24 Stabilization Methods -- I


Stabilization Methods - I

As stated in the preceding chapter, the measures discussed therein are not of a character appropriate for a definite control of the business cycle. Those that are effective at all are merely methods of reducing the amplitude of the cyclical movements and thereby simplifying the subsequent problem of control. We will now turn our attention to the means available for actually governing the economic mechanism to stabilize the economy and eliminate the alternation of booms and recessions.

The first requisite for accurate analysis is that we must determine specifically just what it is that we want to stabilize. The average citizen undoubtedly feels that the establishment of a permanent high level of employment is the number one problem. In the preceding pages, however, it was demonstrated that the market price level is independent of the volume of production (Principle IX), and consequently the cyclical price movements will continue regardless of any action that may be taken with respect to maintaining a high level of employment. It was further shown that these price cycles are inevitably producers of unemployment (barring revolutionary changes in the prevailing attitude toward maintaining wage rates), and any stabilization of employment that might be accomplished would therefore be upset periodically by the business cycle unless some action is first taken to eliminate the cyclical price movements.

When stabilization of prices is mentioned, the assumption is usually made that the expression refers to something on the order of Irving Fisher’s “commodity dollar.” It was the contention of Fisher and his school of thought that the alternating high and low commodity prices that we seem to see in the commodity markets are merely an illusion; that in reality the commodity prices are stable, but the value of the currency varies. What appears to be a price cycle is actually a money cycle, the great “money illusion,” as Fisher called it.196 So the commodity dollar advocates propose to cut the dollar loose from its traditional moorings and manipulate the money values in such a way as to keep the average price of a selected group of commodities at a predetermined level. The Goldsborough Bill introduced into Congress in 1922 was an organized attempt to establish the commodity dollar as a definite national policy.

The methods by which these results might be accomplished are not relevant to the present discussion. For the moment we are interested only in the question as to whether or not this kind of price stabilization, if successful in holding a fixed price level, will actually iron out the cyclical movements without any harmful collateral effects. It is apparent at the outset that Fisher’s theory of the fluctuating value of money is erroneous. As demonstrated in the preceding pages, it is an unbalance between the rates of flow of money purchasing power and goods into the market that is responsible for the price changes originating in the markets (money inflation and deflation), not any actual variation in the value of either one or the other. Furthermore, it is clear from the facts brought out in the previous discussion that any arbitrary change in the wage or tax components of production price is promptly reflected in the market price level. In order to examine this situation more closely, let us go back to the General Economic Equation:

B/V = P

Assuming the commodity dollar plan to be in effect, what happens if the workers in several major industries secure wage increases? Production price now rises to fP, and the higher wages increase money purchasing power a corresponding amount to fB. Volume is, of course, unaffected, and the new production equation becomes

fB/V = fP

But when the increased money purchasing power fB reaches the markets and starts to raise prices, the deflationary methods of the price stabilization scheme come into play. If they work according to theory they bring the price level back to P, the “stable” level. The principles developed earlier show that this could only be done by some kind of an unbalancing reservoir transaction which would withdraw money purchasing power from the stream going to the markets, reducing fB to B, but even without the benefit of this previous consideration, it is clear from the equation itself that no matter how fP is reduced to P, there must be a corresponding reduction from fB to B, as V remains constant.

The purchasing power flowing back to the producers from the markets is now only the amount represented by B, but the wage increase prevents restoration of the original relation B/V = P, and producers must cut the volume of production in order to adjust expenses to income. The attempt to maintain a fixed market price level in the face of higher production costs thus has exactly the same effect as a business depression, throttling industry and creating unemployment.

In this connection it is worth noting that if the “price control” measures that have so much support in some quarters were actually capable of holding the price level down, they would have the same effect as the “commodity dollar” program; that is, they would create an artificial business depression. The two programs are, in fact, merely different versions of the same thing.

It is apparent from the foregoing that the “commodity dollar” proposal is unsound. The desirable end is not stabilization of prices at any specific level, but the maintenance of an equilibrium between production price and market price. If production price rises because of wage increases or higher business taxes, market price must follow. Otherwise economic unbalance will be created where none existed before. Similarly, if production price falls because of technological improvements or other decreases in costs, market prices must not be prevented from taking a corresponding drop. Critics of the price stabilization proposals have recognized this flaw in the commodity dollar scheme, but they have not all realized that these defects do not invalidate the general idea of price stabilization. They merely indicate that the freezing of prices at any specific level is unsound, inasmuch as the system cannot remain in equilibrium unless market prices are left free to follow any changes that may occur at the production end of the mechanism.

