This PDF is a selection from an out-of-print volume from the National Bureauof Economic Research

Volume Title: The Demand for Currency Relative to Total Money Supply

Volume Author/Editor: Philip Cagan

Volume Publisher: NBER

Volume ISBN: 0-87014-376-X

Volume URL: http://www.nber.org/books/caga58-1

Publication Date: 1958

Chapter Title: The Demand for Currency Relative to Total Money Supply

Chapter Author: Philip Cagan

Chapter URL: http://www.nber.org/chapters/c5783

Chapter pages in book: (p. 1 - 37)

The Demand for CurrencyRelative to

Total Money Supply

PHILLIP CAGAN

OCCASIONAL PAPER 62

NATIONAL BUREAU OF ECONOMIC RESEARCH, INC.1958 0

Reprinted from the August 1958 issue of theJournal of Political Economy

University of Chicago, Economics Department

Library of Congress Catalog Card Number: 58-13076

Price: $0.75

NATIONAL BUREAU OF ECONOMIC RESEARCH, Inc.261 Madison Aven'ie, New York 16, N. Y.

NATIONAL BUREAU OF ECONOMIC RESEARCI-I1958

OFFICERS

Gottfried Haberler, ChairmanArthur F. Burns, President

George B. Roberts, Vice-President and TreasurerSolomon Fabricant, Director of Research

Geoffrey H. Moore, Associate Director of ResearchWilliam J. Carson, Executive Director

DIRECTORS AT LARGE

Wallace J. Campbell, Director, Cooperative League of the USASolomon Fabricarit, New York University

Albert J. Hettinger, Jr., Lazard Frères and CompanyOswald W. Knauth, Beaufort, South Carolina

H. \V. Laidler, Executive Director Emeritus, League for Industrial DemocracyShepard Morgan, Norfolk, Connecticut

George B. Roberts, Vice-President, The First National City Bank of New YorkBeardsley Runil, New York city

Harry Scherman, Chairman Book-of-the-Month ClubBoris Shishkin, American Federation of Labor and

Congress of Industrial OrganizationsGeorge Soule, Professor Emeritus, Bennington College

N. I. Stone, Consulting EconomistJ. Raymond Walsh, New York City

Joseph H. Willits, Director, The Educational Survey, University of PennsylvaniaLeo Wolman, Columbia University

Donald B. Woodward, Vick Chemical CompanyTheodore 0. Yntema, Vice-President—Finance, Ford Motor Company

DIRECTORS BY UNIVERSITY APPOINTMENT

V. W. Bladen, TorontoArthur F. Burns, ColumbiaMelvin G. de Chazeau, CornellFrank Fetter, NorthwesternH. M. Groves, Wisconsin

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DIRECTORS APPOINTED BY OTHER ORGANIZATIONS

Percival F. Brundage, American Institute of AccountantsHarold G. Haicrow, American Farm Economic AssociationTheodore V. Houser, Committee for Economic Development

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Harold F. Williamson, Economic History Association

RESEARCH STAFF

Moses AbramovitzGary S. BeckerArthur F. BurnsMorris A. CopelandRichard A. EasterlinSolomon FabricantMilton FriedmanRaymond W. GoldsmithLeo Grebler

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Ui

use MintzGeoffrey H. MooreRoger F. MurrayG. Warren NutterLawrence H. SeltzerGeorge J. StiglerLeo WolmanHerbert B. Woolley

Jacob Viner, Princeton

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TO THE WORK AND PUBLICATIONS

OF THE NATIONAL BUREAU OF EcoNoMIc RESEARCH

1. The object of the National Bureau of Economic Research is to ascertain and topresent to the public important economic facts and their interpretation in a scientificand impartial manner. The Board of Directors is charged with the responsibility of ensuringthat the work of the National Bureau is carried on in strict conformity with this object.

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6. No manuscript may be published, though approved by each member of the specialcommittee, until forty-five days have elapsed from the transmittal of the summary andreport. The interval is allowed for the receipt of any memorandum of dissent or reservation,together with a brief statement of his reasons, that any member may wish to express;and such memorandum of dissent or reservation shall be published with the manuscriptif he so desires. Publication does not, however, imply that each member of the Boardhas read the manuscript, or that either members of the Board in general, or of the specialcommittee, have passed upon its validity in every detail.

7. A copy of this resolution shall, unless otherwise determined by the Board, be printedin each copy of every National Bureau book.

(Resolution adopted Oclober 25, 1926and revised February 6, 1933 and February 24, 1941)

LV

THE DEMAND FOR CURRENcY RELATIVETO THE TOTAL MONEY SUPPLY'

PHILLIP CAGANUniversity of Chicago

public's demand for currency asa fraction of the total money sup-ply has long interested economists

well as bankers. Under fractional-banking, a withdrawal of depos-

s in (non-bank) currency reduces bankand, unless reserves were pre-

iously in excess of the desired level orre otherwise replenished, forces a mu!-pie contraction of earning assets andeposits. A deposit of currency augmentsank reserves and allows a multiple ex-ansion of earning assets and deposits.'hus the public's conversion of its cashalances from one form to the other, ifot offset by other factors, alters the ag-regate amount of the money supply as

as its composition. This effect on thesupply, unlike changes in bank

1 This study is part of a project of the Nationalireau of Economic Research under the over-allrection of Milton Friedman. His suggestions guid-the work in its initial stages and helped greatlyimprove the final product. Generous help was alsoceived from Anna J. Schwartz, whose extensivetowledge of this material made her comments espe-thy useful. Solomon Fabricant, Edward J. Kilherg,lorris Mendelson, and George J. Stigler also made•eful comments. Not all these people entirely:reed with the interpretation of some of the find-gs, and it should not be assumed that they accepte conclusions without reservations.The paper has been approved for publication as

report of the National Bureau of Economic Re-irch by the Director of Research and the BoardDirectors of the National Bureau, in accordanceth the resolution of the board governing National

reports (see the Annual Report of the Na-ned Bureau of Economic Research). It is re-iinted, with the addition of an appendix on datad sources, as No. 62 in the National Bureau's seriesOccasional Papers.

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reserve ratios or issues of Treasury andFederal Reserve money, is not subject todirect control by the monetary authori-ties. However, it can be offset by appro-priate open market operations of thecentral bank and so is an important con-sideration in planning monetary meas-ure$.

There has been a good deal of specula-tion about the factors that underlie thedemand for currency, but empirical in-quiry has been limited chiefly to seasonalvariations in demand because adequatedata covering a long period were notavailable. New estimates of the UnitedStates money supply since 1875 remedythis deficiency.2 Figure 1 shows the ratioof currency to the total money supply3annually from 1875 to 1955. This articledeals with the behavior and determinantsof this ratio, mainly in the long run. Aseparate study of its short-run cyclicalmovements is in preparation.

The currency ratio has varied consid-erably. It was above 30 per cent justafter the resumption of gold payments in1879 and gradually declined to just over7 per cent by 1930. Subsequently it roseto 20 per cent during World War II and

2 These estimates were developed by MiltonFriedman and Anna J. Schwartz. The Supply ofMoney in the United Slates, a forthcoming publica-tion of the National Bureau of Economic Research.

Currency is defined as the hand-to-hand notesand coin issues outside banks of the United StatesTreasury, Federal Reserve banks, and (until 1935)national banks. The total money supply is currencyplus the demand and time deposits of all commercialbanks held by the non-banking public.

then fell to 15 per cent in 1955. The larg-est short-run increases came during\'Vorld Wars I and II and in the early1930's.

These movements cannot in the mainbe explained by any simple correspond-ence with the trends of one or two eco-nomic factors, and in this respect thecurrency ratio differs notably from mostother monetary variables. A favorite ex-planation of the early decline in the ratiois that an increasing proportion of the

people's awareness of them. This mahave contributed to the early decline cthe ratio. But the decline continued ionafter there could have been many peopistill left who failed to adopt the bankinhabit simply because they were ignoranof its advantages. The number of bankincreased faster in the West than in thEast, probably because the West wasparsely settled and many small bankcould serve the growing but scatterepopulation better than a few large banks

I I I I I I I I I I I I I I I _I1875 95 05 15 '5

YLARS

FIG. 1.—Ratio of currency to the money supply annually, 1875—1955

population gradually became familiarwith banking.4 Banking spread rapidlythrough the West in the half-centurypreceding World War increasing theavailability of checking accounts and

See, for example, Irving Fisher, "Will the Up-ward Trend of Prices Continue?" American Econom-ic Review, II (September, 1912), 547—49; and A. C.Pigou, Essays in A pplied Economics (London: P. S.King, 1924), pp. 184—85.

In 1880 the states west of the Mississippi (in-clucling all of Louisiana and Minnesota) had 26 percent of the country's commercial banks and 22 percent of the population; in 1914, these states had 50per cent of the commercial banks and only 30 percent of the population (see Annual Report of theComptroller of Ike Currency [18801, pp. lxxxvi—ix; andBoard of Governors of the Federal Reserve System,Banking and Monetary Statistics, Table 8).

2

In any event, the later increases in thratio point to the influence of factoiunrelated in any simple way to trends ithe growth of the banking habit, anthese same factors may account forsubstantial part of the early decline ithe ratio. Indeed, the number of factoideserving consideration is, by normastandards of empirical analysis,ingly large, and the evidence suggesithat no one of them has predominatethroughout the period since 1875.

The following sections assess the inportance of the various factors that coulhave produced substantial variations ithe currency ratio. The first section

30

23

20

is

10

I-zUS.S

L.Lsses all the variables that seem likley) affect appreciably the public's desire) hold part of its total money balancesi the form of currency. This discussionicludes some preliminary comment onie measurement of these variables and,rhere possible, on their importance. Sub-

sections analyze their effects onLie currency ratio.

I. VARIABLES AFFECTING THECURRENCY RATIO

The desired level of the currency ratioepends on individuals' preferences forLirrency or deposits in the light of theDsts and advantages of holding these orther assets. An individual can easily anduickly make the actual ratio of his cur-

to total money balances equal toLie desired ratio by exchanging his de-osits for currency or vice versa. Thisssumes that there are no restrictions onLiis exchange from the supply side, andormally this is so. However, during cer-

financial crises—1857, 1873, 1893,907, and 1933—banks suspended con-ertibility. At these times individualsould not exchange deposits for currency,nd the desired currency ratio undoubt-ly exceeded the actual ratio (produc-g, as a consequence, a premium on cur-

At all other times the presump-on that the actual and the desired ratiose equal seems valid.The economic theory of demand sug-sts that the expected cost of holdingrrency in lieu of deposits is likely to bee of the major determinants of the de-

red ratio. Given the cost of holding cur-ncy, the desired ratio will then reflect

ie comparative advantages of holdingrrency and deposits. These advan-ges might depend on such variables aspected real income per capita, the vol-e of retail trade, the volume of travel

r capita, the degree of urbanization,3

and the rate of tax on transactions.6There are numerous other possible long-run influences on the currency ratio, andsome will be considered briefly later.Most of these neither help to explain thelong-run decline in the ratio nor seemrelevant to its short-run movements, andtherefore they will not receive much at-tention.

1. THE COST OF HOLDING CXTRRENCY

A rise in the cost of holding currencyleads people to substitute deposits forcurrency, and conversely. The foregonecost of holding currency is measured bythe current rate of return on deposits,since currency typically yields no nomi-nal return. While all deposits once paidinterest, the average return on demanddeposits has been negative since 1934 be-cause service charges have exceeded in-terest payments. Time deposits, on theother hand, have always paid interest, al-though the Federal Deposit InsuranceCorporation and the Board of Governorsof the Federal Reserve System jointly setmaximum rates for insured banks.

Interest paid less service charges ondeposits, however, is not themeasure of the cost of holding currency;we should use the expected net rate of re-turn. Before the introduction of depositinsurance in the 1930's, deposits were notas safe as currency against losses result-ing from changes in economic conditions.The payment of a deposit might be de-layed or defaulted if a bank became in-solvent. Such losses reduce the net returnto deposits. Individuals' expectations oflosses should be deducted from the aver-age rate of interest paid, to find the ex-pected net return. Subjective expecta-

The possible effects of most of these variableson the currency ratio have been recognized before(see, e.g., Irving Fisher, The Pl4rchasing Power ofMoney [New York: Macmillan Co., 1926], pp. 51—52and 165; and Pigou, op. cii.).

tions cannot be measured directly, but itis a plausible hypothesis that expecta-tions of the future rate of loss on depositsare based on past experience and so de-pend largely on some average of pastrates of loss. Such a measure of expectedloss has been used in the statistical analy-sis reported below.

