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between 1914 and 1916, business savings more than quadrupled. When corporation profits declined slightly between 1916 and 1919, corporation savings declined one-half. When corporation profits declined yet more sharply in the depression of 1921, corporate savings fell to about onequarter of what they had been in 1919. The recovery of corporate savings in 1923 was traceable in large measure to the fact that corporate profits in that year were again high.

High production, high profits and high savings bear close relations to each other. Statistical studies thus far made do not show exactly the correspondence between the three factors, but they do indicate a clear relationship. When both profits and production are at a maximum, capital accumulation also tends to be at a maximum.

A third fundamental determinant of fluctuations in volume of savings is the degree to which habits of thrift prevail. Thrift is not a preordained impulse so much as it is a matter of class custom, national education, acquired habit. Thrift depends upon the institutionalized behavior of people. This habit is subject to variations, such as are illustrated by periods of extravagance and wasteful expenditure and periods of extreme economy. As people of various classes become accustomed to saving for investment, and the corporations to the practice of reinvesting their profits in business, the mere force of customary practice carries saving along by its own momentum.

In summary we may observe that, although supply of savings is somewhat affected by high or low interest rates, nevertheless the funda. mental determinants of the wider fluctuations of savings are variations in the volume of production, the amount of business profits and prosperity, and the institutionalized practices and habits of thrift.

Fundamental Causes of Fluctuations in Demand for Capital.Demand is much more sensitive to changes in the interest rate than supply. A high rate acts as a brake upon increasing demand. But just how high the interest rate must go in order to act as a check on demand is a question of how impelling the fundamental forces underlying demand happen to be at the time. The problem, therefore, is to examine the fundamental forces of demand, in their relation to the interest rate.

First, the prospect of profits gives the greatest impetus to demand. Business men demand capital when they believe that by the use of the capital they can gain liberal net earnings. During a large part of the last decade of the 19th century, profit margins were narrow, with the result that business men had scant inducement to use new capital. Demand was low, and largely due to low demand, the interest rate fell to a very low point. Between 1900 and 1913, on the other hand, profit margins increased, and business men, lured on by the prospect of good earnings, entered an effective demand for new capital. This demand was reflected in a rise of interest rates on high grade bonds from around 31/2 per cent to 5 per cent and more. When profits are high during the prosperity stage of the business cycle, business men translate the outlook into a heavy demand for capital and the interest rate rises. Conversely, during depression, with profits on the wane, demand falls off and interest rates follow the decline. Demand, therefore, centers around the anticipation, the hope, the prospect of profits.

Second, the progress of technical inventions and discoveries determines demand. In the decade and a half from 1900 to the outbreak of the World War, fundamental technical changes occurred in the United States which set up a firm demand for new capital. The electrical and the automobile industries, with all their allied lines of production, developed rapidly and vast amounts of capital were required for manufacture, for installation, for repair, for maintenance of output. Population moved from country to town and city, thereby setting up a growing demand for dwelling houses. Moreover, during this period the kind of house demanded involved more elaborate equipment than previous types, and this higher grade of construction added to the demand for more and more capital for housing enterprises. Public utilities during this period multiplied their investment five times over, and expanded at a rate which demanded a high rate of capital accumulation. New and better types of office and factory buildings

. became the order of the day. New highways were constructed on an unprecedented scale. The period was marked by an outburst of technical progress, and a consequent high demand for capital. At the time, supply of capital was increasing materially, but demand outran supply. The future demand for capital will depend greatly upon future inventions and discoveries which revolutionize production processes or add new forms of capital goods to our present standards.

Third, the conditions of peace or war determine demand. War gives rise to an urgent demand for savings, and therefore has the inevitable result of pushing interest rates up. This stiffening of demand is accompanied by a scarcity of productive capital, since practically all of a nation's savings in time of war are devoted to the destructive purposes of military necessity. The series of wars, including the Spanish American, the Boer, the Russo-Japanese, the Balkan, and finally the World War, involved both a world-wide destruction of capital and a world-wide demand for more capital, all of which could have only one effect on the United States as on the other nations,—to raise their interest rates to abnormally high figures.

Briefly put, the nature of demand must be studied from the standpoint of the fundamental sources of demand. These include chiefly the prospect of profits from the use of capital, the growth of technical improvements, and the conditions of war or peace. The growth of population, of course, causes a corresponding growth of need for capital, but this factor tends to make itself effective in the capital markets only in so far as it creates the prospect of profits from the use of additional capital, or stimulates technical progress, or gives rise to war or peace.

