Boom Dampeners

In some respects, the problems involved in setting up a control over the economic mechanism are similar to those encountered in heating a building. Perhaps when we start to survey the heating problem we will find that our walls are thin, the doors and windows are loosely fitted, and an undue proportion of our heat escapes through the ceiling. We could still do a reasonably good job of heating if we install a large enough furnace, but under the circumstances it may very well be desirable to put on some additional side sheeting, weatherstrip the doors and windows, and invest in some insulation. This will cut down the load on the heating system, and will simplify the adjustment of temperature in different parts of the building.

Similarly, we could go ahead, on the basis of the information as to how the economic system operates that has been set forth in the preceding pages, and devise a set of controls that will handle the business cycles just as we find them, and if our program is sound and our control facilities are sufficiently powerful the results will be satisfactory. But here, again, we can simplify our problem quite materially by first taking some steps to plug the worst holes and dampen the cyclical movements to keep them within reasonable limits. This will reduce the task of the control system, and will enable the use of milder methods of control than would otherwise be required. It will be important, however, to make certain that the dampeners that are utilized are actually capable of accomplishing the desired results, and that they do not have any detrimental collateral effects on the economic situation. The various measures of this type that have heretofore been proposed, or are suggested by the results of the present analysis, will now be taken up individually and analyzed from these standpoints.

We have found in our analysis that the business cycle is simply an alternation of money inflation and deflation, unemployment being only a conspicuous side effect with no necessary or direct relation to the cycle. It therefore follows that the measures appropriate for the control of the business cycle are not those which deal with employment, but those which deal with money inflation.

Proposals aimed at countering inflation have been advanced in great numbers since this problem first became a matter of general concern, but most of them are merely variations of a few basic types of action. These proposals can be grouped into two general classes. In the first class are those which, if each operates as effectively as anticipated by its advocates, will be sufficiently powerful and sufficiently responsive to purposeful manipulation to actually control the cycle. These will be discussed in Chapters 24 and 25. The second category, the one to which this chapter is devoted, can be further subdivided into two groups: (1) measures which are wholly ineffective, and (2) measures which have some anti-inflationary effect (or inflationary effect, if they are operated in reverse) and which therefore serve the purpose of dampening the cyclical fluctuations if they are properly applied, but which do not qualify as controls, generally because they do not have any direct and certain connection with the flow of purchasing power. We will begin by considering group (1), the ineffective measures.

Restraint and self-discipline

The call for restraint and self-discipline on the part of individual citizens and economic groups which comes so frequently from public officials-the “jawbone technique,” as it is often called-is nothing more than a gesture. If adequate methods of control are put into effect, such self-denying policies are unnecessary; if no controls are applied all attempts to deal with the cycle by means of “restraint,” etc., are futile. The two actions that provoke most of the calls for restraint, price increases by business firms, and demands for wage increases by labor unions, have no effect on the business cycle, as individual price increases do not change the general price level, and wage increases inflate prices equally at the two ends of the economic mechanism.

Increased productivity

Lowering costs by increasing productivity is just as ineffective in counteracting money inflation as blocking price or wage increases, but here again, the economic profession is prevented from recognizing the true situation by reason of their repudiation of Say’s Law. Without the benefit of this important principle they are unable to see that any change in production price, whether it be upward or downward, is promptly reflected in market price, and therefore has no effect on the type of inflation that is responsible for the business cycle. Myrdal, for example, contended that “higher capacity utilization, following a more rapid growth, will tend to lower costs, which should counteract inflationary tendencies.”182 Of course, higher productivity is a desirable end in itself, and it tends to offset some of the price effects of wage increases, but it has no bearing at all on the type of inflation we are now discussing. It therefore contributes nothing toward the business stabilization that we want to accomplish.

