I The Economic Climate of 1957–58
- International Monetary Fund
- Published Date:
- September 1958
AT THE beginning of 1957, the world economy was still dominated by boom conditions generated by an intense world-wide wave of private and public investment which was reflected in a large demand for capital. Already in some countries there were signs that a period of readjustment was not far off, but most of the payments problems that called for treatment during the first three quarters of the year had their origin in the inflationary methods, involving an excessive expansion of bank credit, which were often used to satisfy this demand. As always at the top of the boom, there was everywhere a dearth of loanable funds, especially for international financing, and a growing tension in the money markets, with each country at the same time feeling the impact of some forces peculiar to itself. In the work of the International Monetary Fund during the last year these factors played a large role.
The financial problems that presented themselves in this situation were greatly intensified early in 1957 by the temporary effects of the tensions that arose in connection with the Suez events and, later in the year, by speculative movements against certain European currencies. The Fund played an important part in easing these tensions. In the last quarter of 1956 and the first quarter of 1957, countries other than the United States had an aggregate deficit of about $1,100 million; during this period, Fund members with strained reserve positions drew from the Fund a net total of $800 million. The magnitude of the payments problems that arose later in 1957 may be approximately indicated by observing that, from the beginning of April to the end of September 1957, countries other than the United States, the Federal Republic of Germany, and Venezuela had gold and dollar deficits totaling nearly $2 billion. In order to finance these deficits the rest of the world drew upon official gold and dollar reserves to the extent of some $1,100 million, and current gold production made something like $300 million available. The remainder, $600 million, was covered by net transactions with the Fund. The Fund was thus able to make an essential contribution both in the emergency situation which appeared in late 1956 and in tempering the strains and stresses of the boom.
During the course of the year there was, however, a gradual change, and at its end the Fund and many of its members were faced with a series of problems which in some important respects were different from those with which they had become accustomed to deal in the preceding years. There had, of course, been no change in the foundations upon which sound economic and financial policy should be based, but, as has happened more than once since the Fund was established in 1946, there was a shift in emphasis. The problems that arise in a cyclical downturn began to cause concern, and policy decisions had to be adapted to this shift.
In one form or another, every economy in the world today has to grapple with the problem of creating conditions favorable to a satisfactory rate of economic growth and to the maintenance of stable prices and high employment. Immediately after World War II, there were widespread fears of a severe slump with large-scale unemployment; not until half a decade had elapsed was it sufficiently realized that the main problem at that time was inflation, not deflation, and that monetary policy had to be directed from that point of view. The first postwar recession in the United States in 1948-49 passed quickly, though underlying maladjustments were revealed in many economies when, for a year or more, prices in the United States ceased to rise, and this set off a series of radical changes in the currency values of a considerable number of countries. The second recession in 1953–54 passed as quickly, recovery in the United States being helped by the continued upward trend in most other countries. The full employment pledges which had been given in many countries in the early postwar years seemed to have been fulfilled, not so much by deliberate action on the part of governments as by the emergence of a dominating upward growth trend. Accordingly, the opinion gradually took hold in many quarters that recessions, except those of a mild kind, were things of the past, and that the problem of the business cycle, at least in its most important manifestations, had ceased to trouble the world. The developments of the past year have shown that the optimism implied in this view is not fully justified. In economies where capital goods and consumer durable goods form a large share of total output, there is still likely to be a tendency in certain sectors for periods of concentration of heavy demand to alternate with periods of readjustment to a less intense demand. It is an important task to ensure that neither the expansion nor the subsequent contraction should be magnified by adverse circumstances affecting costs and prices, the level of personal income, or the flow of international trade and investment, to the point where a general oscillation of activity is generated which affects the whole of the economy.
In the latter part of 1957, a downward cyclical movement of the type described above, a type which has often recurred in the past, was evident in the United States and Canada and in a few other countries. Any such downward trend is likely to have an important impact on the world economy; attention is therefore naturally directed this year particularly to the problems connected with the cyclical fluctuations of business activity. In each country today these problems are being increasingly discussed with reference to its own particular conditions.
