s u p p o r t f o r w h a t
K e y n e s c a lle d “ t h e a c t iv e a n d c o n s t r u c t iv e e le m e n t in
t h e w h o le c a p it a lis t s o c ie t y ” 2 [ 6 ; p . 1 4 9 ] .
F i n a l l y , in f l a t i o n t e n d s t o b r e e d s u c h m is g u id e d
r e m e d ie s a s “ p r ic e r e g u la t io n ” a n d “ p r o f it e e r h u n t in g ” t h a t m a y d o m o r e d a m a g e t h a n t h e i n f la t io n
it s e lf . K e y n e s w a s e s p e c ia lly c r i t i c a l o f t h e te n d e n c y
o f g o v e r n m e n t s t o r e s o r t t o p r ic e c o n t r o ls , w h ic h i n
h is v ie w le a d t o r e s o u r c e m is a llo c a t io n a n d a r e d u c e d
s u p p ly o f g o o d s , t h e r e b y c o m p o u n d in g in f l a t i o n a r y
p r e s s u r e s . 3 R e g a r d in g t h e d is in c e n t iv e s t o r e a l o u t ­
p u t o c c a s io n e d b y c o n t r o ls , h e s a id t h a t “ t h e p r e s e r ­
v a t io n o f a s p u r io u s v a lu e f o r t h e c u r r e n c y , b y t h e
f o r c e o f la w e x p r e s s e d in t h e r e g u la t io n o f p r ic e s ,
c o n t a in s i n it s e lf , h o w e v e r , t h e s e e d s o f f i n a l e c o ­
n o m ic d e c a y , a n d s o o n d r ie s u p t h e s o u r c e o f u lt im a t e
s u p p ly . ” F o r , b y f r e e z in g p r ic e s a t w h a t a r e l i k e l y
t o b e d is e q u ilib r iu m le v e ls , c o n t r o ls c o n s t it u t e “ a
s y s te m o f c o m p e llin g t h e e x c h a n g e o f c o m m o d it ie s
a t w h a t is n o t t h e i r r e a l r e la t iv e v a lu e , ” a n d t h is
“ n o t o n ly r e la x e s p r o d u c t i o n b u t le a d s f i n a l l y t o t h e
w a s t e a n d in e f f ic ie n c y o f b a r t e r ” [ 6 ; p p . 1 4 9 - 5 0 ] .
S u m m a r iz in g t h e f o r e g o in g h a r m f u l c o n s e q u e n c e s
o f in f la t io n , h e c o n c lu d e s t h a t g o v e r n m e n t s t h a t a llo w
i n f l a t i o n t o g e t o u t o f c o n t r o l d o ir r e p a r a b le d a m a g e
t o t h e e s ta b lis h e d s o c ia l a n d e c o n o m ic o r d e r . I n s o
d o in g t h e y a r e “ c a r r y in g a s te p f u r t h e r t h e f a t a l
p r o c e s s w h ic h t h e s u b t le m in d o f L e n in h a d c o n ­
s c io u s ly c o n c e iv e d . ” F o r ,

2 Note
Keynes
[1; pp.
porting

that the very inflationary evils denounced by
are likewise stressed by Buchanan and Wagner
61-5]. This in a book, ironically enough, pur­
to show that Keynes was an inflationist.

3 Buchanan and Wagner [1; p. 54] echo Keynes’ conten­
tion that the harm wrought by controls must be counted
among the major costs of inflation.

By combining a popular hatred of the class of
entrepreneurs with the blow already given to social
security by the violent and arbitrary disturbance
of contract and of the established equilibrium of
wealth which is the inevitable result of inflation,
these governments are fast rendering impossible a
continuance of the social and economic order. . . .
But they have no plan for replacing it [6 ; p. 150].

I t w o u l d b e d i f f i c u l t in d e e d t o f i n d a m o r e d a m n in g
in d i c t m e n t o f in f l a t i o n a n d in f l a t i o n i s t p o lic ie s t h a n
t h a t p r e s e n te d b y K e y n e s i n The Economic Conse­
quences of the Peace. A n y o n e s e e k in g e v id e n c e t h a t
h e w a s a n in f l a t i o n i s t w i l l n o t f i n d i t t h e r e ; o n t h e
c o n t r a r y , n o t o n ly d o e s h e d is p la y a m a r k e d a v e r s io n
t o i n f la t io n , b u t h e a ls o se e s n o c o m p e n s a t in g b e n e f it s
t o o f f s e t it s e v ils .

Policy Advice in Early 1920
K e y n e s ’ c o n c e r n w i t h t h e d a n g e r s o f in f l a t i o n i n f l u ­
e n c e d h is p o lic y a d v ic e in t h e p o s t - w a r b o o m o f 1 9 2 0
w h e n a n o u t b u r s t o f i n f la t io n t h r e a t e n e d t h e B r i t i s h
e c o n o m y . 4 T h e n a s n o w a c r u c ia l p o li c y q u e s t io n
w a s : W h a t is t h e le a s t c o s t ly w a y t o r e m o v e i n f l a ­
t io n ? S h o u ld i t b e d o n e g r a d u a l ly o r s w i f t l y i n o n e
s t r o k e ? K e y n e s ’ a n s w e r w a s c le a r e n o u g h : r e je c t
g r a d u a lis m a n d u s e t h e m o n e t a r y s h o c k a p p r o a c h .
A c c o r d in g ly , w h e n c o n s u lt e d b y A u s t e n C h a m b e r la in ,
t h e C h a n c e llo r o f t h e E x c h e q u e r , i n e a r ly F e b r u a r y
1 9 2 0 , h e u n h e s i t a t in g ly r e c o m m e n d e d “ a s t i f f d o s e
o f d e a r m o n e y ” t o h a lt t h e i n f la t io n [ 3 ; p . 4 5 8 ] . H e
u r g e d a s e v e r e ly r e s t r ic t iv e m o n e t a r y p o lic y , e n t a ilin g
a s te e p j u m p in in t e r e s t r a te s , t o b r e a k t h e i n f l a t i o n ­
a r y b o o m . A s k e d t o s p e c if y t h e d e g r e e o f m o n e t a r y
r e s t r ic t io n h e w o u l d b e w i l l i n g t o t o le r a t e i n o r d e r
t o e n d in f la t io n , K e y n e s , a c c o r d in g t o C h a m b e r la in ,
in d ic a t e d t h a t “ [ h e ] w o u ld g o f o r a f in a n c ia l c r is is
. . . . W o u l d g o t o w h a t e v e r r a t e is n e c e s s a r y . . .
a n d k e e p it a t th a t f o r th re e y e a rs ” [ 3 ; p . 4 5 8 ]. I n
t h is c o n n e c t io n K e y n e s a r g u e d t h a t g iv e n t h e h ig h
i n f l a t i o n a r y e x p e c t a t io n s t h e n p r e v a ili n g , s h a r p i n ­
c re a s e s i n n o m in a l in t e r e s t r a te s w e r e e s s e n tia l in
o r d e r t o r a is e t h e r e a l in t e r e s t r a t e s u f f ic i e n t ly t o
d is c o u r a g e b o r r o w in g a n d s p e n d in g [ 3 ; p . 4 6 3 ] .
T h is , h e a r g u e d , w o u l d n o t c a u s e s e r io u s u n e m p lo y ­
m e n t b e c a u s e t h e r e w a s a w id e m a r g in o f s a fe ty
b e f o r e b u s in e s s w o u l d b e o p e r a t in g b e lo w f u l l c a ­
p a c it y .

4 For the details of Keynes’ advice in this episode see
Howson [3]. All references in this section are to Howson, who reproduces the relevant passages from Keynes’
papers.




K e y n e s ’ a d v o c a c y o f t i g h t m o n e y in t h is e p is o d e
c le a r ly r e s t e d o n h is f e a r o f t h e d a m a g e t h a t c o n t in u ­
in g r a p id in f l a t i o n c o u ld i n f l i c t o n s o c ie t y a n d t h e
c a p it a lis t s y s t e m . H e s ta te d a s m u c h in a m e m o ­
r a n d u m w r i t t e n s h o r t ly a f t e r h is m e e t in g w i t h t h e
C h a n c e llo r o f t h e E x c h e q u e r . H e f e a r e d , h e n o t e d ,
t h a t p e r s is t e n t in f l a t i o n w o u l d g e n e r a te “ s o c ia l u n ­
r e s t ” a n d “ s t r i k e a t t h e w h o le b a s is o f c o n t r a c t , o f
s e c u r it y , a n d o f t h e c a p it a lis t s y s te m g e n e r a lly , ”
e v e n t u a lly le a d in g t o “ s o c ia lis t ic c o n t r o l” o v e r in d u s ­
try .
T h e c h o ic e , h e t h o u g h t , w a s b e tw e e n “ d e a r
m o n e y o r . . . s o c ia liz a t io n o f t h e s u p p ly o f c a p it a l”
[ 3 ; p . 4 5 8 - 9 ] . G iv e n th e s e a lt e r n a t iv e s , K e y n e s w a s
c le a r ly in f a v o r o f d e a r m o n e y , a p o s it io n h e m a in ­
t a in e d f o r t h e r e s t o f h is c a r e e r . H e a c k n o w le d g e d
t h i s i n J a n u a r y 1 9 4 2 w h e n , lo o k i n g b a c k a t h is e a r lie r
p o li c y a d v ic e , h e d e c la r e d t h a t h e w o u l d “ g iv e t o d a y
e x a c t ly t h e s a m e a d v ic e t h a t I g a v e th e n , n a m e ly a
s w i f t a n d s e v e r e d o s e o f d e a r m o n e y , s u f f ic ie n t t o
b r e a k t h e m a r k e t , a n d q u ic k e n o u g h t o p r e v e n t a t
le a s t s o m e o f t h e d is a s t r o u s c o n s e q u e n c e s t h a t w o u ld
o t h e r w is e e n s u e ” [ 3 ; p . 4 6 2 ] . K e y n e s ’ 1 9 4 2 s t a t e ­
m e n t s u g g e s ts t h a t e v e n t h e in t e r v e n in g y e a r s o f t h e
G r e a t D e p r e s s io n o f t h e 1 9 3 0 s h a d n o t le s s e n e d h is
c o n c e r n a b o u t t h e d a n g e r s o f in f la t io n , d a n g e r s t h a t
h e h a d d e s c r ib e d e a r lie r in h is 1 9 2 3 A Tract on
Monetary Reform.

A Tract on Monetary Reform ( 1 9 2 3 )
N o w h e r e d o e s K e y n e s e x p r e s s h is c o n c e r n f o r i n ­
f la t i o n m o r e s t r o n g ly t h a n i n t h e Tract. T h e r e h is
c h ie f f e a r is t h a t in f l a t i o n m a y r e t a r d c a p it a l f o r m a ­
t io n a n d i n h i b i t lo n g - t e r m e c o n o m ic g r o w t h .
He
s p e c ifie s a t le a s t t h r e e w a y s t h a t t h is c a n h a p p e n .
H e n o te s f i r s t t h e in f l a t i o n a r y d is in c e n t iv e t o s a v in g .
B y e r o d in g t h e r e a l v a lu e o f p a s t s a v in g s , in f la t io n
d im in is h e s “ t h e c a p a c it y o f t h e in v e s t in g c la s s t o
s a v e ” a n d d e s t r o y s “ t h e a tm o s p h e r e o f c o n f id e n c e
w h ic h is a c o n d it io n o f t h e w illin g n e s s t o s a v e ” [ 7 ;
p . 2 9 ] . W i t h a s m a lle r p o r t i o n o f n a t io n a l in c o m e
f l o w i n g in t o s a v in g a n d in v e s t m e n t , t h e r a t e o f
c a p it a l a c c u m u la t io n f a lls . A n d s in c e , a c c o r d in g t o
K e y n e s , “ t h e n a t io n a l c a p it a l m u s t g r o w a s f a s t a 9
t h e n a t io n a l la b o r s u p p ly ” f o r “ t h e m a in te n a n c e o f
t h e s a m e s t a n d a r d o f l i f e , ” i t f o llo w s t h a t a f a l l in
c a p it a l g r o w t h b e lo w t h e r e q u ir e d p r o p o r t io n a l r a t e
w i l l lo w e r l i v i n g s t a n d a r d s [ 7 ; p . 2 9 ] , I n s h o r t , b y
d is c o u r a g in g s a v in g a n d c a p it a l f o r m a t io n , in f la t io n
m a y c a u s e a f a l l i n t h e a g g r e g a t e c a p it a l/ la b o r r a t io
( i. e . , t h e a m o u n t o f c a p it a l e a c h la b o r e r h a s t o w o r k

7

w i t h ) a n d a c o r r e s p o n d in g d r o p i n la b o r p r o d u c t i v i t y
a n d o u t p u t p e r c a p it a .
A s e c o n d f a c t o r r e t a r d in g c a p it a l a c c u m u la t io n
is t h e u n d e r c h a r g in g o f d e p r e c ia t io n d u r i n g i n f l a ­
t io n a n d t h e c o n s e q u e n t in a d e q u a t e p r o v i s io n f o r
t h e r e p la c e m e n t o f w o r n - o u t c a p it a l. T h i s o c c u r s
b e c a u s e d e p r e c ia t io n c h a r g e s o n c a p it a l e q u ip m e n t
a r e c o m p u t e d o n t h e b a s is o f o r ig in a l ( h is t o r i c a l )
c o s t r a t h e r t h a n r e p la c e m e n t c o s ts . T h e s e r e p la c e ­
m e n t c o s ts r is e w i t h i n f la t io n . T h u s w h e n p r ic e s r is e
t h e d e p r e c ia t io n c h a r g e s c a lc u la t e d o n t h e b a s is o f
o r ig in a l c o s t a r e t o o s m a ll t o r e p la c e t h e w o r n - o u t
c a p it a l. T h e r e s u l t m a y b e a n u n in t e n d e d d e p le t io n o f
t h e c a p it a l s to c k . “ I n s u c h c o n d it io n s , ” s a id K e y n e s ,
a c o u n t r y “ c a n e v e n t r e n c h o n e x is t in g c a p it a l o r f a i l
t o m a k e g o o d it s c u r r e n t d e p r e c ia t io n . ” F o r i t “ is
o n e o f t h e e v ils o f a d e p r e c ia t in g c u r r e n c y t h a t i t
e n a b le s a c o m m u n it y t o l i v e o n it s c a p it a l u n a w a r e s .
T h e in c r e a s in g money v a lu e o f t h e c o m m u n it y ’ s
c a p it a l g o o d s o b s c u r e s t e m p o r a r i l y a d i m in u t io n i n
t h e r e a l q u a n t it y o f t h e s t o c k ” [ 7 ; p p . 2 7 - 8 ] .
Y e t a t h i r d a d v e r s e e ff e c t o n c a p it a l f o r m a t io n , h e
n o t e d , is t h e in c r e a s e d b u s in e s s r i s k r e s u l t i n g f r o m
in f la t io n . F o r in f l a t i o n a d d s t o o r d in a r y b u s in e s s
r i s k t h e e x t r a “ r i s k d i r e c t l y a r is in g o u t o f in s t a b ilit y
in t h e v a lu e o f m o n e y ” [ 7 ; p . 3 3 ] . T o c o m p e n s a te
f o r t h is e x t r a r is k , b u s in e s s m e n a d d a r i s k p r e m iu m
t o t h e r a t e a t w h ic h t h e y d is c o u n t t h e f u t u r e , a n d t h e
h ig h e r d is c o u n t r a t e d is c o u r a g e s in v e s t m e n t .
T h e d is c o u r a g in g e ffe c ts o f i n f la t io n o n s a v in g , i n ­
v e s tm e n t , a n d g r o w t h w e r e n o t t h e o n ly i n f la t io n a r y
e v ils d e s c r ib e d b y K e y n e s i n t h e Tract. O t h e r s i n ­
c lu d e d ( 1 ) t h e in ju s t i c e a n d in e q u it y r e s u l t i n g f r o m
in f la t io n a r y r e d is t r ib u t io n s o f in c o m e a n d w e a lt h ,
( 2 ) t h e r e s o r t t o s p u r io u s in f l a t i o n r e m e d ie s — e .g .,
p r ic e c o n t r o ls , e x c e s s p r o f i t s t a x e s , p r o f it e e r - h u n t in g
a n d t h e lik e — r e m e d ie s t h a t c o n s t it u t e “ n o t t h e le a s t
p a r t o f t h e e v ils , ” o f t e n d o in g m o r e h a r m t h a n t h e
i n f la t io n t h e y a r e d e s ig n e d t o c u r e , a n d ( 3 ) th e s o c ia l
r e s e n t m e n t a n d d is c o n t e n t p r o d u c e d b y in f la t io n .
T h is r e s e n t m e n t , w h e n d ir e c t e d a g a in s t t h e b u s in e s s
c la s s w h o s e w i n d f a l l p r o f i t s a r e w r o n g l y p e r c e iv e d
a s t h e c a u s e r a t h e r t h a n t h e c o n s e q u e n c e o f in f la t io n ,
w o r k s t o d is c r e d it e n t e r p r is e a n d t o w e a k e n s u p p o r t
f o r t h e p r o d u c t iv e e le m e n t o f s o c ie t y — “ t h e p r o p o f
s o c ie t y a n d t h e b u il d e r o f t h e f u t u r e ” [ 7 ; p . 2 4 ] .
H a v i n g d is c u s s e d t h e a d v e r s e e ffe c ts o f in f la t io n o n
c a p it a l f o r m a t io n , e c o n o m ic g r o w t h , d is t r ib u t iv e
ju s t ic e , a n d s o c ia l s t a b ili t y , r e s p e c t iv e ly , K e y n e s n e x t
c o n s id e r s t h e a lle g e d b e n e f ic ia l o u t p u t e ffe c ts o f i n ­
f la t i o n . H e n o te s t h a t u n a n t ic ip a t e d in f l a t i o n m a y
8




