DESPITE widespread apprehension at the beginning of the year about the possible extent of repercussions of recession in the United States, production and employment in nearly all countries outside the United States and Canada continued to rise throughout 1954, which was one of the most satisfactory postwar years. Not only retail prices, but even wholesale prices and primary product prices in general, remained remarkably stable. Only in some of the underdeveloped countries was there any significant degree of monetary and price instability, stemming from continued difficulty in limiting development to available resources. Except where fluctuations in coffee and rice prices created special problems, the difficulties arising from the instability of export prices, which in earlier years had been a prime cause of disequilibrium for countries specializing in primary production, were less serious in 1954.
Monetary policies in early 1954 had shown a fairly consistent pattern of easier credit. Long-term interest rates were falling in almost every developed country, influenced by the diminution of inflationary pressures and the fear of a general decline in activity, as well as by the improving reserve position of most of the non-dollar world. By the beginning of 1955, however, this consistent pattern was no longer maintained. Interest rates were rising in many developed countries as governments attempted to moderate new expansionary pressures, which in some countries had already led to balance of payments difficulties. In some other developed countries, sustained favorable conditions permitted the continuation of measures easing credit. In the underdeveloped countries, the problem of financing development remained paramount throughout and there was little over-all change in policy.
The trend noted in recent years toward a more extensive use of central bank action continued in 1954 and 1955. For the first time in several years, changes were made in the discount rate in Norway, Sweden, and New Zealand. Accompanying this trend to stronger action by central banks was a continued growth in many countries in general confidence in the currency. This manifested itself in a marked increase in the ratio of time and savings deposits to the money supply. In the 1940’s and early 1950’s, widespread expectations of price increases had fostered a tendency in many countries to reduce to a minimum savings held in banks and other savings institutions. This trend was reversed in 1954, and intermediary financial institutions are regaining their former place in the investment of savings. The increase in the ratio of time and savings deposits to money supply in 1954 was most marked in Germany, Italy, the Netherlands, Sweden, and Switzerland. In most countries, however, these deposits have not quite recovered their prewar importance.
Few countries made major changes in their fiscal policies in 1954 or the early part of 1955. In the developed countries there was some tendency to cut tax rates, but this was less widespread than in the previous year and in most instances the reductions were comparatively small. In the United States, however, there were large tax reductions as a result of the expiration of certain emergency taxes and the adoption of a general tax reform. Despite these tax cuts and the automatic decline in tax receipts resulting from the slackening of business activity, the cash budget deficit decreased in the calendar year 1954 as the result of a fall in cash expenditures. In Germany too, there were considerable tax reductions effective at the beginning of 1955. Relatively small tax reductions in Canada in April 1955 accompanied an expansionary monetary policy. In the United Kingdom, tax relief also granted in April 1955 was considered desirable as a stimulus to production, despite the existence of conditions that had only recently required two increases in the bank rate. On the other hand, Denmark increased indirect taxes to supplement monetary restrictions prompted by balance of payments difficulties, and early in 1955 Sweden restored the levy previously applied to new investment, which had been removed at the beginning of 1954. In most underdeveloped countries, the main fiscal problem is still that of raising enough revenue to finance development expenditures by the government. Compensatory fiscal action, where successfully undertaken, has generally been confined to the adjustment of export and import duties to changes in market conditions and in the balance of payments position.
The recovery of the United States from the business contraction of 1953-54 was an event of outstanding importance in the past year. The contraction was initiated by a decline in retail sales in the second quarter of 1953. At the same time, defense expenditures began to decline, their annual rate falling over the next 18 months by nearly $14 billion. These depressive influences led in turn to a substantial adjustment of business inventories; inventories had expanded at an annual rate of $5 billion in the second quarter of 1953, but in the fourth quarter they were reduced at an annual rate of $4 billion.