In order to deal with recessionary tendencies, it is not sufficient merely to take measures to stimulate the over-all demand for goods and services. There are other essential aspects which have to be considered carefully. One of the most important is the tendency of certain branches of economic activity, and especially of the durable goods industries, to develop during a boom beyond the absorptive capacity of the markets for the goods and services that they produce. The sectors of the economy which are likely to expand in this way will be faced with special problems of adjustment when the boom is over, and at the same time the decline in activity will generally be associated with a weakening, and often a definite fall, in the demand for commercial credit. The adjustments that have to be made take time. Although, in a modern economy, “built-in stabilizers” and appropriate credit and fiscal policies may help to sustain the volume of general demand, all these measures, however useful, and indeed essential, cannot be expected by themselves to ensure stability, as long as important adjustments are not made in many strategic sectors of the economy.
These considerations suggest that, even with the strong growth trends that have been evident since the end of World War II in most of the modern industrialized economies, these economies are still susceptible to the influences that produce cyclical fluctuations. The remedies for reducing the fluctuations to tolerable proportions include a wide variety of measures, for some of which arrangements of a rather permanent character may be required. Continuous attention must be devoted to strengthening the structure of the economy, so that any tensions that appear may be more easily withstood, and any tendencies to self-perpetuating movements in one direction or another may be checked. For example, a strong and well-developed banking structure, including institutional arrangements that will make it possible for the monetary authorities to maintain effective control of the flow of credit, is of vital importance. Sound practices are required for financing stock exchange transactions, and even more important is an adequate system of mortgage financing. The importance of the role of consumer durable goods in a modern economy suggests the wisdom of moderation in the use of installment credit for their acquisition as one means of avoiding abrupt oscillations. Likewise, caution in the use of sliding-scale clauses that link wages rigidly to changes in the cost of living, or associate other contractual obligations with cost changes, would generally facilitate the restoration and maintenance of a proper balance in the economy. The effects of all these elements in the situation are closely related to those of the “built-in stabilizers”—such as unemployment compensation and a progressive tax system—which also tend to moderate general business fluctuations. To a large extent the effects of the stabilizers are automatic, but there is also room for more deliberate action if it should be required by the circumstances of any particular situation.
The main purpose of the more direct action which is expressed in decisions on credit and fiscal policy is to restrain demand when it is excessive, and to stimulate it when it is inadequate. This is not the place to discuss in detail the varied measures of general and selective control, or the changes in the volume or the nature of government expenditure or taxation, which may be found appropriate at different stages of the business cycle. During a recession, measures should be chosen in such a way as to ensure that demand is increased without at the same time increasing costs. There are always delicate problems to be solved in determining the proper timing of each measure, not only because of the effect upon the volume of demand, but also because of the psychological impact both on the general public and on particular sectors of the economy.
These psychological influences are important, since the behavior of the public is always a significant factor in any successful anti-cyclical policy. If the business community is sufficiently alive to changing market conditions, it will be readier to adapt its actions to current trends so that there will be less risk that producers will price themselves out of the market. Moreover, the increasing influence of large economic organizations, in industry, banking, agriculture, and labor, is a fact of great importance in the world economy of today. Some of these organizations have acquired a position of quasi-monopolistic power, which has made it possible for elements of rigidity to appear in the structure of prices that may delay the adjustments demanded by changes in business conditions. Upon these organizations, as well as upon the large state trading organizations, there rests a special responsibility to help and not to hinder the adjustments which are required at each phase of the cycle to maintain or to restore balance.
In both the immediate future and in the longer run, the problems with which the Fund has to deal will be much influenced by the general course of world prices. Long-run forecasts are, of course, not possible, but, for the short run, while the risks of a revival of dangerous inflationary pressures should not be overlooked, there are a number of factors which suggest that in the industrial countries the prospects are now favorable for greater price stability than has generally been experienced since the end of World War II.
The excess liquidity built up during the war seems now to have been worked off, and in many countries the prewar ratio of money volume to gross national product has been re-established. In a number of industrial countries the backlog of demand which had accumulated during and immediately after World War II for housing and public utility and industrial plant has gradually been satisfied, and it should be increasingly possible to finance investment of this kind out of current savings without recourse to inflationary methods. Monetary and fiscal policies that have price stability as their objective now command wide support and may be expected to be more effective in the future, even in boom periods, in limiting the pressure of demand. In the industrial countries in general, wage costs have shown an upward trend. However, this trend has already become less steep, as more attention is paid to the relation between wage increases and increases in productivity. In several countries other than the United States there has been evidence of greater price stability. The U.K. index of the wholesale prices of manufactured products, for example, which rose during the first nine months of 1957 at an annual rate of nearly 4 per cent, has been stable or even tending to decline for six or seven months.
