April Freeman Banner 2014

ARTICLE

Why the Government Can't Control the Business Cycle

JULY 01, 1958 by ANTHONY REINACH

Mr. Reinach’s insight into economic affairs is well-known to Freeman readers.

It is a widely accepted theory that we can rely on the govern­ment, through manipulation of the money supply, to alleviate or cor­rect the excesses of the business cycle. Nothing could be further from the truth.

Unlike the doctor who can quite accurately predict when a dose of medicine will affect his patient, the money managers have no way of knowing when increases or de­creases in the money supply will affect the nation’s economy. In fiscal matters, the extent of the time lag between cause and effect is virtually impossible to predict. The reasons for this are twofold:

1. People cannot be forced to use money. Since 1944, there have been no appreciable excess bank reserves, which means that the banking system during this time has been able to lend and invest all its available funds. But not so in the preceding decade. From1933 through 1943, except for a few months during the 1936-37 boom let when reserve require­ments were boosted quite sharply, there were always excess reserves — money adjudged superfluous in terms of the prudent economic re­quirements at the time. In Janu­ary 1941, after nearly eight years of sharp expansion of the supply of money, almost $7 billion of it — a record high — lay dormant in the banks. In other words, though this money had been pumped into the economy, it was not being used when deemed desirable.

2. People cannot be forced to spend money at a particular rate. The rate or speed with which people spend money is known as "velocity," and refers to the num­ber of times a year money changes hands. One indication of velocity is in the figures published by the Federal Reserve showing the an­nual turnover of demand deposits.

For instance, in New York City, the commercial and financial cen­ter of the country, the current velocity is around 55. Since de­mand deposits turn over less fre­quently in other parts of the country, the national average is perhaps 40. If we include dormant cash and time deposits, 20 would be a minimum estimate for the current national average velocity of our entire money supply.

The current money supply, in­cluding bank deposits and cur­rency, is about $220 billion. Multi­plying that figure by a velocity of 20 gives $4,400 billion as the amount of money work done in a year. It is apparent that a mere velocity reduction from 20 to 19 would more than cancel out the anticipated effects of almost $12 billion of additional "corrective" money. The reverse also holds, so that an increase in velocity would give just that much additional push to the effects of any expan­sion of the money supply.

If the velocity of money could be held constant, it would be easier to predict how changes in the quantity of money would affect the nation’s economy. But the velocity is far from constant. Be­cause it is highly sensitive to pub­lic psychology, it traditionally re­sists arbitrary regulatory influ­ences.

Demand deposit figures for New York City, adjusted for seasonal variation, reached a peak velocity of 156.8 in October 1929. In defi­ance and to the dismay of pump-priming experts, it then went into a steady decline which lasted 11 years and 3 months. A low in ve­locity of 16.3 was reached in Janu­ary 1941 — the same month in which excess bank reserves at­tained their highest point.

For the past 17 years, the ve­locity of demand deposits in New York City has been climbing steadily to its current level of around 55. Another trend reversal could render injections of "correc­tive" money about as effective as a platoon of soldiers charging a swarm of mosquitoes.

ASSOCIATED ISSUE

July 1958

comments powered by Disqus

EMAIL UPDATES

* indicates required
Sign me up for...

CURRENT ISSUE

April 2014

Around the world, people are struggling to throw off authoritarianism, with deeply mixed results. From Egypt to Venezuela, determined people build networks to overthrow their regimes, but as yet we have not learned to live without Leviathan. In this issue, Michael Malice and Gary Dudney discuss their glimpses inside totalitarian regimes, while Sarah Skwire and Michael Nolan look at how totalitarian regimes grind down the individual--and how individuals fight back. Plus, Jeffrey Tucker identifies a strain in libertarianism that, left unchecked, could reduce even our vibrant movement to something that is analogous to the grim aesthetic of architectural brutalism. The struggle for our lives and freedom is a struggle for beauty; it begins inside each of us.
Download Free PDF

PAST ISSUES

SUBSCRIBE

RENEW YOUR SUBSCRIPTION