IV: Internal Monetary and Fiscal Developments
- International Monetary Fund
- Published Date:
- September 1956
The More Developed Countries
For the more developed countries, 1955 was a year of high prosperity. Business confidence everywhere was strong and private investment, especially in fixed capital, reached new high levels. Consumer demand for durable goods also rose strongly. Industrial production was greater than in 1954 in every country in Western Europe and North America and in Japan, and unemployment fell in most countries. Believing the tendency toward expansion to be excessive, monetary authorities in most countries took action to limit the increased demand. Interest rates, particularly short-term rates, rose sharply, and bank lending was checked.
Production, Wages, and Prices
The increase in industrial production varied widely from country to country (Table 20). It was particularly great in West Germany and Austria, but considerably less in the United Kingdom and the Scandinavian countries. The increases in continental Europe are even more striking when viewed in the light of the fact that they followed a period of unprecedented growth, whereas increases of comparable size in North America represented a recovery from the recession of 1953–54.
|Change from||Change from|
|Previous Year||Previous Year|
|United Kingdom||7||5||Germany, Federal Republic of||12||14|
Under the stimulus of rising demand, employment increased in most countries, and in many unemployment fell to new low levels. Particularly satisfactory were the developments in West Germany and in Belgium. In September 1955, the percentage of the labor force unemployed in West Germany fell below 3 per cent for the first time in recent years. In some of the other countries, notably the United Kingdom, the advance of production was impeded by labor shortages.
The tight labor market, together with production advances, was favorable to increases in money wages. The largest increases occurred in France, but those in Sweden, Austria, West Germany, the United Kingdom, Japan, and the United States also exceeded 5 per cent. In Sweden and the United Kingdom, where production increases were below the average in 1955, rising wages tended to push the cost of living up more than in most other industrial countries (Table 21).
|Union of South Africa||…||2||4||Germany, Federal Republic of||7||2||3|
In general, prices were fairly stable in 1955 in the developed countries, considering the degree of activity prevailing. Even wholesale prices, which are somewhat more sensitive to inflationary pressures, rose comparatively little. The pattern of change was much the same for wholesale prices and for the cost of living, with the largest increases in Australia, the United Kingdom, Sweden, and Denmark. In the first months of 1956, the tendency for prices to increase became more widespread.
The balance of payments of most industrial countries developed favorably from 1954 to 1955. Nevertheless, some of these countries encountered payments problems. Particularly in the United Kingdom, Austria, and the Scandinavian countries, there was some concern early in the year about probable payments developments. These countries took a series of financial measures in 1955 and early 1956 which moderated the growth of demand and reduced the pressure on their international reserves. Unlike the early postwar years, when the first reaction to payments difficulties had usually been to tighten exchange restrictions and other physical controls, most countries relied instead in 1955 and early 1956 on financial action to reduce demand. In the circumstances of the period, restrictive financial action served the double purpose of contributing to internal as well as external stability.
These restrictive financial measures were not limited to countries in balance of payments difficulties. Indeed, almost every developed country applied some restrictive monetary measures. Such action was stimulated primarily by indications of incipient price inflation arising from excessive domestic demand. Timely action of this kind by the large trading countries can be most helpful in moderating general swings in world prices. On the other hand, the determination of surplus countries to prevent increases in their domestic price levels means that deficit countries must take somewhat stronger action to attain external equilibrium.
In early 1955, the restrictive action of the authorities usually took the form of monetary rather than of fiscal measures. The most important measures were directed toward interest rates and the volume of bank credit. In some countries, there were actually some tax reductions, and only later was emphasis given to restraints imposed by budgetary action.
