course, if the future should not provide so inflationary a picture, then none of the above need hold.

Representative PATMAN. Gentlemen of the panel, for the committee I want to express appreciation for your attendance here. You certainly have helped us, and we appreciate it very much.

As stated heretofore, if you desire to elaborate more fully on what you have said or what any other person has said in this discussion, you may do so in the final record.

We had expected to have an afternoon session and ask you gentlemen to be with us again, but the committee wants to have an executive session this afternoon, so we are going to forego the opportunity of asking you gentlemen to come back and be with us. We did hold you here about an hour longer than we would have otherwise, for which we thank you very much again.

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD BY MILTON FRIEDMAN, UNIVERSITY OF CHICAGO

1. NOTE ON THE QUANTITY EQUATION

The quantity equation is frequently written:

Stock of money X transactions velocity=total payments for all purposes, and total payments are regarded as the product of an index of prices times an index of physical volume of transactions, so that the equation is written: “MV=PT." This form has serious defects primarily because total payments are so heterogeneous, including, for example, payments for the purchase of securities or property, as well as payments for physical commodities and services. In consequence, it is difficult to give any clear meaning to either P, the average price level at which such transactions occur, or to T, the volume of transactions.

An alternative formulation of the quantity equation is to write: "Stock of money X income velocity=Total money income." Total money income can then be regarded as the product of an index of prices times an index of real income, so that the equation can be written: "Mv=pR," where R is an index of real income, and p is the price index of the goods and services entering into real income, and v is income velocity. This form has the great advantage that the payments considered are much more homogeneous, and hence that both the price level and the index of real income are more meaningful. This is reflected in the statistical fact that whereas there are no good, widely accepted, current measures of T, or P, or even of PT, there are good, widely accepted measures of pR, namely, the national income series currently constructed by the United States Department of Commerce, and of p and R separately.

Income velocity as so defined (v) is a reasonably stable magnitude. The exact number computed for v depends on the particular definition used for the stock of money and for money income. If we regard the stock of money as currency in public circulation plus adjusted demand deposits plus time deposits, and money income as given by the Department of Commerce concept of national income, the value of v is currently around 12. Income velocity has been declining over the last century, from a value apparently around 42 to 5 in the Civil War to its present value. However, the decline appears to have been rather gradual, and income velocity is relatively stable over short periods.

2. PROPOSED MANDATE BY THE CONGRESS TO THE FEDERAL RESERVE SYSTEM I would favor a mandate along something like the following lines: The powers of the Federal Reserve System to buy and sell securities on the open market, to make loans, and to determine the terms on which they will rediscount eligible paper shall be used for promoting reasonable stability in the general level of prices, as measured by a comprehensive index such as the existing Bureau of Labor Statistics wholesale price index number.

One problem this statement does not meet is that which would arise if the prices of a large number of the commodities in the index were at the ceiling imposed by price control. In this case, the price index would become misleading and it would be desirable to rely instead on an index computed from prices not subject to control.

1

3. PROPOSED LONG-RUN REFORM IN OUR MONETARY AND FISCAL FRAMEWORK 1 The monetary and fiscal framework that follows is designed to promote econ'omic stability and, at the same time, to be entirely automatic and to involve no discretionary action by governmental authorities. It covers the fiscal, as well as the monetary, framework because of the intimate connection between the two. It is intended to describe the normal peacetime structure, and some modifications, particularly the issuance of interest-bearing Government obligations, would be appropriate for wartime. The particular proposal is not original; it is an appropriate selection and combination of elements from existing proposals.

The proposal involves four main elements: the first relates to the monetary system; the second, to Government expenditures on goods and services; the third, to Government transfer payments; and the fourth, to the tax structure. Throughout, it pertains entirely to the Federal Government and all references to "government" should be so interpreted.

1. A reform of the monetary and banking system to eliminate both the private creation or destruction of money and discretionary control of the quantity of money by central bank authority. The private creation of money can perhaps best be eliminated by adopting the 100-percent reserve proposal. The adoption of 100-percent reserves would also reduce the discretionary powers of the reserve system by eliminating rediscounting and existing powers over reserve requirements. To complete the elimination of the major weapons of discretionary authority, the existing powers to engage in open market operations and the existing direct controls over stock market, consumer, and real estate credit should be abolished.

Under the 100-percent-reserve proposal, existing commercial banks would, in effect, be separated into two parts. One part would provide depositary facilities. This part would essentially be a "warehouse" of funds, since it would be required to hold reserves, in the form either of currency or of deposits in a central governmental depositary, equal to 100 percent of its deposits. Its income would come from service charges to depositors, unless, as a matter of public policy, it were thought desirable to subsidize this activity, in which case interest could be paid on deposits in the central governmental depositary. The transition to 100-percent reserves could be accomplished without financial disturbance by open-market purchases of governmental obligations by the Federal Reserve System coordinated with the raising of reserve requirements. These purchases would not be inflationary, since the funds provided would be needed for additional reserves.

