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Hence the relatively high discount rate of 4% per cent in 1923, compared with the lowered bond yield, at a time when member banks, owing to sales of securities, were in debt to the reserve banks, added its force to nonmonetary causes; and the combination of circumstances reduced prices to the low index of 145 in May, 1924. Here again the lack of timely action in reducing rates and purchasing securities instead of selling them immediately after prices began to fall in April, 1923, showed itself in that, after the decline in business 1502&-28 28 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 430 STABILIZATION and prices had proceeded in 1924 a panicky purchase of securities was carried on from February to July, 1924, the total increase in holdings of securities amounting to $492,000,000 in 12 months from November, 1923, to October, 1924. This was augmented by a panicky and rapid reduction in discount rates from 4Vk to 3 per cent (New York), the lowest rate in the history of the system since the war. Governor Strong, in his testimony on H. R. 7895 of the first session of the Sixty-ninth Congress (p. 334), ascribed the motives which induced these panicky and excessive operations of the Federal reserve system to the recession in business, the serious bank failures in the West, the relatively high rates of interest and reserve discounts, the perilous condition of the cattle industry approaching national disaster, and the strong feeling throughout the West in favor of radical proposals for legislative and other Government relief. Thus the monetary and nonmonetary circumstances, including public opinion, were such that, when now stimulated by excessive purchases of securities, continued net imports of gold and drastic reductions of discount rates, the price level of commodities shortly responded and rose 11 per cent from June, 1924, to March, 1925, the greatest rise being in agricultural products, which rose 20 per cent from June, 1924, to March, 1925 (Federal Reserve Bulletin May, 1927, p. 313), with the result that factory production, trade, and employment in 1925 increased to almost the full development attained in 1923. (Federal Reserve Board charts on production and employment, pp. 293 and 294.) These events of 1923 and 1924 showed again the failure to employ timely action, under the illusion that only nonmonetary forces caused the rise and fall of the price level, over which monetary and credit policy could have no control. Had stabilization of the purchasing power of money been a guiding principle of the system, then much greater attention would have been given to timely action in the use of its economic instruments. The relatively high rate of 4% per cent would have been reduced in the early part of 1923 when the danger of inflation had been stopped, instead of waiting a year— until May to October, 1924—when only the panicky and drastic reductions could accomplish results; and open market sales, instead of continuing during 1923, would have been changed to open market purchases soon after the price level had started to decline in April, 1923, instead of waiting until November, 1923, followed by excessive purchases needed to get results desired. In either case, nonmonetary causes would have been highly important, and the monetary and credit policy of the system could only operate either to exaggerate or to minimize the nonmonetary forces. But, at the beginning of either monetary or nonmonetary changes when business is hesitating, a very slight use of its powers has much more stabilizing effect than a drastic and panicky use of its powers at a later period when business has been plunging toward inflation or deflation.

This principle of timeliness was elaborately discussed in the tenth annual report of the Federal Reserve Board for the vear 1923, but it has not adequately been observed by the system, because it has had in view changing purposes other than stabilization of purchasing power. Timeliness is the essence of stabilization, and timeliness, for this purpose, apparently can not be brought home to the system until the people, through their representatives, have directed stabiliDigitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis STABILIZATION 431 zation as a primary purpose of the system. Furthermore, the method of learning by experience and experiment has no signficance except with reference to the goal or purpose toward which the experiments and the lessons of experience are directed. Leaving out of account the future expected rise or fall of prices leaves out of account the need of early monetary and credit action in order to stimulate or restrain the nonmonetary forces, both of which afterwards show themselves in the rise or fall of the price level.

Since the middle of 1925 three new events have arisen, upon which the purposes and experiments of the system have not yet had time to yield the conclusions of experience. These are the restoration of gold standards in other countries, the rise of stock and bond prices, and the fall and subsequent rise of commodity prices. United States securities were sold to the amount of $284,000,000 from October, 1924, to January, 1927. This more than offset the net imports of gold during the period from July, 1925, to September, 1927, of $260,000,000. The rates of discount were raised (New York) from the low points of 3 and 3% per cent in 1924 to 4 per cent in the beginning of 1926, and were maintained at that rate (excepting four months) until the middle of 1927. Other reserve banks maintained 4 per cent until August and September, 1927. Wholesale commodity prices fell, from the beginning of 1925 to the middle of 1927, about 11 per cent in the United States, about 17 per cent in England, and about an average of 12 per cent in 14 leading countries having a gold basis. (L. D. Edie, Proceedings, American Economic Association, March, 1928, p. 55.) The fall in the price of industrial or nonagricultural products in America was about 18 per cent from 1923 to March 1927. This was explained by the Reserve Board as partly due to the increased efficiency of American industry, the increased output per person employed during that period being calculated at 10 per cent (Federal Reserve Bulletin, May 1927). Afterwards, witnesses from the Federal Reserve Board expressed the opinion that there should be a fall in prices corresponding to the increase of efficiency in industry and agriculture. This may be taken as one of the goals or purposes toward which the policy of the system is directed over a period of years, namely a gradual reduction of the general price level corresponding to the reductions in costs of production through increased efficiency. Since this is a view widely held by salaried, wage-earning, and creditor classes, made effective by bankers' control of the Federal reserve system, its validity as a goal or purpose of the system should be examined.

Its theoretical, or rather, idealistic basis, appears to be that money incomes of consumers will remain relatively constant and that they therefore, as consumers, can share in the increased efficiency of industry chiefly by reduction in prices, especially retail prices, whereas they lose, as consumers, if prices rise.