This emphasis on monetary policy was no doubt related to the belief that inflationary pressures were coming mainly from the expansion of private expenditures financed by credit. It seemed logical to direct action at the immediate cause. Moreover, it was also believed that the problems were transitory and that monetary policy, being more flexible than fiscal policy, was the most suitable instrument. As time passed, however, it became evident that the pressures were not short-lived and would not be contained by monetary measures alone. Further, the need for increasing rather than curtailing investment was widely accepted in several of the countries where demand had to be restricted. In the United Kingdom, it was particularly evident that the relatively low rate of investment in manufacturing industry was becoming increasingly damaging to the relative competitive position of the country. Since the effects of monetary policy press more heavily on investment than on consumption, attention turned to budgetary measures, which could have stronger effects on consumption. This trend was reinforced somewhat by acceptance of the extent of the influence that could be exercised upon private investment by technical tax measures, such as the variation of investment and depreciation allowances.
In many countries, the monetary measures adopted included increases in the central bank discount rate (Table 22). Particularly large increases were made in the United Kingdom and New Zealand. Even in the United States and the Federal Republic of Germany, which were in strong surplus positions, the increases were substantial. On the other hand, in France and Italy there were no changes at all.
|Germany, Federal Republic of||3.0||4.5||United Kingdom||3.5||5.5|
|Union of South Africa||4.0||4.5||Netherlands||2.5||3.0|
The increased central bank discount rates were, in general, accompanied by rising short-term interest rates. Monetary policy was thereby able to exert some restrictive effect on private borrowers who used the short-term market. More important in some countries were its effects on the liquidity of the commercial banks. In the United Kingdom, particularly, the rise in short-term interest rates early in 1955 attracted deposits from the banks into Treasury bills, and thereby reduced significantly the banks’ liquidity at that time.
There were also some consequential adjustments of long-term rates of interest. These changes in general were less than those in short-term rates, and the differential between short and long rates which had persisted for the past 20 years narrowed considerably, and even disappeared in the United Kingdom. The rate on U.K. Treasury bills rose from 1.79 per cent in December 1954 to 5.18 per cent in March 1956, while the yield on 2½ per cent consols rose only from 3.76 per cent to 4.65 per cent, leaving the long-term rate 0.53 per cent below the short-term rate. Less extreme, but nevertheless considerable, were the changes in Canada and the United States, where the spread between the yields of Treasury bills and of long-term government securities fell in the same period by 1.23 per cent and 0.81 per cent, respectively.
Part of this narrowing probably came from the market expectation that the credit tightness would be temporary and that interest rates would soon fall. Also, the authorities in many countries were apparently less directly concerned with the restrictive effects obtainable in the long-term market than with those in the short-term market. The measures taken to tighten conditions in the short-term market caused a sharp rise in short-term rates. The long-term market was usually permitted to respond to these movements, partly because it would have been a contradiction of the policy that was being pursued to prevent the upward adjustment of long-term rates by expanding central bank credit. But in general the authorities did not take direct action to increase the effects of credit policy upon the long-term market. Central banks did not push sales of long-term securities, nor did finance ministries increase the total of long-term issues at the expense of short-term issues. The absence of direct pressure on the long-term market somewhat reduced the effectiveness of monetary policy, for the long-term interest rate not only affects a wide range of private investments, but also in some countries limits the expansion of bank credit by reducing the willingness and the ability of the banks to acquire funds by the sale of securities. This period consequently does not provide a thorough test of the methods whereby monetary policy can be made effective.
The increases in the yields of long-term government bonds were generally less than one-half percentage point in 1955 (Table 23), and the changes that did occur must be considered small in the context of expansive business investment plans. That action in the short-term market is not the only means of exercising monetary restraint is suggested by the fact that the rise in long-term rates was almost as large in Switzerland and Italy, countries taking no discount rate action, as in most countries actively using the short-term rate for disinflation.
|Germany, Federal Republic of||5.03||4.99||-0.04|
|Union of South Africa||4.25||4.62||0.37|
Other Restraints on Credit
In addition to restricting the availability of credit through increased interest rates, monetary authorities in several countries attempted to reduce the volume of bank credit by appealing to the banks to restrict loans voluntarily. Such an appeal was made in the United Kingdom in July 1955, and there were similar appeals in other sterling area countries and in Scandinavia. Although these appeals generally seem to have been helpful, the effects of voluntary cooperation for quantitative limits on bank lending, which involves the suspension of competition, are likely to be short-lived.