The detailed analysis of the operation of the economic system in the earlier chapters shows very clearly that price changes originating at the production end of the mechanism have no unbalancing effect on the general economy as long as the markets are allowed to adjust themselves to such changes. The fear of excessively high wages, or exorbitant profits, that has been expressed by so many economists is definitely unfounded, so far as any detrimental effect on the general business situation is concerned. Wage increases merely raise prices all the way around, increasing the money purchasing power available for buying goods by the same amount as the market price increase, so that the volume of production remains the same, and the ability of the consuming public as a whole to buy goods remains just where it was before the rise. Whatever losses may be sustained by certain individuals or groups are offset by corresponding gains to others
(Principle XI). To the limited extent that deviations from the normal rates of profit are possible, the same is true of these changes.

On the other hand, price changes originating at the market end of the mechanism by reason of purchasing power reservoir transactions are the central factor in the business cycle, and they do have a very serious effect on the stability of economic life. Without such market-based price changes there would be no cyclical movement of the economy, and all of the objectionable side effects of the cycle would be avoided. It is therefore clear that prevention of these price fluctuations originating in the markets (maintenance of an equilibrium between market price and production price) is the form of stabilization that we want to accomplish.

This redefinition of the goal of the stabilization program makes it evident that there are better methods of handling the control operation than those that have heretofore been suggested. It would still be possible to work with index numbers if we wish to do so. An index of production prices could be compiled to serve the same purposes as the commodity price index, and the stabilization could be based on the ratio of the two indexes. But index numbers are unsatisfactory tools for accurate work, in spite of all of the ingenuity that has been employed in their construction. Price changes, like most other economic movements, are selective, and it is the general rule that the basic commodities, around which the index numbers are mainly compiled, because of the availability of more and better price and volume data, are the least responsive to influences tending toward change. Other large segments of the economy fluctuate much more widely. Services, which represent a major and rapidly growing proportion of the total goods consumed in this country, are largely outside the realm of business statistics, and consequently they are not represented adequately in the standard index numbers. As the Department of Commerce admitted in the statement previously quoted, the indexes “do not include or make sufficient allowance for various intangibles.”150

We can, however, avoid the necessity for dealing with uncertainties such as those involved in the use of index numbers by controlling the cause of market price level fluctuations rather than attempting to gear our control to the price changes themselves. As was brought out in the earlier discussions, market prices would mirror production prices, and there would be a smooth, stable flow of goods and of purchasing power, if it were not for the reservoirs along the line into which some of the purchasing power can be diverted, and from which at other times purchasing power can be drawn to swell the stream going to the markets. Unlike the determination of price levels, the measurement of changes in these money and credit reservoirs is relatively easy. Such measurements can be made and are regularly being made, with a high degree of accuracy. Furthermore, the measurements are simple enough that they can be kept up-to-date at all times. Most of the information that would be needed for control purposes is already available daily.

The transactions carried out by means of the purchasing power reservoirs play an important part in our modern economic life, and it would not be advisable to prohibit them., or to place unduly rigid restrictions on them. But this is not necessary for control purposes. We do not even need to deal with each one individually, other than to keep track of what is happening in each place. Since all purchasing power is alike from the standpoint of its economic function, we can eliminate market price level fluctuations by introducing compensatory transactions of the right magnitude and direction in any reservoir to cancel the net unbalancing effect of the transactions which are currently taking place in all of the money and credit reservoirs.

Since the data that show the condition of the reservoirs are complete and accurate, and can be kept current at all times, the regulation can take the form of a continuous series of minor actions, rather than successive relatively drastic steps. Because of this advantage, plus the fact that only the net excess of transactions one way or the other needs to be neutralized, the control measures can be mild and unobtrusive, particularly if provision is made for curbing speculative excesses, as suggested in the preceding chapter.

