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Property of
The Committee on the History of
the Federal Ressrve System
UNITED STATES MONETARY POLICY:
RECENT THINKING AND EXPERIENCE
HEARINGS
BEFORE T H E
SUBCOMMITTEE ON ECONOMIC STABILIZATION
OF T H E
JOINT COMMITTEE ON THE ECONOMIC REPORT
CONGRESS OE THE UNITED STATES
EIGHTY-THIRD CONGRESS
SECOND SESSION
PURSUANT TO
Sec. 5 (a) of Public Law 304
(79th Congress)
DECEMBER 6 AND 7, 1954
Printed for the use of the Joint Committee on the Economic Report
UNITED STATES
GOVERNMENT P R I N T I N G O F F I C E
.55314
WASHINGTON : 1954
JOINT COMMITTEE ON THE ECONOMIC REPORT
(Created p u r s u a n t to Bee. 5 (a) of Public L a w 304, 79th Cong.)
J E S S E P . WOLCOTT, Michigan, Chairman
R A L P H E* FLANDERS, Vermont, Vice Chairman
RICHARD M. SIMPSON, Pennsylvania
ARTHUR V. WATKINS, U t a h
HENRY O. TALLE, Iowa
BARRY GOLDWATER, Arizona
GEORGE H. BENDER, Ohio
FRANK CARLSON, Kansas
EDWARD J. HART, New Jersey
J O H N SPARKMAN, Alabama
W R I G H T PATMAN, Texas
P A U L H. DOUGLAS, Illinois
RICHARD ROLLING, Missouri
J . WILLIAM FULBRIGHT, Arkansas
GEOVEB W. E N S L E Y , Staff Director
J O H N W.
LEHMAN,
Clerk
SUBCOMMITTEE ON ECONOMIC STABILIZATION
R A L P H E. FLANDERS, Vermont,
U N I T E D S T A T E S SENATE
BARRY GOLDWATER, Arizona
J . WILLIAM FULBRIGHT, Arkansas
II
Chairman
H O U S E OF REPRESENTATIVES
RICHARD M. SIMPSON, Pennsylvania
WRIGHT PATMAN, Texas
CONTENTS
Statement of—
Chandler, Lester V., professor of economics, Princeton University
.
Clark, John D., director, American National Bank, Cheyenne, W y o .
former member of Council of Economic Advisers
Harris, Seymour, professor of economics, H a n a r d University
Prepared statement
i
Supplementary statement
Humphrey, Hon. George M., Secretary of the Treasury; accompanied
by W. Randolph Burgess, Under Secretary for Monetary Affairs;
David M. Kennedy, Assistant to the Secretary; Edward F . Bartelt,
Fiscal Assistant Secretary; and Robert P . Mayo, chief, analysis staff
Debt Division
Land, James N., senior vice president, Mellon National Bank
Trust Co.; Pittsburgh, Pa
Lanston, Aubrey G., Aubrey G. Lanston & Co., Inc., New York. N . Y„
Martin, William McChesney, Jr., Chairman, B^ard of Governors,
Federal Reserve System; accompanied by members of the Board of
Governors of the Federal Reserve System and Reserve Bank Presidents
Mitchell, C. Clyde, Jr., chairman, department of agricultural economics, University of Nebraska
Prepared statement
Shaw, Edward S., the Brookings Institution.
Simmons, Edward C , professor of economics, Duke University
Smutny, Rudolf, senior partner, Salomon Br^s. & Hutzler, New York.
Sproul, Allan, President, Federal Reserve Bank of New York a n d
vice chairman, Federal Open Market Committee
Upgren, Arthur R., dean, The Amos Tuck School of Business Administration, D a r t m o u t h College
Wilde, Frazar B., president, Connecticut General Life Insurance Co.,
a n d chairman, Research a n d Policy committee, Committee for
Economic Development
.
Prepared s t a t e m e n t . .
Additional information submitted for the record:
Background information on the appearance of the Open Market Committee of the Federal Reserve System before the Joint Committee on
the Economic Report, December 7,1954
Correspondence between the staff director of the Joint Committee on
the Economic Report and the Chairman of the Council of Economic
Advisers
Federal Open Market Committee report of ad hoc Subcommittee of the
Government Securities Market—
Analysis of discussions on scope and adequacy of t h e Government
securities market
Call-money facilities
Chairmen of the Federal Reserve banks, members of the Federal
Advisory Committee
Comments of the Federal Reserve Bank of New York on report of
the ad hoc Subcommittee on the Government Securities M a r k e t Findings and recommendations
Government securities market
Ground rules
Individuals and organizations which received a note enclosing
copies of the letter and outline of study for their information
Individuals who received, as addressees, the explanatory letter
and outline of study
Introduction
HI
*w
44
47
51
54
59
160
60
102
218
62
66
73
253
76
223
254
87
89
39
37
257
292
305
291
307
264
260
299
290
291
260
IV
CONTENTS
Additional information submitted for the record—Continued
Page
Federal Open Market Committee, etc.—Continued
Open-market account transactions in United States Government
securities July 1,1951-September 30, 1952
265
Outline of study
286
Preface
257
Summary of conclusions and recommendations
284
Membership of Federal Advisory Council
222
Membership of Federal Open Market Committee, 1951 through 1954„„ 220-223
Memorandum by Congressman Patman from Secretary Humphrey on
history of depository practice of the Treasury Department
184
Membership of the Board
220
Present members of the Federal Open Market Committee
221
Present membership of executive committee of Federal Open Market
Committee, 1951 through 1954
222
Questions by the subcommittee transmitted to the Treasury and the
Board of Governors of the Federal Reserve System
2
Replies to questions addressed to the Treasury and the Board of Governors of the Federal Reserve System
3,30
Reserve bank presidents, list of
220
Statement on action on ad hoc subcommittee report, December 9,1954- 257
Stimulus to Economic Growth, article by John D. Clark, in Washington
Post and Times Herald, December 6,1954
50
UNITED STATES MONETAE! POLICY:-BEOENT
THINKING AND EXPEEIENCE
MONDAY, DECEMBER 6, 1954
CONGRESS OF THE UNITED STATES,
JOINT COMMITTEE ON THE ECONOMIC REPORT,
SUBCOMMITTEE ON ECONOMIC STABILIZATION,
Washington, D. C.
The subcommittee met, pursuant to notice, at 10:05 a. m., in room
318, Senate Office Building, Senator Ralph E. Flanders (chairman
of the subcommittee) presiding.
Present: Senators Flanders, Goldwater, Sparkman and Douglas;
Representatives Talle, Patman, and Boiling.
Also present: Grover W. Ensley, staff director, and John "W. Lehman, clerk.
Senator FLANDERS. I would like first to say I am glad to see you here.
I am glad that our panel is here. I am glad that the attendance in
the uncomfortable chairs in the rear of the room indicates a lively
interest, and I am glad that there are other members of the Joint
Committee on the Economic Report here besides the members of the
subcommittee.
The Subcommittee on Economic Stabilization was appointed by
Chairman Jesse P . Wolcott on April 16, 1954, pursuant to the report
of the Joint Committee on the Economic Report filed with the Senate
and House of Representatives on February 26,1954 (H. Rept. 1256).
The committee report set forth the functions of the Subcommittee
on Economic Stabilization in the following words:
Subcommittee on Economic Stabilization.—The economic situation is obviously
very dynamic. The committee and staff will follow economic trends and developments from day to day to make sure that stabilizing action on the part of Government and business is effective. To facilitate expeditious study and action
in this field the chairman will appoint a Subcommittee on Economic Stabilization.
The subcommittee will hold hearings and conduct meetings as frequently as it
deems necessary and desirable, and will report from time to time to the full
committee on employment, production, and purchasing power trends. It will
follow particularly the role of fiscal and monetary policy in dealing with the
current recession.
The subcommittee and the committee staff have followed the current
economic trends carefully during the past year. The staff has met
frequently with economic analysts of the executive agencies, of business, labor, agriculture, and consumer groups, and the universities.
Members of the committee have joined in a number of these meetings.
As customary, the staff has reported these happenings and developments to all members of the committee. The subcommittee, in its
executive meetings during the course of the past year, felt that recent
economic developments did not warrant a material change in appraisal
l
2
UNITED STATES MONETARY POLICY
of the outlook from that presented by the witnesses at the committee's
hearings last February, and set forth in the committee's report of
February 26. We have consequently not seen the need for subcommittee hearings or special public reports during the recent session of
the Congress. We have reported to the full committee.
During the last 3 years much reliance has been placed on monetary
policy in carrying out the objectives of the Employment Act of 1946.
The Joint Economic Committee has actively studied the objectives
and workings of the United States monetary policy. Thorough studies
were made by subcommittees in 1949-50 and again in 1951-52 under
the chairmanships of Senator Paul Douglas and Representative
Wright Patman, respectively.
Since the inquiry in 1951-52 there have been significant changes in
the national economy and in the use of monetary instruments. I t
seems appropriate, therefore, and in compliance with announced intentions of the committee in its report to the Congress last February
(H. Eept. 1256), to review recent thinking and experience with monetary policy. The use of the term "monetai-y policy" in this study is
intended to include Federal debt management policy. The study will
try to avoid covering the ground of the earlier committee studies, and
will postpone discussion of the immediate economic outlook and the
program to be submitted to the Congress by the President next
January.
The subcommittee, in October, asked the Secretary of the Treasury
and the Chairman of the Board of Governors of the Federal Reserve
System to submit in writing their judgments relating to a number of
questions by November 20 for review by the subcommittee, the committee staff, the panel participants, in advance of today's and tomorrow's
hearings. I will insert at this point in the record the list of questions
that were transmitted to Secretary Humphrey and Chairman Martin.
W e asked Secretary Humphrey to give his judgments on questions 1
and questions 6, 7, and 8; we asked Chairman Martin to comment on
questions 1 through 5.
(The questions referred to above are as follows:)
1. What role did monetary policy play in the period of relative stahility following the Treasury-Federal Reserve "accord" in 1951, in the months of boom late
in 1952 and early 1953, and in the recession of 1953-54?
2. How has the emphasis in the use of monetary instruments changed during
the period since mid-1952? For example, how have the various instruments—
open market operations, discount rates and administration of discount operations,
and reserve requirements—been used under varying conditions? Has there been
any reliance on moral suasion during this period?
3. What is the practical significance of shifting policy emphasis from the view
of "maintaining orderly conditions" to the view of "correcting disorderly situations" in the security market? What were the considerations leading the Open
Market Committee to confine its operations to the short end of the market (not
including correction of disorderly markets) ? What has been the experience with
operations under this decision?
4. What is the policy with respect to the volume of money?
5. Has monetary machinery («) worked flexibly, and (b) has the market
demonstrated flexibility in its responses to changes in policy? For example,
how has the policy of "active ease" been reflected in the level and structure of
interest rate, the volume of credit, and the roles of various types of lenders?
6. Has the debt management policy of the Treasury—both as to objectives and
techniques—been consistent with the monetary policy of the Federal Reserve
throughout the period since mid-1952?
3
UNITED STATES MONETARY POLICY
7. W h a t considerations should dictate the m a t u r i t y distribution schedule of
the Federal debt, first, a s to the long-run ideal to be pursued and, second, as a
practical operating matter, giving weight to timing and contemporary conditions?
8. Are the benefits and costs to commercial banks of handling Government
transactions clear enough, or can they be made clearer, to determine whether
or not the banking system is being excessively compensated or undercompensated?
W h a t about the Treasury cash balance—its size and management? Should the
Government receive interest on its deposits with commercial banks?
Senator FLANDERS. Without objection there will also be inserted in
the record the replies of these two officials.
(The documents above referred to are as follows:)
BOARD OF GOVERNORS OF T H E
FEDERAL, RESERVE SYSTEM,
Washington,
Hon.
November
26, 1954.
R A L P H E. FLANDERS,
Chairman, Subcommittee
on Economic
Stabilization,
Joint Committee on the Economic Report, Washington, D. C.
DEAR SENATOR FLANDERS : I n accordance with the request contained in your
letter of October 26 and with subsequent conversations between members of
your staff and the staff of the Board, there a r e attached copies of the Board's
answers to questions 1 through 5 contained in your press release of November 12,
1954.
Sincerely yours,
W M . M C C . MARTIN,
Jr.
R E P L I E S OF T H E CHAIRMAN OF T H E BOARD OF GOVERNORS OF T H E FEDERAL RESERVE
SYSTEM TO QUESTIONS SUBMITTED BY THE SUBCOMMITTEE ON ECONOMIC STABILIZATION OF T H E J O I N T COMMITTEE ON T H E ECONOMIC REPORT I N CONNECTION W I T H
SUBCOMMITTEE HEARINGS OF DECEMBER 7, 1954
(1) W h a t role did monetary policy play in the period of relative stability following t h e Treasury-Federal Reserve accord in 1951, in t h e months of boom
late in 1952 and early 1953, and in the recession of 1953-54?
Inflationary dangers in prospect in 1951 made essential a shift in credit and
monetary policies of the sort envisaged in the Treasury-Federal Reserve accord.
Review of subsequent developments supports the conclusion that the policies
pursued were helpful in bringing about and maintaining a reasonable degree of
both stability and growth in the economy. The country encountered an economic
problem of unprecedented nature, namely, carrying out, with no further price*
inflation after the 1950-51 spurt, a defense program of exceptional magnitude
short of w a r while permitting moderate expansion in private expenditures. Private demands for goods and services were still in the process of overcoming t h e
effects of w a r and postwar scarcities. Credit and monetary measures, together
with fiscal and debt-management policies, helped to make it possible to cope with
this situation through the mechanism of competitive markets and a free price
system. As a result, the various direct controls imposed early in t h e defense
period could be eliminated, t h u s relieving m a r k e t s of t h e rigidities and inefficiencies inherent in such controls.
The Treasury-Federal Reserve accord was reached after an earlier inflationary
outburst of overbuying, overborrowing, and overpricing in the private economy.
I n t h e first year after its adoption, private spending and borrowing moderated
while the defense program expanded. In t h e second year, however, from the
spring of 1952 to the late spring of 1953, there was a vigorous expansion in private
spending and in private credit demands, just as defense expenditures were reaching a peak and the Federal Government faced t h e need for heavy borrowing t o
meet a deficit. Large capital expenditures, inventory accumulation, and heavy
consumer purchases of durable goods—all financed to a large extent by credit—
together with overtime operations in industry and exceptionally full utilization
of resources generally, threatened to develop into an unsustainable boom. Credit
restraints helped to keep total demands within the limits of t h e capacity of t h e
economy to produce and to spread the volume of spending over a longer period.
T h e boom w a s checked without collapse a n d w a s followed by an orderly and
moderate downward adjustment in activity. The adjustment was cushioned by
progressive action to ease credit markets, a s well a s by t a x reductions a n d other
4
UNITED STATES MONETARY POLICY
fiscal measures. It has not developed into a disastrous depression, as many
quite reasonably feared.
The defense program has now been curtailed to a level more likely to be sustained over an extended period. Many of the more urgent domestic and foreign
shortages resulting from war destruction and postwar reconstruction have been
satisfied. Inventories have been reduced appreciably, and current production is
more nearly in balance with demand. The problem of economic policy has thus
become one of facilitating, yet keeping within sustainable bounds, the normal
growth forces of a free enterprise, competitive economy.
In the remainder of this answer, credit and related economic developments in
the 1951-54 period are described and analyzed in some detail.
Treasury-Federal Reserve accord
When the Korean outbreak occurred, the financial policies of this country were
hampered by problems and methods of operation inherited from the Second World
War and its aftermath. Federal Reserve credit policies for many years had
been handicapped by trying to combine appropriate credit action with the support of Government securities prices. These practices, which were adopted
to meet wartime conditions, contributed in the early postwar period to an inflation that had raised the price level to almost double the prewar average before
it came to an end in 1949.
Following the Korean outbreak and adoption of a greatly enlarged defense
program, inflation resumed. Various attempts to restrain credit expansion while
continuing to support prices of Government securities had unsatisfactory and
diminishing results as mounting sales of securities to the Federal Reserve by
banks and other holders made funds abundantly and cheaply available for
spending, investing, and speculation.
In a move to correct this situation, on March 4, 1951, the Secretary of the
Treasury and the Chairman of the Board of Governors of the Federal Reserve
System announced that "the Treasury and the Federal Reserve System have
reached full accord with respect to debt management and monetary policies to be
pursued in furthering their common purpose to assure the successful financing
of the Government's requirements and, at the same time, to minimize monetization of the public debt."
Following this accord, monetary policies were reoriented. Open market operations were altered over a period so as to adjust the supply of bank reserves to
levels consistent with stable economic growth rather than to support prices of
Government securities. The discount mechanism through which member commercial banks borrow from the Federal Reserve banks was gradually restored
to an effective instrument of credit regulation. Various selective regulatory and
voluntary means for restraining credit extensions in particular areas were
utilized for a time, but to an increasing extent reliance came to be placed upon
the more general measures that operate through the quantity of bank reserves
and through flexible interest-rate movements.
Imposition of credit restraints—Spring of 1051 to spring of 1952
Following the accord, Federal Reserve operations in the short-term Government securities market, except for limited purchases during periods of Treasury
refunding, were only for the purpose of influencing the volume of bank reserves
in accordance with the broad objectives of Federal Reserve policy, namely, to
contribute to stable economic growth. Purchases of long-term securities by the
Federal Reserve were continued in diminishing volume for a number of weeks
following the accord, but after mid-1951 the Federal Reserve bought practically
no long-term bonds.
Under these policies, any bank or other investor wishing to sell Government
securities generally had to depend on buyers in the market, and the free play of
market forces resulted in some fluctuation as well as some rise in rates. Such
price and interest-rate fluctuations perform important functions of a selfcorrective and stabilizing nature, as is explained more fully in the answers to
questions 3 and 5.
It had been widely feared that because of the magnitude of the public debt
the removal of pegs on prices of Government securities would leave the market
with insufficient buyers and holders to carry the debt, and thus would produce
a catastrophic decline in bond values and panic conditions in the Government
bond market. These fears proved unfounded. Would-be sellers either found
buyers at prices they were willing to accept or refrained from selling. New issues
were offered at yields which attracted sufficient buyers. Until late 1952, market
yields on long-term bonds averaged less than 2% percent, with prices fluctuating
UNITED STATES MONETARY POLICY
5
between 05 and 99. The rate on Treasury bills gradually increased, but until
1952 remained generally below the Federal Reserve discount rate of 1% percent
The Federal Reserve purchased short-term securities at times of Treasury
refunding operations in order to steady the market. During periods of peak
seasonal needs for reserves by the banking system, the Federal Reserve bought
securities either outright in the market or from dealers under repurchase agreements for limited periods. At other times, however, System holdings of securities
were reduced in order to absorb reserves in excess of current needs. For the
year ending April 30,1952, although there were wide variations during the period,
total Federal Reserve holdings of United States Government securities declined
slightly as shown in table I.
During this period banks were supplied with some reserves on balance by
other factors, primarily a gold inflow, offset in part by a growing currency
demand. To obtain additional reserves, banks resorted increasingly to borrowing at the Federal Reserve banks; these borrowings fluctuated considerably
in response to temporary needs for reserves and showed a gradual rising tendency.- This was the first time banks had had to borrow to any significant extent
since the early thirties. Since banks are generally averse to borrowing steadily
and the Federal Reserve banks endeavor to discourage continuous borrowing by
individual members, the result of such a situation was to exert restraint on bank
credit extension and thus on growth of deposits.
Federal Reserve credit and bank reserves, changes from April 1951 to April 1952 *
[In billions of dollars]
Federal Reserve credit:
United States securities
Discounts and advances
Other factors affecting reserves (sign indicates effect on reserves) :
Gold stock and foreign balances at Federal Reserve banks
Currency in circulation
Other, net
Member bank reserve balances, total
Required reserves
Excess reserves
—0. 5
4-. 2
-f-1.8
—1.3
+. 3
+.r>
+.6
*>
1
Changes derived from monthly averages of daily figures for the 2 months Indicated.
Figures may not balance because of rounding.
In addition to the adoption of more restrictive monetary measures following
the Treasury-Federal Reserve accord, direct controls were imposed on prices
early in 1951 and the allocation of materials in short supply was made more
rigorous. A general reaction set in from the overbuying, overpricing, and overborrowing of the previous months. In the following 12 months, Government expenditures for defense increased sharply, but expansion in business and consumer expenditures for durable goods halted, and the rate of accumulation of
business inventories was reduced. Consumer expenditures for nondurable
goods and services continued to increase moderately. Private credit expansion
slackened. Prices in general showed little change. Some prices that had previously risen most sharply declined, while some other prices advanced
moderately.
Private credit expansion continued in this period, but the rate of growth was
much slower than immediately after the outbreak in Korea. Commercial banks,
while slowing down their loan increases, added somewhat to their holdings of
short-term Government securities, being motivated to do so by the attraction of
higher rates and by the fact that their longer-term holdings were less liquid than
they had been under the bond support policy. Credit developments in this and
other periods are indicated in table II, which shows changes in outstanding
amounts of selected types of credit and also by selected groups of lenders or
investors for years ending June 30,1950 to 1954.
Although corporate security issues increased from mid-1951 to mid-1952, as a
result especially of needs to finance expanding defense activities, the rate of
expansion in bank loans to businesses and in mortgage credits slackened considerably. Increases in consumer credit and in borrowing by State and local
governments were kept within moderate limits, notwithstanding
continuing
strong demands. The moderation in credit growth wTas due in part to regulation
6
UNITED STATES MONETARY POLICY
of consumer and mortgage credit terms and to the voluntary credit restraint
program carried on by lending institutions. To a considerable extent, however,
the slackened pace in making loans and investments resulted from the limitation
on the availability of bank reserves, higher interest rates, and the reluctance
of lenders and others to sell Government securities at the lower prices then
prevailing.
TABLE II.—Growth in major types of debt and equity financing
[Net increase in amounts outstanding, in billions of dollars]
I
12 months ending June 30—
Distribution of growth b y 1954
Major types:
2.2
5.5
9.9
6.7
-1.3
.4
2.4
1953
2.9 '
3.1
9.4
7.7
2.0
4.9
.2
1952
-0.5
2.0
8.2
7.3
1.5
2.3
1.4
58
28
11 3
17
6.5
1.8
1.0
25.8
30.2
22.8
22 3
.3
8.2
1.8
3.5
4.7
4.0
4.9
3.3
-2.5
6.0
-.1
8.4
2.7
5.7
1.9
3.9
4.5
2.0
4.0
5.2
2.4
3.7
.9
2.1
3.7
-2.6 |
1.5
-.2
1.2
-.9
-1.1.
.9
-2.0
1.6
1.0
19.0
14.7
16.0
Selected holders:
Nonbank holders:
Others, U. S. Government securities only:
1951
.9 i
1.4 1
Total holdings of above financing types accounted for by
17.1
-7.2
11.2
NOTE.—Table shows net changes in selected types of loan extensions and new equity financing. Among
types not included are trade credit other than consumer credit; interbank loans- security issues by foreign
agencies, international organizations, nonprofit and eleemosynary institutions; nonbank loans for purchasing securities; and claims such as shares, passbooks, and insurance policies issued by financial organizations.
Among holders, the most important exclusions are nonfinancial corporations, trusts, governments, and
individuals, except for U. S. Government bonds.
*
These latter changes constituted in effect a decrease in liquidity and resulted
in an increased demand for cash balances. The changed liquidity needs and the
expanding volume of economic activity made possible a further substantial growth
in bank credit and the money supply without generating inflationary pressures.
Demand deposits and currency showed a further expansion of about $7 billion,
or 6 percent, in the 12 months ending April 1952. Savings deposits, which had
actually contracted following the Korean outbreak, increased substantially, as
did savings in other forms.
In summary, it may be said that after the Treasury-Federal Reserve accord
the Federal Reserve endeavored to adjust its policies so as to influence the level
of bank reserves and the money supply in accordance with seasonal requirements,
the capacity of the economy to produce goods and services, and sustainable economic growth in the economy. The discount function was restored as a means of
supplying temporary needs for Federal Reserve credit in a manner that exerted
restraint on unwarranted uses of such credit, thereby complementing open market operations in influencing the availability of credit at member banks. Discontinuation of rigid pegging of Government security prices removed the possibility of monetizing the public debt through sale to the Federal Reserve System
at the initiative of the holders, nonbank as well as bank, and without loss to them.
^The excess liquidity of the economy was thereby removed.
UNITED STATES MONETARY POLICY
7
Resumption of expansionary tendencies—spring
of 1952 to spring of 1953
Beginning in the spring of 1952 the r a t e of increase in defense spending slackened, but there was a renewed expansion of private expenditures and private
credit demands became more vigorous. Around the middle of t h a t year direct
regulation of consumer installment and real-estate credit and the voluntary
credit-restraint programs were discontinued. These actions increased the dependence on general credit measures for restraining excessive credit and monetary
expansion. Total national product increased in the following year as a result of
growing private expenditures both for consumption and investment, including
a building up of inventories. By late 1952 the economy generally was operating
on an overtime basis. Wage rates again rose substantially and consumer prices
advanced slightly ; a t the same time, however, wholesale prices continued to show
more declines than advances.
All major kinds of credit increased more sharply in the 12 months ending
June 1953 than in the preceding 12 months, as shown in table II. The biggest
change was in consumer credit, which increased $5 billion as compared with
only little change during most of the previous year. The United States Govern-.
inent became a net borrower of about $3 billion from the public, as compared
with a reduction in its indebtedness in the previous year. The volume of
mortgage loans completed and of corporate and State and local government
securities issued was moderately larger than in the preceding year. Bank loans
to businesses, reflecting inventory accumulation, expanded very sharply in late
1952 and failed to show the usual seasonal decline in early 1953.
A signilicant characteristic of this period was the amount of credit demands
met from the genuine savings of the public. The net expansion in credit supplied
by nonbank lenders was much greater than in the preceding year, while bank
credit showed a smaller r a t e of increase. Furthermore, a larger portion of the
bank credit represented the investment of savings deposits, which increased by
7 percent. Demand deposits and currency continued to expand but the annual
r a t e of growth declined from 6 to 3 percent.
The Federal Keserve occasionally bought Government securities in this period
but the objective of monetary policy continued to be restraint on undue credit
and monetary expansion. Purchases were made at times of Treasury refundings
during 1952 and subsequently offset in p a r t by sales. Open market operations
were also undertaken in response to seasonal iniluences affecting bank-reserve
needs.
Over the wThole period April 1952 to April 1953, as shown in table I I I , net
purchases were less t h a n enough to cover the drains on bank reserves resulting
from gold outflow and larger currency demands. Banks had to borrow substantial amounts from the Federal Keserve in order to meet growing demands
for credit. Discounts and advances at Federal Reserve banks generally exceeded
a billion dollars from July 1952 to May 1953, and they averaged $1.6 billion in
December 1952. This made banks much more restrained in their willingness
to supply these demands. To make the policy of restraint more effective, the
Federal Reserve discount r a t e was raised from 1% to 2 percent in J a n u a r y 1953.
TABLE III.—Federal Reserve
credit and bank reserves, changes from April 1952
to April 1953 *
[In billions of dollars]
Federal Reserve credit:
United States securities
-f 1.4
Discounts and advances
-f - 8
Other factors affecting reserves (sign indicates effect on reserves) :
Gold stock and foreign balances at Federal Reserve banks
— .7
Currency in circulation
—1.3
Other, net
-f . 1
Member bank reserve balances, total
+ -2
Required reserves
-f * 3
Excess reserves
— . l
1
Changes derived from monthly averages of daily figures for the 2 months indicated.
Figures may not balance because of rounding.
8
UNITED STATES MONETARY POLICY
The restraints did not stop credit and monetary growth. The growth that occurred apparently corresponded closely to the capacity of the economy to absorb
more money without inflation. Since the resources of the economy were generally
fully utilized, any more credit might have resulted in inflationary price rises
and moreover might have built up an unsustainable debt structure. Inflation was
prevented, notwithstanding strong pressures of demand for more credit, and
prices remained relatively stable. In some lines, particularly installment loans
to consumers and inventory loans to business, the rate of expansion was apparently more rapid than could be sustained.
The money market showed a marked response to the strong demand for credit
and the restraints on its availability. Interest rates rose during the period, reflecting the pressures of credit demand in excess of the available supply. The
rise in interest rates was particularly great in the spring of 1953 when yields on
high-grade securities and loans generally reached the highest levels for 15 to 20
years. Treasury bill rates approached 2% percent, the average yield on long-term
Treasury bonds rose above 3 percent,
and a small new issue of 30-year Treasury
bonds bore a coupon rate of S1/^ percent. Rates on new issues of high-grade
corporate bonds exceeded 3 ^ percent, and federally guaranteed mortgages sold at
discounts in the secondary market.
By May 1053 the market developed a condition of tension that threatened to
become unduly severe. This reflected a number of converging factors. Apprehension arose regarding the ability of the credit market to meet borrowing demands of the State and local governments, consumers, home buyers, and business corporations, together with rising Treasury financing needs. The combination of a Government deficit and large private credit demands is exceptional for
a period other than one of active war and it was difficult to gage the problems
that it might present. At that time the Treasury made its offer on a $1 billion
issue of 30-year 3XA percent bonds to raise new money from nonbank investors.
This offering gave probably the first tangible evidence of a striking nature, not
only of the fact that the Treasury had to borrow substantial amounts, but also
that it had to compete against large private borrowing demands for the available supply of savings at competitive rates if resort to the creation of an undue
volume of new money through the banking system were to be avoided.
In addition to Treasury borrowing, private credit demands of various sorts
were exceptionally large. New security issues by corporations and State and
local governments exceeded $7 billion in the first half of the year—larger than
in any previous half-year, and the amount of future issues scheduled was still
large. Some of this borrowing was in anticipation of further stringency. About
this time, also, the ceiling rates on the FHA and VA mortgages were raised after
months of consideration, and a large volume of mortgages which had been held
back pending the authorization of higher rates suddenly came on the market.
The new rates, however, proved low relative to the tight market at the time, and
such mortgages sold at discounts in the secondary market.
The continued high level of member bank borrowing from the Federal Reserve
and the limited availability of reserve funds were keeping banks under pressure. The effect on the money market was a marked rise in interest rates,
which exerted a considerable amount of restraint on private credit demands.
The heavy pressures on the market were due to the growing demand for credit.
The supply of credit actually increased substantially but did not meet all
demands.
Slackening of activity after sprnng of 1953
Early in May 1953 Federal Reserve officials recognized that as a result of a
combination of circumstances, some of which were unexpected, undue tension
was developing in the credit market. They concluded that steps should be
taken to temper restraints curently imposed on member banks, particularly in
view of prospective seasonal credit and currency demands.
The Open Market Committee began early in May to supply reserves by purchasing Government securities and by midyear about $1 billion of securities had
been acquired. Early in July some §1.2 billion of reserves were released to the
banking system by a reduction in member bank reserve requirements. These
actions made it possible for banks to decrease their borrowings sharply and to
subscribe for a new issue of short-term Government securities early in July, as
well as to meet seasonal credit and currency demands around the midyear.
Inflationary forces abated after the spring of 1953 and economic activity commenced to recede from the all-time high level reached in the second quarter of
that year. Business inventory expansion slackened and subsequently contraction
9
UNITED STATES MONETARY POLICY
in inventories set in. Home building plans were temporarily held up because of
financing difficulties. Substantial cutbacks in defense expenditures began to be
made by the Government
As these evidences of business slackening became clearer, the Federal Reserve
further eased credit conditions by purchasing additional securities in the
market. Reserves t h u s made available were enough to cover the effects of a gold
outflow and the customary seasonal rise in currency and credit demands, but
the increases t h a t actually occurred in currency and required reserves were
smaller than expected. Member banks were thus able to use a p a r t of the reserves made available to them to reduce their borrowings a t the Federal Reserve
banks. In February 1954 the Federal Reserve discount rate was reduced to
1% percent.
Developments for the first 12 months following the change in policy are summarized in table IV. In t h a t period the reduction in reserve requirements of
$1.2 billion and Federal Reserve purchases of securities of $1.3 billion enabled
member banks to meet a small further gold outflow, to decrease appreciably
their borrowings a t the Reserve banks, and to obtain reserves needed to cover
further deposit expansion.
TABLE IV.—Federal reserve credit and bank
reserves
[Changes in billions of dollars ']
April 1953 to April 1954 to
April 1954
October 1954
Federal Reserve credit:
United States securities
.
Discounts and advances
Other factors affecting reserves (sign indicates effect on reserves):
Gold stock and foreign balances at Federal Reserve banks—
Currency in circulation
...
Other
Member bank reserve balances, total
Required reserves, due to—
Reduction in requirements
--Growth in deposits
..Excess reserves—
—
2+1.3
-0.2
-1.0
+.1
0
*-.4
-.G
-.2
.-.3
0
-.5
-1.2
+.4
+.2
-l.G
+1.1
0
1
Changes derived from monthly averages of daily figures for the 2 months indicated. Figures may not
balance because of rounding.
- Exclude etrect of $500 million sale of Government securities to Treasury in exchange for free gold carried
in Treasury cash balance.
Since April 1954 reserves needed for customary seasonal and other purposes
have been supplied largely by a further reduction of about $1.6 billion in member
bank reserve requirements. Reserves were supplied a t times by Federal Reserve purchases of Treasury bills, while a t other times to absorb redundant reserves bills were sold or not replaced at maturity. Thus banks have been able
to meet seasonal credit and monetary demands and also to purchase new issues
of Treasury securities with little borrowing.
Total credit demands, particularly for long-term purposes, continued substantial during the latter part of 1953 and in 1954, although less t h a n in the preceding
year. There was a decline in bank loans to business and consumer credit showed
little increase from the middle of 1953 until recently. Mortgage lending began
to pick up in the autumn of 1953 and has since been in record volume, stimulated
in p a r t by considerably liberalized downpayment and maturity terms, especially
under Government mortgage programs. New security issues by corporations
were slightly less than in the preceding year but those of State and local governments were much larger. The Federal Government remained a substantial net
borrower.
Savings continued to meet a large portion of total credit demands as reflected
in the figures of insurance companies, savings and loan associations, and mutual
savings banks as well as in time deposits of commercial banks. The total of demand deposits and currency, which changed little from the spring of 1953 to
the spring of 1954, except for normal seasonal movements, showed a more than
seasonal increase after mid-1954.
As a result of the increased availability of funds and t h e slackened credit
demands, yields on sbort-term Treasury securities declined by the summer of 1954
to the lowest level since 1949. Since the spring of 1954 yields on long-term
Government securities and those on high-grade corporate bonds have been gen
10
UNITED STATES MONETARY POLICY
erally at the lowest level since the Treasury-Federal Reserve accord. Rates
charged by banks on customer loans remained at about last year's higher levels
until mid-March, when the rate to prime borrowers was reduced. Mortgage
interest rates declined somewhat and discounts on guaranteed and insured mortgages were reduced substantially, with small premiums appearing in some areas.
Summary and conclusion
The role and objective of the Federal Reserve in the defense-mobilization
period have been to make possible the provision of adequate credit and money
for full utilization of, and growth in, the country's economic resources. At the
same time, policy endeavored to prevent excessive credit and monetary expansion)
beyond the limits of productive capacity that would lead to inflationary developments and threaten the maintenance of stable growth.
During the period of restraint in 1952-53, Federal Reserve policy looked toward
the avoidance of credit excesses which could cause real trouble once a downturn
had come. This policy sought to even out the flow of capital investment by
fostering deferment of some projects until slack had developed in the economy.
During the period of ease since May 1953, the major contribution has been to
facilitate as large a volume of bank lending as the economy required, and to
provide support for mortgage lending and utility and State and municipal financing which has had its counterpart in a high volume of construction of residential
property, utilities installations, public buildings, and road construction. These
activities have been a substantial offset to declines in defense expenditures and
in business inventories.
(2) How has the emphasis in the use of monetary instruments changed (luring
the period since mid-1952? For example, how have the various instruments—open-market operations, discount policy, and reserve-requirement
changes—been used under varying conditions? Has there been any reliance
on moral suasion during this period?
At any given time, the Federal Reserve System pursues the policy it believes
appropriate for the credit and economic situation. It has three major instruments available for effectuating its policy—open-market operations, discount
policy, and changes in reserve requirements. These instruments are complementary and mutually reenforcing. Extent of reliance on any one of the instruments
depends upon the System's judgment as to what may be most appropriate under
the circumstances to further the general credit policy being pursued.
Description of tlie instruments
Open-market operations are carried out at the initiative of the System by
making purchases or sales of Government securities in the market. Purchases
of securities supply reserves to member banks. Sales of securities absorb or
extinguish member bank reserves. These operations can be used to offset losses
or gains in reserves from changes in such factors as currency in circulation or
gold stock or to expand or reduce the volume of bank reserves.
Discount policy relates to Federal Reserve bank lending to member banks.
The initiative in such credit extensions is taken by individual member banks
when it is necessary for them to build up their reserve positions to required
levels. The discount rates at which the Federal Reserve banks will lend to
member banks are established by each Reserve bank from time to time, subject
to review and determination by the Board of Governors, in accordance with the
credit and economic situation.
Member banks, as a matter of well-established banking practice, are generally
reluctant to operate on borrowed funds, or to stay long in debt. Therefore, under
ordinary circumstances, borrowing at the Federal Reserve by individual banks
is usually on a temporary, short-term basis. In unusual or emergency situations,
of course, Federal Reserve discount credit may be outstanding to individual
banks for longer periods. The general principles governing Reserve bank administration of the discount window arise out of law, regulation, and Federal Reserve
discount experience.
By raising or lowering reserve requirements of the various reserve classes of
member banks—within specified limits for each class as permitted by law—the
Federal Reserve at its initiative may diminish or enlarge the volume of funds
which member banks have available for lending. Action of this type thus
influences the liquidity position of banks and their ability to expand deposits in
relation to their reserves. By their nature, changes in reserve requirements
affect at the same time and to the same extent all member banks within each
reserve class subject to the action.
UNITED STATES MONETARY POLICY
11
/nterrelationship of the instruments
Although any one of these three major instruments will tighten or ease credit
conditions, each of them has a somewhat unique role in carrying out System
credit and monetary policy. Open-market operations have become the chief
instrument by which the System influences on a current basis the volume of
unborrowed reserves of member banks. Such operations are also actively used
to exert important restrictive or expansive pressure on bank credit conditions
when the economic situation calls for fundamental change in these conditions.
Since a purchase or sale of Government securities by the System adds to or
substracts from the reserves of the member banks, it will be reflected initially,
other things unchanged, in the volume of excess reserves held by member banks
or in the volume of reserves that member banks need to obtain by borrowing at
the Federal Reserve banks. Reflecting the reluctance of member banks to incur
indebtedness or remain long in debt, changes in the volume of member bank
excess reserves or borrowing are promptly reflected in conditions of credit availthe Federal Reserve banks. Rejecting the reluctance of member banks to incur
become increasingly indebted and eased as the volume of that indebtedness is
diminished or the amount of excess reserves is increased. Open-market operations are thus a flexible means for helping to achieve whatever condition of
credit tightness, ease, or moderation may be appropriate.
The Federal Reserve discount rate is a pivotal interest rate in the credit
market. In particular, short-term open-market rates tend to array themselves
in relationship to the Federal Reserve discount rate, except in a period when
the reserve positions of member banks are so easy as to obviate the need for
borrowing at the Reserve banks. When through open-market operations bank
reserve positions have been put under pressure (or have been allowed to get
under pressure as bank credit and deposits expand), money rates will tend
to range higher in their relationship to the discount rate. Conversely, as bank
reserve positions ease, they will be lower in relation to that rate.
In a period, for example, when restraint on bank credit and monetary expansion is needed, open market operations and changes in the discount rate need
to be used to reinforce each other. In the first instance, increasing pressure on
bank reserve positions (increased need for borrowing) may be developed through
use of the open-market instrument alone. At a point, however, it will become
appropriate to support the effectiveness of this open-market action by an increase
in the discount rate, strengthening the reluctance of member banks to remain
indebted to the Federal Reserve by making borrowing more expensive as a
means of adjusting bank reserve positions. Such discount rate adjustments tend
to lag behind adjustments in market rates in a tightening credit situation.
With an upward adjustment of the discount rate, market rates may shift
further upward over a period of time as they re-form around the new and higher
discount rate.
In a period when it is appropriate to ease credit conditions, open-market
operations may be undertaken to supply reserve funds. Member banks may use
these funds initially to reduce their borrowing. Since this action will put banks
in a stronger position to increase their lending and investing activities, it will
tend to be reflected in a stronger tone in money markets and in lower market
rates in relation to the discount rate. To reinforce this credit-easing action,
it may be appropriate at some stage to lower the discount rate, thereby keeping
the cost of using this avenue for the temporary adjustment of bank reserve positions more nearly in line with the cost of making these adjustments through
the sale and subsequent repurchase of market paper or securities.
Changes in reserve requirements can be used, like open-market operations, to
tighten or ease bank reserve positions. As with open-market operations, the
effect shows up initially in changes in the volume of member bank excess reserves
and borrowing at the Reserve banks. Its impact on the money market and the
availability of bank credit is, therefore, similar in many respects to that of a
comparable open-market action.
The reserve-requirement instrument, however, is not interchangeable with
the open-market instrument. Unlike open-market operations, the results affect
immediately and simultaneously all banks in each reserve class. Changes in
requirements, moreover, cannot be made frequently—especially on the up side—
without unduly disturbing the operations of individual banks, since in our country
adherence to reserve requirements is a basic rule to be observed in conducting a
banking business. Changes in reserve requirements are, therefore, made infrequently and typically involve a fairly sizable volume of funds. The effects
tend to be large and concentrated within a short period of time. The instrument
12
UNITED STATES MONETARY POLICY
is more appropriate for making a major change in the volume of available bank:
reserves than it is for short-run adjustments. It is not adaptable to affecting
bank reserve positions on a day-to-day and week-to-week basis, as are openmarket operations. Nor is the instrument as sensitive and flexible a means of
affecting general credit conditions as is the combined use of open market and
discount operations. In fact, it may be desirable to engage in partially offsetting
open-market actions in order to cushion the impact of reserve requirement
cnanges in credit markets.
Use of the instruments since mid-1052
In an appended tabulation, exhibit A, the various credit actions taken by theFederal Reserve after mid-1952 are set forth, together with a summary of the
surrounding credit and economic circumstances. A chart, exhibit B, shows the
interrelated effects of these actions on member bank borrowings and excess
reserves. Examination of these measures will make clear the interaction and
interrelation of the major instruments following a pattern similar to that
described above. As may be seen from the accompanying chart, the System did
not fully meet through open-market operations the heavy demands of banks for
reserves in the fall of 1952, with the result that there was a buildup in the volume
of discounts. This pressure on bank reserves was reflected in a rise in interest
rates, particularly in the short-term sector. The restrictiveness of this development was reinforced in early 1953 by an increase in the discount rates of the
Reserye banks from 1% to 2 percent. Restraint on bank reserve positions was
maintained over the first several months of 1953. Reflecting the very strongdemand for credit from a variety of sources, interest rates, both long- and shortterm, rose further.
The revival in this period in the use of the discount* instrument, little used
since the early 1930's, raised some problems of discount administration for the
System. Through a lapse of time some member banks had lost familiarity with
the principles of law and regulation relating to the appropriate occasions for
borrowing at the Reserve banks. Under the excess-profits-tax law then in effect,
it was profitable for member banks in excess-profits-tax brackets to borrow to
increase their tax base, and, in order to improve their tax situations, a few of
these banks began to rely on borrowing at the Reserve bank rather than adjustments in asset positions in maintaining their reserve positions. Some otherbanks seemed willing to remain indebted at the Reserve banks for extended
periods in order to profit from differentials between market rates of interest and
the discount rate. As these developments became apparent, they were dealt with
administratively by the Reserve banks on a case-by-case basis.
With signs of an abatement of the inflationary threat in the spring of
1953, the Federal Reserve modified its credit policy. Easing actions were first
undertaken through the open-market purchases begun in early May and made oa
an increasing scale through June. These open-market purchases were supplemented at mid-1953 by a reduction in reserve requirements. Taken together
these actions made available sufficient reserve funds to meet seasonal reserve
drains and credit needs at the midyear, including large Treasury needs, and
at the same time greatly to ease pressures on bank reserve positions and to
reduce member bank borrowing needs.
Additional open-market actions were taken over the second half of 1953 toexpand further the supply of reserves available to member banks in accordance
with usual seasonal factors. Actual credit demands did not come up to seasonal
expectations, however, and member banks used surplus reserve funds to reduce
their borrowings at the Reserve banks. By early 1954 banks were largely out
of debt to the Reserve banks and over the first half of the year excess reserves
increased steadily, largely reflecting seasonal factors. Easing actions by the
open-market instrument were supported by reductions in the discount rates*
of the Reserve banks first in February and again in April and May. Interest
rates declined sharply over the period in response to this combination of actions and the reduced demand for short-term credit.
UNITED STATES MONETARY POLICY
13
In May of 1054 the Federal Reserve again began to supply bank reserves
through open-market operations and around midyear reserve requirements of
member banks were further reduced. This action was taken in order to promote
further bank credit and monetary expansion and to make available funds to meet
seasonal reserve drains and credit needs, including those of the Treasury. I t
was foreseen that the action would supply more reserves than were called
for a t the time and accordingly open-market sales were made to absorb a p a r t
of the funds. It was anticipated that these funds would be released to the market
over the fall months as needed by open-market purchases and this was done.
Then dovetailing of reserve requirements and open-market actions in the summer
of 1954 illustrates how the impact of a change in reserve requirements may be
cushioned and spread over time by temporarily offsetting open-market measures.
Selective credit actions *
In addition to its general credit instruments, the System had during this period
one continuing instrument of selective credit action, namely, margin requirements on stock market credit. Margin requirements established by the Board of
Governors limit the amount which brokers, dealers, and banks may lend to customers in order to purchase or carry securities. Their statutory purpose is to
prevent undue use of credit for stock market transactions. From the standpoint
of credit and monetary administration, margin requirement regulation serves
to minimize the bearing that stock speculation might have on the use of the general instruments of System policy discussed above.
In February 1953 margin requirements on stock market credit were reduced
from 75 to 50 percent. The 75 percent margin requirement had been set in January 1951 as a preventative measure during that inflationary period. The action
in early 1953 was taken in the judgment that a 50 percent requirement would be
adequate to prevent an excessive use of credit for purchasing and carrying securities.
Use of moral suasion
Moral suasion is generally taken to refer to oral or written statements, appeals,,
or warnings made by the banking and monetary authorities to all or special
groups of lenders with the intent of influencing their credit extension activities.
During the period under review only minor use was made of this instrument
within the Federal Reserve System. 2
The term "moral suasion" is sometimes given a broader meaning to include
any public or private statements made by Federal Reserve officials in the discharge of their responsibilities. As so defined it would include statements made
to promote awareness and understanding of current credit and monetary problems on the part of the public and the financial community. I t would also include conferences with member banks, individually and in groups, and with
others in connection with the administration of various System functions, including particularly the discount function. On the basis of this broader definition, it may be said that moral suasion is constantly being employed by the System
to promote public understanding of System actions and to ensure compliance with
the law and with regulations issued pursuant to the law.
1
At times during the past the Board has also had temporary authority to regulate the
terms of consumer and real-estate credit. Most recently, for example, regulation of consumer credit was undertaken in the early fall of 1950 under temporary authority granted
by the Defense Production Act. The Board suspended such regulation in May 1952, and
in the Defense Production Act amendments approved J u n e 30, 1952, Congress repealed
the authority to regulate consumer credit. In the fall of 1950 the Board was also given
temporary authority to regulate real-estate credit terms. Such regulation was begun in
midfall of t h a t year and suspended in September 1952 to conform with the provisions of
the Defense Production Act as amended. T h a t act continued the authority for real-estate
credit regulation until mid-1953, but required t h a t the regulation be relaxed earlier if
the estimated number of dwelling units started in each of 3 successive months was below*
a seasonally
adjusted annual rate of 1.2 million.
3
For example, the Federal Reserve Bank of Boston, on May 15, 1053, addressed a
letter to all commercial banks in the F i r s t Federal Reserve District calling attention to.
relaxation of credit standards taking place in t h e market for installment credit.
55314—54
2
14
UNITED STATES MONETARY POLICY
EXHIBIT A.—Use of Federal reserve instruments, July 1952-October 1954
Purpose of action
Date
September 1952.
Action
Suspension of regulation of
real-estate credit.
July-December 1952. Limited net purchases of IT. S.
Government securities in
open market to $1.8 billion.
January-April 1953. Sold or redeemed $800 million
net of TJ, S. Government
securities.
Intent with respect to effect
on credit and
money
None.
Restrictiy,e...
..do.
January 1953..
Raised discount rates from 1H —.do....
to 2 percent and buying rates
on 90-day bankers' acceptances from \li to 2)6 percent.
February 1953
Reduced margin requirements None..
on loans for purchasing or
carrying listed securities
from 75 to 50 percent of market value of securities.
May-June 1953-.
Purchased in open market
about $900 million U. S.
Government securities.
Relief of credit m a r k e t
tensions.
Reduced reserve requirements Expansive.-.
on net demand deposits by
2 percentage points at central Reserve city banks and
by 1 percentage point at Reserve city and country
banks, thus freeing an estimated 1.2 billion or reserves.
July-December 1953. Made net purchases in open
.do..
market of U. S. Government securities totaling
$1.7 billion.
July 1953..
January-June 1954.. Limited net sales to about
$900 million of U. S. Government securities in open
market.
.do..
February 1954.
..do..
April-May 1954.,
Reduced discount rates from
2 to iy\ percent and buying
rates on 90-day bankers'
acceptances from 2)6 to 1^4
percent.
Reduced discount rates from
1H to 1)6 percent and buying rates on 90-day bankers'
acceptances from 1% to 1)4
percent.
Explanation
To conform with the terms of the
Defense Production Act, as
amended, requiring suspension of
regulation if housing starts in
each of 3 consecutive months fell
short of an annual rate of 1,200,000
units, seasonally adjusted.
To meet seasonal and other reserve
drains only in part, requiring
banks to borrow some of the
reserves needed so as to restrain
bank credit and deposit expansion at a time when credit demand was very large and the
economy was fully employed.
Purchases in August and September were made primarily at times
of Treasury refunding operations
and were offset in part by subsequent sales.
To offset seasonal changes in factors
affecting reserves and thus to
maintain pressure on member
bank reserve positions.
To bring discount rates as well as
buying rates on acceptances into
closer alinement with open-market money rates and to provido
an additional deterrent to member bank borrowing from the
Reserve banks.
To reduce margin requirements
from the high level imposed early
in 1951, in the judgment that the
lower requirement would be adequate to prevent excessive use of
credit for purchasing and carrying stocks.
To provide banks with reserves
and to permit a reduction of
member bank borrowing from
the Reserve banks at a time when
such borrowing was high, credit
and capital markets were showing strain, and seasonal needs for
funds were imminent.
To free additional bank reserves for
meeting expected seasonal and
growth credit demands, including Treasury financing needs,
and to further reduce the pressure on member bank reserve
positions.
To provide banks with reserves to
meet seasonal and growth needs
and to offset a continuing gold
outflow with little or no additional recourse to borrowing.
This action and the one below were
taken in pursuance of a policy of
active ease adopted in view of
the business downturn.
To absorb only part of the reserves
made available by the seasonal
deposit contraction and return
flow of currency thereby further
easing bank reserve positions.
To bring discount rates as well as
buying rates on bankers' acceptances into closer alinement with
market rates of interest and to
eliminate any undue deterrent
to bank borrowing from the
Reserve banks for making temporary reserve adjustments.
15
UNITED STATES MONETARY POLICY
EXHIBIT A.—Use of Federal reserve instruments, July 1952-Octoler 1951t—Con.
Purpose of action
Action
Date
Intent with respect to effect
on credit and
money
Explanation
.June-October 1954.. Reduced reserve requirements Expansive . To supply the banking system
on net demand deposits by 2
with reserves to meet expected
percentage points at central
growth and seasonal demands for
Reserve city banks and by 1
credit and money, including
percentage point at Reserve
Treasury financing needs.
city and country banks, and
requirements on time deposits by 1 percentage point
at all member banks, thus
freeing about $1.5 billion of
reserves In the period June
16-Aug. 1.
Sold or redeemed U. 8. Gov- Cushioning...
ernment securities totaling
about $1 billion In July and
August.
Reductions in reserve requirements
Made net purchases In open
were offset in part by temporary
market of about $400 million
sales of securities in order to prein September and October.
vent excess reserves from Increasing unduly at the time, but security purchases were resumed
as need for funds developed.
MEMBER BANKS
(3) What is the practical significance of shifting policy emphasis from the view
of "maintaining orderly conditions" to the view of "correcting disorderly
situations" in the security market? What were the considerations leading
the Open Market Committee to confine its operations to the short end of
the market (not including correction of disorderly markets)? What has
been the experience with operations under this decision?
The matters referred to in this question relate to changes in techniques of
System open market operations adopted in the spring of 1953. At that time,
the full Federal Open Market Committee decided to amend its directive to the
executive committee by dropping the clause authorizing operations to maintain
orderly conditions in the market for United States securities and by substituting
therefor a clause authorizing operations to correct a "disorderly situation"
in the securities market. At the same time, the executive committee was instructed to confine its operations to the short end of the market. Closely associated was a decision taken earlier to discontinue direct supporting operations
during periods of Treasury refinancing with respect both to maturing issues
and to new issues being offered, as well as issues comparable to those being
offered in exchange.
These three decisions did not change basic policy objectives. They were taken
after intensive reexamination in 11)52 of the techniques then employed in System
16
UNITED STATES MONETARY POLICY
open market operations with particular reference to the potential impact of such
techniques on market behavior. Their purpose was to foster a stronger, more
self-reliant market for Government securities. Improvement in this market was
desired (1) in order that the Federal Reserve might better implement flexible
monetary and credit policies, (2) to facilitate Treasury debt management operations, and (3) to encourage broader private investor participation in the Government securities market.
The decisions were taken to remove a disconcerting degree of uncertainty that
existed at that time among market intermediaries and financial specialists.
The market was uncertain, first, with respect to the limits the Federal Open
Market Committee had in mind in its directive to "maintain an orderly market
in Government securities." A second uncertainty pertained to the occasions
when the System might decide to operate directly in the intermediate and longterm sectors of the market to further its basic monetary policy objectives, i. e.,
to ease intermediate and long-term interest rates in periods of economic slack
or to firm these rates in periods of exuberance.
Roth of these uncertainties related solely to transactions initiated by the
System outside the short end of the market, transactions which had' as their
immediate objective results other than a desire to add to or absorb reserves
from the market. The effect, however, was to limit significantly the disposition
of market intermediaries and financial specialists to take positions, make continuous markets, or engage in arbitrage in issues outside the short end of the
market.
The constant possibility of official action, which from the standpoint of
investors and market intermediaries would often seem capricious, constituted a
market risk which private investors could in no reasonable way anticipate and
evaluate in formulating their advance judgment about market prospects. Even
a financial intermediary who appraised correctly the emergence of a situation,
where the Committee might decide to intervene, would have little basis for
estimating the exact timing of that intervention, the issues in which it might
be concentrated or the levels at which it might take place. Such estimates are
important to the sensitive rapid trading at very small spreads that is characteristic of a self-reliant securities market. Inability to make them may add a
degree of risk that is more than financial intermediaries are willing to accept.
It became apparent that these uncertainties, so long as they persisted, would
tend to perpetuate a condition of thin markets and sluggish adjustment as between sectors of the market. This impaired the attraction of Government securities as a medium of investment, since their very high status with investors
rests on ready salability as well as on credit qxiality. From the point of view
of the Federal Reserve System, such uncertainties might increase the probability
of situations arising in which the Open Market Committee would be forced to
intervene in various sectors of the market, either to prevent disorderly situations
from arising or to see to it that funds it added to or absorbed from bank reserves
in the pursuit of monetary policies found effective and appropriate response
throughout the credit structure. In taking these decisions, the Federal Open
Market Committee is not absolving itself from concern with developments in
the longer-term sector of the market. It is particularly concerned that its
policies shall be reflected in the cost and availability of credit in those markets.
In the case of all three decisions, subsequent experience with actual operating
results has, on the whole, tended increasingly to substantiate the judgments
that led to their adoption. This is particularly true of operating experience
since June 1958. Wihout any intervention from the Federal Open Market
account, except in the short end, the market for United States Government securities has become progressively broader, stronger, and more resilient throughout all maturity ranges. Experience during April and May 1953, just after the
new techniques were adopted, and before their import was understood, is less
clear. This was the period of mounting tension in the credit and capital markets
analyzed in the answer to question 1.
In the 20 months' period of operations under these decisions, the economic
climate has changed from one of boom to one of reduced levels of activity. Accordingly, Federal Reserve policies have been shifted from restraint against
inflation to the active promotion of ease in the credit markets. Ease in the longterm markets, as well as the short-term money market, has been an important
objective of these policies. Although all open-market operations, for technical
reasons cited below, have been confined to the short end of the market, there
appears to be no example that can be cited from Federal Reserve history where
the cost and availability of credit in all sectors of the securities market has been
UNITED STATES MONETARY POLICY
17
more sensitively responsive to shifts in Federal Reserve policy than during
these months. This applies as fully to the market for long-term funds as for
short-term funds; to the market for mortgage money, for business and industrial,
State, municipal and public financing.
It is important to keep in mind the scope of the decisions relating to the new
open-market techniques. They are decisions of the full Open Market Committee
adopted for the guidance of its executive committee and the manager of the openmarket account. They do not mean that no operations wil be undertaken henceforth outside the short end of the market. They do mean, unless modified by
the Committee, that operations in other than the short end of the market will
have to he specifically authorized by the full Open Market Committee, except
operations to correct a disorderly situation. In t h a t case the executive committee, which can be convened quickly by telephone if necessary, is empowered
to authorize such corrective operations.
Background of new techniques
These three interrelated decisions are designed to hold to a minimum the
technical market repercussions t h a t result in some degree from any operation
on the p a r t of the Federal open market account. In one sense it may be said
t h a t any purchase or sale in a market by any party, private as well as public,
small as well as large, disturbs the market in t h a t it results in a change in demand and supply conditions in t h a t market. The new operating techniques are
not designed to prevent this type of repercussion. Such market response is necessary and desirable if a market is to perform efficiently the function of continuously equilibrating changes in demand with changes in supply. On the contrary,
it is the primary objective of the techniques to contribute, so far as possible, to
the development of such responsiveness in the market for United States Government securities. For this end to be realized, the market must be able to translate
.swiftly an increase in the availability of funds in any one sector of the market
to increased availability in all sectors, and to soften the impact of decreased
availability of funds on any one sector by spreading that impact over other sectors of the market. In a well functioning market capable of such resilient re*
sponse, Federal Reserve policies can make their greatest contribution to economic
stability and growth.
Technical characteristics
peculiar to system transactions.—The
danger t h a t
•operations by the Federal open market account may, if executed through faulty
techniques, exert an unduly disturbing or even disruptive effect upon the market
f o r United States Government securities arises from four characteristics of these
operations by which they a r e differentiated from purchases and sales of securit i e s for the account of private firms and individuals.
First, the dollar amounts of reserve funds that a r e required to be injected into
-or withdrawn from the markets in the course of ordinary day-to-day operations
:are likely to be quite large, much larger than the average amounts bought or
sold in the course of a day for any individual private account. This naturally
p u t s some strain on the market mechanism which is likely to function most
effectively when the aggregate of its transactions is made up of numerous indiTidual transactions of relatively small magnitude.
Second, the open market account deals in reserve funds which provide a basis
l o r a multiple expansion of c r e d i t This means that when it buys it does more
t h a n merely add to the demand side of the market, as do other purchasers. The
.account pays for its purchases with a check on the Reserve banks. Consequently,
i t simultaneously adds to the reserve base sufficient buying power to absorb a
:much larger volume of securities. Conversely, when the open market account
sells a Government security, the problem of the market is more than finding a
ibuyer for that issue, as it must in the case of sales of securities by others. The
purchasers must simultaneously pay for the security with commercial bank
reserve funds which will be subtracted from the reserve base. This withdrawal
of reserve funds will affect positively the supply of securities offered for sale.
Third, transactions by the open market account are not motivated by profit or
loss considerations.
They differ, consequently, from private purchases and
sales which are so motivated. P r i v a t e firms or individuals motivated by profit
and loss considerations will not pursue purchases when prices rise or yields
fall to levels that appear less remunerative t h a n comparable alternative outlets
for their funds, neither will they press sales and take losses with respect to
•either price or yield when alternative courses of action open to them appear less
costly. The result of these motivations in a market with large numbers of
^participants is to generate forces that tend to slow down, or counteract, or limit
18
UNITED STATES MONETARY POLICY
movements in either direction. The importance of these counteracting forces
was effectively illustrated after the accord when the unwillingness of investors
to take losses reduced offerings in the market for United States securities. This
restrained expenditures and helped materially to prevent a continuation or
resumption of the Korean inflation. These same motives do not govern transactions initiated by the Federal open market account, which are undertaken for
policy reasons, and pursued, until policy goals are achieved, without regard to
their effect upon the earnings of the Reserve banks.
Fourth, the Federal open market account is the largest portfolio of United
States securities under single control. Its holdings of marketable United States
securities approximate $2o billion or nearly 1 out of 6 of all such securities
outstanding with the public. Its potential buying power is also very large.
Transactions initiated by the Federal open market account differ, therefore, from
privately initiated transactions not only with respect to their motivation but also
with respect to the potential financial power that lies back of them.
Role of financial intermediaries.—These four basic respects in which transactions in United States Government securities initiated by the Federal open
market account differ from privately initiated transactions find a reflection in
the technical organization of the market for United States securities. They
are particularly important in circumscribing the role which primary dealers in
United States Government securities and other professional intermediaries are
willing to assume in that market
In general, a market such as the market for United States Government securities achieves depth, breadth, and resiliency when there are active within it, at
all times, professional and intermediaries alert and willing, on their own capital
and risk, to make continuous markets and to engage in arbitrage. To make
continuing markets, they must stand willing continuously to quote firm prices
at which they will buy reasonably large quantities of securities from any and
all sellers, including each other. They must be prepared, if necessary, to hold
such securities in their portfolio, pending subsequent resale. Similarly, a professional intermediary must stand ready to quote firm prices at which he will
sell securities in reasonably large quantities to any and all purchasers, and must
be prepared to enter into such contracts for sale even if the particular issues
in demand are not in his portfolio at the time but must subsequently be
purchased from others.
To make continuous markets successfully with his own capital and at his
own risk, the professional intermediary must be alert to possibilities for arbitrage, i. e., he must sense when various issues are offered for sale or sought for
purchase at prices which are mutually inconsistent with each other in terms of
price relationships which may be expected to prevail in the near future. In such
cases, the professional intermediary seeks to sell the issue that is overvalued and
simultaneously to purchase the issue for which there is momentarily less demand.
This requires a keen sense of values, and has the effect of keeping market quotations for comparable values in close alinement with each other. The sensing of
such minor inconsistencies is less difficult when the two issues are in the same
maturity sector of the market. It requires great skill, however, when they lie in
different maturity sectors, for then the professional intermediary must stake his
capital on a judgment as to price and interest rate relationships that may be
expected to emerge as between the various maturity sectors of the list. When
the financial intermediary, alert to possibilities for arbitrage as between the
various maturity sectors, is able to make such judgments successfully, and is
willing to act on them aggressively, the effect is to impart continuity and responsiveness to the whole market. Continuity exists when variations in quotations
as between successive transactions are minor. Responsiveness obtains when the
impact of sales in any particular sector, instead of being concentrated in that
sector, is cushioned and dispersed in greater or less degree throughout all maturity sectors.
Technical repercussions of transactions for system account,—These technical
factors, taken in conjunction, pose the problem dealt with in the decisions discussed in this answer. Since transactions in United States securities initiated by
the Federal open market account differ in important respects from similar transactions for private account, there is a danger that they may set off adverse
repercussions that impair the efficiency of the market as an equilibrating factor
in the economy. The nature of these repercussions may be illustrated by analysis of a sales transaction initiated by the Federal open market account.
In any market, a transaction initiated by the seller is likely to have as one
effect a lowering of price for the commodity sold. In the market for Government
UNITED STATES MONETARY POLICY
19
securities, this means that sales initiated by any seller are likely to And their
first expression in a softening of quotations for the particular security offered
for sale. The softening is likely to be larger, the larger the amount t h a t is
offered. I t is also likely to be larger if there is ground to expect that the specific
offer for sale is only the first of a series of further offers. In the case of offers
from the Federal open market account, these typical reactions and expectations
a r e likely to be accentuated because such sales not only supply issues to the
market for which purchasers must be found but also withdraw reserve funds
from the market and diminish its ability to carry securities. They are made,
furthermore, from the largest portfolio of the United States Government
securities available for sale in the market. For all the market knows, they
may be the forerunner of many more sales to come. Since they are not motivated
by the twin incentives of maximizing gains or minimizing losses t h a t motivate
most other offers that appear in the market, but are made solely in the execution
of monetary policy, they a r e properly regarded a s a possible signal of the attitude
of the monetary authorities with respect to the state of the economy. These
reactions acquire peculiar significance when transactions are initiated outside
the short end of the market because prices fluctuate most widely in these sectors
in response to changes in the availability of securities relative to the demand
for them.
This imposes a handicap upon private dealers and other professional intermediaries in the market whose function it is, first, to provide continuous markets
by carrying portfolios and taking positions throughout all maturity sectors of
the list, and, second, to maintain a consistent relationship between prices of
different individual securities by being alert to possibilities for arbitrage. The
gross operations of these professional elements are very large relative to their
capital at risk. They maintain markets by trading at very small spreads.
If they are alert, they can function effectively when variations in price from
one transaction to the next are small, as they are likely to be when selling
and buying is on private account, limited in volume by the needs of private
investors for outlets for funds on the one hand, or for cash on the other.
Private professional intermediaries face a very different problem when prices
in any group of securities vary sharply between transactions. Then the risk of
making continuous markets and of engaging in arbitrage becomes too great. They
tend to retire to the sidelines, so far as putting their own capital a t risk is concerned. They cease, under these conditions, to make continuous markets, and
confine their activities mainly to acting as brokers. As a result, the market for
issues characterized by such risks becomes thin and moves over a relatively
wider range between transactions. Such a market reacts sharply to relatively
small bids or offers, and quotations that characterize an individual transaction
become a poor guide to the values t h a t would prevail on normal volume.
Technical advantages of operations in the short end of the market.—The danger
t h a t transactions initiated by the open market account may unduly disturb the
efficient functioning of the market is much less acute when they a r e confined to
t h e short end of the m a r k e t There are three main considerations which contribute to this result.
In the first place, the risk assumed by professional intermediaries when they
t r a d e in bills is much less than when they t r a d e in longer term securities. Bills
a r e traded on a discount basis, and the great preponderance of bills outstanding
a t any one time have a maturity of less than 3 months. This means they will
always appreciate to par within t h a t period. Bills a r e ideal collateral, furthermore, and can always be used as security for loans. I t is not too difficult, therefore, to hold them to maturity. The main financial hazard attending professional
operations in bills is that the holder will have to pay more in interest when h e
borrows to carry them than they gain in price as they approach maturity.
Another reason is that the bill market is accustomed to relatively large transactions such as the open market account must undertake in absorbing and releasing reserves. I t is the market in which all financial institutions typically adjust
their day-to-day positions. Trading is continuous and the market is accustomed
to a large volume of individual transactions.
Finally, the financial markets do not attach the same significance to System
operations when they a r e transacted in hills as they do to transactions in other
sectors of the market. Financial experts know t h a t the Federal Open-Market
Committee is more or less continuously engaged in putting funds into or absorbing
funds from this market as it compensates for large day-to-day fluctuations in t h e
amount of float, in Treasury balances, in the demand for currency, and in other
factors. T h e appearance in the bill market of purchase or sell orders initiated b y
20
UNITED STATES MONETARY POLICY
t h e F e d e r a l open m a r k e t account has no general long-term policy significance in
the g r e a t majority of cases, and therefore does not so readily give rise to apprehensions t h a t a change in policy is imminent.
Summary of technical considerations.—To summarize, transactions initiated by
t h e F e d e r a l open m a r k e t account, particularly transactions in intermediate and
long-term issues, may seriously affect the efficiency of the market. The initial
impact of such transactions falls first on the professional intermediaries of the
m a r k e t whose willingness to t a k e positions gives continuity to t h e m a r k e t a n d
w h o s e willingness to engage in arbitrage works to cushion a concentrated impact
of such sales on p a r t of the price structure by spreading their effect in greater or
less degree throughout all m a t u r i t y sectors.
These intermediaries confront great difficulty in estimating how large t r a n s actions for t h e Federal open m a r k e t account may be, how long they m a y continue,
or how large a r e the losses the seller may be willing to absorb. Such estimates,
however, a r e essential to t h e efficient performance of the professional intermediary whose operations make continuous sensitive markets possible. Without
them, dealers and other professional intermediaries have less basis for decision
as to the amounts of securities they can afford to take into portfolio, or the points
a t which they can undertake an arbitrage operation. The ability to make such
supply and demand estimates correctly on the average is a r a r e skill which a professional intermediary in the m a r k e t must possess in high degree to survive.
When market conditions a r e such t h a t approximate supply and demand estim a t e s cannot be made, the continuity and sensitiveness of the market is seriously
impaired. Dealers and other professional intermediaries in the market become
r e l u c t a n t to t a k e positions and to undertake arbitrage. Instead, they tend to
confine their role to that of brokers, operating mainly on a commission basis.
I n t h i s role, they offer to find buyers for issues pressed for sale, and other
sellers for issues in demand, but they do not themselves purchase or sell securities a t their own risk. They do not, therefore, perform the function of giving
breadth and continuity to the market by their willingness to take'securities into
position.
This situation presents a very real dilemma to the monetary authorities. Monet a r y policy is most effective and can make its maximum contribution to economic
stability and growth without inflation a t high levels of output and employment
when t h e entire credit structure is sensitively responsive to its operations. Fede r a l Reserve operations exert their constructive influence most effectively when
they affect t h e cost and availability of credit throughout all sectors of the
m a r k e t . This is particularly t r u e of t h e long-term market where the r a t e of
saving and t h e cost and availability of funds register on capital formation.
The effectiveness of monetary policies is definitely hampered when markets are
thin.
Historical background of new techniques
M a r k e t conditions, adverse to the proper functioning of dealers and other
professionals in the market for Government securities, were strongly in evidence during the period of pegging prior to the Treasury-Federal Reserve accord
of March 1951. Dealers in United States Government securities tended to confine their operations to the broker function, coming to the Federal open market
account for securities when they were in demand in the market and disposing
of securities to the Federal open market account when they were in supply.
Under these conditions, the account itself performed the function of making
continuous markets for most maturity sectors even including the very short end
of the market. I t did so, of course, at the expense of monetary policies appropriate to the stability of the economy. The reserve funds t h a t were made
available almost automatically under the technique of pegging operated to
augment the availability of credit and t h u s to increase the demand for commodities to a volume that was in excess of w h a t could be supplied. The result
w a s to incorporate into the base of the price s t r u c t u r e a spiral of rising costs
a n d prices.
This inflationary process w a s stopped early in 1951 when the Federal Open
Market Committee discontinued pegging the prices of United States Government securities. Thereafter, as is brought out in the reply to question 1, the
reserve funds released or absorbed through open-market operations were adjusted more closely to the needs of a growing economy operating without- inflation a t high levels of activity. The m a r k e t for United States Government
securities showed its basic strength a t t h a t time by adjusting to t h e new situ a t i o n with much less disturbance t h a n many close and informed observers h a d
UNITED STATES MONETARY POLICY
21
expected, and within a few months the operations of the open market account
were almost wholly confined in practice to the short end of the market.
The Federal open market account continued during this period, however, to
engage in operations in support of Treasury refinancing. The volume of reserve
funds released in these supporting operations became, as time passed, a matter
of increasing concern to the Federal Open Market Committee. They were
large in volume and had later to be recovered by offsetting sales if the fueling
of inflationary forces was to be avoided.
Concurrently, there was increasing concern a t the failure of certain sectors
of the market, particularly the long-term sectors, to develop the degree of
depth, breadth, and resiliency that would be desirable from the point of view
(1) of effective refinancing of the public debt, (2) of the effective execution of
monetary policies, and (3) of the effective operation of the market in shifting
or allocating funds among various users.
Specifically, following the accord, the long end of the market was described
by competent observers as "thin." This was illustrated by the fact t h a t prices
of long-term Government bonds fluctuated over a relatively wide range in response to the appearance of relatively small buying or sales orders. I t indicated
that, so far as the longer sectors of the market were concerned, dealers and other
professional intermediaries still tended, on the whole, to confine their operations
to the broker function. Operations undertaken a t their own risk, either to maintain continuous markets or for arbitrage, remained limited on the whole to relatively small commitments, too small to give the market a desirable degree of selfreliance.
It was in this setting that the Federal Open Market Committee undertook, in
1052, to reexamine intensively the techniques employed by the System itself in
its contacts with the market for United States Government securities to see
whether any changes could he made in those techniques that would contribute
to a stronger, more smoothly functioning market. This examination led, among
other things, to the three interrelated decisions that are dealt with in this reply.
These decisions have fostered a more effective and efficient market for United
States Government securities in two w a y s : First, by reducing to a minimum t h e
direct disturbing or disruptive impacts on the market of transactions initiated
by the System; and, second, by establishing a climate of expectations in the
market t h a t would encourage private operators to engage more actively in making
continuous markets and in arbitrage.
The accomplishment of these results has had beneficial effects on System openmarket operations from a monetary point of view. These operations are now
confined to the amounts necessary to effectuate basic monetary policies—that is
to say, they have come to be limited to providing or withdrawing reserve funds
in amounts and a t times appropriate to the general economic situation.
Decision to discontinue support of Treasury
refinaiicing
The decision to discontinue support operations during periods of Treasury
refinancing was mainly important in improving the timing, reducing the volume
and minimizing t h e disturbing or disruptive effects of System operations on the
market. I t s importance in minimizing the volume of operations initiated by the
open-market account and in improving their timing shows up strikingly in the
record of System operations between July 1, 1951; i. e., after the market had
adjusted itself to the accord; and September 30, 10r>2, the last month in which
direct support was given to a Treasury refunding issue. During these 15 months,
direct operations for System account put reserve funds into the market amounting to $2,418 million net, during periods when the Treasury was refinancing.
During the same 15 months the net effect of all open-market operations initiated
by the System in the intervals between these periods of refinancing was to withdraw $1,65S million. In other words, during those l.r> months, a large volume
of sales from System account were made solely to absorb reserve funds in excess
of basic needs that had previously been put into t h e market to support Treasury
refund ings.
This phenomenon has entirely disappeared since the autumn of 1952 when the
practice of giving direct support to Treasury refinancing was discontinued. At
the same time, t h e r a t e of attrition incident to Treasury refunding operations,
i. e., the relative proportion of maturing Treasury securities t h a t have been
presented for cash payment at maturity, has averaged lower than it did in the
period when such direct support was given. This wholly satisfactory result
reflects, of course, the nature and pricing of new securities offered by the Treasury since supporting operations were discontinued as well as improved performance on the part of the market under the new operating techniques.
22
UNITED STATES MONETARY POLICY
Decision to confine operations to the sliort end of the market
The technical considerations that account for the decision to confine operations
to the short end of the market have already been discussed. The decision was
taken to remove an obstacle that appeared to account, in part at least, for an
undesirable degree of "thinness" in the intermediate and long-term sectors of
the United States Government securities market after the accord. It was not
taken without consideration of alternative techniques from the point of view
both of the possible effects of these techniques on market behavior and of their
implications in the development and effectuation of credit and monetary policy.
Alternative to operations at the short end of the market.—The problem of how
to deal with the effects of central bank transactions on market behavior are not
confined to this country. They are present in greater or less degree in all
countries with highly developed credit structures where open market operations
are used as a principal means of effectuating monetary policies. Some monetary
authorities have tried to meet the problem by themselves assuming primary
responsibility for making continuous markets and for arbitrage. They do this
by being themselves prepared to buy or sell in all maturity sectors of the Government securities market. When a particular issue in demand is in relatively
scarce supply in the market, the monetary authority is prepared to make the
desired securities available from its own portfolio. It may then have to purchase
other securities from other sectors of the list to offset the effect of the sale upon
bank reserves, if the basic objectives of monetary policy do not justify an
absorption of reserves from the credit base.
This procedure resembles in many respects that which was employed by the
Federal Reserve System when it was engaged in pegging the prices of Government
securities prior to the accord and for a period afterward during periods of
Treasury refinancing. It has the important difference that no attempt is made
to perpetuate any particular price level for Government securities. Rather, when
this is done, the monetary authority comes to a judgment not only as to the
general interest rate level but also as to what structure of rates would be most
appropriate in the various maturity sectors of the market and is prepared in
its operations to make these levels effective. As economic conditions change,
requiring a different level of interest rates or a different structure of rates as
between the various maturities, the monetary authority uses its own operations to
move the prices of securities quoted in the market and market rates of interest
to levels it rgards as more appropriate to the new situation.
When monetary authorities adopt this technique, the problem of thin markets
and sluggish arbitrage is in a sense eliminated, since the monetary authority is
itself prepared to maintain continuous markets and to establish directly and to
change from time to time the levels of prices and of interest rates which it
regards as appropriate to the various maturity sectors of the market. The
various securities in its portfolio become part of the potential market supply
and it takes over the role of primary jobber to the market. At the same time,
for reasons already noted, dealers and other professional middlemen operating on
their own capital and at their own risk tend to confine their activities to that
of brokerage.
It has been recognized within the Federal Reserve System since the accord
that the technique described above not only had intrinsic defects but was inapplicable to the American economy. Considerable thought has, however, been
given to a variant of this approach, namely, one in which the Federal Open
Market Committee would normally permit the interplay of market forces to
register on prices and rates in all the various maturity sectors of the market
l)iit would stand ready to intervene with direct purchases, sales, or swaps in any
sector where market developments took a trend that the Committee considered
was adverse to high level economic stability.
It will be readily appreciated that this' variant differs decisively from that
described above. Instead of taking affirmative responsibility to make continuous markets and to establish interest rates and prices in all the various sectors
of the list, the Committee under this variant would operate normally in the
short end of the market, absorbing or releasing reserve funds from day to day
in accordance with general policy directives. It would stand continuously
ready, however, to intervene in any sector of the list when it considered such
intervention might further the objectives of monetary policy.
Such intervention would not necessarily have to be decisive. The fact that
the Committee purchased or sold securities at any given quotation would nor
mean that it was prepared to engage in similar subsequent transactions to maintain the same price. Rather, it would seek, by occasional purchases and sales
UNITED STATES MONETARY POLICY
23
At the fringe of the market, to cushion or reverse declines or advances a t some
times and to accelerate them at others. In each case of intervention, the decision
whether to accelerate or cushion would be based on an evaluation of what WHS
considered most appropriate at the time to the achievement of the objectives
of monetary policy.
This variant, which paralleled closely the actual pattern of System operations
during the period following the accord up to the spring of 1053, was not adopted
because it did not appear to offer real promise of removing obstacles to improvement in the technical behavior of the market.
System open marled experience from the accord to March 1053.—During the
greater p a r t of the first 2 years after the accord, the great bulk of transactions
actually undertaken by the System was confined, in fact, to the short end of the
market. These included purchases to support Treasury refinancings, most of
which were executed in the short end of the market. At t h e same time, the
policy statement of the Federal Open Market Committee directed the executive
committee to maintain orderly conditions in the market for United States Government securities. I t was generally understood during this period, both within
the System and in informed market quarters, that it was the policy and desire
of the System t h a t a free market for United States Government securities should
develop and be permitted to make its maximum contribution to economic stability both in the sense of equating the demand for funds for investment witii
t h e supply of savings (with due allowance for the growth factor in the money
supply) and of being permitted to allocate these demands and supplies as between the various sectors of the market. At the same time, it was understood
t h a t the System stood ready through open market operations, without restriction
as to maturity, to check undesirable movements in prices and interest rates.
In comparison with the preceding period in which the practice of pegging
prices and yields contributed to the inflationary potential, this shift in policy
and technique was in the right direction. Despite the forebodings of many who
prophesied that the dropping of the pegs would be followed by chaos, a free
market did develop when the pegs were dropped and did play a major role in
stopping the inflation and in sustaining the economy a t high levels of activity.
There was no catastrophic shift in prices of Government securities. There was
no panic. Confidence in the stability of the dollar was restored. The results
of the action in all major respects, except one, corroborated the judgment of
those who took the responsibility for its initiation.
The exception, already noted, was the thinness that continued to characterize
the intermediate sector and the long-end of the market for United States Government securities. At first, this was generally explained by the fact that a return
to a free market after so long an interval would necessarily be accompanied by
some frictions. I t would necessarily take time, it was felt, for appropriate
mechanisms to develop in the market before it could perform its normal functions
at high efficiency. As time went on, however, these mechanisms failed to develop
adequately and the problem of thin long-term markets continued to exist. I t
was in this setting and, in part, to consider how to deal with this problem, t h a t
the Federal Open Market Committee in 1952 undertook the studies t h a t led to
the three decisions treated in this question.
Decision to change directive icith respect to orderly markets
During the period from the accord to March 1953 there was considerable misapprehension and confusion with respect to the interpretation of the phrase
"orderly markets," a situation which in many respects was justified. The clause
in the directive requiring the executive committee to maintain orderly markets
was in the directive prior to the accord and was the authority under which many
stabilizing operations were taken at t h a t time. The fact t h a t the phrase had
not been changed after the accord but instead had been interpreted less restrictively left legitimate grounds for uncertainty with respect to the interpretation
t h a t might be placed upon it in future operations.
The decision to change the directive to the executive committee "to maintain
orderly markets for United States Government securities" to read **to correct
a disorderly situation in the Government securities market** w a s made to
remedy this misapprehension and confusion. This gave notice t h a t the Federal
Open Market Committee would not intervene to prevent fluctuations of prices
and yields such a s normally and necessarily occur as markets seek to establish
equilibrium between supply and demand factors and to allocate savings as between the different maturity sectors. Instead, it indicated t h a t the market would
have to be clearly disorderly before such intervention would occur.
/
24
UNITED STATES MONETARY POLICY
The primary aim of this shift in operating objectives was to foster in the
market a climate of expectation with respect to System intervention that would
encourage maximum private participation in market activities. In combination
with confinement of operations to the short end of the market, the shift also
contributed to minimizing the disturbing or disruptive effects of System
operations.
Experience ivith the neio techniques
These decisions were taken in March of 1953 in the hope and expectation
that they would provide an environment in which professional intermediaries in
the market would begin to broaden the scope of their operations in a way that
would give greater depth, breadth, and resiliency to the intermediate and longer
sectors. Specifically, it was hoped that these intermediaries, faced mainly by
business and market risks which they were in a position to evaluate and freed
from the risk of disturbing or disruptive repercussions arising from direct intervention by the Federal Open Market Committee, would begin to make more
continuous markets and engage more promptly in arbitrage through all maturity
sectors. It was hoped that they would sufficiently improve the market so as to
minimize the occasions for direct System intervention in these sectors of the
market, intervention either to correct the development of a disorderly situation
or intervention to hasten the market's response to changes in credit and monetary
policy. These expectations to date have been on the whole fulfilled, although,
of course, it is recognized that this approach is still experimental and that insufficient time has elapsed to draw firm conclusions.
The first and most difficult test came in the spring of 1953, within a very short
time after the new techniques were adopted, and before their impact had been
evaluated or understood. This was the period described in the answer to question 1 when great tension developed in the long-term investment market, sufficient tension to require vigorous offsetting action by the Federal Reserve System.
There were many at that time who felt that direct System intervention in the longterm money market was the only remedy that would relieve the situation. This
view gained adherents when the first purchases of bills, initiated by the System
early in May 1953, found relatively small immediate response in relieving tension
in the long-term sector of the market even though the Treasury with its own
funds made some purchases in that sector during this period. Finally, as the
Treasury made larger purchases and the open-market account undertook to
supply reserves in large volume through an aggresive purchase of bills, the
tension began to subside.
Subsequently, all sectors of the market, long, intermediate, and short, have
been characterized by great improvement with respect to their depth, breadth,,
and resiliency. Private arbitrage has brought about a sensitive response to the
System's monetary policy in the long-term sectors of the market. The ease
that for some time has pervaded the money and credit markets may account for
part, but it does not by any means account for all, of these results.
It has been a primary objective of System credit and monetary policy during
this period to encourage an expansion in private activity financed by long-term
funds. This has also been a main objective of Treasury debt management
policy which has refrained from competing with mortgage borrowers and other
potential users of long-term savings. While, under the new techniques, openmarket operations to help effectuate this policy objective have been confined
entirely to putting reserves into the short market, the response in the form of
increased availability of funds in the long-term capital markets, including even
the semi-isolated mortgage market, has been gratifying.
The recession of industrial activity during this period has been exceptionally
mild as compared to other periods, even milder than the recession of 1949 when.
United States security prices were pegged. It would be very difficult to make a
case that direct intervention in the long-term markets during this period would
have induced an even better response.
Such is the experience with the new techniques to date. As previously pointed,
out, it remains for them to be tested in other more normal periods of Federal Reserve operations. Only time and further experience will tell whether problems
not now foreseen will or will not emerge. If they do, it will be the duty of theFederal Open Market Committee to deal with them in the light of its accumulated experience.
Conclusion
The formulation of appropriate credit and monetary policy is, at best, difficultIt requires, first, painstaking search for all the relevant facts that may bear on.
UNITED STATES MONETARY POLICY
25
the economic and financial outlook; second, all the wisdom and insight that experience and operating contacts can bring to the interpretation of those facts,
and, finally, and perhaps most important, humility with respect to any emerging
situation. There are relatively few occasions when the meaning of developing
events is so clear that the monetary authorities can say, "As of today, our policy
should be changed from restraint to ease." A shift in policy emphasis more
typically emerges from a succession of market developments and administrative
decisions in which the range for variation needed in pursuit of any particular
policy gradually shifts from the side of ease to the side of restraint or vice versa.
The various factors that exert an impact on bank reserve positions are
at best difficult to forecast in advance. There is a considerable margin of
uncertainty in any forecast of factors absorbing or supplying reserves. Yet
these forecasts or projections must be made in planning open-market operations.
In consequence, there is frequently much discussion, when prospective purchases or sales are authorized, of whether it would be wiser to deal with the
area of uncertainty in the forecast in the direction of restraint or in the direction of ease. These changing shifts in emphasis do not necessarily mean that
a new policy direction is emerging. Usually, however, by the time the facts
of the economic situation are sufficiently clear to lead to the adoption of a
changed policy directive, it will be found that these day-to-day allowances for
uncertainties in the forecasts of reserve availabilities have begun to be increasingly resolved on the side later indicated by the new policy directive.
Such tentative testing and probing of the responsiveness of the economy to
monetary actions would be much more difficult if the Federal Reserve were
to make itself responsible not only for adding to and withdrawing marginal
amounts of reserve funds from the money market but also for making continuous markets and establishing interest rates and prices prevailing in all
sectors of the security markets. Then any changes in such interest rates and
prices could result only from direct administrative decisions. Such decisions
would carry considerable significance in themselves and would require adequate
justification.
Such justification might not be too difficult to find if the American economy
customarily relied on the import of capital for its development. In that case,
the necessary signals would usually be furnished by movements of prices and
interest rates in the various sectors of the foreign financial market from winch
the capital was imported. In fact, however, the American economy is a highsaving economy that exports rather than imports capital. In this country if
the stmcture of interest rates were too closely controlled, it would be difficult
to tell from the character of the market response whether and when new trends
were developing within the economy. The allocation functions of the market
place in determining relationships between the cost and availability of funds in
the various sectors of the market, short-term, intermediate, and long-term, would
be in abeyance, and responsibility for efficient performance of these important
economic functions would be transferred to the area of official discretionary
action.
In conclusion, it needs to be emphasized once more that it is not contemplated that these new techniques will never be changed. The Federal openmarket committee must always be prepared to tailor the techniques of its operations to the requirements of the economy. In the development of those techniques, situations may wrell arise when the Federal Open Market Committee
will want to operate directly outside the short end of the market.
It must also be emphasized that the new techniques do not imply that the
Federal Open Market Committee is unconcerned about developments throughout
the securities market or that it is committed to dealing only in he short end
of the market whatever may happen to prices and yields of long-term securities.
The Federal Open Market Committee directive specifically and positively enjoins
the executive committee to operate to correct a disorderly situation in the market
for United States Government securities if one develops. Such situations rarely
do develop in efficiently functioning markets. History indicates, however, that
there are occasions when a market becomes clearly disorderly and in itself
threatens economic stability. This happens when a selling or buying movement
feeds on itself so rapidly and so menacingly as to prevent counteracting forces
from developing within the market mechanism. Usually, these situations reflect a serious deficiency or excess of reserve funds and can be corrected by
26
UNITED STATES MONETARY POLICY
operating to adjust the volume of reserves to the requirements of the economy.
Sometimes, however, they occur in response to other factors. Under the Federal Open Market Committee's present directive, the executive committee is
responsihle for diagnosing such a situation if one develops and for dealing with
it decisively without any restriction whatever as to sectors of the market in
which transactions are initiated. (4) What is the policy with respect to volume of money?
The policy of the Federal Reserve System with respect to the volume of money
is to provide as nearly as possible a money supply which is neither so large that
it will induce inflationary pressure nor so small that it will stifle initiative and
growth. Put another way, the policy is to help maintain a volume of money
sufficient to facilitate the consumption and investment outlays necessary to
sustain a high level of production and employment, without leading to spending
and investing at a rate which would outstrip the supply of available goods at
prevailing prices and generate speculative conditions. Judged from this standpoint, the amount of money required varies with such factors a s : the productive
capacity of the economy; the state of business expectations; economic dislocations of various kinds; seasonal fluctuations; and changes in money turnover
or velocity reflecting variations in liquidity and the demand for liquidity on the
part of businesses and consumers.
In the past, the monetary supply has shown considerable fluctuation over the
course of business cycles. It is the policy of the Federal Reserve System to
counteract, insofar as possible, the tendency for excessive cyclical swings in the
volume of money.
An economy which is expanding requires an increasing supply of money to
facilitate its growing volume of transactions. Additions to population and productive capacity and a growing complexity of economic organization give rise to
increased needs for cash balances. It is the policy of the Federal Reserve System
to foster growth in the money supply in accordance with these needs.
Like any other modern monetary system, the monetary system of the United
States is complex. In view of its complexities, it is not feasible to rely upon any
mechanical formula for the determination of the volume of money appropriate to
a given economic situation. This subject is one requiring continuous examination and study—historically, currently, and prospectively—of the various changing forces affecting the economy's need for money.
Our monetary organization and its complexities were discussed at considerable
length in the reply of the Chairman of the Board of Governors to question 28 of
the questionnaire addressed to him in 1951 by the Subcommittee on General
Credit Control and Debt Management, under the chairmanship of Representative Patman. They were also treated again in an article under the title "The
Monetary System of the United States" published in the Federal Reserve Bulletin
for February 1953.
(5) Has monetary machinery fa) worked flexibly, and (b) has the market
demonstrated flexibility in its responses to changes in policy? For example,
how has the policy of "active ease" been reflected in the level and structure of interest rates, the volume of credit, and the roles of various types
of lenders?
The monetary machinery since mid-1952 has worked flexibly, and the market
has responded flexibly to changes in credit and monetary policy. The effectiveness of credit and monetary policy is due in part to its adaptability to changing
economic circumstances. During late 1952 and early 1953, inventories were
rising, the Federal cash deficit was increasing sharply, consumer installment
indebtedness was growing rapidly, capital outlays were being made on a large
scale, credit demands generally were very strong, and forward commitments
were taking on a speculative hue. With the economy already operating at
virtually full capacity and producing in excess of final takings from the market,
these developments constituted a threat to long-term stability and growth.
Accordingly, Federal Reserve policy from mid-1952 to late spring 1953 was
directed toward restraint of further increases in spending financed by bank
credit. With abatement of inflationary pressures in the late spring of 1953, the
Federal Reserve readapted its policies to promote orderly realinement of activities and to foster a climate favorable to resumption of economic growth.
UNITED STATES MONETARY POLICY
27
The influence of credit and monetary policy can be traced through observations
of changes in live interrelated factors: the availability of credit relative to
demand, the volume of money, the cost of borrowing, capital values, and the
general liquidity of the economy. Examination of each of these factors helps
to illustrate the points of "flexibility" and "responsiveness" raised in this
question.