Investment control

Proposals which are based on erroneous economic theories are equally futile. Prominent in this category, especially because of its status as one of Keynes’ principal conclusions, is the belief that the level of business activity and employment can be manipulated by controlling the volume of investment. The supporters of this proposal have convinced themselves that the level of investment is the key to the business situation. “The main topic in the theory of the business cycle,” says R. C. O. Matthews, “is the explanation of fluctuations in investment,”183 and one of the suggestions included in the anti-inflation ideas advanced after the 1930s experience was to “reduce the volume of industrial spending for capital goods.”

The fallacy underlying this line of thought has already been pointed out in detail, and for present purposes it should be sufficient to reemphasize the fact that all goods are alike, so far as the general operation of the economic mechanism is concerned. Shifting purchases from capital goods to consumer goods or vice versa has no more effect on inflation of the general price level than buying margarine instead of butter.

Control of the volume of money

As might be expected from the widespread adherence to some kind of a quantity theory of money, the idea of controlling money volume as a means of regulating the business cycle has a great deal of support, and this idea is prominent in the background of much of the manipulation that is currently being undertaken by the monetary authorities. In view of the confused and contradictory status of the quantity theory, no one seems to have a very clear picture of just what this manipulation is supposed to accomplish, and the only thing on which practically all of those concerned are agreed is that something better than the present system ought to be devised. “Two kinds of suggestions, pointing in different directions, for reducing the possibility of error in a stabilizing money policy are now current,” Stein and Denison said in a 1960 report. “One would prescribe a rule requiring that the supply of money grow at a steady rate, year in and year out. The other would ask the monetary authorities to base their actions more on their forecast of the future and less on present conditions.”184

The foggy state of thinking on this subject is demonstrated by the comments that follow the foregoing statement: “Each of these suggestions has some attraction, but it is not clear that either would yield better results than recent practice. Probably the most one can hope is that the increase of economic knowledge, through research and experience, will permit improvement of monetary policy.”

Whenever the specialists in any branch of knowledge overcome their strong reluctance to admit ignorance, and concede that they will have to wait for an “increase of knowledge” before they can suggest how to improve existing conditions, it is evident that current thought is in a bad state of confusion. In the light of the facts brought out in the preceding pages-the “increase in knowledge” achieved by the use of scientific methods-the reason for the confusion is obvious. It is not possible to arrive at any clear idea as to how the business cycle can be controlled by managing the money supply when, in reality, the quantity of money in the system has no effect on the cycle (Principle XV). The method of increasing or decreasing the money supply may have an effect, but this is an entirely independent consideration. The actual quantity of money in existence at any particular time is completely irrelevant.

Managed currency

In addition to the proposals which contemplate manipulating the quantity of money for control purposes, there are others which envision manipulation of the value of the currency. As usual, the advocates of such plans are divided as to what direction the control measures should take, and we find two different groups proposing to reach the same objective by diametrically opposite routes. One group takes the stand that the money values should be made more flexible and subject to more frequent adjustment The adherents of this school of thought had an opportunity to see their program actually put into operation in the United States. In 1933, largely as a result of advice from Professor G. F. Warren, the administration increased the legal price of gold to $35 per ounce from the long-standing value of$20.67. The avowed object of the move was to devalue the currency and thereby raise the general price level. By its advocates it was conceived as the first of a continuous series of adjustments that would stabilize prices by juggling currency values. The President, with his usual buoyant faith in his convictions of the moment, flatly proclaimed it as a permanent policy and the first step toward a managed currency.185 But, as in so many other “New Deal” experiments, actual results did not conform to the rosy expectations, and the presidential powers of “managing” the currency have not been exercised since the first attempt.

The reason for the failure of this program to accomplish its objectives is not hard to find. So far as the domestic economy is concerned, the goods price level at any particular stage of the business cycle is not determined by the official price of gold but by the cost of production of goods, which, in turn, depends mainly on the wage rate per unit of output. If the average wage rate prior to devaluation was dollars (20.67 standard), and the average goods price level was dollars (20.67 standard), then the devaluation reduced the wage rate to x dollars (35.00 standard). But the goods price level did not remain unchanged, as expected by the Warren group. As required by the General Economic Equation, it had to fall to y dollars (35.00 standard) to maintain the equilibrium between production price and market price. From the standpoint of the consumers, no change at all had occurred.