Toward the end of 1954, aggregate demand in the United States revived. Consumer expenditure, which had been supported by a decline in tax collections and the sustaining influence of larger social security payments, began to rise again. Expenditures on housing increased sharply, under the stimulus of liberalized mortgage conditions introduced by the Federal Government. The continuous rise of construction outlays throughout the year reflected the general confidence that the contraction would not be long lived. Defense expenditures stopped falling in the third quarter of 1954, and finally the inventory adjustment ran its course. In the last months of 1954, stocks of purchased materials and goods in process started to increase, and the continuing decline in inventories of finished goods may have been partly a reflection of unexpectedly large sales.
In the early months of 1955 the expansion continued and broadened. From February unemployment was less than it had been a year earlier, although it remained around 5 per cent of the labor force, considerably above the postwar average. A high degree of business and consumer confidence was indicated by an upturn of expenditure plans for capital goods and durable consumer goods.
Progress toward recovery was at first aided by Federal Reserve policy which was directed toward making credit readily available on terms attractive to borrowers. The effect was achieved principally through a reduction in bank reserve requirements in 1954. Partly owing to this easing of their reserve positions and partly as a result of reduced business borrowing, banks purchased exceptionally large amounts of government securities and greatly increased their lending on residential mortgages. Commercial bank purchases of U. S. Government securities indirectly provided part of the funds made available to other borrowers by individuals and institutions that had reduced their government security holdings.
Interest rates, both long-term and short-term, declined in the United States during the first half of 1954. After August, interest rates on government paper rose moderately, as the more than seasonal expansion of business borrowing was allowed to reduce the net excess of bank reserves. The Board of Governors of the Federal Reserve System announced late in the year the discontinuance of its policy of “active ease” of credit. Thereafter, the excess reserves of member banks declined. During the first four months of 1955, rates on commercial paper, Treasury bills, and longer-term securities rose somewhat, and in April the Federal Reserve Banks raised their rediscount rate from 1½ per cent to 1¾ per cent. In view of the boom in share market prices which had persisted since late 1953, action was also taken in January, and again in April, to restrict the availability of credit for purchasing and carrying corporate stock.
Until early 1955, developments in Canada paralleled those in the United States rather closely. Industrial production fell during the last half of 1953 and the first quarter of 1954, and employment in manufacturing declined. The recession was intensified by a partial failure of the wheat harvest and a contraction of agricultural export markets.
In the first part of 1954, the Canadian authorities followed policies similar to those of the United States. Monetary policy was eased and interest rates fell substantially. In June 1954 the Government stimulated private residential construction by legislation liberalizing the provision of housing finance. These measures assisted in a recovery in the second half of the year. However, the recovery was not complete, and unemployment continued at levels above those of 1953. In early 1955 the expansive monetary policy was continued, interest rates fell, and the discount rate was lowered in February. The Government’s budget for the fiscal year 1955-56 provided for a reduction in tax rates and a small deficit.
The pattern in Western Europe was quite different from that in North America. There was a marked rise in industrial production in practically every country. Employment rose everywhere, and in several countries unemployment reached a practical minimum. In some countries—notably Austria and Western Germany—which have had unemployment problems, there were signs that shortages of industrial manpower were becoming significant in certain sectors. In contrast to 1951, when the post-Korean boom was at its peak, prices remained fairly stable while production was increasing. In almost every country of Western Europe, wholesale prices varied by less than 3 per cent during the year. In a few countries, notably the Netherlands and Norway, retail prices rose somewhat under the impetus of wage increases, though productivity also increased. Toward the end of the year, however, there were some further price increases in several countries, and the maintenance of price stability threatened to become more difficult in the face of further intensification of demand, rising wages, and some rise in import prices.
