1980 Annual Report / FEDERAL R ESER V E BA N K OF RICHMOND. Digitized for FRASER Federal Reserve Bank of St.

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1 1980 Annual Report / FEDERAL R ESER V E BA N K OF RICHMOND

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4 IS S N L IB R A R Y OK C O N G R E SS C A T A L O G C A R D N U M B E R : 16-72o4 Additional < <;t tin.' Aunual Report may :,r- ootained withe;:! clru^c uom thf Bank and Public Relation.-; Department. Feck-raI Reserve Rank of Richmond, P. O. Box 27(>22, Richmond, Virginia

5 T o Our Member Banks: W e a r e p le a s e d to p r e s e n t th e A n n u a l R e p o r t o f th e F e d e r a l R e s e r v e B a n k o f R ic h m o n d. T h e R e p o r t s fe a tu r e a r t ic le a tte m p ts t o d is p e l s o m e p o p u la r m is c o n c e p tio n s r e g a r d in g th e v ie w s o f J o h n M a y n a r d K e y n e s, th e fa m o u s E n g lis h e c o n o m is t, o n in f la t io n a n d it s c o n t r o l. T h e R e p o r t a ls o in c lu d e s h ig h lig h t s o f th e y e a r, a s u m m a r y o f o p e r a tio n s, c o m p a r a tiv e f in a n c ia l s ta te m e n ts, a n d c u r r e n t lis t s o f d ir e c to r s a n d o ffic e r s o f o u r R ic h m o n d, B a lt im o r e, C h a r lo t t e, C h a r le s to n, C o lu m b ia, a n d C u lp e p e r O ffic e s. O n b e h a lf o f o u r d ir e c to r s a n d s t a ff, w e w is h to t h a n k y o u f o r t h e c o o p e r a tio n a n d s u p p o r t y o u h a v e e x te n d e d to u s t h r o u g h o u t th e p a s t y e a r. S in c e r e ly y o u r s, President

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7 KEYNES ON INFLATION Thomas M. Humphrey Not the least of inflation s consequences is the damage done to the reputations of certain prominent economists. A case in point is John Maynard Keynes ( ). Once highly regarded for his brilliant pathbreaking analysis of the causes of mass unemployment in the Great Depression of the 1930s, he is now given low marks for his views on inflation. Popular folklore has it that he was largely unconcerned with inflation from the start, that his subsequent preoccupation with unemployment led him to ignore it altogether, and that, as a result, he favored expansionary measures to eliminate unemployment regardless of their inflationary consequences. Since his death in 1946 his name (or at least the label Keynesian ) has been linked to such inflationist slogans as full employment at any cost and money doesn t matter. It has also found an association with the discredited concept of a stable enduring trade-off between inflation and unemployment as well as with the equally discredited notion that the authorities can peg interest rates and real economic activity at any desired level simply by manipulating the policy instruments they command. On the policy front his name is now popularly identified with excessive government spending, mounting budget deficits, inflationary money growth, and, in Britain at least, with the idea that inflation can be contained with incomes policies and wage-price controls. In the textbooks, his views are caricatured in the stylized Keynes versus the monetarists manner as the opposite of the anti-inflationary views of the monetarists. Small wonder that he has been widely perceived as an inflationist and that our present inflation is often described as the legacy of Keynes.1 1 For a recent expression of this view see Buchanan and Wagner [1] who assert that Lord Keynes himself must bear substantial responsibility for our apparently permanent and perhaps increasing inflation [1; p. 4]. Without Keynes, they write, inflation would not be the clear and present danger to the free society that it has surely now become. The legacy or heritage of Lord Keynes is the... intellectual legitimacy provided to... deficit spending, inflation, and the growth of government [1; p. 24]. The purpose of this article, however, it to show that the foregoing perceptions are wrong: that far from being an inflationist, Keynes deplored inflation, warned repeatedly of its evils, and recommended restrictive demand management policies to prevent it; that far from being an extreme nonmonetarist, he shared the monetarists antipathy to inflation, endorsed their policy goal of price stability, and employed at least five monetarist concepts in his analysis of inflation; and, finally, that far from advocating full employment at any cost, he maintained that even at high unemployment rates expansionary aggregate demand policy must be curbed to prevent inflation. More precisely, this article demonstrates (1) that Keynes was always concerned with inflation, (2) that this concern motivated his advocacy of antiinflationary aggregate demand management policy on at least two occasions (including once in the Great Depression of the 1930s), and (3) that there are enough monetarist elements in his analysis to qualify him as at least a partial monetarist as far as inflation theory is concerned. These points are documented in the following paragraphs, which summarize Keynes own views on inflation. As pertinent now as they were when he first presented them, his views are contained chiefly in the following works: (1) Indian Currency and Finance (1913), (2) The Economic Consequences of the Peace (1919), (3) policy advice given to the Chancellor of the Exchequer in February 1920, (4) A Tract on Monetary Reform (1923), (5) the twovolume A Treatise on Money (1930), and (6) a series of four newspaper articles published in The Times in early 1937, one year after the publication of his famous The General Theory of Employment Interest and Money (1936). Except for the General Theory, which deals mainly with unemployment and will not be examined here, these works are largely concerned with the problem of inflation. They are examined in the order listed above to show the consistency of Keynes anti-inflation attitudes over time. 5

8 Early Writings K e y n e s s t r o n g a v e r s io n t o in f la t io n is e v id e n t in e v e n h is e a r lie s t w o r k. I t a p p e a rs, f o r e x a m p le, in h is Indian Currency and Finance ( ). T h e r e h e e m p h a tic a lly r e je c ts t h e a r g u m e n t t h a t a d e p r e c i a tin g c u r r e n c y is a d v a n ta g e o u s... t o t r a d e, c o n t e n d in g t h a t a n y a d v a n ta g e s d e r iv e d f r o m in f la t io n a re o n ly t e m p o r a r y a n d t h a t t h e y o c c u r la r g e ly a t th e e x p e n s e o f o th e r m e m b e r s o f t h e c o m m u n it y a n d t h e r e f o r e d o n o t p r o f i t th e c o u n t r y a s a w h o le [ 5 ; p. 2 ]. H e ta k e s a n e v e n t o u g h e r a t t it u d e i n h is Economic Consequences of the Peace ( ), c o n d e m n in g in f la t io n in th e h a r s h e s t p o s s ib le te r m s. H e s a y s : Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some [6; pp ]. H e a g re e s w it h L e n in t h a t in f la t io n h a s th e p o t e n t i a lit y o f d e s t r o y in g th e b a s is o f c a p it a lis t s o c ie ty. Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose [6; p. 149]. H e t h e n p r o c e e d s t o s p e c ify a t le a s t f o u r w a y s t h a t r a p id in f la t io n w o r k s t o w e a k e n th e s o c ia l f a b r ic a n d to u n d e r m in e th e f o u n d a t io n s o f t h e c a p it a lis t f r e e - m a r k e t s y s te m. F ir s t, u n fo r e s e e n in f la t io n, h e s a y s, re s u lts in a c a p r ic io u s a n d t o t a lly a r b it r a r y r e a r r a n g e m e n t o f r ic h e s t h a t v io la te s t h e p r in c ip le s o f d is t r ib u t iv e ju s t ic e. B e s id e s it s in e q u it ie s, in f la t io n a ls o r e n d e r s b u s in e s s u n d e r t a k in g s r is k i e r a n d t h e r e b y t u r n s th e p ro c e s s o f w e a lth - g e t t in g... in t o a g a m b le a n d a lo t t e r y. I n g e n e r a t in g r is k a n d in ju s t ic e, in f la tio n s t r ik e s n o t o n ly a t s e c u r ity, b u t a t c o n fid e n c e in th e e q u it y o f th e e x is t in g d is t r ib u t io n o f w e a lth [ 6 ; p ]. S e c o n d, in f la t io n v io la te s lo n g - t e r m a r r a n g e m e n ts b a s e d o n th e a s s u m e d s t a b ility o f th e v a lu e o f m o n e y. I n so d o in g, in f la t io n d is t u r b s c o n t r a c t s a n d u p s e ts a ll p e r m a n e n t r e la tio n s b e tw e e n d e b to r s a n d c r e d ito r s, w h ic h f o r m th e u lt im a t e f o u n d a t io n o f c a p it a lis m [ 6 ; p ]. T h ir d, in f la t io n g e n e r a te s s o c ia l d is c o n t e n t a n d d ir e c ts i t a g a in s t b u s in e s s m e n w h o s e w in d f a ll p r o f it s a re w r o n g ly p e r c e iv e d t o b e th e c a u s e r a t h e r t h a n th e c o n s e q u e n c e o f in f la t io n. T h is d is c o n te n t is e x p lo it e d b y g o v e r n m e n ts w h ic h b e in g m a n y o f th e m... re c k le s s... a s w e ll a s w e a k, s e e k t o d ir e c t o n t o a c la s s k n o w n a s p r o f it e e r s th e p o p u la r in d ig n a t io n a g a in s t th e m o r e o b v io u s c o n s e q u e n c e s o f t h e ir v ic io u s m e th o d s [ 6 ; p ]. o th e r w o r d s, g o v e r n m e n ts a c tu a lly r e s p o n s ib le f o r c a u s in g in f la t io n s e e k t o s h if t th e b la m e o n t o b u s i n e s s m e n w h o c o n s e q u e n tly lo s e c o n fid e n c e in t h e ir p la c e in s o c ie ty a n d b e c o m e th e e a s y v ic t im s o f in t im id a t io n b y g o v e r n m e n ts o f t h e ir o w n m a k in g, a n d a P r e s s o f w h ic h t h e y a r e th e p r o p r ie t o r s [ 6 ; p ]. B y m a k in g b u s in e s s a s c a p e g o a t a n d t a r g e t o f v ili f i c a t io n a n d c o n t r o l, in f la t io n r e in fo r c e s a n t i b u s in e s s a tt it u d e s a n d w e a k e n s s u p p o r t f o r w h a t K e y n e s c a lle d th e a c tiv e a n d c o n s t r u c t iv e e le m e n t in th e w h o le c a p it a lis t s o c ie ty 2 [ 6 ; p ]. F in a lly, in f la t io n te n d s to b r e e d s u c h m is g u id e d re m e d ie s a s p r ic e r e g u la t io n a n d p r o f it e e r - h u n t in g t h a t m a y d o m o r e d a m a g e t h a n th e in f la t io n it s e lf. K e y n e s w a s e s p e c ia lly c r it ic a l o f th e te n d e n c y o f g o v e r n m e n ts to r e s o r t t o p r ic e c o n tr o ls, w h ic h in h is v ie w le a d t o r e s o u r c e m is a llo c a tio n a n d a r e d u c e d s u p p ly o f g o o d s, th e r e b y c o m p o u n d in g in f la t io n a r y p r e s s u r e s.3 R e g a r d in g th e d is in c e n tiv e s t o r e a l o u t p u t o c c a s io n e d b y c o n t r o ls, h e s a id t h a t th e p r e s e r v a tio n o f a s p u r io u s v a lu e f o r th e c u r r e n c y, b y th e fo r c e o f la w e x p re s s e d in th e r e g u la t io n o f p r ic e s, c o n ta in s in it s e lf, h o w e v e r, th e s e e d s o f f in a l e c o n o m ic d e c a y, a n d s o o n d r ie s u p th e s o u rc e o f u lt im a t e s u p p ly. F o r, b y f r e e z in g p r ic e s a t w h a t a r e lik e ly t o b e d is e q u ilib r iu m le v e ls, c o n t r o ls c o n s t it u te a s y s te m o f c o m p e llin g th e e x c h a n g e o f c o m m o d itie s a t w h a t is n o t t h e ir r e a l r e la tiv e v a lu e, a n d t h is n o t o n ly r e la x e s p r o d u c tio n b u t le a d s f in a lly t o th e w a s te a n d in e f f ic ie n c y o f b a r t e r [ 6 ; p p ]. S u m m a r iz in g th e f o r e g o in g h a r m f u l c o n s e q u e n c e s o f in f la t io n, h e c o n c lu d e s t h a t g o v e r n m e n ts t h a t a llo w in f la t io n t o g e t o u t o f c o n t r o l d o ir r e p a r a b le d a m a g e t o th e e s ta b lis h e d s o c ia l a n d e c o n o m ic o r d e r. I n s o d o in g th e y a r e c a r r y in g a s te p f u r t h e r th e f a t a l p ro c e s s w h ic h th e s u b tle m in d o f L e n in h a d c o n s c io u s ly c o n c e iv e d. F o r, 2 Note that the very inflationary evils denounced by Keynes are likewise stressed by Buchanan and Wagner [1; pp. 61-5]. This in a book, ironically enough, purporting to show that Keynes was an inflationist. 3 Buchanan and Wagner [1; p. 54] echo Keynes contention that the harm wrought by controls must be counted among the major costs of inflation. I n 6