The check on bank advances was also supplemented by direct control measures on other sources of capital. For example, in some countries the terms prescribed for consumer credit were made more stringent. In the United Kingdom, the control of capital issues was tightened early in 1956 by a reduction in the limit above which approval is required. In Norway, the reduction of State Bank housing loans was continued, so that less public money was available for housing.
The measures taken in the sterling area countries, in Austria, and in Scandinavia checked the growth of bank credit to the private sector in the second half of 1955, and in these countries the trend was in sharp contrast to the preceding rapid expansion of credit (Table 24).
|Union of South Africa||113||126||119|
Including any holdings of private securities.
Including any holdings of private securities.
The contrast in 1954 between booming production in Western Europe and reduced production in North America disappeared in 1955. Strong demand increases in the United States caused a rapid expansion of industrial production. The expansion was based entirely on growing private demand, for from 1954 to 1955 government expenditures fell by a further $1 billion, and it drew some strength from a revival of demand for durable consumer goods, especially automobiles. But demand was also affected by the pervading confidence in continuing prosperity which made consumers more willing to incur debt and lenders more willing to supply consumer and mortgage credit. Equally, manufacturers’ confidence was translated into large-scale plans for fixed investment. This confidence was maintained, despite the weakness in the agricultural sector, which stemmed from special long-term supply problems.
In view of the high level of demand, particularly of demand financed by credit, the Federal Reserve System took action to moderate the growth of private credit. Discount rates were raised four times in 1955, and again in April 1956. The 3 per cent rate reached in April 1956 by the Federal Reserve Banks of San Francisco and Minneapolis was the highest since 1933, and in the following weeks the yield of Treasury bills was also higher than at any time since that year. Open market policy likewise was directed at restraining the volume of reserves available to the banks, but the authorities did not attempt to stop all growth of bank credit. Commercial banks substantially reduced their holdings of government securities, thereby obtaining resources which enabled them to expand loans to the private sector by 16 per cent in 1955.
In Canada, demand was buoyant in 1955, and production rapidly expanded, reversing the slight downward movement in 1954. The upswing was assisted in the first half of the year by an easy credit policy and some reduction in taxes. In the second quarter of 1955, bank loans started to rise rapidly after 18 months of stability. Later in the year, when the recovery was well established, the objective of monetary policy became one of offering increasing resistance to further expansion. The discount rate, which for some months in the middle of the year had been below the U. S. discount rate, was raised in three stages between August and November from 1½ per cent to 2¾ per cent, which was higher than the rate in the United States at that time. Toward the end of the year, the Bank of Canada discussed with the commercial banks the rapid rise in bank credit and its implications in view of the high level at which the economy was operating. The banks agreed, with minor exceptions, not to make any new “term” loans or direct purchases of long-term corporate securities from issuers. The Bank of Canada also obtained from the commercial banks an undertaking to endeavor to raise their liquid assets to 15 per cent of deposits by May 1956. The bank rate was further increased in April 1956, to 3 per cent.
Whereas in Canada and the United States monetary policy was used to moderate expansion of credit, in the United Kingdom it was applied to the more exacting task of helping to contract it. The continued fall of gold and dollar reserves in 1955, together with an accelerated rise of wages and prices, led to a series of corrective measures. Early in 1955, the bank rate was raised from 3 per cent to 4½ per cent. This was followed by a sharp rise in short-term interest rates and by increased pressure on the banks, as depositors withdrew funds for direct investment in Treasury bills. However, bank advances continued to grow, financed by sales of government securities. In July 1955, the pressure which falling liquidity placed on the banks was supplemented by an appeal from the Chancellor of the Exchequer for a reduction of bank advances. In the second half of the year, advances fell significantly, part of this being attributable to the funding of advances to the nationalized industries. The gold and dollar reserve position did not improve, however, and in October a supplementary budget was introduced. Taxes were increased, housing subsidies reduced, and the unconditional access of local governments to Treasury borrowing was withdrawn.