There were several developments favorable to economic expansion in Western Europe. The sharp reversal in inventory movements in the United States had no counterpart in Europe, where inventories were rather low at the beginning of 1954. Consumer expenditure was fostered by the spread of consumer credit and the increased availability of durable consumer goods, and, still more in some countries, by wage increases which redistributed income in favor of labor and by tax reductions. The upswing was marked by an expansion in the sales of durable consumer goods in most West European countries. Economic expansion was further aided by a considerable growth of exports, particularly from continental Europe. Probably even more important was the expansion of investment, including housing, encouraged in part by the easing of monetary policy and facilitated also by some initial slackness in the metal-using industries.
In most West European countries, the promotion of expansion required little overt action. In the Netherlands, however, where substantial balance of payments surpluses provided a margin of safety, and where considerable restraint had been shown in making wage adjustments in previous years, there was an example of direct action on income distribution in the form of government-sanctioned wage increases. Industrial wage rates rose by 16 per cent in 1954. The Government also reduced tax rates, but the cash budget surplus actually realized was only slightly smaller than in 1953. At the same time, the new commercial bank reserve requirements and a conversion of short-term debt into medium-term increased the monetary authorities’ power to control credit expansion.
Outstanding increases in production were recorded in both Western Germany and France in 1954. Foreign demand and domestic investment were important factors in the expansion in Germany, which was a continuation of the spectacular gains made each year since the currency reform of 1948. The increase in France, which contrasted sharply with the lack of progress in the previous year, was encouraged not only by increased demand for exports but also by tax exemptions for investment and increases in wages of the lowest paid workers. Both countries followed policies designed to lower interest rates. Although the money supply rose substantially, price stability was maintained; 1954 was the first year since the end of the war when a substantial rise in production was achieved in France without general price increases. This price stability in France was of paramount importance in strengthening confidence, stopping the flow of gold into hoards, increasing savings, and hence reducing the Government’s dependence on bank credit.
While domestic output in the Scandinavian countries continued to rise, unsatisfactory balance of payments movements in some of them forced several significant changes in monetary policy in the course of the year. In Denmark, fiscal and, in particular, monetary policies were strengthened considerably when foreign exchange reserves fell drastically in the summer of 1954. To increase the effectiveness of its monetary policy, the Government took steps to ensure that higher interest rates were extended to residential housing, for which loans had previously been granted at fixed low rates. Further fiscal measures were taken in the spring of 1955. In Norway, continued balance of payments pressures caused the Government to adopt more stringent fiscal and monetary measures, especially with a view to reducing the unusually large investment program. For the first time since 1946, the discount rate was changed in February 1955, and long-term rates of interest rose. Further arrangements, including the introduction of additional bank reserve requirements, were made to limit the expansion of credit to the private sector of the economy. In Sweden, where there was a risk that wage increases agreed early in 1955 might intensify pressures already evident in the economy, the discount rate was raised in April from 2¾ per cent to 3¾ per cent, and a new long-term bond issue was offered at 4½ per cent, ¾ per cent above the ruling market rate. By these measures and stricter enforcement of reserve requirements, the Government attempted to establish firmer control over the banking system and to meet a threat of new inflationary pressures.
The United Kingdom shared in the general expansion of production and employment. In the course of the year, unemployment fell even below the level of the immediate postwar years. Consumption expenditure, in particular on durable goods, especially automobiles, grew substantially. Investment also increased, notably in the nationalized industries. On the other hand, there was a slight decline in government expenditures, arising from a reduction in outlays on defense. The tendency to expansion was supported by monetary policy. A general downward trend in interest rates quickened during the year; the movement was most marked in short-term rates, which were influenced by a lowering of the bank rate in May, but long-term rates also fell in all sectors of the capital market. Ordinary share prices showed a strong upward tendency. The private sector of the economy and the nationalized industries increased their borrowing from the banks. On the other hand, the Government’s over-all deficit, including capital expenditures, decreased considerably. Early in 1955 there were indications that the expansionary forces were becoming more pronounced and, in conjunction with other factors, were having an adverse effect on the balance of payments. Accordingly the bank rate was raised from 3 per cent to 3½ per cent on January 27, and to 4½ per cent on February 24, and some restrictions were imposed on hire purchase. When the 1955-56 Budget was introduced in April, the Chancellor of the Exchequer estimated that the scope for increased production in the coming year would be at least as great as in the past two years, while home demand should rise by less. As an incentive to increase production, the Budget provided for a small general reduction in income tax.