9 By combining a popular hatred of the class of entrepreneurs with the blow already given to social security by the violent and arbitrary disturbance of contract and of the established equilibrium of wealth which is the inevitable result of inflation, these governments are fast rendering impossible a continuance of the social and economic order.... But they have no plan for replacing it [6; p. 150]. I t w o u ld b e d if f i c u lt in d e e d t o f in d a m o r e d a m n in g in d ic t m e n t o f in f la t io n a n d in f la t io n is t p o lic ie s th a n t h a t p r e s e n te d b y K e y n e s in The Economic Consequences of the Peace. A n y o n e s e e k in g e v id e n c e t h a t h e w a s a n in f la t io n is t w i l l n o t f in d i t t h e r e ; o n th e c o n t r a r y, n o t o n ly d o e s h e d is p la y a m a r k e d a v e r s io n t o in f la t io n, b u t h e a ls o sees n o c o m p e n s a tin g b e n e fits to o ff s e t it s e v ils. Policy Advice in Early 1920 K e y n e s c o n c e r n w it h th e d a n g e r s o f in f la t io n i n f l u e n c e d h is p o lic y a d v ic e in th e p o s t - w a r b o o m o f w h e n a n o u t b u r s t o f in f la t io n th r e a te n e d t h e B r it is h e c o n o m y.4 T h e n a s n o w a c r u c ia l p o lic y q u e s tio n w a s : W h a t is th e le a s t c o s tly w a y t o r e m o v e in f la t io n? S h o u ld i t b e d o n e g r a d u a lly o r s w if t ly in o n e s tr o k e? K e y n e s a n s w e r w a s c le a r e n o u g h : r e je c t g r a d u a lis m a n d u s e th e m o n e t a r y s h o c k a p p r o a c h. A c c o r d in g ly, w h e n c o n s u lte d b y A u s t e n C h a m b e r la in, th e C h a n c e llo r o f th e E x c h e q u e r, in e a r ly F e b r u a r y , h e u n h e s ita t in g ly r e c o m m e n d e d a s t if f d o s e o f d e a r m o n e y t o h a lt th e in f la t io n [ 3 ; p ]. H e u r g e d a s e v e r e ly r e s t r ic t iv e m o n e t a r y p o lic y, e n t a ilin g a s te e p ju m p in in t e r e s t ra te s, t o b r e a k th e in f la t io n a r y b o o m. A s k e d to s p e c ify th e d e g re e o f m o n e ta r y r e s t r ic t io n h e w o u ld b e w i l l i n g t o t o le r a t e in o r d e r t o e n d in f la t io n, K e y n e s, a c c o r d in g t o C h a m b e r la in, in d ic a t e d t h a t [ h e ] w o u ld g o f o r a f in a n c ia l c r is is.... W o u ld g o t o w h a t e v e r r a te is n e c e s s a r y... a n d k e e p i t a t t h a t f o r th r e e y e a r s [ 3 ; p ]. I n t h is c o n n e c tio n K e y n e s a r g u e d t h a t g iv e n th e h ig h in f la t io n a r y e x p e c ta tio n s t h e n p r e v a ilin g, s h a r p i n c re a s e s in n o m in a l in t e r e s t r a te s w e r e e s s e n tia l in o r d e r t o r a is e th e r e a l in t e r e s t r a te s u f f ic ie n t ly t o d is c o u r a g e b o r r o w in g a n d s p e n d in g [ 3 ; p ]. T h is, h e a r g u e d, w o u ld n o t c a u s e s e r io u s u n e m p lo y m e n t b e c a u s e t h e r e w a s a w id e m a r g in o f s a fe ty b e fo r e b u s in e s s w o u ld b e o p e r a t in g b e lo w f u l l c a p a c ity. 4 For the details of Keynes advice in this episode see Howson [3]. All references in this section are to Howson, who reproduces the relevant passages from Keynes papers. K e y n e s a d v o c a c y o f t ig h t m o n e y in t h is e p is o d e c le a r ly r e s te d o n h is f e a r o f th e d a m a g e t h a t c o n t in u in g r a p id in f la t io n c o u ld in f l i c t o n s o c ie ty a n d th e c a p it a lis t s y s te m. H e s ta te d a s m u c h in a m e m o r a n d u m w r i t t e n s h o r t ly a f t e r h is m e e tin g w it h th e C h a n c e llo r o f th e E x c h e q u e r. H e fe a r e d, h e n o te d, t h a t p e r s is te n t in f la t io n w o u ld g e n e r a te s o c ia l u n r e s t a n d s t r ik e a t th e w h o le b a s is o f c o n t r a c t, o f s e c u r ity, a n d o f th e c a p it a lis t s y s te m g e n e r a lly, e v e n t u a lly le a d in g t o s o c ia lis tic c o n t r o l o v e r in d u s t r y. T h e c h o ic e, h e th o u g h t, w a s b e tw e e n d e a r m o n e y o r... s o c ia liz a t io n o f th e s u p p ly o f c a p it a l [ 3 ; p ]. G iv e n th e s e a lte r n a tiv e s, K e y n e s w a s c le a r ly in f a v o r o f d e a r m o n e y, a p o s it io n h e m a in ta in e d f o r th e r e s t o f h is c a r e e r. H e a c k n o w le d g e d t h is in J a n u a r y w h e n, lo o k in g b a c k a t h is e a r lie r p o lic y a d v ic e, h e d e c la r e d t h a t h e w o u ld g iv e t o d a y e x a c t ly th e s a m e a d v ic e t h a t I g a v e th e n, n a m e ly a s w if t a n d s e v e re d o s e o f d e a r m o n e y, s u ff ic ie n t t o b r e a k th e m a r k e t, a n d q u ic k e n o u g h t o p r e v e n t a t le a s t s o m e o f th e d is a s tr o u s c o n s e q u e n c e s t h a t w o u ld o th e r w is e e n s u e [ 3 ; p ]. K e y n e s s ta te m e n t s u g g e s ts t h a t e v e n th e in t e r v e n in g y e a rs o f th e G r e a t D e p r e s s io n o f th e s h a d n o t le s s e n e d h is c o n c e r n a b o u t th e d a n g e r s o f in f la t io n, d a n g e r s t h a t h e h a d d e s c r ib e d e a r lie r in h is A Tract on Monetary Reform. A Tract on Monetary Reform ( ) N o w h e r e d o e s K e y n e s e x p r e s s h is c o n c e r n f o r i n f la t io n m o r e s t r o n g ly t h a n in th e Tract. T h e r e h is c h ie f fe a r is t h a t in f la t io n m a y r e t a r d c a p it a l f o r m a t io n a n d in h i b it lo n g - t e r m e c o n o m ic g r o w t h. H e s p e c ifie s a t le a s t th r e e w a y s t h a t t h is c a n h a p p e n. H e n o te s f i r s t th e in f la t io n a r y d is in c e n tiv e t o s a v in g. B y e r o d in g th e r e a l v a lu e o f p a s t s a v in g s, in f la t io n d im in is h e s th e c a p a c ity o f th e in v e s t in g c la s s t o s a v e a n d d e s tr o y s t h e a tm o s p h e r e o f c o n fid e n c e w h ic h is a c o n d it io n o f t h e w illin g n e s s t o s a v e [ 7 ; p. 2 9 ]. W i t h a s m a lle r p o r t io n o f n a t io n a l in c o m e f lo w in g in t o s a v in g a n d in v e s tm e n t, th e r a te o f c a p ita l a c c u m u la t io n f a lls. A n d s in c e, a c c o r d in g t o K e y n e s, th e n a t io n a l c a p ita l m u s t g r o w a s fa s t a 9 th e n a t io n a l la b o r s u p p ly f o r th e m a in te n a n c e o f th e s a m e s t a n d a r d o f lif e, i t f o llo w s t h a t a f a ll in c a p ita l g r o w t h b e lo w t h e r e q u ir e d p r o p o r t io n a l r a te w i l l lo w e r l i v i n g s ta n d a r d s [ 7 ; p. 2 9 ], I n s h o r t, b y d is c o u r a g in g s a v in g a n d c a p ita l f o r m a tio n, in f la t io n m a y c a u s e a f a l l in th e a g g r e g a te c a p it a l/ la b o r r a t io ( i.e., th e a m o u n t o f c a p ita l e a c h la b o r e r h a s t o w o r k 7

10 w i t h ) a n d a c o r r e s p o n d in g d r o p in la b o r p r o d u c t iv it y a n d o u t p u t p e r c a p ita. A s e c o n d f a c t o r r e t a r d in g c a p it a l a c c u m u la tio n is th e u n d e r c h a r g in g o f d e p r e c ia tio n d u r in g in f la t io n a n d th e c o n s e q u e n t in a d e q u a te p r o v is io n f o r th e r e p la c e m e n t o f w o r n - o u t c a p it a l. T h is o c c u rs b e c a u s e d e p r e c ia tio n c h a r g e s o n c a p it a l e q u ip m e n t a r e c o m p u te d o n th e b a s is o f o r ig in a l ( h is t o r ic a l) c o s t r a t h e r t h a n r e p la c e m e n t c o s ts. T h e s e r e p la c e m e n t c o s ts r is e w it h in f la t io n. T h u s w h e n p r ic e s r is e th e d e p r e c ia tio n c h a r g e s c a lc u la te d o n th e b a s is o f o r ig in a l c o s t a r e to o s m a ll t o r e p la c e th e w o r n - o u t c a p ita l. T h e r e s u lt m a y b e a n u n in t e n d e d d e p le tio n o f th e c a p ita l s to c k. I n s u c h c o n d it io n s, s a id K e y n e s, a c o u n t r y c a n e v e n t r e n c h o n e x is t in g c a p ita l o r f a il t o m a k e g o o d it s c u r r e n t d e p r e c ia tio n. F o r i t is o n e o f th e e v ils o f a d e p r e c ia tin g c u r r e n c y t h a t i t e n a b le s a c o m m u n it y t o liv e o n it s c a p it a l u n a w a r e s. T h e in c r e a s in g money v a lu e o f th e c o m m u n it y s c a p ita l g o o d s o b s c u re s t e m p o r a r ily a d im in u t io n in th e r e a l q u a n t it y o f th e s t o c k [ 7 ; p p ]. Y e t a t h i r d a d v e r s e e ffe c t o n c a p it a l f o r m a tio n, h e n o te d, is th e in c re a s e d b u s in e s s r is k r e s u ltin g f r o m in f la t io n. F o r in f la t io n a d d s t o o r d in a r y b u s in e s s r is k th e e x tr a r is k d ir e c t ly a r is in g o u t o f in s t a b ilit y in th e v a lu e o f m o n e y [ 7 ; p. 3 3 ]. T o c o m p e n s a te f o r t h is e x tr a r is k, b u s in e s s m e n a d d a r is k p r e m iu m to th e r a te a t w h ic h t h e y d is c o u n t th e f u t u r e, a n d th e h ig h e r d is c o u n t r a t e d is c o u r a g e s in v e s tm e n t. T h e d is c o u r a g in g e ffe c ts o f in f la t io n o n s a v in g, i n v e s tm e n t, a n d g r o w t h w e r e n o t th e o n ly in f la t io n a r y e v ils d e s c rib e d b y K e y n e s in th e Tract. O th e r s i n c lu d e d ( 1 ) th e in ju s t ic e a n d in e q u it y r e s u ltin g f r o m in f la t io n a r y r e d is t r ib u t io n s o f in c o m e a n d w e a lth, ( 2 ) th e r e s o r t t o s p u r io u s in f la t io n r e m e d ie s e.g., p r ic e c o n tr o ls, e x c e s s p r o f it s ta x e s, p r o f it e e r - h u n t in g a n d th e lik e r e m e d ie s t h a t c o n s t it u te n o t th e le a s t p a r t o f th e e v ils, o fte n d o in g m o r e h a r m t h a n th e in f la t io n th e y a r e d e s ig n e d t o c u r e, a n d ( 3 ) th e s o c ia l r e s e n tm e n t a n d d is c o n t e n t p r o d u c e d b y in f la t io n. T h is r e s e n tm e n t, w h e n d ir e c te d a g a in s t t h e b u s in e s s c la s s w h o s e w in d f a ll p r o f it s a r e w r o n g ly p e r c e iv e d a s th e c a u s e r a t h e r t h a n t h e c o n s e q u e n c e o f in f la t io n, w o r k s t o d is c r e d it e n t e r p r is e a n d t o w e a k e n s u p p o r t f o r th e p r o d u c t iv e e le m e n t o f s o c ie ty th e p r o p o f s o c ie ty a n d th e b u ild e r o f th e f u t u r e [ 7 ; p. 2 4 ]. H a v in g d is c u s s e d th e a d v e r s e e ffe c ts o f in f la t io n o n c a p it a l f o r m a t io n, e c o n o m ic g r o w t h, d is t r ib u t iv e ju s t ic e, a n d s o c ia l s t a b ility, r e s p e c tiv e ly, K e y n e s n e x t c o n s id e r s th e a lle g e d b e n e fic ia l o u t p u t e ffe c ts o f i n f la t io n. H e n o te s t h a t u n a n t ic ip a t e d in f la t io n m a y t e m p o r a r ily s tim u la te e c o n o m ic a c t i v it y b y r a is in g p r o f it s a n d p r o f it e x p e c ta tio n s. P r o f i t s r is e, h e s a id, b e c a u s e w a g e s a n d o th e r c o s ts la g b e h in d r is in g p r ic e s d u r in g in f la t io n. A n d w i t h n o m in a l w a g e s la g g in g b e h in d p r ic e s, r e a l w a g e s f a ll, th u s in d u c in g p r o d u c e r s to s te p u p t h e ir e m p lo y m e n t o f la b o r. L ik e w is e, th e la g g e d a d ju s t m e n t o f m a r k e t in t e r e s t ra te s to in f la t io n a n d th e c o n s e q u e n t f a l l in th e re a l c o s t o f b o r r o w in g le a d s p r o d u c e r s t o e x p a n d t h e ir o p e r a tio n s. F in a lly, in f la t io n re d u c e s t h e r e a l b u r d e n o f f ix e d c h a rg e s, th e r e b y g iv in g a t e m p o r a r y f i l l i p t o p r o f it s a n d t o e c o n o m ic a c t iv it y. B u t K e y n e s i n s is te d t h a t a n y s u c h s t im u lu s w o u ld m o s t lik e ly b e s m a ll a n d s h o r t - liv e d. M o r e o v e r i t w o u ld c o n s t it u te a n u n d e s ir a b le o v e r s t im u la t io n o f in d u s t r ia l a c t iv i t y r e q u ir in g u n d u e s t r a in o n c a p a c it y a n d a c o r r e s p o n d in g o v e r - e x e r t io n o f la b o r [ 7 ; p. 3 6 ]. F o r th e s e re a s o n s h e ju d g e d th e o v e r a ll b e n e fits t o b e m in im a l. C o n s e q u e n tly, w h e n K e y n e s w e ig h e d th e b e n e fits o f in f la t io n a g a in s t th e e v ils, h e f o u n d t h e la t t e r t o f a r o u t w e ig h th e f o r m e r a n d a c c o r d in g ly c a m e d o w n h e a v ily in f a v o r o f p r ic e s t a b ility. H e s u m m a r iz e d h is c a s e f o r p r ic e s t a b ilit y b e s t w h e n h e d e c la r e d t h a t, b e c a u s e in f la t io n is u n ju s t a n d d e f la t io n is in e x p e d ie n t..., b o th a r e e v ils to b e s h u n n e d. T h e in d iv id u a lis t ic c a p it a lis m o f to d a y, p r e c is e ly b e c a u s e i t e n t r u s t s s a v in g to th e in d iv id u a l in v e s t o r a n d p r o d u c tio n t o th e in d iv id u a l e m p lo y e r, presumes a s ta b le m e a s u r in g - r o d o f v a lu e, a n d c a n n o t b e e ffic ie n t p e r h a p s c a n n o t s u r v iv e w it h o u t o n e [ 7 ; p. 3 6 ]. I t f o llo w s, h e s a id, t h a t th e g o v e r n m e n t s h o u ld m a k e p r ic e s ta b i l i t y it s p r im a r y p o lic y g o a l. F o r, i f w e a r e to c o n tin u e t o d r a w th e v o lu n t a r y s a v in g s o f th e c o m m u n it y in t o in v e s tm e n ts, w e m u s t m a k e i t a p r im e o b je c t o f d e lib e r a te S ta te p o lic y t h a t t h e s ta n d a r d o f v a lu e, in t e r m s o f w h ic h t h e y a r e e x p re s s e d, s h o u ld b e k e p t s ta b le [ 7 ; p. 1 6 ]. T h e s e a r e h a r d ly th e s e n tim e n ts o f a n in f la t io n is t. O n th e c o n t r a r y, t h e y a r e a n in d ic a t io n o f K e y n e s h a r d - lin e a n t ip a t h y t o in f la t io n a n d h is b e lie f in th e a b s o lu te n e c e s s ity o f p r ic e le v e l s t a b ility. Monetarist Aspects of the Tract T h e a n a ly s is o f in f la t io n c o n ta in e d in th e Tract h a s m u c h in c o m m o n w it h t h e p o s it io n t a k e n b y t o d a y s m o n e ta r is ts. S p e c if ic a lly, in f la t io n is d is c u s s e d w i t h in th e c o n t e x t o f a n a n a ly t ic a l m o d e l t h a t is r e m a r k a b ly m o n e t a r is t in s p ir it, e m b o d y in g s u c h s ta n d a r d m o n e t a r is t in g r e d ie n ts a s ( 1 ) t h e q u a n t it y t h e o r y o f m o n e y, ( 2 ) th e c o n c e p t o f in f la t io n a s a t a x o n re a l 8