In considering these factors it is important to keep in mind that credit and
monetary action is only one of the many factors, although an important one,
affecting the general level of economic activity. The influence of credit and
monetary policy in any period is necessarily conditioned by various other policies
and programs of the Federal Government, by economic and political developments
abroad, and by public responses to a variety of unpredictable events. Also,
the effectiveness of credit and monetary policy in a particular period needs
to be judged in the light of broad experience and observation. One of the
difficulties with such judgments is that iinancial and institutional practices are
constantly changing so that close comparison with past periods may not be
entirely appropriate. These changes result in iinancial adjustments which
differ in responsiveness and degree of lag from one period to another.
Availability of credit
Changes in the availability of credit, while not subject to statistical documentation, may be observed in a general way from the terms and conditions which
lenders require in granting credit, from their passivity or aggressiveness in
seeking out new outlets for loan funds, and by the response that borrowers experience to their applications for credit. During the period of credit tightening
through late spring of 1953, for example, the very large demands for credit
exceeded the substantial volume of funds available for lending and lenders
had to adjust their operations to this fact. Some lenders, particularly banks,
tended to favor short-term credits and reduced their longer term lending.
Other actions to discourage undue borrowing were adopted by various lenders.
Commercial banks tended to require larger minimum deposit balances from
borrowers. Insurance companies tended to write more restrictive call provisions and other features into their private-placement agreements. Mortgage
lenders generally tended to favor paper with shorter terms and to require larger
downpayments. Also, lenders cut back their activities for developing new credit
outlets, became reluctant in many cases to accept new borrowing customers, and
reduced the volume of their lending to borrowers who were marginal in terms
of risk and longrun profitability. These tendencies became more pronounced as
the tightening movement progressed.
With credit easing after the late spring of 1953, these developments were
reversed. In general, lenders found themselves with more funds available relative to the demand than earlier, and were under pressure to keep such funds
fully invested. As a result, uses of credit were promoted that under tighter
money conditions had been postponed or curtailed. The volume of new security
issues was maintained at a very high level throughout the period of business
decline, and a number of these issues, particularly State and local government
revenue issues, were of a type that would not have been brought out in the earlier
period of restraint. Mortgage credit became available on more liberal terms
with respect to downpayment and maturity, and lending commitments to builders
again came to be readily arranged. Consumer credit standards and terras also
eased, although with more lag than in the case of mortgage credit. Commercial
banks, moreover, became more aggressive in term lending and tended to lengthen
somewhat the maturities of their investment portfolios as well as to widen the
area of their investment interest. In some cases these liberalizations went further than had been attained in the preceding period of credit ease.
Volume of money
The accompanying chart shows the movement in demand deposits adjusted plus
currency in circulation, seasonally adjusted, since mid-1952. Federal Reserve
restraints on the expansion of bank credit during the period of inflationary threat
from mid-1952 to late spring of 1953 were effective in curbing growth in the
money supply at a time when pressures for bank credit and monetary expansion
were very strong. During this period, the demand deposit and currency holdings
28
UNITED STATES MONETARY POLICY
of individuals and businesses increased by $3 billion, or about 21/* percent. This
compares with a growth of over 6 percent in each of the preceding 2 years.
Over the past year and a half, the money supply increased further even though
business activity declined over the first half of that period. Demand deposits
and currency of businesses and individuals leveled off during the second and
third quarters of 1953, after allowances for usual seasonal movement, rose moderately thereafter through mid-1954, and subsequently increased sharply. Over
the year ending September 1954, the money supply expanded by $3 billion, or
approximately 2V2 percent This expansion, which reflected primarily an increase in bank holdings of Government securities, is in contrast to the behavior
of the money supply in most previous periods of business decline. In some previous recession periods the money supply contracted, reflecting a significant liquidation of bank credit as a factor of economic recession. Under such circumstances,
curtailed liquidity put consumers and businesses under pressure to reduce their
spending, thus contributing to further recession in activity.
DEMAND DEPOSITS AND CURRENCY
I Billions of Dollars
Seasonally Aijasted
1950
I
I
1952
I
H0
1954
Cost of "borrowing
The accompanying table of selected market interest rates since mid-1952 shows
the changes that have taken place in the cost of borrowing. Reflecting the combined influence of heavy credit demands and restrictive Federal Reserve policy,
interest rates began a general advance in the second half of 1952. The advance
accelerated in early 1953, with peaks for this movement reached in June. Thereafter, the interest rate movement was reversed as Federal Reserve policy shifted
from one of restraint to one of actively fostering credit ease. Market interest
rates declined appreciably through the early part of 1954 and subsequently have
shown little change.
The movement in interest rates spread throughout the credit market, affecting
all types of credit paper and securities, although in different degree. For example, rates charged by banks on customer loans were more sluggish in their response on the downside than were open market rates. However, the responsiveness of market interest rates to the policy of "active ease" was very marked;
the decline in money and capital market rates after mid-1953 was as sharp and
widespread as in the comparable phase of any other business downturn since
World War I.
29
UNITED STATES MONETARY POLICY
Selected money rates
[ M o n t h l y averages]
U . S. G o v e r n m e n t securities
Bills
1.700
1952—Juno
1.824
July..
1.876
Aupust.
1.7S6
September
—
1.783
October
November
_. 1.862
2.126
December
2.042
1963—January
2.018
February
2.082
March
2.177
April.
2.200
May
2.231
June
Change: J u n e 1952 to J u n e
+.531
1953
2.101
1953-July
2.0S8
August
1.876
September
,
1.402
October
1.427
November
1.630
December
1.214
1954—January. _
.984
February
1.053
' March
1.011
April
.782
May
.650
June
.710
July.
.892
August...
1.007
September
.987
October
Change: J u n e 1953 to October 1954
-1.244
Corporate b o n d s
Prime
commercial
paper
Bank
rates
to
customers
3.51
3 to 5
years
Lonsterm
old
scries
2.04
2.14
2.29
2.28
2.26
2.25
2.30
2.39
2.42
2.46
2.61
2.86
2.92
2.61
2.61
2.70
2.71
2.74
2.71
2.75
2.80
2.83
2.89
2.97
3.09
3.09
2.31
2.31
2.31
2.31
2.31
2.31
2.31
2.31
2.31
2.36
2.44
2.67
2.75
+.88
2.72
2.77
2.69
2.36
2.36
2.22
2.04
1.84
1.80
1.71
1.78
1.79
1.69
1.74
1.80
1.85
+.48
2.99
3.00
2.97
2.83
2.85
2.79
2.68
2.60
2.51
2.47
2.52
2.54
2.47
2.48
2.51
2.52
+.44
2.75
2.75
2.74
2.55
2.31
2.25
2.11
2.00
2.00
1.70
1.5S
1.56
1.45
1.33
1.31
1.31
-1.07
-.57
-1.44
3.49
""§."'fil'
~~3.~ 5 4
~~3.~73
+.22
3.74
"3776'
3.72
"z'm
~3.~56
-.17
Municipal
bonds
Aaa
Baa
2.94
2.05
2.94
2.95
3.01
2.98
2.97
3.02
3.07
3.12
3.23
3.34
3.40
3.20
3.19
3.21
3.22
3.24
3.24
3.22
3.25
3.30
3.30
3.44
3.58
3.67
3.50
3.50
3.51
3.52
3.54
3.53
3.51
3.51
3.53
3.57
3.65
3.78
3.86
2.10
2.12
2.22
2.33
2.42
2.40
2.40
2.47
2.54
2.61
2.63
2.73
2.99
+.46
3.28
3.24
3.29
3.16
3.11
3.13
3.06
2.95
2.86
2.85
2.88
2.90
2.89
2.87
2.89
2.87
+.47
3.62
3.50
3.56
3.47
3.40
3.40
3.35
3.25
3.16
3.15
3.15
3.18
3.17
3.15
3.13
3.14
+.37
3.86
3.85
3.88
3.82
3.75
3.74
3.71
3.61
3.51
3.47
3.47
3.49
3.50
3.4J
3.47
3.46
+.89
2.99
2.88
2.88
2.72
2.62
2.59
2.50
2.39
2.38
2.47
2.49
2.48
2.31
2.23
2.29
2.32
-.53
-.53
-.40
-.67
Capital values
Changing interest rates have also affected the economy through the recapitalization of future income, that is, through lowering or raising the dollar value of
existing capital assets, particularly long-lived assets. This response has been
especially noteworthy in the securities markets where prices of outstanding
bonds and investment-type stocks have registered the influence of interest rate
movements as well as, of course, of other factors. The attached table shows
the percentage changes in values in selected types of capital asset over the past
2*£ years.
From mid-1952 to mid-1953, the increase in yields and consequent decline in
prices of United States Government securities and corporate and municipal
bonds reduced significantly the market value of investors' portfolios of such
securities. Stock prices also showed moderate decline over this period despite
prosperous business conditions. These developments were an influence helping
to damp down the boom in capital outlays in this period.
Since mid-1953, rising prices of bonds and stocks have reflected in part the
influence of falling interest rates. This movement in values has tended to help
sustain private capital expenditures during the period when business activity
in other lines was receding somewhat in consequence of the work-off of excess
inventories and reduced defense expenditures following the settlement in Korea.
55314—54
3
30
UNITED STATES MONETARY POLICY
In some investment areas, such as the farm a n d existing residential real estate
areas, values declined somewhat despite falling interest rates. These declines
reflected t h e overriding effect of other factors, for example, t h e reduction in
agricultural income in the case of farm real estate values a n d t h e increasing
supply of new homes in t h e case of residential real estate values. Even in these
areas, however, there is reason to believe that t h e higher capitalization factor
helped to cushion the decline in market values.
Percentage
changes in selected capital
Government bonds (long-term)
_
Corporate bonds (high-grade)
Municipal bonds (high-grade)
.
Preferred stocks (high-grade)
...
Common stocks * (Standard & Poor's series).
values
June 1952June 1953
June 1953October 1954
-7
-6
-12
+9
+8
+10
+14
+33
1
Values of common stocks are, of course, particularly affected by important variables other than the
capitalization factor. These include, for example, changes in earnings and dividends and changes in expectations as to general business developments.
General liquidity of the economy
Changes in t h e volume of money and other highly liquid assets a n d in t h e
value of existing assets affect t h e liquidity of businesses a n d individuals a n d
influence their willingness to spend and invest. They also aifect t h e liquidity
of financial institutions and their willingness to lend a n d i n v e s t
The restrictive credit policy from mid-1952 to last spring 1053 caused existing
assets to decline in liquidity. This development influenced consumers and businesses to screen expenditures more carefully either because they were reluctant
to dispose of interest-bearing securities a t the prices currently prevailing, or
because they were encouraged by rising yields to save and invest in securities
or other savings forms. Also, t h e desire for liquidity was heightened by t h e
fact t h a t access to credit w a s not a s assured a s it h a d been earlier. This p u t
a greater premium on holding cash balances and other liquid assets rather t h a n
spending. T h e relative stability of prices over this period, moreover, fostered
confidence in the value of t h e dollar so t h a t holders of deposits and currency did
not feel pressed to make expenditures immediately in anticipation of higher
prices.
I n contrast, falling interest rates in t h e recent period of monetary ease tended
to make individuals and businesses, a s well a s financial institutions, more liquid
a n d increased t h e proportion of their assets that could be sold a t cost or profit.
This is particularly true of investment portfolios where t h e rise in prices of
marketable United States Government bonds, corporate bonds, State a n d local
government bonds, and corporate stocks made holders more willing to lend a n d
to spend. T h e fact of ready availability of credit, furthermore, reduced t h e
requirements of businesses and individuals generally for liquidity.
Concluding
comment
Viewed a s a whole it appears that credit and monetary policy exerted a wholesome restrictive influence in t h e 1952-53 period of boom and a desirable cushioning and sustaining influence in the economic decline which followed. I n so doing,
it made a necessary and positive contribution to stable economic growth.
UNDER SECRETARY OF T H E TREASURY FOR MONETARY AFFAIRS,
Washington,
November
26,1954.
Hon. K A L P H E . FLANDERS,
Chairman, Subcommittee
on Economic Stabilization
of the Joint Committee
on the Economic Report,
Congress of the United
States,
Washington, D. C.
M Y DEAR M R . C H A I R M A N :
F o r Secretary H u m p h r e y , I am t r a n s m i t t i n g t h e
Treasury's replies to t h e questions your subcommittee directed to us on October
26, 1954, with respect to United States monetary policy and debt management
In recent periods.
Both Secretary Humphrey and I a r e pleased to participate in your subcommittee's review of recent thinking a n d experience i n this important field. T h e
31
UNITED STATES MONETARY POLICY
past 2 years have given us our first real test in a long time of the contribution
t h a t a flexible money and credit policy can m a k e to economic stability and
growth.
As you know, the Secretary is currently attending the Conference of Ministers
of Finance or Economy in Rio de Janeiro, but he still hopes to attend your
subcommittee's hearings on December 7. In any event, I shall be there.
Sincerely yours,
W. RANDOLPH BURGESS,
Under Secretary
for Monetary
Affairs*
Enclosures.
MONETARY POLICY AND DEBT MANAGEMENT
REPLIES IJY T H E TREASURY DEPARTMENT TO QUESTIONS SUBMITTED BY TIIE S U B COMMITTEE ON ECONOMIC STABILIZATION OF T H E J O I N T COMMITTEE ON T H E
ECONOMIC REPORT, NOVEMBER 1954
Question 1. What role did monetary policy play in the period of relative stability
following the Treasury-Federal Reserve accord in 1051, in the months of
boom late in 1952 and early 1953, and in the recession of 1953-54?
This question is being answered fully by Chairman Martin of the Federal
Reserve Board, in his reply to the same inquiry. On the debt-management aspect
of your question, however, we a r e glad to add a few comments from our own
experience since this is the area where final responsibility lies with the Treasury,
rather than with the Federal Reserve.
Early 1953
When we came to the Treasury in J a n u a r y 1953, we were faced with t h e
problem of developing a constructive program for the effective management of a
public debt of more than $265 billion in an economic environment during the?
early months of 1953 where inflationary pressures were still running high.
Production was a t a record high in the spring of 1953 and was exceeding sales,
causing a threatening accumulation of inventories in the hands of manufacturers
and distributors. Defense expenditures were high and plant and equipment
expenditures were setting new records. Unemployment was a t extremely low
levels and industry was spending large amounts for overtime employment.
The Nation's resources were fully utilized and any further sizable expansion
of credit could result only in uneconomic competition for scarce labor and materials a t the risk of further price rises. At this time, consumer credit was expanding rapidly and business loans were continuing to increase a s compared
with the normal expectation of seasonal contraction. New corporate and municipal security issues were a t a record high and new mortgage financing w a s
running ahead of previous years.
Together with the prospect of a large Federal deficit, all of these factors
created inflationary pressures. In addition, controls over prices and wages h a d
just been lifted. This was a situation t h a t called for monetary and credit
restraint, and t h a t is exactly w h a t the Federal Reserve was applying.
Treasury action in debt management in the first half of 1953 was carefully
planned so as to tie in with a Federal Reserve monetary policy of credit r e s t r a i n t .
Debt-management decisions in this period wTere geared to a program designed t o
offer securities attractive to nonbank investors and by so doing avoid the inflationary potential of increased bank ownership of Government securities. I n
February, instead of offering investors who held a maturing certificate merely a n
exchange into another 1-year certificate, the Treasury gave investors the opportunity to go into a 5-year 10-month bond. The market response to the bond
offering was encouraging and indicated t h a t there wras demand for securities
beyond the 1-year area.
As t h e Treasury approached its spring financing and realized t h a t more money
w a s needed than h a d previously been expected, the Treasury offered a billion
dollars of 3^4-percent 25- to 30-year marketable bonds for cash—the first longterm marketable securities issued since the end of World W a r I I financing. In.
addition, close to half a billion dollars of the 3%'s were issued in exchange f o r
those series F and G savings bonds which matured in the calendar year 1953.
The Federal Reserve policy of credit restraint, together with these debt-management actions, permitted t h e heavy credit demands in t h e market to m a k e
a natural correction through t h e operation of a rising level of interest r a t e s r
continuing the trend of 1951 and 1952. T h e Treasury, in doing its borrowing;
paid the rates required by the market in recognition of the principle t h a t th&
Federal Reserve should be free to exercise appropriate monetary a n d c r e d i t
policy.
32
UNITED STATES MONETARY POLICY
Monetary and debt-management policy in the first part of 1953 played an important part in checking the inflationary ground swell.
The period since Map 1953
, By the early summer of 1953 the situation changed. Business demand for
funds lessened and inflationary pressures receded. There were some evidences
of slowing business activity. In this new environment monetary and debt-management policies were directed toward increased availability of credit for appropriate business demands. As a result of the successful use of these policies,
inventory liquidation was able to proceed in an orderly fashion without fear
of a tightening up on loans and capital expansion was encouraged. Interest rates
fell and the path of legitimate credit growth was smoothed.
In its refunding operations in June, and again in August, the Treasury issued
only 1-year certificates in exchange for maturing issues to avoid any tightening
effect on the money market as it adjusted to its new environment. The only
major Treasury cash financing in that period was an offering of $5.9 billion
8-month tax-anticipation certificates to cover the seasonal low in Treasury receipts during the second half of the calendar year.
Monetary policy during the late months of 1953 and during 1954 has stressed
active ease in the money market. The Treasury, therefore, has refrained in the
past year and a half from issuing long-term securities. It has purposely done
its financing so as not to compete for or reduce the long-term money available
for private capital investment or for State and local highway, school, and other
construction projects. This policy has contributed appreciably to maintaining
a high level of economic activity during the last year or so.
Treasury debt management policy, therefore, has been tied in very closely with
monetary policy throughout the last 2 years, first in helping to restrain inflation
and then in helping to avoid deflation. The successful restraint of inflationary
forces eased the task of monetary and debt management policy in avoiding
deflation.
The Federal Reserve and Treasury actions of these past 2 years have conformed
to the principles stated by your own Joint Committee on the Economic Report,
through Senator Douglas' subcommittee in 1950 and Representative Patman's
subcommittee in 1952, which concluded that "* * * we believe that the advantages of avoiding inflation are so great and that a restrictive monetary policy
can contribute so much to this end that the freedom of the Federal Reserve to
restrict credit and raise interest rates for general stabilization purposes should
be restored even if the cost should prove to be a significant increase in service
charges on the Federal debt and a greater inconvenience to the Treasury in its
sale of securities for new financing and refunding purposes."
• That freedom has been restored, just as President Eisenhower promised it
would be in his first state of the Union message in early 1953:
"Past differences in policy between the Treasury and the Federal Reserve
Board have helped to encourage inflation. Henceforth, I expect that their single
purpose shall be to serve the whole Nation by policies designed to stabilize the
economy and encourage the free play of our people's genius for individual
initiative."
Long-run debt management objectives
In the same date of the Union message, President Eisenhower also suggested
that the long-run objective of Treasury debt-management policy was to "prop•erly handle the burden of our inheritance of debt and obligations." At the same
time that we have been working closely with the Federal Reserve in pursuing
policies which would lean against inflation or deflation, the Treasury has also
made progress toward its long-term objective of working toward a better balanced maturity structure of the public debt—one that will contribute, along
with budgetary and monetary policies, to high employment, rising production,
and a stable dollar.
When the present administration came to the Treasury in January 1953, the
debt was too heavily weighted in the short-term area. Short-term securities
tend, by their very nature, to be very liquid—almost like money. When they are
relied upon too heavily, they can add substantially to inflationary pressures.
A large volume of short-term debt also means that the Treasury has to be
.almost continuously in the market refunding short-term securities. When the
Treasury has to engage in so many financings every year, it means that the
.Treasury's impact on the money market is almost continuous, either through the
UNITED STATES MONETARY POLICY
33
planning of a new financing, the financing itself, or the secondary market response to it. This tends to limit the effectiveness of Federal Reserve credit
control operations. The greater the space between Treasury financings, the less
will be the likelihood of this sort of interference.
In addition, Federal debt ownership should be broadly distributed among the
various investor groups in the economy—and within those groups as well. In
a democracy like ours, it is important that citizens participate in its responsibilities as well as its benefits. With a direct stake in their Government's financial
operations, either through individual or group investments in Government securities, they will tend to take a more active part in seeing that the Nation's affairs
are managed in their best interests. That is one of the most valuable functions
that the Treasury savings bond program is performing today.
A widespread debt—in terms of maturities as well as holders—contributes to
the effectiveness of monetary policy aimed at promoting economic stability.
When the Federal debt is widely distributed, action taken by the Federal Reserve
to tighten credit during inflationary periods or to ease credit during deflationary
periods will tend to be more effective as its impact is transmitted through all
parts of the money market.
Improvement in delt structure
The Treasury has made progress in improving the structure of the debt during
the past 2 years, although improvement has at times been slow because of the
need for adjusting our financing to the economic situation of the moment.
The first step in spreading out the debt was taken in the February 1953 refunding, but a more important step was the issuance of the 3Vt percent longterm bond in May. Treasury debt extension was postponed temporarily in the
summer of 1953 as the market was unreceptive and short-term bank financing
contributed to maintaining the volume of money. In the later months of 1953,
however, the Treasury was able to make several modest moves toward lengthening the debt. On three occasions securities were offered which were attractive
principally to commercial banks who were interested in lengthening out their
own portfolios of intermediate-term Government securities. In this way, $7
billion of the debt was extended for periods ranging from 3V> to nearly 8 years.
Debt extension of this type was neutral with respect to Federal Reserve monetary policy. No useful purpose would have been served in flooding the commercial banks with more short-term securities than they wanted. Yet through
issuance of intermediate-term securities, the Treasury was able to improve the
maturity structure of the debt without competing directly in the long-term market for funds that were needed to support a high level of capital expansion in
the economy.
The record of debt management in 1954 follows essentially this same pattern.
Commercial banks again expressed interest in lengthening out their portfolios
and this gave the Treasury the opportunity to spread the debt further through
the use of intermediate-term securities.
In February 1954 investors exchanged $11 billion of maturing issues into
7-year-9-month bonds. In May, August, and October, a total of §13 billion more
intermediate-term bonds and notes were issued—partly for cash and partly in
exchange for maturing securities. The Treasury's latest refunding offer of
8-year-8-month bonds in its December financing has just been announced (November 18) and we have every reason to expect that the new bond will be well
received. This is the longest bond offered since the 3%'s in the spring of 1953.
Even before we include the new December bond, the Treasury has issued
$33 Mi billion of securities in 1953 and 1954 which were beyond the 1-year area.
As a result of these operations from January 1953 through November 1954,
the Treasury reduced the amount of marketable debt maturing or callable within
1 year from $74 billion to $63 billion—a decline of $11 billion. The Treasury
debt in the over-5-year category rose by about $ 8 ^ billion during this period,,
and will increase again in December. Furthermore, the average length of the
marketable debt has risen in 1954, marking the end of a steady 6-year decline
which virtually ended in 1952 and leveled out in 1953.
It is also significant that during 10 out of 12 major financings during 1953
and 1954 (excluding seasonal borrowing in anticipation of tax receipts), the
Treasury offered investors securities longer than 1-year certificates. This is quite
a contrast to the 2 preceding years, when on only 2 occasions out of 13 were
marketable issues offered outside the 1-year area.
34
UNITED STATES MONETARY POLICY
Question 6. Has the debt management policy of the Treasury—both as to objectives and techniques—been consistent with the monetary policy of the Federal
Reserve throughout the period since mid-1952?
In the reply to Question 1, we have already discussed the role that debt management has played in the past 2 years to complement monetary and credit-control
action taken by the Federal Reserve, first in the period through the spring of
1953—when inflationary pressures were still running strong and credit restraint
was appropriate—and then later as the inflationary tide turned and an easier
Federal Reserve money policy encouraged the free availability of credit for legitimate needs.
Fiscal and monetary policy—with an independent Federal Reserve working
in harmony with effective budgetary, tax, and debt policy—is the mainstay
of our program for sound money in America. This is a major plank in the
program of the Eisenhower administration. It is not surprising that it was also
*i major plank in the reports of both of your predecessor subcommittees studying
these matters. It is a fundamental of good government.
In 1950 your Subcommittee on Monetary, Credit, and Fiscal Policies, headed
by Senator Douglas, concluded that—
"We recommend not only that appropriate, vigorous, and coordinated monetary,
credit, and fiscal policies be employed to promote the purposes of the Employment
Act, but also that such policies constitute the Governments primary and principal method of promoting those purposes."
And again in 1952 your Subcommittee on General Credit Control and Debt
Management, headed by Representative Patman, agreed in these words:
"We believe that general monetary, credit, and fiscal policies should be the
•Government's primary and principal means of promoting the ends of price stability and high-level employment and that whenever possible reliance should be
placed on these means in preference to devices such as price, wage, and allocation controls and, to a lesser extent, selective credit controls—all of which involve
intervention in particular markets * * *."
We believe in this policy. Under the present administration, the Federal Reserve has been free to pursue a flexible credit policy conducive to stability and
economic growth.
Independence does not mean isolation. We have worked very closely with
the Federal Reserve Board, with the Federal Reserve bank officials, and with
their staffs all along the line. We know of no occasion in the past 2 years when
debt management decisions were not completely consistent with Federal Reserve
monetary policy.
Question 7. What considerations should dictate the maturity distribution schedule
of the Federal debt, first, as to the long-run ideal to be pursued and, second, as
a • practical operating matter, giving weight to timing and contemporary
;
-conditions?
In the reply to question 1, we discussed our long-term objectives of gradually
moving more of the debt out of short-term securities into the hands of long-term
savers. In the same reply, we also discussed our shorter-run objectives in terma*
of managing the debt in a way that was consistent with monetary policy. A few
additional comments here are in order.
The Treasury's long-term objective of achieving a better debt distribution cannot—and should not—be defined in terms of any specific maturity pattern.
Changing economic conditions require changing perspectives, and debt-management policies, like budgetary and monetary policies, can best serve the Nation's
interests if they are flexible.
An ideal maturity structure of the debt cannot be suddenly achieved or rigidly
maintained. Improvement in the maturity structure of the debt is the composite result of a multitude of financing decisions over the years. We are working with a complicated debt structure which is already in existence. We do not
have the opportunity to set up an entirely new debt structure, so progress must
necessarily seem slow at times. As President Woodrow Wilson said in his first
inaugural address:
"We shall deal with our economic system as it is and as it may be modified, not
as it might be if we had a clean sheet of paper to write upon; and step by step
we shall make it what it ahould be * * *"
In the attainment of an improved debt structure, the Treasury cannot arbitrarily set the maturity distribution of the debt by dictating the terms under
which it will borrow. The market for Government securities is to a large extent
compartmentalized. Many investors are interested only in short-term securities,
UNITED STATES MONETARY POLICY
35
others prefer long-term securities, and still others want a more diversified portfolio. The market expression of demand for various types of securities from
a wide variety of buyers has a powerful effect on the maturity structure of the
debt.
Like other borrowers, the Treasury must meet the test of a free money market.
The success of Treasury financings is dependent on its ability to offer attractive
securities a t those times and in those areas where market demand exists. The
Treasury may be able to encourage investors to lengthen or to shorten their
portfolios by offering them a choice of two issues, one of which may be a little
more attractive to some investors than the other. But it is the investor who
makes the ultimate decision as to which security he will take. He may decide
not to take either one.
There are many ways in which the problem of improving the structure of the
debt may be approached. For example, the average maturity of the debt can be
lengthened by the same amount by putting out a billion dollars of a 30-year bond
or a larger amount of a shorter bond. Yet the particular economic circumstances of the moment may make the shorter alternative an obvious choice if the
long bond would work against Federal Reserve monetary policy rather than
complement it.
, The experience of the last year and a half is again a case in point. During
the transition to a lower level of Government spending, it has been important to
economic stability t h a t the Treasury not put out any long-term bonds which
would interfere with the availability of long-term funds for capital investment.
Under circumstances such as these, improvement of the structure of the debt
may be slowed temporarily.
Obviously, an ideal debt structure must achieve proper balance between short,
intermediate, and long-term debt. A certain amount of short-term debt is necessary and desirable to meet basic liquidity needs of commercial banks and for
nonfinancial corporations, who are building up reserves for taxes and other
short-term needs. But the amount of short-term debt should be kept low enough
so that it does not undermine action taken by the monetary authorities to restrain
undue credit expansion.
Furthermore, a high level of short-term debt already outstanding could create
difficulties for the Treasury in an emergency requiring a substantial expansion
of short-term debt.
Question 8. Are the benefits and costs to commercial banks of handling Government transactions clear enough, or can they be made clearer, to determine
whether or not the banking system is being excessively compensated or undercompensated? What about the Treasury cash balance—its size and management? Should the Government receive interest on its deposits with commercial banks?
This question calls for a brief description of the Treasury depositary system.
The Treasury doesn't make deposits in its tax and loan accounts in commercial
hanks in the same way that the individual goes into a bank and deposits money.
What the Treasury does is to authorize the banks to act on its behalf as a system
of pipelines through which taxpayments and the proceeds from the sale of Government securities flow from the public on their way to Treasury accounts at the
Federal Reserve banks, against which checks are drawn to meet Government
expenses.
Most of the money that follows this route s t a r t s as a deposit in the commercial
banks in their customers' accounts. The payment of taxes or the purchase of
Government securities thus involves the transfer of a deposit from the account of
an individual or corporation to a Government account
Some Treasury deposits in the banks are new deposits, which a r e created when
a bank buys Government securities from the Treasury and pays for them by
giving the Treasury a deposit in the bank. But the newly created deposits don't
stay in the banks very long, because the Treasury begins to d r a w them out after
a few days to pay its bills. When the Treasury pays its bills, the people and business concerns who get the checks deposit them in their banks and thus restore to
the bankings system the funds withdrawn by the Treasury. T h e round t r i p is
completed.
Treasury deposits in commercial banks from these two sources a r e almost
continually on the move. Semiweekly calls for withdrawal of Treasury balances
in the larger accounts, for example, frequently run 25 percent to 50 percent of the
outstanding balance. The average balance of almost $4 billion in these tax and
loan accounts last year looks like a great deal of money—and it is. But it doesn't
36
UNITED STATES MONETARY POLICY
seem quite as big when you compare it with the more than $5 billion of budget
expenditures the Treasury has to meet each month.
The extensive use of this commercial bank pipeline system provides the most
effective method yet devised for maintaining a smooth flow of funds from the
public to the Treasury and back again into the channels of trade through
Government disbursements with a minimum of economic disturbance.
Whenever the Treasury calls in money from the commercial banks and puts it
in the Federal Reserve banks, bank reserves are reduced. Then as the Treasury
spends the money, the disbursement out of the Federal Iteserve causes bank
reserves to go up again. By leaving most of our money on deposit in commercial
banks rather than at the Federal Keserve, the amount of time between the withdrawal and the restoring of bank reserves is narrowed to a practical minimum.
If the uneven flow of Treasury receipts were permitted to go directly to the
Federal Reserve, the banks would have to maintain enough idle reserves to
stand the load of these heavy withdrawals. Their lending capacity would,
therefore, be reduced and interest rates would tend to rise. As it is, the general
public and the whole economy benefit from the more efficient use of these Government funds.
The principal reason, therefore, why the Treasury carries deposits in commercial banks is to assure an orderly flow of funds through the financial community
and avoid jolts and jars. It is in the public interest.
Bank services
The banks perform a great many services for the Treasury. They sell a large
proportion of Treasury savings bonds; they service many of the E-bond payroll
savings plans; they receive subscriptions for marketable Government securities
and handle maturing issues presented for redemption or exchange. Banks participate in the weekly sale and distribution of short-term Treasury bills.
In fact, the banks are the principal salesmen for all the vast billions of Treasury securities. The deposits they thus retain (even briefly) are their incentive
for a vigorous sales effort. Without this arrangement the Treasury could have
to pay commissions for selling its securities. Banks also handle remittances
accompanying employers' withheld tax receipts when they are deposited in the
Government's account.
These and many other services are performed by the banks without compensation other than the value of the Treasury deposit. It should be emphasized that
the size of the Treasury's deposit in any given bank is the result of that bank's
own activities in selling and buying Treasury bonds, handling the flow of taxes,
etc.
Interest on demand deposits
The question whether or not the Government should receive interest on its
demand deposits with commercial banks is related to the broader question of
interest on all demand deposits. The payment of interest on demand deposits
was specifically prohibited by the Banking Act of 1933. This applies to Federal
Government tax and loan deposits, which average around $4 billion, and to the
$% billion balances that the Treasury carries in general bank depositaries. It
also applies to the $10 billion of State and local government demand deposits, and
to the $100 billion demand deposits of individuals and businesses.
The prohibition of payment of interest on demand deposits was partly due to
the belief that some of the serious bank failures of the twenties and early thirties
resulted to a considerable extent from the weakening effect of excessive interest
payments by banks for competitive reasons. At the time of the Banking Act of
1933, an added burden was also being placed on the banks in the form of assessments for Federal deposit insurance. More important still, interest payments
on deposits forced the banks to charge higher i*ates for loans in order to cover
their costs. A resumption of interest on demand deposits would exert pressure
on banks to charge higher loan rates.
It is almost impossible to make a useful analysis of the cost and income of the
banks attributable to Government operations; they fluctuate widely, differ from
bank to bank, and involve such a large part of bank activities. Bank profits have
not been high, however, compared with other kinds of business and compared
with the need to build up capital funds to protect their customers' funds.
Senator FLANDERS. Following the announcement of these hearings
on November 12, the subcommittee was asked as to -whether or not
the Council of Economic Advisers had been given an opportunity to
UNITED STATES MONETARY POLICY
37
present its views on this important subject. The Council was given an
opportunity, but declined at this time. I n order that the record may
be clear on this subject, however, I will insert at this point, without
objection, correspondence between the staff director of the Joint Committee on the Economic Report and the Chairman of the Council of
Economic Advisers.
Without objection, that will be inserted.
(The correspondence above referred to is as follows:)
OCTOBER 1,
1954.
Dr. ARTHUR F . B U R N S ,
Chairman, Council of Economic Advisers, Washington 25, D. C.
DEAR ARTHUR: Before Senator Flanders left for California last week he
asked me to explore t h e possibilities of 2 or 3 days of hearings in early December
on United States monetary policy—recent thinking and experience. There h a s
been a desire on t h e p a r t of some members of the subcommittee to meet with
the Federal Reserve Board of Governors and the Federal Reserve bank presidents more or less informally to discuss monetary policy. This could be arranged
with convenience in early December during the fourth quarterly meeting of t h e
Board and bank presidents here in Washington.
I have prepared t h e attached very preliminary and very confidential plan for
3 days of hearings along t h e lines expressed to me by Senator Flanders. As
always on such studies we like to give the Council of Economic Advisers an
opportunity to be heard either in executive or open session on the subject under
consideration. You will note t h a t on the attached plan we have tentatively reserved time to hear from you. We would, of course, like to hear you but will be
guided by your washes a s to (1) wThether you appear or not and (2) whether
you wTish a closed session or an open session.
In addition to your letting me know your desires in this connection a s soon as
possible, wre would appreciate any suggestions or observations which you may
have a t this time with respect to the questions t h a t will be considered in t h e
study and t h e first-day panel participants. W e will welcome any and all of
your suggestions.
With best regards,
Sincerely yours,
GROVER W. ENSLEY, Staff
Director.
T H E CHAIRMAN OF T H E
COUNCIL OF ECONOMIC ADVISERS,
Washington,
October
11,195$.
Mr. GROVER W. EXSLEY,
Staff Director, Joint Committee on the Economic
Report,
Congress of the United States, Washington 25, D. C.
DEAR GROVER: Thank you for your letter of October 1, in wThich you set out
tentative plans for hearings by t h e joint committee, to be held early in December, on recent monetary happenings and policies in t h e United States.
I appreciate t h e position taken by t h e joint committee in leaving it u p to t h e
Council to decide whether or not to testify.
The month of December is going to be an especially busy time for the Council,
and after weighing all sides of t h e question I have reached the conclusion t h a t
it would be best for me not to appear during the December hearings. My conclusion is reinforced by two facts: First, t h a t the Economic Report is likely to convey
the Council's general thinking on monetary policy; second, that any questions
t h a t members of t h e joint committee may have about the Council's stand could
be cleared up if I testify next year, as I did this year, a t the hearings dealing
with the Economic Report.
Sincerely yours,
ARTHUR F . B U R N S .
Senator FLANDERS. I regret that Congressman Richard M. Simpson,
a member of this subcommittee, is unable to attend these hearings;
he is in Geneva participating in the General Agreement on Tariffs
and Trade Conference. Senator Fulbriglit, another member of this
38
UNITED STATES MONETARY POLICY
subcommittee, also is participating in international discussions at the
"United Nations in New York and it is unfortunate that he, too, can't
be with us. They both have expressed interest in the subcommittee's
inquiry, however, and I am sure will look forward to reading the hearings and the summary of this proceeding.
I do not view these hearings as resulting in a special subcommittee
report but subject to the will of the subcommittee will view them as
part of the educational functions of this committee. The hearings
will be published, and I am sure will take the same place on this subject of monetary policies and debt control that the previous hearings
have taken in colleges, on the shelves of economists, on the shelves of
others who are technically interested and technically concerned with
the problems that we are discussing today.
I am sure that these hearings also will assist the committee in the
formulation of the committee's annual report to the Congress which
is due on March 1.
The plan of the hearings was set forth in the announcement of
November 12. I t includes a panel discussion today composed of recognized monetary technicians arid, I might add, of widely varying points
of view, from universities and from financial institutions.
Tomorrow morning we will hear from Secretary of the Treasury
Humphrey and W. Randolph Burgess, Deputy to the Secretary of the
Treasury. Tomorrow afternoon we will have a roundtable discussion
on monetary policy questions with the six members of the Board ofGovernors of the Federal Reserve System and the presidents of the
12 Federal Reserve banks participating.
They are holding their regular fourth quarterly meeting in Washington the first part of this week, and it seemed advisable, in view of
the interest we have in getting their opinions, not to ask them to make
a separate trip to Washington when they were coming anyway, at a
time which seemed convenient to the members of the committee.
Before getting into the panel discussion this morning, I wonder if
other members of the subcommittee wish to make any introductory
remarks.
There is one other matter before I ask for preliminary comments
from other members of the committee. With the approval of the
subcommittee it would be my plan, unless other plans and better plans
are suggested, to hold this session until 12: 30, to meet again at 2 and
continue in session until about 4. I would hope that the presentations
of the panel could be completed this morning, with perhaps a little
time left for discussion, and that we could spend the afternoon in
discussion, particularly of the members of the panel with each other
with such observation, comment, and questioning as the members of
the committee, both the subcommittee and the main committee, may
see fit to interpose.
Is there any suggestion from other members of the committee or the
subcommittee with regard to the procedure or by way of introductory
remarks?
Representative PATMAN. May I say a word, Mr. Chairman?
Senator FLANDERS. Yes.
Representative PATMAN. First, I commend the chairman for calling
this meeting. I think it is a very fine thing. I think it is well
arranged, and I am particularly glad that the Open Market Committee will be with us tomorrow afternoon.
39
TJNITSD STATES MONETARY POLICY
I assume that is what he had in mind in suggesting that all the
presidents of the Federal Reserve banks be here along with the members of the Federal Reserve Board. All the presidents are either now
or have been or will soon be members of the Open Market Committee,
and for all practical purpose they are functioning as members of the
Open Market Committee.
Senator FLANDERS. That is true.
Representative PATMAN. And I assume that we will be privileged to
ask these distinguished gentlemen questions after they have finished,
and that they will return this afternoon for any further questioning
that we desire.
Senator FLANDERS. That is the plan. The plan is to have the Treasury represented tomorrow morning, and in the afternoon we will
have as long a session as may be necessary. I wouldn't call it off at
4 o'clock if the discussion is still lively. Let's keep going tomorrow
afternoon until we have made a good try at clearing up the various
points of interest in open market operations.
Representative PATMAN. Tomorrow seems to be a very crowded day,
with Mr. Burgess and Mr. Humphrey being heard in the morning.
If we are crowded in the afternoon, will there be an opportunity to
have the members of the Open Market Committee back on Wednesday ?
Senator FLANDERS. I think we might even run through into the
evening if that seems necessary.
Representative PATMAN. Mr. Chairman, I ask unanimous consent at
this point to put in the record excerpts from our hearings in the past
in which I have made request, representing the Democratic members,
for the personal appearance of the Open Market Committee before
the Joint Committee on the Economic Report.
Senator FLANDERS. That we will be glad to do.
(The documents above referred to are as follows:)
BACKGROUND INFORMATION ON THE APPEARANCE OF THE OPEN ISIARKET
COMMITTEE OF THE FEDERAL RESERVE SYSTEM BEFORE THE JOINT
COMMITTEE ON THE ECONOMIC REPORT, SENATE OFFICE BUILDING,
WASHINGTON, D. C , DECEMBER 7,195-1:
JANUARY 1954 ECONOMIC R E P O R T OP T H E
PRESIDENT
CONGRESS OF TIIE UNITED STATES.
J O I N T COMMITTEE ON T H E ECONOMIC REPORT,
Tuesday,
February
2, 195Jh Washington,
Z). C.
The joint committee met, pursuant to notice, at 10:20 a. mM in room 1301, New
House Office Building, Representative Jesse P. Wolcott ( c h a i r m a n ) , presiding.
P r e s e n t : Representative Wolcott ( c h a i r m a n ) , Senators Flanders (vice chairm a n ) , Carlson, Sparkman, Douglas, Fulbright; Representatives Simpson (Penns y l v a n i a ) , Talle, Bender, P a t m a n , and Boiling.
Also present: Grover W. Ensley, staff director; John W. Lehman, clerk.
*
*
*
*
*
*
*
STATEMENT OF H O N . GEORGE M. H U M P H R E Y , SECRETARY OF T H E TREASURY, ACCOMPANIED BY H O N . MARION B. FOLSOM, THE UNDER SECRETARY OF THE TREASURY ;
AND H O N . W. RANDOLPH BURGESS, DEPUTY TO T H E SECRETARY
*
*
*
*
*
*
*
Representative PATMAN. NOW, then, Mr. Chairman, I want to make a request
t h a t we invite the entire Open Market Committee before this committee. Tomorrow, I understand from the agenda, we have Mr. Martin. Of course, Mr. M a r t i n
40
UNITED STATES MONETARY POLICY
is the Chairman of the Federal Reserve Board. But Mr. Martin is just the head
•of one group that is part of the Open Market Committee. The Open Market
Committee, under the laws passed by Congress, has tremendous power. It is
composed of the Board members of the Federal Reserve System, and five Presidents of Federal Reserve banks. I believe that this is worthy of the serious
consideration by the chairman and should be granted for several reasons.
No. 1, the five Federal Reserve bank presidents that are on this Committee are
selected by the private banks. They are not directly under obligation to the
Government at all. They are constituents, we can almost say, of the private
bankers in the district where they operate. There are five of them. To have
just the Chairman of the Federal Reserve Board here, I think is incomplete.
J do not think that he is in a position to answer. Particularly is that true now
when the Board has only six members.
Chairman WOLCOTT. Mr. Patman, I wonder if you would withhold your request
until you have heard Mr. Martin tomorrow, and ask the chairman of the committee to give further consideration to your request, following that, if you still
think it is necessary.
Representative PATMAN. I shall be very glad to yield to the request of the
chairman, but I know now, Mr. Chairman, that he cannot speak for the five
presidents of the Federal Reserve banks. He does not have the power to do so.
And since we know that he does not have this power, I would just suggest that
it might be a fine thing to have all the members of the Board of Governors and
ithe five presidents of the bank here for a panel discussion.
Chairman WOLCOTT. Would it not be better if we delayed any decision in that
nnatter until after he testifies?
Representative PATMAN. Certainly. Thank you very much, Mr. Chairman. I
will propound the other questions to him in writing.
CONGRESS OF THE UNITED STATES,
JOINT COMMITTEE ON THE ECONOMIC REPORT,
Wednesday, February 8f 195-£.
Chairman WOLCOTT. The committee will come to order.
We have with us this morning William McChesney Martin, the Chairman of
the Board of Governors of the Federal Reserve System, and with him are Mr.
Young and Counselor Cherry.
*
*
*
*
*
*
*
Representative PATMAN. I will defer as usual to the judgment of the chairman.
Now, one other line of questioning which I hope will be brief, and I will be
through.
I notice you state here on page 11 that—
"It is and must be closely coordinated with debt management. * * *
"But, so far as credit and monetary policy is concerned, we are on our own In
the Federal Reserve System."
What do you mean there, that you are on your own? That you are kind of footloose and fancy free and the System can do anything it wants to do, and nobody is
the master except the Federal Reserve System? Is that the reasoning, Mr.
Martin?
Mr. MARTIN. No. That is what I commented on earlier. I think that we have
the sole responsibility for monetary and credit policy, and we have to exercise our
own judgment.
Now, the monetary function is like the function of the judiciary, as I answered
a t the time of your questionnaire, Mr. Patman, and I could do no better than a t
that time. It requires objective judgment free of private pressures and free of
political pressures.
Representative PATMAN. Or presidential pressure or congressional pressure?
Mr. MARTIN. Exactly.
Representative PATMAN. All of them?
Mr. MARTIN. All of them.
Representative PATMAN. In other words, you are free, almost another branch
of the Government?
Mr. MARTIN. NO. You have delegated to us
Representative PATMAN. The Congress has.
Mr. MARTIN. The Congress has delegated this to us.
Representative PATMAN. That is the reason I asked the chairman yesterday,
and I hope he does not talk me out of this one—I asked that the Open Market
UNITED STATES MONETARY POLICY
41
Committee appear before our committee, because we ought to be able to see one
time in our lives the people who are actually running the monetary credit policy
of t h e Government.
Chairman WOLCOTT. I am afraid I am going to have to
Representative PATMAN. The Congress has delegated the power to the Open
Market Committee, which you state here, and correctly so. Since we have delegated t h a t power, which the one-hundred-and-sixty-million-and-some-odd people
gave to the 531 Members of Congress, to 12 people, I would just kind of like to see
them a t one time.
I make the request, Mr. Chairman, again, t h a t we call them before this committee.
Chairman WOLCOTT. You said you would like to see them a t one time.
Representative PATMAN. I would like to see them before this committee.
Chairman WOLCOTT. We have a problem with respect to the witnesses. W e
have a tentative program right up through the lGth, and then the staff and t h e
members a r e going to have a terrific job to do to get this report out by March I T h a t is w h a t has been bothering me.
Representative PATMAN. Don't you think this is more important t h a n everything?
Chairman WOLCOTT. 1 do not agree with you t h a t the presence of the Open
Market Committee is more important than the present study during which we
will have other witnesses on the economic report. As I see it now, we would h a v e
to cancel some of these very important panel discussions which we are going to*
have next week to make room for the Open Market Committee. I think t h a t
perhaps the presence of these panels representing labor and agriculture and business and industry and finance generally—I thought, anyway, t h a t their presencewould be of more help to us than the Open Market Committee. T h a t is w h a t i s
bothering me right now. As for myself, I have not made any definite commitment.
Representative PATMAN. All right. I will not insist on i t now, but I do w a n t
you to consider it, because they a r e "it."
CONGRESS OF THE UNITED STATES,
J O I N T COMMITTEE ON THE ECONOMIC REPOKT,
Friday, February 5, 195$.
Chairman WOLCOTT. The committee will come to order.
Representative PATMAN. Mr. Chairman, may I make a request a t this time?
On behalf of the Democratic members of the Joint Committee on the Economic
Report, Senators Sparkman, Douglas, Fulbright, and Representatives H a r t , Boiling, and m y s e l f / i t is requested t h a t the chairman call before this group t h e
Open Market Committee of the Federal Reserve System for questioning.
Chairman WOLCOTT. Well, the chairman will give consideration to the request.
Senator DOUGLAS. The chairman will, of course, with his customary fairness,
hold a meeting of the committee to decide?
Chairman WOLCOTT. I do not see any reason why we should not hold any meetings. If we can get the committee together for that purpose, I don't see a n y
reason why we should not hold a meeting. But today, you know, we a r e running
a little short because of the committee hearings in the Senate on several m a t t e r s
before committees of which members of this committee are members.
Banking,and Currency, for example, in the Senate this morning, is working;
on confirmation of members of the President's Advisory Council.
Representative PATMAN. May I supplement that, Mr. Chairman, with one
brief statement: Mr. Sproul, in making a speech last Monday a week, I believe
i t was J a n u a r y 2*5, emphasized the fact that the Open Market Committee of t h e
Federal Reserve System a r e on their own; t h a t they are almost a separate branch
of Government; t h a t they a r e entitled t o any credit for good t h a t is done, a n d
they should be charged with the responsibility of anything that is not good.
H e made a very courageous statement of his viewpoint, and on the day beforeyesterday, wiien Mr. Martin w a s before this group, he stated emphatically t h a t
t h e Open Market Committee was responsible for anything t h a t h a s happened; ini
other words, and with reference to any change of hard money and high interest
policy, they accepted all responsibility for it.
Since they consider themselves kind of off to themselves they have complete
charge, according to their own statements, of the financial and monetary policy
.of our Government, we are j u s t spinning our wheels talking to anybody else*
They are t h e people we should talk to.
42
UNITED STATES MONETARY POLICY
Chairman WOLCOTT. I want to say that there is perhaps no reason why the
Open Market Committee should not come before this committee. But, as I
said the other day, I do not want that subject to get to be a disproportionate
problem before the committee in the study that we making.
Now, we are up against time. We are expecting to devote the next 2 weeks
to open hearings, principally panel discussions, on these problems that the President has raised in his economic report.
• There will be then not more than a week in which the staff of this committee
will have to get to do some very intensive work on the report if we are going
to meet the deadline by March 1, and I hope we can meet that deadline.
Now, I am certain that there will be no opportunity in the mornings to get the
Open Market Committee or any other witnesses, in addition to those which we
have set out in the agenda, to appear before this committee. I thought that,
perhaps, if it was convenient to the committee, if we could work it in on an afternoon, that we might try to do it. But we have got to take into consideration,
of course, the fact that the House and the Senate will be in session in the afternoon. I, frankly, do not look forward with any pleasure to evening sessions,
and I am going to try to avoid as many evening sessions as I can before this
committee at all times.
Now, if we can get a reasonable number of members of the committee here on
some afternoon, as far as it is convenient, where it does not interfere with their
work on the floors, then we can give consideration to it. But I think it would
be a grave mistake to interrupt the continuity of this schedule that has been
set up, with the hope of an entire morning, as we would have to give to the Open
Market Committee, because I think you would put a disproportionate weight on
the testimony that they would give.
I think we all know about what they wTould testify to anyway. But that is a
matter that the committee can decide when we have a substantial number of
the committee here, and I will be very glad to take it up then and see what
they want to do.
CONGRESS OP THE UNITED STATES,
JOINT COMMITTEE ON THE ECONOMIC REPORT,
Thursday, February 18, 195%.
Chairman WOLCOTT. The committee will come to order. We are continuing
the discussion of the President's economic message, and this morning, as a
summary, we have with us three outstanding economists: Edwin G. Nourse,
Martin Gainsbrugh, and Alvin H. Hansen.
Representative PATMAN. Mr. Chairman, may I propound a parliamentary
inquiry?
Chairman WOLCOTT. Mr. Patman.
Representative PATMAN. In behalf of the Democratic members, I wanted to
ask the chairman if he could give us an idea about our request to have the
Open Market Committee before this committee.
Chairman WOLCOTT. As far as the chairman is concerned, he has not changed
his mind with respect to i t He still has the same doubts that he has already
expressed.
I shall put it this way: The question of open-market operations seems to me
a little disproportionate for us to devote an entire day or 2 days to that question.
We have to get this report out by March 1. We have to do a very quick job if
we are going to do it. Personally, it is my ambition that in this respect we break
precedent, or set a record. As far as I know, this committee has never gotten
out its report by March 1 even though the statute requires it. I though that
possibly we might be able to establish precedent this year for future reports and
get it out by March 1. We have made such good progress so far toward that
end that I would be reluctant to suggest that we devote another 2 days to a
subject which, as I said, has become disproportionate to the whole subject.
So, I would prefer that we wait until such time as we can take a little time
-with them. I might say to members of the committee that whatever loose ends
there are wiiich we will not be able to pick up in working on this report, we
might as well continue with a subcommittee.
If such a subcommittee thinks
it is advisable or essential that wTe have the Open Market Committee before us,
then they may do so.
We know also that the makeup of the Open Market Committee will change
materially on March 1. I don't know whether we should have the present Open
UNITED STATES MONETARY POLICY
43
Market Committee down here only to have a new committee come in on March 1
or whether we should wait until March 1 to have the new committee.
Representative PATMAN. May I suggest that I am in accord with the chairman's views on getting out the report, and I shall not do anything to deter him
in that respect. I know that I am speaking the wishes and will of the other
Democratic members in saying that.
But at the same time, it is not necessary that we hear from the Open Market
Committee before we get out the report. We shall have a reasonable time after
we get out the report. I am not suggesting that it is necessary to have them
to get out this report.
Chairman WOLCOTT. I might suggest, Mr. Patman, that a very short time after
we get out this report, you and I are going to be busy with the Commodity Credit
Corporation and the new housing bill. We have hearings on the Credit Corporation bill next Wednesday and immediately following that, hearings on the housing
bill.
Representative PATMAN. I realize that, Mr. Chairman.
Chairman WOLCOTT. SO, I wonder if you and I want to devote that much time
to the Open Market Committee during the House committee hearings on commodity credit and housing.
Representative PATMAN. I think the Open Market Committee has much to do
with the credit situation. In other words, the Congress has delegated to them
important powers, and I do not believe it would be bad to have them appear at
least once before a congressional committee that has never seen them to my
knowledge.
Chairman WOLCOTT. May we leave it this way, that at the first opportunity
when the committee thinks it advisable we will have the Open Market Committee
down here.
Representative PATMAN. Does that mean within the next month or so, or
something like that?
Chairman WOLCOTT. If we were to set up a subcommittee following these hearings to pick up what loose ends we have, then the subcommittee can have them
before them.
Representative PATMAN. We do not want to withdraw our request. We still
want to urge the chairman at the earliest opportunity to have the Open Market
Committee before this committee.
Chairman WOLCOTT. DO you not think perhaps it might be better to await the
new board?
Representative PATMAN. That new board, Mr. Chairman, is somewhat of a
fiction. It is kind of one-third of a member each time.
Chairman WOLCOTT. Maybe it is an important one-third.
Senator FLANDERS. This morning we have eight economists drawn
from universities and financial institutions. They were supplied a
week ago with the Treasury and Federal Reserve replies to our questions. AVe would like each member of the panel to give a summary
of his views on monetary policy during the past 3 years, this summary
not to exceed 10 minutes.
Now, there are 8 of you—8 times 10 is 80 minutes or an hour and
20 minutes. Two of these documents are a little lengthy. They cannot be disposed of in 10 minutes, and I am wondering whether the
members of the committee present would feel like going through with
these, even the longer ones, without much interruption, so that we
can have the documents all presented during this morning's time. I
will leave that to the desires of the committee.
Representative PATMAN. We will leave it to the chairman.
Senator FLANDERS. I think, then, perhaps we might well do that.
And if either of those with the two longer documents feel that they
can shorten them in any way by giving a synopsis of certain paragraphs or pages, it may leave time for discussion this morning.
Following the opening presentation, we will proceed more informally, giving individual panelists an opportunity to expand their
44
UNITED STATES MONETARY POLICY
remarks or to raise questions with respect to other views and to give
subcommittee members an opportunity to question the panel.
I may say that individual members of the panel may insert in the
record that portion of their prepared statements which they did not
have time to present orally today.
Now these panel members will be called on alphabetically. I don't
know of any fairer way to arrange that, whether it will present the
proper contrasts or opinion, I am not sure, but we will proceed alphabetically. I will list them first and then call on them in turn.
The first is Mr. Lester V. Chandler, professor of economics at
Princeton University, in Princeton. I may say parenthetically that
he was the economist for the Douglas subcommittee.
John D. Clark, director of the American National Bank, Cheyenne,
Wyo., former member of the Council of Economic Advisers.
Seymour Harris, professor of economics, Harvard University,
Cambridge.
James N. Land, senior vice president, Mellon National Bank & Trust
Co., Pittsburgh.
C. Clyde Mitchell, Jr., chairman, department of agricultural economics, University of Nebraska, at Lincoln.
Edward S. Shaw, economist, the Brookings Institution, Washington, D. C , on leave from Stanford University, Palo Alto.
Rudolf Smutny, senior partner, Salomon Bros. & Hutzler, New
York.
Frazar B. Wilde, president, Connecticut General Life Insurance
Co., Hartford.
Now, bearing in mind the desirability of getting this all in during
this morning's session, and hoping to have a little time to spare for
discussion, I would urge those reading their documents to take advantage of the provision for putting the whole statement in the record, and
where it seems possible, summarizing passages or pages.
The first one in the list alphabetically is Prof. Lester V. Chandler,
professor of economics at Princeton.
STATEMENT OF LESTER V. CHANDLER, PROFESSOR OF ECONOMICS,
PRINCETON UNIVERSITY
Mr. CHANDLER. Monetary and debt management policies since the
Federal Reserve-Treasury accord of March 1951, may be evaluated
on two different planes. One plane might be called that of "grand
strategy"—the selection of major objectives and the formulation of
general programs of action for the attainment of .those objectives. The
other plane would be that of "tactics"; this would call for an evaluation of the many individaul actions taken—the accuracy of the analysis of current economic conditions, the accuracy of economic forecasts, and the timeliness and appropriateness of each policy action.
I n the short time available for this opening presentation, I shall confine my remarks to a few aspects of what I have called the grand
strategy level.
As is well known, the^ outstanding event during this period was a
change in monetary objectives, which necessitated the development
of new action programs appropriate to the new objectives. For
nearly a decade prior to March 1951, the dominant objective of our
national monetary policy had been to stabilize interest rates, or at
UNITED STATES MONETARY POLICY
45
least to hold their fluctuationswithin very narrow limits. This was
a demanding objective which at times forced the neglect of all others.
Any tendency toward higher interest rates forced the Federal Reserve
to create enough new money to prevent the rise, no matter how inflationary the injection of the new money and loan funds might be.
Conversely, this objective called for a reduction of the money supply
whenever interest rates tended to decline, whatever might be the effects on employment, production, and price levels.
The most important thing that has happened since March 1951,
has been that considerations relating to the behavior of employment,
production, and price levels have replaced interest rate stability as
the dominant determinants of monetary and debt management policy.
This does not mean that the behavior of interest rates is unimportant; it means only that interest rates should be allowed to
change—and be forced by a positive monetary policy to behave—
in a way that will contribute most to attaining the desired behavior of
employment, production, and price levels.
I t follows, of course, that the monetary and debt management
policies followed since the "accord" must be disapproved by those
who believe that the dominant objective of monetary policy should
be stability of interest rates, whatever else may be happening in the
economy. Their criticisms need not be based on any real or alleged
errors in tactics by the Federal Reserve or the Treasury; these critics
must necessarily disapprove the shift of basic objectives. Those who
insist on desirability of perpetually low interest rates must disapprove
of all restrictive policies, no matter how well justified by other considerations. And those who advocate stable interest rates at a high
level must surely disapprove of the actively easy money policy which
has been in effect for well over a year.
For my part, I approve of the shift of objectives that has occurred
since March 1951. This is not because I believe that monetary and
debt-management policies can alone assure the attainment and maintenance of a satisfactory behavior of the economy. I t is only because I
think that flexible monetary policies can make important contributions,
whereas a policy dominated by the objective of stabilizing interest
rates will often, if not usually, accentuate instability of business
activity and prices.
I t may be in order to make a few comments concerning the types
of policies that would be appropriate to the new objectives. A shift
to the objective of promoting economic stability and growth does not
imply any decrease m Federal Reserve responsibility for developments
in the money market; nor does it imply that Federal Reserve policies
should be any less active. I t is necessary to make this point because
of some puzzling official statements during the period which created
confusion and left the impression that the official policy was to be one
of passivity—of allowing the forces of private supply and private
demand to determine conditions in the money market.
High officials in the Treasury Department have at times suggested
that interest rates should be determined by the market forces of demand and supply, and the Chairman of the Board of Governors made
a memorable speech describing the transition to "free markets," which
was to include a "free money market." This was, in my opinion, an
unfortunate choice of words. There are some respects in which the
money market should probably be largely free of continuing official
55314—54
4
46
UNITED STATES MONETARY POLICY
control. For example, most of us would prefer to rely largely on
competitive market processes to ration and allocate the supply of credit
among the various competing demanders. But to allow the total
supply of money and loans, and the price of loans, to be determined
by private demand and private supply would negate the very idea of
central banking. Central banks exist because we are not willing to
allow the total supply of money and credit, and the cost of credit, to
be determined by the unregulated forces of private supply and demand.
The basic function of a central bank is to regulate the total supply
of money and credit and the terms on which they are made available.
I t should be clear that the Federal Reserve can make its maximum
contribution to economic stability and growth only by recognizing its
continuous responsibility for money market conditions, and by taking
whatever positive actions that may appear conducive to the attainment
of its objectives. There will, of course, be times when the forces of
private demand and private supply will produce in the money market
exactly those conditions that seem most desirable, and when no current
Federal Reserve action will be required. But there will probably be
many more occasions when the forces of private demand and supply
will produce inappropriate conditions so that an active, and perhaj)S
even an aggressive, Federal Reserve policy will be required. A successful policy of economic stabilization cannot be a passive policy.
I t also needs to be emphasized that a shift to the objective of promoting economic stability and growth does not mean that the Federal Reserve should cease to be concerned about the behavior of interest rates, nor that its control of interest rates should be any less
precise than was its control during the pegging period. The Federal
Reserve's mistake during the pegging period was not that it controlled interest rates; the mistake was in stabilizing interest rates—
in making stability of interest rates an overriding objective and in
sacrificing all other objectives. To be successful in promoting economic stability and growth the Federal Reserve should use its power
to control interest rates, but use the power to bring about those changes
in interest rates which will best promote its purposes.
Chairman Martin quite properly emphasized, in his answer to your
questionnaire, that the effectiveness of Federal Reserve policy does not
rely solely on interest rate behavior. When the Federal Reserve increases or decreases the free reserves of the banking system, the supply of money may be increased or decreased in many ways other than
by a reduction or rise of interest rates—by more restrictive or less
restrictive rationing of credit by lenders, by changing standards of
creditworthiness, and so on. Yet, interest rate behavior is important,
and the Federal Reserve should take the responsibility of forcing the
interest rates to behave in a desirable way. In some cases it may succeed in doing this solely by regulating the volume and cost of bank
reserves; in others it may need to exert a direct effect on the prices
and yields of long-term securities by purchasing or selling them. F o r
example, there may be times when long-term yields remain undesirably high despite large excess reserves in the banking system. A t
such times the Federal Reserve may usefully buy long-term bonds,
thereby tending directly to drive their prices up and their yields down.
Chairman Martin may be right in arguing that technical considerations relating to the broadening and deepening of the long-term
market for Government securities justified the policy of confining
UNITED STATES MONETARY POLICY
47
• open-market operations to the short maturities during the transition
period. I t was, however, reassuring to note in his answer to your
questions that this is not necessarily a permanent policy, and that we
may hope that in the future the Federal Reserve will feel free to buy
and sell long-term governments when such operations promise to be
useful in promoting economic stabilization.
Senator FLANDERS. Thank you, Professor Chandler.
The next on the list is our old friend, Dr. John D. Clark, who was a
former member of the Council of Economic Advisers, and appeared
many times before us in that capacity.
Dr. Clark.
STATEMENT OF JOHN D. CLARK, DIRECTOR, AMERICAN NATIONAL
BANK, CHEYENNE, WYO.; FORMER MEMBER OF COUNCIL OF
ECONOMIC ADVISERS
Mr. CLARK. Thank you, Mr. Chairman.
We now have three official descriptions of the economic situation
when our monetary authorities undertook their unhappy experiment
^vith a repressive monetary policy in the spring of 1953. Two come
to this committee from the Treasury Department and the Federal
Reserve Board. The third is the statement of the President himself,
in the White House release of August 12.
The Treasury says that in the early months of 1953 inflationary pressures were "running high." In the next paragraph it says that production was exceeding sales, a condition which hardly fits into the
description of inflation. Otherwise, in its reply to the committee as
well as in the many self-approving statements issued by the Secretary,
the Treasury sticks to its story that in the first quarter of 1953 we faced
inflation pressures serious enough to require the action which halted
economic expansion.
The Federal Reserve Board gives only faltering support to this
rationalization of fiscal and monetary policy in the spring of 1953.
I t opens its response with the statement that a series of circumstances
""threatened to develop into an unsustainable boom." This is indeed
.a new standard of an economic situation requiring rigorous antiinflationary action.
Later in its report, the Federal Reserve discredits its own speculative fears about economic stability early in 1953. Reviewing conditions
in the period April 1952 to April 1953, the Board finds that credit and
monetary growth "corresponded closely to the capacity of the economy
to absorb more money without inflation." Then comes the flat statement that "inflation was prevented" and that "prices remained relatively stable." So there was neither monetary inflation nor price
inflation in the spring of 1953, according to the Federal Reserve, but
only a fear that things were too good to last.
To the President, the first half of 1953 represents "the greatest
prosperity we have yet known," and he does not conceal his yearning
for a return to the happy economic conditions to which he fell heir.
Neither the Treasury's sense of present danger nor the Federal Reserve
pessimism about a coming storm clouded his assurance that our prosperity was real.
These conflicting evaluations of economic conditions in early 1953
fail to explain why our new fiscal managers set out to upset the
48
UNITED STATES MONETARY POLICY
business boom as soon as they entered office in January 1953, An.
extraordinarily stable price level certified to the soundness of a condition of rising employment, production, and consumer buying. Yet
men who 2 months before Inauguration Day were advertising their
intention to use fiscal and monetary policies as antiinflationary instruments would not look at the real economic facts when they came
to power.
They found eager collaborators in the Federal Reserve Board, which
had read the election reports. Never since the war, and for a long time*
before, had the Federal Reserve failed to assist an important Treasury
offering by supporting the market. This continued to be its policy
even after it had discontinued steady pegging of the market price of
Government bonds in 1951. But November 1952 changed all that.
The large refunding operation on December 1 was given no support.
The market, thus advised that the monetary authorities were not
averse to and would not act to halt the rise in interest rates for which,
the financial district had long hungered, promptly started the upward
rush of rates which did not end until the crisis in the following June.
To keep it going until the new team taking over the Treasury could
swing into action, the Federal Reserve raised discount rates in January. The tiny increase of one-fourth of 1 percent could itself have
little effect upon credit. Its purpose was to show that the Federal
Reserve intended to follow the market, not lead it as it had been doing
for years.
Experience with fiscal and monetary policy in the last 2 years has
not taught us much that we did not know. The tightening of credit
and increasing interest rates smothered a business boom, as such policy
is intended and expected to do. The quick reversal of that policy and
the return to one of low interest failed to forestall the induced recession. For a long time cheap and easy credit has had no effect in inducing economic expansion, as the Federal Reserve learned 20 years
ago, and so reported.
The fundamental issue between the supporters of monetary policy
as a prime anti-inflationary instrument and the old Council of Economic Advisers still remains. In November 1950, we placed before
the joint committee our view, in which President Truman concurred,
that an important inflationary movement should be met by increasing
the facilities and volume of production. This process requires cheap
and ample credit, and until the volume of output increases, inflationary pressure will increase and must be curbed by other than monetary
measures of the kind which increase the cost of capital.
Our objection to the use of monetary policy was, of course, that the
one and only way it reduces prices is by bringing about less employment, less output, and less demand for goods and services than would,
otherwise exist.
This characteristic of monetary policy as an anti-inflationary instrument can hardly be denied, but advocates of that policy believe thatthe monetary authorities can use their power with such finesse that
the inflationary movement is stopped but no real damage is done. Our
view was that gentle measures are futile, and strong action is dangerous.
Very great damage has been done this time, and it is clear that the
President is unhappy over the economic decline, quite apart from the
fact that it has cost his party the control of Congress. But the Treas-
UNITED STATES MONETARY POLICY
49
11 ry and the Federal Reserve seem to be complacent. They do not
quite subject us to the stupid and once common argument that the
recession is a "healthy corrective movement," but they seem to feel
that way and they constantly compliment themselves that they have
done well in not bringing on a real depression.
I t seems that no lessons have been learned by the monetary authorities and that we must expect that unless the Congress intervenes they
will continue to yield to the obsession with the danger of inflation
Avhich sticks out of this and every other Federal Reserve report and
is shared by the officers currently in control of the Treasury.
They have shown a willingness to bring economic expansion to an
end when there is no inflation and they only fear inflation may be
coming. But even when they acknowledge that business needs to be
invigorated, they are willing to engage in only meager action because
they are forever beset by the fear that they will find inflation creeping
into the economy.
This haunting fear of inflation will foreclose resort by them to the
only remaining recovery action in the field of monetary policy—a return to the normal legal requirements for bank reserves. The recent
.grudging decreases even when all public officials were eager to induce
greater economic activity illustrate the deep reluctance of the Board
to restore the normal legal reserve requirements and its determination
to hang on to the extra requirements despite the passing of all circumstances which would justify their imposition. The Board is not even
moved by the fact that if normal reserve requirements are restored,
the Board will have a much wider margin within which to maneuver
whenever the new inflation it is always expecting does arrive.
I do not know whether restoring normal legal reserve limits and
the freeing of 40 percent of the large sums now in reserves would
furnish the extra push to the economy which has been needed since
the business slide-off ended 10 months ago. But the other possible
sources of a major and quick-acting push upon the economy require
legislative action in the very fields where legislation moves most
slowly. Restoration of normal legal reserve requirements is the only
program which can be adopted overnight. I t is the one program in
the field of monetary policy which can add to the fresh stimulus to
economic expansion which is coming right now from the resumption
of full-scale automobile production and the collateral improvement
in the steel industry.
Above all, it is a program which can bring trouble only if it first
produces great benefit, and if inflationary trouble does then develop,
the program can be quickly reversed. By this I mean that reducing
reserve requirements can bring inflation only if it first brings about
larger employment, higher personal income, and greater demand for
goods. Even then, there need be no increase in price levels if freer
and cheaper credit has induced the necessary increase in the output
of goods.
A final word about recent developments which indicate the passing
of the illusion that the Federal Reserve and other so-called independent commissions are not subject to executive control. If orders
can be given to the Tennessee Valley Authority and the Atomic
Energy Commission, even to the point of forcing reversal of commission action, Ave may be sure that the Federal Reserve Board will be
forced, if necessary, to fall in line with any national economic policy
50
UNITED STATES MONETARY POLICY
-which the'President determines upon. I t may be, Mr. Chairman,,
that with a little urging from this committee he will tell the Federal
Reserve to give the economy a real shot in the arm, and he will take
his chance with a little inflation for a change.
Representative PATMAN. Mr. Chairman, I ask unanimous consent
to insert in the record at this point a letter from Dr. Clark that was
published in the Washington Post this morning.
Senator FLANDERS. Without objection, it is so ordered.
(The letter above referred to is as follows:)
STIMULUS TO ECONOMIC GROWTH
F o r the fifth time in a few years, the Joint Congressional Committee on the
Economic Report is today beginning an inquiry into the usefulness of monetary
policy as a method to stabilize the economy.
This indicates a precarious status for a policy which only a few years ago
seemed to be thoroughly accredited, and less than 2 years ago was the most
loudly proclaimed of all of the policies of the new team then taking over t h e
Treasury.
The joint committee has become increasingly cool to the idea t h a t the way
to halt inflation is to choke off a business boom by making credit tight and costly.
The study by the Douglas subcommittee led to a unanimous recommendation in.
J a n u a r y 1950 that vigorous use of monetary policy should be "the Government's
primary and principal method of promoting" the economic stabilization which is;
the purpose of the Employment Act of 1946.
The more ambitious inquiry by the P a t m a n subcommittee, with much the same
membership, brought a divided report in J u n e 1952 with the majority nodding
approval of monetary policy in theory, but sharply criticizing its practical,
operation.
When the full committee concluded its study in February 1954 of the actual
use of restrictive monetary policy to smother the fine business boom wThich thenew administration inherited in the first q u a r t e r of 1953, the majority report did
not have one word to say about monetary policy or about the most dramatic and
important economic experiment of the preceding year. In separate statements,
several of the minority members challenged Treasury and F e d e r a l Reserve
policies.
Now that unemployment, the normal result of the successful use of monetary
policy as an anti-inflationary instrument, h a s brought about the loss of administration control of the Congress, it will be interesting to observe where the joint,
committee goes.
I t will be unfortunate if the new subcommittee holds to its agenda and postpones discussion of the current economic situation and of appropriate recovery
programs until after the annual economic report of the President h a s been received late in J a n u a r y . The historical survey it proposes is important, because
history is being distorted, but of far greater immediate importance is the problem of getting the economy off the dead center upon which it has stuck since
last J a n u a r y .
In t h e 1949 recession, the downward slide of industrial production from October
1948 to July 1949 was immediately followed by a recovery movement which with,
almost no hesitation persisted until industrial production reached a new postw a r high in J u n e 1950, before the Korean outbreak. I n the current recession,
the drop in industrial production continued from July 1953 to J a n u a r y 1954. T h e
J a n u a r y 1954 index figure w\ns 125, in October last it w a s 125, a n d in the intervening months it was either 125 or slightly lower.
Why this difference in the course of the economy, and what does it portend?
May we, like the Government officials who each month assure us t h a t recovery
is j u s t around the corner, be complacent, confident t h a t if we a r e patient t h e
normal and powerful forces of expansion which are inherent in our economy will
sooner or later carry us off the economic plateau and in the right direction? Or
should we fear t h a t t h e stalemate is permitting t h e process of progressive
deterioration wThich used to turn recession into depression to overcome t h e
potency of the new stabilization policies which have twice since the w a r sustained the economy against forces of deflation?
UNITED STATES MONETARY POLICY
51
Experience in the postwar economy is too limited to enable the joint committee
to find wholly satisfactory answers to these questions, but the committee can
reach a conclusion about the wisdom of national action without further delay.
For t h e third time this year, a powerful stimulus to economic expansion h a s
appeared. Neither the substantial reduction in personal income taxes nor the
extraordinarily liberal credit program for housing proved to be strong enough,
by itself, to give the economy the necessary push. We did not supplement either
of these stimuli, when it was new and most powerful, with additional impulses
toward recovery. Now we have the entire automobile industry joining in a full
production program, with a corollary expansion of steel production and with
three weeks of Christmas shopping upon us.
We cannot know whether this combination of powerful forces will itself get
the economy into forward stride again. That depends largely uixm the consumer,
and his verdict on t h e strange new car models has not yet been given. But we do
know that this is t h e last occasion for months to come, when private enterprise
will be developing powerful new stimuli to economic activity. After 3 weeks of
Christmas shopping we will face a season of declining employment, of heavy t a x
payments, of decreasing money supply, and of declining business borrowing. The
Federal Government will then have to carry the full burden of formulating and
supporting recovery programs, if recovery is still around t h e corner.
. Surely, i t is the p a r t of wisdom and prudence to exploit t h e fine opportunity
we now have to join the impetus arising from potent Government action to powerful forces of recovery in the private economy. T h a t opportunity will be lost
if we a w a i t the annual economic report of the President.
J O H N D. CLAHK,
^Yashwgton.
(Mr. Clark formerly was vice chairman of the Council of Economic Advisers.)
Senator FLANDERS. The next speaker is Prof* Seymour Harris of
Harvard. Mr. Harris.
STATEMENT OF SEYMOUR HARMS, PROFESSOR OF ECONOMICS,
HARVARD UNIVERSITY, CAMBRIDGE, MASS.
Mr. HARRIS. Mr. Chairman, since my paper is one of the longer ones,
I shall spare you the dull period of listening to it. 1 would like to summarize my position and save you some time, if that is agreeable, and
put my paper into the record. Is that agreeable, Mr. Chairman X
Senator FLANDERS. I am very glad that you feel able to do that*
Professor Harris.
, Mr. HARRIS. Let me begin by saying that in the last few years it
seems to me that the Federal Reserve has had inflationary jitters, the
Treasury has had a strong inflationary neurosis. Xow, I say that this
is true, both in 1952-53, and 1953-54.
In the first place, there was no price decline in 1951,1952,1953, after
March 1951, and therefore one could very well argue that there was
no case for an anti-inflationary policy. I n the first half of 1953 there
was a cash surplus for the Government. There was no evidence at all
of inflationary pressures, with the possible exception of the rise in
inventories.
Despite that fact, in the first half of 1953 the Treasury raised its
rates to such an extent that within a period of 5 months the rate of
interest rose on long-term Government securities as much as they had
risen in the preceding 7 years.
Now, I will say possibly the Federal Reserve's bark is worse than
its bite. I f you look at the total policy, there were a number of antiinflationary policies during this period. For example, they related on
borrowing by the Federal Reserve on securities and real estate credit,
and they dicl not reduce the excess reserves of member banks, and
52
UNITED STATES MONETARY POLICY
for this reason, though the Federal Reserves were claiming a strong
anti-inflationary policy, actually it wasn't quite so strong as claimed
and did less damage, therefore.
Now, when we look at the antirecession policy which began in about
May 1953, what do we find? We find that there was a reversal of
policy, and for this both the Treasury Reserve and the Federal Reserve
deserve credit. They acknowledged their sins and are ready to give
us an expansionary policy; but unfortunately again they are too fearful of inflation.
For example, in the year ending September 1953 there was a rise of
deposits of $1 billion, or less than 1 percent, in the period when the
G N P dropped by 3 percent, and relative to a full employment economy
by 6 percent. During this same period we had a fall in the annual
rate of Government spending of $9 billion, and we have also since the
peak had a fall in private investment of $10 billion. To offset that, we
have a reduction of taxes with a lag at an annual rate of about $9
billion.
I n March 1954 we reached a peak of 3.7 million unemployed, which is
roughly equivalent to 5 million in my own accounting of unemployment.
Now, during this period of inclusion of hourly cuts and* those unemployed but not so counted concern about the economic situation, the
Federal Reserve gave us an average excess reserve in 1954 of $700
million. I would like to compare this figure with the more than 5
billions of excess reserves in 1939, when required reserves were only
one-third as large. In other words, relatively speaking, the Federal
Reserve gave us one-twentieth as large excess reserves as compared to
the 1939 situation.
Now, some may say, of course, that monetary policy doesn't do
much good in recession, and I think that there is probably a good deal
of truth to this, but the Federal Reserve makes no such claim, and
if they are really using monetary policy, why don't they give us a
couple billion dollars of excess reserves.
Again the chairman made a point that I would also like to make very
strongly, namely, there is an awful lot of nonsense in the Treasury
and Federal Reserve statements about the free market. There is no
such thing as a free market in money. As a matter of fact, where
would our monetary system be without the $24 billion of earning
assets of the Federal Reserve.
Total member bank reserves are only $19 billion. You can imagine
where our monetaiy system would be without the $24 billion of earning assets of our central bank.
Now, you may ask: Why does the System fear to such an extent
controlling the rate of interest? Because actually this seems to be
their great fear. They ^ are afraid to control the rate of interest.
Note their statement on intermediaries when they seem so willing to
relinquish much of their control over the rate of interest.
Modern theory of employment and output holds that above all the
authorities should control the rate of interest, and by controlling that
they control, to some extent, the total amount of investment, and if
the authorities control the total amount of investment, to that extent
they stabilize the economy and allow it to grow, and if they do not do
this, then they endanger all other markets, and if we want freedom
UNITED STATES MONETARY POLICY
53
in all markets we doirt want freedom in the rate of interest, the money
market.
In relation to this point, there seems to be a general view in recent
years that the main objective of controlling the price of Government
securities has been to maintain the price of Government securities.
Now, this, to some extent, has been true and particularly from 1945 on
we experienced some inflation that we might not have had if this policy
had not been carried through.
But I think it is a great mistake to assume that our major objective
was to control the price of Government securities. The major objective was to control the rate of interest, and the way to control the rate
of interest was to control the Government security market, and if you
control the rate of interest then, of course, you also to some extent
control investments.
I t is a great mistake also to assume that there was a miraculous
change in policy in 1951, because, as a matter of fact, in the preceding
year the Government was just as much interested in employment ana
output as was any other government.
I am not trying to make this a political speech. The only point I
am trying to make is that Government also, for many years, had been
interested in employment and output, and we might criticize the
administration on the grounds that before 1953 they gave us a little
more inflation than we might have had, but not on the grounds that
they were not interested in maintaining employment and output.
I am very much surprised to hear the Federal Reserve announce
that they are no longer interested in the long-term rate of interest.
At least, what they are telling us is that what they are really trying
to do is to control the short term of interest, and hoping that this will
in turn control the long rate of interest and that they do not generally
intend to deal in long-term Government securities any more.
This is a surprising position. I am very much pleased that Mr.
Smutny also made a point of the difficulties involved for the dealers of
Government securities resulting from the concentration on the shortterm rate.
There also seems to be a theory held by these authorities that it is
almost immoral for banks to hold Government securities. This is
certainly not my theory, and anybody who has studied American
economic history knows this is the most absurd theory, because if you
go back, for example, to the 1940's and take the situation in the early
1950's, you would find there has been a tremendous increase in the
supply of money. That has made a rise possible and was a condition
for the national income of 8 times and real national economic income
of 4 to 5 times.
Now, what made this possible? What made this possible was the
purchase of Government securities by the banks, because of the total
rise of earning assets by banks during this period, two-thirds were in
public securities.
And I would also like to point out that there it is not immoral for
the banks to hold short-term issues or is it unwise to allow a large
amount of short-term issues to be outstanding because, as a matter of
fact, one of the great revolutions in the Government market has been
the increase in snort-term issues, which has been going on ever since
the twenties, and this has been one of the great contributions to bring-
54
UNITED STATES MONETARY POLICY
ing the rate of interest down from 4 percent in the twenties to 3 percent
in the thirties and 2 percent in the forties.
This also lias been a revolution and has had a great effect on our
economy, and I think has made capitalism stronger since it reduced
what Lord Keynes used to call the dead hand of debt.
When we consider the objectives of the authorities, the Treasury objectives, for example, what were they going to do early in 1953 ?
Actually what these people were trying to do was to get Government
bonds out of the banks, and I would like to suggest this is a silly policy.
At any rate, what did they accomplish ?
From 1945 to 1952 Government bonds held by banks declined by 30
percent. From the end of 1952 to the latest month that I could get figures for, the amount of Government bonds in the banks increased by
6 percent, so they obviously failed here.
The Treasury also wanted to lengthen the average maturity of debt.
I don't have the latest figures, but I wanted to point out that, as a
matter of fact, the short-term securities held by the banks are as large,
that is, securities less than 1 year, than they were at the end of 1952,
and the average maturity of the entire debt actually increased in 1953,
though there might have been some reduction in 1954.
So, in a general way, Mr. Chairman, may I conclude, and within 10
minutes, may I say that I believe that to some extent the Treasury was
responsible for our recession. To a smaller extent, the Federal Reserve was.
Now, I think there are some extenuating circumstances. The Treasury was new at this job, and I think they were a little too anxious and
ambitious to bring us back to a free market.
I do hope that they will learn their lesson and learn this is not a free
market.
I also want to agree with the point that somebody else is going to
make presently, namely, that the Treasury policy is going to increase
the cost of financing the debt, and this is a dubious policy for a Treasury that is so strong for balancing the budget.
And one final point, namely, when you look at the total volume of
earning assets for 1952 to 1953, for example (fiscal year), you find
actually the Federal Reserve, and luckily, policy failed because of an
increase in earning assets of $30 billion, only $3 billion were commercial bank assets, and this suggests the Federal Reserve has a job
to do in trying to control the policies of noncommercial banks.
(The prepared statement submitted by Mr. Harris is as follows:)
SUMMARY STATEMENT OF SEYMOUR E. HARRIS, PROFESSOR OF ECONOMICS, HARVARD
UNIVERSITY, ON MONETARY AND FISCAL POLICY SINCE THE MIDDLE OF 1952
{Comments on the statements of Secretary Humphrey and the Federal Reserve
Board)
SUMMARY OF SUMMARY
Whereas, in the first half of 1953, the Federal Reserve suffered from inflationary jitters, the Treasury seems to have contracted a genuine inflationary
neurosis. Whereas the Federal Reserve attacked the mythical inflation with a
scalpel, the Treasury used a sledge hammer. Whereas the Reserve authorities
neutralized their anti-inflationary policies to some extent by recourse to modest
inflationary policies, the Treasury within a period of less than 6 months raised
the rate of interest by as much as it has risen in the preceding 7 years. Whereas
throughout the years 1953 and 1954 the Reserve authorities carried through their
UNIT 3D STATES MONETARY POLICY
55
policies with due humility and expression of the uncertainty of results, the
Treasury expressed no such doubts.
The Treasury, much more than the Reserve, can therefore be held responsible
.for the rise of rates in 1953, for the imposition of an anti-inilationary policy in
the midst of a period of price stability and even price declines, in a period of
Treasury cash surpluses, and hence can be blamed to some extent for the insuing
recession.
In the period of antirecession policy beginning in May 1953, both the Reserve
authorities and the Treasury wisely reversed their policies. And they deserve
credit for doing so. But their policies were not sufficiently bold. By March 1954,
the official unemployment had reached 3.7 millions and an accurate estimate of
total unemployment would be at least 5 millions. Yet the Reserve authorities
provided an increase of excess reserves of but a few hundred million dollars, and
excess reserves averaged but $700 million in the first 10 months of 1954. What
danger would be involved in raising the excess even to $2 billion? (Compare the
excess reserves of $5.2 billion in 1939, when required reserves were but one-third
those of 1953-54 and hence relatively the excess reserves were 20 times as largo
as in 1954. Commercial tnink deposits in the year ending September 1954 had
increased by but $1 billion, or less than 1 percent, and GNP had fallen by 3 percent in the first 9 months of 1954. Yet here where a sledge hammer should have
been used, a scalpel was applied. There was still too much fear of inflation.
With GNP 5 to G percent ($18 to $21 billion) below the full employment level,
the authorities provided us with $1 billion more of bank deposits. Fortunately a
reduction of $3 billion in personal taxes in 9 months (annual rate) prevented a
onore serious drop. The reduced taxes at least in part offset a decline of $9 billion in Government purchases (annual rates).
In part the trouble seems to lie in a fear on the part of the Federal Reserve
(and Treasury) to control the rate of interest aggressively. Rather the Reserve
authorities insist that they merely offset undesirable movements in rates; and
they restrict themselves even within these narrow limits to influencing the shortterm rate. Modern developments in the theory of money and output seem largely
to have escaped those responsible for monetary and debt policy. They seem to
consider the control of the rate of interest on Government securities merely as an
•attempt to raise artificially the price of these assets rather than (as they should)
consider the control on this rate as a means of determining the rate of interest
generally and hence influencing investment and output and thus increasing the
^probability of freedom in all markets.
The Treasury started with a bang. They were going to reintroduce the free
market; to raise interest rates so that banks would dispose of securities and
other purchasers would be attracted; and they would increase the maturities of
securities. There seemed to be no realization in their repeated statements of the
association of bank purchases of Government securities and the required provision of adequate supplies of money. For example from 1914 to 1951, issues
of $66 billion of Government securities to the banks were twice as important as
Jiew loans in contributing towards a rise of $132 billion in bank deposits, in turn
contributing
toward a rise of national income of S.6 times (4 times in real
income).1
At any rate the policies of the Treasury failed. There is no evidence that the
higher rates increased the market for Government securities net. (The reduced
income accompanying higher rates would tend ultimately to have the opposite
effect.) Whereas banks disposed of 30 percent of these Government securities
from 1945 to 1952, from 1952 to 1954 they actually increased their holdings. Even
the program of converting short-term into long-term securities was not clearly
successful. The percentage of issues maturing in 1 year actually rose. Unfortunately the Treasury does not seem to be aware of the revolutionary changes in
rates, with their significance for economic output and Government finance—a decline from 4 percent in the twenties, to 3 percent in the thirties and 2 percent in
the forties. This is intimately tied to increased needs of liquidity and the great
rise in popularity of short-term issues.
I . ROLE OF MONETARY POLICY S I N C E BOOM OF 1 0 5 2
July 1952-April 1953
The Federal Reserve claims that its policy was a restrictive one from the middle
of 1952 to April 1953. Evidence of restrictive policies is to be found, according
1
See my statement in the 1952 hearings on Monetary Policy and the Management of the
JPublic Debt, pp. 3S0-3S9.
56
UNITED STATES MONETARY POLICY
to the Reserve authorities (statement of November 20), in the limitation of open
market purchases of Government securities to $1.8 billion in the second half of
1952 to meet seasonal needs of banks; the sale of $800 million net of United States
Government securities in January-April 1953 to keep member banks in debt to
reserve banks and hence force banks to be more cautious in lending; and a rise
in discount rates and buying rates on bankers' acceptances in January 1952*
This policy of the Federal Reserve raises certain questions.
One, was there a boom the premise upon which this policy was based? In 1951,
the wholesale price level was 114.8; in June 1952, 111.2; by April 1953, 109.4.
The cost of living, was also remarkably stable. In fiscal year 1952 (ending June
30), the Government's operations were not inflationary. Its cash budget was in
balance; and in the first half of calendar year 1953 there was a cash surplus of $2
billion. There was also little evidence of inflation on the stock market. Then
where was the boom? Indeed, the index of industrial production had risen from
a low of 193 in July 1952 to 235 in December 1952 and 243 in March 1953. But
surely a rise of output accompanied by stable or declining prices is no evidence of
a boom. The Federal Reserve and the Treasury seemed to have had inflationary
jitters.
Second, fortunately despite its large claims of an antiboom policy, it is not at
all clear that Reserve policy conformed to its professions. Perhaps the best test
of effectiveness of Federal Reserve policy lies in its effects on member bank
reserves and notably on excess reserves. Excess reserves in June 1952 amounted
to minus $192 million (deficiency of reserves), but ranged (average daily figures)
from a minimum of $535 million (April 1952) to a maximum of $778 million (Sep*
tember 1952) from July 1952 to April 1953. That the policy (fortunately) was
not as restrictive as claimed is evident in the continued rise of bank deposits
(demand), a rise of $7 billion in the second half of 1952. A seasonal decline followed in the first half of 1953. It is also of some interest that in September 1952
the Board suspended regulation of real-estate credit and in February 1953 reduced margin requirements for purchasing or carrying securities from 75 to 50 percent—these are scarcely restrictive policies.
May 1953-October 1954
In this period the Federal Reserve's objective was to treat an expected recession by introducing monetary case. In May-June 1953, the System purchased
$900 million United States securities and in July-December 1953, $1.7 billion; in
July 1953, through a reduction of reserve requirements, the Reserve authorities
freed an estimated $1.2 billion of reserves and in the summer of 1954, an additional $1.5 billion of reserves were freed. (Though the latter was offset to some
extent by sales of securities.)
Clearly the policy of the Reserve System was in the right direction at this time
and carried tnrough with adequate humility and admission of uncertainties of
effects of policies. The only criticism I can make at this time is, was it enough?
By March 1954, unemployment had risen to 3.7 million (more than 2 millions
above the 1952 minimum) ; and if allowance were made for cuts in hours, the
partially unemployed, those with jobs but unemployed (not counted as unemployed), the total might well be over 5 million.
Member bank reserves were allowed to decline during most of 1953, though this
was offset by relaxation of reserve requirements; and after a rise of reserves in
the latter part of 1953 they moved downward again in 1954. The important variable to watch is excess reserves. They fluctuated very little from May 1953 to
October 1954 ($591 million in May 1953 to a peak of $936 million in January
3954 and generally around $700 million; $705 million average in first 10 months
of 1954). Indeed, member banks' borrowing declined to some extent, though this
writer believes the Federal Reserve exaggerates the significance of this factor as
a contractionist force. Total Federal Reserve credit changed insignificantly net
over the 16 months ending October 1954. It is well to compare the excess reserves
of $700 million in 1954 with the $5.2 billion in 1939, the $3.1 billion in 1941, and
amounts substantially in excess of $1 billion during the war. Was not the Federal Reserve again excessively fearful of inflation and, therefore, inadequately
concerned with unemployment?
I I . POLICY RESPECTING VOLUME OF MONEY
In the opening paragraph of its reply to question 4 (Memo of November 23,
1954), the Federal Reserve presents an admirable statement of the objectives of
monetary policy: to provide a supply of money "which is neither so large that it
will induce inflationary pressure nor so small that it will stifle initiative and
UNITED STATES MONETARY POLICY
57
growth * * * sufficient to facilitate * * * outlays necessary to sustain a high
level of production and employment * * *." This statement marks a great
advance over the theory upon which the System was established, namely, accommodate credit to the needs of trade or even over the objective
of the 1920's,
(though not often publicly admitted) of stabilizing prices.2
But some questions may be raised concerning policies pursued or even avowed
in the light of this admirable objective. Thus in the year ending September
30, 1954, demand deposits rose by but $1 billion, or less than 1 percent. Is this
sufficient to match expected annual growth of 3 percent? That GNP declined
by 3 percent in the first three quarters of 1954 vis-a-vis the corresponding period
in 1953, is all the more reason for making the most effective use of monetary
policy. Would it hurt to raise excess reserves to $2 billion?
