Controls Create Inflation

April 16, 1951

Congress can do most to curb inflation by granting the Administration and its agencies fewer control powers, not more.

Price control is not a remedy for inflation. It actually tends to increase and prolong inflation. It distorts and prevents production, and so brings about needless shortages. It diverts the attention of the general public from the real cause of inflation—the increase in money and credit.

It does not follow that the best way to combat inflation is to grant the Federal Reserve authorities more power over money and credit. On the contrary, a more effective step would be to deprive the Federal Reserve authorities of some of the powers they have been abusing for so many years.

Suppose, for example, that Congress deprived the Federal Reserve Banks of the power to buy more government securities. The Treasury would then be obliged to pay high enough interest rates to make its securities attractive to investors on their own merits. It could no longer force the Reserve Banks to peg the price of its bonds. In effect, the government would have to stop selling its bonds to itself. The Reserve system could no longer hold down interest rates artificially by monetizing government bonds.

If government agencies were no longer permitted to increase the supply of money and credit through this device, interest rates would rise. And permitting interest rates to rise—i.e., making credit more expensive—has been the traditional way of bringing inflation to a halt.

Simply permitting interest rates to rise might be enough to halt the present inflation. There are still the possibilities, however, (1) that member banks might increase their holdings of government securities and (2) that, in spite of higher interest rates, private credit might continue to expand. There are several ways in which such developments could be checked.

Further limitations might be put on the power of the member banks to increase their holdings of government securities. The Federal Reserve authorities might be empowered to raise member bank reserve requirements still further. But they should certainly not get this additional power unless it is accompanied by the obligation to increase the reserve requirements of the Federal Reserve Banks themselves. Their reserve requirement against combined liabilities, now only 25 percent, should be restored to the 35 to 40 percent level that existed before 1945. Such an action on the part of Congress would not only restrict further potential credit inflation but would create an immediate increase of confidence in the dollar. Congress should restore the old legal requirements before still further inflation has occurred. The combined reserve ratio of the Federal Reserve Banks is already down to 46.6 percent compared with 56.5 percent a year ago.

Raising legal reserve requirements is a relatively clumsy way of controlling credit. This supplementary device is necessary chiefly because the Federal Reserve authorities have not shown the courage to make full use of the powers they have always had—to increase the discount rate to a noninflationary level and, if necessary, to sell part of their holdings of government securities back to the market. Combined action of this sort could halt inflation overnight.

Just as Congress could do more to curb inflation by placing restrictions on the Federal Reserve authorities than by granting them further control powers, so it could do more by taking some powers from the Federal bureaucracy in general than by adding new ones. Above all, in a time of inflation Congress should discontinue subsidies to farmers, and the “parity” price nonsense, and reconsider all other legislation which arbitrarily forces up production costs.

The Federal Reserve authorities are always asking for more powers for the ostensible purpose of “combating inflation.” But they have in fact used the powers they have in order to create inflation. The way to halt inflation is not through controls by government but through controls on government.