t e m p o r a r ily s t im u la t e e c o n o m ic a c t i v i t y b y r a is in g
p r o f i t s a n d p r o f i t e x p e c t a t io n s . P r o f i t s r is e , h e s a id ,
b e c a u s e w a g e s a n d o t h e r c o s ts la g b e h in d r is i n g
p r ic e s d u r i n g in f la t io n . A n d w i t h n o m i n a l w a g e s
la g g in g b e h in d p r ic e s , r e a l w a g e s f a l l, t h u s in d u c in g
p r o d u c e r s t o s te p u p t h e i r e m p lo y m e n t o f la b o r .
L ik e w is e , t h e la g g e d a d ju s t m e n t o f m a r k e t in t e r e s t
r a t e s t o in f la t io n a n d t h e c o n s e q u e n t f a l l i n t h e r e a l
c o s t o f b o r r o w in g le a d s p r o d u c e r s t o e x p a n d t h e i r
o p e r a t io n s . F in a l ly , in f l a t i o n r e d u c e s t h e r e a l b u r d e n
o f fix e d c h a rg e s , th e re b y g iv in g a te m p o r a r y f illi p to
p r o f i t s a n d t o e c o n o m ic a c t i v i t y .
B u t K e y n e s in ­
s is te d t h a t a n y s u c h s t im u lu s w o u l d m o s t l i k e l y b e
s m a ll a n d s h o r t - liv e d . M o r e o v e r i t w o u l d c o n s t it u t e
a n u n d e s ir a b le “ o v e r s t im u la t io n o f i n d u s t r ia l a c t i v ­
i t y ” r e q u ir in g u n d u e s t r a in o n c a p a c it y a n d a c o r r e ­
s p o n d in g “ o v e r - e x e r t io n ” o f la b o r [ 7 ; p . 3 6 ] . F o r
th e s e r e a s o n s h e ju d g e d t h e o v e r a ll b e n e f it s t o b e
m in im a l.
C o n s e q u e n t ly , w h e n K e y n e s w e ig h e d t h e b e n e f it s o f
i n f la t io n a g a in s t t h e e v ils , h e f o u n d t h e la t t e r t o f a r
o u t w e ig h t h e f o r m e r a n d a c c o r d in g ly c a m e d o w n
h e a v ily i n f a v o r o f p r ic e s t a b ili t y . H e s u m m a r iz e d h is
c a s e f o r p r ic e s t a b ili t y b e s t w h e n h e d e c la r e d t h a t , b e ­
c a u s e “ in f l a t i o n is u n ju s t a n d d e f la t io n is in e x p e d ie n t
. . . , b o t h a r e e v ils t o b e s h u n n e d . T h e i n d i v id u a lis t ic
c a p it a lis m o f t o d a y , p r e c is e ly b e c a u s e i t e n t r u s t s s a v ­
in g t o t h e i n d i v id u a l in v e s t o r a n d p r o d u c t i o n t o t h e
in d i v id u a l e m p lo y e r , presumes a s ta b le m e a s u r in g r o d o f v a lu e , a n d c a n n o t b e e f f ic ie n t — p e r h a p s c a n ­
n o t s u r v iv e — w i t h o u t o n e ” [ 7 ; p . 3 6 ] . I t f o llo w s ,
h e s a id , t h a t t h e g o v e r n m e n t s h o u ld m a k e p r ic e s ta ­
b i l i t y it s p r i m a r y p o lic y g o a l. F o r , “ i f w e a r e t o
c o n t in u e t o d r a w th e v o l u n t a r y s a v in g s o f t h e c o m ­
m u n i t y in t o ‘ in v e s t m e n t s , ’ w e m u s t m a k e i t a p r im e
o b je c t o f d e lib e r a t e S ta t e p o li c y t h a t t h e s t a n d a r d o f
v a lu e , i n t e r m s o f w h ic h t h e y a r e e x p r e s s e d , s h o u ld
b e k e p t s t a b le ” [ 7 ; p . 1 6 ] . T h e s e a r e h a r d ly t h e
s e n t im e n ts o f a n in f la t io n is t . O n t h e c o n t r a r y , t h e y
a r e a n in d i c a t io n o f K e y n e s ’ h a r d - l in e a n t ip a t h y t o
i n f la t io n a n d h is b e lie f in t h e a b s o lu te n e c e s s ity o f
p r ic e le v e l s t a b ilit y .

Monetarist Aspects of the Tract
T h e a n a ly s is o f i n f la t io n c o n t a in e d i n t h e Tract h a s
m u c h in c o m m o n w i t h t h e p o s it io n t a k e n b y t o d a y ’ s
m o n e t a r is t s . S p e c if ic a lly , in f l a t i o n is d is c u s s e d w i t h ­
i n t h e c o n t e x t o f a n a n a ly t ic a l m o d e l t h a t is r e m a r k ­
a b ly m o n e t a r is t in s p i r i t , e m b o d y in g s u c h s t a n d a r d
m o n e t a r is t in g r e d ie n t s a s ( 1 ) t h e q u a n t it y t h e o r y o f
m o n e y , ( 2 ) t h e c o n c e p t o f in f l a t i o n a s a t a x o n r e a l

m o n e y b a la n c e s , ( 3 ) t h e m o n e t a r y a p p r o a c h t o e x ­
c h a n g e r a t e d e t e r m in a t io n , a n d ( 4 ) t h e F is h e r ia n
d is t in c t io n b e t w e e n r e a l a n d n o m in a l in t e r e s t r a te s .
T h e p a r a g r a p h s b e lo w s u m m a r iz e K e y n e s ’ v ie w s o n
th e s e e le m e n ts in o r d e r t o d e m o n s tr a t e t h a t h e w a s
n o t t h e s t e r e o t y p e n o n m o n e t a r is t c a r ic a t u r e o f t h e
te x t b o o k s .

Quantity Theory of Money
T h e K e y n e s o f t h e Tract w a s a n u n e q u iv o c a l a d ­
h e r e n t o f t h e q u a n t it y t h e o r y . “ T h is t h e o r y , ” h e s a id ,
“ is f u n d a m e n t a l. I t s c o r r e s p o n d e n c e w i t h f a c t is n o t
o p e n t o q u e s t io n ” [ 7 ; p . 6 1 ] . H i s o w n v e r s io n o f t h e
t h e o r y a s e lu c id a t e d in t h e Tract is e s s e n t ia lly t h e
s a m e a s t h e m o d e r n m o n e t a r is t v e r s io n a n d e m b o d ie s
t h e f o l l o w i n g m o n e t a r is t e le m e n t s :
(1) a money supply and demand theory of price
level determination,
(2) the notion of money stock exogeneity, implying
money-to-price causality,
(3) the concept of the demand for money as a
stable function of a few key variables, and
(4) a focus on the special role of price expecta­
tions in the money demand function.

R e g a r d in g t h e m o n e y s u p p ly a n d d e m a n d t h e o r y o f
t h e p r ic e le v e l, h e s a id t h a t “ t w o e le m e n t s ” d e t e r m in e
g e n e r a l p r ic e s a n d t h e v a lu e o f m o n e y . “ F i r s t , t h e
q u a n t it y , p r e s e n t a n d p r o s p e c tiv e , o f [ m o n e y ] in
c ir c u la t io n . S e c o n d , t h e a m o u n t o f p u r c h a s in g p o w e r
w h ic h i t s u it s t h e p u b lic t o h o ld in t h a t s h a p e ” [ 7 ;
p . x v i i i ] . E ls e w h e r e in t h e Tract h e s a y s t h a t t h e
p r ic e le v e l “ d e p e n d s o n t h e c u r r e n c y p o lic y o f t h e
g o v e r n m e n t a n d t h e c u r r e n c y h a b it s o f t h e p e o p le , in
a c c o r d a n c e w i t h t h e q u a n t it y t h e o r y o f m o n e y ” [ 7 ;
p . 7 1 ].
H a v i n g d e c la r e d t h a t g e n e r a l p r ic e s d e p e n d o n
m o n e y s u p p ly a n d d e m a n d , h e n e x t p r e s e n te d t h e
q u a n t it y t h e o r y in t h e f o r m o f t h e e q u a t io n P =
M / D o r M / P = D , w h ic h s a y s t h a t t h e p r ic e le v e l,
P , a d ju s t s t o e q u a te t h e r e a l ( p r ic e - d e f la t e d ) v a lu e o f
t h e g iv e n n o m in a l m o n e y s t o c k , M , w i t h t h e p u b lic ’ s
r e a l d e m a n d f o r i t , D . 5 H e t h e n p r o c e e d e d t o a n a ly z e
t h e v a r ia b le s o f t h e f o r e g o in g e q u a t io n . R e g a r d in g th e
5 Keynes [7; p. 63] employed a slightly different nota­
tion, writing the equation as n=pk, where n denotes the
nominal money stock, p the price level, and k the quan­
tity of real cash balances people desire to hold. He also
presents a more elaborate version of the equation, namely
n = p(k + rk'), where k and k' denote real cash balances
held by the public in the form of currency and checking
deposits, respectively, and r is the ratio of cash reserves
that banks hold behind their deposit liabilities.




n o m in a l m o n e y s t o c k , M , h e s a id t h a t i t is a n e x o g e ­
n o u s v a r ia b le c o n t r o lla b le b y t h e c e n t r a l b a n k s u c h
t h a t c a u s a t io n r u n s f r o m m o n e y t o p r ic e s r a t h e r t h a n
v ic e - v e r s a a s c la im e d b y s o m e b e lie v e r s in a p a s s iv e ,
d e m a n d - d e t e r m in e d m o n e y s t o c k . T h e m o n e y s u p p ly ,
K e y n e s d e c la r e d , is “ u n d e r t h e c o n t r o l ( o r o u g h t t o
b e ) o f t h e c e n t r a l b a n k in g a u t h o r it i e s ” w h o t h u s
p o s s e s s t h e m e a n s t o s t a b iliz e p r ic e s [ 7 ; p . 6 8 ] .
W i t h r e s p e c t t o t h e e q u a t io n ’s m o n e y d e m a n d c o m ­
p o n e n t , D , K e y n e s s t a t e d t h a t i t is d e t e r m in e d b y
s e v e r a l u n d e r ly in g f a c t o r s i n c lu d in g ( 1 ) “ w e a lt h , ”
( 2 ) “ h a b it s , ” ( 3 ) in t e r e s t r a t e s ( “ t h e e s tim a t e d a d ­
v a n t a g e s o f k e e p in g m o r e c a s h o n h a n d c o m p a r e d
w i t h t h o s e o f . . . in v e s t in g i t ” ) , a n d ( 4 ) e x p e c te d
in f l a t i o n ( “ t h e t r u s t o r d is t r u s t w h ic h t h e p u b lic
fe e l i n t h e p r o s p e c t o f t h e f u t u r e v a lu e ” o f t h e c u r ­
r e n c y ) [ 7 ; p p . 6 2 , 6 4 , x v i i i ] . H e r e is t h e m o n e t a r is t
n o t io n o f t h e d e m a n d f o r m o n e y a s a s ta b le f u n c t io n
o f a f e w k e y v a r ia b le s .
O f th e s e f o u r v a r ia b le s K e y n e s p a id p a r t ic u la r a t ­
t e n t io n t o t h e e x p e c te d r a t e o f in f la t io n , p o in t in g o u t
t h a t it s in c lu s io n i n t h e m o n e y d e m a n d f u n c t io n
m e a n s t h a t m o n e y d e m a n d is n o t c o m p le t e ly in d e ­
p e n d e n t o f m o n e y s u p p ly . F o r , a c c o r d in g t o h im ,
r a p id in c r e a s e s in m o n e y s u p p ly m a y g e n e r a te e x p e c ­
t a t io n s o f f u t u r e in f l a t i o n ( e x p e c t a t io n s t h a t c o n s t i­
t u t e t h e a n t ic ip a t e d d e p r e c ia t io n c o s t o f h o ld in g
m o n e y ) a n d t h e r e b y l o w e r r e a l m o n e y d e m a n d . T h is ,
h e n o t e d , im p lie s t h a t m o n e y g r o w t h a ffe c ts p r ic e s
b o t h d i r e c t l y a n d a ls o i n d i r e c t l y t h r o u g h th e p r ic e
e x p e c t a t io n s v a r ia b le in t h e m o n e y d e m a n d f u n c t io n .
T h e in d i r e c t e ff e c t m a g n if ie s t h e i n i t i a l im p a c t o f
m o n e y g r o w t h o n in f la t io n , c a u s in g p r ic e s t o r is e
f a s t e r t h a n t h e m o n e y s t o c k it s e lf . I n h is o w n w o r d s ,
“ a c h a n g e i n [ t h e m o n e y s t o c k ] d u e t o c a u s e s w h ic h
s e t u p a g e n e r a l e x p e c t a t io n o f a f u r t h e r [ i n f l a t i o n ­
a r y ] c h a n g e in t h e s a m e d ir e c t io n , m a y p r o d u c e a
more t h a n p r o p o r t io n a t e e ff e c t o n [ p r i c e s ] ” [ 7 ; p .
6 6 ] . P r ic e s o u t s t r ip m o n e y , h e s a id , b e c a u s e i n f l a ­
t io n a r y m o n e y g r o w t h , b y g e n e r a t in g e x p e c t a t io n s o f
f u t u r e in f l a t i o n a n d t h e r e b y r a is in g t h e a n t ic ip a te d
d e p r e c ia t io n c o s t o f h o ld in g m o n e y , re d u c e s t h e
d e m a n d f o r r e a l c a s h b a la n c e s a n d s t im u la te s a
c o r r e s p o n d in g r is e in m o n e y t u r n o v e r . T h is e x p e c t a t io n s - in d u c e d r is e i n t h e c ir c u la t io n v e lo c it y o f
m o n e y p u t s a d d it io n a l u p w a r d p r e s s u r e o n p r ic e s ,
t h u s m a g n if y in g t h e im p a c t o f m o n e y g r o w t h o n
in f la t io n .
K e y n e s p o in t e d o u t t h a t t h i s s e q u e n c e o f e v e n ts h a d
a c t u a lly o c c u r r e d in t h e G e r m a n h y p e r in f la t io n o f
1 9 2 2 - 1 9 2 3 w h e n p r ic e s r o s e f a s t e r t h a n th e n o m in a l
9