Control the rate of interest? The Federal Reserve response to question 3
(why the shift of emphasis "from maintaining orderly conditions to the view
of correcting disorderly situations?") is disturbing to this reviewer of Federal
Reserve policy.
It is a widely accepted view today that the fundamental job of the central
banking system is to influence the total supply of money as a means of determining the rate of interest. Moreover, this indirect method of control should be
implemented by direct purchase and sales of long-term Government securities—
we cannot depend merely on the interrelations of short- and long-term rates to
accomplish our objectives.
Then here are our objections to the Federal Reserve policy as suggested by
the reply to question 3 :
1. The Reserve wrongly fears a control by the monetary authority in cooperation with the Treasury of the return on Government securities (question 3, pp.
1-3, 22-24). They seem to lose sight of the fact that control of the return on
government securities is not only a means of pegging the price of these assets
but, more important, it is a means of controlling prices of all long-term assets
and hence influencing investment and contributing toward freedom in all other
markets. Free markets are not likely to persist without adequate output, in
turn dependent on rates of interest and investment. The primary objective is
to control the rate of interest, not to depress rates of interest on Government
securities. But I hasten to add that the monetary authority also has some
responsibility for maintaining prices of Government securities in a world where
Government finance is of first-rate importance—though this objective should be
related to other objectives of monetary policy.
2. It is absurd to assume that the money market is a free market. The Federal Reserve has created $24 billion of reserves primarily through the purchase
of securities. This has provided not only the cash required to put money into
circulation but has contributed in an important way toward the .$19 billion of
member-bank reserves which are the basis of the deposits of the country. Where
would we be without the Federal Reserve and without the Federal Reserve
determination of monetary supplies?
3. It is difficult to understand why, out of deference to the intermediaries in
the Government security market who are supposed to give the market breath
and stability and who through arbitage operations are supposed to assure a
consistency of prices of different issues of Government securities, the Federal
Reserve should sacrifice its initiative and control of the market. The major
objective is to determine interest rates, not merely offset undesirable changes
in rates as is proposed at one point (question 4, pp. 20-21), and the way to do
this is through Federal Reserve operations.
4. At least we can say for the Federal Reserve that, though it disclaims any
intention to take the initiative, nevertheless through purchases and sales it
sometimes does. Moreover, in its statement of policy with respect to the volume
of money, the authorities say they take into account such factors as productive
capacity, state of business expectations, and "changes in money turnover or
velocity reflecting variations in liquidity and the demand for liquidity on the
part of business and consumers" (question 4, p. 1). Xo better intent to influence
the rate of interest could be found than a determination to offset increased
liquidity by the creation of additional money.
I I I . TREASURY DEBT F I N A N C I N G
Apparently the Treasury moved in at the beginning of 1953 even more convinced than the Federal Reserve that inflation was the great danger. It made
3
See my Twenty Years of Federal Reseve Policy, 1933, especially vol. 1,
UNITED STATES MONETARY POLICY
58
clear its objectives at the outset: (1) Free the Government bond market, with
rates of interest to be determined by the free market; (2) the resultant higherrates would move securities out of the banks into the hands of the public and
thus destroy deposits and cut inflationary pressures; (3) there would follow
a great lengthening in the maturity of the Federal debt.
The Treasury showed little of the humility of the Federal Reserve. At the
very outset a 1spectacular rise in short-term rates was put into effect. The
famous April S ^-percent bond issue followed, an issue which for a while demoralized the bond market. Indeed, whereas the Federal Reserve used a scalpel,
the Treasury had produced a sledge hammer. The resultant rise in interest
rates contributed to the recession which followed. (A supplementary statement to be submitted to the Joint Committee of announced objectives of the
Treasury should be compared with Secretary Humphrey's statement of November
1954.)
Treasury policy was based on certain misapprehensions.
First, the threat of inflation was not serious if present at all; and hence the
economy should not have been jeopardized by a sudden major rise in rates.
Second, the response of additional purchases of securities to any practical
rise of rates is not likely to be large. (Purchases depend on alternative attractions, for example, the pull of the stock market, which the authorities stimulated
by reducing margins and, in 1954, by reducing interest rates; and purchases seem
to depend on income even more than upon rates of interest. But higher rates
cut income.)
Third, the vogue of short-term securities is explained by the vast expansion
of deposits, the need of tax anticipation securities, etc. Though at one point
the Treasury pays lip service to this need of tailoring securities to market needs,,
the general meaning gleaned from Treasury statement of policy is that shortterm issues are dangerous. The fact is that, in the last generation, adapting,
securities to market needs has brought a large rise in the proportion of shortterm securities and contributed greatly toward reducing rates of interest from
the 4 percent level in the twenties, to 3 percent in the thirties, and to 2 percent
in the forties. The resultant savings on Federal Government interest payments
are about $3 billion yearly.
Let us see how much the Treasury has accomplished.
1. Has the Treasury succeeded in forcing Government securities out of the
banks (and thus deflating deposits)? The answer is no. In fact the record
from 1952 to 1954 is much worse than from 1945 through 1952.
U. S. Government securities held by commercial banks
[ Billion dollars]
Change
End 1945, 90.8
End 1952, 63.4
_
End 1952,63.4
Aueust 1954. 67.0
-27.4
+3.6
Percent
change
—30
+6
Source: Federal Reserve Bulletin, November 1954.
What is more, other borrowers were apparently not influenced greatly by higher
rates. For example, here is the percentage of Government securities held by
insurance companies and savings and loan associations (latest figures available,
Federal Reserve Bulletin, November 1954) :
Securities held as percent of assets
December 1952
Life-insurance companies
Savings and loan associations.
14.0
7.9
June 1953
13.3
8.1
August 1954
11.2
6.8
2. Has the Treasury succeeded in achieving substantial lengthening of maturities? The answer is "No." (Again, I rely on the last published figures, exclusive of the late November refunding.)
UNITED
STATES
MONETARY
59
POLICY
Major changes in Federal securities, JP.Jo-.l)
[Billion dollars]
December 1945December 1952
Short-term bills a n d certificates
I n t e r m e d i a t e notes
_
Marketable b o n d s . . . .N o n m a r k e t a b l e bonds
Special issues
-
-
.-
_
December 195*October 1954
Percent
change
-30.0
+33.0
-37.4
+10.0
+9G.0
-16.7
+7.5
-40.7
+9.1
+19.15
-0.8
+6.9
+4.4
-.9
+3.1
Percent
change
-2
+20
+6
-1
+8
Source: Federal Reserve Bulletin, November 1954.
In making this comparison we should allow for the fact that the first period
covers 7 years, the second only 21 months (one-quarter as long). But it is clear
that the Treasury in reducing short-term issues has not been as successful as
the previous administration. In fact the short-term issues were 19.8 percent of
the debt outstanding in 1945, 14.4 percent at the end of 1952, and 13.5 percent
at the end of October 1954. Against this it should be noted in favor of the
Treasury that there was a rise in the marketable bonds outstanding (but contrary to objectives, in the hands of banks). But also note the large rise in notes
outstanding. The average maturity, however, declined from 3 10.77 years in
1946 to 6.77 years in 1953; but there was no improvement in 1953.
Finally, the Treasury had to yield on its objective of raising rates. Here it
had a large success in the first half of 1953, though unfortunately a success in a
mistaken policy; but it had to retrace its steps and help depress rates in 1954.
Instead of seeking to issue long-term securities at higher rates of interest, the
Treasury now introduced a new policy, and a much improved one: they would
not issue long-term securities which might compete with the long-term private
issues.
Before the issue of April 1953 of S^-percent 30-year bonds, the Treasury had
issued a G-year 2%-pereent bond in July 1952 and a 5-year 2MrPercent bond.
The 3%-percent issue marked a dramatic rise in rates.
Interest rates moved as follows:
Taxable Treasury bonds
Average 1945„_
D e c e m b e r 1952
_
„
„
„»„_
2.37
2.75
(o) 12-20
years
J u n e 1953
_
M o o d y ' s AAA
corporate b o n d s
2.83
2.97
lb) 20 years
a n d after
3.09
3.29
3.40
Source: Treasury Bulletin.
It will be noted that whereas the yield of taxable Treasury bonds rose by
0.38 percent in 7 years, 1945 to 1952, aside from the additional rise associated
with the rate on long-term bonds, the rise in the 6 montlis, December 1952 to
June 1953, was 0.34 percent, or almost as much as in the preceding 7 years.
The later rise in corporate bonds was even more spectacular.
(The following statement was submitted in response to the chairan's invitation to the panelists to extend their remarks in the record.)
man
SUPPLEMENTARY STATEMENT BY SEYMOUR E.
HARRIS
On the invitation of Senator Flanders, I make the following comments (unfortunately, I have not had the time to prepare an additional statement promised
in my written evidence) :
1. I emphasize again that what monetary policy can do in a depression is
distinctly limited. But in a boom more may be attained. Hence I suggest that
3
CED, Managing t h e Federal Debt, 1954, p. 10.
60
UNITED STATES MONETARY POLICY
excess reserves should be increased. Not as much as Dr. Clark proposed, but
at least enough to increase purchases of assets. If the banks then purchase
more Government securities, they will then move on to other assets as the price
of Government securities rises; that is, the return declines. But what of the
stock market? asks Senator Goldwater. The market may be rising too much.
If this is so by all means deal with the market directly. Why are margins
50 percent now?
2. I stress again the point that continued rises of output are likely to mean
some inflation. Bottlenecks, wage inflation, other factors raising short-period
real costs are relevant. In periods of 15 million unemployed or even 4 million,
the effect of rising output is likely to be some increase of prices—more in the
latter condition. Those responsible for policy have to weigh the gains against
the losses. Our objective should be growth and stability; but we are likely to be
confronted with some inflation as we grow. I doubt that any fiscal or monetary
policy of 10o5 vintage will stop the small but steady inflation except at the
expense of material unemployment. Is it worth the risk?
3. Then note that the major expansion of loaning assets by far in 1952-53 and
1953-54 (fiscal years) was made by noncommercial banks—not really under Federal Reserve control. They saved us from a much greater recession—and saved
us from excessive caution of the monetary and Treasury authorities.
4. Much was said about the importance of the rate of interest. Mr. Wilde
argued it did not matter; Mr. Smutny that it did. In my opinion, it depends.
It is important for long-term contracts (e. g., housing) and can be decisive when
there is not too much pessimism around (e. g., 1954-55).
5. Indeed, as Professor Chandler says, monetary policy should not be used to
correct structural maladjustments. But it is also well to remember that structural maladjustments are associated with price-cost relationships. And when
prices exceed costs (in, say, slightly inflationary periods) the same industries
that would have been considered structurally maladjusted now become adjusted.
Senator FLANDERS. You did well, Professor Harris, and we appreciate i t
The next speaker is Mr. James Land, senior vice president of the
Mellon National Bank & Trust Co. of Pittsburgh.
Mr. Land.
STATEMENT OF JAMES N. LAND, SENIOR VICE PRESIDENT, MELLON
NATIONAL BANK & TRUST CO., PITTSBURGH, PA.
Mr. LAND. Monetary policy since mid-1952 has made significant
contributions to economic stability.
I t is clear that the measures of monetary restraint taken in the latter
part of 1952 and the first part of 1953 had a retarding effect on the
volume of residential construction, and it is equally clear that the
policy of active ease in the money market which was initiated in June
1953 has stimulated residential construction.
I n the field of State and local public construction, there have been
somewhat similar results. Some projects were postponed or delayed
during the period of relatively tight money because of the difficulty of
financing under the conditions then prevailing. The advent of easier
and more readily available money turned the tide the other way and
the volume of State and local public construction is now rising at a
faster rate.
Money conditions also probably influenced the timing of business
expenditures for new plant and equipment, although to a lesser extent
than in the case of residential and public construction.
I n these various areas of the economy, particularly in residential
construction, monetary regulations cut something off the peak of the
boom which culminated in the spring of 1953 and helped to some extent
to fill in the succeeding valley.
UNITED STATES MONETARY POLICY
61
Twenty years ago easy money was largely ineffective in stimulating
business. Water was put before the horse, but the horse would not
drink.
This time the horse has been drinking.
Throughout the recent period of changing business conditions, commodity prices on the whole have been unusually stable. Monetary
regulation undoubtedly contributed to this stability.
Those who are directing monetary and related fiscal policy are
entitled to a large measure of satisfaction over the results they have
been able to achieve through the application of such policy.
From the standpoint of the future, however, there is cause for grave
concern in some of the difficulties which were encountered in applying
a policy of monetary restraint.
In its efforts to acquire greater freedom to restrain monetary expansion, the Federal Reserve, late in 1952 and during the first several
months of 1953, modified its policies with respect to United States
Government securities, seeking only to prevent disorderly markets
rather than to maintain orderly markets. Among other things, it
abandoned the practice it had previously followed of assisting in the
United States Treasury's refunding operations by bidding a small
premium in the market for each maturing issue (other than bills) and
exchanging all of the securities so purchased for the new refunding
issue.
The Treasury was confronted with several large refunding operations in the latter part of 1952 and the first part of 1953 and in addition it had to raise a considerable amount of cash. This financing
was accomplished under increasingly difficult conditions, reflected in
declining prices for Government securities, including new issues.
The relative aloofness of the Federal Reserve, the record over several months of new issues successively selling below their issue prices
and the prospect of heavy seasonal deficit financing by the Treasury
combined to produce on the 1st day of June 1953 a near panic in the
Government securities market. I t was only with considerable difficulty that the Treasury was able to sell an issue of bills on that date.
In part the market disturbance was an overreaction by the public
to various policy statements made by Federal Reserve and Treasury
officials in preceding months. The public would have had a better
balanced viewpoint if it had attached more importance to the fact
that the Federal Reserve had begun to buy moderate amounts of Government securities in May 1953.
The unfortunate events of June 1, 1953, made drastic action necessary, and this took the form of heavy open-market purchases of
Treasury bills by the Federal Reserve during June, followed in July
by reductions in the percentage reserve requirements of member banks.
In early July the Treasury was able to sell quite successfully a certificate issue of nearly $6 billion.
The change in Federal Reserve policy which was made largely under
the compulsion of the crisis of June 1, 1953, coincided fairly closely with a downturn in business, and this made continuation of an easy
money policy appropriate.
But suppose the boom had gone on unabated. Would the Federal
Reserve have been able to reinstate an adequately effective policy of
monetary restraint? I doubt that it would, in view of the con5531-4—54
5
62
UNITED STATES MONETARY POLICY
tinuing large financing needs of the Treasury. In my opinion, the
events which culminated on June 1, 1953, indicate that monetary
regulation by the Federal Reserve must be to a very substantial
extent the prisoner of the Treasury's necessities when the Treasury
is compelled to engage in large and frequent operations to refund
maturities and finance deficits.
I t is cause for satisfaction that the present Treasury administration regards lengthening of the debt as one of its primary objectives.
The issues which it has put out for this purpose have been limited
largely to the 2%- to 9-year range, but refundings of this character
can accomplish a great deal in the way of reducing the number of
maturities per annum.
We have apparently learned to use the accelerator of easy money
quite successfully. What we now need to do is to create the conditions under which the brake of monetary restraint can be more
successfully applied in the future when appropriate.
If we use the accelerator too much, and the brake not enough, we
shall drift into renewed inflation.
Senator FLANDERS. Thank you, Mr. Land.
Now we have C. Clyde Mitchell, Jr., chairman of the department
of agricultural economics at the University of Nebraska, in Lincoln.
I may remark that the University of Nebraska has a wonderful
collection of elephant fossils, and if anyone is driving through Lincoln, Nebr., I urge them to stop and see two things:
One is the wonderful State capitol, built without debt, and the
other is that marvelous collection of elephant fossils.
They show the growth of the elephants in the first period of a kind
of a long-nosed thing which apparently grubbed in the mud in the
Nile Delta, up to the present magnificent specimens which now roam
the earth.
Now we will return to our order of the day.
Senator DOUGLAS. Mr. Chairman, would you forgive a question. I
have not had the privilege of inspecting this collection of elephant
fossils, but do they show the reason for the decline and disappearance
of the elephant from North America ?
Senator FLANDERS. They, sir, give no untrue record of history.
Mr. MITCHELL. We suspect it is the Nebraska winter, Senator
Douglas.
Senator FLANDERS. NOW, Mr. Mitchell.
STATEMENT OP C. CLYDE MITCHELL, JR., CHAIRMAN, DEPARTMENT OF AGRICULTURAL ECONOMICS, UNIVERSITY OP NEBRASKA, LINCOLN, NEBR.
Mr. MITCHELL. I n agriculture the American ideal of the expanding,
prosperous economy is failing in the most obvious fashion. Monetary
policy of the past 3 years must bear a great deal of the blame. While
objecting to the restrictive monetary policy of the immediate past,
however, I desire to expand my objections to a broader subject—the
economic theory of which monetary policy is only a part
Senator FLANDERS. Excuse me just a moment. I note t h a t yours is
one of the longer presentations.
Mr. MITCHELL. YOU can trust me, Senator, to keep it to 10 minutes.
Senator FLANDERS. I am sure I can trust anyone from Nebraska.
UNITED STATES MONETARY POLICY
63
Mr. MITCHELL. Thank you.
Continuing my statement: I desire to expand my objections to a
broader subject—the economic theory of which monetary policy is
only a part—concepts accepted by the Federal Reserve Board and the
administration—concepts of capital formation and economic growth
which are entirely unsuited to our Nation.
If America intends to make a national policy of full-employment
work, we are going to have to revise some widely accepted but highly
unrealistic ideas about our economic system. One of them is a belief
that underlies all the opinions presented by the Federal Reserve and
Treasury officials, a belief tjiat something called the free market rate
of interest should be a major factor in determining when and how
much our Nation should expand its economic growth.
Monetary policy is too important to be entrusted to the market.
There are three good reasons for this statement, either one of which
would be sufficient to justify it. In the first place, it is quite certain
that the real world does not fulfill the conditions necessary to create
the type of free market in wThich the traditional economic theorv
would have meaning; the theory, that is, of capital formation through
prior saving and its regulation through the interest rate. There is
thus no valid justification in economics for preferring the so-called
free price rather than a controlled price for capital funds.
In the second place, the traditional idea that a modern nation's
capital-goods expansion is brought about through prior saving is
incorrect, both in theory and in the actual history of modern civilization. I n truth, for society to plan and govern its capital formation in
essential lines, and to set whatever rates of rental it desires for such
funds, are completely sensible politico-economic behavior.
Third, we have discovered, particularly since 1051, that whenever
we attempt to use the so-called indirect methods of control on capital
formation, they either do not work or work badly. This is particularly true with regard to agriculture. National welfare demands
that there be made available to agriculture within the next few years,
at low interest rates, very large increments of capital funds. Other
industries whose rapid capital growth is also essential are in the same
position. These essential industries should not have been penalized
with higher interest and curtailed fund availability in the past 3 years,
and should not in the foreseeable future.
To develop these arguments in any detail would require far more
time than is at my disposal. In this brief argument and in the longer
paper you have before you, therefore, I am devoting major attention
to arguments that seem to me to have been not so often presented.
Last February, before this committee, I objected to the administration's proposal for agriculture on the grounds that it was based
on unrealistic economic theory and that it was not designed to fulfill
the responsibilities placed upon the administration by the term of
section 2 of the Employment Act of 1946.
My criticism of our Nation's monetary policy since the accord of
1951 follows identical lines. This policy has been based on the same
incorrect economic reasoning and likewise is not consistent with the
aims of an expanding economy.
The accord of 1951 placed the power of decision over an important
factor of economic growth in the hands of men and institutions
64
UNITED STATES MONETARY POLICY
devoted to the belief that there is something deeply significant and
valuable in the way the price of rented money is set in the market.
This belief led these men and these institutions to take action which
struck hard at two classes of citizens—farmers, and low- to middleincome home builders. The excuse for this widely advertised hard
money policy was twofold: (1) that we were in an inflationary
period, (2) that the so-called indirect methods, particularly those
resulting in across-the-board curtailment of investment funds and in
higher interest, are the best way to slow down inflation. Underlying
these two was the implicit assumption that inflation is unquestionably
something we must prevent.
I should like to object to these two excuses and to the underlying
assumption:
(1) Whether we were in an inflationary period or merely a period
of healthy prosperity consistent with reasonably full employment is
a highly debatable subject. The definition of the terms "prosperity^
and "controlled inflation" are practically indentical. People who
would benefit from a stable or falling price level considered the situation inflationary, whereas people who would benefit from reasonably
full employment and a generally bullish economy considered it healthy
prosperity. Certainly for agriculture, the past 3 years have brought
severe losses. Farmers will never agree with administration spokesmen that we have, to use their words "shifted from unsustainable inflation to stability." For farmers, the shift has been from moderate
prosperity to depression. There is no other word that can describe a
drop of 14 percent in net income from 1951 to 1954 (from 14.5 to 12.5
billion dollars).
(2) My objection to the second excuse (that "indirect methods"
should be used) is one with which your committee is familiar; I shall
merely summarize it. Indirect methods to control capital formation
work badly, bearing particularly hard upon some of the most essential and "conservative" industries in society, for example, farming
and home construction. For our Nation to follow an expanding—
econonry goal and carry out the ambitious terms of the Employment
Act demands that interest rates for capital-goods formation in worthy
industries remain at low level, preferably trending downward, but
certainly never rising.
If speculative and too-rapid capital formation in certain lines ever
needs to be curbed, for example, the building of race tracks, Mr.
Chairman, let it be curbed by direct means, such as materials rationing, instalment-credit curbs, and other selective controls. On the
developmental side, capital funds for the things which America
urgently needs may often have to be directed positively and selectively.
This is consistent with the social and economic planning which is normal in our complex society. That capital funds for such essential
purposes should be rationed through the supposed impersonal operation of something called the free-price system is not an inevitable
nor even a necessary rule of our society. Yet our present national
monetary policy assumes, first, that ours is a free-price regulated
economy and, second, that interest, the price for which money is
rented, must be set by the impersonal market.
UNITED STATES MONETARY POLICY
65
I suggest that we look at the world around us—that we recognize
that through political action our society itself decides (or condones
the decision by various private groups) upon many prices and production decisions—perhaps most of them. Our general policy—if
there be one—is something like this: We leave many decisions to
private interests, of course, but we do so not becouse of any basic trust
in the "natural laws" which force private interests to decide correctly.
We do so mainly because most of these decisions left to private interests do not impress us as being important enough, or the private controls obnoxious enough, to warrant intervention.
Whenever society decides that intervention is necessary in any case,
there is no valid appeal from this decision, certainly not to anybody
of absolute principles with which economics can supply us.
Whenever we are faced with a serious situation that demands the
creation of new capital goods, we create those goods. Whenever institutional rearrangements are necessary, to print money or expand credit
to aid in construction, wTe make them. Because our Nation, and indeed
all modern technological civilizations, always have a great deal of
underutilized capacity within them, even in wartime, this can customarily be done with little or no increase in prices.
In the material in appendix I, below, I suggest that the process of
capital growth in our economy, and particularly in agriculture, needs
to be understood and used in the national interest to achieve planned
expansion of our economy.
I object also to the underlying assumption that inflation must always be prevented. There are two main types of inflation: (1) That
with rather full employment, as in the United States during recent
periods, and (2) that with unemployment—like the Chinese type. I
take it for granted that most economists now recognize that the only
type we could have in this country is the former, the best answer to
which always lies in increasing production, and in increasing capital
funds available to the specific lines in which production must be most
rapidly increased.
I t is unfortunate that the same word, "inflation," is also used to
describe the wild price flight that takes place when the technological
productive capacity of a country has been wrecked by physical means.
Most economic textbooks, failing to recognize the reasons for the
Chinese type, imply that it wTill come about as an inevitable result of
letting the United States type "go too far." Nothing could be further
from the truth.
The only plausible objection to the full-employment type of inflation in this country is that it can bring about changes in the distributive shares going to various classes of our people, particularly upsetting to persons and institutions on pensions and other fixed incomes.
I have discussed this problem at greater length in appendix I I , below.
I can summarize by saying that our society, if it decides that mild,
controlled inflation is a safer policy for implementing the Employment
Act than rigid price stability, is perfectly capable of handling the
problems such a policy creates, including the problems that prosperity
creates for fixed-income classes.
66
UNITED STATES MONETARY POLICY
(The unread portion of the statement submitted by Mr. Mitchell is
as follows:)
APPENDIX I. T H E ROLE OF CREDIT IN AN EXPANDING ECONOMY, W I T H PARTICULAR
REFERENCE TO AGRICULTURAL CREDIT
I.
SUMMARY OF T H I S APPENDIX
1. Economic progress in welfare terms (goods and services), is assumed to
be the goal toward which social planning is directed. The United States has
expressed in the Employment Act of 1946 the intention to pursue a course of
economic progress in an expanding economy.
2. Such progress will continue to result, as it has in the past, mainly from
the association of more (and more efficient) capital equipment with the factors
of labor and management.
3. Productive credit assists in bringing about that association (of more capital
equipment with the labor and management factors). Availability and use of
credit which facilitates the creation of more capital equipment is therefore a
condition of progress.
4. Serious deficiency in credit availability to various people engaged in agriculture is one important factor standing in the way of efficient production. If
the United States is successfully to maintain an expanding economy, these
deficiencies must be made up rather rapidly.
5. Tentative suggestions are made in this article that new and different
methods of supplying credit to agricultural producers will be needed in the
next few years. These methods at first glance appear to be radically different
from those employed by agricultural credit institutions, particularly before
1933. They are different from those envisioned in traditional economic theory
which frowns on capital goods accretion in the absence of prior moneysaving.
However, a closer examination indicates that with regard to capital goods formation: (1) the areas of the American economy which have made the most
progress have benefited from considerable cultural fiat and social action with
regard to production credit, and (2) the traditional theory of capital goods formation contains basic logical faults and probably never deserved the adherence
of economists in the first place. In short, it is possible that these suggestions
are realistic rather than radical and involve only the extension to agriculture of
ideas long accepted in industrial production.
6. More rapid progress in the field of agricultural capital formation will
probably result from social action programs additional to and of a more comprehensive nature than have been tried in the past 20 years. Methods should be
found to establish competent farm producers in a well-equipped productive operation at the time in their lives at which it is most likely that they will be able to
produce efficiently.
7. If plans along the lines of these suggestions are put into effect, they will
change the nature of the obligations which the farm producer owes to the rest
of the community. A tentative exploration is made in this article into the
nature of these changes.
H . A SHORT EXCURSION I N T O TRADITIONAL IDEAS OF CAPITAL GOODS FORMATION
A. Robinson Crusoe and Ins fish net
The earliest economic thinkers were impressed with the way in which division
of labor and specialization could increase the production of any group of workers
dramatically, beyond that amount the workers might contrive without specialization. These theorists recognized the influence of capital goods upon increased
productive efficiency, and correctly reasoned that an increase in the production of
capital goods was a necessary condition of economic progress. For various
reasons, the fathers of economic thought devoted far less attention to the technological conditions of capital goods creation than they did to economic conditions, rather narrowly defined. In the famous story of Robinson Crusoe, who built
a fish net to increase his haul of fish beyond the amounts he could catch with
his bare hands, theory took what is perhaps a wrong turn. In order to feed
himself while he spent 2 or 3 weeks weaving the net, Crusoe first needed a supply
of food. He saved berries. Saving thus appeared to the theorists to be necessary
prior to the construction of capital goods.
UNITED STATES MONETARY POLICY
67
B. Capital goods formation limited by savings
From this interpretation of fishing technology grew the idea that capital goods
formation is limited by money savings. Basic to the theory of capital goods
formation are the assumptions of the logical system in which capital goods formation is only one part: The laissez-faire system of distribution, in which prices
serve as the .directing force for economic decisions and bring about both eiliciency
in production and equity in distribution of the products of man's work. These
assumptions can be summarized in the phrase "perfect competition in a perfect
market," and include, subsidiarily, mobility of factors of production, and the
economic man.
Given these assumptions, in a free society, full and efficient employment of all
factors of production would be assured as if by an unseen hand. For society to
progress, new capital goods needed to be introduced into the system. Such introductions could be made only by those who could save money. Capital goods
formation was therefore conceived to be limited by moneysaving. Moneysavers
were changed from the usurious devils of a slightly earlier age into benefactors
of society, by the writings of Adam Smith and his followers.
<7. Forced savings
If money means benefaction, then could a ruler, by printing a great deal of
money, become a great benefactor? For a long time the people in charge of printing paper money have been intrigued by the tremendous power in the finger with
which they push the starting button of the printing press. It appeared that
at a motion of this finger they could bring into being great warships, buildings,
dams, highways, and national monuments. But simple intelligence convinced
almost everyone that such magic could not possibly be true; that these impressive
accomplishments were the product of artisans and laborers and engineers rather
than the button-pushers in the printshop.
In fact, the button-pushers, toiling not and sweating not, were deemed to be
a rather irresponsible crew in aspiring to perform magic feats. Economic
logicians took pains to point out the danger of letting the printing-press operators
direct such important human activities as calling forth warships and buildings.
Given the assumptions of the economic system which the theoreticians believed
described our world, of course, the printing-press operators were positively dangerous. Although they might print money which called forth in the construction
of capital goods, their action took the entire matter of saving out of the hands
of those fortunate members of society who could save, and forced everyone, particularly the poor people, to save whether they wanted to or not, or whether they
could spare anything from their meager existence or not. The printing-press
money forced savings by pushing prices up, particularly of the things that the
poor people have to buy. This early discovery that money printing might get
new industries built was therefore never given adequate study because it was
almost from the start believed to be irresponsible and sinful.
D. Capital goods formation in an underemployed economy
However, the theoreticians discovered that in the real world, money can sometimes be printed and put into circulation to build new capital equipment without
raising prices or forcing anyone to save. This can happen whenever there are
resources which are not being fully utilized in the economy. If the amount of
underutilized resources is large, governments can print large amounts of money,
or credit-creating institutions can create large amounts of credit, and large
amounts of new capital goods can be built, using the slack resources.
The admission bv present-day economists educated in the classical tradition
that it is possible to bring about the creation of new capital goods by social
action (printing money or expanding credit) without prior moneysaving by
capitalists and without forced saving by consumers generally, points out a serious
limitation in the usefulness of traditional theory. It constitutes an admission
that society, acting through laws and other institutional factors, can direct our
economy and do it well. Society can do it better in the real world, from a
goods and services standpoint, that the automatic and impersonal forces of
price and competition which (by the theoreticians at least) have been depended
upon for 200 years. The theoreticians excuse themselves by admitting that
the real world exhibits underemployment of resources, which the theoretical
world ruled out. However, a few modern economists are reexamining the original
Idea, and ask if the building of the first fish net did not itself require underempfoved resources. How did Robinson Crusoe manager to store up enough
68
UNITED STATES MONETARY POLICY
berries for his :j weeks of net-making? He must have lived in a surplus-producing area—a partially underemployed economy. In a society fulfilling rigorously
the assumptions of the classical theory, it is entirely possible that there never
could have been any capital-goods creation. It is probable that in every society,
everywhere, enough underemployed resources exist (or can be freed by adoption
of new techniques) to allow great amounts of progress through social redirection
of resources.1
Et Capital formation ly social dictate
Whether or not we believe that the theory of capital-goods formation through
prior-savings was faulty from its beginning, most economists today acknowledge
that society quite properly engages in the process of dictating a great part of the
capital-goods formation that now takes place.
Whenever our society makes the decision that certain things must imperatively be built, those things are built, whether or not anyone had previously
saved enough money to build them. The wartime expansion of our Nation's
capital equipment is an excellent example, of course. The doubling of capital
equipment in the last 15 years has occurred mainly because of social direction.
That social direction included the creation of funds, the allocation of scarce
materials, Government construction of plants, guaranteed or supported prices,
preferential tax treatment, and many other similar measures. An exact measurement is impossible of the extent to which America's capital goods have increased
due directly and indirectly to social action. The chief economist with a large
American corporation argued that I was wrong, in an article I wrote in 19o3 in
which I said that "more than half, and perhaps almost all" of America's doubling
of capital goods has occurred because of social action. He conceded the war
plants had been built with RFC and other direct Federal money, but concluded
that the balance, much more than half, was expansion from private funds. But
that misses the point. Those private funds, profits of American business, were
as large as they were because of definite decisions made by the American people.
The decision to fight the war and to build war-related industry was a social
decision. Once that decision had been made, most profits became automatically
guaranteed for some years to come, not only in the war industries but also in all
the less- and non-essential industries. Practically all of these industries enjoyed
the most tremendous prosperity they had ever known. Savings from the net
profits of private corporations did of course finance a great deal of the growth,
but most of these net profits resulted directly from social decisions completely
outside of the realm of a society governed by the laissez-faire doctrine.
There can be no doubt that a great deal of such net profits resulted from the
existence of patents, trade-marks, price fixing, and other modifications of pure
competition which society has decreed or acquiesced in. There can be no doubt
that rapid tax writeoffs, coupled with the fact that the Government directly
influences about one-fourth of the total income flow in the Nation, now guarantee
business stability at a high-profit level for much of the so-called private enterprise sector. I should like to repeat my 1953 statement to which the aforementioned business economist objected: "The doubling of capital equipment
that has taken place in the past 14 years has occurred very greatly (more than
half, and perhaps almost all) because of the creation of funds beyond the
amounts saved by capitalists, and certainly beyond the amounts capitalists
could have saved had our economy been competitive in the classical sense." In
other words, the funds for capital-goods creation were funds created by society,
or allowed to be created because society has not thought it wise to force business to be classically competitive. In other words, the United States has
through social programs directly created or has underwritten the creation of
most of our capital goods. The effect of this great increase in capital equipment has been a tremendous increase in physical productivity, in goods and
services, of the American economy. The results are undoubtedly better, in the
physical-productivity sense, than a purely competitive society could have
achieved.
I I I . T H E C H A N G I N G RATIO OF CAPITAL VALUE TO LAltOR I N T H E 2 0 T H CENTURY
During the course of the industrial development of modern society, the money
investment in capital equipment per worker has of course increased greatly. The
average cost of capital equipment associated with each worker in American industry is more than $10,000; it is almost twice this amount in railroads and utilities.
*A better understanding of these factors can enable us to do a more realistic job in
aiding the underdeveloped areas of the world to industrialize themselves.
UNITED STATES MONETARY POLICY
69
Investment in capital goods per worker has increased greatly in the past half century as the size and complexity of industrial operations have increased. The
worlds of finance and industry have long been organized in such a way as to
provide these large amounts of capital equipment without requiring either the
laborer or the entrepreneur to make prior savings of large amounts of money
funds. Indeed it is almost an axiom of business that new industrial enterprises
be started with little or no money. (The entrepreneurs are expected to have production ability, but even that is not necessary—engineers can be hired.) Promotional ability is perhaps the main requisite to starting industrial enterprises, and
on so precarious a basis (in the technological sense) funds are raised from
investors. The promoters usually receive no-value common stock for their promotional efforts; the cost of physical plant and working funds are supplied by
investors in preferred stocks and bonds. Competent studies, such as were made
by Berle and Means and others, have shown that complete control, i. e. ownership
of all common stocks, of America's largest industries was achieved with an investment of only about 7 percent of the real construction cost of the industries—the
other 93 percent was furnished by investors who received securities bearing little
or no right of control over the industries.
Great physical performance of the American industrial system has characterized past years, and profitable financial performance has characterized most of
them. These two factors have adequately justified the optimistic hopes of an
institutional system that permits entrepreneurs and laborers with ideas and abilities, but without money, to associate themselves with thousands of dollars worth
of capital equipment during the best and most productive periods of their
lives.
To take the different course suggested by Robinson Crusoe economics wTould be
unthinkable—to require an industrial entrepreneur to work up the ladder from a
common laborer to a skilled laborer to a small backyard shop to a larger shop to a
small factory to a larger factory, buying the more expensive equipment in each
case from the money savings he had made by abstaining from spending part of his
income in the prior stage. He would be senile before he had saved the price of
one forging hammer.
America's Horatio Alger folklore to the contrary notwithstanding, that is not
the way an industrial economy makes progress.
Progress is made because society has made a complex chain of decisions, some
legal, some institutional, which bring entrepreneurs and workmen together to
work, during the most productive period of their lives, with capital goods which
society has decreed shall be created.
Modern societies have learned, though most elementary economics texts avoid
this fact, that economic growth is self-financing. As the conservative London
Economist editorialized, in discussing the "lessons of the war," we have learned
that "anything that is possible physically is possible financially." This is true
because in modern societies, there are always rather highly flexible elements of
underemployment of many resources, even in the times of greatest emergency,
and further because when banks and governments create funds the prospect of
economic growth so increases property values as to justify the creation of the
funds.
Of course a recognition of this process does not mean that governments or
banks can safely create money by whim. If the new money is not matched by
real phvsical growth and productivity increase, inflation results. In some cases
of forced-draft increases, as in war, considerable effort must be expended in
areas of stress bv controlling some prices, allocating some materials, and altering
some of labor's ^mobility. However, the generalization is a safe one that our
technological ability to increase our capital equipment (and therefore our productivity) makes it possible for us to finance the increases. This is the exact
reverse of the teaching of traditional economics.
Acceptance of this more modern way of looking at the problem of progress
and growth underlies the Employment Act of 1940. That act expresses with
the highest ceremony possible in our society, formal act of Congress signed by
the President, and implemented by a top-rank professional staff, that we have
to a large extent adopted a new theory of economic development, that we as a
sovereign Nation will do whatever is necessary to maintain an expanding,
growing economy.
IV. CAPITAL GOODS FOB AMERICAN AGRICULTURE I N T H E
FUTURE
If this is a realistic picture of the changed and more realistic explanation of
the tremendous technological progress made in the Western World, and in
the United States in particular, to what extent has agriculture shared in these
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UNITED STATES MONETARY POLICY
changed concepts? As compared with industry, agriculture has shared very
little. This generalization is not intended to belittle the great significance of
the social action programs of the last 20 years. Price supports, incentive payments, farm credit at reasonable rates, supervised credit of FSA-FHA, road
building and the REA*s~all of these have helped many farm producers to
adopt new methods, invest in new capital equipment, and greatly increase their
productivity. However, as between industry and agriculture, with regard to
their ability to do an adequate job of meeting the challenge of an expanding
economy for the next 2 or 3 decades, the gap is still great. In considering how
to improve the physical efficiency and productivity of America's farms in the
future, I should like to direct attention to some new
methods of expanding the
amount of capital equipment available to farmers.5
Agriculture is the main residual area in which the "save first before building"
idea prevails. Twenty years of social and political concern with the farm problem has partially changed this idea, but in the main too many people still think
that there is an agricultural ladder, and that the task of climbing it need not be
materially eased by Government.
I submit that the same general type of technological and financial revolution
that has brought our industrial society to the place it is today needs to take
place in agriculture.
On the most successful farms the physical revolution has already taken place.
The farm that can support a family in decent middle-class living now requires
an investment of more than $40,000. About the maximum that a farmer can
borrow for such an enterprise, without parental or other family assistance, is 50
percent. Raising $20,000, or even $10,000, is a difficult matter for most American
farmers. For the young farmer it is usually impossible.
To improve agricultural productive efficiency for the America of the future
will require that methods be found to enable competent farm producers to associate themselves with adequate capital equipment early in life, when their vigor
and ambition are highest.
As in the case of industrial America, the association should prove successful.
A farmer who can thus associate himself should ordinarily achieve physical
productivity high enough to pay his initial loan off within about 20 years. In
such cases, the increased productivity has amply justified the loan. If, however,
the prevailing farm-finance pattern of today is continued, those 20 years of
highest physical ability must often be partially wasted on inadequate and illequipped farm enterprises.
V. IF SOCIETY TAKES A HAND
American planners should consider whether or not we should participate in
the process of making capital funds available to increase farming efficiency in an
expanding economy to an extent beyond anything contemplated in present laws
and institutions. To this end, capital funds up to 90 or 100 percent may need to
be supplied to farmers who give evidence of being good entrepreneurs. Implicit
in this proposal is, of course, the proposal that some measure of competence be
devised and applied to applicants for funds.3
Much of the new investment funds thus made available would be from sources
outside of agriculture. Whether the loans come from private financial institutions, private institutions with Government guaranties, or Government lending
agencies, they will inevitably be more impersonal than is customary in present
farmer-country banker relationships. Outside credit will probably require, and
probably should receive, considerable guarantee of stability, as far as interest
and principal payments are concerned. This stability feature in industry has
been important in the wide acceptance of the principal of outsiders furnishing
capital funds. If the principle is extended to agriculture, income stability of
farmers becomes a very important factor. Incomes in agriculture need to be
made more stable from two standpoints: (1) The quality of the entrepreneural
decisions needs to be kept high to insure productive efficiency on the individual
farm, and (2) farm incomes need to be stabilized to avoid fireat variations.
3
Although "equity" to farm people in access to social capital is important, productive
efficiency
is the matter here under consideration.
3
Lest thi9 be considered too radical a departure from American practice -we should
remember that society through both public and private action has often furnished 100
percent of the capital funds required by promoters to set up new industries. These promoters very often would not have been able to give even a fraction of the evidence of
technical ability that we have customarily required for the smallest rehabilitation loan
of the Farmers Home Administration.
UNITED STATES MONETARY
POLICY
71
If society takes a hand in the provision of capital funds for agriculture, it
will undoubtedly demand a hand in the selection of the farm enterpreneurs and
in periodic examination to see how they are discharging their stewardship."
Furthermore, if society takes a hand in the selection and examination of farm
enterpreneurs, we will need to devote considerable study and understanding
to the problem of keeping social participation democratically responsive and
maintaining the greatest possible decentralization of authority and freedom of
action of the individuals concerned.
Finally, if society decides to take a hand in such matters, it will have to safeguard itself from possible adverse consequences of its action. For example,
stability in land prices and proper land use would undoubtedly need to be achieved
through legal action—otherwise easing of agricultural credit could result in
wild bidding up of land prices, or land might be ill used for one short-run purpose when social considerations would require it to be used differently for longrun conservation ends.
CONCLUSION TO APPENDIX I
If agricultural productive efficiency is to keep up with the demands of our
expanding economy, entirely new arrangements must be devised for providing capital funds to farm operators. The point has been made here that the
prospects for growth justify the creation of capital funds by the Government and
by banks, in much the same manner as the capital funds have been created for
America's industrial growth. Both the amount of funds created and the interest
rate charged for the rent of these funds are subjects for social decision. There
is no valid reason for letting either of them fluctuate adversely as long as capital growth is needed in important industries.
APPENDIX II. PRICE STABILITY AS A GOAL?
We economists are almost all honest men; we all are sincere in our quest for
roughly the same goals (adequate production, decent income, and maximum possible individual freedom) ; why is it then that we arrive at such widely different
recommendations? One of the main reasons is that we start with completely
different assumptions as to the nature of man and society, and we inevitably
arrive at different answers. For example, if we start with an assumption that
is implicit in the work of most American economists that prices are the proper
governor for most economic decisions, the conclusion is bound to follow that a
policy which promises more price freedom at any point is always better than a
policy which promises less. This is a common feeling of economists, whether
they are discussing farm prices or the price at which money is loaned. I think
it is only fair to point out that even though the overwhelming majority
of professional economists probably believe such things, they are not true.3 In our
complex society decisions are made under the influence of a number of forces
other than price; most of the prices which show up as a part of America's economic transactions are themselves influenced by forces which are either modifications or violations of, or excluded by definition from, the free market as it must
be defined by traditional economic theory.
American political reality has agreed with the foregoing analysis as to the
factors that should influence economic production and distribution for many dec*
ades—not just since 1933. The economists have ordinarily disagreed. Who
has been more nearly right, the American governmental processes, or the economists? Economists should at least keep their minds open. The prima facie
case for a self-regulated society whose major activities are directed by free
market prices has been wrecked both by logic and by experience.
* In industry, society has in some cases demanded such a hand, and in some cases not.
SEC regulations public-utilitv regulations, wage-and-hour laws, and hundreds of other
welfare measures are examples of society taking a direct hand in management. An indirect hand is taken in the many cases in which some businesses are assisted, others
inhibited, by tariffs, patents, and various other oligopoly positions allowed or condoned
by society
°Host of the economists have invested many years of their lives in learning the analytical tools of the pure competitive, laissez-faire, price-regulated economic system. They are
undoubtedly swayed by the fact that retooling would be so costly for themselves that it
would be personally cheaper for them to try to change the rules under which the American
economic system operates. Furthermore, the alternative tools of the more realistic sociopolitico-economic theories are usually ill regarded by economists—they are full of inexactness psychology, sociology, political science, and other social ideas not nearly so
clean and sharp as economics, Vhich deals precisely with prices and quantities and uses
calculus and geometry. So most economists prefer to hold on to the beautifully embellished but highly unrealistic theory based on the free-market assumptions.
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UNITED STATES MONETARY POLICY
Another questionable assumption most economic writers make is to assume
that our national economic policy should be aimed at price stability. Again we
find that economists and America have disagreed for well over a hundred years.
America's political activities are influenced to a great extent by segments and
groups in our population, some inflationary in their demands, some deflationary.
In general, farmers, laborers, and entrepreneurs have been in the former category ; in the latter have been white-collar workers, pensioners, and annuitants,
both individuals and institutions whose wealth or income was measured in fixed
dollar amounts.*
Any time a discussion of American policy begins with the assumption that a
stable price level is a major goal of society, it is bound to conclude that any policy
that does not work against inflation is an incorrect policy. Yet it is quite possible
that America's physical production increases most dramatically in times of controlled but nevertheless continual mild inflation, with tremendous increments
of created capital funds pumped into the system at specific points. Certainly the
inflationist idea wins in the political arena every
time it is clearly presented.
The So percent of our people (approximately) 7 included in the segments which
seem to prefer a little bit of inflation have in recent years been able (aided by
the overriding urgency of depression and war) to stack the deck sometimes
against the 15 percent who would have profited by stability or deflation.8 Again,
we must face the question: Who is right, the majority of the economists or the'
majority of the American people?
Of course, stacking the deck against the 15 percent is to be regretted. There
have been various practical suggestions in their behalf. For example, school
teachers and other future pensioners are now encouraged to put half their
savings into common stocks and real property. Some people suggest that insurance companies should do the same. (None of these suggestions is helpful
to low-income people who have no savings aside from their interest in retirement or social-security funds.)
Some economists nowadays sincerely believe that to attempt to maintain a
stable price level is potentially very dangerous to our economy, and that the
welfare of the 85 percent should not be tied inflexibly to a stability fetish to
guarantee the purchasing power of bonds and retirement funds owned by the
smaller group. The case for controlled inflation has not yet been proved, of
course. A number of great problems (in addition to those of the endowed universities and pensioners) remains to be solved. But the case against controlled
inflation has not been proved either.
In the stable-price economy beloved by the traditional economists, private decisions would govern where to, whether to, and how fast to expand America's
industrial economy. It is ordinarily admitted by such economists that periods
of stagnation and contraction might occur; but freedom from socialistic control
has always assumed to he a benefit sufficient to offset a growth rate considerably
below the feasible and desirable. If we intend to keep America fully employed,
it is my opinion that we should maintain a slightly bullish pressure on price
levels. This, interestingly enough, will probably make governmental intervention
in capital growth less necessary, simply because it should minimize the occurrence
of the types of crisis in which the Government is called on "to do something."
There are numerous other good reasons for this expansive policy; for example,
foreign trade expansion probably depends on it—imports will be received in
America with far less business anguish in times of steady upward movements.
Even in an economy of controlled inflation, a large amount of decision making
as to investment will nevertheless be retained in private hands. However, the
total of all investment decision making.will be kept expansionist, led by easy
credit and such incentives as rapid tax writeoffs in specified lines, and pushed
by Government contracts. In a stable-price economy, reluctant, nonexpansive
corporate managers feel they cannot be badly hurt because of their reluctance,
and might, if depression ensues, prove to be men of great wisdom and parsimony.
In an economy of controlled inflation, such men are fools, and become less and
less important as their neighbors seize the torch of industrial progress and
development. The American people have recognized the truly incredible rate
6
Here, too, we must recognize that economists have a vested interest in the traditional
assumption. They customarily fall into one or more of the deflation-oriented groups because
offixedsalaries and institutional jobs.
7
This is, of course, an oversimplification, inasmuch as there are many people who have
interests
in both categories. Primary interest is the point here, however.
s
In all modesty, this minority never publicly professes to want anything better than
stability.
•
UNITED STATES MONETARY POLICY
73
at which our industrial economy has developed under controlled inflation. They
apparently do not feel that their personal freedoms have suffered too much iii
the process. When truly great performance is urgently needed, even imperative
as in the case of war, there is never a serious question of whether to use controlled inflation; it is only a question of where to set the controls and where
to pump in the incentives.
CONCLUSION TO APPENDIX I I
At least two factors will press America in peacetime to continue mild inflationism : (1) The belief that the free world must dramatically outproduce the Soviet's
rising industrial might; to do this, investment decision making needs a shove
toward expansionism comparable in scope with what it got in the war. (2) The
acceptance, both popularly and in law (the Employment Act), of the idea that
the American economy is badly managed if it does not produce in peacetime
for peaceful purposes the expanding volume of goods and services of which three
wars have shown us capable.
One of the main—perhaps the main—argument of the Federal Reserve System
and the Treasury for raising the general structure of interest rates is that such
a policy is required "to fight inflation." This appendix has suggested that these
institutions were probably fighting the wrong thing.
Senator FLAXDERS. Thank you, sir.
You have kept within the normal time; you have propounded a
number of questions which I find it difficult to keep from pursuing
myself, but since we have agreed to go through the list, we will wait
until later.
The next one in alphabetical order is Mr. Edward S. Shaw, of the
Brookings Institution, on leave from Stanford University. Mr. Shaw.
STATEMENT OP EDWARD S. SHAW, THE BBOOKINGS
INSTITUTION
Mr. SHAW. I t would take more courage and wisdom than I can
muster to answer question I confidently and explicitly. So I take
some comfort from the fact that official answers from the Treasury
and the Federal Reserve are neither complete nor quite complimentary.
The Treasury view seems to be that restraint was necessary in early
1053 and that the May issue of 3*4 percent bonds was a salutary measure of restraint. I understand the Federal Reserve to say that excess
liquidity was removed after April 1951 and that monetary growth
balanced real growth until "unduly severe" tensions developed in
May 1953. In this view the 31/4 percent issue was a tension that
needed offset by a roughly equivalent open-market-buying operation.
Neither of these views recurs to the theme of the Council of Economic
Advisers, in its report of last January, that signs of impending deflation were evident at the turn of 1952 to 1953.
My own ill-defined impression is that monetary restraint was skillfully balanced against forces of expansion in 1951-52; that monetary
and debt restraints were pressed too hard and too long in early 1953;
and that subsequent easy finance was at least congenial to the specific
pattern taken by the late recovery. I t is still too early for the casual
observer to guess whether restraint has been renewed too quickly.
The reply of the Federal Reserve to question I I is generally very
lucid and instructive. I have a single quibble. The reply tells us
why changes in legal reserve requirements are a defective instrument
of control. I t does not tell why so defective an instrument is used
so frequently. There must, under some circumstances, be merits to
balance the defects.
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UNITED STATES MONETARY POLICY
One does gain the impression that, in taking so skeptical a view of
both variable reserve requirements and operations in long-term securities, our central bank is tending toward an immaculate, highchurch, and 19th century view of its responsibilities.
One defect allegedly is that "* * * the results [of a change in requirements] affect simultaneously and immediately all banks in each
reserve class." In many instances results so widespread would appear desirable on a money market as extensive as ours. Now that the
Federal Reserve has denied itself access to the long-terra market, the
pervasive effects of change in reserve requirements may be especially
valuable.
The large and infrequent changes in reserve ratios, which the Federal Reserve takes to be the result of defects in the instrument, may
instead be responsible for those defects. Open-market operations of
comparable magnitude can also be a shock to the markets.
Question I I I and the Federal Reserve's reply to it touch on fundamental issues in central banking theory. The Federal Reserve has
made this decision: to deal only on the short end of the market; to
lend no support during Treasury operations f to intervene in disorderly markets. The result, it is said, should be to develop a private middlemen's inventory of Government securities that will absorb
minor market disturbances. Private enterprise will preserve orderly
markets.
Then long rates may vary less in short periods, reducing market
risks for all investors in long-term securities. This should mean an improved market for Treasury long debt. Changes in long-term rates
should become a more reliable index of changes in the terms of trade
between savers and investors and, hence, a more reliable guide for
monetary policy. Other advantages to the Federal Reserve may fee
expected, including a reduction in the turnover of its portfolio.
The Federal Reserve has bowed off on the long market. I t will
no longer manipulate relative market supplies of long-term and shortterm securities. That function passes to the Treasury. The Treasury proposes to push out long securities, at relatively high rates of
interest, when excess liquidity is contributing to cyclical boom. I t
will borrow short, at low rates of interest, when more liquidity may
soften a c}Tclical recession. Debt management is stepping into the
market arena from which the Federal Reseiwe has withdrawn*
The Treasury, with a new look, to be sure, has apparently gained
in a new accord, prestige lost in the accord of 1951.
There are disadvantages in this particular way of dividing responsibility between monetary action and debt management which are,
after all, different techniques for attaining identical results.
I t raises interest costs on the public debt, because long borrowing
is done when long borrowing is clear. These extra costs appear to be
in part a social cost of reviving the middleman function on the
Government security market. The new technique may mean higher
costs, too, because the Treasury, without central banking support,
may need to put more favorable prices on its long-term issues. Finally, Treasmy techniques for managing the rate structure are less agile
than central banking techniques, so that the range of fluctuations in
rates may not be reduced after all.
I n recent years commercial banking has lost ground to other institutional channels for lending and investing. Money has become less
UNITED STATES MONETARY POLICY
75
important among the financial assets that feed inflation. I t is being
superseded to a degree by savings deposits, savings and loan shares,
insurance policies, and other vehicles of saving. Control by direct
or indirect means of the institutions that create and issue these media
is increasingly vital to economic stability. There has been some reason to believe in recent years that the Federal Reserve was developing
indirect controls over nonmonetary financial institutions through its
operations in long-term Treasury issues. Now it appears that the
Federal Reserve has abandoned the experiment and is limiting its
area of responsibility to the traditional commercial banking field.
Comments by the Federal Reserve on question I V and comments
in other connections by the Treasury supply a clean-cut statement
of national monetary and debt policy. Within the business cycle the
range of fluctuation in interest rates is to be increased, by Federal
Reserve action to stabilize the money supply and by Treasury policy
of refunding on the cyclical rise. Over longer periods, the money
supply is to grow along the narrow line that separates inflation from
unemployment while the public debt is to be dispersed largely in
funded form to investment-type portfolios.
The policy of cyclically variable interest rates is correct if it does
not jeopardize the recoveries that constitute economic growth. I object only to refunding when it is most expensive. I t should be the
central bank, not the Treasury, that sells long-term securities in
cyclical recoveries. Refunding ideally should occur in recession when
a successful operation, supported by the banking system, can assist in
reducing long-term rates of interest.
I n response to question V, the Federal Reserve indicates gratification that the money supply did not contract in the recent recession. I t
traces monetary stability primarily to bank purchases of Government
securities and suggests that hereafter the substitution of Government
issues for private securities in bank portfolios will brace the money
supply against the contractive forces of recession. My own impression
is that the money supply held firm in part because the recession has
been so mild. Private borrowing at banks continued strong. With
incomes still high, the public continued to want large money balances.
We should not be surprised in a more decisive recession if the public
insists on economy in its cash balances, as it did in 1048-49. Nor
should we be worried about a contraction in money balances if it is
voluntary on the public's part and if, hence, it coincides with falling
interest rates.
Two queries come to mind in connection with the Treasury reply
to question VI. First, issue of a 5-year, 10-month bond in February
1953 is said to have been a measure of restraint on inflation, yet issues
of comparable maturity in late 1953 are said to have been neutral with
respect to Federal Reserve monetary policy. I t is not clear why
lengthening of the debt is at times a restraint and at other times
neutral in the monetary sphere. Second, if the explanation for this
anomaly is that the intermediate securities are placed away from
banks in booms but in banks during recessions, one wonders whether
it is necessary to pay the banks so well for lending capacity that
"would otherwise be idle.
I n general, question V I I has elicited a most helpful response from
the Treasury. The doctrine officially laid down is a quite remarkable
advance over traditional dogma that the only good debt at any time
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UNITED STATES MONETARY POLICY
is either long or long dead. I wish to question only the Treasury's
excessive inodesty in claiming that it must cope with a free money
market. The bulk of official testimony in these replies has been that
the money markets, short and long, are not free and cannot safely be
left free. They are the segment of the economy that must be so
controlled as to communicate to other segments the signals that inflation or deflation have gone too far. These markets cannot be regarded as free in any important sense when they are managed and
manipulated by the instrumentalities of the central bank and the
public debt.
The final question barely touches on the fringes of vital and highly
disputatious issues. I t has to do with a minor aspect of the relationship between banking and government. The maintenance of Treasury
balances with commercial banks and the various agency services that
the banks perform for the Treasury should be considered in the
broader context.
Securities of the Federal Government were over 40 percent of all
commercial-bank earning assets in mid-1954. Earnings and sale
profits on Government securities approximated 30 percent of member-bank earnings in the first half of 1954, significantly more than
enough to cover all taxes on all banking operations. The banks are
deep in the business of monetizing public debt, and they are paid well
for it. Private assets in their portfolios are sheltered by Government
guaranties; excessive competition is restricted by Government authority ; expensive services are provided by an independent agency of
Government. The banks, in return, provide an efficient payments
mechanism and a principal channel for allocation of the community's
savings. My judgment is that such minor aspects of bank-Government
relationships as are suggested in question V I I I cannot be considered
judiciously apart from aspects of much deeper significance.
Senator FLANDERS. Thank you, Mr. Shaw.
Our next witness is Mr. Rudolf Smutny, senior partner of Salomon
Bros. & Hutzler, New York. I take it, sir, your firm deals actively
in Government securities?
Mr. SMUTNY. Mr. Chairman, that is correct.
Senator FLANDERS. Thank you; you may proceed.
STATEMENT OF RUDOLF SMUTNY, SENIOR PARTNER,
SALOMON BROS. & HUTZLER
Mr. SaruTNY. I would also like to say, Mr. Chairman, it is the first
time in 38 years in Wall Street that I have been called an economist.
My approach to the problems here under discussion is that of the
bond dealer who specializes in the institutional investment market,
of which United States Treasury obligations constitute so large a
part.
The unpegging of Government securities prices in March 1951, was
long overdue. Pegged prices, being economically unsound, simply
did not work. They destroyed the freedom of the market and made
buyers and sellers largely dependent on the Federal Reserve banks.
They encouraged some institutional investors to put short-term funds
to work in the long-term market. They tended to lodge the initiative
in the creation of reserve balances with the holders of Treasury securities, and, as a corollary, to deprive the Reserve authorities from
UNITED STATES MONETARY POLICY
77
exercising their proper influence on the availability and cost of
credit.
In the "pegged" market dealers were many times, for all practical
purposes, merely messengers. At such times all market decisions
rested with the Federal Reserve authorities. "Unpegging" the market restored its freedom of action, and broadened the scope of trading
activity.
I t seems to me that debt management and credit control policies
during the past 2 years have, on the whole, been sound. My only
criticism is that, during the transition period in the early part of
1953, the Government bond market was left without even interim
token support from the monetary authorities. Moreover, and more
important, it was needlessly subjected to many utterances regarding
future financing policy which tended to upset market stability. I t
seems evident, too, that the price decline in Government securities at
that time was sharper than was warranted by supply-and-demand
factors. For example, during the period January-May 1953 Treasury
2y2 percents of 1967-72 declined by 5.8 percent while high-grade corporate bond prices decreased by about 4.875 percent. The sharp break
in prices of Government obligations naturally had an unsettling effect
on the entire money and capital market.
Fortunately the situation was soon rectified, and from mid-1953 to
the present time, the debt management policies of the Treasury and
the credit policies of the Federal Reserve have been handled' with
consummate skill. They have been geared to assist the money and
capital markets and to help direct the flow of capital into corporate
securities and mortgages so that corporate capital expenditures, and
business and residential construction might be stimulated.
"While the supply of Government securities is very large, the present
demand for long-term Government bonds is not impressive. There is,
however, a very strong demand for short-term Government obligations
with maturities of not more than 1 year. This is illustrated by the
fact that from the beginning of 1954 through the first week in November, 40 major life-insurance companies, the leading institutional investors, purchased United States Treasury bonds to the extent of $360
million, which figure came to only 3.5 percent of their total investments
of $10.5 billion. On the other hand, they acquired bills and certificates
of indebtedness to an amount of $2,132 million, or 20.3 percent of the
total.
The incidence of greatest demand, therefore, is in the short-term
market, and a major sector of that market, United States Treasury
bills, in the chosen medium in which the Open Market Committee
operates to influence the reserves of the member banks, a factor which,
from time to time, greately intensifies demand-supply ratios in this
short-term area. So long as the economy is as active as it is today, and
building construction continues at a high level, it is doubtful whether
institutions, other than banks, will be large investors in long-term
Government bonds. Rather, they will endeavor, as in the immediate
past, to acquire high-grade bonds and mortgages which afford a better
return than that obtainable on United States Government obligations.
The fact that, early in 1953, Government bonds decreased considerably
in price and that their marketability was materially reduced has also
lessened their popularity to some extent.
55314—54
6
78
UNITED STATES MONETARY POLICY
However, I believe we should not overlook even a minor opportunity
for issuing long-term bonds and lengthening the average maturity
of the Federal debt. We know that many smaller institutional investors, such as public and private pension funds, and a wide variety
of local governmental and labor-union funds are always in the market
for offerings of the highest yielding marketable Treasury security,
regardless of maturity. Over the period of time under discussion a
moderate amount of long-term bonds could have been placed with
such relatively small institutional buyers. And, I think, that had
public offerings of even lesser amounts of long bonds been made they
would undoubtedly have served to cushion the pronounced price markup in the general bond market which has since occurred as a result of
the actions of the monetary authorities.
Now I should like to turn to the problem of reserve balances and
Open Market Committee operations. The reserve balances of the
commercial banks are the basis of our credit system. The most important factors which increase or reduce reserve balances and thus
expand or contract credit are: Changes in reserve requirements by
the Federal Reserve Board, borrowing by the member banks from
the Federal Reserve, and open-market operations by the Federal Reserve banks. Right now, I believe, open-market operations ought to
be reexamined in the light of recent experience.
As previously indicated the Federal Reserve banks in conducting
open-market operations now deal exclusively in Treasury bills. Now
the bill market is one of the most important segments of the money
market. Through it financial institutions and industrial corporations
provide for their liquidity. Banks must, of necessity, keep a large
volume of bills on hand in order to cope with their daily cash swings.
Many corporations keep their tax accruals in bills and use them to
maintain their liquid assets. As a result of this pressing financial
need for short-term paper there is a large and constant demand for
Treasury bills. Hence, when the Federal Reserve conducts openmarket operations in the bill market it can have a pronounced effect
on yields.
This reliance on bills as the sole vehicle for open-market operations
is doubtless due to respect for the traditional Anglo-American central
banking practice of operating exclusively in "the nearest thing to
money"; also, perhaps to a fear of even seeming to sponsor anything
remotely resembling the discarded "pegs." However, under present
circumstances open-market operations do not appear fully to be
achieving the desired objectives. The volume of bank loans has consistently lagged, and the level of bank rates has remained unchanged.
Many corporations have cut down on bank loans and built up their
emissions of short-term paper. Therefore, when "the nearest thing
to money" is in persistent and relatively short supply, and when openmarket operations in bills in pursuit of a policy of "active ease" have
merely resulted in declines in bill and commercial paper yields while
leaving the volume of loans unchanged, it may be surmised that something more than operating in the bill market is needed.
UNITED STATES MONETARY POLICY
79
An arbitrary increase in the supply of bills is not the answer. I
think, rather, that it is to be sought in widening the scope of openmarket operations to include securities other than Treasury bills. To
this end the Federal Reserve should use its authority to buy and sell in
the open market Treasury obligations with maturities, "in the first
instance, of up to 1 }^ear, and should this prove ineffective, after suitable
trial, then be authorized to operate up to 3 years. After all, the
amount of Treasury securities due within 1 year, other than bills, is far
larger than the entii*e Federal Reserve portfolio of Treasury securities.
I do not believe such a liberalization of open-market operations
would do violence to the traditional central banking practice of operating solely in "the nearest thing to money." At the same time it would
reduce undue pressure on the bill rate. I think we must all concede
that, thus far, the policy of "active ease" has had a much more pronounced effect on the level of bond prices and the yields on short-term
paper than it has had on the volume of commercial loans and the level
of bank rates. I do not believe that the modest increase in the area
of open-market operations here proposed would have any significant
effect whatever on the long-term Government market. Certainly it
could hardly be construed as a return to the unsound practice of pegging the prices of long-term bonds.
I would like to comment on just one more point, which, while not
covered in the questionnaire, is, nevertheless, germane to this discussion. All of us—businessmen, bankers, economists, and public officials—have our jobs to do. We are all concerned, of course, with the
overall well-being of the national economy. However, those of us
engaged in the rugged competition of private enterprise have to think
first of making a living and keeping solvent. We have to keep our
eyes on the main objective, and, it must be confessed, the national
economy is apt to become a rather remote concern. This is only natural. Nevertheless, I think we would all agree that concern for the
well-being of the national economy is not the job of our public officials
alone. Our own actions, therefore, ought, at all times, to take into
account the public interest in our activities.
I t is now amply evident, for example, that committing short-term
funds in the long-term Government market did not, in the long run,
serve the best interests of all concerned. Turning to more recent
events, it now seems apparent that raising the prime rate at a time
when conditions in the bond market were extremely critical was not
the wisest course of action. I am proud to recall that, at that time,
when Treasury 3 % percents of 1938-78 fell to a discount while still
"when issued," we at Salomon Bros. & Hutzler, and many other investment firms as well, ran advertisements in nationally circulated newspapers unequivocally recommending their purchase.
The lesson in recent financial history is clear for all to see. The job
of managing the national economy is not solely that of the monetary
authorities. I t is our job, too. To do it well we must learn to practice
the art of financial statesmanship and to conduct our private activities
within the moral as well as the legal boundaries set by our public
responsibilities.
UNITED STATES MONETARY POLICY
80
(The tables and advertisement referred to in Mr. Smutny's statement follow:)
TABLE I.—Life-insurance company investments (based on reports from $0 major
companies)
Year 1954
through week
ended Nov. 6
Mortgage loans:
Farm loans
_.
Loans on dwellings and business property...
Real estate: Real estate acquired for investment.
Railroad securities:
Bonds
Stocks
Public utilities:
Bonds.
Stocks..
_
-.
Industrials:
Bonds..
Stocks
Governments:
U. S. Treasury bonds
__
—
U. S. Treasury bills
U. S. Treasury certificates
V. S. Treasury notes
_
..
Canadian Government bonds
Other foreign governments
_.
..—
State, county, municipal
_
_
_Miscellaneous:
Bonds
.—
Stocks
-Total.
_
._
__
-_
Total.
$274, 689,200
3,370, 030,554
117, 897.175
2.6
32.1
1.1
235, 625,813
11. 612,312
2.2
.1
345,066
193,326
8.2
2.1
1, 733, 065, 752
86, 980,818
16.5
361, 662,104
2,065, 136,032
67, 097,253
62, 545,477
108, 572,375
16, 162,554
432, 825.176
3.5
19.7
.6
.6
1.0
.2
4.1
458, 338,238
25, 571,199
4.4
.2
10,509,350,424
100.0
3,644,719,754
117,897,175
6,402,375,840
344,357,655
34.7
1.1
60.9
3.3
10,509,350,424
100.0
220,
_
Recapitulation:
Mortgages
Real estate
Bonds
Stocks
_.
Percent
of total
TABLE II.—Market yield on Treasury bills percent per annum
January
February
March
_
April
May
June
1953
1954
1.96
1.97
2.01
2.19
2.16
2.11
1.18
.97
1.03
.96
.76
.64 |
1953
July
August... _
September,
2.04
2.04
1.79
~.
November.December
-~
...
. .
1954
7°
.92
1 01
.98
1.44
1.60
TABLE III.—Interest-bearing marketable public debt of the V. S. Government of
selected maturities (as of Dec, 15,1954—000,000)
U p to 1 y e a r inclusive of D e c .
15,1955 (excludes T r e a s u r y bills
T r e a s u r y bills)
Percent
T r e a s u r y bills
_.
Certificates of I n $28,382
debtedness...
12,218
T r e a s u r y notes
2
2,611
Treasury bonds
Total
43,211
1
$19,509
Percent
100.0
65.7
28.3
6.0
100.0
19,509
1 to 3 years
100.0
3 to 5 years
Percent
» $10,063
2 7,176
58.4
41.6
17,239
100.0
1 to 5 years
Percent
Percent
2
$5, 728
16,271
21,999
26.0 i $15,791
74.0 3 23,447
40 2
59 S
39,238,
100.0
100.0
Includes4 issues of l}i percent notes amounting to $2,911,000,000 of which the Federal Reserve System
owns
all but about $200,000,000 thereof.
3
Includes all Treasury bonds with a first redemption date within this period.
81
UNITED STATES MONETARY POLICY
Holdings
of V. S. Government securities, including guaranteed securities,
Federal Reserve banks {as of Nov. 2Jh 195 Jf—000,000)
Amount
U p to 1 year
1 to 5 years
5 vears a n d over
__
_
_
Total
of the
Percent
$15,804
6,321
2,428
64.4
25.7
0.9
24, 553
100.0
[This advertisement appeared in the New York Times, New York Herald Tribune, the
Wall Street Journal, and the Xew York World-Telegram and Sun ou April 20, 1053]
UNITED STATES TREASURY
3 ^ - P E R C E N T BONDS, D U E J U N E 15,
{noncallable
1983
prior to June 15, 197S)
We consider these Bonds most attractive for all investors where the maturity
meets their requirements.
We recommend t h a t holders of Series F and G United States Savings Bonds,
maturing this year, exchange them for the new United States Treasury 3 % Percent Bonds. This exchange privilege expires April 30,1933.
SALOMON BROS. &
HUTZLER
Members New York Stock Exchange
SIXTY WALL STREET, N E W YORK 5 , N . Y .
Boston; Cleveland; Chicago; San Francisco
Mr. SMTJTNT. Mr. Chairman, I would like to request that my
detailed answers to the eight questions be made a permanent part of
the record.
Senator FLANDERS. Thank you, sir.
(The answers previously referred to follow:)
ANSWERS BY RUDOLF SMUTNY, SENIOR PARTNER, SALOMON BROS. & HUTZLER, TO
THE QUESTIONS PROPOUNDED BY THE SUBCOMMITTEE ON ECONOMIC STABILIZATION
OF T H E J O I N T COMMITTEE ON T H E ECONOMIC REPORT OF T H E CONGRESS OF T H E
UNITED STATES
1. W h a t role did monetary policy play in the period of relative stability
following the Treasury-Federal Reserve accord in 1931, in the months of boom
late in 1952 and earlv in 1953, and in the recession of 1953-54?
Answer: The 1951 accord between the Treasury and the Federal Reserve
System paved the way for the effective employment of monetary policy, first,
to combat the threat of further inflation; second, to promote economic stability;
a n d third, to head off unduly deflationary tendencies in the economy. Pegged
prices for Government bonds had a number of undesirable effects. They encouraged commitment of short-term funds in the long-term market. They promoted
monetization of long-term debt, thus adding to inflationary trends. They tended
to lodge t h e initiative in the creation of reserve balances with the holders of
Treasury obligations r a t h e r than with the Federal Reserve authorities. They
helped to make economic policy unwarrantedly subservient to Treasury finance.
They deprived the market of freedom of action.
At the time of the accord we were still in a shooting w a r in Korea, and our
economy was under severe pressure. Not only was there a considerable demand
for goods and manpower on the p a r t of the Federal Government for building
up the Nation's defenses, but there was also a strong demand for capital and
labor from the private sector of the economy to meet civilian requirements as
well as to construct defense plants. After the outbreak of the Korean w a r
wholesale prices rose by 17 percent from J u n e 1950 to March 1951.
F o r a few months following the accord the Federal Reserve policy continued
to be one of restraint. Thereafter, however, the policy might be termed one of
82
UNITED STATES MONETARY POLICY
neutrality, since the authorities realized that to restrict the availability of bank
credit might interfere with defense efforts. Approximately the same policy
was followed by the Federal Reserve during 1952.
Toward the end of 1952, and particularly in the early part of 1953, the policies
of the Reserve authorities underwent a considerable change. The policy of
neutrality was again changed to one of restraint. In January 1953 the discount
rate was raised from 1% to 2 percent, the first change in nearly 2V2 years.
Member-bank indebtedness increased from a general level of under $500 million
in the first half of 1952 to over a billion dollars in the second half of 1952 and
the first few months of 1953. These changes were accompanied by a considerable
increase in money rates and a correspondingly sharp decline in prices of Government securities. The Treasury bill rate on new issues rose from 1.78 percent
in October to 2.13 percent in December and 2.23 percent in June 1953. The
price of the 2 % -percent Victory bonds witnessed a decline of 5.8 percent from
the end of 1952 to the begining of June 1953, one of the sharpest drops on record.
The credit policy followed by the Federal Reserve also led to a decline in the
availability of bank credit. As the member banks became more heavily indebted
to the Reserve banks, they became more hesitant to extend credit. Coupled
with aggressive borrowing by the Treasury in active competition with private
borrowers, this had a decided effect on the capital market. Rates of interest on
mortgages increased. FHA-insured mortgages sold at substantial discounts and
the flow of capital into private securities and mortgages was reduced.
While it is my opinion that the Federal Reserve authorities and the Treasury
went perhaps a little too far and too fast in restraining credit expansion, their
objectives were achieved. The forces of inflation were brought to a halt by the
middle of 1953. This experience seems to demonstrate that if interest rates
go high enough, and portfolio depreciation in financial institutions becomes sufficiently severe, inflationary booms can be halted.
When the Federal Reserve and the Treasury realized that the inflationary
forces had run their course and that some deflationary pressures were becoming
apparent, their policies were quickly changed. Member bank reserve requirements were lowered in July 1953 and again a year later. Open-market purchases
were carried out on a large scale, with the result that holdings of Government
securities of the Federal Reserve banks increased by over $2 billion from April
to December 1953. Excess reserves increased by $333 million from the end of
April 1953 to the end of April 1954 and by $656 million to the end of September.
Prices of Government obligations, long term as well as short term, increased
considerably. The Treasury restricted its borrowing and refunding operations
to securities which did not compete with private borrowers, and hence stimulated the flow of funds into the building industry and capital investments by
corporations.
While, of course, other factors and governmental measures also played an
important role, the changed credit- and debt-management policies of the Reserve
authorities and the Treasury contributed materially to the fact that the readjustment, despite the decline of $4.6 billion in national-security expenditures in
fiscal 1954 and a reduction of $4 billion in business inventories in 1 year, did
not go very far. The index of industrial production decreased by 10 percent
from its peak in July 1953 to the lowest point reached in 1954. Unemployment
did not exceed 3,725,000. Commodity prices, on the whole, remained stabie and
disposable personal income actually increased.
The credit policies of the Reserve authorities and the debt-management policv
of the Treasury, from the middle of 1953 to the present time, have been skillfully
handled. Reserve requirement changes have been used sparingly and banks have
been encouraged to use their discount privileges freely. In so doing they have
apparently been brought into direct touch with Federal Reserve thinking concerning general economic conditions and the banking policy appropriate to such
conditions. If any criticism is to be made, it is that the change in policy in
3953 might have taken place a month or two earlier, and that some intervention
by the monetary authorities in the Government bond market would have prevented such a drastic decline as took place.
2. How has the emphasis in the use of monetary instruments changed during
the period since mid-1952? For example, how have the various instrumentsopen market operations, discount rates, and administration of discount operations, and reserve requirements—been used under varying conditions? Has
there been any reliance on moral suasion during this period?
Answer. All the credit instruments at the disposal of the Reserve authorities
have been used during the period since mid-1952. However, increasing use has
been made of the discount mechanism, while open-market operations have been
UNITED STATES MONETARY POLICY
K t t ^
83
" * * — ^ ™» ™* only to
Se CUri eS i n
TateTo °i ™ r ^DUrin
. ti;l U S P e r^i 0 d / c ^o n s3i dme i0 an bt h s and raSSl ttf dteSSS
L l i l
v E
'
' l e reliance was placed on
moral suasion. Various utterances were made by high officials of the Federal
e m
d t h e r SUry a11
h£K2Ff
r,
? f
'.
of which tended to depress the Government
bond 1market
and
to curb the willingness of the banks to extend credit
7 opi
on
rnOL ^
5 i ' the moral suasion, if anything, went too far, and at t'imes did
more harm than good. If any lesson is to be learned from the experience of
the early part of 19o3, it is that the Federal Reserve and the Treasury should
rely more on action and less on pronouncements. The actions can be studied
and their consequences ascertained. The utterances are at times enigmatic in
character and may be—and often are—misinterpreted.
The moment the inflationary pressures began to disappear and signs of an
economic decline set in, the credit and debt management policies of the authorities underwent a considerable change. Reserve requirements were lowered in
July 1953 and also in June-August 1954. The Reserve banks began to buy large
amounts of Treasury bills in the open market, thereby enabling the member banks
not only to repay their indebtedness to the Reserve banks but also to increase
their excess reserves materially.
Since the middle of 1953 the policies of the Reserve authorities and of the
Treasury have been handled with skill, and both have contributed materially to
the stability of the economy.
3. What is the practical significance of shifting policy emphasis from the view
of maintaining orderly conditions to the view of correcting disorderly situations
in the security market? What were the considerations leading the Open Market
Committee to confine its operations to the short end of the market (not including
correction of disorderly markets) ? What has been the experience with operations under this decision?
Answer: So long as the policy of the Reserve authorities was to maintain
orderly conditions in the Government bond market, dealers and investors more
or less knew what actions to anticipate on the part of the Federal Reserve. So
far, nobody in authority has described what the term "correcting disorderly situations" means. The fact of the matter is that the Reserve banks have not intervened in the market for quite some time. Even in the first half of 1953, when
prices of Government bonds declined sharply and their marketability was materially reduced, the authorities did not find it advisable to intervene. Apparently,
they did not consider the Government bond market disorderly at that time. I t
would be helpful if some explanation were to be forthcoming from the monetary
authorities as to what comprises a disorderly situation in the bond market
Although the Federal Reserve Board in its annual reports makes public the
deliberations of the Open Market Committee, it is extremely difficult for an outsider to analyze the considerations which led the Committee to confine its operations to the short end of the market. This answer can best be given by those
responsible for the decision.
The experience with operations under this decision, in my opinion, has not been
entirely satisfactory. As I stated in my opening statement to the committee,
the policy of the Federal Open Market Committee of operating only in Treasury
bills has caused bills to fluctuate widely at times, and has induced corporations
to turn more to the commercial paper market than formerly, which has not helped
to increase the volume of loans. Because the bill rate has fluctuated so extensively, bills have become a less desirable investment instrument for corporations,
institutional investors and banks. This has also tended to reduce the earnings
of the commercial banks. While it is evident that Federal Reserve policy should
not concern itself with earnings of member banks, it must be borne in mind that
the cost of doing business for banks has increased considerably and that a sound
banking system is essential to the Nation's economy. The large commercial banks,
in particular, play an important role in the money and capital markets.
The operations in bills imply that consideration about total bank reserves is
suflicient; it does not recognize that such open-market operations have a magnified impact initially on a limited number of the (larger) banks, particularly those
jn New York City. Geographical differences are ignored, as well as differences
between bank and nonbank buyers and sellers.
Since, in my opinion, the experience wTith Federal Reserve open-market operations confined exclusively to Treasury bills has not been satisfactory, I believe that
tbe Federal Open Market Committee should be given the power to operate in all
UNITED STATES MONETARY POLICY
84
Treasury obligations with, in the first instance, a maturity up to 1 year and
then, if need be, up to 3 years. This would have a stabilizing effect not only on
Treasury bills but also on the entire financial market. It would enable the Reserve banks to assist the Treasury more effectively, if necessary, in its refunding
and borrowing operations.
4. What is the policy with respect to the volume of money?
Answer: As far as I can judge, from the point of view of an investment house
actively engaged in the money and capital markets, the supply of money is ample.
Since the middle of 1953, the Reserve authorities have followed a consistent
policy of providing the member banks with adequate reserves to enable them to
meet all the legitimate requirements of industry and trade and the Government.
Money rates, on the whole, are easy. With the exception of fluctuations brought
about by the flow of funds and the movement of gold and currency, money rates
have been relatively low and have stimulated the flotation of a large volume of
tax-exempt securities, as well as the sale of mortgages.
5. Has monetary machinery (a) worked flexibly, and (&) has the market
demonstrated flexibility in its responses to changes in policy? For example,
how has the policy of active ease been reflected in the level and structure of
interest rates, the volume of credit, and the roles of various types of lenders?
Answer: The policies of the Reserve authorities and the Treasury have been
highly flexible. During the first few months after the accord, and again in the
latter part of 1952 and the first half of 1953, measures were taken to tighten the
money market and to reduce the availability of bank credit. These measures
were reflected fairly promptly in the movement of interest rates, as may be seen
from the following figures.
Movement of money rates and bond yield*, January IdSl-Jnne 1058
[Percent]
Treasury
bills
(new issues)
1.39
1.52
1.59
1.61
1.69
1.62
1.82
1.78
2.04
2.18
2.20
2.23
1951—January
April...
July....
October.
1952—January
April...
July....
October.
1953—January
April...
May....
June
Prime
Long-term
commercial Government's
paper
(4-6 m o n t h s )
1.86
2.13
2.31
2.21
2.38
2.35
2.31
2.31
2.31
2.44
2.68
2.75
2.39
2.56
2.63
2.61
2.74
2.64
2.61
2.74
2.80
2.97
3.09
3.09
During the middle of 1953, the policies underwent a change and were directed
toward easing the money market. The lowering of reserve requirements and
Federal Reserve open-market purchases increased materially the volume of excess
reserves. Money rates went down, as may be seen from the following figures:
Movement of money rates and bond yields, June 1953-October 195Jf
[Percent]
Treasury
bills
(new issues)
1953—June
Aupust
October
December.
1954—January,..
March
May
July
September.
October....
2.23
2.09
1.40
1.63
1.21
1.05
.78
.71
1.01
1.03
Prime
Lon^tertn
commercial
Government's
paper
<2#»s)
(4-6 m o n t h s )
2.75
2.75
2.55
2.25
2.13
2.00
1.59
1.43
1.31
1.31
3.09
3.00
2.83
2.79
2.68
2.51
2.52
2.47
2.51
2.52
UNITED STATES MONETARY POLICY
85
Lower interest rates and increased availability of bank credit, as well as the
changed debt-management policy of the Treasury, have had a favorable effect on
the capital market. T h e volume of securities offered, particularly tax-exempts,
has increased considerably, the mortgage market h a s improved, and lower interest
rates on mortgages have helped to stimulate building activity.
6. H a s t h e debt-management policy of the Treasury—both as to objectives and
techniques—been consistent with the monetary policy of the Federal Reserve
throughout t h e period since mid-1952?
Answer: The debt-management policy of the Treasury has been closely coordinated with the policies of the Reserve authorities. For example, when the
policy w a s one of restraint, the Treasury cooperated by floating longer term issues
(to mid-1953). Later, when active ease was desired, the Treasury shortened
its new issues and made them more attractive to banks, thus aiding an increase
in the money supply. The use of tax-anticipation series reduced the impact of
seasonal changes in tax receipts on the money market.
Up to t h e middle of 1953 both were endeavoring, to the best of their ability,
to tighten money. Since the middle of 1953 the policies of both have been geared
to make money easy and to stimulate the flow of capital into corporate securities
and mortgages. The cooperation between the Treasury and the Reserve authorities seems to have been carefully thought out and well handled. However, I do
think greater boldness in the issuance of long-term bonds, such as the Treasury
3^4s, might well have been consistently undertaken. As a general thing, whenever a change in any m a t t e r of policy is contemplated, there is always a temptation to avoid action on the plea that "the time is not ripe." Since the end of
the war there have been several periods during which truly long-term Treasury
bonds could have been issued. Even during the period of time since mid-1953
the Treasury could, a t each financing period, have offered a basket of issues which
included, in each instance, a long-term bond whose dollar amount could have
been left to the discretion of the market place.
Doubtless there would have been very little interest in such a long bond on
the p a r t of commercial banks, savings banks, and insurance companies. But
pension funds, both public and private, and a wide variety of local governmental
and labor-union funds a r e always in the market for offerings of the highest yielding marketable Treasury security, regardless of maturity, and it is conceivable
that, over a period of time, a moderately large amount of long-term bonds could
thus have been marketed. In addition, if such offerings had been made, a
psychological check on the pronounced markup in the general level of bond prices
which h a s since occurred would have been set. Violent swings in the bond
market a r e not beneficial to overall economic stability and impose, besides,
undesirable burdens on the long-term institutional investor.
7. W h a t considerations should dictate the maturity distribution schedule of
the Federal debt—first, as to the long-run ideal to be pursued; and, second,
as a practical operating matter—giving weight to timing and contemporary
conditions?
Answer: The long-run ideal in maturity distribution of the Federal debt
would be, briefly, as follows: To have an adequate amount of bills and certificates outstanding to meet the liquidity requirements of the economy; to have
an adequate amount of Government obligations with a maturity of 1 to 10 years
to meet the needs of investors who desire to space their m a t u r i t i e s ; and, finally,
to have a considerable amount of long-term securities primarily in the hands of
ultimate investors, such as individuals, corporations, pension funds, and insurance companies. Because the Federal debt was increased so rapidly during
the war, the existing maturity distribution leaves a great deal to be desired.
Debt management is a very complicated affair, however, and h a s to be handled
with extreme care. T h e problem should not be approached with preconceived
notions or the desire to establish ideal conditions within a short time.
Debt management has an important effect on the flow of capital into corporate
securities as well as into mortgages. The supply of capital is limited to the savings of t h e people, unless, of course, it is desired to monetize the debt, which is
unsound and leads to inflation. Since the Federal debt, is very large and the
amount of marketable securities coming due within 1 year totals about $60 billion,
it is evident t h a t if t h e Treasury were willing to pay a high enough r a t e of interest it could preempt all the savings of the Nation. Obviously, such a policy would
be undesirable and unsound.
The debt-management policy must be tailored to prevailing economic condit i o n s . In periods when industry is not operating a t capacity and there is more
than normal unemployment, the Treasury in its refunding operations should not
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UNITED STATES MONETARY POLICY
compete with other borrowers for long-term funds. It should leave the capital
market to private borrowers and political subdivisions. When private borrowers,
such as industrial corporations, home builders, and the construction industry in
general, borrow money, they use it for purposes which stimulate the economy.
The same is true of borrowing by States and local governments for public works.
When the Treasury, on the other hand, refunds matured or called obligations
into long-term bonds, it merely mops up that amount of capital without favorably
influencing the economy.
The short-term money market is usually the cheapest and most easily accessible
source of funds. In principle, as far as the public debt is concerned, it would
be desirable to keep it free for emergency needs, and for the execution of depression fighting financial strategy, as, for example, when the Federal budget is deliberately unbalanced in an effort to maintain or to stimulate economic activity.
Under existing conditions it would seem advisable for the Treasury to offer
some long-term bonds as previously indicated. That is, a moderate amount to
meet the requirements of State pension funds, labor-union funds, and smaller
institutional investors, whose investments consist largely of Government securities. At present, private investors, and especially institutional investors, are
more interested in obtaining a higher yield than prevails on Government securities, or, in buying tax-exempt obligations. The debt-management policy of the
Treasury, particularly as regards efforts to lengthen maturities and to reduce
the volume of the floating debt, must therefore be handled with great care and
must be based on existing conditions and not on preconceived theories.
8. Are the benefits and costs to commercial banks of handling Government
transactions clear enough, or can they be made clearer, to determine whether or
not the banking system is being excessively compensated or undercompensated?
What about the Treasury cash balance—its size
and management? Should the
Government receive interest on its deposits wTith commercial banks?
Answer: It is difficult for a noncommercial banker to make an authoritative
statement as to whether the banking system is being excessively compensated or
undercompensated. It seems clear, however, that the banks are rendering many
services to the Treasury for which they are not being compensated. I might mention, for example, the handling of E, F, G, and H bonds, which involves a great
deal of labor and which the banks are cheerfully doing as a patriotic duty. Also,
the banks have been in the forefront in most bond drives and have otherwise
rendered valuable services to the Treasury.
In view of the magnitude of the Federal budget, the Treasury should have a
working balance of about $5 billion in order to be in a comfortable position. A
large cash balance can be used to assist monetary policy. For example, it can
ease the strain of heavy tax payments. Or, its manipulation can reenforce a
contraction, for example, by shifting idle balances from commercial banks to the
Federal Reserve. If there is a temporary monetary stringency, a large cash
balance would enable the Treasury to postpone new financing until conditions
improved.
It would not be advisable for the commercial banks to pay interest to the
Government on its deposits. By the Banking Act of 1933 the commercial banks
were prohibited from paying interest on demand deposits. This was done in
order to avoid keen competition for deposits among the banks through the payment of higher and higher interest rates, which past experience indicated had had
an adverse effect on banking policies and bank lending and investing activities.
It would l>e unfortunate, indeed, if legislation were to be nasserl to enable the
Treasury to obtain interest on demand deposits. This might lead to a renewal
of the unsound practices which existed prior to 1033. In view of the large number of services rendered by the commercial banks to the Treasury, the insistence
that the banks pay interest on Government deposits would undoubtedly have an
adverse effect on their relationship.
There are other arguments opposing interest on deposits: One is that of favoritism, that the Government would he given better treatment than other demand
depositors. Second, a cost-minded Treasury might be tempted to keen a maximum of funds with the bank to earn the interest, drawing them out just afterpayment days, instead of gradually as required. This would make for wide
swings in bank reserves, especially at interest-payment davs. And, at the same
time, the banks* costs will have risen, since its interest payments to depositors
(the Government) will be higher.
Tn my opinion, therefore, it would be unsound for the Treasury to require that
it be paid interest on its deposits with the commercial banks.
UNITED STATES MONETARY POLICY
87
Senator FLANDERS. Our next witness—I may say that all of you
have cooperated in making your brief presentations.
Our next witness is Mr. Wilde, Frazar B. Wilde, president of the
Connecticut General Life Insurance Co.
I am interested to note, Mr. Wilde, that you are in a present office
or position which I once held myself, as Chairman of the Research
and Policy Committee of the Committee for Economic Development.
STATEMENT OF FRAZAR B. WILDE, PRESIDENT, CONNECTICUT
GENERAL LIFE INSURANCE CO., AND CHAIRMAN, RESEARCH
AND POLICY COMMITTEE, COMMITTEE FOR ECONOMIC DEVELOPMENT
Mr. WILDE. Mr. Chairman, I feel honored to try to be in your position, because I am not an economist, and I do not think that the work
of our complicated civilization which we are now trying to run, is
such that any one of us has enough knowledge to carry out on our
own, so with the committee's permission I wish to make a brief statement with respect to this paper.
I have tried to make the following points: First, that a flexible
monetary policy is useful and constructive and is within the general
interest if it is operated by a central bank, and that bank is free to use
its individual judgment.
I have said that I believe that a flexible monetary policy helps, and
it has always helped in fighting inflation, and it can function in restraining unhealthy moves.
I t has an equally valuable positive function in that it enables an
increase of the money supply in proportion to legitimate growth
demands of industry, trade, and commerce.
I t is my opinion that the Nation could use a flexible monetary policy
as an important instrument in contributing to our objectives of growth
and high levels of employment without inflation, but this does not
mean that we should place our sole reliance on monetary policy.
A given situation will require several measures, but a flexible monetary policy is important for at least three reasons. First, its timing
is more flexible. This would contrast particularly with budget policy.
K"ow, I feel that budget policy is an important part of any program
for the prevention of inflation as a deterrent to sound growth. But
there are political and economic obstacles to excessive reliance on
budget surpluses as a means of controlling inflation. Monetary policy
is the most sensitive and flexible instrument, and I do not believe that
an adequate anti-inflation program is possible without it.
