Full text of Review (Federal Reserve Bank of St. Louis) : November 1969

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

FEDERAL RESERVE BANK
O F ST. L O U IS
NOVEMBER 1969

Progress in Controlling Inflation
Monetary and Fiscal Influences on
Economic Activity — The Historical
Evidence............................................................. 5
The Effects of Inflation (1960-68) .................. 25

Vol. 51, No. 11




Progress in Controlling Inflation
S t OPPING the acceleration of price increases is
currently the most important objective of national
economic policy. The other major objective, “full em­
ployment” defined as an unemployment rate below
4 per cent, has been achieved since late 1965. The
method that has been chosen to achieve stable prices
is to curtail growth in total spending (GNP). His­
torically, a slowing of total spending has been ac­
companied by a slowing in the growth of real product,
followed by a slowing in the rate of increase in prices
and by subsequent recovery in the growth rate of
real product. Consequently, the question arises as to
what is implied for the course of real product under
the current anti-inflation policy.

The Current Anti-Inflation Program
Economic developments in 1969 are proving that
historical patterns of output and prices are reliable
guides for any assessment of the success of the present
anti-inflation program. Total spending for goods and
services rose at a 7.8 per cent annual rate from mid1968 to the third quarter of this year, less than the
9.6 per cent increase in the previous year but still far
in excess of the growth rate of the economy’s pro­
ductive potential. Prices have advanced at a 4.8 per

Demand and Production
R atio S cale

R a tio S cale

Quarterly Totals a* Annual Rates
S e a so n a lly A djusted

Billions o f Doll

Billions o f P ol la rs

cent rate since mid-1968, a much faster rate than in
the previous year. Real output, on the other hand,
increased at only a 2.8 per cent rate over the past five
quarters, down from the 5.3 per cent increase in the
year ending in mid-1968.
Final sales have slowed somewhat since mid-1968,
but their growth continues at a relatively rapid rate.
These sales grew at an 8.8 per cent rate from mid1967 to mid-1968 and since mid-1968 have increased
at a 7.8 per cent annual rate.

Fiscal Conditions
Federal fiscal policy has continued restrictive in its
impact on economic activity since mid-1968, when the
Revenue and Expenditure Control Act of 1968 was
passed. On a high-employment basis, the national in­
come accounts budget was in surplus at a $7.8 billion
annual rate in the third quarter, down slightly from
the previous two quarters, but in marked contrast to
the $13.7 billion annual rate of deficit in the first half
of 1968. This shift of the budget from a large deficit
to substantial surplus was accomplished by a sharp
reduction of expenditure growth and enactment of the
10 per cent tax surcharge.
1961

1962

1963

1964

1965

1966

1967

1968

1969

Q GNP in current d o llars .
Source: U.S. D epartm ent o f Com m erci
[2 GNP in 1958 dollars.
Percentages are a nnual rates o f change betw een periods indicated. They are presented to a id in
com paring most recent developments with past "trends."
la te s t d a ta p lo tte d: 3rd q uarter

Page 2



Federal expenditures have risen at a 5.9 per cent
annual rate since mid-1968, compared with a 11.7
per cent increase in the previous year. Defense
spending has slowed markedly, rising at only a 2.8

F E D E R A L R E S E R V E B A N K O F ST. L O U I S

per cent rate since mid-1968, compared with a 13.9
•per cent average rate of increase during the period
from 1965 to 1968.
Budget prospects for calendar 1970 indicate that
the overall fiscal restraint w ill continue at least
through the first half. Current estimates include re­
striction of the rate of growth in Federal expenditures
at a 3 per cent rate until at least mid-1970. The tax
program includes a reduction of the tax surcharge to
5 per cent on January 1, 1970 and repeal of the
investment tax credit retroactive to April 20, 1969. If
these expenditure and taxing expectations are real­
ized approximately, the degree of fiscal restraint will
continue through the first half of 1970, with the highemployment budget at an estimated $9 billion rate
of surplus. If, on the other hand, the surtax is allowed
to expire at the end of this year, this budget would
be at an estimated $5 billion rate of surplus in the
first half of 1970.
W hile the high-employment budget suggests con­
tinuation of the current posture of fiscal restraint in
early 1970, the degree of restraint may be greater
than this budget suggests. Consumers and businesses,
to some degree, react to changes in tax rates, which
they consider to be temporary, by adjusting their rate
of saving rather than their spending. As a result,
changes in tax rates are significant in the short run
because they signal a change in the allocation of re­
sources between the Government and the private sec­
tor. According to this interpretation, the expected
course of Federal spending, rather than the net budget
position, may in fact provide a more reliable indica­
tion of the degree of fiscal restraint in the near future.

Recent Monetary Actions
Monetary actions became moderately less expan­
sive early in 1969, and since early summer a consid­
erable degree of restraint has been exercised. The
money stock has been about unchanged in the last
four months, compared with a 4.4 per cent annual
rate of growth in the first half of the year and a
7 per cent increase in 1968. The demand deposit
component of money declined at a 1.2 per cent
rate from June to October, after decelerating from a
7 per cent increase in 1968 to a 3.7 per cent rate of
growth in the first half of 1969.
The monetary base, uses of which are total bank
reserves and currency held by the public, has in­
creased only slightly since early June. The money
stock and the monetary base usually grow at similar
rates, as in 1968 when they both grew 7 per cent, and



NOVEMBER 1 9 6 9

M on ey Stock
R a tio S ca le
B illio n s o f D o lla rs

R a tio S ca le
B illio n s o f D o lla rs

Monthly Average, of Doily Figures

210

200

190

180

170

160

150

140

130
1961

1962

1963

1964

1965

1966

1967

1968

1969

Percentages are annual rates of change between periods indicated. They ore presented to aid in comparing
most recent developments with past "trends."
Latest data plotted: October preliminary

in the last three months when they have both been
about unchanged. However, small shifts frequently
occur in the multiplier relationship between the mon­
etary base and money.1 Since early June, the con­
tinuing outflow of time deposits from commercial
banks has been a major factor causing a net increase
in the multiplier. Federal Reserve credit increased
at only a 0.8 per cent annual rate from June to
October, after increasing at a 6 per cent rate in the
first part of the year and 10 per cent in 1968. Member
bank reserves declined at about a 9 per cent annual
rate from June to October, after being about un­
changed during the first part of the year, and growing
8 per cent in 1968.
Interest rates have risen recently, though most
rates are still below early October peaks. Over the
past year interest rates have increased markedly,
with yields on prime four- to six-month commercial
paper rising about 3 percentage points. In contrast,
Regulation Q ceilings have remained unchanged, and
the discount rate has been increased only three-fourths
of a percentage point during the past year. The dis­
count rate is currently about one percentage point
below the three-month Treasury bill rate, compared
with a spread of about one-fourth of a percentage
point a year ago.
Volume of commercial paper outstanding has con­
tinued to increase rapidly, up $7.8 billion since last
’ See Jerry L. Jordan, “Elements of Money Stock Determina­
tion,” this Review, October 1969, pp. 10-19.
Page 3

F E D E R A L R E S E R V E B A N K O F ST. L O U I S

December, compared with a $3.4 billion increase in
the corresponding period of 1968. In contrast, the
outstanding volume of large negotiable certificates of
deposit at large commercial banks declined by $12.1
billion from last December to October 1969. Low
Regulation Q ceilings relative to market rates have
prevented banks from competing effectively for funds,
thereby directing funds through other channels such
as the commercial paper market. W hether the rerout­
ing of funds from commercial banks through other
channels is an indication of monetary restraint is
doubtful. It is clear, however, that the rerouting of
funds promotes inefficiences in the channeling of
funds from savers to investors.

Economic Conditions
Total spending, that is, nominal GNP, continued to
grow from the second to the third quarter at about the
same rate as in the three previous quarters, despite
the restrictive position of monetary and fiscal policy.
The composition of the increase in total spending in
the third quarter, however, indicates a slowing of
total spending might be expected in the immediate
future.
Though total spending continued to advance at a
rapid rate, private final sales rose much more slowly
in the third quarter. Total spending was buoyed by
increases in the rate of inventory accumulation and
the Government pay increase. If these increases are
not indicative of a trend, the slowing of private final
sales may portend further slowing in the pace of
economic activity.
Measures of income, employment and production
indicate that there was some slowing in the pace of
economic activity during the third quarter. W hile this
observation is based on a very short period, it is con­
sistent with the restrictive nature of monetary and
fiscal actions. Personal income slowed to a 4.8 per
cent rate of increase in October, after rising at a
8.8 per cent rate in the January to September period.
Payroll employment rose at a 2.4 per cent rate in the
July to October period, compared with a 3 per cent
rate in the previous six months. Industrial produc­
tion, slowed by reductions in primary metals output,
declined at a 2.9 per cent rate from July to October,
compared with a 6.1 per cent rate of increase from
December to July.
Conforming to the usual patterns of lags of price
effects behind total spending, price trends have con­
tinued upward. The general level of prices rose at a
5.4 per cent annual rate from the second to the third
quarter, compared with a 4.6 per cent increase in the

Page 4


NOVEMBER 1 9 6 9

previous year. Wholesale prices of industrial com­
modities have risen at a 3.7 per cent rate over the
past year. Consumer prices have risen at a 6 per cent
rate since the first of the year, compared with a 5 per
cent rate in the previous year.

Outlook for Prices and Output
The current stabilization program is directed to­
ward slowing total spending as the necessary means
of limiting the advance of prices. Recent trends in
income, employment and production suggest that
this program of restrictive monetary and fiscal actions
has begun to take effect, though as yet there has been
no discernible effect on prices. Past experience,
however, indicates that restraint in total spending has
its effect first on output growth, and only later on
prices. The rate of increase in output must be ex­
pected to slow, as an inevitable by-product of an
anti-inflationary program. It is of interest, therefore,
to trace out the possible course of real output during
this transition period.
Total spending has decelerated only slightly since
mid-1968. The restrictive economic policies should
soon begin to affect demand growth significantly.
The rather steady rate of demand growth has been
accompanied by a slowing in the growth of real out­
put and an acceleration in the rate of price increase.
To aid in the exploration of the outlook for the
near-term, alternative growth rates of money and
Federal expenditures can be postulated, and the most
probable future movements in total demand, output
and prices, projected on a basis of historical ex­
periences, can be examined. The monetary and fiscal
restraint that has already occurred provides the basis
for substantial further slowing in output growth, and
for gradual slowing in the rate of price advance. The
choice of alternative rates of monetary expansion at
this point (fourth quarter 1969) w ill be instrumental
in determining the extent and duration of the slowing
of total output. Prices can be brought down more
rapidly by restricting growth in money severely, but
with larger cost in terms of restriction of real output.
Monetary and fiscal restraints are probably being
manifested in reduced total dollar demand and real
output growth. The task of policymakers is to avoid a
prolongation of a degree of restraint which would
lead to excessive restriction of output growth, but at
the same time to avoid a premature reversal of the
policy of restraint such that significant progress would
not be made in effectively reducing inflationary
pressures.

Monetary and Fiscal Influences on Economic
Activity —The Historical Evidence*
by MICHAEL W . KERAN

In November 1968 this R e v i e w included an article which tested the relative importance of monetary
and fiscal influences on economic activity for the postwar period 1953-68. The conclusions of that article
were that monetary influences had a stronger, more predictable, and faster impact on economic activity than
fiscal influences.
The intent of this article is to consider the same issue in a longer, historic context (1919-69). Have mone­
tary influences dominated economic activity in periods when financial and institutional factors were substan­
tially different, as in the 1920’s, and when the general trend of economic activity was largely depressed, as in
the 1930’s? The results presented in this article indicate that monetary influences have dominated fiscal influ­
ences on economic activity in all subperiods considered, with the single exception of the years covering
W orld W ar II. This article also presents evidence that the movements in the money stock have been dom­
inated by the behavior of the monetary authorities and not by the behavior of the public.

SURJECT of continuing interest in professional
and recently in popular economic writing is the rela­
tive role of monetary and fiscal influences in deter­
mining economic activity.1 This debate has been re­
newed by Leonall Andersen and Jerry Jordan
(AJ) in an article published in this Review.2 That
article presented evidence which indicated that mon­
etary influences had a larger, more predictable, and
faster effect on economic activity than fiscal influ­
ences in the period from 1953 to 1968.
“The content and presentation in this article have been
substantially improved by the suggestions of the author’s
colleagues in the Research Department of the Federal
Reserve Bank of St. Louis: Homer Jones, Leonall Andersen,
Christopher Babb, Denis Karnosky, and W illiam Yohe. In
addition, he received valuable comments and criticisms from
Oswald Brownlee, Karl Brunner, Philip Cagan, Albert Cox,
Milton Friedman, Harry Johnson, John Kalchbrenner, Thomas
Mayer, David Meiselman, and Allan Meltzer.
l This issue was first raised in a somewhat different context by
Milton Friedman and David Meiselman in “The Relative
Stability of Monetary Velocity and the Investment Multi­
plier in the U.S.” Stabilization Policies, The Commission on
Money and Credit, Prentice-Hall, 1963.
2Leonall C. Andersen and Jerry Jordan: “Monetary and Fis­
cal Actions: A Test of Their Relative Importance in Eco­
nomic Stabilization,” this Review, November 1968.



These results have stimulated considerable interest
and discussion.3 The ensuing debate has mainly con­
fined itself, however, to the time period used in the
original AJ article (1953-68). Since other economic
experiences might suggest a different assessment of
monetary and fiscal influences, it seems useful to ex­
pand the testing periods to include a longer period
in United States economic history.
It is reasonable to assume that tests obtained from
a wider range of experience would go a long way
3Richard G. Davis, “How Much Does Money Matter?”,
Monthly Review, Federal Reserve Bank of New York, June
1969; Edward M. Gramlich, “The Role of Money in Economic
Activity: Complicated or Simple?,” Business Economics, Sep­
tember 1969; “The Usefulness of Monetary and Fiscal Policy
as Discretionary Stabilization Tools,” (presented at the Ameri­
can Bankers Association, Conference of University Professors,
Milwaukee, September 19 6 9 ); Frank de Leeuw and John
Kalchbrenner, ‘ Monetary and Fiscal Actions: A Test of Their
Relative Importance in Economic Stabilization — Comment,”
this Review, April 1969; Paul S. Anderson, “Monetary Velocity
in Empirical Analysis,” Controlling Monetary Aggregates, pre­
pared by the Federal Reserve Bank of Boston, September 1969;
M. J. Artis and A. R. Nobay, “Two Aspects of the Monetary
Debate,” National Institute Economic Review, Vol. XLIX
(August 19 6 9 ), pp. 33-51; and W ilfred Lewis, Jr., “ ‘Money
is Everything’ Economics — A Tempest in a Teapot,” National
Conference Board Record, Vol. VI, No. 4 (April, 19 6 9 ), pp.
32-35.
Page 5

F E D E R A L R E S E R V E B A N K O F ST. LO U I S

toward answering some of the questions raised about
the A J article. If the dominance of monetary influ­
ences prevailed in earlier periods, then confidence
in the reliability and stability of the original results
and their continued applicability is enhanced. On
the other hand, if the dominance of monetary influ­
ences is shown to be confined to only the most re­
cent time period, then it could be asserted that special
circumstances are at work in the present period which
could not be relied upon to continue. The intent of
this article is to test the relative impact of monetary
and fiscal influences on economic activity in the
United States on a quarterly basis from 1919 to 1969
and for selected subperiods.
This article is organized in the following way.
First, a brief and highly simplified review is given
of some of the theoretical and statistical issues which
have been raised in connection with the type of tests
used by AJ. This review will allow us to see what can
and cannot be deduced from any results. Second, the
test results for the 50-year period from 1919 to 1969,
w ith 200 quarterly observations, will be presented,
together with a historical review and comparison.
Finally, the statistical reliability of the results will be
considered.

Theoretical and Statistical Issues
There are two primary ways to study the relative
importance of monetary and fiscal influences on eco­
nomic activity. First, their effects can be inferred
within the context of a fully specified and statis­
tically estimated structural model of the economy, as
in the FRB-MIT model.4 The monetary and fiscal
variables are introduced in the structural model at
those points where their functional roles are indicated
by economic theory. The measured impact on eco­
nomic activity of the monetary and fiscal variables
is dependent upon the explicit transmission mechan­
ism which is postulated and built into the structural
model. Second, monetary and fiscal influences can be
measured by direct estimation of a single regression
equation. In this case, some measure of economic
activity is regressed directly against the monetary
and fiscal variables without specification of a trans­
mission mechanism.
4See Frank de Leeuw and Edward M. Gramlich, “The Chan­
nels of Monetary Policy,” Federal Reserve Bulletin, June
1969. A structural model is one in which the major behavioral
assumptions of a theory are explicitly included in the statistical
estimates. It is fully specified if there are as many equations
as there are endogenous variables.