The fact that even during a recession the cost of living has continued to rise has caused some concern in the United States. But this rise is largely attributable to a strength in farm prices which may be temporary and to increases in rents and the prices of other services from levels that had been abnormally low in relation to the general level of commodity prices. The prices of U.S. manufactured products have shown some tendency to fall in the first half of 1958, and when account is taken of the price reductions made by means of rebates of one kind or another, the downward movement may have been even greater. The narrowing of profit margins in some important lines of production provides further evidence that the previous persistent upward trend of prices has been arrested.
With narrowing profit margins, it is natural that greater attention should be paid to cost accounting and to the need for adjusting costs to improvements in productivity. The adjustments that are called for in the current cost and price situation need not result in any slowing down of economic expansion. On the contrary, sustained development and a healthy social life are more likely under a regime of monetary stability than by the continuation of inflationary pressures with all the distortions and uncertainty that they create.
In some important countries, the authorities are now able, with less difficulty than in the past, to take the effective measures that are needed to deal with the business cycle. Under the rules of the gold standard, it was the general practice to wait for an influx of gold before market credit conditions could be eased. Today, the U.S. authorities, thanks to the substantial gold holdings at their disposal—the United States is still in possession of more than half the monetary gold stocks of the world—are able to relax credit even when there is an outflow of gold. Whatever embarrassments the current world distribution of gold reserves may present to certain countries, it is reassuring to know that some of the large industrial countries are able to face the task of preventing excessive cyclical fluctuations without being hampered by any insufficiency of international reserves.
Industrial activity has slowed down in some countries, mainly because of a cyclical decline following a boom generated at home. But a decline may also be a consequence of a slackening in activity abroad, or it may be an autonomous development determined by the credit and other policies adopted to defend the foreign exchange position. In some countries indeed, not one but several of these influences have been at work. It follows that no sweeping generalizations are possible, even if attention is Confined to the industrialized countries, about either the general economic conditions of these countries at the present time or the policies that would be most appropriate for them.
In Europe some cyclical decline has been most clearly discernible in the Benelux countries. Although it is possible that similar tendencies are beginning to make themselves felt in some other countries in Europe, it is important to note that in nearly all of them business activity has continued at a high level. In not a few countries there was something like a normal seasonal upturn in the spring of 1958. This was true in the Federal Republic of Germany, Italy, and Austria, as well as in France. In some of these countries, production and export figures in early 1958 compared favorably with those of 1957, whiles their terms of trade were improved by the lower prices of imported raw materials There was a continued demand for commercial credit, of account had still generally to be taken in forming credit policy.
In the United Kingdom there have been only slight signs of a cyclical decline in activity; the rate of growth has, for some years been affected by the policies adopted to counteract inflationary tendencies and so to prevent any deterioration of confidence in sterling. The economic policy of the United Kingdom is directed toward the maintenance of an orderly expansion at home is compatible with price stability and a sound balance of payments position. The authorities have regarded the maintenance of confidence in sterling as the foremost responsibility of their country, not only not only in the immediate interest of the British people, but also in view of the position of sterling as a reserve currency and medium for international finance and settlements.
After a pronounced boom in Japan early in 1957, which was accompanied by a balance of payments deficit, resolute antiinflationary measures were taken in association with financial assistance from the Fund. These measures affected the rate of economic activity, but they were also speelily effective in improving the balance of payments, a matter which is always of considerable importance for a country so dependent as Japan on international trade, and therefore on conditions abroad. As in the United Kingdom, the authorities decided that the maintenance of the present parity and the establishment of a healthy balance of payments position should be regarded as a main consideration in the formation of policy. Although Japan’s exports have encountered some difficulties, early in 1958 they were still running at a rate some 8 per cent higher than in the first quarter of 1957.