11 m o n e y b a la n c e s, ( 3 ) t h e m o n e t a r y a p p r o a c h t o e x c h a n g e r a te d e t e r m in a tio n, a n d ( 4 ) th e F is h e r ia n d is t in c t io n b e tw e e n r e a l a n d n o m in a l in t e r e s t ra te s. T h e p a r a g r a p h s b e lo w s u m m a r iz e K e y n e s v ie w s o n th e s e e le m e n ts in o r d e r t o d e m o n s tr a te t h a t h e w a s n o t th e s te r e o ty p e n o n m o n e t a r is t c a r ic a tu r e o f th e te x tb o o k s. Quantity Theory of Money T h e K e y n e s o f th e Tract w a s a n u n e q u iv o c a l a d h e r e n t o f th e q u a n t it y t h e o r y. T h is t h e o r y, h e s a id, is fu n d a m e n ta l. I t s c o r r e s p o n d e n c e w it h fa c t is n o t o p e n to q u e s t io n [ 7 ; p. 6 1 ]. H is o w n v e r s io n o f th e t h e o r y a s e lu c id a te d in th e Tract is e s s e n tia lly th e s a m e a s th e m o d e r n m o n e t a r is t v e r s io n a n d e m b o d ie s th e f o llo w in g m o n e t a r is t e le m e n t s : (1) a money supply and demand theory of price level determination, (2) the notion of money stock exogeneity, implying money-to-price causality, (3) the concept of the demand for money as a stable function of a few key variables, and (4) a focus on the special role of price expectations in the money demand function. R e g a r d in g th e m o n e y s u p p ly a n d d e m a n d t h e o r y o f th e p r ic e le v e l, h e s a id t h a t t w o e le m e n ts d e te r m in e g e n e r a l p r ic e s a n d th e v a lu e o f m o n e y. F ir s t, th e q u a n t it y, p r e s e n t a n d p r o s p e c tiv e, o f [ m o n e y ] in c ir c u la t io n. S e c o n d, th e a m o u n t o f p u r c h a s in g p o w e r w h ic h i t s u its t h e p u b lic t o h o ld in t h a t s h a p e [ 7 ; p. x v i i i ]. E ls e w h e r e in th e Tract h e s a y s t h a t th e p r ic e le v e l d e p e n d s o n th e c u r r e n c y p o lic y o f th e g o v e r n m e n t a n d th e c u r r e n c y h a b its o f th e p e o p le, in a c c o rd a n c e w it h th e q u a n t it y t h e o r y o f m o n e y [ 7 ; p. 7 1 ]. H a v in g d e c la r e d t h a t g e n e r a l p r ic e s d e p e n d o n m o n e y s u p p ly a n d d e m a n d, h e n e x t p r e s e n te d th e q u a n t it y t h e o r y in th e f o r m o f th e e q u a tio n P = M / D o r M / P = D, w h ic h s a y s t h a t th e p r ic e le v e l, P, a d ju s t s t o e q u a te th e r e a l ( p r ic e - d e f la t e d ) v a lu e o f th e g iv e n n o m in a l m o n e y s to c k, M, w it h th e p u b lic s r e a l d e m a n d f o r it, D. 5 H e th e n p ro c e e d e d t o a n a ly z e th e v a r ia b le s o f th e f o r e g o in g e q u a tio n. R e g a r d in g th e 5 Keynes [7; p. 63] employed a slightly different notation, writing the equation as n=pk, where n denotes the nominal money stock, p the price level, and k the quantity of real cash balances people desire to hold. He also presents a more elaborate version of the equation, namely n = p(k + rk'), where k and k' denote real cash balances held by the public in the form of currency and checking deposits, respectively, and r is the ratio of cash reserves that banks hold behind their deposit liabilities. n o m in a l m o n e y s to c k, M, h e s a id t h a t i t is a n e x o g e n o u s v a r ia b le c o n t r o lla b le b y t h e c e n tr a l b a n k s u c h t h a t c a u s a tio n r u n s f r o m m o n e y t o p r ic e s r a t h e r th a n v ic e - v e r s a a s c la im e d b y s o m e b e lie v e r s in a p a s s iv e, d e m a n d - d e t e r m in e d m o n e y s to c k. T h e m o n e y s u p p ly, K e y n e s d e c la r e d, is u n d e r th e c o n t r o l ( o r o u g h t to b e ) o f th e c e n t r a l b a n k in g a u t h o r it ie s w h o t h u s p o s s e s s th e m e a n s t o s ta b iliz e p r ic e s [ 7 ; p. 6 8 ]. W i t h re s p e c t t o th e e q u a t io n s m o n e y d e m a n d c o m p o n e n t, D, K e y n e s s ta te d t h a t i t is d e te r m in e d b y s e v e r a l u n d e r ly in g f a c t o r s in c lu d in g ( 1 ) w e a lth, ( 2 ) h a b it s, ( 3 ) in t e r e s t r a te s ( th e e s tim a te d a d v a n ta g e s o f k e e p in g m o r e c a s h o n h a n d c o m p a r e d w it h th o s e o f... in v e s t in g i t ), a n d ( 4 ) e x p e c te d in f la t io n ( th e t r u s t o r d is t r u s t w h ic h th e p u b lic fe e l in th e p r o s p e c t o f th e f u t u r e v a lu e o f th e c u r r e n c y ) [ 7 ; p p. 6 2, 6 4, x v i i i ]. H e r e is th e m o n e t a r is t n o t io n o f th e d e m a n d f o r m o n e y a s a s ta b le f u n c t io n o f a f e w k e y v a r ia b le s. O f th e s e f o u r v a r ia b le s K e y n e s p a id p a r t ic u la r a t t e n t io n to th e e x p e c te d r a te o f in f la t io n, p o in t in g o u t t h a t it s in c lu s io n in th e m o n e y d e m a n d f u n c t io n m e a n s t h a t m o n e y d e m a n d is n o t c o m p le te ly in d e p e n d e n t o f m o n e y s u p p ly. F o r, a c c o r d in g t o h im, r a p id in c re a s e s in m o n e y s u p p ly m a y g e n e r a te e x p e c t a t io n s o f f u t u r e in f la t io n ( e x p e c ta tio n s t h a t c o n s t i tu t e t h e a n tic ip a te d d e p r e c ia tio n c o s t o f h o ld in g m o n e y ) a n d th e r e b y lo w e r r e a l m o n e y d e m a n d. T h is, h e n o te d, im p lie s t h a t m o n e y g r o w t h a ffe c ts p r ic e s b o th d ir e c t ly a n d a ls o in d ir e c t ly t h r o u g h th e p r ic e e x p e c ta tio n s v a r ia b le in th e m o n e y d e m a n d f u n c t io n. T h e in d ir e c t e ffe c t m a g n ifie s t h e i n it ia l im p a c t o f m o n e y g r o w t h o n in f la t io n, c a u s in g p r ic e s to r is e fa s t e r th a n th e m o n e y s to c k its e lf. I n h is o w n w o r d s, a c h a n g e in [ t h e m o n e y s to c k ] d u e to c a u s e s w h ic h s e t u p a g e n e r a l e x p e c t a t io n o f a f u r t h e r [ in f l a t io n a r y ] c h a n g e in t h e s a m e d ir e c tio n, m a y p r o d u c e a more t h a n p r o p o r t io n a t e e ffe c t o n [ p r ic e s ] [ 7 ; p. 6 6 ]. P r ic e s o u t s t r ip m o n e y, h e s a id, b e c a u s e in f la t io n a r y m o n e y g r o w t h, b y g e n e r a t in g e x p e c ta tio n s o f f u t u r e in f la t io n a n d t h e r e b y r a is in g th e a n tic ip a te d d e p r e c ia tio n c o s t o f h o ld in g m o n e y, re d u c e s th e d e m a n d f o r r e a l c a s h b a la n c e s a n d s tim u la te s a c o r r e s p o n d in g r is e in m o n e y t u r n o v e r. T h is e x p e c - ta t io n s - in d u c e d r is e in th e c ir c u la t io n v e lo c ity o f m o n e y p u t s a d d it io n a l u p w a r d p r e s s u r e o n p ric e s, th u s m a g n if y in g th e im p a c t o f m o n e y g r o w t h o n in f la t io n. K e y n e s p o in te d o u t t h a t t h is s e q u e n c e o f e v e n ts h a d a c tu a lly o c c u r r e d in th e G e r m a n h y p e r in f la t io n o f w h e n p r ic e s ro s e fa s t e r t h a n th e n o m in a l 9

