Easy Money=Inflation

July 8, 1957

Secretary Humphrey’s defense of the Administration’s economic record was an admirable presentation. It was also (what was not evident in the headlines) a lucid lesson on the causes of inflation, and one of the most impressive answers yet made to the advocates of cheap money.

The Secretary presented “a record of a prospering America with new high levels of employment, rising income, and increasing purchasing power.” True, he had an easier time praising the early record of the Eisenhower regime than the later one, and under questioning by Senator Byrd made some qualifications not in his original statement. He admitted that the national debt had increased, not decreased, in the four Eisenhower years. When Senator Byrd confronted him with General Eisenhower’s 1952 promise to reduce spending to $60 billion, he made the political blunder of replying: “That was before he was elected.” And he had no convincing answer when Senator Byrd pointed out that a slipping back only to the levels of national income of two years ago would result in a budget deficit of $12 billion, or when the senator went on to express the belief that the “new inflation” that started last year will “in all likelihood continue and may, in fact, be accelerated.”

But to one contention Secretary Humphrey did have a convincing answer. This is the contention of the inflationist that the Administration has been reducing the volume of credit, and causing “inflation” and higher prices by raising interest rates.

HOW CREDIT EXPANDED

As to the volume of credit, the Secretary had no difficulty in showing that it has actually “expanded substantially in the last four years.” “There is more credit outstanding today than ever before.” In fact, as the Secretary pointed out, if we count mortgage, consumer, corporate, and other forms of nonbank credit, the total has increased over 1952 by the staggering sum of $146.5 billion ($135.8 billion from “savings” and $10.7 billion “from bank credit expansion, or increased money supply”). The “tight money” complaint, as the Secretary showed, merely reduces itself to this—that the government has put some limits on monetary expansion.

And Humphrey gave the best official answer yet made to the frequent contention that an increase in interest rates raises prices because interest rates are a cost of production. On the basis of the gross sales of all manufacturers, he pointed out that of the cost of an article selling for $100, about 33 cents represents interest During the ten-year period since 1946 “prices of goods that consumers buy rose 27½ percent, or $27.50 on a $100 item [due to labor and other costs], compared with the 20-cent increase due to higher interest.”

INTEREST AS A COST

His comparisons in home-building were no less impressive. A house that cost $10,000 to build in 1946 would cost $19,000 in 1957. If the interest rate on an FHA mortgage increased from 4 percent in 1946 to 5 percent in 1956, then the monthly mortgage payment (on the basis of 15 percent down and a twenty-year amortization) would increase from $51.51 on the 1946 house to $106.58 on the 1957 house. Only $8.71 of this increase would be due to the higher interest cost; the other $46.36 would be due to other costs raised by inflation.

But to hold down interest rates artificially is to encourage borrowing and thereby to increase the money-and-credit supply. It is this increased money supply that raises prices and constitutes the heart of inflation.

The real criticism to be made of the Federal Reserve is not that it has kept credit too scarce and interest rates too high, but that it has yielded to inflationist pressure. It has made credit too plentiful and kept interest rates too low. It is precisely because interest rates are too low that the demand for credit still exceeds the supply. A discount rate of only 3 percent (when 91-day Treasury bills yield 3.404 percent) is inflationary. The Fed might be well-advised follow the example of Canada, and keep the discount rate always at least ¼ of 1 percent above the bill rate. This would also show that the Fed was merely following the market, and not arbitrarily raising interest rates.