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The Role of the Federal Reserve as Re3.ated to Farm Credit Needs in the Current Economic Situation Remarks by Mr. Chas. N. Shepardson, Member, Board of Governors, Federal Reserve System, before the National Farm Credit Directors' Conference, Hotel Statler, St. Louis, Missouri, on September 26, 1956. fha p ^•^rren^Economlc Situation Let us begin by taking a brief look at the current situation.. The e concom y as a whole is in the midst of a strong expansive movement. ori£ ^ cc°nsumer attitudes show confidence in the future. Business With demands pushing available supplies in important lines and with wage rates rising, both ^Ustr-i T and consumer prices have been advancing to new highs. Prices of deducts have tended to firm this year, following earlier sharp declines, Au £ust they were above the year-earlier level. Demands for credit are t*0ri " both at banks and in the long-term capital markets and interest rates } s een advancing. Abroad, too, vigorous demands are continuing to press available resources in most countries. Most broad measures of economic activity in this country are at or highs. The Board's index of industrial production in August had th • the June level and a rise seems likely in September. Nonfarm employ- ment i n , v Ugust returned to the June record level and unemployment, at 2.2 mil- ' a s about the same as a year earlier. In the third quarter, GNP may reach rate of &414. billion, up $6 billion from the preceding quarter despite st e l strike, and up $17 billion or 4 per cent from a year earlier, probably of which reflected higher prices. Another substantial increase in output appears to be in the making for the fourth quarter with the - 2total likely to approach an annual rate of U 2 G billion, partly due to antici- Fated large scale production of 1957 automobiles this fall. The most striking single expansive development this year has been th ne V hurst of business spending for plant and equipment. The most recent Com- ^ee-S.E.C. Survey of nonfarm business intentions to spend on fixed capital indi(J ates an annual rate of spending of $38 billion in the fourth quarter, up 7 • 7 billion from the preceding quarter. For the year 1956 total fixed capital °utlays are estimated at $35.5 billion, about $7 billion or one-fourth larger thaa the previous high in 1955. The strength and resiliency of the economy are indicated by the fact that total product and personal incomes have continued to increase despite 8hca, P declines in sales of new automobiles and in residential construction a ° t i v i t r from late 1955 to the spring of 1956. To a significant extent, inrlus- resources that were devoted to these purposes in 1955 have been channeled Producing plant and equipment this year. Consumers have continued the active use of short-term credit at levels has slightly below last year's peak. . While total outstanding instalment credit «ot risen as rapidly as in 1955, this is largely due to the high and rising e although the volume of new housing units started in 1956 may be some I5 per 51(1 of repayments on earlier extensions of instalment credit. cent below the 1.3 million of 1955, the value of total construction tiv* — including business and public, as well as residfcnt3.al — has been re volume. Due to this strong demand and other influences, building °stacord ar e up significantly. Q Turning from private to public expenditures. State and local outlays instruction and other purposes have risen steadily and are scheduled to - 3ri!;e further. Federal purchases of goods and services, after too years of rel- little change, are also likely to rise in the year ahead. Periods of rapid economic growth like the present are certainly from the standpoint of the high level of employment and consumption ^at they imply, but they also give rise to difficult economic problems. tae As labor force and productive facilities approach full utilization, further Mansion in purchasing power and spending cannot readily be matched by addioutput of goods and services. a It leads instead to higher prices. This Elation. Experience teaches us that an unrestrained inflationary boom beri erally involves unsound credit expansion, distorted price relationships, nci e conomic dislocation, and usually leads to collapse. Our best safeguard this is to restrain inflationary pressures and prevent them from get°ut of hand. ^^L.