Why ‘Tight Money’

July 15, 1957

The report on June 26 of the subcommittee on Fiscal Policy of the Congressional Joint Economic Committee was obviously a political compromise. Like all such compromises it contained double talk; it said two mutually contradictory things at once.

It began by admitting that “the rapid expansion of Federal government spending . . . has contributed significantly to inflationary pressures.” It had much to say about the need for economy. But: “At the same time, a number of soft spots in the economy emphasize the need for continuing alertness . . . which may require revisions in current public policies”—i.e., deficit spending and “relaxation of present general credit controls.”

Now there are always “soft spots,” even in the midst of the biggest inflationary boom. And if we are to abandon anti-inflationary policy the moment it shows signs of being effective, if the only flexibility we are willing to permit is in the upward direction, then we are in effect committed to a continuance of inflation. Stabilization after an inflationary boom is always painful. It necessarily brings some “soft spots,” recessions in some industries. A stable “full employment” economy, with simultaneous full employment in all lines, and no losses or soft spots anywhere, exists only in a Keynesian dream world. A policy aimed at maintaining constant full employment in every line, and with constantly rising wage rates, is a policy of inflation.

A RARE MERIT

But the Congressional subcommittee report does have an outstanding and (in view of present political pressures and confusions of thought) a rare and unexpected merit. It does support the Federal Reserve’s so-called “tight money” policy. It does declare that “public policies to cope with increases in the price level must take the form of general fiscal and monetary restraints on the expansion of total spending.”

The report shows unusual economic sophistication. It throws proper doubt on the recent fashionable “cost-price push” theory of inflation: “Present inflationary pressures frequently are attributed to the so-called cost-price push, as distinct from the traditional inflation resulting from excessive demand. Whether or not the distinction is valid, it is evident that general price increases can occur without increasing unemployment only if demand is adequate to support the higher price level. The basic problem is an inadequate level of savings out of current income.”

This is correct; but it could have been stated much more clearly and forcibly. The “excessive demand” that causes inflation means excessive monetary demand. Excessive monetary demand comes from excessive money supply. Excessive money supply is the result of increasing the supply of money and credit more than the supply of goods and services.

MONEY VS. WAGE RATES

And the supply of money and credit is excessively increased whenever interest rates are held down by Federal Reserve policy below the level at which unhampered market forces would have fixed them. When interest rates are artificially held down by governmental policy, borrowing is over-stimulated; excessive money and credit are created through the banking system, and prices (including wage rates) are pushed up. This is the essence of inflation.

Expansion of the money supply is both the necessary and the sufficient cause of inflation. An increase in wage rates in neither a necessary nor a sufficient cause. Without an increase in the money supply, an increase in wage rates would lead merely to unemployment. Increased wage rates lead to inflation not through economic necessity but through political pressure. First the government sets up or retains a legal framework (the Norris-LaGuardia Act, Walsh-Healey Act, minimum-wage law, Wagner-Taft-Hartley Act) under which wage rates are forced up. Then there are pressures from every side to give everybody the additional monetary means to pay for the goods and services at the higher prices made necessary by the higher wage rates.

We can stop this “wage-price spiral” the moment we have the economic understanding and the political courage to do so.