Knowledge that Transforms

THE postwar international economic and monetary settlement, especially Bretton Woods Final Act and original draft of International Trade Charter,' were based on conviction that national economic policies (including a policy of full employment) could always be harmonized with full adherence to an international system of unplanned market economies by alteration of foreign exchange rates. This is most clearly brought out by Lord Keynes' famous defense of Bretton Woods Agreement in House of Lords: . . we intend to prevent inflation at home, we will not accept deflation from dictate of influences from outside. other words, we abjure instruments of bank rate and credit contraction operating through increase of unemployment as a means of forcing our domestic economy into line with external factors; 2 and that In fact, plan introduces in this respect an epochmaking innovation in an international instrument, object of which is to lay down sound and orthodox principles. For instead of maintaining principle that internal value of a national currency should conform to a prescribed de jure external value, it provides that its external value should be altered if necessary so as to conform to whatever de facto internal value results from domestic policies, which in themselves shall be immune from criticism by Fund. Indeed, it is made duty of Fund to approve changes that will have this effect. That is why I say that these proposals are exact opposite of gold standard. I He furthermore contended that additional liquid reserves provided by international action would be sufficient to act as a buffer until equilibrating influence of alteration in exchange rates made its effects felt: the wheels of trade are to be oiled by what is, in effect, a great addition to world's stock of monetary reserves, distributed, moreover, in a reasonable way. 4 U. S. orthodox school assumed elasticities of demand for exports and imports to be great. 5 Indeed they were afraid that depreciation would be abused in order to obtain full employment by stimulating exports; and, accordingly, insisted that Fund should not permit lowering of exchange value of a currency before a long and large deficit in balance of payments occurred so as to be sure that disequilibrium was sufficiently to justify a change in value of currency. 6 There was no suspicion even that depreciation might not work or that it might generalize disequilibrium in system. difference between fundamental and temporary disequilibria in balances of payments was never defined, nor was there an attempt made to inquire into nature and causes of such disequilibria so as to be able to adapt remedial measures to specific 'U. S. Department of State. This was presumably an American product but it is characteristic of British delusions about future of Western Europe as an industrial center in a non-planned world that draft followed almost verbally proposals put forward-in a personal capacity by Professor J. E. Meade in Economic Basis of a Durable Peace (London, I940). On implications of opportunity to compete with U.S. on equal terms of Western Europe under rule of so-called non-discrimination, compare my essays, The Charter of ITO, Bulletin of Oxford University Institute of Statistics, Vol. 9, No. 3, and 'Britain and Geneva Tariff Agreements, Ibid., Vol. 9, No. 12. 2 Seymour E. Harris, Editor, New Economics (New York, I947), p. 3743Ibid., p. 376. This judgment was clearly based on excessive optimism with regard to relations of U. S. and Western Hemisphere in general to rest of world, an optimism brought out clearly in his famous forecast that The chances of dollar becoming dangerously scarce in course of next five or ten years are not very high (The Balance of Payments of U. S., Economic Journal, June I946, p. i85). 'Ibid., p. 372. 'G. Haberler, this REVIEW, XXVI (November I944), P. I9I. 6Ibid., p. i8i.