£.ederal Reserve System The Congress has delegated to the Federal Reserve System the function re gUlating the flow of credit and money. Sound credit and monetary policy restrain inflationary forces during an upswing. It can also bslp Prom &ofLe increased spending and economic recovery during a recession. Along Maintenance of an appropriate relationship between Federal income and ei PencJSi i-t°ures and proper management of our large public debt, monetary and credit Pol institutes our principal tool for promoting a sustainable growth in ec °nomy together with a rising level of prosperity. Federal Reserve policy seeks these results by influencing the avail- ^ y in th ie and cost bank reserve funds. As you doubtless know, member banks federal Reserve System are required to keep a prescribed percentage of - A - their outsta?ding deposits as a balance in their accounts with the Reserve B ai<k in thoir strict. The volume of reserve funds available to the banking s 3totem and the cost of obtaining those funds have an important influence on tne supply of bank credit available to the public and on the cost, or rate interest, which borrowers have to pay for it. Indirectly, therefore, the authority of the Federal Reserve System to regulate bank reserve positions en8 -blQs the System to exert considerable influence over the total flow of money anci credit through the markets of the economy and over the level of spending those markets. The Federal Reserve System has three principal instruments for in- fencing bank reserve positions. Our principal instrument is the purchase sale of securities, mainly Treasury obligations, in the open market, com0i % referred to as "open market operations." A purchase of securities by +L System Open Market Account adds to bank reserve funds and bank deposits, tends to encourage credit and monetary expansion. A sale of securities, ° n ^ e other hand, reduces reserves and deposits and tends to restrain credit monetary expansion. Such purchases and sales provide our most flexible and frequently Uc,ed instrument of monetary and credit policy. They are adaptable both for ^king minor adjustments and for effecting major shifts in bank reserve positio and they are easily and promptly reversible if the situation requires. In ^ i t i o n to their use for regulating the volume of reserves as needed in w the general economic situation, open market operations serve as the in re % which the System ordinarily provides for the seasonal rise and fall serve needs for credit. They are also used from time to time throughout - 5the year to offset what otherwise might be the disturbing effects of shorter- fUn fluctuations in the supply of reserves. A second instrument for influencing member bank reserve positions is th 8 discount mechanism. The Federal Reserve Act makes provision for member to obtain additional reserves by borrowing from the Reserve Banks either discounting their customers' notes or by obtaining secured advances. ln The W e s t rate charged for this service is knov/n as the discount rate. Borrowing at the Reserve Banks is regarded as a privilege rather than a ri ght of Federal Reserve membership. a It is intended to be used primarily on temporary basis to tide banks over periods of unusual drains of funds. tens ive and continuous borrowing is discouraged. S su Ex- In a period when demand out- pply and banks find it necessary to meet part of their need for funds °ugh borrowing even in the face of a rising discount rate, they tend to ^Pt more restrictive loan and investment policies. PSj?:lo(3s S of lagging demand, idle facilities or rising unemployment, when the yst ein Ve On the other hand, in feels that credit expansion should be encouraged, it provides additional s to the banking system and lowers the discount rate, thus enabling banks °ff their borrowing and expand their loans. The least frequently used instrument for affecting bank reserve pOSi- t^ng .l s the Board's authority to change member banks' reserve requirements, i* Wcentage of outstanding deposits which member banks must keep in the form Of Glance at the Reserve Bank. a An increase in these requirements tends to Restrictive effect on monetary and credit expansion in all banks, while a auction in requirements tends to have a stimulating effect. ves H Since these form the basis for a multiple expansion of bank credit in all member * changes in reserve requirements provide a powerful instrument, suitable - 6Primarily for longer run adjustments in the need for reserves or where an init i a t e sharp impact on monetary and credit conditions is essential. Hp -^.nt_Federal Reserve Policy Since early 1955, Wlth with output in many lines pressing against capacity, upward price movements widely evident, and with demands for credit strong, the p ederal Reserve System has been following a policy of limiting credit expansion °rder to prevent e::ceppivo borrowing from undermining the stability of the ec °&omy Sea and the value o f t h e doiiar# Reserves have been adjusted to meet the sonal needs of agriculture and industry, although not in amounts to meet th e desires of all potential borrowers. In these circumstances, banks have it necessary to meet a part of their reserve needs through increased bo Moving at the Reserve Banks at rates that have risen gradually from 1-1/2 cent in April 1955 to 3 per cent at the present time. These actions have placed banks under increasing reserve pressure have induced them to adopt more prudent and selective loan and investment ^^eies. b 3 As a result, the rate of growth in bank credit and the money supply ee n relatively small and interest rates have risen sharply, reflecting limited availability of funds relative to the demand for them. Here I would emphasize that the policy of restraint which has been folT Vre d has been one of retarding the rate of growth in the money supply to 0rri1 to the rate of growth in production, rather than