Second, as compared with direct controls or with selective measures, monetary policy has the merit of being a general, overall, impersonal instrument and, as a matter of fact, direct controls are not likely
to be available except and save in time of war, and I think are an
inferior instrument, even if they were available, and I do not understand the confidence that some of our panel members have if our country would permit select measures or direct controls, if they were to
have this good instrument.
t Thirdly, I believe that our recent experience with a flexible, twosuled monetary policy has been most encouraging and justifies its continuation; and I think we have demonstrated that monetary policy
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UNITED STATES MONETARY POLICY
can be of assistance in the development of a healthy boom, and without
developing serious consequences.
I n my opinion, the most important consequences of a flexible monetary policy are its effects upon the stability and growth of the economy.
Monetary policy should not only attempt to counter the short-term
inflationary and deflationary movements, but should gear the money
supply to our long-run growth potential; and, I believe, therefore,
that the policy should be judged in terms of these important effects
and not in terms of who gets or who pays higher or lower interest
rates.
As a matter of fact, it is exceedingly hard to trace the income distribution effects of a rise of interest rates and to make any judgment as
to the desirability of these effects. There are a number of reasons
for it.
First, the initial payers or receivers of interest are, for the most part,
not the ultimate payers or receivers. The large financial institutions
which receive interest as payments represent millions of depositors
and policyholders; in other words, we are dealing with literally millions of people who are both debtors and creditors at the same time,
which is a relatively new economic development in this country.
On the other hand, corporations and governments which pay interest represent millions of customers and taxpayers. You cannot
trace and be dogmatic about who receives and who pays.
Now, secondly, the alternative to higher interest rates is not simply
lower interest rates, but lower interest rates on a larger volume of
credit. Interest rates are kept from rising wThen demand is active
by an expansion of the volume of credit. I t is not clear that financial
institutions would earn more from higher rates than from lower rates
on a larger volume. I make that point because there is an apparent
belief on the part of some students that institutions are always narrowly and selfishly concerned with high rates as being more profitable.
That is not necessarily true.
Third, along with higher interest rates usually go losses on capital
accounts, that is, the market prices of investments decline. The net
effect of this would vary for different investors.
In general, the net distributional effects of higher or lower interest
rates are so diffuse and uncertain that they could not be a major factor
in deciding upon monetary policy.
I n my paper I have belabored inflation, urged that we should
concentrate at all times on stability and upward growth instead of
taking undue risks with inflation.
Now, that may be a personal bias, but I am always alarmed at the
relaxation of my friends, many of whom, perhaps, may be skillful
enough to take temporary advantage of inflationary conditions, but
I read the history of the world, and I look at countries like France,
which have capable people, who have great national resources, and
th& continual inflation of a country like that is one of the major
deterrents to its growth. I t cannot get capital for capital expansion
which they need, when people have no confidence in the future value
of the money.
I may be biased because of the fact that my business sells money for
future delivery, and to me it is a pretty wicked thing to consider
the possibility that people will make present sacrifices for future protection, and then get dollars of much lower value.
UNITED STATES MONETARY POLICY
89
I am not talking about this country going into an extreme inflation,
but I am talking about the continuous erosion, deterioration that can
happen if we adopt what to me might be reckless monetary and fiscal
policies.
I think it is quite unfair for large groups of the population, because
it does lead to booms and busts of employment, with human suffering
and money losses, which unemployment causes, and I am quite unable
to be relaxed and optimistic about expansion with mild inflation as
being a sound and safe thing to do.
I have developed the theme that the difficulty with providing flexible monetary policy is because there is quite a lack of public understanding of how it is and how it can best function. The history of
the last few years to me is evidence of the great use of monetary policy
and accompanying extensive criticisms.
I t requires a combination of at least three major elements: Favorable, friendly, optimistic environment; sound, constructive fiscal
policy; flexible, healthy monetary credit and debt management policy.
These are the ultimates which in combination can lead to a steady
growth which the country desires, and which we believe it can have.
I do say that this growth should be upward progressively; it cannot
be in a straight line without any fluctuation. I t will go above a straight
line of growth and progress, and we will dip below it if we are going
to have a free society, and I do not want to have a society that is
entirely regulated and planned, because I do not think it is either
good judgment or in the American spirit
That is the end of my remarks.
(The prepared statement of Frazar B. Wilde is as follows:)
FLEXIBLE MONETARY POLICY AND INFLATION—STATEMENT SUBMITTED BY FRAZAR
B. W I L D E , PRESIDENT, CONNECTICUT GENERAL L I F E INSURANCE CO., HARTFORD,
CONN., AND C H A I R M A N , RESEARCH AND POLICY COMMITTEE, COMMITTEE FOR
ECONOMIC DEVELOPMENT
My name is F r a z a r B. Wilde. I am president of Connecticut General Life
Insurance Co., Hartford, Conn.
The views expressed in this testimony are my own, and are based on some 20
years of experience in the management of an insurance company portfolio as well
as a bank trustee. I n addition to my business experience I have been for some
years active in the work of the Committee for Economic Development, a nonprofit organization of businessmen conducting research on economic problems.
Currently I am chairman of the research and policy committee of the CED. I
have distributed to the members of jTour subcommittee copies of two policy statements t h a t our committee h a s issued on the subjects of the present hearing. I
do want to make it clear, however, t h a t I am appearing today, in response to your
invitation, as a n individual and not attempting to register the considered current
position of CED, which can only be done through its formal papers.
A central bank which recognizes its responsibility to contribute to economic
stability and growth, and carries out its duty by following a flexible monetary
policy, is bound to be unpopular. Many of the reasons for this are unrelated to
the merits of a flexible policy as such. This is the climate in which any inquiry
into central banking operations is inevitably conducted. If any useful results
are to come out of such an inquiry, we must at the outset take this climate into
consideration.
The principal reasons for this unpopularity a r e obvious, and yet a r e constantly
forgotten by the critics. The most important of these arise out of the occasional
need for restraining action on the p a r t of a central bank.
Even those who accept a flexible monetary policy in principle frequently object
in practice, when r e s t r a i n t is the order of the day. Since people do not like to
be restrained, and since they seldom agree on the correct timing and on the extent
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UNITED STATES MONETARY POLICY
of credit restriction, even though they accept the idea in theory, we find our
monetary authorities generally in hot water. The sound direction of a flexible
monetary policy is always handicapped and troubled by basic human emotional
characteristics.
The second reason arising out of the occasional need for restraint is that some
do not believe in the use of a restraining monetary policy at any time. They
question the effectiveness and the appropriateness of combating inflationary
pressures by the use of general monetary and credit restraints and prefer other
instruments. They feel that relatively low interest rates are appropriate under
all conditions.
A third reason for the underlying unpopularity of a central bank is that a
large part of the public finds monetary matters difficult to understand and is
either indifferent to or confused about them. At any rate, it is easily swayed by
the propagandist, whether he is the businessman or the politician.
A fourth reason is a historical tendency on the part of many groups in this
country to distrust and to criticize banks and banking. By tradition, bankers
are a convenient scapegoat.
For all of these reasons it is difficult to make a rational evaluation of central
banking operations. We should remember too that it is even more difficult, in
such an atmosphere, for a central bank to carry out successfully a flexible
monetary policy. Unfair and excessive criticism is never conducive to good
administration.
As a result, the central bank's imposition of restraint is in practice almost
universally criticized and its expansion of the money supply, while more generally accepted, is often condemned as too little and too late. The unfortunate
thing is that a good deal of such criticism comes from persons who believe
implicitly in the theoretical virtues of a flexible monetary policy. Too often the
practical result of these conflicts is an excessive reliance on easy money.
I . THE UNPOPULARITY OF RESTRAINT: 1950-51
A striking illustration of this principle—in terms of debt management as
well as of central banking practices—appeared in the fall of 1930 and the early
spring of 1951. By that time there was increasing criticism of the Treasury
and Federal Reserve, who were collaborating at the insistence of the administration in maintaining pegged prices for Government bonds. While there was
good reason to believe that the Federal Reserve, recognizing inflationary dangers.
had wished to discontinue the practice at an earlier date, no important action
had been taken up to the end of 1950. The majority of those who understood
the crippling effect upon the Federal Reserve of maintaining a pegged Government securities market were in agreement that this practice should be discontinued. The Federal Reserve has a major role in contributing to the maintenance
of a sound and growing economy, and fixed prices for Government bonds, which
might have been justified during wartime, were wholly unwarranted 5 years after
the war.
Those who believed that fixed prices should be maintained included several
groups. There were those partisans who felt that to change this policy was
a direct criticism of the administration. There were others who felt that low
interest rates per se were desirable regardless of the actual and potential
danger of inflation they created. Few, if any, who understood the true function of central banking and the need for freedom in operations, and certainly
none who had respect for sound money, wanted the support program continued.
At long last, in March of 1951, an accord was reached permitting flexibility
in Government bond prices. This involved some retreat in prices. Immediately
there was a hue and cry, and it didn't all come from politicians.
The purchaser of a marketable bond, whether an individual or an institution,
must be willing to accept the fact that in a free, capitalistic economy, security
prices are certain to fluctuate. When there has been a heavy demand for investment funds or bank loans relative to supply, interest rates are bound to increase
and bond prices must reflect this situation, other things being equal, by going
lower.
Many buyers of Government securities had forgotten that this fluctuation is
normal. They had been spoiled by the abnormal wartime condition of pegged
prices which had existed for a long time. They grew to think that par and, in
many cases, a premium over par was the natural price for their securities. This
attitude is difficult to understand—in fact, quite incomprehensible—as to institutions whose buyers certainly know, or should know, the history of the market
place. It is easier to understand in the case of individuals with little experience
UNITED STATES MONETARY POLICY
91
in bond buying; but these, for the most part, were not the persons involved. The
unsophisticated investor usually held E-bonds or some other nonmarketable
security which did not fluctuate in price.
Many seasoned investors were most vociferous, particularly after the end of
the war, in contending that in a free economy lixed prices and price supports
should be abandoned everywhere. Then when the fixed price for bonds was withdrawn, some of these same people expressed dismay and unhappiness that it
should happen to them and their institutions.
The fact is that many people who should have supported a flexible monetary
policy, even if it affected their own institutions,
failed to do so. This episode is
an excellent example of the way in wThich human nature tends to resist, even
against the arguments of reason, any restraining pressure on the economy.
I I . T H E CASE FOB A FLEXIBLE MONETARY TOLICY
In my opinion the Nation should view a flexible monetary policy as a principal
instrument for contributing to our objectives of economic growth and high levels
of employment without inflation.
This does not mean that we should place sole reliance upon monetary policy.
Any given situation will require a complex of measures. But a flexible monetary
policy is an important and especially valuable instrument in our kit of tools for
at least three reasons.
First, its timing is more flexible. This is especially true as compared with
budget policy. I would certainly agree that budget policy should be an important
part of any program for the prevention of inflation. But there are political and
economic obstacles to excessive reliance upon budget surpluses as a means of
restraining inflation. Monetary policy is the most sensitive and flexible instrument and I do not believe that an adequate anti-inflation program is possible
without it.
Second, as compared with direct controls, or with selective measures, monetary policy has the merit of being a general, overall, impersonal instrument
As a matter of fact, direct controls are not likely to be available except in wartime, and would be an inferior instrument even if available.
Third, I believe that our recent experience with a flexible, two-sided monetary
policy has been promising and warrants continuation.
In my opinion the most important consequences of a flexible monetary policy
are its effects upon the stability and growth of the economy. Monetary policy
should not only attempt to counter the short-term inflationary and deflationary
movements, but should gear the money supply to our long-run growth potential.
I believe therefore that the policy should be judged in terms of these important
effects and not in terms of who gets or who pays higher or lower interest rates.
As a matter of fact, it is exceedingly hard to trace the income distribution effects
of a rise of interest rates and to make any judgment as to the desirability of the
effects. There are several reasons for this.
First, the initial payers or receivers of interest are for the most part not the
ultimate payers or receivers. The large financial institutions which receive
interest represent millions of depositors and policyholders. On the other hand,
the corporations and governments which pay interest represent millions of customers and taxpayers. We do not know who ultimately receives or who pays.
Second, the alternative to higher interest rates is not simply lower interest
rates, but lower interest rates on a larger volume of credit. Interest rates are
kept from rising when demand is active by an expansion of the volume of credit.
It is not clear that financial institutions would earn more from higher rates than
from lower rates on a larger volume.
Third, along with higher interest rates usually go losses on capital accounts,
that is, the market prices of investments decline. The net effect of this would
vary for different investors.
In general, the net distributional effects of higher or lower interest rates are
so diffuse and uncertain that they could not be a major factor in deciding upon
monetary policy.
H I . A FLEXIBLE MONETARY POLICY I N PRACTICE
How has a flexible monetary policy worked? The first 6 months of 1953 provide a spectacular illustration combining both the techniques of debt management
and the operations of our central banking system.
As many read the signs, the economy was giving definite evidence of boom
in the closing months of 1952 and early spring of 1953. The demand for funds
for permanent capital and for inventory accumulation was sharply accelerated.
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UNITED STATES MONETARY POLICY
Demand for residential and commercial mortgage funds, for municipal funds, and
for consumer credit was pyramiding. The situation required the central banking authorities to refrain from adding to the credit supply. Their duty was
clear. If boom and bust was to be avoided or mitigated through banking procedures, this was a time to let the borrowers compete for whatever credit was
in existence, rather than to expand credit, no matter how vociferous the demand.
Some would have said that sharp restrictions of credit were in order. The
authorities lived up to their responsibilities. They restrained expansion of the
credit, base and, because the demand was far greater than current resources,
money and credit became scarce, and interest rates increased as a matter of
course.
During this period, in furtherance of sound debt management policy—namely
to lengthen the debt—the Treasury offered a long-term obligation. In order
to assure the success of this issue, it was necessary because of market conditions to place a 3% percent coupon on the bond.
In April and May, and running into June, the demands for capital and credit
increased. Potential borrowers tended to stampede the capital market and interest rates increased sharply. Many borrowers who really didn't need funds at
the moment sought money or credit lines immediately, probably in expectation of
higher interest rates to come. A psychological situation developed which was
perhaps the more acute because the issue of a long-term bond coupled with a
restraining monetary policy had not been encountered in the market place for
many years. The Federal Reserve quietly made bank reserves more readily
available in May, and the clear-cut realization by the market in June that monetary policy was not a one-way street—that it indeed was flexible—brought the
stampede to a halt.
The impact of this episode on production, trade, and commerce was slight.
There was enough money available for current use in trade and commerce and
for the payment of construction bills. Some demands for future funds, it is
true, were not met at the time. It was not imperative that they should be, and
no serious damage resulted to the country as a whole. The postponement of
new building because a commitment could not be obtained was not serious. A
new housing development or a new factory was merely postponed. This was
entirely proper in view of the high rate of building and the full utilization of
men and materials at the time, and probably contributed to the mildness of the
subsequent recession.
The same observation could be made in respect to other sectors. Further
inventory accumulation would have been detrimental to the economy and would
only have aggravated the later decline.
Some strain developed in the mortgage market in the spring of 1953. The
situation was a complicated one. When overall credit is restricted and money
becomes scarce, those sectors of the investment area which are weakest will
register the greatest difficulty. The mortgage area was weak for several reasons. A large volume of mortgages had been issued for several years. Institutions tend to operate portfolios under the theory of diversification. Many
banks and insurance companies had as many mortgages in their portfolios as
they wanted. They were anxious to balance by buying more securities. The
mortgages in many cases, because of small size and scattered locations with
apparent greater credit risk and handling expense, were relatively unattractive
as compared to bonds. The result was a shrinkage of prices for mortgages
ottered for sale and a reduction in the commitments made for new mortgages.
Xo great harm if any, resulted to the economy from deferring commitments.
Any sound project, whether it was a new housing development or a new commercial enterprise, was simply deferred and this was highly desirable in view
of the full employment conditions in the building trade. In the case of housing
already constructed, where the builder wished to sell and found it difficult to
arrange mortgage financing, there was a possible loss. Either he didn't make
the sale immediately or he accepted a lower price. This was not as serious a
situation as it sounds. It did not in most cases mean an actual loss, but merely
a reduction in profit. So we're back again to a basic situation; namely, that in a
profit and loss economy there will be times of loss or reduced profits which we
must accept if they are a result of a sound overall national policv, namely,
credit restriction to prevent an unhealthy boom.
Viewed broadly, the operation of banking restraint in the early spring of 1953
is a good illustration of sound policy in the money and credit field and not, as
the critics claim, a misuse of it.
During such a period, when restraint had to be and was exercised, it is to
be expected that some administrative mistakes would be made. With the bene
UNITED STATES MONETARY POLICY
93
fit of hindsight some things would be done differently. Certain isolated instances might be discovered where there was actual economic damage, but the
total of these individual cases of damage would bulk very small in the whole
economy. Even overall, nonselective restraints are not perfectly uniform in
their impact; it cannot be otherwise. But, overall restraints are much better
than any attempt to use selective credit restrictions in time of peace. Under
the latter practice very great mistakes are almost inevitable and large elements
of inequity develop . . .
This experience teaches something which has been known for some time,
namely, the need of constant efforts to improve the market for Government bonds.
The Government debt is very large and will continue to be of great magnitude.
The capacity of the market mechanism to handle a large volume of longer term
issues needs improvement so that more orderly markets may prevail in periods
of strain. But this must not be done at the expense of eliminating price fluctuations which are vital to the success of any flexible monetary policy.
People have said that the Federal Reserve should have publicized its intention to reverse a tight money policy if conditions indicated thte wisdom of reversal. It is a fact that in May and June such a reversal was under way, but no
categorical public statement to this effect was made. 1 think it is important that
the basic objectives and instruments of Federal Reserve policy be generally understood. But, publicity for day-to-day changes of direction seems to me a rather
debatable proposition. At any given time actions speak louder than words. For
the Federal Reserve to discuss fully its actions and the reasons for them at the
time they are taking place is certainly debatable, and it may be undesirable.
This much is certain—the Federal Reserve is entitled to great commendation
for what it did. It identified changes in the situation in May and had the moral
courage to act in accordance with the changed evidence.
IV. I N F L A T I O N AND FLEXIBLE MONETARY POLICY
Belief in the desirability of a flexible monetary policy is, to my mind, necessarily allied to the belief that inflation is one of the great menaces to any modern
society. The wickedness of inflation is in its gross inequity. The great majority
of people, and those least able to protect themselves, are the great sufferers in
periods of inflation—people who have saved, people on salaries, working people
in the majority of instances—despite the fact that certain union groups seem
strong enough at times to keep their wages in line with the depreciated buying
power of the dollar.
The impact of inflation in the period running from the end of the war until
1953 was not felt as acutely as the depreciation in the value of the dollar would
indicate. This was due to a high rate of employment and to multiple breadwinners in the family and other factors such as overtime; but, even with these
advantages, there was great distress among millions of workers and people who
were retired and on pensions.
We expect in this country an increasing group of older citizens enjoying their
retirement through income arising partly out of Government social insurance,
partly out of private insurance, and partly out of their own thrift. Their standard of living will be jeopardized if we accept either the idea that inflation is not
a bad thing or that we cannot control it.
The fact that monetary policy standing alone would be unable to cope with
inflation is no reason for abandoning it. Courageous use of monetary measures
is one of the most effective policies in the fight against inflation. Of course, fiscal
Policy, debt management, and growth of production are all factors which must
be included in our attempts to conduct a successful, free society.
Congress, reflecting the ambition of our country for constant progress, has
expressed its viewpoint in the Employment Act of 1946. The Federal Reserve,
along with other agencies of the Government, is expected to make its contribution to the objectives of this act. No central bank, no matter how long its experience nor how wisely executed its responsibilities, could carry out this directive
in the sense in which some interpret it. The idea that at all times—every week,
every month, and every year—we could have full employment of all the citizens
in this country who might under any conditions wish to be employed is a concept
of Utopia. No free society could ever hope to attain it and the Congress itself,
ns the debate shows and as the act's statement of policy shows, did not expect
it. This country can have, within the framework of a free, competitive, capitalistic society, a dynamic and evergrowing standard of living together with high
employment—and certainly without serious unemployment. Most of us believe
that we can do this and at the same time respect the individual and his freedom
55314—54
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UNITED STATES MONETARY POLICY
so that we can say that while we make material progress we are still a free
society.
Progress will not always be in a straight line. There must be periods when
the growth will be above the line, ana some when it will drop below. If we reduce
the severity of these fluctuations and still march on the upward path, our country
will make a major contribution to modern civilization.
The program necessary to accomplish this goal will require continuous collaboration and the maximum of cooperation between all groups in our country. No
one law or resolution passed by the Congress can hope to do it. Sound fiscal,
monetary and debt management policies, as well as a stimulating environment,
must be included.
Senator FLANDERS. Thank you, sir.
Now we have a little better than a half hour. I n order to give
time for the other members of the subcommittee, I am at this time
planning to raise only some general questions to some of which the
members of the panel may, if they wish, engage in their discussion
with other members of the panel this afternoon.
One is this: I get the impression that some members of this panel
feel that high levels of production, employment, consumption, can
only be readied through means of inflation. If I have correctly understood some of the documents which have been presented, I would hope
that that question would be discussed among you this afternoon.
Another observation which I would like to make is that I get the
impression at times in this discussion that there is some ultimate
value assigned to stability or to inflation or to other elements of debt
management and credit control, aside from its effects on men—aside
from its human results. I would like to make the observation that
personally I cannot assign any important objectives that are not human
objectives. I am not going to catechize them at this time—I hope
the rest of you will.
In connection with the presentation of Professor Mitchell, I was a
little bit puzzled by his, what seemed to me to be, indication of a need
for great investment or at least considerable investment in agriculture,
without taking into account what seems to be to the onlooker a situation of agricultural surplus and overproduction at current prices.
That is all I wish to say at the present time, in general. As the man
said, I am "instigating" you gentlemen to question each other this
afternoon.
Now, Mr. Patman, have you any questions you would like to ask
at this time?
Representative PATMAN. Possibly I should raise certain questions,
Mr. Chairman, so that the panel will be in position to discuss them
this afternoon.
I think you have had some good statements filed today, Mr. Chairman. I have enjoyed every one of them, and I have certainly profited
from the information that has been furnished. I would like to raise
this question for discussion this afternoon: Are the members of the
panel satisfied with the present Federal Reserve System as now
constituted or should changes be made?
The Open Market Committee is the most powerful Committee in
the United States; it is more powerful even than the Congress in many
fields. The Constitution gives the power to coin money and regulate
its value to the Congress. The Congress has* in turn, delegated that
ower and authority to the 12 members of the Open Market Committee,
ometimes I think it is more important that the Open Market Committee meet in Washington and do something to help the country than
S
UNITED STATES MONETARY POLICY
95
it is for the Congress, because Congress has delegated to that Committee so much of its power and authority.
Since that committee has so much power to determine whether or
not we have sufficient money or lack of money, or whether or not we
are going to have high interest rates or low interest rates, in fact
whether or not we have a depression or prosperity, the question I would
like to raise is whether we should have anyone on that board or committee except people who are charged directly and solely with protecting the public interest.
That committee, as now constituted, has 7 members of the Board
of Governors when membership of the Board is complete. Because
of the vacancy on the Board there are only 6 on the Open Market
Committee now. There are also five presidents from the Federal
Reserve banks.
The Federal Keserve bank presidents are elected by the bankers
in their districts, either directly or indirectly. The question in my
mind is whether or not a person who is in any way obligated to a
business that is to be regulated or controlled by it should have anything to do with the great power and policymaking provision that the
Congress has delegated to the Open Market Committee.
I remember when the Federal Reserve Act was passed, President
Wilson referred to the fact that bankers should not run it any more
than railroad owners should run the Interstate Commerce Commission.
Of course, if railroad owners were to run the Interstate Commerce
Commission they wTould not only fix the rates of railroads but they
would fix the rates of the buses and the trucks and the airlines and
express companies. I just wonder if we have not gone quite far in
terms of the role the bankers play in the Federal Reserve System.
If so, is that in the public interest or should it be changed ?
May I say further that Mr. Eccles, Marriner Eccles, was on the
Board of Governors, I guess, longer than any other one person, and
1 recall one time he made this statement:
When a Reserve bank president sits as a member of the Federal Open Market
Committee, he participates in vital policy decisions which affect all banking.
So far as I know, there is no other major governmental power entrusted to a
Federal agency composed in part of representatives of the organizations which
are the subject of regulations by that agency.
Another question that has been raised here by the panel members
is about the ownership of Government bonds by the banks. I have no
objection to the banks owning Government bonds when it is necessary
to give them ample earnings. I believe in a privately owned commercial banking system. I believe in a profitable banking system,
because if they are not allowed to make profits they cannot function
satisfactorily for the people, so we want a profitable banking system.
I do not object to their owning bonds, but should we allow them to
fill their portfolios with bonds to the extent that they have no desire
or not a sufficient desire to make local loans and serve the local communities they are obligated to serve when, in fact, that is the reason
they were given charters.
The question in my mind is, with banks filled with Government
bonds like they are, and getting so much from their Government security holdings, and they are pretty well satisfied with their earnings
as to whether or not they are performing their local functions in a
satisfactory way. What raises my suspicions in that respect is that
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UNITED STATES MONETARY POLICY
small-loan companies are springing up all over the Nation, taking
over functions that the banks, I think, should normally perform. ^ Is
that due to the fact that the banks in certain localities are not taking
care of their local needs? I would like the panel to discuss that
question.
I would like a discussion, in particular, about the present setup of
the Open Market Committee and the Federal Reserve System, and
next as to whether or not the banks are 'doing their duty and whether
or not they are persuaded or disuaded from supplying local needs
because they get so much of their income from riskless securities of
the Federal Government.
Senator FLANDERS. Thank you, Mr. Patman.
Much of this discussion which we have listened to so far seems to
occur in a peculiar sort of vacuum. For instance, there is no reference made to the situations external to the monetary system, although
connected with the debt system, which have tremendously influenced
our whole economy.
No mention, as I remember, was made of the inflation which followed on the beginning of the war in Korea.
Again, no mention was made of the great drop in Government
expenditures in the fiscal year 1954, and a presumably still greater
drop in 1955, which resulted in a decrease of defense production.
Those things are things pertinent to the whole problem, and it
seems to me that monetary and fiscal policy should be considered with
reference to that war inflation and with reference to that decrease in
defense expenditures.
Senator Goldwater.
Senator GOLDWATER. I have two questions that have come to me that
I think we should discuss briefly this afternoon. Throughout the
presentation of most of these papers I have been impressed with the
seeming thought of the authors that low interest will solve most of
our problems—our economic problems.
I would like the panel to give this consideration during the lunch
hour. If that is true, why did not low interest rates help or why did
they not add more between 1933 and 1939 than they did ? The thesis
that you now hold that we should keep interest rates low, that it is an
obligation of the Government, does not quite seem to hold water in
view of the fact that the market between 1933 and 1939 was a constantly downward one, and business—the business indexes—never
recovered from the low of 1932, actually, until the start of the war.
I have another question that comes to my mind, too, that I think
is of importance: The desire to get money into our economy is the
most important attitude that I think we should consider—investment
capital, if you want to call it that.
I n view of that, we should explore the fields from which that investment capital will come.
I would like to know the attitude of the panel on tax reductions
based on a sound fiscal policy as a means of getting more and more
money into the economy to stimulate its growth.
I am prompted to ask that question for discussion in view of the
rather healthy condition of the economy at the present time, particularly in the construction business, that I personally feel was brought
about in a large measure by the relief in the recently enacted tax bill
in the investor levels or investor areas.
UNITED STATES MONETARY POLICY
97
That is all I have, Mr. Chairman. I will pursue those further this
afternoon.
Senator FLANDERS. Senator Douglas?
Senator DOUGLAS. I am afraid we are raising more questions than
the panel will have time to deal with this afternoon, but I would like
to raise one general question, if I may.
It would seem to me we should have a dual set of goals. We should
have, on the one hand, substantial growth and substantially full employment, and, on the other hand, substantial stability in the price
level. Both of them are needed.
Now, I had always hoped that those two aims might be consistent.
I know that some say that they are inconsistent; that we have to have
at least a moderate degree of inflation in order to get substantially
full employment and growth. I hope that may not be true, but, at
any rate, let us consider the question as to whether or not it is. Others
are so afraid of imaginary dangers of inflation that they sometimes
seek a fall in the price level at the expense of growth and full employment. I would like to raise the theoretical question as to whether
it is not possible to attain both of those goals, and, if so, how; and,
secondly, I would like to point out that period from March 1951, the
date of the so-called accord, to December of 1952 was one, on the whole,
of substantially full employment and also of substantial stability in
the price level.
I have taken a monthly record of prices and I find that on the wholesale index, the index fell from 116.5 in March of 1951 to 109.6 in
December of 1952, or a fall of 7 points; that in the field of consumer
prices there was a rise from 110.4 to 114.1; and if you take an average
of the two, there was substantial stability or perhaps a 1-percent
decline.
Therefore, I would like to suggest that in those 21 months we had
a successful economic policy in which those goals were combined.
Was that accidental ? Was it just happenstance or were there factors
behind it?
I would like to have some discussion both on that practical feature
and on the theoretical issue this afternoon, if that meets with the
approval of the group.
Senator FLANDERS. Thank you, Senator Douglas. ^
Mr. Talle, have you any thoughts for the consideration of this
panel?
Representative TALLE. Mr. Chairman, I have a couple of questions
in my mind, but I would prefer to withhold them so that we may proceed immediately to sit at the feet of this impressive faculty of
teachers.
Senator FLANDERS. We have 20 minutes or so left of the time that I
announced; we ought to do something with it.
Representative PATMAN. May I ask Dr. Clark a question, Mr. Chairman?
Senator FLANDERS. YOU may do so.
Representative PATMAN. If I properly interpret your statements,
Dr. Clark, you suggest that the Federal Reserve should use reserve requirements instead of the open market operations.
Mr. CLARK. Yes,
sir.
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UNITED STATES MONETARY POLICY
Representative PATMAK. Would you go so far as to fix a standard or
a guide to govern them to the extent that open market operations
would be unnecessary ?
Mr. CLARK. Open-market operations to support important Treasury financing should always be undertaken by the Federal Reserve.
I n order to stabilize its own holding of Government bonds, it will then
be necessary after the financing has been concluded, for the Federal
Reserve to ease out its open-market purchases, doing it slowly;
whereas their first move would have been an aggressive, rapid one.
That, I think, is the extent of open-market operations that would
benefit the present situation. I t would have too small an effect upon
the total economy at this time to engage in open-market operations
for the purpose of adding to the reserves of banks.
On the Federal Reserve action with respect to reserves, the point I
would make, first of all, is that there is not at this time any circumstance that justifies the imposition of reserve requirements higher than
the limits fixed by the Federal law, and under those
Senator DOUGLAS. When you say "normal" or "legal" limits, do
you mean the minimum limits, Dr. Clark? I notice you used the
phrase "normal," and I was not certain what you meant by that,
whether it was the minimum that you meant.
Mr. CLARK. Yes; they are the minimum.
Representative PATMAN. None of them are normal now.
Mr. CLARK. They are prescribed by the Congress, and they ought
to be respected excepting when there are circumstances that make it
necessary for the Federal Reserve to use its extraordinary discretionary power to increase those limits to twofold. Now, I do not
know what would be the effect of this. I t would be a massive movement, and we apparently need some massive movement right now to
start the economy under way, because we have had nearly a full year
of nonexpanding economic activity. We have seen one thing which
develops in a period in which the economy lags, and that is a slow
lowering in the rate of private capital investment, a prime factor in
maintaining the economy and in bringing it upward to the level established by the Employment Act.
Representative PATMAN. I will have to admit, Dr. Clark, that I
have not looked with favor on the use of reserve requirements, because of what I consider to be an unfortunate experience we had
in 1936.
You will recall on June 15,1936, the veterans of World W a r I were
delivered about a billion and a half dollars in money in payment of
what was called the bonus of the First World War.
I n order to offset that and acting on predictions that had been
made, unwarranted predictions and unjustified predictions by the
monetary authorities, who said it would be highly inflationary, the
Federal Reserve Board, for the first time since it had the power—
it was given the power by Congress shortly before—doubled the reserve
requirements of banks and contributed to the downturn in the early
p a r t of 1937. Since then I have not looked with favor on the use of
the power to alter reserve requirements, but, at the same time, I recognize that it depends upon how it is used and the people who have the
authority to use it.
I t looks like a very effective weapon to me, a very effective weapon.
I know it worked in 1936 because I witnessed the disastrous effect it
had upon the economy.
UNIT CD STATES MONETARY POLICY
99
Mr. CLARK. Mr. Patman, may I repeat what I said, that from the
standpoint of the monetary authorities themselves, it should be highly
desirable to gain leeway for action if they hereafter need to use reserve
requirements boosts in order to meet some inflationary situations.
As it is now, they have very little leeway. The reserve requirements
have been reduced so slightly in the past year
Representative PATMAN. That is only in certain banks, Dr. Clark.
Do you think that the authorities should reduce them for certain
banks, or certain categories or should they be reduced in proportion as
Congress provided in the formula used for the reserve requirements
of banks? I n other words, where it is 26 and 20 and 14, if there is
going to be any reduction, should it be uniform across the board, or
should.they be allowed to reduce the 26 if they want to one-half,
and not touch the others at all ?
You know the last year or 2 or 3 years, rather, reductions have been
made in the first 2 categories, I think, but not much in the lower
ones; is that right?
Mr. CLARK. Well, there was not very much leeway in the lowest
category on time deposits.
Representative PATMAN. On demand deposits.
Mr. CLARK. They were only 3 percent above the normal limit.
Representative PATMAN. I am talking about demand deposits.
Mr. CLARK. On demand deposits, they did reduce the central reserve
bank limits a little more than the others, but I was sympathetic to
that because I agree with the idea that there are no longer any conditions in our banking system that make it necessary to have a higher
reserve requirement for Chicago and New York than they have for
the other so-called reserve cities.
Representative PATMAN. Well, that brings up a different theory
entirely from the congressional act.
Mr. CLARK. But the larger reduction for those two cities, I think,
was just
Senator FLANDERS. I wonder if any other members of the panel
would like to comment on this question of using to a greater extent
than, perhaps, as the primary tool, the reserve requirements rather
than other tools at the disposal of the Treasury or the Federal
Reserve ?
Mr. SMUTNY. Mr. Chairman, may I say a word in reference to
that?
In the first place, I do not believe the reserve requirement is a flexible enough instrument. I n other words, you cannot bounce the reserve requirements around. I n other words, you are trying to use
that as a substitute for the Open Market Committee.
Now, if you have excess reserves, and the Federal Reserve wishes
to let some'bills mature rather than doing it, would you go ahead and
change the reserve requirements that week, would you follow it the
following week by a change in reserve requirements? You would
have to confuse the banks with that situation I t is not as mobile and
flexible an instrument as the purchase and sale in the open market
would be.
Point No. 2 is that the change in the central bank, the reserve requirements of the central bank is, of course, the recognition of the
difference that exists now, which did not exist in prior years, that the
deposit relationship with the interior has, has become much more im
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UNITED STATES MONETARY POLICY
portant, the correspondent bank does not have to depend as much on
the large New York and Chicago banks, so why should they be discriminated against, you might say, in having a higher reserve requirement as far as the central banks are concerned. 1 think that is something that has to be taken into consideration today.
Representative PATMAN. Dr. Clark suggested that both be used.
Mr. S K U T N Y . Well, at times it can be, but it is not an instrument
that should be used as actively, let us say, in my opinion.
Senator FLANDERS. Do any others of the panel wish to comment
on the question ?
Mr. HARRIS. May I make just one comment, and that is that there
is some advantage in using the reserve requirements in that it more
or less affects the prices of all assets; whereas open-market operations tend to disturb the Government bond market exclusively, at
least at the beginning, and from that viewpoint, there sometimes may
be some advantage in using changes in reserve requirements as against
indulging in very large open-market operations.
Mr. CHANDLER. May I make a couple of comments about that ?
Senator FLANDERS. Yes, sir.
Mr. CHANDLER. The first is that I see no reason to presume that it is
better to have reserve requirements down toward the lower part of
the range than it is to have them up toward the top part of the range.
The purpose of reserve requirements is not to assure liquidity to the
individual bank; it is a device for limiting the money supx^ly. I
think that one of the reasons why changes in reserve requirements
are so unfavorably looked upon instrument of policy is that so many
people still persist in looking on them as a means of assuring liquidity,
and that is not the primary purpose.
The other thing that should be pointed out is that the Federal
Reserve will probably be reluctant to use this instrument repeatedly
and frequently so long as the great bulk of American banks are free
to leave the Federal Reserve System if they wish to do so. Every
time the reserve requirements are raised, it creates new irritation on
the part of the member banks who feel they are unfavorably discriminated against.
Senator FLANDERS. Any other comments ?
Mr. LAND. I would like to comment on the geographical nature of
the present reserve requirements, in that they are based on the geographical location of the banks as related to demand deposits. I t
would be well if somewhere along the line they could be recast so
that they are based on the nature of the deposits and not on the location
of the deposits.
Mr. WILDE. I would like to make this observation about the tools
of the Federal Reserve. I t seems to me, as a practical matter, in a
country that moves as fast as ours does, the open market is the most
flexible and the most useful and, then, secondly, the rediscount rate
and, third, the change in the reserve requirements.
Representative PATMAN. Excuse me, the rediscount rate is not being
used; is it ?
Sir. WILDE. I t is occasionally used.
Representative PATMAN. Seldom used.
UNITED STATES MONETARY POLICY
101
Senator FLANDERS. You are so classifying them with relation to
the ease and quickness of application or with regard to the desirability
of the results %
Mr. WILDE. I think they are practically the same, the ease and
readiness and flexibility contribute to their being the most practical
instruments, in that order.
Senator FLANDERS. Why is not the rediscount rate on the whole, to
the extent that it is used, more rapid and direct in its application
than the reserve requirements?
Mr. WILDE. Well, I do not believe, Senator, that I could answer
that with conviction. As a bank director, sitting on this side, it seems
to me that it would not make too much difference. But I guess just
watching what the Federal Reserve was doing in the open market,
as to the open-market policy, was an indication of how we should
conduct ourselves more practically than with changes in the rediscount
rate.
Senator FLANDERS. Perhaps an interesting subject, although we
can spend more time than we have this afternoon, would be, there is
some indication of the reasons for the disuse of the rediscount-rate
device, which was originally the primary device of the Federal Reserve System, and I have seen some indications that it is being revived
to some extent, at least, now. I do not knowT whether that is right or
not. If it is, the reasons for that would be of interest.
Representative PATMAX. Mr. Chairman, may I suggest, of course,
the banks would have to get in debt and expect to get into debt before
that device would be worthwhile. If you will recall, at one time
the rate was raised in the early part of 1953, and the interpretation
placed on this action, and I think properly, wTas that it was purely a
psychological move, that they were letting the bankers of the country
know that money is not going to be as easy, it is going to be a little
tighter. I t wTas what you might term an unconversational understanding among the monetary authorities that they were going to
make money just a little bit tighter, and if they were to lower it, it
would imply that they were going to make money a little bit easier.
In practice I do not think it has been worth anything except psychologically.
Mr. SMUTXY. Mr. Chairman, may I add to what Mr. Patman said?
Senator FLAXDERS. Yes.
Mr. SMUTXY. Actually, as Mr. Patman mentioned, after all, reserve
requirements only come into use when some bank is borrowing and
at the Federal Reserve. The rediscount rates affect all the banks.
Now, therefore, would it not be a good idea to study the relationship between our reserve requirements in the United States versus
those that pertain to banks in Canada and England?
If you look at those rates they are very substantially below ours;
of course, they have fewer banks, that is true, but, as you know, there
are a very minor number of banks in comparison to the 11,000 banks
wo have, but nevertheless in Canada, if I recall their reserve requirement rates correctly, I think they are using something around 8 or 9
percent;, and in England G percent.
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UNITED STATES MONETARY POLICY
Now, after all, we are tying up substantial funds of the assets of
a bank in the use of reserve requirements in this country in the rates
we have.
Senator FLANDERS. We have arrived at the announced time for
adjournment.
Mr. Ensley?
Mr. ENSLEY. Mr. Chairman, we have received a statement from
Aubrey G. Lanston & Co. relative to the questions that the Treasury
and the Federal Reserve answered and, with your permission, we
would like to insert the statement in the record at this point.
Senator FLANDERS. Without objection, that will be done.
(The statement of the Aubrey GL Lanston & Co., is as follows:)
STATEMENT BY AUBREY G. LANSTON, AUBREY Gt LANSTON & Co., INC., NEW
YORK, N. Y.
The contribution to monetary policy made oy earlier committee hearings
The earlier hearings on monetary policy under the chairmanships of Senator
Douglas and Representative Patman produced many expert points of view, a
record of events, and helpful data that otherwise would not have become available. These served to enlighten students and to broaden public knowledge. The
complex: nature of the things that must be considered in evolving monetary policy
was fully demonstrated. The need for flexibility consistent with changing economic conditions was driven home to a mass of people, some of whom had rarely
given this matter any thought.
The conclusions reached by these earlier subcommittees lacked complete agreement on some important points, but the areas of agreement were sufficiently
broad that this served as a mold by which future developments in monetary policy
could be, and have been, shaped.
The ensuing years have been marked by more than ordinary progress. They
haye been years of change; of change in the direction of more widely accepted
monetary policy objectives. The methods and techniques employed, and the
workings of monetary policy have undergone change, also.
The results have been multifold. People throughout the world have become
more sure of the toughness, the resiliency, and the lasting qualities of American
economic life. The public has demonstrated a renewed confidence in the stability
of the currency. Generally, people have acquired more confidence in the longer
run economic future. People have begun to believe, once more, that the horizons
of our economic future are the widening, limitless ones of a society wherein individuals are permitted, and encouraged, to initiate new ideas and methods; to be
free to apply these with their full energy and to be rewarded more commensurately—free of the hampering restrictions of a self-perpetuating bureaucracy.
At the top of these rewards is the better safeguard privilege of freedom—freedom
to run the details of one's own life.
Both the Douglas and the Patman subcommittees have contributed substantially to these ends because they helped to release monetary policy so that
it could do the job of which it is capable, to free it so that it might better serve
our kind of economy—the most dynamic the world has known.
I believe that these hearings, under the chairmanship of Senator Flanders,
will help to preserve the healthy changes that have been made, and to promote
further progress.
Monetary policy is a three-wheeled vehicle
As you know, monetary policy is not a one- or a two-wheeled vehicle. I t is three
wheeled. Treasury debt management can't do the job by itself, neither can
Federal Reserve credit policy. The two of them alone can't do it, either, at least
very well. This is because the big wheel of the vehicle is the Treasury cash
budget and the changes that occur in this; that is, whether a cash surplus or a
cash deficit comes at an appropriate time as we roll along through different kinds
of business conditions.
UNITED STATES MONETARY POLICY
103
It therefore would be futile to attempt to analyze, or to weigh the objectives
and the workings of debt management as though these could operate in a vacuum.
The same is true of Reserve credit policy. The actual and prospective results
in the Treasury cash budget cannot be ignored.
A monetary policyt or the absence of one?
In fact, the results in this budget—and I refer to both the actual and the prospective results in the cash budget—have a lot to do with the facility with which
the debt can be managed. The way the debt is managed has a lot to do with the
workings of credit policy. If the Treasury budget results are particularly bad,
such as an actual or prospectively large cash deficit during a business boom, the
impact on the Treasury's management of the debt is bound to produce a compounding, adverse impact on Reserve credit policy. The grinding and crashing
repercussions that may be produced will be heard, felt, and seen throughout the
Nation. But these are not the workings of a monetary policy—they are the consequences of not having one.
Such a situation might better be described as one wherein Treasury and Reserve officials are forced to struggle to prevent the big wheel of the Treasury's
deficit from running amuck in a way that might produce anything from mild economic instability to inflation or worse.
Responsibility and improvisation
Congress cannot be careless with respect to the results in the Treasury cash
budget and still discharge its responsibility for the creation and proper functioning of monetary policy.
If the Congress ignores whether the Treasury has a cash surplus or deficit,
and whether these results are consistent with changes in the conditions of business, and the accompanying economic climate, the Nation is headed for trouble.
In the absence of an appropriate cash budget result, any review of the objectives and workings of Treasury debt management and Reserve credit policy confines justifiable conclusions with regard to monetary policy pretty much to
whether, in the resultant adverse monetary background, Treasury and Reserve
officials have worked well together, and have done as much as might be expected
of welMntentioned, well-informed human beings. It is not a question of how
well, or how badly, monetary policy may have functioned; the omission of the
required budget result means that monetary improvisation had to make up for
an absence of policy.
My review of the objectives and workings of monetary policy aims to illustrate
the part that is played by the Treasury's cas budget results
It seems to me that I might best review the objectives and workings of Treasury debt management and credit policy over the last few years by pointing out (1)
flow, during the boom period of 1952-53, a Treasury cash surplus might have enabled monetary policy to contribute more to economic stability and (2) how the
Treasury's cash deficits multiplied the problems the Treasury and the Federal
Reserve had to resolve.
It will be seen from this, I am sure, that the Treasury and the Reserve have
done a good job.
The relationship betiveen the Treasury security market and monetary policy
The committee asked several questions about the Treasury security market
and its use in connection with the development of credit policy. These questions,
and the answers, also develop the relationship between the Treasury market and
•monetary policy. In the Reserve's response to question 3 it describes the workings of the Treasury market; it tells how the normal functioning of the market
was obstructed by past Reserve open-market operations; of how a return to
these would cause^ the market to become less rather than more self-reliant. The
Reserve's explanation is the most complete I have seen.
But, because I live with the Treasury security market throughout most hours of
the day, and sometimes the night, and because I have a sincere conviction about
the importance of an adequate Treasury market to the future welfare of our
economy, I want to add some comments of my own. I want to tell you why I
believe the Treasury security market must be free—as it is now—to reflect in
market prices and yields, the public's desire to buy and sell Treasury securities
and their transactions. No other kind of market will adequately reflect the
response of the public to business and credit conditions and to monetary policy.
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UNITED STATES MONETARY POUCY
I want to sav something about the kinds of alternatives that might be devised
to replace the'present publicly made market for Treasury securities. As I see
it, the alternatives are an inflexible monetary policy and consequential inflation
or an increasing number of selective controls, of diverse sort; ones that would
serve, once more, to undermine our competitive form of enterprise and to infringe
upon individual freedoms.
Should the newborn free play in the Treasury security market be considered a»
experiment or a permanent characteristic?
In the Reserve's reply to question 3 it describes three decisions that have
been made with respect to the conduct of its open-market operations. It says
the purpose of these was to foster a stronger, more self-reliant market for
Treasury securities in order to contribute as far as possible, to the development
of a responsiveness, by that market, to monetary policy. It adds that the results,
on the whole, have fulfilled its expectations. Then it goes on to say that this
approach, to open-market operations, is still experimental, that insufficient time
has elapsed to draw firm conclusions.
As you know, a minority of Reserve officials hold that these decisions went too
far in imposing limits on the open-market operations. This minority urges a
partial return to the very kinds of open-market practices that, as the Reserve's
replies carefully point out, abort the normal functioning of the Treasury
market I hold the firm belief that any action taken by the Reserve which
permits the Treasury security market to more fully reflect the response of the
public to credit policy is not an experiment—unless flexible monetary policy,
competitive enterprise, and individual freedoms also are to be viewed as an
experiment. Contrariwise, if the clock were to be turned back toward more
open-market intervention in and manipulation of Treasury security prices and
yields by the Reserve banks that would be an experiment to see if the Reserve
could go back part way. The last such experiment turned out badly. I want to
discuss what might happen if we tried to embark on another.
IFe have a good market for Treasury securities; it still has some problems—these
can be resolved
The functioning of the Treasury market has constantly improved; it is considerably improved compared with that of 1% years ago. In fact, we have a
pretty good market. I am concerned only that our aim continue to be to promote and to improve the functioning of this market. The Reserve has helped
mightily to bring about improvement. The Treasury also has helped. Yes, we
still have some major problems to resolve.
The further help of the Reserve, of the Treasury, and of those who have either
a responsibility for or an interest in monetary policy is needed. I do not believe
I overstress the importance of an adequate public Treasury security market
when I say that failure to maintain it, and improve it, might make it more dimcult to combine flexible monetary policy, competitive enterprise, individual freedoms, and a large national debt compatibly.
Suppose the Treasury had had a cash surplus during 1932-53
When business activity is at a high level, as it was from mid-1952 to mid-1953,
it is not surprising to see a strong demand for capital and credit accompany the
boom. Had the fiscal policy of the Government produced a cash surplus throughout this period this surplus could have been used to reduce the Treasury debt held
by the general public. Had this been effected through the retirement of Treasury
securities held by nonbank investors, more money would have become available
with which to meet the private demand for capital and credit. Surplus tax
receipts would have been channeled back into productive investment, interest
rates would have been under less upward pressure, a lesser demand for bank
credit would have been generated. The Treasury would have been placed in a
better position to lengthen its debt.
Had the Treasury cash surplus been used to retire Treasury securities held by
the commercial banks, the availability of private bank credit would have been
increased without the necessity for quite as much restraint in credit policy, and
without a too large increase in the money supply.
The impact on monetary policy, from mid-1952 to mid-1953, of the Treasury cash
deficits
But fiscal policy did not produce Treasury cash surpluses. For fiscal 1952 the
Treasury managed to just about break even on a cash basis. For the second half
of calendar 1952 the Treasury had to finance a substantial seasonal cash deficit.
UNITED STATES MONETARY POLICY
105
'This was only partly offset by a cash surplus during the first half of calendar
1S53. Moreover, the cash deficit for the second half of that calendar year, 1953,
promised, early in the spring, to be quite large. When the market awakened to
its true size (in May) the results were explosive. These Treasury cash deficit
needs were important in the factors that precipitated the mild crisis in the money
and bond markets in May and June (1953).1
The reasons for this were quite plain. After all, the Treasury had to raise
the money from either nonbanks or banks. Individuals could not be expected to
supply much, if any, of the Treasury's cash needs. Nonfinancial corporations
were seeking additional funds. Nonbank financial institutions were being asked
to supply more private credit and capital than they could raise, even by selling
Treasury securities on balance. And, so—the only remaining source of funds was
the commercial banks.
The supply of bank credit available to private borrowers had proven to be an
exhaustible amount, borrowers had begun to anticipate further increases in
borrowing costs, they began to hoard bank credit by taking more than they
needed—if they could get it.
With this sort of a background, in this sort of climate, how willingly and
how readily would the Reserve make available the bank reserves necessary to
support Treasury cash deficit financing through the banks? How high would
interest rates go? Was this to be the death knell of a flexible monetary policy,
or the return to a 4-percent rate for Treasury bonds?
Belief in the stalwart resolution of Treasury and Reserve officials to prosecute
a policy of monetary restraint, to the extent necessary to cope with this new
inflationary threat, was mixed with a belief that the increasing tightness of
credit conditions would soon bring about its own correction. The latter proved
to be the case and when Reserve officials acted to shift their aim with an insight
and intuition that has been rare in central bank history, the quick turnaround
in the availability of reserve credit produced stabilizing forces—instead of an
expectancy that might have arisen, namely, of a new rapidly spiraling inflation.
The actual and prospective results of fiscal policy in the period of mid-1952
through mid-1953 are outstanding examples of how an inappropriate fiscal
result dominates Treasury debt management and creates, for the Federal Reserve, a series of difficult and hazardous decisions.
The buildup in the amount of the near-dated debt and in Treasury debt-management problems
The Treasury, as far back as December 1949, had recognized, apparently, the
desirability of extending the near-dated debt. During the 12 months, to November 1950, the Treasury came to market 3 times with securities of from 4%- to
5-year term. Thereafter throughout a period of about 15 months—TreasuryReserve differences, the resulting accord, and the unexpected release of the
Treasury market (from years of manipulation by the Reserve banks) made
longer-than-1-year financing impractical.
By February 1952 the Treasury found it possible to return to longer-term
financing with modest success. In May, it offered 6-year bonds, but this was
to meet a part of its cash deficit requirements; it did not serve to reduce the
near-dated debt.
By the time the present Treasury administration took over, in January 1953,
the amount of the near-dated debt 5 (in the form of marketable issues) had
approached or exceeded the peak levels of January 1, 1946 (see charts 1A, IB,
2A, and2B).
Adverse market conditions existed during the first half of 1953. These came
about partly because of the heavy demands for capital and credit. They also
were an inevitable consequence-of the only appropriate credit policy in such
circumstances—namely one of restraint. This overall situation plus the Treasury's second half-year cash deficit requirements again prevented the Treasury
1
There is some element of surprise in the picture. Treasury announcements, In connection with the offering of the 3*4 -percent bonds did not adequately reflect the size of
the Treasury's forthcoming cash needs. Re the much-debated 3^-percent offering: A
straight cash offering of these bonds might have been successful. This is clearly indicated
J>y the initial reaction of bond firms throughout the country and of many professional
investors. Actually, however, the SVi's were offered for Tcash and for exchange. The
terms of the exchange encouraged many to convert into 3^ s for the purpose of reselling
these. This sort of secondary market supply figured importantly in the setting up of
iresh
forces for a decline In bond prices.
. ,_, A
A , a
a
Measured either by the total due in 1 year or the total due within 2 years.
106
UNITED STATES MONETARY. POLICY
from making any net reduction in its near-dated maturities in spite of the
change in credit policy to an easy-money objective. As a matter of fact, by
January 1,1954, the near-dated debt had increased by a substantial amount
Once again—the Treasury had to rely largely on the banks
The Treasury cash deficit and refunding needs of May 1953, and thereafter,
must have urged upon Reserve officials some greater degree of active ease than
might have been necessary otherwise. Obviously, the Treasury had to seize
upon the more favorable market conditions to reconstruct its maturity schedules.
Among what classes of investors could this be accomplished? Not much help
could be expected from individual investors, except through a more aggressive
campaign to sell series E and H bonds. If nonfinancial corporations were to be
persuaded to hold more Treasury securities substantial progress in this direction
meant, conversely, that a like amount of the profits and cash resources of businesses would not be turned back into investment, production, and payrolls.
Nonbank financial institutions continued to be sellers of Treasury securities
on two counts: one, to take up forward commitments entered into earlier and,
two, to meet the enlarged capital market demand emanating from toll road,
other new money financing, mortgages and, later, to refund bank loans.
Thus, once again the Treasury was forced to rely largely on the banks.
Treasury success, and a backwash
During 1954, the Treasury has come to market seven times. On five of these
occasions it has sold notes or bonds designed to lengthen the debt. On four such
occasions the Treasury's financing has resulted in substantially reducing the
amount of its 1-year debt. All such operations took place in a climate provided
by a subnormal demand for bank credit and a credit objective of active ease.
In these circumstances the existence or promise of a further cash deficit did not
constitute an adverse market force.
Early in 1954, the declining trend in bank loans, the easy money policy of the
Reserve and Treasury debt-lengthening operations served to multiply the forces
which were pushing the yields of short-term Treasury securities to lower and
lower levels. There was first the normal, sharp decline.that had come from the
shift in credit policy in June 1953 plus the turn-of-the-year ease. The decline ir
loans, the loan outlook, and Treasury refunding began to operate with force as
we moved through the first quarter of 1954. As a consequence of the latter, a
sharp reduction in the amount of short-term issues outstanding occurred.
Indeed, by June 1954, the erosion in the yields on short-term Treasury securities became so pronounced that the Reserve was forced, more or less, to employ
methods which, while they would continue to effectuate "active ease,** also would
act to prevent the yields on short-term Treasury securities from disappearing
altogether.
Then, there was the other side of the coin, namely, a corresponding increase
in the amounts of Treasury securities outstanding in other maturity areas, notably in issues of from about 4- to 9-year term. During the latter part of 1954,
the increase in the supply of these issues had become large enough to cause
their yields, and those on most issues of longer Treasury securities, to retrace
most of the decrease that had taken place during the earlier portion of the year.
The relative movements of such yields on Treasury securities is shown on
chart 7.
It may be noted that the differences between the yields offered on short-term
Treasury securities (of up to 2-year term) and those of longer term (5 years or
more) became, and remain, quite wide. In fact, these yield spreads are about
the widest on record. This was a natural result of the Treasury's having to
take the bull by its horns if it, finally, was to be able to effect any substantial
reduction in its near-dated debt.
• The income-consciousness of banks, during 1954, plus the success of the Treasury's
debt-lengthening programs makes for a sharply triggered bond market—one
that could lead to a rather sharp decline in bond prices
The primary reason that the Treasury was able to effect a substantial reduction
in this portion of its debt was that bank investors, on whom the Treasury had
to rely, became increasingly income minded; that is, the desire to maintain
future income, or to purchase insurance against too large a drop in earnings,
-caused them to be willing to decrease the amount of their short-term holdings
below a level they might have wished had loans been increasing.
UNITED STATES MONETARY POLICY
107
Consequently, the liquidity of banks has been sharply reduced. In terms of
deposit liabilities, the ratios for member banks (expressed in terms of Treasury
securities with a term of 2 years or less) are about as low as they were at the
beginning of 1951 and 1952—the low points for the postwar era. In terms of risk
assets the situation is about the same. (See chart 6C.)
At the present time business activity is increasing. It is expected that this
will continue—at least for some months. If it does, then the risk assets of banks,
particularly loans, may turn upward sooner than many now hope. Bank deposits
will follow suit.
The Treasury cash budget result necessary to underpin an acceptable monetary
policy in such circumstances, and the minimum result that might be necessary to
maintain general confidence would be nothing short of a balance between the
Treasury's cash receipts and disbursements. An appropriate monetary policy
would call for a cash surplus.
A balance (in the cash budget) would mean no increase in the Treasury debt
held by the public, although an increase in the total debt would occur. A cash
surplus should permit a reduction in publicly held debt. This would be expected
to take place through the retirement of publicly held, maturing obligations. The
commercial banks are the largest holders—would such retirement be made from
bank portfolios? If so, what would be the attitude of the commercial banks
toward their longer Treasury security holdings?
In a period when both bank deposits and risk assets are rising, bankers may
become more conscious of their liquidity needs. Will individual banks then
seek to prevent another lowering of their liquidity ratios by attempting to sell
Treasury bonds of longer term? Who will the buyers be? Attempts by individual banks to sell means that banks as a group—the mainstay of the present
level of Treasury security prices—will have reversed their position. In such
event, Treasury bonds could fall in price rather sharply, before private bank
credit expands very much.
Therefore, the Treasury bond market has become very sharply triggered: its
response to any relaxation in the present credit objective of active ease would be
quick—possibly anticipatory.
The short-term sector also is becoming more sharply triggered and any further
nptnrn in short-term intes could touch off a slide in the prices of longer dated
issues
As I mentioned earlier, several forces have operated to reduce the yields on
short-term Treasury securities—declines in loans, a credit policy of active ease
and a large, steady drop in the amount of publicly held short-term Treasury
securities. The problem of getting the near-dated debt under better control has
been pretty much accomplished. The fact that the amount of short-term issues
outstanding may not undergo further reduction, removes one factor that helped
to bring about the present relatively low yields on these securities. A revival
of the loan demand, or the prospect of a less than seasonal decline in loans
during the early part of 1955 would remove a second such force.
Consequently, and in spite of the reduction in the short-term debt outstanding,
yields on these and on money market securities in general may prove to be surprisingly sensitive to any change away from the present degree of "active ease."
But, an appropriate credit policy has to concern itself with other matters
besides the condition of the market for Treasury securities; for example, the
money supply and the rate of change in it, the overall economic climate and
expectancies, and the like. So, even though an upturn in the yields on short-term
Treasury and other money-market issues might touch off a slide in bond prices,
the Reserve might nonetheless consider that economic conditions require a less
heavy accent On active ease within the near future.
Wide yield spreads between sJiort-ter?n and longer term issues are an invitation
to many investors to lengthen maturity but it's a danger signal, toot in the
present situation
There is a rather general belief among investors that extensions of maturity
should be made largely when these can be effected at reasonably good increases
m yields. In other words, the recent and prevailing wide yield spreads between
short and longer term Treasury issues have been a factor in making possible
the Treasury's sales of many longer dated securities, as well as being a consequence of these sales. At the same time, investors have been able to take the
108
UNITED STATES MONETARY POLICY
view that the higher income to be obtained on these longer issues compensated
them for the increased risk to principal that had to be assumed.
Conversely, however, when interest rates are low (bond prices high) increases
in the yields of successively longer maturities are wider than is the case when
bond prices are low. Reference to chart 7 will illustrate this—note the difference
between the yields prevailing on Treasury securities of varying terms during
1951-52 and during the second quarter of 1953.
Consequently, when longer term bonds are purchased (at relatively high prices
during periods of easy money) the possible loss through some subsequent downturn in prices is substantially larger dollarwise, than are the potential gains
(through further price increases). The compensating factor of the increase in
income that was obtained when the bonds were purchased becomes, at this time,
a thing of the past. The prospective gain versus loss equation begins to dominate
the attitude of the investor. This is particularly apt to be the case if a large
number of investors (in this case bankers) believe their portfolios have become
out of balance (too few short-term and too many longer-term holdings) for the
current and prospective outlook.
Such a set of circumstances would make it more necessary than heretofore
that a further advance in the levels of business activity be paralleled by the
expectancy of a Treasury cash surplus. This might be used to retire short-term
issues and thereby (1) cause banks and others to become more reluctant to
sell longer Treasury securities while (2) it also would provide banks with the
reserves needed to extend private credit.
A lot of charts
In my remarks I have referred to certain of the charts that accompany this
statement. A brief explanation of all the charts is appended to them.
One particular chart that shows the Treasury security holdings of the Federal
Reserve banks, ID, deserves comment before I leave this general area.
Did the Reserve banks prefer certificates to billsf
Throughout most of the 1940's, the Reserve's holding of Treasury bills was
quite large proportionately. Today, and for the past several years, they have
been quite small although the Reserve's open-market practice has been to confine
its purchases and sales largely to such securities. The reasons for this are
excellently set forth in the Federal Reserve's replies to the committee's questions.
In the refunding of 2 weeks ago the Treasury made 2 short-term offerings,
a new 1%-percent certificate and an additional amount of the lVs's of August
1955. The latter was said to be largely to permit the Reserve banks to achieve
a more even distribution of their holdings. This Treasury move invites questions : Bid the Reserve prefer to diversify its certificate holdings or to diversify
by a reduction in certificates and an increase in bills? Why did the Treasury
offer the Reserve additional certificates, instead of offering additional amounts
of the weekly series of Treasury bills?
A nutshell picture of the progress made by the Treasury in debt reconstruction
and some delayed-action problems that have been created
The Treasury has been able to reduce its near-dated debt so substantially that
the major portion of this task should be completed for now. Moreover, by withdrawing savings notes from sale, and by permitting series F and G bonds to
mature without receiving any specific new refunding offerings, a net decrease
may develop in the outstanding amount of the nonmarketable debt. This may
give the Treasury more leeway with which to meet the steadily mounting requirements of the Government accounts. Also, while the short-term holdings of the
commercial banks have been reduced at a rather rapid rate during 1954, the
speedup in the tax payments of corporations may provide some offsetting supply
of short-term securities over the next few years.
Altogether the Treasury has gained considerable elbow room for future debt
management. The pressure of a too-large near-dated debt has been eliminated.
Some delayed-action problems may have been created. These originated in
the large cash deficits that had to be financed from mid-1952 to date. The best
way of resolving these potential problems would be for Congress to make sure
the Treasury has a substantial cash surplus should business activity continue
upward. Such a fiscal policy goal could promote that sort of business trend
if it is gone about in a manner that is not hostile to business.
UNITED STATES MONETARY POLICY
109
/ / we get off to a bad start in the fnatter of the Treasury cash budget we are
bound to head for problems.
Congress needs to find a way to make fiscal
policy more consistent with appropriate, flexible monetary policy objectives
W h a t I have been trying to say, and to illustrate by the events of the past few
years, amounts to t h i s : Monetary policy has to begin with fiscal policy, t h a t is,
with the Treasury budget result. As in everything else, if we get off to a bad
s t a r t we a r e headed for problems from there out. The results in t h e Treasury
budget over the past few years have compounded the difficulties of managing
the debt. They were a major factor in building a near-dated debt t h a t was out
of all reasonable proportion. This has not been the fault of the Treasury—regardless of which administration—it was the consequence of Treasury cash
deficits.
The objectives t h a t have guided debt management and credit policy during the
past several years have been excellent.
In working out monetary policy, a great many human judgments obviously
were required of Treasury and Reserve officials. H u m a n judgments are frail.
But we should recognize that human judgments are not necessary only in connection with a flexible monetary policy. They are just as necessary, and more
of them a r e required of a monetary policy t h a t is inflexible—designed for inflation. They are even more necessary to and far more numerous in the conduct
of most alternative forms of selective controls.
We, therefore, should not confuse concepts and objectives with judgments.
We can expect from judgments, not perfection, only good performance. We have
met with extremely good performance by Treasury and Reserve officials during
recent years.
The presently most pressing problems of monetary policy are therefore the
results t h a t flow from fiscal policy, the Treasury cash budgets. Surely the Congress can find some way to provide for changes in the r a t e s of taxation and to
control Treasury expenditures so t h a t the Treasury cash budget can be more
consistent in the future with the appropriate objectives of a flexible monetary
policy, one t h a t must deal with changing economic conditions.
Now I would like to t u r n to the matter of the Treasury security m a r k e t and
the m a n n e r in which this market ties into monetary policy.
Is the public market for Treasury securities a free one?
Of course, the public market for Treasury securities is not "a free market,"
in t h e sense of the term. But the public market must be an adequate one. It,
therefore, must enjoy freedom to reflect fully, into market prices and yields, the
transactions of the general public. Such transactions can take place only in a
market free of direct intervention from the Reserve, 3 because the public's transactions m u s t reflect t h e competition of the m a r k e t place and take place in the
environment of the actual and prospective condition of the Treasury's budget,
the objectives a n d the decisions of debt management and of credit policy and of
business conditions. Only in such a market can the fluctuations in interest
rates reflect accurately the supply and demand of Treasury securities t h a t constitute t h e country's response to changes in business activity and in monetary
policy. T h e resulting fluctuations in interest rates are the product of what has
happened, w h a t is happening, and of future expectancies. Monetary policy of
any kind would become befogged if it were not guided by interest-rate fluctuations
of this kind. Some refer to the fluctuations in interest rates a s t h e best thermometer we have by which to judge the health of the economy.
Of course, there are alternatives to the kind of a public Treasury security market
we now have
Other alternatives to an adequate public Treasury security market can be
devised. For example, the Treasury could engage in market transactions for its
accounts, a n d / o r for t h e sinking fund, a n d / o r in the name of the stabilization fund,
for the purpose of providing a market for its securities. This could take t h e place
of the public m a r k e t t h a t is maintained through the private firms t h a t a r e the
intermediaries. No one can say whether the Treasury officials charged with
handling the individual transactions in a market made by the Treasury could
or would do so in a way t h a t these fully reflected into prices and yields the
transactions of the public. But I don't believe we could take a chance because
3
Or the Treasury.
55314—54
8
110
UNITED STATES MONETARY POLICY
some Treasury administration in the future might try. Even Barnum couldn't
fool the public forever, and the monetary pressures that could build up would
assert themselves in other ways—in price increases, in inflation of the usual
kinds, and in an increase in the overall costs of all of us and in the costs of
government. The latter, alone, would be many, many times the reduction in
Treasury borrowing costs that might come from the Treasury's manipulation
of interest rates.
Or, the Federal Reserve banks, with their gigantic portfolio, could engage
in market purchases and sales of Treasury securities partly to provide a market,
or for the purpose of facilitating the attainment of credit-policy objectives that
some claim could be done in this fashion, or to further the success of Treasury
financing. Each of these types of open-market operations would take on, in time,
the characteristics of the past price-fixing operations—the experiment that was
such a costly failure. The Reserve then would act as some kind of a benevolent
dictatorship; so that interest rates would reflect only the assessment made by
Reserve officials as to the prices and yields on specific issues and on maturity
sectors that were "proper."
Are toe interested in thermometer readings or the health of the patient?
If fluctuations in interest rates are the best thermometer we have with which
to judge the response of the public to the administrations of credit policy, then
any of these alternatives would be strange ones to adopt. Even the more moderate alternatives, such as advocated by those who would broaden the scope of
the Reserve's open-market operations, would be dangerous, in my judgment.
It would be like applying heat and cold alternately to the bulb of the thermometer
so that we could obtain the temperature readings we wanted to see. Surely,
we would learn little from this about the health of the patient.
How can the Reserve intervene to directly affect the prices and yields of Treasury
securities only a little and not too mucht
Some who nevertheless would have the Reserve discard its present narrow
concept of open-market operations for an expanded one claim that it is not enough
to produce and to absorb reserves; that the prices and yields on Treasury securities in the different maturity sectors are important, and may not correspond to
their judgments of a proper response from the market; that credit policy cannot
rely on what they claim to be the imperfect arbitrage within and between markets
and, therefore, the Reserve should engage in open-market operations anywhere
in the entire maturity range of the market.
I cannot understand, and I have been unable to obtain a plausible explanation,
in practical terms, of how the Reserve could intervene just a little and be sure
such intervention would be within limits that would be consistent with creditpolicy objectives; that is, any credit-policy objective except active ease.
I have sought and I have been unable to obtain a plausible explanation, in
practical terms, of how the Reserve might further the success of Treasury
financing by the purchase of exchangeable and newly offered securities without
running afoul of credit-policy objectives, except ones of wanton ease. Nor has
anyone been able to tell me how decisions would be made that this or that
Treasury financing would justify Reserve support, whereas this or that one
would not.
I have asked what would happen (1) if the Reserve were to start to buy securities in the Treasury bond market because it felt prices were below some
preconceived idea of an appropriate level, and (2) the amount of such purchases
began to exceed that which could be made consistent with the prevailing creditpolicy
objective. Should the Reserve banks in such a circumstance stop their
Ptu « i n g J , I f ^ e y d i d ' t h e subse <iuent price decline might reach a level substantially below that which Reserve oflScials disapproved initially.
If
^% 5? s e r V ul s t a r t e d o f f s u c h a buying program and purchases definitely
exceeded those that could be made consistent with the prevailing credit-policy
objective, should the Reserve continue to buy on the grounds it might be impractical to stop such purchases? If so, which will have taken precedence—the
management of the Government security market or the obiectives of credit policy?
sometimes it is said that, in any such events, the Reserve could sell other
securities. If that is true then, as always happens, intervention in the normal
functioning of a market at one point, requires supporting interventions a second,
UNITED STATES MONETARY POLICY
111
and at a third point until, finally, intervention turns into the necessity of managing the entire market; That is what happened before.
I could give you illustration upon illustration of how Reserve Intervention
that aimed at directly affecting the prices and yields of Treasury securities has
interfered with the normal functioning of the market; of how it first drives the
Intermediaries to cover and then the investor and of how, in the end, the Reserve
becomes—it is inevitable—a not-so-benovolent dictator. But instead let me
remind you of what happened when the Reserve attempted to further a Treasury
financing of which Reserve officials fully approved. In November 1950 the
Treasury offered a 5-year 1%-percent note—precisely the terms the Reserve
thought the Treasury should offer. The Reserve undertook to further the success
of the financing. Before the Reserve got through, it had acquired $2.7 billion, or
40 percent of the new issue.
To this I would add that when the Reserve starts to intervene during Treasury
financing periods, investors and the intermediaries, the Government security
dealers, have no basis whatsoever for judging the market or the real reception
that might have been accorded the new issue. Many thereupon follow the
prudent course and sell. When the Reserve does not intervene, a new issue
may touch par or break it and thereby actually uncover more buying power than
the Reserve would have any desire to supply. This happened shortly after the
offering of the 1%-percent notes of 1957 this fall; it happened the other day in
the new 2 y2-percent bonds of 1963.
As the Reserve moves Jin to intervene in the prices and yields of Treasury
securities the public marUet begins to move out
The basis upon which the public decides to buy or sell Treasury securities in a
market that is conducted through dealers, who serve as intermediaries, is a
composite of the needs and desires of individual investors plus their evaluation
of current and future supply and demand, business conditions, and monetary
policy. When the market is subject only to these forces and is free of attempts
by the Reserve to directly affect prices and yields, we get a full response to
monetary policy, and the Treasury has the benefit of this response when it has to
engage in financing.
When, however, the Reserve moves to directly affect prices and yields, for whatever purpose, the public and the dealer intermediaries have to reconsider their
ability to weight supply-demand and the usual factors of response to monetary
policy. They begin, instead, to spend an increasing proportion of their time
worrying about the character, scope, and timing of the Reserve's intervention.
In fact, they begin to ignore the significant purposes of credit objectives. The
entire public market slows down. Its normal functioning becomes increasingly
impaired. The so-called imperfect arbitrage becomes more imperfect. The
market's responses to the objectives of credit policy become more slow, or too
quick, and sometimes these have boomeranged in such degree as to emasculate the
Reserve's objectives.
Further, I believe it is correct to say that on about every occasion since the
creation of our tremendously large public debt, Reserve open market operations
that aimed to affect directly the prices and yields of Treasury securities attained
a size multifold that which was expected of these, and considerably more than
could be made consistent with the credit or monetary policy objectives of the
time.
If the Reserve were to expand its open market operations and thereby move
in, so to speak, then the public Treasury market has no other option but to begin
to move out.
Judgments as to what the reactions of others will be and one actual reaction
I have heard it said that these are matters of individual judgments, that it is
a matter of individual judgment as to whether the public and dealer intermediaries would react along the lines I have outlined and as stated in the Reserve's
replies. This is another one of the things I cannot understand. The study made
by an ad hoc committee of the Reserve Open Market Committee is replete, I am
sure, with innumerable instances of how dealer intermediaries (and the public)
have reacted to such intervention in the past. Why should they react differently
in the future?
Yet, even within recent weeks, I have heard it said that dealer firms, such as
ours, would not discontinue their endeavors to enterprise in the Treasury market,
112
UNITED STATES MONETARY POLICY
or to develop it, and that we would not curtail the size of the commitments we
normally accept. To such a judgment, I can offer a reply which has the greater
merit of being, at least, the conviction of one dealer as to what he would have to
do to conform with prudent standards of conduct.
Were the Reserve to intervene again to directly affect the prices and yields of
Treasury securities my firm would immediately seek to employ its capital in
other fields; we could not afford to risk our capital in the same way and to the
same extent that we do under the present, more normal functioning of the market.
We would have to examine the desirability and the profitability of conducting a
lower volume of transactions as an agent or broker.
Tivo troublesome problems ivhich remain unresolved
The techniques adopted by the Reserve to foster a stronger, more self-reliant
Treasury security market have contributed mightily to that objective. It is
gratifying to know that the Reserve finds its expectations to have been fulfilled,
on the whole. I think we do have a pretty good market in Treasury securities
today. But, as I said earlier, we must continue to aim to develop this market
and to enlarge its scope.
The biggest sector of the market, from the point of view of the size of transactions, and the manner in which it may be used to effectuate credit policy is the
short-term end, and more particularly, the bill market. All these short-term
Treasurys compete with other money-market securities. Because, short-term
Treasurys are the premier money-market investment, they usually sell to yield
less than other such instruments, including Federal funds. To maintain a
market of desirable breadth and resiliency throughout all market conditions
dealers need to carry a rather substantial inventory. But, dealers cannot afford
to do this, as a regular thing, unless the interest rates they pay to carry their
inventory are equal to or less than the rate of return on the securities in inventory. This is not usually the case where short-term issues are involved.
When the Reserve, beginning with the end of World War I, decided to foster
and promote a broad, active market for bankers' acceptances, it ran into exactly
this problem with the same results; when the cost of money needed to carry
inventory was higher than the rate of return received from the inventory, dealers
proceeded to reduce their holdings. Then, as now, the result is that the market
loses some of its breadth and activity, and the securities involved are not as
suitable as they might be to many investors.
The second problem stems from a change that had taken place in the methods
employed by member banks to make day-to-day adjustments in their money
positions. Before securities became the principal medium for such adjustments,
the ability of one member bank to increase its reserves or to invest surplus
funds brought about corresponding changes in the reserve position of the banking*
system. Today, Treasury securities are the principal medium for making such
adjustments, and the results differ. Sales and purchases of Treasury bills, and
other short-term Treasury securities, undertaken by individual banks, do not
result in producing or absorbing reserves for the banking system as a whole; at
least, not in ordinary circumstances. Fluctuations occur in the yields of Treasury
bills and short-term Treasury securities, some redistribution of excess reserves
or of borrowings at the Reserve banks takes place, but no increase or decrease
occurs in the reserve position of the banking system as a whole. This means
that money market conditions undergo relatively minor change, if any.
The Treasury, too, has helped to promote a better functioning Treasury security
market—it can help more
In October 1953, Secretary Humphrey called for more enterprise in the money
and bond markets with a view to developing a broad and vigorous market in
Treasury securities. He pointed out that this was vitally important because
the behavior of this market is.watched and magnified throughout the country
and the world. The Treasury has helped to promote such a market. It has
done so by gradually concentrating its short-dated maturities, other than Treasury bills, into four maturities a year instead of the larger number that used to he
outstanding. This served, as the Treasury reply points out, to leave the market
more free to function normally and to reflect the public's response to credit
policy.
UNITED STATES MONETARY POLICY
113
Perhaps the Treasury could help more along the same lines. For example,
it could increase the amount of its weekly bill offerings with a view to reducing
the number of its other maturities to two a year.
But there also are other ways in which the Treasury can help. Since these are
technical I will not go into them except to say that their purpose would be to
attract more bond firms, and more young people, into the business of regular
daily dealings in Treasury securities. Although the size of the Treasury debt
has been multiplied many times in the past 15 years there has not been much of
an increase in the number of specialists, the intermediaries, who regularly deal
in the Treasury security market. Most of us who head these firms have been
in the business for 25 years or more. The number of young people coming up to
take our pla ,*esr throughout the industry, is too few.
The hard core of the public Treasury market is made by the specialists and
their dealings with each other. Through these, the supply and demand flowing
into one specialist may be matched oft* with that flowing into another. In such
clearances, a constant testing process is also achieved wherein the specialists
themselves derive what is called "the feel of the market." If there were more
specialists, more intermediaries, this hard core would be, not only enlarged, but
made harder, definitely more resilient and the market would become, automatically, more self-reliant. At the same time, an enlargement in the number of
firms would mean a wider opportunity for young men. The Treasury security
market needs them.
Progress has beat made, more progress can be made, in the same way, icith the
help of the same people and with the help of others
To sum up this portion of my remarks: The public market for Treasury securities is not "free" in the way some have misused the term. The public market is
more free than it used to be, and it must remain so because the available alternatives would make it difficult to keep competitive enterprise, monetary policy,
individual freedoms and the large national debt a compatible combination.
Attempts on the part of the Reserve to intervene directly, to affect the prices
and yields of Treasury securities, would be an experiment that would amount to
seeing whether the Reserve could go only part way back to the past price-fixing
operations which proved to be a costly experiment. When the Reserve moves in
to intervene in the market for Treasury securities, the public market has no
option but to begin to move out. The normal functioning of the market becomes
impaired, and the need for further intervention on the part of the Reserve is soon
called for. It is not necessary to rely solely on human judgments for guidance
in these matters. The working papers of the Reserve System are replete with
innumerable instances of how the public and the dealer intermediaries have
reacted. Furthermore, I have told you how my firm, one such intermediary,
would react.
There are some troublesome problems which still remain unresolved. The decisions made by the Reserve with respect to its open market operations, and the
techniques with which these have been given substance, have contributed mightily
to the resolution of some problems of the Treasury security market. The Treasury has contributed in other ways. Both the Reserve and the Treasury can
contribute in additional ways, as can all who have a responsibility for and an
interest in monetary policy.
APPENDIX
THE CHARTS
Charts 1A and IB show the maturity distribution of the marketable Treasury
securities on two slightly different bases (1) essentially representative of the
Treasury's potential liability to meet its maturities and (2) with certain
taxable bonds shown to their first call date.
Charts lC and ID show the holdings of the Government accounts and the
Federal Reserve Banks. When considering the problems of the reconstruction
of the Treasury's maturities (which have to do largely with marketable issues)
these holdings should be subtracted. Over the years the amounts involved (in
each case) are apt to enlarge. This means that unless the total Treasury debt
114
tfNITED STATES MONETARY POLICY
increases, the amount of marketable debt that is publicly held (charts 2A and
2B) must decrease. Such decreases normally would be expected to come about
by retirement of maturing obligations (a shrinking of near-dated debt).
But, in any event, the size of the problems and of the progress made should
not be measured in terms of either the total debt or the total marketable debt.
It is better viewed as two separate problems, (1) the nonmarketable debt, and
(2) the marketable debt that is publicly held (charts 2A and 2B).
On the matter of savings bonds and notes, for the past 4 years the amount
outstanding has decreased. This is partly because savings notes are no longer
issued. Maturities of the P and G bonds have not received, recently, any specific
refunding offerings. Holders have had the choice of reinvesting in the series
J and K bonds, or the series E and H bonds subject to the various limits on
each.
At the present time the prospects, under present Treasury policy, are that
savings notes will decrease fairly steadily, as may the aggregate outstanding
amounts of series F, G, J, and K bonds. Series E and H bonds should increas,
but not sufficiently to offset the decreases in other savings bonds and in savings
notes. This means that decreases in the total amount of such nonmarketable
obligations may make it possible for the necessary increases to occur in the
holdings of Treasury accounts, without having to effect withdrawals of marketable debt held by the public.
At the same time, the decrease in this nonmarketable debt may be larger than
can be placed with the Treasury accounts, and this would require an increase
in publicly held debt. If a Treasury cash surplus exists, it could be used
to meet any such net redemptions.
Chart 4 shows the lack of any visible relationships between the net current
assets of nonfinancial corporations and their Treasury security holdings. It
shows, however, a very marked correlation between such holdings and Federal
income-tax liabilities. Since the current amount of the latter should decrease
under the speedup plan for corporate tax payments, the Treasury security
holdings of businesses may decline. This would provide some increasing
amounts of short-term securities for commercial banks that might be needed in
view of the prospective further reduction in their liquidity ratios.
Charts 5A and 5B show the same two kinds of maturity distribution that appear earlier, in this instance, for the holdings of nonbank financial institutions.
Chart 5C indicates that such investors have evidenced no concern about the
decline that has taken place in their holdings of Treasury securities while their
assets have been undergoing a substantial increase. We would expect these
trends to continue as long as an adequate supply of non-Treasury investments
is available.
Charts 6A and 6B show, the maturity distribution of the holdings of commercial banks. Charts 6C shows the principal assets and liabilities of all
member banks and illustrative changes in their liquidity ratios.
Chart 7 is largely self-explanatory—it shows the relative fluctuations in the
yields on Treasury securities of various term.
UNITED STATES MONETARY POLICY
115
CHART IA
OUTSTANDING MARKETABLE TREASURY SECURITIES
INCLUDING INVESTMENT SERIES B BONDS IN 4 ~ 5 YEARS
EXCLUDING TAX ANTICIPATION SECURITIES AND POSTAL SAVINGS 80NDS
PARTIALLY TAX- EXEMPT BONDS TO FIRST CALL DATE
TAXABLE BONDS TO MATURITY EXCEPT WHEN ACTUALLY CALLED
Billions of Dollars
200
1940
1945
January I unless otherwise noted
1950
1955
I960
Aubrey G. Lonslon ft Co. Inc.
116
UNITED STATES MONETARY POLICY
CHART IB
OUTSTANDING MARKETABLE TREASURY SECURITIES
MATURITY DISTRIBUTION SAME AS CHART IA EXCEPT TAXABLE BONDS
WITH COUPON RATES OF 2lfe% AND HIGHER TO FIRST CALL DATE
Billions of Dollars
200.
1940
1945
January I unless otherwise noted
1950
1955
I960
Aubrey G. Lansfon 8 Co.Inc.
117
-UNITED STATES MONETAEY , POLICY
CHART IC
HOLDINGS BY U.S. GOVERNMENT ACCOUNTS
Billions of Dollars
75
1
1 .
1
1
50
TOTALvy^
H
25
SPECIAL
ISSUES
^*-—TTON-
^^MARKETABLE
MARKETABLE
, 7/1
_ l
1940
!
1 1 1 1 -
!_l
4
1945
January I unless otherwise noted
1950
i
l
l l 1
It/i7
J
1955
I
1
'
l
I960
Aubrey G. Lanston 6 Co. Inc.
UNITED STATES MONETARY POUCCT
118
CHART I D
HOLDINGS BY FEDERAL RESERVE BANKS
PARTIALLY T A X - E X E M P T BONDS TO FIRST CALL DATE
TAXABLE-BONDS T O MATURITY EXCEPT WHEN ACTUALLY CALLED
Billions of Dollars
40.
•
Vi
1 1 1 1
30
U
A
r
20
/ TOTAL
i
1—
k
/
\
f TOTAL WITHIN
1 YEAR
—
f
III M 1
10
r"
f II BILLS
&LL. J
1940
-.1
1945
January I unless otherwise noted
1 T
1. .1 1
1950
1 1 1 !
1955
1 1 hlJ
I960
Aubrey G. Lcnsfon & Co. Inc.
UNITED STATES MONETARY POLICY
119
CHART 2A
OUTSTANDING MARKETABLE TREASURY SECURITIES
HELD BY THE GENERAL PUBLIC
(EXCLUDING U.S. GOVT. ACCOUNTS AND RR. BANKS)
INCLUDING INVESTMENT SERIES B BONOS IN 4 - 5 YEARS
EXCLUDING TAX ANTICIPATION SECURITIES AND POSTAL SAVINGS BONOS
PARTIALLY TAX-EXEMPT BONDS TO FIRST CALL DATE
TAXABLE BONDS TO MATURITY EXCEPT WHEN ACTUALLY CALLED
Billions of Dollars
200
1945
f t unhst otherwise noted
1955
I960
Aubrey G. Lcniton & Co Inc.
120
UNITED STATES MONETARY POLICY
CHART 2 B
OUTSTANDING MARKETABLE TREASURY SECURITIES
HELD BY THE GENERAL PUBLIC
(EXCLUDING U.S. GOVT ACCOUNTS AND F.R.BANKS)
MATURITY DISTRIBUTION SAME AS CHART IA EXCEPT
TAXABLE BONDS,WITH COUPON RATES OF 2 \ % AND
HIGHER TO FIRST CALL DATE.
Billions of Dollars
200
1940
1945
January I unless otherwise noted
1950
1955
I960'
Aubrey G. Lonsfon 8 Co.lit
"UNITED STATES MONETART: POLICY
121
CHART 3
SAVINGS NOTES AND SAVINGS BONDS OUTSTANDING
Billions of Dollars
1
i
SAVINGS NOTES
\
SERIES F,G, J
AND K
SERIES H
-SERIES A T O E
-
J 1 I
1940.
L I .1
1945
i:
i i i l
r
1950
(FISCAL
YEARS)
i
1—
1955
I
I
1 L_l
I960
Aubrey 6. Lanston 8 Co. Inc.
TOTCTED STATES MONETAKY POLICY
122
CHART 4
NON-FINANCIAL CORPORATIONS
Billions of Dollars
125
1-
I
I 1 — 1—
100
75
I
I
I
!
NET CURRENT/^
ASSETS /
50
25
[/
/
US. TREAS.
\ SEC.
v<
FED. INCOME TAX
LIAB.
H i
7/1
1 1
1940
1
1945
Jonuory I unless othtrwae noted
1 1 .1 _ ..,
1950
7/1
I_l. 1 I.I 1
1955
1 ..!_ 1, 1
I960
Aubrty G. L a m ton a C a l n t
UNITED STATES MONETARY POUCY
123
CHART 5A
HOLDINGS BY NON-BANK FINANCIAL INSTITUTIONS
INCLUDING INVESTMENT SERIES B BONDS IN 4 - 5 YEARS
EXCLUDING TAX ANTICIPATION SECURITIES AND POSTAL SAVINGS BONDS
PARTIALLY TAX-EXEMPT BONDS TO FIRST CALL DATE
TAXABLE BONDS TO MATURITY EXCEPT WHEN ACTUALLY CALLED
DiHions of Dollars
40
1940
1945
January I unlets otherwise noted
1950
1955
I960
Aubrey G. Lanston 8 Co. Inc.
TINITED STATES; MONETARY ' POLICY
124
CHART5B
HOLDINGS BY NON-BANK FINANCIAL INSTITUTIONS
MATURITY DISTRIBUTION SAME AS CHART IA EXCEPT TAXABLE
BONDS WITH COUPON RATES OF 2 1/2% AND HIGHER TO FIRST CALL DATE
Billions of Dollars
40
1940
January
1945
I unless otherwise noted
1950
1955
I960
Aubrey G. Lonston & Co. Inc.
125
UNITED STATES MONETARY POLICY
CHART 5C
NON-BANK FINANCIAL INSTITUTIONS
Billions of Dollars
200
L
1 1 1 1
100
1—
150
/
- 1 —1
ASSETS
50
yy
i
i
i
tARKETABLE DIREC T
GOVTS.
1 1 1 „.L_
i
1940
1945
January I unless otherwise noted
55314—54
1)
I960
7/1
|_ 1 I I I
11/17
1
1955
1
1 I
I
I960
Aubrey G. Lanston 8 Co. Inc.
126
UNITED STATES MONETARY POLICY
CHART 6A
HOLDINGS BY COMMERCIAL BANKS
INCLUDING INVESTMENT SERIES B BONDS IN 4-5 YEARS, EXCLUDING TAX ANTICIPATION
SECURITIES AND POSTAL SAVINGS BONDS, PARTIALLY TAX-EXEMPT BONDS TO FIRST
CALL DATE,TAXABLE BONDS TO MATURITY EXCEPT WHEN ACTUALLY CALLED
Billions of Dollars
' 100 r
1940
1945
January I unless otherwise noted
1950
1955
I960*
Aubrey 6. Lanston 6 Co. Inc..
UNITED STATES MONETARY POLICY
127
CHART 6B
HOLDINGS BY COMMERCIAL BANKS
MATURITY DISTRIBUTION SAME AS CHART IA EXCEPT TAXABLE
BONDS WITH COUPON RATES OF 21/2% AND HIGHER TO FIRST CALL DATE
8'ilHons of Dollars
100
1940
1945
January I unless otherwise noted
1950
1955
I960
Aubrey G. Lanston 8 Co. inc.
128
UNITED STATES MONETARY POLICY
CHART 6C
CHANGES IN THE LIQUIDITY OF ALL MEMBER BANKS
MEASURED IN TERMS OF HOLDINGS OF U.S. TREASURY SECURITIES
TREASURY SECURITIES WITHIN 2 YEARS! MATURITY DISTRIBUTION SAME AS
CHART IA EXCEPT TAXABLE BONDS WITH COUPON RATES OF Z UZ% AND
HIGHER TO FIRST CALL DATE
PRINCIPAL
LIABILITIES AND
ASSETS
Billions of Dollars
150
Adjusted demand,interbank
U.S. Govt., and
time deposits
100
Deposits less
reserve balances
Loans plus other
securities
^^^
50
Treasury securities
within 2 years
I
r\
I
i
i
i
i
.I...I. i n . , i _ I
i l l
ILLUSTRATIVE CHANGES IN MEMBER BANK LIQUIDITY
PERCENTAGES OF TREASURY SECURITIES WITHIN 2 YEARS TO
(A) LOANS PLUS OTHER SECURITIES
(B) DEPOSITS LESS RESERVE BALANCES
Percent
150
A
100
/
60
B
1 i r
7/1
I_I_
1940
1945
January I unless otherwise noted
11/17
1 1 11 1 1
1950
1955
1 1 1 1 J
I960
Aubrey C. Lonston 8 Co. Inc.
CHART 7
FLUCTUATIONS IN MARKET YIELDS OF
TREASURY SECURITIES OF VARIOUS MATURITIES
AND IN THE AWARDS OF TREASURY BILLS
1951 THROUGH 1954 TO DATE
TREASURY BILL AWARDS AS OF THE NEAREST ISSUE DATE TO THE
15 TH OF EACH MONTH. OTHER YIELDS FROM YIELD CURVES DRAWN AS OF
THE 15 TH OF EACH MONTH.
Q
l l M I I M i l l l l l l l I I i r l l l l l l l M I M M l l l I I I M l l i t l l l l H i l l I If l l M M M I H i l l I f M M I I I M I I I I I I H I M i l l I M i l l M i l l
J M J S D M J S D M J S D M J S O M J S D M J S D M J S D M J S D M J S O
1951
1952
1953
1954
1955
1956
1957
1958
1959
Aubrey G. Lonston 8 Co. Inc.
