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Published online by Cambridge University Press: 07 November 2014
The Canadian government's post-war policy of supporting the prices of government bonds and thereby restricting the workings of the free price system in regard to interest rates stood in decided contrast to its policy in most other fields, including since 1950 the field of exchange rates. As recently as 1954, the wisdom of this policy was reaffirmed by Mr. Graham Towers, then Governor of the Bank of Canada. In his view, freeing the interest rate at the end of the war would not have been a wise policy since the Canadian price level “could not have been held substantially below that which occurred in the United States without sacrificing an appreciable part of the increase in production which was achieved here.” This paper examines this apparent contradiction between the government's preference for price control in the field of interest rates and for the workings of the free price system elsewhere in the economy, and in the light of this analysis evaluates Canada's post-war monetary policy down to 1954.
This paper was completed in 1955, before the government's conversion to a belief in the use of monetary control to check inflation. The reader may apply the lessons from post-war experience to more recent periods.
1 Canada, House of Commons, Standing Committee on Banking and Commerce, Decennial Revision of the Bank Act, 22nd Parl., 1st sess., 03 18, 1954 (Ottawa, 1954), 691.Google Scholar Because Canada's post-war monetary policy has already been discussed extensively elsewhere, I have confined myself mainly to a discussion of the theoretical issues. For more details on the factual background the reader may wish to consult, in addition to Mr. Tower's statement, some of the following: Timlin, M. F., “Becent Developments in Canadian Monetary Policy,” American Economic Review, Supplement, XLIII, 1953, 42–53 Google Scholar; Clark, W. C., “Canada's Post-War Finance,” Canadian Tax Journal, I, no. 1, 01-Feb., 1953 Google Scholar; Mclvor, B. C. and Panabaker, J. H., “Canadian Post-War Monetary Policy, 1946-52,” this Journal, XX, no. 2, 05, 1954, 207–26.Google Scholar ( Neufeld, E. P., Bank of Canada Operations, 1953-54 (Toronto, 1955)Google Scholar, was not available to me when this paper was written.)
2 Cf. Friedman, M., “A Monetary and Fiscal Framework for Economic Stability,” American Economic Review, XXXVIII, 1948, 245–6.Google Scholar
3 American Monetary Policy (New York, 1951), 4.Google Scholar
4 On the demand-pull side would be listed all those factors that contributed to a high level of spending in this period–the accumulated backlog of investment and consumer demand, the urgent export demand arising out of the need for reconstruction in Europe, and the large volume of liquid assets available to finance these demands. On the cost-push side would be included attempts by trade unions to raise wage rates, increases in freight rates and other public utility rates, higher prices on imported products, increases in excise or sales taxes, and readjustments in the structure of prices and wages that could be expected to ensue with the end of price control.
5 These two totals have clearly diverged in the post-war period. In Canada, for example, between 1946 and 1952, the quantity of money increased by over 28 per cent, yet during the same period the total volume of liquid assets (money, inactive savings deposits, and Dominion government bonds) increased by little more than 1 per cent.
6 The effects of the higher interest rates in providing an incentive to postpone investment expenditures or to increase the rate of saving will be discussed later.
7 See Robertson, D. H., Essay in Monetary Theory (London, 1940), 43–4.Google Scholar
8 The difference between the first loop-hole (the possible shift from savings to demand deposits) and the two discussed here is one of degree and opinions may differ on the relative importance of each. To some extent they will overlap, since money held idle in anticipation of a rise in interest rates may be held in savings accounts.
9 Cf. Lutz, F. A., “The Structure of Interest Rates,” Quarterly Journal of Economics, LV, 1940–1941, and the references given therein.Google Scholar
10 Though opinions differ on what constitutes a moderate decline in bond prices, it is difficult to conceive of a temporary decline of from 20 to 25 per cent as other than moderate when it is compared with the permanent decline of one-thira or more in the real purchasing power of bonds that actually occurred. Moreover, in a rational market gifted with foresight, the long-term rates at which bonds were issued during the war would have anticipated the temporary period of higher short-term rates after the war. Since the rate during the war was largely determined by the government it should have been incumbent on the government to set a long-term rate, say a twenty-year rate, which was an average of the expected short-term rates over the ensuing twenty years, including a period of very low or zero short-term rates during the war, a short period of high short-term rates after the war, and an ensuing period of rates at more normal levels.
11 The recent rise and fall in long-term rates suggest that these fears may have been unfounded.
12 Thus between October, 1945, and the same date in 1948, Canada's wholesale price index of raw and partly manufactured goods advanced 55 per cent whereas wage rates increased only 38 per cent. A readjustment of this type is not one that can easily be achieved without some upward movement in prices, partly because wage earners will resist any reduction in their money wage rates and partly Tbecause they will also press for wage increases to prevent the reduction in real wage rates which such a readjustment may tend to force upon them.
13 In defence of its failure to carry this policy any further, the government has argued that it is not possible to keep the value of the Canadian dollar at a substantial premium over the United States dollar. People think of the normal rate of exchange between the two currencies as par and if the Canadian rate went to a substantial premium, it is argued, there would be a substantial amount of speculation in anticipation of a return of the rate toward par. Though it is difficult to evaluate this argument, I am inclined to discount its importance. If the higher value of the Canadian dollar reflected a lower level of prices which gave our dollar an increased purchasing power within the country, it is difficult to believe that speculators, exporters, and importers would not have recognized that fact. There seems to be no greater reason for supposing that the United States and Canadian dollar must have the same long-term value in terms of gold than there is for supposing the same about the British and Australian pound. And in this latter case such an expectation does not seem to exist.
14 For a somewhat similar view see Eastman, H. C., “Recent Canadian Economic Policy: Some Alternatives,” this Journal, XVIII, no. 2, 05, 1952, 135–45.Google Scholar
15 Standing Committee on Banking and Commerce, Decennial Revision of the Bank Act (1954), 695.Google Scholar
16 These estimates are based on data given in the Canadian Statistical Review, 1953 Supplement.
17 In March, 1946, over 60 per cent of the debt was in maturities of ten years or more and a further 12 per cent had from five to ten years to go until maturity. Less than 15 per cent of the debt was redeemable within one year, the remaining 13 per cent being in maturities of from one to five years. This contrasts with the situation in the United States where at the end of the war some 28.5 per cent of the total direct and guaranteed debt was in the form of securities due within one year. See Canada, House of Commons Debates, 06 27, 1946, p. 2974 Google Scholar, and Abbott, C. C., The Federal Debt (New York, 1953), 22.Google Scholar
18 Throughout 1946, the chartered banks' holdings of government securities with maturities of two years or less averaged about $1.6 billion, which was ample to provide all the funds needed for additional loans. Unlike the American banking system, where the numerous small units make it necessary for the banks to keep a substantial amount invested in short-term assets which can be turned into cash to meet any shifts in funds, the Canadian banking system with its few large branch banks has little real need to hold a significant amount or short-term securities, though traditional banking prejudices may make the banks feel that this is necessary.
19 Standing Committee on Banking and Commerce, Decennial Revision of the Bank Act (1954), 694.Google Scholar