Food prices, particularly those of grains, and the relationships among wages, prices, and incomes, occupy central roles in this the third of the post-VJ-Day upsurges in the commodity markets.' Did the partial failure of the grain crops in 1947 upset a situation that was approaching stability? Can wage rate increases bring such a simultaneous enlargement of consumer incomes and expenditures that price advances are not restrained? From consideration of these questions will emerge some points bearing on prospective price movements. i. Since VJ-Day the demand for food has been repeatedly misjudged. Instead of burdensome surpluses, we have had shortages. Each year Europe's needs have been greater than anticipated and our own postwar demand has been unexpectedly high.2 A year ago, following bumper crops, we had wage adjustments justified chiefly by what had happened to the working family's food budget. And now we are facing this familiar sequence again, but not solely because of the partial failure of the grain crops. Although the grain situation has had a direct effect on the prices of cereal products in 1947, neither meat nor dairy product supplies yet have been curtailed thereby.3 For the year as a whole (last few months projected), the Bureau of Agricultural Economics reports annual production rates for meats and milk above, and for eggs slightly below, the I946 rates. Rather than attempting the questionable task of making seasonal corrections in quarterly production rates, the gist of the comments of key persons in the government are reported here. The meat production rate up until the first of September clearly had not been reduced below what otherwise would have occurred as a result of high grain prices and reduced supplies. Since September i, the publicized reduction in hog weights has been offset approximately by larger numbers of livestock slaughtered, particularly of cattle, than would have occurred if grain supplies had been ample. While milk production has declined slightly as the year has advanced, the contribution of high grain prices to this development has been offset by an unusually long pasture season and a pressure to feed heavily from the large supply of soft corn. From such facts as these we come to the conclusion, and a disturbing conclusion it is, that this year's price increases for foods, except cereal products, and traceable chiefly to the growth of domestic consumer demand.4 Even had the grain crops been normal we would have experienced retail price movements for non-cereal foods similar to those which have occurred.5 2. In a manner similar to the misjudging of the postwar food situation, a pessimistic error has dominated much of the forecasting of the level of incomes and of consumer and business outlays. In part, such forecasts were built on t are reported here. The meat

For practical reasons it will probably be useful to carry the clearing through in compensation units. In banks and in other firms, this unit will be handled exactly as any other kind of foreign exchange. Between the central banks of the countries in question an agreement may be made to the effect that the central banks can draw on each other in compensation units, and thus put the necessary funds at the disposal of the commercial banks of the country, and the public. This credit between the countries will be only of a temporary character because the credit relations will be extinguished within the prescribed limits of tolerance as soon as the trade is effectuated. For instance if, as a consequence of compensatory trade, the central bank of country A should be credited for an amount in compensation units with the central bank of country B, and this bank in turn should be credited for a corresponding amount with the central bank of country C, which finally should be credited for a similar amount with the central bank of country A, then all these credits would, of course, be extinguished simultaneously -within the given tolerated deviation -if the central bank of country A draws on the central bank of country B and sends this draft to the central bank of country C. If the system shall function according to its purpose, it is necessary that the licenses which are granted are also actually used. Experience will show if this can be assumed to take place by itself with the degree of approximation wanted, or if special measures will have to be taken to assure it.

THE graphic method of determining the level of income which is consistent with a consumption function and given investment is familiar to most students.1 The method is that of plotting the aggregate demand function (consumption demand function with investment superimposed vertically) against national income; the intersection of this line with a forty-five degree line through the origin indicates the level of income at which income equals assumed investment plus derived consumption. But this forty-five degree line method suffers from the disadvantage that consumption must explicitly be related to the national income or gross national product. It is common nowadays to assume that consumption is related to disposable income, and to assume as well that taxes, government transfer payments, and corporate savings are themselves related to gross national product, so that the consumption-gross national product relationship is a derived one. In the graphic solution as ordinarily presented, a change in the tax structure cannot be assumed without having the shape of the derived consumption-GNP relationship affected. So, where graphic methods are desired, an elaboration that allows separate manipulation of the tax function and the consumption function is of some advantage. This paper will present a graphic method which goes one step further than the forty-five degree line method, that is, one which portrays the solution when consumption is explicitly related to disposable income, the latter being explicitly related to the gross national product.2 The method is simple. We have two relationships, here assumed linear for convenience. One is the consumption-disposable income relationship, in the form C a + bDI, in which the parameter b measures the marginal propensity to consume. The other is the disposable income-gross national product relationship, in the form DI = c + dGNP, where the parameter d measures the marginal ratio of DI to GNP.3 Both these relationships are plotted on Chart i. Measuring GNP along the horizontal