55314—54 (Face p. 128)
UNITED STATES MONETARY POLICY
129
Senator FLANDERS. We will return at 2 o'clock.
(Whereupon, at 12:30 p. m., a recess was taken until 2 p. m., the
same clay.)
AFTERNOON SESSION
(Senator Flanders presiding)
(Present: Senators Flanders, Douglas, Sparkman, Goldwater, and
"Representative Patman.)
(Also present: George W. Ensley, staff director, and John W. Lehman, clerk. )
Senator FLANDERS. The hearing will please come to order.
There is the problem of initiating a chain reaction, and the thought
that I have had in mind was this.
Since we worked out in the morning session alphabetically beginning at the beginning of the alphabet as represented here with Mr.
Chandler, I think we will start the afternoon, the more free discussion
of the afternoon, commencing at the other end of the alphabet. Mr.
Wilde, I will ask you to make any observations which may seem
pertinent to you about the discussion we had this morning, and
initially we will proceed up the line in reverse order, but with a little
more informality, a little more questioning back and forth, and it
would not be completely undesirable if the discussion became so
lively eventually that it had occasionally to be brought to order.
The members of the subcommittee and the main committee are
invited to contribute to the discussion as they see constructive opportunity while the panelists are talking with each other.
So, Mr. Wilde, will you commence the discussion.
Mr. WILDE. Senator it is very nice to be waiting in a food line to
be first, but in an intellectual feast it is better to be last and then you
can make a much more cogent and forceful statement than if you are
first.
Without any particular speech to make, I would like to say that
the impact of the discussion this morning on me makes me feel that
we give too much emphasis to the probability that through very expansive monetary policy we can drive the economy forward and have
full employment.
I am not one who has that overall feeling. I believe that other
elements must join to accomplish that result, and I have been trying
in a small way in my formal paper to mention it.
I am talking about such things as fiscal policy, with particular reference to the kind of a tax structure the country has, and I am talking
about the intangibles which are covered in a term that I used, "environment.'7
Those, to me, are awfully important if we are going to have the kind
of a country that we all want, and I use the three of monetary, fiscal,
and environment as the necessary trio that will produce a successful
result, and I get, as I say, the impression that many members of the
panel are more persuaded to the overriding importance of maximum
use of monetary policy on the expansion side as the device that will
accomplish more than I believe it will.
Senator FLANDERS. Thank you, sir.
Mr. Smutny, what struck you in the discussion this morning?
130
UNITED STATES MONETARY POLICY
Mr. SMUTNY. Well, I felt this. I would like rather to follow a
little bit on some of the questions that you would ask, if that is in
order, some of the things that have occurred to you.
You said development of a high level of our economy could only
be reached through inflation. I think, whether we like it or not, as
far as our setup is concerned, free endeavor, free enterprise, we are
bound to have a natural tendency toward inflation. I t naturally feeds
upon itself, the desirability of business to expand, new operations.
Naturally, to get new jobs and the expansion of our general economy
along the lines that we hadn't conceived of years ago——
Senator FLANDERS. Are you now thinking of inflation in the sense
of a rising price level or in some other sense ?
Mr. SMUTNY. NO, I am not thinking of a rise. I am thinking of the
expansion of the economy itself, not a rise in the price level.
I feel that it is the natural tendency in our country, after all, to expand the entire business sphere and sometimes in that expansion new
industry, and so on and so forth, that we have industries we hadn't
dreamed of would develop 4 or 5 years ago, there is a misnomer of th<*
use of inflation, inflationary tendency in prices.
I think we have stability, stability has been created as far as the
price level is concerned through the operations, the monetary fiscal
operations as we have seen them. I think we approve very heartily
of what has been done.
I think that the purchasing power of the dollar has been kept stable
and the price level was kept stable in an expanding economy, but the
natural tendency, however, is toward inflation basically, I t has to
be as long as you are expanding.
Senator FLANDERS. I S it toward inflation as represented in the price
level; is that our natural tendency?
Mr. SMUTNY. I think it is a question of demand that has built up,
and demand begets production, and the answer to inflation is just a
single word: production. Once you have production, you don't have
inflation.
Senator FLANDERS. So now you are using inflation in the price-level
sense.
. Mr. SMUTNY. In the price-level sense. I don't think inflation in the
price-level sense is necessary as long as our economy is free to expand,
and I differ greatly with Mr. Mitchell, who felt that our economy had
to be regulated.
We have been through an era of regulation, that regulation breaks
down no matter how good our intentions might be, through the administration thereof. AVho can administer certain price levels ? How do
you know one price level is correct?
S
You can't substitute anything for the general give and take of purchasing and selling of the market place, and the minute that you get
regulation, you have abnormalities created in the market place, you
have black markets, and so on and so forth, things that we are familiar
with.
I would like to answer Mr. Patman with reference to the Federal
Keserve System, the Open Market Committee's power, more power
than the Congress. I think that, speaking as an individual, a tremendous confidence has been created throughout our country in the operation of the Federal Reserve System
UNITED STATES MONETARY POLICY
131
Senator FLANDERS. I don't want to bring up anything extraneous,
but since the comparison is between the Federal Reserve System and
Congress, would you care to—well, I will end right there.
Mr. SMUTNY. I would like to stick to Representative Patman's
statement, the way he put it.
He said are we satisfied with the Federal Reserve System, and I
would say that the Federal Reserve System, the way it has conducted
itself certainly over the years has begotten itself a tremendous amount
of confidence outside of the general banking system.
You referred to the fact that the, composition of the Open Market
Committee are primarily bankers. If you look back at the history of
Chairman William McChesney Martin of the Federal Reserve Board
as the president of the New York Stock Exchange, his experience
with the market, and so on and so forth
Representative PATMAN. May I interrupt you there. I wasn't talking about the Board of Governors. I was talking about private banks
being represented on a committee that is supposed to perform public
functions like the Open Market Committee, the five private bankers,
are the ones I was referring to.
Mr. SMUTNY. In compliance with the Federal Reserve Act, on the
Federal Reserve Board you have people other than bankers that we
are familiar with, businessmen and so on and so forth, and their composite opinion is valuable. I don't think you could say John Jones,
just because he is a banker, favors the banking industry. If anything,
he has a high regard for what is good for the Nation as a whole.
There is one other question you brought up about the ownership
of Government bonds and that banks should stick to loans locally, in
the local places where they were situated in favor of purchasing
Government bonds.
Actually I think you put the cart before the horse. They have
purchased Government bonds due to the fact that the demand for
loans has receded, and the purchase of Government bonds has a portfolio relationship of necessity as far as the bank policy is concerned.
You have a certain percentage in governments, a certain percentage
in cash, bills, and so forth, and you wouldn't want the banks to use
their entire assets in loans. The fact that loans in banks have receded
is the reason that their bond portfolios have risen over the past years.
Also I think you brought out something in reference to the fact
that finance companies have asserted the privileges of the banks to
extend loans to individuals.
I have had a great deal of experience in reference to that, probably
having placed the largest amount of finance paper privately of any
of the investment bankers. All my experience has been this.
The banks have avoided going into the personal-loan business due
to their experience in 1933, and so on and so forth. They chucked
that out the window in 1936 and 1937, which you will find was primarily due to the fact they did not have the managerial experience to
go into the finance market, not that there was something principally
wrong with financing an individual in their time-payment plans.
I t is only recently, of recent vintage, you might say, that some of
our large banks have gone into that market, and the finance companies
have been built up, it is true, due to their ability and experience in that
type of credit, and the banks have avoided it.
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UNITED STATES MONETARY POLICY
I t seems to me that confidence in the finance companies has been
justifiably established. You don't look down the nose at somebody
who is going ahead and buying a car on time-payment plan. ^ Nowadays it is the general experience that this is the way to finance
automobile and other purchasers, and that actually what we are doing
today is mass financing of mass production.
If you haven't got mass financing you can't have mass production,
and that is the basis of it, and we are coming into an atomic age when
the whole volume of financing will be expanded terrifically, when we
consider the amount of money that will be expended on atomic plants,
hundreds of millions of dollars, we will say, in one plant, then we have
some comprehension of additional mass financing and larger markets
necessary to maintain it.
I think Senator Goldwater said low interest rates didn't solve the
problem in 1933-39. As a personal reflection on that era, it seems
to me that business wasn't encouraged.
The difference between our present status and that status was the
approach to the individual. You said, "Here, John Jones, you will
rake the leaves from right to left and we will pay you so much, and rake
them tomorrow from left to right and we will pay you twice as much."
Well, that didn't support the economy because it didn't produce
anything.
Actually today we are trying to maintain general gross national
product. We are encouraging business to expand along certain lines.
The fact that money is cheap creates more employment because
business can borrow that much more cheaply, and you can go ahead
and expand your business generally, which creates employment from
that angle.
I n my opinion this seems to be the proper approach, along with the
general tax reduction.
Senator DOUGLAS. Sir. Chairman, may I ask a question? I think
it was not merely during the period from 1933 to 1939 that low interest
rates failed to provide the volume of private production, but from
the outset the great depression in October 1929 to 1933 in which you
had the familiar lowering of interest rates unaccompanied by expansion in private activity, and, on the contrary, accompanied by
precipitous decline, so while I don't wish to score any party advantage
over this point, since you picked out the period 1933-39 as a whipping
point, I would like to point out that this previous period was one in
which low interest rates did not effect recovery, and, as a matter of
fact, was at least accompanied by the sharpest decline in economic
activity in the known record of the world.
Mr. SMUTNY. May I answer that, Mr. Chairman. Isn't that what
this panel is here for and what we are trying to avoid today, that as
a result of tremendous expansion in business you got what was commonly used in the terminology of the Federal Reserve, "that a bubble
existed on top of an inflationary move," and that is what you are trying to avoid, or at least trying not to create the same situation as we
once went through in 1929?
The sum of what was said this morning, at least from my reaction
to the panel, and particularly was very emphatic in wanting to go on
record against any encouragement of regulation in our markets. Our
markets must be kept free.
UNITED STATES MONETARY POLICY
133
Any regulatory agencies that are built up suffer through the fact
of lack of administration, and I feel that the greatest benefit to the
country at large is to keep our markets free from regulatory bodies.
Senator FLANDERS. YOU will be willing to defend that thesis if it
is challenged later, I take it?
Mr. SMUTNY. Yes, sir.
Senator FLANDERS. Mr. Shaw.
Mr. SHAW. There are so many
issues, Mr. Chairman, that it is hard
to know just which ones to pick on first.
Senator FLANDERS. Well, take the worst ones.
Mr. SHAW. I have listed 2 or 3 specific ones and then 2 general ones
that strike me as being of peculiar importance. First a technical
matter brought up by Mr. Clark.
He has urged that legal requirements be reduced to their legal
minima of 13, 10, 7, 3, percent. There is no peculiar virtue in these
percentages. They are a historical accident.
The effect of lowering them would be immediately to create an
enormous volume of surplus reserves in the hands of the commercial
banks, and, in the present stage of events, I have little doubt that the
immediate reaction of the banks would be heavy buying of Government securities, whereupon the Federal Reserve, despite present pronouncements, perhaps would sell Government securities of various
maturities so that the effect would be simply transfer assets from the
Federal Reserve to the commercial banks, conceivably so reducing the
portfolio at the Federal Reserve banks that for any repressive purposes under subsequent inflationary developments the open-market
operation would be immobilized and the rising reserve requirements
would have to be used.
This is difficult, as was pointed out this morning, because not all
commercial banks are members of the Federal Reserve.
It seems to me that this is a step toward displacing one control
instrument, open-market operations, with another control instrument,
a rising legal reserve requirement for the purpose only of adding to
the earnings of the commercial banks on their Government security
portfolios.
Senator FLANDERS. I S what you are saying in effect that the reserves
should be set at such a point that you can easily move either way?
Mr. SHAW. I t should be desirable to move them in both directions.
The present legal limitation is still significantly above present effective
reserve requirements.
Senator FLANDERS. Have you any notion just how far above it
should be at this particular time?
Mr. SHAW. I should think it would be quite adequate under present
circumstances, but I admit being very sympathetic a number of years
ago when the Federal Reserve requested the authority from the Congress to set higher maxima on legal reserve requirements than are
now in effect.
A second minor and technical point, Mr. Patman ? s relatively minor
Point, not absolutely so, Mr. Patman. The question was raised as
to whether under some circumstances, at least, Government bonds
^vonld be so attractive that banks would not lend locally. They would
choose to hold Government securities.
Well, this is precisely what is desired under some circumstances.
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UNITED STATES MONETARY POLICY
Under some circumstances where local loans have been pressed so hard
with the local resources already in heavy use that the effect does not
give more employment, but it simply brings prices up, under such
circumstances it is desirable that the central bank should raise prices
of Government securities so that commercial banks will not lend more
for employment purposes or for output purposes on local markets, and
that in other circumstances when the generality of local areas is having
unemployment difficulties, that the central bank should make buying
and holding of bonds unattractive to banks so that they would be
under pressure to lend locally.
This is the technique of credit control, and it worries me just a
little bit that the Federal Reserve, in foregoing the use of dealings
in long securities, is giving up some of its grip on this particular pressure, causing local banks to be more interested at the right time in
local loans and less interested at the right time in local loans.
Another relatively minor matter, the composition of the Open Market Committee. I think it is known in the historical context originally
the Federal Reserve was not known at all as we regard it now. In
fact, a comparison of the present hearings with the hearings of
1012-14 would indicate very great advances in our understanding of
how central banks operate.
A t that time the central bank was supposed to be essentially a passive
instrument in the money market, giving accommodation to legitimate
business, commerce, and agriculture when it should need it. I t was
not supposed to be, it was not intended to be, an aggressive agent
increasing or decreasing the supply of money for some such goal as
stabilizing price levels.
Since it was felt the central bank was set up to insure there would
be adequate credit accommodation for major economic interests in
the country, those interests were represented, and since it was a mechanism for bringing the commercial banks together into a tightly knit
organization no longer suicidally inclined, it was felt the commercial
banks should be represented, all this quite validly, I think, under that
original conception of central banking.
This is no longer the conception of central banking that it should
feed credit to certain specific interests, so I think the Congress might
well consider some of the stipulations in the Federal Reserve Act
regarding the representation of certain specific groups from which are
omitted, let's say, labor unions and college professors.
VFe should review those regulations to see whether something more
relevant to the general interest might not be substituted.
And one final minor matter: We have been debating a good deal the
role of monetary policy in 1952-53. I don't think anyone of us is in a
position yet to say how great the effect of the change in interest rates
running from 1946, for that matter, will be when easy money was
terminated. I don't see how anyone of us can say how powerful the
punch was that this progressively tightening monetary policy brought
or how powerful the punch has been in terminating the recession.
As one looks at the superficial data, he is inclined to say that monetary policy probably was not very important. The decline in gross
national product apparently was concentrated in two major fields:
(1) The spending of the Federal Government in relation to its receipts,
and (2) in the accumulation of business inventory.
UNITED STATES MONETARY POLICY
135
The demand for residential housing slumped very little. The
demand for consumer durables slumped very little. I t doesn't appear
because of the specific place where recession occurred that monetary
policy could have been primary phenomenon.
To the professional economist this looks like an inventory cycle—
a very minor inventory cycle of the type that we expect in a free-enterprise society.
Now, as to two general issues, there has not been in this country for
a very long time an intelligible debate on the ultimate goal in monetary
policy.
Some people have an absolute goal in mind—lengthening the public
debt; other people have another goal in mind—stabilizing interest
rates; other peojjle have in mind stabilizing price supports; other
people have a different goal—stabilizing employment. These are not
mutually compatible goals. If one stabilizes employment, he cannot
stabilize prices.
Senator DOUGLAS. D O you feel that firmly?
Mr. SHAW. I feel that quite firmly, that if one is going to stabilize
employment in a technologically developing society where unit costs
are falling, then he perhaps is going to have falling prices.
On the other hand, money wage rates and farm prices are being
pushed ahead of rising productivity in a growing economy, .then full
employment is going to need a rising cost level.
I t seems to me that full employment and price stability except under
the very special circumstances where there is no net change in technological productivity and no net change in price
Senator DOUGLAS. May I take up your first proposal, increasing
efficiency. Isn't it possible to absorb the increased output per manhour through increased money wages and money distribution, which
in turn would be financed through an expansion of bank credit commensurate with the increase in production so that the price level would
be kept relatively constant.
Mr. SHAW. If factor prices rise.
Senator DOUGLAS. I n money terms as well as in real terms.
Mr. SHAW. Yes, this isn't offset. I should put my answer in net
terms.
Senator DOUGLAS. Isn't that really the point. During a period in
which output is expanded both in terms of total and hours, output per
hour as well as total output, you should have commensurate expansion
in total monetary purchasing power to help stabilize the price level.
Mr. SHAW. I think this is probably the rather fortuitously successful result of policy. I don't think it can be counted upon that factor
prices will rise perfectly in step with technological advance.
Senator DOUGLAS. Of course, this cannot be done in perfect step,
but if there is validity, and there seems to be long-run validity in the
approximately 3 or 4 percent increase in output per year, doesn't that
point to approximately a 3 or 4 percent increase in the supply of money,
assuming the velocity to be constant? Isn't that a fairly good rule,
granted that the adjustment isn't perfect?
Mr. SHAW.. Well, my answer would still be, I think, Senator Douglas, that if our goal is full employment, then—and let me put it this
way. Maintenance of stable prices is going to require that there be a
closely comparable rate of increase in productivity technically to go
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UNITED STATES MONETARY POLICY
right along with the increase in factor prices which is determined
really by factors other than an increase in productivity.
Senator DOUGLAS. Excuse me, Mr. Chairman. Perhaps I am prolonging this discussion unnecessarily.
Representative PATMAX. I t is a very important point.
Senator DOUGLAS. YOU speak of prices in terms of money. You
have got to have an increase in the money supply and in factor prices.
If you assume that the banking mechanism determines the total supply
of money, then the increase in factor money prices is contingent upon
a prior increase in the supply of money, and therefore it seems to me
that it is perfectly consistent to have expanding output and stable
prices.
The other problem, however, is where you have ,to have some fever,
where you have to have some inflation to get full utilization. I hope
this will be very seldom. But it presents a different question. I still
see no necessity for falling prices.
Mr. SHAW. No, I would rather expect rising prices, Senator. I
would rather expect that if we were to succeed in maintaining consistent full employment, which would mean consistent pressure upon
the total available supply of resources, that it would be highly improbable that the prices of those resources would stay stabilized within
the lisnits of rising productivity. I would expect money factor
prices to gain more rapidly than physical productivity.
Senator DOUGLAS. Why is that inevitable?
Mr. SHAW. Simply because of the bargaining position on the part
of the supply factors as against the demand factors.
Senator FLANDERS. We have here a most important question. Suppose we make mental or physical note of it and continue on, and then
come back to it.
Mr. MITCHELL. My first remark, Senator Flanders, would be on
one of the two questions you raised, and of course it would be on the
same thing that Mr. Shaw and Senator Douglas have been speaking
of.
I would like to see if I can't provide one of the little bricks that
would fill the chinks in their argument.
Senator Flanders mentioned before lunch those of us who suspect
that some inflationary pressure, however mild, is necessary if we are
really to maintain full employment. Senator Flanders asked if high
levels could be reached and maintained only with inflation.
Now, I wouldn't say it that strongly. I t is possible logically and it
is historically a fact that for a time at least they perhaps can be
maintained without inflation. But I believe t h a t the chances for
steady growth are better if a mild but certain upward pressure is
kept on prices.
I t makes several things possible, for example, that are not possible
if we try rigorously to keep a very delicate balance, exactly on keel
as far as prices are concerned.
Agriculture, Senator Douglas, is one of the things that appears to
me to be chronically depressed even when the general price level is
stable. I n that year you picked for illustration before lunch, 195152, when the general price level was pretty steady, agriculture lost
seven joints from parity.
Senator DOUGLAS. I t shot up tremendously in the preceding year.
UNITED STATES MONETARY POLICY
137
Mr. MITCHELL. Well, that is quite true, but the drop hurt worse
than the rise had helped, because marketing margins had become rigid
at the higher level. However, I think one of the points that would
make me agree with Mr. Shaw is the fact that this Nation isn't a
chart like the economists like to draw with such a thing as wages and
factor prices falling neatly in place. It is a combination of hundreds
of different charts and some major industries behave in quite different
ways.
1 would say that I am about to be convinced by some figures that
I have been studying for the past year and a half
Senator FLANDERS. YOU feel it coming, do you ?
Mr. MITCHELL. That the general economy must rise about Zy2 to
4 percent in physical productivity, and about iy 2 to 2 percent on top
of that in price inflation for a total of 5 to 6 percent gross national
dollar product a year for agriculture to hold its own.
Agriculture, it seems to me, is a chronically depressed industry for
a number of factors which I have gone into in the papers I presented
before this committee in February, if we try to maintain a very delicate stable price.
Senator DOUGLAS. You mean because of the inelastic demand?
Mr. MITCHELL. That and several other factors, Senator Douglas;
for example, the tendency of the marketing margin always to grow.
Another point, we recognize that there will be fluctuations up and
down because of the sheer administrative impossibility of keeping
national indexes exactly level.
Now in that case there are bound to be some depressed and somewhat underemployed periods, if we try to hold exactly level and avoid
inflation as the plague.
If we plan a slightly rising trend for prices in this country, fluctuations would go for a period below the trend line, but can still
nevertheless be kept above the line of acute trouble.
What I am saying is that at times when we are above the trend line,
We will be overemployed.
I think you all recognize what a flexible thing this full-employment
concept is. You can be overemployed by bringing women out of the
homes and older people out of retirement, and so on.
There will be periods of somewhat overemployment alternating
>vith periods of less employment, but still well within the limits of
reasonably full employment, and the result will average out pretty
well, UIKTI think we could still say it would fulfill the requirements
of the Employment Act.
Another point, imports are much easier in a long period of gradually rising price levels, and if we mean what we say, that we want
to improve our international trade position, if we want to increase
our international trade, we have got to find some way to keep business
from yelling so hard whenever we make an attempt to open our
borders to a few more foreign commodities.
In time of a steadily rising price level, as other economists have
pointed out, particularly Sumner Slichter in an August 1951,1 believe,
Harper's article, "How* Bad Is Inflation/' Slichter points out, I think
correctly, that we cannot really have an increasing international trade
in this country unless we have a slightly rising price level.
Our local manufacturers, farmers, laborers, and merchants simply
won't allow it.
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UNITED STATES MONETARY POLICY
Senator FLANDERS. If I may say, the experience of New England
with free trade as compared with the South has left us with the distinct
impression that it is a very painful thing.
Senator DOUGLAS. Well, since that issue has been injected, may I
say that while I sympathize with the plight in which New England
now finds itself, and while I would like to see a revival of New England industries and am against the special favors which the South
gives, I would like to point out that New England for generations received special favors from the Government by means of the tariffs
which the textile and other New England industries were able to impose, and that in a sense New England is now suffering or being punished for the sins of their fathers and grandfathers. They levied
tribute upon the United States for decades.
Senator FLANDERS. Those favors were accessible to anyone, and
when the South finally began to take advantage of them, New England
suffered very naturally, but I still say that it suffered from internal
free trade.
Senator DOUGLAS. May I say that from the time of Henry Clay and
the foundation of the Whig Party, which later became the Eepublican Party, New England prospered at the expense of the rest of
the United States, and I think in a sense the protection which New
England received during that period atrophied their will, their courage, their resolution and desire for experimentation, and combined
with the system of trusteeship which they built up in Boston, and
which Mr. Marquand has characterized in his novels, this is partially
to blame, although not wholly, for the plight that New England now
finds itself in.
Now I say that, and at the same time I do not approve of the unfair
tax advantages and the excessive protection against wage scales which
some of the southern communities hold forth to entice industry from
New England.
Senator SPARKMAN. Don't look so straight at me, Paul. We don't
do these tilings in Alabama.
Senator DOUGLAS. My good friend from Vermont, when he enters
this piteous plea about the hardships of removing the tariffs, leaves
me somewhat cold.
Mr. SHAW. May I come back to the discussion for just a moment?
Senator FLANDERS. Yes.
Mr. SHAW. I t seems to me, Mr. Douglas, in illustrating full employment and continuous full employment, the odds favor inflation, and
that if it is not New England or the South, then it will be agriculture
or trade unions that will be insisting on a larger share than the one
they have, a more fair share of the national output. This means a
rise in their money returns and inflationary pressures.
Senator DOUGLAS. This is a fundamental point, and it goes back to
the issue that Mr. Patman has raised.
In a period of comparatively full employment where the danger
is inflation, I would like to have the bankers run the banking system
of the country, and I would trust them more than the politicians to
determine the total amount of bank credit to be created.
But in a period of recession or depression, if we are unfortunate
enough to have a depression, I am afraid that the conservative policies of the bankers would probably not then be adequate to expand
UNITED STATES MONETARY POLICY
139
active purchasing power, and if they did not then I would favor the
politicians stepping in.
I t is a somewhat humorous way of putting the matter, but I am
suggesting a 2-platoon system to run the Federal Reserve System.
Let the educated bankers run it during the period of prosperity and
the educated politicians run it during the period of depression.
Senator FLANDERS. Who makes the shift?
Senator DOUGLAS. The people.
Mr. MITCHELL. I must disagree with Senator Douglas. I am afraid
if we did it that way, the bankers by their action would make certain
that there would be a shift.
Senator GOLDWATER. Mr. Chairman.
Senator FLANDERS. Had you finished?
Senator GOLDWATER. I just wanted to ask Senator Douglas if he
called that the two-platoon system.
Senator DOUGLAS. That is the two-platoon system.
Mr. SMUTNY. Actually, when you come right down to it^ the basic
ingredient of prosperity or continuity of prosperity is confidence.
Confidence has been gained by our banking system through, I think,
the leadership of the Federal Reserve. Although we have looked at
this possibility in a slightly humorous light here, it is a very serious
thing.
Confidence in the banking system must depend upon the action of
the Federal Reserve, in my opinion.
Mr. CHANDLER. Mr. Chairman, may I make a comment on the
implication that general monetary policy should be used to cure
structural defects in the economy.
It seems to me that general monetary policy, was never designed for
that purpose and could never accomplish it.
For example, if it be true today that the farmers are not getting
their share of the real national income, I do not see how you can possibly cure their situation by having a continuous and perhaps a cumulative inflation, because this would be a situation in which everybody's
money income would be going up, in which everybody's prices would
be going up, and I can't see anything about the process that would
raise the price of farm products relative to the price of other things.
The farmers' trouble is not a low absolute price level; it is a low pnce
level for their .products relative to the prices of things they have to
buy. And it seems to me it might get continuously worse rather than
better.
The other point relates to those American industries that suffer
competition from imports.
. An inflationary situation would raise costs as well as prices, and the
rising costs would be suffered by the American industries competing
with imports just as well as by the other industries. ^
So it seems to me we may get into very great difficulties here by
expecting general monetary policy to cure stiuctural defects that require a reallocation of resources.
Some of these adjustments may be made easier if we maintain full
employment, but not necessarily by a rise in the price level, and I am
not yet pessimistic enough to think you must have continuously rising
prices to have something like full employment.
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UNITED STATES MONETARY POLICY
Senator FLANDERS. May I make just two observations on my own.
One is that if the thesis is maintained that a continuously, even though
slightly rising price level, is the simplest and best way to maintain a
high degree of employment, I think it is also true that anything approaching full employment by the interaction of the labor market
leads to higher prices.
Now, the Lord, I think, made the hen before He made the egg^ but of
that 1 am not quite sure. Maybe Hen made the egg first, but I think
He made the hen first, and this is a hen and Qgg proposition.
The other thing is just a matter of tactics. I t is inadvisable for those
who feel that an increase in foreign trade is good in itself to attempt to
make great gains except in times of high employment. I t just can't
be done, so I think that that had better be put down as one of the facts
of life.
Mr. WILDE. Mr. Chairman, I wanted to ask, in view of Mr.
Mitchell's emphasis on the chronic depression of the farmer, whether
that is a correct premise.
Now, our company has been in a farm business, or was in a big way,
owning over 1,500 farms, when I became president in 1930, so I have
had personal experience.
Commencing with the Second World War, in 1942, the farmer has
had a high degree of overall prosperity, and it ran through the fifties,
and it is still quite high, relative to any historical periods. In other
words, it has been about 12 years where agriculture, instead of chronic
distress, has been generally prosperous.
Now, individual farmers through the vicissitudes of weather have
not done well, but on an overall basis agriculture has been good. If we
have chronic distress, I don't understand the term.
We do have a problem with agriculture which is partly political and
partly economic, looking into the future, because of the relative inflexibility of demand, and a great deal of this prosperity that I claim the
farmers had arose out of an abnormal demand.
So it was perfectly natural that in the last 2 or 3 years, with a reduced worldwide demand for agricultural products, there wTould be
a reduction in profit, but to say depression and chronic depression, I
do not understand.
Senator FLANDERS. Now, I would suggest, since there are 4 who
have not been heard from formally and 3 who have not been heard
from either formally or informally, that we ask Mr. Mitchell to conclude within the next few minutes, and we will move on.
Mr. MITCHELL. I would like to suggest that I wait until the next
time around, because the next question is the one you raised, Senator
Flanders, on why I think a great agricultural investment revolution
is needed in the face of the apparent surplus.
Senator FLANDERS. You promise to keep that in mind.
Mr. MITCHELL. Right.
Senators FLANDERS. Thank you.
Mr. Land?
Mr. LAND. I would like to address myself first to Mr. Patman's
question as to the effect of banks' holding securities on banks' willingness to make loans.
I think under normal conditions there is very little effect, that is,
in the sense of restricting a bank's willingness to make loans. Banks,
UNITED STATES MONETARY POLICY
141
if they are going to stay in business, have got to attract and hold
depositors, and there is no better way to do that than by making loans.
No bank that I know anything about under normal conditions
decides that it will not make a good loan because it wants to retain
a Government security.
There is one condition, however, under which banks may tend to
turn clown loan requests, and that is when the Government securities
market is down in price. If Government securities are selling materially below what banks paid for them, then banks may tend to turn
down loan requests. But that is exactly the time when that is the
right thing to do.
In other words, that is the period of monetary restraint, and that
is the right policy for banks to be following. That is the policy which
the Federal Reserve intends that they shall follow at that time.
As far as banks taking care of personal loans, that has been developed to a very large extent in this country. Our bank is thought of
as being a bank for big business, and it is a bank for big business, but
we have gone directly into the personal loan business in the last 8 or
10 years, and indirectly we have gone into it to a very large extent.
By that I mean wTe make loans to finance companies all over the
country. Most of the money which finance companies lend is bank
money.
In other words, the finance companies borrow from banks and relend it to customers, so that really a very large amount of bank money
is being put out on small personal loans. My question about it is not
whether it is enough but whether maybe we are not becoming too
adept at it.
Also, I would like to say that I agree very largely with what Mr.
Patman had to say about the discount rate. I think within recent
years its effect has been mainly psychological. I t has had very little
practical bearing.
Banks, as a matter of policy, borrow as little from the Federal Reserve and as infrequently as they can, so what the rate is is not too
much a practical matter with the banks, but it has a general psychological effect, and that is all it has had in recent years.
In addition to what Mr. Smutny had to say about why low interest
i*ates did not work in the 1930's, I would like to make this observation.
The 1930's followed a period in which many people got in trouble by
borrowing money.
Most people had a psychology of wanting to stay away from debt,
having some very bitter experience in borrowing money. The will to
borrow was lacking.
JS'OW, we have had a period of time when practically nobody has got
in trouble by borrowing money, and a lot of people have made a lot
of money by borrowing money.
"We have entirely a different psychology now, and easy money does
stimulate business under these conditions, whereas in the lOSO's it had
substantially no effect.
Senator FLANDERS. May I ask you a question there? The question
*s: In the case of borrowing money, is there any difference either in
the psychology of the borrower or the lender where the project from
^hich the money borrowed is something whose results are easily
calculable ?
55314—54——10
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UNITED STATES MONETARY POLICY
For instance, a bond issue for a utility plant or a soundly based realestate operation, on the one hand, or, on the other hand, something
in which there is an element of venture or risk.
Doesn't the effect of a low interest rate apply almost wholly to those
easily calculable undertakings? What difference does it make as between 2y2 and 4 percent on something which, if it works out, will bring
in a great deal more ? Take a manufacturing operation, not a wildcat
operation.
Mr. LAND. I was going to say, as far as business expenditures are
concerned, I think the rate of interest has practically no effect.
I n other words, whether business pays 3 percent or 3 ^ percent for
money really hardly could be found in the final result, there are so
many other factors of so much more importance.
Easy money produces its greatest effect in two areas of the economy,
residential construction and State and local public construction.
There the interest element is a big part of the total cost, and I think
we have seen that working in the last year.
Senator FLANDERS. I t becomes more important as the length of the
amortization is extended ?
Mr. LAND. That's right, where the interest element is a large part
of the total.
I n business the interest element is not a large part of the total. I n
residential carrying charges and in State and local carrying charges
interest is a very important part.
Mr. SMUTNY. Mr. Chairman, might I interpose there for a moment?
I beg to differ. I think that the interest element is very important,
as far as business is concerned.
I can bring out through experience that in 1953, when interest rates
started to run up competition for loans on the part of the Treasury
we immediately found that industry rushed into the market and did a
tremendous amount of financing.
Subsequent to that, this year of 1954, we have seen some instances
where industry has called the obligations that were issued in 1954
because they could be refundecl at a lower rate, so therefore the interest
rate does really become an important factor.
Mr. LAND. Only as to timing.
Mr. SMUTNY. I know there is a great deal of difference when you
borrow on money and pay 3*4 percent or 4*4 percent.
Mr. LAND. I have never seen a corporate budget where the rate of
interest made one bit of difference. I n other words, you see all sorts
of corporations laying out budgets for the next year or so.
Senator DOUGLAS. Are you speaking of working capital now or fixed
capital? I can see that in the case of working capital a change in
the interest rate is not particularly important, but on a long-time
investment would not a change
Mr. LAND. I have never seen a corporation make up two sets of
figures, one based on this assumed interest rate, and on the other
Senator DOUGLAS. But for current operations; isn't it?
Mr. LAND. F o r working capital?
Mr. SMUTNY. I n 1953 we had two instances of the largest corporations of the United States deferring issuance of bonds because of the
interest rate.
Mr. LAND. I grant you that a period of disturbed interest rates, a
period of disturbed market prices, can affect the timing of business
UNITED STATES MONETARY POLICY
143
expenditures. I t can cause things to be put off, but on the question of
whether expenditures are going to be made or not made, I think
interest rate is almost immaterial.
Mr. WILDE. Mr. Land, I see no evidence in our current experience
that interest rates on housing are vital, within quite some range.
A house today is bought as a package. The significant thing is the
downpayment and the monthly payment, and the buyer doesn't inquire about the rate of interest. He will buy it at 4% percent just as
quickly as at 4 percent. More houses are being financed this year than
when the rate was 4 percent.
I t is in the cost, but it is so small spread over the years that the buyer
doesn't know it or doesn't bother about it. "How much do I have to
pay down, how much do I have to pay monthly ?"
Senator FLANDERS. H e doesn't inquire, then, as to the period required for amortization ?
Mr. WILDE. Not particularly. He is principally interested from the
straight merchandising angle, "How much do I have to pay down,
how much do I have to pay a month?" He buys his automobile the
same way.
Senator FLANDERS. I S he thinking of his monthly payments, really,
in terms of rent?
Mr. WILDE. Yes, he does, and that is why he doesn't regard the
components of it as important. I t is: Can he pay that monthly rent
from his paycheck ?
Mr. LAND. I grant you he doesn't break up the monthly charge into
its components, and yet interest is undoubtedly the largest component.
Mr. WILDE. I t is a very large component, but if we hadn't had quite
so much easy credit, I think the gross cost of a house wouldn't have
been as high and he might have had a better buy.
Senator FLANDERS. Thank you, Mr. Land.
Now, Mr. Harris.
Mr. HARRIS. Senator Flanders, I want to make you a little happy
and tell you that here is an economist who agrees with you on New
England tariff. I might say you may be interested to know that I
am going to Washington next week to represent the six New England
Governors on this issue, to point out to the Tariff Commission that
the tariff is only one part of national policy, and that when you are
doing a job on New England you ought to take into account not only
the tariff but everything else the Federal Government has done to
New England.
This is the present, Senator Douglas. I am not talking about the
past.
Senator DOUGLAS. New England always wants to have the past
forgotten.
Mr. HARRIS. And I might say, Senator Douglas, and I think I told
you this before, that if New England continues to lose its textile industry at the rate of the last 3 or 4 years, there will be no textile production left in New England in 10 years, and it would be a shame if
through a tariff, a reduction of the tariff, the amount of competition
the New England textile industry has to face would be increased.
Although I still call myself a free trader, I think you can't be too
doctrinaire about these issues.
• Senator FLANDERS. May I interpose a moment?
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UNITED STATES MONETARY POLICY
There was a certain watchdog of the Treasury in the House many
years ago; 1 forgot his name and 1 forgot who made the remark, but
he opposed every appropriation in the rivers and harbors bill until
it came to an appropriation for the Illinois River, whereupon he
favored it, and someone got up and said:
'TIs sweet to hear the watchdog's surly growl tarn hark of welcome as we
near our home.
You and I are in the same box, but I think we have a modicum of
reason on our side.
Mr. HARRIS. I am sure we do—a great deal.
I might say, Senator Flanders, if you will continue in this position
you will be ruled out of the trade association of economists, as I am
about to be.
Now, getting back to the issue we have been discussing, I think both
Senator Douglas and Senator Flanders raise the issue, and several
others, of whether we can have both stability and growth/ I think
Mr. Wilde expressed some doubts on this issue.
Now, I am inclined to think—of course, this is a matter of judgment—you weigh one against the other.
For example, in the campaign—I am not saying this for political
reasons, either—the statement was made often in 1952 that the dollar
was only a 50-cent dollar. This, of course, was true and was a legitimate charge to make against the Democrats.
On the other hand, nobody did say there were four times as many
dollars around, which is also an important part of the whole story..
Of course, you don't expect the whole story in campaigns.
At any rate, this is the problem, that inflation does to some extent
contribute to growth, and it is very difficult, if you are interested in
growth, to draw the line exactly, and assure no price increase. If you
go back to 1913 you would find that we have had a price increase of
about 125 percent over a period of about 40 years. In that same
period we have increased our real income by 4 times, and had 2 major
Avars.
Now, is this really such a bad record? This amounts to a cumulative compound increase of prices of only a little bit more than
2 percent.
Let me also point out to you that between 1948 and 1954, there has
been an increase in prices of only G percent, which is quite a remarkable degree of stability, considering all the activity we have had.
Let me also point out that from 1951 through 1958 we had an increase in gross national product of 10 percent, in addition to price
stability, and this is also a rather remarkable thing.
Senator DOUGLAS. Mr. Harris, that is just the point that I would
like to appeal to, that for 21 months we did have an approximate price
stability at approximately full employment and growth, and the question I would like to raise is whether that was purely accidental or
whether things weren't done pretty well during that period prior to
the change of heart on the part of the Federal Reserve System and the
development of a new regime at the Treasury.
Senator FLANDERS. Senator Goldwater.
Senator GOLDWATER. I would like to ask your opinion of whether
or not the majority of that gross national product—I won't say the
majority, a large portion of it—went into nonconsumer goods, didn't;
have some effect on that so-called period of stability i
UNlfED
STATES MONETARY POLICY
145
We were producing, as I recall it, from 14 to 35 percent of our gross
national product during that 10-year period for national defense or
nonconsumer goods.
Mr. HARRIS. That's correct, Senator Goldwater, and I just jotted
down some figures for 1951 to 1953.
Here we had an increase of G X P of $37 billion, increase in consumption was $21 billion, a little more than half; investments were
down by $3 billion; Government was up by $21 billion.
There is no doubt about the high level of Government spending
having a good deal to do with it, just as I would say the fall of $9 billion in Government spending last year has certainly helped to bring
about recession, but this has been oll'set by a corresponding decline in
taxes with a small lag, so you might say the net effect of these Government operations was zero.
There was some small fall-off in investment, so I would say in a
general way I don't know, Senator Douglas, whether it was accidental
or whether this was all planned.
I think there was certainly some planning in it. TTe had our President's Council of Economic Advisers.
The thing certainly worked beautifully, and it suggests that the
thing is possible, and certainly we had all kinds of fiscal and monetary
policies, although I myself feel monetary policies can be pretty powerful on the rise, but not too powerful on the decline. Our experiences
seem to indicate this.
Mr. Wilde said a great deal about the danger of inflation. France
has had a devaluation of 99 percent in 33 years. Latin America had
an increase in prices of 500 percent, on the average, since 1939. People
don't save under these conditions, but when you look at our own price
history, we have had too much inflation, we could have had less, but,
on the whole, considering what we have achieved, the inflation hasn't
really been too bad.
I can understand why an insurance man would be worried about
inflation, but you have to look at the whole thing, not only the stability
of the dollar but the amount of growth and how much the small
amount of inflation we have had has contributed toward that growth.
I am sure we have had more growth because of the amount of inflation we have had. I am not trying to defend inflation. I think we have
had too much of it, but I don't think we should leave out of account
what has accompanied inflation.
Senator DOUGLAS. Mr. Chairman, would I be impolite if I filed a
demurrer.
Senator FLANDERS. YOU don't mean a demurrer—a brief.
Senator DOUGLAS. T O the degree that you stimulate growth through
inflation, you have done it by transferring purchasing power from
those who have fixed incomes, notably the salaried groups, and also
those whose incomes come from bonds, pensions, and so on.
Senator FLANDERS. Don't forget the widows and orphans.
Senator DOUGLAS. They are included in these other two categories.
And you have transferred income from them to the adventurous
classes of society, with the result that you have undoubtedly stimulated investment, but you have also increased nightclub spending, too,
in the same way, and I question whether this is a policy which should
be consciously followed.
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UNITED STATES MONETARY POLICY
I t seems to me that it is something that should be avoided, if it is
at all possible, and that we should try to hold to a doctrine of price
stability, yet substantial, full employment, with investment financed
out of savings rather than through transfer of income or the creation
of additional short-time capital.
Senator FLANDERS. Senator, not to interrupt, but would you say
that again ? There were three points. One was maintenance of employment, maintenance of production, and expansion out of savings?
Senator DOUGLAS. Well, price stability.
Senator FLANDERS. Price stability; that's right.
Senator DOUGLAS. Economic growth, and substantially full employment.
Senator FLANDERS. Economic growth and substantially full employment.
And the increase of employment and production that comes from
the increase of population, do you expect that to come from savings
or would you allow a corresponding growth in the credit money?
Senator DOUGLAS. Oh, you have got to have a corresponding growth
in credit money.
Mr. MITCHELL. If it were financed all out of savings, the price
would drop, so you have to have an equivalent inflation of credit.
Senator DOUGLAS. That's right. I would not call it inflation, but
rather an increase in money to stabilize prices.
Senator FLANDERS. I just wanted to get that clear.
Senator GOLDWTATER. Mr. Chairman, isn't it time—and I direct
this to you, Mr. Harris—we have only had in our economic history
one very short period of so-called stability in prices? We have just
gone through that, and that was brought about by very, very unusual
circumstances, and I think you and I agree.
I don't think it is an experiment that we want to continue. I agree
with these other gentlemen that price stability is something that is
rather impossible, just as employment stability has proven to be
impossible in the past, but maybe we can work out the secret.
Mr. HARRIS. Senator Goldwater and also Senator Douglas, I would
say this:
I think we are all aiming at the same thing. I think, for example,
the Federal Reserve is trying to give us growth, high employment,
and price stability. I think they have tried to give us price stability
but they also have given us some unemployment. This is the issue.
I would be inclined to risk a certain amount of price instability,
say, even an increase of 2 or 3 percent, and get rid of, say, one or two
million unemployed. I would be ready to take that risk. The authorities don't seem to be ready to take that risk, or they would give us a
much higher level of excess reserves, it seems to me.
Senator FLANDERS. Then, in brief, on this question, you feel that
the opportunities for the maintenance of employment, and I presume
of production and a stabilized standard of living, is improved if thereis a slight expansion of inflation?
Mr. HARRIS. That's right; a slight inflation is what we want.
Senator FLANDERS. That is what I wanted to get clearly in mind
from you.
Senator GOLDWATER. Mr. Chairman, would that be in excess of
what we would consider normal inflation ?
UNITED STATES MONETARY POLICY
147
Mr. HARRIS. I wouldn't worry too much about 1 or 2 percent a year.
I would certainly try to keep it down to that.
I would say 125 percent over the last 40 years is a little too much,
but we must not forget we had these two major wars, and I once made
an estimate of how much inflation we had in World War I I compared
to World War I, on the basis of the percentage of the economy going
to war and compared with the Civil War, and our record in World
War I I is 4 times as good as in World War I, and 12 times as good as
in the Civil War.
Senator GOLDWATER. Where did the dangers of inflation come in
this last period; during the second war or the second war and Korea ?
Mr. HARRIS. I t was sort of a postponed inflation which we should
have had in World War I I , in the absence of controls, so I would
count as part of the World War I I inflation some of the inflation
we had after World War I I .
I will try to answer 2 or 3 more questions rapidly because I don't
want to take too much time.
Congressman Patman raised an interesting question about whether
it would be a good thing for the banks to have a large volume of
public securities which kept them from lending money to the public.
I was talking about public securities in terms of giving us an
appropriate amount of money. I n other words, the banks have to
hold adequate earning assets to create adequate surplus of money.
Now, I would agree with Congressman Patman that if they were to
do the job by lending to the public, as originally suggested by the
Federal Reserve Act, that is one thing, but since they don't seem to be
able to do this, I would say it is important to hold a certain amount of
public securities, or inadequacy of money will injure the economic
system.
On the issue Senator Goldwater raised, why didn't the low interest
rates in 1933-39 do us any good, I would say it didn't do us much good,
and the reason is there are sometimes factors that are much more
important than interest rates.
If businessmen lack confidence, if prices are falling steadily, if their
anticipations are very pessimistic, then you can cut the interest rates
down to zero and it wouldn't have much of an effect. But it would
have a greater effect in the situation we are in now where there isn't
this widespread pessimism.
Now, the other point I wanted to make, a point I made this morning,
I want to emphasize very much, and I think it is a very fortunate
thing, it would be an awfully good thing, for example, one might
argue it would be a very good thing if the net result of the Federal
Reserve policy was that they control not only the commercial banks
but all other lenders of funds, but the fact of the matter is that they
don't do a very good job—I seem to have lost a sheet on which I had
these notes, but I can give them to you—if you look, for example, at the
1952-53 fiscal year when they were trying to restrict credit, you will
find there was an increase of $30 billion in loans and advances, and of
these $30 billion the commercial banks provided only $3 billion.
In other words, we had some expansion, fortunately, during this
period, despite the attempts to restrict the total supply of financing,
and this was because of the fact that the Federal Reserve bank did not
control the noncommercial bank lenders, and exactly the same thing^
has happened in 1953-54.
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UNITED STATES MONETARY POLICY
In fact, virtually all loans in the fiscal year 1958-54 have been made
by noncommercial bank lenders, and this is something we have to keep
in mind.
Senator FLANDERS. Are you saying, in effect, that you would like to
see the Federal Reserve control expanded over nonmember banks, and
perhaps over some other lending institutions ?
Mr. HARMS. 1 will be a little more subtle than that, Senator. I was
trying to say I would like to see them take over this control if they do
a good job.
If they don't, I think it is just as well that the control lies with the
insurance companies and the savings and loan associations, and so
forth, but this is an area, it seems to me, where the Federal Reserve
System hasn't really got to first base.
One final point and I will quit, and that is, I was talking to one of
the gentlemen of the Federal Reserve right after lunch, and he said:
"Don't you know that we know you have to control the rate of
interest?"
Well, all I can say is I wish anybody would read page 24 of the
answer to the intermediaries in this. I won't bother to read it to you
now, and see if you feel it is an adequate statement of what Federal
Reserve policy should be on the rate of interest.
I am glad to know that some of the high authorities believe that
they should control the rate of interest, but I defy the Congress to
read this reply and say that there is a clear statement the Federal
Reserve is ready to go out and control the rate of interest, rather than
wait until something disorderly happens.
Mr. SMUTNY. Mr. Chairman, may I inject something here, please?
Senator FLANDERS. Yes.
Mr. SMUTNY. That is the following: I don't think any statement
has been made here either on the panel or any recognition has been
made of the fact that savings are institutionalized now.
Years ago the individual saver was quite a factor in the bond
market. Today actually a vast amount of funds available for investment is not through the individual in the bond market, but through
institutions of deposit insurance companies, and so forth.
We do not sell bonds to the individual. We sell bonds to the institutions, the savings banks and insurance companies, and a vast change
has taken place in our entire investment market, and thereby the effect
of the operations of the open-market operations of the Federal Reserve
on bond prices is so important because the vast savings of the people
have become institutionalized. I think that is a factor that should
have due recognition.
Senator FLANDERS. Thank you.
Now, Mr. Clark.
Mr. CLARK. Mr. Chairman, I feel that the concentration of attention upon what monetary policy has done and can do in a period of
inflationary danger gives a sense of unreality to this meeting.
No one is bothered about inflation today. We are bothered about
the fact that the economy under monetary and other policies has not
been progressing since the first of the year, and unemployment has
not been cured, and the number of employed has not been rising at all.
let alone in step with the large increase in the labor force and the
working force.
UNITED STATES MONETARY POLICY
149
Now, the agenda for the meeting bars us from discussing and
analyzing the condition today as it may lead to our proposing policies
to bring about economic recovery other than monetary policies, but
surely we do within the limits here imposed have occasion to consider
whether monetary policy during the past year has advanced the cause
of prosperity in this country, whether there is now some condition
which may be improved by monetary policy, and if so, what monetary
policy can do for us.
I have suggested one monetary policy which now might be adopted,
that would have terrific impact upon the economy and perhaps would
give us the additional drive which we need to get out of the stalemate
which has existed since January. We are going to have the industrial
production figures for November in a few days. The circumstances
which made it possible to bring out these figures before the end of
October hardly exist now, so we have to wait until well into December.
And those are going to be tricky figures that you must look at with
considerable sophistication. We know that there has been a very
large increase in employment in the automobile industry, and we know
that there has been an attending increase in steel production, an increase in employment in steel production.
And if the economy otherwise has done nothing more than continue
on the dead center which it has occupied since January, we are bound
to have a noticeable increase in the industrial production index, and
it will fool the casual observer into thinking that it means that longawaited recovery has finally come around the corner.
Senator FLANDERS. Excuse me just a moment.
Mr. CLARK. Yes, sir.
Senator FLANDERS. But
was not the recession in part due to the
decrease in unemployment in just these same industries? Why
shouldn't you take it on the upturn as well as on the decrease?
Mr. SMUTNY. No, sir.
Mr. CLARK. Now, Mr.'
Chairman, to answer that, I have to again
caution you against the acceptance of bare statistics.
This apparent decreased unemployment, we find, occurs in a situation where the labor force is not expanding. We know actually
the working population is growing; wTe know that in the past 2 years
it has increased by a net of more than a million and a half, but we
do not find that in the official statistics, and the unemployment figure is
merely a residual figure, the difference between the number who say
they are hunting for jobs and thereby are qualifying for inclusion in
the labor force, and the number of those who say they have jobs.
Why is it that the labor forces does not show an expansion in
the statistics? I t is because in periods of slow business, many people
yho otherwise would be looking for jobs, knowing that now there
is no need to do it because they cannot get them, do not classify themselves when interrogated, as being people who look for jobs, so that
kaves them out of the labor force.
Senator DOUGLAS. Would you amend that statement to say do
not so classify themselves or are not so classified by the enumerators?
Mr. CLARK. I do not know that that is just what happens, Senator.
I think they are asked; I do not believe the interrogators undertake
to classify them, excepting on a basis of their own responses. Maybe
that is not what happens.
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UNITED STATES MONETARY POLICY
Senator FLANDERS. Are you taking into account the seasonal decrease in the labor force on the part of those who seek employment
during the vacation, and go back to school ?
Mr. CLARK. Well, of course, that is a real reduction in the labor
force; we must take that into account. But having consideration for
all of these factors, Mr. Chairman, I think that the figures on unemployment are understated.
Senator DOUGLAS. That is correct.
Mr. CLARK. And if we took those real figures, could get the real
figures, we would find there has been no improvement in unemployment.
How could there be when production has not been increased ? And,
along with that, since you asked me to comment upon the subject, I
take advantage of the opening, I read the other day a story about a
Government release relating to the number of people who are no
longer on the list of those continuing claims for unemployment insurance because they have exhausted their rights.
I t was a very surprising figure of people who did have unemployment insurance no longer are receiving benefits and, therefore, are
not listed in that statistical item, which has been dropping somewhat,
and who are, perhaps, not unemployed at.this time.
I do not want to overdraw the pessimistic picture of the economy
today. A year ago, I think I was, perhaps, the most outspoken of
the optimists who saw a fine business year ahead in 1954.
If the agenda permitted us to discuss the situation that, I think,
Mr. Chairman, if you will permit me, ought to be engaging the interest of the committee today, I think I could point out the reason for
the error in my optimistic view that the slideoff would soon end, and
that immediately thereafter, as happened in 1049, business recovery,
business expansion, would begin.
Now, perhaps November is going to put us over the hump; perhaps
the tremendous impulse to the economy which will come from the
combination of increasing production and employment in the automobile industry, increasing production and employment in the steel
industry, a n d t t i e 3 weeks of frantic Christmas shopping which is
ahead of us, will give the''economy the push it needs. The basic
factors have all been there all the time, and I wish that we could see
some way to add to these forces of the private-enterprise system, which
are now giving us the third chance this year to.come out of the
doldrums, that we will be able to add to these forces some impulse
from Government action.
Senator FLANDERS. D O you see that impulse as coming in the monetary and debt-management field?
Mr. CLARK. I see no sign of it, and that is what I mean.
Senator FLANDERS. I mean, you do feel that it should come from
that?
Mr. CLARK. No, indeed. I think the suggestion I made of one
monetary policy which would be well worth trying was suggesting to
you the poorest of the three major actions which are possible and
which, I think, ought to be taken; but it is the poorest. I do not know
what would happen—I rather agree with Mr. Shaw, that the effect of
increasing free reserves, freeing reserves, would be no increase in
lending; there is no indication that bank lending is in any way restricted now by the reserve situation. The banks would simply put
the monev into Government bonds.
UXITSD STATES MONETARY POLICY
151
I do not agree with him that that would mean that the Federal Reserve would have to furnish the bonds. Why should it ?
If the banks went into the market and bought the Government bonds,
it would mean a substantial increase in the price of bonds, a reduction
in the rate of return, and Mr. Humphrey would have that day he has
been so eager. He would be able to refund succeeding maturities on
a market that would not destroy the 2~y2 percent rate of the Victories.
Mr. SMUTXEY. In my opinion, this is an endorsement on your part
of the policies of the Federal Reserve and the Treasury, in direct contravention of your first statement.
. Senator FLANDERS. NOW, then, you do feel that so far as the existent
or nonexistent recession is concerned, that in the field of our inquiry
today, we might well consider the change in the excess reserves of
the banking system ?
Mr. CLARK. Yes, sir; and that it could not do harm. I t would have
to create prosperity, full employment, a larger purchasing power
before it could reach the point where inflationary danger was appearing. You cannot have inflation
Representative PATMAX. May I interrupt the gentleman ?
Mr. CLARK.
Yes.
Representative PATMAN. I agree with Mr. Shaw's statement that
reserves should not be reduced to the lowest point, but there should
be a point in between so that in the event it was necessary they could
be either lowered or raised in the future to take care of the situation.
Mr. CLARK. NO ; I think if you are going to be daring enough to
move, because you feel it is necessary to move, you had better use all
jour ammunition. I see no advantage whatever in retaining any
margin above the legal minimum.
Representative PATMAX. Would you reduce it right down to 7, 10,
•and 13?
Mr. CLARK. I would, for this reason, Mr. Patman: "We can see right
now from our experience since last August—and we learned, as Senator Goldwater pointed out, in the thirties, that the action to reduce
the rate of interest is of itself of very little significance in a period
•of depression or recession.
So the only reason that we should preserve for the Federal Reserve
some larger opportunity to act would be to enable it to act in the other
direction, to impose restraints through the addition to reserve requirements which, I can tell you, is an action that does hurt banks.
There is not any difficulty coming to a bank when you reduce the
reserve requirements; it is a harmless process, it enables the bank
"to buy some more Government bonds.
But when you raise reserve requirements, since all banks try to keep
fairly close to their reserve limit in their investments and their lending, it means that they have got to dispose of Government securities
or they have got to withdraw from some profitable loans in order to
meet the new reserve requirements, and there is not any doubt about
that being a repressive action.
Let us give the Federal Reserve enough leeway so that they can act
that way instead of having them caught, as we were in 1047 and 1948,
£hen some of us were joining the Federal Reserve in approving the
Eceles' plan, an action which he had to propose because they were up
to their limit already on legal reserve requirements.
Senator FLANDERS. Well, Mr. Clark, we thank you.
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UNITED STATES MONETARY POLICY
Representative PATMAN. May I ask him one question ?
Senator FLANDERS. Yes; you may.
Representative PATMAN. DO you mean to say that we are in for
serious trouble if we do not take drastic action like that, Mr. Clark?
Mr. CLARK. NO ; I said that it may be that this very important additional economic activity in the automobile and steel industries in
November will be found sufficient to get us over the hump; but if it
is not, there will not be a similar opportunity coming to us for several
months, because 3 weeks from today we enter upon a period of seasonal
business letdown.
Senator GOLDWATER. Mr. Chairman, I would like to ask just one
question.
Senator FLANDERS. Senator Goldwater.
Senator GOLDWATER. What are we talking about in terms of money,
in numbers of billions of dollars, in this suggestion of yours %
Mr. CLARK. The decrease to the legal minimum of 3, 7, 10, and lo
percent would mean freeing approximately 40 percent of the present
reserves, and that would be $7 billion.
Senator GOLDWATER. What was the amount of the last release, I
think, in May or June of 1953 ?
Mr. HARRIS. The total was 2y2 billion, I think, of all releases.
Representative PATMAN. Senator Goldwater, would you yield for
just a question there since it is an opportune time?
Senator GOLDWATER. Yes.
Representative PATMAN. You state about $6 billion in reserves that
would be released.
Mr. CLARK. $7 billion.
Representative PATMAN. That means a potential S42 billion in
added credit then in the banking system. The banking system can
expand to minimum of G to 1, and it might well be 10 to 1. That
would mean a potential credit expansion of about $70 billion.
Mr. CLARK. *p70 billion of lending power
Representative PATMAN. That is what I mean; it is not just $7
billion, it is 10 times that.
Mr. CLARK. It is $7 billion added reserves. You are assuming too
much, Mr. Patman, if you convert that directly into increased lending.
Representative PATMAN. What I mean it is possible.
Mr. CLARK. They will not make the loans when they have excessive
reserves there today. Why should the addition of excess reserves
send them on a spending spree ?
Representative PATMAN. They could buy more riskless securities.
Mr. CLARK. They could buy Government bonds, and wouldn't that
be a good thing. Let us help the Secretary refund on a long-term
basis a lot of these coming maturities.
Mr. SMUTNY. Mr. Chairman, can I ask one question, please, of
Professor Chandler because of the fact that he referred in the middle
of the talk there about the fact that we were in a recession again, and
quoted the figures that the unemployed were somewhere around o
million people.
After all, we recognize in 1953 that every time we got up to bat
we knocked a home run, but you cannot expect to continue that, and
in 1954, with 3 million unemployed, against a relationship, if you go
UNITED STATES MONETARY POLICY
153
back to the records, where unemployed persons would run up as
high as 9 million, and in 1933, 13 million—3 million with GO million
employables does not seem to me to be too far out of line.
Senator FLANDERS. I t is not out of line statistically, but I think
whenever we look at statistics of that sort we have to make them human
and it is too much.
Senator GOLDWATER. Mr. Chairman, one other question: I was
prompted to ask this because of a story in this morning's paper indicating some concern about the situation in the stock market.
Now, I neither subscribe to that nor do not subscribe to it. What
do you think that the release of this money would do to the stock
market?
Mr. CLARK. The immediate effect would be oil the bond market.
Senator GOLDWATER. Yes.
Mr. CLARK. And usually, I think, they believe that the shifting of
interest from the one market to the other cools off the first market— .
the one they are moving out of.
I am not able, though, to add any useful comment upon the relationship of the stock market and its boom to our economic problem.
Within a few weeks, within less than a month, after the first Council
of Economic Advisers was appointed, the business world greeted us
with a market collapse. We wondered what that portended—that
was in September 1946—there was a very serious collapse.
Well, it did not portend anything except great prosperity, and ever
since then I have been willing to exclude the stock-market condition
from my analyses of economic conditions.
Senator GOLDWATER. D O you think that there should be any concern
then today about the stock market's being a little bit on the high side?
Mr. CLARK. Well, I do not feel any myself, Senator.
Senator GOLDWATER. I do not either; I just wondered how you felt
about it.
Mr. WILDE. Mr. Chairman, I would venture a guess that, based on
historical precedents, if you had a radical change in reserve requirements, it would be interpreted as more inflation out of Washington
that tends to drive the stock market higher.
Mr. LAND. I would like to add my agreement to that. I feel that
that would be the result.
Senator FLANDERS. Now, there is a patient man at the end of the
line, Mr. Chandler. He did dip into the discussion once, but he is
entitled to enter it on his own account.
Mr. CHANDLER. Mr. Chairman, I hope I may be pardoned if I do
not make any comments on American tariff policy or the policy of the
Southern States in attracting industry.
Senator FLANDERS. I also call your attention to the fact that we
have not talked about the gold standard yet.
Mr. CHANDLER. I should like to neglect that, too, if I may.
First I should like to make a comment or two about the proposal to
reduce reserve requirements to the minimum permitted b^ law. I t has
already been brought out that this would add something in the neighborhood of 7 to 7y2 billion dollars to the volume of excess reserves
which is already well over a half billion, making something in excess
of $8 billion in excess reserves.
One thing that shoud be a primary rule in central banking is that
you must always leave yourself some way of reversing your policy if
the situation calls for it. To try to move from a situation of 8 or Sy2
154
UNITED STATES MONETARY POLICY
billion dollars of excess reserves to one of mild restraint, which would
call for a degree of finesse that I doubt any central banker has.
I am sure that he could not eliminate that volume of excess reserves
by increasing reserve requirements, and do it with such finesse as to.
avoid adverse results. .
This would be using a most inflexible kind of expansionary instrument of a type that could not be used in the other direction without
great potential danger.
Senator FLANDERS. In other words, are you saying that you would
tend to keep the bank reserves not too far—the bank reserve requirements not too far—away from the actual situation; is that what you
are saying?
Mr. CHANDLER. A specific prescription is always dangerous, but
I would suggest the thing to do is to leave the reserve requirements
where they are today, and if any further easing is necessary, to do that
through open-market operations that have high flexibility attached
to them.
I would like to make a comment on one other topic which has turned
out to be a key to our discussion this afternoon. That is whether
full employment and relative price stability are consistent with each
other.
There are certain circumstances in which it, obviously—where they
obviously contradictory. For example, the situation you had in 1930
was one of widespread unemployment; it was perfectly obvious that
one needed not only an increase in demand, but some Vise of prices,
at least of some prices, to get anything like full employment. In
that kind of situation we need some price rise in order to get, or even
approach, full employment levels.
But some of our economists, and the public at large, have learned
the wrong lesson from that experience. They assume that when you
already have full employment you cannot maintain full employment
without having further price rises.
Now, it is for that reason that I would dismiss, as largely without
meaning, the statistics presented by Professor Plarris, indicating the
great rise in real income per person today as compared with that in
1939. I do not think there is a person at this table who would want to
return to the 1939 level.
Mr. HARRIS. I never gave 1939 figures in my statement, Mr. Chandler; I gave 1914 and 1951.
Mr. CHANDLER. 1914?
Mr."HARRIS. Yes.
Mr. CHANDLER. Well, I
would submit that a very considerable part
of that increase was achieved during the twenties when you had relatively stable commodity prices.
There were certain other periods of price stability in which the rate
of growth was also quite satisfactory.
We come to a much more ticklist question when we approach the
one that was uppermost in Professor Shaw's mind: When you already
have full employment, can you maintain it without further priceinflation ?
UNITED STATES MONETARY POLICY
155
We do not have the ability to forecast, yet there is, I think, one
real ray of hope in the point that Professor Shaw brought out, namely,
the continuing technological improvement and the rising productivity
which would give us room for wage increases offset by increases in
output, so that we can perhaps have relatively stable prices and rising
wage rates at the same time, while maintaining full employment.
I have just one further point on that subject. I t is often stated
that we would have a better chance of maintaining full employment
if we had controlled inflation at the rate of 2 or 3 percent a year or
some other relatively modest figure. I do not see any magic in those
numbers.
It seems to me that an annual increase of zero percent is, perhaps,
just as feasible as 2 or 3 percent.
What reason do we have to believe that we can set up expectations
of 2- or 3-percent rises in price levels a year and still maintain full
employment ? Wouldn't you have exactly the same problem of costs
tending to outrun prices, and so on, so that you would get unemployment unless you speeded up the rate of growth ?
I do not know of any economist who has analyzed the problem
of maintaining full employment while you have automatic escalator
clauses in every contract; but I see no reason to believe it would be
any easier than operating within the framework of a relatively stable
price level.
Senator FLANDERS. Well, we have been through the list.
Representative PATMAN. Mr. Chairman, may I ask if it it would
be asking too much of the chairman to find out from the panel by a
lifting of hands or some similar way as to how they stand on free
convertibility of gold?
Senator FLANDERS. I am sorry I mentioned it.
Representative PATMAN. Well> the chairman mentioned it, and I
know from that it is a very important question which should be
considered.
Senator FLANDERS. Let me first have an introductory show of hands.
How many of those across the table wish to raise their hands on that
question? Will you raise your hands to show your willingness to
express yourself?
(There was a showing of hands.)
Senator FLANDERS. A majority of them.
Mr. HARRIS. Will you define the term. What does this mean? Do
you mean United States present convertibility ?
Representative PATMAN. Yes.
Senator FLANDERS. The present convertibility of gold.
Mr. SHAW. May I ask for a more explicit definition ? A t what price
is gold to be freely convertible ; and to whom ?
Representative PATMAN. The same price as it is now.
Mr. SHAW. And to whom and from whom?
Representative PATMAN. Domestic, of course.
Senator FLANDERS. That expresses itself to me, Mr. Patman, as
keing able to go to the bank and getting a $20 gold piece for a
Christmas present.
Representative PATMAN. That is right.
156
UNITED STATES MONETARY POLICY
Senator FLANDERS. I do not know what the economic significance
of that is, but that is what free convertibility means to me.
Representative PATMAN. Just like it was before we did not have it.
Senator FLANDERS. Yes.
We are now taking a poll on that subject. All of those who believe
that I ought to get a $20 gold piece to give away at Christmas when
1 go to the bank, please raise your right hands.
Senator DOUGLAS. Just a minute, Mr. Chairman, you certainly
would not limit the convertibility of gold to a desire for Christinas
presents, would you?
If you convert money into gold, it could be for any purpose. This
is a very apt illustration of it, but it is too restricted.
Senator GOLDWATER. Mr. Chairman, I think Professor ShawT raised
a very good point there as to the time element. I know in our
discussions last year
Senator FLANDERS. I n my lifetime.
Senator GOLDWATER (continuing). I n the Committee on Banking
and Currency—in your lifetime, well, that is a long time.
Senator FLANDERS. Thank you.
Senator GOLDWATER. But that was one of the important things
raised last year in our hearings, is when. There was not much
question
Mr. SHAW. The price, qf course, is a highly critical, factor, and
also given the price, what collateral changes there may be in the
reserve requirements of the Federal Reserve banks, because depending on the price and on these reserve requirements, this can be a highly
deflationary operation.
Senator DOUGLAS. I suggest we poll the experts on $35 an ounce.
Senator FLANDERS. I would like to put this question properly.
Representative PATMAN. Leave out the Christmas present.
Senator FLANDERS. All right.
Is this the. question that you gentlemen would be willing to express
yourselves on:
Can you conceive of any proper action to be taken within the near
future which would lead desirably to a free gold, interchangeability
of gold with dollars \ Is that a good way to state that ?
Now, all in favor say "aye," or raise your right hand.
(No response.)
Senator FLANDERS. All opposed, raise their right hands.
(There was a showing of seven hands.)
Senator FLANDERS. 1 noted there was one person not voting. I do
not know what to do about him.
Mr. LAND. I probably was the one not voting; I do not think it makes
much difference whether gold-coin convertibility is restored or not.
Mr. SMUTNY. Mr. Chairman, could I bring "in something that has
not been brought up today ?
Senator FLANDERS. Yes.
Mr. SMUTNY. I do not think there has been really any recognition
of the extension of maturity of obligation of the United States Government by the Treasury.
I n all Treasury refundings in which we participate, there has been
an attempt on the part of the Treasury to extend the debt, and to
reduce the amount and the number of refundings in each year, and
UNITED STATES MONETARY POLICY
157
with the last refunding operation, December 2's, which, as you know,
amounted to some $17 billion, you will find that the average maturity
of United States Government marketable securities outstanding now
has been increased to the longest maturity period of time that they
have had, I think, in quite some years, if you go back to statistics.
«
At present the average maturity is somewhat over 4 years, being
4 years and 3 months.
Senator FLANDERS. HOW far does it go back before Ave again approach that average length of maturity, can you say offhand 'i
Mr. SMUTNY. YOU mean how does this compare with what it was
in 1933?
Senator FLXVNDERS. Yes; if that average length of maturity is higher
than it has been in the recent past
Mr. SMUTNY. That is right.
Senator FLANDERS (continuing). How far back do you have to go
to find a similar average length of maturity?
Mr. SMUTNY. I n 1951 average debt of United States marketable
bonds was 4 years and 4 months.
Senator FLANDERS. Well, that is interesting.
Mr. HARRIS. Mr. Chairman, may I make one comment, since Mr.
Chandler commented on my views on full employment and the price
level? I t will take a half minute.
I just want to say that on the basis of experience, where you have
a rise of output, whether it is at a low employment level or a high,
although greater at a high, there is a tendency for prices to rise.
This is true of our own history, and I simply say let us try to get
a stable price level and growing employment, but in practice what
you are likely to find, especially as a result of wages to inflation, and
despite technological improvement; you are likely to find when output rises, on the average, you are likely to have some price rise. This
is one of the costs of progress.
Senator FLANDERS. NOW, there is a raised hand. Some of the members of this panel have engagements which they must meet. I t had
been my plan to adjourn at 4 o'clock; it is 4 now.
I hate to discourage one upraised hand.
Mr. MITCHELL. This is on that agricultural question; I can get it
over with in 2 minutes, if you wish.
Senator FLANDERS. TWO minutes?
Mr. MITCHELL. I am recognized for 2 minutes?
Senator FLANDERS. YOU are recognized for 2 minutes.
Mr. MITCHELL. Senator Flanders asked why I was recommending
a great agricultural investment surge in the face of our apparent
surpluses.
Well, as my paper, presented to this committee in February indicated, I do not think there is any such thing as a surplus in the human
sense with regard to food and fiber, only in the economic sense, which
Cleans that Ave have got to find the answer not by cutting down production but by discovering better ways to distribute what American
abundance can produce.
America will need a half more dairy food; we will have to get out
°f butter, but we will have to produce more fluid milk, and get it into "
the mouths of great numbers of American children who do not have
enough of it for good teeth, bones, an adequate diet.
55314—54
11
158
UNITED STATES MONETARY POLICY
America will have to have one-third more meat, two-thirds more
fruits and vegetables, if decent diets are to be attained, and I assume
they will be under a fully employed economy.
Even wheat and cotton, which are export products, will still be
needed in the world, and there again it is a problem of distribution,,
not one of curtailing production.
But consider the credit needs of the agricultural producers, at least
half of them, 2y2 million farmers. If we aim that way the next 10
years, they need to undergo a virtual revolution in their way of producing, and they are going to have to get out of the cash crops into
dairy, fruits, vegetables, and livestock products. They are going to
need $5,000 to $10,000 each over the next 10 years in new credit to
achieve this kind of revolutionary production change.
Now, banks are not making that type of loan, they do not, they cannot. These are 7- to 10-year loans, and banks cannot, under banking
laws and statutes and lending habits.
I wish they could. A number of banks in the Midwest are finally
hiring farm managers to help in the revolutionary type of farmmanagement change that will go with that kind of intermediate credit
loan.
In the past, whenever we have needed revolutions in credit for
farmers, such as we needed to assist low-income farmers who were bad
credit risks for the usual commercial banks, we found that credit, plus
supervision, was necessary. I am suggesting that that will be necessary for the middle third of American agriculture, too, in the future.
If private banks are not able to revolutionize their own way of doin^
business, and if they do not change their ideas of the proper length
of time; in other words, if they do not change to a 7- to 10-year reorganization loan, there is going to be a demand for Government once
again to get into the agricultural credit field.
Senator FLANDERS. I was just going to say that I was about to thank
you for your 2 minutes' worth, and you have explained yourself, I
think, quite clearly.
Now, I take it, you are not quite through with your explanation?
Mr. MITCHELL. Not quite.
Senator FLANDERS. YOU can extend it in the record.
Mr. MITCHELL. My article goes into that, so I think that is enough
time for me.
Thank you.
Senator FLANDERS. We thank you all.
Representative PATMAN. Mr. Chairman, all of them will be permitted to extend their remarks?
Senator FLANDERS. Yes; all will be permitted to extend their remarks in the record, and I—in fact, it is allowable to extend the debate
in the record, to one degree. That is, I do not think we would want to
extend it by each one reading what the other had said about him, and
coming back twice. Once will do.
We have had a very—for the chairman at least—pleasant and an
informative roundtable, and I hope that we may meet again.
Everyone has made a contribution. I am sure that the Representatives and Senators join me in that statement.
The meeting is adjourned until 10 o'clock tomorrow morning.
(Whereupon, at 4:05 p . m., the subcommittee recessed, to reconvene
at 10 a. m., Tuesday, December 7,1954.)
UNITED STATES MONETAE! POLICY: EECENT
THINKING AND EXPERIENCE
TUESDAY, DECEMBER 7, 1954
CONGRESS OP THE UNITED STATES,
J O I N T COMMITTEE ON THE ECONOMIC REPORT,
SUBCOMMITTEE ON ECONOMIC STABILIZATION,
Washington, D, C.
The subcommittee met, pursuant to recess, at 10:10 a. m., in room
318, Senate Office Building, Senator Ralph E. Flanders (chairman
of the subcommittee) presiding.
Present: Senators Flanders (chairman of the subcommittee), Watkins, Goldwater, Sparkman, Douglas; Representatives Talle, and
Patman.
Also present: Grover W. Ensley, staff director; and John W. Lehman, clerk.
Senator FLANDERS. The hearing will please come to order.
Yesterday we had a panel of economists and bankers who discussed
their various points of view, and I think everyone who was here will
agree tliese points of view were various, on the monetary and credit
policies of the two branches of the Government which are most concerned with those questions, the Treasury and the Federal Reserve
Board.
Today we pursue the line of thought and the line of questioning
introduced yesterday.
Having fieen informed and stimulated by these widely varying
points of view, we will have before us today the two branches of the
Government concerned, who have very kindly offered to explain their
positions, and defend them to the extent that they believe defense
is necessary. We also greatly appreciate the fine cooperation we
have had from both the Treasury and the Federal Reserve Board in
the preparation of their answers to the questions provided by this subcommittee prior to the hearings. These materials were inserted in
the record at the opening of the hearings yesterday (pp. 3, 30).
We are first privileged to have with us this morning, Mr. George
Humphrey, Secretary of the Treasury, and with no further introduction,' Secretary Humphrey, wTill you open this discussion.
159
160
UNITED STATES MONETARY POLICY
STATEMENT OF HON. GEOKGE M. HUMPHREY, SECRETARY OF THE
TREASURY, ACCOMPANIED BY W. RANDOLPH BURGESS, UNDER
SECRETARY EOR MONETARY AFFAIRS; DAVID M. KENNEDY,
ASSISTANT TO THE SECRETARY; EDWARD F. BARTELT, FISCAL
ASSISTANT SECRETARY; AND ROBERT P. MAYO, CHIEF, ANALYSIS STAFF, DEBT DIVISION
Secretary HUMPHREY. Mr. Chairman, with your permission, I
would suggest that we might make more progress if I made a relatively
short statement, and then if Mr. Burgess w^ould go through some charts
with explanations which he has to offer and then, after having laid out
that program, we would both be here and available for questions. I
think that, perhaps, we would save time if questions could be postponed until we had finished that, and then the whole matter would be
before you, and it would be much easier to answer questions in that
way rather than, perhaps, to anticipate some of the things that we may
answer as we go along.
Senator FLANDEKS. We operated on that basis yesterday; I think
we found it satisfactory, although we do hope that there will be a little
time left after your uninterrupted flow of information.
We will proceed on that on that basis.
Secretary HUMPHREY. In that case, Mr. Chairman, I will be glad to
start with this statement.
We welcome this opportunity to appear before your subcommittee to
review the fiscal and debt management policies of the Treasury from
the point of view of their economic influence.
At the outset and before considering in detail the activities of the
Treasury during the past 2 years, I want to make a few general comments on the direction of our entire fiscal program as well as the principles guiding us in the management of the public debt.
The administration's budgetary and tax policies, along with its debt
management policies, have all been designed to promote high employment, rising production, and a stable dollar.
We have in fact been following the policies advocated by your
predecessor subcommittees that—as stated in the Douglas report of
January 1950, in language reaffirmed in the Patman report of June
1952, as follows: "appropriate, vigorous, and coordinated monetary,
credit, and fiscal policies" should "constitute the Government's primary and principal method" of promoting the purposes of the Employment Act, and further, their additional recommendation—
that Federal fiscal policies be such as not only to avoid aggravating economic
instability but also to make a positive and important contribution to stabilization,
at the same time promoting equity and incentives in taxation and economy in
expenditures.
Government spending programs have been cut by billions of dollars.
Waste and extravagance have been eliminated in many areas.
Economy in Government and efforts to get the Federal budget under
even better control are continuing without letup. These efforts are of
great importance to the future of our country and are fundamental in
the administration's honest money program.
Major tax reductions and comprehensive tax revisions, along with
the ending of price and wage controls, are removing barriers to economic growth and restoring individual initiative and enterprise.
UNITED STATES MONETARY POLICY
J 61
Savings in Government spending which have been returned to the
people in the form of tax cuts are helping sustain the economy, increase
employment and production.
Progress is being made toward getting our huge public debt in
better shape, so that its maturities can be handled more easily and
debt operations will not stimulate either inflation or deflation. Treasury financings have been designed to tie in with action taken by
the Federal Reserve System to keep the supply of money and credit
in line with the needs of the country.
The principles we have been following in the management of the
large public debt are not new. They are, likewise, principles that
have been laid down by your predecessor subcommittees after extensive study and careful consideration of the fundamental role they can
play in effective monetary policy.
The first principle is that monetary and debt management policies
should be flexible. To be effective they must lean against inflation
as well as deflation. As put by the Douglas subcommittee and reaffirmed by the Patman subcommittee, and I quote once more:
Timely flexibility toward easy credit at some times and credit restriction at
other times is an essential characteristic of a monetary policy that will promote
economic stability rather than instability.
The second principle is that Treasury debt management operations
should be consistent with current monetary and credit control policies
of the Federal Reserve. This means close cooperation at all times
between the Federal Reserve and the Treasury.
The answers which we have already submitted to your subcommittee's questions detail the actions we have taken in cooperation
with the Federal Reserve during the past 2 years in carrying out
these principles. They show the manner in which our debt operations
have been designed to complement monetary action taken by the Federal Reserve to promote economic stability, first by helping to restrain
inflation and then later by helping to avoid deflation.
The record has not always been as impressive. As you know, at
the time of the earlier congressional hearings on monetary policy
and debt management, the economy had been under strong inflationary pressures. Monetary policy had been largely ineffectual in helping to control inflation because of the previous administration's policy
of selling mostly short-term securities and using the powers of the
Federal Reserve System to hold down interest rates artificially. A
fundamental conclusion of both of your predecessor subcommittees
was that such action was not in the best interests of the Nation. This
Was their considered judgment in language used in their report.
This administration has followed these principles because we believe
them to be fundamental principles of good government. We believe
the record of the past 2 years has indicated their effectiveness in giving
us honest money and laying a firm foundation for the sound growth
an
£ prosperity of our country.
That concludes my statement. I will ask Mr. Burgess if he will
take up the matter of his charts with explanations that will illustrate
this point.
Mr. BURGESS. Mr. Chairman, I hope this does not look too much
hke a television show, but it seems to us, perhaps, the best way of
Presenting the facts of what we have been trying to do so that Ave
c
an lay them before you.
162
UNITED STATES MONETARY POLICY
The first chart shows what we are dealing with, the public debt,
running back to 1916. I t went up in World W a r I as high as $26
billion, and then was reduced by 1930 to $16 billion; then during the
depression it worked up to $48 billion, just before the outbreak of
World W a r I I .
Chart I
THE PUBLIC DEBT
Dec. Dec.
Dec.
Dec.
Dec. Apr.
Dec.
"Excluding Victory Loon proceeds used to repay dttt in 1946,
MblllMSlllWftlHlWy
ft-IZC*
I n World AVar I I the debt shot up to $280 billion. That top figure
in a sense was a bookkeeping operation, because you will recall that
in the Victory loan of 1945 we borrowed more than proved to be
necessary. We did not know that war expenditures were going to
taper off so quickly, and so there was $20 billion left on deposit with
the banks which was used in 1946 to scale down the debt, so that a
figure of $260 billion would be a fairer figure of what it really cost us
in terms of the national debt.
The first debt reduction due to budgetary surpluses took place in
1947, 1948, and 1949, and they reduced the debt by $8 billion to $252
billion.
Then came the Korean war, and the $27 billion increase since 1949
represents the Korean war and the efforts to meet the cold war. So
we are left at the present time with a debt of close to $279 billion.
Now, there is a way of putting the debt in its setting, and it is interesting to relate the Federal debt to our other debts of the people.
Back in 1939, we had a total debt structure of $208 billion, and the
$48 billion of Federal debt was at that time 23 percent of the entire
debt structure. The State and local debt was $20 billion, corporation
debt $89 billion, and individual debt $51 billion, as shown in chart 2.
UNITED STATES MONETARY POLICY
163
Chart 2
PUBLIC AND PRIVATE DEBT
^ ^ 5 . ™ , ^ ^
B)|72A
By the end of the Avar the Federal debt had swelled up to $260
billion, using that adjusted figure, which was 58 percent of the total
debt structure in December 1940. During the war the other segments
of the debt were held back because of shortage of goods and inability
to start building operations, and so on.
Now, since that time, the Federal debt has risen, as indicated here,
to $279 billion, which is now 40 percent of the total debt structure;
that is, as the other sections have risen, the Federal debt becomes a
smaller proportion of the whole debt structure. These others have
gone up pretty smartly. The State and local debt is expanding.
v3f course, that includes these road programs which are in a sense selfhquidating; and then corporation debt has doubled since just after
the war, and individual debt has risen much more than that; it includes
consumer credit, of course, and the big item is mortgages.
Now, once again in the w7ay of showing the problem of the burden
ox the debt, the left-hand side of chart 3 shows the debt per capita of
tJ
je population. Before World War I that was only $12. At the end
of that war it had risen to $245. I t went down to $130; it was $363
before we entered World W a r I I , and it went up to $1,832 by December
U46. Then it shrank, partly due to payoffs and partly due to the
growth of the population, to $1,690, and it is fair to say that since 1949,
lle
increase in the population and the increase in the debt have more
or less kept pace with each other, so that the per capita debt is about
Sesame.
UNITED STATES MONETARY 1 POLICY
164
Chart 3
BURDEN OF T H E DEBT
Debt as % of
National Income
136%
1600
114%
194%
800 h
191619 "30 '39 '46 '49 '54
'
Dec
Offc« tt tM S«nt*y trf tw h*wy
'Apr. Dec.
1916
19 '30 '39 '46 49 '54
1
Dec.
' Apr. Det
' t-IIOT
Now, a rather more cheerful way of looking at it—we ought to serze
on any aspect of the debt that we can that is cheerful—is to relate the
debt to the national income.
After World War I the debt was 33 percent of the national income.
Before we entered World War I I , it was 62 percent, and it rose so
that it was larger than the national income, 136 percent; it was reduced by 1949 to 114 percent; because income was growing and there
was some debt retirement.
The debt has come down now to 94 percent of national income.
That is due to 2 causes, 1 of which is not so good. That is inflation.
Inflation has increased the national income in terms of dollars, so
that a part of the adjustment of the debt to national income is due to
inflation, so that it has caused in a sense the kind of evil you want to
try to avoid.
But part of it is due to good, solid causes, the growth of production
and the expansion of the economy.
There is one thought
Senator DOUGLAS. Mr. Chairman, is Dr. Burgess including in his
analysis—would it be appropriate if I asked a question at this time.
Senator FLANDERS. Yes, you may do so.
Senator DOUGLAS. The question I wanted to ask is this: If you take
the carrying charges on the national debt as a percentage of national
income, isn't the showing still more favorable because what we have
had has been, until very recently, a very sharp fall in interest rates?
I made some computations indicating that as a percentage of national income the interest on the national debt in 1933 was a larger
percentage than it wyas in 1952.
UNITED . STATES MONETARY POLICY
165
Mr. BURGESS. Yes, we have those figures. The interest rates now,
for example, are actually lower, the rate of interest is lower, than it
was 2 years ago, so that
Senator DOUGLAS. I think as a percentage of national income, the
cost of the national debt to the community was lower in 1952 than it
had been in 1933, because roughly you have had a fall from 4 percent
to 2 percent.
Mr. BURGESS. Yes, those figures are in the right area, Senator; I
will have the figures inserted in the record.
Computed annual interest charge on interest-bearing public debt as a percent of
national income
Computed
annual
interest
charge (as
of June 30)
1932
1933
1934
1952
1953
1954
1
2
_._
.
^
_
Millions
$672
742
842
5,981
6,431
6,298
National
income
(calendar
year) i
Millions
$42,500
40,200
49,000
291,000
305,000
2 298,900
Interest
charge as a
percent of
national
Income
Percent
1.58
1.85
1.72
2.06
2.11
2.11
Rounded to nearest hundred million.
Annual rate for first three-quarters.
It shows that—we have two ways of going at this problem of the
debt I t is an ugly thing to have such a big debt. One way is to try
to keep it down and try to pay it off, and the other is to grow up to
i t This, of course, means that one of the important things we are
dealing with in respect to the debt is to encourage a dynamic growing
economy.
Now, to come to the debt action in the past 2 years: As Secretary
Humphrey has said in his presentation, one of our objectives was to
gear our operations with the operations of the Federal Reserve System,
and that is in accordance with the recommendation of your two
subcommittees.
Chart 4 is an attempt to single out from the great mass of economic
facts one or two that might shed some light on the situation that we
have been facing.
The first thing you will notice is the color on the left side of this
chart The pink color is the area during which the Reserve System
was exercising credit restraint. Now, those are the years from 1951
through to May 1953. We put in that color in a gradually deeper
shade because they were gradually increasing their credit pressure
during that period. The evidence of their policy, of course, is contained in the reports of the Federal Reserve Board, which shows the
policies they were following during those years.
Now, what were the economic events against which they were doing
so? This solid black line represents industrial production, as shown
hy the index of the Federal Reserve Board. The dotted line represents business inventories, and this lower dashed line represents the
UNITED STATES MONETARY POLICY
166
Chart 4
ECONOMIC INDICATORS AND MONETARY ACTION
*Bil.
%
Industrial Production ,
:•••+<•••••,
80 (t947-V9'/00;Scale Right)
••••.••••
•••r****
\
70
120
(Scale Left)
Credit Restraint—»|«—Credit Ease
132
124
Business Inventories
130
DemandDeposits
andCurrency*\
116
June
1951
Dec.
June
1952
Dec.
June
Dec.
1953
June
Dec.
1954
Note; Seasonally adjusted data.
tffarfthtfamvyif fetuwr
volume of money, as shown by adjusted demand deposits and currency.
Now, the interesting thing is that production was going through a
great bulge from the middle of 1952 until about August of 1953, a
bulge that carried it well above the levels that it had been and is now;
in fact, it carried it above the highest level reached during the war.
Now, that bulge represented in considerable measure the increase
of inventories, as well as the normal flow of production into consumption ; inventories increased something like $7y2 billion over that
period, and at the same time, you had a period of rapid credit growth.
There was a budget deficit of $9.4 billion in the fiscal year 1953.
At the same time in this period, the wage-price controls were removed so that you had again a question of restraining possible overexpansion.
Now, this area over here on the right represents a period when
the Reserve System was operating under a policy of credit ease, again
as demonstrated by the reports that they made in the annual reports
of the Federal Reserve Board.
One of the things about it is that they turned their policy about
very quickly when there was evidence of change in the business atmosphere ; even before it showed up in inventory figures and in the production index.
# Now, our problem was to adjust our debt action to this sort of a
situation.
There were two major problems of debt management that we faced.
One was to do exactly what the Secretary indicated, to adjust our debt
management to the business situation, and to the monetary policy, and
the other was gradually over a period to lengthen out the debt so it
would not be so heavily concentrated in short-term maturities.
167
UNITED STATES MONETARY POLICY
Now, the first job with the volume of money rising, and with an
inflationary situation in the early months of 1953, was to see that our
debt operations did not add to the volume of bank credit, that is, that
our securities were sold as largely as possible outside the banks; and
chart 5 shows that from January 1 to May 1, 1953, bank holdings of
governments showed a decline rather than an increase. The Federal
Reserve holdings also were down a little.
Then after the change in policy, commercial bank holdings of securities went u p ; the volume of money increased in accordance with what
you would call a classical pattern. I t no longer was so important for
us to concentrate on selling outside the banks, but on the contrary,
some increase in the volume of bank credit was a desirable thing for
the economy.
Chart 5
OWNERSHIP OF T H E DEBT
$6il.
Commercial Banks and
Federal Reserve Banks
Nonbank Investors
Gov!
-"Invest
Accts.
150 h
100
\+*Individuals
Pension
i^Funds
—Com!
50h
-*-Institutions
+Jtorps.
and Misc.
Federal
^Reserve
Jan. I, May I,
Dec. I,
Jan. I, May I,
Dec.I,
1953 *53
*54
1953'53
'54
tf * • WlUry tf tht huury
Now, the right-hand side shows the absorption of Government securities by nonbank investors. The corporations and miscellaneous
group increased their holdings slightly throughout the period; nonbank institutions, which means insurance companies and savings
banks, and so on, decreased their Government holdings over this period,
as compared with no change during early 1953. That was in a way
a beneficial thing because they were putting the money in mortgages
and in industrial securities and in other investments which created
employment and offset the recessionary tendencies of the period.
Pension funds held $6 billion of Government securities in that
period, and they now hold $7 billion, when those figures are rounded
off; that is a steadily growing market for Government securities.
Individuals have increased their holdings slightly, and that is where
our savings-bond program comes in, which is a long-term program
for getting individuals to buy Government securities, and getting a
wide distribution of the debt.
168
UNITED STATES MONETARY POLICY
Another steady absorption of the debt outside the banks is in the
trust funds of the Federal Government—social security, unemployment funds, and so on—and that has increased over this period of 2
years by $3% billion.
I n a way, it is a kind of funding of the debt although it is, of course,
on call if there is heavy unemployment or other economic situations
that may lead to a more rapid withdrawal of social-security funds.
Now, responding to these changes in policy and the change in the
pressure on the situation, you have had this change in long-term bond
yields (chart 6). They have been going up since early in 1951; in fact,
if I projected the chart back further, they would show some rise before
then. The rise was, of course, sharper in these last months of the
boom period in 1953, when there was more pressure on the situation
from the Federal Reserve, and when we were selling a billion dollars
of long-term bonds outside of the banking system.
Chart 6
LONG-TERM BOND YIELDS
%
Corporate?*^ / ^ \
3.2
z.eh
sS-\y /"N*<
/
' . . M * * * * . 'X'««T
!"K
as./
2.4
Govts / .*-r
1
/^Municipals'
A
*••#•••••••.•••••
\S
\
2.0
1951
* Moody's Aaa.
Ctttt «T (f« SiCftrtfry ef t *
1952
1953
1954
* Standard andPoor's High-grade,
iMMy
There is one rather interesting thing about this chart, which is
that the rate on municipal bonds—and that is the broad figure of the
municipal and State, of course, with the big element being State bonds.