The other part of the existing commercial banks would take over its lending and investing functions. It would be an "investment trust," and would operate entirely with its own capital, or with funds obtained by the issuance of securities. The separation of this lending funtcion of the banking system from its depositary function would make unnecessary existing detailed legal control over the types of loans that may be made or investments that may be acquired. This part of the present commercial bank would need to be subject only to the regulations now governing other lenders.

These modifications would leave as the chief monetary functions of the banking system the provision of depositary facilities, the facilitation of check clearance, and the like; and as the chief function of the monetary authorities, the creation of money to meet Government deficits or the retirement of money when the Government has a surplus.2

2. A policy of determining the volume of Government expenditures on goods and services-defined to exclude transfer expenditures of all kinds-entirely on the basis of the community's desire, need, and willingness to pay for public services. Changes in the level of expenditure should be made solely in response to alterations in the relative value attached by the community to public services and private consumption. No attempt should be made to vary expendi

1 This statement is largely a summary of a proposal described and analyzed at greater length in my article entitled "A Monetary and Fiscal Framework for Economic Stability," published in American Economic Review, XXXVIII (June 1948), pp. 245-64, and reprinted in Readings in Monetary Theory (Blakiston Co., 1951), pp. 369-93.

2 The adoption of 100 percent reserves is essential if the proposed framework is to be entirely automatic. It should be noted, however, that the same results could, in principle, be achieved in a fractional reserve system through discretionary authority. In order to accomplish this, the m netary authorities would have to adopt the rule that the quantity of money should be increased only when the Government has a deficit, and then by the amount of the deficit, and should be decreased only when the Government has a surplus, and then by the amount of the surplus.

tures, either directly or inversely, in response to cyclical fluctuations in business activity. Since the community's basic objectives would presumably change only slowly-except in time of war or immediate threat of war-this policy would, with the same exception, lead to a relatively stable volume of expenditures on goods and services.

3. A predetermined program of transfer expenditures, consisting of a statement of the conditions and terms under which relief and assistance and other transfer payments will be granted. Such a program is exemplified by the present system of social security under which rules exist for the payment of old-age and unemployment insurance. The program should be changed only in response to alterations in the kind and level of transfer payments the community feels it should and can afford to make. The program should not be changed in response to cyclical fluctuations in business activity. Absolute outlays, however, will vary automatically over the cycle. They will tend to be high when unemployment is high and low when unemployment is low.

4. A progressive tax system which places primary reliance on the personal income tax. Every effort should be made to collect as much of the tax bill as possible at source and to minimize the delay between the accrual of the tax liability and the actual collection of the tax. Rates, exemptions, etc., should be set in light of the expected yield at a level of income corresponding to reasonably full employment at a predetermined price level. The budget principle might be either that the hypothetical yield should balance Government expenditure, including transfer payments (at the same hypothetical level of income) or that it should lead to a deficit sufficient to provide some specified secular increase in the quantity of money. The tax structure should not be varied in response to cyclical fluctuations in business activity, though actual receipts will, of course, vary automatically. Changes in the tax structure should reflect changes in the level of public services or transfer payments the community chooses to have. A decision to undertake additional public expenditures should be accompanied by a revenue measure increasing taxes. Calculations of both the cost of additional public services or transfer payments and the yield of additional taxes should be made at the hypothetical level of income suggested above rather than at the actual level of income. The Government would thus keep two budgets: the stable budget, in which all figures refer to the hypothetical income, and the actual budget. The principle of balancing outlays and receipts at a hypothetical income level would be substituted for the principle of balancing actual outlays and receipts.

Under the proposal, Government expenditures would be financed entirely by either tax revenues or the creation of money, that is, the issue of non-interestbearing securities. Government would not issue interest-bearing securities to the public; the Federal Reserve System would not operate in the open market. This restriction of the sources of Government funds seems reasonable for peacetime. However, in time of war or immediate threat of war, involving a substantial expansion of governmental expenditures expected to be temporary, it would probably be desirable to finance part of these expenditures by borrowing from the public through the issuance of interest-bearing securities. Provision should therefore be made for this exception under the stated conditions.

Under the proposal, deficits or surpluses in the Government budget would be reflected dollar for dollar in changes in the quantity of money; and, conversely, the quantity of money would change only as a consequence of deficits or surpluses. A deficit means an increase in the quantity of money; a surplus, a decrease.