12 m o n e y s to c k. H e a ls o n o te d t h a t t h e s a m e s e q u e n c e o f e v e n ts e x p la in e d t h e p e r p le x in g f a l l in t h e r e a l o r p r ic e - d e fla t e d m o n e y s to c k t h a t h a d p u z z le d G e r m a n o b s e r v e r s a t th e tim e. T h a t is, h e s a id t h a t t h e e x - p e c ta tio n s - in d u c e d f l i g h t f r o m c a s h a n d th e c o r r e s p o n d in g r is e in v e lo c it y h a d c a u s e d p r ic e s in G e r m a n y t o r is e fa s t e r t h a n th e n o m in a l m o n e y s to c k t h e r e b y p r o d u c in g t h e o b s e rv e d s h r in k a g e o f t h e r e a l o r p r ic e - d e fla te d m o n e y s to c k. C o n v e r s e ly, h e n o te d t h a t e x p e c ta tio n s o f s lo w e r m o n e y g r o w t h t h a t r e d u c e th e p u b lic s d e g re e o f... d is t r u s t o f th e f u t u r e v a lu e o f th e m o n e y w i l l le a d t o s o m e in c r e a s e s in t h e ir u s e o f i t r e s u ltin g in a r is e in t h e r e a l m o n e y s to c k [ 7 ; p. 47). F in a lly, K e y n e s e m p lo y e d th e q u a n t it y t h e o r y in h is p o lic y a n a ly s is, a r g u in g ( 1 ) t h a t in f la t io n is c a u s e d b y a n e x c e s s s u p p ly o f m o n e y, ( 2 ) t h a t s u c h m o n e t a r y e x c e s s c o u ld s te m f r o m f a lls in m o n e y d e m a n d a s w e ll a s f r o m ris e s in m o n e y s u p p ly, ( 3 ) t h a t th e c e n t r a l b a n k p o s s e s s e s th e p o w e r t o p r e v e n t t h e la t t e r a n d c o u n te r a c t t h e f o r m e r, a n d ( 4 ) t h a t i t s h o u ld e m p lo y t h is p o w e r t o s t a b iliz e p r ic e s. F o r p r ic e s ta b i l i t y h e r e c o m m e n d e d d e lib e r a te c o u n t e r c y c lic a l m o v e m e n ts in th e m o n e y s u p p ly t o o ffs e t o r n u l l i f y th e p r o c y c lic a l im p a c t o f c h a n g e s in m o n e y d e m a n d o n p r ic e s. H e t h o u g h t t h a t r e a l m o n e y d e m a n d f lu c tu a te d w it h th e s ta te o f b u s in e s s c o n fid e n c e, f a l l in g in b o o m s, r is in g in s lu m p s, a n d th e r e b y a m p l if y in g c y c lic a l m o v e m e n ts o f p r ic e s. T h e c h a r a c t e r is tic o f th e c r e d it c y c le, h e s a id, c o n s is ts in a te n d e n c y o f [ r e a l c a s h b a la n c e s ] t o d im in is h d u r in g t h e b o o m a n d in c r e a s e d u r in g th e d e p r e s s io n [ 7 ; p. 6 7 ]. T o c o u n t e r a c t th e s e h e a d v o c a te d d e lib e r a te m o n e t a r y c o n t r a c t io n in b o o m s a n d m o n e t a r y e x p a n s io n in s lu m p s. T h e t im e t o d e fla te th e s u p p ly o f c a s h, h e s a id, is w h e n r e a l b a la n c e s a r e f a l lin g... a n d... th e t im e to in f la t e th e s u p p ly o f c a s h is w h e n r e a l b a la n c e s a r e r is in g, a n d n o t, a s s e e m s t o b e o u r p r e s e n t p r a c tic e, th e o th e r w a y r o u n d [ 7 ; p ]. I n s o s ta tin g, h e r e je c te d th e m o n e t a r is t c a s e f o r a f ix e d m o n e ta r y g r o w t h r a te r u le ( w h ic h h e a r g u e d is b o u n d t o le a d t o u n s te a d in e s s o f th e p r ic e le v e l w h e n m o n e y d e m a n d f lu c t u a t e s ) in f a v o r o f d is c r e t io n a r y m o n e t a r y m a n a g e m e n t [ 7 ; p. 6 9 ]. I n th e m o d e r n w o r ld o f p a p e r c u r r e n c y a n d b a n k c r e d it, h e d e c la r e d, th e r e is n o e s c a p e f r o m a m a n a g e d c u r r e n c y [ 7 ; p ]. N o t e, h o w e v e r, t h a t w h ile h e r e je c te d th e m o n e t a r is t c a s e f o r r u le s in s te a d o f d is c r e t io n in th e c o n d u c t o f m o n e t a r y p o lic y, h e d id v o ic e th e m o d e r n m o n e t a r is t c o m p la in t t h a t d is c r e t io n a r y m o n e ta r y m o v e m e n ts f r e q u e n t ly te n d t o b e p r o c y c lic a l r a t h e r th a n c o u n t e r c y c lic a l. T h a t is, h e c o m p la in e d t h a t th e B r it is h m o n e t a r y a u t h o r it ie s h a d p e r v e r s e ly e n g in e e r e d m o n e t a r y e x p a n s io n s in b o o m s w h e n m o n e y d e m a n d w a s f a l lin g a n d m o n e t a r y c o n t r a c t io n in s lu m p s w h e n m o n e y d e m a n d w a s r is in g th e r e b y a g g r a v a t in g r a t h e r t h a n m it ig a t in g in f la t io n a n d d e fla tio n. T h e s e p o lic y e r r o r s n o t w it h s t a n d in g, h o w e v e r, h e r e m a in e d a s t r o n g a d v o c a te o f d is c r e t io n a r y m o n e t a r y in t e r v e n t io n in th e p u r s u it o f p r ic e s t a b ility. Inflation as a Tax on Real Money Balances T h e s e c o n d m o n e t a r is t in g r e d ie n t t h a t K e y n e s e n u n c ia te s in th e Tract is th e c o n c e p t o f in f la t io n a s a t a x o n r e a l m o n e y b a la n c e s. A s n o te d b y t h e la te H a r r y J o h n s o n, t h is in f la t io n t a x a n a ly s is c o n s titu te s a n e s s e n tia l p a r t o f th e q u a n t it y t h e o r y a p p r o a c h t o in f la t io n. C o n s is te n t w it h t h a t a p p r o a c h, K e y n e s a rg u e s t h a t in f la t io n is a m e th o d o f t a x a t io n w h ic h th e g o v e r n m e n t u s e s to s e c u re th e c o m m a n d o v e r r e a l re s o u rc e s, re s o u rc e s ju s t a s r e a l a s th o s e o b ta in e d b y [ o r d in a r y ] t a x a t io n [ 7 ; p. 3 7 ]. W h a t is r a is e d b y p r in t i n g n o te s, h e w r ite s, is ju s t a s m u c h ta k e n f r o m th e p u b lic a s is a b e e r d u t y o r a n in c o m e t a x [ 7 ; p. 5 2 ]. R e g a r d in g th e in f la t io n t a x h e s a y s t h a t a g o v e r n m e n t c a n liv e b y t h is m e a n s w h e n i t c a n liv e b y n o o th e r. I t is th e f o r m o f t a x a t io n w h ic h th e p u b lic f in d h a r d e s t to e v a d e a n d e v e n th e w e a k e s t g o v e r n m e n t c a n e n fo r c e, w h e n i t c a n e n fo r c e n o t h in g e ls e [ 7 ; p. 3 7 ]. I n d is c u s s in g th e in f la t io n t a x, K e y n e s s tre s s e s t h a t i t is a t a x o n c a s h b a la n c e s. T h e b u r d e n o f t h e t a x, h e s a y s, f a lls o n c a s h h o ld e r s, i.e., on the holders of the original... notes, whose notes [after inflation] are worth... less than they were before. The inflation has amounted to a tax... on all holders of notes in proportion to their holdings. The burden of the tax is well spread, cannot be evaded, costs nothing to collect, and falls, in a rough sort of way, in proportion to the wealth of the victim. No wonder its superficial advantages have attracted Ministers of Finance [7; p. 39]. H e n e x t e x p la in s h o w in f la t io n a r y m o n e y c r e a t io n tr a n s f e r s r e a l r e s o u r c e s f r o m c a s h h o ld e r s t o t h e g o v e r n m e n t. H e n o te s t h a t a g iv e n, s a y, 2 5 p e r c e n t i n f la t io n r a te r e q u ir e s a n e q u iv a le n t r a te o f r is e o f c a s h h o ld in g s ju s t t o m a in t a in r e a l m o n e y b a la n c e s a t d e s ir e d le v e ls. T o a c c o m p lis h th is, c a s h h o ld e r s c u t e x p e n d itu r e s o n g o o d s a n d s e rv ic e s a n d a d d th e u n s p e n t p ro c e e d s to m o n e y b a la n c e s. T h e re d u c e d 10

13 p r iv a t e o u t la y f o r g o o d s a n d s e rv ic e s re le a s e s r e s o u rc e s w h ic h th e g o v e r n m e n t a c q u ir e s w it h n e w ly is s u e d m o n e y t h a t is t h e n a d d e d t o p r iv a t e c a s h b a l a n c e s. I n t h is w a y in f la t io n e n a b le s t h e g o v e r n m e n t t o a p p r o p r ia t e r e a l re s o u rc e s f r o m c a s h h o ld e r s ju s t a s s u r e ly a s i f i t h a d ta k e n p a r t o f t h e ir e a r lie r m o n e y b a la n c e s a n d s p e n t th e p ro c e e d s o n g o o d s a n d s e r v ic e s. H o w m u c h th e g o v e r n m e n t g e ts d e p e n d s u p o n th e q u a n t it y o f r e a l b a la n c e s th e p u b lic w is h e s to h o ld w h e n th e in f la t io n r a te is 2 5 p e r c e n t. A s s u m in g th e p u b lic d e s ir e s r e a l b a la n c e s t o t a lin g $ 3 6 m illio n, th e g o v e r n m e n t s t a x ta k e is 2 5 p e r c e n t o f t h a t s u m o r $ 9 m illio n. O r, a s K e y n e s h im s e lf p u t i t in d is c u s s in g th e e ffe c ts o f th e h y p o t h e t ic a l 2 5 p e r c e n t in f la t io n t a x o n r e a l b a la n c e s o f $ 3 6 m illio n, b y th e p ro c e s s o f p r in t i n g th e a d d it io n a l n o te s th e g o v e r n m e n t h a s tr a n s f e r r e d t o it s e lf a n a m o u n t e q u a l t o $ 9 m il lio n, ju s t a s s u c c e s s fu lly a s i f i t h a d r a is e d th is s u m i n t a x a t io n [7 ; p. 3 9 ]. K e y n e s d is c u s s io n o f th e in f la t io n t a x in c lu d e s a s o p h is tic a te d a n a ly s is o f th e o p t im a l r a t e o f in f la t io n f r o m th e p o in t o f v ie w o f m a x im iz in g t a x r e v e n u e. I n t h is c o n n e c tio n h e m a k e s f o u r p o in t s. F ir s t, f r o m th e f o r m u la t h a t t a x y ie ld e q u a ls t a x r a t e tim e s t a x b a s e, i t f o llo w s t h a t th e y ie ld o f t h e in f la t io n t a x is th e m u lt ip lic a t iv e p r o d u c t o f th e in f la t io n r a te ( t a x r a t e ) a n d r e a l c a s h b a la n c e s ( t a x b a s e ), r e s p e c tiv e ly. S e c o n d, th e t a x b a s e is n o t in v a r ia n t t o t h e t a x r a te b u t f a lls w h e n th e la t t e r ris e s. T h a t is, w h e n th e g o v e r n m e n t ra is e s th e t a x r a te th e t a x b a s e te n d s to s h r in k a s p e o p le s e e k t o a v o id th e in f la t io n t a x b y c h a n g in g t h e ir h a b its a n d e c o n o m iz in g o n r e a l m o n e y h o ld in g s. W e r e t h is n o t s o, s a id K e y n e s, th e r e w o u ld b e n o l i m i t t o th e s u m s w h ic h th e g o v e r n m e n t c o u ld e x tr a c t f r o m th e p u b lic b y m e a n s o f in f la t io n [7; p. 4 2 ]. T h ir d, b e c a u s e th e t a x b a s e s h r in k s w it h ris e s in th e t a x ra te, th e g o v e r n m e n t w i l l r e a liz e m o r e r e v e n u e f r o m a t a x r a te r is e o n ly i f i t c a u s e s a le s s - t h a n - p r o p o r t io n a t e f a ll in th e b a s e. A g o v e r n m e n t h a s to r e m e m b e r, h e s a id, t h a t e v e n i f a t a x is n o t p r o h ib it iv e i t m a y b e u n p r o f ita b le, a n d t h a t a m e d iu m, r a t h e r th a n a n e x tr e m e, im p o s it io n w i l l y ie ld th e g r e a te s t g a in [7; p. 4 3 ]. F o u r t h, i t f o llo w s t h a t th e r e is o n e in f la t io n r a t e t h a t m a x im iz e s t a x r e v e n u e a n d t h a t o c c u rs w h e r e th e p e r c e n ta g e i n c re a s e in th e t a x r a te e q u a ls th e p e r c e n ta g e s h r in k a g e in th e t a x b a s e, i.e., w h e r e th e e la s t ic ity o f r e a l m o n e y d e m a n d w it h re s p e c t to th e in f la t io n r a t e is u n it y. H e r e is th e c o n c e p t o f th e t a x - m a x im iz in g r a te o f in f la t io n t h a t p la y s s u c h a k e y r o le in th e m o d e r n m o n e t a r is t a n a ly s is o f in f la t io n a r y fin a n c e. Monetary Approach to Exchange Rates A t h i r d m o n e t a r is t c o n c e p t u s e d b y K e y n e s in th e Tract w a s th e m o n e ta r y a p p r o a c h t o e x c h a n g e r a te a n a ly s is. T h is a p p r o a c h r e s ts o n th e v ie w t h a t th e e x c h a n g e r a t e b e tw e e n t w o n a t io n a l c u r r e n c ie s is d e te r m in e d b y th e r e s p e c tiv e n a t io n a l m o n e y s u p p lie s a n d d e m a n d s in th e t w o c o u n tr ie s a n d th e r e s u lt in g e ffe c ts o n t h e ir r e s p e c tiv e g e n e r a l p r ic e le v e ls. R e g a r d in g th e m o n e t a r y a p p r o a c h, K e y n e s s a id t h a t th e f o r e ig n e x c h a n g e s d e p e n d... o n th e r e la tiv e p r ic e le v e ls e s ta b lis h e d h e r e a n d a b r o a d b y th e re s p e c tiv e c r e d it [ i.e., m o n e t a r y ] p o lic ie s a d o p te d h e r e a n d a b r o a d [7 ; p ]. H e re a c h e d t h is c o n c lu s io n b y c o m b in in g th e q u a n t it y t h e o r y o f m o n e y w it h th e p u r c h a s in g p o w e r p a r it y t h e o r y o f e x c h a n g e ra te s. T h e q u a n t it y t h e o r y o f c o u r s e s a y s t h a t th e g e n e r a l p r ic e le v e l is d e te r m in e d b y th e d e m a n d - a d ju s te d m o n e y s to c k, i.e., b y th e n o m in a l s to c k o f m o n e y p e r u n it o f r e a l m o n e y d e m a n d. A n d th e p u r c h a s in g p o w e r p a r it y d o c t r in e, h e e x p la in e d, h o ld s t h a t th e e x c h a n g e r a te te n d s t o e q u a l th e r a t io o f th e p r ic e le v e ls in th e t w o c o u n t r ie s c o n c e rn e d. T a k e n t o g e th e r, th e q u a n t it y t h e o r y a n d th e p u r c h a s in g p o w e r p a r it y d o c t r in e im p ly t h a t th e e x c h a n g e r a te is d e t e r m in e d b y r e la tiv e d e m a n d - a d ju s te d m o n e y s to c k s o p e r a t in g t h r o u g h r e la tiv e n a tio n a l p r ic e le v e ls.6 F r o m th e f o r e g o in g K e y n e s c o n c lu d e d t h a t i f b o th c o u n t r ie s in f la t e t h e ir c u r r e n c ie s a t th e s a m e r a te th e e x c h a n g e r a te w i l l s ta b iliz e, w h e r e a s i f t h e y in f la t e a t d if f e r e n t r a te s th e e x c h a n g e r a te w i l l a p p r e c ia te in f a v o r o f th e c o u n t r y w it h th e lo w e r in f la t io n r a t e a n d d e p r e c ia te a g a in s t th e c o u n t r y w it h th e h ig h e r in f la t io n r a te. 7 H e a ls o c o n c lu d e d t h a t f lo a t in g e x c h a n g e r a te s in s u la te a c o u n t r y f r o m in f la t io n a r y m o v e m e n ts d e v e lo p in g a b r o a d. T h a t is, h e c o n te n d e d th a t, u n d e r f lo a t in g e x c h a n g e ra te s a n in f la t io n a r y r is e in f o r e ig n p r ic e s w o u ld b e o ffs e t b y a n e q u a l a n d o p p o s ite f a ll in th e e x c h a n g e r a te le a v in g th e d o m e s tic c u r r e n c y 6 Note that this version of the monetary approach ignores certain nonmonetary determinants of exchange rates, namely (1) the real terms of trade and (2) the relative prices of traded and nontraded goods, respectively. As pointed out by Keynes, these factors may be safely disregarded only when the source of exchange rate disturbance is of a predominantly monetary origin. Regarding such monetary shocks, he argues that they have in fact been so dominant in their influence that the theory has been actually applicable with remarkable accuracy [7; p. 82], 7 In his words, the rate of exchange can be improved in favour of one of the countries by a financial policy directed towards a lowering of its internal price level relatively to the internal price level of the other country [7; p. 88]. 11