That has gone up faster than the yield in the other categories, due
to the fact that the huge volume of State and municipal issues was
pressing on the market and congesting the market during that period.
The amounts were so large that they overflowed the true tax-exempt
market and had to go over into the life-insurance companies and
other investors, so that State and local governments really lost a great
deal of the benefit of tax-exemption.
All these yields have come down sharply since that time, and are
now lower than they were in the latter part of 1952.
UNITED STATES MONETARY POLICY
169
The corporate yields are about even with what they were in late
1951 and 1952, and the Government yields are somewhat lower.
Now, one thing that we have been watching very intently during
all this period in our policy—and the Federal Keserve.has been
watching it as well—is the flow of money into new investment in
the form of mortgages and corporate and municipal securities. The
employment of money in those markets has been a great underlying
strength in this transition period.
Chart 7
NEW MORTGAGES AND S E C U R I T Y ISSUES
Quarterly I 9 5 K 5 4
$Bil
Mortgages
(Nonfarm recordings
$20,000 or less)
Corporate and
Municipal Securities
Corporate
Mimic/pa/
f
1951 '52 53
1951 52 '53 '54
tftttrfM&DMiyirgittMiuiy
Now, as to the restraining money policies in early 1953, the lefthand side of chart 7 shows the mortgage market, as represented by
nonfarm recordings of $20,000 or less; and the right-hand column
fehows new corporate and municipal securities in separate areas.
The credit restraint policy in 1953 came at a time when there were
Very heavy offerings of mortgages in the market, and similarly when
there were very heavy offerings of these securities.
The higher interest rates and decreased credit availability led to
the deferment of a certain amount of mortgage financing, and a certain amount of corporate and municipal financing. This meant that
the work represented by that financing was available during the
latter part of 1953 and 1954 to help hold things up.
I noticed one of the speakers yesterday said that he believed that
the policy took something off the peak, and helped to fill in the valley.
That, of course, is exactly what we were trying to do.
We were watching all during this period very carefully to see
that money was freely available in these markets, and it is rather
interesting that as you look at the charts, you will have difficulty
in finding when this credit restraint policy was because the high
volume of financing went on rather continuously. The presumption
170
UNITED STATES MONETARY POLICY
is that without the policy of credit restraint and subsequent ease more
financing would have been done in early 1953 and less later on.
Now, a few words about the other phase of our financing.
The first and most important phase is to adjust our debt management policy to the business situation and to the policies of the central bank in such a way as to encourage, and not discourage, a high
level of employment and honest money.
The other problem, the longer-term problem, is to distribute this
debt more widely among the people, and to lengthen the maturities,
partly so we will not run into embarrassing jams in having so much
financing to do in any one year, and partly also to see to it that the
amount neld by the banks is gradually reduced because that has a
long-term inflationary tendency.
We do not want to reduce it any faster than the economic situation
callp for, but some bank reduction is good over a period.
Now, chart 8 is an attempt to show the structure of the debt todtiy.
The left-hand column is the total debt, and then a group of blocks
are shown to represent the marketable debt of $158 billion. About
$63 billion of that now matures within 1 year, and of that close to $20
billion is in the form of Treasury bills. About $39 billion matures in
1 to 5 years, and $56 billion in over 5 years. All callable bonds are
considered to their first call date.
Chart 8
STRUCTURE OF THE DEBT DECEMBER 1954
Total
Marketable: $158 Billion
Nonmarketabte:$l2l Billion
$Bil.
SpecialIssues^
to TrustFunds -mm
Tim*toMaturity*
200
OverS X
Years ^^
100
\ Convertible
Bonds>etc.
LttoS
d Years
mV\
•fid rf * • feo*-Y * f
56:
Mkr^Bonds
Within
/Year
Wi**y
The other section of the debt is the nonmarketable debt and that
amounts to $121 billion. Of that, $20 billion is convertible bonds,
savings notes, and miscellaneous issues. About $12 billion of that is
the 2% percent bonds which were used in refunding a great big indigestible lump of 2y2 percent marketable bonds in the spring of 1951
UNITED STATES MONETARY POLICY
171
Savings bonds total $58.5 billion. We think that is a good way to
get the debt better distributed.
Then there are the special issues to the Government trust funds.
Of the amount held by the Government trust funds, part is in special
issues, which we issue directly from the Treasury, and part is in
marketable bonds; the figures on the chart are the specials.
Now, I want to show you what we have been trying to do on the shortdated debt. Chart 9 is an illustration.
Chart 9
MARKETABLE DEBT DUE WITHIN ONE YEAR
(Callable Bonds to Earliest Call Date)
^Effect of the passage of time
When we came in, the marketable debt due within 1 year was about
$74 billion. Before we got through the calendar year of 1953, it had
risen to $76 billion. We had not been able to do as much about it as
we would have liked to because we faced, as you know, a deficit of
$9.4 billion in 1953, and the credit situation was such that it was not
desirable during the summer and early fall of 1953 to put any
financing out other than short terms, so we wound up with $76 billion.
Now, over the past year we have gradually reduced that $76 billion
due within a year to $63 billion; $3% billion of debt was paid off;
$24% billion was refunded into issues longer than 1 year; most of
that went.to the banks, but it stretched out their maturity to put their
holdings in more manageable form. Then, as an illustration that you
have to run pretty fast in this business to stand still, $15 billion of
debt issued in earlier years came within the 1-year total. I t had been
linger, and time had gone on, and it came within the 1-year period.
That brings us out with $63 billion maturing within a year, which is
a more manageable figure than at the end of 1953.
'172
UNITED STATES MONETARY POLICY
Now, another way of illustrating the change in the debt as to maturities is by figuring out the average length of the marketable debt.
As I say, there has been a period during the last 2 years when we
had to temporize with this problem—when we could not go out and
try to spread the maturities very vigorously.
We have been criticized for not putting out long bonds this year.
I think we were absolutely right in not doing so, because it would have
been clearly in competition with the enormous loan funds in the mortgage market and the new issue market. We have had to work within
rather narrow limits, and those are the limits set largely by the maturities the banks are interested in. But we have tried to stretch out
our maturities.
Chart 10
AVERAGE LENGTH OF THE MARKETABLE DEBT
(Callable Bonds to Earliest Call Date)
YEARS
4.9
Calendar 1 9 5 3 - 5 4
Calendar 1951-52
4.3
.3.8
3.7J
if oilnewissues
fadbm
j-fsercerts.
' »' *' t '* * * > ' ' '
1951
>
!
•
»
*
1952
'
•
•
'
1953
•
•
*
•'• )
I
'
* - '
•
»'
1954
*Adjustedto exclude 2%s exchanged fornonmarketable 2%s.
Chart 10 shows the average length of the marketable debt, which
was 4.0 years at the beginning of 1951. Then it went steadily down
as the Treasury financed itself largely with short-term issues, so that
at the beginning of 1953 it was 3.8 years. That is the average length
of the entire marketable debt.
Now, as I have indicated before, in 1953 we did reasonably well just
to hold even. We came out at the end of the year with about the same
figures as at the beginning. This year we have been able to stretch
out the debt somewhat in ref undings, particularly in February and in
our current December financing, so Ave will finish up the year with
an average length of debt of about 4.3 years.
I f we had refunded all the securities that matured during 1953 and
1954 in 1-year certificates, the average length of the whole marketable
debt would have been only 2.8 years.
UNITED STATES MONETARY POLICY
173
Now, chart 11 is a final chart. That does not draw any conclusions,
but it keeps our sights upon the horizon, and relates to where we now
are in the economic picture and to where we were in the past.
I present this familiar chart of wholesale market prices running
back to 1810, over 144 years, just to have that in mind.
Chart II
WHOLESALE PRICES
%
1947-49=100
100
80
60
40
20
0
IE110
18!50
I9(DO
1950
ttotfttoStnUryrf t * >*•*•?
In a way, it is not too good an index, as Senator Douglas knows.
But it does give a pretty good indication of the trend of prices,
although we have to rely on relatively thin data as you go further
back. I t shows that each war, the War of 1812, the Civil War, the
First World War, the Second World War, and the Korean war, and
the cold war have tended to produce a rise in wholesale prices.
Another interesting feature of it is that the general trend line,
except for those war bulges, was moderately level over the first 125
years or so of that period. After each war we did tend to come back
to the old price level, right or wrong, so that when people say, "Well,
in my mother's day prices were just so much cheaper than they are
now," that is really only true in the last 15 years or so.
Certain prices did go down, and certain others went up. The price
of manufactured goods came down over the long span. The prices
of many other articles tended to go up.
But here we are with a new kind of thing. We have got one war
piled on another, and it leaves us in what is in the history of the past,
an inflated position. But we are trying something new this time.
We are trying to hold the general level of prices stable rather than
trying to go back to any previous level.
Our firm belief is that we should benefit best from a stable-price
level rather than trying to go backward and forward. I think it does
55314—54-
-12
174
UNITED STATES MONETARY POLICY
indicate that the inflationary forces are always there, waiting around
the corner to leap on us. The fact is that the present high-price level
does represent a tragedy for many people who have accumulated
savings; but any attempt to readjust it would bring more of a tragedy
than you would correct by doing it.
We are trying to do something new; we are trying to use all our
forces to give us stability instead of the pattern you see on that chart
I think, Mr. Chairman, that concludes it.
Senator FLANDERS. Thank you, Mr. Burgess.
I would like to pick up a question which arises from your last few
words. Are we to conclude from what you have just said that your
main interest in these matters is in price stability? There are other
criteria, but price stability seems to be the one that you have emphasized.
Mr. BUKGESS. Well, I think if I emphasized that exclusively, it
would be a mistake, because what we want is economic stability and
growth, Mr. Chairman; the buying power of the dollar is a most important element in that, but it is certainly less important than having
a good, sound, solid economic growth.
We believe that a stable dollar is one of the very important desiderata of growth as well, but, as in the old Federal Reserve days,
there is not any single measure that you can follow and recognize
exclusively as the guide. As the Congress, indeed, demonstrated
when it was considering the Employment Act, they found they had
to use a pretty broad brush to paint the objectives that they wanted.
Senator FLANDERS. NOW, getting it into human terms, we think
of high production and consumption. Do you feel that a stable price
level leads to those ends?
Mr.
BURGESS. Yes,
sir.
Senator FLANDERS. One thought came to my mind in connection
with your chart No. 4, which showed the rapid increase of industrial
production up until the middle of 1953, the rise in business inventories slightly beyond that, and then a gradual decrease.
Would not a drop, not in wholesale prices necessarily, but a drop
in the general price level have moved the inventories? I t seems as
though that used to be considered the old free-market operation, but
this time there was not any particular decrease in prices to the consumer, so the inventories dropped off slowly. As they were worked
off, production went down.
Mr. BURGESS. That is one of the very extraordinary features of this
business movement.
As you indicate, in previous ones, there has tended to be an adjustment in prices which has helped to move the goods. I think that,
perhaps, there has been a little more price adjustment than shows in
the indices, the sale of cars at discount or white goods, and so on. One
can debate that question that you raise at great length. The difficulty
is that if you do have a sharp drop in prices it tends to accentuate
the whole movement, and may lead you into a spiral downturn.
I think also that the fact that there was no great drop in prices
was an indication of confidence in the future that business had, so
they thought they would wait it out, and so far it looks as though
they may have been right in so doing.
UNITED STATES MONETARY POLICY
175
Senator FLANDERS. Then in business practice and in certain governmental operations we must qualify some of our ideas about the
automatic effects of free market supply and demand on production,
and employment. We think of that as sort of a norm which we look at
occasionally; is that about the size of.it?
Secretary HUMPHREY. Well, I think, Mr. Chairman, in connection
with this, just from a practical viewpoint, that we had large consumer buying during all this period, and I think that with that large
consumer buying, that was the thing that tended to help stabilize the
situation, and the goods kept moving, and there was not the pressure,
the price pressure, that you otherwise would have.
Further than that, you have not had the great rise in prices immediately preceding it, either, that usually occurs just before this sort
of thing.
Senator FLANDERS. Yes.
Secretary HUMPHREY. SO that with the combination of rather stable prices on the way up, and with a continuing distribution going
on, you did not have the wide price swings that you might otherwise
have had during the last 2 or 3 years. I would not say that that phase
of our economy was gone for all future time.
Senator FLANDERS. Well, that is a good subject for contemplation;
I will not press it further.
Now, there is one element in our debt structure which ought to be
perfectly simple to me, but somehow or other I get tangled up every
time I look at it. That is the special issues to trust funds; who owes
what to whom. These funds flow in from the States and from the
beneficiaries into the Treasury; with this money the Treasury buys
for its own account some special issues which are put into trust funds
as reserves against future payments.
How do these issues get into circulation as Government funds?
Are they paid out?
Secretary HUMPHREY. I can illustrate this in a kind of common
garden way.
Senator FLANDERS. That is the only way I shall understand it.
Secretary HUMPHREY. And by a little story that I have told before.
I had a businessman one day speak to me about these funds, and he
said, "Isn't that just crooked? Aren't you just deceiving people by
that?"
And I said, "Well, I really don't think so." I said, "You have"—
this was a businessman running a large business—I said, "You have a
substantial pension fund for your company, don't you?" And he
said, "Yes," that they had a big pension fund; that every year they
contributed to that pension fund so as to not have a big burden all come
at one time, and that they, perhaps, were not actuarilly sound, but they
reached toward actuarial soundness in their fund, and they kept putting annual deposits each year in this fund so the fund would be
available for use when the occasion required it.
I said, "Now, what have you done with that fund? How have you
got it invested?"
He said, "Why, we have our fund invested in Government bonds.
-»hat is what we put our fund's investment in."
176
UNITED STATES MONETARY POLICY
I said, "That is exactly what we do. The United States has its
funds invested in exactly the same way. We charge to income annually an amount to bring these funds into the realm of actuarial
soundness."
You can get into all kinds of arguments about actuarial soundness,
but it is in that realm. Then I said, "We invest our money in Government bonds just as you do."
Senator FLANDERS. And the money received for those bonds is available for expenditures ?
Secretary HUMPHREY. That is right.
Senator FLANDERS. I have another question.
Secretary HUMPHREY. I will just say one more thing, that I think
we should never fail to keep in our minds: That practice—while I do
not know what else you can do with your money, or how else you
would handle it—does hold this fear that we might just as well recognize. This applies particularly to unemployment funds or other
funds that are subject to emergency withdrawal. In the event of an
emergency withdrawal, an emergency need for funds, not only the
private funds will be wanting to sell their bonds in order to turn them
into casli to use the cash currently, but the Government funds—for the
same emergency purpose—would do the same thing. So that we might
run into a period where you would have the private funds and the
Government funds and a number of other people all trying to realize
on funds which they have laid aside in bonds for their protection.
Then you might have an emergency in which you would have an
excess of Government bonds offered on the market which might
present a serious problem for the time being.
Senator FLANDERS. One further question on that line: How much
interest does the Government pay itself, and does it make any difference ?
Secretary HUMPHREY. Well, I think it does make a difference. I
think you have to treat these funds just as you would treat the private
funds.
Senator FLANDERS. Except that you do not have to market them.
Secretary HUMPHREY. You may have to market them sometime.
Senator FLANDERS. I t would then be these very instruments which
you put into the trust funds that you would market in an emergency?
Secretary HUMPHREY. N O . They would be changed into the kind
of thing that would sell to meet the market condition at the time.
Senator FLANDERS. Then the marketability is not a determinant of
the interest which you pay yourself ?
Secretary HUMPHREY. Not necessarily.
Senator FLANDERS. Well, I have always wondered how you determined the interest you should pay yourself and whether, as debtor,
you ever had any arguments witli yourself as creditor on that particular subject.
As I say, I personally do not see that it makes any difference.
Secretary HUMPHREY. Many of the interest rates are fixed by law.
So that part is settled.
Senator FLANDERS. Yes; I see.
I n order to give time for others, I will be as brief as possible m
questioning.
We had some discussion here yesterday to indicate that there was
something in the nature of a near panic in the money market around
UNITED STATES MONETARY POLICY
177
June 1 last year. Would you say that that was a correct description
of what happened ?
Mr. BURGESS. Well, Mr. Chairman, I think that is a little exaggerated. There was no doubt about it; the market was disturbed and
disorderly for some days. The new 3% percent bonds went to a discount of just over 1 percent; it was not very bad. I t restored itself
reasonably well.
The Federal Reserve put money into the market through the purchase of Treasury bills, and that was taken as an indication of a change
in policy. The market cleared itself up over a period of weeks. I t
undoubtedly was a crisis of sorts.
Of course, most changes from a boom to a leveling off in economic
conditions do have some sort of crisis, and in the light of other crises,
this was a relatively mild one.
Senator FLANDERS. D O you feel that it would be helpful if the
Reserve System went back to the policy of offering some support while
securities were being marketed, or are you content to go along with the
plan of their holding off during that period ?
Mr. BURGESS. Well, I want to say, first, that during these nearly
2 years that we have been working with the debt, we have had very
fine cooperation from the Federal Reserve System. We have not been
conscious of any deficiency in their cooperative efforts.
Now, I think in the discussion yesterday, and in other discussions,
there was a tendency—you may wTant to ask Mr. Martin about this—
to overstate the decision of the Eeserve System to stay out of the
market.
I think they have always qualified that by saying that if the market became thoroughly disorderly they would be prepared to go in and
do whatever was necessary to straighten the market out.
Senator DOUGLAS. Mr. Chairman, before you proceed, might I refer
to the previous question asked of Mr. Burgess ?
Senator FLANDERS. Yes.
Senator DOUGLAS. Mr. Burgess, you spoke of the fact that in June
of 1953 the new bonds fell by only 1 percent, but is it not true that
the bonds of older issues had fallen by approximately 10 percent?
Mr. BURGESS. Well, they fell by 10 percent from 1951 to June of
1953.
Senator DOUGLAS. Yes; but I mean was not the sudden decline from
March to June of 1953?
Mr. BURGESS. That was not 10 percent, Mr. Senator. As I remember it, it was about 4 points—from 94 to 90. Those bonds had already
been declining for 2 years. The decline was sharper, admittedly, in
that last period.
Senator DOUGLAS. Excuse me.
Senator FLANDERS. NOW, one other question: Is there such a thing
as a free market for paper representing debt when, in your chart
^To. 2, vou show that at the present time 40 percent of the total public
and private debt is Federal, and back in 1946, 58 percent was Federal ?
t How can a market be free when so much of it is on the terms of a
single issuer?
Mr. BURGESS. Well, Mr. Chairman, of course, it is not entirely free.
We are in and out of the market constantly, and the Federal Reserve,
with almost $25 billion of governments, is a constant factor in the
market. I t is a relative term, but the market is certainly freer than
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UNITED STATES MONETARY POLICY
it was, a great deal freer, and the question is how much leeway there
is for the natural forces of supply and demand for money to operate.
Now, we believe that things will be healthier if the natural forces
of supply and demand have a good deal of leeway to operate, and
that they tend to be self-corrective of difficulties in the market—I say
tend to be.
When we are such large factors, the Federal Reserve and ourselves,
we always have to be alert to the market, and ready at some point to
see that at least we do not upset it, and at times to act as a stabilizing factor, but whatever freedom you can give it we believe is very
useful.
Senator FLANDERS. Mr. Patman?
Representative PATMAN. Mr. Secretary, you mentioned the possibility of an emergency arising through the sale of Government securities by these trust funds to take care of their obligations. Don't you
consider that a pretty good reason to consider support for Government bonds under certain conditions, at least?
Secretary HUMPHREY. Well, I think that I would answer that just
exactly as Mr. Burgess answered the previous question. I think
that there are times when there ought to be some attempt to stabilize
market conditions; but that, by and large, the best thing we can do is
to keep our activities in such shape that we are not influencing the
market either way, but to let the market use its natural correctives
to the greatest possible extent.
Representative PATMAN. Will you put that first chai't back up,
about the public debt; that is $279 billion? You do not list Federal
Reserve notes in that, do you?
Secretary HUMPHREY. NO.
Representative PATMAN. Federal Reserve notes, after all, are obligations of the United States Government, carrying the same obligation as a bond, is that right, Mr. Secretary ?
Mr. BURGESS. They are secured obligations; they have gold and the
assets of the Federal Reserve System behind them.
Representative PATMAN. But they are obligations. They state on
their face, just like a Government bond; they are obligations of the
United States Government.
Now, when the Federal Reserve bank, for instance, buys $1 million
in Government bonds, and it gives $1 million in Government Federal
Reserve notes, that is paying out one form of Government obligation
for another.
You are just listing one of them up there now in the public debt.
Why should not the Federal Reserve notes be listed because there are
$30 billion worth of them outstanding today, and the Government
has got to pay every one of them ?
Secretary HUMPHREY. Well, you understand this does not attempt
to reflect all of the obligations of the Government in any way.
Representative PATMAN. I know, but this is a debt obligation.
Secretary HUMPHREY. There are a whole lot of obligations much
larger than that. If we put in all of the contingent liabilities and all
the other things, you would have a far different picture than this.
Representative PATMAN. We have an enormous debt, the total debt
being $G97 billion, public and private.
Now, 1 percent interest on that would be $6,970 million.
UNITED STATES MONETARY POLICY
179
In view of the fact that the public debt—I mean the national debt—
represents such a large part of that, don't you think the cost of money
should be considered in all the policies that you are adopting, Mr.
Secretary ? Should it be a major factor ?
Secretary HUMPHREY. The cost is an important factor.
Representative PATMAN. I t is an important factor, of course.
Now, Mr. Burgess said a while ago that he placed the level of prices,
the buying power of the dollar, I believe, No. 1 on your list in importance.
Secretary HUMPHREY. I think that is very important.
Representative PATMAN. What would you list second?
Secretary HUMPHREY. For what purpose ? I do not know what
Representative PATMAN. For the purpose of looking after the public interest and economic interest of the Nation.
Secretary HUMPHREY. Well, I think what we are trying to do is
this: We are trying to create stable conditions and conditions that
are favorable for the making of jobs. I think this whole thing gets
back to the people and the making of jobs.
Representative PATMAN. That is the point I am coming to, Mr. Secretary. Don't you think that full employment is more important than
the level of prices ?
Secretary HUMPHREY. I think the making of jobs is probably the
most important thing that this country has to do. We have a growing
population, and I think the basis of our prosperity, of the living of
the people in this country, gets back to the making of jobs.
Representative PATMAN. Well, I am glad to hear you say that because that puts the Employment Act No. 1, does it not ?
Secretary HUMPHREY. Well, I do not know that I would say the
Employment Act, is it?
Representative PATMAN. Well, I mean the policies set forth.
Secretary HUMPHREY. I think I would put it just as I set forth, the
making of jobs.
Representative PATMAN. And the policies set forth
Secretary HUMPHREY. There are certain things that help to make
jobs, and certain things that help to discourage that.
Representative PATMAN. I think that is the Employment Act. ^
Secretary HUMPHREY. And I think we ought to help to make jobs.
Representative PATMAN. Isn't that one of the things in the Employment Act, the making of jobs ?
Secretary HUMPHREY. I will not quarrel with you on words; in
toy point of view it is making jobs.
Representative PATMAN. I think you have dovetailed it in, and I
think it parallels the Employment Act. I am glad to hear you say
that is more important than the level of prices.
I want to ask you about this 314-percent bond issue of last year.
When was that issued, April 1 or April 30 ?
Secretary HUMPHREY. I do not remember the exact day, but it was
in April.
Representative PATMAN. I believe it was dated May 1.
Mr. BURGESS. Yes; for payment on May 1.
Representative PATMAN. I t was announced in the early part of
April.
Secretary HUMPHREY. Some part of April.
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UNITED STATES MONETARY POLICY
Representative PATMAN. I cannot understand, Mr. Secretary, why
you put out that issue at all. You did not have to have the money ?
Secretary HUMPHREY. We needed to borrow about a billion dollars,
and we wanted to do it that way for a number of reasons. One reason that does not show in the charts I would like to just call to your
attention: We had had since early in the Korean war extensive controls in our economy. Those controls covered many prices, wages, and
so forth.
We had great bureaus down here exercising those controls. During
the latter part of the preceding year there had been some discussion
as to whether or not those controls could be taken off.
When we first came into this Government, there was a great division
of opinion as to whether or not the controls could be removed. I t was
thought that it was beneficial by some to get controls off just as rapidly
as possible, and let the economy begin again to function freely.
I t was said by others that if that were done we would have a runaway inflation, prices would go right through the ceiling, and we would
have a lot of difficulties.
That was the atmosphere in which we were operating in the early
part of the spring of 1953. We decided that it would be best for the
economy if those controls were removed, and removed just as rapidly
as possible, to return the economy to a free operating basis.
I n order to attempt to keep prices from running away, with the
removal of those controls, there were several things that could be
taken into account. One of them was the productive power of industry coming u p ; another was prospective demand; another was some
restraint on credit which would help dissuade speculative buying for
inventory purposes, and all those things were taken into account, and
this issue was part of the program that was used in taking off those
controls. We did take off the controls, and all of the calamity howls
that we might set off an impossible price rise proved to be false, and
our prices did not rise. We went along without the controls, and I
am sure the country was much better off because we did so.
Representative PATMAN. I have great respect for your judgment,
Mr. Secretary, but I don't think that was related to issuing $1 billion
in 3*4 percent bonds.
Secretary HUMPHREY. That was part of the program.
Representative PATMAN. NO. 1, it was not necessary to issue them.
You had the money.
No. 2, the rate was excessive, as is evidenced by the fact that a purchaser of the 3 % percent bond at the low point, selling them at the
high point within 1 year, would have made more than 15 percent.
Secretary HUMPHREY. Everybody had the same chance. The
bonds have always been freely traded in the market.
Representative PATMAN. A windfall.
Secretary HUMPHREY. Everybody had a chance. They were available in the market at par or below all during May and June.
Representative PATMAX. Somebody got an awful windfall in that.
That is about the biggest windfall I know of in the history of Government bonds.
Secretary HUMPHREY. The bonds went belowT par after they were
put out and they didn't get above par again until July.
Representative PATMAN. I know, but some people bid on those
bonds, tlieir subscriptions were cut in half and the commercial banks
UNITED STATES MONETARY POLICY
181
got them. Mr. Burgess said you were trying to take them out of the
commercial banks.
Secretary HUMPHREY. There were plenty in the market for many
weeks. Nobody was denied an opportunity.
Representative PATMAN. And another question, Mr. Humphrey:
Why did you permit the F- and G-bond holders to exchange their
bonds at 3 1 /! percent, and not permit the E-bond holders to do the
same thing ?
Secretary HUMPHREY. I will ask Mr. Burgess to answer that.
Mr. BURGESS. Well, the E-bonds are an entirely different kind of
bond. The E-bond holder was already getting 3 percent for a bond
that is completely protected from all fluctuation? in the market.
Representative PATMAN. I know, but this is 3*4. You let the F
and G's, getting 2.9 percent, the same that the E's were getting, exchange theirs that were maturing for the 3 % percent, although you
didn't permit the little fellow, the E-bond holder, to do.
Mr. BURGESS. We did permit him, Mr. Congressman. Any E-bond
holder that wanted to cash in his bonds and buy the others had the
full privilege of doing it. They were available in the market.
Representative PATMAN. If he could get them through a bank or a
broker who would be paid a commission.
Secretary HUMPHREY. Of course, he could get them. But the
E-bond buyer is a completely different kind of buyer. He is a small
buyer who doesn't want to take the risk of the market. He, typically,
hasn't any reason to buy 3)/±s or 2%'s, or any other marketables.
Now, for example, suppose you sold 2%'s to the E-bond buyer, he
would have suffered, as you indicated awhile ago, 10 percent
Representative PATMAN. I am not talking about 2y2 percent. I
am talking about 3 % percent.
You gave the F and G holders, who are in a higher income class than
the E bondholders, an opportunity to exchange their maturing bonds
that were drawing 2.9 percent interest for the 3 ^ percent without
going through any market or anything else, just exchange them, but
you did not permit the little fellow with the E bonds, to do the same
thing, and that is the point I can't understand.
Secretary HUMPHREY. Well, I just want to insist that the E-bond
man could get his money at any time from the banks and invest it in
that market if he wanted to.
Representative PATMAN. Why didn't you give him the same privilege you gave the F and G holders ?
Secretary HUMPHREY. He had it automatically.
Representative PATMAN. Well, he didn't.
Secretary HUMPHREY. He could cash his bonds and take the money
and put it in the other bonds.
Representative PATMAN. E's are held by the little fellows.
Secretary HUMPHREY. Sure.
Representative PATMAN. The F and G's by the big* fellows. You
specifically stated in your notice that the F and G bondholders could
make an exchange directly with the Treasury. They didn't have to
go through a broker or a bank. They just made a direct exchange of
their 2.9 percent bonds for the 3*4 percent bonds.
You made it very easy for them which was fine, but why didn't you
let the E bondholder do the same thing? He had the same type bond.
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UNITED STATES MONETARY POLICY
2.9 percent. Why didn't you let him exchange them for the 3%
percent bonds ?
Secretary HUMPHREY. He could automatically have done exactly
the same thing by redeeming his E bonds.
; As a matter of fact, we have given holders of maturing E bonds an
even better proposition. They can automatically extend their bonds
and get 3 percent interest on an obligation that can be turned into
cash on demand without any market risk. The fact that the great
majority of holders of matured E bonds did not turn them in to buy
the 314 percent marketable bond is fairly good proof that they preferred to keep the E bonds.
Representative PATMAN. I know you went to a lot of trouble to do
it. You made it easy for one and hard for the other. That is what I
can't understand.
Secretary HUMPHREY. No; there wasn't any trouble for anybody.
Representative PATMAN. And brokers' commissions, possibly, and
expenses of different kinds.
Secretary HUMPHREY. N O . There are no brokers' commissions or
anything like that. All those bonds are redeemed without charge.
Representative PATMAN. The reason I say you shouldn't have put
this issue out, Mr. Humphrey, is because you had nearly $6 billion in
the banks that could have been used and should have been used. There
was never a time during that year that you didn't have 2 or 3 times the
amount of that issue in the banks, subject to your use, if you wanted
to use it, and that is the reason I can't understand it.
Secretary HUMPHREY. TWO or three times the amount of issue
hasn't got a thing to do with it. What we need to have is cash funds
to operate on, and I don't think you can find a business in the country
that operates any closer than we do on cash on hand.
Representative PATMAN. I know, but Congress
Secretary HUMPHREY. We have been operating with less than 30
days' cash must of the time we have been here.
Representative PATMAN. YOU are overlooking something.
Secretary HUMPHREY. Wait a minute.
We've been keeping less cash than was on hand relative to expenditures at any time for a long time prior to that. We have operated
this Government with relatively less money than has been used for
years.
Representative PATMAN. YOU are overlooking something. Congress has very wisely provided for a $5 billion overdraft between you
and the Federal Reserve banks.
In other words, if you exhaust these funds, you can get $5 billion
directly from the Federal Reserve banks at any time. You have a
$10 billion leaway there.
Wily should you want over 5 billion? And if you don't want over
five, why don't you use this money that is in the banks?
Secretary HUMPHREY. Do you want an answer to that?
Representative PATMAN. I do.
Secretary HUMPHREY. The day you are talking about we had in the
tax and loan accounts in commercial banks four billion, nine eightythree
Representative PATMAN. What day was that?
Secretary HUMPHREY. That was the last day of March. The end
of April, we had $1,589 million in these accounts.
UNITED STATES MONETARY POLICY
183
Representative PATMAN. Well, that is three times as much.
Secretary HUMPHREY. The end of May, we had $2,109 million and
so the end of June we had $3,071 million.
Representative PATMAN. I have here on March 31, you had $6,108
million; on April 28, you had $3,627 million.
Secretary HUMPHREY. I think your trouble is you are counting in
there a billion dollars of gold that wras on hand, and about $500 million
in Federal Reserve accounts.
Representative PATMAN. I think that's right. You had $500 million in the till.
Secretary HUMPHREY. I am talking about usable cash in our working accounts in the commercial banks.
The figures I just gave you are the correct figures.
Representative PATMAN. I reiterate according to your own figures,
not counting this $1 billion of which you have used about half since
you had about $1 billion gold and $500 million usable cash.
Not counting that you still had 2 and 3 times as much money all
during that period as the amount of this bond issue, and what I can't
understand is why you would issue a bond and at three and a
quarter
•
Secretary HUMPHREY. I t was an amount of
Representative PATMAN. Wait just a minute. Let me finish.
Why you would issue bonds and of the highest rate clear out of reach,
as evidenced by the fact that they had gone so high since that time,
when you didn't need the money. You could have gotten every bit of
that money from the banks and had twice as much left there.
In addition to that, if-you needed more money, you could have
gotten $5 billion from the Federal Reserve banks as you are permitted to do by congressional law.
Secretary HUMPHREY. Well, now you are saying two things at
once. You are saying first we didn't need the money and, second, you
are saying we could have gotten the money elsewhere.
Repersentative PATMAN. NO. N O . 1,1 will close right there. You
didn't need it.
Secretary HUMPHREY. Whether we got it one place or another is
not what you are now talking about. You are now saying we didn't
need the money.
Representative PATMAN. That's right.
Secretary HUMPHREY. I am saying we did need the money, as shown
by our balances where, at the end of April, we had $1.8 billion in
the tax and loan accounts. Do you know how long that lasts? We
were spending $6 billion a month at that time.
Representative PATMAN. That doesn't make any difference, Mr.
Secretary. Why keep on saying that?
Secretary HUMPHREY. AVe had on hand about 10 days of cash.
You pretty nearly have to write checks
Representative PATMAN. That is not alarming at all, when Congress
has very wisely provided that you can get $5 billion instantly from
the Federal Reserve banks. I t is in the law. You asked for the
law to be renewed here a while back.
Secretary HUMPHREY. YOU have got to have it right now if you
are going to write checks against it.
Representative PATMAN. YOU can get it right now, draw it on the
Federal Reserve. That is the only bank you draw on, anyway.
184
UNITED STATES MONETARY POLICY
Secretary HUMPHREY. "Wait a minute. Now you have switched
again. Now you are talking about where you get the money, not
whether we need it or not. Let's talk about one thing at a time.
Representative PATMAN. That came up.
Secretary HUMPHREY. A S to whether we needed it ?
Representative PATMAN. That came up, assuming you did need it.
I don't say you needed it, you didn't need it.
I n other words, you put out an issue to give somebody—you didn't
do it deliberately, I am not charging you with that. There is nothing
personal in this, Mr. Secretary—you gave these fellows a big windfall.
I t gave these people a big windfall equal to about 15 percent in one
year on the finest and best securities on earth.
I t has never happened before, I don't think in any country on earth,
and when you didn't need the money and you had twice that much in
the banks that you could use, as to why you would do it, I still can't
understand, to save my life.
Secretary HUMPHREY. I think if you will look at the figures, you
will understand it much better.
Representative PATMAN. Furthermore, why should you keep those
deposits in these banks at all, anyway ? You don't have to.
Secretary HUMPHREY. There is another subject, and we will be very
glad to talk about that.
Representative PATMAN. All right, now, I have your very fine comprehensive report on that, for which I now want to express my thanks.
The report is very full and very complete. I ask that it be inserted
in the record at this point.
(The report referred to is as follows:)
T H E SECRETARY OF T H E TREASURY,
Washington,
Hon.
October 29,195fh
WRIGHT PATMAN,
House of Representatives,
Washington 25, D. 0.
DEAR MR. PATMAN : In response to your letter of September 3, which I acknowledged on September 13, I am enclosing herewith a memorandum giving you the
history of the depositary practice of the Treasury Department, legislative authority therefor, and other information concerning the maintenance of deposit
accounts by the Government in commercial banks.
I t r u s t that this memorandum will furnish the information you desire.
Very truly yours,
G. M. H U M P H R E Y ,
Secretary
of the
Treasury.
W H Y T H E FEDERAL GOVERNMENT K E E P S F U N D S I N COMMERCIAL B A N K S
This memorandum has been prepared in response to Congressman Patman's
letter to the Secretary of the Treasury, dated September 3, 1954, regarding the
practice of the Federal Government in keeping funds in the commercial bank&
of the Nation. T h e memorandum presents the following information requested
by Congressman P a t m a n :
1. History of depositary practice of the T r e a s u r y Department.
2. Legislative authority.
3. Complete and definitive statement explaining the operations of, and
reasons for, this practice.
4. Specific terms on which banks accept these deposits.
5. Precisely how decisions a r e arrived a t as to leaving funds on deposit
and to transferring them.
6. Why these funds are not transferred to the Federal Reserve banks,
immediately upon receipt.
7. W h a t t h e high, low and t h e average balance carried in commercial
depositaries h a s been during the fiscal year ending J u n e 30,1954.
8. Same information for each of the 12 F e d e r a l Reserve districts.
UNITED STATES MONETARY POLICY
185
1. History of depositary practice of tlw Treasury Department
Except for brief intervals the United States Government has throughout its
history followed a practice of depositing its public funds in the banks of the
Nation. Among the first acts of Alexander Hamilton as Secretary of the Treasury was the designation of the Bank of North America and the banks of New
York, Massachusetts, and Maryland as depositaries of Government funds.
The First Bank of the United States, chartered in 1791, served as a Government depositary and fiscal agent. When the bank was not rechartered, the
Government funds were transferred to State banks. The act authorizing the
chartering of the Second Bank of the United States in 1816 specifically authorized the Secretary of the Treasury to deposit Government funds "in places in
which the said bank and branches thereof may be established." When the Second
Bank ceased functioning as a national institution in 1830, the Government again
relied upon State banks to act as depositaries.
In 184G a system was set up to separate, as completely as possible, the Government's financing operations from the money market. Congress passed a law
establishing the Independent Treasury System, and the Government became
its own banker. This act created four subtreasuries, located in New York,
Boston, Charleston and St. Louis. Their duties were to receive deposits of
public moneys, to make disbursements, and to transfer money from one point
to another, functions theretofore performed by commercial banks.
The financial history of the ensuing years proved the inadequacy of the
Independent Treasury System to meet the needs of a growing country. This
System received a serious setback at the beginning of the Civil War when the
attempt to collect in specie the money which the Treasury needed to finance
the war forced the suspension of specie payments. The result was the establishment in 1863 of the National Banking System, which provided for the designation of these banks as depositaries of public funds.
One of the disadvantages of the Independent Treasury System, not fully
met by the National Banking System, was its inability to supply business with
sufficient note circulation when£ needed and to avoid over expansion when speculation reached the danger point. It was not capable of keeping pace with the
growth of business in the United States and had become obsolete by the time
the Federal Reserve System was established in 1914.
The Federal Reserve Act contained authority for the Federal Reserve banks
to act as fiscal agents for the United States Government and to hold deposits
of Federal funds. In order to give the Federal Reserve banks time to become
organized, the Treasury did not appoint them as fiscal agents until January 1,
1916. The Independent Treasury System was abolished by act of Congress,
approved in May of 1920, when the remaining duties of the subtreasuries were
taken over by the Federal Reserve banks. However, it was necessary for the
Treasury to continue to utilize commercial hanks as depositaries in those principal cities which did not include Federal Reserve banks or branches.
In the Second Liberty Bond Act of 1917, the Congress provided for the establishment of Treasury war loan accounts to take care of the financing of the
Liberty loans. These accounts were originally established to enable the banks
to retain, until withdrawn by the Treasury, the proceeds arising from sale
of Liberty bonds to such hanks or their customers. Later authority for use of
these accounts was extended to the sale of other Government securities, including United States savings bonds and Treasury savings notes. Under the Current Tax Payment Act of 1943, and later legislation, withheld income taxes,
certain quarterly income and profit-tax payments, social-security taxes and
excise taxes are deposited in these accounts which have become known as tax
and loan accounts.
2. Legislative authority
. The legislative authority for deposit of Government funds in commercial banks
is provided under several basic acts of Congress. Citations of these acts and the
pertinent provisions are as follows:
(1) Revised Statutes, section 5153, derived from the act of June 3, 1864
(13 Stat. 113. as amended), relating to the designation of national bank associations as depositaries of public moneys:
'All national banking associations designated for that purpose by the Secretary of the Treasury, shall be depositaries of public money, under such regulations as may be prescribed by the Secretary; and they may also be employed
as financial agents of the Government; and they shall perform such reasonable duties, as depositaries of public money and financial agents of the Govern-
186
UNITED STATES MONETARY POLICY
ment, a s may be required of them. The Secretary of the T r e a s u r y shall require
the associations t h u s designated to give satisfactory security, by t h e deposit
of United States bonds and otherwise, of the safekeeping and prompt payment
of the public money deposited with them, and for the faithful performance of
their duties as financial agents of the Government: * * * " (12 U. S. C. 90).
(2) The Federal Reserve Act of December 23, 1913 (38 Stat. 259) a s amended
on May 7, 1928 (45 Stat. 492), relating to the designation of member banks as
depositaries:
.
"All banks or t r u s t companies incorporated by special l a w or organized under
the general laws of any State, which a r e members of the Federal Keserve System,
when designated for t h a t purpose by the Secretary of t h e Treasury, shall be
depositaries of public money, under such regulations as may be prescribed by
the Secretary * * •» (12 U. S. C. 332).
(3) The act of September 24, 1917, with regard to authority to deposit the
proceeds of sales of bonds, certificates of indebtedness, a n d w a r savings certificates (40 Stat. 291, as amended) :
"The Secretary of the Treasury, in his discretion, is authorized to deposit,
in such incorporated banks and t r u s t companies as he may designate, the proceeds, or any p a r t thereof, arising from the sale of the bonds and certificates
of indebtedness, Treasury bills, and war-savings certificates * * * and arising
from the payment of internal-revenue taxes, * * *" (31 U. S. C. 771).
(4) Act of J u n e 19, 1922 (42 Stat. 662), relating to depositaries in foreign
countries, territories, and insular possessions:
"The Secretary of the Treasury may designate such depositaries of public
moneys in foreign countries and in the territories and insular possessions of
the United States as may be necessary for the transaction of the Government's
business, under such terms and conditions as to security and otherwise, as he
may from time to time prescribe: Provided, T h a t in designating such depositaries
American financial institutions shall be given preference wherever, in the judgment of the Secretary of the Treasury, such institution is safe and able to render
the service required" (31 U. S. C. 473).
(;">) Act of J u n e 11, 1942 (56 Stat. 356), relating to insured b a n k s :
"AH insured banks designated for t h a t purpose by the Secretary of the Treasury
shall be depositaries of public moneys of the United States * * * and the Secret a r y is hereby authorized to deposit public money in such depositaries, under
such regulations as may be prescribed by the Secretary; and they may also be
employed as financial agents of the Government; and they shall perform all
such reasonable duties, as depositaries of public money and financial agents
of the Government a s may be required of them. T h e Secretary of t h e Treasury
shall require of the insured banks thus designated satisfactory security by the
deposit of United States bonds or otherwise, for t h e safekeeping and prompt
payment of public money deposited with them and for the faithful performance
of their duties a s financial agents of the Government * * *" (12 U. S. 0. 265).
(0) The Current Tax Payment Act of 1943 (57 Stat. 126) with respect to the
designation of depositaries for withheld t a x e s :
" T h e Secretary may authorize incorporated banks or t r u s t companies which
a r e depositaries or financial agents of the United States to receive any taxes
under this chapter in such manner, a t such times, and under such conditions
as he may prescribe; and he shall prescribe t h e manner, times, and conditions
under which the receipt of such t a x e s by such depositaries and financial agents
is to be treated a s payment of such taxes to the collectors" (26 U. S. C. 1631).
(7) Section 6302 (c) of the Internal Revenue Code of 1954 (derived from the
act of August 27,1949, 63 Stat. 66S), with respect to depositaries for collections:
Use of Government Depositaries.—The Secretary or his delegate may authorize I< ederal Reserve banks, and incorporated b a n k s or t r u s t companies which
a r e depositaries or financial agents of the United States, to receive any tax
imposed under the internal revenue laws, in such manner, a t such times, and
under such conditions as he may prescribe * * *."
S. Complete and definitive statement explaining the operations of, and reasons
for, this practice
The Congres h a s vested in the Secretary of the T r e a s u r y authority to utilize
the services of the Federal Reserve banks and the commercial banks of the
country as depositaries and fiscal agents of the Government. Not only h a s the
Congress granted authority to the Secretary to utilize t h e services of banks
out it has also established, by law, the basic procedures for handling t h e receipts
and expenditures of the Government.
UNITED STATES MONETARY POLICT
187
The 12 Federal Reserve banks a r e now the principal fiscal agents of the United
States Government. Each Reserve bank maintains an account in the name of
the Treasurer of the United States. Into these accounts virtually all Government receipts eventually are credited, and from them nearly all payments are
made.
Implementing the Treasurer's accounts a t the Federal Reserve banks is a
nationwide network of deposit accounts in commercial banks. Most of the money
collected by the Government feeds into the United States Treasurer's accounts
at the Reserve banks through the banking system of the country. Any incorporated bank is eligible to qualify a s a Government depositary. All Government deposits in banks must be secured by a pledge of collateral security, this
collateral usually being in the form of United States Government securities.
(a) Operation of Special Depositaries {Taw and Loan Accounts).—The
system
of "special depositaries" originated during World W a r I. T h e first Liberty Loan
Act of 1917 provided t h a t banks purchasing securities issued under terms of
the act, for their own accounts or for the accounts of their customers, could
deposit the proceeds from such purchases into special accounts known as w a r
loan accounts. Until 1935, deposits in these accounts were not subject to reserve
requirements. Originally the banks were required to pay 2 percent interest on
such deposits. However, this was considerably below prevailing interest rates
at that time. I n the early 1930's, this interest r a t e was lowered and then eliminated entirely along with interest payments on other demand deposits in keeping with the provisions of the Banking Act of 1933.
During the 1930's, receipts from the sale of Government securities were relatively small and comparatively little use was made of the w a r loan accounts.
The heavy borrowing requirements of the Federal Government accompanying
World W a r I I provided a need for the Treasury to utilize more fully the war
loan accounts. The act of April 13,1943 (57 Stat. CO), suspended, for the duration
of hostilities plus 6 months, against balances in these accounts, all reserve requirements and Federal deposit insurance assessments. The reserve and insurance requirements were reimposed after J u n e 30,1947.
Following World W a r II, the Congress provided for wider use of these accounts by authorizing the Treasury to use them for processing certain tax
receipts. Beginning with March 1948, the banks were permitted to credit to
these accounts their receipts of withheld income taxes, which previously had
been turned over to the Federal Reserve banks monthly or more frequently.
On J a n u a r y 1, 1950, the Treasury revised the system for deposit of withheld
income taxes and extended the provisions for deposit to w a r loan accounts to
include deposits of payroll taxes from the old-age insurance program. The
war-loan accounts were renamed tax and loan accounts on J a n u a r y 1,1950.
Other appropriate taxes have since been made eligible for deposit in these
accounts. Under a special arrangement, large quarterly payments (checks of
$10,000 or more) of income and profits taxes, may be deposited in t a x and loan
accounts when, and to the extent, that the funds are not immediately needed by
the Treasury. This arrangement w a s first provided for quarterly tax payments
of March 1951.
Beginning in July 1951, railroad retirement taxes became eligible for deposit
to these accounts. In July 1953, certain excise-tax payments became eligible.
It must be borne in mind that deposits are not made by the Treasury into
these accounts. Deposits to the tax and loan accounts occur in the normal course
of business under a uniform procedure applicable to all banks whereby customers
of banks deposit t a x payments and funds for purchase of Government securities.
In most cases t h e transaction involves merely the transfer of money from a
customer's account to the Government's account in the same bank. On occasions,
to the extent authorized by the Treasury, banks a r e permitted to deposit in these
accounts proceeds from subscriptions entered for their own account as well a s for
the account of their customers.
The working cash of the Treasury is held mainly in the Federal Reserve banks
and branches. The Treasury draws upon these balances for its daily disbursements. As these balances become depleted they a r e restored in p a r t through
various receipts deposited t o the Treasurer's account a t the Federal Reserve
banks. However, the larger part of receipts to these accounts is derived by
calling in funds from the t a x and loan accounts. Well over half of the Government receipts now flow through tax and loan accounts.
In order to reduce t h e administrative cost to the Treasury by avoiding making
Sequent withdrawals from small accounts, Treasury h a s classified special
depositaries into group A and group B. The present classification places in
group A those banks whose Treasury t a x and loan account balance as of Febru-
188
UNITED STATES MONETARY POLICY
ary 1G, 1954, was less than $150,000. Banks with balances in excess of this
amount on that date are classified in group B. Banks are regrouped at least
once a year. Still another classification in use is what is known as X balances.
These are the balances derived from deposit of large quarterly payments of
income and profits taxes. These balances are usually depleted more rapidly
than those of the A and B accounts. These X balances may be held by banks
of both group A and group B.
Calls for withdrawals from group B depositaries and on X balances are usually
announced on Monday or Thursday and payments scheduled for several working
days subsequent thereto. Withdrawals from group A depositaries are made
less frequently, usually only once a month.
The tax and loan accounts are very active, and the How of deposits and withdrawals is rapid and continuous. As a result of the uneven flow of the Government's receipts and expenditures the balances fluctuate considerably. (See
attachments 1 and 2.) Using end-of-the-month figures, the balances in these
accounts fluctuated during the fiscal year 1954 from $6,090,000,000 on July 31,
1953, to $2,400,000,000 on January 31, 1954. The volatility of these accounts
is indicated by the frequency and size of withdrawals made against uncalled
balances in the group B accounts. (See attachment 3.) Withdrawals from
these larger accounts are usually made twice weekly and frequently reach 25 to
50 percent of the balance in the account as of a particular date. The single
monthly withdrawals on the smaller accounts usually equal or exceed 50 percent
of the balances.
The volume of receipts and disbursements flowing through the tax and loan
accounts has increased almost steadily during the past 7 years as follows:
[In millions of dollars]
Fiscal year
194S
1949
1950
1951
Receipts
$3,575
15,231
16,876
24,128
Withdrawals
$7,765 1952
15,233 1953
15,380 ! 1954
21,716
Fiscal year
Receipts
$36,492
41,267
41,645
Withdrawals
$37,066
43,302
39,880
Out of approximately 14,500 eligible banks in the United States, nearly 11,000
have qualified as tax and load depositaries.
(b) Operation of other depositaries.—While the principal balances are held
in the tax and loan accounts of special depositaries, relatively small amounts
(aggregating about $500 million) are held in other types of depositaries which
are designated by the Treasury to hold balances of Government funds and to
perform certain services for the Government. It is the policy of the Treasury
to utilize the facilities of the Federal Reserve banks and branches to the fullest
extent possible for these services. However, as these facilities are available
at only 3G points in the United States, it has been necessary to supplement them
by designating banking institutions as depositaries at other points when justified
by the volume and character of essential Government business. These depositaries, which extend to all areas of the United States, our Territories and insular
possessions, and foreign countries, are briefly described as follows:
General depositaries: There are approximately 1,420 general depositaries
which hold about $400 million of Government deposits exclusive of balances
they may have in tax and loan accounts. This type of depositary is authorized
to maintain on its books an account in the name of the Treasurer of the United
States. It is maintained only at points where there is a necessity to meet cash
requirements of Government officers for payrolls or other expenditures, or to
receive deposits of cash from depositors of public moneys. General depositaries
are given a stated balance which is fixed in relation to the volume of business
in the Treasurer's account and which may be retained until the need therefor
no longer exists. All moneys received in excess of the authorized amount must
immediately be remitted to the Federal Reserve bank of the district.
Limited depositaries: Limited depositaries are designated at such points as
are required to receive up to specified maximum amounts deposits made by postmasters, officers of United States courts, and other ofiicers in special cases for
credit in their official checking accounts with the depositary. As a general
rule, no Treasurer's balances are maintained in limited depositaries for this
purpose.
UNITED STATES MONETARY POLICY
189
Bank draft depositaries: These depositaries are designated by the Treasury
to issue bank drafts to Government officers in exchange for funds received by
the officer for the account of the United States. These designations are made
when the volume of business does not justify a general depositary. Small
Treasurer's balances are maintained in these depositaries. The balances are
fixed in relation to volume of business handled.
Depositaries for State unemployment compensation accounts (social security)
and veterans' unemployment compensation benefit payment accounts: Depositaries for State unemployment compensation accounts are designated for the
purpose of handling receipts and payments for social security unemployment
compensation under arrangements with the Social Security Board. Likewise,
depositaries for veterans' unemployment compensation are those designated to
handle the receipt of Government funds and the payment of unemployment
compensation to veterans under arrangements with the Veterans' Administration. In both instances payments are made by checks signed by State officials.
Treasurer's balances are maintained in these depositaries.
Banking Facilities: Banking facilities are those offices provided by commercial
banks, primarily at military posts, to render certain necessary banking services
to the post and its personnel. These services include cashing Government
checks, furnishing cash for payrolls, receiving deposits of Government funds, and
similar services. The facilities are located at Army posts, Air Corps installations, naval stations, military and veterans' hospitals, Atomic Energy Commission plants, and other Government establishments where regular banking
services
are not readily available. Treasurer's balances are maintained wTith the banks
designated to operate banking facilities.
Check-Cashing Facilities: Because of the large concentration of Government
employees in the District of Columbia and adjoining area, certain banks have been
designated for cashing of Government payroll checks for noncustomers. Treasurer's balances are maintained with these banks.
Territorial and Insular Depositaries: These may be either general or limited
depositaries located in the Territories or insular possessions of the United
States.
Foreign Depositaries: Banks in foreign countries may be designated as general
depositaries, limited depositaries, or depositaries of foreign currency. Substantial amounts of foreign currency are acquired from foreign governments
without payment of dollars in connection with various economic, technical and
military foreign-aid programs, as well as in settlement for lend-lease, surplus
property, etc. Foreign branches of American banks are given preference wThen
available and able to render the service required.
As a basis of offsetting expenses incurred by the banks in handling Government
business of this nature the Government has long followed a practice of maintaining Treasurer's balances with the depositaries, or, as with limited depositaries,
authorizing Government officers to maintain minimum operating balances in their
official checking accounts.
Briefly, the procedure followed in establishing these depositaries and in determining the balances to be authorized for handling Government business is as
follows:
The request to establish a particular depositary is generally initiated by a
Government officer in the field, who presents to his administrative officer in
Washington the reasons for needing a Government depositary in the particular
area. An estimate is made of the amount of business the depositary would be
called upon to perform. If the Washington headquarters of the agency agrees
with its field officer that a depositary is necessary, the agency requests the
Treasury to designate such depositary. In addition to considering the volume
of business to be transacted and the possibility of utilizing other depositary
t facilities already established, the Treasury will usually estimate, or call upon
the banks under consideration for designation to estimate, the cost of performing
such service. Any possible earnings accruing to the bank as a result of serving
as a Government depositary must be shown as an offset against cost.
If, in view of all factors concerned, it is believed to be in the best interests
°f the Government to establish a depositary, the Treasury will issue the
accessary designation. A Government deposit will be made to the depositary
m
an amount sufficient to offset the expenses incurred by the bank for servien t the Government. The initial allotment of a Treasury balance to a depositary must be based upon an estimate. Each depositary is advised that
the initial allotment will be subject to adjustment upon the basis of the volume and character of the Government business actually handled./ Depositaries
55314—54
13
190
UNITED STATES MONETARY POLICY
submit monthly analyses of business handled and their costs. Due to differences in the size and location of banks, nature and volume of business handled,,
etc., it is not practicable to adopt uniform standards which may be applied
to all banks. However, based upon experience gained in reviewing analyses
submitted by banks throughout the Nation, and even in foreign countries, and
a day-to-day review of cost studies made by banking associations and individual banks, certain guides have been established for use in determining reasonableness of bank costs.
Treasury balances maintained with these depositaries are generally time deposits. They are subject to both reserve requirements and Federal deposit
insurance assessments. Depositaries at present are required to compute the
earning value of the average daily loanable balance in the Treasurer's account
at the rate of 2 percent per annum for analysis purposes. Depositaries may, if
they so desire, purchase 2 percent depositary bonds, in amounts equal to their
authorized Treasury balances. The depositary bonds are held as collateral
security for the Treasury balance. If the depositaries do not purchase depositary bonds, they must pledge other acceptable collateral.
(c) Reasons for this practice.—The Treasury uses commercial banks as depositaries of Government funds for two reasons: (a) The system provides the
most efficient and most economical way of transacting the Government's'business and (&) it reduces to a minimum the effect of Treasury financial operations
on the economic stability of the country. These advantages will be discussed in
turn.
There have already been described those services which are performed for
the Government by the commercial banks and for which the Treasury authorizes
maintenance of Government balances as an offset to bank costs. In addition,
the banks incur expenses in rendering a number of other important services for
which no reimbursement is made.
One of the most important public services the banks render is the sale and
issuance of United States savings bonds, either by direct cash sales or through
the servicing of payroll savings plans. They do this work without charge to
the Treasury, notwithstanding the fact that in many cases it is necessary to
employ full-time employees on the work. The banks distribute announcements
and receive subscriptions for the purchase of marketable securities, and they
handle matured marketable securities for redemption or for exchange into
new issues, all without reimbursement by the Government.
Commercial banks render considerable assistance to the Treasury in the weekly
sale and distribution of Treasury bills. Treasury bills are usually issued with
maturities of 91 days, with an issue maturing each week for 13 consecutive
weeks. The proceeds of these bills are not,deposited in tax and loan accounts.
In bidding for Treasury bills, many subscribers submit their tenders through
commercial banks. The banks check with dealers on possible bid ranges and
enter their customer's bid for the amount requested. This work is done without
compensation to the banks.
In World War I and again in World War II the banks played a major role
in the success of the war-loan drives. Three-quarters of the dollar volume of
war-loan campaign sales were made through commercial banks.
Banks handle without charge to the Government remittances from employers
in connection with the deposit of withheld income and social-security taxes. As
a means of assisting the Treasury in preventing or reducing tax evasion, banks
furnish the Internal Ilevenue Service, without charge, information regarding
large currency transactions. They report to the Internal Revenue Service
interest paid on savings accounts and the payment of dividends where banks
act as financial agents for corporations. They cooperate with the Government's
foreign funds control activity in order to prevent leakage of American assets
into certain foreign hands, requiring the keeping of supplemental records and
the^ filing of many reports with the Treasury.
There are only a comparatively few areas where banks receive fees for services
such as the redemption of savings bonds and the servicing of Commodity Credit
Corporation crop loans. These services entail risks of loss as well as expense
which the Government could hardly expect the banks to assume without reimbursement. For instance, when a bank redeems a United States savings bond,
it is liable for any loss resulting from an error in identification.
Thus the banks perform for the Government, and particularly for the Treasury,
a number of indispensable services. Most of these services are performed free
of charge, either as a public service or in the interest of fostering good customer
relations. Without such services a large increase in the number of Federal
employees would be necessary and a large expense to the Government would be
UNITED STATES MONETARY POLICY
191
entailed. Even though the Government did perform these services itself, and
at a great cost, it could not provide many of these services as expeditiously and
as conveniently for the public as can the banking system. By having the commercial banks perform certain fiscal agency functions of the Federal Government
in conjunction with serving the regular business needs of their customers these
functions can be handled most efficiently and most economically for the Government. This arrangement works to the mutual advantage of the Government, the
public, and the banking system.
The second reason for depositing Government funds in the commercial banks
of the Nation is that this practice provides the most effective method yet devised
for maintaining a smooth flow of funds from the banking system into the Treasury and back again into the channels of trade through Government disbursements.
Nearly all Government disbursements are made from funds held on deposit
in the Federal Reserve banks. This means that virtually all funds, both receipts
and expenditures, sooner or later, flow through the Treasurer's accounts with the
12 Federal Reserve banks. When checks drawn on the commercial banking
system for payment of taxes or purchase of Government securities are deposited
in the Treasurer's accounts at the Federal Reserve banks, there is an equivalent
drain on member bank reserves, since the member banks pay the checks by
drawing the amounts from their reserve balances held in the Federal Reserve
banks. Each payment from the public into a Federal Reserve account involves
a corresponding reduction in bank reserves. Each disbursement by the Treasury
from a Federal Reserve account causes an equal increase in member bank reserves. The impact of these money flows could be held to a minimum if each
day's inflow of funds into the Federal Reserve accounts were approximately
offset by a corresponding amount of disbursements. Obviously it is not possible
for the Government to time its borrowing operations and to make its tax collections in such a manner that daily receipts will equal the Government's daily disbursements. The uneven flow of Government receipts and expenditures and the
need for spacing cash borrowing operations make such perfect balancing impossible. However, the likelihood of abrupt changes resulting in intense stringency in the money market can be lessened immeasurably by Treasury's practice
of initially funneling a considerable part of its receipts from borrowing and
taxation into its deposit accounts at the commercial banks. In this manner,
reserves are not withdrawn from the banking system until such time as they can
be returned by Treasury disbursements. Through the utilization of its tax
and loan accounts the Treasury can largely neutralize the money market impact
of the flow of funds through its accounts and can so regulate the impact of Treasury financing operations on the money market as to avoid disruption to the
market.
If the special depositary system did not exist there would be heavy drains on
bank reserves during periods of heavy taxpayments or of large-scale borrowing
operations. The banks would have to draw down their reserves to transfer funds
to the Treasurer's accounts at the Federal Reserve banks. In order to meet
this drain on their reserves the banks would have to liquidate Government
securities previously purchased, restrict normal extension of credit to their
customers, or obtain credit from the Federal Reserve System. As the balances
built up in the Federal Reserve banks were disbursed by the Government they
would be deposited by the customers of the commercial hanks and bank reserves
Would be built up again. The Federal Reserve System would then have to
absorb the resulting excess reserves. These fluctuations in bank reserves would
have an extremely disrupting effect on the money market and the Nation's
business.
Not only does the system of tax and loan accounts make it possible to leave
funds in the banking system until such time as they are required for Government disbursement, but it also permits such funds to be retained in the conijnunities from which they come. For example, assume that a commercial bank
jn Panhandle, Tex., sells $100,000 of savings bonds to its customers. This money
is left on deposit in Panhandle until such time as it is needed to pay the Government's bills. If this money should be immediately deposited in the Federal
Reserve bank before it can be returned to channels of trade through Government
disbursement, the money in the community of Panhandle would be transferred
to Dallas. Without the tax and loan accounts there would be during periods of
J^avy taxpayments or during borrowing operations tremendous shifting of funds
between banks and communities.
On occasion, the Treasury, in anticipation of heavy tax receipts during heavy
tax months, will, under statutory authority, replenish balances at Federal Re-
192
UNITED STATES MONETARY POLICY
serve banks by borrowing directly from such banks through the issuance of
special certificates of indebtedness, rather than withdrawing funds from Treasury tax and loan accounts. These funds are borrowed for only a few days and
enable the Treasury temporarily to make disbursements in excess of its current
receipts thus providing the banks with additional reserves in advance of a later
unavoidable drain. Such an operation is, of course, consistent with the overall policy of smoothing out the effects on bank reserves of the Government's
financing operations.
The tremendous growth of the Federal Government budget and of the public
debt in recent years has made Treasury operations the largest and most important
single influence on the flow of funds through the money market. Federal fiscal
. operations growing out of an annual budget of more than $G0 billion and a public
debt of more than $275 billion also underscores the importance of the Treasury
maintaining a sufficiently large cash operating balance to be able to meet any
unusually heavy drains upon the Treasury. The Federal Government, like any
private corporation or business, cannot be prudently managed if its cash operating margin is so close that every time unexpected bills come in, it has to rush out
and borrow the money to cover them.
In the case of the Federal Government it seems reasonable to carry an operating
reserve at least equal to a month's expenditures. Not only are there great
fluctuations in the Government's receipts and expenditures within the year, but,
in addition, there is a huge volume of demand debt outstanding—such as sav
ings bonds—which adds to both real and potential demands on the Treasury.
Many of these fluctuations are predictable and cash can be built up ahead of
time. But the timing of many of the demands cannot be anticipated exactly
and the Treasury has to be prepared to meet them. By providing an effective
mechanism for smoothing out the impact of the Government's financial operations
on the banking system and the economy, the Treasury tax and loan accounts
render a service of inestimable value.
4' Specific terms on which banks accept deposits
Specific terms on which banks accept deposits are spelled out in Treasury circulars, the more important of which are Circulars 92 and 176. However, for
the major types of depositaries the most important terms are: (1) The banks
must be designated by the Treasury subject to qualifications set by the Treasury,
(2) the banks must pledge collateral at least equal to deposits, (3) deposits
may not exceed limitations set by the Treasury, (4) deposits are subject to
reserve requirements and Federal deposit insurance assessments, (5) the banks
must perform the services stipulated in the designation and submit such reports
as prescribed by the Treasury. All deposits to tax and loan depositaries are
of a demand nature and can be called by the Treasury at any moment.
5. Precisely how decisions are arrived at as to leaving funds on deposit and to
transferring them
Treasury's calls for withdrawals of funds are based upon its cash requirements.
Balances with the Federal Reserve banks are maintained at a fairly constant
level adequate to cover expected daily cash needs and to provide for a proper
regional distribution of funds. A day-to-day analysis is made of these balances, of anticipated direct deposits to the Federal Reserve accounts, and of
estimated disbursements. Calls for withdrawals are issued on tax and loan
accounts to the extent that additional funds will be required to meet Treasury s
daily cash requirements.
As pointed out earlier the calls generally provide that payments be made
several days subsequent to date of call. The calls provide for withdrawal oi
a specified percentage of the balance within the account. All accounts are treated
uniformly except that withdrawals from banks holding balances in excess of
$150,000 are made more frequently than from banks holding balances in smaller
amounts. The Treasury does not take money from one bank to put into another.
It draws out money as needed for Government expenditures.
6'. Why these funds are not transferred to Federal Reserve banks immediately
upon receipt
There are two principal reasons why funds are not transferred to Federal
Reserve banks immediately upon receipt. The most important one is that sucne
a procedure would have damaging effects on the economy of the country. Th
second reason is that it would result in no financial gain to the Treasury--;
on the contrary, it could easily result in increased overall costs of Government
. financing.
193
UNITED STATES MONETARY POLXCY
As discussed at considerable length earlier in this memorandum, the immediate transfer of Government funds from commercial bank accounts to Federal
Reserve accounts would disrupt the even flow of money and the Nation's system
of bank reserves. Serious dislocations would occur if the Government receipts
should be transferred immediately from local communities to the Federal Reserve banks, perhaps long before the money is returned to channels of trade by
Government disbursements. This action would, in fact, remove the economic
stability advantages now derived from the use of tax and loan accounts.
There would be no financial gain to be derived from such action inasmuch as
it does not cost the Treasury any more to keep the money on deposit in commercial
banks than in the Federal Reserve banks. While no interest is received from the
commercial banks on their Government deposits, neither would interest be
received if the money were immediately deposited in the Federal Reserve banks.
Moreover, all Government deposits in Treasury tax and loan accounts are fully
protected by collateral pledged by the commercial banks.
On the other hand, such action would likely result in substantially increasing,
the Government's general financing costs. The transfer of the funds immediately to Federal Reserve banks might affect commercial banks* decisions to buy,
Government securities and banks might feel that they should be reimbursed for
the numerous services the Treasury now receives free of charge, such as issuance
of savings bonds and assistance in the sale of marketable issues.
7. What the high, loiv, and the average balance carried in commercial depositaries
has been during the fiscal year ending June 80,1954
The high, low, and average balances in the tax and loan accounts by months
for fiscal year 1954 are shown in the following table:
Tax and loan balances fiscal year 1954
[In millions]
July 1953..
August....
September,
October...,
November
December-
High
Low
$7,493
6,448
5,642
5,164
5,177
4,194
$1,649
5,758
3,984
2,812
2,573
2,302
Average
$4,944
6,095
4,957
3,698
4,268
3,223
J a n u a r y 1954.
February
March
April
May
June
High
Low
$3,114
3,659
4,54t>
4,727
4,574
4,836
$2,081
2,507
2,450
2,698
1,902
1,722
Average
$2,536
3,129
3,450
3,541
3,303
3,297
The tremendous fluctuations occurring in these balances is well illustrated for
the month of July 1953, when the balance ranged from a high of $7,493 million
down to $1,649 million.
The above figures do not include balances in general and limited depositaries.
These balances are fairly consistent running usually slightly below $500 million
(see attachment 4). If balances in these depositaries exceed certain stated
maxima the excess is immediately sent to the Federal Reserve banks.
An important yardstick in assessing whether Treasury tax and loan balances
appear to be unduly high or dangerously low is to measure the Government's cash
operating balance (which is made up primarily of tax and loan balances but also
includes our deposits in Federal Reserve banks and gold in the general fund) in
terms of average monthly budget expenditures. As pointed out previously, to be
on the safe side this operating reserve ought to be at least equal to 1 month's
operating expenditures. For the 1954 fiscal year as a whole, for example, budget
expenditures averaged $5.6 billion a month and the end of month cash operating
balances averaged about $5.4 billion—less than a month's expenditures. Furthermore, the fiscal year average hides the fact that there were many times during
the year when the balance was under $ 3 ^ billion, or less than two-thirds of a
month's outgo.
Viewed historically, the Treasury's cash balance margin in relation to budget
expenditures has been much smaller recently than earlier years. Obviously, it
was necessary to carry unusually high balances during World War II, but even
111
the 1930's the average balance was well over double the average monthly
^penditm-es. (See attachment 5 for table and chart showing Federal expenditures and the operating cash balance for fiscal years 1932-54.)
194
UNITED STATES MONETAEY POLICY
8. Same information for each of the 12 Federal Reserve districts
Tax and loan balances fiscal year 1034 by Federal Reserve districts
[In thousands of dollars]
L o w balance
H i g h balance
F e d e r a l Reserve district
Date
Boston
N e w York_.__„
Philadelphia
Cleveland
Richmond
Atlanta
Chicago
St. Louis
Minneapolis
Kansas City
Dallas
S a n Francisco
*
„ J u l y 16,1953
...
do
A u g . 24, 1953.
J u l y 17-19, 1953
J u l y 16, 1953
J u l y 17,1953
J u l y 21-23,1953
J u l y 17-19, 1953
J u l y 16, 1953
J u l y 17-19,1953
J u l y 16,1953
July 18,19,1953,-/.
Amount
Date
Amount
$286,805
2,905,084
322,799
543,362
282,285
310,802
1,231,064
228,094
197,628
232,659
179,397
840,138
J u n e 15,1954
do
J u l y 14,1954
M a y 12,1954
J u l y 14,1953
do
J u n e 15,1954
J u l y 14,1953
J a n . 11,1954
J u l y 14,1953
do
J u l y 10,1953
$91,024
407,287
88,265
135,992
77,253
59,499
344,189
64,721
57,467
68,502
56,593
166,437
Average
balance
$182,961
1,219,953
204,344
325,170
160,855
156,795
744,767
137,914
102,020
152,002
114,557
370,189
L I S T OF A T T A C H M E N T S
1. Treasury tax and loan accounts—deposits and withdrawals and balances by
A, B and X accounts (table).
2. Treasury tax and loan accounts—analysis of deposits, withdrawals and balances (table).
3. Calls on Treasury tax and loan accounts (table).
4. Deposits in banks (table).
5. Federal expenditures and operating cash balance (table and chart).
195
UNITED STATES MONETARY POLICY
ATTACHMENT NO. 1.—Treasury tax and Joan accounts—Deposits, withdrawals
and oalances in A, Bf and X accounts
]In millions]
Balance * (at end of period)
WithD e p o s i t s ' drawals *
G r o u n A Groun B
"X"
b a n k s accounts * T o t a l
banks
Period
"Fiscal year:
1941
1942
1943
1944
...1945.
1946
1947
1948
1949
1950
1951.
1952
_
1953
1951
"Fiscal vear 1954:
1953:
July..
_
August
. September
_
October u
November
. . . -_December _
1954:
January
*
„_„
February
._.„ ....
_
March
_
April
_
May.
June
1
...
$661
1,679
«7,607
* 18,007
a 22 622
$12,447
$575
731
231
272
1,S01
160
1,611
347
2,921
285
2,404
327
1,915
217
1,527
553
1,944
$767
6,902
33,231
54; 018
50,102
27,007
7,430
8,575
15,231
16.876
24,128
36,492
41,267
41,645
$911
5.884
27,243
43,678
45.487
36,609
19.488
7,765
15,233
15.380
21.716
37.066
43,302
39,880
7,336
2,545
3,110
1,969
4.404
2,339
3,718
3,410
3,681
4,331
2,752
3,526
422
324
476
368
461
428
6,268
5,501
4,779
2,521
4,084
2,930
1,349
2,369
4,607
2,494
4,486
4,636
2,301
1,316
3,685
3,601
3,656
3,903
382
391
264
336
652
553
2,024
3.067
2,321
2,936
3,451
1,944
$2,991
2,885
1,328
2,339
$661
1,679
7,667
18,007
22,622
* 13,020
962
1,772
1,774
3,270
5,680
5,106
3,071
4,836
0,690
5,825
5,255
2,893
4,545
3,358
1,794
2,339
2,406
3,458
4,379
3,273
4,103
4,836
Deposits consist of proceeds from sales of securities, deposits on account of withheld taxes, beginning
March 22, 1948, denosits on account of taxes withheld under the Federal Insurance Contributions Act,
"beginning Jan. 1,1950, deposits on account of Railroad Retirement taxes, beginning July 1,1951, and deposits
on1 account of excise taxes, beginning July lf 1953.
Includes calls by Treasury and voluntary prepayments accepted by Treasury.
•' Effective May 11, 1943, Federal Reserve banks were instructed to establish subsidiary controls so as
to classify war loan depositaries in their districts into two groups, group A including all depositaries having
balances of $300,000 or less and croup B those having balances of more than $300,000. Various amendments
"have
since been made to the original disposition, the current dividing line being $150,000.
4
Represents income taxes deposited undpr a special procedure, first adopted in March 1951, for crediting
in tax and loan accounts the proceeds of checks of $10,000 or more. This procedure is usually followed in
quarterly tax payment periods.
• Breakdown
~»„.,. k linto
ai B banks not available.
i l w ^A and
6
Does not agree with daily Treasury statement. Breakdown based on telegraphic reports for last day
of fiscal year which was a Saturday.
196
UNITED
STATES MONETARY
POLICY
ATTACHMENT N O . 2.—Treasury tact? and loan
accounts- -Analysis
withdratvals
and balances
of
depositsr
[In millions]
Credits t o tax a n d loan accounts
Proceeds from sales of
securities
Poriod
Savings Savings Other
notes
bonds
Fiscal year:
(3)
1941
__.
.„
<33)
1942 . . - *
(3)
<33)
()
1943 - ._ ( 33 )
<)
3
1944
()
()
<33)
1945
(3)
(
)
1946
O
<*)
1947
»$4,493 > $2,937
$804
1948
«3,931 *2,024
1949
3,878
4,879
1950
5,834
3,755
1951
3,347
3,390
1952
2,738
4,678
2,227
1953
2,231 10,285
2,667
1954
2,333 11.164
3,457
J u l y 1953
5,874
378
240
August
-_- - -__
363
211
September
911
211
October
681
222
November
.
.
2,150
208
263
J a n u a r y 1954
389
February.
339
March
396
April..
996
349
May...
*
.
.
2,144
300
June
330
Taxes
Total
Income
credits
taxes
not
Others
withheldi
h
h
$6,971
13,270
10, 227
4,791
136
2,134
180
2,341
$1,820
6,473
7,287
10,331
13, 581
15,858
19,899
708
1,971
1,988
1,066
2,046
2,077
961
2,029
2,076
969
2,043
1,966
$767
6,902
33,231
54,018
50,102
27,007
7,430
8,575
15,231
16,876
24,128
36,492
41, 267
41,645
7,336
2,545
3,110
1,970
4,404
2,339
1,349
2,369
4,606
2,494
4,486
4,636
OutW i t h - Balance standing
a
t
end
drawcalls at
of
als
period end of
period
$911
5,884
27,243
43,678
45,487
36,609
19,488
7,765
15,233
15,380
21,716
37,066
43,302
39,880
3,718
3,410
3,681
4,331
2,752
3,526
2,301
1,317
3,685
3,601
3,656
3,903
$661
1,679
7,667
18,007
22,622
13,020
962
1,772
1,774
3,270
5,680
5,106
3,071
4,836
6,690
5,825
5,255
2,893
4,545
3,358
2,406
3,458
4,379
3,273
4,103
4,836
(4)
$2,103
291
796
804
310
1,400
1,475
934
1,233
938
1,825
1,728
888
1,782
1,261
345
1,501
1,101
1,487
1,688
1,233
I
* Represents income taxes deposited under a special procedure, first adopted in March 1951, for crediting
in tax and loan accounts the proceeds of checks of $10,000 or more. This procedure is usually followed
in quarterly tax payment periods.
* Represents withheld income taxes, beginning ' Mar. 22, 1948; taxes withheld under the Federal
Insurance Contributions Act, beginning Jau. 1, 1950; Railroad Retirement taxes, beginning July 1,1951;
and excise taxes, beginning July 1,1953.
3 Breakdown not available.
* Not available.
* Partly estimated.
197
UNITED STATES MONETARY POLICY
ATTACHMENT NO. 3.—Galls on Treasury tax and loan accounts, fiscal year 1954
[In millions]
A accounts i
Date
B accounts *
Calls
Calls
Calls
Uncalled
balance
Percent Amount
1953
July 2
July 6
July 9
July 13
July 16
July 20
July 23
July 27
July 30
Aug. 3
Aug. 6
Aug. 10..
Aug. 13
Aug. 17
Aug. 20
Aug. 24
Aug. 27
Aug. 31
Sept. 3
Sept. 10
Sept. 14.
Sept. 21
Sept. 24
Sept. 28
Oct.l
Oct. 5
Oct. 8
Oct. 13
Oct. 15
Oct. 19
Oct. 2 2 . . . .
Oct. 2 6 . . .
Oct. 29
Nov. 2
Nov. 5 . . .
Nov. 9
Nov. 12_
Nov. 16
Nov. 19
Nov. 23
Nov. 2 5 . . .
Nov. 30 .
Dec. 3_
Dec. 7,
Dec. 10
Dec. 2 2 . . .
Doc. 28
Dec. 30
50
$133
245
230
50
177
177
50
219
219
50
202
202
See footnote a t end of table.
10
22
22
$161
387
413
$1,450
1,211
916
8
4
5
5
10
5
6
9
4
541
278
336
325
613
313
350
501
216
6,214
6,136
5,967
5,698
5,181
5,016
4,981
4,554
4,518
9
6
16
16
7
16
6
6
6
13
18
6
24
13
8
8
8
14
12
6
9
8
10
5
8
9
18
18
19
10
15
10
12
24
496
352
928
897
365
694
254
251
280
648
860
283
993
480
268
251
220
370
298
151
211
197
441
217
364
427
812
760
723
350
398
274
358
702
5,019
5,369
4,355
4,498
3,580
3,258
3,102
3,924
4,135
3,927
3,271
3,241
2,574
2,221
2,106
2,133
2,149
1,925
1,819
1,811
1,886
1,902
3.559
3,433
3,821
3,731
3,093
2,437
2,019
1,923
1,662
2,465
2,348
1,730
20
15
6
5
587
321
133
101
1,288
1,821
1,769
1,786
245
230
Uncalled
balance
Percent A m o u n t
$133
50
1954
Jan. 4
Jan. 2 1 . .
Jan. 25
Jan.28. .
Uncalled
balance
Percent Amount
_ ._
50
X accounts'
(*)
$424
(»)
106
198
UNITED STATES MONETARY POLICY
ATTACHMENT NO. 3.—Calls on Treasury tax and loan accounts, fiscal year 1954—
Continued
[In millions]
A accounts
Date
l
Calls
Calls
Calls
Percent Amount
Percent Amount
50
$206
$206
75
363
121
50
188
188
50
313
313
Uncalled
balance
Uncalled
balance
Uncalled
balance
Percent Amount
1954.
Feb 1
Feb. 4
F e b . 11
F e b . 15
F e b 18
F e b . 23
F e b . 25
Mar. 1
M a r . 4 . ..
M a r . 11
M a r . 15
M a r . 18. .
Mar. 25.. _
M a r . 29
Apr. 1
A p r . 5__
Apr. 8 . ,
A p r . 12
A p r . 15
A p r . 19
A p r . 22
A p r . 26
_
..
A p r . 29
May 3.
May 6
M a y 10 . „
M a v 13
M a y 17-.
M a y 20
__
M a y 24
May 27„
Junel-.
June 3
June 7 . . .
J u n e 10
_
J u n o 14 .^
J u n e 17,^
X accounts 3
B accounts *
12
4
4
6
15
6
27
14
15
$243
99
93
144
429
199
871
429
400
$1,679
2,033
2,224
2,168
2,2S7
2,545
1,870
1,566
1,550
55
1,081
884
25
14
16
45
30
21
580
2,183
no
7 259
122
246
722
1,001
203
274
487
150
281
503
158
845
3S0
3S6
430
979
221
196
2,090
2,055
1,962
1,316
1,311
1,250
1,274
864
861
766
2,834
2,946
2.331
2,0*58
1,891
1,673
844
725
890
5
10
30
33
7
32
24
10
18
15
4
24
11
12
15
40
10
15
(B>
(s)
$115
226
294
807
569
$343
1,391
1,318
692
226
237
5fr
71
1
2
8
Accounts with balances of $150,000 and under (approximately 8.000 banks).
Accounts with balances over $150,000 (approximately 2.500 banks).
These accounts are used during heavy tax-payment periods to avoid excessive strain on bank reserves.
Income-tax checks of $10,000 and over are deposited in them.
4
100 percent of uncalled balances.
1
100 percent of remaining balances.
• 80 percent of uncalled balances.
' Includes $8.7 million special call of 28 percent on New Orleans district only to adjust for error made by
that bank on previous B call.
NOTE.—Banks arc segregated into groups A and B in the Interest of economy. Calls are made usually
twice a week upon the group B banks (the larger banks but smaller in number) and about once or twice
a month on the group A banks.
Source: Office of the Fiscal Assistant Secretary.
UNITED STATES MONETARY POLICY
199
ATTACHMENT NO. 4.—Deposits in hanks
(End of month figures) on basis of daily treasury statement*
[In millions]
Commercial b a n k s
E n d of m o n t h or fiscal year
Federal
Reserve
banks
(available)
June:
1941
1942
1943
1944...
1945..
1946
1947
_
1948
19J9
1950
"„_„
1951
1952.„j
1953.
Fiscal year 1954:
J u l y 1953
August..
September.. .
October. . .
November
December
J a n u a r y 1954 .
February
March
April
May
June. _
Fiscal year 1955:
J u l y 1954 . .
August
S e p t e m b e r . __
October.
November...
December
General
depositaries
Special depositaries
(tax a n d
loan accounts) *
Foreign
depositaries
Total
Total
$1,024
603
1,038
1, 442
1,500
1,006
1,202
1,928
438
950
338
333
132
$03
69
228
235
225
227
215
213
238
270
319
397
413
$661
1,679
7.667
18,007
22, 622
12,993
902
1,773
1,771
3,26S
5,680
5,106
3,071
$53
51
12
16
5
14
20
27
33
37
52
49
$724
1,801
7,946
18,254
22,803
13,225
1,191
2,006
2,036
3,571
6,030
5,555
3,533
$1,748
2,404
8,984
19, G96
24,303
14,231
2,393
3,934
2,474
4,521
6,374
5,888
3,005
548
496
642
602
451
346
404
548
722
579
422
875
423
420
460
440
420
409
484
422
459
427
426
433
0,090
5,825
5,255
2,892
4,545
3,358
2,406
3,458
4,379
3,273
4,095
4,836
102
102
119
121
122
89
86
89
87
91
88
88
7,215
6,347
5,840
3,453
5,087
3,856
2,976
3,969
4,925
3,791
4,009
5,357
7,703
6,843
6 482
4 115
5,538
4,202
3,380
4,517
5,647
4,370
5,031
6 232
727
511
704
480
399
416
2,538
4,078
3,469
88
86
89
3,100
4,563
3,974
3,833
5,074
4,078
1
3
These figures do not include Saturday transactions when Saturday falls on last day of reporting period.
Prior to Jan. 1,1950, these accounts were designated as war lean accounts.
_
|
NOTE.—There are approximately 14,ff0 rarks eligible to held Grvcrrrrcrt (^rcFiTF."" As of Aug. 31,1654^,
there were 1,422 general depositaries; 11,113 special depositaries; ard 34 foreign depositaries.
ATTACHMENT NO. 5.—Treasury operating cash balance and average Federal
budget expenditures fiscal years 1932-5%
[In billions of dollars]
Fiscal year
Average
Average
monthly
operating
budget
cash balance > expenditures
1932...
1933
1934...
1935..
1930....
1937..
1938....
1939..
1940..
1941..
1942....
1943...
1
0.4
.6
2.1
2.4
1.8
1.6
2.3
2.3
1.7
1.5
2.3
5.8
13-month average of end of month figures.
0.4
1944
1945
.4
.6
1946
.5
1947
.7
1948
. 6 1 1919
.6
1950
1951
•7 1952
.8
1953
1.1
1954
2.8
6.6
Average
operating
cash balance
Fiscal y e a r
...
12.9
16.0
20.1
7.2
3.9
4.4
4.5
5.3
5.2
5.7
5.4
l
Average
monthly
budget
expenditures
7.9
8.2
5.1
3.3
2.S
3.3
3.3
3.7
5.5
6.2
5.6
TOUTED STATES MONETARY POLICY
200
FEDERAL EXPENDITURES AND OPERATING CASH BALANCE
SBil.
/I
i
Z
l
15
Avenge v
Cash Balance
(End of Month)
to
Average Monthly
Expenditures ^ p '
V-—"^
•v.
r ^ n n n n n n
'35
1932
'40
P
'45
Fiscal Years
CfllH Of VM SKUtky Of M
*50
•54,
i
tHWy
Representative PATMAN. But you say essentially in your memorandum that it is necessary to do this—I am not trying to use your
language, or put words in your mouth, but the impression I received
is—it is necessary to do that because the banks went to a lot of trouble
in selling bonds.
Secretary HUMPHREY. NO. That is not right.
Representative PATMAN. And rendering other services, and that you
wanted to compensate the banks by leaving these deposits there a certain time.
Secretary HUMPHREY. N O .
Representative PATMAN. Was my conclusion correct or was it incorrect?
Secretary HUMPHREY. I t is incorrect.
Representative PATMAN. All right, why did you want to leave all
this five or six billion dollars there all the time ?
Secretary HUMPHREY. We have to have it for working funds that
move in and out. When you are spending as we are anywhere from
four and a half to six billion dollars a month, you have to have cash
on hand to pay your bills with, to meet your checks as your checks are
presented.
Representative PATMAN. Let's analyze t h a t .
Secretary HUMPHREY. So we have to keep a working balance on
hand to meet our bills.
JSTow, the reason we do it through the banks is because with the
money coming in and the money going out, if we keep this money
spread throughout the country and run tax and loan accounts in the
commercial banks we have less dislocation of funds througout the
country and we don't pull one area way down and build another area,
way up.
UNTTED STATES MONETARY POLICY
201
Private deposits in a bank are just shifted to Government deposits
in the same bank until we have to pay our bills. We don't put most
of that money there ourselves, you know. I t gets there as people pay
their taxes or buy bonds. That's all explained in the material I sent
you in October, and again in the answer to question 8 of the subcommittee's questionnaire.
Representative PATMAN. That is the object of the Federal Reserve.
Let the banks go to the Federal Reserve and borrow temporarily.
Secretary HUMPHREY. By doing it this way we avoid that difficulty.
Representative PATMAN. But you are going around the Federal
Reserve,
Secretary HUMPHREY. We keep an even flow of money throughout
the country and we do not dislocate bank reserves or bank balances by
doing it in this way. I t is the way you get the most even flow you can
possibly work out, and that is very desirable.
Representative PATMAN. I don't want to take up too much time, Mr,
Chairman.
There is nothing personal in this, but there is just 2 or 3 New York
banks that had a quarter of a billion dollars all the time that you were
putting <out this issue, and I venture to say that there wasn't a time
that the banks, just a few banks in New York City, didn't have as
much as $1 billion on deposit, and I can't understand why you would
keep that money on deposit when it is unnecessary.
Secretary HUMPHREY. We don't discriminate among banks. Why
don't you come up, Mr. Patman, and sit
•
Representative PATMAN. Wait just a minute, please. I f the banks
render service, pay them for it. I want them adequately compensated.
I am not trying to take anything away from them, but I don't
believe in just having those accounts there, keeping that money there
idle and unused. You don't eyen check on it.
Secretary HUMPHREY. D O you keep a personal checking account?
Representative PATMAN. You don't even check on these banks.
Secretary HUMPHREY. Do you keep a personal checking account?
Representative PATMAN. I try to.
Secretary HUMPHREY. YOU try to keep a balance in it, don't you,
so your checks are good?
Representative PATMAN. That's right.
Secretary HUMPHREY. And that balance has something to do with
the amount of checks you are going to write.
Representative PATMAN. But you don't check on these banks, you
check on the Federal Reserve.
Secretary HUMPHREY. The effect is the same as checking on the
banks.
Representative PATMAN. Don't you call on them for a certain percentage?
Secretary HUMPHREY. That's right.
Representative PATMAN. I n other words, you check on the Federal
Reserve.
Secretary HUMPHREY. I t is the same thing as checking on the banks,
because we are constantly transferring funds, day by day from those
accounts to our accounts at the Federal Reserve were the checks are
paid.
Representative PATMAN. And I just wonder if some person were
charged for failing to pay his taxes and the defense lawyer should
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UNITED STATES MONETARY POLICY
contend before the jury that the charge really is that this taxpayer
didn't turn it over to the corner national bank so that the corner
national bank could use it, it might have some weight on the jury in the
collection of taxes, and this money is powerful money, every dollar
of it; they expand six times.
I n other words, if they have $1 billion on deposit, they can make
loans aggregating $6 billion, and if they charge them 6 percent like
the Small Business Administration charges, that you happen to be
connected with, 6 percent, that would be 36 percent interest there.
Secretary HUMPHREY. The fact that we have a billion dollars on
deposit in the banks certainly does not mean that they can turn around
and expand their lending power by $6 billion. These are deposit
liabilities; they aren't reserves, which are assets. It's the reserves that
enter into the expansion of lending power—not the deposits.
I think it might be very helpful to you if you would come up and
sit with E d Bartelt for a while and see this actual operation and see
how fast you have to move when you are trying to pay $6 billion
worth of bills with only $4 billion worth of money.
Representative PATMAN. Well, that is the reason Congress very
wisely provided that you had that $5 billion cushion there, $5 billion,
and that is a fine cushion, and that could take care of any of these
temporary upsets, or upsets that are not temporary.
Secretary HUMPHREY. The authority given the Treasury to borrow
up to $5 billion directly from the Federal Reserve was never intended
to cover anything but situations where temporary borrowing is helpful, as around tax dates. Its purpose is to smooth out the effect on
the economy of short-run peaks in the Government's cash receipts
and disbursements. Now the Treasury and the Federal Reserve have
never used this borrowing authority on other than a temporary basis
and have no intention of doing so. If we did, I think the Congress
would properly object.
Representative PATMAN. NOW, another thing, and I shall be
through, Mr. Chairman, about the interest rates on the housing,
and particularly the veterans' loans, the Veterans' Administration,
and the F H A .
There was pressure brought to bear to raise those interest rates.
Do you have coordination between the Treasury and the Federal
Reserve?
You know what they are doing, don't you ? They have been telling
you all the time.
Secretary HUMPHREY. We have very cordial relations with them,
and we try to keep informed as well as we can.
Representative PATMAN. YOU knew that the Federal Reserve was
going to take an about-face on May the 6th last year and reverse
their policy and take the easy-money road instead of the hard-money
road, didn't you?
Secretary HUMPHREY. I knew that they were buying some bills
in the open market at some point, but I can't tell you exactly when.
Representative PATMAN. That was May the 6th.
On Saturday, May 2, 4 days before that, the Veterans' Administration raised the interest rates on veterans loans. The F H A raised
interest rates on F H A mortgages.
Now, if you have liaison between the Treasury and the Veterans'
Administration and the F H A , why didn't you warn them not to raise
UNITED STATES MONETARY POLICY
203
those interest rates, that the Federal Reserve was going to change
its policy in a few days, and there would be no need to raise them?
The excuse was—and it was a good excuse—that the mortgage lender is entitled to a 1^-percent spread, and, as long as the long-term
Government rate was 2y2 percent, he was satisfied with 4 percent.
That was a 1%-percent spread.
But, when the long-term Government bond rates went up under
this hard-money policy and they kept going up and got to 3, with
a great deal of logic and reason, and it is very persuasive, the mortgage lenders said, "We are entitled to a 4%-percent rate to make
that spread V/2 percent."