Effect of Variations in the Interest Rate upon Supply and Demand.—The previous discussion has dealt particularly with the effect

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of supply and demand upon the interest rate. We may now consider more particularly the effect of changes in the interest rate upon supply and demand. A rise of the interest rate seems to have very little efficacy in increasing the supply of savings, unless the more fundamental conditions governing supply are themselves favorable. That is to say, unless production is high, profits good, and habits of thrift steady, the rising interest rate seems to be more or less ineffective as a means of swelling the supply of savings. No matter how much the interest rate is raised, if production is low and profits low, the volume of saving tends to fall off. Perhaps it would be true to add that, under such conditions, the rise of interest rates makes the decline of savings less than it otherwise would be. We are not concerned to deny that the interest rate does have an influence, but rather to stress the fact that other influences on supply are more fundamental and give a much sounder basis for prediction of interest movements.

As has already been noted demand is much more responsive to interest variations than supply. Low interest rates, for instance, during periods of depression, tend to stimulate business to recovery. High rates, during periods of boom and inflation, tend to check the undue expansion and curb the excessive demand for capital. Interest is a most important regulator of demand. By manipulation of discount rates, central banks in other countries and Federal Reserve banks in the United States are able to regulate, to an important degree, the demand for capital

Principal Types of Fluctuations of Interest Rates.-Four principal types of movements occur in interest rates, these types being similar to other price movements in the economic field. The types of movements may be listed as seasonal, cyclical, secular, residual.

The seasonal fluctuations are indicated by the chart on page 277.

It is to be noted that the Federal Reserve Banks have had the effect of greatly modifying the seasonal fluctuations. The years 1917-1923 are not satisfactory years for calculating seasonal variations, since much of this period is affected by war and post-war abnormalities. But we may draw some fairly reliable conclusions from the pre-war years if the assumption is made that seasonal movement has been reduced onehalf since the establishment of the Federal Reserve system. Seasonal movements apply chiefly to short-term commercial interest rates. Bond rates show a practically negligible seasonal variation. The normal variation for commercial rates is an easing of rates in January, a mild upward turn during February and March, a down trend through the summer, a stiffening of rates in late summer, a high point reached by the end of October or early November, and a slight down turn in November followed by firmness until about the end of the year. These seasonal variations are important in interpreting month to month changes in money rates, both because they determine the cost to business men of their funds for working capital and because they influence any

predictions or forecasts of future turns of the interest rate. At the present time, under Federal Reserve moderation of seasonal changes, rates may be one-seventh higher at one period of the year than at another. A variation of rates which may alter the cost to the business man of his loans by as much as one-seventh is a very important cost item.

OPEN MARKET INTEREST RATES FOR 60-90 DAY COMMERCIAL PAPER

IN THE UNITED STATES

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Cyclical fluctuations of interest rates are indicated by the accompanying diagram. The rates represented are those on choice doublename 60-90 day commercial paper. Seasonal and secular influences have been eliminated by statistical processes, and the chart shows therefore the cyclical fluctuations free from the other two influences :

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* See H. B. Vanderblue, Problems in Business Economics, p. 31. This diagram is based upon the research of the Harvard University Committee on Economic Research.

Interest rates tend to lag behind commodity price movements in the business cycle. They rise and fall more slowly than prices. When prices rise, lagging interest rates mean low business costs. As prices reach their crest, interest rates are likely to continue their ascent. The result is heavy interest costs, and a general financial strain among banks and business concerns. As this strain makes itself felt, prosperity comes to an end, and crisis and depression ensue. High rates check prosperity. On the other hand, when rates have fallen and money is cheap, business tends to be stimulated. Interest rates play a most important role in the major movements of business cycles.

The long-time trend of the interest rate is indicated by the following chart:

LONG-TIME TREND OF INTEREST RATES IN THE UNITED STATES

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W. Randolph Burgess, Management and Administralion, Volume 6, p. 4. Small circies show average rates each year ; tops of lines show highest and bottoms of lines lowest rates. Figures for early years are taken from a study by Dr. F. R. Macaulay.

Although the interest rate here referred to is for short-term commercial paper, it nevertheless indicates accurately enough the trend of

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