During 1954 the Japanese monetary authorities achieved an important success in their attempt to halt inflation. In earlier years the money supply had increased continuously and the cost of living went up each year. Wholesale prices in December 1953 were nearly 50 per cent higher than in 1950. Foreign exchange reserves had declined considerably in 1953, and Japan also had to face the certain prospect that receipts from expenditures by U. S. Armed Forces would decline sharply. At the end of that year, strong monetary action was initiated. The Bank of Japan undertook to reduce its loans to private banks, by applying increasingly high charges on rediscounts beyond certain limits. These measures were aided by a recovery of confidence in the currency, which led to a significant increase in time deposits. Loans by the Bank of Japan fell substantially in the latter half of 1954, and the growth of the money supply was checked. Wholesale prices declined a little during the year, and the effectiveness of the tightening of credit is indicated by the fall of share prices, which contrasted with a rise in almost every other country. Production for 1954 as a whole was greater than in 1953. The fall in foreign exchange reserves was checked and substantial gains were made late in the year.
In 1954 and early 1955, many underdeveloped countries still found it difficult to establish or maintain internal monetary stability, and their problems were often intensified by the pressing claims of development programs. The diversity of the experiences of the underdeveloped countries in 1954 again demonstrated that the degree of success attained in maintaining monetary stability while they are pressing forward with development depends upon their economic policy as a whole rather than upon any single factor in it. The significance of a budget deficit will be greatly influenced by measures taken at the same time to ensure a balanced growth of production, or to protect the equilibrium of the economy as a whole in other ways.
In most Asian countries, 1954 was a year of comparative domestic monetary stability. But in a number of Latin American countries inflationary pressures with varying degrees of intensity were important. The most serious situations appeared to be those in Bolivia, Brazil, and Chile.
Most of the Asian and a few of the Latin American countries that had been suffering from a fall in export earnings had, by 1954, adjusted their economies to the new situation. For some countries, the subsequent recovery in the prices of certain commodities, such as jute, rubber, and tea, with a consequent improvement in their terms of trade, made the adjustments required of them less farreaching than they otherwise would have been. Coffee prices, however, which had increased in the last few years, fell sharply in the second half of 1954 and in early 1955.
Some countries that faced balance of payments deficits because their domestic income and price levels had not been adjusted to lower export earnings attempted to maintain incomes in export industries by various kinds of subsidy, while imposing more stringent exchange restrictions to correct the balance of payments. Such efforts, however, cannot produce results that are satisfactory for the economy as a whole; they usually create inflationary pressures or intensify pressures already operating in the economy, while they also tend to become progressively more difficult to enforce.
In spite of a fall in government revenues as the Korean war boom collapsed, many underdeveloped countries had maintained their developmental expenditures, and by 1954 some governments, at least in Asian countries, were again increasing these expenditures. Although efforts to expand government revenues through improved tax collection and other tax measures have continued, government expenditures have increased by as much as, if not more than, the increases in revenues, and in many underdeveloped countries there are still substantial government budget deficits. Where this has led to, or been accompanied by, an expansion of domestic output, or where large foreign reserves accumulated in earlier years have been used to finance imports, no inflationary pressures have arisen. In India, for example, the trend of wholesale prices over the last few years and also for most of 1954 has been downward, despite budget deficits. The offsetting factor in India has been the large increases in both agricultural and industrial production resulting not only from favorable weather but also from earlier government investment, such as the expansion of irrigation works. In the fiscal year 1955-56, a budget deficit larger than that shown in the 1954-55 revised estimates is expected, but the Indian Government does not anticipate inflation.