It is irresistible logic and reason, so the VA and F H A were persuaded to raise that rate on the theory that the long-term rate was
going to remain 3 percent. I am not trying to say that it was bad
faith or you did anything that was wrong. However, you, or someone in your organization, failed to exercise due diligence in stopping
that tremendous raise which went into effect. Four days later the
necessity for it was changed but the increase has never been rescinded.
They are continuing to pay that high rate.
Secretary HUMPHREY. A S soon as you get through, I will tell you
why.
Representative PATMAN. I am through now.
Secretary HUMPHREY. What happened was this, that with these
interest rates as they were, veterans were not able to get their loans
because the loans didn't pay enough interest.
Representative PATMAN. I explained that. I t was partly because
the long-term interest rate was increasing and partly because an increase was expected after you issued the 3*4 percent 30-year bond.
Secretary HUMPHREY. That's right, and that is what the interest
rates were then, and that is what the interest rates were for months
later. Investors wouldn't lend them enough money at 4 percent. We
wanted the veterans to have the benefit of getting that money to use,
and so they changed the interest rate, so that veterans could have the
benefit of the law and actually build some houses, rather than having
something on the books that wouldn't work.
Representative PATMAN. I am in sympathy with the objective of
building homes for veterans.
Secretary HUMPHREY. That is why it was done.
Representative PATMAN. But why do that just before you knew
that the policy
Secretary HUMPHREY. Because we wanted them to be able to build
some houses.
Representative PATMAN. That the policy that caused the 3 percent
long-term rate, which would,justify 4y2 percent for mortgages, that
policy was going to be changed in a few days ?
Secretary HUMPHREY. And it didn't change in 3 days, and you
knew it wouldn't work in 3 days.
Representative PATMAN. I t didn't even go into effect in 3 days.
Secretary HUMPHREY. That's right, and the veterans have had the
benefit all the rest of the time of having something that would work.
Representative PATMAN. Why haven't you reduced it since? Why
don't you reduce it now ? Why don't you reduce it today ?
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UNITED STATES MONETARY POLICY
Secretary HUMPHREY. Because it is still working in the right way.
Representative PATMAN. But you are getting a 2-point spread when
they never did want but 1%-point spread.
Secretary HUMPHREY. The veterans are getting the benefit of it
right now.
Representative PATMAN. They are getting a 2-point spread.
Secretary HUMPHREY. And one of the great things that has happened has been this great building going on, and that is one of the
reasons for it.
Representative PATMAN. I t looked like just increased interest, Mr.
Secretary, and you know 1 percent interest is a lot of money.
You take 1 percent on $697 billion, it is $6.7 billion a year.
That is about $50 per person. That's about $200 per family of 4
a year.
That means that they have got to divert that much purchasing
power, at least that much purchasing power is diverted from comforts
and conveniences of life to the family to paying interest.
Secretary HUMPHREY. Mr. Patman, you know perfectly well
Representative PATMAN. That is a lot of money.
Secretary HUMPHREY. That the real interest cost depends not only
on the dollar amount of interest but also on the amount of principal
If you have to cut your principal to make the rate fit, you might
better adjust the rate and keep the principal.
Now, that is the way it was done. The home builders began to
get the money they needed, they began to go forward, they began to
build things, and we have had the benefit of that, and they have had
the benefit of it ever since.
Representative PATMAN. They would have still gotten it if you
hadn't raised it, because the monetary policy was changed.
Secretary HUMPHREY. N O .
Representative PATMAN. And the direction was 2y2 percent longterm, and they were perfectly satisfied with the V/2 percent spread.
Under your policy they are not only getting 1%, they are getting a
2 spread which they never asked for.
Secretary HUMPHREY. One is theory and the other is practice. One
won't work and the other did.
Representative PATMAN. I would like to yield my time for the
present, and when the others get through I have another question or
two I would like to ask.
Senator FLANDERS. Before calling on the next member of the subcommittee, I am reverting to a suggestion made by Mr. Patman a
few minutes ago to the effect that there might be some correspondence
between a Federal Reserve note and a Government bond, each of them
representing an obligation.
Now, I have on my bedside table a book called the Treasury of
American Humor. I read it when I get distraught.
I have here in my hands another document which I would call
Humor of the American Treasury, and I think it is decidedly humorous, Mr. Secretary. I t says: "Federal Reserve note, the United States
of America will pay to the bearer"—I am the bearer—"on demand
$20."
I turn it in, they hand it back. Now, I think that is Humor of the
American Treasury.
UNITED STATES MONETARY POLICY
205
Eepresentative PATMAX. But don't overlook the fact that you can
pay debts, including taxes, with that, and they don't hand it back.
Senator FLANDERS. But it says that in the fine print, print so fine
that I have difficulty in reading it. The humorous part is the way in
which it is redeemed.
Eepresentative PATMAN. Well, you are making it humorous, Mr.
Chairman, when the fact is you turn it in on taxes and they keep it.
They don't give it back to you.
Senator FLANDERS. Senator Goldwater.
Senator GOLDWATER. I don't have a question at this time, except one
that might clear the record a little bit.
Mr. Secretary, during the last colloquy with Eepresentative Patman, I am sure he didn't want to indicate this but, nevertheless, he
did, that your actions in the spring of 1953 added 1 percent to the
total debt of the country. Now, what portion of the total debt did
that 1 percent actually apply to ?
Secretary HUMPHREY. Oh, it was a very, very small percent.
Senator GOLDWATER. I t wouldn't add $50 to $200 per family, as
might be indicated by the question?
Secretary HUMPHREY. Oh, no, no.
Eepresentative PATMAN. I said it was creeping in that direction.
It would have finally gone clear across the board.
Secretary HUMPHREY. I t is almost infinitesimal when you take it
as you have indicated.
Senator GOLDWATER. Thank you.
Senator FLANDERS. Senator Sparkman.
Senator SPARKMAN. Thank you, Mr. Chairman. I am not a member of the subcommittee. I pass.
Senator FLANDERS. Senator Douglas.
Senator DOUGLAS. Mr. Secretary, there is a question which Congressman Patman raised as to whether the May issue should have been
issued at all. The question I should like to raise is whether however
it was wise to raise the interest rate as rapidly and as quickly as you
did, namely, from 2% to 3*4 percent. I would like to ask whether it
was the fact that you wanted to check past inflation of prices, which
caused you to raise the interest rate by this amount, which was half a
percent in absolute terms, and relatively almost one-fifth.
Secretary HUMPHREY. NO, Senator. The reasons we put out a longterm issue at that time were that we were trying to stretch the debt
out and trying to help Federal Reserve in its monetary restraint
policy.
Senator DOUGLAS. Mr. Humphrey, that goes back to the question
Mr. Patman raised. I t does not deal with my question.
Secretary HUMPHREY. NOW, that is as to the reasons for putting out
the issue. Now, as to the interest rate which you are now speaking
about
Senator DOUGLAS. That's right.
Secretary HUMPHREY. A S to the interest rate itself, the thing that
determines the interest rate itself is this, and it determines the interest
rate almost always: We have quite wide markets in bonds, in these
Government bonds. Every day somebody is buying and selling Government bonds.
Every day the public is fixing the interest rate that will be paid on
Government bonds, and as you go through the list, you will find what
55314—54
14
206
UNITED STATES MONETARY POLICY
the public is willing to pay for certain maturities of these bonds daily,
so that the Treasury doesn't fix the interest rate.
The public fixes the interest rate, and we have to adopt a rate, when
we have an issue to sell, which is what the public is demonstrating
daily that they are willing to buy bonds a t
Senator DOUGLAS. I n other words, you need to give 3 % percent in
order to issue the bonds at par?
Secretary HUMPHREY. That is right.
Senator DOUGLAS. What are they selling for now?
Secretary HUMPHREY. They are selling considerably above that
figure.
Senator DOUGLAS. Aren't they selling for 110 ?
Secretary HUMPHREY. Yes.
Senator DOUGLAS. May I say this. To err is human. We all make
mistakes.
Secretary HUMPHREY. Sure.
Senator DOUGLAS. Senators make mistakes, Secretaries of the
Treasury make mistakes, and so on.
Secretary HUMPHREY. Sure, lots of them.
Senator DOUGLAS. But in view of the fact that a year and a half
after issuing this 3*4 percent interest rate has produced price of bonds
at 10 percent higher than par, if you could have foreseen what was
going to happen, would you have put it up at 3 % percent ?
Secretary HUMPHREY. Yes; let me put it this way:
Let's go back to when we took off the controls. I think to leave the
controls on would have been a very bad thing. If when we took the
controls off we had had runaway prices, that would have been bad,
too. I think either one of those would have hurt the public so much
more than any possible change in this relatively small amount of
interest rate that there is no comparison.
Senator DOUGLAS. NOW you are going back to the price question.
Secretary HUMPHREY. That was the price at the time.
Senator DOUGLAS. You mean, the price of bonds or the price of
commodities ?
Secretary HUMPHREY. The price of interest. The price of borrowed
money, as fixed by the market at that time, was that price. That is
where it came from. We didn't pick it out of thin air.
Senator DOUGLAS. Just a minute, Mr. Humphrey.
I n view of the tremendous importance of Government issues, you
certainly cannot say that the Government merely accepts the interest
rate fixed by the market.
You helped fix that interest rate. The raising of the interest rate
from 2% to 3 % percent caused all interest rates to move up.
Secretary HUMPHREY. NO. The interest ratesSenator DOUGLAS. When the public debt was only a small fraction of
the total debt, then perhaps you could argue that the Government
merely has to accept the interest rate dictated by the market, but when,
according to your own figures, it forms such a large percentage of the
fluid capital, certainly the terms upon which you issue Government
bonds affect other interest rates.
You do not merely accept the market. You help to determine the
market, and that was evidenced in what happened to the price of previous issues at lower rates of interest, which went down because you
were raising the interest rate. I t is what happened in interest rates
UNITED STATES MONETARY POLICY
207
where other flotations had to be issued immediately afterwards. I
don't think you can say you merely accept conditions. You help
frame conditions.
Secretary HUMPHREY. Let me see if I can explain that to you as we
see it, and let's get it into very simple terms.
We are selling eggs, and the current price that eggs are selling for is
.50 cents a dozen. Now then, we come along and we have some eggs to
sell. If we go out and offer those eggs at 55 cents, nobody is going to
buy them, so if we have a dozen eggs to sell, we have to offer them at a
price that the market will take. If we come out and offer them at
above the market, nobody is going to buy them. If we come out and
offer them approximately at the market, we have a chance to sell them.
Now then, we do affect the market somewhat by the amount of eggs
that we do offer. If we came out with thousands of cases, we would
present an oversupply of eggs and it would tend to push the market
down. If we came out with a very little bit and there was a strong
demand, we would have to come at approximately the market.
Now, the same thing is true of bonds. These bonds, the rate that
people were buying bonds for at the very day we put these bonds out
was, as nearly as we could figure it, about 3*4 percent. Now, by coming out and adding some more bonds to the supply we, of course, did
io some extent affect the rate.
That is why we put out as small an issue as we did, because we didn't
want to affect the rate any more than we could help, so we met the
market with as small an amount as we could that we thought would not
affect the rate, and in that way did not increase interest rates by these
bonds over what they then were.
Senator DOUGLAS. Well, Mr. Humphrey, the analogy which you
draw between the housewife who sells eggs, a few dozen eggs, on the
market of millions of dozens of eggs, and therefore sells only an infinitesimal proportion to the total eggs sold, and hence has to accept
the price, is not applicable to the Government, which sells a large proportion of the securities which are issued.
Secretary HUMPHREY. NOW, wait just a minute.
Senator DOUGLAS. There is a difference. You are assuming perfect
competition in the egg market and carrying it over into the bond market, which doesn't apply.
Secretary HUMPHREY. NO, I don't think that is correct, Senator.
We sold just a little over $1 billion, and compared with the Government debt outstanding at that time in the hands of the public—leaving out the Government accounts—it looks very small. We put out $1
billion or a little better, and there was outstanding in the hands of
the public at that time about $220 billion. Now, when you put 1 out
in 220, it isn't such a large proportion, after all.
Senator DOUGLAS. Then you were treating this as purely an extraordinary occurrence raising the interest rate on this one issue ?
Secretary HUMPHREY. We didn't raise it.
Senator DOUGLAS. But it didn't indicate any permanent policy ? I s
that what you are now saying?
Secretary HUMPHREY. We didn't raise the interest rate. We accepted the interest rate as the market had it determined that day, and
we took that interest rate and offered to sell our goods at the price the
market was paying at that time.
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UNITED STATES MONETARY POLICY
Senator DOUGLAS. The previous issues of comparable bonds, as I
remember it, drew some 2%
Secretary HUMPHREY. I don't know what their market yield was.
Senator DOUGLAS. I S that not true, that they drew W/± percent?
Secretary HUMPHREY. NO, it is not true, and the reason is this:
Interest is a function of both principal and rate, and unless you take
into account both principal and rate you can't figure interest Interest of $2 on $100 of principal is 2 percent. That same $2 on a principal
of $50 is 4 percent.
Senator DOUGLAS. Then let me ask you this
Secretary HUMPHREY. SO you always have to take two things into
account to figure what interest is.
Senator DOUGLAS. What was the yield on comparable Government
securities at the time ?
Secretary HUMPHREY. I t was approximately this same rate.
Senator DOUGLAS. %y± percent?
Secretary HUMPHREY. That's right.
Mr. BURGESS. There is a difference in maturity.
Secretary HUMPHREY. For that maturity.
Mr. BURGESS. There weren't any Government bonds that long outstanding at that time. The longest bonds were 2%'s which had become medium-term maturities. They were selling around a 3 percent
yield basis.
Senator DOUGLAS. Three?
Mr. BURGESS. That's right.
Senator DOUGLAS. That is what I understood.
Secretary HUMPHREY. But that was for a shorter maturity.
Senator DOUGLAS. May I just finish?
Secretary HUMPHREY. YOU have got to take maturity principal,
and interest into account in figuring what a new interest rate should
be.
Senator DOUGLAS. NOW you have introduced a third dimension.
Secretary HUMPHREY. That is always true.
Senator DOUGLAS. May I say I can understand your raising the rate
to 3 percent, but I have thought that that extra quarter of a percent
was a mistake; that the yields were 3 percent on comparable securities.
Secretary HUMPHREY. NO, they weren't comparable. Those were
medium-term maturities, and were much shorter.
Now, we thought, based on all those rates
Senator DOUGLAS. H O W long is this issue?
Mr. BURGESS. The longest marketable bonds outstanding then were
December 1967-72's, so you were stretching this new issue very substantially into an area where there was no marketable debt outstanding. The new issue was more than 10 years longer.
Senator DOUGLAS. That raises the question immediately as to
whether you should have issued it for so long a period.
Secretary HUMPHREY. All right. We thought that it was the right
thing to do, and I still say that I believe it was the thing to do if it
was helpful in deterring runaway markets in commodities, and I think
it was.
Senator DOUGLAS. NOW, when you speak of deterring runaway
markets in commodities, I think there has been a lot of—I won't say
issued by you, Mr. Humphrey, but a lot of—misappreh ension on this
point.
UNIT3D STATES MONETARY POLICY
209
Sometimes this rise in the interest rate has been spoken of as a
move to check price inflation. I am happy to see that this morning
neither you nor Mr. Burgess have advanced that argument.
I have here a sheet of wholesale prices and consumer prices, and
they indicate that wholesale prices fell from 116.5 in March 1951 when
the accord between the Treasury and the Reserve was negotiated, to
109.6 in December of 1952, and approximately to 110 in March of
1953, so that there has been a fall in wholesale prices.
There had been a slight increase in consumer prices from 110.4,
110.3 in March 1951, to 113.6 in March of 1953, but if you take the
two together, there was roughly price stability. I n fact, there was a
slight price decline, so that I do not think it can be maintained as
some have maintained in their speeches that this was necessary to
check price inflation, and I hope the record is clear that whatever
the justification may have been for it, that this was not a justification.
Would you agree with that?
Secretary HUMPHREY. Let me put it this way, Senator, I have to get
these things into very simple form or I don't understand them myself.
Senator DOUGLAS. YOU are a very clever man, Mr. Humphrey, to
T>e able to put them in a simple form.
Secretary HUMPHREY. T O just be simple about it, when you take
controls off there are several things that have to be taken into account
in judging where prices will go.
In the first place you have to judge as best you can looking ahead,
and it is always easier to be a Monday morning quarterback than it
is to do the job Saturday afternoon. Looking ahead you have to
judge how the relative increase in productivity was coming up in
production of goods. That was increasing.
There was a lot of plant capacity that was coming in, and it was
increasing. You also had to look at what the demand probably was
going to be.
Now in addition to all of that, there was the question of how purchasing agents throughout the country thought things were going.
They don't study economics particularly; they just go the way you
and I go along in judging how things are going to go. If they think
prices are going to go up, they want to raise their inventories to protect themselves. If they think prices are going down, they cut down
on their inventories somewhat.
If it costs them a little more money to carry an inventory, they are
not quite so apt to speculate with it.
So that with all of these things, with the production, gaging the production that would probably be available, gaging the demand that
would probably be made, and with it costing a little more to carry a
speculative inventory, all those things converged to a point where you
didn't have an increase in speculative inventory.
And it was the most fortunate thing in the world that we didn't
get it because we were accumulating inventory at that time, anyhow,
and if we had added substantially to our inventory accumulation at
that time we would have had a much farther down curve in business,
which was what you were predicting yourself only a few months ago.
Senator DOUGLAS. Mr. Humphrey, for the record I have never made
any predictions. I have never made any predictions about the future.
The record is perfectly clear on that point. I merely stated what
Tvas occurring, namely a decline in industrial activity or a recession.
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UNITED STATES MONETARY POLICY
Secretary HUMPHREY. I n any event, we didn't have that severe
down curve partly because we had not had that speculative inventory
buying.
Senator DOUGLAS. NOW, Mr. Humphrey——
Secretary HUMPHREY. All these things contributed to stop that, and
I think that by and large the whole thing did stop the inventory
accumulations that would have driven us further down had it occurred.
Senator DOUGLAS. Then wThat you were afraid of was not past increases in prices, but anticipated increases in prices.
Secretary HUMPHREY. That is right.
, Senator DOUGLAS. Resulting from the removal of controls.
Secretary HUMPHREY. That is what many people said. That is
what the big argument was, and there are many people who argued
. very sensibly that if those controls w7ere removed, there would be an
immediate rise in prices that would be uncontrolled.
Representative PATMAN. Would you permit an interruption there?
Senator DOUGLAS. Certainly.
Representative PATMAN. He said if those controls were removed.
Secretary HUMPHREY. That is right.
Representative PATMAN. Indicating that you were going to take
them off.
Secretary HUMPHREY. That is right.
Representative PATMAN. The 83d Congress in 1953—isn't it a fact,
Mr. Secretary, that the Defense Production Act of 1952 passed in the
82d Congress provided for the automatic decontrols that went into
effect, and practically all of them had been removed before April 1953?
Secretary HUMPHREY. Onlv because we took them off.
Representative PATMAN. They were automatic.
Secretary HUMPHREY. And if they had been taken off earlier, we
would have been better off. If that had been done in the fall before,
we would all have been better off.
Senator DOUGLAS. As a matter of fact, Mr. Humphrey, even under
the imposition of controls, what we had was a fall in wholesale prices.
The controls pegged prices at their peak, of January-May 1951 but
did not appreciably impede the rise in prices. The trouble had occurred by the time controls were imposed, and a business fall of 7
points.
Secretary HUMPHREY. Of course, you don't know what the peak
would have been if you hadn't had them. When a control is put on,
it will always peg it at the peak because that is where you stop the
rise.
Senator DOUGLAS. What I am trying to say, is I see no evidence that
there was any pent-up inflationary movement at the time the interest
rate wTas raised so sharply, and that this wras taken as an indication
of Government policy.
The rise was not merely an isolated occurrence. I t was said to he
the shape of things to come, and the result was that it was not merely
a coincidence that the yield on municipals went up, that other yields
went up as well due to the falling of prices of securities already issued.
I t had a profound effect, and the very fact that it was not needed was
shown in that within a month you reversed yourself. I wish that as
public men we didn't always have to take the position that we are infallible. I t is possible that we make mistakes, honest mistakes.
TJNIT2D STATES MONETARY POLICY
211
Secretary HUMPHREY. I am not taking that position at all, but if we
had to do it again tomorrow, I would do exactly the same thing, and
let me tell you why.
I think that one of the greatest things that has happened has been
the stabilization that has resulted during this period, the maintenance
of that stability, the stopping of inflation. We had been for 15 years
i n a period of self-imposed inflation that was fostered and carried on,
and it was depreciating the value of the dollar very rapidly.
Now the value of the dollar stopped depreciating. I t all has to do
with the reduction of Government expenditures, with the handling of
the taxation, with all of these things that all contributed, and it is not
a bookkeeping fetish or anything of the kind.
The stopping of this inflation saved the people of America, the
savers of America, the people of America a great deal of money, and
it has stabilized the economy. I t has helped to make jobs for them
to work at, and I think it is the foundation of the conditions that we
have today.
Senator DOUGLAS. I t is always impertinent to play the role of amateur psychiatrist, Mr. Humphrey, but I would say that your subconscious has oozed out in your reply, because now you are making emphasis upon the checking of inflation, which a few minutes ago you
disavowed.
Secretary HUMPHREY. NO ; I didn't disavow it. I never disavowed
it. I have said right straight along that our objective has been to
stop these inflationary pressures. Our objective has been to stop this
depreciation of the dollar, and so far we have done it.
Senator DOUGLAS. This is my point: That had already been done
by the Federal Treasury Reserve Board in March 1951, as indicated
by what happened after that.
Secretary HUMPHREY. NO ; that is not the whole story.
Senator DOUGLAS. What I think happened is you carried over your
impression of what existed prior to that accord into a period in wThich
it no longer applied.
Secretary HUMPHREY. NO ; I don't think so. In any event, it has
worked.
Senator FLANDERS. Will the Senator yield ?
Senator DOUGLAS. I have taken up too much time.
Senator FLANDERS. I would just like to express this situation as I
see it. I may not be seeing it rightly.
In the first place, inflation was checked before you, sir, came to the
Treasury. I n the second place, a new factor entered after you came
to the Treasury in that controls were removed. The assumption you
are making, which seems to me a valid assumption, is that positive
action on your part was required to maintain an already existing situation in the face of the removal of controls.
That, at least, is the way I see the picture. And just one other
point, and that is this: that you have disavowed the direct fixing of
interest rates by saying that you put that issue out at the market.
There had to be an element of judgment in your case because there
^ere no Government issues of that length of maturity in the market.
You had to make a judgment as to what the market was for maturities
for that length. I t would seem to me then that your policy is either
approved or disapproved on the basis of your decision to issue securities of greater length than any that were present in the market.
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UNITED STATES MONETARY POLICY
Secretary HUMPHREY. That is right, Mr. Chairman. You might
want to add that there were, of course, other influences that also bore
on this.
We inherited a $9% billion deficit that year, which was an inflationary pressure in itself, so that to say that inflationary pressures were
all removed is not correct.
We were under many inflationary pressures at that time. Consumer
credit was rising rapidly. New issues of corporate and municipal
securities were running very high and credit demands were threatening to spill over at a time when our productive capacity was already
fully utilized. We felt it necessary to resist those pressures so that
we would not have a runaway rise in prices, and we could stabilize
the dollar.
Now, the proof of the pudding is in the eating. What was done
did stabilize prices.
I t did arrest the threatened rise and it continued stabilization and
the value of the dollar didn't depreciate further. That is very beneficial for the American people in the form of jobs, in the form of savings, in the form of insurance, in the form of pensions, in all the things
that the American people want to have.
Senator FLANDERS. Senator Douglas, you still have the floor.
Senator DOUGLAS. I don't want to monopolize the questioning, but
I would say this.
I think this argument that it was necessary for stabilization is very
dubious. I t is true that the money supply was increasing, but it is
also true that production was increasing, and it is important to view
those two together in relationship to each other.
If you have the normal increase in production of 3 percent a year,
and as a matter of fact, it was going up close to 5 percent a year
during the preceding year, you can have some increase, a corresponding increase in the money supply without any inflationary effect on
prices, and that is precisely what had been happening.
The Federal Reserve had allowed the money supply to increase in
absolute terms, but not in relative terms. This is something that I
think monetary managers should consider, not merely the question of
absolute increases, but relative increases, and it is only when the relative supply of money is increasing more rapidly than the index of
production or physical production that you get'into danger.
Our good friends at the Treasury, I think erred in just being
frightened at the absolute increase, and disregarded that increase in
production which counterbalanced the increase of money, and had
enabled stable prices to be maintained, which would have continued.
And the very fact that it wasn't necessary is shown in that within
a month the Treasury had to beat a retreat, that interest rates were
lowered, that this issue now stands out as a sore thumb at a price of
110, that the verdict of the market to which the Secretary has appealed has been that that was not necessary.
Now, I say it was a bad mistake, but I believe it was an honest
mistake. But I know how hard it is for public figures to admit mistakes. I sometimes find it difficult myself, Mr. Secretary. But I
think nothing is gained by trying stubbornly to maintain a position
that you are correct, when history indicates you were wrong.
UNITED STATES MONETARY POLICY
213
Secretary HTOIPHREY. Senator, I have made a great many mistakes
in my life, and I expect to make a lot more, and I have never been a
bit backward in admitting them.
On the other hand, when you are looking forward and making judgments and those judgments work in practice, that is the test after all,
I am not much of a theoretical economist. I don't care too much
about the theory of it as long as it works.
This one worked, and it worked well, and therefore I think it was
all right.
Senator DOUGLAS. NOW, Mr. Secretary, I have kept off of this question of whether it worked, but since you have raised it, I want to
address myself to that very point.
You say it has worked because prices have been stable, but there
is no doubt that that rise in interest x\ates checked production, checked
volume of output during the second half of 1953 and contributed to
the recession and contributed to the employment of human beings.
Now, I do not say that it was the sole factor in the i^ecession. I
have never argued that. But I do say the rise of one-half percent in
interest rates helped it along.
Secretary HUMPHREY. I t is a mighty good thing it did check inflation.
Senator DOUGLAS. Did you consider the increase in unemployment,
which has been very severe in many regions of this country ? If you
took that into consideration, then I think you would not be quite
as self-satisfied with this decision that you say "worked."
Senator FLANDERS. May I interrupt a moment, Senator ?
Senator DOUGLAS. Certainly.
Senator FLANDERS. I t seems to me that one part of the production
that it checked was the flow of production into inventories.
Secretary HUMPHREY. That is right; that is exactly right.
Senator DOUGLAS. Well, did it?
Senator FLANDERS. Yes.
Secretary HUMPHREY. Yes; it did, and if it hadn't we would have
been in a lot worse trouble.
Senator DOUGLAS. But for about 5 months inventories continued to
increase despite the rise in interest rates
Secretary HUMPHREY. And think how bad it would have been if it
hadn't helped to check it.
Senator DOUGLAS. Your own chart shows that the inventories did
not begin to decline until October, and you had placed your increase
in interest rates into effect in May.
Secretary HUMPHREY. That is simply illustrating your point that
we did need a check.
Senator FLANDERS. NOW, I am anxious that Mr. Talle, if you will
excuse me, shall have an opportunity, and so it is his turn now.
Representative TALLE. Thank you very much, Mr. Chairman. I
will not take any time.
Senator FLANDERS. Well, now it lies between those who have already spoken. Let's see if Senator Sparkman would like to ask
any questions.
Senator SPARKMAN. NO, Mr. Chairman, don't save any time for me.
I am a visitor, not a member of this subcommittee.
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UNITED STATES MONETARY POLICY
Senator FLANDERS. You are welcome as a member of the full committee.
Mr. Goldwater?
Senator GOLDWATER. Mr. Chairman, I have one question to ask,
brought about by the chairman's first suggestion that possibly the law
of supply and demand hasn't been working during this period of inventory adjustment Isn't it true that temporary price reductions are
not noted in price indexes?
Secretary HUMPHREY. That is right.
" Senator GOLDWATER. Isn't it true that there has been in this country
a great deal of price reductions, particularly in the automobile field
and appliance field in the past 9 to 10 months?
Secretary HUMPHREY. In almost every field, Senator, there have
been sales involving price reductions moving substantial quantities
of goods that have tended to reduce inventory, and those price decreases are not noted in the figures.
Senator GOLDWATER. So wouldn't you say it would be safe for me
to assume that the fact that the law of supply and demand has been
allowed to operate with a minimum of Government interference has
been the dominant factor in the present economic condition of the
country ?
Secretary HUMPHREY. That is exactly right, and price concessions
have been effective in that operation.
• Senator GOLDWATER. Thank you.
Senator DOUGLAS. Mr. Chairman, before we break up could I give
a Biblical quotation which I think is applicable.
Senator FLANDERS. Well, now just before we have the Bible, I want
to say that I, not quite tacitly, have offered Mr. Patman a chance to
say something more.
Representative PATMAN. I will certainly yield to a Biblical
quotation.
^ Senator FLANDERS. I don't believe you can quote the Bible indefinitely, so let's
Senator DOUGLAS. I was going to only use the Bible as a jumping-off
point.
Senator FLANDERS. Just give us the jumping-off point, anyway.
Senator DOUGLAS. Mr. Secretary, it finally comes down to this.
You believe this increase in interest rates, or at least the extra quarter
of a percent, was necessary to check increases in prices which had
not yet occurred but which might do so, or increases in inventories
which had not yet occurred but which might.
I n other words, it was a faith that there would have been inflation
in the future if this had not occurred.
That reminds me of St. Paul's definition of faith. I t is the substance of things hoped for, the evidence of things not seen. But in
this connection I would like to point out that despite the rise in the
interest rate, inventories continued to accumulate until October, and
on a seasonal basis even until November, and that within a month
almost the Treasury and the Reserve, finding that they had made a
mistake, though they did not wish to admit it publicly, had reversed
their policies, and it was after the fall in the interest rates that the
inventory ceased being accumulated.
UNITED STATES MONETARY POLICY
215
Secretary HUMPHREY. These curves, Mr. Senator, as you know
begin to show up long afterwards. If you don't live way ahead of
;the curves, you are going to be in a lot of trouble.
Senator GOLDWATER. Mr. Chairman, a question on that point.
Isn't it true that new orders in both retailing and manufacturing
at that particular period were at quite a high point, and they had to
:be filled.
Secretary HUMPHREY. That is right.
Senator GOLDWATER. A businessman just can't cancel orders because
he thinks something is going to happen.
Secretary HUMPHREY. If you wait until you see it on the chart, you
will go broke.
Senator GOLDWATER. That is right.
Representative PATMAN. I raised the question of permitting the
banks to have so much of the Government's money on hand all the
time, an amount which in the recent past has been around 6 or 7
billion dollars.
Secretary HUMPHREY. I think our average is about 4 billion, but I
won't quarrel with you over a billion or 2.
Representative PATMAN. I want the banks to be profitable. I am
not going to do anything that will keep them from making money
because they are so important in our entire economy.
But it occurs to me in permitting them to hold so much of the
Government's money, every dollar of which has a potential credit
of $G—in other words, if they have $6 billion, they can extend loans of
$36 billion, that we are doing a lot for them that could possibly make
them become a little indifferent toward talking to small-business people
who want local loans.
The point is this, Mr. Secretary. I just feel like it is just doing
too much toward making these banks a little bit indifferent and careless toward local loans, and I just wanted to invite that to your
attention.
The value of the dollar today is about the same as it was in early
1953?
Secretary HUMPHREY. Yes.
Representative PATMAN. NOW, during that time the gross national
product has gone down; hasn't it?
Secretary HUMPHREY. I t has gone down a little, a very small
percentage.
Representative PATMAN. Dr. Burgess said you have to run awfully
fast in this game to stand still.
j Now, I think that is a good statement, but in our economy if we
just stand still, if that line is just even, it doesn't go up, it goes just
exactly like it has been, we are going backward; aren't we?
Secretary HUMPHREY. Mr. Patman, we have a growing economy.
This country is growing right now. We have got to make more jobs
for more people all the time.
Representative PATMAN. That is right, that is what I am talking
about.
Secretary HUMPHREY. And this country is going to have a continual
growth. I am a great believer in America. We are not going to
stand still.
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UNITED STATES MONETARY POLICY
Representative PATMAN. NOW, gross national product is the indexisn't it ?.
Secretary HUMPHREY. YOU aren't going to keep making new records
every day.. You are going to catch your breath now and then, and
then run again.
Representative PATMAN. When are we going to start running ?
Secretary HUMPHREY. We are on the way up right now.
Representative PATMAN. Right now? I t must have been the last
month.
Secretary HUMPHREY. I t started last month and the month before.
Representative PATMAN. Mr. Clark yesterday made a very interesting statement. He seems to be concerned that if the economy does not
respond adequately to the current automobile and steel expansion, this,.
coupled with the usual post-Christmas letdown, may not leave our
economy in good condition. He suggested then that we should take a
drastic step.
We should reduce reserve requirements of banks down to the bare*
minimum. Of course, that would release a lot of reserves and that
would increase the potential lending power of the banks by possibly
$75 billion. I would be afraid of it. I think it is too much.
But if the country doesn't respond to this stimulation via expanded
automobile the steel production and doesn't come back after the seasonal letdown anyhow, do you not think we should do something
drastic ?
Secretary HUMPHREY. There is nothing in the present situation that
would lead me to believe we should do anything drastic now.
I have no idea of it, and I don't think it is worthwhile to speculate*
on a lot of thoughts that nobody knows whether they are going to*
come true or how they will work out.
Senator FLANDERS. Are there any other questions that any of themembers of the panel or any members of the committee here wish to*
ask?
If there are no other questions, we will call this hearing adjourned,,
and we are particularly grateful to the Secretary and the Under*
Secretary. We meet again at 2 o'clock when we have a most remarkable aggregation of talent. Never before has the entire Federal
Reserve System faced a group of Senators and Representatives.
(Whereupon, at 12:20 p. m., a recess was taken until 2 p. m., the?
same day.)
AFTERNOON SESSION
Present: Senators Flanders (presiding), Goldwater, Sparkman,Douglas, and Watkins; Representatives Patman and Talle.
Also present: Grover W. Ensley, staff director, and John W Lehman, clerk.
Senator FLANDERS. The hearing will come to order.
Congressman Patman ?
Representative PATMAN. Mr. Chairman, the Federal Reserve System, made up of the regional banks and the central governing board
in Washington, has been established for 41 years.
The O pen Market Committee, with its broad powers over the
economy, has been in existence for 20 years. I n all that long history,
this is the first time that any congressional committee has had the opportunity of meeting face to face with the men who, through their
UNITED STATES MONETARY POLICY
217
position in the Reserve System and their control over the availability
of credit and purchasing power, have more power than almost any
group, in shaping the destinies of the economy of the Nation.
While the Chairman of your Board and some of the presidents of
individual banks have appeared before Congress from time to time,
never before has the top management of the Reserve System appeared
as a group before representatives of the Congress, as you are appearing today.
In many ways, this is strange and, I believe, an unfortunate fact.
I t is strange and unfortunate because however one may choose to
describe the relationship between Congress and the System, the fact
is that under the Constitution, the powers to coin money and regulate
the value thereof are expressly placed in the Congress.
The fact that Congress has seen fit, as a practical matter, to entrust
or delegate the day-to-day exercise of this power to the Reserve System,
does not lessen the ultimate power or responsibility of the Congress in
this respect, nor does it make the functions which you and the Reserve
System perform any less public governmental functions.
Congress, recognizing that restrictive monetary policies must sometunes be strongly stated to control inflation, has chosen to endow the
System with a considerable degree of independence. But under the
Constitution this independence can never rise above the relationship
of a faithful and trustworthy servant and a responsible, watchful
master, in this case the Congress.
Since the country cannot prosper without a sound basic economy
and sound credit conditions, since the economy cannot exist without
an adequate medium of exchange by which goods and services change
hands, the powers which the Congress has delegated to the System are
in many ways closer to the destiny of the country than many of the
other congressional powers.
In many respects, the actions which you take at your regular meetings of the Open Market Committee are thus more important to the
well-being of the plain citizen and to business, labor, and agriculture
than most of the actions taken by a long session of the Congress itself.
I am sure that as individuals you fully appreciate this responsibility,
but there can be no harm in its reiteration and emphasis.
I n a dynamic and delicately balanced economy, such as we have,
actions taken by monetary authorities must be constantly sensitive to
economic changes and threatened instability.
Yours is thus a day-to-day task as well as a sensitive vital one.
Since it is such a sensitive and serious responsibility, it is appropriate that those entrusted with it should report frequently to the
Congress, whose constitutional powers they exercise through delegation.
I t is true that the Board of Governors does file an annual report
with the Congress. Ideally this report should be even more complete
than it is. For example, it should contain details on the volume of
open-market purchases and sales which have to be made in pursuance
of the policies determined upon.
I t should report the success of the operation undertaken and explain
fully the thinking behind the decisions and policies. Faithful and
full reporting to the principal is expected of every agent.
I t might indeed well be that reports should be made more frequently
than once a year.
218
UNITED STATES MONETARY POLICY
I hope that this hearing today will establish a precedent which will
lead to similar meetings and your appearance before congressional
committees regularly.
I certainly hope and feel sure that none of us want another 41 years
to go by before repeating a meeting similar to this.
Thank you, Mr. Chairman.
Senator FLANDERS. Congressman Patman referred to the fact that
this is an unusual occasion. I t is a fact that a group of Congressmen
and Senators who have the kind of responsibility that is laid upon theJoint Economic Committee have never before asked this group as a
whole to appear before us.
I might remark, parenthetically, that in the 41 years of the Boards
and in the 20 years of the Open Market Committee, it took a Republican Congress and the Republican chairman to get this result achieved,
and
Senator SFARKMAN. You-just did get under the wire, Mr. Chairman..
Senator FLANDERS. There is an old hymn about the prize:
The prize secure, the wrestler nearly fell, bore all he could endure,, and bore*
not always well.
But the idea is that he won nevertheless.
Now, this is an unusual occasion. I think it is very much to theadvantage of the Open Market Committee, the Board and the other
members and the group of presidents and this committee to be personally acquainted with each other.
I assume there are opening statements to be made by Mr. Martin,.
the chairman, and by Mr. Sproul the Chairman of the Open Market
Committee. That being the case in order not to take any furthertime from the statements we will want to begin with Mr. Martin,
immediately.
Let me first say that we greatly appreciate the care and thought
which have gone into the preparation of the answers to the series of*
questions propounded by this subcommittee to the Federal Reserve
Board prior to the hearings. These materials were inserted in the
record at the opening of the hearings yesterday (p. 3).
Mr. Martin ?
STATEMENT OF WILLIAM McCHESNEY MARTIN, JR., CHAIRMAN,,
BOARD OF GOVERNORS, FEDERAL RESERVE SYSTEM, ACCOMPANIED BY MEMBERS OF THE BOARD OF GOVERNORS OF THE
FEDERAL RESERVE SYSTEM AND RESERVE BANK PRESIDENTS
Mr. MARTIN. Mr. Chairman, this is the first time that I have everreally felt comfortable in appearing before a committee of Congress,,
because I have a lot of artillery with me today.
Usually, I am up here all alone, although I am flanked by my veryable staff assistants; but it seems to me very helpful for us to have a.
meeting of this sort, and I would like to reiterate what Congressman.
Patman has said.
UNITED STATES MONETARY POLICY
219
I have no prepared statement today, but I would like to make a few
comments on the Federal Reserve System, along the lines that are
contained in the opening statement that Mr. Patman has given us.
The Federal Reserve System, I have tried to emphasize, has the word
"System" in its title, and I believe that to be the most important word
in its title.
In the history of credit and money policy in this country, it is
obvious that the Congress has struggled to know how best to administer this great power that it has. The Congress has evolved, in
accordance with the American way of life, an institutional concept,
recognizing that decisions on money and credit policies are like the
decisions of the judiciary, in that they depend for their effective
exercise upon freedom to analyze the problems and act on the problems
that, as Mr. Patman rightly says, occur from day to day and week t a
week and month to month and year to year, free of political pressures
on the one hand, and of private pressures on the other hand. Therefore, in establishing the Federal Reserve System, after long and careful discussion, the Congress determined that they would not have
a single bank with many branches, but that they would have a regional
system, and that that regional system would be knit together by a
governing board in Washington. You have today at this table the
operating heads of the 12 Federal Reserve banks and the 24 branches
under those 12 banks, as well as the members of the Board of Governors
that knit the System together in Washington.
We might also have had here today the Federal Advisory Council^
a statutory body which the Congress provided for in the Federal
Reserve Act, and we might have had the chairmen of the 12 Federal
Reserve banks and the some two-hundred-and-fifty-odd directors of
the Federal Reserve banks, who are also an integral part of the System.
Now, this System represents a trusteeship over money which the
Congress has granted to the Federal Reserve System under a trust
indenture, which is the Federal Reserve Act.
That trust indenture can be changed at any time by the Congress,,
but it is under that trust indenture that we are acting, and what I am
outlining as the regional system of the Federal Reserve is in accord
with the trust indenture which you have given us to operate under.
Now, it is my firm conviction that credit and monetary policy has
to be conducted not on a one-man basis, but by bringing together from
all over the country, a country as large as this, a composite of views
in such a way that they .will be brought to bear on policy so that we
will have some understanding of what we are trying to do, as well as
some recognition of the nature of the problem.
And so, today it gives me a great deal of pleasure to be here and to*
be surrounded by my artillery, and to be in a position so that I do not
have to answer all of the questions.
Now, I would just like to make one further comment, and that has
to do with the questions which have been asked us by Mr. Ensley and
the very able staff of your committee. They are very good questions;.
they are very searching questions, and they are questions that we
welcome having the opportunity to answer at this time and put in the>
record.
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UNITED STATES MONETARY POLICY
We think they are deserving of study and careful consideration,
and Ave welcome your comments and your judgment on them because
only in that way can we be helpful.
I want you to know that the Board and the staff and many of the
people in the System have worked as diligently and as faithfully as
they can to give you the best answers that we can to these questions.
Thank you.
Senator FLANDERS. Thank you, Mr. Martin.
With regard to the artillery which you have massed here, I may say
that they are not arranged in any respect with regard to their bore or
the weight of the projectiles; they go alphabetically from Mr. Balderston, Mr. Bryan, Mr. Earhart, and then, take a great leap, and end up
with Mr. Williams and Mr. Young.
I thought it would be interesting to know that we use the alphabet
instead of protocol.
Without objection, we will insert in the record at this point brief
notes on the members of the Board and the presidents, and a listing of
the present members of the Federal Open Market Committee. In response to a request from Congressman Patman there is also included
the membership of the Federal Open Market Committee and of the
executive committee of the Federal Open Market Committee, March
1951 through February 1954, and a list of the present members of the
Federal Advisory Council.
(The documents referred to follow:)
MEMBERS OF BOARD
William McChesney Martin, Jr., C h a i r m a n : Effective date of appointment
April 2, 1951; term expires J a n u a r y 31, 1956; formerly president of New York
Stock Exchange, chairman and president of Export-Import B a n k ; and a t the
time of his appointment was Assistant Secretary of t h e Treasury.
M. S. Szyinczak: Effective date of appointment J u n e 14, 1933; reappointed
effective F e b r u a r y 3,1936, and February 1,1948; term expires J a n u a r y 31,1962;
formerly engaged in banking; professor, DePaul University, Chicago, 111.; and
a t the time of his appointment was comptroller of t h e city of Chicago.
J a m e s K. Vardaman, J r . : Effective d a t e of appointment April 4, 1946; term
expires J a n u a r y 31,1900; formerly engaged in business and banking in St. Louis,
Mo., and a t the time of his appointment was naval aide to t h e President of
t h e United States.
J a m e s Louis Robertson: Effective date of appointment F e b r u a r y 18, 1952;
t e r m expires J a n u a r y 31, 1964; formerly special agent of F B I , Counsel to the
Comptroller of the Currency, and a t the time of his appointment w a s F i r s t Deputy
Comptroller of the Currency.
Abbot L. Mills, J r . : Effective d a t e of appointment February IS, 1952; term
expires J a n u a r y 31, 1958; formerly engaged in banking since 1920, and at the
time of his appointment was first vice president of t h e United S t a t e s National
Bank, Portland, Oreg.
C. Canby Balderston: Effective date of appointment August 12, 1954; term
expires J a n u a r y 31, 1966; formerly director and deputy c h a i r m a n of Federal
Reserve bank of Philadelphia, and a t the time of his appointment was dean,
Wharton School of Finance and Commerce, University of Pennsylvania.
RESERVE B A N K PRESIDENTS
J. A. Erickson, president, Federal Reserve Bank of Boston, since December 15,
1948. At the time of his appointment a s president he w a s executive vice president of the National Shawmut Bank of Boston, having been associated with that
institution since 1920.
Allan Sproul, president, Federal Reserve Bank of New York, since January 1,
1941. He h a s been associated with the Federal Reserve System since 1920, first
serving as head of the division of analysis a n d research and a s s i s t a n t Federal
Reserve agent a t the Federal Reserve Bank of San Francisco until 1930 when he
UNITED STATES MONETARY POLICY
221
came to the Federal Reserve Bank of New York as assistant deputy governor and
secretary.
Alfred H. Williams, president, Federal Reserve Bank of Philadelphia, since
July 1, 1941. At the time of his appointment as president he was dean of the
Wharton School of Finance and Commerce of the University of Pennsylvania,
having been a member of the faculty of the Wharton School since 1915.
Wilbur D. Fulton, president, Federal Reserve Bank of Cleveland, since May 14,
1953. He began his service with the System as an examiner at the Federal
Reserve Bank of Cleveland in 1933, advancing through the positions of chief
examiner, vice president in charge of the Cincinnati branch, and first vice
president.
Hugh Leach, president, Federal Reserve Bank of Richmond, since March 12,
1936. He began his service with the Federal Reserve System in 1920 as a clerk
in the auditing department of the Federal Reserve Bank of Richmond and
advanced to positions of auditor, managing director of the Charlotte and Baltimore branches, and first vice president.
Malcolm Bryan, president, Federal Reserve Bank of Atlanta, since April 1,
1951. He taught economics at the University of Georgia, 1925-36; economist
with Board of Governors of the Federal Reserve System, 1936-38; vice president
of the Federal Reserve Bank of Atlanta, 1938-41, and first vice president,
1941-46; vice chairman of Trust Company of Georgia, 1946-51.
Clifford S. Young, president, Federal Reserve Bank of Chicago, since March 1,
1941. He began his service with the Federal Reserve System in 1921 as an
assistant examiner at the Federal Reserve Bank of Chicago, advancing through
the positions of examiner, assistant Federal Reserve agent, and vice president
and secretary.
Delos C. Johns, president, Federal Reserve Bank of St. Louis, since February 1,
1951. He was in general law practice in Kansas City until 1945 when he was
appointed general counsel and secretary of the Federal Reserve Bank of Kansas
City.
Oliver S. Powell, president, Federal Reserve Bank of Minneapolis, since July 1,
1952. He has been associated with the Federal Reserve Bank of Minneapolis
in various official capacities since 1920, except for his service as a member of
the Board of Governors from September 1,1950, to July 1, 1952.
H. Gavin Leedy, president, Federal Reserve Bank of Kansas City, since August
28, 1941. Engaged in the general practice of law prior to 1924, at which time
he became counsel for the Federal Reserve Bank of Kansas City. Prior to his
appointment as president, he served as general counsel, vice president, and first
vice president.
Watrous H. Irons, president, Federal Reserve Bank of Dallas, since February
15, 1954. Professor of banking and finance at the University of Texas prior to
coming to the Federal Reserve Bank of Dallas in 1945 as director of research.
He was a vice president of the Dallas Reserve Bank at the time of his appointment as president.
Cecil E. Earhart, president, Federal Reserve Bank of San Francisco, since October 17, 1946. He began his service with the Federal Reserve System in 1917 as
an auditing clerk at the Federal Reserve Bank of San Francisco, advancing
through the positions of cashier, vice president, and first vice president of that
institution.
PRESENT MEMBERS OP THE FEDERAL OPEN MARKET COMMITTEE
William McC Martin, Jr., chairman (Chairman, Board of Governors of the
Federal Reserve System)
Allan Sproul, vice chairman (president, Federal Reserve Bank of New York)
C. Canby Balderston (member, Board of Governors)
Malcolm Bryan (president, Federal Reserve Bank of Atlanta)
H. G. Leedy (president, Federal Reserve Bank of Kansas City)
A. L. Mills, Jr. (member, Board of Governors)
J-L. Robertson (member, Board of Governors)
AI. S. Szymczak (member, Board of Governors)
•James K. Vardaman, Jr. (member, Board of Governors)
Alfred H. Williams (president, Federal Reserve Bank of Philadelphia)
^- S. Young (president, Federal Reserve Bank of Chicago)
55314-^54
15
222
UNITED STATES MONETARY POLICY
P R E S E N T M E M B E R S H I P OF EXECUTIVE COMMITTEE OP FEDERAL
O P E N MARKET COMMITTEE
William McC Martin, Jr., Chairman
Allan Sproul, Vice Chairman
J . L. Robertson
M. S. Czymczak
Alfred H. Williams
FEDERAL ADVISORY
COUNCIL
William D. Ireland, Boston district
Henry C. Alexander, New York district
Geoffrey S. Smith, Philadelphia district
George Gund, Cleveland district
Robert V. Fleming, Vice President, Richmond district
Wallace M. Davis, Atlanta district
E d w a r d E. Brown, President, Chicago district
W. W. Campbell, St. Louis district
Joseph F. Ringland, Minneapolis district
Charles J. Chandler, K a n s a s City district
Geo. G. Matkin, D a l l a s district
John M. Wallace, San Francisco district
H e r b e r t V. Prochnow, Secretary
MEMBERSHIP
OF FEDERAL OPEN M A R K E T COMMITTEE,
FEBRUARY 1 0 5 4
MARCH
1053
THROUGH
(NOTE.—March 1 is the beginning of t h e committee's organization year.)
William McC. Martin, Jr., Chairman (Chairman, Board of Governors of the
Federal Reserve System)
Allan Sproul, Vice Chairman (president, Federal Reserve Bank of New York)
J. A. Erickson (president, Federal Reserve Bank of Boston)
R. M. E v a n s (member, Board of Governors)
R a y M. Gidney (president, Federal Reserve Bank of Cleveland) *
Delos C. J o h n s (president, Federal Reserve Bank of St. Louis)
A. L. Mills, J r . (member, Board of Governors)
Oliver S. Powell (president, Federal Reserve Bank of Minneapolis)
J . L. Robertson (member, Board of Governors)
M. S. Szymczak (member, Board of Governors)
J a m e s K. Vardaman, J r . (member, B o a r d of Governors)
MEMBERS OF EXECUTIVE COMMITTEE OF FEDERAL OPEN M A R K E T COMMITTEE,
M A R C H 1 0 5 3 T H R O U G H FEBRUARY 1 0 5 4
William McO. Martin, Jr., Chairman
Allan Sproul, Vice Chairman
J . A. Erickson
R. M. Evans
A. L. Mills, J r .
- M E M B E R S H I P OF FEDERAL OPEN M A R K E T COMMITTEE, MARCH, 1 0 5 2 T H R O U G H
FEBRUARY 1 0 6 3
William McC. Martin, Jr., Chairman (Chairman, B o a r d of Governors of the
Federal Reserve System)
Allan Sproul, Vice Chairman (president, Federal Reserve Bank of New York)
Malcolm Bryan (president, Federal Reserve Bank of A t l a n t a )
C. E. E a r h a r t (president, Federal Reserve B a n k of San Francisco)
R. M. Evans (member, Board of Governors)
*On June 11, 1953, W. D. Fulton (president, Federal Reserve Bank of Cleveland) assumed his duties as a member of the Federal Open Market Committee, succeeding Eay *i*
Gidney, whose resignation was effective Apr. 16, 1953.
UNITED STATES MONETARY POLICY
223
Hugh Leach (president, Federal Reserve Bank of Richmond)
A. L. Mills, Jr. (member, Board of Governors) a
Oliver S. Powell (member, Board of Governors)
J. L. Robertson (member, Board of Governors)
M. S. Szymczak (member, Board of Governors)
James K. Vardaman, Jr. (member, Board of Governors)
C. S. Young (president, Federal Reserve Bank of Chicago)
MEMBERS OF EXECUTIVE COMMITTEE OF FEDERAL OPEN MARKET COMMITTEE,
M A R C H 1 0 5 2 THROUGH FEBRUARY 1 0 5 3
William McC. Martin, Jr., Chairman
Allan Sproul, Vice Chairman
Hugh Leach
Oliver S. Powell 3
James K. Vardaman, Jr.
M E M B E R S H I P OF FEDERAL OPEN MARKET COMMITTEE, MARCH 1 9 5 1
THROUGH FEBRUARY 1 9 5 2
Thomas B. McCabe, Chairman * (Chairman, Board of Governors of the Federal
Reserve System)
Allan Sproul, vice chairman (president, Federal Reserve Bank of New York)
Marriner S. Eccles (member, Board of Governors)
R. M. Evans (member, Board of Governors)
Ray M. Gidney (president, Federal Reserve Bank of Cleveland)
R. R. Gilbert (president, Federal Reserve Bank of Dallas)
H. G. Leedy (president, Federal Reserve Bank of 8Kansas City)
Edward L, Norton (member, Board of Governors)
Oliver S. Powell (member, Board of Governors)
M. S. Szymczak (member, Board of Governors)
James K. Vardaman, Jr. (member, Board of Governors)
Alfred H. Williams (president, Federal Reserve Bank of Philadelphia)
MEMBERS OF EXECUTIVE COMMITTEE OF FEDERAL OPEN MARKET COMMITTEE,
MARCH 1 9 5 1 THROUGH FEBRUARY 1 9 5 2
Thomas B. McCabe, Chairman *
Allan Sproul, Vice Chairman
Marriner S. Eccles *
M- S. Szymczak
Alfred H. Williams
Mr. Sproul, we would now like to have a few remarks from you.
Mr. SPROUL. Mr. Chairman, if I heard you correctly, you spoke of
toe as the Chairman of the Federal Open Market Committee. I am
only the Vice Chairman. The Chairman of the Board of Governors
is also Chairman of the Federal Open Market Committee.
I share with Chairman Martin the pleasure in having my associates
here, having undergone, as he has, at times, the dubious privilege of
being here alone without the support of these associates.
T * designation of Oliver S. Powell as a member of the Board of Governors was effective
Com * 1052 » a t w l l i c h time he ceased to be a member of the Federal Open Market
I As of July 1, 1952, A. L. Mills, Jr., as first alternate, succeeded Oliver S. Powell,
ftf +1? BTo ap rr (i ll o1f0 5 1 ' William McC. Martin, Jr., succeeded Thomas B. McCabe as Chairman
s tM
Governors and as Chairman of the Federal Open Market Committee.
IQ*O a art *a sL*o fNorton
resigned as a member of the Board of Governors effective Feb. 1,
t h a t rtate
«T *
ceased to be a member of the Federal Open Market Committee,
nf
or *\r April 1951, William McC. Martin, Jr., succeeded Thomas B. McCabe as chairman
.the
executive
committee.
1]
i July 1951, Oliver S. Powell, as first alternate, succeeded Marriner S. Eccles.
224
UNITED STATES MONETARY POLICY
I am going to speak of something which I am sure is not the major
concern of your hearing, just as it is not the major concern of the Federal Open Market Committee, but nevertheless it is something which
I do not think was covered, from my point of view, in the answers
submitted to you by the Chairman of the Board of Governors and,
therefore, if 1 may take your time, I would like to refer to it. It is,
perhaps, what might be called the negative, in answer to your question
No. 3.
Your subcommittee addressed five questions to the Chairman of the
Board of Governors, and his answers have been made available to
other participants in these hearings, as well as to the public.
With respect to the answers to questions 1, 2, 4, and 5,1 am in general and substantial agreement, even though there might be some
shades of difference of opinion or degrees of emphasis in answers to
the same questions which I might prepare.
This suggests the first point I would like to make: So far as general
credit policy is concerned, there has been a high degree of unanimity
within the Federal Reserve System throughout the period covered by
your inquiry, that is, since March 1951.
Our differences, or my differences with other members of the Federal Open Market Committee, have related to the techniques of open
market operations, not to general credit policies.
I t is to these questions of techniques that your question No. 3 is
directed. Here again I can express a good deal of agreement with
much that is included in the ansAver of the chairman. I t is a persuasive and stimulating discussion of the issues involved. Yet there is
also a good deal with which I disagree, and my conclusions as to the
most effective use of open market operations, to implement credit
policy and to promote economic growth and stability, diverge quite
sharply from those set forth in the answer of the Chairman.
His answer is, of course, responsive to the question of the subcommittee, which asked for affirmative support of the actions of the Federal Open Market Committee to which it refers, not for the arguments
for and against such actions.
Obviously, there is not time here for a full-dress presentation of
the negative side of the question. I should like to make certain points
which, I think, are significant to an understanding of the problem,
however, and I should be glad to submit to the committee later, if it so
desires, a written statement of views which might match the answer
of the chairman in completeness and I would hope, in persuasiveness.
First, as a matter of background, I think I should say that I am
not for pegging Government security prices nor for trying continuously to determine the structure of interest rates by means of open
market operations. As one of the principals in the fight to free the
Federal Reserve System from the pegging of prices of Government
securities, throughout a difficult period of controversy on this point,
beginning in 1946,1 think I have the right to make this clear. And,
as one who has a great deal of respect for the operations of the market
place, I would not want to be classed with those who believe that a
continuously better result can be obtained, so far as the structure of
interest rates is concerned, by completely substituting the judgment of
the Federal Open Market Committee for the market place. If w e
want to find out how the patient is doing, there must be some place
where we can take the patient's pulse.
UNITED STATES MONETARY POLICY
225
Now, taking up the real issues in this minor problem. The least
controversial issue was dropping from the directive of the Federal
Open Market Committee the clause authorizing open market operations to maintain orderly conditions in the market for Government
securities, and substituting for it a clause authorizing operations to
correct disorderly situations in the market. I voted in favor of this
change, and thought it desirable, not just as a question of semantics.
But I would stress the avoidance of disorderly situations rather than
their correction after they have happened.
One of the virtues of credit control is supposed to be its ability to
take prompt action to head off financial disturbances which might
otherwise have harmful repercussions throughout the economy. If
open-market operations in longer term Government securities can be
used to this end, I would use them rather than wait until a disorderly
situation or a crisis has developed, and only then depart from operations solely in Treasury bills.
The most controversial issue was the instruction by the Federal
Open Market Committee that open-market operations must be confined to the short end of the Government securities market, except
in correcting disorderly situations which, in practice, has come to
mean confining operations to Treasury bills. I did not get the impression that the action was merely an assertion of the power of the Federal
Open Market Committee to determine whether and when the System
Open Market Account should engage in transactions outside of the
short end of the market. There need not be any question of the power
of the full committee to determine the conditions and the general timing of operations in the longer term areas of the market.
I was concerned with the strong emphasis which I thought wTas
given to permanence of the "bills only" doctrine. Suggestions for publishing a set of rules of the game, references to a constitution for openmarket operations, and the repeated argument that Government security dealers could not create a broad, continuous market if we did
not forego operations in long-term securities—except to correct disorderly conditions—gave me the disturbing impression that we were
in danger of placing ourselves in a straitjacket which would not
permit us to accomplish what the Congress and the public might expect
us to accomplish in terms of monetary management.
I, therefore, welcomed the statement in the answer of the chairman
to your question No. 3 that the door is being kept open to a change in
the present basic technique of open-market operations, and the recognition in his answer that the present approach to open-market operations is still experimental and that insufficient time has elapsed to
draw firm conclusions as to its performance. The publication of these
views should help to dispel the idea that present techniques have been
adopted for all time, and should help to avoid further hardening of the
dangerous opinion that any future operations by the System in the
long-term market will be the signal of a critical situation.
I also welcome the repeated references, in the answer of the chairman, to the concern of credit policy with developments in the longterm sector of the market and the assertion of the particular concern
of the Federal Open Market Committee that its policies be reflected
in the cost and availability of credit in the long-term markets. I t has
been, and still is, my contention that this concern can find its best
226
UNITED STATES MONETARY POLICY
expression, at times, in open-market operations specifically directed at
these longer-term markets.
This is, perhaps, the variant approach to open-market operations
briefly commented upon, and summarily dismissed, beginning on page
20 of the answers of the chairman to your question No. 3. As set
forth there, it is described as a method of operation in which—
the Federal Opea Market Committee would normally permit the interplay of
market forces to register on prices and rates in all of the various security sectors
of the market, but would stand ready to intervene with direct purchases, sales,
or swaps in any sector where market developments took a trend that the committee considered was adverse to high-level economic stability.
That seems to me to be an eminently reasonable approach to our
problem, but it has never really been tried—not even in the period
1951-53 to which the chairman refers. And now it has been dismissed on what I believe is the shaky assumption that it "did not
appear to offer real promise of removing obstacles to improvement in
the technical behavior of the market."
This probably brings us down to the nub of the differences. The
Chairman's answer to your question No. 3 embraces the view, with
which I agree, that the "depth, breadth, and resiliency" of the Government securities market, or its "continuity and responsiveness,"
should be furthered by all means that are consistent with a credit
policy of maximum effectiveness, and that, in general, the greater the
"depth, breadth, and resiliency" of the market, the greater will be the
scope and opportunity for effective credit control through open-market operations. But the proof of that pudding must be found in the
actual market, not in a theoretical discussion of a supposedly ideal
market.
The answer of the Chairman asserts that the market has become increasingly stronger, broader, and more resilient since the Committee
adopted the "bills only" technique. I t suggests most persuasively
why, theoretically, this should be so. But it does not prove that it
has actually happened. I n fact, I wonder whether we are talking
about the same market, and what are the definitions of "strength" and
"breadth" that are being used. I t is my information and observation
that the market for longer term securities has remained at least as
"thin," under existing open-market procedures, as it was before these
procedures were adopted.
I think it has lost depth, breadth, and resiliency, whether you view
it in terms of dealer willingness to take position risks, volume of trading, or erratic price movements. We must not be misled by the claims
of one or two dealers who urge the present techniques and now proclaim that they are helping to create a broader market for Government
securities.
I do not think we have helped to create such a market. And, therefore, I do not see how the responsiveness of cost and availability of
credit in all sectors of the market since June 1953 can have been the
result of a progressive strengthening of the Goverment security
market growing out of the actions of the Open Market Committee with
respect to the open-market techniques. Much of the success of the
System's actions during this period has derived from the promptness
of adaptation of overall credit policy to changes in the economic situation, and to a high degree of coordination of Federal fiscal policy and
debt management with credit policy. For the rest, it has sometimes
UNITED STATES MONETARY POLICY
227
taken massive releases of reserves, under the techniques adopted or in
support of those techniques, to accomplish what might have been
accomplished more economically with the help of limited direct entry
into the long-term market.
I am hopeful, therefore, that the present period of experimentation
will not be too long extended, and that we shall soon have an opportunity to experiment with the middle way—the variant approach—
which I mentioned earlier.
One final comment should be made, perhaps, in connection with
your question 3 on the discontinuance by the Federal Open Market
Committee of direct supporting operations in the Government's security market during periods of Treasury financing.
I would agree that the system open market account should not, as
a matter of routine, provide such direct support, but I would also
say that we cannot, as a matter of routine, turn our back on such
support.
The emphasis in the present approach to Treasury financing is good.
The Treasury should meet the test of the market, in relation to other
credit needs of the economy, to the fullest possible extent. But too
rigid application of this doctrine is questionable as a matter of market
procedure and Treasury-Federal Reserve relationships. I n periods
of credit ease, when policy considerations point to the need of keeping
Treasury demands from draining credit away from desirable private
use, reliance on bill purchases alone may lead to unwanted consequences. The flooding of funds into the bill market, in order to
assure adequate credit in the areas tapped by the Treasury, may produce an undue enlargement of bank reserves, or an extreme distortion
in Treasury bill prices and yields, or both.
There will also be times, particularly in periods of credit restraint,
as distinguished from the recent period of overall credit ease, when
rigid application of the present rule may result in serious collisions of
debt management and credit policy, which might have been avoided
without jeopardizing the overall public interest.
Now, let me repeat, what I have been discussing are disagreements
over techniques of open-market operations, not over general credit
policy. I t is good to have these differences opened up, and I hope
that this hearing will result in more discussions of the problems involved by an informed public. We in the Federal Reserve System
cannot consider ourselves to be the sole repositories of knowledge in
these matters. What I have been most afraid of is that we might
come to think that we can indulge in the luxury of a fixed idea. There
is no such easy escape from specific and empirical decisions in central
banking. We cannot have a general f ormula, a kind of economic law,
which will serve the ends of credit policy under all sorts of economic
conditions.
I apologize if I have taken too much of your time.
Senator FLANDERS. Mr. Sproul, the responsibility of the congressional committee across the table from you lies ultimately in recommendations for legislation. As preparatory to that, it lies in comprehension of the problem concerning which we are to recommend.
You have contributed to that comprehension. I t is not quite clear
in my mind whether you have the feeling—but I judge you do not
have the feeling—that the structure which has been set up by legislation needs changing. At least if you do have the idea that it needs
228
UNITED STATES MONETARY POLICY
changing, I did not note that you brought it out in your discussion.
Mr. SrRouL. I have no such idea.
Senator FLANDERS. SO that you were engaged in the necessary and
often difficult task of increasing our comprehension.
Mr. SPROUL. I hope so.
Senator FLANDERS. Yes; thank you.
Did I note that the points to which you addressed yourself related
largely to the technique of operation ?
Mr. SPROUL. Yes, you did, and they related to your question No. 3
which you addressed to the Chairman of the Board of Governors.
Senator FLANDERS. Yes.
Mr. SPROUL. I t was an attempt to supplement his answer.
Senator FLANDERS. And the general impression I got from ^our
statement was that you were not personally favorable to too rigid
rules, but felt that there should be a good deal of flexibility.
You mentioned that in connection with the question of whether the
Board and the Open Market Committee should concern itself solely
with the short end of the market. I think you raised the same
question of rigidity with regard to another point, as to whether the
open market system should intervene in the markets at the time
when the Treasury was floating a new issue.
In both of those cases, I take it, you feel that it is not wise to have
too rigid rules to go by ?
Mr. SPROUL. I think that is right. But I think my fellow members
were not abandoning concern with other parts of the market than this
short market. They were really confining their operations to that
part of the market, but are still concerned, as I am, with the other
areas of the market.
Senator FLANDERS. Yes.
Mr. SPROUL. But, in general, I w7as objecting to too rigid rules of
conduct.
Senator FLANDERS. I think we have our minds clearer on that, I
think, at the moment.
I would like to ask Chairman Martin to give us his understanding
of the way in which the controls applied to the short end of the
market affected (1) the whole range of Government securities and (2)
affected the longer range purposes of the Federal Reserve Board's
sphere of influence.
Mr. MARTIN. I would like to say, Mr. Chairman, that I am glad
this statement is available. I hope that the members of the committee
will read Mr. Sproul's statement along with the statement that I
have made here, because this is a fairly complex subject.
Now, as Mr. Sproul has stated, this discussion is over techniques and
procedures, not over policy itself.
Having come out of the Treasury and into the Federal Reserve, and
having seen the open-market operation from both sides of the fence,
my own view is directly contrary to Mr. SprouPs. I believe that the
depth, breadth, and resiliency of the market is being improved: That
is, that we are developing a broader, stronger, more vigorous market
when the trade, so to speak, knows in a general way that we will deal,
for the most part, though not as a fixed rule, nor for all time—as I
have been very careful to spell out in my answer—in the closest equivalent to money that there is.
UNITED STATES MONETARY POLICY
229
Now, that does not mean that we are not interested in interest rates
or that we are not influencing interest rates. I t does mean that we
confine ourselves to supplying and absorbing reserves in the shortest
area of the market and let the processes of the market channel those
reserves throughout all the other areas and maturity sectors of the
market. As Mr. Sproul states, and as I state, this is still an experimental technique, but it is my view that we will do better by not applying the slide rule to the market, thus permitting the market to make
its own adjustments around the supply of reserves that we put in.
Now, Mr. Sproul would disagree with me as to how effective this
technique has been during the period it has been in use.
My own judgment is that it has been very effective and very useful,
and has contributed to a better Government securities market; but
that is a matter that I think the Open Market Committee will continue
to wrestle with for some time to come. Our sole objective is to operate
in the most effective way in the public interest.
Senator FLANDERS. Perhaps I wished to ask an earlier question than
the one which I just asked you, which related to the way in which, in
your judgment, operations on short-term obligations affect interest
rates, as a whole and, presumably, affect the market for the long-term
operations.
There is, perhaps, a question which should be asked before that on©.
The primary question might be: What is the Federal Reserve System
for? What are your ultimate objectives?
I may interpose there a remark of my own which is to the effect that
in my conception, all governmental objectives are ultimately human
objectives, they are for the sake of people.
Is there too long a connection, in your mind, from the open-market
operation on short-term paper down here to where Mr. X lives so that
it is difficult for you to tell us what this has to do with Mr. X?
Mr. MARTIN. Let me say, first, that I think that funds spread faster
through the market with minimum intervention than with maximum
intervention.
Now, when we talk about a free market, we are not talking about
absolving the Federal Reserve of its responsibility to regulate the
money supply. That is the problem that you gentlemen have charged
us with resolving. We do that by supplying reserves and absorbing
reserves. I t is my conviction that we do the most service, for the
individual that you are talking about, consonant with the concept of
private competitive enterprise, by giving the play of the market the
maximum influence that it can have without disruptive effects.
Senator FLANDERS. But now without going through all the multiple
steps down to Mr. X , you are saying this: that the policies you have in
mind lead toward a high degree of freedom in the market for Government securities and other evidences of debt; that, in your judgment,
it supports the free competitive system and that, in your judgment,
a reasonably free competitive system, as free as is practicable, in
consideration of other interests, does lead toward a better living for
Mr. X ? I s that the chain that you are going to follow ?
Mr. MARTIN. That is my contention.
Senator FLANDERS. I just wanted to establish that chain, because
otherwise I have comparatively little interest in this hearing, just
between you and me.
230
UNITED STATES MONETARY POLICY
Now, that having been established, I shall shortly stop my questions,
except for one horse which I want to trot out of the stable in a
minute. I would like first to have your idea as to how your operations
largely confined to short-term paper affect interest rates all through
the structure and affect the long-term paper, as well.
Mr. MARTIN. Well, I think the process of arbitrage, which is the
adjustment which Mr. Sproul thinks has more of a lag than I think
it has, takes place very quickly in the market for Government
securities.
I believe that when we inject funds via the closest equivalent to
money that there is—and do not forget that does not always have to
be 90-day bills, they might not be available, I am talking about the
short end of the market—that the injection of those funds will quite
rapidly permeate to the other areas of the market and will be reflected by the forces of the market in changes in interest rates throughout the market.
Now, if we should operate directly in all maturities, we could, perhaps, be wise enough to know just what the relationships between the
prices of different securities ought to be at all times. But we would
have to use a slide rule to determine these relationships. While I
respect Mr. SprouFs judgment, I think that that is a step toward
pegging which he deprecates just as much as I do.
Senator FLANDERS. The question then arises as to the timelag; the
question is how quickly the one operates or how slowly, and whether
it operates too slowly or not.
One other question on this point. When you speak of the nearest
tiling to money, you are speaking of short-term securities which are
taken up by the banks ?
Mr. MARTIN. That is right.
Senator FLANDERS. And it is the fact that they are taken up by
the commercial banking system which makes them the nearest thing
to money; am I right in that? And that long-term instruments which
may be bought for semipermanent investment do not have the same
effect of injecting money into the market as the short-term ones.
Mr. Sproul points out they can be taken u p by others than banks
also. Any purchase by the Open Market Committee injects money
into the market.
Senator FLANDERS. Yes, that is right.
Mr. MARTIN. Yes.
Senator FLANDERS.
Without any excuse whatsoever except that the
horse is an old friend of mine, I would like to lead my steed out of the
stable. I t came to my mind a number of times in the discussion yesterday and this morning. For the life of me, when we speak about the
quantity of money, I cannot understand why there is so little interest
in the Board or anywhere else that I can find, in the velocity of money.
Do you consider that is a constant ?
Mr. MARTIN. Oh, I do not think that is correct, Senator. There is
a very real interest in the Board in the velocity of money, and also in
the individual Reserve banks.
Senator FLANDERS. Do you have information on that in your bulletin
and on your charts ? I t seems to me one knows little about money if
one does not join velocity and volume.
Representative PATMAN. Mr. Chairman, is it not in the Federal
Reserve Bulletin each month?
UNITED STATES MONETARY POLICY
231
Mr. MARTIN. Yes. We do have information in the monthly Federal
Reserve Bulletin on the rate of turnover of demand deposits in New
York City and other reporting centers. The data are also shown in
our chart book.
Senator FLANDERS. I t is a very important factor.
At this point, I will turn over the questioning to other members of
the committee, and I would also like to say that I think it will not be
out of order from your standpoint, Mr. Chairman and Mr. Vice Chairman, if other members of the Board and other members of the group
of presidents, join in the discussion from time to time as you come
across something in which they have particular interest or knowledge.
That is agreeable to all, I take it.
Mr. Patman?
Representative PATMAN. Thank you, Mr. Chairman. I n order to
bring out the importance of this great committee, the Open Market
Committee, composed of the members of the Board of Governors of
the Federal Eeserve System and the five presidents who are on the
Board at this time, of the Federal Reserve banks, I desire to quote
Mr. Eccles, who testified before the Banking and Currency Committee,
in which he stated:
^ Now, the fact that the interest is where it is, of course, is not just an accident.
The rates during the twenties and during the last war, had there been an Open
Market Committee, which there was not, in the Federal Reserve System, they
could have financed the last war and financed the Government during the
twenties, at prevailing rates.
Mi\ Monroney, who was then a member of the House and sitting on
the Banking and Currency Committee of the House, asked this
question:
Do you mean to say that with your present Open Market Committee and the
operation of the Federal Reserve as it now stands, that regardless of what the
national income is or other economic factors, that you can guarantee to us that
our interest rate will remain around 2.06 percent?
Mr. ECCLES. We certainly can. We can guarantee that the interest rate, so
far as the public debt is concerned, is where the Open Market Committee of the
Federal Reserve desires to put i t
I bring that out to show the tremendous power of this great committee that has been properly delegated, this power, by the United
States Congress.
Certainly, the Congress itself cannot carry out the constitutional
requirement relating to the money and credit supply; it must delegate
that power. We have done the right thing by delegating the power.
But the point is, this committee has the power to determine whether
we have high interest rates or low interest rates, or whether we have
good times or bad times.
This committee also has the power to send over to the Bureau of
Engraving and Printing and get the printed money of our country,
the Federal Eeserve notes, and properly distribute those Federal
•Reserve notes; and I assume in the course of a year that runs into
billions of dollars. The power that is lodged in this committee is
tremendous.
During the last 40 years, the Federal Eeserve System has taken
$135 billion worth of Federal Eeserve notes from the Bureau of Engraving and Printing. I bring that out to show the importance of
this committee.
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UNITED STATES MONETARY POLICY
Now, Chairman Martin, all these people are not members of the
Open Market Committee. Of course, the Board is now composed, I
assume, of six members, since you recently had a vacancy.
The other five members of the Open Market Committee representing
the presidents of Federal Reserve banks, who are they ?
Mr. MARTIN. I might ask them to raise their hands, that will be
the simplest way. (Members of the Federal Open Market Committee
are listed on pp. 220,223 of the hearings.)
Representative PATMAN. Mr. Sproul is always a member, is he
not?
Mr. SPROUL. That is by statute.
Representative PATMAN. The statute made you a permanent member, that is the New York member.
Now, the other change from time to time, and these other gentlemen who are here, representing Federal Keserve banks, they either
have been—they are now or will be members of the Open Market
Committee; is that right?
Mr. MARTIN. That is correct.
Representative PATMAN. And that is the reason you brought them
along?
Mr. MARTIN. Well, I was requested to bring them.
Representative PATMAN. You work together, do you not, when you
have a meeting of the Open Market Committee?
Mr. MARTIN. We usually do.
Representative PATMAN. Don't you have a meeting of all the presidents at the same time?
Mr. MARTIN. We usually do.
Representative PATMAN. And they, in effect, represent the Open
Market Committee, whether they are officially on it that year or not?
Mr. MARTIN.
Yes.
Representative PATMAN. In other words, the ordinary Federal Reserve bank, like Dallas, would have one-third of a vote at each meeting?
Mr. MARTIN. Oh, no; oh, no.
Representative PATMAN. I mean for all practical purposes. Of
course, there is somebody officially on there.
Mr. MARTIN. No, you underestimate the stamina of the members
of the Committee.
Representative PATMAN. I should not have named Dallas; I should
have named some other city.
But now, then, these 11 members represent the Open Market Committee. The executive committee that carries out the orders and instructions of this committee, how many are they ?
Mr. MARTIN. There are five.
Representative PATMAN. They are five. Now, you are always on
that Committee, Mr. Sproul is always on that committee; who "is on
that committee now representing the banks ?
Mr. MARTIN. Will the three members that are on the executive committee, please raise their hands.
Senator FLANDERS. Mr. Sproul is a member, I mean at the present
time.
Mr. MARTIN. Mr. Williams
Representative PATMAN. And Mr. Sproul for the banks, and Mr.
Martin, and who else for the Board?
Mr. MARTIN. Mr. Robertson and Mr. Szymczak.
UNITED STATES MONETARY POLICY
233
Representative PATMAN. They are the ones on now. Who will be
on next year in Mr. Robertson's and Mr. Szymczak's places?
Mr. MARTIN. Well, it will go by rotation.
Representative PATMAN. I am bringing it up to indicate whether
or not you have a certain policy or formula to go on, that certain people
will come in automatically; is that right?
Mr. MARTIN. Well, we have a system of rotation; yes.
Representative PATMAN. All right.
Now, then, there is a vacancy on this Board. Who is the Vice Chairman of the Board of Governors?
Mr. MARTIN. There is no Vice Chairman at the present time.
Representative PATMAN. Does not the law say there shall be a Vice
Chairman ?
Mr. MARTIN. The President has the power to appoint a Vice
Chairman.
Representative PATMAN. Well, does not the same law that says
"shall appoint," does it not say that the President shall designate a
Vice Chairman?
Mr. MARTIN. The law says that; you will have to take that up
with the President, Mr. Patman.
Representative PATMAN. Well, I have taken it up with him.
How long has it been since you had a Vice Chairman ?
Mr. MARTIN. I think it has been a number of years. I. would have
to look up the exact elate.
Representative PATMAN. Is there any particular reason why you do
not have a Vice Chairman, except that the President has just failed
to designate one?
Mr. MARTIN. Well, we have had your committee and Senator Douglas' committee investigating us, and that has been one of the reasons
why we have been studying the problem
Representative PATMAN. What does that have to do with the Vice
Chairman's selection?
Mr. MARTIN. Well, it only has to do with the fact that there might
have been some changes in the composition of the Board.
Representative PATMAN. I do not see where that had anything to do
with the failure of the President to—I am honestly seeking the correct
information about that, Mr. Chairman.
Mr. MARTIN. Well, I am merely
Representative PATMAN. HOW does that have anything to do with
the failure to designate a Vice Chairman of the Board, when the law
says that the Vice Chairman shall be designated?
Mr. MARTIN. I think it depends on whom you are going to designate,
and I think that is a matter for the President to decide.
Representative PATMAN. That is what I say. But don't you think
that the President should be importuned by the Board or call it to his
attention?
I will not place that burden on you and require an answer.
How did it happen that the hard-money policy was pursued in the
spring of 1953 right up to a few days after rates on veterans' guaranteed-mortgage loans were raised?
I will finish this and then ask you to comment. Does this not indicate either a failure of liaison among Government agencies or that the
change in monetary policy was deliberately delayed until this action,
234
UNITED STATES MONETARY POLICY
unfavorable to veterans and other mortgage borrowers, was put into
effect? What is your answer to that, Mr. Martin? I n other words,
the interest rates on F H A insured and VA guaranty of veterans'
loans were raised about 3 days before the Board met and decided to
reverse its policy.
If I understand correctly, you testified before another committee
that the Board met on May 6,1953, and decided to reverse policy; am
I correct in that or not?
Mr. MARTIN. I think May 6 is the date.
Representative PATMAN. When you decided to reverse your policy
that meant that interest rates would decline, did it not?
Mr. MARTIN. NO. I t takes some time for policy to work, and it
might have been changed again. As you pointed out very ably in your
statement, this is a fluid operation. We decided to reverse the policy
on May 6. We could not be sure then how long the reversal would be
or what the degree of the reversal would be. That was something
that had to unfold with time.
Now, the rates to which you refer had no connection with our action
^whatever.
They had been out of line with the market for some time past. So
far as I was concerned, and so far as I know, nobody from those
agencies consulted with me with respect to this change in direction
of monetary policy. There was no way of telling on May 6 or even
on June 1 whether our change in policy would continue or how far
it would go.
Representative PATMAN. Let us see if we agree on that rate being
too low for some time. Is it not a fact, Mr. Martin
Mr. MARTIN. I did not say too low; I said out of line with the
market.
Representative PATMAN. Language like that is very appropriate
and discreet; I am not trying to criticize it. The truth is that the
mortgage lenders were satisfied with 4 percent as long as the longterm Government bond rate was 2y2 percent; is that not right? In
other words, they were satisfied with a 1%-percent spread.
Mr. MARTIN. The volume of mortgages that was being placed with
investors at that time was not really high. The change in mortgage
interest rates was made to bring them in line with the market, so that
mortgage credit would be more readily available to veterans and
others.
Representative PATMAN. Well, am I correct in stating that the
lenders, mortgage lenders, were satisfied with a 1%-percent spread
which was considered the traditional spread over a long period of
time, and they were satisfied with i t ; am I right about that or not?
Mr. MARTIN. I really do not know.
Representative PATMAN. All right; that is my contention anyway,
whether it is right or wrong. I t was the spread they accepted for a
long time.
Then when your hard money policy went into effect, commencing
in January 1953, Government bonds commenced to slide, and 1
issue went down to 89. That made interest rates go up in proportion
and, as Government bonds declined to where the 2 ^ ' s sold at a price
that yielded 3 percent, the mortgage lenders came in and said: "Now,
we are entitled to an increase in the Veterans' rate from 4 to 4%
percent; we are entitled to an increase in the F H A rate from 4*4 to 41/2
UNITED STATES MONETARY POLICY
235
percent. The traditional spread is 1% percent, and since the longterm rate is now 3 percent, we are entitled to 4%." Was it not on
that basis that the interest rate on VA- and FHA-backed home mortgages was finally increased?
Mr. MARTIN. I have to go back a little bit, Mr. Patman. The socalled hard money policy that you are talking about was really
initiated at the time of the Treasury-Federal Eeserve accord, and it
was not a case of
Eepresentative PATMAN. Well, you will cause me to take up these
whole 40 minutes, and I did not want to do that, Mr. Chairman.
Mr. MARTIN. Well, in this kind of operation I cannot take a single
specific point out of the picture as a whole. We are dealing with a
process that goes on, with many ramifications. You cannot at any
precise point say, "this is the end result." The forces of the market
had been playing in the direction of higher interest rates, in my judgment, for some time.
Representative PATMAN. Well, it commenced in 1946 for the shortterm rate ?
Mr. MARTIN. I do not remember the precise date.
Eepresentative PATMAN. But here is what I am talking about:
The day before the inauguration, the rediscount rate was raised by
important banks, most of the others had already raised it, Federal
Eeserve banks, one-half of 1 percent, was it not, January 1953 ?
Now, the rediscount
Mr. SPROTJL. One-fourth of 1 percent.
Mr. MARTIN. One-fourth of 1 percent.
Eepresentative PATMAN. One-fourth of 1 percent, excuse me.
You know the rediscount rate is believed to have little practical
significance outside of its purely psychological value, am I right on
that or not?
Mr. MARTIN. The rediscount rate is a very important rate.
Eepresentative PATMAN. Nobody was borrowing
Mr. MARTIN. Don't you think $2 billion is a lot of borrowing?
Eepresentative PATMAN. I S it not a fact that you have said it was
strictly psychological?
Mr. MARTIN. Oh, no. The borrowings through the discount windows rose to $2 billion.
Eepresentative PATMAN. Well, at any rate, that was my understanding. I t was strictly psychological to let the Federal Eeserve banks
know that we are going to have tighter credit conditions, and "you
fellows might just as well get ready for it." This is just kind of
an unconversational understanding.
Mr. MARTIN. The adjustment of the discount rate at that time was
to bring it closer in line with the market then existing.
Eepresentative PATMAN. But that is when I thought that notice
was given to the world that you were starting on a real hard money
policy, and I think the bankers of the country recognized that as a
signal, that is what I thought.
But, anyway, when the bonds began to decline afterwards more than
they had in the past, and much more rapidly, and as the interest rates
went up, that is when lenders began to ask for a higher interest rate
on housing loans, and the rate was increased just 4 days before you
took an about-face on your policy, Mr. Martin.
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UNITED STATES MONETARY POLICY
I t occurs t o m e that there should be—if there was no liaison between
your department and these other lending agencies, there should be.
What liaison do you have?
Mr. MARTIN. I think we have pretty good liaison. I want to point
out that when the policy was changed on May 6, there was no certainty at that time that we would continue the new policy. I t gradually unfolded in response to developments.
Representative PATMAN. A S to how long you would do it.
Mr. MARTIN. YOU have to move very delicately in this operation,
and that is the way we started to move.
Representative PATMAN. I see.
This morning I interrogated the Secretary of the Treasury about
the debt of the Government, and the question came up about the ability
of the Treasury to borrow money from the Federal Reserve banks to
take care of their unpaid bills. I think it has been referred to in the
past as the Treasury overdraft. You know the bill I am talking
about?
Mr. MARTIN. That is right.
Representative PATMAN. For years, commencing about 10 or 12
years ago Congress has passed a law which has been extended each
year, sometimes 2 years at a time, that gave the Treasury the privilege,
if it wanted to, to call on the Federal Reserve banks to finance any
short-term obligations or debts up to $5 billion. Now, that is still
the law, is it not ?
Mr. MARTIN. That law was passed by the Congress.
Representative PATMAN. And it is up to the Secretary of the Treasury as to whether or not it is used, is it not ? I t requires no action
on the part of the Federal Reserve banks.
Mr. MARTIN. Oh, yes, it requires action. The law gives the Reserve
banks the power but does not make it mandatory on them. We discuss
every instance with the Secretary of the Treasury.
Representative PATMAN. I know, but you cannot refuse to give the
credit, can you ?
Mr. MARTIN. We could. Also, if we thought it was being abused
we could bring it to your attention.
Representative PATMAN. I know, you would bring it to the attention of Congress, but, as long as there is the law, you feel that you are
compelled to finance any expenses of the Government up to $5 billion
directly between Federal Reserve banks and the Treasury without
going through the open market or the banks or any brokerage office.
You are obligated to do that, are you not?
Mr. MARTIN. Not obligated—the Reserve banks have the authority.
I n practice, it is a very short-term operation.
Representative PATMAN. Well, that is right.
Mr. MARTIN. And I know of no instance when it has been abused.
Representative PATMAN. I am not talking about the abuse of it;
I am talking about the use of it; use, not abuse.
Now, the point I am making is why should you have any deposits
in banks at all ? I will not ask you to answer that, because it is really
the Treasury's business when they can call on you any time, and you
will finance any of their obligations up to $5 billion; that is the reason
I say that they should not keep six or seven billion dollars in the banks
all the time; it is unnecessary.
UNITED STATES MONETARY POLICY
237
Now, if the banks need that to compensate them for other things,
why, pay them for it. I do not want to deprive the banks of anything,
but I do not want to keep idle and unused balances there. I am just
trying to show that the Federal Reserve banks may advance to $5 billion to the Treasury at any time, as long as this law is upon the statute
books; that is right, is it not?
Mr. MARTIN. Only if they felt it proper. The authority is one that
is used in connection with short-term advances.
Representative PATMAN. That is right; yes, sir; that is all. I will
not press you on it, Mr. Martin.
Mr. SPROUL. I would question that, Mr. Congressman.
Representative PATMAN. All right, Mr. Sproul, what is your question about it?
Mr. SPROUL. I think the Congress has shown great reluctance to
grant that power to the Secretary of the Treasury to borrow directly
from the Federal Reserve banks, because it was unwilling to have such
a grant of power' except for very short-term use under very special
conditions, and that the whole legislative history of the power wTould
be one which would justify us in coming immediately to the Congress
if the Secretary of the Treasury tried to abuse the power in the way
you suggest.
If Congress wants to indicate that is the way it should be used,
that would be a different matter, but it has not so far, and there iS"
nothing in the legislative history to suggest it.
Representative PATMAN. I do not agree with you, Mr. Sproul. I
have been on the committee that has handled it ever since it first
passed.
Senator FLANDERS. Will you yield for a moment?
Representative PATMAN. Yes, Mr. Chairman.
Senator FLANDERS. I t is my recollection that in the Finance Committee we have considered that authority primarily as a means for
getting past the hump of the income-tax payments. From the standpoint of the Senate, at least, I think we had that purpose primarily
in mind.
Representative PATMAN. That is right; that was given as an illustration. I n other words, there is a certain time that the Treasury
needs money. That was an illustration that lias been given. I t is
given in the House all the time.
But the point is, and the fact remains, that the Treasury has the
power to draw upon the 12 Federal Reserve banks up to $5 billion to
finance its bills; that is the law of the United States Congress, and
signed by the President of the United States; and, for that reason,
there is no reason why you should have these idle deposits in the
banks.
. Now, I will go right ahead. Since the Secretary of the Treasury
is legally enjoined from holding Government bonds, and properly so,
for the reasons that we know, since their value may be influenced by
his official decisions, should the chairman and members of the Federal
Eeserve Board, and the Open Market Committee, of course, be restricted in a similar manner as to trading in bonds and stocks whose
levels can be influenced by monetary decisions? If the public buys
stocks because of the easy money decision of the Board, isn't someone,
the Board, in a good position to profit by advanced knowledge of these
decisions?
55314—54
16
238
UNITED STATES MONETARY POLICY
What kind of rules or regulations do you have, Mr. Chairman, about
members of the Board dealing in Government bonds or stocks on the
market ? Do you have any ?
Mr. MARTIN. I am glad to tell you that I do not own a single stock,
and I do not trade in stocks or bonds.
Representative PATMAN. I am not questioning you personally, Mr.
Chairman, but I am just asking, as a matter of policy, for the Government of the United States.
Mr. MARTIN. I understand that, but I would like to put that in the
record in connection with this case. I do not have a single stock nor
own a bond, outside of series E bonds, personally, because I take my
job that seriously.
So far as rules and regulations are concerned, we do not have any
statutory rule on the part of the Board of Governors. However, the
Board has a rule which is annually called to the attention of every
employee that if he uses confidential information for any improper
purpose he will be subject to appropriate disciplinary action. I know
that the individual Reserve banks have watched this matter very
closely and that their staffs are subject to a similar rule.
We take this matter extremely seriously. I do not believe there is
any rule which would precisely bind people that would be effective.
^ You are depending upon the integrity of this group. Nobody realizes
'more clearly than I do from my long association in markets how easy
it would be to abuse the position that we have; that is why I am very
careful not to make comments on margin requirements or comments
on Federal Reserve policy in open meetings or around the country
because it could be construed by speculators for their own use. I cannot prevent that sort of discussion from going on, but I have been
extremely careful about making any comments of that sort.
Representative PATMAN. I do not bring this up to impugn the
motives of yourself, Mr. Chairman, or any other member.
Mr. MARTIN. I understand that, Mr. Patman.
Representative PATMAN. I am just asking that as a matter of information, knowing that the Government has always been very careful
about things like that, and I did not know of any rules.
Now, you do not have any rules yourself except just each member
is supposed to do what is ethically right and not do anything wrong;
but what about the people who conduct the Open Market Committee?
I read in a financial paper not so long ago that about a hundred
people had something to do with the operation of the Open Market
Committee; is that right or not?
Mr. MARTIN. I do not know the exact number.
Representative PATMAN. Mr. Sproul might tell us about that since
he has charge of the Open Market Committee. I mean the executive
part of it.
Mr. SPROUL. There are not a hundred people who know what the
policy of the committee is and how it is going to be executed.
Representative PATMAN. H O W many know that, Mr. Sproul?