m o n e y s t o c k . H e a ls o n o t e d t h a t t h e s a m e s e q u e n c e
o f e v e n ts e x p la in e d t h e p e r p le x in g f a l l i n t h e r e a l o r
p r ic e - d e f la t e d m o n e y s t o c k t h a t h a d p u z z le d G e r m a n
o b s e r v e r s a t t h e t im e . T h a t is , h e s a id t h a t t h e e x p e c t a t io n s - in d u c e d f l i g h t f r o m c a s h a n d t h e c o r r e ­
s p o n d in g r is e in v e lo c i t y h a d c a u s e d p r ic e s i n G e r ­
m a n y t o r is e f a s t e r t h a n t h e n o m in a l m o n e y s t o c k
t h e r e b y p r o d u c in g t h e o b s e r v e d s h r in k a g e o f t h e r e a l
o r p r ic e - d e f la t e d m o n e y s to c k . C o n v e r s e ly , h e n o t e d
t h a t e x p e c t a t io n s o f s lo w e r m o n e y g r o w t h t h a t r e d u c e
t h e p u b lic ’ s “ d e g r e e o f . . . d is t r u s t o f t h e f u t u r e
v a lu e o f t h e m o n e y ” w i l l “ le a d t o s o m e in c r e a s e s i n
t h e ir u s e o f i t ” r e s u l t i n g in a r is e i n t h e r e a l m o n e y
s t o c k [ 7 ; p . 47).
F i n a l l y , K e y n e s e m p lo y e d t h e q u a n t it y t h e o r y i n h is
p o lic y a n a ly s is , a r g u in g ( 1 ) t h a t in f l a t i o n is c a u s e d
b y a n e x c e s s s u p p ly o f m o n e y , ( 2 ) t h a t s u c h m o n e ­
t a r y e x c e s s c o u ld s te m f r o m f a l ls i n m o n e y d e m a n d
a s w e ll a s f r o m r is e s i n m o n e y s u p p ly , ( 3 ) t h a t t h e
c e n t r a l b a n k p o s s e s s e s t h e p o w e r t o p r e v e n t t h e la t t e r
a n d c o u n t e r a c t t h e f o r m e r , a n d ( 4 ) t h a t i t s h o u ld
e m p lo y t h is p o w e r t o s t a b iliz e p r ic e s . F o r p r ic e s t a ­
b i l i t y h e r e c o m m e n d e d d e lib e r a t e c o u n t e r c y c lic a l
m o v e m e n t s in t h e m o n e y s u p p ly t o o f f s e t o r n u l l i f y
th e p r o c y c lic a l im p a c t o f c h a n g e s in m o n e y d e m a n d
o n p r ic e s .
H e th o u g h t th a t re a l m o n e y d e m a n d
f lu c t u a t e d w i t h t h e s ta te o f b u s in e s s c o n f id e n c e , f a l l ­
in g in b o o m s , r is i n g i n s lu m p s , a n d t h e r e b y a m p l i f y ­
in g c y c lic a l m o v e m e n t s o f p r ic e s . “ T h e c h a r a c t e r is t ic
o f t h e ‘c r e d i t c y c le ’ ,” h e s a id , “ c o n s is t s in a te n d e n c y
o f [ r e a l c a s h b a la n c e s ] t o d im in is h d u r i n g t h e b o o m
a n d in c r e a s e d u r i n g t h e d e p r e s s io n ” [ 7 ; p . 6 7 ] . T o
c o u n t e r a c t th e s e h e a d v o c a te d d e lib e r a t e m o n e t a r y
c o n t r a c t io n i n b o o m s a n d m o n e t a r y e x p a n s io n in
s lu m p s . “ T h e t im e t o d e f la t e t h e s u p p ly o f c a s h ,” h e
s a id , “ is w h e n r e a l b a la n c e s a r e f a l l i n g . . . a n d . . .
t h e t im e t o in f la t e t h e s u p p ly o f c a s h is w h e n r e a l
b a la n c e s a r e r is i n g , a n d n o t , a s s e e m s t o b e o u r
p r e s e n t p r a c t ic e , t h e o t h e r w a y r o u n d ” [ 7 ; p . 1 4 9 ] .
I n s o s t a t in g , h e r e je c t e d t h e m o n e t a r is t c a s e f o r a
f ix e d m o n e t a r y g r o w t h r a t e r u le ( w h ic h h e a r g u e d
“ is b o u n d t o le a d t o u n s te a d in e s s o f t h e p r ic e le v e l”
w h e n m o n e y d e m a n d f lu c t u a t e s ) in f a v o r o f d is c r e ­
t io n a r y m o n e t a r y m a n a g e m e n t [ 7 ; p . 6 9 ] . “ I n t h e
m o d e rn w o r ld o f p a p e r c u rre n c y a n d b a n k c r e d it,”
h e d e c la r e d , “ t h e r e is n o e s c a p e f r o m a ‘m a n a g e d ’
c u r r e n c y ” [ 7 ; p . 1 3 6 ] . N o t e , h o w e v e r , t h a t w h ile h e
r e je c t e d t h e m o n e t a r is t c a s e f o r r u le s in s t e a d o f d is ­
c r e t io n in t h e c o n d u c t o f m o n e t a r y p o lic y , h e d id
v o ic e t h e m o d e r n m o n e t a r is t c o m p la in t t h a t d is c r e ­
t io n a r y m o n e t a r y m o v e m e n t s f r e q u e n t ly t e n d t o b e
10




p r o c y c lic a l r a t h e r t h a n c o u n t e r c y c lic a l. T h a t is , h e
c o m p la in e d t h a t t h e B r i t i s h m o n e t a r y a u t h o r it i e s h a d
p e r v e r s e ly e n g in e e r e d m o n e t a r y e x p a n s io n s i n b o o m s
w h e n m o n e y d e m a n d w a s f a llin g a n d m o n e ta r y c o n ­
t r a c t i o n i n s lu m p s w h e n m o n e y d e m a n d w a s r is i n g
t h e r e b y a g g r a v a t in g r a t h e r t h a n m i t i g a t i n g i n f la t io n
a n d d e f la t io n . T h e s e p o li c y e r r o r s n o t w it h s t a n d i n g ,
h o w e v e r , h e r e m a in e d a s t r o n g a d v o c a t e o f d is c r e ­
t io n a r y m o n e t a r y in t e r v e n t i o n i n t h e p u r s u it o f p r ic e
s t a b ilit y .

Inflation as a Tax on Real Money Balances
T h e s e c o n d m o n e t a r is t in g r e d ie n t t h a t K e y n e s
e n u n c ia te s in t h e Tract is t h e c o n c e p t o f in f l a t i o n a s a
t a x o n r e a l m o n e y b a la n c e s . A s n o t e d b y t h e la t e
H a r r y J o h n s o n , t h is in f l a t i o n t a x a n a ly s is c o n s t it u t e s
a n e s s e n tia l p a r t o f t h e q u a n t it y t h e o r y a p p r o a c h t o
in f la t io n .
C o n s is t e n t w i t h t h a t a p p r o a c h , K e y n e s
a r g u e s t h a t i n f la t io n is “ a m e t h o d o f t a x a t io n ” w h ic h
th e g o v e r n m e n t u s e s to “ s e c u re th e c o m m a n d o v e r
re a l re s o u rc e s , re s o u rc e s ju s t as re a l as th o s e o b ­
t a in e d b y [ o r d i n a r y ] t a x a t io n ” [ 7 ; p . 3 7 ] . “ W h a t is
r a is e d b y p r i n t i n g n o t e s , ” h e w r i t e s , “ is j u s t a s m u c h
ta k e n f r o m t h e p u b lic a s is a b e e r d u t y o r a n in c o m e
t a x ” [ 7 ; p . 5 2 ] . R e g a r d in g t h e i n f la t io n t a x h e s a y s
t h a t “ a g o v e r n m e n t c a n liv e b y t h is m e a n s w h e n i t
c a n liv e b y n o o t h e r . I t is t h e f o r m o f t a x a t io n w h ic h
th e p u b lic f i n d h a r d e s t t o e v a d e a n d e v e n t h e w e a k e s t
g o v e r n m e n t c a n e n fo r c e , w h e n i t c a n e n f o r c e n o t h in g
e ls e ” [ 7 ; p . 3 7 ] .
I n d is c u s s in g t h e in f l a t i o n t a x , K e y n e s s tre s s e s t h a t
i t is a t a x o n c a s h b a la n c e s . T h e b u r d e n o f t h e t a x ,
h e s a y s , f a lls o n c a s h h o ld e r s , i.e .,
on the holders of the original . . . notes, whose
notes [after inflation] are worth . . . less than
they were before. The inflation has amounted to
a tax . . . on all holders of notes in proportion to
their holdings.
The burden of the tax is well
spread, cannot be evaded, costs nothing to collect,
and falls, in a rough sort of way, in proportion to
the wealth of the victim. No wonder its super­
ficial advantages have attracted Ministers of Fi­
nance [7; p. 39].

H e n e x t e x p la in s h o w i n f l a t i o n a r y m o n e y c r e a t io n
t r a n s f e r s r e a l r e s o u r c e s f r o m c a s h h o ld e r s t o t h e g o v ­
e r n m e n t . H e n o te s t h a t a g iv e n , s a y , 2 5 p e r c e n t i n ­
f la t i o n r a t e r e q u ir e s a n e q u iv a le n t r a t e o f r is e o f c a s h
h o ld in g s j u s t t o m a in t a in r e a l m o n e y b a la n c e s a t
d e s ir e d le v e ls . T o a c c o m p lis h t h is , c a s h h o ld e r s c u t
e x p e n d it u r e s o n g o o d s a n d s e r v ic e s a n d a d d t h e u n ­
s p e n t p ro c e e d s t o m o n e y b a la n c e s .
T h e re d u c e d

p r iv a t e o u t la y f o r g o o d s a n d s e r v ic e s re le a s e s r e ­
s o u r c e s w h ic h t h e g o v e r n m e n t a c q u ir e s w i t h n e w ly
is s u e d m o n e y t h a t is t h e n a d d e d t o p r iv a t e c a s h b a l­
a n c e s . I n t h is w a y in f l a t i o n e n a b le s t h e g o v e r n m e n t
t o a p p r o p r ia t e r e a l r e s o u r c e s f r o m c a s h h o ld e r s ju s t
a s s u r e ly a s i f i t h a d t a k e n p a r t o f t h e i r e a r lie r m o n e y
b a la n c e s a n d s p e n t t h e p r o c e e d s o n g o o d s a n d s e r ­
v ic e s . H o w m u c h t h e g o v e r n m e n t g e ts d e p e n d s u p o n
t h e q u a n t it y o f r e a l b a la n c e s t h e p u b lic w is h e s t o
h o ld w h e n t h e i n f la t io n r a t e is 2 5 p e r c e n t. A s s u m in g
t h e p u b lic d e s ir e s r e a l b a la n c e s t o t a lin g $ 3 6 m i l lio n ,
t h e g o v e r n m e n t ’ s t a x t a k e is 2 5 p e r c e n t o f t h a t s u m
o r $ 9 m i l l i o n . O r , a s K e y n e s h im s e lf p u t i t i n d is ­
c u s s in g t h e e ffe c ts o f t h e h y p o t h e t ic a l 2 5 p e r c e n t
in f l a t i o n t a x o n r e a l b a la n c e s o f $ 3 6 m i l l i o n , “ b y t h e
p r o c e s s o f p r i n t i n g t h e a d d it io n a l n o te s t h e g o v e r n ­
m e n t h a s t r a n s f e r r e d t o it s e lf a n a m o u n t e q u a l t o
$ 9 m i l l i o n , j u s t a s s u c c e s s f u lly a s i f i t h a d r a is e d t h is
s u m i n t a x a t io n ” [ 7 ; p . 3 9 ] .
K e y n e s ’ d is c u s s io n o f t h e in f l a t i o n t a x in c lu d e s a
s o p h is t ic a te d a n a ly s is o f t h e o p t im a l r a t e o f in f la t io n
f r o m t h e p o in t o f v ie w o f m a x im iz i n g t a x r e v e n u e .
I n t h is c o n n e c t io n h e m a k e s f o u r p o in t s . F i r s t , f r o m
t h e f o r m u la t h a t t a x y ie ld e q u a ls t a x r a t e t im e s t a x
b a s e , i t f o llo w s t h a t t h e y ie ld o f t h e i n f la t io n t a x is
t h e m u lt ip lic a t i v e p r o d u c t o f t h e i n f la t io n r a t e ( t a x
r a t e ) a n d r e a l c a s h b a la n c e s ( t a x b a s e ) , r e s p e c t iv e ly .
S e c o n d , t h e t a x b a s e is n o t in v a r ia n t t o t h e t a x r a t e
b u t f a lls w h e n t h e la t t e r r is e s . T h a t is , w h e n t h e
g o v e r n m e n t ra is e s t h e t a x r a t e t h e t a x b a s e te n d s t o
s h r in k a s p e o p le s e e k t o a v o id t h e i n f la t io n t a x b y
c h a n g in g t h e i r h a b it s a n d e c o n o m iz in g o n r e a l m o n e y
h o ld in g s .
W e r e t h is n o t s o , s a id K e y n e s , “ t h e r e
w o u l d b e n o l i m i t t o t h e s u m s w h ic h t h e g o v e r n m e n t
c o u ld e x t r a c t f r o m th e p u b lic b y m e a n s o f i n f l a t i o n ”
[7; p . 4 2 ] . T h i r d , b e c a u s e t h e t a x b a s e s h r in k s w i t h
r is e s in t h e t a x r a te , t h e g o v e r n m e n t w i l l r e a liz e
m o r e r e v e n u e f r o m a t a x r a t e r is e o n ly i f i t c a u s e s a
le s s - t h a n - p r o p o r t io n a t e f a l l in t h e b a s e . “ A g o v e r n ­
m e n t h a s t o r e m e m b e r , ” h e s a id , “ t h a t e v e n i f a t a x
is n o t p r o h ib it iv e i t m a y b e u n p r o f it a b le , a n d t h a t a
m e d iu m , r a t h e r t h a n a n e x t r e m e , im p o s it io n w i l l
y ie ld t h e g r e a t e s t g a in ” [7; p . 4 3 ] . F o u r t h , i t f o llo w s
t h a t t h e r e is o n e i n f la t io n r a t e t h a t m a x im iz e s t a x
r e v e n u e a n d t h a t o c c u r s w h e r e t h e p e r c e n ta g e i n ­
c re a s e in t h e t a x r a t e e q u a ls t h e p e r c e n ta g e s h r in k a g e
i n t h e t a x b a s e , i.e ., w h e r e t h e e la s t ic it y o f r e a l m o n e y
d e m a n d w i t h r e s p e c t t o t h e in f l a t i o n r a t e is u n it y .
H e r e is t h e c o n c e p t o f t h e t a x - m a x i m iz in g r a t e o f
in f l a t i o n t h a t p la y s s u c h a k e y r o le in t h e m o d e r n
m o n e t a r is t a n a ly s is o f in f l a t i o n a r y f in a n c e .




Monetary Approach to Exchange Rates
A t h i r d m o n e t a r is t c o n c e p t u s e d b y K e y n e s i n t h e
Tract w a s t h e m o n e t a r y a p p r o a c h t o e x c h a n g e r a t e

a n a ly s is . T h is a p p r o a c h r e s t s o n t h e v ie w t h a t th e
e x c h a n g e r a t e b e t w e e n t w o n a t io n a l c u r r e n c ie s is
d e t e r m in e d b y t h e r e s p e c t iv e n a t io n a l m o n e y s u p p lie s
a n d d e m a n d s in t h e t w o c o u n t r ie s a n d t h e r e s u lt in g
e ff e c t s o n t h e i r r e s p e c t iv e g e n e r a l p r ic e le v e ls . R e ­
g a r d in g t h e m o n e t a r y a p p r o a c h , K e y n e s s a id t h a t th e
f o r e ig n e x c h a n g e s “ d e p e n d . . . o n t h e r e la t iv e p r ic e
le v e ls e s ta b lis h e d h e r e a n d a b r o a d b y t h e r e s p e c t iv e
c r e d i t [ i. e . , m o n e t a r y ] p o lic ie s a d o p te d h e r e a n d
a b r o a d ” [ 7 ; p . 1 4 6 ] . H e r e a c h e d t h is c o n c lu s io n b y
c o m b in in g t h e q u a n t it y t h e o r y o f m o n e y w i t h th e
p u r c h a s in g p o w e r p a r i t y t h e o r y o f e x c h a n g e r a te s .
T h e q u a n t it y t h e o r y o f c o u r s e s a y s t h a t t h e g e n e r a l
p r ic e le v e l is d e t e r m in e d b y t h e d e m a n d - a d ju s te d
m o n e y s t o c k , i.e ., b y t h e n o m in a l s t o c k o f m o n e y p e r
u n i t o f r e a l m o n e y d e m a n d . A n d t h e p u r c h a s in g
p o w e r p a r i t y d o c t r in e , h e e x p la in e d , h o ld s t h a t t h e
e x c h a n g e r a t e t e n d s t o e q u a l t h e r a t io o f t h e p r ic e
le v e ls i n t h e t w o c o u n t r ie s c o n c e r n e d . T a k e n t o ­
g e t h e r , t h e q u a n t it y t h e o r y a n d t h e p u r c h a s in g p o w e r
p a r i t y d o c t r in e im p l y t h a t t h e e x c h a n g e r a t e is d e t e r ­
m in e d b y r e la t iv e d e m a n d - a d ju s t e d m o n e y s to c k s
o p e r a t in g t h r o u g h r e la t iv e n a t io n a l p r ic e le v e ls . 6
F r o m t h e f o r e g o in g K e y n e s c o n c lu d e d t h a t i f b o t h
c o u n t r ie s in f la t e t h e i r c u r r e n c ie s a t t h e s a m e r a t e th e
e x c h a n g e r a t e w i l l s t a b iliz e , w h e r e a s i f t h e y in f la t e a t
d if f e r e n t r a t e s t h e e x c h a n g e r a t e w i l l a p p r e c ia te in
f a v o r o f t h e c o u n t r y w i t h t h e lo w e r in f la t io n r a t e a n d
d e p r e c ia te a g a in s t t h e c o u n t r y w i t h t h e h ig h e r i n f l a ­
t io n r a t e . 7 H e a ls o c o n c lu d e d t h a t f lo a t in g e x c h a n g e
r a t e s in s u la t e a c o u n t r y f r o m i n f la t io n a r y m o v e m e n ts
d e v e lo p in g a b r o a d . T h a t is , h e c o n t e n d e d t h a t , u n d e r
f lo a t in g e x c h a n g e r a te s a n i n f l a t i o n a r y r is e i n f o r e ig n
p r ic e s w o u l d b e o ff s e t b y a n e q u a l a n d o p p o s ite f a l l
in t h e e x c h a n g e r a t e le a v in g t h e d o m e s t ic c u r r e n c y

6 Note that this version of the monetary approach ignores
certain nonmonetary determinants of exchange rates,
namely (1) the real terms of trade and (2) the relative
prices of traded and nontraded goods, respectively. As
pointed out by Keynes, these factors may be safely dis­
regarded only when the source of exchange rate distur­
bance is of a predominantly monetary origin. Regarding
such monetary shocks, he argues that they have in fact
“been so dominant in their influence that the theory has
been actually applicable with remarkable accuracy” [7;
p. 82],
7 In his words, “the rate of exchange can be improved in
favour of one of the countries by a financial policy
directed towards a lowering of its internal price level
relatively to the internal price level of the other country”
[7; p. 88].