Page 6


N OV E M B E R 1 9 6 9

The Large Structural Model Approach
There are advantages and disadvantages associated
with each of these approaches. An important ad­
vantage of the large structural model is that it allows
one to distinguish between direct and indirect mone­
tary and fiscal influences, and to see how subsectors
of the economy are affected. In formal terms a struc­
tural model is essentially a hypothesis of the model
builders about the interrelations in the economy. The
statistically estimated equations represent compon­
ents of that hypothesis. If it turns out that the model
builders’ view of the economic mechanism is reason­
ably correct, then the “structural richness” of the
large models permits a wider range of questions to
be answered.
The major disadvantage of structural models is that
the model builder may have omitted an important
channel of transmission and, consequently, incorrectly
estimated the magnitude of the monetary or fiscal
influences. Indeed, even if the model builder has a
good idea of the transmission channels, it may be
technically impossible to estimate them because the
channels have not or cannot be quantified. For exam­
ple, assuming that the cost of borrowing is an im­
portant link in the monetary transmission mechanism,
it is quite possible that this is not accurately measured
by market interest rates. Both changes in credit ra­
tioning and compensating balance requirements, for
which there are no available quantified measures,
could affect the cost of borrowing yet not be re­
flected in changes in market interest rates.

The Single Equation Approach
An advantage of the single equation approach is
that if the monetary and fiscal variables are correctly
specified, and if they are not themselves determined
by economic activity, they w ill capture the direct and
indirect impact of monetary and fiscal influences on
economic activity, irrespective of the transmission
channels. The single equation approach avoids the
problem of specifying and measuring specific links
between monetary and fiscal influences and economic
activity, and w ill generally be consistent with a wide
range of theories (hypotheses) about the structural
interrelations in the economy.
One major disadvantage of the single equation
approach used here is that it can deal with only a
single question, the relative impact of monetary and
fiscal influences on economic activity. It does not
distinguish between the direct and indirect impact
of the monetary and fiscal influences on economic

F E D E R A L R E S E R V E B A N K O F ST. L O U I S

activity or how subsectors of the economy are
affected.5 In addition, both the structural model ap­
proach and the single equation approach face the
same problem of selecting measures of monetary and
fiscal influences which are exogenous in a statistical
sense.
In order to derive results which are comparable
with A J’s work, the single equation approach (the
so-called St. Louis equation) is used here. However,
before presenting the test results, it would be useful
to consider what can and cannot be implied by using
this approach. First, as was previously noted, the
single equation approach restricts us to considering
just one question — the relative impact of monetary
and fiscal influences on economic activity. W e cannot
say what the channels of the influence are.
Second, the single equation approach used here
does not allow us to discriminate between economic
theories. Take the generalized statement of the single
equation which is used in this article:
AY = oto + oci AM + 0C2 AF
where

AY = changes in economic activity,
AM = changes in monetary influences,
A F = changes in fiscal influences.

The parameters, a j and a 2, indicate the magni­
tude of the impact of monetary and fiscal influences,
respectively, on economic activity, and a 0 is a proxy
for the net trend of all other influences on economic
activity. Assume for the moment that the statistical
results of a test using this format substantially favor
monetary influences ( A M) over fiscal influences
( A F ) in determining economic activity (AY). These
results do not provide clear-cut evidence to help an­
swer the question of whether the Keynesian IncomeExpenditure Theory or the Modern Quantity Theory
is a better representation of the economic world.
Both theories provide an operational rule for mone­
tary influences, and thus the dominance of the mone­
tary variable does not discriminate between them.6
A test of competing economic theories can be con5One way to handle this disadvantage is to regress the mone­
tary and fiscal variables against the components of GNP to see
which broad sectors of the economy are affected. See Leonall
C. Andersen, “Money and Economic Forecasting,” Business
Economics, September 1969, for the results of such a test.
6There are a number of empirically estimated Keynesian eco­
nomic models which have a “weak ’ monetary sector. Evidence
that monetary influences are important would tend to cast
doubt on the usefulness of those models. However, this is more
a criticism of the particular model and not the underlying
Keynesian theory. W ithin the context of standard Keynesian
theory, there are circumstances where strong monetary and
weak fiscal influences could exist.



NOVEMBER 1 9 6 9

ducted only if the alternative behavioral assumptions
are made explicit.7
Third, the single equation approach does not
necessarily tell us anything about monetary and fiscal
policy decisions of the authorities. If the independ­
ent variables have been chosen properly, they will
indicate monetary and fiscal influences on the econ­
omy. One can assert that such influences are simul­
taneously a measure of the policy intentions of the
authorities only if additional external evidence is pro­
vided, which indicates that the policymakers have
acted either consciously or otherwise to systematically
control the monetary and fiscal variables used in the
equation.8
The third point can be clarified with an example:
Assuming there are two countries, A and B. Statistical
tests indicate that the monetary variable dominates
the fiscal variable in influencing economic activity in
each country. However, it is also known that Country
A does not have a central bank, while Country B
does. Obviously, we can only talk about discretionary
monetary policy in Country B, but we can talk about
monetary influence in both countries. In Country A,
the monetary variable is dominated by factors other
than by the actions of a central bank —perhaps
by the domestic gold supply. In Country B (with a
central bank), the monetary variable could be dom­
inated by the central bank; however, our statistical
results do not provide any evidence with respect to
that issue. Such evidence can be derived only by an
explicit investigation of the behavior of the central
bank in Country B. Thus, discretionary monetary
policy and monetary influences are not necessarily
measured by the same variable."
7A test of competing economic theories conceptually could be
conducted either with a single reduced-form equation or with
a more fully specified structural model. W hen Friedman and
Meiselman, “The Relative Stability . . .” attempted such a test
using the single equation reduced-form approach, a consid­
erable controversy occurred within the economics profession.
To the best of the author’s knowledge, no one has attempted
to compare competing theories by a test of alternative struc­
tural models.
8Such information would come from studies of the “reaction
function” of the policy-making authorities. There have been
a number of such studies of the monetary authorities. For
example: ( 1 ) William Dewald and Harry Johnson, “An
Objective Analysis of the Objectives of American Mon­
etary Policy, 19 5 2 -19 6 1,” Banking and Monetary Studies,
ed. Deane Carson (Homewood, Illinois: Richard D. Irwin,
19 6 3 ); ( 2 ) James W . Christian, “A Further Analysis of the
Objectives of American Monetary Policy,” The Journal of
Finance, volume XXIII, June 1968; (3 ) Michael W . Keran,
and Christopher T. Babb, “An Explanation of Federal Re­
serve Actions (19 3 3 -6 8 ),” this Review, July 1969; (4 )
John Wood, “A Model of Federal Reserve Behavior,” Staff
Economic Study No. 17, Board of Governors of the Federal
Reserve System.
nThis point is quite important and open to some misunderstand­
ing. To link monetary policy with the indicator of monetary
Page 7

F E D E R A L R E S E R V E B A N K O F ST. LO U I S

Given this array of caveats with respect to the
single equation approach, it is nevertheless highly
useful in indicating monetary and fiscal influences
on economic activity. The key reason has already
been discussed. An economy is an extremely complex
array of interrelated and interdependent markets tied
together by the price mechanism. Millions of indi­
vidual decision-making units participate in these
markets. In this complex web of interrelationships,
attempts at specific and detailed measurement of the
channels through which monetary and fiscal in­
fluences operate on economic activity are quite
hazardous.
Given the complexities of the economy and the
existing uncertainty about the transmission mechan­
ism, it is useful to measure the monetary and fiscal
influences directly, without constraining them to op­
erate within our imperfect notions about how they
operate. Freedom from this type of specification error
is perhaps the principal virtue of the single equation
approach.

Problems of the Single Equation Approach
The key methodological and statistical problems
with the single equation approach are related to
selection of appropriate indicators of monetary and
fiscal influences. First, a theoretical justification for
using particular variables is required. Such justifica­
tion naturally evolves from the various economic the­
ories (hypotheses) which have been developed to
explain the determination of aggregate economic ac­
tivity. For example, bank credit or free reserves are
unlikely indicators of monetary influence because
there is no well-specified economic theory from which
these variables are a derivable consequence. Even
if statistical results indicate a close relation between
bank credit and economic activity, it is difficult to
interpret the results. On the other hand, the money
stock is a good choice as an indicator of monetary
influence because it plays an important role in both
the Keynesian Income - Expenditure Theory and the
Modern Quantity Theory of Money.
Second, there must be evidence that the actions
of monetary and fiscal authorities determine the
influence, it is not necessary that the authorities consciously
control the value of the monetary variable. All that is
required is that in controlling some monetary variable the
authorities in the process also dominate movements in the
variable used to indicate monetary influences. If the author­
ities have not deliberately attempted to control the variable
which is the best indicator of monetary influence, then their
policy actions could be criticized. However, this is not neces­
sarily an argument against using that variable as an indicator
of monetary influence.

Page 8


NOVEMBER 1 9 6 9

movements in the variables selected. It is not neces­
sary that the policymakers have acted consciously to
control the specific variables used; it is only neces­
sary that policy actions systematically dominate
movements in the indicated variable.
This leads naturally to the third and final condi­
tion. To be able to interpret the regression coefficients
meaningfully in the single equation approach, the
monetary and fiscal variables must be statistically
exogenous. The economic meaning behind this condi­
tion is that the variables selected to represent mone­
tary and fiscal influences should not be contemporan­
eously determined by the behavior of the public, as
measured by changes in economic activity. If this
exogeneity assumption is not satisfied, the direction
of causality is uncertain, and a close statistical asso­
ciation with economic activity does not provide any
evidence of the magnitude of the impact from mon­
etary and fiscal influences. This is the so-called
“reverse-causation argument” against the single equa­
tion approach.
The next section presents the results of various
statistical tests of monetary and fiscal influences on
economic activity. The last section w ill consider the
reverse-causation argument and whether movements
in the monetary variables are dominated by the mon­
etary authorities or by the public. Because the
theoretical justification for the monetary and fiscal
variables used in this article has already been con­
sidered in the AJ-article, it will not be presented here.

Monetary and Fiscal Influences
The test procedure used in this article is to regress
quarter-to-quarter changes in a measure of economic
activity against quarter-to-quarter changes in the
indicators of monetary and fiscal influence. Because
of the length of the test period (1919-69), data prob­
lems were encountered. For example, the most widely
used measure of economic activity (nominal GNP),
and the most widely used measure of fiscal policy
(high-employment receipts and expenditures of the
Federal Government), are not available on a quar­
terly basis before 1946. These deficiences in the data
necessitated developing proxies for these measures.
A proxy for nominal GNP was constructed to
measure economic activity. The proxy consists of the
scaled product of the Industrial Production Index
(IPI) and the Consumer Price Index (CPI), both of
which are available on a monthly basis in continuous
time series back to February 1919. Each is the broad­
est available measure of real output and prices, and

NOVEMBER 1 9 6 9

F E D E R A L R E S E R V E B A N K O F S T. L O U I S

C h a rt I

R a te s o f C h a n g e

Nominal GNP and Economic Activity

R a te s o f C h a n g e

Q uarterly data at annual rates.
[l_Economic A c tiv ity is measured by the scaled product of the Consumer Price Index (CPI) and the Industrial Production Index (IPI)
m u ltip lied by Gross N ation al Product (GNP) in the base years 1957-59: /C P H P tV •$457.4 billion=Econom ic A ctivity
\ 10 , 000 /

Sources: GNP-U.S. D epartm ent o f Commerce;
Economic A ctivity-In d u stria l Production Index, Board of Governors of the Federal Reserve System;
Consumer Price Index, U.S. D epartm ent of Labor

their scaled product is an index of economic activity.
To convert this value index into a dollar measure, it
was multiplied by the value of nominal GNP in the
base years of the value index (1957-59).10 By this
method an index of quarterly economic activity,
measured in billions of dollars, was constructed for
the period 11/1919 to 11/1969.

larger swings over the business cycle than does nom­
inal GNP. However, for the purpose of measuring
the changes in economic activity from one quarter to
the next, this proxy appears to be both useful and
reasonably accurate.11 Chart I shows the quarter-toquarter rates of change in nominal GNP and in our
proxy from 1947 to 1969.

This proxy for economic activity clearly has a num­
ber of defects. The service industries, levels of gov­
ernment and agriculture are excluded. In addition,
industrial production traditionally grows at a faster
trend rate than overall real output because it is more
responsive to increases in productivity. Also, it shows

11 The regressions between rates of change of nominal GNP
•
•
(GNP) and our proxy variable (Y ) appear as follows:

10The formula used to compute this measure of economic
activity (Y ) is:

Y = F r a r ] • ($457-4 billion)



1/1947 — IV/1952
GNP = 3.78 + .45 Y
(3 .53 ) (8 .2 4 )

R2 = .74
D -W = 1.82

1/1953 — 1/1969
GNP =

3.42 +
.40 Y
(1 1 .4 4 ) (15 .8 0 )

R* = .80
D -W = 1.55
Page 9

F E D E R A L R E S E R V E B A N K O F ST. L O U I S

As a measure of fiscal influence, changes in the
national debt ( A D) and actual Federal Government
expenditures ( AE) (purchases of goods and services
plus transfer payments) were used. Data on tax re­
ceipts are available, but because of the strong influ­
ence which economic activity has on the value of tax
receipts, it was not used.
Because AD is also influenced by changes in tax
receipts, only the results using Government spending
are reported. The use of Federal Government spend­
ing as our single measure of fiscal influence is not as
serious a drawback as it might first appear. Andersen
and Jordan (AJ) found that the strongest measure of
fiscal influence was achieved by using Federal Gov­
ernment expenditures alone. The observed level of
Government spending which is used from 1919 to
1945 is not significantly different from the highemployment level of Government spending which AJ
used, and which is used here for the subperiods from
1946 to 1969.12
As measures of monetary influence, three varia­
bles were tested: total reserves of member banks, the
monetary base, and the narrowly defined money stock
( currency holdings of the nonbank public and private
demand deposits). The separate use of monetary and
fiscal variables in these regressions implies that one
can think of monetary and fiscal influences as having
separate impacts on economic activity. This may not
be the case. One well-known fiscal influence on mon­
etary actions can occur because of “even-keel” ac­
tions. “Even-keel” is the policy of the Federal Reserve
to stabilize money market conditions during periods
when the United States Treasury is floating a new
issue of securities. Thus, an increase in Government
spending financed by an increase in debt could in­
duce an increase in the money stock because of
Federal Reserve “even-keel” actions. This issue can
be dealt with only by asserting that all factors which
affect the money stock are monetaiy and all factors
which affect Government spending are fiscal. This is
not unreasonable, since the Federal Reserve could
stop even-keel actions if it chose to do so.
The tests of monetary and fiscal influences were
run using four measures of change: quarterly first
differences, quarterly central differences, quarterly
first rates of change, and quarterly central rates of
change. Only the results with quarterly first differ12The only difference between the observed levels of Gov­
ernment spending and the high-employment level of Gov­
ernment spending is an adjustment for unemployment
compensation payments. These payments did not start until
1937 and did not amount to a significant figure until after
W orld W ar II. See Chart III for sources of data for Gov­
ernment spending, money stock, and economic activity.

Page 10


NOVEMBER 1 9 6 9

ences of the money stock and Government expendi­
tures are reported in this article. However, alternative
measures of change and alternative measures of mon­
etary and fiscal influences give substantially similar
results.13
In each test the form of the equation was estim­
ated with money alone, fiscal alone, and a combina­
tion of the two. Alternative time lags between t-1
and t-10 were tried using the Almon distributed-lag
technique.14 The form of the equation selected and
the time lags to represent each time period were
chosen on the basis of minimum standard error of
estimate adjusted for degrees of freedom.15
The total period was divided into five subperiods:
1919-29, when economic conditions were generally
prosperous; 1929-39, when economic conditions were
generally depressed; 1939-46, when the United States
was approaching or was in a total w ar situation;
1947-52, the early postwar adjustment period and
finally, 1953-69, a period when economic conditions
were again generally prosperous. These subperiods
cover a sufficiently wide range of economic condi­
tions to provide an indication of monetary and fiscal
influences under a variety of economic circumstances.
A summary of the regression results is reported
in Table I. For the total period 1919-69, the mone­
tary variable is statistically significant and the fiscal
variable is statistically insignificant at the 95 per cent
confidence level. In the five subperiods, the monetary
variable is significant in all but the subperiod cover­
ing the war years, 1939-46. The absence of a statis­
tically significant monetary variable in this period is
probably due more to the inadequacies of the data
than to a lack of a relationship. Because of price
13The other results are available upon request.
14The Almon lag technique, by constraining the distribution
of coefficients to fit a polynomial curve of n degree, is
designed to avoid the bias in estimating distributed-lag
coefficients which may arise from multicollinearity in the lag
values of the independent variables. The theoretical justifi­
cation for this procedure is that the Almon constrained
estimate is superior to the unconstrained estimate because it
will create a distribution of coefficients which more closely
approximates the distribution derived from a sample of infin­
ite size. In order to minimize the severity of the Almon con­
straint, the maximum degree of the polynomial was used
in each case. The maximum degree is equal to the number
of lags plus one of the independent variables up to five lags.
Following the convention established by Shirley Almon,
“The Distributed Lag Between Capital Appropriations and
Expenditures,” Econometrica, Vol. XXXIII, No. 1 (January
19 6 5), if there are n lags, t+ 1 and t —n —1 are both con­
strained to zero. The regressions were also run without
constraining the beginning and ending values to zero, and
the results are virtually identical.
15For a discussion of this criteria for selecting lags, see Leonall Andersen, “An Evaluation of the Impact of Monetary
and Fiscal Policy on Economic Activity,’ Papers and Pro­
ceedings, Business and Economic Statistics Section, Ameri­
can Statistical Association, August 1969.