14 p r ic e o f f o r e ig n g o o d s u n c h a n g e d. F o r t h is re a s o n h e b e lie v e d t h a t f lo a t in g e x c h a n g e r a te s w e r e a n a b s o lu te n e c e s s ity f o r a n y c o u n t r y t r y i n g t o a c h ie v e d o m e s tic p r ic e s t a b ility v ia t h e o p e r a t io n o f d o m e s tic m o n e ta r y p o lic y. W i t h re s p e c t t o h is a n a ly s is o f e x c h a n g e r a te s, th e K e y n e s o f th e Tract b e lo n g s in t o d a y s m o n e t a r is t c a m p. Nominal versus Real Interest Rates F in a l ly, K e y n e s e m p lo y e d in th e Tract t h e m o n e t a r is t o r F is h e r ia n d is t in c t io n b e tw e e n n o m in a l a n d re a l in t e r e s t ra te s, i.e., b e tw e e n th e in t e r e s t r a t e a c tu a lly c h a r g e d o n lo a n s a n d th e in f la t io n - c o r r e c t e d le v e l o f t h a t r a te. W i t h r e s p e c t t o th e t w o ra te s h e s ta te d th e f o llo w in g p o in ts. F ir s t, f o r a n y g iv e n n o m in a l r a te, in f la t io n re d u c e s th e r e a l r a te b e lo w th e n o m in a l ra te. T h e r e a l r a te f a lls r e la t iv e t o t h e n o m in a l r a te b e c a u s e b o r r o w e r s c a n r e p a y t h e ir lo a n s in d e p r e c i a te d d o lla r s, i.e., in m o n e y w h o s e r e a l p u r c h a s in g p o w e r is le s s th a n th e a m o u n t o r ig in a lly b o r r o w e d. S e c o n d, th e n o m in a l r a t e e m b o d ie s e x p e c te d in f la t io n w h ic h m a y t e m p o r a r ily la g b e h in d a c tu a l in f la t io n r e s u ltin g in in c o m p le te a d ju s t m e n t o f th e n o m in a l ra te. T h ir d, i f th e n o m in a l r a te d o e s n o t f u l l y r e f le c t r is in g p r ic e s, th e n e v e n h ig h m a r k e t ra te s m a y t r a n s la te in t o lo w o r n e g a tiv e r e a l r a te s a f t e r c o r r e c t io n f o r in f la t io n. A s K e y n e s h im s e lf e x p r e s s e d it, in a period of rapidly changing prices, the money rate of interest seldom adjusts itself adequately or fast enough to prevent the real rate from becoming abnormal [7; p. 20]. Thus, when prices are rising, the businessman who borrows money is able to repay the lender with what, in terms of real value, not only represents no interest, but is even less than the capital originally advanced; that is, the real rate of interest falls to a negative value, and the borrower reaps a corresponding benefit [7; pp ]. I n s u c h c a s e s, h ig h n o m in a l r a te s a r e n e it h e r o n e ro u s to b o r r o w e r s n o r a d e t e r r e n t t o b o r r o w in g a n d s p e n d in g. O n th e c o n t r a r y, t h e y a r e a b a r g a in t o b o r r o w e rs a n d, a t le a s t t e m p o r a r ily, a s t im u lu s t o e c o n o m ic a c t iv it y. T h e c o n te n t io n t h a t h ig h n o m in a l in te r e s t ra te s m a y c o r r e s p o n d t o lo w o r n e g a tiv e r e a l ra te s d u r in g p e r io d s o f r a p id in f la t io n a n d, t h e r e fo r e, m a y f a il t o d is c o u r a g e b o r r o w in g a n d s p e n d in g, u n d e r lie s th e m o d e r n m o n e ta r is t a r g u m e n t t h a t n o m in a l ra te s th e m s e lv e s a r e a n u n r e lia b le in d ic a t o r o f th e d e g re e o f m o n e ta r y e a s e o r t ig h tn e s s. F o u r t h, n o m in a l r a te s te n d t o b e b id d e d u p b y e a g e r b o r r o w e r s d u r in g p e r io d s o f in f la t io n, im p ly in g t h a t h ig h m a r k e t in t e r e s t r a te s a r e a r e s u lt n o t a c a u s e o f r is i n g p r ic e s. I t is f o r t h is r e a s o n, s a id K e y n e s, t h a t a h ig h b a n k r a te s h o u ld b e a s s o c ia te d w i t h a p e r io d o f r is in g p r ic e s, a n d a lo w b a n k r a te w it h a p e r io d o f f a l lin g p r ic e s [7; p. 2 0 ]. F if t h, in th e lo n g r u n n o m in a l r a te s te n d t o f u l l y a d ju s t f o r in f la t io n a n d th e r e a l r a te r e t u r n s t o it s p r e e x is t in g e q u i lib r iu m le v e l. T h e a p p a r e n t a b n o r m a lit y o f th e m o n e y [ n o m in a l] r a te o f in t e r e s t a t s u c h tim e s [ i.e., in p e r io d s o f r a p id i n f l a t i o n ], s a id K e y n e s, is m e r e ly th e o th e r s id e o f th e a tt e m p t o f th e r e a l r a te to s te a d y it s e lf [7 ; p. 2 0 ]. I n s t a t in g th e s e p o in ts, K e y n e s c lo s e ly f o llo w e d I r v i n g F is h e r, p e r h a p s t h e le a d in g m o n e t a r is t o f th e tim e. I n fa c t, c o n s id e r in g a ll th e m o n e t a r is t e le m e n ts in th e Tract, i t is h a r d to e s c a p e th e c o n c lu s io n t h a t, in th e s a t le a s t, K e y n e s w a s la r g e ly a m o n e t a r is t in h is a n a ly s is o f in f la t io n. I t is h a r d to r e c o n c ile th e K e y n e s o f th e Tract w it h t h e s te r e o ty p e n o n m o n e t a r is t K e y n e s o f th e m o d e r n te x tb o o k s. I t is e v e n h a r d e r t o s q u a r e th e K e y n e s o f t h e Tract w it h th e c a r ic a tu r e o f h im a s a n o u t - a n d - o u t in f la t io n is t. F o r a s s h o w n a b o v e, t h r o u g h o u t t h e Tract h e w a s e x tr e m e ly h o s t ile t o w a r d in f la t io n, d e p lo r in g it s e v ils, m in im iz in g it s b e n e fits, a n d c a llin g f o r it s q u ic k r e m o v a l. N o r d id h e c h a n g e h is m in d in h is A Treatise on Money ( ). T o b e s u re, th e r e h e t e n t a t iv e ly a d v a n c e s a t h e o r y o f in f la t io n - in d u c e d g r o w t h a n d e v e n c o n je c tu r e s t h a t m ild g e n tle in f la t io n m a y h a v e c o n t r ib u t e d t o th e in d u s t r ia liz a t io n o f t h e W e s t. B u t h is b a s ic s ta n c e is u n m is ta k a b ly t h a t o f a n a n t i in f la t io n is t a n d h e s t ill c o m e s d o w n s t r o n g ly in f a v o r o f a b s o lu te p r ic e s t a b ility a s th e id e a l p o lic y g o a l. A Treatise on Money (1930) I f th e Tract is fa m o u s f o r it s q u a n t it y t h e o r y - in f la t io n t a x a n a ly s is, th e Treatise is e q u a lly fa m o u s f o r it s c e le b r a te d fu n d a m e n ta l e q u a tio n s o f p r ic e s a n d th e c o r r e s p o n d in g d is t in c t io n b e tw e e n in c o m e i n f la t io n a n d p r o f i t in f la t io n. 8 C o n s t it u t in g th e c e n tr a l a n a ly t ic a l c o r e o f th e Treatise, th e f u n d a m e n ta l e q u a tio n s e x p re s s p r ic e le v e l in c re a s e s a s t h e s u m o f t w o c o m p o n e n ts, n a m e ly ( 1 ) in c re a s e s in p r o f it p e r u n it 8 For a recent exposition of the fundamental equations and the corresponding concepts of income and profit inflation, see Patinkin [11; pp. 33-8]. What follows draws heavily from Patinkin. 12

15 o f o u t p u t, a n d ( 2 ) in c re a s e s in u n it c o s ts o f p r o d u c t io n ( c h ie f ly la b o r c o s ts ). O f th e s e t w o c o m p o n e n ts o f p r ic e c h a n g e n a m e ly c h a n g e s in p r o f it a n d c h a n g e s in c o s ts, r e s p e c t iv e ly K e y n e s la b e ls th e f o r m e r p r o f it in f la t io n a n d th e la t t e r in c o m e in f la t io n. P r o f i t in f la t io n o c c u rs w h e n p r ic e s a r e o u t r u n n in g c o s ts, le a v in g a la r g e a n d g r o w in g m a r g in f o r p r o f it. B y c o n tr a s t, in c o m e in f la t io n o c c u rs w h e n w a g e s a re r is in g a s f a s t a s p r ic e s th e r e b y p r e v e n tin g p r o f it g r o w th. I t s h o u ld b e n o te d t h a t K e y n e s in c o m e in f la t io n d o e s n o t c o r r e s p o n d to w h a t to d a y is c a lle d c o s t- p u s h in f la t io n, i.e., a n e x o g e n o u s r is e in w a g e s a n d h e n c e p r ic e s c a u s e d, f o r e x a m p le, b y th e e x e r c is e o f tr a d e u n io n m o n o p o ly p o w e r. R a t h e r i t is th e i n d u c e d e n d o g e n o u s r e s u lt o f a n in c re a s e d d e m a n d f o r la b o r a n d o th e r r e s o u rc e s g e n e r a te d b y p r i o r p r o f i t in f la t io n. 9 F o r, a c c o r d in g t o K e y n e s, m o s t in c o m e in f la t io n s d o n o t s te m f r o m a u to n o m o u s ( s p o n ta n e o u s ) in c re a s e s in w a g e s c a u s e d b y th e p o w e r s a n d a c tiv it ie s o f tr a d e u n io n s [8, p ]. I n s t e a d t h e y s te m f r o m p r o f it - in d u c e d ris e s in th e d e m a n d f o r ( a n d h e n c e p r ic e s o f ) la b o r a n d o th e r f a c t o r r e s o u rc e s. T h a t is, a p r o f i t in f la t io n s tim u la te s f ir m s t o e x p a n d o u t p u t a n d h e n c e t h e ir d e m a n d f o r f a c to r s o f p r o d u c t io n. T h is le a d s t o a b id d in g u p o f f a c t o r p r ic e s t h a t ra is e s p r o d u c t io n c o s ts a n d g e n e r a te s in c o m e in f la t io n. T h is p ro c e s s c o n tin u e s u n t il w a g e s a n d o th e r f a c t o r p r ic e s r is e s u f f ic ie n t ly to e lim in a te e x c e s s p r o f it s. 10 S e e n t h is w a y, in c o m e in f la t io n s p o s s e s s th r e e d is t in c t iv e fe a tu r e s. T h e y o c c u r a t th e e x p e n s e o f p r o f it in f la t io n s, e v e n t u a lly a n n ih ila t in g th e la t t e r. T h e y n e e d n o t c a u s e a r is e in p r ic e s s in c e th e y a r e la r g e ly o ffs e t b y c o m p e n s a tin g f a lls in p r o f i t in f la t io n. F in a lly, t h e y a re a c r u c ia l p a r t o f th e p ro c e s s t h a t t r a n s f o r m s in f la t io n - e n g e n d e r e d p r o f it s in t o c o s ts a n d t h e r e b y te r m in a t e s th e t e m p o r a r y s t im u lu s t o e c o n o m ic a c t iv it y. H a v in g d e v e lo p e d th e d is t in c t io n b e tw e e n p r o f i t a n d in c o m e in f la t io n, K e y n e s u s e d i t to a n a ly z e th e e ffe c t o f in f la t io n o n o u t p u t a n d e c o n o m ic g r o w t h. R e g a r d in g th e s e e ffe c ts h e re a c h e d t w o m a in c o n c lu s io n s. F ir s t, o n ly p r o f i t in f la t io n h a s th e p o w e r t o s tim u la te o u t p u t a n d g r o w t h. I t is th e t e a c h in g o f t h is t r e a t is e, h e s a id, t h a t th e w e a lth o f n a tio n s is e n r ic h e d, n o t d u r in g in c o m e in f la t io n s, b u t d u r in g p r o f i t in f la t io n s... a t tim e s, t h a t is t o s a y, w h e n p r ic e s a re 9 This point is stressed by Patinkin [11; p. 37]. 10 See Keynes [8; pp ] and Patinkin [11; pp. 37, 45]. r u n n in g a w a y f r o m c o s ts [ 9 ; p ]. M o r e p r e c is e ly, p r o f i t in f la t io n s t im u la te s b o th c u r r e n t a n d lo n g - t e r m r e a l o u t p u t. I t s t im u la te s c u r r e n t o u t p u t b y r a is in g p r ic e s r e la tiv e to w a g e s th u s lo w e r in g r e a l w a g e s a n d in c r e a s in g e m p lo y m e n t. A n d i t s tim u la te s lo n g - t e r m r e a l o u t p u t b y s h if t in g in c o m e f r o m w a g e s to p r o f i t th e r e b y p e r m it t i n g f a s te r c a p it a l a c c u m u la tio n a n d a h ig h e r r a te o f e c o n o m ic g r o w th. I n s h o r t, th e e ffe c ts o f p r o f i t in f la t io n in c lu d e th e s p ir it o f b u o y a n c y a n d e n te r p r is e a n d th e g o o d e m p lo y m e n t w h ic h a re e n g e n d e r e d ; b u t m a in ly th e r a p id g r o w t h o f c a p ita l w e a lth a n d t h e b e n e fits o b ta in e d f r o m t h is in s u c c e e d in g y e a r s [ 9 ; p ]. T h e s e b e n e fits, h o w e v e r, a r e p o s s ib le o n ly w h e n p r ic e s a re o u t r u n n in g c o s ts, le a v in g a s u b s t a n t ia l m a r g in o f p r o f it t o fin a n c e in v e s tm e n t a n d g r o w t h. T h e y c a n n o t o c c u r in in c o m e in f la t io n s w h e r e w a g e s r is e a s fa s t a s p r ic e s a n d th u s a n n ih ila te th e v e r y p r o f it s t h a t c o n s t it u te b o t h th e m e a n s a n d th e in d u c e m e n t to e c o n o m ic g r o w t h. I t f o llo w s t h a t in c o m e in f la t io n, u n lik e p r o f it in f la t io n, is in c a p a b le o f e n h a n c in g g r o w t h. S e c o n d, w h a t m a tte r s f o r in v e s t m e n t a n d g r o w t h is h o w lo n g i t ta k e s f o r p r o f i t in f la t io n t o g iv e w a y to in c o m e in f la t io n, a n d t h is d e p e n d s o n th e s p e e d o f a d ju s t m e n t o f w a g e s to p r ic e s. I f th e in t e r v a l is s h o r t a n d w a g e s a d ju s t r a p id ly t o p r ic e s, th e n in f la t io n w i l l h a v e l i t t l e o r n o im p a c t o n c a p ita l f o r m a t io n a n d g r o w th. B u t i f th e in t e r v a l is lo n g a n d w a g e s a d ju s t s lo w ly to p r ic e s, th e n th e s t im u lu s m a y b e c o n s id e r a b le a n d p r o f i t in f la t io n, in K e y n e s o w n w o r d s, b e c o m e s a m o s t p o t e n t in s t r u m e n t f o r th e i n c re a s e o f a c c u m u la te d w e a lth [ 8 ; p ], R e g a r d in g th e in t e r v a l, K e y n e s a p p a r e n t ly f e lt t h a t i t h a d in d e e d b e e n lo n g in p a r t ic u la r h is t o r ic a l e p is o d e s q u it e lo n g e n o u g h, h e s a id, to in c lu d e ( a n d, p e r h a p s t o c o n t r iv e ) t h e r is e... o f th e g re a tn e s s o f a n a t io n [ 9 ; p ]. I n t h is c o n n e c tio n h e a d v a n c e d t h e h y p o th e s is t h a t th e e a r ly in d u s t r ia liz a t io n o f E n g la n d a n d F r a n c e h a d b e e n p o w e r e d b y p r o f it in f la t io n. I t is u n t h in k a b le, h e d e c la r e d, t h a t th e d iffe r e n c e b e tw e e n th e a m o u n t o f w e a lth in F r a n c e a n d E n g la n d in a n d t h e a m o u n t in c o u ld e v e r h a v e b e e n b u il t u p b y t h r i f t a lo n e. T h e in t e r v e n in g p r o f i t in f la t io n w h ic h c r e a te d th e m o d e r n w o r ld w a s s u r e ly w o r t h w h ile i f w e ta k e th e lo n g v ie w [ 9 ; p ]. L e s t o n e w r o n g ly c o n c lu d e f r o m th e fo r e g o in g t h a t K e y n e s o f th e Treatise w a s a n o u t - a n d - o u t in f la t io n is t, th r e e c a u t io n a r y o b s e r v a tio n s s h o u ld b e m a d e. F ir s t, h e w a s r e f e r r in g to g e n t ly r is in g p r ic e s a n d n o t t o th e r a p id d o u b le - d ig it in f la t io n t h a t is u n f o r t u 13