11

p r ic e o f f o r e ig n g o o d s u n c h a n g e d . F o r t h i s re a s o n
h e b e lie v e d t h a t f lo a t in g e x c h a n g e r a t e s w e r e a n
a b s o lu te n e c e s s ity f o r a n y c o u n t r y t r y i n g t o a c h ie v e
d o m e s t ic p r ic e s t a b ili t y v ia t h e o p e r a t io n o f d o m e s t ic
m o n e t a r y p o lic y . W i t h r e s p e c t t o h is a n a ly s is o f
e x c h a n g e r a te s , t h e K e y n e s o f t h e Tract b e lo n g s in
t o d a y ’s m o n e t a r is t c a m p .

Nominal versus Real Interest Rates
F i n a l l y , K e y n e s e m p lo y e d i n t h e Tract t h e m o n e ­
t a r is t o r F is h e r ia n d is t in c t io n b e t w e e n n o m in a l a n d
r e a l in t e r e s t r a te s , i.e ., b e t w e e n t h e in t e r e s t r a t e a c t u ­
a lly c h a r g e d o n lo a n s a n d t h e in f la t io n - c o r r e c t e d le v e l
o f t h a t r a t e . W i t h r e s p e c t t o t h e t w o r a t e s h e s ta te d
th e f o l l o w i n g p o in t s . F i r s t , f o r a n y g iv e n n o m in a l
r a te , in f l a t i o n re d u c e s t h e r e a l r a t e b e lo w t h e n o m in a l
r a te . T h e r e a l r a t e f a lls r e la t i v e t o t h e n o m in a l r a t e
b e c a u s e b o r r o w e r s c a n r e p a y t h e i r lo a n s in d e p r e c i­
a te d d o lla r s , i.e ., in m o n e y w h o s e r e a l p u r c h a s in g
p o w e r is le s s t h a n t h e a m o u n t o r i g i n a l l y b o r r o w e d .
S e c o n d , t h e n o m in a l r a t e e m b o d ie s e x p e c t e d in f la t io n
w h ic h m a y t e m p o r a r ily la g b e h in d a c tu a l i n f la t io n
r e s u l t i n g in in c o m p le t e a d ju s t m e n t o f t h e n o m in a l
r a te .
T h i r d , i f t h e n o m in a l r a t e d o e s n o t f u l l y r e f le c t
r is i n g p r ic e s , t h e n e v e n h ig h m a r k e t r a t e s m a y t r a n s ­
la t e in t o lo w o r n e g a t iv e r e a l r a t e s a f t e r c o r r e c t io n f o r
in f la t io n . A s K e y n e s h im s e lf e x p r e s s e d it ,
in a period of rapidly changing prices, the money
rate of interest seldom adjusts itself adequately
or fast enough to prevent the real rate from
becoming abnormal [7 ; p. 20]. Thus, when prices
are rising, the businessman who borrows money
is able to repay the lender with what, in terms of
real value, not only represents no interest, but is
even less than the capital originally advanced;
that is, the real rate of interest falls to a negative
value, and the borrower reaps a corresponding
benefit [7 ; pp. 19-20].

I n s u c h c a s e s , h ig h n o m in a l r a t e s a r e n e it h e r o n e r o u s
t o b o r r o w e r s n o r a d e t e r r e n t t o b o r r o w in g a n d s p e n d ­
in g . O n t h e c o n t r a r y , t h e y a r e a b a r g a in t o b o r r o w ­
e rs a n d , a t le a s t t e m p o r a r ily , a s t im u lu s t o e c o n o m ic
a c t i v it y . T h e c o n t e n t io n t h a t h ig h n o m in a l in t e r e s t
r a te s m a y c o r r e s p o n d t o lo w o r n e g a t iv e r e a l r a te s
d u r in g p e r io d s o f r a p id in f l a t i o n a n d , t h e r e f o r e , m a y
f a i l t o d is c o u r a g e b o r r o w in g a n d s p e n d in g , u n d e r lie s
t h e m o d e r n m o n e t a r is t a r g u m e n t t h a t n o m in a l r a te s
t h e m s e lv e s a r e a n u n r e lia b le i n d i c a t o r o f t h e d e g r e e
o f m o n e t a r y e a s e o r t ig h t n e s s .

12




F o u r t h , n o m in a l r a t e s t e n d t o b e b id d e d u p b y e a g e r
b o r r o w e r s d u r in g p e r io d s o f in f la t io n , i m p ly in g t h a t
h ig h m a r k e t in t e r e s t r a te s a r e a r e s u l t n o t a c a u s e o f
r i s i n g p r ic e s . “ I t is f o r t h is r e a s o n , ” s a id K e y n e s ,
“ t h a t a h ig h b a n k r a t e s h o u ld b e a s s o c ia te d w i t h a
p e r io d o f r is i n g p r ic e s , a n d a lo w b a n k r a t e w i t h a
p e r io d o f f a l l i n g p r ic e s ” [7; p . 2 0 ] . F i f t h , i n t h e
lo n g r u n n o m in a l r a te s t e n d t o f u l l y a d ju s t f o r i n f l a ­
t io n a n d t h e r e a l r a t e r e t u r n s t o it s p r e e x is t in g e q u i­
l i b r i u m le v e l.
“ T h e a p p a r e n t a b n o r m a lit y o f t h e
m o n e y [ n o m in a l] r a t e o f in t e r e s t a t s u c h t im e s [ i. e . ,
i n p e r io d s o f r a p id i n f l a t i o n ] , ” s a id K e y n e s , “ is
m e r e ly t h e o t h e r s id e o f t h e a t t e m p t o f t h e r e a l r a t e
t o s te a d y i t s e lf ” [ 7 ; p . 2 0 ] .
I n s t a t in g th e s e p o in t s , K e y n e s c lo s e ly f o llo w e d
I r v i n g F is h e r , p e r h a p s t h e le a d in g m o n e t a r is t o f t h e
t im e . I n f a c t , c o n s id e r in g a ll t h e m o n e t a r is t e le m e n ts
in t h e Tract, i t is h a r d t o e s c a p e t h e c o n c lu s io n t h a t ,
in t h e 1 9 2 0 s a t le a s t, K e y n e s w a s la r g e l y a m o n e t a r is t
in h is a n a ly s is o f in f la t io n . I t is h a r d t o r e c o n c ile t h e
K e y n e s o f t h e Tract w i t h t h e s t e r e o t y p e n o n m o n e ­
t a r is t K e y n e s o f t h e m o d e r n t e x t b o o k s . I t is e v e n
h a r d e r t o s q u a r e t h e K e y n e s o f t h e Tract w i t h t h e
c a r ic a t u r e o f h im a s a n o u t - a n d - o u t i n f la t io n is t . F o r
a s s h o w n a b o v e , t h r o u g h o u t t h e Tract h e w a s e x ­
t r e m e ly h o s t ile t o w a r d in f la t io n , d e p lo r in g it s e v ils ,
m in im i z in g it s b e n e f it s , a n d c a llin g f o r it s q u ic k
r e m o v a l.
N o r d id h e c h a n g e h is m in d in h is A Treatise on
Money ( 1 9 3 0 ) . T o b e s u r e , t h e r e h e t e n t a t iv e ly a d ­
v a n c e s a t h e o r y o f in f la t io n - in d u c e d g r o w t h a n d e v e n
c o n je c t u r e s t h a t m il d g e n t le in f l a t i o n m a y h a v e c o n ­
t r ib u t e d t o t h e in d u s t r ia liz a t io n o f t h e W e s t . B u t
h is b a s ic s ta n c e is u n m is t a k a b ly t h a t o f a n a n t i­
in f l a t i o n i s t a n d h e s t i l l c o m e s d o w n s t r o n g ly i n f a v o r
o f a b s o lu te p r ic e s t a b ili t y a s t h e id e a l p o li c y g o a l.

A Treatise on Money (1930)
I f t h e Tract is f a m o u s f o r it s q u a n t it y t h e o r y i n f la t io n t a x a n a ly s is , t h e Treatise is e q u a lly f a m o u s
f o r it s c e le b r a t e d “ f u n d a m e n t a l e q u a t io n s o f p r ic e s ”
a n d t h e c o r r e s p o n d in g d is t in c t io n b e t w e e n in c o m e i n ­
f l a t i o n a n d p r o f i t i n f la t io n . 8 C o n s t it u t in g t h e c e n t r a l
a n a ly t ic a l c o r e o f t h e Treatise, t h e f u n d a m e n t a l e q u a ­
t io n s e x p r e s s p r ic e le v e l in c r e a s e s a s t h e s u m o f t w o
c o m p o n e n t s , n a m e ly ( 1 ) in c r e a s e s in p r o f i t p e r u n i t

8 For a recent exposition of the “fundamental equations”
and the corresponding concepts of income and profit
inflation, see Patinkin [11; pp. 33-8].
What follows
draws heavily from Patinkin.

o f o u t p u t , a n d ( 2 ) in c r e a s e s in u n it c o s ts o f p r o d u c ­
t io n ( c h ie f l y la b o r c o s t s ) . O f th e s e t w o c o m p o n e n t s o f
p r ic e c h a n g e — n a m e ly c h a n g e s in p r o f i t a n d c h a n g e s
i n c o s ts , r e s p e c t iv e ly — K e y n e s la b e ls t h e f o r m e r
“ p r o f i t i n f l a t i o n ” a n d t h e la t t e r “ in c o m e i n f l a t i o n . ”
P r o f i t in f l a t i o n o c c u r s w h e n p r ic e s a r e o u t r u n n in g
c o s ts , le a v in g a la r g e a n d g r o w in g m a r g in f o r p r o f i t .
B y c o n t r a s t , in c o m e in f l a t i o n o c c u r s w h e n w a g e s a r e
r is i n g a s f a s t a s p r ic e s t h e r e b y p r e v e n t in g p r o f i t
g ro w th .
I t s h o u ld b e n o t e d t h a t K e y n e s ’ in c o m e i n f la t io n
d o e s n o t c o r r e s p o n d t o w h a t t o d a y is c a lle d c o s tp u s h in f la t io n , i.e ., a n e x o g e n o u s r is e i n w a g e s a n d
h e n c e p r ic e s c a u s e d , f o r e x a m p le , b y t h e e x e r c is e o f
t r a d e u n io n m o n o p o ly p o w e r . R a t h e r i t is t h e i n ­
d u c e d e n d o g e n o u s r e s u lt o f a n in c r e a s e d d e m a n d f o r
la b o r a n d o t h e r r e s o u r c e s g e n e r a te d b y p r i o r p r o f i t
i n f la t io n . 9 F o r , a c c o r d in g t o K e y n e s , m o s t in c o m e
in f la t io n s d o n o t s te m f r o m a u t o n o m o u s ( “ s p o n t a n e ­
o u s ” ) in c r e a s e s in w a g e s c a u s e d b y “ t h e p o w e r s a n d
a c t i v it ie s o f t r a d e u n io n s ” [ 8 , p . 1 5 1 ] . I n s t e a d t h e y
s te m f r o m p r o f it - in d u c e d r is e s in t h e d e m a n d f o r
( a n d h e n c e p r ic e s o f ) la b o r a n d o t h e r f a c t o r r e ­
s o u r c e s . T h a t is , a p r o f i t i n f la t io n s t im u la t e s f i r m s
t o e x p a n d o u t p u t a n d h e n c e t h e ir d e m a n d f o r f a c ­
t o r s o f p r o d u c t io n . T h i s le a d s t o a b id d in g u p o f
f a c t o r p r ic e s t h a t r a is e s p r o d u c t io n c o s ts a n d g e n e r ­
a te s in c o m e in f la t io n . T h is p r o c e s s c o n t in u e s u n t i l
w a g e s a n d o t h e r f a c t o r p r ic e s r is e s u f f ic i e n t ly t o
e lim in a t e e x c e s s p r o f i t s . 10 S e e n t h is w a y , in c o m e
in f la t io n s p o s s e s s t h r e e d is t in c t iv e f e a t u r e s .
They
o c c u r a t t h e e x p e n s e o f p r o f i t in f la t io n s , e v e n t u a lly
a n n ih ila t i n g t h e la t t e r . T h e y n e e d n o t c a u s e a r is e in
p r ic e s s in c e t h e y a r e la r g e ly o ff s e t b y c o m p e n s a t in g
f a lls in p r o f i t in f la t io n . F i n a l l y , t h e y a r e a c r u c ia l p a r t
o f t h e p r o c e s s t h a t t r a n s f o r m s in f la t io n - e n g e n d e r e d
p r o f it s in t o c o s ts a n d t h e r e b y t e r m in a t e s t h e t e m ­
p o r a r y s t im u lu s t o e c o n o m ic a c t i v it y .
H a v i n g d e v e lo p e d t h e d is t in c t io n b e t w e e n p r o f i t a n d
in c o m e i n f la t io n , K e y n e s u s e d i t to a n a ly z e t h e e ff e c t
o f in f l a t i o n o n o u t p u t a n d e c o n o m ic g r o w t h . R e g a r d ­
in g th e s e e ffe c ts h e r e a c h e d t w o m a in c o n c lu s io n s .
F i r s t , o n ly p r o f i t in f l a t i o n h a s t h e p o w e r t o s t im u la t e
o u t p u t a n d g r o w t h . “ I t is t h e t e a c h in g o f t h is t r e a t ­
is e ,” h e s a id , “ t h a t t h e w e a lt h o f n a t io n s is e n r ic h e d ,
n o t d u r i n g in c o m e in f la t io n s , b u t d u r i n g p r o f i t i n f l a ­
t io n s . . . a t t im e s , t h a t is t o s a y , w h e n p r ic e s a r e

9 This point is stressed by Patinkin [11; p. 37].
10 See Keynes [8; pp. 241-2] and Patinkin [11; pp. 37,
45].




r u n n in g a w a y f r o m c o s ts ” [ 9 ; p . 1 3 7 ] . M o r e p r e ­
c is e ly , p r o f i t in f l a t i o n s t im u la t e s b o t h c u r r e n t a n d
lo n g - t e r m r e a l o u t p u t . I t s t im u la t e s c u r r e n t o u t p u t
b y r a is in g p r ic e s r e la t iv e t o w a g e s t h u s lo w e r in g r e a l
w a g e s a n d in c r e a s in g e m p lo y m e n t . A n d i t s t im u la t e s
lo n g - t e r m r e a l o u t p u t b y s h if t i n g in c o m e f r o m w a g e s
t o p r o f i t t h e r e b y p e r m i t t i n g f a s t e r c a p it a l a c c u m u la ­
t io n a n d a h ig h e r r a t e o f e c o n o m ic g r o w t h . I n s h o r t ,
t h e e ffe c ts o f p r o f i t i n f l a t i o n in c lu d e “ th e s p i r i t o f
b u o y a n c y a n d e n t e r p r is e a n d t h e g o o d e m p lo y m e n t
w h ic h a r e e n g e n d e r e d ; b u t m a in ly t h e r a p id g r o w t h
o f c a p it a l w e a lt h a n d t h e b e n e f it s o b t a in e d f r o m t h is
in s u c c e e d in g y e a r s ” [ 9 ; p . 1 4 4 ] . T h e s e b e n e f it s ,
h o w e v e r , a r e p o s s ib le o n ly w h e n p r ic e s a r e o u t r u n ­
n in g c o s ts , le a v in g a s u b s t a n t ia l m a r g in o f p r o f i t t o
f in a n c e in v e s t m e n t a n d g r o w t h . T h e y c a n n o t o c c u r
in in c o m e in f la t io n s w h e r e w a g e s r is e a s f a s t a s p r ic e s
a n d t h u s a n n ih ila t e t h e v e r y p r o f i t s t h a t c o n s t it u t e
b o t h t h e m e a n s a n d t h e in d u c e m e n t to e c o n o m ic
g r o w t h . I t f o llo w s t h a t in c o m e in f la t io n , u n lik e p r o f i t
in f la t io n , is in c a p a b le o f e n h a n c in g g r o w t h .
S e c o n d , w h a t m a t t e r s f o r in v e s t m e n t a n d g r o w t h is
h o w lo n g i t ta k e s f o r p r o f i t in f l a t i o n t o g iv e w a y to
in c o m e in f la t io n , a n d t h is d e p e n d s o n t h e s p e e d o f
a d ju s t m e n t o f w a g e s t o p r ic e s . I f t h e in t e r v a l is
s h o r t a n d w a g e s a d ju s t r a p i d l y t o p r ic e s , t h e n i n f l a ­
t io n w i l l h a v e l i t t l e o r n o im p a c t o n c a p it a l f o r m a t io n
a n d g r o w t h . B u t i f t h e in t e r v a l is lo n g a n d w a g e s
a d ju s t s lo w ly t o p r ic e s , t h e n t h e s t im u lu s m a y b e
c o n s id e r a b le a n d p r o f i t i n f la t io n , i n K e y n e s ’ o w n
w o r d s , b e c o m e s “ a m o s t p o t e n t in s t r u m e n t f o r t h e i n ­
c re a s e o f a c c u m u la t e d w e a l t h ” [ 8 ; p . 2 6 7 ] , R e g a r d ­
in g t h e in t e r v a l, K e y n e s a p p a r e n t ly f e l t t h a t i t h a d
in d e e d b e e n lo n g in p a r t i c u l a r h is t o r i c a l e p is o d e s —
“ q u it e lo n g e n o u g h , ” h e s a id , “ t o in c lu d e ( a n d , p e r ­
h a p s t o c o n t r iv e ) t h e r is e . . . o f t h e g r e a tn e s s o f a
n a t io n ” [ 9 ; p . 1 4 1 ] . I n t h is c o n n e c t io n h e a d v a n c e d
t h e h y p o t h e s is t h a t t h e e a r ly in d u s t r ia liz a t io n o f
E n g la n d a n d F r a n c e h a d b e e n p o w e r e d b y p r o f i t
in f la t io n . “ I t is u n t h in k a b le , ” h e d e c la r e d , “ t h a t t h e
d if f e r e n c e b e t w e e n t h e a m o u n t o f w e a lt h in F r a n c e
a n d E n g la n d in 1 7 0 0 a n d t h e a m o u n t in 1 5 0 0 c o u ld
e v e r h a v e b e e n b u i l t u p b y t h r i f t a lo n e . T h e i n t e r ­
v e n in g p r o f i t in f l a t i o n w h ic h c r e a t e d th e m o d e r n
w o r l d w a s s u r e ly w o r t h w h ile i f w e t a k e t h e lo n g
v ie w ” [ 9 ; p . 1 4 5 ].
L e s t o n e w r o n g l y c o n c lu d e f r o m t h e f o r e g o in g t h a t
K e y n e s o f t h e Treatise w a s a n o u t - a n d - o u t i n f l a t i o n ­
is t , t h r e e c a u t io n a r y o b s e r v a tio n s s h o u ld b e m a d e .
F i r s t , h e w a s r e f e r r i n g t o g e n t ly r i s i n g p r ic e s a n d
n o t t o t h e r a p id d o u b l e - d ig it in f l a t i o n t h a t is u n f o r t u ­
13