NOVEMBER 1 9 6 9

F E D E R A L R E S E R V E B A N K O F ST. L O U I S

Table I

INDICATO RS O F M O N E T A R Y
INFLUENCES O N
AY =

(A M )

AND

FISCAL

E C O N O M IC A C TIVITY

do - | - Q i A m

(AE)

(AY)

- f - a2 a e

(Q u a rte rly First Differences —- Billions o f Dollars)
Time Periods

11/1919 — 1/69

Lags*

t-6

ao

1.92

111/1929 — 11/39

t-3
t-5
t-5

.36

5.62

**

(.5 1 )

(3 .1 6 )

— .51
6.32
(1 .3 9 )

1 /1 9 4 7 — IV /5 2

t-1 0

— .07
(.2 8 )

(.5 4 )
111/1939 — IV /4 6

2.89

a2 A e
(sum)

(4 .3 1 )

(2 .3 4 )
11/1919 — 11/29

ai A m
(sum)

3.65

5 .4 0
(3 .4 1 )
— 1.21
(.5 9 )
13.82

R2
D-W
.32
1.15
.35
1.58

-7 .9 7
(1 .9 5 )

.39
1.86

.35

.66

(.8 1 )

1.60

-3 .3 7

implies that for every $1 increase in
the money stock there w ill be a
$5.50 increase in economic activity
after three to five quarters. These
are remarkably stable coefficients. In
the postwar subperiods, however, the
coefficients are substantially larger,
and they are also different with
respect to each other. In the 1947-52
period the coefficient on the mon­
etary variable is 13.82 with a tenr
quarter lag in its impact. In the
1953-69 period the coefficient is 8.85
with a four-quarter lag. W hat does
this variation in the value of the
monetary coefficients imply?

.72

The difference in the values of the
coefficients between postwar subpe­
1.71
(1 .0 7 )
(.7 4 )
(4 .7 0 )
riods is due to the different length of
lags. These lags are selected on the
N o te : R egression coefficients are the top figu res; their “ t” statistics appear below
basis of minimum standard error of
each coefficient, enclosed by parentheses. R 2 is the percent o f variations m
the dependent variable which is explained by variations in the independent
estimate, adjusted for degrees of free­
variable. D -W is the D urbin-W atson statistic.
♦Lags are selected on the basis o f m inim um standard error, adjusted f o r degrees
dom. The results for the 1947-52 sub­
o f freedom .
** Fiscal variable om itted fo r 1919-29 because it increased the standard error o f
period with a four-quarter, rather
the estimate.
than a ten-quarter lag, had a mone­
tary variable coefficient of 7.24. This value is quite
controls, the measure of economic activity was sub­
close to the 8.85 value for the 1953-69 subperiod
stantially understated between 1939 and 1946. There­
where
the minimum standard error estimate was with
fore, it is not surprising that the variables measuring
a
four-quarter
lag.
the influences of stabilization actions were not
statistically significant in that period.
The higher average value of the monetary co­
The fiscal influence was statistically significant in
efficients in the postwar subperiods over the prewar
only one of the five subperiods, 1947-52. However,
subperiods is due to the weakness in the proxy se­
the sign of the coefficient is negative due to special
lected to measure economic activity. The most com­
fa c to rs w h ic h a re e x p la in e d b e lo w .
p le te m e a s u re o f e c o n o m ic a c tiv ity is n o m in a l GNP.
However, it is available on a quarterly basis only
In general, the results with respect to both mone­
since 1946. As previously indicated, our proxy for
tary and fiscal variables for the period 1919-69 and
economic activity tends on the average to grow more
the subperiods conform closely to the results reported
rapidly than nominal GNP because its “real” com­
in the AJ article for the period 1953-68. The co­
ponent is measured by industrial production. This
efficient of determination (R2), which measures the
factor did not bias the value of the coefficients in the
per cent of variations in AY due to variations in AM
prewar subperiods, because the Great Depression in­
and AE, is lower than that reported by AJ. This result
sured that our proxy did not grow significantly
is not surprising considering that our proxy is prob­
between 1919-29 and 1929-39. For the postwar sub­
ably inferior to nominal GNP as a measure of
periods, however, the substantial and continuous in­
economic activity.
creases in economic activity probably have caused
an upward bias in the size of the monetary variable
Recause of the major importance of the monetary
coefficient presented in Table 1. For the 1953-69
influence, it is useful to look at the estimated co­
period, AJ had a monetary variable coefficient with
efficients of the monetary variable during the various
a four-quarter lag of 5.63, using nominal GNP.
subperiods. In both of the prewar subperiods, 1919-29
This value is almost identical to prewar subperiods
and 1929-39, the estimated coefficients on the mone­
tary variable are almost the same, around 5.50. This
when economic activity is measured with our proxy.
1/1 953 — 1/69




t-4

(.8 4 )

(3 .5 1 )

(4 .1 2 )

1.42

8.85

— .84

2.74

.47

Page 11

F E D E R A L R E S E R V E B A N K O F ST. LO U I S

NOVEMBER 1 9 6 9

Thus, it is quite possible that if quarterly nominal
GNP figures were available back to 1919, the esti­
mated value of the monetary coefficients would have
been close to 5.50 in all subperiods.

Testing Propositions
The propositions which A J tested were whether
monetary or fiscal influences were ( 1 ) stronger, (2)
more predictable, and (3) faster in their impact on
economic activity. They concluded that the evidence
for the 1953-1968 period strongly favored the domin­
ance of monetary over fiscal influences. These same
propositions are tested in this article and provide
additional evidence that monetary influences consist­
ently have been stronger, more predictable, and
faster in their effect on economic activity than have
fiscal influences. The results are detailed below.
Which is Stronger? — To measure the relative
strength of monetary and fiscal influences, we need
to know which has the largest impact on economic
activity. This question can be answered by making
an appropriate comparison of the coefficients of the
monetary and fiscal variables. If the variables on
which these coefficients are estimated have the same
dimension and magnitude of variation, then the com­
parison can be made directly. These conditions, how­
ever, are not satisfied with these data. Money is a
stock variable measured as first differences, and Fed­
eral Government spending is a flow variable meas­
ured as first differences at annual rates. Also, the
degree of variation in the two variables differs sub­
stantially. In general, the fiscal variable has fluctuated
more than the monetary variable (see Chart III on
pages 16 and 17).
To make the estimated coefficients of the mone­
tary and fiscal variables comparable for an assessment
of their relative impact on economic activity, they
were transformed into beta coefficients. The “sum”
Table II

BETA COEFFICIENTS
Am
(s u m )

11/1919 — 1/69

.3 3 1 *

11/1919 — 11/29

.5 1 5 *

111/1929 — 11/39

.5 9 3 *

111/1939 — IV /4 6
1 /1 9 4 7 —

IV /5 2

1/1 953 — 1/69

-.1 5 3
1.7 6 8 *
.7 2 6 *

A e
(sum )

-.0 2 6
—

-.8 0 3
.21 9
-2 .3 4 7 *
— .159

N ote: "B eta coefficients” are equal to the estimated coefficient
tim es the standard deviation o f the independent variable over
the standard deviation o f the dependent variable. See A rthur
S. Goldberger, E conom ic T h eory (J oh n W iley & Sons, 1964)
p p . 197-98.
•Significant at the 95% level o f confidence.

Page 12



T able III

t VALUES
Am
(sum )

Ae
(sum )

11/1919 — 1/69

4.31

11/1919 — 11/29

3.16

-0 -

111/1929 — 11/39

3.41

-1 .9 5

111/1939 — IV /4 6

-

— .28

.59

.81

1 /1 9 4 7 — IV /5 2

3.51

— 4.12

1/1 953 — 1/1969

4.70

-1 .0 7

N ote: A t value is a statistical indicator o f the confidence one may
have that the "tru e relation ship" between the independent
and dependent variable has the same sign as the statistically
estimated coefficient o f that relationship.

beta coefficients are presented in Table II. For the
whole period the monetary influence is large and
statistically significant, while the fiscal influence is
negative and statistically insignificant. This result
also applies to each of the subperiods, except for
W orld W ar II and the early postwar periods (193952). During the W orld W ar II years the monetary
influence is statistically insignificant and negative, and
the fiscal influence is insignificant and positive. For
the early post-World W ar II years the fiscal influ­
ence is statistically significant and negative. This
postwar regression result seems to be due to special
factors which are outlined below.
Which is More Predictable? — The monetary or
fiscal variable with the more statistically significant
coefficient is also more reliable in that its relationship
to economic activity is more predictable. Statistical
significance is measured by the t values of the co­
efficients of the monetary and fiscal variables when
measured against the same dependent variable, which
in this case was AY. A t value is a statistical in­
dicator of the confidence one may have that the
“true relationship” between the independent and
dependent variable has the same sign as the statis­
tically estimated coefficient of that relationship. The
larger a t value, the more confidence we have that
the monetary and fiscal variables are related to eco­
nomic activity. The t values of the sum coefficients
are presented in Table III. For the whole period, the
t value of the monetary variable is substantially
larger than the t value of the fiscal variable. The
same statement also holds with respect to the t values
of the monetary and fiscal variables in the sub­
periods, with the exception of the w ar and early
postwar periods (1939-52). Thus, in general, the
monetary variable has a more predictable effect on
economic activity than the fiscal variable.

F E D E R A L R E S E R V E B A N K O F ST. L O U I S

NOVEMBER 1 9 6 9

C h a r t II

Beta Coefficients of M o n e ta ry a n d Fiscal Influences
First Differences

N o te : B e ta c o e f f ic ie n t s a r e f o r th e M o n e y S to ck (AM ) a n d G o v e r n m e n t E x p e n d itu re s (AE), a n d a re c a lc u la te d a s th e p r o d u c t s o f th e re g re s s io n
c o e ffic ie n ts f o r th e r e s p e c tiv e v a r ia b le s tim e s th e r a tio o f th e s ta n d a r d d e v ia t io n o f th e in d e p e n d e n t v a r ia b le s to th e s t a n d a r d d e v ia t io n o f
E c o n o m ic A c tiv ity (AY).
L a g s w e re s e le c te d o n th e b a s is o f th e m in im u m s t a n d a r d e r r o r o f e s tim a te .
T h ese c h a r ts a r e d e r iv e d fro m th e s ta tis tic a l re s u lts w h ic h a re s u m m a r iz e d in T a b le I.

W hich Works Faster? —The relative promptness of
monetary or fiscal influences can be measured by
observing which variable has a shorter time lag in
influencing economic activity. This can be seen in
the quarterly patterns of the regression coefficients
after they have been transformed into beta coeffi­
cients. The latter are plotted in Chart II and are
derived from the same set of statistical results sum­
marized in Table I. The fiscal variable has about the
same impact as the monetary variable in the con­
temporaneous quarter during the total period 1919


1969. However, in the succeeding quarters the fiscal
influence declines and becomes negative, while the
monetary influence continues to be positive through
the third lagged quarter. The quarterly pattern of
the monetary influence in the subperiods is quite
similar to that of the total period. The pattern of the
fiscal influence varies irregularly over subperiods.
However, in all subperiods except the war period
1939-46, the monetary variable has a consistently
faster influence on economic activity than the fiscal
variable.
Page 13

F E D E R A L R E S E R V E B A N K O F ST. LO U I S

Historical Review
The statistical results reported above are estimated
on the basis of the average response of economic
activity to monetary and fiscal influences within each
of the periods selected. A different w ay of looking
at monetary and fiscal influences on economic activity
is to investigate specific historic episodes. Chart III
on pages 16 and 17 is designed to assist in that inves­
tigation. In the lower tier of the chart the monetary
and fiscal variables are plotted as rates of change on
a common axis. In the upper tier of the chart eco­
nomic activity is also plotted in its rate-of-change
form.16
The most interesting comparisons are to be found
where the monetary and fiscal influences are operat­
ing in opposite directions. In those periods the move­
ment in economic activity w ill indicate which influ­
ence is dominant. The monetary and fiscal variables
move in opposite directions in the periods 1919-21,
1931-32, 1939, 1948-50, and 1966-67. In each of these
years economic activity, after a short lag, moved in
the same direction as the monetary variable and in
the opposite direction to the fiscal variable. As a
matter of fact, all cyclical movements in the money
stock were followed by proportional cyclical move­
ments in economic activity. Of the twelve cyclical
movements in economic activity from 1919 to 1969,
eleven are preceded by corresponding movements in
the money stock.17 The single exception is the
deceleration in economic activity in 1951, which is
discussed below.
1919-1929 — Although this period was one of gen­
eral economic prosperity, there were three cyclical
declines in this ten-year period. The first and most
severe occurred in late 1920 and early 1921. During
the remainder of the 1920’s two shorter and milder
declines occurred; in late 1923 to early 1924, and in
1927.

NOVEMBER 1 9 6 9

Federal Government spending showed substantial
fluctuation in the earlier part of the period and very
little movement in the middle and latter part of the
period. This experience reflected the demobilization
after W orld W ar I and the conservative spending
policies of the Harding and Coolidge administrations.
The statistical results reported in Table I, page 11,
omit the fiscal variable entirely for this subperiod, be­
cause its inclusion raises the standard error of the
estimate (adjusted for degrees of freedom) and
thus contributes nothing to the explanation of move­
ments in economic activity. This is not true of any
other subperiod in this study.
1929-1939 — The first part of this period is un­
doubtedly the most depressed in the entire economic
history of the United States. It was not the sharpness
of the decline that was so disastrous. There were
more rapid declines in both 1920 and 1937. Its dura­
tion was disastrous. Economic activity declined at an
annual rate of 20 percent or more for ten of the
eleven quarters between late 1929 and late 1932.
Sustained recovery did not start until the middle of
1933, when 25 per cent of the labor force was un­
employed and the price level was 24 per cent below
its 1929 level. This recovery lasted, with one signifi­
cant interruption in 1937, through the end of the
period.
Monetary influences during this period have been
characterized by a number of observers as being
especially ineffective. The results presented in this
article indicate that quite the opposite was the case.
Monetary influences played an important role in the
declines in economic activity in 1929-33 and 1937-38,
and in the recovery in the intervening years.

Each of these cyclical movements in economic
activity is matched by a corresponding movement in
the money stock. Money switched from a 15 per cent
rate of increase in the fourth quarter of 1919 to a 16
per cent rate of decline in the first quarter of 1921.
This was the sharpest five-quarter deceleration in the
money stock recorded during our fifty-year period.
The money stock had pronounced, though milder,
decelerations in 1923 and late 1926.

Although the initial decline in the third quarter
of 1929 apparently was not due to tight money in­
fluence (the money stock did not decline until the
fourth quarter of 1929), the fact that the economic
decline lasted for more than three years is associated
with a decline in the money stock.18 The initial five
quarters of decline in the money stock were rela­
tively mild. After reaching an annual 9 per cent rate
of decline in the first quarter of 1930, it slowed to a
3 per cent rate of decline in the fourth quarter of
1930. Then, for the next four quarters, the money
stock decelerated substantially and reached an an­
nual rate of decline of 18 per cent in the fourth

16Rates of change are used to allow comparisons over long
time periods on a similar basis.
17Milton Friedman and Anna Schwartz made a similar obser­
vation in “Money and Business Cycles,” Review of Eco­
nomics and Statistics, February 1963.

18Milton Friedman and Anna Schwartz, A Monetary History
of the United States, (Princeton, New Jersey: Princeton
University Press, 19 6 3 ), chapter 7, go into considerable
detail describing how Federal Reserve actions dominated
movements in the money stock during this period.