If everything had remained unchanged in the rest of the world, the net effect would have been a devaluation of the dollar in foreign exchange. But the foreign currencies would then have been grossly undervalued with respect to the true value of the dollar (its buying power), since the dollar was not overvalued to begin with. This would have created an intolerable trade situation. The foreign governments therefore accommodated themselves to the American action by altering their own gold prices. Within a short time everything was back where it started, except that the world-wide price of monetary gold was higher, an increase that had no economic significance, since, as pointed out in Chapter 15, the price of gold is now arbitrary.

The prices of some commodities are determined in the international markets, and during the interim period before the necessary adjustments were completed there was some increase in the prices of these commodities. The general belief in economic circles was (and still is) that an increase in the price of some goods has a tendency to be communicated to others, and thus exerts an influence toward raising the prices of all goods. It was therefore thought that these price increases in the goods affected by the international markets would cause a rise in the domestic price level. But the rise never materialized.

The analysis of the economic system in terms of purchasing power shows that the expected result is impossible. As long as the average wage rate in terms of U.S. currency is not altered, any rise in the price of one commodity must result in a decrease in the average of all other prices, not an increase, inasmuch as a constant wage rate under the short-term condition of unchanged productivity means a constant total money purchasing power. When production volume and total money purchasing power remain constant, average market price, the quotient of these two quantities, also remains constant, and any increases in the prices of individual items must be counterbalanced by corresponding decreases in the prices of other items. The actual experience with devaluation in terms of gold, which was so contrary to what its sponsors expected, was therefore exactly in accord with what the theory outlined in the earlier pages of this work predicts.

There is still a substantial amount of support, particularly among politicians and “supply side” economists, for a return to the gold standard. This just the reverse of what the “managed currency” advocates want to do; it is a return to a more rigid monetary standard rather than a change to a more flexible one. As brought out in Chapter 15, however, the gold standard has no significance in application to one nation alone, and it is no longer possible for more than one nation to maintain free convertibility at fixed rates. As matters now stand, therefore, the suggestion of a return to the gold standard is only a nostalgic dream.

One Hundred Percent Bank Reserves

Another proposal is based on the assumption that bank credit is the cause of economic instability. It proposes to eliminate inflationary bank credit by requiring the banks to maintain one hundred percent reserves against demand deposits at all times. The objective of this plan, says R. P. Kent, “is to strip the commercial banks of their power of money creation. With such a plan in effect, the monetary authorities would have direct and complete power to determine what changes in the volume of money should be permitted; for the commercial banks would no longer be able to “blow up' a dollar of reserves into several dollars of deposit money.”186

As explained in Chapter 15, the pyramiding of credit that this plan is intended to prevent is wholly illusory. The reserves can be “blown up” into demand deposits, to be sure, but this means nothing, as the economic effect of the loans that create the deposits is opposite to that of the deposit, and these effects cancel each other. The bank-created deposits disappear if an attempt is made to use them. Demands made upon them must be met by money withdrawn from the bank reserves, or obtained from outside sources. The objective at which the one hundred percent reserve plan is aiming is thus in operation already. Only the monetary authorities (in the United States, the Federal Reserve system), can issue new money.

