DEARER MONETT HIGHER INTEREST RATES ACT TO CURB INFLATION

Press, Volume XCI, Issue 27556, 13 January 1955, Page 8

DEARER MONETT HIGHER INTEREST RATES ACT TO CURB INFLATION

[By

"LYNCEUS"

of the ''Economist”}

[From the “Economist” Intelligence Unit)

London, January 3.—One of the most significant economic trends marked the closing weeks of 1954 and is persisting into 1955 has been a tendency towards a hardening of credit and a rise in interest rates in the most important money markets of the world. It has been particularly noticeable in the United States and the United Kingdom. Germany has participated in this movement, the ripples of which have been steadily widening and have touched such widely dispersed areas as Australia, South Africa and the Scandinavian countries. bo far this hardening of money rates has been apparent only in the structure of open market rates. It has not received the stimulus or confirmation of a rise in central bank official rates of discount— though rumours and expectations of such an adjustment in official rates have been and are widely prevaHow do we account for this phenomenon in the money markets? Are there any indications that it will proceed much further in 1955? The answers to these questions are of considerable importance. They will help to determine the shape of the world economy and the behaviour of security markets in this new year. The simple and obvious answer to the first question is that the rise in interest rates is an indication of an increased demand for credit and capital which is not being accompanied by a corresponding adjustment in their supply. That answer, however, explains nothing. We must look into the causes of the increased demand for credit and, equally important, into the reasoning that has led the monetary authorities in the most important countries in the world to refrain from giving that increased demand the response of a proportionately increased supply of credit—a response which in these days of managed currencies could be made without the slightest technical difficulty. The first and most important reason for the increased demand for credit has been the rise in industrial production, which has been so marked a feature of the latter part of 1954. In Great Britain that rise has continued almost uninterruptedly throughout the year. That has also been the experience of the main European industrial countries. In the United States, however, the recovery from the modest recession which began in mid-1953 and lasted until mid-1954 has been compressed in the second half of last year. The United States economy is so dominant a factor in the world situation that the recent recession in that country must be regarded as a most potent factor in the international credit situation until around the autumn of 1954. The persistence of relatively cheap money in Britain and other sterling countries and over a large part of Europe was in large measure a reflection of the slack which had developed in the United States economy. As soon as that slack was taken up and industrial production began to recover, it was natural to expect an almost immediate hardening of credit conditions in the United States and to see the contagion of that movement spread rapidly to the sterling area and to Western Europe. British Economy at Full Stretch

. While production in the United States has been recovering, the British economy has continued to operate at full stretch and to call for an increasing volume of credit. This industrial demand for credit has also been fed by the rebuilding of stocks of raw materials and semi-manufactured goods, which had been allowed to run down during the period of economic recession in the United States. For many commodities, such as rubber and copper, this rebuilding of stocks has been taking place on the basis of steadily rising prices and this again has helped to contribute to the expansion in the demand for credit.

Not only production and industrial inventories have increased: consumption has also shown every sign of rising to all-time record levels on both sides of the Atlantic. In Great Britain this increasing consumption has been stimulated by the removal earlier in 1954 of all restrictions on hire purchase or consumer credit. There are no comprehensive statistics of the volume of such credit outstanding in Great Britain; but indications from such industries as the motor-car trade, which provide their own statistics of hire-purchase contracts, suggest that since the autumn of 1954, when these restrictions came off. the total of hirepurchase credit outstanding has risen by 50 per cent. The necessarily incomplete and tentative estimates'made of the total amount of such credit suggest that the amount involved lies between £400,000,000 and £500.000.000 It is, therefore, not only the demand for industrial credit but for consumer credit which has gone up. Demand for Long-term Capital Another direction from which the credit situation has been affected is the steadily increasing demand for long-term capital. In Britain industrial investment, which in recent years had been at somewhat undesirably low levels, has recently shown signs of picking up vigorously. New capital issues are steadily increasing. The programme for helping under-developed countries, undertaken under the Colombo Plan, and soon to be reinforced by the American programme for Aid to Asia, is absorbing a slowly but steadily increasing amount of resources. The increased demand for capital has inevitably left its mark on the market for shorter-term credit.

It now remains to be considered why the authorities in the United States, Great Britain and elsewhere have not met this expansion in the demand for credit and capital by allowing supplies to adjust themselves to it at the previously prevailing level of interest rates. In their attitude can be read obvious evidence of policy. Ey resorting to the appropriate open market operations the required expansion of credit supplies could have been provided overnight. The fact that this adjustment has not been made and that, although credit has been expanding, it has not done so at a rate that would have safeguarded previously existing levels of interest rates, must be taken as a sign that the banking and governmental authorities in the United States, Britain, and other countries, are now conscious of the pull towards inflation which is beginning to manifest itself over a large part of the world, and are going out of their way to counter it by allowing credit to become somewhat scarcer and, therefore, dearer.

The movement need not be expected to proceed very far. There is certainly no intention of producing deflation. The days when monetary policy was used to bring down the general level of costs and prices have been left in the pre-Keynesian era. There is, however, all the difference between using the monetary and credit machine for deflationary action and the appropriate adjustment of interest rates to put a curb on the inflation of costs and prices, of which there is so much evidence, in the situation today. It must not be assumed that intelligent management of a currency necessarily implies a permanent erosion of the value of money. The benefit of the doubt will always lie in that direction, but we must expect corrective action now and again; and it is such corrective action which is now being taken on both sides of the Atlantic. The implication must be read favourably in, namely that in the view of the authorities the prospect for 1955 is that of a continuing high level of economic activity and a corresponding maintenance in the demand for capital and credit.