While the volume of world trade did not grow in 1957 at the same rate as in previous years, the fairly satisfactory level at which it was maintained made it easier to defend policies of monetary stability and fiscal and credit measures to strengthen the balance of payments position. In the first quarter of 1958 imports into the United States were only 1 per cent less than in the first quarter of 1957. U.S. exports indeed declined by 18 per cent, but in the early months of 1957 they were swollen by exceptionally high shipments of goods for which demand was affected by efforts to expand stocks or by the Suez events. Up to the time of writing this Report, the decline of economic activity in the United States and Canada had had, with only few exceptions, little harmful effect on activity in other industrialized countries. There are several countries which did not have to take any measures to counteract a recession arising from either external or internal disturbances; in administering their fiscal and credit policies, they were of course still concerned with the maintenance of a healthy balance in their own economies, while they could also take into account the fact that any lowering of interest rates abroad made it easier for them too to reduce their own interest rates, insofar as that seemed appropriate.
Many of the primary producing countries present a less happy picture. The prices of many industrial raw materials have been weakening since the second half of 1955, a movement to which many causes have contributed, including rapidly expanding output and, for some commodities, increased competition from substitutes or new products, such as artificial rubber, textile fibers, or aluminum. The weighted average price of raw materials of importance to the trade of the primary producing countries1 fell by roughly 9 per cent in the 12 months preceding the closing of the Suez Canal. There was subsequently a brief upturn, the effects of which had, however, for the most part disappeared by the first quarter of 1957. The flattening out of industrial production accelerated the downward movement, and between the first quarters of 1957 and 1958, these prices declined by some 15 per cent. The average prices of foodstuffs were comparatively firm up to the early months of 1957, but thereafter they too declined, mainly as a result of increased supplies which terminated temporary shortages of some of these products. When the prices of the main exports of a primary producing country show a persistent downward trend, the country is subjected to severe strains, the effects of which could also extend to other countries. This could add to the depressive effect on world demand and consequently on the course of world trade.
The wide diversity of the circumstances in which the prices of raw materials and foodstuffs move up and down suggests that there is no easy solution of the market problems of these commodities. A renewed expansion of industrial production and international trade will, as a rule, help the primary producers, but even after that has happened, some difficulties will remain and may require arrangements of various kinds in which both national and international action may play a part. The great importance of this whole complex of problems is becoming more and more recognized. The countries most immediately concerned naturally are anxious to diversify their economies; but when foreign exchange receipts are declining, the financing of development plans becomes increasingly difficult. Well before the present recession, several of these countries were still beset by inflation. Although in some countries there is still a danger that inflationary tendencies may become overwhelming, there is fortunately a growing desire to restore stability, both internally and in the balance of payments.
A number of countries have adopted comprehensive stabilization programs. During the time when the measures thus envisaged are taking effect, there is a need for financial assistance from abroad; to several such countries the Fund has furnished financial resources as well as technical help.
Despite the marked differences between the situations of different countries and groups of countries, it is satisfying to be able to report that in more and more countries appropriate steps are being taken to deal with their problems by means of fiscal and credit policy. There are still many dangers to guard against. In conditions of recession it is even more important than in conditions of boom that financial and economic policies should be compatible with the maintenance and expansion of the volume of world trade. While countries with balance of payments difficulties would certainly run great risks in applying expansionary policies at such a time, countries in a strong position have a special responsibility to maintain internal demand and production at high levels, thus ensuring a buoyant market for imports and contributing to the expansion of world trade.
The prevention and correction of excessive cyclical fluctuations is a responsibility primarily for the large industrial countries—a task which they should undertake both in their own interest and in the interest of the rest of the world. There will, however, be a better prospect for the success of their efforts if the less developed countries are fully aware that stability cannot be assured to them merely by the efforts of others, and that they cannot be spared the obligation to adapt their own economies to fluctuations between high and low demand. This has special importance for countries whose exports consist mostly of raw materials; it may also apply to exporters of foodstuffs, such as coffee, whose prices may fluctuate widely, even if demand is reasonably stable, in response to the impact of the fluctuations in supply to which these commodities are liable.
