The tendencies we are to consider which slow down or temporarily reverse a change of spending obviously give no security against a gradual attrition of the dollar and no final security against panicky inflation. Nor do they guarantee that we shall not have a decline in demand to the point of disaster. But they do increase the latitude within which monetary policy can operate without producing results that are too obviously objectionable.
The average person in a healthy economy believes that, basically, economic conditions will not change sufficiently to warrant a radical alteration in his standards of business judgment in the immediate future. If he is thinking of buying certain shares, he will not buy them quite regardless of price. When the cost of building rises, some people go ahead and build anyhow, but some drop out. Most business firms in the market for additional labor and raw materials do not stubbornly insist on buying their planned quota without regard to cost; they may postpone their purchases, or they may use substitutes. If there were not a great deal of give and take and flexibility of plans, it would be hard to see how we could have a well-integrated cost-price structure or a reasonably stable general level of prices. Changes in demand in particular sectors would break up workable price relationships, and a general increase of demand would be self-aggravating and explosive.
The increase of production that generally occurs during a period of increased spending also serves as a stabilizing factor. During the period 1940-43 industrial production more than doubled. Even after the slack has been taken up in the labor supply, the rapid increase of new plant and equipment applying the latest scientific and engineering developments makes possible a further rapid growth of output. Traditionally, new investment has been held to such a low yearly average level that we are just beginning to grasp what a continued high level of investment in industrial research and equipment can do.
The fact that prices are so largely administered and wages so generally negotiated between employers and strong unions gives a certain viscosity to the price structure. Though present-day procedures undoubtedly cause a gradual upward push on the price level, they nevertheless seem to slow down the self-stimulating effects of an increase of spending. To a degree they prevent the panic spread of price increases. In a period of crumbling demand they slow down the panic flight toward high-grade debts and cash.
But that is not the whole story. Though some defense against too rapid a change of prices is favorable to a workable relationship among them, the ability of power groups to resist a downward readjustment is now so great that it renders the economy highly vulnerable in the event of a serious decline in demand. Instead of a general workable realignment of prices on a lower basis, great discrepancies develop, and production and employment decline. So while price and wage inflexibility on the downward side may prevent a price panic, if it is too great it aggravates the declines in business profits, in business activity, and in capital values.
During a period of increased spending in this country there has generally been an increase of private wealth, and the public have therefore found a larger amount of debt assets acceptable even after making allowance for changes in the price level. The large increase of savings in the form of life insurance, pension funds, and savings and loan accounts increases the demand for debt instruments by the financial institutions concerned. Private investment accounts require more bonds to give portfolio balance, and business corporations need more short-term obligations to serve as secondary reserve assets. The inflationary effect of a growing debt structure tends to be moderated.
The modern tax structure has certain automatic stabilizing tendencies that are well known. Moreover, the public believe that additional fiscal measures are likely to be used if they become really necessary, and that they are effective. In fact the public at present are inclined to overestimate the effectiveness of fiscal measures. In time of war, wage controls may at least retard the upward adjustment of wage rates, and the higher profits resulting from the wage lag can be taken largely in taxes.
Under the gold standard, people certainly believed that a rise of prices was ultimately limited by the supply of gold, even though they could imagine only vaguely what the limit was. Perhaps this was their main reason for thinking that prices fluctuated within a kind of natural range. But though the international gold standard has disappeared as a really operative mechanism, the idea of a natural limit to a rise of prices persists and serves as a retarding influence when prices go well beyond what they have been in recent years.
Where it is recognized that the monetary system is administered, or at least that administrative controls are highly important, the public believe that those in authority will maintain the integrity of the dollar in some practical sense even though they may not succeed in preventing a temporary rise in prices. There is a confidence, colored by emotion, in the country's political and economic strength and in the fundamental wisdom of those in charge of the government, and a belief that, if particular persons blunder too badly, our system will get rid of them.
The general lack of knowledge of how the monetary system functions has slowed down inflation at times. The issue of greenbacks and its implications in wartime can be understood by everyone. But the maintenance of very low interest rates through expanding the reserve deposits of the member banks by the Federal Reserve and thus providing for the further expansion of commercial bank deposit liabilities, is more illusive. Had the public fully understood the implications of the Treasury's monetary policy in the forties--the saturation of the economy with cash to the point where Treasury securities would be acceptable at about the lowest yields in history--it seems probable that the rise of prices would have been much greater than it was.
Belief that price rises and declines have their natural limits is based also on historical analogy. Booms always have come to an end in the United States without any fantastic inflation and have commonly been followed by a fall of prices, sometimes a great and long-lasting fall. This idea based on historical analogy is blended with a common theory of business fluctuations that booms must come to an end from nonmonetary causes. Some theories of fluctuations hold also that depressions are curative and nurture the germ that brings prosperity, thus providing a kind of natural limit to a fall of prices. The theory of secular stagnation, that gained wide popularity during the thirties, is less optimistic about the healing effects of depression, but it tries to assure us that, regardless of monetary policy, a country with a high productive capacity is in no danger of serious inflation.
Although people have less faith than formerly in the ability of the economy to maintain prosperity under its own steam, there is a great deal more confidence that the government will intervene with public spending and that the intervention will be effective. Undoubtedly there has been a revolution in the country's thinking about the responsibility of the government for maintaining a reasonable degree of prosperity. The annual report of the President on the economic state of the country and what should be done about it and the discussions before the Joint Economic Committee bear witness to this fact, though there is plenty of other evidence. It is widely believed that no political administration can permit serious depression and remain long in office. On the other hand, new faith in price controls and rationing gives assurance that the government will be successful in avoiding serious inflation. The increased possibilities of using the naked power of the state to control economic behavior do in fact make runaway inflation less likely.
Thus there are many features of the economy and widely held views about the way it functions which tend to keep the prospects of profits from swinging too quickly and too widely in one direction. Ordinarily, therefore, a moderate extension of commitments will serve to reconcile the public to holding the existing volume of debt assets on terms made effective by the conditions of liquidity. The retarding tendencies prevent the cumulative effect of a large debt structure and low interest rates from becoming explosive under ordinary circumstances. They show the effect of the public's taking the long view of business prospects and the price level and of not being too easily influenced by either the business prospects or the monetary policy of the day.
On the whole, experience makes such caution seem good common sense. After all, wholesale prices in this country have never stayed above the level of the year 1801 for any great length of time until after the Second World War, and as recently as 1940 they were well below that level. Although price level comparisons tend to lose a good deal of their significance for periods that are quite remote, in the present instance such impressions as they give us are reassuring rather than alarming. At the present time the index is only about 65 per cent above that for 1801 and only a little more than twice the average for the past 160 years--despite the Second World War, the Korean War, the cold war, and the foreign aid program. Altogether, it is a remarkable performance in withstanding economic strain and one likely to make a prospective "bear" on the American dollar take a good second look.
In each period, however, there is a somewhat different experience that impresses people most. The public of 1947, looking back on what they regarded as especially relevant, thought it improbable that prosperity would last much longer. Their attitude made them more willing to hold the large volume of debt assets at very low rates. By the middle fifties people were more willing to believe in the probability of a permanently high level of employment, with recessions mild and without any major break in prices. As the experiences of the thirties fade more into formal history, fears of major depression become less, and fears of creeping inflation become greater.
Although our past experiences prevent the monetary policy of the present from having too rapid an impact on the economy, we must not suppose that monetary conditions count for little. Any tradition about what is likely to happen to business and to the price level will break down in the face of monetary conditions that fail for long enough time to support it.
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