Before taking up a consideration of the various practical programs that have been proposed for the purpose of governing the flow in and out of the money and credit reservoirs (proposals that have been made in other language, as the reservoir concept herein developed has not hitherto been recognized in its true light), it will be advisable to take a brief look at the suggestion that we should meet the situation at the opposite end of the economic mechanism; that is, by controlling production or by storage of products, rather than by controlling storage of the circulating medium.

An example of this type of approach is a plan proposed by Benjamin Graham during the depression of the thirties that envisions the stabilization of prices by the storage of a selected group of durable commodities under government auspices, and the unlimited privilege of exchange of money for these commodities, and vice versa, at a fixed rate (in units made up of a specified quantity of each commodity).197 The theory is that when the market price of these commodities falls below the established standard there would be an advantage is selling to the government storage agency, and enough of the supply would thus be withdrawn from the market to bring prices back to normal. When market prices rise above the standard enough would be bought from the government agency instead of through the markets to cause a lowering of the market price. The expectation is that the stabilizing of the prices of these commodities would exert a stabilizing effect on the market price level as a whole.

We have found that control of the business cycle requires maintaining a constant relation between the flow of goods and the flow of money purchasing power, The control can theoretically be exercised over either of these flows. Graham’s plan attacks the problem by setting up a control over goods market volume rather than over purchasing power. But storage of goods in the required amounts is out of the question. Commodity storage practiced on the small scale contemplated in the Graham plan would merely shift the price instability from the stored commodities to all other goods. In order to stabilize the prices of goods-in-general by this means it would be necessary to provide goods storage sufficient to balance the net excess of transactions into or out of the purchasing power reservoirs. This would involve storing billions of dollars worth of goods, and is clearly impractical.

Furthermore, this plan, like so many other proposals for economic control, applies the regulation in the wrong place. Price stabilization is not an end in itself; it is only sought as a means of stabilizing business activity, consumption, and employment. Even if it were feasible to apply this storage plan on such a huge scale that price stability could actually be achieved by this means, this would not solve the problem at which it is really aimed. It would create the kind of instability that we are trying to eliminate, as it would introduce variations into the flow of goods that did not previously exist.

While this plan gained some attention during the depression of the thirties, when the authorities were desperate for some kind of an answer to the problem, it was quickly dropped when the depression experience was subjected to more critical examination after the emergency was over. This was, of course, a reflection of the fact that the shortcomings of the plan had already become apparent to those who studied the situation carefully. It has, however, been necessary to give the subject some consideration here in order to complete the theoretical picture of the possible methods of control, and also to lay the groundwork for discussion of a different kind of manipulation of the goods reservoirs that we will take up in the next chapter.

The post-depression review did include consideration of the following suggestion: “Increase production to match the ‘excessive’ supply of money.” The thought here is that since money inflation is due to the availability of too much money purchasing power relative to the volume of goods currently produced, the remedy is to increase the volume of goods to an equality with the amount of money purchasing power. If the volume of goods could be increased independently of the purchasing power, this idea might have some merit, but, as has been emphasized repeatedly in the preceding pages, it is impossible to produce goods without at the same time and by the same act producing an equal amount of purchasing power. An unbalanced excess of money purchasing power therefore cannot be corrected by increasing production.

Another variation of the production control idea is based on the “overproduction” theory of the business cycle, which was widely accepted during the depression era of the thirties. This theory contends that we are producing too much during the boom periods, and that the depression or recession comes about because of the necessity for cutting down production to enable using up the accumulated surpluses. The proposed control system therefore contemplates reducing the volume of production during the inflationary phase of the cycle, and assumes that this reduction will automatically result in an increased amount of production during the low stages of the cycle.

The falsity of the assumptions on which the overproduction theory is based is now generally recognized, and for present purposes it should be sufficient to say that the business cycle is a result of totally different causes. Whatever variation in production takes place during the successive phases of the cycle is an effect of the cyclical variation, not the cause thereof.

Thus all of the proposals that envision economic stabilization by storage of goods or regulation of the volume of production are inherently unsatisfactory. Even those proposals that are theoretically feasible are unworkable in practice, due to the physical limitations on the possibility of goods storage. Furthermore, the method by which the control is supposed to be exercised is objectionable per se. Maintenance of a steady flow of goods to the consumers is one of the prime objectives of economic policy, and any measure which aims to achieve business stability by introducing arbitrary irregularities into the flow of goods is prescribing a cure which may be as bad as the disease. The economic unbalance that causes the cyclical swings can be corrected only by attacking it where it originates: in the money purchasing power stream flowing to the markets.