n a t e ly s o c o m m o n t o d a y . M o r e p r e c is e ly , h e w a s
r e f e r r in g t o s lo w c r e e p in g s e c u la r in f l a t i o n o f n o
m o re th a n 1 to 2 p e rc e n t p e r y e a r. T o d a y s u c h m ild
i n f la t io n w o u l d b e v ie w e d a s c o n s t it u t i n g v i r t u a l p r ic e
s t a b ili t y . S e c o n d , h is a n a ly s is o f b e n e f ic ia l in f l a t i o n
r e f e r s c h ie f ly t o c a p it a l- p o o r p r e in d u s t r ia l s o c ie tie s
a n d n o t t o w e a l t h y m o d e r n c a p it a lis t e c o n o m ie s .11
M o s t o f h is h is t o r i c a l e x a m p le s a r e t a k e n f r o m t h e
p r e - c a p it a lis t o r e a r ly - c a p it a lis t e r a w h e n w e s t e r n
E u r o p e w a s “ v e r y p o o r i n a c c u m u la t e d w e a l t h ” a n d
“ g r e a t ly i n n e e d o f a r a p id a c c u m u la t io n o f c a p it a l”
[ 9 ; p . 1 4 5 a n d 8 ; p . 2 6 8 ] . U n d e r th e s e c o n d it io n s
i t is c o n c e iv a b le t h a t s lo w ly - c r e e p in g p r o f i t in f l a t i o n
m ig h t in d e e d h a v e s p u r r e d i n d u s t r ia liz a t io n n o t o n ly
b y d i v e r t i n g r e s o u r c e s f r o m c o n s u m p t io n t o c a p it a l
f o r m a t io n , b u t a ls o b y b r e a k in g f e u d a l b o n d s , s t im u ­
la t in g e n t e r p r is e , e n c o u r a g in g m a r k e t - o r ie n t e d a c ­
t i v i t y , a n d w id e n in g t h e s c o p e o f t h e m a r k e t . T h e s e
la t t e r b e n e f it s , h o w e v e r , a r e n o lo n g e r a v a ila b le t o
w e a lt h y , m a r k e t - o r ie n t e d m o d e r n c a p it a lis t e c o n o ­
m ie s t h a t a r e m o r e l i k e l y t o f i n d s e c u la r in f l a t i o n a
c u r s e r a t h e r t h a n a b le s s in g . F o r t h is r e a s o n K e y n e s
r e f r a in e d f r o m r e c o m m e n d in g e v e n s l i g h t l y i n f l a t i o n ­
a r y p o lic ie s f o r m o d e r n e c o n o m ie s .
F i n a l l y , i t s h o u ld b e r e m e m b e r e d t h a t K e y n e s w a s
r e f e r r i n g t o p r o f i t in f l a t i o n c h a r a c t e r iz e d b y p r ic e s
p e r s is t e n t ly r i s i n g f a s t e r t h a n w a g e s a n d n o t t o
m o d e r n in f la t io n s in w h ic h w a g e s s o m e tim e s r is e
a h e a d o f p r ic e s o r a t le a s t f o l lo w t h e m w i t h o u t d e la y
t h e r e b y w i p i n g o u t t h e p r o f i t s g e n e r a t e d b y t h e p r ic e
in c r e a s e s .12 A s p r e v i o u s ly m e n t io n e d , K e y n e s h e ld
t h a t i n f l a t i o n s t im u la t e s g r o w t h o n ly i f w a g e s la g
s u b s t a n t ia lly b e h in d p r ic e s le a v in g a la r g e a n d p e r ­
s is t e n t m a r g in o f p r o f i t t o f in a n c e c a p it a l f o r m a t io n .
T h is w a g e la g , h o w e v e r , is h a r d ly c h a r a c t e r is t ic o f
m o d e r n in f la t io n s in w h ic h w a g e s r is e s w i f t l y n o t
o n ly t o r e s t o r e r e a l e a r n in g s e r o d e d b y p a s t i n f la t io n
b u t a ls o t o p r o t e c t r e a l e a r n in g s f r o m e x p e c t e d f u t u r e
in f la t io n . T h e c le a r im p lic a t io n is t h a t K e y n e s w o u l d
h a v e o p p o s e d th e s e m o d e r n in f la t io n s , w h ic h a c c o r d ­
in g t o h is a n a ly s is a r e in c o m e r a t h e r t h a n p r o f i t
in f la t io n s .
A c c o r d in g ly , i t is n o t s u r p r is in g t h a t K e y n e s , a t t h e
e n d o f a lo n g p a s s a g e e x t o l l i n g t h e h is t o r i c a l a c c o m ­
p lis h m e n t s o f p r o f i t in f la t io n , n e v e r t h e le s s d e c la r e d ,
“ I a m n o t y e t c o n v e r t e d , t a k i n g e v e r y t h in g i n t o a c ­
c o u n t , f r o m a p r e fe r e n c e f o r a p o lic y t o d a y w h ic h ,
w h ils t a v o id in g d e f la t io n a t a l l c o s ts , a im s a t t h e
11 On this point see Haberler [2; pp. 98-100].
12 See Haberler [2; p. 99].
14




s t a b ili t y o f p u r c h a s in g p o w e r a s it s id e a l o b je c t iv e ”
[ 9 ; p . 1 4 5 ] . T h e r e is n o r e a s o n t o b e lie v e t h a t h e
e v e r c h a n g e d t h a t p o s it io n . O n t h e c o n t r a r y , t h e r e
is s t r o n g e v id e n c e t h a t h e r e m a in e d a d e t e r m in e d fo e
o f i n f la t io n a n d a n a d a m a n t p r o p o n e n t o f p r ic e s ta ­
b i l i t y e v e n t o t h e e x t e n t o f w a r n i n g o f t h e p o t e n t ia l
d a n g e r o f in f l a t i o n i n 1 9 3 7 w h e n t h e u n e m p lo y m e n t
r a t e w a s in e x c e s s o f 1 0 p e r c e n t o f t h e la b o r f o r c e .

Articles in The Times (1937)
T h e m o s t c o n v in c in g e v id e n c e o f h is c o n t in u i n g
s t r o n g o p p o s it io n t o in f l a t i o n in t h e 1 9 3 0 s , e v e n a f t e r
t h e p u b lic a t io n o f h is c e le b r a t e d General Theory,
a p p e a r s in f o u r a r t ic le s h e w r o t e f o r The Times in
e a r ly 1 9 3 7 .13 T h e r e , i n d is c u s s in g p o lic ie s f o r d e a lin g
w i t h u n e m p lo y m e n t a t t h e b u s in e s s c y c le p e a k o f
1 9 3 7 , h e m a d e i t a b u n d a n t ly c le a r t h a t h is p r i m a r y
c o n c e r n w a s p r e v e n t i n g in f la t io n . I n p a r t ic u la r , h e
a r g u e d t h a t t h e 1 9 3 7 u n e m p lo y m e n t r a t e , a lt h o u g h
v e r y h ig h ( “ in d e e d , a s h ig h a s 1 2 ^ p e r c e n t ” ) , w a s
n e v e r th e le s s a t it s m in im u m n o n in f l a t io n a r y le v e l a t
w h ic h d e m a n d p r e s s u r e m u s t b e c u r t a il e d t o p r e v e n t
in f la t io n .
A c c o r d in g ly , h e r e c o m m e n d e d a s h a r p
c u tb a c k i n g o v e r n m e n t e x p e n d it u r e o n t h e g r o u n d s
t h a t t h e e c o n o m y w a s r a p i d l y a p p r o a c h in g t h e p o in t
w h e r e f u r t h e r in c r e a s e s i n a g g r e g a t e d e m a n d w o u l d
b e p u r e ly in f la t io n a r y . “ I b e lie v e , ” h e s a id , “ t h a t w e
a r e a p p r o a c h in g , o r h a v e r e a c h e d , t h e p o in t w h e r e
t h e r e is n o t m u c h a d v a n t a g e i n a p p ly in g a f u r t h e r
g e n e r a l s t im u lu s a t t h e c e n t r e ” [ 4 ; p p . 1 1 , 4 4 , 6 5 ] .
I n s o s t a t in g , h e id e n t if ie d t h e n o n in f l a t io n a r y f u l l
e m p lo y m e n t r a t e o f u n e m p lo y m e n t ( N I F E R U )
b e lo w w h ic h in d u s t r ia l b o t t le n e c k s f r u s t r a t e t h e i n ­
t e n d e d o u t p u t a n d e m p lo y m e n t e ffe c ts o f a g g r e g a t e
d e m a n d e x p a n s io n p o li c y s o t h a t m a in ly p r ic e s r is e . 14
B e y o n d t h a t p o in t , h e s a id , n o n in f l a t io n a r y r e d u c ­
t io n s i n jo b le s s n e s s c o u ld o n ly b e a c h ie v e d b y s p e c if ic
s t r u c t u r a l p o lic ie s d e s ig n e d t o lo w e r t h e f u l l e m p lo y ­
m e n t r a t e o f u n e m p lo y m e n t it s e lf .

13 These articles are reprinted and discussed in Hutchison
[4]. Unless otherwise noted, all references in this section
are to Hutchison.
14 The N IF E R U concept also appears in the General
Theory where Keynes asserts that, beyond a certain
point, structural impediments (“a series of bottle-necks” )
would prevent the noninflationary expansion of output
and employment long before full capacity is reached. At
the bottleneck point any further increase in aggregate
demand would, in his words, largely “spend itself in
raising prices, as distinct from employment” [10; pp.
300-1].

A s f o r t h e e x is t in g h ig h le v e l o f t h a t u n e m p lo y m e n t
ra te , h e a ttr ib u te d i t t o s tr u c tu r a l r ig id it ie s in th e
B r i t i s h e c o n o m y , i n p a r t i c u l a r t o a s u b s t a n t ia l m is ­
m a t c h b e t w e e n t h e lo c a t io n a n d s k i l l m i x o f t h e la b o r
f o r c e a n d t h e lo c a t io n a n d c o m p o s it io n o f d e m a n d .
A s h e p u t i t , “ t h e e c o n o m ic s t r u c t u r e is u n f o r t u n a t e ly
r i g i d ” a n d t h i s r i g i d i t y p r e v e n te d o u t p u t a n d e m ­
p lo y m e n t f r o m r e s p o n d in g t o in c r e a s e s in a g g r e g a t e
d e m a n d s o t h a t o n ly p r ic e s r is e [ 4 ; p p . 1 1 , 6 5 - 6 ] .
I t f o l lo w s , h e s a id , t h a t t o a c h ie v e n o n in f l a t io n a r y
r e d u c t io n s i n u n e m p lo y m e n t “ w e a r e m o r e i n n e e d
t o d a y o f a r i g h t l y d is t r ib u t e d d e m a n d t h a n o f a
g re a te r a g g re g a te d e m a n d ” [ 4 ; p p . 11, 6 6 ] . I n o th e r
w o r d s , n o n in f l a t io n a r y r e d u c t io n s i n u n e m p lo y m e n t
c a n n o t b e o b t a in e d b y e x p a n s io n a r y a g g r e g a t e
d e m a n d - m a n a g e m e n t p o lic ie s b u t r a t h e r “ r e q u ir e a
d if f e r e n t t e c h n iq u e ” [ 4 ; p p . 1 1 , 1 4 , 4 4 , 6 6 ] . T o t h is
e n d h e a d v o c a t e d s p e c if ic s t r u c t u r a l p o lic ie s t o r e d u c e
u n e m p lo y m e n t o n t h e g r o u n d s t h a t n o n in f l a t io n a r y
r e d u c t io n s i n u n e m p lo y m e n t c o u ld o n ly b e a c h ie v e d
v ia m e a s u r e s t h a t e r a d ic a t e s t r u c t u r a l r i g i d i t i e s a n d
lo w e r t h e e q u ilib r iu m u n e m p lo y m e n t r a t e it s e lf . I n
s o a r g u in g , h e f o r e s h a d o w e d b y 3 0 y e a r s t h e m o d e r n
m o n e t a r is t c o n c e p t o f t h e n a t u r a l r a t e o f u n e m p lo y ­
m e n t . 15 H e a ls o r e f u t e d t h e p o p u la r c o n t e n t io n t h a t
h e w a s a n i n f l a t i o n i s t w h o a d v o c a te d f u l l e m p lo y m e n t
a t a n y c o s t. T h a t is , h is 1 9 3 7 a r t ic le s a m p ly d e m o n ­
s t r a t e t h a t , f a r f r o m b e in g a n i n f la t io n is t , h is m a in
c o n s id e r a t io n w a s p r e v e n t i n g in f l a t i o n — e v e n a t a
t im e w h e n t h e u n e m p lo y m e n t r a t e e x c e e d e d 1 2 p e r ­
c e n t. T h e s a m e a r t ic le s s h o w t h a t , f a r f r o m a d v o ­
c a t in g f u l l e m p lo y m e n t a t a n y c o s t, h e c le a r ly t h o u g h t
t h a t t h e r e w a s a f a i r l y h ig h le v e l o f u n e m p lo y m e n t
a t w h ic h e x p a n s io n a r y a g g r e g a t e d e m a n d p o li c y
s h o u ld b e c u r b e d t o p r e v e n t in f la t io n . F r o m t h a t
le v e l d o w n w a r d h e in s is t e d t h a t u n e m p lo y m e n t m u s t
b e d e a lt w i t h n o t b y t h e g e n e r a l e x p a n s io n o f a g g r e ­
g a t e d e m a n d b u t r a t h e r b y s p e c if ic s t r u c t u r a l p o lic ie s
t h a t r e d u c e t h e n o n in f l a t io n a r y u n e m p lo y m e n t r a t e
it s e lf . I n s h o r t , t h e r e is n o t h in g i n t h e a r t ic le s t o

15 Hutchison stresses this point, arguing that Keynes
“suggested a similar concept to that now called— follow­
ing Professor Milton Friedman— a ‘natural rate’ of un­
employment in that he stressed ‘the unfortunately rigid’
elements in the British economy which made it undesir­
able to try to reduce unemployment further by the ex­
pansion of central government demand” [4; pp. 14-15].
Moreover, “ Keynes’s ‘different technique’ . . . corre­
sponded, in some important respects, with what today,
following Professor Friedman, is described as reducing
the natural rate of unemployment” [4; p. 46]. Similarly,
Samuel Brittain writes that “Keynes’s idea of the level of
unemployment which would exist without demand defi­
ciency seems astonishingly similar to Milton Friedman’s
‘natural’ rate of unemployment” [4; p. 63, n. 21].




s u g g e s t t h a t K e y n e s h a d e v e r c h a n g e d h is m in d a b o u t
in f la t io n . O n t h e c o n t r a r y , h e s h o w s t h e s a m e c o n ­
c e r n f o r i n f la t io n i n h is 1 9 3 7 a r t ic le s t h a t h e e a r lie r
d is p la y e d i n t h e Tract.

