Money Supply in Inflation

Report Outline
Monetary Policy in Control of Inflation
Federal Reserve and Monetary Controls
Limits on Federal Reserve Independence
Special Focus

Monetary Policy in Control of Inflation

The nation entered its ninth year of uninterrupted economic growth in February 1969 with more to worry about than to cheer about. The longest span of prosperity in American history has spawned an inflation which sent consumer prices up 4.7 per cent in 1968, the biggest yearly rise in the cost of living since 1951. As the Nixon administration came into office announcing that inflation was its main economic concern, the country was already beginning to witness what an economist described as “a dramatic collision of two very powerful forces.” Albert T. Sommers of the National Industrial Conference Board pointed out that in early 1969 “Business has been much stronger than was expected [last summer], and the strength of business has induced much tougher policy restraints.”

After waiting in vain since mid-1968 for the 10 per cent surcharge on income taxes to curb inflation, the Federal Reserve System in December took steps to decrease the money supply, tighten bank credit, and raise interest rates. It pushed up the basic rate on Federal Reserve lending to commercial banks—the discount rate—by one-half of a percentage point, to 5½ Per cent, on Dec. 17. The nation's money supply increased at an annual rate of only 3.7 per cent in January, in contrast to the 6.5 per cent average for all of 1968. Reduction of the rate of increase was accomplished in part through sale of government securities—an action which has the effect of diminishing the lendable funds of commercial banks by several times more than the actual value of the securities sold. Between the year-end and early February, the Fed had disposed of a half-billion dollars' worth of its holdings of government securities.

The effect of these moves became apparent in the money markets. Major commercial banks on Jan. 8 raised their “prime” interest rate for the third time in less than six weeks, making their best customers pay a record 7 per cent on borrowings. Others paid more. George Romney, Secretary of Housing and Urban Development, on Jan. 24 raised the interest rate ceiling on government-backed mortgages to 7½ per cent, up from 6¾ per cent, in an effort to attract funds to the housing market. Some states elevated permissible rates under their usury laws to 8 per cent and beyond. The Treasury on Jan. 29 had to offer the highest yield (6.42 per cent) since the Civil War to sell notes maturing in only 15 months. Corporation bonds of the highest quality passed the 7 per cent mark in January, some of them bearing record high interest rates.