Some of the measures discussed in the preceding chapter were aimed in this correct direction, but these measures fail to qualify as effective control devices primarily because they operate indirectly, and hence do not have the positive and certain effect that is necessary for accurate control. Restriction of credit, for example, tends to discourage withdrawals from the money reservoirs, but there is no direct relationship. We cannot say that an increase of x percent in the rediscount rate will reduce the use of credit by y percent. What we need is a mechanism that does have this kind of a direct connection. If our reports indicate that the reservoir withdrawals are currently exceeding inputs by a million dollars per day, then for positive control of the situation we need a direct mechanism whereby we can divert a million dollars per day from the swollen money purchasing power stream until the excess withdrawals from the consumer reservoirs cease.

The most obvious means of accomplishing this objective is to utilize government fiscal policy. The government is continually receiving a large inflow of money from taxation and other sources, and there is a corresponding outflow of similar proportions. On the average these two streams are equal, unless the government has deliberately embarked on an inflationary course, but there is no requirement that a continuing equilibrium be maintained, and at any particular time there is usually a net excess either of receipts or of expenditures. Such an excess constitutes an input into or a withdrawal from a purchasing power reservoir, and these reservoir transactions have exactly the same effect on economic equilibrium as transactions of equal magnitude in the private sector. Since the government transactions are subject to deliberate control, if control seems advisable, we have here the kind of a direct and positive mechanism that we need for the purpose of offsetting the fluctuations in the flow into and out of other purchasing power reservoirs.

A general recognition of the potential of government financial dealings as a means of control of the level of business activity has been achieved in the last few decades, and “compensatory fiscal policy” currently receives widespread support, at least in principle. Unfortunately, however, present-day economic thought fails to distinguish between the problem of economic stability and the employment problem. As a result, fiscal policy is not primarily utilized, or advocated, for the purpose of maintaining a stable level of prices and business activity, an objective to which it is well adapted, but for the purpose of minimizing unemployment, an objective toward which it can make no more than a temporary and uncertain contribution, and this only at a rather high cost in the form of inflation.

This subject was given a great deal of attention in the era following the 1930 depression. Arthur Smithies gave this report as of 1948:

The idea of a government commitment to maintain full employment through fiscal policy became widely accepted... The Employment Act of 1946 in this country originated as a proposal to achieve full employment through fiscal policy alone.198

But a commitment to do something means nothing at all unless that something can be done, and the fact that unemployment is still our most critical domestic problem emphasizes this point. Disappointing results are inevitable as long as fiscal policy is directed toward the wrong objective.

Many of the economists who analyzed the position of economic theory in the post-depression review mentioned earlier were uneasy about the relation between employment and inflation. “It is possible.” reported Thorp and Quandt (1959) “that monetary policy... may create a conflict between two ultimate objectives of society: namely between full employment and price stability,”200 and Smithies admitted that “we have as yet no answer to our main question of fiscal policy: is it possible to prevent inflation and achieve maximum production at the same time?”199 Over the next few years Keynes and his disciples gave an “authoritative” negative answer to this question, as indicated in the following statement:

With remarkable prescience, both Keynes and Mrs. Robinson foresaw in the prewar period the dilemma facing most western nations today: the impossibility of achieving simultaneously, and without price or wage controls, the twin goals of full employment and price stability.79

In the absence of any contradictory experience, or new theoretical understanding, the existence of this “dilemma” is accepted by modern economists of all schools of thought, as noted in the discussion in Chapter 2. Notwithstanding the near unanimity of this opinion, it is definitely wrong. Coexistence of full employment and zero inflation is not impossible. What is impossible is to attain both goals by means of the same measure, as the monetary authorities, following the advice of the economists, have been trying to do. There is no common solution for both problems. But, as has been explained in the preceding pages, both goals can be reached if they are approached separately, each by the methods appropriate for that problem. What is necessary to recognize is that monetary and fiscal measures are stabilization tools, not employment tools, and they should be used, when and as needed, for stabilization purposes only, leaving the employment situation for treatment by measures specifically adapted to employment.