L -u n ciu cU n g Core

T h e m a in c o n c lu s io n o f t h i s e s s a y is t h a t K e y n e s
w a s n e it h e r t h e s u b t le i n f l a t i o n i s t n o r t h e e x t r e m e
n o n m o n e t a r is t t h a t h e is s o m e t im e s d e p ic t e d a s b e in g .
O n t h e c o n t r a r y , h is w r i t i n g s r e v e a l t h a t h e c o n ­
s is t e n t ly d e p lo r e d in f l a t i o n , t h a t h e w a r n e d u n c e a s ­
in g l y o f it s d a n g e r s , a n d t h a t h e u r g e d t h a t it s a v o id ­
a n c e b e m a d e a p r i m a r y o b je c t iv e o f p u b lic p o lic y .
I n th e s e re s p e c ts h e s h a r e d m u c h w i t h m o d e r n m o n e ­
t a r is t s , e v e n t o t h e p o in t o f u s in g s im i la r a n a ly t ic a l
to o ls .
I n t h a t p e r s p e c tiv e , a k e y q u e s t io n is h o w t h e m is ­
c o n c e p t io n t h a t h e w a s a n in f l a t i o n i s t c o u ld h a v e
a r is e n . W h e t h e r i t s t e m m e d f r o m h is General
Theory ( w h e r e h e p r e s c r ib e d d e f ic it - s p e n d in g e a s y
m o n e y p o lic ie s t o e lim in a t e e x c e s s iv e u n e m p lo y m e n t )
o r f r o m t h e t e n d e n c y o f s o m e s e lf - s t y le d m o d e r n
K e y n e s ia n s t o in v o k e h is m a g ic n a m e in b e h a lf o f
t h e ir o w n in f l a t i o n a r y f u l l- e m p lo y m e n t s c h e m e s , o r
e v e n f r o m h is o w n a d v o c a c y o f d is c r e t io n o v e r r u le s
in t h e c o n d u c t o f m o n e t a r y p o li c y , h is r e p u t a t io n a s
a n in f la t io n is t is h i g h l y u n d e s e r v e d . F o r , w i t h
r e s p e c t t o t h e General Theory, h e d id n o t in t e n d f o r
h is e x p a n s io n is t p o li c y p r e s c r ip t i o n s t o a p p ly t o i n ­
f la t i o n a r y s it u a t io n s . O n t h e c o n t r a r y , a s d o c u ­
m e n t e d a b o v e , h e a b a n d o n e d th e s e p r e s c r ip t io n s i n
e a r ly 1 9 3 7 u p o n t h e f i r s t s ig n s o f a p o s s ib le in f la t io n .
N o r w o u l d h e h a v e h a d a n y t h in g b u t s c o r n f o r
m o d e r n K e y n e s ia n p o lic ie s d e s ig n e d t o t r a d e o f f
h ig h e r i n f la t io n f o r l o w e r u n e m p lo y m e n t . H i s in s is ­
te n c e o n t h e p r im a c y o f t h e g o a l o f a b s o lu te p r ic e
s t a b ili t y w o u l d h a v e b e e n i n d ir e c t c o n f lic t w i t h s u c h
i n f la t io n a r y p o lic ie s .
F i n a l l y , h is s u p p o r t o f d is ­
c r e t io n o v e r r u le s d id n o t r e v e a l a n in f l a t i o n a r y b ia s
o n h is p a r t b u t r a t h e r a b e lie f t h a t d is c r e t i o n a r y
p o lic y w a s n e c e s s a r y t o c o m p e n s a te c h a n g e s i n t h e
d e m a n d f o r m o n e y a n d h e n c e t o a c h ie v e p r ic e le v e l
s t a b ilit y . T h a t is , h e d if f e r e d f r o m t h e p r o p o n e n t s o f
m o n e t a r y r u le s n o t o v e r t h e o b je c t iv e o f p r ic e s ta ­
b i l i t y p e r s e , b u t r a t h e r o v e r t h e m e a n s t o a c h ie v e
t h a t o b je c t iv e . T h e r e is n o t h in g i n h is w r i t i n g s t o
in d ic a t e t h a t h e e q u a t e d p r o p e r d is c r e t i o n a r y p o li c y
w i t h t h e u s e o f p r ic e i n f l a t i o n t o e x p a n d o u t p u t a n d
e m p lo y m e n t. O n t h e c o n t r a r y , h e t h o u g h t t h a t d is ­
c r e t io n a r y p o li c y o f f e r e d t h e b e s t m e a n s o f a v o id in g

15

i n f la t io n a n d a c h ie v in g p r ic e s t a b ilit y .
I n s h o rt,
g iv e n h is b e lie f s a b o u t t h e e ffic a c y o f d is c r e t io n a r y
p o lic y , h is a d v o c a c y o f s u c h p o lic y w a s p e r f e c t ly
c o n s is t e n t w i t h h is a n t ip a t h y t o in f la t io n . T h a t a n t i ­

p a t h y a m p ly ju s t if ie s F . A . H a y e k ’ s ju d g m e n t t h a t i f
K e y n e s w e r e a liv e t o d a y h e w o u l d b e “ o n e o f th e
m o s t d e t e r m in e d f ig h t e r s a g a in s t i n f l a t i o n ” [ 4 ; p . 4 0 .
n . 1 ],

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1.

Buchanan, Jam es

M., and W agner,

Richard

E.

7.

D em ocracy In D e fic it: The Political Legacy of
Lord K eyn e s. N ew Y o rk : Academ ic Press, 1977.

2.

H aberler, G ottfried. Inflation, Its Causes and
Cures.
Revised and enlarged edition. W ash ing­
ton, D. C .: A m erica n Enterprise Institute fo r
Public P olicy R esearch, 1966.

3.

H ow son, Susan. “ ‘A D ear Money M an’ ? : Keynes
On M onetary P olicy. 1920.”
Economic Journal
(June 1973), pp. 456-64.

4.

H utchison, T. W .
K eyn es Versus The ‘K e y n e s­
L on d on : The Institute o f Econom ic
A ffa ir s , 1977.

------ _ _ -----. A Tract 07i M onetary R eform . 1923.
A s reprinted in K eynes’ Collected W ritings, Vol.
IV . London: M acm illan, 1971.

8. —------- — —.

A Treatise on M oney, Vol. I : The
P ure Theory o f M on ey.
1930.
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K eyn es’ Collected W ritings, V ol. V .
L on don:

M acm illan, 1971.
9

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. A Treatise on M on ey, Vol. I I : The
A pplied Theory o f M o n ey. 1930. A s reprinted in
K eynes’ Collected W ritin gs, V ol. V I.
London:
M acm illan, 1971.

ians' . . .?

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K eynes, John M. Indian Currency and Finance.
1913. A s reprinted in K eynes’ Collected W ritings,
Vol. I. L on don : M acm illan, 1971.
The Econom ic Consequences of the
.. —----- —
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1
6



. The General T heory of E m ploym ent
In terest and M oney. 1936. A s reprinted in K eynes’
Collected W ritings, V ol. V II. L on don : M acmillan,
1973.

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Patinkin, Don.
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versity Press, 1976.

Highlights
Earnings and Capital Accounts
N e t e a r n in g s b e f o r e p a y m e n ts t o t h e U n it e d
S ta te s T r e a s u r y in c r e a s e d b y $ 1 9 7 ,8 3 1 ,9 4 7 .8 7 t o
$ 9 5 7 , 2 0 6 , 0 0 0 .0 0 in 1 9 8 0 . S i x p e r c e n t s t a t u t o r y d i v i ­
d e n d s t o t a lin g $ 3 ,6 6 6 > 1 1 8 .2 9 w e r e p a id t o F i f t h D is ­
t r i c t m e m b e r b a n k s , a n d t h e s u m o f $ 9 5 0 ,0 8 7 ,4 8 1 .7 1
w a s t u r n e d o v e r t o t h e U n i t e d S ta te s T r e a s u r y .
C a p it a l s t o c k in c r e a s e d b y $ 3 ,4 5 2 , 4 0 0 . 0 0 t o
$ 6 1 , 6 8 5 , 2 0 0 . 0 0 a s m e m b e r b a n k s in c r e a s e d t h e i r
s t o c k h o ld in g s in t h is B a n k , a s r e q u ir e d b y la w , t o
r e f le c t t h e r is e in t h e ir o w n c a p it a l a n d s u r p lu s
a c c o u n ts . T h e B a n k ’ s s u r p lu s a c c o u n t in c r e a s e d
$ 3 , 4 5 2 , 4 0 0 . 0 0 t o $ 6 1 ,6 8 5 ,2 0 0 .0 0 .

The Monetary Control Act of 1980
T h e M o n e t a r y C o n t r o l A c t o f 1 9 8 0 ( M C A ) is
T i t l e I o f a la r g e r p ie c e o f le g is la t io n c a lle d t h e
D e p o s it o r y I n s t it u t io n s D e r e g u la t io n a n d M o n e t a r y
C o n t r o l A c t o f 1 9 8 0 , s ig n e d in t o la w o n M a r c h 3 1 ,
1 9 8 0 . T h is is t h e m o s t c o m p r e h e n s iv e p ie c e o f
f in a n c ia l le g is la t io n s in c e t h e 1 9 3 0 s , a n d i t h a s
s ig n i f i c a n t im p lic a t io n s f o r t h e o p e r a t io n s o f b o t h
p r iv a t e f in a n c ia l in s t it u t io n s a n d t h e F e d e r a l R e ­
s e r v e S y s te m . T h e M C A h a d a la r g e im p a c t o n
B a n k a c t iv it ie s a n d t h e b u d g e t d u r in g 1 9 8 0 , a n d t h is
im p a c t w i l l c o n t in u e t o b e f e l t in t h e c o m in g y e a r .
I m p o r t a n t c h a n g e s m a n d a te d b y t h e M C A t h a t a re
a f f e c t in g B a n k o p e r a t io n s in c lu d e :
( 1 ) o p e n in g t h e d is c o u n t w in d o w t o a ll d e p o s i­
t o r y i n s t it u t io n s h o ld in g r e s e r v a b le l i a b i l i t i e s ;
( 2 ) u n iv e r s a l r e s e r v e r e q u ir e m e n t s a n d d e p o s it
r e p o r tin g ; a n d
( 3 ) o p e n in g a c c e s s t o n e w c la s s e s o f c o n s t it u ­
e n ts a n d b e g in n in g p r ic in g t o a ll u s e r s o f F e d e r a l
R e s e r v e s e r v ic e s .

n o r s , r a is e d t h e d is c o u n t r a t e t o 1 3 p e r c e n t f r o m i t s
p r e v io u s le v e l o f 1 2 p e r c e n t s e t o n O c t o b e r 8 , 1 9 7 9 .
T h is a c tio n c a m e a s a r e s u l t o f t h e S y s t e m ’ s c o n c e r n
t h a t r e c e n t e c o n o m ic d e v e lo p m e n ts , in c lu d in g t h e
la r g e in c r e a s e in t h e p r ic e o f im p o r t e d o il, w e r e
a d d in g t o in f la t io n a r y p r e s s u r e s a n d m ig h t le a d t o
f u r t h e r d e s t a b iliz in g p r i c i n g d e c is io n s .
E f f e c t iv e M a r c h 1 7 , a 3 p e r c e n t s u r c h a r g e w a s
in s t it u t e d o n c e r t a in a d ju s t m e n t c r e d i t b o r r o w in g s b y
b a n k s w i t h d e p o s its o f $ 5 0 0 m i l l i o n o r m o r e w h e n
s u c h b o r r o w in g s o c c u r r e d s u c c e s s iv e ly i n t w o o r
m o re re s e rv e w e e k s o r in m o re th a n f o u r re s e rv e
w e e k s in a c a le n d a r q u a r t e r . T h e s u r c h a r g e , w h ic h
d id n o t a p p ly t o b o r r o w in g s u n d e r t h e s e a s o n a l o r
e m e r g e n c y lo a n p r o g r a m s , w a s d e s ig n e d t o d is c o u r ­
a g e f r e q u e n t u s e o f t h e d is c o u n t w in d o w a n d t o
e n c o u ra g e b a n k s w it h a cce ss to m o n e y m a rk e ts to
a d ju s t t h e i r lo a n s a n d in v e s t m e n t s m o r e p r o m p t l y t o
c h a n g in g m a r k e t c o n d it io n s . I t w a s a ls o in t e n d e d t o
b r in g c o s ts o f c r e d i t a t t h e d is c o u n t w in d o w in t o
r o u g h a lig n m e n t w i t h s h o r t - t e r m r a t e s in t h e m a r k e t .
I n v ie w o f t h e s u b s e q u e n t d e c lin e i n m a r k e t r a te s
t h e s u r c h a r g e w a s e lim in a t e d e f f e c t iv e M a y 7 .
T h e d is c o u n t r a t e w a s s u b s e q u e n t ly r e d u c e d t o 1 2
p e r c e n t o n M a y 2 9 , t o 11 p e r c e n t o n J u n e 1 3 , a n d t o
1 0 p e r c e n t o n J u l y 2 8 , 1 9 8 0 , t o b r i n g i t in t o c lo s e r
a lig n m e n t w i t h s h o r t - t e r m r a t e s g e n e r a lly . E f f e c t iv e
S e p te m b e r 2 6 , t h e r a t e w a s in c r e a s e d f r o m 1 0 p e r ­
c e n t t o 11 p e r c e n t a s p a r t o f t h e S y s te m ’ s c o n t in u i n g
p o lic y t o d is c o u r a g e e x c e s s iv e g r o w t h i n t h e m o n e ­
t a r y a g g r e g a te s . I n t a k i n g t h i s a c t io n t h e B o a r d a ls o
t o o k n o t e o f t h e la r g e in c r e a s e s in b o r r o w in g s a t t h e
F e d e r a l R e s e r v e d is c o u n t w in d o w s t e m m in g f r o m th e
g r o w in g d if f e r e n t ia l b e t w e e n s h o r t - t e r m m a r k e t i n ­
t e r e s t r a t e s a n d t h e 1 0 p e r c e n t d is c o u n t r a t e t h a t h a d
b e e n i n e ff e c t s in c e J u l y 2 8 .

A n in - b a n k M C A T a s k F o r c e w a s f o r m e d e a r ly in
t h e y e a r t o h e lp c o o r d in a t e t h e m a n y a c tio n s r e q u ir e d
t o im p le m e n t th e s e c h a n g e s . A l l o f t h e B a n k d e p a r t ­
m e n t s a r e r e p r e s e n te d o n t h i s g r o u p .

O n N o v e m b e r 1 7 , t h e d is c o u n t r a t e w a s r a is e d t o
1 2 p e r c e n t a n d a 2 p e r c e n t s u r c h a r g e w a s im p o s e d o n
b o r r o w in g b y f in a n c ia l i n s t it u t io n s w i t h d e p o s its o f
$ 5 0 0 m illio n o r m o re . T h e p u r p o s e w a s th e sa m e as
t h a t o f t h e S e p t e m b e r 2 6 r a t e in c r e a s e . O n D e c e m ­
b e r 5 , t h e d is c o u n t r a t e w a s r a is e d t o 1 3 p e r c e n t a n d
t h e s u r c h a r g e w a s in c r e a s e d t o 3 p e r c e n t.

Discount Rate

Fiscal Agency

O n F e b r u a r y 1 5 t h e D ir e c t o r s o f t h e R ic h m o n d
R e s e rv e B a n k , w it h a p p ro v a l o f th e B o a rd o f G o v e r­

A n o n - lin e s e c u r itie s t r a n s f e r ( C P D ) s y s te m b e ­
c a m e f u n c t io n a l d u r i n g t h e f i r s t q u a r t e r o f 1 9 8 0 . B y




17

t h e e n d o f t h e y e a r 2 1 m e m b e r b a n k s in t h e R ic h ­
m o n d , B a lt im o r e , a n d C h a r lo t t e t e r r it o r ie s w e r e
s e n d in g a n d r e c e iv in g t h e ir o w n C P D t r a f f ic , t h e r e b y
r e d u c in g r e s o u r c e r e q u ir e m e n t s a t th e R e s e r v e B a n k .

Computer Operations
O n e m o re m e m b e r b a n k c o m p u te r lin k w a s c o n ­
n e c te d t o t h e F i f t h D i s t r i c t C o m m u n ic a t io n s S y s te m
in 1 9 8 0 , r a is in g t h e t o t a l n u m b e r o f b a n k c o m p u t e r
in t e r f a c e s t o s e v e n .
T e r m in a ls w e r e in s t a lle d in
e ig h t a d d it io n a l m e m b e r b a n k s , r a is in g t h e t o t a l to
3 4 b a n k s d ir e c t l y c o n n e c te d t o th e F i f t h D i s t r i c t
C o m m u n ic a t io n s S y s te m .
T h e M o n e t a r y C o n t r o l A c t h a d a s ig n if ic a n t i m ­
p a c t o n a u t o m a t io n in t h e p r e p a r a t io n f o r : ( 1 ) t h e
in c r e a s e d n u m b e r o f f in a n c ia l in s t it u t io n s u s in g t h e
B a n k ’ s s e r v ic e s , ( 2 ) t h e e x p a n d e d v o lu m e a n d t y p e
o f s t a t is t ic a l in f o r m a t io n b e in g r e p o r t e d , a n d ( 3 ) th e
e x p a n d e d a c c e s s t o a n d p r ic in g o f F e d e r a l R e s e r v e
s e r v ic e s .