2. EXPECTED REAL INCOME PER CAPITA

Checking deposits offer a convenientmethod of exchanging money withoutrisk of loss in transit; they also provide apermanent receipt for debts paid. In ad-dition, holding balances in reputablebanks avoids the hazards of keeping cur-rency on hand. These advantages maywell mean that the services of a dollar ofdeposits are preferred to those of a dollarof currency. If so, the currency ratiowould tend to decline as real income percapita rose, other things, such as thecomparative rates of return on the twokinds of assets, remaining constant. Thatis, both deposits and currency are consid-ered superior to other assets as a form ofholding wealth, but not equally so, de-posits being superior to currency.7 Thisdoes not mean that, for a given level ofincome, deposits are preferred to cur-rency, no matter how large a fraction ofmoney balances is already held as depos-its; if this were so, no currency would beheld at all, since some deposits pay inter-est and currency pays none. For a givensize of the total balance, a sufficiently

For evidence on the historical superiority ofmoney over other assets see Richard Selden, "AStudy of Monetary Velocity in the United States,"in Milton Friedman (ed.), Studies in the QuantityTheory of Money (Chicago: University of ChicagoPress, 1956), Part V.

For some purposes it may be preferable to definethe superiority of assets in terms of changes in totalwealth rather than of changes in income, as is donein the text. The empirical difficulties o measuringtotal wealth, however, largely rule out the formerapproach.

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small fraction held as currency makesextra dollar of currency preferablean extra dollar of deposits. Neverthelesit may still be true that, beyond thpoint in the size of the balance and in ticorresponding level of income, the i:

come elasticity of deposits is greater thithat of currency. A rise in real inconwould then lead to a decline in the curency ratio. As we shall see, the highincome elasticity of deposits appearsexplain most of the long-run decline ithe ratio.

Since real income proves to be an irportant determinant of the currencratio, shifts in the distribution of inconmay also affect the ratio and might doeven if the ratio of total money balancto money income for each income grouwere unchanged. The share of total 1:come received by the lower-incongroups has increased over time, whicmay have worked to increase the curency ratio. The effects of such shifts adifficult to distinguish from those of tigradual rise in real income, however, bcause our information on them is limiteto a few points in time. I have not atempted to analyze them, and the oserved effect of changes in real inconprobably incorporates any effect prduced by long-run changes in the ditribution of income.

3. THE VOLUME OP RETAIL TRADE

One advantage of currency over dposits is wide acceptability. Checsigned by a person unknown to tidrawee can prove to be worthless and.are customarily not honored untilclear the drawer's bank. Because of titime usually required for clearings,use of checks is limited to transactionswhich delayed payment creates no dificulties. Where wide acceptability is iiportant, as in cash-and-carry transa

Lons between strangers, the use of cur-predominates. If we suppose that a

onstant fraction of retail transactionswolves the use of currency and that thisraction is substantially higher than forther types of transactions, then the cur-ency ratio would vary directly with)ng-run movements in the fraction ofotal transactions made through retailtores. Such a relation is the main ex-danation of seasonal variations in theurrency ratio: the ratio typically reachests high point for the year during the

spurt in retail trade. Can thiselation explain long-run movements inhe currency ratio?

There are no figures on the fraction of,otal transactions made through retailtores. Statistics on money flows, whichielp to fill this deficiency, cover only thelery recent period. It is still possible toudge roughly the long-run behavior of.his fraction by looking at the product ofwo of its components: (a) the value of

sold through retail stores as a frac-ion of the value of total commodity out-ut and (b) the value of total commodityutput as a fraction of total transac-ions.8

Estimates of the first component arehown in Table 1 by decades from 1879o 1949. The fraction of total output fun-.eled through retail trade, as measuredy these figures, has changed little. Overhe entire period the estimated fraction

within 5 percentage points of 70 per.ent. These figures even overstate the'ariability in the importance of retail

8 These two fractions take no account of pur-bases of consumer services, which presumably areaid for with currency to roughly the same extent asther retail transactions. The growth of consumerrvices has outstripped that of commodities androbably also that of total transactions and has pro-uced a rise over time in the proportionate use ofurrency. It does not, therefore, account for the long-in decline in the currency ratio.

outlets. There is a slight upward bias inthe trend of the percentage arising fromthe unavoidable inclusion in the denomi-nator of a declining quantity of goodsexchanged through barter; for our pur-poses the denominator should measureonly goods sold in exchange for money.

The second component—the value oftotal commodity output as a fraction oftotal transactions—could change radi-

5

TABLE 1*

GOODS SOLD THROUGH RETAIL STORESAS FRACTION OF TOTAL COM-

MODITY OUTPUT, 1879-1949Years Per Cent1879 701889 671899 681909 691919 661929 721939 751949 73

* Source: Harold Barger, Distribution'sPlace in the American Economy since 1869(National Bureau of Economic Research,1955), Table 10, line 6 times line 8.

cally over time only if the volume ofwholesale and financial transactions orconsumer services (discussed in n. 8)changed substantially relative to totalcommodity output. A relative rise inwholesale and financial transactions,which are conducted mostly with checks,would decrease the currency ratio. Wedo not know whether such a rise has oc-curred, but, even if it has, its effect on thecurrency ratio has probably been slightbecause a fairly large part of total moneyholdings is held by individuals. If the im-portance of wholesale and financial trans-actions has been growing, presumablythe proportion of total cash balances heldby businesses, which make most of thesetransactions, has also. The money hold-ings of all businesses, including non-bankfinancial intermediaries, has been onlyabout 30 per cent of the total in recent

decades,° however, and this includes theholdings of the large number of busi-nesses engaged in retail trade, which arenot reported separately.

It seems likely that a decline in thefraction of all transactions made throughfirms that sell directly to the public hasnot been an important factor producingthe long-run decline in the currencyratio

4. THE VOLUME OP TRAVEL PER CAPITA

The amount of currency used to trans-act a given volume of retail trade maynonetheless vary substantially. Sincepayments by check require that partiesto a transaction be known to each other,currency is likely to supplant checkswhen a person buys where he is notknown or when he does not have the op-portunity to establish a line of credit.These difficulties bother travelers in alltransactions, and we might expect a di-rect relation between the currency ratioand an index of travel."

An index of miles traveled per capita,which is the best measure we can get, isfar from perfect for present purposes.The increasing speed of transportationallows a person to travel the same dis-tance in less time and therefore perhaps

This percentage covers currency and commer-cial bank deposits only (see reports on liquid-assetholdings in Federal Reserve Bulletin and SolomonShapiro, Distribution of Deposits and Curren-cy in the United States, 1929—39," Journal of 1/icAmerican Statislical Association, XXXVIII [Decem-ber, 1943], 438—44). Savings and loan associationsare included with financial intermediaries in thispercentage, although they are not so treated in thefirst source cited.

10 Changes in the form of retail transactions mayalso have affected the currency ratio. Thus, for ex-ample, the growth in sales of consumer durables,which involve a lump-sum payment unless boughton the instalment plan and are conveniently pur-chased by check, has undoubtedly stimulated theuse of checks. I have not analyzed this factor, be-cause it seems less important for the period preced-ing 1900, when the decline in the currency ratio wasgreatest, but such effects of the form of retail trans-actions on the currency ratio deserve further study.

6

with less need for currency. The need £currency probably rises more with tiduration of the trip than with the nuliber of miles covered. Nevertheless, tinumber of miles of intercity travelcapifa by passengers on all formstransportation (cars, buses, trains, aiplanes, and boats) should reflect majchanges in the demand for currency aning from the inconveniences of paying Jcheck when away from home. Such aindex of travel was constructed for tiperiod 1921—51. It has a strong upwaitrend and little year-to-year fluctuatioiowing to the persistent growth in autmobile travel, which makes up mostthe total except during the early 1920'The volume of travel thus seems unablto explain the major fluctuations in tFcurrency ratio since World War I, ambecause the long-run trend of travelalmost surely been upward, it cannotplain the long-run decline in the ratibefore World War I.

The possibility that travel accountfor part of the wartime increase inuse of currency will be considered lateiotherwise we may disregard this facto:

5. THE DEGREE OF

There are two possible effects ofbanization on the currency ratiowork in opposite directions. First, urbarization, like travel, causes people t

U Travel may cause increases in the use of tra'eler's checks, which are best classified as a formcurrency, but such increases would reduce, raththan raise, the currency ratio as computed for Fig.That ratio includes banks' traveler's checks in tidenominator with deposits because of the imposbility of segregating them in the basic data. Trayer's checks have formed a very small fraction of ttotal money supply, however, and could not possibbe important for explaining the variations in tCurrency ratio.

The outstanding traveler's checks of the Amecan Express Company, which can be estimated anually from its balance sheet, have not been includin the money figures. This company is said to issabout half of the total traveler's checks outstandinIt is the only non-bank issuer.

'ade where they are not known, which)uld reduce the use of checks. Historical:counts suggest that it was once muchLore common for laborers to buy onedit between pay periods, at least innail communities, and to pay their ac-imulated debts on payday. Payment of

purchases in this way would de-the use of currency relative to de-

osits. The growth of cities may have re-uced this practice and so have increasedie use of currency. To be sure, chargexounts are still widely used even in

cities, but their over-all importanceiay have decreased. Certainly the im-ersonal nature of urban trade itself dis-

the use of checks and credit, al-iough we do not know how seriously.

should consider the possibility thatus effect has been important.A second, quite different, effect of ur-

anization on the currency ratio is some-.mes deduced from various facts sug-esting that larger bank deposits are heldy individuals in cities than in the coun-

The implication drawn is that urbanfe provides familiarity with the advan-

ges the banking habit. For example, theayment of wages by check is more corn-ion in urban than in rural employments.'he inconveniences of banking by mailid the possible inefficiencies of smallanks may also have limited the spread

banking in rural communities, thoughily the most sparsely settled areasould seem to be unable to support oneank, or at least a branch of a nearbyank. Branch banking is illegal in manyates, but it is questionable whether thisrohibition would have endured if rural

had demanded banking fa-lities that could be supplied economi-illy only by branch banks.While the use of bank deposits relativeincome is possibly lower in rural areas

ian in cities, the same can be said of7

currency. All the preceding argumentsays is that rural areas have less demandfor all kinds of money than cities do, orat least that they probably did untilquite recently because barter was preva-lent in frontier areas and because wageswere paid partly in kind. This impliesnothing about the proportionate demandfor currency and deposits. The questionis whether migrants from rural areas tocities become familiar with banking prac-tices and expand their use of checkingfacilities at the expense of currency.Without evidence, there is little basis onwhich to judge.

Combining the second effect of ur-banization with the first throws theover-all effect of this variable into doubt.These two supposed effects of urbaniza-tion on the currency ratio work in op-posite directions, and there is no a prioribasis for expecting their net effect towork one way or the other.'2

The nature of the data largely rulesout a resolution of this problem by time-series analysis. Urbanization has pro-ceeded very steadily,'3 affording little

There are other possible indirect effects of ur-banization. Here is one: A change in the average payperiod over time could produce a change in the cur-rency ratio. For example, longer periods between in-come receipts would require larger money balancesand would lead to the deposit of a larger fraction ofsuch balances in banks by households in order toavoid holding too large an amount in currency. Whatevidence there is suggests that the pay period hasdeclined through the years as part of the urbaniza-tion process, because of the tendency of urban fac-tories to adopt shorter pay periods than have beencommon in rural employments. Changes in the payperiod, therefore, cannot explain the long-run de-cline in the currency ratio.

13 Bureau of the Census figures on the percentageof the United States population in urban centers(2,500 population and over) by decades are asfollows:

1870 261880 281890 351900 401910 46

It seems unlikely that the pattern of these figuresdepends much on the exact definition of urban cen-ters used.

1920 511930 561940 561950 59

chance to disentangle its effects statisti-cally from those of real income, which hasalso grown fairly steadily.

It is nonetheless clear that urbaniza-tion, whatever the direction in which itoperates, has not played a dominant rolein determining the currency ratio. If ur-banization increased the use of currency,it could not account for the steady de-cline in the ratio. If urbanization on bal-ance reduces the use of currency, itslargest conceivable effect accounts foronly two-fifths of the decline in the ratio.To see this, let us make the extreme as-sumption that urban residents use nocurrency whatsoever. Then the amountof urbanization that occurred from 1880to 1910, when the effect of this variableon the currency ratio seems to have beenthe greatest, would have produced but 42per cent of the observed decline in theratio.'4 With a more realistic assumptionabout the use of currency by urban resi-

14 Let stand for the average currency ratio perperson in urban centers, and mu for the average sizeof total cash balances held by each person in urbancenters as a proportion of the average size through-out the United States. The subscript r will denoterural areas, and U and R will denote population inurban and rural areas, respectively. Then the aggre-gate currency ratio, Ca, can be represented by(U\ IR

Ca = Cu + m,.

In 1880 Ca was 0.31, and the proportion of the popu-lation in rural areas was 0.72. Setting Cu equal to zerogives the maximum decline in Ca from urbanization,because any rise in the first term of the identity off-sets the decline in the second term. Assuming thatCu equals zero, then, and substituting the foregoingvalues into the identity, we have

0.31=0+c1m,(0,72), or O.43'crmr.For 1910, assuming no change in regional ratios ex-cept for the proportion of the population in ruralareas, which fell to 0.54, we have

0.23 = 0+0.43(0.54).This gives a maximum decline in Ca 01(0.31 — 0.23),or 0.08, which is 42 per cent of the observed declineof (0.31 — 0.12), or 0.19.

dents, much less of the actual deciicould be attributed to urbanization.

