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onsisting of vault cash, excess reserve balances, or short term Government curities. Presumably this reserve would be held chiefly in securities, since therwise it would earn no revenue. Assuming that the reserve would be big gough to absorb the bulk of the short-term securities, this procedure would olate the markets for certificates from the rest of the money market and make

possible to apply credit restriction of the traditional type without raising the
ist of short-term money to the Government.

That is a correct summary of your recommendation?
Mr. Eccles. That is right. What date is that?
Senator O'MAHONEY. This was printed in the Harvard Business
eview for the winter of 1947. It was his analysis of the Federal
Pserve System Report for 1945.
Mr. Eccles. Yes, that is right.
Senator BALDWIN. 1946, you mean, Senator?
Wr. EccLEs. No. 1945.
Senator Baldwin. You said it was printed in 1947.
Senator O'MAHONEY. That is right. All I know is what I read
I the title page.

I did not see it in the Harvard Business Review. Vír. Chairman, I think I should say for the record, that when I fer to the article by Mr. Hardy, that I do not understand his article

have been an endorsement of the plan but an analysis of the plan
iggested by the Board.
Mr. EccLEs. Yes. I had understood that.
Senator O’MAHONEY. Now, would you tell us again how this
rond reserve system would operate as against the restraint upon
asiness borrowing? In other words, some of the criticism which has
en directed against this suggestion, as I understand it, is that it
ould have the result of almost prohibiting business credit.
Mr. Eccles. No; it would not at all, because in the first place, it
guld only prohibit to the extent that reserves were unavailable.
The only way you prohibit bank credit completely would be a
10-percent reserve requirement. That would mean, of course,
e banks had no means of getting credit.
Now, there is no such proposal and the banks would have access

sources of credit with this reserve requirement in effect. One
ould be the discount rate. The discount window of the reserve
inks. Banks can borrow from the reserve banks.
Sow, they could not borrow with the ease with which they borrow
day. with the 1 percent discount rate, which is tied to the short-
rm Government rate. So that you could then raise the discount
te substantially, if this were in effect, whereas you cannot do it
day, because the banks prefer to obtain reserves by transferring
um governments. So the discount rate is ineffective. It would then
effective as a restraint upon the bank lender. It would not mean
could not get credit, but he would be restrained. He would not
t it with the ease and at the rate he would get it today. And he
mld pay a much higher rate, which he would pass on to the borrower,
d there would be that general restraint there, which does not exist
lay.
Senator O’MAHONEY. What would be the effect upon the demand

scarce raw materials and labor?
Mr. Eccles. There could be speculation in this credit. Of course,

banks say there is none, but it is very difficult to say when an

STANFORD LIBRARIES

inventory is a little bit bigger than it needs to be. It is just one of those things that if credit were a little more difficult, and costlier, there would certainly be less future buying, and there would be less speculative pressures.

If the short term rate for private borrowing went up considerably, it would have some influence upon the long rate, and if the long rate for capital financing went up, it would be a real deterrent on long term commitments.

Senator O'MAHONEY. What would be the effect on price?

Mr. EccLEs. Well, the effect on price would come if you reduced the demand for raw materials or for construction, for the products that are in short supply. If you reduced the demand you certainly would stop the inflation. Inflation is only the effect of demand and demand is created by having the money and credit available.

If you made it less available, you would reduce the pressure, and prices might go down. At least, you would stop them from going up.

Senator O'MAHOENY. If this policy is not followed, what is the alternative?

Mr. EccLEs. I do not know of any as a substitute in the credit field.

Senator O'MAHONEY. I do not mean as a substitute. Suppose this policy is not followed. What other policy is there to restrain the continuing spiral of prices?

Mr. EccLEs. Well, the most effective one is fiscal policy. The fiscal policy that has been in effect has been the only important antiinflationary factor we have had in the entire economy, because during the past year, there has been a fairly substantial budgetary surplus.

In other words, the Goverment is collecting from the economy in taxes more than it is spending by five or six or seven billion dollars.

The figure is certainly running at that rate.

Now, that money is taken out of the economy and it is not put back into the economy. That money is used to retire the governments held by the Federal Reserve. It just does not go back. Or it is used to retire the bank held debt. So the bank loses a deposit on one side when the taxpayer pays his taxes and when the Government retires its maturing short term Government debt. The bank loses a Government security on the other side of the ledger.

In other words, this is a reversal of the wartime bank-financing process. That is exactly what you do when you get budgetary surpluses, and it is an anti-inflationary factor and it is the most important single element as a means of controlling both inflation and deflation.

Senator O'MAHONEY. Now, the Government has reduced the national debt by about $20,000,000,000 through the application of surplus and excess balance.

Mr. EccLEs. Well, most or the biggest part of the reduction in the public debt was, of course, not out of surplus.

Senator O'MAHONEY. Out of excess balance.

Mr. EccLEs. Out of excess cash balance that the Government got in the eighth war loan drive which it did not need.

Senator O'MAHONEY. But by whatever the source, the payment of that $20,000,000,000 on the debt was anti-inflationary.

Mr. EccLEs. No. Now, let me make this clear.

