in the first period, rose in the second. Total bank loans, which h risen by $10.5 billion in the first (nine-month) period, rose by $5. billion in the following year, and it appears were more largely co centrated on purposes having to do with the defense effort in t second period than in the first. The principal factors affecti member bank reserve balances during the later period are summarize. in Table 6. The addition to the reserves available for commerc bank expansion, which had been $1.1 billion in the earlier nine-mont period, was $1.3 billion in the later one-year period. The Gover ment security portfolio of the Federal Reserve banks declined slight in the later period, but gold, which had been flowing out of the countr in the earlier period, was flowing in during the later. Money circulation, which had remained unchanged during the earlier perio increased substantially during the later period." TABLE 5.-Factors affecting the money supply (consolidated accounts of the Federa [Billions of dollars] Increase in investments other than Government securities.. Increase in loans.. Increase in gold stock.. Increase in net assets of banking system___. Increase in capital and miscellaneous accounts, net... Increase in assets held per contra to deposits and currency. Decrease in cash and deposits held by the Treasury and deposits held by foreign banks (not part of the money supply). Increase in Treasury currency (not issued by the banking system). Increase in money supply- +1 +1 +1! +91 -1.0 +8.5 +19 +0.1 +10.41 NOTE.-Direction of change of individual items indicated in words; "plus" and "minus” signs indiest: effect on money supply. Detail may not add to totals because of rounding. Source: Board of Governors of the Federal Reserve System. TABLE 6.—Increase in reserves available for expansion in the banking system March 28, 1951, to March 26, 1952 [Billions of dollars] Decrease in Government security holdings of the Federal Reserve banks. -0.1 Decrease in all other Federal Reserve credit... Increase in monetary gold stock.. Increase in money in circulation_. Decrease in Treasury, foreign bank, and other nonmember deposits in the Other factors, net... Increase in member bank reserve balances_ 1 Less than $50 million. +1.3 NOTE.-Direction of change of individual items indicated in words; “plus” and “minus" signs indicate effect on member bank reserve balances. Detail may not add to totals because of rounding. Source: Board of Governors of the Federal Reserve System. Treasury, foreign bank, and other nonmember deposits with the Federal Reserve banks-fluctuations in which are not of long-run significance but which occasionally dominate the situation in periods as short as a year-were extremely important in the later period, as the Treasury balance with the Federal Reserve banks declined from the unusually high level of $1.1 billion on March 28, 1951 to substantially zero on March 26, 1952. There is at least a possibility that, if this decline had not occurred, there would have been some offsetting increase in Federal Reserve credit of some type. Indeed, the portion of the decline immediately following the March 15 tax date had been arranged by the Treasury, presumably in collaboration with the Federal Reserve, in order to avoid the Federal Reserve operations which might otherwise have been nec essary in order to have averted a temporary credit stringency. rose loans, The results are certainly not impressive as a demonstration of the riod, short period efficacy of general monetary policy, but must be judged more in the light of the available alternatives. In the absence of the strongense effer monetary policy represented by the "accord," the money supply factos might have risen more sharply and bank loans have leveled off less dares than they did. sum for om A striking sidelight is the absence of short period correlation between rlier in changes in prices and changes in the money supply. The money The supply increased very little during the period of sharply rising prices, decline but commenced to rise briskly after prices had leveled off. The t of the history of changes in prices and money supply over a much longer er. period, as reviewed in the testimony before the Subcommittee, shows earlier a general correspondence between changes in prices and changes in money supply (adjusted for the growth of the economy and for changes in customs with respect to the holding of cash balances) over long ts of the periods, but a notable absence of short-run correlation between such he Postal changes. This is brought out very well in Chart 2, taken from the testimony of Mr. Reierson. In the short run, changes in the velocity of circulation-over which the authorities have little control-are likely to be of greater importance. In the period between the Korean outbreak and early 1952, short-run changes in prices correlated very well with changes in velocity and not at all with changes in money supply. This is shown clearly in Chart 3, which was introduced in the hearings by Senator Flanders. On the basis of the evidence, the Subcommittee is convinced of the importance of changes in the money supply in influencing prices in the long run, but does not believe that short-run changes in the money supply provide a reliable basis for explaining short-run price changes. d by While the factors just discussed, and doubtless others, were operating to check the inflation, the fiscal situation worsened-although, due to