Cross-sectional analysis can cast futher light on the effect of urbanizatioon the currency ratio. Two types of sucanalyses could be useful. One could conpare over time different regions of tFUnited States that had substantially diferent rates of urbanization. The othcould make an international comparisoiThe first is presently ruled out by thabsence of data on currency holdings bregions, without which any direct estmate of regional currency ratios issible. Barred from the first type of anal3sis, I shall use the second. However, thlack of good monetary and populatiostatistics for most countries limits conparison to one foreign country—GreaBritain. Britain nevertheless providesrevealing comparison with the UniteStates, because its rate of urbanizatiodeclined sharply after 1900, while thAmerican rate remained high.more, it seems unlikely that any oth€factors had strong differential effects 0:the currency ratios of the two countrie5

The data underlying an estimate of thcurrency ratio for Great Britain are sulject to considerable error, especially fcthe years before 1921, and the results cthis comparison, presented in Tablemust be taken with extreme caution. Thtable lists as fully as the data allow thperiods of steady decline in the UniteStates ratio, thereby excluding WorlWars I and II and the 1930's. Therun movement of the British ratio is sim:lar to that of the American ratio with fe'exceptions. The former rose slightly duiing the period 1895—1903, though th:rise could well reflect an error in theures. The American ratio reached iiminimum in 1930, but the decline in tliBritish ratio continued until 1936. (Datfor 1921—36 are included in Table 2 f

8

:omparison.) Both ratios rose duringVorid Wars I and II and declined after-yard. However, the British ratio started.0 rise again after 1950.

For the period before World War II,he British currency ratio declined, onhe average, about half as fast after 1900i.s in the preceding two decades, and thislower pace corresponds with a sharpIrop in the rate of urbanization. In theJnited States, which had about as much

TABLE 2*

CoMPARIsoN OF CURRENCY RATIO WITHURBANIZATION: GREAT BRITAIN

AND THE UNITED STATES

A. RURAL TO URBAN POPULATION MOVEMENTt(PER CENT PER DECADE)

Period Great Britain United States880—90 8.7

.890—1900 .5.3 5.5

.900—10 1.3 7.2

.910—20 1.3 6.4

.920—30 1.0 5.7

.930—50 0.5 1.7

B. NUMERICAL CHANGE IN CURRENCY(PERCENTAGE POINTS)GREAT UNITED STATES

Per PerPERIOD Total Year Total Year

[883—88.. . —2.9 —0.6 —6.1 —1.21888—95... —4.1 — .6 —4.7 —0.71895—1903. +1.1 + .1 —3.3 —0.41903—14... —3.5 — .3 —6.3 —0.61921—30... —2.5 — .3 —4.3 —0.51921—36... —3.9 — .31945—50... —3.7 — .7 —3.7 —0.71950—55... +3.611 +0.711 —1.6 —0.3

Sources: For Great Britain, Census 1951 England and Waleseneral Tables (London: H.M. Stationery Office, 1956), p. 3;

Lnd Census 1951 Scotland, III (Edinburgh: H.M. Stationery)ffice, 1954), xxvii. For the United States, Statistical Abstract

p. 20.The figures for Great Britain are for the second year of

decade; those for the United States are for the first yeareach decade. The definitions of rural and urban areas for

England and Wales, Scotland, and the United States all differ.Elowever, the figures give a fair approximation of rural-urbannovement over time for a wide range of applicable definitions.

t The increase in urban population in excess of the increase:hat would have occurred if the ratio of urban to rural popula-ion at the beginning of the period had remained constant,iamely,

(

U is number of persons living in urban places and R isnumber of all others. The subscript i refers to the end of the

urbanization after 1900 as before, therewas also a reduction in the annual rate ofdecline of the currency ratio, though itwas somewhat smaller than in GreatBritain. The decline after 1895 in theUnited States was less than half as fast asthe decline from 1883 to 1888 but wasmore than half as fast as the decline from1888 to 1895. On the whole, there is onlya small difference between the behaviorof the ratios for these two countries, even

period and t — 1 to the beginning of the period.If we express this number as a percentage of total popula-

tion at the beginning of the period and rearrange terms, we get

100

This formula was used to compute Part A of the table.1861—91 at a decennial rate.

§ Great Britain: For 1914 and earlier years, currency in-cludes estimates of total gold coin and bank notes issued (in-cluding bank holdings) for Great Britain and Ireland (estimatesof silver coins were included for the period 1883—88 only) (seeStatistics for Great Britain, Germany, and France, 1867—1909[Sen. Doc, 378 (61st Cong., 2d sess.)] [National Monetary Com-mission, 19101) and E. Victor Morgan, Studies in British Fi-nancial Policy, 1914—25 [London: Macmillan, 19321, p. 217).The years shown are the only ones for which these estimatesare available. Deposits are estimates of total deposits with allbanks in Great Britain and Ireland (see René P. Higonnet,"Bank Deposits in the United Kingdom, 1870—1914," Quarte,1yJournal of Economics, LXXI (August, 19571, 330, Table I,col. 1). These figures for currency and deposits are rough esti-mates subject to considerable error. Moreover, they includebank-vault cash, interbank deposits, and Treasury cash hnid-ings. They are thus in error insofar as the ratio of currency todeposits held by banks and the Treasury differs from that ofmoney held by the public. Only part of this error is avoidedby ignoring the level of the currency ratio and looking at itschange over time. Some rough estimates made to exclude bankholdings suggest that the error from including them is not solarge as to destroy the usefulness of these figures for presentpurposes. However, the deposit figures are reportedly too lowprior to 1890 because of incomplete coverage, so that the cur-rency ratio is too high on that account prior to 1890; thus itsmeasured decline from 1888 to 1895 is probably too large.

For 1921 and later years, currency includes mid-year amountsof notes and coins outside banks estimated by the researchoffice of the Bank of England (see Bank of StatisticalSummary, various monthly numbers beginning with May,1932; revised figures for are given in Morgan, op. cit.,Table 29 p. 224). This series was adjusted to exclude noteissues of banks in excess of their vault cash. Deposits referto the middle of the year. They are the sum of (a) public depositsat the Bank of England; (b) deposits less float of the Londonclearing banks (see Central Statistical Office, Annual StatisticalAbstract); (c) an interpolation of total deposits at a date nearthe end of the year with Scottish joint-stock banks (see TheBanker's Almanac and Yearbook, section on "General Informa-tion"); and (d) estimates of total deposits with private banks inGreat Britain and Ireland through 1937, after which they werenegligible (see Sir Walter T. Layton and Geoffrey Crowther,An Introduction to the Study of Prices ILondon: Macmillan &Co., Ltd., 1938J, appendix Table IV, p. 254). "Other accounts"at the Bank of England, which are not shown separately frominterbank deposits before 1924, were excluded throughout; theyare relatively small, and their exclusion does not appear to be asource of great error.

While all interbank deposits and float items have not beeneliminated, the figures have fairly complete coverage and, in themain, appear to be reasonably accurate.

United States: Same as for Fig. 1.I) Excluding Scottish banks, reports for which were un-

available for the latest years. They represent a small part ofthe total, and their exclusion cannot affect the figures much.

9

though their urbanization rates contrastsharply.

By this evidence, urbanization worksto reduce the currency ratio slightly. Hadthe United States been fully urbanizedby 1875, therefore, its ratio would prob-ably have declined a little more slowlythan it did but certainly would have de-clined nonetheless. Apparently the twomain effects of urbanization previouslydiscussed largely cancel out, so that thenet effect is fairly small. The unreliabilityof the early data for Great Britain, how-ever, makes this conclusion tentative andmakes further study of a wide range ofcountries desirable.

6. RATE OP TAX ON TRANSACTIONS

The last variable to be considered isthe rate of tax on transactions. Somepeople evade taxes by making as manytransactions as possible with currencyand not reporting them to the tax collec-tor. In the absence of independent evi-dence on transactions, such as canceledbank checks, tax evasion is difficult todetect. Obviously, evasion will occur on alarge scale only if the tax rate is highenough to create sufficient incentive. Themost extensive tax on transactions with ahigh rate is the income tax, and even herethe rates have become exceptionally highonly since the late 1930's. The nature ofmany income payments makes theirtransaction with currency highly imprac-tical, so that the possibility of evasion byuse of currency is effectively limited tothe income of unincorporated businessesand independent professional practice.As for other taxes, most sales and excisetaxes have fairly low rates and are dif-ficult to evade. The tax variable will bediscussed further in connection with war-time increases in the currency ratio.

This completes the list of variablesthat were examined for their contribu-

tion to long-run movements in the curency ratio. The foregoing discussitgave reasons for neglecting the effectstwo—'the volume of retail trade andtravel—and for attaching only minor irportance to a third—urbanization. Thleaves three variables—interest on dposits, real income, and the tax on tranactions—whose relative importance rmains to be assessed. One way of doirthis is by a correlation of time-serifdata, which is reported later. Anothiway, taken up in the next section, is bydetailed examination of themovements in the currency ratio dunnWorld Wars I and II. The wartime dmand for currency may have been afected by special factors not presentother times, which need to be considerein addition to the factors already dicussed.

II. WARTIME INCREASES IN THEDEMAND FOR CURRENCY

If we take the 1940 level of the cuxrency ratio as roughly "normal," currency in circulation in 1945 was 8.1 pecent above normal, which implies thathere was $10.1 billion "excess" currenc:in that year. This excess cannot be attributed to changes in either interespayments or real income; such changewere not pronounced during this perio(see Fig. 2), and their effects tended toffset each other. During World Warthe increase in the ratio was less prcnounced. If the 1914-47 level of the ratiis considered normal, currency in circulation was 3 per cent above normal in 191k(The subsequent analysis largely ignorethe World War I period becausesary data on other factors are not avaiable.)

The excess wartime demand for cuirency has attracted a great deal of attertion and is generally attributed to one (

10

lye factors. Conceivably, all five couldiave contributed about equally to it.yet, as will be shown, all but one of them

actually account for only a minorraction of the total increase, and that)ne—income tax evasion—could accountor nearly all of it. This variable, there-ore, will be singled out as the probablenain cause and will be discussed first.rhe other proposed explanations, dis-cussed afterward, are black markets,travel, the size of the armed forces, andchange of residence.'5

1. EVASION OF TAXES

The use of currency to conceal taxabletransactions was probably higher duringand after the war, primarily because in-come tax rates were raised substantiallyearly in World War II and have not beenappreciably reduced since. Income re-ceived, held, and spent without priordeposit in a bank usually defies detec-tjOn.16 A tax on income thus leads somepeople to receive income and make ex-penditures as far as possible without theuse of checks. To be sure, incorporatedbusinesses and most wage and salaryearners have little or no such reason forpreferring payments in currency. The

15A sixth explanation—foreign demand for Unit-ed States currency to hoard—has been unofficiallyestimated by the Federal Reserve Division of Re-search to account at most for about one-tenth of the1940—45 increase in currency. This estimate suggeststhat foreign demand had a relatively small effect onthe currency ratio and, for present purposes, can beignored.

But not always, as the following incident dra-matically proves:

"Tax investigators recently closed in on a Dallasarea dentist who stashed $20,000 of unreported in-come in a coffee can. He arrived home one day todiscover his wife had thrown the can into the trash.After finding that neighborhood trash already hadbeen collected, he hired a bulldozer for $5,000 [sicland carefully sifted the city dump. By the time thefrantic dentist finally located the coffee can, thewhole town—as well as interested Governmentagents—knew about its contents" (Wall Street Jour-nal, April 11, 1957).

former undergo public audits, and mostof the latter have their income tax with-held, a device that frustrates whatevertemptations to defraud the governmenthigh tax rates may arouse. Even beforewithholding was introduced early in thewar, most individuals who wished to bepaid in currency could not hope tochange the pay practices of their em-ployers but had to seek out currency-paying employments. It is doubtfulwhether, at the low income tax rates pre-vailing before the war, many companiespaid workers in currency solely to attractwould-be tax evaders and thus to be ableto pay lower wages. We may expect that,if evasion of income taxes through theuse of currency were widespread, itwould occur primarily among small unin-corporated businesses, including inde-pendent professional practice.

How large, then, could the demand forcurrency be from unincorporated busi-nesses and professional practice alone?One easy and revealing way of judgingthe size of this demand is to compare anestimate of unreported income based onthe quantity of excess currency circulat-ing in 1945 with an independent estimateof unreported business and wage income.