Discussion

The failure of the attempts that have thus far been made to control the business cycle, and the general realization that, for all we know, and despite all of the optimistic pronouncements to the contrary, another Great Depression may strike at any moment, has inevitably led to doubts as to whether economic stability is possible at all under our present economic organization. Comments along this line have been remarkably similar over a long period of time. Frank H. Knight (1953) took a pessimistic view. The business cycle, he said, “is extremely hard to deal with-probably impossible to correct adequately-without destroying the essential freedoms of economic life, for the ordinary citizen as well as for business itself.”187 Thorp and Quandt (1959) questioned both the competence of the controllers and the adequacy of their tools. “The first question that arises is whether or not any men or institution can have enough economic knowledge and wisdom so that there is a strong probability that they will do more good than harm. Secondly, are the instruments which are available to them such as to be effective.?”188

This work answers both of Thorp and Quandt’s questions in the affirmative. A systematic analysis of economic processes has revealed the precise cause of economic fluctuations, and once the cause is known, the nature of the remedy becomes obvious. It remains only to devise, or to select from among those already available, effective measures of this nature that will accomplish the objective without undesirable collateral effects. All of the proposals discussed in Chapter 22 and the preceding portions of this chapter are completely worthless for control purposes. Taken in conjunction with the fact that none of the measures thus far tried has achieved any significant degree of control of the cycle, this may give the impression that the skepticism expressed by the economists quoted in the preceding paragraph is well founded. But the truth is that adequate tools for the purpose are readily available once we recognize exactly what we want to accomplish, and have the criteria by which we are able to determine what actions will contribute toward that end. At this point we will proceed with a discussion of the proposals of Group Two: those which actually are of some value in a control program, because they have some effect in reducing the amplitude of the cyclical fluctuations.

Curtailment of speculative credit

”Since 1933 the Federal Reserve has been directed by law to restrain the undue use of bank credit for speculation in securities, real estate, or commodities.”189 The principal instrument now utilized for this purpose is the power to change the margin requirements on security purchases. When market prices are below normal levels the margin requirements are lowered, making it easier to buy. When prices go up the margins are raised, decreasing the ability of the speculators to pyramid large holdings on inadequate equity foundations. This program has a definite value as a means of reducing economic fluctuations. In fact, the choking of an incipient speculative boom may very well serve to prevent a major disturbance of general credit conditions. Margin control should therefore be listed as one of the desirable components of a well-rounded stabilization program.

Relating margin requirement to earnings

One of the objections to the control of the security market by raising and lowering margin requirements in the manner in which this is now done is the human element involved in making the decisions as to when action should be taken and as to the magnitude of the change. Perhaps action may be taken at the wrong time, or delayed until it is ineffective. There is more than a suspicion that some of the credit control measures taken prior to the 1928-29 boom were just the opposite of what should have been done. It is also true that this method of regulation necessarily involves proceeding by a succession of jumps rather than operating smoothly and unobtrusively as an ideal control would do. It would clearly add much to the effectiveness of the control if it could be made automatic rather than depending on human judgment.

In recognition of these facts it has been proposed that the margin requirements be based on average corporate earnings rather than on arbitrary Federal Reserve policies.190 Although there are some rather obvious difficulties involved in putting such a plan into operation, the idea does seem to have considerable merit, particularly in connection with a complete economic stabilization program such as that which will be developed in the subsequent pages. Such a full-scale program will tend to stabilize corporate earnings to a substantial degree, and will avoid many of the complications that might be encountered in applying the plan under present conditions where earnings are so highly volatile.

Relating margin requirements to the long-term price trend

A modification of the foregoing proposal that should make the control operation smoother and less open to objections would base the margin requirements on the relation of current prices to the long-term trend. It is unsound policy to permit borrowing on values in excess of this long term trend, values that as a whole are purely fictitious and will disappear as soon as any economic stress develops, putting the general credit structure into a vulnerable position. At the peak of the 1929 boom the long term trend of common stock prices on the New York Stock Exchange, in terms of the most commonly quoted price index, was in the neighborhood of 100. If the margin requirement were 50 percent, the loan value would have been about 50. Actually the average price in the market at that time was around 220 instead of 100. The additional 120 was a fictitious value created by speculation, not a real value, and the lending of anything more than 50 on a market valuation of 220 was unsound finance, as the aftermath definitely proved. In order to maintain the 50 percent margin on a real value basis, the legal margin at the peak should have been nearly 80 percent.