In Burma, deficit financing mainly for development did not lead to domestic inflationary pressures, partly because domestic output increased. Also, foreign reserves were allowed to fall. The main single influence affecting the movement of reserves was debt repayments to India and the United Kingdom; the movement was also accelerated by declining export prices for rice. In order to stem the decline of reserves, the Government not only introduced strict import controls in early 1955, but also cut expenditures, including those of a developmental nature, with a view to making its development program more realistic in relation to available resources.
Deficit financing by the Government of Indonesia during the last few years has made more difficult the problem of adjusting the economy to a lower level of export earnings. The Government’s indebtedness to the central bank (Bank Indonesia) increased from Rp 5,398 million at the end of 1953 to Rp 8,599 million at the end of 1954. The money supply consequently increased, and by December 1954 was 45 per cent larger than at the end of the previous year. Wage increases in industry, which exceeded any real increases in productivity, also contributed to the inflationary tendency.
Underdeveloped countries can try to reduce the excess demand attributable to inflated domestic incomes by cutting government expenditures or by adopting measures to increase government revenue. However, these adjustments are always difficult and often slow. One of the most successful of such attempts was made in Ceylon. Beginning with the year 1953-54 and continuing in 1954-55, Ceylon’s budget aimed at economic development with financial stability. In order to avoid inflation and to leave private savings to finance private investment, it was decided that total government expenditures were not to exceed total government revenues plus receipts from borrowing abroad, and the Government reduced its net domestic debt during the year. The rise in the export price of tea during 1954 contributed in no small measure to the success of the Government’s efforts, for it made possible an expansion of government revenue by means of several increases in the export duty on tea. For the first time in several years a cash surplus was achieved in 1954.
The upward movement of prices and the money supply that had been in progress in Brazil for a long time was accelerated in 1954, wholesale prices increasing by about 30 per cent. An important contributory factor was a substantial rise in the foreign price of coffee in the early part of the year. Later, when world coffee prices fell and a minimum export price was maintained, the financing of coffee stocks produced a considerable expansion of bank credit. The fiscal operations of both the Federal Government and the state governments again resulted in large deficits. These factors and the delayed impact of the substantial increase of minimum wages that had taken place in 1954 limited the effectiveness of measures, including sharply increased reserve requirements, which were adopted in October to curtail the expansion of commercial bank credit. Commercial bank credit leveled off, and lending by the Bank of Brazil was under better control in the early part of 1955. Prices continued to rise in early 1955, although at a somewhat slower rate.
In Bolivia the cost of living index doubled in 1954, and in Chile it increased by 70 per cent. In both countries the financing of government deficits, which in turn permitted substantial expansion of private credit, was an important cause of inflation. These fiscal problems had yet to be solved in early 1955. In Bolivia substantial extensions of central bank credit to the government-owned Mining Corporation and the Mining Bank, to enable them to continue financing tin exports at the official exchange rate in the face of rising costs, contributed to the severe inflationary pressure.
In Mexico, the devaluation of the peso in April 1954 from 8.65 to 12.50 per U. S. dollar was followed at first by a considerable flight of capital, general uncertainty, and continued slackness in business. This uncertainty was overcome toward the end of the year, however, and industrial production increased rapidly in the first quarter of 1955. As prosperity returned, measures were taken to limit the expansion of the money supply and the rise in prices. During the first year after the devaluation, the money supply increased by roughly 20 per cent as central bank credit was extended to the Government and its agencies. Prices rose by 19 per cent from March 1954 to March 1955. In order to ensure monetary restraint, government credit institutions agreed to forego further recourse to the central bank, and the Federal Government adopted a balanced budget for 1955. Private credit was restricted by high reserve requirements which in effect limited credit extension to roughly 25 per cent of any increase in deposits. By the spring of 1955, the outflow of capital had been reversed and reserves, aided also by favorable exports of agricultural products, were higher than they had been at the beginning of 1954.