Credit and Monetary Policy

Abstract

PERHAPS THE MOST IMPORTANT ROLE that banks play in orthodox credit theory is preventing or restricting unhealthy booms from which depressions grow, although they are likewise assigned to the task of easing the strains incident to panic and precipitate liquidation. Leadership in such operations as these is assigned to the central banks, which, although always closely associated with Government authority, are assumed to have sufficient freedom of action to enable them to meet their responsibilities according to their own ideas. This is the orthodox idea. Is it what has actually happened in practice? We find ourselves in a very different position today from the one we held in 1929 and '30. We find ourselves with a huge Government debt. We are riding the crest of an economic boom. We have a huge supply of money, which of course includes bank deposits-we have full employment-large bank borrowings from the Federal Reserves Banks-yet we feel that we are faced with the ultimate outlook of a downturn in the economy. We should not be unduly alarmed at the huge Federal debt that piled up during two major fighting wars and a depression, because intelligent management could turn the debt into a powerful tool for the maintenance of high employment, stable prices, and economic progress. Federal Reserve action should be directed toward maintaining high employment and stable prices, and not toward keeping interest rates artificially low, as was done during the postwar period, to lighten the Treasury's financing burden. The Federal Reserve System should be free to deal with the money market on the basis of its effects on employment and prices and not on the basis of the needs of the Treasury for securing low-cost funds. A rise in interest rates and a tightening of credit supply should be employed whenever the flow of credit is too great.