Page 14



F E D E R A L R E S E R V E B A N K O F ST. LO U I S

quarter of 1931. For the next six quarters the de­
clines became progressively smaller. Finally, at the
end of 1933 the money stock registered the first
quarterly increase since the third quarter of 1929.
The money stock had shown continual quarterly
declines for almost four years.
Economic activity moved parallel with the money
stock pattern in 1929-33. Although the first year de­
cline was substantial, it was less than the four-quarter
decline in 1920-21, and only moderately greater than
the four-quarter decline in 1923-24. In the first half
of 1931 the rate of decline actually slowed, respond­
ing to the less restrictive monetary influences. How­
ever, in the next year the decline in economic activity
increased sharply. In the year ending June 1932, it
declined by 37 per cent. In late 1932, economic activ­
ity finally stopped declining, and in early 1933 it
started to increase. This increase generally continued
until the middle of 1937, when it was temporarily
reversed by the tight money influence which de­
veloped in late 1936.
During this period fiscal influences, as measured
by changes in Federal Government expenditures,
were quite erratic. They were highly expansionary
in the years 1931, 1933 to early 1934, 1936, and 1938.
On the other hand, they were restrictive in the years
1932, 1935, and 1937. This pattern sometimes con­
formed with and sometimes opposed monetary in­
fluences. But in every case economic activity moved
consistently with the direction and magnitude of
monetary influences.
1939-1946 —Data for the w ar years are presented
to make the series complete. However, with compre­
hensive price controls tending to create a discrepancy
between the equilibrium and observed growth rate
in economic activity, there is little to be learned about
monetary and fiscal influences from this period. Our
results indicate that the monetary variable was not
statistically significant during this period. The fiscal
variable had a strong positive influence in the quarter
in which the Government spending took place, but
tended to “washout” after five quarters, leaving only
a small positive net influence.
1947-1952 — There were three cyclical expansions
in this period: early 1947-48, late 1949 and 1950, and
in 1952. There were cyclical contractions in the inter­
vening years. The movements in the money stock did
a good job of “tracking” the movements of economic
activity during this period, with the single exception
of the deceleration in economic activity which oc­
curred in 1951. This is the only deceleration in



NOVEMBER 1 9 6 9

economic activity in the fifty-year period which was
not anticipated by movements in the money stock.
A quite plausible explanation for this phenomena
is provided by Friedman and Schwartz.19 In March
1951 the United States Treasury Department and the
Federal Reserve reached an “Accord,” which per­
mitted the latter to abandon its war-induced policy
of pegging the price of Government bonds. Even
though the Federal Reserve did not take advantage
of this increased flexibility in policy actions immedi­
ately, the public act of abandoning support of the
Government bond market greatly reduced the ap­
parent liquidity of the public. The public was no
longer assured that conversions between Government
bonds and money could take place at a fixed and
known price. This caused a substantial, one-time in­
crease in the liquidity demand for money balances
relative to income, and a decrease in the velocity of
money in a period when velocity had typically been
rising.
This experience suggests not only that permanent
changes in the demand for money independent of
changes in income can weaken the observed relation
between money and income, but that such changes
in money demand are relatively rare. Such changes
generally have been associated with some specific
historic event which changes the previous institutional
relations with respect to the liquidity of nonmoney
assets.
The other unique factor about this subperiod is
that the fiscal variable is statistically significant and
negative. Weidenbaum has provided a plausible ex­
planation for this.20 He has shown that Government
spending influences economic activity not when the
bills are paid and the goods are delivered to the Gov­
ernment, but when the orders are placed with in­
dustry, which must then hire employees and open
plants to produce the products.
This discrepancy does not lead to serious bias in
measuring Government spending except when there
is a sharp acceleration or deceleration in this variable.
This was clearly the case in the Korean W ar, when
Government spending went from an annual rate of
decline of 38 per cent in the second quarter of 1950
to an annual rate of increase of 83 per cent in the
first quarter of 1951 and then fell to an annual rate
of increase of 13 per cent in 1952. This “whiplash”
19Friedman and Schwartz, pp. 598 and 612.
20M urray L. Weidenbaum, “The Federal Government Expend­
ing Process,” Federal Expenditure Policy for Economic
Growth and Stability, (Washington, D.C.: Joint Economic
Committee of Congress, U.S. Government Printing Office,
November 19 5 7 ), pp. 493-506.
Page 15

C h a r t III

Rates o f C h a n g e

C h a n g e s in M o n e y S u p p ly a n d G o v e r n m e n t E x p e n d it u r e s
in R e la tio n to C h a n g e s in Economic A c t iv it y

Q u a rte rly d a ta a t a n n u a l ra te s .

p o s tw a ry e a rs (1947-74) c o n s e q u e n tly has been e n la rg e d to fa c ilita te c o m p a ris o n s a m o n g the th re e series.
[L E c o n o m ic A c tiv ity is m e a s u re d b y the sc a le d p ro d u c t o f the C o n su m e r P rice In d e x (CPI) a n d the In d u s tria l P ro d u c tio n In d e x (IPI)

Page 16



Rates o f C h a n g e

S o urces: M o n e y S u p p ly : 1919-46, M ilto n F rie d m a n & A n n a J .S c h w a rtz “ A M o n e ta ry H is to ry o f th e U n ite d S ta te s ; 1947-19 6 9 "B o a rd o f

♦The m a g n itu d e o f flu c tu a tio n s in th e th re e s e rie s p lo tte d d e c re a s e d c o n s id e ra b ly a fte r W o r ld W a r II. The ra te o f c h a n g e scale fo r the

m u ltip lie d b y G ro s s N a tio n a l P rod uct(G N P ) in the ba se y e a rs 19 57-59:

C h a r t III

/CPI • IPlV $ 4 5 7 .4 b illio n - E co n o m ic A c tiv ity

vism)

G o v e rn o rs o f the F e d e ra l R eserve S ystem ; F e d e ra l G o v e rn m e n t S p e n d in g : 1917-28, estim a te d fro m U.S. H is to ric a l S ta tis tic s ,
B u re a u o f C ensus; 1929-1945, e s tim a te d fro m N a tio n a l Inco m e & P roducts S up p le m e n t, U.S. D e p a rtm e n t o f C o m m e rc e ;
19 46-69, Federal Reserve B ank o f St. L o u is; E conom ic A c tiv ity : In d u s tria l P ro d u c tio n In d e x , B o a rd o f G o v e rn o rs o f the F e d e ra l
R eserve System ; C o n su m e r P rice In d e x , U.S. D e p a rtm e n t o f L a b o r

Page 17

F E D E R A L R E S E R V E B A N K O F ST. L O U I S

N OV E M B E R 1 9 6 9

1953-1969 —This is the period which was covered
in the original AJ study. W hile their measure of
economic activity, nominal GNP, differs from the
proxy used here and described in footnote 10, their
results and ours are similar in most respects, as can
be seen in the comparison of summary results in
Table IV.
In each case the monetary and fiscal measures
are the same ( the money stock and government
spending). Only the measure of economic activity
differs. The first equation is based on our proxy of
economic activity and is drawn from Table I. The
second equation is based on nominal GNP.22 In each
case the monetary variable has a positive coefficient
which is statistically significant and the fiscal variable
has a coefficient which is statisticially insignificant
and close to zero in value. Both equations are suffi­
ciently well specified to pass the Durbin-Watson
( D- W) test for autocorrelation, and the lag struc­
tures are the same when selected on the basis of
minimum standard error of estimate. The value of
21This is shown by the following regression:
1/1947 - IV/1956
(Quarterly First Differences)
AY = 1 .1 1 + 7.82 2 A M t-i - 1.13 S A E t- i
( .48) (3 .3 1) i= o
(1.7 6 ) i= o

R2 = .27
D -W = .98

where 2 stands for sum of monetary or fiscal influence from
period t to period t-3. Lags were selected on the basis of
minimum standard error of estimate adjusted for degrees
of freedom.
22The results with respect to nominal GNP differ slightly from
the original Andersen-Jordan results because of the different
lag structure. The lag structure in their original article
(contemporaneous and three-lag values) was selected on
the basis of minimum standard error of the coefficient
attached to the monetary variable. The present lag structure
(contemporaneous and four-lag values) was selected on
the basis of minimum standard error of the entire equation
adjusted for degrees of freedom. In this case, the different
criteria did not change the results in any significant way.
Page 18



MONETARY A N D

FISCAL INFLUENCES O N

E C O N O M IC ACTIVITY, MEASURED AS A

PROXY

(A Y ) A N D AS N O M IN A L G N P (A G N P )
( 1 /1 9 5 3 — 1 /1 9 6 9 )
Dependent
V ariable

la g s *

<32 AE

Ay

f-4

1.42
( -72)

8.85
(4 .7 0 )

- .84
(1 .0 7 )

.47
1.71

A gnp

t-4

2.59
(3 .1 9 )

5.63
(6 .9 4 )

.08
( .2 4 )

.65
1.78

Constant
Term
ao

M onetary
Influence
o

If we had chosen a somewhat longer time period
in which to measure the impact of monetary and fis­
cal influences, the strong negative offset estimated
with respect to AE would have lost; its statistical
significance. W e would have had results for the early
post-World W ar II subperiod which were comparable
to the results of the other subperiods.21

Table IV

5
<

movement in Government spending follows by about
two or three quarters an equally sharp movement in
economic activity. As a result, AY and AE moved
in opposite directions in this period. This is the cause
of the statistically significant negative coefficient of
AE with respect to AY.

Fiscal
Influence

R2
D-W

N ote: Regression coefficients are the top fig u re s; their “ t” values
appear below each coefficient, enclosed by parentheses. R 2 is
the per cent o f variations in the dependent variable which is
explained by variations in the independent variable. D -W is
the D urbin-W atson statistic.

the monetary coefficient is greater with the proxy
measure of economic activity ( AY) than with nom­
inal GNP (AGNP), which is due to the greater aver­
age value and amplitude of the proxy. The coefficient
of determination ( B2) is larger with AGNP than
with AY. This is as would be expected if, as seems
reasonable, nominal GNP is superior to our proxy as
an indicator of economic activity.
There were four cyclical declines in this period,
each of which was led by a decline in the money
stock. Government spending registered three cyclical
declines, two of which corresponded to periods of
decline in the money stock and one (in 1967) which
did not. As noted in our investigation of earlier pe­
riods, economic activity declined following a decline
in Government spending only when accompanied by
a decline in the money stock.

Determining the Values of the Monetary
and Fiscal Variables
An assessment of the reliability of the relations
presented above will depend upon whether the
estimated coefficients for the monetary and fiscal
variables are exogenous. This problem arises in all
statistical work, and no fully satisfactory solution has
been found to test for exogeneity in either single
equation or in large structural models.23 However,
in the single equation test of monetary and fiscal in­
fluences on economic activity employed here, one
potential source of bias is found in the so-called “reverse-causation” argument. This asserts that the ob­
served correlation between M and Y is not because
changes in M cause changes in Y, but because changes
23In statistical theory, a variable is exogenous if it is un­
correlated with the “true” error term of the equation.
Unfortunately, only the measured error term in any equa­
tion is observable, so this test cannot be made.

F E D E R A L R E S E R V E B A N K O F ST. L O U I S

in Y cause changes in M. If this possibility cannot be
rejected, then a more elaborate statistical test is
needed to compare monetary and fiscal influence
on economic activity.-4
The fiscal variable used here (total Federal Gov­
ernment spending, including transfer payments) is
generally accepted as being determined by the fiscal
authorities and not by the behavior of the public in
the marketplace. For the purposes of our test we
will assume that the fiscal variable is statistically inde­
pendent or exogenous. W ith respect to the monetary
variable (the narrowly defined money stock), there is
considerable controversy as to whether its value is
determined by the monetary authorities or by the
public. For this reason we w ill concentrate our em­
pirical investigation on the money variable. It will be
shown that the reverse-causation argument is not
supported by the evidence. In addition, the available
evidence indicates that the actions of the monetary
authorities dominate the movements in the money
stock.

Does Economic Activity Affect Money?
In order to evaluate the significance of the reverse-causation argument, w"e need some indicator of
the public’s potential influence on the money stock.
The indicator chosen is our proxy variable for eco­
nomic activity (Y). This proxy has two advantages:
first, it is the broadest available measure of aggregate
economic activity and, as such, most actions of pri­
vate decision-making units in the economy are re­
flected in it. Second, it allows us to consider directly
the important statistical question of whether move­
ments in Y lead to movements in M.
In order for economic activity to affect the money
stock, it must operate through some transmission
mechanism.25 The Brunner-Meltzer money stock
identity provides a useful structure within which to
consider the several ways that economic activity could
affect the money stock.28 In this context the money
24A t the least, one would need an equation to explain the
monetary and fiscal variables by factors which themselves
were independent of income.
25The approach used here to test for the influence of the
public on the money stock was suggested by the work of
Leonall C. Andersen, “Additional Empirical Evidence on
the Reverse-Causation Argument,” this Review, August
1969.
26For a systematic exposition of this approach, see Albert
Burger, “An Analysis and Development of the BrunnerMeltzer Nonlinear Money Supply Hypothesis,” Working
Paper No. 7, Federal Reserve Bank of St. Louis, May 1969.



NOVEMBER 1 9 6 9

stock (M ) is defined as the product of the money
multiplier (m ) and monetary base (B ):
M = mB

The sources of the monetary base consist of various
kinds of credit extended by the monetary authorities
to the rest of the economy. The use of the monetary
base is divided between currency holdings of the
nonbank public and reserves of commercial banks.
The money multiplier, which is defined as
m = — ------- 1 + k ---------r (l+T + g)+k

,

is largely determined by the behavior of the public,
including commercial banks; k represents the ratio of
private currency holdings to private demand depos­
its; t represents the ratio of private time deposits to
private demand deposits; g represents the ratio of
Government deposits in commercial banks to private
demand deposits; and r represents the ratio of total
bank reserves and total bank deposits.27
Economic Activity and the Monetary Base — The
influence of economic activity on the money stock
could operate either through the monetary base (B)
or the money multiplier (m). To test whether eco­
nomic activity has influenced the monetary base,
regressions were run for the total period (1919-69),
and for each of the five subperiods reported above.
The results are presented in Table V. For the entire
50-year period changes in the monetary base have a
statistically significant relation with changes in eco­
nomic activity. However, economic activity explains at
most only 4 percent of the variance of the changes in
the monetary base; that is, the R2 was .04. For
every $1 billion increase in economic activity, there
is associated only an $8 million increase in the base
in the same quarter.
Equally weak relations between AY and AB were
found in the subperiods. Only the first (1919-29)
and the last (1953-69) subperiods had statistically
significant coefficients, while the R2 varied between
.01 and .15.
These results imply that the public, operating
through economic activity, has only a small effect on
the monetary base, and that this effect has varied
27For a detailed discussion of the determinants of the multi­
plier and its influence on the money stock, see Philip Cagan,
Determinants and Effects of Changes in the U.S. Money
Stock, 1875 -19 60 , (New York: National Bureau of Economic
Research, 19 6 5 ); and Jerry L. Jordan, “Elements of Money
Stock Determination”, this Review, October 1969.
Page 19

F E D E R A L R E S E R V E B A N K O F ST. L O U I S

NOVEMBER 1 9 6 9

substantially over time in both
Table VI
degree and significance. Allow ­
THE INFLUENCE OF STABILIZATION (FR), EVEN-KEEL (A D ) A N D
ing for the influence of lagged
F IN A N C IA L (r-rn) OBJECTIVES OF THE M O NETARY AUTHORITIES
values of AY on AB does not
O N THE M O NETARY BASE (A B )
change the results presented
in Table V, except for 1947-52
A B t = c i FR + C2 A d
C3 (r-rn )
(Q
u
a
rte
rly
First
Differences
—
B
illions
o f Dollars)
when the R2 increases to .24
Time
S
tabilization
Even-Keel
Dummy
and the coefficient becomes
Financial
Periods
Objective
Objective
Objective
V ariab le*
R2
D-W
statistically significant.
e i FR
C2 A d
C3 (r-rn )
Monetary Authorities and the
11/1929 — IV /1 9 3 9
.33
— .219
.401
.553
.59
1.75
Monetary Base — Another po­
(6 .7 6 )
(2 .8 6 )
(3 .6 5 )
(1 .9 5 )
_
1 /1 9 4 0 — IV /1 9 5 2
.01
.070
.46 9
.46
1.90
tential source of control of the
(6 .3 2 )
(.3 7 )
(.8 1 )
monetary base is through the
1/1 953 — IV /1 9 6 8
.19
.018
.69
1.84
.123
.415
actions of the monetary au­
(2 .2 8 )
(1 -7 3 )
(2 .6 9 )
(5 .5 8 )
thorities. There have been a
N ote: Regression coefficients are the top figu res; their “ t” values appear below each coefficient,
number of studies which have
enclosed by parentheses. R 2 is the p ercent o f variations in the dependent variable which is
explained by variations in the independent variable. D -W is the Durbin-W atson statistic.
related policy targets of the
♦In 1929-39 the Dumm y V ariable is designed to accou nt fo r the im pact on the m onetary base o f the
rise in the price o f gold in February 1934. I t assumes the value o f 1 fo r the first and second
monetary authorities, such as
quarters o f 1934 and zero fo r all other quarters. In 1953-68 the Dumm y V ariable accounts f o r the
change
in presidential adm inistration. It assumes a value o f zero from 1/1953 to 11/1962 and a
income stabilization, to various
value o f one from III/1962 to IV /1968.
indicators of monetary actions,
such as the money stock (Dewith respect to income, employment, and prices, re­
wald and Johnson), total member bank reserves
flected in the Federal Reserve Open Market Commit­
(Dewald), free reserves (W ood), and the monetary
tee
policy statements as proxied by the level of free
base (Keran and Babb). A ll these studies conclude
reserves
(FR); an even-keel objective with respect
that the monetary authorities have dominated move­
to
Government
debt financing, measured by
ments in the money stock or some closely allied vari­
changes
in
the
national
debt ( A D) ; and a financial
able. The last named study will be briefly reviewed
objective with respect to stability of the financial
here because it deals explicitly with control of the
system, measured by deviations of Corporate Aaa
monetary base by the authorities.
bond yields from “normal” yield levels (r-rn).28 In
Keran and Babb found that a large proportion
addition, economically “random” events, such as
of the movements in the monetary base can be ex­
changes in the price of gold in 1934 and changes in
plained by the desire of the monetary authorities to
presidential administrations, have also influenced the
achieve three objectives: a stabilization objective
actions of the monetary authorities with respect to
Table V
changes in the monetary base ( AB) . These events
THE INFLUENCE O F E C O N O M IC ACTIVITY (A Y )
are represented by “dummy variables” in Table VI.
O N THE M O NETARY BASE (A B )
ABt =

bo + b i A Y t

(Q u a rte rly First Differences — Billions o f Dollars)
Time
Periods

bo

bi Ay

!? .

