The basic means of preventing inflation is, therefore, to reduce aggregate demand to the point where it matches the quantity of product supplied by a full-employment economy. Four major groups demand the products of our economy—consumers, businesses, governments, and foreigners; it is the combined demand of all four groups which puts inflationary pressures upon prices. A broad anti-inflationary policy should reduce the demands of all, but not necessarily proportionately.
Flexible Monetary and Fiscal Policies. The most pervasive, impersonal, and effective way to reduce the aggregate demand is through restrictive monetary and fiscal actions by the federal government. A restrictive monetary policy can raise the interest cost and reduce the availability of funds that consumers, businesses, and state and local governments are able to offer for goods and services. By keeping taxes high, reducing federal expenditures, and generating a cash surplus in the federal budget, the government can also keep spendable funds out of the hands of the public and reduce the claim that the government is making on the limited supply of goods and services.
The mere fact that Uncle Sam may be more than covering his expenditures by current tax revenues does not exonerate the federal government from the charge of inflationary behavior. Even if the government is paying as it goes, it should, along with other types of buyers, reduce its expenditures on goods and services at a time when total demand is excessive.
The Pinch of Credit Restraint. The efficiency and impersonality with which a tight money policy reduces aggregate demand is the reason that, in a free economy, it must always be the strategic weapon in the battle against inflation. When the monetary reins are drawn up tightly, everyone feels the pinch to some degree. The family finds it harder to get mortgage loans for the new home; the businessman must put off his plan for plant modernization or expansion; state and municipal officers feel obliged to defer projects for community facilities.
Tight money is the means whereby the limited supply of labor and materials is rationed among competing bidders. It prevents people from bidding up the prices of this limited supply. It does not postpone physical projects in the aggregate, because there is, in any case, only so much labor and so much material to go around.
But is credit restraint intolerably uneven in operation? The restrictive monetary policy followed in 1956 has been attacked on the ground that it severely hampered small businesses and municipalities, while failing to reduce the investment of "big business." Chairman Martin of the Fed
eral Reserve Board gave pertinent evidence on this subject in his testimony before the Joint Economic Committee of Congress on February 5, 1957.
The volume of new business loans made by commercial banks during the last half of 1956, when credit restraint became most severe, declined about one-eighth. The decline was of equal proportion in all major loan-size groups, and there was little change in the average size of the loans made. With interest costs rising generally, the rise on small loans was actually less than on large loans. This suggests that credit curbs have been biting impartially into the demands for funds of both large and small businesses.
It is also a fact that the profitability and liquidity of smaller businesses have improved relative to larger corporations during the past year. Worthy small businesses, unable to get accommodations from their banks in particular cases, may borrow from the Small Business Administration, which increased its loan approvals from $55 million in 1955 to $122 million in 1956. It is difficult to infer from this evidence that, despite difficulties here and there, monetary restraints have affected small businesses as a whole to an "intolerable" degree.
Tight money does seem to have moderated the rise in "big" business expenditure on plant and equipment during 1956, though by less than was really desirable. Many firms publicly announced deferral of expansion projects. Although actual spending much exceeded planned spending for plant and equipment during the year 1955, it did not do so during 1956.
State and municipal bond issues sold for new money during 1956 amounted to $5.4 billion, or about one-tenth less than in 1955. But archaic legal limits on debt, tax rates, and interest rates, as well as tight money, appear to have adversely affected municipal bond marketings. In any event, the reduction was in issues to finance toll-highway construction and public housing projects. Financing of school construction and community facilities—presumably more urgently needed—continued at the record level of 1955. Like business corporations, states and municipalities had to pay higher interest rates for long-term money; but the money-cost differential in their favor continued to be substantial at the end of 1956.