In undertaking an analysis of the practical methods that are available for applying fiscal policy to the stabilization program, it should be emphasized at the outset that the objective to be accomplished by a stabilization program, as we have identified it in the foregoing pages, is to counterbalance the net excess of money purchasing power reservoir transactions, whatever direction and magnitude that net excess may take. Thus the effectiveness of any specific measure is determined by the extent to which it contributes toward this objective, and any merit that it may have from some other standpoint is irrelevant. A measure that increases production, for example, may be quite helpful in relieving distress during a depression, but production adds equally to the stream of goods and the stream of purchasing power, and therefore accomplishes nothing toward correcting the purchasing power unbalance that causes the depression. Such a measure has no value for stabilization purposes, however useful it may be in other respects.

The same is true, in large part, of most of the so-called “built-in stabilizers” which are so widely hailed as bulwarks of the present-day economy. “Unemployment insurance,” says Arthur F. Burns, “is the nation’s first line of defense against depressions. When business activity falls off, the payment of insurance benefits promptly rises and this offsets in part the decline of income from productive employment.”201 Galbraith views the situation in these terms: “Unemployment insurance means that a man’s purchasing power is protected when he loses his job. It falls, but no longer to zero. Thus a measure designed to reduce the insecurity associated with unemployment also acts to counteract the loss of output-the economic inefficiency-associated with depression.”202

Now let us analyze these transactions from the purchasing power standpoint and see whether these confident expectations are justified; whether unemployment insurance actually makes any contribution toward correcting the purchasing power unbalance that is the root of the trouble. This is not an inquiry as to whether or not such insurance is justified. As Galbraith pointed out, this measure is “designed to reduce the insecurity associated with unemployment,” and the justification for putting it into effect rests upon these grounds. But both Burns and Galbraith claim that it is also an anti-depression measure, and it is this claim that we want to examine.

As matters now stand, if a recession gets under way, the volume of unemployment increases. Payment of unemployment benefits then rises. If the funds for making such payments are obtained by withdrawal of money from storage, the rising payments would swell the money purchasing power stream, and would actually have the kind of a compensating effect that is necessary to offset the deflationary consumer reservoir transactions. But the unemployment funds are not normally held in cash by the state agencies that handle the payments; they are either invested in securities or are deposited in the banks. In order to convert the securities into cash they must be sold. The amounts paid by the purchasers of these securities then decrease the money purchasing power available for buying goods-in-general by exactly the same amount that the purchasing power is increased by the unemployment benefits. The net effect on the economic unbalance is therefore zero.

Where the money is withdrawn from the banks rather than from investments, the final result is the same if the banks find it necessary to reduce their loans or investments in order to meet the demand for cash. No contribution toward stabilization is made unless (1) the banks happen to have excess reserves from which the funds can be obtained, or (2) the need for cash is met by new currency issued through the Federal Reserve rediscount procedure. The action of the built-in stabilizers is therefore very uncertain, and there is no assurance that the stabilizing effect will materialize at all.

A better case can be made out for those programs such as the income tax, which rises and falls in conformity with the general state of business. Here again, however, the ultimate effect is dependent entirely on the means which are employed to meet the varying demands on the Treasury. If the loss in revenue due to a decrease in income tax collections is offset by inflationary means-by currency issues or by drawing upon bank reserves-and the same mechanisms are employed in reverse to dispose of excess collections during boom times, the stabilizing effect is actually realized. But if the losses in revenue in the downswing are offset by the sale of bonds to the general public, or by bank borrowing that results in the sale of securities or curtailment of loans by the banks, or by a reduction in government expenditures, the built-in stabilizers do not stabilize. During an upswing there is little possibility that these so-called stabilizers will accomplish anything at all, as higher tax receipts normally stimulate government expenditures, and even if the excess tax collections are not spent, they will have the required deflationary effect only if they add to bank reserves or are utilized to retire currency, neither of which is at all likely during a period of expanding business activity.

The same considerations apply with even greater force to similar “stabilizing' efforts by private business. Economists usually look with favor on these efforts. Most of them would probably agree with this statement: “The practice of accumulating reserves (by private enterprises) in prosperous times and disbursing them as dividends when current profits are low is all in the right direction.”203 But such reserves contribute to stability only if they are maintained in the form of cash, and business concerns cannot afford to accept the penalty of loss of earning power that would result from carrying unnecessary cash balances, nor would they want to retain custody of such large amounts of cash if they did accumulate them. Any excess cash is deposited in the banks, and in a period of rising business activity the banks promptly turn around and lend the money to someone else.