D-W

11/1919 — 1/1 969

.31
(8 .1 7 )

.008
(2 .9 8 )

.04

.58

111/1919 — 11/1929

-.0 1 2
(.6 8 )

.009
(2 .4 2 )

.12

.64

111/1929 — 11/1939

.20
(3 .3 9 )

.004
(.4 1 )

.02

.85

111/1939 — I V / 1946

.99
(7 .3 0 )

-.0 1 2
(1 .1 4 )

.01

1.09

1 /1 9 4 7 — IV /1 9 5 2

.12
(1 .4 5 )

.012
(1 .7 6 )

.08

.87

1/1 953 — 1 /1 969

.34
(6 .2 4 )

.012
(3 .4 5 )

.15

.87

N ote: Regression coefficients are the top figures: their t values
appear below each coefficient, enclosed by parentheses. R 2 is
the percent o f variations in the dependent variable which is
explained by variations in the independent variable. D -W is
the Durbin-W atson statistic.

Page 20



Two of the three subperiods considered by Keran
and Babb were approximately the same as subperiods
in the present study (1/1953 to IV/1968) and 1/1940
to IV/1952). Another subperiod in that study was reestimated to match the 1929-39 subperiod in this
study. The results are presented in Table VI. In each
case, fifty percent or more of the variations in AB
are explained by the actions of the monetary authori­
ties. In contrast, where the actions of the public
were assumed to operate, the best results explained
fifteen percent or less of the variance in AB (see
28They have also shown that in the 1953-68 period, Federal
Reserve open market operations (adjusted for changes in
reserve requirements) were also explained by the same
three objectives plus an additional money market objective,
which in effect offset the noncontrolled sources of the
monetary base.

F E D E R A L R E S E R V E B A N K O F ST. L O U I S

NOVEMBER 1 9 6 9

Table V ). The acceptable Durbin-Watson statistics in
Table VI suggest that no important explanatory varia­
bles have been omitted from the monetary authori­
ties’ explanation of AB. On the other hand, low
Durbin-Watson statistics in Table V imply that im­
portant explanatory variables have been omitted from
an economic activity explanation of AB.

Economic Activity and the Money Multiplier —
Another channel through which economic activity
could influence the money stock would be through its
influence on the money multiplier. As indicated above,
most of the ratios which are involved in determin­
ing the multiplier depend upon the behavior of the
public, including commercial banks.
Table VII presents the results relating changes in the
money stock ( A M ) to changes in the monetary base
( AR) and economic activity (AY) . Assuming that the
monetary authorities determine movements in the
base, and that the public operating through economic
activity influences the money multiplier, our results
indicate that for the total period (1919-69) both the
monetary authorities (AR) and economic activity
( AY) explain 67 per cent of the variance in AM.
However, the beta coefficients, which indicate the
“typical” influence of each independent variable on
the dependent variable, show that the monetary au­
thorities operating through the base ( AR) have an
impact on the money stock ( A M) which is 3V2 times
as large as the public influence operating through
economic activity ( A Y ). The results for the subperiods
are substantially the same as for the total period. The
coefficient for the monetary base is statistically sig­
nificant in all subperiods, while that for economic
activity is statistically significant in only the first two
subperiods (from 1919 to 1939). There was one sub­
period (1929-39) where the beta coefficients in­
dicated that economic activity was more important
than the monetary base in determining movements

The values of the coefficients in Table VI for the
prewar (1929-39) and postwar (1953-68) subperiods
were similar with respect to the income stabilization
objective (FR) and the financial stabilization objec­
tive (r-rn),29 supporting the hypothesis that the mon­
etary authorities have acted in a largely consistent
manner in controlling the monetary base (AR) . Dur­
ing the war and early postwar period (1940-52), the
Federal Reserve followed a single-minded policy of
supporting the Government bond market. The results
in Table VI reflect this, with only the even-keel vari­
able statistically significant in that subperiod.
The results presented here indicate that it is the
behavior of the monetary authorities (Table VI)
rather than economic activity (Table V ) which have
dominated movements in the monetary base (AR).
There is no evidence that the reverse-causation argu­
ment holds with respect to AR.

29For an explanation of all variables used in Table VI and
of the difference in the even-keel sign between (19 2 9 -3 9 )
and (19 5 3 -6 8 ), see Keran and Babb, pp. 9-15.

Table VII

RELATIVE INFLUENCE OF E C O N O M IC ACTIVITY (A Y ) A N D THE
M O NETARY BASE (A B ) O N
AMt =

d, +

THE M O N E Y STOCK (A M )

d, A Y t +

d2 ABt

(Q u a rte rly First Differences — B illions o f Dollars)
Time
Periods

Beta Coefficients
do

d iA Y t

d 2A B t

R2

D -W

Ay

Ab

11/1919 — j/1 9 6 9

.094
(1 .4 4 )

.023
(4 .6 1 )

1.89
(1 7 .7 8 )

.67

1.32

.198

.755

11/1919 — 11/1929

.075
(1 .7 2 )

.025
(2 .4 9 )

2.41
(5 .5 7 )

.61

1.43

.288

.64 0

111/1929 — 11/1939

.064
(.6 3 )

.063
(4 .4 5 )

.71
(2 .8 6 )

.42

1.21

.54 6

.351

111/1939 — IV /1 946

.82
(2 .5 2 )

.022
(1 .4 5 )

1.69
(6 .3 5 )

.57

1.73

.181

.791

1 /1 9 4 7 — IV /1 9 5 2

.37
(2 .2 7 )

.019
(1 .4 1 )

1.46
(3 .6 3 )

.46

.9 7

.230

.598

.032
(-2 4 )

.014
(1 .9 2 )

1.94
(8 .0 0 )

.59

1.56

.166

.696

1 /1 953 — 1/1 969

N ote: R egression coefficients are the top fig u res; their “ t ” values a p p ear below each coefficient, enclosed by parentheses. R 2 is the p ercent o f
variations in the dependent variable which is explained by variations in the independent variable. D -W is the Durbin-W atson statistic.




Page 21

F E D E R A L R E S E R V E B A N K O F ST. L O U I S

NOVEMBER 1 9 6 9

Table V III

RELATIVE INFLUENCE OF E C O N O M IC A C TIVITY
M O NETARY BASE (A B ) O N THE M O N EY
Amt =

eo

(AY)

A N D THE

MULTIPLIER (A m )

61 A Y t -)- b 2 A B t

(Q u a rte rly First Differences — B illions o f Dollars)
Time
Periods
H /1 9 1 9 — 1/1 969

Beta Coefficients
e0

e iA Y t

e2ABt

R2

D-W

Ay

Ab

.001
(•1 4 )

.001
(4 .0 3 )

-.0 3
(4 .2 0 )

.12

.96

.19 4

— .288

11/1919 — 11/1929

.01 1
(1 6 2 )

.004
(2 .5 3 )

-.1 6
(2 .3 7 )

.16

1.45

.438

-.4 0 3

111/1929 — 11/1939

— .004
(.3 1 )

.0 0 7
(4 .0 4 )

— .16
(5 .1 6 )

.50

.98

.441

— .575

111/1939 — I V / 1 946

.038
(3 .0 5 )

.001
(1 .3 2 )

-.0 3 4
(3 .3 4 )

.32

1.27

.274

— .528

1 /1 9 4 7 — IV /1 9 5 2

.008
(2 .2 4 )

.0001
(1 .4 5 )

— .028
(2 .9 8 )

.24

.95

.062

— .308

.0001
(2 .1 8 )

-.0 1 1
(2 .6 6 )

.09

1.56

.10 0

— .332

1/1 953 — 1/1 969

.0001
(.1 5 )

N ote: Regression coefficients are the top figu res; their " t ” values a p p e a r below each coefficient, enclosed by parentheses. R 3 is the p ercent o f
variations in the dependent variable which is explained by variations in the independent variable. D -W is the Durbin-W atson statistic.

in the money stock. The strength of the economic
activity variable in that period reflects the substantial
decline in the multiplier. The multiplier declined dur­
ing the early part of that period (1929-33) due to
a change in the currency-deposit ratio (k), which
reflected the run on banks by households as they at­
tempted to convert their bank deposits into currency.
These results are not changed when lagged values
of AY and AB are added to explain AM. W ith four
lags the statistical significance of the coefficient for
AY disappears in 1919-29, while in 1953-69 the co­
efficient for AY becomes negative. This latter result
is inconsistent with the usual reverse-causation argu­
ment, which asserts a positive relationship.
The results presented in Table VII imply that eco­
nomic activity has had some influence on changes in
the money stock, presumably through its influence
on the money multiplier, especially in the important
1929-39 period. However, the observed influence of
economic aotivity on the money stock would over­
state its true influence if offset by the actions of the
monetary authorities operating through the monetary
base. For example, if part of the actions of the mone­
tary authorities had been designed to offset the in­
fluence of economic activity on the money multiplier,
then the observed association of economic activity
and the money stock would be, at least, statistically
ambiguous.
Table VIII indicates this is the case. It shows the
relative impact of the public operating through eco­
nomic activity ( AY) , and the monetary authorities
Page 22



operating through the monetary base ( AB) , on the
money multiplier ( Am) . In the total period and in
all subperiods the influence of economic activity
( AY) is positive and the influence of the monetary
base ( AB) is negative. The beta coefficients indicate
that in all subperiods (including 1929-39), the mone­
tary authorities offset or more than offset the influence
of the public on the money multiplier. Thus, the
significance of the association of economic activity
and the money stock reported in Table VIII is weak­
ened, because those movements in the money multi­
plier induced by economic activity have been offset
by changes in the monetary base.
The conclusions which can be drawn from these
statistical tests are (1 ) that the monetary base is the
dominant factor in determining movements in the
money stock, both directly (Table VII) and indirectly
(Table V III), by offsetting other influences on the
money stock; and (2) that the monetary authorities
are the dominant factor in determining movements
in the monetary base (Table VI). Thus, for the pur­
poses of the single equation regressions used in this
article, there are no statistical reasons for not treat­
ing the money stock as substantially controlled by
the monetary authorities in all subperiods (including
1929-39).

Summary
The intent of this article is to measure the impact
of monetary and fiscal influences on economic activ­
ity over as long a period of American histoiy as
available data permit (1919-69), and for selected

F E D E R A L R E S E R V E B A N K O F ST. LO U I S

subperiods. This was done to see if different financial
institutions, Government involvement in the economy
and general economic conditions which existed dur­
ing this long period have substantially affected the
relative impacts that monetary and fiscal influences
have had on economic activity.
For the whole period and for each of the sub­
periods (except the war years 1939-46), the rela­
tive impacts of monetary and fiscal influences have
been remarkably stable. Changes in the money stock
(the indicator of monetary influence) have consist­
ently had a larger, more predictable, and faster im­
pact on changes in economic activity than have
changes in Federal Government spending (the in­
dicator of fiscal influence). This basic relationship
is observed in the economically depressed period of
1929-39 and in the prosperous periods 1919-29 and
1953-69.30
A historical investigation of the past fifty years
reveals that in every case where the monetary varia­
ble and the fiscal variable moved in opposite direc­
tions, economic activity moved in the direction of the
monetary variable and opposite in direction to the
fiscal variable. Every cyclical movement in the money




NOVEMBER 1 9 6 9

stock since 1919 has been followed by a proportional
cyclical movement in economic activity.
Both the statistical results and the historical in­
vestigation provide strong support for the case that
monetary influences have a significant impact on eco­
nomic activity over the business cycle. An important
implication of these results is that monetary policy
should be given a central role in any economic
stabilization program.
30The author was surprised at the consistency of the mone­
tary influence during the various subperiods. Before con­
ducting the research reported in this article, he considered
that monetary influences on economic actiyity were strongly
significant only during periods of generally strong business
conditions like the 1920 s and 19 60 ’s, while fiscal influences
were dominant in periods of generally weak business condi­
tions like the 1930’?. In the March 1967 issue of this Review
(page 1 4 ) , he said: “during the 1930’s business expectations
of the future were so badly impaired by the depression ex­
perience that even large change in financial variables like
money, . . . would not be sufficient to induce new invest­
ment and consumption.” In the November 1967 issue (page
8) he made the same statement in a slightly different
context: “If the forces which create strong private demand
should disappear, i.e., loss of optimistic expectations by firms
and households, the rate at which money is made available
to the economy may not result in a predictable change in
income.”
The results reported in this article do not support the
above quotations. Monetary influences have dominated fiscal
influences on economic activity in both periods of secular
boom and periods of secular recession.

This article is available as Reprint No. 47.

The Appendix to this article, which begins on the next page, considers
the fiscal influence in more detail.

APPENDIX

M ost of the readers of this article w ill not be sur­
prised w ith ou r results, w h ich indicate th at m onetary
influences h ave had a m ajor im pact on econom ic activity.
M ost econom ists b elieve th at m oney m atters. H ow ever,
th ey m ay be surprised at the consistently w eak or non­
existent fiscal influence w h ich our results im ply. This
A pp endix w ill explore one possible explanation fo r these
surprising results.
T able IX shows the im pact o f fiscal influences (m easured
b y changes in F ed eral G overn m ent spending) on eco­
nom ic a ctivity w ith ou t taking m on etary influences into
consideration. N otice in T able IX that the sign and
statistical significance o f the fiscal influences differ sub­
stan tially fro m the results presented in T able I, w h ere
m on etary influences are explicitly accounted for. In T a­
b le IX, the fiscal influences are positive and statistically
significant fo r the entire period and fo r each o f th e sub­
periods. T he single exception is the period 1 9 4 7 -5 2 ,
w h ere special factors explained in the text tend ed to
bias the fiscal m easure. On the oth er hand, the fiscal
influences m easured in T able I w e re statistically insigni­
ficant and n eg ative fo r th e en tire p erio d and fo r each
o f the sub-periods, again w ith the single exception o f the
p erio d 1 9 4 7 -5 2 .

A com parison o f the results in T able I and T able IX in­
dicates th a t fiscal influences on econom ic a ctivity m ay
be strongly dep enden t upon how G overn m ent spending
is financed. F ed eral G overn m ent expenditures can be
paid fo r either b y tax receipts from the public, b y issuing
bonds to the public, or b y expansion o f the m oney supply.
The results in T able IX, w h ere the fiscal influences
are positive and statistically significant, do not d iffer­
entiate b etw een the altern ative m ethods of financing
G overn m ent spending. T able I, h o w ever, b y explicitly
including changes in the m oney stock, im plies that
G overn m ent spending financed b y m oney creation is
accounted fo r b y the m on etary variable. O nly th at portion
of G overn m ent spending w h ich is financed b y taxation
and selling bonds to th e p u b lic is m easured b y the
fiscal v a ria b le .1 These results ind icate that th e strength
o f the fiscal influences on econom ic a c tivity is dep enden t
upon the m ethod o f financing G overn m ent spending.
If spending is financed b y increases in the m oney stock,
it has a m easurable effect on econom ic activity. If it is
financed b y taxes or selling bonds to the public, there
is no m easurable fiscal influence on econom ic activity.