16 n a t e ly s o c o m m o n to d a y. M o r e p r e c is e ly, h e w a s r e f e r r in g t o s lo w c r e e p in g s e c u la r in f la t io n o f n o m o r e t h a n 1 t o 2 p e r c e n t p e r y e a r. T o d a y s u c h m il d in f la t io n w o u ld b e v ie w e d a s c o n s t it u t in g v ir t u a l p r ic e s t a b ility. S e c o n d, h is a n a ly s is o f b e n e fic ia l in f la t io n r e fe r s c h ie f ly t o c a p it a l- p o o r p r e in d u s t r ia l s o c ie tie s a n d n o t t o w e a lth y m o d e r n c a p it a lis t e c o n o m ie s.11 M o s t o f h is h is t o r ic a l e x a m p le s a r e t a k e n f r o m th e p r e - c a p it a lis t o r e a r ly - c a p it a lis t e ra w h e n w e s te r n E u r o p e w a s v e r y p o o r in a c c u m u la te d w e a lt h a n d g r e a t ly in n e e d o f a r a p id a c c u m u la t io n o f c a p it a l [ 9 ; p a n d 8 ; p ]. U n d e r th e s e c o n d it io n s i t is c o n c e iv a b le t h a t s lo w ly - c r e e p in g p r o f i t in f la t io n m ig h t in d e e d h a v e s p u r r e d in d u s t r ia liz a t io n n o t o n ly b y d iv e r t i n g r e s o u r c e s f r o m c o n s u m p tio n t o c a p it a l f o r m a tio n, b u t a ls o b y b r e a k in g fe u d a l b o n d s, s t im u la t in g e n te r p r is e, e n c o u r a g in g m a r k e t - o r ie n t e d a c t i v i t y, a n d w id e n in g th e s c o p e o f t h e m a r k e t. T h e s e la t t e r b e n e fits, h o w e v e r, a r e n o lo n g e r a v a ila b le to w e a lth y, m a r k e t - o r ie n t e d m o d e r n c a p it a lis t e c o n o m ie s t h a t a r e m o r e lik e ly t o f in d s e c u la r in f la t io n a c u rs e r a t h e r th a n a b le s s in g. F o r t h is re a s o n K e y n e s r e f r a in e d f r o m r e c o m m e n d in g e v e n s lig h t ly in f la t io n a r y p o lic ie s f o r m o d e r n e c o n o m ie s. F in a l ly, i t s h o u ld b e r e m e m b e r e d t h a t K e y n e s w a s r e f e r r in g t o p r o f i t in f la t io n c h a r a c te r iz e d b y p r ic e s p e r s is te n tly r is i n g f a s t e r th a n w a g e s a n d n o t t o m o d e r n in f la t io n s in w h ic h w a g e s s o m e tim e s r is e a h e a d o f p r ic e s o r a t le a s t f o llo w th e m w it h o u t d e la y th e r e b y w ip in g o u t th e p r o f it s g e n e r a te d b y th e p r ic e in c re a s e s.12 A s p r e v io u s ly m e n tio n e d, K e y n e s h e ld t h a t in f la t io n s t im u la te s g r o w t h o n ly i f w a g e s la g s u b s t a n t ia lly b e h in d p r ic e s le a v in g a la r g e a n d p e r s is te n t m a r g in o f p r o f i t t o f in a n c e c a p it a l f o r m a tio n. T h is w a g e la g, h o w e v e r, is h a r d ly c h a r a c t e r is t ic o f m o d e r n in f la t io n s in w h ic h w a g e s r is e s w if t ly n o t o n ly t o r e s t o r e r e a l e a r n in g s e r o d e d b y p a s t in f la t io n b u t a ls o to p r o t e c t r e a l e a r n in g s f r o m e x p e c te d f u t u r e in f la t io n. T h e c le a r im p lic a t io n is t h a t K e y n e s w o u ld h a v e o p p o s e d th e s e m o d e r n in f la t io n s, w h ic h a c c o r d in g t o h is a n a ly s is a r e in c o m e r a t h e r t h a n p r o f i t in f la t io n s. A c c o r d in g ly, i t is n o t s u r p r is in g t h a t K e y n e s, a t th e e n d o f a lo n g p a s s a g e e x t o llin g th e h is t o r ic a l a c c o m p lis h m e n ts o f p r o f i t in f la t io n, n e v e r th e le s s d e c la r e d, I a m n o t y e t c o n v e r t e d, t a k in g e v e r y t h in g in t o a c c o u n t, f r o m a p r e fe r e n c e f o r a p o lic y t o d a y w h ic h, w h ils t a v o id in g d e f la t io n a t a ll c o s ts, a im s a t th e 11 On this point see Haberler [2; pp ]. 12 See Haberler [2; p. 99]. s t a b ilit y o f p u r c h a s in g p o w e r a s it s id e a l o b je c t iv e [ 9 ; p ]. T h e r e is n o re a s o n t o b e lie v e t h a t h e e v e r c h a n g e d t h a t p o s it io n. O n th e c o n t r a r y, t h e r e is s t r o n g e v id e n c e t h a t h e r e m a in e d a d e t e r m in e d fo e o f in f la t io n a n d a n a d a m a n t p r o p o n e n t o f p r ic e s ta b i l i t y e v e n t o th e e x t e n t o f w a r n in g o f th e p o t e n t ia l d a n g e r o f in f la t io n i n w h e n t h e u n e m p lo y m e n t r a te w a s in e x c e s s o f 1 0 p e r c e n t o f t h e la b o r f o r c e. Articles in The Times (1937) T h e m o s t c o n v in c in g e v id e n c e o f h is c o n t in u in g s t r o n g o p p o s itio n t o in f la t io n in th e s, e v e n a ft e r th e p u b lic a t io n o f h is c e le b r a te d General Theory, a p p e a rs in f o u r a r tic le s h e w r o t e f o r The Times in e a r ly T h e r e, in d is c u s s in g p o lic ie s f o r d e a lin g w it h u n e m p lo y m e n t a t t h e b u s in e s s c y c le p e a k o f , h e m a d e i t a b u n d a n t ly c le a r t h a t h is p r im a r y c o n c e r n w a s p r e v e n t in g in f la t io n. I n p a r t ic u la r, h e a r g u e d t h a t th e u n e m p lo y m e n t r a te, a lt h o u g h v e r y h ig h ( in d e e d, a s h ig h a s 1 2 ^ p e r c e n t ), w a s n e v e r th e le s s a t its m in im u m n o n in f la t io n a r y le v e l a t w h ic h d e m a n d p r e s s u r e m u s t b e c u r t a ile d t o p r e v e n t in f la t io n. A c c o r d in g ly, h e r e c o m m e n d e d a s h a r p c u tb a c k in g o v e r n m e n t e x p e n d it u r e o n th e g r o u n d s t h a t th e e c o n o m y w a s r a p id ly a p p r o a c h in g t h e p o in t w h e r e f u r t h e r in c re a s e s in a g g r e g a te d e m a n d w o u ld b e p u r e ly in f la t io n a r y. I b e lie v e, h e s a id, t h a t w e a r e a p p r o a c h in g, o r h a v e re a c h e d, th e p o in t w h e r e th e r e is n o t m u c h a d v a n ta g e in a p p ly in g a f u r t h e r g e n e r a l s t im u lu s a t th e c e n t r e [ 4 ; p p. 1 1, 4 4, 6 5 ]. I n s o s t a t in g, h e id e n t if ie d th e n o n in f la t io n a r y f u l l e m p lo y m e n t r a t e o f u n e m p lo y m e n t ( N I F E R U ) b e lo w w h ic h in d u s t r ia l b o ttle n e c k s f r u s t r a t e th e i n te n d e d o u t p u t a n d e m p lo y m e n t e ffe c ts o f a g g r e g a te d e m a n d e x p a n s io n p o lic y s o t h a t m a in ly p r ic e s r is e. 14 B e y o n d t h a t p o in t, h e s a id, n o n in f la t io n a r y r e d u c tio n s in jo b le s s n e s s c o u ld o n ly b e a c h ie v e d b y s p e c ific s t r u c t u r a l p o lic ie s d e s ig n e d to lo w e r th e f u l l e m p lo y m e n t r a te o f u n e m p lo y m e n t it s e lf. 13 These articles are reprinted and discussed in Hutchison [4]. Unless otherwise noted, all references in this section are to Hutchison. 14 The N IFERU concept also appears in the General Theory where Keynes asserts that, beyond a certain point, structural impediments ( a series of bottle-necks ) would prevent the noninflationary expansion of output and employment long before full capacity is reached. At the bottleneck point any further increase in aggregate demand would, in his words, largely spend itself in raising prices, as distinct from employment [10; pp ]. 14