Demand continued high in early 1956. Unfilled vacancies for labor continued to exceed by a large margin the small number of wholly unemployed. Wages were rising more rapidly than productivity, and the cost of living increased more than in most other industrial countries. In February 1956, the Bank of England announced a further rise in the bank rate, to 5½ per cent. Short-term interest rates were again forced up, Treasury bills giving a yield of 5.18 per cent in March. But long-term rates rose relatively little, the yield on consols, which in December 1955 had been 4.39 per cent, increasing only to 4.65 per cent. In February 1956, the Government suspended the arrangement introduced two years earlier for investment allowances for tax purposes and introduced more stringent hire-purchase conditions and control of public investment and private borrowing. The 1956–57 budget, introduced in April 1956, again emphasized the restriction of demand by encouraging saving, making small additions to taxes, and planning a reduction in government expenditure.
In the overseas sterling area, Australia, New Zealand, and the Union of South Africa, rising demand in early 1955 had been fed by a considerable expansion of bank credit. During the year, this expansion was checked in each of these countries. The primary part of this change was played by the external deficit, to the extent to which it affected the liquidity of the banking system. In addition, however, the authorities took important restrictive action. In order to discourage borrowing from the central bank, New Zealand raised the discount rate to 7 per cent, which was considerably above the maximum bank overdraft rate of 5 per cent. Active use was also made of the power to vary reserve requirements to make the discount rate effective. Long-term interest rates advanced a little in 1955 and were raised again in 1956. In contrast to most of the more highly developed countries, Australia used more stringent import restrictions. Central bank policy was aimed at checking the growth of expenditure which endangered both internal and external stability. The decline in exchange reserves was allowed to have a progressively heavier impact on bank liquidity. Appeals were made for voluntary restraint both by the banks and by organizations providing consumer credit. From the middle of 1955, bank credit began to decline slightly. Early in 1956, the authorities reduced substantially their support of government bond prices, bank interest rates were increased, and fiscal measures increased taxation by roughly 10 per cent. In South Africa, inflationary pressures were somewhat milder. Interest rates were increased, but during most of the year the short-term rate was kept significantly lower than that in the United Kingdom. In September 1955, the South African Government increased both the bank rate and the interest rate on government bonds, thus bringing the South African rate structure into line with rates in London. When the latter were again raised early in 1956, however, the South African Government, anxious to avoid a contraction of domestic activity, especially of building, did not follow suit. Instead, it placed restrictions on capital movements to the sterling area; capital transactions by South African residents with other sterling area countries were made subject to licensing, with the exception of purchases of South African shares in London.
In Europe, the tightening of monetary policy was most pronounced in the Scandinavian countries and West Germany. In Denmark, the already strongly restrictive monetary policies were continued throughout 1955; at the same time, there was renewed emphasis on fiscal measures to reduce consumption, and housing construction was limited by a reduction of building licenses and a substantial decrease in the government funds available for mortgages. In Sweden and Norway, there were significant increases of interest rates; in Norway, the discount rate was raised for the first time in the postwar period. However, the primary emphasis in Norway seems to have been given to direct negotiation with the banks to limit lending and to the continued reduction of State Bank housing loans. In Sweden, the liberal rules on tax-free amortization of fixed investment were curtailed, and increases in corporate taxes were introduced to check the upward trend of prices. A country-wide agreement was accepted by the Swedish trade union movement, which provided for a wage increase in 1956 of about 4 per cent, roughly comparable to the estimated increase in production.
In the Federal Republic of Germany, production rose very rapidly in 1955, but for the first time the number of unemployed fell to a point where it no longer provided a cushion preventing further expansion of demand from being translated into price increases. Its past history has made Germany particularly aware of the dangers of inflation, and the authorities acted to maintain a restrictive pressure on demand. Discount rates were raised three times, reaching 5½ per cent in May 1956. The Government continued to run a substantial cash surplus, owing to rapidly mounting revenues and a lag in budgeted expenditure.