Table IX

IM PACT OF FISCAL INFLUENCES
ON

E C O N O M IC ACTIVITY
A

y =

f„ +

(AE)

(AY)

fi AE

(First Differences — Billions o f Dollars)
R2/D-W

Lags*

fo

f l A E (sum )

H /1 9 1 9 — 1 /1 969

t-6

3.83
(5 .1 6 )

.81
(3 .0 1 )

.13
.96

11/1919 — 11/1929

t-7

1.73
(2 .4 4 )

3.2 7
(2 .7 8 )

.41
1.58

111/1929 — 11/1939

t-1 0

-3 .4 5
(2 .2 5 )

18.28
(2 .1 8 )

.14
1.49

111/1939 — IV /1 94 6

t-4

4.29
(2 .9 1 )

.53
(2 .1 1 )

.61
1.43

1 /1 9 4 7 — IV /1 952

t-4

9.38
(3 .9 1 )

— 1.49
(1 .7 6 )

.09
.81

1 /1 9 5 3 — M /1 9 6 9

t-3

6.08
(2 .9 5 )

1.71
(2 .1 5 )

.08
1.13

N ote: R egression coefficients are the top figu res; their “ t” values appear below each
coefficient, enclosed by parentheses. R 2 is the p ercent o f variations in the dependent
variable which is explained by variations in the independent variable. D-W is the
D urbin-W atson statistic.
^Selected on the basis o f m inimum standard error o f estimate, adjusted fo r degrees o f
freedom .

24
Digitized for Page
FRASER


M ost w riters on pu blic finance and
fiscal p o licy2 h ave g enerally asserted
th at th e im pact o f G overn m ent spend­
ing on th e econom y is influenced b y
h o w th e spending is financed. The
most expansionary m ethod is through
increasing the m oney supply, and the
least expansionary m ethod is through
increases in taxes. T he results p re ­
sented in this A pp endix are consistent
w ith those assertions.
'The role of commercial banks is ambiguous
in this analysis. If banks buy Government
bonds and induce the Federal Reserve to
increase total reserves, it is treated as an
increase in the money supply by the mon­
etary authorities. However, if the com­
mercial banks buy Government bonds,
independent of any increase in reserves,
it is treated the same as a purchase of
bonds by the general public.
-Richard Musgrave, The Theory of Public
Finance, (New York: McGraw-Hill, 19 5 9 );
Alvin Hansen, Monetary Theory and Fiscal
Policy, (McGraw-Hill Company, 19 4 9 );
and O. H. Brownlee and E. D. Allen, The
Economics of Public Finance, Second Edi­
tion, Englewood Cliffs, New Jersey: Prentice-Hall, Inc., 19 5 6 ).

The Effects of Inflation (1960-68)
by ALBERT E. BURGER

I HE MAJOR GOALS of economic stabilization
policy are a full-employment level of real output
and a stable price level. Over the first five years of
the current economic expansion which began in early
1961, the goal of full employment dominated discus­
sions of policy. In January 1966 the interim target
goal of 4 per cent unemployment was reached.
Since early 1966 most studies of unemployment have
been concerned with unemployment by specific
classes or groups rather than total unemployment.
At an aggregate level, the problems of achieving a
stable price level have increasingly dominated the
attention of the policymakers and the public.
The objective of a full-employment level of real
output is a desirable goal of economic stabilization
policy. If the economy is operating at less than its
potential level of real output there is waste, not only
from the standpoint of individuals who are un­
employed, but from an aggregate viewpoint. There
is less real output being produced than the economy
could produce, given its endowment of factors of
production, the degree of skill and training of the
labor force, and the available technology. By mov­
ing from a position of underemployment to one of
maximum utilization of resources, a larger flow of real
goods may be made available for all members of the
economy.
Most people can see the inherent dangers of socalled hyperinflation. Germany in the post-World
W ar I period, when prices rose by a factor of 100
billion in one year, the Eastern European countries
of Poland and Hungary in the 1921-23 period, and
China in the post W orld W ar II period, stand out as
very clear examples of the severe political as well as
economic consequences of hyperinflation.
However, to the individual, effects of inflation are
less immediately clear when the rate of change of
prices increases from 1.3 per cent to 5 per cent over
a period of four years, as was experienced in the
United States during 1964-68. Indeed, sometimes there
is even confusion as to just what the term inflation
means. A careful distinction must be made between



changes in relative prices of assets and changes in the
same direction of prices of all assets except money.1
Changes in relative prices play an important role in
a dynamic growing economy. In a market-directed
economy such as ours, changes in relative prices of
goods and services and classes of factors of production
are the mechanism by which resources are directed to
produce the real goods and services that maximize
the satisfaction of individuals in the economy.
Individuals purchase real goods and services be­
cause the consumption of these items yields satisfac­
tion (or as economists would say, utility) to the in­
dividual purchaser. Exactly defined, inflation refers
to a situation where an individual can no longer pur­
chase as large an amount of utility for a given money
outlay. Because a satisfactory means has not been de­
veloped to quantify the utility that individuals receive
from consuming goods and services, a less exact
definition of inflation must be used.
The term inflation is applied operationally to a
situation where the exchange value of the medium
of exchange (money), in terms of real goods and
services, is decreasing. W e attempt to measure
whether the general level of prices has increased, or
whether there has only been a change in relative
prices, by the use of a price index. Changes in the
price index reflect changes in the total cost of a rep­
resentative market basket of goods. For example, if
a price index rises from 100 to 105 over a period
of time, w e say that the exchange value of money
in terms of this representative market basket of goods
is 4.8 per cent less.
The purpose of this article is to examine the effects
of inflation on individuals in their separate roles as
income earners and holders of financial and real as]An individual’s holdings of assets, the current dollar value
of which measures his nonhuman wealth, may be divided
into two broad classes — real assets and financial assets. Real
assets are items which yield a direct flow of consumption or
production services to the asset holder. Financial assets are
items that represent a claim on real assets or other financial
assets.
Page 2.5

NOVEMBER 1 9 6 9

F E D E R A L R E S E R V E B A N K O F ST. LO U I S

sets. The analysis is limited to the eight-year period
1960 through 1968. No attempt is made to discuss
long-run trends. For comparison purposes, the period
from 1960-68 is divided into two four-year periods:
1960-64 when overall prices remained relatively sta­
ble, and 1964-68 when the rate of increase of prices
accelerated.
The analysis is limited to the effects of inflation on
individuals in their separate roles on the average.
Any one individual is not exclusively an income
earner, not just a homeowner, nor just a holder of
financial assets. Quite likely, he is all three. W e can
judge whether a particular individual “benefited” or
“lost” in a given period of time only by examining his
total balance sheet. During the latter comparision
period some individuals experienced greater increases
in real income flows and in the real value of the stock
of assets they held than during the 1960-64 period.
Others fared worse with respect to these items than
during the earlier comparison period.2

An Overall Look at the Period
1960 Through 1968
A t the aggregate level, both of the comparison pe­
riods show remarkable economic expansion. Over the
first four-year period, real GNP increased by $93.4
billion, a 19 per cent increase. During the next four
years, real GNP grew by an additional $126.5 billion,
up 22 percent.3 Per capita real GNP also rose mark­
edly, by 12 per cent from 1960 through 1964, and
then by 16 per cent from 1964-68.
The two periods were dissimilar in at least two
important aspects: prices and unemployment. The
first period, 1960 through 1964, was characterized by
a period of prevailing price stability: the consumer
price index rose at an average rate of 1.2 per cent,
wholesale prices showed almost no change, and the
broader index, the GNP deflator, rose at an average
annual rate of only 1.3 per cent. The second fouryear period was characterized by an accelerating
price level. From an increase of only 1.3 per cent in
1964, the consumer price index increased at an aver­
age rate of 1.7 per cent in 1965, increased to a 2.9 per
cent rate for 1966, slowed in the mini-recession of the
2Since the household sector is a net monetary creditor (its
monetary assets exceed its monetary liabilities), this sector
loses real wealth in periods of inflation to net debtor sectors
such as the government sector and business sector.
3The 22 per cent increase in real GNP in the latter four years
is an even more remarkable rise when one considers that this
increase was achieved starting in 1965 from a much higher
level of resource utilization than prevailed in 1960-61.
26
Digitized forPage
FRASER


Consumer Price Index
R atio S cale

R a tio S cale

1957-59=100

1961

1957-59=100

1962

1963

1964

1965

1966

1967

1968

1969

Source: U.S. D epartm ent o f Labor
Percentages are annual rates o f change com puted from a nnual a verages o f m on thly data.
Latest d a ta p lotted: September

first part of 1967, and then again began its upward
movement. Over the last half of 1967, the consumer
price index rose at a 3.8 per cent annual rate and
then accelerated to a 4.7 per cent rate for 1968.
The first of our four-year periods was characterized
by unemployment above 5 per cent. In 1962 the un­
employment rate was 5.5 per cent, a sharp drop
from 6.7 per cent in the previous year. Over the next
three years the unemployment rate remained at ap­
proximately the 1962 level. The second period, 1964
through 1968, is characterized by another sharp break
in the per cent of the labor force unemployed. In
1965 the unemployment rate fell to 4.5 per cent and
in 1966 reached an average of 3.8 per cent, a low
level believed almost unattainable in a growing eco­
nomy in the early 1960’s.
U n e m p lo y m e n t Rate

F E D E R A L R E S E R V E B A N K O F ST. L O U I S

Let us now turn to the consideration of each of
several different groups and see how, on the average,
each of these groups actually fared in our two com­
parison periods.

How Do We Judge Whether Individuals
Have Benefited or Lost?
If over a period of time an individual’s ability to
command real output increases, we say he has
“benefited.” If over a period of time an individual’s
ability to command goods and services decreases, we
w ill say he has “lost.”

Real versus Nominal Benefits and Losses
An individual’s ability to command goods and
services depends upon his ability to command money
balances. Over time, however, the exchange ratio be­
tween a given amount of goods and services and a
given amount of money balances may change. A
change in the amount of money balances a person
can command is referred to as a change in his nominal
command over goods and services. A change in the
amount of goods and services a given amount of
money balances commands is called a change in the
individual’s real command over goods and services.
A careful distinction must be made between nominal
and real gains and losses. For example, if a person’s
holdings of money balances rises from $100 to $200,
his nominal gain is a doubling of his money balances.
If, however, over the same period of time, prices of
all goods and services double, then his real gain is
zero. The confusion of nominal gains with real gains
is called a “money illusion” by economists. Economists
attempt to strip away the veil of money by adjusting
nominal changes with a price index.

Two Measures
Two closely related measures of an individual’s
command over real output are used to decide whether
he has benefited or lost during a period of time. The
first measure is income, which is defined as the flow
of money payments an individual receives over a
period of time. A person’s income is one major de­
terminant of the amount of goods and services he can
command over time.

NOVEMBER 1 9 6 9

Assets and liabilities are divided into two major
classes — real and monetary. Monetary assets refer to
assets exchangeable only for a fixed amount of dollars.
Real liabilities are obligations to deliver a real asset
whose exchange value in terms of money may vary.
The individual’s balance sheet appears as:
Assets

Liabilities

Monetary Assets
Real Assets

Monetary Liabilities
Real Liabilities
Net W ealth

If the dollar value of the items on the left-hand
side of the ledger equals the dollar value of the items,
excluding net wealth, on the right-hand side of the
ledger, then net wealth equals zero. To the extent
that the dollar value of assets exceeds the dollar
value of liabilities, the net wealth of the economic
unit is greater than zero.
If the net wealth of an economic unit expressed
in current dollars rises between two periods in time,
then the economic unit’s available command over
money balances has risen. However, we would say the
economic unit benefited only if this greater potential
command over money balances represents command
over a larger set of real goods and services.

Income Flows
Most individuals, when looking back over two pe­
riods of time and attempting to judge whether they
fared better in the first period or in the second period,
consider not only changes in their holdings of assets,
but also consider how their flow of nominal income
changed. To many individuals this last consideration
is the more important of the two.
When asked in which of two periods he benefited
more, an individual’s answer will probably depend
upon the answers to these two questions:
(1 ) In which period did his income increase
the most?
(2) In which period did changes in his income
allow him to command the greatest increase
in flows of real goods and services?

The second measure used is net wealth. An eco­
nomic unit’s net wealth is defined as: Net W ealth =
Assets — Liabilities.4

Although questions (1 ) and (2) are related, they
are not identical. Referring to the discussion of
nominal versus real changes w e note that the period
which shows the greatest increase in nominal terms
is not always necessarily the same period that reflects
the greatest increase in real terms.

4The difference between assets and liabilities may also be
represented by the terms net worth or equity.

In the 1960 through 1964 period, employment of
production and non-supervisory workers in nonag-




Page 27

F E D E R A L R E S E R V E B A N K O F ST. LO U I S

NOVE MB ER 1 9 6 9

N o m in a l a n d Real Gross A v e ra g e W e e k ly Earnings
o f P rod uctio n o r N o n s u p e rv is o ry W o rk e rs
„ ..

D o lla r s

on P riva te N o n a g ric u ltu ra l P a yro lls
,

„ 5 r ---------- ---------------------------------

'

Ann“ ° " >° '°

D o lla r s

-----------------— -----------------------115

To gain some insight into the relative income per­
formance of different categories of workers, let us
examine selected working groups as presented in data
of the Bureau of Labor Statistics.

Skilled Compared to Unskilled Workers

7 5 '------------------------------------------------------------------ -------------------------------------------1960
1961 1962 1963 1964 1965 1966 1967 1968 1969

75

(J.E a rn ing s in c u rre n t d o lla rs .
12 N o m in a l e a rn in g s d e fla te d b y th e c on sum e r p ric e in d ex 1957-59=100.

As illustrated in Table I, both skilled and unskilled
workers experienced a more rapid rise in nominal
wages in the most recent period than in the previous
four-year period. However, changes in real wages
show quite a different picture. Since 1964, as the rate
of increase of prices rose year after year, the per­
centage increase in real wages of both skilled and
unskilled workers was only about one-half as large
as in the 1960-64 period of relatively stable prices.
Neither skilled nor unskilled workers benefited more
in inflation than in the comparison period of price
stability.

S o u rc e : U.S. D e p a rtm e n t o f La bo r

ricultural establishments expanded by 5.4 per cent,
and gross average weekly earnings rose by 13.2 per
cent in nominal terms and 8 per cent in real terms.
Over the next four years employment in this area
accelerated, increasing by 14.2 per cent. Average
weekly earnings grew by 18 per cent. However, con­
sidering the rapid rise of prices, the real gain in
purchasing power was about 5.2 per cent, only about
two-thirds as great as that experienced during the
previous four years of general price stability.

Comparatively, unskilled workers benefited least
from the recent period of inflation. In 1964 their flow
of real wages permitted them to command 8.7 per
cent more real goods and services than in 1960. In
1968, after four years of inflation, real wages of un­
skilled workers had risen only 4.1 per cent.

Union Workers
Table II presents average hourly wage rates for
classes of union workers in selected trades. Table III
shows the percentage changes in nominal and real

EARN IN G S OF SKILLED A N D

UNSKILLED WORKERS

(1961 = 100)
Skilled8 (M aintenance)

Year

Nom inal Index
Average
Hourly
Earnings

Per Cent
Change

(
1960

Average
Hourly
Earnings

1960-64 \
1964-68 )

96.5

Unskilledb (P lant)

Real Index
Per Cent
Change

(

N om inal Index
Average
Hourly
Earnings

1 9 6 0-64 \
1964-68 )

9 7 .57

Per Cent
Change

Real Index
Average
Hourly
Earnings

/ 1 9 6 0-64 \
\ 1964-68 )
96.50

1 9 6 0 -6 4 \
1964-68 )

(
9 7 .5 7

1961

100.00c

100.00

100.00d

100.00

1962

103.10

101.88

103.20

101.98

1963

105.90

1964

108.80

1965

111.40

105.59

113.20

107.30

1966

115.50

106.45

116.80

107.65

1967

120.30

107.80

121.80

1968

126.90

103.42
1 2.7%

16.6

104.92

109.11

106.60
7.5%

4.0

110.00

128.40

104.10
14.0%

106.08

8.7%

109.14
16.7

110.40

a Includes carp enters; electricians; m achinists; m echanics; m echanics autom otive; p a in ters; pip efitters; and tool and die makers.
^Includes janitors, porters and clea n ers; and laborers, material handling.
cThe dollar figure fo r 1961 is approxim ately $2.89.
d The dollar figure fo r 1961 is approxim ately $1.93.
S ourer: U. S. D epartm ent o f Labor, Bureau o f Labor Statistics, H andbook o f L abor Statistic«, 1969, Table 94. pp . 200-201.