17 A s f o r th e e x is t in g h ig h le v e l o f t h a t u n e m p lo y m e n t r a te, h e a t t r ib u t e d i t t o s t r u c t u r a l r ig id it ie s in th e B r i t i s h e c o n o m y, in p a r t ic u la r t o a s u b s t a n tia l m is m a tc h b e tw e e n th e lo c a t io n a n d s k ill m ix o f t h e la b o r fo r c e a n d t h e lo c a t io n a n d c o m p o s it io n o f d e m a n d. A s h e p u t it, t h e e c o n o m ic s t r u c t u r e is u n f o r t u n a t e ly r i g i d a n d t h is r i g i d i t y p r e v e n te d o u t p u t a n d e m p lo y m e n t f r o m r e s p o n d in g t o in c re a s e s in a g g r e g a te d e m a n d s o t h a t o n ly p r ic e s r is e [ 4 ; p p. 1 1, ]. I t f o llo w s, h e s a id, t h a t t o a c h ie v e n o n in f la t io n a r y r e d u c t io n s in u n e m p lo y m e n t w e a r e m o r e in n e e d to d a y o f a r i g h t l y d is t r ib u t e d d e m a n d t h a n o f a g r e a t e r a g g r e g a te d e m a n d [ 4 ; p p. 1 1, 6 6 ]. I n o th e r w o r d s, n o n in f la t io n a r y r e d u c t io n s in u n e m p lo y m e n t c a n n o t b e o b ta in e d b y e x p a n s io n a r y a g g r e g a te d e m a n d - m a n a g e m e n t p o lic ie s b u t r a t h e r r e q u ir e a d if f e r e n t te c h n iq u e [ 4 ; p p. 1 1, 1 4, 4 4, 6 6 ]. T o t h is e n d h e a d v o c a te d s p e c ific s t r u c t u r a l p o lic ie s to re d u c e u n e m p lo y m e n t o n t h e g r o u n d s t h a t n o n in f la t io n a r y r e d u c t io n s in u n e m p lo y m e n t c o u ld o n ly b e a c h ie v e d v ia m e a s u re s t h a t e r a d ic a te s t r u c t u r a l r ig id it ie s a n d lo w e r th e e q u ilib r iu m u n e m p lo y m e n t r a t e it s e lf. I n s o a r g u in g, h e fo r e s h a d o w e d b y 3 0 y e a r s th e m o d e r n m o n e t a r is t c o n c e p t o f th e n a t u r a l r a te o f u n e m p lo y m e n t. 15 H e a ls o r e f u t e d t h e p o p u la r c o n t e n t io n t h a t h e w a s a n in f la t io n is t w h o a d v o c a te d f u l l e m p lo y m e n t a t a n y c o s t. T h a t is, h is a r t ic le s a m p ly d e m o n s tr a te th a t, f a r f r o m b e in g a n in f la t io n is t, h is m a in c o n s id e r a t io n w a s p r e v e n t in g in f la t io n e v e n a t a t im e w h e n t h e u n e m p lo y m e n t r a te e x c e e d e d 1 2 p e r c e n t. T h e s a m e a r t ic le s s h o w t h a t, f a r f r o m a d v o c a tin g f u l l e m p lo y m e n t a t a n y c o s t, h e c le a r ly t h o u g h t t h a t t h e r e w a s a f a i r l y h ig h le v e l o f u n e m p lo y m e n t a t w h ic h e x p a n s io n a r y a g g r e g a te d e m a n d p o lic y s h o u ld b e c u r b e d t o p r e v e n t in f la t io n. F r o m t h a t le v e l d o w n w a r d h e in s is te d t h a t u n e m p lo y m e n t m u s t b e d e a lt w it h n o t b y th e g e n e r a l e x p a n s io n o f a g g r e g a te d e m a n d b u t r a t h e r b y s p e c ific s t r u c t u r a l p o lic ie s th a t r e d u c e t h e n o n in f la t io n a r y u n e m p lo y m e n t r a te it s e lf. I n s h o r t, t h e r e is n o t h in g in th e a r t ic le s t o 15 Hutchison stresses this point, arguing that Keynes suggested a similar concept to that now called following Professor Milton Friedman a natural rate of unemployment in that he stressed the unfortunately rigid elements in the British economy which made it undesirable to try to reduce unemployment further by the expansion of central government demand [4; pp ]. Moreover, Keynes s different technique... corresponded, in some important respects, with what today, following Professor Friedman, is described as reducing the natural rate of unemployment [4; p. 46]. Similarly, Samuel Brittain writes that Keynes s idea of the level of unemployment which would exist without demand deficiency seems astonishingly similar to Milton Friedman s natural rate of unemployment [4; p. 63, n. 21]. s u g g e s t t h a t K e y n e s h a d e v e r c h a n g e d h is m in d a b o u t in f la t io n. O n th e c o n t r a r y, h e s h o w s th e s a m e c o n c e r n f o r in f la t io n in h is a r t ic le s t h a t h e e a r lie r d is p la y e d in th e Tract. L -unciucu ng Core T h e m a in c o n c lu s io n o f t h is e s s a y is t h a t K e y n e s w a s n e it h e r t h e s u b tle in f la t io n is t n o r th e e x tr e m e n o n m o n e ta r is t t h a t h e is s o m e tim e s d e p ic te d a s b e in g. O n th e c o n t r a r y, h is w r i t i n g s r e v e a l t h a t h e c o n s is t e n t ly d e p lo r e d in f la t io n, t h a t h e w a r n e d u n c e a s in g ly o f its d a n g e r s, a n d t h a t h e u r g e d t h a t it s a v o id a n c e b e m a d e a p r im a r y o b je c t iv e o f p u b lic p o lic y. I n th e s e re s p e c ts h e s h a r e d m u c h w i t h m o d e r n m o n e ta r is t s, e v e n to th e p o in t o f u s in g s im ila r a n a ly t ic a l to o ls. I n t h a t p e r s p e c tiv e, a k e y q u e s tio n is h o w th e m is c o n c e p tio n t h a t h e w a s a n in f la t io n is t c o u ld h a v e a ris e n. W h e th e r i t s te m m e d f r o m h is General Theory ( w h e r e h e p r e s c r ib e d d e f ic it - s p e n d in g e a s y m o n e y p o lic ie s to e lim in a te e x c e s s iv e u n e m p lo y m e n t ) o r f r o m th e te n d e n c y o f s o m e s e lf - s t y le d m o d e r n K e y n e s ia n s to in v o k e h is m a g ic n a m e in b e h a lf o f t h e ir o w n in f la t io n a r y f u ll- e m p lo y m e n t s c h e m e s, o r e v e n f r o m h is o w n a d v o c a c y o f d is c r e tio n o v e r r u le s in th e c o n d u c t o f m o n e t a r y p o lic y, h is r e p u t a t io n a s a n in f la t io n is t is h ig h ly u n d e s e r v e d. F o r, w it h re s p e c t to th e General Theory, h e d id n o t in t e n d f o r h is e x p a n s io n is t p o lic y p r e s c r ip tio n s t o a p p ly t o i n f la t io n a r y s it u a tio n s. O n t h e c o n t r a r y, a s d o c u m e n te d a b o v e, h e a b a n d o n e d th e s e p r e s c r ip t io n s in e a r ly u p o n th e f i r s t s ig n s o f a p o s s ib le in f la t io n. N o r w o u ld h e h a v e h a d a n y t h in g b u t s c o r n f o r m o d e r n K e y n e s ia n p o lic ie s d e s ig n e d t o t r a d e o f f h ig h e r in f la t io n f o r lo w e r u n e m p lo y m e n t. H is in s is te n c e o n th e p r im a c y o f t h e g o a l o f a b s o lu te p r ic e s t a b ilit y w o u ld h a v e b e e n in d ir e c t c o n f lic t w i t h s u c h in f la t io n a r y p o lic ie s. F in a l ly, h is s u p p o r t o f d is c r e t io n o v e r r u le s d id n o t r e v e a l a n in f la t io n a r y b ia s o n h is p a r t b u t r a t h e r a b e lie f t h a t d is c r e t io n a r y p o lic y w a s n e c e s s a r y t o c o m p e n s a te c h a n g e s in th e d e m a n d f o r m o n e y a n d h e n c e to a c h ie v e p r ic e le v e l s t a b ility. T h a t is, h e d if f e r e d f r o m th e p r o p o n e n ts o f m o n e t a r y r u le s n o t o v e r t h e o b je c t iv e o f p r ic e s ta b i l i t y p e r se, b u t r a t h e r o v e r th e m e a n s t o a c h ie v e th a t o b je c tiv e. T h e r e is n o t h in g in h is w r i t i n g s to in d ic a t e t h a t h e e q u a te d p r o p e r d is c r e t io n a r y p o lic y w it h th e u s e o f p r ic e in f la t io n t o e x p a n d o u t p u t a n d e m p lo y m e n t. O n th e c o n t r a r y, h e t h o u g h t t h a t d is c r e t io n a r y p o lic y o ff e r e d th e b e s t m e a n s o f a v o id in g 15

18 in f la t io n a n d a c h ie v in g p r ic e s t a b ility. I n s h o r t, g iv e n h is b e lie fs a b o u t th e e ffic a c y o f d is c r e tio n a r y p o lic y, h is a d v o c a c y o f s u c h p o lic y w a s p e r fe c t ly c o n s is te n t w it h h is a n t ip a t h y to in f la t io n. T h a t a n t i p a t h y a m p ly ju s t if ie s F. A. H a y e k s ju d g m e n t t h a t if K e y n e s w e re a liv e t o d a y h e w o u ld b e o n e o f th e m o s t d e te r m in e d f ig h t e r s a g a in s t in f la t io n [ 4 ; p n. 1 ], References 1. Buchanan, James M., and W agner, Richard E. Democracy In D eficit: The Political Legacy of Lord K eynes. New Y ork : Academic Press, Haberler, G ottfried. Inflation, Its Causes and Cures. Revised and enlarged edition. W ashington, D. C.: Am erican Enterprise Institute fo r Public Policy Research, Howson, Susan. A Dear Money Man?: Keynes On M onetary Policy Economic Journal (June 1973), pp Hutchison, T. W. Keynes Versus The K eyn esians'...? London: The Institute o f Economic A ffa irs, Keynes, John M. Indian Currency and Finance A s reprinted in Keynes Collected Writings, Vol. I. London: Macmillan, The Economic Consequences of the Peace A s reprinted in Keynes Collected W ritings, Vol. II. London: Macmillan, A Tract 07i M onetary Reform As reprinted in Keynes Collected W ritings, Vol. IV. London: M acmillan, A Treatise on M oney, Vol. I : The Pure Theory of M oney A s reprinted in K eynes Collected W ritings, Vol. V. London: Macmillan, A Treatise on Money, Vol. I I : The Applied Theory of M oney A s reprinted in Keynes Collected W ritings, Vol. VI. London: Macmillan, The General Theory of Em ploym ent Interest and M oney A s reprinted in Keynes Collected W ritings, Vol. V II. London: Macmillan, Patinkin, Don. K eyn es M onetary Thought: A Study of Its Developm ent. Durham : Duke University Press,

19 Highlights Earnings and Capital Accounts N e t e a r n in g s b e fo r e p a y m e n ts t o t h e U n it e d S ta te s T r e a s u r y in c re a s e d b y $ 1 9 7,8 3 1, t o $ 9 5 7,2 0 6, in S ix p e r c e n t s t a t u t o r y d i v i d e n d s t o t a lin g $ 3,6 6 6 > w e r e p a id t o F i f t h D is t r i c t m e m b e r b a n k s, a n d th e s u m o f $ 9 5 0,0 8 7, w a s t u r n e d o v e r t o th e U n it e d S ta te s T r e a s u r y. C a p ita l s to c k in c re a s e d b y $ 3,4 5 2, to $ 6 1,6 8 5, a s m e m b e r b a n k s in c r e a s e d t h e ir s to c k h o ld in g s in t h is B a n k, a s r e q u ir e d b y la w, t o r e f le c t th e r is e in t h e ir o w n c a p it a l a n d s u r p lu s a c c o u n ts. T h e B a n k s s u r p lu s a c c o u n t in c re a s e d $ 3,4 5 2, t o $ 6 1,6 8 5, The Monetary Control Act of 1980 T h e M o n e t a r y C o n t r o l A c t o f ( M C A ) is T i t l e I o f a la r g e r p ie c e o f le g is la t io n c a lle d th e D e p o s it o r y I n s t it u t io n s D e r e g u la t io n a n d M o n e t a r y C o n t r o l A c t o f , s ig n e d in t o la w o n M a r c h 3 1, T h is is th e m o s t c o m p r e h e n s iv e p ie c e o f fin a n c ia l le g is la t io n s in c e th e s, a n d i t h a s s ig n ific a n t im p lic a t io n s f o r th e o p e r a tio n s o f b o th p r iv a t e fin a n c ia l in s t it u t io n s a n d th e F e d e r a l R e s e rv e S y s te m. T h e M C A h a d a la r g e im p a c t o n B a n k a c tiv it ie s a n d th e b u d g e t d u r in g , a n d t h is im p a c t w i l l c o n t in u e to b e f e l t in th e c o m in g y e a r. I m p o r t a n t c h a n g e s m a n d a te d b y th e M C A t h a t a re a ffe c t in g B a n k o p e r a tio n s in c lu d e : ( 1 ) o p e n in g th e d is c o u n t w in d o w t o a ll d e p o s i t o r y in s t it u t io n s h o ld in g r e s e r v a b le lia b i l i t i e s ; ( 2 ) u n iv e r s a l r e s e r v e r e q u ir e m e n ts a n d d e p o s it r e p o r t in g ; a n d ( 3 ) o p e n in g a c c e s s t o n e w c la s s e s o f c o n s t it u e n ts a n d b e g in n in g p r ic in g t o a ll u s e rs o f F e d e r a l R e s e r v e s e rv ic e s. A n in - b a n k M C A T a s k F o r c e w a s f o r m e d e a r ly in th e y e a r to h e lp c o o r d in a te th e m a n y a c tio n s r e q u ir e d t o im p le m e n t th e s e c h a n g e s. A l l o f th e B a n k d e p a r t m e n ts a r e r e p r e s e n te d o n t h is g r o u p. n o r s, r a is e d th e d is c o u n t r a t e t o 1 3 p e r c e n t f r o m it s p r e v io u s le v e l o f 1 2 p e r c e n t s e t o n O c to b e r 8, T h is a c tio n c a m e a s a r e s u lt o f th e S y s te m s c o n c e r n t h a t r e c e n t e c o n o m ic d e v e lo p m e n ts, in c lu d in g th e la r g e in c re a s e in th e p r ic e o f im p o r t e d o il, w e r e a d d in g to in f la t io n a r y p r e s s u r e s a n d m ig h t le a d t o f u r t h e r d e s ta b iliz in g p r ic in g d e c is io n s. E f f e c t iv e M a r c h 1 7, a 3 p e r c e n t s u r c h a r g e w a s in s t it u t e d o n c e r t a in a d ju s t m e n t c r e d it b o r r o w in g s b y b a n k s w it h d e p o s its o f $ m il lio n o r m o r e w h e n s u c h b o r r o w in g s o c c u r r e d s u c c e s s iv e ly in t w o o r m o r e r e s e r v e w e e k s o r in m o r e t h a n f o u r r e s e r v e w e e k s in a c a le n d a r q u a r t e r. T h e s u r c h a r g e, w h ic h d id n o t a p p ly to b o r r o w in g s u n d e r th e s e a s o n a l o r e m e r g e n c y lo a n p r o g r a m s, w a s d e s ig n e d t o d is c o u r a g e f r e q u e n t u s e o f th e d is c o u n t w in d o w a n d to e n c o u r a g e b a n k s w i t h a c c e s s t o m o n e y m a r k e ts t o a d ju s t t h e ir lo a n s a n d in v e s tm e n ts m o r e p r o m p t ly t o c h a n g in g m a r k e t c o n d it io n s. I t w a s a ls o in te n d e d t o b r in g c o s ts o f c r e d it a t th e d is c o u n t w in d o w in t o r o u g h a lig n m e n t w it h s h o r t - t e r m r a te s in th e m a r k e t. I n v ie w o f th e s u b s e q u e n t d e c lin e in m a r k e t r a te s th e s u r c h a r g e w a s e lim in a te d e ffe c tiv e M a y 7. T h e d is c o u n t r a te w a s s u b s e q u e n tly r e d u c e d t o 12 p e r c e n t o n M a y 2 9, t o 11 p e r c e n t o n J u n e 1 3, a n d to 1 0 p e r c e n t o n J u ly 2 8, , t o b r in g i t in t o c lo s e r a lig n m e n t w it h s h o r t - te r m r a te s g e n e r a lly. E ff e c t iv e S e p te m b e r 2 6, th e r a t e w a s in c r e a s e d f r o m 1 0 p e r c e n t t o 11 p e r c e n t a s p a r t o f th e S y s te m s c o n t in u in g p o lic y to d is c o u r a g e e x c e s s iv e g r o w t h in th e m o n e t a r y a g g re g a te s. I n t a k in g t h is a c tio n th e B o a r d a ls o t o o k n o te o f th e la r g e in c re a s e s in b o r r o w in g s a t th e F e d e r a l R e s e r v e d is c o u n t w in d o w s t e m m in g f r o m th e g r o w in g d if f e r e n t ia l b e tw e e n s h o r t - t e r m m a r k e t i n te r e s t ra te s a n d th e 1 0 p e r c e n t d is c o u n t r a te t h a t h a d b e e n in e ffe c t s in c e J u ly 2 8. O n N o v e m b e r 1 7, th e d is c o u n t r a t e w a s r a is e d t o 1 2 p e r c e n t a n d a 2 p e r c e n t s u r c h a r g e w a s im p o s e d o n b o r r o w in g b y fin a n c ia l in s t it u t io n s w it h d e p o s its o f $ m il lio n o r m o r e. T h e p u r p o s e w a s th e s a m e a s th a t o f th e S e p te m b e r 2 6 r a t e in c re a s e. O n D e c e m b e r 5, th e d is c o u n t r a te w a s r a is e d t o 1 3 p e r c e n t a n d th e s u r c h a r g e w a s in c r e a s e d t o 3 p e r c e n t. Discount Rate O n F e b r u a r y 1 5 th e D ir e c t o r s o f th e R ic h m o n d R e s e r v e B a n k, w it h a p p r o v a l o f th e B o a r d o f G o v e r Fiscal Agency A n o n - lin e s e c u r itie s t r a n s f e r ( C P D ) s y s te m b e c a m e f u n c t io n a l d u r in g th e f i r s t q u a r t e r o f B y 17