Planning
B e s id e s c o o r d in a t in g d e v e lo p m e n t o f t h e B a n k
O p e r a t io n s P la n f o r t h e F i f t h D i s t r i c t , t h e P la n n in g
D e p a r t m e n t u n d e r t o o k s tu d ie s d e s ig n e d t o id e n t if y
o p p o r t u n it ie s f o r i m p r o v in g o p e r a t in g e f f ic ie n c y a t
b o t h t h e D i s t r i c t a n d S y s te m le v e ls . E x a m in e d w e r e
U . S . G o v e r n m e n t c h e c k t r u n c a t io n p r o c e d u r e s ,
a lt e r n a t i v e m e t h o d s f o r s h ip p in g n o n c a s h c o lle c tio n
it e m s , a n d m i n im u m c o n t r o l s t a n d a r d s f o r t h e h a n d ­
l i n g a n d s t o r a g e o f v a lu a b le s .
T h e M C A h a d a s u b s t a n t ia l im p a c t o n P la n n in g
D e p a r t m e n t a c t iv it ie s d u r in g t h e y e a r . T h is d e p a r t ­
m e n t is t h e p r i m a r y s o u r c e o f a d m in is t r a t iv e a n d
a n a ly t ic a l s u p p o r t f o r t h e M C A T a s k F o r c e w h o s e
r e s p o n s ib ilit ie s in c lu d e t h e e x e c u t io n o f a n im p le ­
m e n t a t io n p la n f o r t h e M C A p r o je c t , a s w e ll a s t h e
d e v e lo p m e n t o f a c o n t in g e n c y p la n t o a s s e s s t h e o p e r ­
a t io n a l im p a c t s o f a c c e s s t o a n d p r ic in g o f S y s te m
s e r v ic e s .

Research Department - Statistical Division
S e v e r a l m a j o r d e v e lo p m e n ts in 1 9 8 0 d ir e c t l y
a ff e c t e d o p e r a t io n s a n d r e s p o n s ib ilit ie s o f t h e S t a ­
t is t ic a l D iv i s i o n . I n J a n u a r y 1 9 8 0 , t h e B a n k ’ s S e n io r
18




M a n a g e m e n t a p p r o v e d a p r o p o s a l t o c o n s o lid a t e t h e
c o lle c t io n a n d p r o c e s s in g o f a ll e x t e r n a l r e p o r t s ( d a t a
c o lle c te d f r o m e n t it ie s o u t s id e t h e B a n k ) in t h e D i v i ­
s io n . C o n s e q u e n t ly , d e p o s it r e p o r t s a n d r e la t e d s e rie s
w e re tr a n s fe r re d fr o m th e B a n k A c c o u n ts D e p a r t­
m e n t a t t h e R ic h m o n d O f f ic e a n d t h e A c c o u n t in g
D e p a r t m e n t s a t t h e o t h e r o ff ic e s t o t h e S t a t is t ic a l
D iv i s i o n . T h e p h a s e d t r a n s f e r o f o t h e r r e p o r t s t o
th e D iv i s i o n w i l l c o n t in u e t h r o u g h t h e f i r s t q u a r t e r
o f 1981.
T h e p a s s a g e o f th e M o n e ta r y C o n tr o l A c t o f 1 9 8 0
r e q u ir e d a ll d e p o s it o r y i n s t it u t io n s o f f e r in g t r a n s ­
a c t io n a c c o u n t s o r n o n p e r s o n a l t im e d e p o s its t o
r e p o r t d e p o s it d a t a d ir e c t l y t o t h e F e d e r a l R e s e r v e
b e g in n in g O c t o b e r 3 0 . O v e r 1 ,0 0 0 F i f t h D i s t r i c t
i n s t it u t io n s a r e f i l i n g w e e k ly r e p o r t s a n d a p p r o x i ­
m a t e ly 5 0 0 m o r e w i l l b e r e p o r t in g q u a r t e r ly .
A n o t h e r s ig n if ic a n t d e v e lo p m e n t a f f e c t in g th e
D iv i s i o n d u r i n g 1 9 8 0 w a s t h e C r e d it R e s t r a i n t P r o ­
g r a m ( C R P ) in e ff e c t f r o m M a r c h t o J u ly . F o u r
n e w r e p o r t s w e r e in it ia t e d u n d e r t h e C R P . O f th e s e ,
t h e m o s t e x te n s iv e c o lle c te d in f o r m a t io n o n c o v e r e d
c o n s u m e r c r e d i t f r o m c o m m e r c ia l b a n k s a s w e ll a s
f r o m r e t a ile r s w h o e x te n d e d c r e d it .

Examining
T h e r e s p o n s ib ilit ie s o f t h e d e p a r t m e n t c o n t in u e d to
e x p a n d , d u e t o b o t h t h e in c r e a s in g n u m b e r o f S ta te
m e m b e r b a n k s a n d t h e g r o w t h in a s s e ts u n d e r e x a m i­
n a t io n r e s u l t i n g f r o m m e r g e r s . T h e y e a r a ls o s a w a n
in c r e a s in g a m o u n t o f t h e d e p a r t m e n t ’s r e s o u r c e s d e ­
v o t e d t o c h e c k in g S ta te m e m b e r b a n k s f o r c o m p l i­
a n c e w i t h t h e n u m e r o u s c o n s u m e r - o r ie n t e d la w s a n d
r e g u la t io n s t h a t h a v e b e e n a d o p t e d in r e c e n t y e a r s ,
w i t h a b o u t 2 0 p e r c e n t o f t h e f ie ld s t a f f n o w in v o lv e d
in t h is e f f o r t .

Culpeper Office
P la n s a r e u n d e r w a y t o r e p la c e in e a r ly J a n u a r y
1 9 8 1 t h e C o n t r o l D a t a M l 0 0 0 c o m m u n ic a t io n s c o m ­
p u t e r w i t h a n e w C y b e r 1 0 0 0 c o m p u t e r c a p a b le o f
a c c o m m o d a t in g a d d it io n a l t r a f f i c a n d p r o v i d in g r e l i ­
a b le s e r v ic e f o r s e v e r a l y e a r s t o c o m e . T h is e q u ip ­
m e n t e v e n t u a lly w i l l b e s u p e r s e d e d b y t h e n e w p a c k e t
s w it c h s y s te m d e s ig n a t e d F R C S - 8 0 w h ic h w i l l s t a r t
s e r v ic e in 1 9 8 2 .

New Building - Baltimore
C o n s t r u c t io n o f t h e n e w B a lt im o r e B r a n c h b u i l d ­
in g b e g a n i n J a n u a r y a n d w a s o n s c h e d u le a t y e a r e n d . C o m p le t io n is p la n n e d f o r t h e t h i r d q u a r t e r o f
1 9 8 2 . T h e p r o je c t y ie ld e d a n u n e x p e c t e d a r c h a e o ­
lo g ic a l b o n a n z a w h e n e x c a v a t io n u n c o v e r e d m o r e
t h a n 5 0 ,0 0 0 a r t if a c t s a n d h is t o r i c a l r e lic s .

Federal Reserve Membership
T h e f o l l o w i n g n e w ly c h a r t e r e d b a n k s i n t h e F i f t h
D i s t r i c t o p e n e d f o r b u s in e s s d u r in g 1 9 8 0 a s m e m b e r s
o f th e F e d e ra l R e s e rv e S y s te m :
National Banks
Upshur National Bank
Buchannon, W est Virginia
Heritage National Bank
Huntington, W est Virginia
(Successor to The Metro Bank of
Huntington, Inc.)
Liberty National Bank
Charleston, South Carolina

July 1
September 15

December 1

T h e f o llo w in g S ta te - c h a rte re d b a n k s c o n v e rte d to
m e m b e r s h ip in t h e F e d e r a l R e s e r v e S y s te m d u r in g
1980:
Bank of Newport News
Newport News, Virginia

March 27

Bank of Suffolk
Suffolk, Virginia

April 24

Bank of W est Point
West Point, Virginia

April 30

The Suburban Bank
Henrico County, Virginia
The Peoples Bank of Chesterfield
Chesterfield, Virginia
The Bank of Middlesex
Urbanna, Virginia

May 15

August 28

December 31

Changes in Directors
F i f t h D i s t r i c t m e m b e r b a n k s e le c te d o n e C la s s A
a n d o n e C la s s B d ir e c t o r t o t h r e e - y e a r t e r m s o n t h e
R ic h m o n d B o a r d o f D ir e c t o r s in e a r ly f a l l. J . B a n k s
S c a r b o r o u g h , C h a ir m a n a n d P r e s id e n t , P e e D e e
S ta te B a n k , T im m o n s v ille , S o u t h C a r o lin a , w a s




e le c te d a C la s s A d i r e c t o r b y b a n k s in G r o u p 3 t o
s u c c e e d F r e d e r ic H . P h i l l i p s , S e n io r V ic e P r e s id e n t ,
V i r g i n i a N a t io n a l B a n k , R o a n o k e , V i r g i n i a , w h o s e
t e r m e x p ir e d a t t h e e n d o f 1 9 8 0 . L e o n A . D u n n , J r . ,
C h a ir m a n , P r e s id e n t , a n d C h ie f E x e c u t iv e O f f ic e r ,
G u a r d ia n C o r p o r a t io n a n d S u b s id ia r ie s , R o c k y
M o u n t , N o r t h C a r o lin a , w a s e le c te d b y b a n k s in
G r o u p 2 a s a C la s s B d ir e c t o r t o s u c c e e d T h o m a s A .
J o r d a n , C o n s u lt a n t , A s h e b o r o , N o r t h C a r o lin a ,
w h o s e t e r m e x p ir e d D e c e m b e r 3 1 , 1 9 8 0 .
T h e R ic h m o n d B o a r d r e a p p o in t e d J o s e p h M .
G o u g h , J r . , P r e s id e n t , T h e F i r s t N a t io n a l B a n k o f
S t. M a r y ’ s, L e o n a r d t o w n , M a r y la n d , t o a t h r e e - y e a r
t e r m o n t h e B a lt im o r e B o a r d . N ic h o la s W . M it c h e l l ,
P r e s id e n t a n d D i r e c t o r , P ie d m o n t F e d e r a l S a v in g s
a n d L o a n A s s o c ia t io n , W i n s t o n - S a le m , N o r t h C a r o ­
lin a w a s a p p o in t e d t o a t h r e e - y e a r t e r m o n t h e C h a r ­
lo t t e B o a r d t o s u c c e e d J o h n T . F ie ld e r , P r e s id e n t ,
J . B . I v e y a n d C o m p a n y , C h a r lo t t e , N o r t h C a r o lin a ,
w h o s e t e r m e x p ir e d a t t h e e n d o f 1 9 8 0 . J . B . A ik e n ,
J r . , C h a ir m a n o f t h e B o a r d , G u a r a n t y B a n k a n d
T r u s t C o m p a n y , F lo r e n c e , S o u t h C a r o lin a , w a s
a p p o in t e d t o f i l l t h e u n e x p i r e d t e r m o n t h e C h a r lo t t e
B o a r d o f J . B a n k s S c a r b o r o u g h w h o r e s ig n e d t o
b e c o m e a m e m b e r o f t h e R ic h m o n d B o a r d .
T h e B o a r d o f G o v e r n o r s r e d e s ig n a t e d M a c e o A .
S lo a n , E x e c u t iv e V ic e P r e s id e n t a n d C h ie f O p e r ­
a t in g O f f ic e r , N o r t h C a r o lin a M u t u a l L i f e I n s u r a n c e
C o m p a n y , D u r h a m , N o r t h C a r o lin a , a s C h a ir m a n o f
t h e B o a r d f o r 1 9 8 1 . S te v e n M u l l e r , P r e s id e n t , T h e
J o h n s H o p k i n s U n i v e r s i t y a n d H o s p i t a l, B a lt im o r e ,
M a r y la n d , w a s r e a p p o in t e d t o a t h r e e - y e a r t e r m a s
C la s s C d ir e c t o r a n d r e n a m e d D e p u t y C h a ir m a n o f
th e B o a rd f o r 1 9 8 1 .
R o b e r t L . T a t e , C h a ir m a n o f t h e B o a r d , T a t e
I n d u s t r ie s , B a lt im o r e , M a r y la n d , w a s a p p o in t e d b y
th e B o a r d o f G o v e r n o r s t o a t h r e e - y e a r t e r m o n t h e
B a lt im o r e B o a r d . M r . T a t e s u c c e e d e d C a t h e r in e B .
D o e h le r , D i r e c t o r o f D e v e lo p m e n t , B a lt im o r e R e ­
g io n a l C h a p t e r o f A m e r ic a n R e d C r o s s , B a lt im o r e ,
M a r y la n d , w h o s e t e r m e x p ir e d D e c e m b e r 3 1 , 1 9 8 0 .
T h e B o a r d o f G o v e r n o r s a ls o a p p o in t e d W i l l i a m S .
L e e , I I I , P r e s id e n t , D u k e P o w e r C o m p a n y , C h a r ­
lo t t e , N o r t h C a r o lin a , t o a t h r e e - y e a r t e r m o n t h e
C h a r lo t t e B o a r d , e f f e c t iv e J a n u a r y 1, 1 9 8 1 . M r . L e e
s u c c e e d e d R o b e r t E . E lb e r s o n , P r e s id e n t , C h ie f
E x e c u t iv e O f f ic e r , a n d D i r e c t o r , H a n e s C o r p o r a t io n ,
W i n s t o n - S a le m , N o r t h C a r o lin a .
19

Federal Advisory Council
T h e B o a r d o f D ir e c t o r s r e a p p o in t e d J . O w e n C o le ,
C h a ir m a n o f t h e B o a r d , F i r s t N a t io n a l B a n k o f
M a r y la n d , B a lt im o r e , M a r y la n d , t o a o n e - y e a r t e r m
a s t h e F i f t h F e d e r a l R e s e r v e D i s t r i c t r e p r e s e n ta t iv e
t o t h e F e d e r a l A d v i s o r y C o u n c il b e g in n in g J a n u a r y 1,
1 9 8 1 . T h e t w e lv e - m e m b e r C o u n c il, c o n s is t in g o f o n e
m e m b e r f r o m e a c h o f t h e F e d e r a l R e s e r v e D is t r i c t s ,
m e e ts in W a s h in g t o n a t le a s t f o u r t im e s a y e a r w i t h
t h e S y s t e m ’ s B o a r d o f G o v e r n o r s t o d is c u s s b u s in e s s
c o n d it io n s a n d o t h e r t o p ic s o f c u r r e n t in t e r e s t to t h e
S y s te m .

Changes in Official Staff
A t t h e R ic h m o n d O f f ic e , E liz a b e t h W . A n g le ,
V ic e P r e s id e n t , e le c te d t o t a k e e a r ly r e t ir e m e n t in
F e b r u a r y a f t e r o v e r 3 0 y e a r s o f s e r v ic e . J o h n W .
S c o t t w a s p r o m o t e d t o R e s e a r c h O f f ic e r a s o f F e b ­
r u a r y 1, w i t h r e s p o n s ib i lit y f o r t h e S t a t is t ic a l D i v i ­
s io n o f t h e R e s e a r c h D e p a r t m e n t .
I n M a r c h , G e o r g e C . R a n k in , F i r s t V ic e P r e s id e n t,
r e t ir e d a n d w a s s u c c e e d e d b y J im m ie R . M o n h o llo n
w h o h a d b e e n S e n io r V ic e P r e s id e n t in c h a r g e o f t h e
B a lt im o r e O f f ic e s in c e 1 9 7 4 . M r . M o n h o llo n w a s
r e p la c e d a t t h e B a lt im o r e O f f ic e b y R o b e r t D .
M c T e e r , J r . , o f t h e R ic h m o n d O f f ic e , w h o w a s p r o ­
m o t e d t o S e n io r V ic e P r e s id e n t . T h e s e p r o m o t io n s
w e r e e f f e c t iv e M a r c h 1. A t t h e s a m e t im e V ic e
P r e s id e n t R o y L . F a u b e r b e c a m e s e n io r o f f ic e r in
c h a r g e o f t h e F is c a l A g e n c y f u n c t io n in R ic h m o n d

20




a n d A u b r e y N . S n e llin g s , V ic e P r e s id e n t , w a s t r a n s ­
f e r r e d f r o m t h e R e s e a r c h D e p a r t m e n t t o b e s p e c ia l
a s s is t a n t t o t h e P r e s id e n t .
R a y m o n d E . S a n d e r s , J r . , S e n io r V ic e P r e s id e n t
a t t h e R ic h m o n d O f f ic e , d ie d o n A p r i l 1 3 a f t e r a n
e x te n d e d illn e s s . A t t h e B a lt im o r e O f f ic e , C h a r le s P .
K a h le r , A s s is t a n t V ic e P r e s id e n t , c h o s e e a r ly r e t i r e ­
m e n t in A p r i l a f t e r o v e r 4 2 y e a r s o f s e r v ic e .
I n J u l y a t t h e R ic h m o n d O f f ic e , T i m o t h y Q . C o o k
w a s p r o m o t e d t o V ic e P r e s id e n t a n d B r u c e J .
S u m m e r s a n d W a l t e r A . V a r v e l w e r e d e s ig n a te d
R e s e a r c h O f f ic e r s . I n t h e C h a r le s t o n O f f ic e , R ic h a r d
L . H o p k i n s w a s a p p o in t e d V ic e P r e s id e n t a n d
S a m u e l W . P o w e ll, J r . , w a s p r o m o t e d t o A s s is t a n t
C a s h ie r a t t h e B a lt im o r e O f f ic e .
E f f e c t iv e A u g u s t 1 6 , J o s e p h F . V iv e r e t t e w a s a p ­
p o in t e d S e n io r V ic e P r e s id e n t w i t h r e s p o n s ib ilit y f o r
t h e C a s h , P e r s o n n e l, P r i n t i n g a n d S u p p lie s , G e n e r a l
S e r v ic e , R e c o r d s M a n a g e m e n t , a n d P r o t e c t io n D e ­
p a r t m e n t s . A ls o a t t h e R ic h m o n d O f f ic e i n A u g u s t ,
B r u c e S u m m e r s w a s n a m e d A s s is t a n t V ic e P r e s id e n t
a n d t r a n s f e r r e d t o t h e P la n n in g D e p a r t m e n t .
In
S e p te m b e r , T h o m a s C . J u d d w a s a d d e d t o t h e s t a f f
a t t h e C o m m u n ic a t io n s a n d R e c o r d s C e n t e r i n C u l­
p e p e r a s C o m m u n ic a t io n s O f f ic e r .
W o o d y Y . C a in w a s p r o m o t e d t o O p e r a t io n s O f f i ­
c e r a t t h e C h a r lo t t e O f f ic e i n O c t o b e r , a n d in
N o v e m b e r , G . R o n a ld S c h a r r w a s m a d e A s s is t a n t
C a s h ie r a t t h e R ic h m o n d O f f ic e .
I n D e c e m b e r, R o b e rt L . H e tz e l a n d M a r v in S.
G o o d f r ie n d w e r e p r o m o t e d t o R e s e a r c h O f f ic e r s
e f f e c t iv e J a n u a r y 1, 1 9 8 1 .