The currency ratio, excluding moneybalances of incorporated businesses, was15.5 per cent'7 in June, 1940, which canbe taken as roughly normal because in-come tax rates were then relatively low.(Because data on unincorporated busi-nesses separately are unreliable, suchbusinesses are included with all individ-uals.) This ratio implies normal currencyholdings in June, 1945, of $12.4 billionfor individuals and unincorporated busi-

11

Based on figures for ownership of liquid assets(Federal Reserve Bulletin, June, 1948, p. 658, andJuly, 1954, p. 710). These figures exclude mail floatfrom checking accounts, and this was added backaccording to the proportionate holdings for eachgroup of demand deposits excluding the float.

nesses. In that month this group actuallyheld $23.2 billion, an excess of $10.8 bil-lion.18 If it is assumed that all, or almostall, unreported income is transacted withcurrency, it follows that $12.8 biffion wasthe amount of money held against unre-ported income.'9 What level of such in-come does this figure imply? As a roughapproximation, we can multiply this esti-mate by the ratio of annual personal dis-posable income to total personal moneybalances, excluding incorporated busi-nesses. This ratio shows the quantity ofannual personal expenditures and sav-ings normally handled by a dollar ofmoney. In 1945 this ratio was 1.66, whichwould put unreported income at $12.8billion times 1.66, or $21 billion. How-ever, the real value of money balanceswas unusually large in that year; appar-ently many people had accumulatedmoney savings with the intention of pur-chasing postwar consumer goods notthen available. Such savings should per-haps be excluded from these calculations.We may do so by using the ratio of per-sonal disposable income to personal bal-ances in a normal year. In 1940 it was1.84, and in 1950, 1.96. These ratios esti-

Total holdings for all groups were $25.3 billion,as estimated in Friedman and Schwartz, op. cit.,from which holdings of corporations were deducted(Federal Reserve Bulletin, be. cii.).

10 This takes account of the currency that wouldordinarily be used. Suppose that cash balances heldagainst unreported income are M, all of which iscurrency. Thus M equals the $10.8 billion excesscurrency plus the currency that would normally beheld against this income. One way to estimate thelatter is to estimate the "normal" currency ratio.For 1945 we may take this to be 15.5 per cent, thefigure for all groups in 1940 except corporate busi-ness, which is probably an overstatement for unin-corporated businesses alone and so is biased unfavor-ably for the hypothesis being tested. Then, 0.155Mis the normal amount of currency held, and M isfound as follows:

1O.8+O.155M—M andM— 12.8.

mate unreported income in 1945 atand $25 billion, respectively. Thus thestimate of excess currency in circuiatioiin 1945 implies that from $21 to $25 billion of income was unreported.2°

A comparison of this range with a cornparable, independent estimate of unreported income will give one indicationthe wartime increase in currency that resuited from tax evasion. While such anestimate can be made only indirectly andis obviously subject to considerable er-ror, a very rough figure is available. Itputs unreported income for 1945 at about$15 billion.2' Compared with the preced-ing figures, this suggests that high in-

20 This range is equivalent to from 50 to 60 percent of total non-corporate business income, in whichmost non-reporting presumably occurs. (The de-nominator of these percentages is the sum of thefollowing items as estimated by the Department ofCommerce: income of unincorporated enterprises,farms, and professional practice; rental income ofpersons; and income, including wages and salaries,from personal services and from services to privatehouseholds. Except for the last item, these figuresexclude all wages and salaries. For some excludedwages and salaries income taxes are not withheld atthe source, and the figures thus exclude some incomewhich may not be reported. In this respect these per-centages are somewhat too high.)

21 I am indebted to C. Harry Kahn for this esti-mate and the following description of its derivation:The estimate was obtained by adjusting the Com-merce Department's personal income estimates tocomparability with the income concept used on taxreturns; namely, adjusted gross income (AGI). Thefollowing items were subtracted from total AGI toobtain an estimate of unreported income: (1) AGIreported on taxable and non-taxable returns as tab-ulated in Statistics of Income for 1945 and (2) anestimate of the amount of AGI not reported becauseit was below the $500 filing requirement for thatyear. The resulting estimate of unreported AGI is$17,537 million, which includes dividends and inter-est. To eliminate the latter, Selma Goldsmith's esti-mate of $2,612 million for unreported dividends andinterest (see Studies in Income and Wealth [NationalBureau of Economic Research), XIII, 302) was subtracted from $17,537 million, which gives $14,925million. This figure is a residual and is thereforsubject to the errors in both of its derivatives. It iobviously an indirect and crude estimate of unreported income.

12

ome tax rates account for 60—70 per centf the wartime increase in currency.22

This evidence is admittedly circum-tantial and for that reason unreliable.'hree considerations underlie the impor-ance that I nonetheless attach to thisactor.

First, the foregoing argument rests onwo assumptions, both of which appear.ighly plausible: (a) unreported business

ncome involves the use of currency al-exclusively,23 and (b) the amount of

urrency so used per dollar of income istot less than the amount of money useder dollar of all income. If these two as-umptions are correct, the preceding esti-nate of the effects of income tax evasionn the currency ratio is not overstated.

these assumptions are not en-:irely valid, but it is hard to believe thathey are grossly inaccurate.

Second, it is likely that assumption b isar too conservative and that the amount

of currency held against a dollar of unre-ported income is much greater, on theaverage, than the amount of money heldagainst a dollar of regular income. Unre-ported income produces an abnormal de-mand for currency to hoard. The amountof currency hoarded by the tax evaderreported in an earlier footnote does notseem unnatural under those circum-stances, though it is very large by or-dinary standards. Such hoarding on awide scale would increase the use of cur-rency enormously. For this reason it

These rates did not fall appreciably from war-time levels during 1945—55, and the moderate de-cline in the currency ratio iii the postwar periodmust be attributed to other factors, such as the risein interest paid on deposits and in per capita realincome.

23 In the case of retail stores and certain servicesvhere receipts are mostly in the form of currency,proprietor or worker who wished to evade income

taxes would make his expenditures with currencyand not first deposit his receipts in a bank, as isisually done.

13

seems plausible to attribute three-fourthsor even all of the wartime increase in thedemand for currency to income tax eva-sion.

Finally, possible alternative explana-tions, even when taken together, seemunable to account for very much of theincrease, or at least not for as much as theincome tax variable by itself, as the fol-lowing discussion shows.

2. BLACK MARKETS

Black-market activities, which in-crease the demand for currency in orderto conceal transactions, were prevalentwhen price controls were in effect duringand after World War II and to a lesserextent during World War I. Black-mar-ket operations in wholesale trade surelyinvolved the use of large denominationsof currency, say twenty-dollar bills andover, because of the large transactionsrequired. Such operations can be dis-missed as unimportant contributors tothe wartime increase in currency for thefollowing reason: Data on the denomina-tion of the currency 1940—45 show thatthe value of bills of twenty dollars andover, not all of which by any means rep-resented a demand arising from illegalactivities, rose from 49 to 60 per cent ofthe total value of the currency.24 Thisincrease of 11 per cent of the currencyoutside banks in 1945 amounted to $2.8billion, about one-quarter of the $10 bil-lion abnormal demand for currency.Even this figure overstates the effect, aswill be shown in a moment.

Insofar as black marketing involved24 From the Federal Reserve Bulletin. The corre-

sponding percentage for bills of fifty dollars and overwas roughly constant during 1940—45.

These figures cover currency in bank vaults aswell as in public circulation and so are not entirelyappropriate. But the denomination of currency inbanks is likely to reflect demands to be expectedfrom depositors' withdrawals and so to parallel thedenomination of currency in public circulation.

evasion of income taxes—and much of itprobably did—its effect was taken intoaccount in the preceding subsection. Notall wartime tax evasion reflected blackmarketing, however, and the evidence ondenomination of currency is one check oiithe importance of black marketing inwholesale trade as an independent factor.While tax evasion might also have in-volved some hoarding of large-denomina-tion bills, most evasion probably in-volved transactions of average size thatdid not use large bills; thus the relativelysmall size of the increase in the amountof large bills does not mean that taxevasion was unimportant.

Of course, black marketing at the re-tail level would not use large denomina-tions of currency, and it was reported tobe widely prevalent during the war, espe-cially in food sales. But retail transac-tions are typically made with currency inany event, and therefore the retail blackmarket could not have produced a greatincrease in the use of currency.

Before dismissing this factor, weshould consider the evidence further, be-cause the increased use of large bills dur-ing the war was thought to be a glaringindication of widespread black marketingand tax evasion. In 1945 the Treasuryhoped to discourage these illegal prac-tices by having banks report exchangesinvolving substantial amounts of cur-rency or large bills. In 1947 two lawswere proposed in Congress, though neverenacted, to exchange the currency out-standing for a new one.25 The intentionwas to wipe out hoards acquired throughillegal activities. It is not clear whetherthe exchange would have had the in-tended effect, but it might have if funds

5239 and H.J. Res. 315 (80th Cong., 2dsess.); see James J. Quinn, "New Money for Old—Hot or Cold?" in Commercial and Finincial Chron-icle, November 27, 1947.

illegally acquired were held in large bithwhich presumably could not be quickidisposed of, and which would not haybeen redeemed for the new currency fofear of raising suspicion about theisource.

It is extremely doubtful whether thbasic premise of thesethe increased demand for large bills involved illegal transactions—was trueWhat the argument underlying thesproposals overlooks is that a rise iprices tends to raise the average denomination of the currency proportionatelyInflation increases the average dollaamount of and so the average payment uses larger bills than before. Thus some part, perhaps all, ofincrease in the use of large bills was dwto the inflation. This is confirmed by thfollowing comparison.

The average denomination of the currency, weighting the value of each de-nomination by the number of bills oicoins outstanding and excluding billsover $1,000, increased by 84 per centfrom 1940 to 1945.26 This overstates thedesired increase by some undeterminedamount because of the wartime liinita-tion on the production of coins: dollarbills had to be substituted to some extentfor coins in currency holdings, whichraised the average denomination of cur-rency in circulation. We may use theaverage denomination of checks clearedby Federal Reserve banks as a roughmeasure of the average size of transac-tions. The increase in the average de-nomination of checks from 1940 to 1945

The number of one-cent and five-cent pieceEoutstanding is available, but the breakdown of sub-sidiary silver had to be approximated from figureson coinage (from Annual Report of the Director ofMint). Estimates of the average denomination olcoins outstanding derived by various methods are al.roughly the same; the method used, therefore,likely to be fairly accurate.

14

vas 70 per cent.27 The increase in thedenomination of currency ex-

ceeds this figure by a relatively smallamount and perhaps would hardly ex-ceed it at all if we were able to correct forthe limitation on coin production. Thusthere was little shift to the use of largebills that cannot be attributed to theconcurrent inflation28 arid that could re-flect instead increased demand arisingfrom black marketing.

3. TRAVEL

As already mentioned, the per capitanumber of intercity passenger miles onall forms of transportation seems an ac-curate enough measure of travel, even

27 Calculated from data on check clearings (ex-cluding United States government checks) publishedin the Annual Report of the Board of Governors of theFederal Reserve Syslem.

28 The percentage increases in the average denom-ination of currency and the average amount ofchecks are much larger than the concurrent increasein price indexes. For example, the implicit price in-dex of the Department of Commerce for gross privateproduct increased by about 36 per cent from 1940to 1945. This means either (1) that the average dol-Jar amount per transaction for some reason rose morethan prices during the war, or (2) that some of theprice rise of about 30 per cent shown by the implicitprice index from 1945 to 1948 occurred, in effect, be-fore 1945 but was not reflected in quoted prices andso in the index until after the removal of pricecontrols.

The subsequent decline in the average denomi-nation of transactions partially supports the firstpossibility. The average denomination of checks fell11 per cent from 1945 to 1953. That of currency fellabout 30 per cent in the same period, but about halfof this was probably due to the removal of restric-tions on coin production. This evidence suggests thatthe average denomination of transactions rose about11 per cent more than prices during the war. An al-ternative explanation, however, is that averageprices actually paid declined 11 per cent after thewar following the disappearance of wartime scarci-ties but that, because of price controls, the index ofquoted prices did not show this decline, just as itmay not have shown all the previous rise. Price con-trols could have caused a discrepancy to develop be-tween the actual and the measured price movementsby leading consumers to shift toward higher-pricedor lower-quality items or to countenance retail blackmarketing.

15

though it is not entirely appropriate.This variable can be dismissed for pres-ent purposes, because the volume oftravel declined during the early years ofWorld War II, owing to the sharp cur-tailment of the use of automobiles, whichaccounted for almost 90 per cent of totalintercity travel in 1940.29 The volumewas higher in 1941 than in 1945 but roseappreciably in the early postwar years.Only an increase in travel during the warand a subsequent decline would accountfor the behavior of the currency ratio.

4. THE SiZE OF THE ARMED FORCES

Servicemen lead an unsettled life inwhich bank connections are usually oflittle value. A man entering the armedforces will increase his use of currency perdollar of income, and a large rise in thenumber of servicemen may produce asubstantial increase in the use of cur-rency. This factor is not likely to be im-portant, however, because new entrantsto the armed forces also experience a sub-stantial reduction in money income. In1945 the average payroll of the entirearmed forces was $1.77 billion a monthhigher than in and only part ofthis difference was paid in United Statescurrency or paid directly to servicemen.To a large extent foreign currencies wereused overseas, and many servicemen hada substantial part of their pay sent di-rectly to dependents or invested in sav-ings bonds. Let us nevertheless supposethat the entire military payroll was paidmonthly in currency and held in thatform during each month until spent. Asfor hoarding, it is unlikely that service-men typically carried much more than a

The index of the per capita volume of travel forthe 1940's is as follows: 1940, 100; 1941, 111; 1942,98; 1943, 93; 1944, 99; 1945, 108; 1946, 119; 1947,116; 1948, 116; 1949, 122.