Deficits or surpluses themselves become automatic consequences of changes in the level of business activity. When national money income is high, tax receipts will be large and transfer payments small; so a surplus will tend to be created, and the higher the level of income, the larger the surplus. This extraction of funds from the current income stream makes aggregate demand lower than it otherwise would be and reduces the volume of money, thereby tending to offset the factors making for a further increase in income. When national money income is low, tax receipts will be small and transfer payments large, so a deficit will tend to be created, and the lower level of income, the larger the deficit. This addition of funds to the current income stream makes aggregate demand higher than it otherwise would be and increases the quantity of money, thereby tending to offset the factors making for a further decline in income.

The proposal therefore automatically produces monetary and fiscal effects promoting stability in aggregate income, output, and prices.

EXTENSION OF TESTIMONY OF R. F. MIKESELL

I should like to discuss briefly a question which has been brought up in a previous meeting of this committee, namely: Would a return to a system of internal gold convertibility in the United States assist or encourage the return to convertibility on the part of other countries?

First of all I would like to refer to my previous statement to the effect that anything which promotes the stability of the United States dollar will provide a more favorable climate for internal stability and balance of payments equilibrium in other countries. Now I believe that a return to internal gold convertibility in the United States, would make it more difficult for our monetary authorities to promote price and income stability in this country. Monetary action is concerned to a considerable degree with the control of banking reserves. Sudden flights to and from gold on the part of our own citizens in response to speculative and psychological influences would make difficult a proper control of banking reserves. Should we experience a very heavy gold drain, our monetary authorities would have to be guided by the objective of maintaining gold convertibility rather than by the much more important objectives of maintaining stable prices and incomes at high levels of production and employment.

While I believe that we should encourage and assist other countries in restoring the convertibility of their own currencies into dollars, other countries would find it very difficult to do so under a system which permitted internal redeemability into gold. Most countries need to mobilize their gold reserves in order to provide a cushion against fluctuations in their balance of payments without having to resort to exchange and trade controls. Few countries have sufficient gold reserves to be able to withstand large internal gold drains as well as those occasioned by periodic fluctuations in their balance of payments. In short, I believe that a return to internal gold redeemable in the United States would not contribute to the achievement of the kind of international monetary system which we are seeking.

Representative PATMAN. We will recess until tomorrow morning at 10 o'clock.

(Thereupon, at 1:05 p. m., the committee adjourned, to reconvene at 10 a. m., Wednesday, March 26, 1952.)

MONETARY POLICY AND THE MANAGEMENT OF THE

PUBLIC DEBT

WEDNESDAY, MARCH 26, 1952

CONGRESS OF THE UNITED STATES,
SUBCOMMITTEE ON GENERAL CREDIT CONTROL

AND DEBT MANAGEMENT OF THE

JOINT COMMITTEE ON THE ECONOMIC REPORT,

Washington, D. C.

The subcommittee met, pursuant to recess, at 10: 10 a. m., in the caucus room, Senate Office Building, Representative Wright Patman (chairman of the subcommittee), presiding.

Present: Representative Patman, Senator Flanders, Representatives Bolling and Wolcott.

Also present: Grover W. Ensley, staff director, and Henry Murphy, economist for the subcommittee.

Representative PATMAN. The committee will please come to order. We have with us this morning five witnesses we are very anxious to hear from. I will first tell the committee something about them. Also for the purposes of the record, the members of the subcommittee will all be here this morning. They seem to be late getting in, but they have their own personal problems. Senator Flanders will be here, Mr. Bolling will be here, Mr. Wolcott will be here, and Senator Douglas has two other meetings and will be a little late, but he is

coming.

We have with us this morning G. L. Bach, professor of economics and dean of the Graduate School of Industrial Administration, Carnegie Institute of Technology, Pittsburgh, Pa., formerly a member of the staff of the Board of Governors of the Federal Reserve System, formerly a member of the staff of the Hoover Commission and author of the staff report on the Federal Reserve System, formerly a consultant to the Treasury Department.

E. A. Goldenweiser, member of the Institute for Advanced Study, Princeton, N. J.; formerly president of the American Economic Association, and for many years Director of Research and Statistics and Economic Adviser to the Board of Governors of the Federal Reserve System, consultant to the CED on monetary policy.

Harold Stein, staff director of the Committee on Public Administration Cases, now the interuniversity case program (the purpose of these organizations being to prepare materials for the university teaching of public administration by the "case method"), consultant to the Public Administration Clearing House, and formerly consultant to the Hoover Commission and the Bureau of the Budget, in Government service from 1934 through 1947.

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