Some recognition is already being given to these points. The Federal Reserve explains that “modern suprvisory appraisal of bank assets emphasizes sustainable banking values rather than current market values. In this way bank supervisory authorities and exminers try to exclude from bank asset valuation the transitory influences associated with economic fluctuations.”191 Present-day margin requirements are clearly more realistic than those which prevailed prior to 1930. However, the situation will never be fully satisfactory as long as the control over the valuation is merely something that the authorities “try” to exercise in an unsystematic way. The undesirable aspects of present practice will be fully overcome only when the valuation for lending purposes is put on a definite and specific basis that eliminates human judgment.

The desirability of strict control over the speculative use of credit is particularly indicated by the point brought out in Principle XIII, the fact that increases in the prices of securities, real estate, and other capital assets already in the hands of consumers finance themselves, and hence such prices can gyrate wildly up and down without any regard for realities, as far as the original enthusiasm or the subsequent pessimism of rhe speculators can overcome good judgment. In lending on the strength of speculative value increases, bankers are filling their vaults with nothing more substantial than dreams.

A particularly attractive feature of the proposed automatic system of margin control is that it can also be applied to the making of loans on real estate security by banks and other lending institutions subject to government supervision. Much of our present trouble originates from fluctuating real estate values, and in some respects this is more serious than the stock market situation. On the whole, the losses in stock market operations are borne by those who can absorb them without undue personal hardship, but the worker who loses his home because inflated values are punctured has suffered a real catastrophe, and it is not surprising that he should thereafter lend a ready ear to the political and economic extremist. There can be a certain amount of variation even on a cash basis, but there is no question as to the responsibility of credit for the major swings. Prohibition of loans exceeding a specified percentage of the valuation adjusted to the long term trend would have a definite stabilizing effect.

There will no doubt be some criticism of this idea on the ground that it will make the acquisition of a home very difficult when prices are high, but the obvious answer is that such purchases should be curtailed when prices are abnormally high. The individual who has to wait until prices come back to normal levels will be well compensated for the waiting by getting his house for a more reasonable price.

It has been suggested that stabilization of business activity could be accomplished, at least in part, by limiting the amount of increase in credit to conform to the long term trend of increase in business volume. The advocates of this measure point out that the annual increase in business is in the neighborhood of four to five percent, and that whenever the increase in credit exceeds this percentage by any substantial amount a speculative boom develops, ultimately terminating in some kind of collapse.

This idea of credit limitation is entirely in line with the principles developed herein, which show that credit is one of the important causes of variations in economic activity, but it does have some serious weaknesses. If the limitation is to be effective it cannot have any significant amount of flexibility, and this may seriously handicap the banking system in its task of taking care of short term fluctuations. Furthermore, it does not have the direct connection with the flow of purchasing power that is essential to get prompt and certain results from application of the controls. We therefore cannot count on credit policies as full-scale economic control measures, but there are some kinds of credit control which can profitably be used for the purpose now under consideration: that of dampening the cyclical swings. In the United States such controls are exercised mainly by the Federal Reserve System, and it is significant that the governors of that system are confident that their actions are actually contributing to the stabilization of the economy. The following is a quotation from one of their official publications:

Federal Reserve influence on the flow of bank credit and money affects decisions to lend, spend, and save throughout the economy. Reserve banking policy thus contributes to stable economic progress.192

Restriction of consumer credit

Consumers utilize short-term credit principally for the purchase of durable goods and financing improvements of property, and utilize long-term credit mostly for financing construction or purchase of homes. These requirements are not very sensitive to minor changes in the interest rate, and the available tools of the banking system are therefore relatively inefficient in controlling the volume of this kind of credit. When some curtailment is advisable, as in wartime, it is usually necessary to resort to some direct prohibition such as that contained in Regulation W, issued during World War II. Such restrictions on individual freedom of action are highly unpopular, and it is quite unlikely that any program designed to operate through the medium of direct concumer credit control would have enough popular support to make it feasible, even it it did theoretically have some good features. Borrowing for business purposes, on the other hand, is usually an unemotional transaction, and it is also much more sensitive to changes in the interest rate and in the ease with which credit can be obtained. It is therefore more amenable to purposeful control. All of the credit control measures that will be discussed in the subsequent pages are aimed primarily at influencing the amount of business borrowing.