one of reducing the supply. T ^Ugations for Agriculture As you well know, during most of the past several years, price and lnG ome trends in agriculture have been counter to those in most of the noneconomy. s Fortunately for agriculture, these divergent trends have shifted °Biewhat in 1956. Farm prices and incomes have improved materially from the ° w level at the beginning of the year. It is not uncommon, however, to have such divergent trends in various 5e &nents of an economy as vast and complex as ours and policy makers in the ^stem, as elsewhere, must appraise all of these divergent trends in arriving a conclusion as to the general direction of the economy. liggj During a period the present, this problem is especially acute since we all recognize the of an improvement in net farm income at the same time that we see the need Restraint on the inflationary pressures in the rest of the economy. In appraising economic developments in agriculture, as in other areas, it i 3 important to try to determine their cause. A decline in price of cattle, Sample, could mean a real change in consumer attitudes toward spending ^Sht indicate, or be a forewarning of, a general decline in consumer ex^ure. Or it might mean a readjustment, within a strong consumer demand to an increase in market supplies, or to a lessened demand for aniexport, or expansion. Monetary policy appropriate for the one situate* mi ght not be proper for the other. The declines in farm prices and incomes in recent years, for the most ' appear to have been adjustments to the progressive increases in farm pro^tin 011 and to the declines in foreign takings from their postwar peaks, rather indication of weakening in consumer demand. This view is clearly - 8su PPorted by prospects for some curtailment in production, increases in crop ®*ports and the resulting improvement in the farm price situation since the ginning of the year. I t i s alj:o supported by the recent strengthening of d *®and pressures generally and by the inflationary tendencies in the industrial Se ctor. Nonetheless, the fact that it seemed desirable to retard the growth °f the money supply and to let interest rates rise during a period when farm Pn °es and incomes uere lagging meant that the effects of this policy on an lri(i Ustry already in some difficulties needed to be considered with great care. speared, however, that in taking steps to curb inflation we were also actlng ^ the best interests of agriculture. Pluse In the face of burdensome farm sur- s, inflationary developments could do little to raise farm product prices. ^t f V tlle -^ same time, with the farmers' increasing need for off-farm pi^oduckien* Su PPlies and services, price increases for such items could prove to be a serUs further burden to agriculture. As you doubtless know, credit costs to farmers average something less an five per cent of total farm costs even with the rise in farm debt last It therefore seemed preferable to accept some reduced availability of * °redit and some increase in credit costs if we could thereby restrain infla tionary pressures that could only result in further increases in the other Mnetv P'-live per cent of farm costs. As a matter of fact, we have found little evidence of reduced avail^ilixz+ y of f a r m credit for credit-worthy farmers. - 9Th p Reserve as a Source of Farm Credit This leads me to a discussion of the role of the Federal Reserve fystem as a direct source of farm credit. As I have indicated, the principal function of the Federal Reserve Astern i s to regulate the flow of credit and money in the interest growing national economy. of a sound You will readily appreciate the fact that the System could not properly favor any particular segment of the economy. p The Reserve Act is not, of course, a farm credit act. At the same time, Congress has recognized in the Federal Reserve Act th e v ital importance of adequate agricultural credits. ln Since their inception ^13, the Federal Reserve Banks have been authorized, at least indirectly, to Provide a certain measure of credit assistance to agriculture, and since lOOo J the Reserve Banks have had authority to extend credit directly to certain of ne farm credit agencies of Government. Basically, the concept of the original Federal Reserve Act was that Reserve Banks should provide credit to their member banks only for temporary ocls at and only on the basis of self-liquidating commercial paper having a M t y at the time of discount of not more than 90 days. It was recognized, that agricultural paper was just as sound and as self-liquidating as dlnai 7 commercial paper but that the marketing of farm crops and livestock Iriall y requires a longer period of financing than commercial transactions. this reason, the original Act allowed a maximum maturity of six months for C u l t u r a l paper, instead of the basic 90-day limitation. Since 1913, there have been various changes and additions in the law ectin g the extent to which the credit facilities of the Federal Reserve - 10 Astern have been made available directly or indirectly in the field of agriCu lture. Let me briefly summarize the present situation. In the first