The mere fact the business enterprises enter these amounts as “reserves” on their books means nothing from the standpoint of the economy in general. The money that they do not disburse is spent by others, and the end result is the same as if these firms has paid the dividends currently and thus permitted the stockholders to spend the money. If the reserves are invested instead of being deposited in the banks, the purchasing power is simply transferred to the sellers of the securities. When these securities are sold during a recession to obtain funds with which to pay dividends, this process is reversed. The buyers of the securities transfer purchasing power to the business, which then turns it over to the stockholders. All of these transactions are exchanges at the same economic location, hence in each case the total amount of purchasing power available for the buying of goods remains exactly the same as it was to begin with (Principle XV).

The factors which make the stabilization efforts of the individual firms fruitless are inescapable from a practical standpoint, as the cost of maintaining large idle cash balances is prohibitive. However, the government is not limited in this manner, and it would be entirely feasible to handle government fiscal operations in a countercyclical manner, so that the inputs into or withdrawals from the government money reservoirs counterbalance the net total of the transactions affecting the other consumer money reservoirs.

Keynes’ “deficit spending” policy, which has been the cornerstone of the U.S. government’s countercyclical efforts since the depression days of the 1930s, is aimed in this direction. Just how to appraise the results of this policy has been a matter of much controversy. On the one hand, it is clear that the problem has not been solved. The admitted fact that the threat of recession, and perhaps depression as well, still hangs over us is positive proof of this. But it is also clear that the policy that has been followed has, on several occasions, injected a certain amount of life, or at least semblance of life, into the economic picture. As matters now stand, therefore, a continuation and extension of deficit spending is strongly advocated by one faction and bitterly opposed by another. Some of Keynes’ disciples have even gone so far as to contend that it is no longer possible for a private enterprise economy to operate on a self-sustaining basis, and that a permanent deficit spending policy is essential to prevent utter collapse of the economic structure.204

For some reason, probably connected with their orientation toward sociological objectives, spending seems to have a peculiar fascination for the economists. As Viner put it, “It must not be forgotten that spending in itself is for the spenders the supreme pleasure.”206 It is common practice among the Keynesians to extol the merits of government spending and to minimize its disadvantages. “Deficit spending,” Burns and Watson explain, “is part and parcel of the growth of government initiative and enterprise as a dynamic element in the economic system”205 (whatever that means).

But the hazards of unrestricted spending are clearly visible to less visionary individuals. Despite the arguments advanced by the deficit spending enthusiasts, it is apparent to anyone who thinks clearly on the subject, or who reads the pages of history, that spending of borrowed money cannot continue indefinitely, even if it did have desirable effects while it lasted, Governments are no more exempt than individuals from the unpleasant fact that there is a limit to their credit. Sooner or later that limit is reached, and the borrowings must then stop. Other governments have found this out through painful experience. In our case the limit is higher than ever before, due to the wealth and productive capacity of the nation, but only the very credulous will contend that no such limit exists. Nor can it be avoided by bookkeeping trickery. Ultimately the day of reckoning will arrive.

The opposition to the free spending school of thought includes a group holding the view that in times of business depression the government should practice rigid economy, and should balance the budget by levying sufficient taxes to meet all expenses. The economy feature of this program is sound, not only during depressions, but at other times as well. Every dollar spent by the government means one dollar less for use by individual citizens to meet their own personal needs. No government expenditure is desirable, therefore, from the standpoint of the average individual, unless he gets as much benefit from it as he would from spending his proportionate share in his own way. A certain proportion of the normal government expenditures obviously meets this test. But there is a tendency, even in normal times, to overload the government payroll, and in depression periods, when other jobs are scarce, this overloading approaches the proportions of a national scandal. Government economy is a contribution to the general welfare at any stage of the economic cycle.

But the balanced budget doctrine does not have an equally solid footing. The use of credit to meet temporary exigencies is a sound policy. A farmer, for example, should not be expected to live within his income month by month, and alternate between feast and famine, depending on whether or not his crops are in season. If he does not happen to have reserve funds sufficient to take care of the lean months, it is entirely in order to rely upon credit until he receives the income from his labors. Government credit operations to meet temporary conditions are equally justified, but borrowing to “increase demand” by additional spending is an unsound practice that serves no useful purpose.