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Senator O'MAHONEY. Was it not? Mr. EccLEs. Let me make this clear. Not entirely. To the (tent that the Government had blank billions of dollars in its waran deposits, that was not an inflationary deposit, because it could ot be spent by individuals and corporations. Senator O’MAHONEY. But it could have been spent by Congress. Mr. EccLEs. That is right. But to the extent that the Governient pulled out that balance, which did not come from taxes, since a ubstantial part of it came from banking finance, in the first place, ractically half of the Government's balance came from an inflationary. rocess, and they reversed the inflationary process when they paid the anks off. Senator O’MAHONEY. So, to the extent that that $20,000,000,000 tas not paid, it had a deflationary effect?

Mr. EccLEs. Yes. If that $20,000,000,000 had been spent by the jovernment, it would have been $20,000,000,000 more of inflation.

Senator O’MAHONEY. I understand. Your testimony now, this norning, is that the expansion of bank credit through October has seen about $12,000,000,000?

Mr. Eccles. In the two-year period. Senator O’MAHONEY. So that the general over-all debt of the entire conomic system, after having been reduced on the one hand, is being ncreased on the other?

Mr. ECCLES. As a matter of fact, the Government surplus has been ess deflationary than the bank credit expansion has been inflationary, because the bank credit expansion has been greater than the Governnent's surplus which was applied on the bank debt. Senator O’MAHONEY. They represent the opposite extremes.

Mr. EccLEs. That is right, exactly.. To the extent that bankcredit expansion is greater than the budgetary surplus it nullifies the effect of the budgetary surplus.

Senator O’MAHONEY. So if bank-credit expansion is permitted to increase, unless we reduce the public debt at the same time or reduce other outlays, the general net effect will be inflation.

Mr. ECCLES. That is right. The more bank credit expands, the bigger your budgetary surplus has to be to offset it.

The CHAIRMAN. Did you take account of the fact that some $2,700,000,000 or so of taxes taken in go into these old-age reserve funds?

Mr. EccLEs. Oh, yes.
The Chairman. That must be added to any budgetary surplus.

Mr. ECCLES. That should, and we do add it in and consider it. Any money collected out of the spending stream used to pay bankheld debt or Federal Reserve debt is anti-inflationary, and is a complete offset to bank credit expansion to industry or otherwise.

Senator FLANDERS. Mr. Eccles, there are two or three questions I would like to ask you.

On the foot of page 4, I gather that the measures you are proposing might restrict the credit going into housing.

Do you think it would decrease the amount of housing we build? Mr. Eccles. I am glad you brought that question of housing up because I hurriedly, late last night and this morning, had a statement

made up. I thought housing might come up. In fact, I think Senator Taft mentioned to me that he would like me to be prepared to say something on housing credit.

If I may, I will just make a statement on this housing thing. I am not speaking for anybody but myself on this, because I have not had a chance even to discuss it with anybody else.

I want that understood, that it is just my own views that I have put together in a hurry.

One of the most inflationary factors—perhaps the most inflationary single factor-in the present situation is excessively easy mortgage credit for housing. During the past 2 years the amount of such mortgage debt has increased by more than $9,000,000,000 and the rate of current mortgage lending has risen from about $550,000,000 per month to about $1,000,000,000 per month. Terms of lending have eased substantially as compared with prewar. A large propor tion of recent loans has been made on an installment basis af 4-percent interest on the unpaid balance for a period of between 2 and 25 years. Most of these loans have been made for a very high percentage of current sale price which is greatly inflated.

More than half of the current unprecedented volume of mortgage lending is sponsored by the Federal Government under legislation enacted by Congress. The Government must therefore assume much of the responsibility for any adverse effects of this type of lending Prices of houses have advanced from 25 to 35 percent during the past 2 years. A large number of families of moderate and low income have been encouraged to assume mortgage debt which will be beyond theit means when the present inflationary period is over, and is becoming increasingly burdensome as the cost of living goes up. Sellers and builders of houses have been enabled to make exorbitant profits, The Government has assumed and continues to assume contingent liabilities of great proportions.

It is entirely inconsistent to restrict credit terms on automobiles and other consumer durable goods partly to reduce the inflationary pressures and partly to protect the buying public, ånd at the same time to make housing credit terms so easy as to stimulate inflation and encourage people to go too deeply in debt. Any anti-inflationary program of the Government will lose much of its effectiveness so long as the Government sponsors the present inflationary housing-credit program.

Easy credit bas greatly increased the effective demand for both old and new housing far beyond the supply and this has greatly inflated prices. In an effort to meet the demand and take advantage of this profitable market, builders have undertaken to construct a larger volume of housing than there are resources readily available to finish. As a result, published prices of materials have advanced and, in addition, a gray or premium market has developed for many building materials. In this competitive market, the services of labor are also being actively bid for and bonuses and other extras bave become common.

The predominant feeling in the building industry is that only by building at current rates or even higher can the housing shortage be met and only by keeping demand high can the current levels of production be maintained. The prices that are being established now, however, are too high for long-sustained building. At inflated prices of materials and labor and inflated profits for builders a few more houses

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