place, paper representing loans made by member banks to ^mers, including livestock paper, can be discounted by the member banks with tVi 0e Reserve Banks if the paper has a maturity of not more than 9 months — tl)e originai ma turity but the maturity at the time of discount. not Of course, the ^°ceeds of the paper must be for true agricultural production or marketing PUr Poses; the Reserve Banks under the law cannot discount such paper if the Pr c ° eeds are to be used for fixed investments, such as land, buildings and Winery. Secondly, the Reserve Banks can make advances to their member banks, only on ordinary agricultural paper, but also on the security of obligati0v. the Federal intermediate credit banks. Bg^u v. Thirdly, the Reserve Banks have authority to purchase Federal Land b °nds and intermediate credit bank debentures, but only short-term obliga- ° n s ^ith maturities of not more than 6 months at the time of purchase. Finally, the Reserve Banks have authority to discount paper directly * th e intermediate credit banks although such discounts must have the specific of the Federal Reserve Board. These last two provisions were enacted at the time the land banks ^ intermediate credit banks were created, a time when banks and others were u °tant lenders. Their purpose was to assist in establishing confidence in ligations of these two institutions in the open market. With a ready r °r these obligations well established, there has been no need to call °n the Federal Reserve for this support. Their use would be inappropriate 11 Under present conditions when the System is struggling with the problem of too ^ W a l extension of credit. However, they are still in effect and would be a73 liable for use in event of a recurrence of the conditions that brought a ° u t their enactment. There are two other statutory provisions which do not relate specif- ica U y to agricultural credit but under which agricultural credit could con- Cei vably be provided through the Federal Reserve Banks. One authorizes the Rp es erve Banks to make advances to any corporation on the security of Govern- eri t obligations j the other authorizes advances to member banks on any satis- fact ory type of collateral, whether or not technically eligible for discount. ^ever, both of these provisions were enacted in the early 1930's as emergency ^^Utqs to stimulate credit under the uncertain economic conditions existing at that time, and they are not suited for use today when conditions are very cliffy Moreover5 any advances under these provisions would, under the law, to bear a premium rate of interest higher than the regular discount rate. On various occasions in the past, suggestions have been made that Reserve credit be made more directly and more liberally available to F -i the * credit agencies of the Government. In 1940, for example, and again ^ 9 , bills were introduced to permit the Reserve Banks to make loans to Q *Q^eral Land Banks for periods up to one year and at the regular Federal <Ve discount rate on the security of farm loan bonds or obligations of the ^States. At that time the Federal Reserve Board questioned the desirability Uc k a broadening of the law. It pointed out that it would result in a •^ination against member banks of the Federal Reserve System since it - 12 w °uld permit the land banks to borrow for longer periods and at a lower rate tha n member banks themselves could borrow on similar security. The Board also tinted out that such a change in the law would be likely to encourage requests similar authority by other agencies of the Government and that important Nations of credit policy were involved in enabling governmental credit agenCles to have direct access to Federal Reserve credit facilities. This brings us back to the basic question whether any such further bt °adening of the authority of the Reserve Banks to provide long-term credit to institutions, such as the land banks and intermediate credit would not be inconsistent with the fundamental purposes of the Federal iie serve System. The System's primary function is not simply to provide financ- llg > whether to farmers, businessmen or even to the member banks of the System. Its Principal concern is its ability to influence the entire supply of money credit in the best interest of the economy as a whole. As far as the functions of the System are concerned, it is more important to be able 0 ^ant or withhold credit as a means of regulating the over-all supply of than it is to provide the financial needs of individual borrowers or ^ticular segments of the economy. This can best be done by restricting its ens t0u ion of credit to member banks over which it can exercise some control gh it3 power to regulate reserves. At the same time, the Federal Reserve System constantly has in mind 8 Q P cial problems presented in the field of agricultural credit. Ga As I have ted, it has authority under the law to provide a certain measure of assistthat field, and,to the extent consistent with over-all national credit ^ and the public interest, the System is prepared to exercise that authority , n °ase of need.
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