Although Keynes did not stress the point, and he may not even have realized it, what his prescription for overcoming deflation reall} amounts to is to give the economy a big dose of inflation. As our findings indicate, this is the natural and logical remedy for the disease. Keynes was therefore on the right track, but his “deficit spending” program is not one indivisible entity that has to be accepted or rejected in its entirety; it is a combination of two things , borrowing and spending. The purpose of the borrowing is to provide an additional money purchasing power flow into the markets to make up for the amount that is being withdrawn from the stream to fill the private money and credit reservoirs. The government spending that Keynes included in his program accomplishes nothing toward this objective, while it provokes reactions that are detrimental to the economy.

Both experience and the theory developed in this work emphasize the point that the government’s fiscal program for dealing with deflation should not involve any increase in spending. All of the benefit that can be obtained is due to the increase in the money purchasing power flow to the markets by reason of the credit transaction. No further economic benefit can result from spending this money on unnecessary activities, and it is entirely possible that the additional spending will cause secondary reactions that will nullify all or most of the good effects of the increased money flow, just as actually happened in the United States between 1932 and 1939.The proceeds of the borrowing should be used exclusively to replace taxation, current taxes being reduced by the amount that is brought into the treasury through credit operations. When prosperity returns it will be necessary to raise taxes above the normal levels to compensate for the reductions in times of stress, but the total tax load will not be increased, as it is where the borrowed money is spent on additional government projects. The taxpayers will have the same total amount to pay as if the budget were kept in balance, but they will be able to make the payments at those times when they are in the best position to pay.

Money purchasing power injected into the system through the tax reduction channel does not have the detrimental effect associated with those programs that take from the taxpayers to give to other groups. There may be some individual discrepancies, but on the whole, the taxpayers who get the benefit of the reduction are the same ones who ultimately pay the higher taxes to restore the balance. This avoids the unfavorable reactions that result from measures which divert earned income to finance questionable projects or to support able-bodied individuals in idleness. The existing pay-as-you-go income tax policy is particularly well adapted to the prompt and effective bolstering of purchasing power by means of government credit operations, since a temporary reduction in taxes affects the majority of workers almost immediately, and gets the stimulus down to the grass roots of consumer buying without delay.

As will be brought out in the next chapter, a flexible tax is not necessarily the best of the available means of controlling the business cycle, but it is a sound and effective method of accomplishing the desired results, and it has one outstanding merit: there is no practical limit to the extent to which it can be used.

For this reason, even if another primary control method is adopted, as will be recommended in the conclusions stated in Chapter 26, a tax adjustment program should be authorized and held in reserve, ready to be employed in the event of heavy surges that are beyond the capacity of the primary control mechanism. If the control program is put into effect during a time when there is a relatively large unbalance in the money flow, which is quite likely, since actions toward setting up facilities for keeping out of trouble are usually deferred until we actually get into trouble, it will be necessary to activate the tax adjustment program at the start of the control operation, and to continue it until the fluctuations subside to the point where the less drastic measures will suffice.

It should hardly be necessary to point out that the feasibility of controlling the business cycle and maintaining price stability by government actions, either by tax adjustments or by other appropriate measures, is predicated on the assumption that what we are talking about is levelling out the fluctuations due to variable consumer expenditures and other non-governmental actions. If the government itself is causing the unbalance, we are powerless to do anything about the situation, as the inflationary actions by the government will have preempted the tools by which stabilization could otherwise be accomplished. Unless the government can bring its expenses down to the level of its income, or levy enough taxes to bring its income up to the level of its expenses, we will simply have to accept the inevitable inflation.

But the taxpayers would do well to realize that they cannot escape paying the bill for whatever their government spends. If they exert enough pressure to prevent a timid or self-centered government from imposing a large enough tax to cover current expenses, this gains them nothing. If the deficit is financed by borrowing, the taxpayer incurs an interest burden immediately. If it is financed by currency expansion, the amount of the deficit is automatically added to the market prices. For the purposes of this analysis we are presuming that it will be recognized by all concerned that it is futile to talk about measures to stabilize the economy unless the government first puts its own house in order, and stops creating the very conditions that we are undertaking to eliminate.

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