Digitized forPage
FRASER
28


Per Cent
Change

4.1

NOVEMBER 1 9 6 9

F E D E R A L R E S E R V E B A N K O F ST. LO U I S

Table II

AVERAGE U N IO N W A G E SCALES® FOR SELECTED TRADES
(N O M IN A L HOURLY W A G E S )
Printing

B uilding

Year

Local
Transit

Local Trucking

Journey­
man

Helpers &
Laborers

Book
& Job

News­
papers

Drivers

Helpers

1960

$3.86

$2.88

$3.08

$3.48

$2.68

$2.38

$2 .37

1961
1962
1963
1964

4.02
4.15
4.31
4.4 6

3.0 6
3.15
3.26
3.4 0

3.18
3.24
3.3 7
3.4 7

3.58
3.66
3.75
3.84

2.78
2.89
3.02
3.14

2.48
2.55
2.68
2.79

2.46
2.55
2.65
2.76

1965
1966
1967
1968

4.6 4
4.83
5.09
5.43

3.54
3.67
3.83
4.05

3.58
3.69
3.81
4.0 0

3.9 4
4 .0 7
4.2 7
4.4 7

3.2 6
3.3 9
3.5 9
3.78

2.90
3.0 0
3.21
3.36

2.88
3.00
3.22
3.4 4

a The scales represent the m inimum wage rates (exclu din g holiday and vacation p aym ents).
S ou rce : U. S. Departm ent o f Labor, Bureau of Labor Statistics, H andbook o f L a bor Statistics, 1969, Table 83, p. 170.

wages for each of these classes of union workers in
the two four-year comparison periods. These tables
illustrate that many of the union groups covered ex­
perienced more substantial percentage increases in
nominal wages over the 1964-68 period than during
the 1960-64 period.

White Collar Workers
Table IV shows that a broad class of workers in
white collar jobs experienced a more rapid rise in
nominal wages in the latter period than in the 1960-64
period. Nevertheless, as was the case with most of
the union groups surveyed, white collar workers re­
ceived a substantially smaller percentage increase
in real wages in the more recent four-year period.
In the 1964-68 period real wages of white collar
workers included in Table IV rose only 3.5 per cent,
less than one-half the increase in the 1960-64 period
of widespread price stability.

However, looking at changes in real wages in Table
III, it appears that most union groups received smaller
percentage increases in real wages in the recent pe­
riod of rapidly rising prices than in the 1960-64
period. The increases in the payments received for
productive services by union workers in local truck­
ing, building, and printing trades in the 1964-68 pe­
riod represented substantially smaller percentage
increases in their command over real goods and serv­
ices than what they experienced in the previous fouryear period. Only local transit workers, of the groups
considered, received the same percentage rise in real
wages in both periods.

Professional Workers
A third category of workers is labeled professional
workers. Examining Table V w e see that, unlike the
skilled or unskilled categories, or union and white
collar categories, the selected groups of professional
workers in Table V received substantially larger in-

Table III

C H AN G ES IN

U N IO N

W A G E S a FOR SELECTED TRADES

Building
Journeyman
1960-64
1964-68

Printing
Helpers and
Laborers

Book 8< Job

N om inal

Real

N om inal

Real

1 5.5%
21.7%

10.4%
8.5%

18.1%
19.1%

12.5%
6.2%

Nom inal
1 2.7%
15.3%

Newspapers
Real

Nom inal

7.5%
2.7%

10.3%
16.4%

Local Trucking
Drivers
19 60-6 4
1964-68

Real
5.2%
3.8%

Local Transit
Helpers

Nom inal

Real

N om inal

Real

Nom inal

Real

17.2%
20.4%

11.9%
7.0%

17.2%
20.4%

11.8%
7.5%

16.5%
24.6%

11.0%
11.4%

“Real wages are calculated by deflating nominal wages with the consum er price index, using 19fi0 — 100.




Page 29

NOVEMBER 1 9 6 9

F E D E R A L R E S E R V E B A N K O F ST. L O U I S

Table IV

EAR N IN G S OF W HITE COLLAR WORKERS8
(1961 =
Year

100 )

N om inal Index

Real Index

Per Cent
Change
/ 1 9 6 0 -6 4 \
y 1964-68 )

Average
W eekly
Earnings
1960

96 .80

97.88

1961

1 0 0 .0 0 1’

100.00
102.08

1962

103.30

1963

106.20

1964

109.20

Per Cent
Change
/ 1 9 6 0 -6 4 \
^ 1964-68 /

Average
W eekly
Earnings

rapid rate. For example, real wages of engineers rose
5.4 per cent in the three-year period 1964-67, slightly
less than the 5.6 per cent increase in real wages dur­
ing the previous three years. From 1967 to 1968
average salaries of engineers in nominal terms rose
by 7.6 per cent. This sharp rise in nominal terms
offset the continued upward movement in prices, and
as a result, their real wages showed an increase of
8.9 per cent from 1964-68.

103.71
105.30

12.8%

1965

1 12.30

106.45

1966

1 15.90

106.82

1967

120.90

1968

126.80

108.33
16.1

Wealthholders

7.6%

109.03

3.5

aO ffice clerical category which includes a broad range o f w hite collar
workers. Included are typists, stenographers, different classes o f
clerks, keypunch operators, bookkeeping and office boys and girls.
bThe dollar figure fo r 1961 is approxim ately $77.10.
S ou rce: U. S. Departm ent o f Labor, Bureau o f Labor Statistics,
Handbook o f L abor Statistics, 1969, Table 94, p . 198.

creases in both nominal and real wages in the three
year period 1964-67 of rapidly rising prices than in
the 1961-64 period of price stability.
Most of these groups made marked gains in real
terms in 1968 when prices were rising at their most

An individual has available to him a wide array
of real and financial assets in which he can hold his
wealth. He may acquire real assets such as land,
houses, or other real goods, or he may acquire one
of the many different types of financial assets.

Financial Assets
Financial assets may be divided into two broad
classes, money and other financial assets. The basis
for distinction used here is that money is the financial
asset which yields no nominal return to the holder.
Other financial assets yield, or are expected by
wealthholders to yield, a nominal or money rate of
return.

Table V

EARN IN G S OF SELECTED CLASSES OF PROFESSIONAL WORKERS
Accountants
Year

Average
Annua]
Salary

Attorneys
Realb

Nom inal

Average
Annual
Salary

Per Cent
Change

$6 ,324

1964

6,8 40

1967

7,820

1968

8,277

Average
A nnual
Salary

4.3%

7 ,1 1 7

7.9

$8 ,136

8,532

4.9%

10,293

$6,684

1964

7,3 20

Average
Annual
Salary

1967
1968

8,432
8,931

Per Cent
Change

(
7,0 59
7,5 56

22.0

7,6 79

Average
Annual
Salary

Realb

Per Cent
Change

8.8

8,004
9,078
9,771

(

9.5%

22.1

7,718

1 9 6 1 -6 4 \
1964-6 8 )
5.6%

8,134
8,402

“ Figures fo r 1960 n ot available. Figures based on the “ II ra tin g” in H andbook o f L abor Statistics.
DReal wages are calculated by deflating normal wages with the consum er price index, 1961 — 100.
S ou rce: U . S. D epartm ent o f Labor, Bureau o f Labor Statistics, H andbook o f L abor Statistics, 1969, Table 89, p . 191.

Page 30



Per Cent
Change

$7 ,308

$ 7,308
5.6%

Average
A nnual
Salary

/ 1 9 6 1 -6 4 \
\ 1964-6 8 )

1 9 6 1 -6 4 \
1964-68 )

$6,684
9.5%

7.6

Engineers

/ 1 9 6 1 -6 4 \
\ 1964-6 8 )
1961

1.1%

8,8 50

20.6

N om inal

Real1’
Per Cent
Change

8,228
8,658

Chemists

Average
Annual
Salary

Per Cent
Change
/ 1 9 6 1 -6 4 \
\ 1 9 6 4 -6 8 )

9,662

7 ,0 0 7

N om inal

Year

)

$ 8,136

6 ,5 9 6

21.0

Average
Annual
Salary

Per Cent
Change
/1 9 6 1 - 6 4
\ 1 96 4 -6 8

/ 1 9 6 1 -6 4 \
\ 1 9 6 4 -6 8 /
$6 ,324

8.2%

Realb

Nom ina!
Per Cent
Change

( 1961-64 \
\ 1964-68 )
1961

(1961-68)'

8.9

F E D E R A L R E S E R V E B A N K O F ST. L O U I S

N OV E MB E R 1 9 6 9

For an analysis of the effects of inflation on the
holders of financial assets we shall distinguish effects
on the wealthholder’s nominal wealth from effects on
his real wealth; and the impact of inflation on his
flow of returns in nominal and real terms.
For purpose of analysis seven widely held financial
assets were selected:
(1) savings and loan shares
(2) mutual savings bank deposits
(3) time deposits at commercial banks
(4) corporate bonds
(5) U. S. Government bonds
(6) municipal bonds
(7) common stock
Several major differences exist between groups of
these assets. The first three, savings and loan shares,
mutual savings bank deposits, and time deposits at
commercial banks, represent legal claims to fixed
amounts of money. In most cases, this claim may be
exercised on demand by the holder of the claim or
after only a short period of time. The next three
items, corporate, U.S. Government, and municipal
bonds, represent rights to a fixed amount of money
only at maturity, usually much longer into the future.
From the time they are issued until maturity, their
magnitude of exchange value in terms of money
depends upon the valuation which market partici­
pants place on the future flow of money payments
they offer. Our last financial asset, common stocks,
does not represent a claim to any fixed money pay­
ment, either currently or in the future.

Table VII

PERCENTAGE INCREASES IN YIELDS O N
FIXED DOLLAR VALUE F IN A N C IA L ASSETS
N om inal Percentage
Increase
1960
to
1964
Savings and Loan Shares
Savings Deposits at
M utual Savings Banks

8.0%

1964
to
1968
1 2.0%

Real Percentage
Increase
1960
to
1964

1964
to
1968

3.1%

- 0 .2 %

17.0

18.5

11.6

5.6

Time and Savings Deposits
at Commercial Banks
33.6

31.2

27.5

17.0

S ou rce: U. S. Savings and Loan League Savings and Loan Factbook,
1969, Table 6, p. 17.

year period the consumer price index rose 4.8 per
cent. As a result of the rise in the price level, the
command over real goods and services represented
by the $1,000 in fixed dollar financial assets was re­
duced to $954.20 in 1964. During the second com­
parison period the holder of this type of asset suffered
a much greater real loss. As the price level rose 12
per cent from 1964 through 1968, the asset holder
found that his initial $1,000 in 1960 dollars repre­
sented only about $850.34 in real purchasing power
in 1968.

From the flow side, holders of this type of asset
experienced substantial increases in nominal payments
in both periods. In the first comparison period the
nominal return on all three fixed dollar value finan­
Fixed D ollar Value Financial Assets —To give some
cial assets rose more rapidly than the price level, and
initial comparisons, let us assume that in mid-1960
hence the real rate of return received by holders of
an individual bought $1,000 of one of the fixed
all three of these assets rose. For example, as shown
dollar value assets. At the end of each period his
in Table VI, the holder of a $1,000 in savings and
wealth would still be $1,000 in nominal terms. How­
loan shares received a flow of $41.70 in dividends in
ever, the asset holder lost real command over goods
nominal terms in 1964 compared to $38.60 in 1960.
and services in both periods. During the first fourAs illustrated in Table VII this represented an 8 per
cent increase in nominal terms and
a 3.1 per cent increase in real terms.
Table VI
During the second comparison
YIELDS O N FIXED DOLLAR VALUE F IN A N C IA L ASSETS®
period, although the nominal yields
1960
1964
1968
on these assets rose sharply, much
Nom inal
Real
Real
Real
Nom inal
N om inal
of the increase in nominal terms was
Yield
Yield
Yield
Yield
Yield
Yield
taken up in price increases.3 As
Savings and lo a n Shares
$ 3 8.60
$38.60
$ 4 1.70
$39.79
$ 4 6 .7 0
$39.71
Table VII shows, in nominal terms
Savings Deposits at
the yields on savings and loan
M utual Savings Banks
3 4 .70
34.70
38.74
40 .60
48 .10
40 .90
shares rose by an additional 12 per
Time and Savings Deposits
a t Commercial Banks

25.60

25.60

3 4 .20

32.63

44 .90

38.18

“These yields are calculated using the exam ple o f $1000 in assets.
S ou rce: U . S. Savings and Loan League Savings and Loan Factbook, 1989, Table 6, p. 17.




5The much smaller increases in real yields
on fixed dollar financial assets in the sec­
ond period to a significant degree reflects
the fact that their maximum nominal
yields are fixed by regulatory authorities.

NOVEMBER 1 9 6 9

F E D E R A L R E S E R V E B A N K O F ST. L O U I S

cent, raising nominal yields on $1,000 of shares to
$46.70. However, in real terms the yield on savings
and loan shares fell slightly from $39.79 in 1964 to
$39.71 in 1968.
The nominal yield on time deposits at commercial
banks rose more rapidly than the price level from
1964 through 1968, and holders of this financial asset
experienced a 17 per cent increase in real yields on
these assets. However, these results were much less
than the 27.5 per cent increase in real yields holders
of debt obligations of commercial banks obtained dur­
ing the four years of prevailing price stability.6
Financial Assets with Money Values Fixed Only at
Maturity — In this section we examine how holders
of three widely held classes of bonds fared during
our two comparison periods. The dollar value of these
assets is fixed only at maturity. As the market places
different valuations on the flow of money payments
offered by these assets, the money exchange value
of these assets varies over the life of the bond.
This revaluation of money flows offered by bonds
is represented by inverse movements of their prices
and yields. As the public places a lower valuation
on the stream of payments which the claim represents,
the market price of the bond falls and its effective
yield rises. The relationship between prices and ef­
fective yields can be seen in Table VIII.

In the 1964-68 period of accelerating price infla­
tion, bond holders suffered much larger capital losses
in nominal and real terms. From 1964 through 1968
the price of U.S. Government bonds fell 14.4 per
cent, municipal prices fell 16.1 per cent, and corporate
bond prices declined 19.7 per cent. Not only did bond
holders experience a drastic decline in nominal values
of their assets, but as the rise in the price index ac­
celerated, they found the exchange value in real
goods of their declining nominal values fell about
2% times as rapidly as during the 1960-64 period of
relatively stable prices.
Common Stocks — Of the broad classes of financial
assets being considered, only common stocks in­
creased both the nominal and real wealth of the
asset holder in both periods. In the 1964-68 period
the Standard and Poor’s 500 Stock Index (a broad
measure of the magnitude of the money exchange
value of common stocks) rose 21.3 per cent. How­
ever, this was only 60 per cent as great a percentage
increase as the 36 per cent rise in the Stock Index in
the 1960-64 period.7
A much larger rise in the consumer price index in
the more recent period meant that holders of com­
mon stocks not only fared worse in the second period
in nominal terms, but they also fared considerably
worse in real terms. It is interesting to note that in
the second period the real wealth of holders of com­
mon stock rose only 8.1 per cent, compared to 29.8
per cent in the period 1960-64.

The holder of U.S. Government bonds over the
1960-64 period would have suffered about a 2 per
cent decline in the nominal value of his bonds. Hold­
7The market prices of common stocks are heavily influenced by
ers of corporate bonds would have found in 1964 that
the level of business activity. 1960 was a trough in business
activity. To remove some of the cyclical influence on our
the price of these bonds was approximately the same
analysis, an average of 1959, 1960, and 1961 was used for
as in 1960. Holders of municipal bonds would have
1960.
been able to sell these assets in
1964 at a 7.3 per cent higher
price than in 1960. In real
Table V III
terms, the rise of the consumer
AVERAGE A N N U A L YIELDS A N D PRICES O F SELECTED BO NDS
price index reduced the real
Corporate
U nited States
State and Local
value of any given money claim.
Aaa
Government
M unicipal
Bonds
Bonds
Year
Bonds
Hence, in real terms holders of
Average
Average
U.S. Government and corporate
Average
Price
Yield
Price
Yield
Yield
Price8
bonds were worse off in 1964
$ 1 0 3 .9 0
4.41%
$ 9 4 .6 0
3.69%
4.01%
$8 6.22
1960
than in 1960; only holders of
4.35
9 5 .2 0
3.60
107.80
3.90
87.55
1961
municipal bonds gained in real
96 .20
86.94
3.30
112.10
4.33
3.95
1962
terms.
111.30
4 .2 6
96 .80
3.28
4.00
86.31
1963
6The above discussion should not lead
to a confusion between levels and
percentage changes in levels. The
person who held $100 0 of savings and
loan shares over the 1960-68 period
would have received, on the average,
a much larger flow of returns in nom­
inal and real terms than if he had
held a time deposit account at a
commercial bank.

