U.S. MONETARY POLICY AND THE BALANCE OF PAYMENTS, 1950-60*

Abstract

SINCE THE WORLD-WIDE revival of flexible monetary policy in the early 1950's, European nations have used the state of the balance of payments as a major determinant of monetary policy. They have employed a restrictive policy when reserves were low, to curb imports, divert production to exports, and encourage capital inflows. In the period under study, 1950-60, the United States experienced a chronic balance-of-payments deficit, yet its monetary policy was oriented to domestic considerations. In addition, United States business cycles differed in timing and intensity from European cycles. These factors led at times to wide differentials between United States and foreign interest rates. These interest-rate differentials caused persistent outflows of shortterm capital and lending on foreign dollar bonds. The net outflow from these two sources was $4.6 billion in the years 1951-59, about one-third of the net balance-of-payments deficit over the nine-year period. Interest rates more nearly in line with those of other countries would have prevented at least some of this outflow, which was greatest during periods of widest interest-rate differentials. However, one major component of United States capital flows-direct investment-fluctuated with the domestic business cycle and consequently was not sensitive to interest-rate differentials. Foreign capital in this country showed less direct sensitivity to interest rates than did United States capital. Interest rates affected foreign short-term capital indirectly by influencing other elements in the balance of payments, but these capital movements did not generally react independently of interest-rate differentials. Interest-rate changes did, however, cause shifts between foreign and official holders of dollars and among different types of dollar assets. Gold movements were also affected only indirectly by monetary policy, through its influence on other balance-of-payments items in determining the side of the deficit. Foreign long-term capital in the United States showed some direct sensitivity to interest rates, but the magnitudes of these flows were small.