AFTER A DECADE or so of comparative disuse, a number of countries have, in recent years, turned increasingly to an active use of monetary policy. There is nothing monotheistic about this revival. It is generally appreciated that monetary techniques can be fully effective only in combination with proper budgetary and other policies.
Monetary policy itself is being revived in a form somewhat different from the one familiar in prewar days. In addition to the simple classical techniques of discount rate changes and open market operations, central banks have added a variety of new and complex weapons to their armory. The underlying economic situation has changed in many countries, and now that the usefulness of monetary policy in general is widely recognized, the chief point of interest about its recent revival is the manner in which it is being adapted to the present needs of different countries. Granted the need for its active use, the question that becomes important is the choice of the proper techniques for the purpose.
In this analysis of monetary policy during the years since World War II, attention will first be directed to the factors that led to the comparative neglect of monetary policy during the forties and to the forces responsible for its revival in recent years. Then a brief general survey of the different monetary techniques and their comparative usefulness will be given. 1
In the later sections of the paper, the monetary techniques employed in the postwar years by six countries—the United States, the United Kingdom, Belgium, France, Germany, and the Netherlands—will be surveyed. A rather broad span of years is chosen so as to provide a proper perspective for recent developments. The emphasis throughout is on the techniques used, and on the different ways in which different countries have tackled similar problems. Needless to say, circumstances differ sufficiently in these six countries to warrant development along different lines; and attention is given to these differences.
Mr. Patel, economist in the Financial Problems and Policies Division, was educated at the University of Bombay, the University of Cambridge, and the Harvard Graduate School, and was formerly Professor of Economics in the University of Baroda.
This paper was prepared in the autumn of 1952. Developments since then are not discussed here.
Although monetary policy can influence the process of both an increase and a decrease in effective demand, the emphasis here is on the former because of its greater relevance today.
If the banks were trying to maximize profits, they would raise the rates on their loans in any case if the demand for bank loans were inelastic. But, in practice, the rates of banks are sluggish and in some countries they are related, by custom, to the discount rate.
In fact, it is more difficult politically for a government to put the proceeds of new loans in cold storage than it is for a central bank to keep idle the funds it raises by open market operations.
That is, any expansion of bank credit arising from the improvement in their liquidity.
At the end of 1945, holdings of U.S. Government securities by the commercial banks amounted to nearly 60 per cent of their deposits, against approximately 30 per cent at the end of 1941.
In the two years, the Treasury sold some bonds from government investment accounts and offered a new long-term nonmarketable bond to institutional investors at 2½ per cent.
Part of this increase, however, was in response to the higher reserve requirements introduced in 1948.
Present legal minimum and maximum requirements, respectively, on net demand deposits are as follows: central reserve cities, 13 and 26 per cent; reserve cities, 10 and 20 per cent; country, 7 and 14 per cent. On time deposits at all member banks, the minimum and maximum requirements are 3 and 6 per cent, respectively. Nonmember banks are subject to reserve requirements prescribed by individual states.
The administration of margin requirements by the Board of Governors is done under Regulation T applying to brokers and Regulation U applying to banks.
The Federal Housing Administration and the Veterans Administration also issued similar regulations to produce a tightening of housing credit under federal programs.
The postwar peak of the federal debt was reached in February 1946.
The federal debt was approximately 45 per cent of GNP in 1939, 118 per cent in 1946, and 65 per cent in the third quarter of 1952.
Before the war, the sterling debt was roughly 40 per cent more than GNP.
Before the war, the total investment of commercial banks in government securities was significantly smaller than their loans to business and individuals; but in 1945, government investments were nearly three times private loans.
Subsequently, the ratio declined a little, as a result of the refinancing operations that fell due in October.
In 1939, loans to the Government by commercial banks amounted to 80 per cent of their private loans; but at the end of August 1952, they were still 125 per cent of private loans.
See Table 10. The ratio of money supply to national income may, however, exaggerate the extent of the flight from money that developed after the end of 1945. In the postwar period, black markets have declined in significance and black market prices have risen less than official prices. Insofar as official national income estimates disregard black markets, the growth of national income is exaggerated.
At present, the penalty rate is 1½ per cent higher than the bank rate of 4 per cent.
The price of the napoleon on the Paris market is generally significantly higher than that of the same weight of bar gold, and the Government is in a position to influence the price of napoleons, within limits, by increasing their supply on the market.
The new central banking system in Germany is modeled on the Federal Reserve System in the United States. Each of the eleven lands constituting the Federal Republic has its own legally independent Land Central Bank which is subordinate to the main central bank, the Bank Deutscher Lander, in the sphere of credit control. However, the capital of the Bank Deutscher Länder is held by the Land Central Banks, whose presidents constitute eleven of the twelve members of the governing body of the central bank. The central banking system is formally independent of the Government; but in August 1951, the Federal Government was given a larger voice in the formulation of central banking policy.
Equalization claims were also given to insurance companies and to building and loan associations.
New government securities have come into existence since the currency reform, but their magnitude is small. In August 1952, the new internal debt amounted to about DM 1.3 billion, against a national income of about DM 90 billion.
“Bank places” are localities at which there is a Land Central Bank or a branch of one.
These unemployment estimates apparently include a significant proportion of persons that are not employable; this is due to the large number of refugees from Eastern Germany.
The base period is the end of January 1951.
The budget deficit of approximately Bfr 60 billion was the result of heavy expenditure on behalf of allied forces and for the reconstruction of transport facilities.
No part of this deficit, however, was covered by the use of counterpart funds.
Before the war, loans to the Government by the banks were nearly 60 per cent of their private loans; but at the end of 1945, government loans were seven times the amount of private loans.
However, insofar as the provisions concerning the blocking or nonnegotiability of assets as a part of the currency rehabilitation decrees applied to the assets of the banks, this was tantamount to compulsory reserve requirements. But it is difficult to assess the significance of this factor.
The near-money assets include short-term Treasury securities, tax certificates, freely available balances at the Treasury, cash advances and day-to-day loans to municipalities, etc., and time deposits. For a description of these items see the Netherlands Bank, Report for the Year 1951 (Amsterdam, 1952).
Even these banks were given the option of choosing a credit ceiling which limited their credits to industry to an amount 5 per cent higher than the level reached on the base date. Different provisions had to be made for smaller banks and agrarian banks, thus illustrating the need for complex arrangements in a scheme of reserve requirements.
Another step, of a somewhat different nature, was taken in May 1951, when forward purchases of foreign exchange were made subject to a 25 per cent advance payment in guilders. This added to the pressure on bank reserves insofar as importers had to seek credit at an earlier stage. The provision was withdrawn in the second half of the year.
For example, the reduction of subsidies and other government expenditures, reduction of the building program, acquiescence in a cut in real wages by the trade unions, higher taxes, and some tightening of import restrictions.
These powers include prohibiting certain loans, putting a limit to certain types of loans, prescribing reserve requirements in the form of different assets in relation to deposits or parts of them, etc. However, the central bank is enjoined to consult credit institutions before exercising these powers.