30 National Income Supplement (1954), p. 181.

month's pay at any one time, and thereis no reason to believe that the accumu-lated money savings that servicemenkept back home with their families con-tained a higher fraction of currency thanthe savings of civilians. On these assump-tions, then, pay in currency remainedwith servicemen an average of about twoweeks after it was received and so in-creased the amount in circulation byonly $0.9 billion, and this takes no ac-count of the currency that servicemenheld when they were civilians. Even un—der more extreme assumptions, the pos-sible increase in currency from thissource seems negligible.31

5. CHANGES IN RESIDENCE

During World War II war industriespaid high wages and attracted workersfrom peacetime employments; this shiftin employment often involved a changein residence. In addition, many wivestried to live near the places in the UnitedStates where their soldier husbands werestationed. Migrants undoubtedly foundthe use of credit difficult until they be-came better known and so temporarilyhad to use more currency than before.This increased use of currency must havelasted from several months to a year ormore after each change of residence.Many of the migrant war workers mayalso have been people who previously

31 In an interesting recent work on the currencyratio, Stephen L. McDonald finds a close correlationduring the period 1939—53 between the ratio of cur-rency outside banks to demand deposits adjustedand military pay as a percentage of personal income;he attributes a large part of the wartime increase incurrency to this factor ("Some Factors Affecting theIncreased Relative Use of Currency since 1939,"Journal of Finance, XI [September, 1956b 313—27).The high correlation proves little, however, for manyother variables affecting the currency ratio rose dur-ing the war and would be highly correlated with theratio. For the reason given in the text, I cannot be-lieve that currency holdings of servicemen wereimportant.

had low incomes and made little use obanking facilities; they would not immediately acquire the banking habiupon receiving high wartime wagesWhile this last factor works in the samway as a redistribution of income, thrise in the income of these people waassociated with their change in residenceand the effects of the two are closely related.

One way to measure such changes irresidence is by changes in state populations resulting solely from migration.32 I:we add up the increase in civilian popula-tion from migration of only those statesshowing a gain, we find that 2.3 millionpeople moved between April 1, 1940, andJuly 1, 1942, and 2.8 million betweenJuly 1, 1942, and July 1, 1945. These to-tals understate the number of civilianschanging residence, because intrastatemovements are excluded and peopleleaving a state with net gains reduce thereported number of newcomers. This un-derstatement does not seem to be great,however; most of the migrants took jobsin newly expanded war industries, thelargest of which were concentrated in afew states. They therefore moved acrossstate lines, primarily in one direction.Indeed, these figures, by including allmembers of a migrating family, probablyoverstate the movement of incomeearners.

What is the largest increase in cur-rency that could conceivably result?Gross average weekly earnings in manu-facturing, which exceeded average week-ly take-home pay, were $44.39 inLet us make the extreme assumptionthat the average migrant was paid asmuch as the average of all factory

16

32 Bureau of the Census, Current Population Re-ports (Ser. P-25, No. 72 [May, 1953}), Tables 5 and6.

Statistical A bstracl (1956), p. 220.

yorkers and that migrants used no creditbanking facilities for three years but

:ept their entire weekly pay in currencyor the full week between payments be-ore spending it. The use of extra cur-

then amounts to oniy $124 million$44.39 times 2.8 million). Even if all theyorkers who migrated between April,L940, and July, 1945, did not use banks:hroughout the period, the rise in cur-

could have been, at most, $226Tiillion ($44.39 times 5.1 million), a mi-iute part of the $10 billion increase we

to explain.It is possible, of course, that many mi-

also kept their accumulated say-ngs in the form of currency. Savings ac-:umulated before moving would prob-thly not raise the currency ratio, forthere is no reason to believe that mi-

lowered the fraction of their ac-:umulated money savings previouslyLield with banks, except perhaps tem-porarily while actually traveling. How-ever, if many migrants kept all their say-[ngs from increased wartime earnings in.urrency, such hoards would raise theurrency ratio. But it is doubtful whetherriigrants hoarded much currency in viewf the attractive alternative available inJnited States savings bonds and of thetrong pressures put on workers to enlistn payroll savings plans. The wide war-ime participation in these plans34 attests:0 their importance and creates seriousloubt that hoarding by migrants was anajor source of increase in the currencyatio.

34After a steady rise during 1943, the number ofof firms offering payroll savings plans

eached 85 per cent of all employees of business andndustry by June, 1944. The average deduction from•articipating workers' pay was 9—10 per cent, andbout half the employees in non-agricultural em-loyments participated (see Report of the Secretary

f the Treasury [19441, pp. 52—53).

III. STATISTICAL ANALYSIS OFTIME-SERIES DATA

One way to test the foregoing findingsis by a correlation of time-series data.Such a correlation was run for the period1919—55, using the interest, income, andincome tax variables only. Other vari-ables that may to some extent have beenimportant, urbanization in particular,were disregarded. Urbanization corre-lates highly with the income variable,and the effects of the two cannot be dis-entangled in a time-series correlation.The income variable can serve as proxyfor urbanization as well. The other vari-ables examined for their contribution tothe wartime increases in the currencyratio would probably correlate highlywith the income tax variable and would,if used, also create multicollinearity inthe regression. Since the income tax vari-able seems by all odds the most impor-tant for the wartime period, it alone wasused.

1. DESCRIPTION OF THE DATA

Interest paid on deposits.—Judgingfrom the behavior of the demand forcommodities, we might expect the mostimportant determinant of the demandfor currency relative to deposits to be thecost of holding one in lieu of the other, orthe net rate of interest on deposits. Thedata needed to construct a time series ofthis variable are available. Since 1919there are comprehensive annual figuresfor member banks on interest paid ontime and demand deposits, and on serv-ice charges on demand deposits. Since1934 such data are available for all in-sured commercial banks. These can beused to represent all commercial banks.Before 1919 the data for commercialbanks are too incomplete to be used withany confidence, and the correlations aretherefore limited to the period 1919—55.

17

Much better figures for mutual savingsbanks are available back to 1875 andbefore. However, a comparison of inter-est payments by savings banks since1919 with those paid on demand depositsindicates that short-run fluctuations inthe two series do not correspond at allclosely; thus the rate on savings depositscannot serve as an estimate of the rate ondemand deposits for the earlier period.The banks' rates are useful, how-ever, in showing the general movementof interest payments before 1919.

Statistics on interest paid on deposits,as already noted, take no account oflosses suffered by depositors in banksthat become insolvent and so do notmeasure the net rates that depositors asa group expect to receive. In the past,these losses 'were not inconsequential. Intwelve crisis years from 1865 to 1933, de-positors suffered an average annual rateof loss of three-fourths of 1 per cent,35though in most other years the annualrate was fairly low. Since the late 1930'sthe great majority of banks have joinedthe Federal Deposit Insurance Corpora-tion, and the loss to depositors has beennegligible. Available data on the percent-age of deposits lost through bank failuresshow actual past losses rather than thelosses depositors expect in the near fu-ture. Naturally, expectations cannot bemeasured directly. Yet, since depositorsmust normally rely on past experience informing their expectations, it seems rea-sonable that some average of past ratesof loss, giving greater weight to ratesmore recent in time, would approximatethe expected rate. An average using ex-ponential weights has been employedelsewhere with apparent success to esti-mate the expected rate of change inprices and to estimate expected income;36

Annual Report of Federal Deposit InsuranceCorporation (1940), p. 63.

18

there is every reason to believe thatpectations are formed in a similar way ithe present instance. Of course, anment based on these other results is fl(conclusive; the main test is with thpresent data. Here an exponentiallweighted average of past losses was useto estimate expected losses throughFor later years, when deposit insurancrapidly came into effect and actual losswere negligible, expected losses were asumed to be zero. While zero is obviousltoo low a figure for the period immediately following the introduction of dLposit insurance, it is certainly more aicurate than a figure based on the experience of the previous years, and there ino basis for selecting an intermediate fit,ure. As will be shown shortly, these estimates give better results than use of thcurrent loss rate throughout. Whethethe particular weighting pattern for thperiod before 1934 is the most appropriate one need not concern us. Because thmagnitude of losses is small comparewith interest payments, the series derived for the expected net return on deposits is little affected by the exactof the weighting pattern.

The series is plotted in Figuri2 (it is inverted because of its inverse relation to the currency ratio). Figurealso shows the currency ratio and twother series to be described presentlyThe series are plotted onscales to bring out their percentage variations.

Movements in the currency ratio anthose in expected net interest paymentcorrespond closely. In particular, thespayments account for a large part of thsharp rise in the ratio after 1930. Correlation coefficients computed betwee:

30See Friedman, op. cit., Part II; and M. Friedman, A Theory of the Consumption Functiontional Bureau of Economic Research, 1957), p.

0.10

'U

'Ua.

0.50

1.00

'U2.00-J

>

0In

-j-J0-J

950 -12.510.0

5.0 z'UU

1.00.75

1919 '30 '35 '40 '45

YEARS

Fio. 2.—Determinants of the currency ratio annually, 1919—55. Ratio scales (adjusted by regressiontext).

20.0CURRENCY FSAT1O

15.0 -

7.5EXPECTED NET RATE OF RETURN

ON DEPOSITS

(INVERTED)

INCOME

I I I I

logarithms of the two series show thatthe interest series accounts for 79 percent of the total variation in the currencyratio since 1919. With correction for cur-rent losses only, instead of correction forthe weighted average of past losses, thecorrelation is lower; that is, the estimatedexpected net return gives better resultsthan the current net return.

Let us next see how much of the resid-ual variance can be explained by the twoother variables—expected real incomeper capita and the rate of tax on income.These variables are shown in Figure 2;the former is shown inverted because ofits inverse relation to the currency ratio.

Expected real income per capita.—Thisvariable is estimated from an average ofpast levels of net national product in con-stant prices, weighted by an exponentialcurve that gives greater importance tomore recent levels and divided by thepopulation. It would have been more ap-propriate to use national income than netnational product, but the latter serieshad already been averaged by the ex-ponential weights for another study andwas used because it was readily available.In any event, the trends in the two seriesare very similar. The averaging proce-dure smooths out cyclical fluctuations inthe underlying data, which seems appro-priate because the use of currency rela-tive to deposits is likely not to be ad-justed for variations in real income thatare not viewed as permanent. This meth-od of deriving expected income has beenused successfully elsewhere to explainaggregate consumption (see n. 36).

Rate of tax on inconie.—The use of cur-rency to evade income taxes is measuredby the annual percentage of personal in-come collected for income taxes. The useof this series presumes that the amountof tax evasion depends directly on therewards. An ideal measure would be the

20

marginal rate levied on the average leveof income for which taxes are not withheld, permitting currency to be usedaid evasion. The measure used is noideal, since it gives the average rate pai'on total personal income and excludeevaded taxes, but it seems close enougifor present purposes. The measure ignores other incentives to use currency foconcealing illegal transactions that hayvaried appreciably in volume, such as thiproduction and sale of alcoholic beverages during national prohibition. Alsothere may be lags between the impositiolof increased tax rates and attemptsevade them. The percentage of personaincome taxed (see Fig. 2) reachedplateau in 1943, while the currencycontinued to rise for another year, whiclmay reflect such a lag. The sharp rise iithe currency ratio in 1918 (see Fig. 1may likewise reflect the increase in income taxes as a percentage of personaincome from nearly zero in 1916 to abou1.8 in 1917, suggesting that tax evasioilagged by about a year. No attempt habeen made to take account of such lags

2. IAITLTIPLE CORRELATION OF THETIME-SERIES DATA

The three variables just discussed werused in a multiple correlation to explaiiannual variations in the currencyfor the period 1919—55. Theregression function, with theratio and three independent variables iilogarithmic form, accounts for 89 pecent of the variation in the ratio. Intwo-variable regression of the currenc:ratio on interest payments, mentione(earlier, the latter accounted for 79 pecent of the variation in the ratio, so thathe additional two variables account fo,about half of the remaining 21 per cent othe variation. Thus interest paymentwere the main determinant of the ratio ii

his period.37 In Figure 2, each independ-at variable is plotted on a vertical scalehat is proportional to the relative mag-itude of its contribution to changes inhe currency ratio in the multiple regres-ion. The combined contribution of thehree variables is shown by the lighterne. Comparison of the actual and thestimated ratio indicates that variations:i the currency ratio during the war pen-ds are largely accounted for by increasesa the personal income tax. It does notppear that any of the other variablesonsidered, which were discarded be-ause of insufficient importance butnight have had some influence, wouldxplain the differences between the ac-ual and the estimated series for the cur-ency ratio. The serial correlation dis-dayed by these differences probably re-Lects persistent errors in the data, the in-adequacy of the logarithmic regressionunction, and perhaps cyclical factors notepresented by the independent van-

Even if too much importance has beenL.ttributed to the income tax variable andome combination of the discarded van-Lbles in fact accounted for a sizable part

the wartime increases in the currency'atio, the estimated regression coeffi-:ients for the interest and real-incomeiariables are probably not greatly in er-or. Time series for the discarded van-Lbles would have a pattern much likebat of the income tax variable, so thatbe interest and real-income variablesvould still account for the same varia-ions in the currency ratio. Only a minor

This is also brought out by the square of the)artial correlation coefficients, which is the fraction

residual variance in the currency ratio explainedthe addition of a third independent variable to a

egression on the other two independent variables.['he square of this coefficient for interest paymentss0.69; for expected real income per capita, 0.47; andor the income tax variable, 0.43.