Summary of Operations
C heck C learing and C ollection

1980

1979

Dollar amount
Commercial bank checks1 ___________________________________________

741,369,600,000

714,089,000,000

Government checks2 ________________________________________________

91,400,000,000

63,013,000,000

Return ite m s________________________________________________________

6,957,135,000

5,676,940,000

Number of items
Commercial bank checks1 ___________________________________________

1,443,163,000

1,389,330,000

Government checks2 ________________________________________________

95,651,000

87,800,000

Return ite m s_________________________________ _______________________

19,520,000

18,623,000

11,539,645,000

10,179,492,700

C urren cy and C oin
Currency disbursed— Dollar amount _________________________________
Coin disbursed— Dollar amount ______________________________________

353,645,400

348,661,050

Dollar amount of currency destroyed ________________________________

2,617,200,000

2,546,100,000

Daily average of currency destroyed
Dollar amount ______________________________________________________

10,345,000

10,063,636

Number _____________________________________________________________

1,528,000

1,495,549

Total loans made during y e a r ______________________________________

26,701,157,400

23,096,013,800

Daily average loans outstanding __________________________________

141,392,930

125,243,000

D isco u n t and Credit
Dollar amount

Number of banks borrowing during the y e a r ________________________

137

F isca l A g e n c y A ctiv itie s
Marketable securities delivered or redeemed
Dollar amount ______________________________________________________

446,338,547,000

308,530,971,050

Number _____________________________________________________________

318,456

213,738

Dollar amount ______________________________________________________

77,449,000

72,019,342

Number ____________________________________________ _ _____________
_

243,976

224,372

Coupons redeemed

Savings bond and savings note issues
Dollar amount ______________________________________________________

596,148,000

510,114,499

Number _____________________________________________________________

6,522,420

11,767,172

Dollar amount ______________________________________________________

1,332,876,000

1,071,204,205

Number ----------------------------------------------------------------------------------------------

15,361,122

12,350,954

2,513,352,000,000

2,215,380,011,105

2,338,642

1,947,639

Savings bond and savings note redemptions

T ra n sfers of F u n d s
Dollar amount ________________________________________________________
Number ________________________________________________________________

1 Excluding checks on this Bank.
2 Including postal money orders.




21

Comparative Financial Statements
Condition
A sse ts:

December 31, 1980

Gold certificate account ________________________ __ __________ _ ______
_

$

December 31, 1979

961,000,000.00

$ 1,292,576,481.10

Special Drawing Rights certificate account__________________________

229,000,000.00

161,000,000.00

Coin ___________________________________________________________________

42,937,198.60

44,639,596.20

Loans to depository institutions ___________________________________

189,185,000.00

164,909,000.00

Federal agency obligations ________________________________________

717,839,368.03

672,851,758.16

Bills ______________________________________________________________

3,588,486,743.19

3,705,423,089.10

Notes _____________________________________________ _______________

4,823,099,366.01

4,626,870,992.09

Bonds _____________________________________________________________

1,387,546,400.29

1,191,854,543.41

TOTAL U. S. GOVERNMENT SECURITIES ___________________________

9,799,132,509.49

9,524,148,624.60

TOTAL LOANS AND SECURITIES __________________________________

10,706,156,877.52

10,361,909,382.76

Cash items in process of collection____________________________________

3,034,877,202.14

2,821,954,663.42

Bank premises ________________________________________________________

88,547,571.76

83,446,999.67

LOANS AND SECURITIES:

U. S. Government securities:

11,135,218.00

7,758,728.35

Other assets ___________________________________________________________

Furniture and equipment, n e t ________________________________________

495,748,049.87

326,310,848.43

Interdistrict settlement account ______________________________________

218,946,955.13

— 361,656,862.10

T O T A L A SS E T S _____________________________________________

$15,788,349,073.02

$14,737,939,837.83

$10,786,594,664.00

$10,304,492,825.00

1,637,764,391.98

1,308,242,753.39

L ia b ilitie s :
Federal Reserve notes ______________
d e p o s it s

:

Depository institutions ___________
U. S. Treasurer— general account

315,585,848.33

Foreign ___________________________

18,156,000.00

15,847,000.00

Other _____________________________

22,791,145.06

74,424,344.28

TOTAL DEPOSITS _________________

1,678,711,537.04

1,714,099,946.00

Deferred availability cash items ___

2,988,745,638.30

2,430,601,041.20

Other liabilities _____________________

210,926,833.68

172,280,425.63

T O T A L L IA B IL IT IE S _____

15,664,978,673.02

14,621,474,237.83

61.685.200.00

58.232.800.00

61.685.200.00

58.232.800.00

$15,788,349,073.02

$14,737,939,837.83

C apital A c c o u n t s :
Capital paid i n __________________________________________________

T O T A L L IA B IL IT IE S AN D C AP ITA L ACCOU NTS

22




Earnings and Expenses
E A R N IN G S :

1980

Loans to depository institutions__________________________________________

1979
$

17,374,399.63

Interest on U. S. Government securities ________________________________

1,016,533,101.41

Foreign currencies _______________________________________________________

6,128,921.52

Other earnings____________________________________________________________

_______ 253,335.48

$ 13,256,414.35

TOTAL CURRENT EARN IN G S ____________________________________________

1,040,239,758.04

817,737,338.67
3,641,489.85
______ 152,310.66
834,787,553.53

EXPENSES:
Operating expenses (including depreciation on bank premises) after
deducting reimbursements received for certain Fiscal Agency and
other expenses _________________________________________________________

59,718,019.37

Cost of Federal Reserve currency_______________________________________

8,191,402.62

7,215,432.61

NET EXPENSES _________________________________ -_____________________

67,909,421.99

60,761,940.07

C U RRENT N E T E A R N IN G S _____________________________________

972,380,336.05

774,025,613.46

ADDITIONS TO CURRENT NET EARNINGS ____________________________________

53,546,507.46

4,927,256.79

______ 839,715.89

16,347,840.48

12,573,629.68

DEDUCTIONS FROM CURRENT NET EARNINGS:

Loss on sales of U. S. Government securities (net) ________________

193,568.04

Losses on Foreign Exchange transactions____________________________
A ll other ______________________________________________________________
total

DEDUCTIONS ___________________________________________________

N E T AD D IT IO N S OR D E D U CTIO N S _____________________________

565,652.30
____16,913,492.84
-11,986,236.05

Assessment for expenses of Board of Governors _______________________
N E T E A R N IN G S BEFORE P A Y M E N T S TO U. S. T R E A SU R Y
Dividends paid ___________________________________________________________

12,850,377.22
-12,010,661.33

3,188,100.00

2,640,900.00

$ 957,206,000.00

$759,374,052.13

$

$

3,666,118.29

Payments to U. S. Treasury (interest on Federal Reserve notes) ____

950,087,481.73

Transferred to surplus __________________________________________________

3.452,400.00

TO T AL ______________________________________________________________

83,179.50

3,485,252.34
754,286,849.79
1,601,950.00

$ 957,206,000.00

$759,374,052.13

Balance at close of previous y e a r _______________________________________

$

58,232,800.00

$ 56,630,850.00

Addition account of profits for year ____________________________________

_____ 3,452,400.00

1,601,950.00

Surplus A ccou n t

B A L A N C E A T CLOSE OF CU R R E N T Y E A R ___________________

$

61,685,200.00

$ 58,232,800.00

C apital Stock A ccou n t
(Representing amount paid in, which is 50% of amount subscribed)
Balance at close of previous y e a r _______________________________________

$

Issued during the year __________________________________________________

58,232,800.00
3,927,800.00

$ 56,630,850.00
3,296,950.00

62,160,600.00
Cancelled during the y e a r ________________________________________________
B A L A N C E A T CLOSE OF C U RRENT Y E A R ___________________




59,927,800.00

_______ 475,400.00

1,695,000.00

$

61,685,200.00

$ 58,232,800.00

23

(December 31, 1980)

Richmond
Maceo A. Sloan ______________ Chairman of the Board
Steven Muller _________________Deputy Chairman of the Board

Class A
Vincent C. Burke, Jr. _________ Chairman of the Board and Chief Executive Officer
The Riggs National Bank of Washington, D. C.
Washington, D. C.
(Term expires December 31, 1981)
William M. Dickson __________ President and Senior Trust Officer, The First National Bank in Ronceverte
Ronceverte, West Virginia
(Term expires December 31, 1982)
Frederic H. Phillips __________ Senior Vice President, Virginia National Bank
Roanoke, Virginia
(Term expired December 31, 1980)
Succeeded by:

J. Banks Scarborough
Chairman and President
Pee Dee State Bank
Timmonsville, South Carolina
(Term expires December 31, 1983)

Class B
James A. Chapman, Jr. _______ Chairman of the Board and Chief Executive Officer, Inman Mills
Inman, South Carolina
(Term expires December 31, 1982)
Thomas A. Jordan ____________ Consultant
Asheboro, North Carolina
(Term expired December 31, 1980)
Succeeded by:

Leon A. Dunn, Jr.
Chairman, President, and Chief Executive Officer
Guardian Corporation and Subsidiaries
Rocky Mount, North Carolina
(Term expires December 31, 1983)

Paul G. Miller _______________ Chairman of the Board and Chief Executive Officer, Commercial Credit Company
Baltimore, Maryland
(Term expires December 31, 1981)

Class C
Steven Muller _________________President, The Johns Hopkins University and Hospital
Baltimore, Maryland
(Term expires December 31, 1983)
Paul E. Reichardt ____________ Chairman of the Board and Chief Executive Officer
Washington Gas Light Company
Washington, D. C.
(Term expires December 31, 1982)
Maceo A. Sloan __________ ____Executive Vice President and Chief Operating Officer
North Carolina Mutual Life Insurance Co.
Durham, North Carolina
(Term expires December 31, 1981)

Member of Federal A dvisory Council
J. Owen Cole _________________Chairman of the Board, First National Bank of Maryland
Baltimore, Maryland
(Term expires December 31, 1981)

24




Baltimore
Pearl C. Brackett_____________ Assistant/Deputy Manager, Baltimore Regional Chapter of American Red Cross
Baltimore, Maryland
(Term expires December 31, 1981)
Edward H. Covell ____________ Vice President, Country Pride Foods Limited
General Manager, Delmarva Division
Easton, Maryland
(Term expires December 31, 1982)
Catherine B. Doehler _________ Director of Development, Baltimore Regional Chapter of American Red Cross
Baltimore, Maryland
(Term expired December 31, 1980)
Succeeded by: Robert L. Tate
Chairman of the Board
Tate Industries
Baltimore, Maryland
(Term expires December 31, 1983)
Joseph M. Gough, J r . __________ President, The First National Bank of St. Mary's
Leonardtown, Maryland
(Term expires December 31, 1983)
*Joseph H. McLain ____________ President, Washington College
Chestertown, Maryland
(Term expires December 31, 1981)
A. R. Reppert ________________ President, The Union National Bank of Clarksburg
Clarksburg, West Virginia
(Term expires December 31, 1982)
Hugh D. Shires ______________ President and Chief Executive Officer, The First National Bank and
Trust Company of Western Maryland
Cumberland, Maryland
(Term expires December 31, 1982)

Charlotte
J. B. Aiken, J r . _______________ Chairman of the Board, Guaranty Bank and Trust Company
Florence, South Carolina
(Term expires December 31, 1982)
*Naomi G. Albanese ___________ Dean, School of Home Economics, University of North Carolina at Greensboro
Greensboro, North Carolina
(Term expires December 31, 1982)
W. B. Apple, Jr. ----------- President, First National Bank of Reidsville
Reidsville, North Carolina
(Term expires December 31, 1982)
Hugh M. Chapman ______ __ __ Chairman of the Board
The Citizens and Southern National Bank of South Carolina
Columbia, South Carolina
(Term expires December 31, 1982)
Robert E. Elberson ___________ President, Chief Executive Officer, and Director, Hanes Corporation
Winston-Salem, North Carolina
(Term expired December 31, 1980)
Succeeded by: William S. Lee, III
President and Chief Operating Officer
Duke Power Company
Charlotte, North Carolina
(Term expires December 31, 1983)
John T. Fielder ______________ President, J. B. Ivey and Company
Charlotte, North Carolina
(Term expired December 31, 1980)
Succeeded by: Nicholas W. Mitchell
President and Director
Piedmont Federal Savings and Loan Association
Winston-Salem, North Carolina
(Term expires December 31, 1983)
Henry Ponder ------------- President, Benedict College
Columbia, South Carolina
(Term expires December 31, 1981)
*Branch Board Chairman.




25

Officers

(January 1, 1981)

Richm ond

Baltimore

Robert P. Black, President

Robert D. McTeer, Jr., Senior Vice President

Jimmie R. Monhollon, First Vice President

William E. Pascoe, III, Vice President
Gerald L. Wilson, Vice President

Welford S. Farmer, Senior Vice President
James Parthemos, Senior Vice President and
Director of Research
John F. Rand, Senior Vice President
Joseph F. Viverette, Senior Vice President
Lloyd W. Bostian, Jr., Vice President
J. Alfred Broaddus, Jr., Vice President
Timothy Q. Cook, Vice President
George B. Evans, Vice President
Roy L. Fauber, Vice President
William C. Glover, Vice President
Robert B. Hollinger, Jr., Vice President
William D. Martin, III, Vice President and
General Counsel
Arthur V. Myers, Jr., Vice President
Chester D. Porter, Jr., Vice President
Aubrey N. Snellings, Vice President
Andrew L. Tilton, Vice President
James F. Tucker, Vice President
J. Lander Allin, Jr., Assistant Vice President
Fred L. Bagwell, Assistant Vice President
Jackson L. Blanton, Assistant Vice President
William E. Cullison, Research Officer
Wyatt F. Davis, Chief Examiner
William C. Fitzgerald, Assistant General Counsel
Marvin S. Goodfriend, Research Officer
Bradley H. Gunter, Assistant Vice President and
Secretary
Robert L. Hetzel, Research Officer
John C. Horigan, Assistant Vice President
Thomas M. Humphrey, Research Officer
Harold T. Lipscomb, Assistant Vice President
Hobert D. Pierce, Assistant Vice President
Joseph C. Ramage, Assistant Vice President
Barthonhue W. Reese, Assistant Vice President
James D. Reese, Assistant Vice President
John W. Scott, Research Officer
Frank D. Stinnett, Jr., Assistant Vice President
Bruce J. Summers, Assistant Vice President
Walter A. Varvel, Research Officer
Jack H. Wyatt, Assistant Vice President
Robert D. Bouck, Assistant Counsel
G. Ronald Scharr, Assistant Cashier
James R. Slate, Assistant Counsel
Donna G. Vaughn, Assistant Cashier
David B. Ayers, Jr., General Auditor
H. Lewis Garrett, Assistant General Auditor

26




Ronald B. Duncan, Assistant Vice President
Ronald E. Gould, Assistant Vice President
Robert A. Perry, Assistant Vice President
Victor Turyn, Assistant Vice President
Samuel W. Powell, Jr., Assistant Cashier

Charlotte
Stuart P. Fishburne, Senior Vice President
Thomas E. Snider, Vice President
Winfred W. Keller, Assistant Vice President
Harry B. Smith, Assistant Vice President
Robert F. Stratton, Assistant Vce President
Jefferson A. Walker, Assistant Vice President
Woody Y. Cain, Operations Officer

Charleston
Richard L. Hopkins, Vice President

Columbia
Boyd Z. Eubanks, Vice President
R. Wayne Stancil, Assistant Vice President

Culpeper
John G. Stoides, Vice President
Albert D. Tinkelenberg, Vice President
James G. Dennis, Assistant Vice President
Thomas C. Judd, Communications Officer














Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102