Page 32


1964

4.15

84.46

3.28

111.50

4.4 0

9 5 .1 0

1965

4.21

83.76

3.34

110.60

4.49

9 3 .9 0

1966

4.66

78.63

3.90

102.60

5.1 3

86.10

1967

4.85

76 .55

3.9 9

100.50

5.51

81.80

1968

5.25

72.33

4.48

9 3 .5 0

6.18

76 .40

3 The dollar price per $100 bond.
Source: Federal Reserve Bulletin

F E D E R A L R E S E R V E B A N K O F ST. L O U I S

In the first comparison period the dividend pay­
ments received by stockholders rose from $13.4 billion
to $17.8 billion, a 33 per cent increase. In the 1964-68
period the flow of dividend payments rose to $24.6
billion, a 38 per cent increase. In nominal terms, the
percentage increases in the flow of payments to
stockholders was somewhat greater in the latter pe­
riod. However, the increased flow of dividends in the
latter period represented a somewhat smaller increase
in real purchasing power, 23 per cent, compared to
27 per cent in the earlier period.
The assertion that common stocks are a better
hedge against inflation than the other types of finan­
cial assets we considered is borne out by the evi­
dence. However, although stockholders fared better
in inflation relative to holders of the other financial
assets we discussed, holders of common stock bene­
fited much more in the earlier period of extensive
price stability than in the latter period of rapidly
rising prices. It seems difficult to support an assertion
that stockholders benefited more in inflation when the
percentage increase in their real wealth was much
greater under four years of generally stable prices
than under four years of rapidly rising prices.

Real Assets
Sometimes the general assertion is made that infla­
tion destroys the incentive to save by wiping out the
real value of wealth accumulated by past acts of
saving. This statement fails to take into account that
saving may occur by additions to wealth in the form
of real assets as w ell as financial assets. As the magni­
tude of the exchange value of money in terms of real
goods and services falls, holders of real assets benefit
from inflation in nominal terms and suffer no loss in
real terms. To examine the effects of inflation on
holders of real wealth w e have selected two real
assets, land and houses.
Land —As shown by Table IX, the average mar­
ket value of an acre of farmland increased in both
comparison periods. In the 1964-68 period of inflation,
the average market value of an acre of farmland rose
by 29 per cent, compared to an 18.5 per cent in­
crease over the previous four years.
When we adjust both nominal increases for price
level changes, the spread between the two periods
is reduced. However, in contrast to all the financial
assets discussed, the real wealth of landowners
showed a somewhat larger percentage increase in the
period of rapidly rising prices, 15 per cent, com­
pared to 13 per cent in our comparison period of
widespread price stability.



NOVEMBER 1 9 6 9

Table IX

AVERAGE MARKET VALUE OF FARM LAND
Year

Average Price
Per Acre

1960

$1 16.48

1961

118.22

1962

124.19

1963

129.59

1964

138.00

1965

145.75

1966

157.00

1967

167.00

1968

178.00

S o u rce: U. S. Departm ent o f A griculture, Agricultural Finance
R eview , V olum e X X I X . Supplem ent, A p ril 1969, Table 39,
p. 65.

Houses — Over the eight-year period we are con­
sidering, the price of houses rose sharply. From $13,800
in 1960, the average construction cost of new homes
increased to $15,550 in 1964, and then rose to $18,675
in 1968. To analyze the effects of inflation on home­
owners the net wealth measure is used.
W e must take into account at least two other fac­
tors in order to use the net wealth measure. The ma­
jority of the funds used for the purchase of most
homes are borrowed. W hen a person borrows to pur­
chase a house, he generally agrees to pay a fixed
monthly payment to the mortgage lender for a period
of years; he agrees to give up a fixed amount of nom­
inal purchasing power each month until the mort­
gage is paid off. The homeowner decides to forego
present and future command over real output for
present and future command over the flow of serv­
ices from a specific real asset, a house.
The second factor we must consider is that over
time a real asset is used up, or depreciates. In gen­
eral, as a house is used over a period of time, the
flow of services it can provide decreases, hence the
market value placed on the flow of services offered
by the house also declines.
To take into account the two factors, mortgage
buying and depreciation, three assumptions are made
in the following example:
(1) A house is bought in 1960 on a 25-year mort­
gage with 20 per cent of the purchase price as
a down payment.
(2) The mortgage is repaid in equal monthly install­
ments over the 25-year period.
(3) The house depreciates at the same rate as the
mortgage is paid off.
Page 33

F E D E R A L R E S E R V E B A N K O F ST. L O U I S

Using assumptions (1) through (3) in our example,
we have:
Purchase price of a house in 1960
=, $13,800
Downpayment = 20 per cent of $13,800 = $ 2,760
Mortgage = 80 per cent of $13,800
= $11,040
Yearly mortgage repayments =
$11,040 h- 25 years = $441.60
Yearly depreciation of house
= $441.60
1960 BALANCE SHEET
Assets
Liabilities

$13,800 = real assets =
market value
of house

$11,040 = monetary
liability =
mortgage
$ 2,760 = net wealth

A t the end of 1964 the balance sheet has changed.
Over the four years 1961 through 1964, the home­
owner repays $1,776.40 of his mortgage (4 x $441.60),
and his house depreciates by this amount. The mar­
ket value of his house in 1964 equals the construction
cost of a new house ($15,500) less the depreciation
of his home ($1,766.40).
1964 BALANCE SHEET
Assets
Liabilities

$13,784.60 — market value
of house

$9,273.60 = outstanding
mortgage
$4,511.00 = net wealth

A t the end of 1968, the average homeowner has
repaid an additional $1,766.40 on his mortgage, and
his house has depreciated by this amount. The market
value of his house in 1968 is $18,675 (the construc­
tion cost of a new house) minus $3,532.80 (eight
years of depreciation).
1968 BALANCE SHEET
Assets
Liabilities

$15,142.20 = market value
of house

$7,507.20 = outstanding
mortgage
$7,635.00 = net wealth

Examining the balance sheets we see that over
each comparison period the homeowner experienced
a substantial rise in nominal net wealth. In the first
period nominal net wealth rose by 63.4 per cent, and
in the second period by 69.3 per cent.
Table X illustrates the contribution of factors act­
ing to change the net wealth position of the home­
owner. The use of the house over time decreases the
market value of its flow of services and hence opera­
tes to decrease the net wealth of the homeowner
(decreases the dollar value of his real asset). The
repayment of the mortgage decreases the homeown­
er’s monetary liabilities and hence operates to in­
Digitized for Page
FRASER
34


NOVEMBER 1 9 6 9

crease his net wealth. Assuming no change in the
general price of houses there would be no change
in his net wealth.
However, due to the marked increase in the gen­
eral construction cost of houses over each period, the
market value of the real asset held by the home­
owner increased. In the 1960-64 period the rise in the
construction cost of houses resulted in an increase
of $1,751 in the homeowners nominal net wealth. At
the end of the first four-year period, the homeowner
in our example could have sold his house for approxi­
mately what he paid for the house in 1960. In 1968,
because the construction cost of houses advanced
more rapidly in the 1964-68 period than over the pre­
vious four years, he could have sold his house at a
price almost 10 per cent above what he paid in 1960.
W hen we adjust the changes in nominal net wealth
for changes in prices over our two periods, we also
record substantial gains for the homeowner. In real
terms, the homeowner’s net wealth rose by $1,544 in
the four-year period 1960-64 and then showed an
even greater increase in the 1964-68 period, increas­
ing by $2,188.
Again to clarify the meaning of the term “benefited,”
we mean that the homeowner’s real command over
goods and services increased. For example, between
1960 and 1964 his real net wealth was augmented by
$1,544. If he had sold his house at its market value of
$13,784.60 in 1964 and repaid his outstanding mort­
gage, his command over real goods and services
would have been $1,544 greater than if he sold his
house and repaid his mortgage in 1960. Over the
more recent four-year period, the homeowner in our
example benefited even more in the sense that his
real command over goods and services rose by $2,188.
For the potential home buyer, the purchase price
of a house is only one consideration. Another major
consideration is the cost of borrowing funds to make
Table X

CO M P O N E N TS OF C H AN G ES IN H O M E O W N E R ’S
N O M IN A L NET W EALTH
Per ods
Changes in N om inal N et W ealth

1960-6 4

1964-6 8

Due to depreciation o f house

-$ 1 ,7 6 6 .4 0

-$ 1 ,7 6 6 .4 0

Due to general rise in prices
of houses

+ $ 1 ,7 5 1 .0 0

+ $ 3 ,1 2 4 .0 0

Due to repaym ent o f mortgage

+ $ 1 ,7 6 6 .4 0

+ $ 1 ,7 6 6 .4 0

Total

+ $ 1 ,7 5 1 .0 0

+ $ 3 ,1 2 4 .0 0

F E D E R A L R E S E R V E B A N K O F ST. L O U I S

the purchase. During the first of our comparison
periods the contract rate on conventional first mort­
gages remained fairly stable at around 5.75 to 5.85
per oent. On balance, it would not have cost our
average individual more in nominal terms to obtain
funds to finance the purchase of a home in 1964 than
earlier in the first period.
The second period shows quite a different picture.
Over this period the cost of financing a home in­
creased along with other market interest rates.
Whereas the average cost of financing a new home
by a conventional first mortgage was 5.78 per cent in
1964, this rate rose to an average of 6.83 per cent
for 1968 and was at 7.08 per cent in the second half
of 1968. On balance, if instead of buying a home in
1964, an individual had delayed buying a home un­
til the second half of 1968, not only would the aver­
age construction cost of the home have been about
20 per cent higher, but the financing costs would have
risen by 22.5 per cent.
In real terms, if a person had financed a home on
a conventional first mortgage during the period 1961
through 1965, he would have gained in real terms
during the following three years. However, after
1965 the current cost of mortgage financing rose
faster than the consumer price index. If a person
delayed buying a house in 1965, when mortgage
rates were about 5.74 per cent, until 1966 when
mortgage rates rose to an average of 6.14 per cent,
he would not have experienced a reduction of his
real financing costs to the 1965 level until late 1968.
Suppose our average individual became an average
homeowner in 1960. Using our example, we assume
he purchased a $13,800 house in 1960 with a 20 per
cent downpayment and the balance financed over 25
years with a financing cost of 5.75 per cent. On this
basis, his monthly payments would be $69.48. Our
individual has decided to give up $69.48 a month
in nominal command over goods and seivices in ex­
change for the flow of services from a house.
By 1964 the homeowner would still be giving up
$69.48 a month in nominal purchasing power. How­
ever, since the consumer price index rose by 4.8 per
cent over these four years, he would be giving up
slightly less in real purchasing power each month,
about $66.30 in real purchasing power.
In contrast, the average homeowner found that,
in the four-year period since 1964, the real purchas­
ing power he was giving up each month decreased
about 2 V2 times as rapidly as over the previous four



NOVEMBER 1 9 6 9

years of general price stability. In our illustration
the real purchasing power of $69.48 in 1960 dollars
fell to $59.08 in 1968.

Retired Persons
One of the common maxims in most discussions
of the effects of inflation is that people on fixed in­
comes, especially retired persons, “lose” during peri­
ods of inflation. Since inflation is a situation where
the magnitude of the exchange value of money in
terms of real assets declines, individuals whose flow
of money payments remains fixed find their income
commands a smaller flow of real goods and services
in an inflationary situation. The truth of the assertion
that retired persons lose during inflation depends
upon the assumption that their income payments re­
main “fixed” and that net nominal increases in the
value of their other assets do not offset their loss of
real income.
One form of income flow to retired persons is social
security benefits. As illustrated by Table XI the aver­
age amount of monthly benefits received by retired
persons did not stay fixed over the 1960 through
1968 period.
Beflecting several increases in social security bene­
fits, average monthly payments to retired workers rose
from $74.04 in 1960 to $98.86 in 1968. In the second
half of the period, when prices began to rise rapidly,
benefits rose by 27.4 per cent compared to an increase
of only 4.8 per cent over the 1960 through 1964 period.
Considering the rise in the consumer price index over
each period, the purchasing power in real terms of
Government transfer payments to retired persons
Table XI

AVERAGE A M O U N T OF M O N T H LY O A S D H I3
BENEFITS T O RETIRED WORKERS"
Year

A verage M o nthly
Benefits

1960

$ 7 4.04

1961

75.65

1962

76.19

1963

76.88

1964

7 7 .57

1965

83.92

1966

84.35

1967

8 5 .37

1968

98 .86

a01d-age, Survivors, Disability, and Health Insurance P rogram .
^Persons aged 65 and over (and aged 62-64, begin n in g in 1956 fo r
women and 1961 fo r m e n ). A verage benefits in current-paym ent
status at end o f period.
S o u rce: U. S. Departm ent o f Health, Education and W elfare, Social
S ecurity Bulletin, Septem ber 1969, p. 42.

Page 35

F E D E R A L R E S E R V E B A N K O F ST. L O U I S

was about the same in 1964 as in 1960, then increased
by approximately 13.6 per cent from 1964 through
1968.8
For many retired persons, social security payments
comprise only a portion of the income they depend
upon after retirement. A portion of their income
derives from returns from financial assets they have
purchased over a period of years. Such assets include
the value of life insurance, savings and loan shares,
bank deposits, bonds and common stock. In the sec­
tion on the effects of inflation on holders of financial
assets, we saw that holders of these assets did not
fare as well in the recent 1964-68 period of rapid
price inflation as in the 1960-64 period of much more
stable prices.
To the extent that retired persons held real assets,
they were made no worse off by inflation and, de­
pending on the asset, may have benefited. Many
people, when they reach retirement age, have paid
off the mortgage on their home. As the price of
homes has risen, the magnitude of the exchange value
of this asset in terms of other real assets has increased.
Alternatively, since they are no longer net debtors
with regard to their house, they do not benefit as
much from inflation as those individuals who are still
net debtors on their homes.
On balance, rapidly rising social security benefits
offset part of the effects of inflation on retired persons.
However, unless they were solely dependent upon
such payments for retirement income, it does not ap­
pear that retired persons made any real gains in the
period from 1964 through 1968. In fact, compared to
the previous four years of price stability, in many
cases retired persons may have suffered a decline in
their ability to command real output.
8The change in real purchasing power for retired persons may
have been less than indicated by deflating by the consumer
price index. The prices of many services, which might be
expected to weigh more heavily in retired person’s budgets,
such as medical care, physicians’ fees, property taxes, and
public transportation, increased over 2 0 per cent during this
period compared to a 12 per cent rise in the total index.




NOVEMBER 1 9 6 9

Conclusions
We have concluded that, of all the classes of
workers considered, only certain groups of profes­
sional workers, such as accountants, attorneys, en­
gineers, and chemists, could be said to have benefited
more with respect to income flows in the 1964-68
period of inflation than in the previous period of
general price stability. The broad classes of skilled
workers, unskilled workers, union workers, and white
collar workers that were examined all benefited less
in the 1964-68 period than during the 1960-64 period.
Individuals, on the average, in their separate roles
as asset holders, benefited more in the 1964-68 period
than in the 1960-64 period only in their roles as
owners of real assets — land and houses. W ith respect
to all financial assets considered except common
stocks, individual asset holders lost during the latter
period. Holders of common stocks, although they did
not lose in the 1964-68 period, benefited substantially
less than during the 1960-64 comparison period.
Finally, to the extent that retired persons are solely
dependent upon social security benefits, the sharp
upward revisions of these transfer payments resulted
in a rise in retired persons’ real command over goods
and services. However, to the extent that retired per­
sons also depended upon insurance payments, fixed
dollar value securities, and bonds, they lost real pur­
chasing power in the 1964-68 period.
Any particular individual can only determine in
which of our comparison periods he fared better by
examining his total balance sheets for both compari­
son periods. This article has attempted to give a gen­
eral framework in which the individual can complete
this analysis. Rather than making broad assertions
about the nebulous “evils of inflation,” a definition of
benefit and loss has been presented for the reader.
If the individual is alerted to the dangers of confus­
ing nominal benefits with real benefits, he has a
means of judging the effects of the recent inflation on
his own ability to command real output.

This article is available as Reprint No. 48