A substantial increase in bank credit and a deteriorating payments position led Austria to intensify credit controls in 1955. The discount rate was raised in May and November, and quantitative restrictions on commercial bank credit were reinforced and extended to other credit institutions.
France and Italy took no important restrictive monetary measures. In both countries, the rise in production was sufficient to permit a significant increase in the money supply without inflationary effects. For France, however, some inflationary pressures re-emerged in the winter of 1955–56 as a result of events in Algeria and of a severe winter which reduced agricultural production, and prices accordingly rose.
Belgium and the Netherlands, both countries with satisfactory foreign payments positions, also took relatively mild monetary measures in the past year. The central bank discount rate was raised in both countries. There were some significant tax reductions in the Netherlands, the effects of which, however, were partly offset by speeding up tax collections and by reducing depreciation allowances.
Prices remained stable in Japan throughout 1955. Production expanded, although the corresponding increase in employment was less satisfactory. Private banks continued their repayment of loans from the central bank until by December 1955 these debts had been considerably reduced. In the past, the monetary authorities had been able to exercise considerable influence over commercial bank operations by varying the conditions on which central bank credit was made available to them. In view of the diminished reliance of the commercial banks upon rediscounting with the central bank, it became necessary to develop new techniques of control. The first steps in this direction have been taken by selling government bonds to the banks.
The Less Developed Countries
Although internal prices, as measured by cost of living indices, were stable or declined slightly in 1955 in a number of less developed countries (Table 25), inflationary pressures continued to be strong in many of them. The rate of price increase exceeded 10 per cent in Chile, Bolivia, Indonesia, Korea, Paraguay, Brazil, Turkey, Nicaragua, Mexico, Thailand, and Burma. In several of these countries, the inflation of 1955 was a continuation of the experience of earlier years.
|Money Supply 1||Cost of Living 1|
|Countries Classified by Percentage|
Increase in Money Supply, 1955
|Increase below 5 per cent|
|Increase, 5 to 10 per cent|
|Increase, 11 to 20 per cent|
|Increase above 20 per cent|
Changes are from end of one year to end of following year.
Change from November 1954 to November 1955.
Change from October 1954 to October 1955.
Change from September 1954 to September 1955.
Changes are from end of one year to end of following year.
Change from November 1954 to November 1955.
Change from October 1954 to October 1955.
Change from September 1954 to September 1955.
Expansion in effective demand will usually be excessive if the money supply increases much more rapidly than the growth of the economy. In more than half of the countries shown in Table 25, the rate of increase of the money supply in 1955 exceeded 10 per cent, and several of them encountered inflationary pressures that resulted in substantial price rises.
In some of the countries where there were comparatively moderate increases in the money supply in 1955, domestic credit expansion would have resulted in a considerably greater increase in the money supply if there had not been a partially or wholly offsetting reduction in the foreign assets of the banking system. Significant reductions of foreign asset holdings in Colombia, Egypt, El Salvador, Honduras, the Philippines, and Uruguay reflected import surpluses.
On the other hand, the large increases in the money supply in Mexico and Ceylon can be attributed to balance of payments surpluses and the accumulation of foreign exchange reserves. Mexico, for example, has added large amounts to its reserves since the devaluation of the peso in April 1954. While the money supply increased by 20 per cent in 1955, the foreign assets of the Mexican banking system rose by an amount equal to 32 per cent of the 1954 money supply. Strict credit and budgetary policy not only prevented any secondary credit expansion arising from the increase in foreign assets, but also offset one third of its direct effects. Prices continued to rise in 1955, and by December they were 30 per cent higher than at the time of the 45 per cent devaluation in April 1954. But the rate of price increase has slowed down, wholesale prices increasing by only 3 per cent in the six months ended March 1956.