21

qualification of the results seems re-quired. Since time series of the discardedvariables, unlike income taxes, might de-cline after 1945, the interest and real-income variables may account for less ofthe decline in the currency ratio sinceWorld War II than the regression at-tributes to them. The future behavior ofthe ratio will show to what extent thisqualification is called for.

3. ELASTICITIES OF DEMAND FOR CURRENCY

The variation in the currency ratio as-sociated with each of the three variablesused in the regression does not neces-sarily measure the magnitude of their in-fluence. The amount of this associationdepends partly on the relative extent towhich the variables happened to varyduring the period covered, The regres-sion coefficients, on the other hand, showthe effect on the currency ratio of equalpercentage fluctuations in each variable.These coefficients are given by the re-gression function derived from the mul-tiple correlation:

log = —0.21 log X1 — 1.16 log X2

+ 0.22 log X3+a constant,where C/M stands for the currency ratioand X1, X2, and X3 stand for expectednet interest paid on deposits, expectedreal income per capita, and the percent-age of personal income taxed, respec-tively. The logarithmic form of the func-tion may not give the best possible fit,but it was used because it allows us tomeasure elasticities easily.38

All the coefficients have the appropri-ate sign. Interest payments are negative-ly related to the currency ratio, indicat-ing a shift to deposits when these pay-ments rise; expected real income per

38 The standard deviations of the regression co-efficients are 0.02, 0.21, and 0.04, respectively.

capita is also negatively related, indicat-ing that deposits are a superior asset tocurrency and are held in greater propor-tion as real income rises; the income taxvariable is positively related to the cur-rency ratio, indicating that a higher taxrate brings currency into greater use.The percentage changes in the ratio cor-responding to a 1 per cent increase ineach of the independent variables areroughly —4-, —1, and +4-, respectively.

These numbers measure the elasticityof demand for currency with respect tothe three variables in the special sensethat the quantity of money is held con-stant along the demand curve, A differ-ent elasticity would be obtained by usingsome more general restriction, such asconstant total wealth. To derive the elas-ticity under the latter restriction, weshould have to know how the demand formoney changed with variations in the in-dependent variables for a given totalwealth. The present elasticity conceptseems appropriate for most purposes,since the demand for currency is usuallydiscussed in the context of a given de-mand for money.

From the point of view of commercialbanks, however, these numbers are notentirely appropriate. Banks are inter-ested in changes in the currency ratio as apossible source of drain on their reservesand therefore want to know what thechange in the demand for currency wouldbe if they were to keep the quantity ofdeposits unchanged. A fall in the interestrate on deposits, for example, both raisesthe demand for currency and lowers thedemand for deposits, and the elasticityestimated here measures only the first ofthese two effects. To measure their com-bination, we add the absolute values ofthe effect on currency, d log C/d logand the effect on deposits, d log D/d log

of a change in any one variable. The

22

former quantity normally has a negativsign with respect to interest payments oreal income; so we reverse its sign tmake it positive. Adding the resuitintwo quantities, we get39

dlogC diog DdlogX1

dlog (C/M)dlogX1

(2

For the income tax variable, the signs Ithe preceding identity would be reversed. Thus the elasticity of demand focurrency (ignoring sign) with respect tany variable, the quantity of depositheld constant, can be found by raising bthe factor MiD the absolute value of thcorresponding elasticity with the quantity of money held constant. The rangof this factor over the period sincewas from 1.52 in 1878 to 1.08 in 1930With deposits unchanged, thewith respect to interest payments (ignoring sign), therefore, ranged from 0.23 t0.32, which is quite low, though considerably above zero. The elasticity with respect to income taxes had thesame rang

Another way to arrive at this result is to derivthe demand elasticity for currency with respect tany variable under the restriction that theof deposits remains unchanged. This can be donefollows:

if dD = 0,

dlogC dc/Cd log log X1,'

dC_(M'\ DdC_(M\(M—C)dC—CdLC DI MC '\. DI (C/M)

Hence

fM\ C

(d logC'\ = d log (C/M) (Mlog Xi)dD=o'' d log

With respect to the income tax variable, the signs oboth sides are positive, and with respect to the othetwo variables, they are negative.

in absolute value. For expected real in-come per capita, the corresponding elas-ticity (ignoring sign) ranged from 1.25 to1.76, well above unity.

IV. VALIDITY OF THE STATISTICAL RE-SULTS FOR THE EARLIER PERIOD

The foregoing analysis indicates thatthe main determinants of the currencyratio since 1919 are summarized by re-gression function (1). Let us see whetherthese findings are consistent with theevidence for the period before 1919.While an analysis of this early period isdifficult because of the lack of reliabledata on all the variables, the steady de-cline in the currency ratio greatly sim-plifies the problem: we can ignore theminor short-run movements in the ratioand deal only with its long-run rate ofdecline. A logarithmic function fitted byeye to the ratio for the period 1875—19 19has a slope between —2.6 and —2.7 percent per year (compounded continu-ously). The trend selected depends tosome extent on the interpretation givento the rise in the ratio from 1875 to 1878.Varying fractions of this rise were dis-regarded in calculating the range for theslope just given, for reasons to be dis-cussed in a moment.

The next step is to compute trends fornet interest paid on deposits and ex-pected real income per capita in this pe-riod, to see whether these trends, on thebasis of the regression coefficients for thelater period, will explain the trend in thecurrency ratio. (There was no personalincome tax during most of the early pe-riod.)

The difficulty of this task is lessenedby the relatively small changes in inter-est paid on deposits from the 1880'sthrough the 1920's. The evidence is mea-ger and not entirely reliable, but most ofit suggests that these rates stayed within

a rather narrow range, except for a sharpfall from the mid-1870's to the early1880's. This fall is associated with themajor decline in short-term commercialrates in 1874 that followed the financialpanic of 1873. If we can rely on the lim-ited data available for that period, thefall in rates on deposits was approxi-mately 30 per cent. Thereafter, there ap-pears to have been a slight further declinein these rates from about 1889 to 1900and a rise of similar size from 1900 to1916. The data suggest that the size ofthis fall and the subsequent rise is rough-ly 15—2Q per cent. There is no need totake account of losses on deposits in thisperiod, since, except during occasionalcrises, they were relatively small.

The decline in interest rates beginningin the mid-1870's seems to explain part ofthe rise in the currency ratio from 1875to 1878 (see Fig. 1). If we accept the esti-mate of 30 per cent for the size of thisdecline, an interest elasticity of —-i- im-plies a 6 per cent rise in the currencyratio, which is about half its actual risefrom 1875 to 1878. Part of the other halfmay be attributed to the aftereffects ofthe 1873 panic, which undoubtedly led toincreased losses on deposits and tem-porarily made currency much safer tohold.4° Consequently, I ignored half tothree-fourths of this rise in calculatingthe long-run trend of the ratio.

23

40 Suspensions of state (though not of national)banks rose moderately in 1873—76 and sharply in1877—78. The annual number of suspensions in thelatter two years was three times greater than in theyears immediately following (see Hisloricaltics [ser. N135—138]).

Passage of the Bland-Allison Silver-Coinage Actin February, 1878, might have created fears of in-flation and of the failure of resumption scheduled for1879. If it had, the public might have substitutedgold coin for other money, thus raising the currencyratio. Gold coin in the hands of the public rose byroughly $20 million from 1878 to 1879, but this is toolittle to help in explaining much of the rise in thecurrency ratio.

The apparent decline in interest ratesfrom 1889 to 1900 and the subsequentrise thereafter until 1916 appear to bequite small, and consequently the effectof these changes is difficult to judge. As-suming that the previous estimate oftheir size (15—20 per cent) is correct andapplying an elasticity of one-fifth, weget, at most, a rise and fall of 4 per cent(or about half of a percentage point) in thecurrency ratio. Such variations wouldpartly explain why the rate of decline inthe ratio in the fifteen years following1900 was more rapid than before. But theamplitude of these variations isand the evidence is too slim to warrantany firm conclusions.

Taking the period from 1875 to 1919 asa whole and neglecting deviations fromtrend, we can calculate whether thegrowth in expected real income per capitacan account for the average decline in theratio of 2.6 to 2.7 per cent per year, sinceinterest-rate changes apparently cannot.The expected income series rises, on theaverage, about 2.0 per cent per year(compounded continuously) during thisperiod. The two trends thus imply an in-come elasticity for the currency ratio be-tweeri —1.3 and — 1.4. Siuce the elastic-ity computed from the regression for thelater period was — 1.16 with a standarderror of 0.21, the two elasticities are wellwithin the range to be expected fromrandom variation in the estimates. Theeffect of growth in. income alone, there-fore, as judged by its size in the later pe-riod, was sufficient to have caused theobserved long-run decline in the currencyratio in the early period.4' This effect, asnoted earlier, probably incorporates anyeffects of a shift in the distribution ofincome.

This comparison of trends leaves openthe possibility that a small part of thelong-run decline in the ratio may have

been due to other factors. Randomtions may have made the regressionficient of the real-income variablelarge. In addition, as noted in the lassection, this variable may accountless of the decline in the currency rati(since World War II than was attributeto it and so have a lower true coefficienthan is indicated by the regression. If sochanges in real income cannot accounfor the entire decline in the currenc'ratio in the early period. TJrbanization

41 There is one piece of evidence on interest ratethat suggests somewhat different conclusions. I1870 the comptroller of the currency made a surveof the interest payments of all national banks. Hifindings impiy that the average rate of interest paion all deposits of these banks was 1 per cent peannum. The average rate paid in the 1920's by member banks was about 2.25 per cent. There is no mdication that national or member banks had much different rates in the preceding decade. On the basis othis evidence the rate rose from 1870 to World WaI by one and a quarter times.

There are several reasons for questioning threlevance of this rise for present purposes. Thcomptroller gave no details on his survey, so that iLaccuracy and even the exact definition of the datahe reported are unknown. Furthermore, it is con-ceivable that banks gave services in those days(made non-pecuniary interest payments) that areno longer offered (it is difficult to form an accuratepicture of banking practices so many years ago).Finally, a rate of 1 per cent for national banks is scfar out of line with the rates paid by mutual savingsbanks in New York State and Massachusetts atsame time, as judged by the differential in latezperiods, that one feels compelled to question its cornparability with the later data.

Let us nonetheless suppose that it is correct.residual effect of real income can be readily calcu-lated: With an elasticity of one-fifth, a rise in thinterest rate from 1 to 2.25 per cent would accountfor 25 per cent of the decline in the currency raticup to World War I. Since the downward slope inratio was 2.6—2.7 per cent per year and since 25 peicent of this may have been due to the intereSt-raterise, about a 2.0 per cent per year decline can battributed to real income. Real income rose at a rateof 2.0 per cent per year, so that the elasticity ofeffect on the ratio might have been only —1.0 in.stead of —1.3 to —1.4, as reported in the text.is much closer to the estimate of the elasticity foithe period 1919—55 arid gives stronger evidencethe entire decline in the ratio up to World War I carbe attributed to the growth in real income.

24

those effects were found to be minor butrobably not negligible, may thereforeccount for a small part of the decline inhe ratio. Possibly, too, a slight growth)f banking in excess of the long-run ef-ects of rising real income resulted in partrom a gradual adoption of checking fa-ilities until 1900 or later, for a variety ofeasons connected with the nation's corn-nercial growth and geographical expan-ion.42 This is the usual explanation;iven in historical discussions of banking.'Vhile it cannot be tested, it seems plau-ible enough. But it appears to be faress important than many have thought.

This conclusion is not invalidated byhe objection that the effects of general

factors were included in the effect.scribed to the rise in real income. Theize of the effect of a rise in real incomevas estimated from data for the later

period, by which time the importance ofaspects of growth had certainly di-

minished greatly. The income effect wasnevertheless large enough to account forsubstantially all the decline in the cur-rency ratio in the early period, when. theother factors contributing to the growthof banking were, from all indications, thestrongest.

V. STTh{MARY

The ratio of currency to the totalmoney supply has fluctuated consider-ably since 1875, and no one variable canaccount for all its movements. While

many variables could affect the currencyratio, only three seem to have played amajor role. In terms of the usual demandanalysis, a price and an income variable—the expected net rate of interest paidon deposits and expected real income percapita—have been major determinantsof the demand for currency relative todeposits. These two variables cannot ex-plain exceptional wartime increases inthe currency ratio, however, and variousother possible causes of these increaseswere considered. Only attempts to con-ceal income payments in order to evadehigh tax rates seem capable of creatingenough additional demand for currencyto account for the wartime increases.This finding, however, rests on indirectevidence and is tentative.

