Cheap Money and Inflation

May 21, 1956

The steady shower of criticism that has beaten upon the Federal Reserve authorities since they increased prevailing discount rates to 2¾ percent in April reveals the strength and extent of the inflationary sentiment that has developed in this country.

The criticism has come both from within and outside the Administration. Treasury Secretary Humphrey and Dr. Arthur Burns, the President’s chief economic adviser, were reported to be opposed to the increase. Commerce Secretary Weeks and Labor Secretary Mitchell have publicly questioned its wisdom or necessity at this time. State and city officials complain that it will raise the cost of their borrowing. Builders and other businessmen are grumbling. And of course inflationists are raising cries of alarm.

President Eisenhower, however, in two press conferences, has stoutly maintained the political independence of the Federal Reserve authorities. It is good to have this independence reaffirmed. But it is perhaps even more important to point out that the decision in favor of monetary restraint is the right one, and the only safe one at the present time.

William McChesney Martin, Jr., the chairman of the Federal Reserve Board, has made an excellent defense of this decision. “We fight inflation,” he declares, “partly because it is the forerunner of deflation. . . . If I thought inflation would create jobs and prosperity, I might be for it. But I am convinced that, apart from transitory effects, the result of inflation is destruction of jobs and prosperity.”

It is also heartening to report that two of the largest banks in New York, the Guaranty Trust Co. and the First National City Bank, have made admirable defenses of the Reserve banks’ increase in interest rates in their May letters. The Guaranty Trust points out that much has been made of the fact that the latest advance carried the prevailing discount rate to the highest level in 23 years. But what most commentators do not mention, the Guaranty Survey goes on to point out, is that the present rates, viewed in a longer perspective, “are not high but low. Not until 1930 did any Federal Reserve discount rate go below 3 percent. . . . Only by comparison with conditions during and since the depression are current rates high. . . . A rise in money rates usually indicates an increasing utilization of available credit resources and a corresponding need for restraint. Under such conditions, a refusal to follow the market would amount to positive intervention on the side of easy money, overexpansion of credit, and inflation.”

Both the Guaranty and National City letters then go on to point out the numerous indices of present-day inflation. “Excessive borrowing, pressure at bottlenecks, rising wages and prices,” declares the National City, “are all evidence that people are trying to get more out of the economic organization than it can presently produce. This is the general situation, despite the soft spots, and it is the essence of the inflationary trend.”

In fact, the Keynesian game of “cheap money forever” shows signs of playing itself out. cheap money and inflation can work their apparent miracles only as long as creditors do not expect further inflation. As soon as they do expect it, they demand much higher interest rates to compensate for real capital losses. Higher interest rates are now worldwide. The Bank of England’s discount rate is now 5½ percent. The chief remedy required here at home is to restore confidence in the dollar.

The case for monetary restraint was summed up impressively in the President’s latest annual economic report: “Success in preventing depression depends in large part upon a willingness to avoid the excesses that can so easily develop during prosperity. . .. If credit on easy terms were available to everyone at a time when the economy is already working close to capacity, the consequence would be a scramble for limited resources and a cumulative bidding up of prices. . . . A government that sought to prolong prosperity by such devices would be taking a road that all too often has ended in disaster.”