Both the Fund and its members must, of course, take account of the adjustments called for by the broad changes in world economic conditions that have occurred during the past year. Where inflation continues to be the most immediate problem, the Fund will not relax its efforts to persuade the members concerned that their first duty is to apply effective countermeasures. Some of the Fund’s members, however, are already, or may soon be, face with difficulties arising from a slackening of world trade. It may be that fears of a further deterioration of their trading conditions will never be realized, and that, without any far-reaching measures, the world will shortly resume the economic progress that has almost come to be regarded as normal. In the meantime, how ever, there is some danger that these fears may slow down unduly the movement toward freer trading conditions. Recession conditions create a dangerously fertile ground for the growth of protectionist sentiment. Even while international trade was expanding rapidly in the boom, appeals were often made to the more powerful industrialized countries to relax the trade restrictions that were restraining the growth of trade, and thus to make possible the strengthening of reserve positions, particularly of the weaker countries. There is a growing understanding of these needs, but these appeals have not always met with the response that was hoped for with the appearance of declining activity, there is always the danger of greater pressure to maintain, or to raise, the barriers that hamper international trade. Experience has shown increases in trade barriers to be a short-sighted method of obtaining temporary relief from the pressures of recession. Such relief will create distortions in the economies where the restrictions are applied; and since it is necessarily obtained at the expense of other countries, it may quickly provoke reactions sufficient to destroy even the short-term benefits that it appears to promise. It is of course important that, as far as lies within the Fund’s power, its members should continue to feel assured that support from the Fund will be readily available in any situation where the expectation is justified that the member too will do whatever lies within its power to complete the adjustments demanded by changing circumstances. The record of 1957-58 has shown that, both in boom conditions and as the effects of recession began to appear, many members have been able to act on this assurance.
The effects of fluctuations in international trading and financial conditions are eventually concentrated upon the foreign exchange reserves of individual countries. In a country whose reserves are not large enough to permit it to accept without great concern the calls that may be made upon them, the impact of crisis is likely to be so sudden that it may be difficult even to initiate the long-term adjustments that must at some time be made. Several countries have found themselves in this situation during the past year. To a substantial extent, indeed, the responsibility for building reserves in good times rests upon the individual country itself. It can now be seen that some countries have been insufficiently careful in this respect. During boom years they have tended to act as if the high prices that they were then receiving for some of their exports would be maintained; with a reversal of the market situation they have been left with reserves insufficient to permit the adoption of orderly policies of readjustment. They have accordingly been particularly vulnerable to any subsequent pressure that threatened to weaken their payments positions further.
A few countries other than the United States, e.g., the Federal Republic of Germany, Venezuela, Italy, and Austria, substantially increased their gold and dollar reserves in 1957. However, the total of the increases in these reserves by countries other than the United States was only slightly greater than the total of decreases, and the increases were concentrated in a few countries. Although for the world as a whole outside the United States total official gold and dollar reserves were only a little greater at the end of 1957 than a year earlier, there was a further substantial increase in 1958, which during the first four months of the year amounted to about $800 million, a large part of which accrued to countries in Western Europe.
There is always some risk that a country, overwhelmed by immediate, heavy pressures upon reserves, may feel obliged hurriedly to take emergency measures which are likely to be harmful to itself and ultimately to distort the pattern of world trade and delay the resumption of the normal long-term processes of economic growth. This risk is diminished if such countries are able to draw upon financial assistance from outside. Later sections of this Report will show how such assistance helped in mitigating the difficulties of several countries during the past year. Financial assistance was forthcoming from several quarters, and the Fund’s own contribution was substantial. As an increasing number of countries show that they are aware of the inadequacy of short-term measures, which affect merely the symptoms rather than the causes of their payments difficulties, and are therefore prepared to carry through far-reaching adjustments of their monetary and economic policies, there is a strong justification for the provision of international credit to help them bridge any temporary gaps that the normal course of world trade fluctuations may inflict upon them. In this connection, although the Fund still has substantial resources at its disposal, the question has been raised, whether in the circumstances of today, with world trade greatly expanded and a larger Fund membership, its resources are sufficient to enable it fully to perform the duties that have been placed upon it.
As was pointed out in the Annual Report of 1952, “the cure for a depression will require national measures to maintain or stimulate effective demand, especially in the great industrial countries. It may take time, however, before these measures bring recovery. The Fund can assist members which in the meantime may be faced with serious balance of payments difficulties, and by so doing help to reduce the deflationary pressure on the world economy as a whole.” The Fund’s resources, even if they were much larger than they are, could not be the decisive factor in such a situation; all countries must share in the responsibility for effective action to deal with recession. In any event, the important immediate task when a decline in activity sets in is to ensure that the deterioration will be checked as soon as possible, and that by the establishment of a strong monetary structure the members of the Fund will build a firm foundation for renewed recovery and the expansion of international trade.
The list includes the prices of nonferrous metals, cotton, wool, burlap, rubber, oilseeds, and hides.