For the period 1919—55 a multiple re-gression of the currency ratio on the ex-pected net rate of interest on deposits,expected real income per capita, and in-come taxes as a percentage of personalincome yielded estimates of the elasticityof demand for currency with respect tothese three variables. These estimateswere found to be consistent with the datafor the period from 1875 to World War I.In this period the rise in expected real in-come per capita accounted for most or allof a steady decline in the currency ratio.

The analysis can be summarized byhazarding a prediction of the probablefuture course of the currency ratio. As-suming no change of consumer habits inthe use of currency, we may expect theratio to decline proportionately with thegrowth in real income per capita. Any in-crease in the interest rate paid on depos-its or any reduction in the personal in-come tax would hasten the decline. Thus.with no change in reserve requirements,commercial banks can look forward to along-run expansion of their deposit lia-bilities in excess of the growth in Federal

These perhaps include a growin.g familiaritywith banking (related partly, no doubt, to the in-crease in white-collar employment) and an increas-ing fraction of total payments made through themails between persons in separate parts of thecountry.

These factors pertain to the demand side. I knowof no factors on the supply side that would producea gradual growth of banking; presumably at anypoint in the nation's development, except perhapsfor short periods of adjustment, the public couldhave had as many banking facilities as it was willingto pay for.

25

Reserve credit and Treasury currency.This expansion will reflect a decline in thecurrency ratio like that which occurreduntil 1930 and was subsequently inter-rupted, first by a fall in net interest ratespaid on deposits during 'the depressionand then by an increase in the personal

income tax during World War IIWhether this decline in the ratio wilcontinue much further or whether thenis some level considerably above zerthat marks the minimum extent to whicideposits can be substituted for currency,the future course of the ratio will tell.

APPENDIX

DATA AND SOURCES

1. RATIO OF CURRENCY TO THETOTAL MONEY SUPPLY

The annual figures shown in Figure 1 arefor August, 1875—81, and June, 1882—1955.It would have been appropriate to use anannual average of monthly ratios for themultiple correlation reported in the text,since all the other variables refer to fullyears. However, such an average would havediffered little from these mid-year ratios.

The numerator of the ratio is total cur-rency outside banks and the Treasury. Thedenominator equals the numerator plus timeand demand deposits with commercial banksheld by the non-banking public. Traveler'schecks of banks, which are a form of cur-rency, are included with deposits in thebasic data and cannot be separated. Theyare known to be small in amount, however,and cannot affect the figures appreciably.Deposits with mutual savings banks and thePostal Savings System, which are sometimesincluded in the money supply, were ex-

For some evidence suggesting that they are notclose substitutes for commercial bank deposits anda detailed explanation of the money figures, seeFriedman and Schwartz, op. cit.

cluded.43 In any event, the major move-ments in the currency ratio are not sig-nificantly altered by including them.

2. EXPECTED NET RATE OF RETURNON DEPOSITS

For 1919—55, this series is shown in col-umn 5 of Table A and equals the rate of re-turn on deposits in column 1 minus the ex-pected rate of loss on deposits in column 3.Earlier figures are presented in Tables B andC.

The rate of return on deposits is based onthe rates of interest paid (less any chargesreceived) by member or insured commercialbanks on time and demand deposits. Since1927, separate rates for time and demanddeposits can be derived. For each year aweighted average of these rates was taken,using weights based on the distribution of thetwo kinds of deposits in all commercial bankson June 30. For 1919—26 no breakdown of rateson time and demand deposits is available,and an average rate paid by member bankson all deposits was used. The member-bank

26

TABLE A

DETERMINANTS OF THE CURRENCY RATIO, 1919-55

(1) (5) (6) (7).919 2.06 2.04 561 2.23920 2.10 2.06 564 1.87921 2.23 2.13 533 1.60

1922 2.26 2.17 557 1.751.923 2.24 2.13 584 1.201924 2.25 2.11 602 1.231925 2.22 2.08 618 1.231926 2.23 2.08 642 1.261927 2.24 2.09 657 1.201928 2.31 2.18' 668 1.281929 2.30 2.16 688 1.611930 2.26 2.01 672 1.561931 .92 1.46 643 0.981932 .73 1.27 388 0.77933 0.39 545 0.94934 0.95 0.95 331 1.01935 0.68 0.68 548 1.16936 0.51 0.51 583 1.32937 0.47 0.47 624 2.06

1938 0.44 0.44 632 2.121939 0.36 0.36 653 .471940 0.28 ' 0.28 687 .611941 0.21 .... .... 0.21 7371942 0.16 .... .... .... 0.16 774 3.521943 0.09 .... .... .... 0,09 803 10.71944 0.10 .... .... .... 0. 0 828 10.61945 0.13 .... .... .... 0. 3 852 11.81946 0.14 .... .... .... 0.14 873 10.31947 0.14 .... .... .... 0.14 875 11.01948 0.13 .... .... .... 0.13 880 9.771949 0.12 .... .... .... 0.12 866 8.931950 0.12 .... .... .... 0.12 893 8.781931 0.13 .... .... ... . 0.13 914 11.01952 0.16 .... .... .... 0.16 927 12.31953 0.19 .... .... .... 0.19 942 12.21954 0.21 .... .... .... 0.21 945 11.21935 0.22 .... .... .... 0.22 970 11.3

Negligible after 1933. In computing cols. 3 and 4, the following percentage rates of loss were used f or earlier periods:1915—18,0.02; 1901—14, 0.05.

t Assumed to be zero after 1933.

rate is slightly below the rate derived for allcommercial banks, primarily because timedeposits, which pay higher rates than de-mand deposits, are more important relativeto demand deposits in non-member than inmember banks. The figures for 1919—26 weretherefore raised by 0.19 percentage points,which is the average difference between thetwo series for 192 7—30.

The various rates of interest used werefound by dividing the appropriate average

27

quantity of deposits into the amount of in-terest payments (less service charges) as re-ported in aggregate earnings statements.For 1942—55 earnings statements are avail-able for all insured commercial banks.44 For1934—41 these banks did not report servicecharges on demand deposits as a separateitem but did show interest paid on time de-posits. For the other rates, statements of all

"Annual Report of the Federal Deposit InsuranceCorporation.

INTERESTYEAR ON DEPOSITS

LOSSES ON DEPosrrs*

EXPECTED REALANNUAL

PEREXPECTED NET CAPITA

RETURN (DOLLARS O.F(Col. [11—Col. [3]) 1929 VALuE)

PER CENTAGEoi PERSONAL

TAXEDExponential

ActualPer Year as a Percentage

(2) (3)0.02 0.020.06 .040.18 .080.11 .090.16 .110.19 .140.14 .140.18 .150.13 .150.09 .130.15 .140.48 .250.88 .460.46 .461.62 0.84

LinearAverage t

of Deposits(4)

0.02.03.08.10.13.16.16.16.1613

.13

.25

.47

.510.91

member banks were used45 to derive rates ondemand deposits, 1927—41; on time deposits,1927—33; and, as already noted, on all de-posits combined, 1919—26. Member-bankrates for demand and time deposits before1942 were adjusted to the level of the cor-responding later rates covering all insuredcommercial banks, using the difference be-tween overlapping segments. This adjust-ment was similar to the adjustment for1919—26 described in the preceding para-graph. The adjustment was small, indicatingthat the average rates for member bankswere not altered much by including non-member insured banks. The adjustment wasnonetheless necessary to prevent a breakwhere the two segments of the series werejoined.

The denominator used for the rates was aweighted average of June and adjacent De-cember figures for deposits; it was selectedto correspond to the quantity on which in-terest was paid or service charges were im-posed. For time deposits, this quantity wasthe total amount outstanding. For demanddeposits, this quantity was individual de-mand deposits since mid-1933 (when inter-est on United States government depositswas discontinued), individual plus UnitedStates government demand deposits for1927 to mid-1933, and all demand depositsfor 1919—26. Interest paid on interbank de-mand deposits was reported separately after1926 and was excluded from the numeratorof the ratio for all later years. Cashier's andofficer's checks were excluded from demanddeposits in these computations, on the pre-sumption that fees from these services arecombined with other items in the earningsstatement. There are no figures for estimat-ing the average fee received per dollar ofsuch checks outstanding, and this item was

Banking and Momelary Statistics, pp. 262—63;and Federal Reserve Bulletin. Before 1933 these state-ments do not give charges on demand accounts sepa-rately, and gross payments on these accounts there-fore had to be used, but it can be presumed that suchcharges were relatively small. In any event, anyservice charges before 1933 could be imposed simplyby paying a lower rate of interest and presumablywere.

neglected altogether. It is not clear whethor not most of these checks act as a substtute for currency in much the same waydemand deposits do and whether, for oipurposes, fees for them should be counteda charge on deposits. Since the quantitythese checks is relatively small, feesthem, however treated, would have neligible effects.

The expected rate of loss on deposits isweighted average of past rates of loss. Thtwo alternative weighted averages shown iTable A give substantially the same resultThe one in column 3 was used to derive thexpected net rate of return shown in colum5. The series in column 3 is based on exponential weights. As explained in the texthese are the same weights as those useelsewhere to derive expected income froractual income. The alternative series in column 4 is based on the arbitrarythat expected losses are determined by actual average losses over the preceding flyyears; the weights of the years decline byequal amount each year going backward 1:time. In comparison, the exponential pattern puts only 87 per cent of its weight oxthe first five years. Both weightedare dated as of the end of each year but weriassumed to apply to the entire year. It wafurther assumed that expected losses immediately fell to zero after 1933 because deposit insurance was instituted on January 11934.

28

These estimates of expected losses are nothe best that can possibly be derived, whatever the criterion proposed. However, iseems appropriate to take account of pasevents in these estimates, and th.emethods of doing so, which give almost identical results, are simple and reasonableThus both methods should give a mudcloser approximation to expected losses thaithe use of annual losses themselves withouany weighting of past values.

The data on actual losses borne by cornmercial bank depositors were based oFDIC estimates.46 The FDIC also publisheaverage deposits for the appropriate periodE

46Annuai Report (1940), pp. 66 and 69.

rom which losses per dollar of deposits cane computed. These estimates of losses ex-lude all amounts eventually recovered byepositors. Actual losses after 1933 were neg-igible, owing partly to the institution ofLeposit insurance.

The published estimates of losses coveryears since 1920 and certain over-

ipping segments of the preceding years.)nly an average rate is given for the periods

TABLE BRATE OF INTEREST PAID BY COM-

MERCIAL BANKS FOR VARI-OUS YEARS, 1889_1912*

(Per Cent per Year)

1915—19 and 1901—20. In the weighted aver-age of loss rates, the average rate for 1915—19 was assumed to apply to each of theyears it covers. A rate was estimated for1920 by interpolating between rates for ad-jacent years on the basis of the number ofbank failures.47 The rate so derived for 1920and the published rate for 1915—19 wereused to compute a figure for total losses for1915—20. This in turn was deducted from thetotal given for 1901—20 to derive an averagerate for 1901—14 that was used for each yearof the period. The derived series of rates isshown in column 2 of Table A. Of course, the

Banking and Monetary Statistics, p. 283.

rates applied to individual years before 1920are only approximate, but they are quitesatisfactory for deriving the weighted aver-ages because the weighting patterns attachless importance to rates more distant intime and thereby reduce considerably theeffects of any errors in the earlier rates.

Tables B and C list the comparable ratesreadily available on interest payments be-fore 1919.48 The rates in Table B, whichcover commercial banks, were taken fromthe Annual Report of the Comptroller of theCurrency. The rates before 1900 come from asurvey made by the comptroller in 1899 forselected years back to All rates inTable B are for deposits not payable on de-mand, so far as their classification can bedetermined. However, the type of depositscovered by the data for 1889—99 and for1.9 12 is not specified, and they may be anaverage that includes some or all demanddeposits as well.

In the 1870 Annual Report (p. xii) thecomptroller gives figures on interest paid byall national banks for the year. From this anaverage rate of 1 per cent paid on all depositswith these banks can be derived, as reportedin note 41. This is much lower than the ratesin Table C for later years, presumably be-cause it covers demand as well as other de-posits, while those in the table apparentlycover time and savings deposits only. Be-cause of this and other possible incompara-bilities, the 1870 rate was excluded from thetable.

With this one exception, there are dataonly for mutual savings banks for the years

Available figures covering state commercialbanks in Kansas beginning with 1902 are not shown(see "Trends in Rates of Bank Earnings and Ex-penses," Federal Reserve Bulletin [1938], pp. 102—26,Appendix Table XII). These data point to a dou-bling in the interest rate on deposits from 1902 to1914. This rise is much larger than that indicated bythe rates for 1899 and 1912 in Table B and wouldlargely explain a rate of decline in the currency ratioduring that period more rapid than that indicated bythe logarithmic trend line fitted to the whole periodsince 1875. It would be hazardous to draw any con-clusions from these data, however, because of theirlimited coverage.

Annual Report (1899), I, xxvii.

National Non-nationalYear Banks Banks

1889 3.6 4.01894 3.5 3.91899 2.8 3.41910 3.7t1911 § 3.21j1912 3.0 . .