20 th e e n d o f t h e y e a r 2 1 m e m b e r b a n k s in th e R ic h m o n d, B a lt im o r e, a n d C h a r lo t t e t e r r it o r ie s w e r e s e n d in g a n d r e c e iv in g t h e ir o w n C P D t r a f f ic, th e r e b y r e d u c in g r e s o u r c e r e q u ir e m e n ts a t th e R e s e r v e B a n k. Computer Operations O n e m o r e m e m b e r b a n k c o m p u t e r lin k w a s c o n n e c te d t o th e F i f t h D is t r i c t C o m m u n ic a tio n s S y s te m in , r a is in g th e t o t a l n u m b e r o f b a n k c o m p u te r in te r fa c e s to s e v e n. T e r m in a ls w e r e in s ta lle d in e ig h t a d d it io n a l m e m b e r b a n k s, r a is in g th e t o t a l to 3 4 b a n k s d ir e c t ly c o n n e c te d to th e F if t h D is t r ic t C o m m u n ic a tio n s S y s te m. T h e M o n e t a r y C o n t r o l A c t h a d a s ig n ific a n t im p a c t o n a u t o m a t io n in th e p r e p a r a tio n f o r : ( 1 ) th e in c r e a s e d n u m b e r o f f in a n c ia l in s t it u t io n s u s in g th e B a n k s s e rv ic e s, ( 2 ) th e e x p a n d e d v o lu m e a n d t y p e o f s t a t is t ic a l in f o r m a t io n b e in g r e p o r te d, a n d ( 3 ) th e e x p a n d e d a c c e s s t o a n d p r ic in g o f F e d e r a l R e s e r v e s e rv ic e s. Planning B e s id e s c o o r d in a t in g d e v e lo p m e n t o f th e B a n k O p e r a t io n s P la n f o r th e F i f t h D is t r ic t, th e P la n n in g D e p a r t m e n t u n d e r t o o k s tu d ie s d e s ig n e d to id e n t if y o p p o r t u n it ie s f o r im p r o v in g o p e r a t in g e ffic ie n c y a t b o th th e D i s t r i c t a n d S y s te m le v e ls. E x a m in e d w e r e U. S. G o v e r n m e n t c h e c k t r u n c a t io n p r o c e d u r e s, a lt e r n a t iv e m e th o d s f o r s h ip p in g n o n c a s h c o lle c tio n ite m s, a n d m in im u m c o n t r o l s ta n d a r d s f o r th e h a n d lin g a n d s to r a g e o f v a lu a b le s. T h e M C A h a d a s u b s ta n tia l im p a c t o n P la n n in g D e p a r t m e n t a c t iv it ie s d u r in g th e y e a r. T h is d e p a r t m e n t is th e p r im a r y s o u rc e o f a d m in is t r a t iv e a n d a n a ly t ic a l s u p p o r t f o r th e M C A T a s k F o r c e w h o s e r e s p o n s ib ilit ie s in c lu d e th e e x e c u tio n o f a n im p le m e n t a t io n p la n f o r th e M C A p r o je c t, a s w e ll a s th e d e v e lo p m e n t o f a c o n tin g e n c y p la n to a ssess th e o p e r a tio n a l im p a c ts o f a c c e s s to a n d p r ic in g o f S y s te m s e rv ic e s. Research Department - Statistical Division S e v e r a l m a jo r d e v e lo p m e n ts in d ir e c t ly a ffe c te d o p e r a t io n s a n d r e s p o n s ib ilit ie s o f th e S ta t is t ic a l D iv is io n. I n J a n u a r y , th e B a n k s S e n io r M a n a g e m e n t a p p r o v e d a p r o p o s a l to c o n s o lid a te th e c o lle c tio n a n d p r o c e s s in g o f a ll e x te r n a l r e p o r t s ( d a ta c o lle c te d f r o m e n titie s o u ts id e th e B a n k ) in th e D i v i s io n. C o n s e q u e n tly, d e p o s it r e p o r t s a n d r e la te d s e rie s w e r e t r a n s f e r r e d f r o m th e B a n k A c c o u n t s D e p a r t m e n t a t th e R ic h m o n d O ffic e a n d th e A c c o u n t in g D e p a r tm e n ts a t th e o th e r o ffic e s to th e S ta t is t ic a l D iv is io n. T h e p h a s e d t r a n s f e r o f o th e r r e p o r t s t o th e D iv is io n w i l l c o n t in u e t h r o u g h th e f i r s t q u a r t e r o f T h e p a s s a g e o f th e M o n e t a r y C o n t r o l A c t o f r e q u ir e d a ll d e p o s ito r y in s t it u t io n s o f f e r in g t r a n s a c tio n a c c o u n ts o r n o n p e r s o n a l t im e d e p o s its t o r e p o r t d e p o s it d a ta d ir e c t ly to th e F e d e r a l R e s e r v e b e g in n in g O c to b e r 3 0. O v e r 1,0 0 0 F i f t h D is t r i c t in s t it u t io n s a r e f i l i n g w e e k ly r e p o r ts a n d a p p r o x i m a t e ly m o r e w i l l b e r e p o r t in g q u a r t e r ly. A n o t h e r s ig n ific a n t d e v e lo p m e n t a ff e c t in g th e D iv is io n d u r in g w a s th e C r e d it R e s t r a in t P r o g r a m ( C R P ) in e ffe c t f r o m M a r c h t o J u ly. F o u r n e w r e p o r t s w e r e in it ia t e d u n d e r th e C R P. O f th e s e, th e m o s t e x te n s iv e c o lle c te d in f o r m a t io n o n c o v e r e d c o n s u m e r c r e d it f r o m c o m m e r c ia l b a n k s a s w e ll as f r o m r e t a ile r s w h o e x te n d e d c r e d it. Examining T h e r e s p o n s ib ilit ie s o f th e d e p a r tm e n t c o n tin u e d to e x p a n d, d u e to b o th th e in c r e a s in g n u m b e r o f S ta te m e m b e r b a n k s a n d th e g r o w t h in a s s e ts u n d e r e x a m i n a tio n r e s u ltin g f r o m m e r g e r s. T h e y e a r a ls o s a w a n in c r e a s in g a m o u n t o f th e d e p a r t m e n t s r e s o u rc e s d e v o te d to c h e c k in g S ta te m e m b e r b a n k s f o r c o m p lia n c e w it h th e n u m e r o u s c o n s u m e r - o r ie n te d la w s a n d r e g u la tio n s t h a t h a v e b e e n a d o p te d in r e c e n t y e a rs, w it h a b o u t 2 0 p e r c e n t o f th e f ie ld s t a f f n o w in v o lv e d in t h is e ff o r t. Culpeper Office P la n s a re u n d e r w a y to r e p la c e in e a r ly J a n u a r y th e C o n t r o l D a t a M l c o m m u n ic a t io n s c o m p u t e r w it h a n e w C y b e r c o m p u te r c a p a b le o f a c c o m m o d a tin g a d d it io n a l t r a f f ic a n d p r o v id in g r e l i a b le s e r v ic e f o r s e v e ra l y e a r s to c o m e. T h is e q u ip m e n t e v e n t u a lly w i l l b e s u p e rs e d e d b y th e n e w p a c k e t s w itc h s y s te m d e s ig n a te d F R C S w h ic h w i l l s t a r t s e r v ic e in

21 New Building - Baltimore C o n s t r u c t io n o f t h e n e w B a lt im o r e B r a n c h b u il d in g b e g a n in J a n u a r y a n d w a s o n s c h e d u le a t y e a r - e n d. C o m p le t io n is p la n n e d f o r th e t h i r d q u a r t e r o f T h e p r o je c t y ie ld e d a n u n e x p e c te d a r c h a e o lo g ic a l b o n a n z a w h e n e x c a v a tio n u n c o v e r e d m o r e th a n 5 0,0 0 0 a r t if a c t s a n d h is t o r ic a l r e lic s. Federal Reserve Membership T h e f o l lo w in g n e w ly c h a r te r e d b a n k s in th e F i f t h D is t r i c t o p e n e d f o r b u s in e s s d u r in g a s m e m b e r s o f th e F e d e r a l R e s e r v e S y s t e m : National Banks Upshur National Bank Buchannon, West Virginia July 1 Heritage National Bank Huntington, West Virginia September 15 (Successor to The Metro Bank of Huntington, Inc.) Liberty National Bank Charleston, South Carolina December 1 T h e f o l lo w in g S ta t e - c h a r t e r e d b a n k s c o n v e r te d to m e m b e r s h ip in th e F e d e r a l R e s e r v e S y s te m d u r in g : Bank of Newport News Newport News, Virginia March 27 Bank of Suffolk Suffolk, Virginia April 24 Bank of West Point West Point, Virginia April 30 The Suburban Bank Henrico County, Virginia May 15 The Peoples Bank of Chesterfield Chesterfield, Virginia August 28 The Bank of Middlesex Urbanna, Virginia December 31 Changes in Directors F i f t h D is t r i c t m e m b e r b a n k s e le c te d o n e C la s s A a n d o n e C la s s B d ir e c t o r to th r e e - y e a r t e r m s o n th e R ic h m o n d B o a r d o f D ir e c t o r s in e a r ly f a ll. J. B a n k s S c a r b o r o u g h, C h a ir m a n a n d P r e s id e n t, P e e D e e S ta te B a n k, T im m o n s v ille, S o u th C a r o lin a, w a s e le c te d a C la s s A d ir e c t o r b y b a n k s in G r o u p 3 to s u c c e e d F r e d e r ic H. P h illip s, S e n io r V ic e P r e s id e n t, V ir g in ia N a t io n a l B a n k, R o a n o k e, V ir g in ia, w h o s e t e r m e x p ir e d a t th e e n d o f L e o n A. D u n n, J r., C h a ir m a n, P r e s id e n t, a n d C h ie f E x e c u t iv e O f f ic e r, G u a r d ia n C o r p o r a t io n a n d S u b s id ia r ie s, R o c k y M o u n t, N o r t h C a r o lin a, w a s e le c te d b y b a n k s in G r o u p 2 a s a C la s s B d ir e c t o r t o s u c c e e d T h o m a s A. J o r d a n, C o n s u lta n t, A s h e b o r o, N o r t h C a r o lin a, w h o s e t e r m e x p ir e d D e c e m b e r 3 1, T h e R ic h m o n d B o a r d r e a p p o in te d J o s e p h M. G o u g h, J r., P r e s id e n t, T h e F i r s t N a t io n a l B a n k o f S t. M a r y s, L e o n a r d t o w n, M a r y la n d, to a th r e e - y e a r t e r m o n th e B a lt im o r e B o a r d. N ic h o la s W. M it c h e ll, P r e s id e n t a n d D ir e c t o r, P ie d m o n t F e d e r a l S a v in g s a n d L o a n A s s o c ia t io n, W in s t o n - S a le m, N o r t h C a r o lin a w a s a p p o in te d t o a th r e e - y e a r t e r m o n th e C h a r lo t te B o a r d to s u c c e e d J o h n T. F ie ld e r, P r e s id e n t, J. B. I v e y a n d C o m p a n y, C h a r lo t t e, N o r t h C a r o lin a, w h o s e t e r m e x p ir e d a t th e e n d o f J. B. A ik e n, J r., C h a ir m a n o f t h e B o a r d, G u a r a n t y B a n k a n d T r u s t C o m p a n y, F lo r e n c e, S o u th C a r o lin a, w a s a p p o in te d to f i l l th e u n e x p ir e d t e r m o n t h e C h a r lo t t e B o a r d o f J. B a n k s S c a r b o r o u g h w h o r e s ig n e d to b e c o m e a m e m b e r o f th e R ic h m o n d B o a r d. T h e B o a r d o f G o v e r n o r s r e d e s ig n a te d M a c e o A. S lo a n, E x e c u t iv e V ic e P r e s id e n t a n d C h ie f O p e r a tin g O f f ic e r, N o r t h C a r o lin a M u t u a l L i f e I n s u r a n c e C o m p a n y, D u r h a m, N o r t h C a r o lin a, a s C h a ir m a n o f th e B o a r d f o r S te v e n M u lle r, P r e s id e n t, T h e J o h n s H o p k in s U n iv e r s it y a n d H o s p it a l, B a lt im o r e, M a r y la n d, w a s r e a p p o in te d t o a th r e e - y e a r t e r m a s C la s s C d ir e c to r a n d r e n a m e d D e p u t y C h a ir m a n o f th e B o a r d f o r R o b e r t L. T a te, C h a ir m a n o f th e B o a r d, T a t e In d u s tr ie s, B a lt im o r e, M a r y la n d, w a s a p p o in t e d b y th e B o a r d o f G o v e r n o r s t o a th r e e - y e a r t e r m o n th e B a lt im o r e B o a r d. M r. T a t e s u c c e e d e d C a t h e r in e B. D o e h le r, D ir e c t o r o f D e v e lo p m e n t, B a lt im o r e R e g io n a l C h a p te r o f A m e r ic a n R e d C ro s s, B a lt im o r e, M a r y la n d, w h o s e t e r m e x p ir e d D e c e m b e r 3 1, T h e B o a r d o f G o v e r n o r s a ls o a p p o in te d W i l l i a m S. L e e, I I I, P r e s id e n t, D u k e P o w e r C o m p a n y, C h a r lo tte, N o r t h C a r o lin a, t o a th r e e - y e a r t e r m o n th e C h a r lo tte B o a r d, e ffe c tiv e J a n u a r y 1, M r. L e e s u c c e e d e d R o b e r t E. E lb e r s o n, P r e s id e n t, C h ie f E x e c u t iv e O f f ic e r, a n d D ir e c t o r, H a n e s C o r p o r a t io n, W in s t o n - S a le m, N o r t h C a r o lin a. 19