the extremely high taxes imposed after Korea and raised again in the sfall of 1951, it continued remarkably good considering the tremendous rise in defense expenditures. As contrasted with the budgetary surplus (on a conventional accounting basis) of $5.1 billion during the nine months ending in March 1951, there was a deficit of $5.0 billion in the year ending in March 1952. On a cash basis, the surplus of $7.7 billion in the earlier period was contrasted with a deficit of $0.6 billion in the later period." The Subcommittee is inclined to assign some of the credit for the turn in the inflationary situation to each of the positive factors cited above but cannot say confidently which of them should be accorded primacy, or the order in which they should be arranged. Neither can it be sure what weight should be given to the worsening in the fiscal situation as an offset to the positive factors. Over the period actually under review it may well be that the more superficial factors listed under (1) and (2) were of the greater importance. Over a longer period of time, however, the fiscal and monetary factors would doubtless be dominant. Even in the short run, they are of special importance because, unlike factors originating in the "outside economy," they are subject to a considerable degree Although the change in the fiscal situation doubtless worked in favor of higher prices for the period as a whole, the large "tax bite" in March 1951 may have contributed to the down-turn which began in that month. CHART 2.-PRICES, PRODUCTION, AND THE MONEY SUPPLY, 1919-51 1919 25 WHOLESALE PRICES 00 100 50 NOTE. The definition of money supply used in this chart (taken from the testimony of Mr. Roy Reierson at p. 638 of the Hearings) is somewhat different than that used through out the remainder of the report. The essential characteristics of the chart, however, would be the same with any definition of money supply. , 1919-51 30 CHART 3.-MONEY SUPPLY, TURN-OVER OF BANK DEPOSITS, AND WHOLESALE Source: Introduced by Senator Flanders; appears at p. 720 of the Hearings. of control by the Government. It is only by persisting in app priate fiscal and monetary policies that the Government can make full contribution to price stability and high-level employment or the longer period. 3. Could a More Vigorous Monetary Policy Have Averted the Pri Rise? The preceding discussion gives rise to the question: "Could more vigorous monetary policy have averted the price rise betwee the outbreak in Korea and March 1951?" This breaks down in the two sub-questions: (1) Would the earlier adoption of the monetar policy represented by the "accord" have averted the price rise, an (2) could it have been averted by a much more vigorous monetar policy? The monetary policy initiated by the accord was not a particl ularly stringent one. At their low during the year following the accord, the prices of 20-year 2-percent Government bonds di not fall appreciably below 96, nor did the yield on such bonds ris appreciably above 2.80 percent. It is doubtful that a monetar policy of this order of stringency, if it had been adopted promptly after the outbreak in Korea, would have had a substantial effect in moderating the price rise which followed. The great bulk of the opinion expressed in the hearings was that the effect of such a policy would not have been substantial, and the bulk of the opinion of the professional economists who answered the questionnaire was that the expansion of credit was not the principal cause of the post Korean price rise (Compendium, pp. 1043-1066). The reasons for these opinions are clear. The forces working for a price rise were powerful. The outbreak of war seemed imminent. Consumers were badly scared that prices were going to rise substan tially and, even more important, that goods would become unavailable. They hastened to the stores "to get there before the hoarders." These sentiments were shared by businessmen here and abroad-who repeated the same actions at their level. The demand for raw mate rials was sharply augmented, causing price rises of the magnitude shown in Table 1 (p. 11). Consumers and businessmen generally held large cash balances and other types of liquid assets. The low level of business loans relative to the gross national product showed that large numbers of business firms had large unused lines of credit of A-1 quality which the banks would have been loath to dishonor. Neither would instalment sales have been materially discouraged by a slight rise in their (already high) implicit interest rates. A monetary policy of the intensity of that subsequently initiated by the accord would not have prevented the banks from honoring their prime lines of credit (including those to instalment finance companies) by selling shortterm governments-which they held in abundance at prices very close to cost and by selling long-term governments at yields of around 2.80 percent. The above discussion refers principally to the so-called "mechanical" impact of an increasing intensity of monetary policy. In addition, actions of a deflationary character by the Federal Reserve Systemsuch as increases in the rediscount rate often have an additional psychological impact through their effects on the expectations of businessmen. In this way, actions by the Federal Reserve System often have a much greater influence on the price situation than would appear justified by their direct effects alone. The early months after |