* Unless otherwise indicated, rates are for"other" deposits (presumably only time de-posits, though possibly also some orall demand deposits) as opposed to 'savings"deposits. The distinction refers to the period ofnotice required for withdrawals. J-Iowever,there is little difference between rates on time

savings deposits in years when both are re-ported separately by commercial banks.

t For time deposits only. The rate reportedfor demand deposits is 2.4 per cent.

For time deposits of state commercialbanks only. The rate reported for demand de-posits is 2.6 per cent. For private banks, thereported rates are 3.9 per cent for time depositsand 2.9 per cent for demand deposits.

§ Not available.II For state commercial banks only. The re-

ported rate for private banks is 3.8 per cent.

29

before 1889. These are shown in Table C be-ginning with 1870 and extended, in order togive comparable figures for a long period,through 1916. Several states have reports ofmutual savings banks covering years before1889, but only for New York and Massachu-setts are the relevant data aggregated.5° Therates in Table C are based on these data.The rates shown for the years 1889 and1894—1916 cover all reporting mutual sav-ings banks in the United States (includingreporting stock savings banks before 1909)and are from the comptroller's Annual Re-porl.

The avai1able data on rates paid by com-mercial banks indicate a decline of one-sixthfrom 1889 to 1899; after that they areunclear. While the rates appear to be high in1910, they are down to 1899 levels in 1911—12; such short-term movements obscure thetrend of the rates from 1899 to 1912. Theseries for mutual savings banks indicate asharp decline in interest rates paid, startingabout 1875 and ending about 1880, and aslight further decline from 1889 to 1900 thatwas retraced by 1916. The decline from 1875to 1880 was about 30 per cent.

The behavior of short-term commercialinterest rates tends to confirm the move-ments in rates paid by mutual savingsbanks. After 1874 commercial rates fluctu-ated widely but do not exhibit the well-known long-run movements shown by bondyields. The trend of commercial rates isroughly horizontal from 1876 to 1891, slight-ly downward from 1891 to 1899, upwardfrom 1899 to 1907, and downward againfrom 1907 to These movements aresimilar to those in payments by mutual sav-ings banks, except for the last segment, and

See New York State, Report of the Superin-lendent of the Banking Department Relative to SavingsBanks and Trust Companies (1891), pp. 10 and 11;and Massachusetts, Annual Report of the Board oJCommissioners of Savings Banks (1876), and subse-quent volumes.

See Frederick R. Macaulay, Some TheoreticalProblems Suggested by the Movements of Interest Rates,Bond Yields and Stock Prices in the United Statessince 1865 (National Bureau of Economic Research,1938), Chart 20, p. 217.

30

even this could perhaps be interpretedhaving a horizontal trend with large cyclicdips in 1908 and 1915.

The unanimity of the evidence on shorterm rates for the early period suggests

TABLE CRATE OF INTEREST PAID BY MUTUAL SAVINGS

BANKS, 1870—89 AND 1894—1916

(Per Cent per Year)New York Massa- United

Year State* chusettsf Year States1870. ... 5.5 . . . § 1889... 4.01871.... 5.4 . .

1872.... 5.7 . . . § 1894... 3.71873.... 5.5 . . 1895... 4.01874. ... 5.4 . . . § 1896... 4.01875.... 5.2 6.2 1897... 3.71876.... 4.7 5.7 i.898... 4.01877.... 4.3 5.0 1899... 3.41878.... 4.4 4.1 1900... 3.51879.... 4.1 3.7 1901... 3.51880.... 3.7 3.9 1902,.. 3.51881.... 3.5 4.0 1903... 3.51882.... 3.5 4.0 1904... 3.51883.... 3.5 4.1 1905... 3.61884.... 3.4 4.2 1906... 3.51885.... 3.4 4.1 1907... 3.61886.... 3.4 4.1 1908... 3.61887.... 3.4 4.1 1909... 3.81888.... 3.4 4.1 1910... 3.91889.... 3.4 4.1 1911... 4.0

1912... 3.91913... 3.91914... 3.91915... 3.81916... 4.0

* Interest paid during the calendar year divided by anaverage of deposits at the beginning and the end of the year.This sertes can be extended beyond 1889 and back to 1860. Be-tween 1860 and 1869 the rates varied from 4.4 per Cent in 1861to 5.7 per cent in 1869.

t Reported average dividend on deposits for year endingOctober 31. This series can be extended beyond 1889. The onlyrate reported for years before 1875 is one of 4.8 per cent for 1865(see Report of/he Superinfrndent, [18761, p. 371). For a Summaryof data for 1892 to 1906 see the report for 1906, I, viii.

Rates through 1908 are those of reporting mutual andstock savings banks and thereafter of mutual savings bank,only.

§ Not available.fl Indicated in source to be slightly too high.

interest rates on commercial bank depositsfollowed the same general movements,though certainly with much less amplitude.A comparison of interest rates on deposits inmutual savings banks and in commercia]banks since 1919 indicates that, althoughshort-run variations in the two rates ar€likely to differ, the large variations reflectinglong-run movements appear toThis agreement is reasonable, since interesi

ayments depend on the return from earn-ig assets, all of which in the long run haveields that move roughly together. It seems

therefore, to assume that the declineom .1875 to 1880 and the following smallecline and rise in interest paid by mutuala.vings banks correspond to similar move-ients in interest paid by commercial banks.

3. EXPECTED REAL INCOME PER CAPITA

This series, shown in column 6 of Table Aor 1919—55, is an exponentially weightedverage of annual figures for real net na-ional product in 1929 prices,52 divided byhe mid-year population residing in con-mental United States. The movements in

national product do not differ appre-iably from those in national income exceptluring wartime, and for these years the)riginal series was replaced by an extrapola-ion of its prewar trend. The series for netiational product, therefore, can be used to•epresent national income with sufficient ac-:uracy for present purposes. No other esti-nate of expected real income of this kind

the entire period 1919—55 wastvailable when the regression reported in the:ext was computed, and it seemed unneces-;ary to compute one specially for this study.

The weighting pattern used was the samets that developed elsewhere, as explained inthe text, except that no adjustment wasnade for an expected upward trend. As a

the series is slightly lower than itwould be if adjusted for expected trend.Elowever, this downward bias has no effect)fl relative changes in the series and, there-Fore, on the regression coefficients.

References in the text to the trend of ex-Dected real income per capita before 1919refer to the trend of the series on expectedreal income described above minus thetrend of population in continental Unitedstates as reported in decennial censuses.

4. PERCENTAGE OP PERSONAL INCOME TAXED

This series, shown in column 7 of Table AFor 1919—55, is the ratio of personal income

b2 Described and used by Friedman and Schwartz,

taxes to personal income for each calendaryear.

The numerator is the sum of federal,state, and local income taxes. For 1929—55,Department of Commerce figures were used.These figures include the amount of refunds,which, although small, should, but cannot,be excluded. For 1925—28, collections of fed-eral income taxes53 for calendar years wereused. Before 1925 these collections were re-ported together with those from corporateincome taxes and could not be separated.Hence federal personal income tax liabili-ties54 were used, instead, for 1919—24. Forthe years after 1924, actual collections gen-erally exceeded these liabilities. For 1919—24, therefore, the liabilities were increasedby 18 per cent to give a corrected estimateof collections; this percentage is the relativeamount by which collections exceeded lia-bilities in 1925. Earlier figures used for thestate and local income tax were collectionsas compiled for 1925—31 by Roy G. Blakey55and as estimated for 1919—24 by C. HarryKahn.56

Department of Commerce estimates oftotal personal income were used in the de-nominator of the ratio. For 1929—55 they areofficial estimates published in the NationalIncome Supplement to the Survey of CurrentBusiness; before that, they are unofficial es-timates.57 These earlier estimates differ con-ceptually from the later ones and for thatreason are too low; they were raised by therelative amount of their understatement in1929 (3.8 per cent).

From the same sources the ratio can beextended to earlier years. (State and localincome taxes are unavailable before 1919 butare small and can be neglected.) For 1919,the ratio was 2.26 per cent; for 1917, 1.80 per

31

Annual Report of the Secretary of the Treasury.Bureau of Internal Revenue, StatLstics of in-

come.55 his The State Income Tax (Minneapolis:

University of Minnesota Press, 1932), p. 65.561n connection with a study of the National Bu-

reau of Economic Research, as yet unpublished.Published by the National Industrial Confer-

ence Board in its Economic Almanac (1956), p. 443.

cent; and for 1916 back to 1913, the ratiowas well below one-fourth of 1 per cent. Theincome tax amendment was passed in 1913,providing this source of federal revenue forthe first time since the Civil War period.

5. VOLUME OF TRAVEL PER CAPITA

This series, shown in Table D for 1921—51, shows miles of intercity travel divided bythe mid-year population residing in con-tinental United States. Miles of intercitytravel were compiled from several sources.While the figures are subject to considerableerror, they probably give an accurate pic-ture of the year-to-year direction of changein miles traveled. In the period covered, theseries increases in every year except 1932—33, 1938, 1942—43, and 1947.

Beginning with 1937, estimates of thetotal volume of intercity passenger trafficfrom the Animal Report of the InterstateCommerce Commission were used with slightmodification. In 1952 their coverage wassubstantially broadened. These recent fig-ures are not shown, since they are not com-parable with the earlier data. For the yearsshown in Table D, the figures are reasonablycomparable and cover all forms of intercitytravel: electric and steam railways, inlandwaterways, airways, buses, and automobiles.All the data except those for automobiletravel were reported by the companies oper-ating the facilities and cover their respectivesectors with a fair degree of accuracy. "In-tercity traffic" includes some commutation,most of which falls outside the meaning oftravel as used in this study. The overstate-ment on this account may be appreciable,but it seems unlikely that the series grosslymisrepresents the time pattern of travel.Some of this overstatement was eliminatedby substituting for the series used by theICC another series giving non-commutationtraffic on Class I steam railways.58 This sub-stitution leaves the total series understatedby the amount of intercity non-commuta-tion traffic on electric railways, which isprobably small, and overstated by commu-

58 From annual volumes of Interstate CommerceCommission, Statistics of Railways.

32

tation traffic of intercity bus lines and autlmobiles, the second of which is conceivabiquite large. In general, the ICC figures useto estimate travel, except for automobileare fairly representative of major movments. These figures were extended back t1921 with little loss in coverage or acciracy.59

However, the accuracy of these figurehas little effect on that of the total travel sries: automobile travel has been more tha80 per cent of the total since 1928 and wa

TABLE D

ESTIMATED VOLUME OF INTERCITY TRAVELPER CAPITA, 1921-51

(Miles per Year)

Year Volume Year Volum19211922

670 1

730 1

937938

1,901,86i

19231924

860 1

980 1

939940

1,9612,081

1925 1,080 1 941 2,3011926 1,220 1 942 2,0411927 1,280 1 943 1,9411928 1,340 1 944 2,0511929193019311932

1,490 19451,520 19461,560 19471,430 1948

2,2512,4712,4012,421

19331934

1,420 19491,540 1950

2,54(2,611

19351936

1,620 19511,760

2,891

more than 50 per cent even in 1921. The figures on automobile travel are subject to substantial error, especially for the earlier yearsYet they are probably more reliable thaione might expect them to be, knowing nothing of their derivation. After 1935 they anbased on broad sample surveys conducteby the Public Roads Administration.for earlier years, also compiled by thi

Sources for the basic data are as follows: Noncommutation travel on Class II railways,cited, is available since 1922. For 1921, anwas made based on total railway travel (HisloricaStatistics [ser. K-41]). Travel on inland waterways before 1937 was negligible and was neglected. For aitravel, domestic miles flown by revenue passenger(Historical Statistics [ser. K-254]) were used fo1930—36 and were assumed to be zero before 1930For intercity bus travel, estimates were made fronfigures published in the magazine Bus Transta.tion.

ncy, are published in Historical Statisticsbout any explanation of their derivation.wever, they closely follow and presum-y are based on the consumption of motor1. The figures on fuel consumption are de-ed from fuel-tax revenues. Fuel consump-n multiplied by miles driven per gallones an estimate of total vehicle-miles. For-iately for our present purposes, thoughfortunately for automobile users, thisiltiplier is known not to have changedich over the years. Thus using the sameimate of miles per gallon throughout thenod introduces little error.Difficulties arise, however, when totalssenger vehicle-miles are divided into ur-n and rural travel and when the resultingtire for rural travel is enlarged by a factor)resenting the average number of pas-igers per vehicle to give total rural pas-

senger-miles. "Rural" here means "on ruralroads" and undoubtedly refers to muchmore than non-commutation travel, butthere is no way to improve the derivation ofthese figures, and rural travel was used asthe closest available approximation. Theconversion of total vehicle miles into ruralpassenger-miles is based on various surveys,some of which were first conducted onlyafter 1941. In extending the series, trendsindicated by these surveys were extrapo-lated back to 1921. This procedure is subjectto considerable error, but these trends prob-ably maintained a fair degree of year-to-yearstability and could not, under any ordinarycircumstances, have varied very much fromthe estimated levels.80

80 The basic data on automobile travel were takenfrom Statistics (ser. K-236 and K-236a)and Public Roads Administration, Highway StaSis-it cs—Summary to 1945 (1947), p. 34.

33