What You Should Know About Inflation

The proposal to restore “selective” or “qualitative” credit controls is revived so often by persons who are regarded as monetary authorities, and is so frequently referred to by them as “one of the necessary weapons to combat inflation,” that some further analysis is desirable.

The proposal has the sanction of precedent, for whatever that is worth. Our government used “selective” credit controls at various times between 1941 and 1952. They have been widely imposed in Europe. But the results hardly warrant emulation. Selective credit control is merely one more step along the road toward a command economy. It leads logically back to investment control and to price control.

Selective credit controls are, in fact, government control of short-term investments. The pressure for them comes from special groups of borrowers who want to be favored at the expense of the rest. It comes from monetary managers who lack the courage to refuse such demands; who lack the courage to let general interest rates rise to the point where they will halt inflation. When the price of any commodity is held down by government control, the demand soon exceeds the supply, and the commodity is then rationed. Selective credit controls are merely government rationing of credit.

To ration credit is, of course, to discriminate among would-be borrowers. The decision is thrown into politics and determined by political pressures. This has already happened. Buying a house, even if you can’t afford it, is considered so laudable that the taxpayers have been forced to guarantee 95 per cent of the purchase price for you. Buying a refrigerator to put into the house, or a car to get to work from it, is considered much less laudable, so that the terms on which the seller was allowed to extend credit even at his own risk were tightened or “liberalized” by bureaucratic decree. Buying shares in Wall Street (i.e., investing in largescale industries that increase production and create jobs) is considered so antisocial that the government forbids the seller or the lender to accept less than a down payment of 90 per cent of the full price.

Government “selective” credit decisions are made, in short, on the basis of popular pressures and prejudices. Even if the record were better than this, what are we to say of a system which gives a group of government bureaucrats power to encourage borrowing for one purpose and to discourage it for another; to decide that there should be a boom in industry X but that industry Y should be choked to death? The only reason why “selective” credit controls, here and abroad, have not proved intolerably disruptive is that (for reasons explained in the preceding chapter) such controls seldom achieve their aims.

I shall deal here with only one or two of the many arguments that have recently been put forward in favor of selective credit schemes. It is contended, for example, that “over-all quantitative credit control” is “a pretty crude weapon.” The truth is that it would be hard to conceive of a more precise and truly selective instrument for allocating the supply of real savings among credit-worthy borrowers than over-all market interest rates that are allowed to reflect the real conditions of supply and demand. It is nonsense to say that a general rise in interest rates hits only “the little fellow” and favors “the big corporations.” One might just as well argue that a general rise in wage rates hits only the little project and helps the big project. Any general rise in costs merely shuts off the marginal projects, regardless of size, that do not seem likely to earn the higher costs.

This is the meaning and function of free markets, in the price of loanable funds as in the price of raw materials and in wages.