Appendix

Just what is the money supply-supply of what? At stake is the definition of money, a bitterly fought issue for centuries. Monetary policies were built on arbitrary definitions, ranging from the ,eighteenth century doctrine (David Hume) that all credit instruments are money, even bonds and 135 MONEY SUPPLY AND INFLATIONshares of common stocks, to the dogma underlying the Peel's Bank Charter Act of 1844 that only gold coins and Bank .of England notes were to be counted. Presently, there is virtual agreement that the concept has to be broader than the latter definition and narrower than the former, stilileav ing a wide range of "freedom" for arbitrary choice. Of course, the choice of a definition depends on the functional purpose it is supposed to serve. What we want to know is the volume of all media of exchange, and of claims on the same, that are or may become effective demand for goods and serv ices. Accordingly, we have to include not only the "active" money in process of being turned over during a chosen period but also all other instru ments which might be used for payment, even if they are "idle" at the time.

ALL DEPOSITS ARE MONEY What, then, is the justification for using the figure of cash-plus-demand-deposits as the measure of the money supply, excluding the time and sav ings deposits--as it is customary in Europe? None whatsoever, unless it is sheer convenience. True, checking accounts have a higher "velocity of circu lation" than savings accounts. 1 But the latter do turn around; withdrawals amount to 60 per cent or more of incoming payments. Savings accounts are subject to a mere 30 days' notice provision, which is not being enforced; they serve also as a 136 AN INFLATION PRIMER base for "pyramiding" deposits. This is implicitly recognized by the law that prescribes mandatory minimum-liquidity reserves for all kinds of bank deposits, except those of the government, consider ing them as "idle" purchasing power. (The banks hold an equal amount of government securities against government deposits.) The Federal Reserve Bulletin's monthly tabula tion of the monetary and banking system's Con solidated Conditions includes under "deposits ad justed and currency" alIso-called time deposits (an improper designation). But savings and loan associations are omitted on the grounds, presum ably, that they are not banks in the legal termi nology. Yet/ their "savings capital" -that grows at an annual rate of $6 to $7 billion (I)-is no different in monetary character from savings deposits in banks, though not subject to statutory cash reserve requirements. Nor are these deposits turned over at a much lower rate. True, there is no legal obli gation to redeem them on demand. But they are being paid out, and the owners regard them as equivalent to cash.

In their own minds, money is what people consider as purchasing power., available at once or shortly. People's "liquidity" status and financial dispositions are not affected by juristic subtilities and technicalities. One kind of deposit is as good as another, provided it is promptly redeemable into legal tender at virtual face value and is ac137 MONEY SUPPLY AND INFLATION cepted in settling debts. The volume of total de mand for goods and services is not affected by the distribution of purchasing power among the di verse reservoirs into which that purchasing power is placed. As long as free transferability obtains from one reservoir to the other, the deposits can not differ in function or value. SAVINGS AND SEMANTICS For the decision to buy a home it is irrelevant whether the money needed for down payment is held in a bank, in a savings institution, or in a safe box. The "money supply" is available in any case.

A source of confusion is the identification of savings deposits with savings. The former are no more and no less "saved" than are the funds put on a checking account or the currency held in stock ings. In all three cases, someone is refraining from consumption (for the time being); in all three, the funds constitute actual purchasing power. And it makes no difference in this context how the pur chasing power is generated originally: dug out of a gold mine, "printed" by a governmental agency, or "created" by a bank loan. As a matter of fact, savings banks and associations do exactly what commercial banks do: they build a credit struc ture on fractional reserves. They do so even more "effectively" than the commercial banks, due to the higher reserve requirements for demand de posits. 138 AN INFLATION PRIMER The fact alone that for credit expansion the commercial· banks indiscriminately utilize all de posited funds, whether on demand or on savings accounts, should dispel the semantic confusion caused by the ambivalent use of the term "sav ings."

POTENTIAL MONEY But then, are all claims on stated sums of cur rency to be considered as parts of the money sup ply? Or where is the line to be drawn? As in most matters human, there is no cut-and-dried line of demarcation. There are numerous shades of tran sition from money to non-money. It all depends on the circumstances which determine the judg ment of the market place. Everything is money, to repeat, that is usable as such or is readily monetizable. That brings us to the "potential" money supply. The actual money supply, whether active or idle, consists of legal tender and its substitutes. But there are credit instruments which, though not directly usable to make payments, can be turned at all times and without loss of capital into active purchasing power. Bankers' acceptances, high-class commercial paper and "street loans" were used for this function at one time or another. Since 1934, treasury securities of not more than one-year lifetime (bills, notes, certificates) have taken over the function on an unprecedented scale.