Manipulation of the rediscount rate

Considerable experience has been gained with the use of the Federal Reserve rediscount rate as a means of controlling credit. By law the Federal Reserve Board has been given the power to raise or lower the rate charged the member banks for money which they secure by “rediscounting” eligible paper at the Federal Reserve banks. Inasmuch as this rediscount rate affects the cost of money to the banks, any change has an indirect effect on the interest rates charged by the banks and on their willingness to lend, and hence either encourages or discourages borrowing, depending on the nature of the change that is made.

The results that have been obtained by the use of this device indicate that it is effective to some degree in restricting credit during a boom, but does practically nothing toward increasing borrowing during a depression. The explanation is that the Federal Reserve has the upper hand during the boom. The member banks have already made loans to the extent of their own resources, and they cannot go any farther without rediscounting at the Federal Reserve Bank. On the other hand, the limit to borrowing during a depression, or even a recession of any consequence, results from a scarcity of would-be borrowers who have both the inclination to borrow and the abiltvy to meet the stringent collateral requirements that are imposed under these conditions. The member banks have plenty of excess reserves of their own to meet the needs of those borrowers whom they consider good risks, and the “easy credit” policy of the Federal Reserve System has little or no influence on the transactions.

The need for adjustments in the rediscount rate will be reduced to a minimum when measures of the type that will be discussed in Chapters 24 and 25 are put into effect for the purpose of an actual control of the business cycle, but if the Federal Reserve System is to retain its power to create new money, ability to adjust the rediscount rate would seem to be a desirable adjunct, as a means of exercising a certain amount of influence over the demand for this new money.

Changing reserve requirements

Another credit control tool, made available to the Federal Reserve in 1933, is that of changing the legal reserve requirements of commercial banks. The action of this device is explained by the Federal Reserve as follows:

Two things happen when required reserve percentages are changed. First, there is an immediate change in the liquid asset or secondary reserve position of member banks. If reserve percentages are raised, banks that do not have enough excess reserves to cover the increase in requirements must find additional reserve funds by selling liquid assets in the market or by borrowing from other banks or from the Reserve Banks...

If reserve percentages are lowered, individual banks find themselves with a margin of excess reserves available for investment in earning assets and for debt repayment. Since banks maintain their earnings at the highest level consistent with solvency by keeping their own resources as fully invested as possible and by avoiding debt, their usual response to a lowering of reserve requirements, after retiring any indebtedness, is to acquire earning assets.193

In the terms of reference of this present work, all of the foregoing can be succinctly expressed by saying that the effect of varying the reserve percentages is to change the amount of money that the banks must keep in storage. As explained in Chapter 15, the significant quantity in banking practice, so far as the general operation of the economic system is concerned, is the size of the reserves: the amount of money purchasing power actually held in storage in the banking reservoir. An increase in the reserve requirements means that the banks must keep more money in storage. If they do not have excess reserves they must take some action to curtail the amount of loans relative to deposits, thereby withdrawing money from the circulating purchasing power stream and diverting it to storage. A decrease in the reserve requirements enables them to draw money from storage and put it back into the active stream of purchasing power by increasing loans or purchasing securities.

A change in the reserve requirements is thus the kind of an action that is necessary in order to offset inflationary or deflationary trends, but here again the response to such changes is not specific enough to enable using this device as the primary control. Furthermore, there are practical obstacles that make the changes in reserve percentages “less flexible and continuously adaptable” than other “instruments of monetary management,”194 as the Federal Reserve System itself sees the picture. These changes are therefore useful more as an auxiliary control device than as an essential feature of the control mechanism.