I realize that the best exact standard for stabilization is a matter of controversy, though any proposed standard is better than none.

But I submit that this goal of general price reduction is mistaken as against the purpose of maintaining a stable purchasing power of money over commodities with its minor variations as above described.

Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 432 STABILIZATION If it is a goal of the system to adapt its policy toward a gradual decline in prices proportionate to the increase in efficiency, it is the same as saying that the purpose is both to increase the value of the gold standard measured by a general fall in prices, and to increase the commodity purchasing power of the dollar, measured by the same fall. The wording of the bill may be improved, but the object evidently is to incorporate the gold standard in the Federal reserve act, where it now exists only by implication; to stabilize its value or purchasing power, thereby stabilizing the purchasing power of the dollar redeemable in gold; and thus to prevent a Federal reserve policy directed toward a general fall in prices whether alleged to proceed from a nonmonetary cause, such as improved efficiency, or otherwise.

One justification of such a direction by the Congress to the Federal reserve system is that of the supreme public interest in having the producing classes, who are the sellers of products, retain the gains derived from their own energy and initiative in increasing their efficiency. If general prices fall proportionately to increased efficiency, then, in general, manufacturers, farmers, and wage earners fail to get the gains of their own increasing efficiency, since they have no efficiency margin to be shared as higher profits and higher wages.

This general fall of prices discourages the expansion of industry and agriculture, and especially discourages the starting up of new industries to absorb the employees laid off by those industries that are increasing their efficiency. So that, with a general fall in prices, the illusion is created that improvements in technology are a cause of unemployment, whereas a more important cause is the depression in industry and agriculture which prevents reemployment of those displaced by improvements in technology. In a period of rising prices improvements in efficiency do not seriously cause unemployment but they do in periods of falling prices. But since rising prices, beyond the needs of full production and employment, bring an unearned surplus to producers or sellers at the expense of consumers and tyuyers, it is by means of the reasonable stabilization of the dollar's purchasing power that producers get the income earned by their own efficiency, and consumers are protected against unearned income going to producers.

Besides this, the greatest number of consumers, including manufacturers, farmers, and wage earners, can not become consumers until they are first producers. While statistics of employment and unemployment, reflecting as they do, changes in prices, production, and profits, are inadequate, yet various estimates agree in indicating a decline in employment when prices in general are falling, and an increase in employment when prices in general are rising, if they do not rise beyond the point of full employment. An illusion respecting the real earnings of labor, that is, its purchasing power is created by the imperfect statistics of employment. The computed statistics of real earnings of labor are based on the average rates of earnings of those actually on the factory pay rolls, and these show great stability from 1890 to 1914, and then a rapid rise from 1915 to the present time. This rise was not greatly affected by the rise of prices and the accompanying increased prosperity and scarcity of labor from 1915 to 1920, and it continued even during the

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extreme depression of 1920 and 1921, when millions of laborers were unemployed. (Chart, Commons: Real Earnings and Wholesale Prices.) Evidently, the unemployed laborers are not taken into account in these computations, but if the computations of average earnings were made, not merely for those on the pay rolls, but for all laborers dependent on industry for wages, both employed and unemployed, then the average real earnings of the labor population as a whole would fluctuate widely according to the state of employment and unemployment, and corresponding closely to the changes in the wholesale price index. A tentative estimate of this kind is made in the chart above referred to, Curve (1).

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This shows that average real earnings, or purchasing power of all laborers, both on and off pay rolls, follows closely the ups and downs of the average price level. Especially during the years 1915 to 1920 when labor was in great demand, the average real earnings of both employed and unemployed labor rose about 34 per cent, whereas the pay-roll average shows a rise of only 14 per cent. On the other hand, during the fall of prices and its accompanying depression of industry and the unemployment of 1921, the average real earnings of all laborers fell about 22 per cent, although the earnings of payroll employees continued to rise at the rate of 2 or 3 per cent per year. Similar contrasts appear for subsequent years.

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ported by legislation. The stability of employment will be obtained in so far as stability in these various fields is accomplished.

But the most important stability, upon which all others depend, is the stable purchasing power of money, because all of them must use money in accomplishing their own stability, and no stability of particular prices can be adequately accomplished if the purchasing power of money rises or falls unduly. This is the proper field for monetary and credit policy.

The restoration of the gold standard in foreign countries is definitely provided for in this bill, although the reserve system has used its powers for that purpose by implication. In 1925 the reserve banks took such action by extending to England a provisional revolving credit, if needed, to the extent of $200,000,000, and by beeping rates in the discount market low. Again, in the middle of 1927, the restoration and the maintenance of the gold standard in Europe imposed upon the reserve system the necessity of taking drastic action. The system then reversed its open-market operations by purchasing about $290,000,000 United States securities between April, 1927, and December, 1928, and by reducing the rate of discount to Sy2 per cent. Evidence shows that these operations were probably taken upon the representations of European central banks, the substance of which was that any great loss of gold to this country would require those countries to raise their rates of discount and thereby make more serious the existing depression of industry and decline in prices in those countries. This would reduce their effective demand for American exports, chiefly agricultural products. In acting favorably toward these European representations, the Federal reserve system, by buying securities and reducing the rates of discount, was acting in conformity with the clause in section (h) of this bill which directs that " Relations and transactions with foreign banks shall not be inconsistent with the purposes expressed in this amendment."

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