139 MONEY SUPPLY AND INFLATION They are alternatives to cash, having ready market as interest-yielding near-demand deposits which cannot go in default-if only because the central bank is expected to monetize them, in ultimate resort. (This is implicit in its policy of maintain ing an "orderly market" for government obliga tions.) Thereby, they become equivalents of money and a temporary repository of major funds in the hands of the public. At the end of last May about $45.4 billion of short (up to one year) treasuries, or $21 billion more than five years earlier, was held by nonbank investors. They are primeliquid assets, in the market's opinion, just like bank balances, because they can be turned into cash on short notice. Liquidation before maturity may cause a loss if the interest rate has risen after the purchase; but the owners either do not contemplate such pre mature liquidation or expect to be compensated by the return they had earned in the meantime.

Funds are being shifted from deposits into short treasuries, and vice versa; in the process, the vol ume of demand deposits appears to undergo a de flation, or the opposite. Which is what happened recently. As customers depleted their accounts in order to buy federal short maturities, the "money supply" in terms of currency-plus-demand-deposit has contracted for the simple reason that the banks used the proceeds from the sale of treasury securi ties to reduce their debts at the federal reserve 140 AN INFLATION PRIMER banks. But of course, the total money volume actual and potential combined-was not affected. "LIQUIDITY" VERSUS MONEY SUPPLY The question at stake is not to find a definition suitable for the textbooks. The question is: to de termine the "dimension" relevant for monetary policy. As the (British) Radcliffe Report put it cogently: The immediate object of monetary action is to affect the level of total demand.

Monetary action works upon total demand by altering the liquidity position of financial institutions and of firms and people desiring to spend on real resources; the supply of money itself is not the critical factor. [Italics ours.] Committee on the Working of the monetary Sys tem Report) London, August, 1959, p. 135. The conventional money-supply notion is totally unsatisfactory, even misleading, as a quanti tative base for the understanding (forecasting?) of price-level trends and for the guidance of m~ne tary policy. In this country, as in Britain, the central bank's .attempts to check the inflation are to a large extent, if not altogether, frustrated by the unwieldy volume of overhanging "liquidity." A classiccase of the thoughtlessapplication of a conventional concept has been provided by the economists of the International Monetary Fund. In 1952, they announced with fanfares that the Western world's inflation troubles were over141 MONEY SUPPLY AND INFLATION prices have caught up with the inflated "money supply." They forgot all about the vast volume of monetizable public debt almost everywhere. The dismal record of that forecast did not inhibit Per Jacobsson, the IMF's managing director, to come out lately with the same wishful statement that "wartime inflation" has come to an end and price stability has returned to the free world.

This is not the first time that Mr. Jacobssonhas expressed such unwarranted optimism. As head of the Bank for International Settlements, he made the following statement in the 1954-55 Annual Report of that institution (p. 80): "It seems, in deed, very likely that, provided the world remains at peace, the inflationary phase of postwar eco nomic development has now come to an end." A more realistic application of the concept appears. in the August, 1960, Monthly Review of the Federal Reserve Bank of Atlanta. The comment (without reference to Mr. Jacobsson) is: "Has the economic environment changed so much that the money supply is no longer excessive as it was in most of the postwar period? He who would give a firm answer, to this question at this point would be foolhardy, indeed." 1. Actually, a large, but statistically unknown, portion of demand deposits is permanently inactive. Currency, too, is being "hoarded" in substantial volume. Yet the "idle pur chasing media" are generally counted as part of the active money supply. Compare the June, 1957, Special Bulletin of the American Institute for Economic Research, Great Barrington, Mass.

142 BIBLIOGRAPHY: A SELECTION Adams, Walter, and Gray, Horace M. Monopoly in America. New York: Macmillan Company, 1955. Backman 1 Jules.' Wage Determination-An Analysis of Wage Criteria. Princeton, N.J.: D. Van Nostrand Go., Inc., 1959. Bauer, Peter T., and Yamey, Basil S. The Economics of Under developed Countries. Chicago: University of Chicago Press, 1957'. Bell, J. W., and Spahr, W. E. (eds.). A Proper Monetary and Banking System for the United States. New York: Ronald Press Co., 1960. Briefs, G6tz. Unionism Reappraised. Washington, D.C.: Amer ican Enterprise Association, 1960. Brown, A. J. The Great Inflation 1939-1951. London: Oxford University Press, 1955. Chamberlin, Edward H. The Economic Analysis of Labor Union Power. Washington, D.C.: American Enterprise Association, 1958. Fisher, Robert Moore. Twenty Years of Public Housing. New York: Harper &Brothers, 1959. Harwood, E. C. Cause and Control of the Business Cycle. 5th ed. Great Barrington, Mass.: American Institute for Eco nomic Research, 1957.