Several countries which had been suffering from serious inflation took steps to control the situation in 1955 and early 1956. In Chile, where inflation had been a continuing problem for many years and the rate of price increase accelerated in 1955, a comprehensive program of fiscal and monetary reforms was adopted early in 1956, with a view to curbing inflation and insuring internal stability. As part of this program, the Government overhauled the exchange system, as noted elsewhere in this Report, limited the traditional automatic annual increases in wages to one half of the cost of living increase in 1955, and adopted measures to restrict credit through portfolio ceilings and tightening of rediscount policy. Measures were also proposed to Congress to increase revenues and reduce public expenditures. In the first quarter of 1956, the rate of increase in the cost of living was less than one half, and in the expansion of bank credit approximately one half, of the rate in the first quarter of 1955.
Indonesia made a fairly successful effort to reduce its budget deficit in order to ease inflationary pressures. During the second half of 1955, government borrowing from the banks declined for the first time in several years; but credit expansion to the private sector, which had been more or less under control in 1954, increased rapidly during the entire year. However, steps were taken to control the availability of bank credit to the private sector, including more stringent requirements for prepayment on imports.
Prices continued to rise in Argentina in 1955, though less sharply than in the last months of the previous year. The Government increased taxes in early 1956, and also levied a special nonrecurrent tax equivalent to 20 per cent of income and excess profits tax liabilities of 1955. Price controls, which had been relaxed at the end of 1955, were again tightened. The stabilization of wages was also attempted, but in February 1956 an emergency wage and salary increase of 10 per cent was permitted. Despite the taxation increases, the 1956 budget still showed a deficit equal to about one third of total government revenue.
Turkey was one of the few less developed countries that changed its bank rate in 1955, the discount rate of the central bank, which had remained unchanged since February 1951, being raised in June 1955 from 3 per cent to 4½ per cent. In Syria, a program to check the rapid expansion of bank credit included a small increase in the discount rate and, more important, the establishment of minimum cash reserves and the prescription of advance deposits for opening letters of credit. Reserve requirements in Bolivia were raised in October 1955 from 20 per cent of demand deposits and 10 per cent of time deposits to a uniform percentage of 40 per cent against both types of deposit. Colombia in April 1956 reimposed a supplementary reserve requirement of 60 per cent against increases in demand deposits, practically doubled the advance deposits required from importers, and took other measures to limit bank credit. In Israel, the authorities tightened credit restrictions in late 1955 by requiring authorized banks to obtain cash deposits from importers for the opening of documentary credits.
In Peru, a penalty charge on commercial bank reserve deficiencies was introduced in September 1955. This penalty rate was raised in November, while reserve requirements against increments over the November level in bank deposits were increased from 50 per cent to 70 per cent for sight deposits and from 25 per cent to 35 per cent for time deposits. There was also a slowing down of public investment.
In Burma, the adverse payments developments described earlier led the authorities to take substantial financial measures. Drastic reductions were decreed in government expenditures in 1955–56, especially on new development projects, and the estimated budget deficit was reduced to about 40 per cent of the deficit in 1954–55.
India provides an example of the manner in which a less developed country, not highly dependent on foreign trade, can finance fairly large development expenditures without inflationary pressures. The year under review marked the end of India’s First Five Year Plan, which had been implemented without any inflation during the period as a whole. Although the planned development outlays were not fully realized, the goal of a 5 per cent increase in per capita real income had been achieved by 1953–54, the third year of the Plan. A cautious credit policy was maintained throughout, and the absence of inflationary pressure was also due in part to the emphasis given to increasing production of food and to favorable weather conditions. There was some upward movement of prices in the early months of 1956. A Second Five Year Plan adopted for the period ending in 1960–61 has the objective of raising national income by 25 per cent, compared with an estimated 18 per cent increase during the first Plan. It contemplates the provision of additional employment opportunities which will be adequate not only to absorb the increase of about 10 million persons in the working population during the Plan period but also to reduce underemployment. In the Second Five Year Plan, there is a significant gap between planned expenditures and the resources likely to be available, and greater emphasis is to be placed on heavy industries.
Several countries took steps during the past year to improve the structure of their financial institutions. Central banks were established in Libya, and the Federation of Rhodesia and Nyasaland; Syria, Malaya, and the Gold Coast are contemplating, or have taken steps for, the establishment of such institutions.