The effects of foreign trade on the domestic price level and porchasing power flow were discussed in Chapters 16 and 17. No further comment is necessary at this time, except to say that in the overall control of the reservoir transactions any unbalace in foreign trade has the same effect, and must be treated in the same manner, as any other transaction. affecting the money reservoirs.

Discussion

As emphasized in the theoretical development, direct credit dealings play only a small part in the modern economy, and credit, from a functional standpoint, is primarily a means of making withdrawals from money storage. Bank depositors make both deposits and withdrawals, but there is a continuing excess of deposits, and the net result of the transactions between the bank and its depositors is that money goes into bank storage. Credit is a device whereby this money can be withdrawn from storage for use by other individuals or agencies. Unfortunately, the inputs and the withdrawals do not always stay in balance. Quite the contrary, the normal tendency is toward an unbalance either in one direction or the other. When economic conditions are such that the consumers are inclined to be cautious and save rather than spend, thus increasing the amount of money available for lending, the borrowers have less opportunity for profitable use of the money, and they therefore reduce, rather than increase, their borrowings. Conversely, in those periods when the consumers are inclined to spend rather than save, the demand for loans is greater than normal. The result is that we experience an alternating cycle of inputs into money storage and withdrawals from that storage, part of the general phenomenon of the business cycle.

The credit control operations of the Federal Reserve System that have been discussed in the preceding pages are aimed an dampening these cyclical movements by restricting the amount of credit during the upswing and making it easier to obtain during the downswing. Experience has indicated that these operations do actually make some contribution toward their objective, but their usefulness is limited by the fact that they operate indirectly and hence their effect is somewhat uncertain.

In terms of the automobile analogy, we may say that we have here some devices that will turn the wheels of the car and thus change the direction of motion. But changing direction is not our objective; it is merely a means to an end. Our real objective is to stay on the road, and this requires much more than merely being able to turn the wheels. First, we must have some way of knowing where the road is, so that we will know exactly when and how much to change our course. Second, we must have a positive control system, so that we will know not only the kind of a response that the system will make to our control actions but also the magnitude, or at least the approximate magnitude, of the change that will result from a specific amount of application of the control system.

Keeping the economic machine on a smooth course requires economic information and facilities of an analogous nature, but existing economic theory and practice do not meet these requirements. There is no clear understanding, either among bankers or among economists, as to where the smooth economic road is located. Consequently, when it becomes evident that the economy is in trouble because it is off course, no definite indicator is available to define the amount of change that will have to be made in order to get back on the road. Nor is there even any general agreement as to which direction the change should take. Almost every move that is made by the regulatory agencies comes under fire from some quarter. As expressed by Reynolds,

The Federal Reserve Board will never win a popularity contest. It has the peculiar misfortune to come under attack from precisely opposite standpoints.195

This inability to chart a clear course, together with the fact that most of the tools available to the Federal Reserve and other government agencies lack the direct and positive connection with the business cycle that would produce just the right amount of movement even if those agencies had some reliable means of identifying the correct action, explains the erratic performance record of the credit control measures.

The significant accomplishment of the theoretical development in the earlier chapters, so far as the stabilization question is concerned, is the positive identification of the factor that determines the direction in which the cycle is moving, and the magnitude of the movement. From the facts brought out in this investigation it is now apparent that the presence of reservoirs in the circulating stream of money purchasing power is the key to the whole situation. Here is where the business cycle originates, and here is where it must be controlled, if the control is to be effective. By measuring the changes that take place in the levels of these reservoirs-something that can easily be done on a continuous basis-we can determine exactly what is currently happening, and by taking appropriate action on the basis of this information we can counterbalance any tendency to move away from the equilibrium condition, thus keeping the economy on a permanent even keel. The various practical methods of taking this appropriate action will be explored in the next two chapters.

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