Mr. SrROUL. Really only the members of the committee and the
manager of the system of the open-market account can know that in
its entirety, although the staff of the committee itself will know pretty
largely what the Open Market Committee has in mind, but the rest
of the 100 people that you read about must have been people who
are
UNITED STATES MONETARY POLICY
239
Representative PATMAN. Clerks and stenographers.
Mr. SPROUL (continuing). Clerks and stenographers and secretaries
who do not know what the policy is and could not make any use of
the information they have if they had any designs or desire to.
Representative PATMAN. Do you have any rules or regulations about
the ownership of stocks and bonds, whether it is Government bonds or
otherwise?
Mr. SPROUL. We have the rule that no one in our bank is allowed
to purchase securities on margin. There is no prohibition against
their purchasing securities of any kind outright.
We also have a general rule that no one is to engage in any transactions of any sort, particularly financial transactions, which would
in any way bring the bank or the system into disrepute, and that is
the kind, the only kind, of rule I think you can make to cover this
situation which must place great reliance on the honor and integrity
of the individuals you are working with.
Representative PATMAN. Do you not agree, Mr. Sproul, that since
the Congress has had a standing rule that the Secretary of the Treasury, for instance, could not even own a Government bond, that that is
notice to all other agencies, such as your own, that similar rules should
probably be adopted?
Mr. SPROUL. That is a matter for the Congress to decide. Whether
you get better results from a hard and fast rule of that sort, as to
which there may be legal or technical evasions^ or whether you get
better results by having the general rule and trying in every way you
can by adequate supervision to see that it is enforced, I could not say.
Representative PATMAN. All right.
Now, I will make it short, Mr. Chairman.
To prevent the accumulation of unemployment, and restore employment and production to normal capacity, it is estimated that we should
increase the gross national produt rate by about $30 billion above
the current rate in the next year. A normal capacity gross national
product rate in 1955 should reach $386 billion.
Can we do this, Mr. Martin, and still have a sound money policy ?
Mr. MARTIN. I cannot comment on whether it takes $30 billion of
increase in the gross national product to provide that number of jobs.
Representative PATMAN. Well, we will change that. I t is down
$14 billion from last year, isn't it?
Mr. MARTIN. I want to say that it is my absolute conviction that
inflation will not create jobs and sustain them. If we maintain a
stable price level and a sound dollar, I believe we will create jobs that
will be sustained and that will really add something to our economy.
I think that it would be a delusion to believe that we can disregard
stability, the stability of the dollar, and create jobs by froth of the
sort that occurs often from waste and extravagance and incompetence
and imprudence, and all the bad habits that go alon<r as byproducts of
inflation. If we were to believe that, we would be doing a disservice to
our goal of having as high levels of employment as we can possibly
have in this country.
Representative PATMAN. Which do you consider comes first, full
employment or a stable price level ?
Mr. MARTIN. I do not believe you can separate them. I t depends
on your
240
UNITED STATES MONETARY POLICY
Representative PATMAN. Suppose there is an alternative, I mean,
you cannot have both right at the present time. Which, would you
select?
.
Mr. MARTIN. The definition of the term "full employment" is a
difficult one. But if you are talking about full employment in terms
of having it for just a couple of months and then having the jobs disappear, that is one thing. If you are talking about employment
that is
Representative PATJMAN. Lasting.
Mr. MAKTIN (continuing). Permanent, lasting employment, I believe you can
Representative PATMAN. YOU think the price level should come
first?
Mr. MARTIN. I think it is an important ingredient. I do not know
on which you put the most emphasis at a given time because the level
of employment has an effect on the price level.
Representative PATMAN. I want to ask Mr. Sproul a question.
Mr. SPROUL. May I make a comment on that question %
Representative PATMAN. Certainly, sir.
Mr. SPROUL. I agree with the findings of the Patman subcommittee
of the Joint Committee on the Economic Report that high-level employment and price stability are not necessarily incompatible, and I
would like to see that spelled out in the declaration of policy in the
Employment Act of 1946.
I think those who would seek to obtain high-level employment by a
form of creeping inflation, induced by credit policy, are trying to
correct structural maladjustments, inevitable in a highly dynamic
economy, by debasing the savings of the people. They should tell the
holders of savings bonds, savings deposits, building and loan shares,
life-insurance policies and pension rights, and other small savers, that
a rise in prices of say 3 percent a year is a small price to pay for removing the swings of unemployment.
If our dynamic, growing economy throws too many people out of
work from time to time, we will have to devise further means, resting
on the whole economy, to take care of the situation. "We cannot debauch credit policy, trying to make it do the job, and we should not
steal the savings of the people with one hand, while we promise them
a steady job with the other.
Representative PATMAN. I want to ask you a question, Mr. Sproul:
What was the nature of the Government bond transactions carried out
by the New York Federal Reserve Bank from May 27 to June 10,
1953? What significance, if any, did the $20 million reduction in
the New York bank's bond portfolio have for the investors in the
Government bond market? Did the inter-bank bond transactions
carried out in this period have any connection with the break in
bond prices on June 1 ?
Mr. SPROUL. I cannot speak for every transaction during that
period or on that date, but I would say that the actions of the New
York banks were only one small part of a whole market situation
which developed at that period. Our transactions, as you know, were
wholly in Treasury bills during the period you mentioned.
Representative PATMAN. As I understand it, the Open Market Committee has been in operation for 20 years and the Federal Reserve for
41 years. Before the Open Market Committee was officially set up
UNITED STATES MONETARY POLICY
241
by law, each bank carried on its own open market operations; did it
not?
Mr. SPROUL. Yes, it did.
Representative PATMAN.
One of the first reasons for having any
open market operation was to get more earnings; was it not?
Mr. SPROUL. That was the original reason, but that quickly lost its
meaning. The ultimate reason, and the continuing reason, for the
Open Market Committee is to get coordination of open market operations throughout the system.
Representative PATMAN. Well, naturally, it was easy for a bank to
get Federal Reserve notes and trade them for Government bonds and
keep the bonds and collect the interest. They had earnings that way,
and that is what started the open-market operations, as I understand
it from your testimony and Mr. Martin's testimony in the past. But
now I thought all the banks had to go along together in their bond
selling and buying. I though that your bank, Mr. Sproul, was just a
part of the Federal Reserve System—of course, it is a huge part, a
major part—but it is a part, and that of the bonds that were bought by
the Open Market Committee, you got your share and no more; is that
right?
Mr. SPROUL. We get our proportionate share.
Representative PATMAN. That is what I mean.
Mr. SPROUL. I t is based on the total assets of the Reserve banks
with a formula related to it.
Representative PATMAN. That is what I am trying to say, your proortionate share. Why was it along during that period that your
ank lost about $20 million in Government bonds and the banks, say,
at Boston and at Atlanta, I believe they were, gained about $20
million ? Plow did that happen ?
Mr. SPROUL. Because in the formula which we then used there were
allowances for the differences in the expenses and the reserve needs
of the individual reserve banks. There is an adjustment made at
the end of every quarter, and there may have been an adjustment at
that time which transferred some securities from the New York
bank to some of the other Federal Reserve banks, but it had nothing
to do with the open-market transactions; it was a wholly interna]
transfer of a small amount of securities between the reserve banks.
Representative PATMAN. NOW, the banks engage in no open-market
operations themselves, I mean individually as a bank?
Mr. SPROUL. Under the law, the Federal Open Market Committee
directs the Federal Reserve
Representative PATMAN. That is right. They are compelled to
carry out whatever the Open Market Committee says in the way of
banks?
Mr. SPROUL. That is right.
Representative PATMAN. Suppose wrage rates, Mr. Martin, through
the process of collective bargaining, are adjusted upward, and
threaten a sound money policy. Will monetary policy be pennitted
to adjust itself to wage developments?
Mr. MARTIN. Money policy will have to take each individual situation as it comes along. Now you are talking about wage rates which,
in a country as large as this, cannot be adjusted at least at this time,
across the board. "You would have to be talking about it in a particular segment of industry.
242
UNITED STATES MONETARY POLICY
Representative PATMAN. Well, suppose we put it another way*
Suppose, in order to rid our country of unemployment, it becomes a
real problem, that we have a certain degree of inflation or anything
else you want to call it, expansion, and the cost of production goes up.
Now, what will you do, will you try to have policies, restrictive
policies, that will cause production to go down, or will you increase
the flow or volume of money so that the purchasing power will be
increased to take care of the added production ?
Mr. MARTIN. Monetary and credit policy is just one factor in the
economy. I t cannot make people borrow money if they do not think
they can make a profit on it. Credit by itself is not a source of jobs.
I t is just, as I have said a number of times, a stream or a river that
courses through business and commerce and from which business and
commerce can derive assistance, but it is not in itself a force which
will give us the millennium. I t never will be.
Representative PATMAN. Thank you, Mr. Chairman. I will stop.
I have taken up too much time.
Senator FLANDERS. You have not taken up your full allotment.
The thought came to me as I listened to the discussion that there was
one question that came up upon which we might hear from the presidents from the different Federal Reserve banks. The question was
raised as to the very short timelag which I would think myself was a
little bit unf ox-tunate, between that historic bond issue and the raising
of the mortgage rate from 4 percent to 4=y2 percent.
The question is raised whether that increase was justified by a forthcoming increase in rate or whether it stood on its own? I would like
to know if there are any of the presidents here who would like to
comment on the question as to whetlier there was, previous to this issue,
a satisfactory amount of mortgage money available for financing home
building, and whether they would have felt it necessary to raise the
rate in any event in order to get sufficient funds flowing for home
building.
Do any of you wish to comment on that ? What was the condition
in your area, Mr. Leach ?
Mr. ERICKSON. Mr. Chairman, I might comment that as far as a
satisfactory amount is concerned, that is a very difficult thing to
answer. There were bankers who would not buy mortgages at 4
percent at the time. They had to have a higher rate if they were
going to do that. Both the F H A and VA were pinched in getting
their mortgages out.
Senator FLANDERS. And the lending institutions were not interested
at that time in a 4-percent rate ?
Mr. ERICKSON. That is right.
Senator FLANDERS. Had that existed for some time ?
Mr. ERICKSON. I t was growing in intensity; yes.
Senator FLANDERS. When the rate was raised to 4%, money flowed
more freely into that market, and building increased; was that your
experience, Mr. Irons?
Mr. IRONS. Speaking for Dallas, I would say that our experience
was the same in that during the latter part of 1952 and the early part
of 1953 it was very difficult to get mortgage money at 4 percent Subsequently, when the rate was raised, there was an increased flow of
money into mortgage lending—very definitely.
UNITED STATES MONETARY POLICY
243
Senator FLANDERS. And that resulted in a definite increase in new
housing ?
Mr. IRONS. Well, there have been very substantial increases, yes;
but the big increase has come in more recent times since the relaxation
of the credit terms. However, that increase in the rate did serve to
bring about a better flow of money into the mortgage market and
create a better mortgage market situation.
Senator FLANDERS. I S there any variation of the experience of the
presidents on that matter ?
Senator SPARKMAN. Mr. Chairman, may I intervene there ?
My recollection is not in accord with the statements made. I know
that that pressure was before us on the Banking and Currency Committee for a long time with reference to raising the interest rates.
The interest rates were raised on June 6 or June 3, was it—it was
somewhere about that time.
I believe, if you will check, you will find that it was several months
after that before there was any appreciable easing up of the housing
mortgage; the home-mortgage market. I remember we remarked on
it frequently during that time, and it is my opinion that the thing that
started moving money into the home-mortgage market was not the
increase in the interest rate. As a matter of fact, it seemed for 2 or 3
months to have the adverse effect, to dry it up still further.
I believe that the record will show that there was no appreciable
effect until sometime probably several months after the reversal of the
policy that the chairman referred to was anounced and put into effect.
Now, I think that is something that could very easily be explored,
but in my own opinion, that is what we would find to be true.
Senator FLANDERS. From your point of view and from the experience you have just given, that would seem to raise significant questions
as to the fundamental importance of the interest rate in expanding
business.
Now, is that not a rather serious blow at all the theory of monetary
controls and their effects, at least from your story, which I think you,
knowing you, I am sure you are prepared to document with suitable
statistics—does not your story indicate that the interest rate is not the
all-powerful thing we are accustomed to think it ?
Senator SPARKMAN. I do not know that you could draw a conclusion such as that. I think there are many factors that must be considered in connection with this.
I think the putting out of the bond issue that was discussed here this
morning, produced a shock that resulted in many things that probably
were not regular taking place, and I think that probably was true in
connection with the home-mortgage market.
I am not saying that under normal conditions the increase in the
interest rate would not have poui-ed more money into the home-mortgage market, but I think, first of all, at that particular time, the psychology of the situation was that many people who ordinarily would
have made money available, waited expecting a still higher rate, and
I think others who might have poured it in were afraid of what was
going to happen, they were waiting to see.
Senator FLANDERS. Mr. Fulton?
Mr. FULTON. I n the investment of funds by banks, there is one
factor that all banks look to, which is liquidity.
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UNITED STATES MONETARY POLICY
A t that time, when the mortgage market became very tight, banks,
by and large, had rather full portfolios of mortgage loans. The
banks had rather large demand deposits which could not be invested
in mortgage loans. Such deposits go largely into short-term securities and business loons. Mortgages had been in supply and had been
absorbed in large quantities. Regardless of interest rates, mortgages
will not be absorbed by the banking system when it feels that it is
impairing its liquidity by taking on more. That, I think, was part
of the situation at that time. I t was not wholly an interest-rate
problem but also a matter of liquidity, so far as the banks were
concerned.
Subsequently, funds became available as time deposits grew and
business loans fell off. Also banks improved their liquidity by achieving a better distribution of long-term and short-term obligations. But
primarily it was the availability of funds from the standpoint of
maintenance of liquidity and the ability of banks to meet their obligations that influenced that market at that time.
Senator FLANDERS. Any other comments on this ?
Senator GOLDWATER. Mr. Chairman, I would like to comment on
this because I recall, with Senator Sparkman, having sat through
these hearings. There seems to be, from the figures in the Economic
Indicators of November of this year, on page 17, very little change
in construction during the particular period we have been talking
about.
If we look at the 1953 monthly average we find 2.9, 2.8 billions
of dollars; that is 2.9 billions monthly average, and if you go through
the year of 1953 by months from September, you find that that change
is very, very little, and if you bring it un at the present time, the
change is very little; I think that substantiates the remarks of these
gentlemen that the law of supply and demand probably influences the
building a lot more than interest rates.
Senator FLANDERS. Have you any other questions you would like
to ask?
Senator GOLDWATER. I have none; they may come.
Senator FLANDERS. All right.
Senator SPARKMAN. Mr. Chairman, it has just been pointed out to
me that in the Economic Indicators on page 18, showing the housing
starts, it shows that they continued to go down, and were going down
rather steeply right up until December of 1953, so there was no early
response to the increase in interest i\ates.
Senator FLANDERS. Yes.
Representative PATMAN. I t was May 3 when it was announced.
Senator SrARiorAN. Yes; I believe that is true.
Well, back in May or June 1, and you can see that the curve is going
down rather sharply right on through the end of the year.
Senator GOLDWATER. I am talking about dollars, you are talking
about building
Senator SPARKMAN. I am talking about housing starts which represented, of course, mortgages that went into effect.
Senator GOLDWATER. I disagree. Mortgages are reflected by money,
I do not think by starts, but tliere again I feel that the facts that were
brought out during our hearings were that the market had become
rathei saturated, had a greater effect on starts than the fact that
UNITED STATES MONETARY POLICY
245
the interest was 4 or 4 ^ or any rate we might have put it at or
agreed to put it at.
Senator SPARKMAN. Well, I don't agree that the market—that we
had enough houses, if that is what you mean by the market having
become saturated. They very fact that during the present year we are
building 1,300,000 houses, that many, indicates there was no saturation, and still is none.
Senator GOLDWATER. There was a saturation at that point or they
would have been sold. There has been an adjustment period as there
has been in automobiles, as there has been in everything.
The point I wanted to bring out was in dollars to our economy
there hasn't been any appreciable fall-off or increase anytime during
the period we are talking about.
Senator SPARKMAN. I don't follow you, in view of the number of
starts. That is what counts in the housing market.
Senator GOLDWATER. We are talking about mortgages, and that
relates to the dollar market.
Senator SPARKMAN. The two certainly go together.
Senator FLANDERS. Senator Douglas, have you any questions?
Senator DOUGLAS. Yes, sir; I would like to have the gentlemen discuss what seems to have been a change in Federal Reserve policy
beginning in December of 1952 and January 1953 from that which
had prevailed during the period of the so-called accord.
I not only approved of that accord, but possibly had something
to do with its conclusion, and I think it was a very great step forward.
I would like now to point out what I have been trying to point out
at previous meetings, that in the ensuing 21 months, namely, March
1951-December 1952, we did not have what Mr. Martin has referred
to as a "hard money" policy.
We moved instead from an easy money policy into, say, that we had
a flexible money policy, because during that period of 21 months the
index of fiscal production rose by 6 percent on an unadjusted basis
to 9 percent on a seasonal or adjusted basis, somewhere between 6 and
9 percent.
During that period, too, member bank reserves in the system rose
by 5 percent, approximately, that is. The Reserve was buying Government securities at approximately the same rate as the index of fiscal
production advanced.
I t is true that loanable funds by banks were increased somewhat
more than that, but the net result was a stable price level and maintenance of full employment.
I congratulate the Federal Reserve System and the Open Market
Committee for the work which they did during these 21 months.
The question I raise is whether it was wise to change this policy, as
I think it was changed in December of 1952 or January 1953.
Now I would like to point out that during the ensuing months according to the Reserve's own statement in its tabular form here, that
the Open Market Committee sold or redeemed $800 million net of
United States Government securities or certain other adjustments so
that member bank reserves at least did not increase. Loans by banks
and demand deposits declined.
I think that the open market operations had some effect on this.
Loans by member banks decreased by about 6 percent, but the index
of fiscal production during this time, from December to April, actually
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UNITED STATES MONETARY POLICY
rose, rose on an unadjusted basis by 4 percent, on a seasonal basis by
approximately 3 percent.
This is the question I would like to raise: Whether the Reserve did
not take fright at something which was nonexistent, namely, inflation,
in fact there was no inflation, that the price level had been stabilized.
But the Reserve adopted a restrictive policy at a time when a restrictive policy was not needed, and failed, at the very least to increase
the money supply at a time when it should have been increased, and
possibly actually diminished the money supply, with the result that it
had some adverse effect upon the level of business activity, and contributed to the decline of business which set in during the summer of
1953.
Now this is a question I should like to have answered.
Mr. MARTIN. I will accept your amendment of the word "hard" to
"flexible," if you would like, Senator, to start off the discussion. I
will accept your amendment of the word "flexible" for "hard."
Senator DOUGLAS. I did not think you adopted a hard money policy
in March 1951, and I may say I am oposed to both a hard and an easy
money policy as evils in themselves.
What I want is a supply of money which, taking into account
velocity, moves with the volume of trade and production, to maintain
two purposes: namely, substantially full employment and substantial
stability in the price level, and I want to suggest that for 21 months
both of those conditions were satisfied.
Mr. MARTIN. I wouldn't agree that they were completely satisfied.
I hope that all the members here will discuss this.
In the early months of 1953 there was forming what my colleague,
Mr. Sproul, has called a bubble on top of a boom. We were endeavoring to stem it, and perhaps were slow. There was in the economy at
that time, as I see it, a great deal of what I have described before as
waste, extravagance, incompetence, inefficiency, and imprudence. All
that was a part of the hysteria that went on in the post-Korea days.
We finally reached a point where we permitted the credit mechanism
to function once again as one of the governors in the economy.
Senator DOUGLAS. What were you afraid of? Production increasing, prices were stabilized, and there was substantially full employment?
Mr. MARTIN. Look at what was happening to inventories, for example. Do you think you can just build up inventories more and
more and let production go up higher and higher, and that there will
never be any adjustment, particularly when shortly thereafter there
was going to be an end to the constant increase in defense expenditures I
Now, all of those were factors that had to be taken into account in
our policies. As we approached the spring of 1953 we had the expectations of the market revolving around all of these developments. Some
of them were misconstrued by the market. I t seems to me that you
can't eliminate the fact that inventories were rising rapidly at the
same time that production was continuing very high.
Senator DOUGLAS. Well, high production is not evil.
Mr. MARTIN. I didn't say it was evil. I am just talking about it in
relationship to inventories and the fact that we were heading towards
a precipice.
Perhaps we jammed on the brakes at one point a little bit too tight.
I have admitted this. We are certainly not infallible in our judg
UNITED STATES MONETARY POLICY
247
ments. Within a few areas we are bound to make some mis judgments.
But by and large it seems to me that the situation was kept well in
hand. I believe we would have had much more unemployment and
further distress if we had not pursued those policies.
Senator DOUGLAS. I think you make a mistake, myself. There is
a further inconsistency which I find.
You say that you wanted to reduce latent inflationary tendencies
back doors which did not manifest themselves in the price index, but
at approximately the same time, namely February of 1953, you diminished the margin requirements for the purchase of securities from 75
percent to 50 percent.
Now, that is, of course, a directly inflationary move so far as the
prices of stocks are concerned, namely, that it permits a much greater
purchase of stock with a small amount of individual cash, and I fail
to see why you should be wanting to deflate one section of the market
and inflate another at the same time. I think this shows gross inconsistency. I would be interested in your answer to that.
Mr. MARTIN. I can take a long time, not on that question, but on the
inconsistencies that were bound to develop after the Korean hysteria.
Before the "accord," we invoked almost every possible control short
of the one control which would have been effective, that is, general
control, to try to restrain the inflation that followed the Korean outburst. Now, in the early stages of that
Senator DOUGLAS. Well, my objection is that when Korea started
you did not do that; that instead, you became the handmaiden—I don't
think you were on the Board then, but that the Reserve became the
handmaiden—of the Treasury and permitted a greater increase in
prices than was needed.
My criticism of the Reserve was that during that period they contributed to inflationary forces, so I think the record of the Reserve up
to 1951, March 1951, was a bad record, largely because the Tx*easury
turned on the heat and the Reserve didn't have the courage to restrain
itself. But I think from March 1951, to December of 1952 it was a
good record.
Now you moved in the other direction. Having given in one period
excessive doses of castor oil and then getting the organism on a healthy
basis for 21 month, you proceeded to dose the organism up with excessive does of bismuth.
Isn't there a happy medium which can be maintained? Having
reached virtue for 21 months, isn't it possible for the Federal Reserve
to maintain it for a further period?
Mr. MARTIN. Senator, we are struggling for the happy medium all
the time.
Senator DOUGLAS. I don't think you have succeeded.
Mr. SZYMCZAK. Mr. Chairman, I think the Senator recalls certain
facts, because the Senator was very closely identified with some of
them at the time. If we made a mistake in pegging the Govermnent
security market, it was made at a time when the war began with Pearl
Harbor. We pegged the Government security market at that time
to help the Treasury through the financing of the war, and that was all
to the good. Nobody could complain about winning the war. We
needed money to win the war. That pegging was done on our own
initiative.
248
UNITED STATES MONETARY POLICY
Now, the difficulties that arose were subsequent to the end of the
Avar. We did try to unpeg, and we did unpeg the short-term Government security market. The short-term rates were up as a result.
We continued to move in that direction together with the Treasury,
and, of course, it was very difficult to unpeg once we had pegged and
continued the pegs too long after the war, as you know. Many people who had securities and valued them, at the pegged price, banks,
individuals, insurance companies, and many others, in addition to the
Treasury, did not want to see a drop in the price of the securities they
held. That would make the refunding by the Treasury more difficult.
And, therefore, when we finally did get to Korea, we announced
in August—Korea was in June 1950—we announced a higher discount
rate, and also not only announced the higher discount rate but
announced a tight money policy throughout.
I t was from that point on until March that we had the discussions
with the Treasury, and while we kept on pegging the long-term securities, you will recall, we kept dropping that long-term support price
to par. Our attempt was to unpeg the long-term market.
We finally did unpeg in March 1951, and by the end of that year
we completely unpegged the Government security market. You, Senator, will recall that because you were very helpful, particularly at
that time.
Now, as we got into the latter part of 1952 and early 1953 we did
have a capital situation, we did have abnormal inventory increases,
and the demand for credit kept increasing—it was partly psychological—for in a cyclical, dynamic, competitive economy such as ours the
greater the rise in demand for credit to build up inventories the greater
the* urge for more credit. True, the price level was not rising and
production and employment were at high levels.
But what we were trying to do was not to take away credit for
growth, but not to supply the amount of credit that was being asked
for by the market to build up inventories to unsound and unstable
heights. We stood on the side line, not giving the reserves that building up of inventories required in order to expand credit further and
thus expand the inventory and allied elements further.
Subsequent events proved that course to be right, because it was
the inventory condition of industry and others throughout the country, plus the reduction in defense expenditures that came in the second
half of 1953, that brought on the downturn. I t would have been much
worse had we allowed the inventories to increase to even greater heights
through an additional supply of credit.
Senator DOUGLAS. But in your tabular statement, exhibit A, you say
from January to April you sold or redeemed $800 million net.
Mr. SZYMCZAK. We were buying as well as selling, but that was net;
yes.
Senator DOUGLAS. You thus diminished member bank reserves, and
therefore diminished their lending capacity.
Mr. SZYMCZAK. The essence of that situation was that business was
seeking much more credit because of the great demand to build up
inventories—which demand was feeding on itself in a competitive
economy.
They were just building up inventories hand over fist, and the
demand was so great that to the extent we didn't satisfy the demand
by adding the reserves required, of course the rate went up because
UNITED STATES MONETARY POLICY
249
of the demand and supply relations—and not because we pushed up
the rate.
Senator DOUGLAS. Well, are you happy—may I ask you this—at
having made such a large increase in funds available for the purchase
of stocks ?
Mr. SZYMCZAK. Well, that is a different question because the total
amount of credit involved there Avas not large. I t was about 1 to 2
billion, so we wished to make an equitable adjustment in February
1953, and therefore we placed margin requirements on a basis where
we could increase or decrease margin requirements as required rather
than move by 25 percent once in a while and thus dramatize our action
beyond its actual worth.
I t was merely an adjustment that gave us a better base from which
to operate. I t wasn't at all related to the credit or economic situation
because the amount of credit in that sector of our economy was relatively small.
And, of course, it doesn't necessarily relate itself to price. I t does
relate itself to volume.
Senator DOUGLAS. The more you stimulate purchases, the greater is
the effect on the general level of stock prices. The low margin requirements in the twenties certainly contributed in part to the stock market
boom in the late twenties.
Mr. SZYKCZAK. Of course, as you know, when the S E C and margin
requirements were considered by Congress there was a question
whether margin requirements shouldn't because of other considerations be placed in the SEC, and somebody suggested that since it was
credit no matter what the other considerations that it should be placed
in the Federal Reserve, and that is how Congress placed it in the
Federal Reserve. But, so far as the actual amount of credit is concerned, it is and was relatively small—especially as related to other
credit sectors of the economy.
Senator FLANDERS. Mr. Talle, have you any questions you would
like to ask?
Representative TALLE. NO, thank you, Mr. Chairman.
Senator FLANDERS. I might say that at times we get confused with
some of these complicated subjects.
I have a very simple one which I would like to present. I would
like to have a poll of the members of the Federal Reserve Board and
then have the presidents of the Federal Reserve banks polled on a
simple question, but I will first ask you if you are willing to be
polled. We tried it on the economists yesterday, and they were all
"willing.
This is the question taken from the report, the Patman report, of
the 2d session of the 82d Congress:
We believe that to restore the free domestic convertibility of money into gold
coin or gold bullion would militate against rather than promote the purposes
of the Employment Act, and we recommend against such restoration.
First, I would like to ask the members of the Board whether they
are willing to be polled on that subject, convertibility of gold.
All appear to be willing to be polled, so will those who favor the
free domestic convertibility of money into gold coin or gold bullion
raise their hands?
t Mr. VARDAHAX. Mr. Chairman, may I ask if you refer only to the
immediate foreseeable future?
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UNITED STATES MONETARY POLICY
Senator FLANDERS. Yes; foreseeable future; let's call it that.
All in favor of convertibility in the light of the foreseeable future,
raise your hand.
(There was no showing of hands.)
Senator FLANDERS. All against.
(There was a showing of hands by a majority of the group.)
Mr. SZYMCZAK. I don't think you can answer it "yes" or "no." I
think the question is whether we wish to return to the institutional
method once adopted, or whether we think we can use the powers we
have without going back to gold convertibility.
Senator FLANDERS. You think we can do what we want to, without
going back to convertibility ?
Mr. SZYMCZAK. I don't think we need it. We can get along without it, but I have no very strong objection to it.
Senator FLANDERS. We have, I think, a clouded but not too direct
a poll on that. Perhaps I will put it for the presidents in this
form:
I will again read the paragraph and ask if you agree with it. Are
you willing to be polled ?
Mr. SFROUL. I would prefer not to be polled on such a question,
under such conditions, although my views are very well known.
Senator FLANDERS. You are excused.
Mr. SPROUL. Thank you.
Senator DOUGLAS. I think the record should be very clear on this
point, that Mr. Sproul is not pleading the fifth amendment.
Mr. ERICKSON. Mr. Chairman, is there a time limit there?
Senator FLANDERS. No, there is no time limit in this statement.
Are you ready, however, to express approval or disapproval with
the statement? All who approve, raise the right hand.
Representative PATMAN. Why don't you read it off, Mr. Chairman.
We have had so much discussion, I think it has been lost sight of.
Senator FLANDERS. This is the proposition:
We believe that to restore the free domestic convertibility of money into gold
coin or bullion would militate against rather than promote the purposes of the
Employment Act, and we recommend against such restoration.
All who feel they can accept that statement raise their hand.
(There was a showing of 10 hands.)
Senator FLANDERS. All opposed ?
All who wish to amend the statement by inserting the words "in the
foreseeable future," raise their hands.
(There was a showing of hands.)
Mr. BRYAN. Mr. Chairman, I would have liked to have voted for
it because it would have made central banking so easy.
Senator FLANDERS. YOU might just explain yourself on that.
Mr. BRYAN. Well, last year it would have been very simple when
the Atlanta district was losing reserves, I would have raised the
rediscount rate to attract them back, and so forth and so on. I would
have had no qualms, no problems of intellect or conscience.
Senator FLANDERS. D O you want it that way ?
Mr. BRYAN. NO.
Senator FLANDERS.
I think we got a vote on that. I hope there will
be no recount.
I just received word that I must leave a little bit earlier than I had
intended to.
UNITED STATES MONETARY POLICY
251
Is there anyone who wishes to proceed with further questioning?
We have quite a record already.
Senator DOUGLAS. Mr. Chairman, I don't wish to proceed with any
further questioning, but I am told that there is a report of an ad hoc
subcommittee of the Open Market Committee dealing with some of
the questions discussed this afternoon, and I request that it be made
part of the hearings.
Senator FLANDERS. I am not quite sure what documents wou are
referring to, Senator Douglas.
Senator DOUGLAS. I believe it refers to a point which you raised
earlier, at the very beginning of your questioning this afternoon.
The documents, since they are documents either of the Open Market Committee or of the Executive Committee, are naturally not
known to Members of Congress. I naturally am not certain of the
exact content, but I think they will be known to the Open Market Committee and to the subcommittee itself.
Senator FLANDERS. YOU are not suggesting the minutes?
Senator DOUGLAS. NO, no; the report.
Senator FLANDERS. The report of the Open Market Committee ?
Senator DOUGLAS. The report of an ad hoc subcommittee.
Representative PATMAN. YOU mean, it made a report today?
Senator DOUGLAS. No; it was made earlier.
Senator FLANDERS. Mr. Martin, I would like to have you comment
on that. I am not just clear what the document is.
Mr. MARTIN. I" think the reference is to an ad hoc subcommittee
report which was made on the subject, referred to at the start of this
hearing, on which Mr. Sproul and I are in disagreement.
Senator FLANDERS. I t would seem to me that the disagreement was
quite clearly expressed. I wonder what more there is in the ad hoc
report? Does it censure eitherof you?
Mr. MARTIN. I t doesn't censure either of us. I t contains analytical
and descriptive material, as well as recommendations.
Representative PATMAN. Does it condemn you?
Senator FLANDERS. Yes, or commend you?
You feel that it was descriptive material; did you say ?
Mr. MARTIN. Well, as far as I am concerned, I am perfectly willing
to make it available to the committee for publication, if they wish it.
Senator FLANDERS. I t would seem to me offhand, Senator Douglas,
that we had a fairly clear expression of the difference of opinion between the two men.
Senator DOUGLAS. Mr. Chairman, I was the one who 2 years ago
Jttoved that the very spicy exchange of correspondence between the
Treasury and the Federal Eeserve Board in 1950 and 1951 be made
part of the official records.
Mr. Martin at that time was very reluctant to have those documents
brought forward, but they were published, and I think they contributed greatly to an understanding of the monetary history during
the period 1950-51. Now, since those documents were published, I
think they did, in general, help everybody.
I think the publication of this document would be of some assistance. I n short, I believe that the Federal Reserve, the Open Market
j^ommittee, should not conduct their operations with the secrecy which
has previously attended them, that the more we have an airing of
differences on these matters, the better educated Congress and the
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UNITED STATES MONETARY POLICY
public will be, that sunlight is not to be feared, that honest differences
are not to be feared, and that there is nothing quite like facts and
knowledge.
Senator FLANDERS. We will ask the Open Market Committee, then,
to make that available for inclusion in the record.
Mr. SraouL. I would like to say something on that, Mr. Chairman.
I have been, and continue to be, of the view that this was a working
paper, prepared by an ad hoc committee of three members of the
Federal Open Market Committee for the consideration of the full
committee, not as a public document.
I believe it would be a. bad precedent if we began publishing working papers of the committee, inhibiting and corroding free discussion
within the committee.
I n this case, to complete the record would require the publication
of all letters and documents commenting on the ad hoc report prepared by the majority and minority members of the Open Market
Committee. The ad hoc committee report did not have unanimous
acceptance.
There would inevitably be a lot of deadwood in this material. There
were 14 items of action culled out of the ad hoc committee report, but
only 3 of these were of significance so far as present policy is concerned, and only 2 of these 3 recommendations—confining open market operations to short-term securities and support of Treasury financing operations—have been the subject of continuing debate.
If there is a real public interest in these two matters, the way to feed
that interest is by public discussion of these issues, such as we have
today, uncluttered with a lot of extraneous material such as is included
in the ad hoc committee report. The answer of the Chairman of the
Board of Governors to question No. 3 of this subcommittee's questionnaire is an example of the kind of discussion of these issues which I
would say is constructive. I have tried to present my opposing views.
I regret to say that the public interest in these matters does not seem
to be great nor intense. Tlie minor clamor for publication of the
ad hoc committee report, with few exceptions—and this does not include Senator Douglas—has come mostly from the curious, or those
who think they see a chance of stirring up trouble within the System,
or between the System and the Congress. I would not pander to that
curiosity, or to the decisive urge.
This does not mean that there is anything that needs to be hidden
or covered up in the ad hoc committee report or that we want to shut
out the sunlight. There isn't anything to be hidden in the report. It
merely means that publication of this internal working document is
not necessary if we want to discuss soberly and constructively the issues of current policy, which, I believe, would benefit by more informed discussion, both within and outside the System.
Mr. VARDAMAN. Mr. Chairman, may I, as one member of the Board,
gladly follow the lead in this instance of Chairman Martin, who states
that he sees no objection to the publication of the ad hoc report.
I regard the ad hoc report as far more than a working paper. If,
when publication of the ad hoc report takes place, it becomes advisable
to reveal documentary evidence filed with the Board in the form of
letters and other forms connected with it, then we should give those
papers, if you please, to this committee for editing before publication,
UNITED STATES MONETARY POLICY
253
but I would like very much to see the ad hoc report published for the
information of this committee.
Mr. BRYAN. Mr. Chairman, I would like to say that I also support
the publication of that report.
I had the honor to be a member, and I think the committee would
be in error if it believes that it was a mere working paper. We have
had here a most fundamental attack upon the policy of the System.
I believe that this committee deserves the whole history out of which
that policy was evolved.
Senator FLANDERS. I would suggest to the committee that this material be placed in its hands, and that then the committee itself, the
subcommittee itself, determine on the use of the material, if that is
satisfactory. (See statement by Chairman Flanders on action taken
on ad hoc subcommittee report, p. 257 and following.)
Mr. WILLIAMS. Mr. Chairman, may I suggest also that the subcommittee may wish to call someone into consultation to get the implications of full disclosure here.
Senator FLANDERS. I will be glad to have comments from all those
concerned as to significances which don't appear in the material.
Representative PATMAN. Mr. Chairman, I ask unanimous consent
that when it is received that it be left up to the chairman and Senator
Douglas as to whether or not it goes in.
Senator DOUGLAS. Oh, no; I am not a member of the subcommittee,
so I should not serve on it. I think you should serve, Congressman
Patman.
Senator FLANDERS. I regret that I must go.
Representative PATMAN. I want to bring up one question. These
people are so cooperative, I want to ask them what is going to happen
in the next few months.
Senator FLANDERS. We will have a lot of hearings in January and
February when the full committee will consider these matters.
Representative PATMAN. I bow to your judgment, Mr. Chairman.
Senator FLANDERS. Additional statements to clarify the presentation can be offered for insertion in the record.
(By direction of the chairman, the following is made a part of the
record:)
(The following comments on the Treasury and Federal Reserve statements of
December 6, 1954, to the Joint Committee on the Economic Report have been
submitted by Edward C. Simmons, professor of economics, Duke University,
Durham, N. C, in response to an invitation by the subcommittee to present
material for inclusion in the record:)
The statements of the Treasury and the Federal Reserve reveal that monetary
and debt-management policy is formulated on only vague and indefinite criteria.
Such things as stability and growth of the economy are frequently mentioned as
having a bearing on policy matters, but these concepts are not reduced to objective criteria. One cannot tell whether or not the desired goals have been
reached. Both agencies express satisfaction with their achievements, yet both
seem to reveal uncertainty as to events preceding and following the downturn
in the spring of 1953. In view of the admitted inability to forecast the faith
expressed in ability to apply discretionary judgment is quite remarkable.
The Treasury's expressed view is that floating debt can be excessive and also
that long-term financing may not be undertaken when long-term funds are needed
to finance private investment outlays. This may explain why the Treasury does
not bother to argue the case for funding. Much is made in the Treasury statement of the quite modest achievements in the direction of lengthening maturities.
The Federal Reserve statement is very long and very technical. It provides an
abundance of information on recent central bank operations, particularly as to
sales and purchases of Government securities, although the attempt to expound
55314—54
17
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UNITED STATES MONETARY POLICY
w h a t is meant by "preventing disorderly conditions" is hardly successful. On
monetary policy proper, the outcome is only slightly better. Year-to-year changes
in bank reserves are commented upon, but one cannot be sure t h a t what happened w a s the result of design or of conjecture. Similar changes in the
economy's stock of demand deposits a r e discussed, but one never learns what
should happen to this most important economic quantum, nor can one tell
whether the Federal Reserve h a s been successful in bringing about the result it
desired. The discussion of monetary policy is conducted along with the discussion of a great many other matters, and one cannot always tell whether these
matters a r e means or a r e ends of the same order of importance as monetary
policy.
At various places in the Federal Reserve statement one encounters language
such as policy is "* * * to influence the level of bank reserves and the money
supply in accordance with seasonal requirements, the capacity of the economy
to produce goods and services, and suitable growth in t h e economy." Obviously,
a target so poorly defined can never be said to have been missed.
Question No. 4 is allocated only i y 3 pages of text, although other answers
extend over much more space. Reference is made to a Federal Reserve statement
to the P a t m a n subcommittee and to an appended 16-page reprint from the Federal
Reserve Bulletin. Both of these, as the reply indicates, are concerned with describing the complexities of the monetary mechanism and only incidentally if
a t all with answering the question, "How much money does a n economy need?"
Some may doubt if question No. 4 is answered by saying t h a t monetary policy is a
complex m a t t e r upon which the Federal Reserve brings t o bear its best judgment
Specifically the lengthy statement cast little light on the causes of the marked
seasonal and other short-run fluctuations in member bank reserves and the stock
of money, although these would seem to be subjects for comment in a discussion
of monetary policy.
Neither the Federal Reserve nor the Treasury may be said to have failed to
answer the questions. Much of the difficulty lies in t h e questions themselves.
They do not call for incisive replies.
(The following memorandum was submitted December 8, 1954, in
response to the invitation by the subcommittee to present material for
inclusion in the record: )
MEMORANDUM TO SENATOR FLANDERS, C H A I R M A N , SUBCOMMITTEE ON ECONOMIC
STABILIZATION, J O I N T COMMITTEE ON T H E ECONOMIC REPORT
(By A r t h u r R. Upgren, Dean, the Amos Tuck School of Business Administration,
D a r t m o u t h College, Hanover, N. H.)
i—LIQUIDITY
The two ideas I would like to forward a s being the major responsibilities of
our banking system a r e assistance in avoiding deep economic declines and acceptance of the responsibility to maintain liquidity. I think the void in liquidity
all through the latter 1920's and up to 1933 is simply t h e negative of too much
credit inflation which we so commonly think of a s coming with wTars. When we
have such credit inflation we have rising prices. Similarly wthen the banking
system in short of liquidity, we have our busts and s h a r p falling prices. Each
is r a t h e r inexcusable but of the two, the existence of illiquidity is by far the
most needless and most damaging.
This can be illustrated by the record of the banking system. Up to the end
of the 1920's our banks in the Midwest were very illiquid. Country banks probably had about 10 or 12 cents on each dollar of deposit in liquid assets. Out in
t h a t section of the country when the break came, something of t h e order of
15 to 22 percent of all deposits were withdrawn. T h e net result was that
in the United States 15,000 banks failed from 1921 forward. Some readjustment immediately following the First World W a r was inescapable but the loss
of t h e banks, the absence of liquidity, and t h e colossal damage inflicted on tbe
American people following the year 1930 was mostly needless and could probably
have been avoided if we had discovered some way to create the needed liquidity.
Today all the banks a r e extraordinarily liquid and the western banks are more
liquid than the banks of Wall Street. In Denver this summer bank statements
released a t t h a t time revealed a liquidity r a t i o ranging from CO to 75 percent.
Comptroller of t h e Currency, Ray Gidney, recently reported t h a t all the member banks were 62 percent liquid.
UNITED STATES MONETARY POLICY
255
Thus we have solved the problem of liquidity and in fact, we probably have
an oversurplus of liquidity in the banks a t this time.
But this liquidity is surely "going to run out" sooner or later.
One recent estimate suggested that total commercial bank credit outstanding
in 2000 will be a t least .$2,000 billion. If it is, t h a t will be about the slowest r a t e
of increase we have ever known for such a period.
If we should have bank obligations of that size, we would need a banking system which would be a t least 20 percent liquid, or better, 25 percent. This will
call for a liquidity in absolute amount of about 400 to 500 billion dollars. You
will readily appreciate t h a t is far short of the liquidity which is likely to be
had by the banking system on a basis of scanning of all the liquid assets which
might come to the banks. I think our national debt is not going to be appreciably increased; I think Europe is going to retain most of the world's newly
mined gold; and I am not inclined to think that short-dated liquid paper of the
business system will be developed in any large amount.
Thus we could say t h a t we might, by 1973, be lulled into such a state of complacency by the liquidity we then shall have enjoyed for 28 years, t h a t we could
have a repetition of 1873. The banking system already is using a fair share of
its liquid assets and certainly will be expanding its deposits as soon a s we have
further economic growth and expansion which is probably proceeding a t the very
present time. This is indeed a long-run problem. I t will be a problem for the
next 15 to 25 years. B u t its delineation and the experience we have had with
it in the past, reveals how completely we have ignored it.
If memory is correct in this matter, in 1S57 and in 1S93 the British Parliament indemnified the Bank of England for any damage or loss t h a t might be
caused by its overissue of bank notes. T h a t overissue of bank notes broke the
extreme tightness in the money markets on both of those occasions. Y e t . i n
1933, 40 years after one experience and 85 years after the other, we got into
the same kind of a jam and it was the central bank which did not perform the
function. I t accepted failure. Banks were needlessly sacrificed because the
central bank and the Treasury did not provide liquidity.
If a crop is to be grown in the arid West, water must be sprinkled upon the
fields. Out in Minnesota and Wisconsin farmers a r e now instructed by the
State universities in the techniques to be followed to grow more t h a n 100 bushels
of corn per acre. To do so fertilizer must be spread upon the fields in very
large amount.
This analogy may be used for an economy. If it is to survive the shocks and
moderate recessions, then t h a t economy must be sprinkled generously with
liquidity. I think the struggles of the American people for 12 years reveal this
very fact. I n 1837 we so lacked liquidity t h a t the State of Wisconsin passed a
law making banking illegal for approximately the same length of time t h a t prohibition made liquor illegal about 80 years later. T h e people were disgusted
with a banking system t h a t could break so completely. We only need remind
ourselves of l a t e r dates of other illiquidity. These were, as I remember, the
outstanding ones when financial crashes made the most noise, 1857, 1S73, 1SS4,
1803, 1907, 1921, and 1933.
Today we have the Employment Act of 1946 which has been considered the
economic capstone of all economic and financial policies of the Federal Government. I am sure t h a t to promote t h a t high level productive employment for the
people, we shall find ways and means to increase debts, "the promises men live
by" as H a r r y Scherman once defined debt.
I I — F U T U R E DESIRABLE FISCAL AND MONETARY POLICY
I now t u r n very briefly to the side of monetary policy for the future. I t
seems to me t h a t this can be simply stated. The American people are very
literate, fiscally speaking, as has been evidenced by their willingness to bear
taxes. In t h e F i r s t World W a r we produced about one-third of Government expenditures by taxation and prices fell only a little short of reciprocally short
of tripling. T h e wholesale price index went to 247. In World W a r I I we taxed
f
or 40 percent of total expenditures—and there was no improvement in this
ratio when there could have been the most improvement in this ratio, namely
in 1944. In consequence, prices almost doubled, the index rising to 190. After
Korea, at least except for one larger deficit in fiscal J u n e 30, 1953, wo taxed for
95 percent of total Federal expenditures. The net result h a s been t h a t t h e inflation in wholesale prices has been only 10 percent and in consumer prices only
about 15 percent. In addition, we h a v e had remarkable stability of the price
level for %y2 years. The rise in t h a t period, which h a s been slight in t h e con-
256
UNITED STATES MONETARY POLICY
sumer price index, has been wholly an adjustment to the needs of the earlier,
1950-51, sharp rise in wages. It has not been the result of any recent inflationary
pressure.
Moreover, as a result of this high rate of taxation we have the happy consequence of now being able to reduce taxes as rapidly as defense expenditures are
being reduced. That has been very stimulating to the economy in the past year.
In 1946., and the years following, defense expenditures had to come down by
$54 billion, or from $100 billion of spending to $46 billion of spending before we
could have any tax reduction on the basis of the $46 billion tax revenues we then
had. Happily defense expenditures declined by almost $68 billion so that we did
have tax reductions which I have estimated were worth the difference of about
$14 billion. But those tax reductions were only $1 for each $5 of expenditure
reduction.
In the last year we have been able to have almost $1 of tax reduction for $1
of defense expenditure reduction and still retain a balanced budget. This tax
reduction has been sufficient to sustain personal disposable income without any
diminution at all despite a decline in personal incomes (before taxes) which decline has been caused by somewhat shorter hours and somewhat increased unemployment, slightly offset by some increases in hourly wage rates. In addition,
this tax reduction has been able to convert the declining earnings of corporations due to an approximate 7 percent decline in sales, into an absolute increase in profits for most companies. The importance of this increase in profits
is that a good record of profits is the most important single requirement for a
good record of continued high capital investment by industry. That continued
high investment is expected now for 1955, now seems likely, according to recent
reports.
What is needed is education to the fact that monetary policy should be flexible
and liberal at any time when there is unemployment above, say a 3-percent
figure, or about 2 million unemployed. Moreover, that liberality and easiness
in monetary policy should continue until the reduction in unemployment comes
at a very much slower rate and there is a tendency toward wage rates and toward
price levels to rise. That is the only guide I would give for monetary policy. It
is the guide that when we have unemployment, policy should be liberal and
generous and there should be tax reductions. As unemployment subsides and
does not seem to be able to drop any more, nor employment rise, and as prices
tend to rise somewhat and especially wage rates rise, then monetary policy should
be restrictive.
+
This leads to the fact that the simulation of an economy must, however, come
primarily out of fiscal policy. Tnen when restraint is needed, since taxes are
said not to be something the American people will vote quickly, monetary policy
can be used to restrain that growth of credit at "too fast" a rate. "Too fast"
means, of course, that the rise of prices is beginning and the rise in wage rates
at an increasing rate becomes apparent and total employment is not appreciably
lifting—barring, of course, a rise in the labor force.
Such a policy even if somewhat slowly applied at times, here I refer to the
restraining monetary policy, will provide the liquidity which the country needs.
I would like to think that we would be imaginative enough, and abstract
enough in our thinking as was Gustave Cassell, to create liquidity in a very
abstract way. But we know we do not wish to create liquidity by emissions
of excessive amounts of currency. Thus we must fall back on the orthodox and
accepted form of creating liquidity which is an enlargement of the Federal
debt. If there are other ways and they can be widely accepted, they certainly
should be offered and adopted.
In summary, I see our economic history as showing that our society has for
about 200 years in this country struggled to provide needed liquidity. The
struggle became so tense and arduous at times that we placed great premium
upon gold and silver mining and we could not meet demand so that we had
complete collapses. The struggle was also attended with extremely high
interest rates such as the 9 percent call money rate of 1929 and the 8 percent
borrowing rate of some good industrial companies in 1921. We have eased on
that but that only means there will be debt expansion of the banking system,
the central banks, and therefore we need to face up to the creation of liquidity
so that we may retain for ourselves the fruits of these new modern, more orderly
scheduling of debt repayment which contributes so very greatly to the high
prosperity of the American people and which provide places in which they can
so satisfactorily lodge their savings.
This is the time for a discussion of these issues because the issues are not
"hot" at the present time. Thus, we should be able to place it in perspective
UNITED STATES MONETARY POLICY
257
so t h a t we would be certain to take action to provide needed liquidity when t h a t
time comes. I n my own view t h a t time will not come immediately ahead but
could come by perhaps the year 1905 or the fateful 100th anniversary of 1873,
in 1973.
I t seems to me, therefore, that the maintenance and creation of liquidity is
one function of the banking system. The second function is the sharp r e s t r a i n t
by monetary policy in the event of any inflation and excessive boom. The monetary authorities can act. June 1953 showed us t h a t their action need not endanger the banking system as so many bad falsely predicted in connection with
their arguments for 100 percent support prices for all Government securities.
Fiscal policy then can be via tax reduction, the powerful lever to move an
economy upward in the event an adequate full level of employment is not
maintained and in the event output of the economy is not expanding as we
know it can a t rates of a t least 3 percent per year.
STATEMENT BY CHAIRMAN FLANDERS ON ACTION ON AD Hoc
DECEMBER 9,
1954
SUBCOMMITTEE REPORT,
The subcommittee h a s decided to release and make p a r t of this record the
report of the ad hoc Subcommittee on the Government Security Market of the
Open Market Committee dated November 12, 1952. At the hearing on December
7 the Subcommittee received arguments both pro and con, with respect to
publication of the document from officials of the Federal Reserve System. Our
decision to publish the document is based upon the following statement by
Chairman William McChesney Martin, contained in the record above: "Well,
as far as I am concerned, I am perfectly willing to make it available to the
committee for publication, if they wish it."
The subcommittee believes that proper procedure has been followed in this
matter since the head of the agency involved has assented to its publication.
This view is concurred in by Senator B a r r y Goldwater and Congressman Wright
Patman, members of the subcommittee. Senator J. W. Fuibright and Congressman Richard Simpson were unavailable for the hearings and did not
participate in this decision.
We have advised both Mr. Martin and President Allan Sproul that the document will be published, and have invited them to append any additional papers
that they believe should be published simultaneously with the ad hoc report.
They are appended.
/
'
FEDERAL OPEN
MARKET COMMITTEE REPORT OF AD Hoc SUBCOMMITTEE ON
GOVERNMENT SECURITIES MARKET, NOVEMBER 12,1952
THE
PREFACE
Securities of the Federal Government have come to play a unique role in the
flexibility and sensitiveness of the American money market. Our financial
institutions now hold the bulk of their secondary or operating reserves invested
in these issues, particularly in the shorter term securities. This is true especially
of commercial banks but also of insurance companies and savings banks, as well
as savings and loan associations. I t is also increasingly true of many of our
larger industrial corporations. As a result, any change in the demand for funds
or their supply is felt promptly in the open market for Government securities.
When our financial institutions gain funds, they usually invest immediately in
Government securities, and, conversely, when they have net payments to make,
they liquidate Government securities. When their customers borrow or opportunities for profitable investment arise, financial institutions switch out of
Government securities, and when loans are paid or investments are sold the
Proceeds a r e usually invested, a t least temporarily, in Government securities.
The resulting daily turnover of securities in the m a r k e t is enormous. I t reflects
the transactions by which thousands of individual financial institutions and
business organizations keep their funds fully employed a t interest, without
sacrifice of their ability to meet the changing financial requirements of their more
basic business operations.
Arbitrage transactions add to this daily turnover in the market. T h e r e is
no credit risk in a portfolio of Government securities, i. e., no possibility t h a t
the holder will not be able to obtain cash a t p a r a t maturity. The relative
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UNITED STATES MONETARY POLICY
prices at which different issues trade, therefore, reflect predominantly changes
in the demand for and the supply of loanable funds in the money market as a
whole and also as between the various short-term, intermediate, and long-term
sectors of the market. Since trading is done at commissions or spreads as small
as one sixty-fourth ($150.25 per million) and even smaller in very short issues,
there are constant opportunities for arbitrage of small differentials in prices
when the impact of buying or selling is especially heavy in some particular sector of the market. The secondary reserve portfolios of practically all the large
financial institutions are managed by skilled professionals to take advantage of
such opportunities.
The Federal Open Market Committee is a major factor in this market. At
present its portfolio consists wholly of United States Government securities. It
is the largest existing portfolio under one control. When the Federal Open
Market Committee adopts a policy directive, it is executed in the market
for Government securities. It takes the form of a series of specific transactions in Government securities. Total transactions for the account—purchases
and sales—mount up to billions of dollars in the course of a year.
The impact of these operations is not measured by the volume of transactions
alone. It is much greater, for example, than the impact of a similar volume
of purchases and sales by a private investor. The Federal Open Market
Committee releases or absorbs reserve funds when it operates in the Government securities market. When the Committee buys, it augments not only its
own holdings of Government securities but also the ability of other investors
to enter the market on the bid side Conversely, when the Committee sells
Government securities, it does much more than add to the market supply of
such securities. The reserves that it absorbs subtract also from the capacity
of the banking system to carry Government securities.
It is necessary to keep these basic features of the money market in mind
in considering the subcommittee's report. They help to explain why relatively
small operations, sometimes even rumors of operations, by the Federal Open
Market Committee may give rise to such quick and pervasive response not only
throughout the money market and the investment markets generally but also
in business psychology. Any purchase or sale of Government securities by the
Committee adds to or subtracts from the reserves of the member banks and is
promptly reflected in the tone of the money market. A relatively small injection
of funds through the purchase of bills will ordinarily find a response in the
market for long-term securities. Large purchases of bills could scarcely fail to
elicit such a response.
These transactions condition the tone of the money market and the general
availability of credit because they immediately affect the value of securities in
the operating portfolios of leading financial and business institutions. They
cause changes in the prices of the specific issues bought or sold, and affect opportunities for arbitrage as between various issues and sectors of the market.
As a result, a new pattern of yields emerges as between all different issues and
sectors of the market. When the readjustments have worked themselves out, both
the prices of Government securities and the pattern of their yields will have
been affected. Both the absolute and the relative market values of the securities that constitute the liquid operating reserves of all our major financial institutions will have changed. In other words, there will have occurred a shift in
the financial liquidity of the money market and of the economy.
Experience has demonstrated that the climate or tone of the money markets
tends to respond directly to the volume of member bank borrowing at the
Federal Reserve banks. Changes in the volume of borrowing represent the first
response of member banks to losses or accessions of reserve funds from any
source, including open-market operations of the Federal Open Market Committee. It constitutes, in fact, an essential link in the mechanism by which these
operations exert a magnified effect on the money markets. When such borrowing is low, the tone of the money market is easy, that is, funds tend to be easily
available at going interest rates for all borrowers who are acceptable as credit
risks. When member banks themselves are heavily in debt to the Federal Reserve
banks, the tone of the money market is tight, that is, marginal loans are
deferred and even better credit risks may have to shop around for accommodation.
These responses seem to be independent, to some extent, of the level of interest rates, or of the discount rate. For example, the tone of the money market
might be easy even though the discount rate were 4 percent. This would happen
mainly in a situation where the volume of member-bank borrowing was low.
Conversely, the tone of the money market might be on the tight side when the
UNITED STATES MONETARY POLICY
259
discount rate was 1% percent. This would occur when member banks were
heavily in debt.
The fact that the tone of the money market is responsive to the level of member
bank borrowing at the Reserve banks gives a unique character to the role of
open-market operations in the effectuation of credit and monetary policy. They
can be used flexibly to offset the net impact on bank reserves of other sources
of demand and supply of reserve funds in such a way as to result in an increase
or decrease of member-bank borrowing, or, if desired, to maintain a level of
such borrowing that is fairly constant from week to week, or month to month.
This means that when the Federal Open Market Committee decides that a
tone of tightness, or ease, or moderation, in the money markets would promote
financial equilibrium and economic stability, it has the means at hand to make
the decision effective.
Changes in the discount rate cannot be used in this way. They can exert
powerful effects upon the general level of interest rates, but cannot be counted
on to insure that the relative availability or unavailability of credit at those
rates will be appropriate to the requirements of financial equilibrium and economic stability.
Neither can changes in reserve requirements be used with this precision. There
are many administrative and technical problems which militate against the continuous or frequent use of this instrument of policy. Even if these did not exist,
however, the instrument is much too blunt to be used to maintain member-bank
borrowing from week to week or month to month at an appropriate level.
In short, open-market operations are not simply another instrument of Federal
Reserve policy, equivalent or alternative to changes in discount rates or in reserve
requirements. They provide a continuously available and flexible instrument of
monetary policy for which there is no substitute, an instrument which affects
the liquidity of the whole economy. They permit the Federal Reserve System
to maintain continuously a tone of restraint in the market when financial and
economic conditions call for restraint, or a tone of ease when that is appropriate.
They constitute the only effective means by which the elasticity that was built
into our monetary and credit structure by the Federal Reserve Act can be made
to serve constructively the needs of the economy. Without them, that elasticity
would often operate capriciously and even perversely to the detriment of the
economy.
They require an efficiently functioning Government securities market characterized by depth, breadth, and resiliency. It is with these characteristics of the
market that this report is mainly concerned. The subcommittee was authorized
shortly after the Federal Open Market Committee decided that the continued
maintenance of a relatively fixed pattern of prices and yields in the market for
Government securities was inconsistent with its primary monetary and credit
responsibilities. The Federal Open Market Committee felt that a freer market
for Government securities would lessen inflationary pressures and better promote
the proper accommodation of commerce, industry, and agriculture. It came to
the conclusion, in fact, that a securities market, in which market forces of supply
and demand and of savings and investment were permitted to express themselves
in market prices and market yields, was indispensable to the effective execution
of monetary policies directed toward financial equilibrium and economic stability
at a high level of activity without detriment to the long-run purchasing power
of the dollar.
Accordingly, the subcommittee was authorized to examine and report on the
relevance and adequacy of the Federal Open Market Committee's own procedures and operations in the new context. Transactions for the Committee's
account exert a powerful impact on that market. It is important that they be so
executed as to avoid disruptive technical repercussions. In particular, it is
important that technical operating procedures and practices, conceived in the
atmosphere of war finance and developed to maintain a fixed pattern of prices
and yields in the Government securities market, be reviewed to ascertain whether
or not they tend to inhibit or paralyze the development of real depth, breadth,
and resiliency in today's market that operates without continuous support.
This is the problem with which the subcommittee has been most concerned.
The absorption and release of reserve funds which results from Federal Open
Market Committee transactions should constitute a constructive factor in the
Government securities market, as well as in the economy generally. Without
open market operations, appropriately conceived and executed when there is need
to absorb or release reserve funds, it would sometimes be impossible for the
market to evaluate correctly fundamental trends in the economy as they affect
the supply of money relative to its demand.
260
UNITED STATES MONETARY POLICY
It is evident, therefore, for the well-being of the Government securities market
itself, that the possibility be minimized of disruptive technical market repercussions from Committee transactions. It is also evident that the Federal Open
Market Committee should be in a position to operate promptly and in appropriate volume at all times, without fear of such adverse technical market repercussions, when the need for operations exists. This requires a Government
securities market characterized by great depth, breadth, and resiliency. Without
a market possessing these characteristics, the Committee might, on occasion, find
itself unable to discharge its responsibilities,
INTRODUCTION
(1) The Federal Open Market Committee, at its meeting on May 17, 1951,
authorized an ad hoc subcommittee to study and report on the operations and
functioning of the Open Market Committee in relation to the Government securities market. The subcommittee was organized in April and May 1952, as
follows: Wm. McC. Martin, Jr., chairman; Abbot L. Mills, Jr., Malcolm Bryan.
Robert H. Craft, vice president and treasurer of the Guaranty Trust Co., of New
York, was appointed technical consultant to the subcommittee, and was given
leave of absence by the Guaranty Trust Co. to devote his full time to its work.
(2) Efforts have been made to keep the executive committee of the Federal
Open Market Committee, all the Governors of the Board, and all' of the presidents of the Federal Reserve banks informed of the activities of the subcommittee. The interval, amounting to nearly a year, between the authorization
of the subcommittee and its actual establishment reflected the desirability of
deferring the study until the conclusion of the hearings of the Patman subcommittee of the Joint Committee on the Economic Report, as well as the desirability of permitting some experience to accumulate on operations of the
Committee under the more flexible conditions that followed the TreasuryFederal Reserve accord of March 5, 1951.
Procedures of the subcommittee
(3) As its first step, the subcommittee, with the help of suggestions from
the executive committee, prepared an outline of study which was sent to a list
of the individuals and institutions active in the market for Government securities, either for information or response. So that there, would be no misconceptions, the outline and letters were made available to the press.
(4) Beginning June 9, 1952, the subcommittee held 10 sessions with recognized dealers, 11 meetings with unrecognized dealers, and S meetings with nondealers intimately familiar with the operations of the Government securities
market, discussing the material covered in the outline of study. The subcommittee also received letters from other individuals to whom the outline was sent.
Stenographic notes of the discussions were taken for the convenience of the
subcommittee but are not part of the record, since they were not subsequently
cleared with the discussants.
(5) The outline of study, together with the list of individuals and institutions to which it was sent, and the covering letters by Chairman Martin, are
attached to this report as appendix A. Mr. Craft has prepared a technical
analysis of the correspondence and discussions focused on the outline of study
which is attached as appendix B. Mr. Craft has also prepared a memorandum,
entitled "Ground Rules," with respect to certain problems before the subcommittee which is attached as appendix C. A memorandum from the staff, discussing the possibilities of reopening an open market call money post to finance
dealers' portfolios, is attached as appendix D.
T H E GOVERNMENT SECURITIES
MARKET
Size, participation, and composition
(6) Of the total gross Federal debt of $265 billion, about $145 billion are outstanding in marketable form. Ownership of the marketable debt is about as
follows: Commercial banks have about $00 billion; corporations about $15
billion; mutual savings banks, life insurance companies, and State and local
governments about $7 billion each; casualty insurance companies about $5
billion; Federal agencies and trust funds about $3 billion; and savings and loan
associations and foreign governments about $2 billion each. All other investors,
including individuals, trust funds, private pension funds, endowments, etc., own
around $13 billion in the aggregate. The Federal Reserve banks, which have
nearly $24 billion, or about one-sixth of the marketable securities, have by far
UNITED STATES MONETARY POLICY
261
the largest single holding in the market, about 10 times larger than the next
largest portfolio under one control.
(7) The marketable debt is comprised of $20 billion of Treasury bills, $17
billion of certificates, .$30 billion of notes, $36 billion of bonds due or callable
in 5 years, $17 billion of longer term bonds not restricted as to bank ownership,
and $27 billion of restricted bonds. Commercial banks hold about one-third of
the bills and certificates, half of the notes, and two-thirds of the bank-eligible
bonds. It is roughly estimated that business corporations hold about half of
the bills, one-fourth of the certificates, and much lesser proportions of the notes
and bonds. Savings institutions, including life insurance companies, pension
funds, etc., own the bulk of the long-term bonds. Federal Reserve holdings are
heavily concentrated at the present time in certificates, notes, and short-term
bonds.
Market structure and actviity
(8) The Government securities market provides the mechanism through which
marketable Government securities have their secondary distribution. It is an
over-the-counter market; it is really a group of markets made by the various
dealers and knit together into a unit by an extensive communications system.
About 20 dealers, including some banks with trading departments, comprise the
basic structure of this market. The focus of the market is in New York, and
most dealers have a network involving branch offices, representatives, correspondents, local investment houses, or the like through which they maintain
contact with major Government security holders throughout the country. There
are a number of secondary dealers who also trade in Government securities,
frequently as a part of the broader over-the-counter business.
(9) The volume of transactions in marketable Government securities runs to
a very large figure—on an average several hundred million dollars a day.
These transactions are typically made by dealers without commission on a very
narrow spread between the price at which they will buy and the price at which
they will sell. So-called inside markets are typically made on spreads ranging
from %2 ($312.50 per million dollars) for long-term bonds down to an 0.01 in
yield ($25 per million dollars) on 90-day bills. As a usual thing, transactions of
good size—as much as $1 million or more for long-term bonds and up to $5 million
or more for short-term issues—are executed on-the-wire with customers. Trading is thus on a split-second basis, in large amounts in relation to dealer capital,
and on close margins. Alert arbitraging is also constantly going on among
the various issues of securities, both by dealers and by other active elements in
the market. Success or failure in professional trading in such a market turns
importantly on ability to appraise changing market factors quickly and accurately.
(10) The Federal Reserve stands in a key position with respect to the entire
money and capital market in this country and particularly with respect to the
Government securities market System contacts with the market for United
States Government securities take four main forms—transactions in Government
securities made for the account of the system, extension of credit by a Federal
Reserve bank to the nonbank recognized dealers through purchases of shortterm securities under repurchase agreement, transactions made as agent for
Treasury and foreign accounts or for member banks, and the gathering and
dissemination of information on developments in the Government securities
market. Aside from some transactions executed by the other Reserve banks
for the account of member banks, these points of system contact with the market
are focused at the trading desk at the Federal Reserve Bank of New York.
Trading desk facilities and activities
(11) The trading room at the Federal Reserve Rank of New York is equipped
with some 10 or 32 key-type telephone stations with direct lines to each of 8
dealers in New York City, plus several trunklines for outside calls. These phones
are manned continuously by 4 or 5 people regularly assigned to direct contact
work with the dealers. Instantaneous contact can be made either by the personnel at the trading desk or by any 1 of the 8 dealers simply by pushing the
proper key. At least one officer of the Bank is always on call at the desk during
trading hours.
(12) Other personnel assigned to the trading desk handle special tasks of
various kinds such as transactions for Treasury agencies, foreign accounts, or
for member banks in the New York district. Clerks maintain current price
quotations on all Government securities on a large quote board, which can
easily be seen by any of the personnel on the trading desk. The quotation board
itself lists quotations on all Government securities as received hourly from
262
UNITED STATES MONETARY POLICY
several dealers. From these quotations a composite or average quotation for
each issue is computed. Routine reports on developments in the stock market
and corporate and municipal bond markets are received and transmitted to the
operating personnel on the trading desk.
Transactions
(13) Purchases and sales of securities for the System open market account are
supervised by the manager of the account and are made in accordance with
instructions issued by the Federal Open Market Committee. Such transactions,
both on a repurchase and on an outright basis, (as well as all transactions in
Government securities made by the New York bank for foreign accounts, member
banks, or the Treasury) are now confined to 10 recognized dealers. This strict
limitation of the dealer group with which the account now trades was formalized
by the committee in 1914. Previously, the Federal Reserve Bank of New York
had followed a less formal arrangement with a larger group of dealers.
(14) The policy of confining open market account business to a small group
was adopted by the Federal Open Market Committee in 1944 in an attempt to
deal only with that portion of the market where the final effort at matching
private purchases and sales takes place. This approach was based on the hope
that by operating closely with a small group of key dealers responsive to its
discipline, the Federal Open Market Committee could peg a pattern of low interest
yields in a period of heavy war financing with minimum monetization of the
debt.
(15) In accordance with the instructions of the Federal Open Market Committee, open market transactions are practically always made on an agency
basis, that is, not with dealers as principals but with other holders, using
dealers as brokers. This has meant that dealers could not ordinarily sell to
the account from position. The Commitee has specified that the commission
allowed shall not exceed $150.25 per million dollars on notes and bonds, and
$100 per million dollars on certificates and bills. In practice it generally has
been smaller on maturities of less than one year. Repurchase agreements are
by their nature made with the nonbank recognized dealers as principals.
(1G) Transactions executed by the trading desk are never made for cash,
I. e., for delivery the same day, but rather for regular delivery the following
day (occasionally for delayed delivery). For short-term issues, however, a large
part of transactions made by others in the market is on a cash basis. The account will not knowingly buy securities handled by dealers on a cash basis.
(17) In addition to transactions for the System's open market account, a large
volume of purchases and sales is made by the New York bank for domestic and
foreign accounts. Acting as fiscal agent for the Treasury, the New York bank
transacts business for various Government agencies and trust funds. These
transactions may be of a routine nature or may involve special operations designed to support the market. Foreign central banks and other foreign agencies
also employ the New York Federal Reserve Bank as agent and channel purchase
or sale orders on Treasury issues through it. Member banks in the New York
Federal Reserve District—usually smaller banks in outlying areas—also use
the New York bank for what are typically odd-lot transactions. All of these
transactions by the bank as agent are handled through the trading desk.
(18) Transactions for the open market account are normally handled by any
1 of 4 or 5 persons who maintain constant direct contact between dealers and
the account. Transactions for the Treasury, foreign agencies, or member banks
are usually handled by an individual on the trading desk who is not one of the
persons regularly contacting dealers for information or normally trading for
open market account. Thus, the dealers can generally distinguish between
agency transactions and those for the open market account on the basis of the
origin of the call from the trading desk. There are also other clues in the
trading operation which dealers can use in appraising the source of a transaction.
At times, however, the regular procedures of the desk may be changed in order
to conceal the operations of the open market account. Orders for the account
may be channeled through the individual who ordinarily handles foreign agency
and member bank business, or those who usually trade for the open market
account may take over business to be done for agency or foreign accounts.
Pending the weekly report of condition of the Federal Reserve banks, the actual
operations of the account may thus be screened from the market or the market
may be led to believe that the Federal Open Market Committee was active at
a time when it was not.
(19) The volume of transactions in Government securities carried out by the
New York bank's trading desk for foreign, Treasury, and member bank accounts
UNITED STATES MONETARY POLICY
263
is very substantial. In the 12 months ending June 30, 1952, such business
amounted to about $2.4 billion, of which $1.5. billion was in bills, $000 million
in certificates and notes, and $300 million in bonds. These transactions
amounted to about one-third the volume of total trades for open market account; they were almost as large as open market transactions other than in
periods of Treasury refunding.
(20) Federal Reserve banks outside New York also transact business in Government securities as a service for some of their member banks. In the 12
months ending June 30, 1952, $1.9 hillion of such business was handled. While
some Reserve banks confine such dealings to those dealers qualified to transact
business with the open market account, others do business with a wide group
of investment houses.
Information arrangements
(21) The 4 or 5 individuals assigned to contacting dealers at the New York
trading desk are constantly receiving oral reports from dealers, maintaining
current records of reported transactions in the market, and checking and relating
the information thus received with various written reports also submitted by
the dealers. In addition, 1 or 2 of these contact men report to various interested
officials in and out of the System on current trends in the market.
(22) Before the market opens each day, several meetings are held with representatives of recognized dealers. These meetings, which are limited to approximately 10 minutes each, are scheduled on a rotating basis, with 2 or 3 dealer
organizations participating each day. At the meetings, the dealer representatives report on the major transactions handled in the market during the previous
trading session. They also pass on other information about the Government
securities market or other aspects of the money and capital market. The meetings are largely devoted to reporting by dealers rather than to an exchange of
information, as the comments of the Committee's representatives in attendance
are very guarded.
(23) During trading hours in the market, contact is maintained regularly
between the trading desk and each recognized dealer in New York City. Any
transactions involving a million dollars or more are currently reported to the
trading desk. A worksheet is maintained on the transactions for the day, divided
into various categories of securities, with a general description of the type
of customer involved in each trade. This transaction sheet provides a quick
general picture of the demand or supply of various types of securities in the
market. Important discrepancies between the information on this transaction
. sheet and the written reports submitted by dealers on their volume and positions or the oral reports made during the morning session are usually clarified
by checking further with the dealer.
(24) On days when auctions for Treasury bill issues are being held, one of
the contact persons on the trading desk makes several special calls to all
dealers to get their appraisals of developments in the auction. At about 11: 30
a. m., each one of the dealers gives his estimate of the level at which customer
bids (i. e., bids of nonbank investors who usually submit them as customers of
banks) will be submitted and also as to the lowest price level at which awards
will be made. Again, at about 1 p. m., dealers will be contacted to see if there
has been any change in sentiment. Based on the information received, bids are
submitted for the amount of maturing bills held in the portfolio. The manager
of the foreign department is also informed as to the market estimate of the
bill auction and he then determines at what price bids for foreign agencies will
be submitted.
(25) Supplementing the information received verbally by the trading desk,
various written reports of a statistical nature are also made by dealers. Daily
reports are received from each of the recognized dealers, as well as many of
the nonrecognized dealers, on their current positions broken down into various
categories. Reports are also made on the total transactions handled each day
in each of those categories. Thus, shortly after the opening of the market on
any day, the trading desk personnel has available to it data on the current
long and short positions of each dealer, the aggregate positions of nearly all
dealers in the market, and the volume of transactions in various classes of
securities made by each dealer and the aggregate of such transactions.
(26) The trading desk also received from other departments of the New York
bank a daily report'On the reserve position of each of the central reserve city
banks in New York City and reports on the money market factors affecting the
264
UNITED STATES MONETARY POLICY
New York market, including a prediction of the effect of these factors for the
ensuing day. The most recent figures on factors affecting reserves of all member
banks are also supplied to the desk, as well as frequent projections of major
factors affecting bank reserve positions over the next 2 weeks. Estimates supplied
on Treasury receipts and expenditures are compared each Monday and Thursday
with the operating personnel at the Treasury in a discussion of the amount of
calls on tax and loan accounts to be made and the timing of such calls; this
contact is handled at the trading desk by an officer of the securities department.
(27) At regular intervals during the day, information on market prices is
given by the trading desk personnel to representatives of the Treasury and of
the Federal Reserve Board. In addition to the routine price reports, a summary
of market developments during the day is given shortly after the market closes
to the Treasury and the Board. Flash reports are sent to each Federal Reserve
bank president twice daily—at about 11 a. m. and after the close.
(28) Two regular reports on developments in all securities markets are issued
by the New York bank, and trading desk personnel contribute a summary of
developments in the Government securities market to each of these reports.
One of these is a daily report to the Board of Governors which is distributed
to various System representatives and to the Treasury. A somewhat more com-,
plete report is made weekly to the Federal Open Market Committee, and circu->
lation of this report is limited to a list approved by that Committee.
FINDINGS AND RECOMMENDATIONS
Structure of the market
(29) It is the conviction of the subcommittee, based on its intimate discussions
with a very large segment of key participants in the United States Government
securities market, that that market at the present time possesses, with one
exception noted below, the organizational elements essential to successful performance of its functions. It is competently staffed, and its operations cover
the relevant sections of the community.
(30) The only serious qualification that the subcommittee makes to these generalizations relates to certain deficiencies in the credit facilities available to
dealers. During recent months, the rates paid by dealers to carry their portfolios of United States Government securities have averaged above the yield
on these portfolios. This amounts to a negative "carry" and obviously affects
seriously the ability of the dealer organization to maintain broad markets.
This problem has become more serious since the discussions with the dealers.
At the time of those discussions, the dealers dealt at length with the problem
of negative carry but they were referring, for the most part, to periods of stringency of very limited duration, not to the kind of continuing stringency that
prevailed in most of the third quarter of 1952. The subcommittee advances suggestions to correct this deficiency later in the report.
(31) It is likewise the conviction of the subcommittee that the market for
United States Government securities is already sufficiently broad, experienced,
competitive, and arbitrage minded as to minimize the success of attempts of
private operators to "rig" the market.
(32) The market has developed a considerable degree of resiliency and ability
to handle itself since the accord. After years of pegging, it took a few months
for the establishment of market equilibrium, but this was achieved without the
development of disorderly conditions and with none of the drastic changes in
prices and yields that had been feared by so many. In the long-term area, this
equilibrium has now been maintained for more than 1 year without material
Federal Reserve intervention. Subsequent to mid-year 1951, total dealings of
the open-market account in securities of longer than 14 months' maturity have
amounted to $32 million, excluding securities acquired in exchange for maturing
issues. Most of these transactions occurred in late November and late December
of last year.
(33) The actual record of transactions by the Federal Open Market Committee
since mid-1951 is shown in the following table:
265
UNITED STATES MONETARY POLICY
Open market account transactions in V. S. Government securities*—July 1,1951Sept 30, 1952
[In millions of dollars]
Total
Class of security
Purchases
Maturing issues (rights)
Other securities maturing:
Within 91 days
91 days to 14 months
14 months to 5 years
5 years to 10 years
Over 10 years
Total
Sales
3,059
„
During periods
of
refundinga
Other than periods
of refunding
Purchases
Purchases
Sales
Sales
3,059
541
341
1,568
594
1
3
23
2,206
2,277
5
6
5,248
4,488
3,947
372
1,154
1,834
1,123-
3
1,027
253
1
3
17
1,529
1,301
2,959
2
i Excludes repurchase agreements with dealers and brokers and purchases and sales of special certificates
from and to Treasury.
* Commitments from date of announcement to closing of books, plus all transactions in new securities on
a when-issued basis.
(34) The table indicates that the Federal Open Market Committee has concentrated its transactions very heavily in short maturities since mid-1951.
Purchases of issues of over 14 months were negligible, despite the fact that this
record covers a period during which the price of Victory's moved between §95%
and $99%, and that both the market and the Committee were feeling their way
out from the conditions that prevailed under the pegs. The $32 million of
transactions in the intermediate and long-term sector are the only ones that
could properly be described as undertaken by the Committee to "maintain an
orderly market."
(35) It would be inaccurate, however, to describe the present market for
United States Government securities as possessing depth, breadth, and resiliency
to the full degree that would be desirable for the efficient conduct of effective
and responsive open-market operations. It is important that there be no misunderstanding of the intent of the subcommittee in making this qualification.
The subcommittee is not referring to the degree of fluctuation that has characterized prices in the market for Government securities since the accord.
Considering the pressure on the economy and on the supply of savings, the range
of price fluctuation in the market for Government securities has been moderate.
The subcommittee refers rather to the psychology that still pervades the market,
to the confusion among professional operators in the market with respect to
the elements they should take into consideration in the evaluation of future
market trends, and to their apprehension over the attitude toward prices in the
market on the part of the Federal Open Market Committee and of its representatives on the trading desk. This psychology would not characterize a market
that possessed real depth, breadth, and resiliency.
(36) In strictly market terms, the inside market, i. e„ the market that is
reflected on the order books of specialists and dealers, possesses depth when
there are orders, either actual orders or orders that can be readily uncovered,
both above and below the market. The market has breadth when these orders
are in volume and come from widely divergent investor groups. It is resilient
when new orders pour promptly into the market to take advantage of sharp and
unexpected fluctuations in prices.
(37) These conditions do not now prevail completely in any sector of the
market. They are most nearly characteristic of the market for Treasury bills,
but even in that market reactions have been sluggish on more than one occasion
since the accord. They are least characteristic of the market for restricted
264
UNITED STATES MONETARY POLICY
New York market, including a prediction of the effect of these factors for the
ensuing day. The most recent figures on factors affecting reserves of all member
banks are also supplied to the desk, as well as frequent projections of major
factors affecting bank reserve positions over the next 2 weeks. Estimates supplied
on Treasury receipts and expenditures are compared each Monday and Thursday
with the operating personnel at the Treasury in a discussion of the amount of
calls on tax and loan accounts to be made and the timing of such calls; this
contact is handled at the trading desk by an officer of the securities department.
(27) At regular intervals during the day, information on market prices is
given by the trading desk personnel to representatives of the Treasury and of
the Federal Reserve Board. In addition to the routine price reports, a summary
of market developments during the day is given shortly after the market closes
to the Treasury and the Board. Flash reports are sent to each Federal Reserve
bank president twice daily—at about 11 a. m. and after the close.
(28) Two regular reports on developments in all securities markets are issued
by the New York bank, and trading desk personnel contribute a summary of
developments in the Government securities market to each of these reports.
One of these is a daily report to the Board of Governors which is distributed
to various System representatives and to the Treasury. A somewhat more com-,
plete report is made weekly to the Federal Open Market Committee, and circu-J
lation of this report is limited to a list approved by that Committee.
FINDINGS AND RECOMMENDATIONS
Structure of the market
(29) It is the conviction of the subcommittee, based on its intimate discussions
with a very large segment of key participants in the United States Government
securities market, that that market at the present time possesses, with one
exception noted below, the organizational elements essential to successful performance of its functions. It is competently staffed, and its operations cover
the relevant sections of the community.
(30) The only serious qualification that the subcommittee makes to these generalizations relates to certain deficiencies in the credit facilities available to
dealers. During recent months, the rates paid by dealers to carry their portfolios of United States Government securities have averaged above the yield
on these portfolios. This amounts to a negative "carry" and obviously affects
seriously the ability of the dealer organization to maintain broad markets.
This problem has become more serious since the discussions with the dealers.
At the time of those discussions, the dealers dealt at length with the problem
of negative carry but they were referring, for the most part, to periods of stringency of very limited duration, not to the kind of continuing stringency that
prevailed in most of the third quarter of 1952. The subcommittee advances suggestions to correct this deficiency later in the report.
(31) It is likewise the conviction of the subcommittee that the market for
United States Government securities is already sufficiently broad, experienced,
competitive, and arbitrage minded as to minimize the success of attempts of
private operators to "rig" the market.
(32) The market has developed a considerable degree of resiliency and ability
to handle itself since the accord. After years of pegging, it took a few months
for the establishment of market equilibrium, but this was achieved without the
development of disorderly conditions and with none of the drastic changes in
prices and yields that had been feared by so many. In the long-term area, this
equilibrium has now been maintained for more than 1 year without material
Federal Reserve intervention. Subsequent to mid-year 1951, total dealings of
the open-market account in securities of longer than 14 months' maturity have
amounted to ,$32 million, excluding securities acquired in exchange for maturing
issues. Most of these transactions occurred in late November and late December
of last year.
(33) The actual record of transactions by the Federal Open Market Committee
since mid-1951 is shown in the following table:
265
UNITED STATES MONETARY POLICY
securities1- Tuly 1,1951-
Open market account transactions in XJ. 8, Government
Sept. 30, 1952
Jin millions of dollars]
During periods
of
refunding 2
Total
Class of security
Purchases
Maturing issues (rights)
Other securities maturing:
Within 91 days91 days to 14 months
14 months to 5 years,.
5 years to 10 years
Over 10 years__ Total
Sales
.
_ _
Sales
Purchases
Sales
372
1,154
1,834
1,12a
2,959
3,059
3,059
._ __ . . .
Purchases
Other than periods
of refunding
541
341
1,568
594
1
3
23
2,206
2,277
5
6
3
1,027
253
1
3
17
5,248
4,488
3,947
1,529
1,301
2
1 Excludes repurchase agreements with dealers and brokers and purchases and sales of special certificates
from
and to Treasury.
2
Commitments from date of announcement to closing of books, plus all transactions in new securities on
a when-issued basis.
(34) The table indicates that the Federal Open Market Committee has concentrated its transactions very heavily in short maturities since mid-1951.
Purchases of issues of over 14 months were negligible, despite the fact that this
record covers a period during which the price of Victory's moved between $95%
and $99%, and that both the market and the Committee were feeling their way
out from the conditions that prevailed under the pegs. The $32 million of
transactions in the intermediate and long-term sector are the only ones that
could properly be described as undertaken by the Committee to "maintain an
orderly market."
(35) It would be inaccurate, however, to describe the present market for
United States Government securities as possessing depth, breadth, and resiliency
to the full degree that would be desirable for the efficient conduct of effective
and responsive open-market operations. It is important that there be no misunderstanding of the intent of the subcommittee in making this qualification.
The subcommittee is not referring to the degree of fluctuation that has characterized prices in the market for Government securities since the accord.
Considering the pressure on the economy and on the supply of savings, the range
of price fluctuation in the market for Government securities has been moderate.
The subcommittee refers rather to the psychology that still pervades the market,
to the confusion among professional operators in the market with respect to
the elements they should take into consideration in the evaluation of future
market trends, and to their apprehension over the attitude toward prices in the
market on the part of the Federal Open Market Committee and of its representatives on the trading desk. This psychology would not characterize a market
that possessed real depth, breadth, and resiliency.
(36) In strictly market terms, the inside market, i. e., the market that is
reflected on the order books of specialists and dealers, possesses depth when
there are orders, either actual orders or orders that can be readily uncovered,
both above and below the market. The market has breadth when these orders
are in volume and come from widely divergent investor groups. It is resilient
when new orders pour promptly into the market to take advantage of sharp and
unexpected fluctuations in prices.
(37) These conditions do not now prevail completely in any sector of the
market. They are most nearly characteristic of the market for Treasury bills,
but even in that market reactions have been sluggish on more than one occasion
since the accord. They are least characteristic of the market for restricted
266
UNITED STATES MONETARY POLICY
bonds. In these issues, there has prevailed persistently since the accord a wide
gap between the prices at which the least firm holders are willing to sell and
potential buyers are willing to purchase. Within this gap, quotations have fluctuated widely, either in response to relatively small buy or sell orders, or, more
frequently, as a result of professional efforts to stimulate interest by marking
quotations up or down.
(38) In the view of the subcommittee, the persistence of this condition operates to weaken the effectiveness of open-market operations and emphasizes
the importance of steps to improve the depth, breadth, and resiliency of the
market. Since the Committee's transactions are among the most important
factors that condition the market, the Federal Open Market Committee has an
obligation to scrutinize its own organization and its own operations to see in
what respects, if any, they can safely be modified, if the effect of such modification would contribute to the depth, breadth, and resiliency of the market.
Role of the System in the market
(39) It is the unanimous view of the subcommittee that the Federal Open
Market Committee should keep its intervention in the market to such an absolute minimum as may be consistent with its credit policy. This position rests
not only on the fact that the System's primary role has to do with credit policy
in the broad sense, but also because of important'technical considerations related to the highly desirable development of strength in the private market for
United States Government obligations. The normal functioning of the market
is inevitably weakened by the constant threat of intervention by the Committee.
In any market, the development of special institutions and arrangements that
serve to provide the market with natural strength and resilience and to give it
breadth and depth tend to be greatly inhibited by official "mothering." Private
market institutions of this kind are repressed particularly by the constant possibility of official actions which, by the market's standards, will frequently seem—
and be—capricious. Such actions constitute a risk that cannot reasonably be
evaluated in advance and anticipated in the formulation of individual, private
judgments of market prospects.
(40) The subcommittee has come to the conclusion—fully supported by the
testimony before it—that the Federal Open Market Committee bears a real
measure of responsibility for part of the lack of depth, breadth, and resiliency
in the Government securities market. There is not only the history of many
years of closely controlled markets, but also the fact that the Committee has not
yet been specific with respect to what it means by a free market for United
States Government securities. In replies to the Patman questionnaire, in
official publications, and in public speeches by its personnel, the Committee has
indicated that it contemplates operating in a free market from here on out,
but at the same time the policy record of the Federal Open Market Committee,
published in the 1951 annual report, shows that it is still committed to the
"maintenance of orderly markets," which clearly implies intervention.
(41) This inconsistency has not added to dealer or customer confidence. To
take positions in volume and make markets, dealers must be confident that a
really free market exists in fact, i. e., that the Federal Open Market Committee
wil permit prices to equal demand and supply without direct intervention other
than such as would normally be made to release or absorb reserve funds. They
have no such assurance. To the dealers, and to professional buyers and sellers
of Government securities, the pronouncements of the Federal Open Market
Committee mean (1) that it has dropped the pegs, (2) that it is willing to see
fluctuations in the market, but (3) that it is watching these fluctuations closely
and is prepared to intervene on occasion whenever it considers intervention necessary. From the dealer's point of view, this means that the Federal Open Market Committee desires a fluctuating market but will not necessarily permit one
to develop that is free. Their conclusion is that they are operating in a fluctuating market subject to unpredictable, however reluctant, intervention by the
Federal Open Market Committee.
(42) The distinction has a vital bearing on the ability of the market mechanism to function with depth, breadth, and resiliency. It is in the nature of a
dealer's business that he is constantly exposed to market risk from both sides
of the market. One test of his professional skill and, indeed, of his fitness
to be in the market at all is the ability to judge the factors in a free market
with sufficient foresight and prudence to preserve or even augment his relatively thin margin of capital, whichever way the market turns. He does this
by reversing or covering his positions at times or by alert arbitrage of markets
for particular issues that are out of line. Thus he is able to function continu
TJNITED STATES MONETABT POLICY
267
ously and to make markets. He cannot do this, however, with anything like
the same degree of skill in a market that is subject to unpredictable and overpowering intervention by the Federal Open Market Committee. The Committee,
with practically unlimited resources to back up its intervention, is not guided
in its operations by considerations of profit, and unlike other investors, is not
forced to cover its operations to minimize loss. Such intervention can impose
drastic risks on a dealer or other holders, particularly if the intervention Is in
intermediate or long securities where the dollar impact on the capital position
of modest changes in yields is large.
(43) It is easy to understand why dealers, with their lack of confidence in
the Committee's intentions to restore a free market, would be reluctant to go very
far in taking positions. To do so would not only involve the risk of being wrong
in their evaluation of economic and market trends, but also of being wrong in
guessing at what point the Federal Open Market Committee might feel it necessary to intervene. A difference of a few thirty-seconds in the level of prices of
such intervention would not necessarily be of great moment to the Federal Open
Market Committee, but it might be of real importance to a dealer's operations.
(44) It is the judgment of the subcommittee that the lack of professional
dealer confidence in the intentions of the Federal Open Market Committee is justified, and that it is not enough for the development of an adequate market that the
Committee's intervention be held to a strict minimum. It is important that the
dealers be assured, if it is at all possible to give such assurance, that the Committee is prepared to permit a really free market in United States Government
securities to develop without direct intervention for the purpose of establishing
particular prices, yields, or patterns of yields.
(45) When intervention by the Federal Open Market Committee is necessary
to carry out the System's monetary policies, the market is least likely to be seriously disturbed if the intervention takes the form of purchases or sales of very
short-term Government securities. The dealers now have no confidence that
transactions will, in fact, be so limited. In the judgment of the subcommittee, an
assurance to that effect, if it could be made, would be reflected in greater depth,
breadth, and resiliency in all sectors of the market.
(46) Such assurance would not impede open market operations by the Committee designed either to put reserve funds into the market or to withdraw them
to promote economic stability. It would simply guarantee that the first impact
of such purchases and sales would fall on the prices of very short-term issues,
where dollar prices react least in response to a change in yield, and where the
asset value of a portfolio is least affected. A dealer organization, even though it
operates on thin margins of capital, can live with impacts such as these and consider them a part of its normal market risks.
(47) Nor would such an assurance prevent the effects of open market operations, initiated in the short-term sector, from spreading to other sectors of the
market in the form of changes in prices, yields, and the pattern of yields. These
changes would come about as a result of market arbitrage, i. e., of the exercise of
market skill by the professionals who make up the market, the dealers who specialize in matching bids and offers and the professional managers of portfolios
who are constantly balancing their investments to take advantage of shifts in
prices and yields between the different sectors of the market. A dealer can
survive, even if the capital value of long-term issues reacts sharply, when these
reactions are brought about as a result of market trading and arbitrage. His
risk exposure, on positions in intermediate and long-term issues, is much greater
when these changes are induced by direct intervention at arbitrary prices by
the Federal Open Market Committee.
(48) The subcommittee realizes the difficulties involved for an operating body,
such as the Federal Open Market Committee, in giving any assurance that would
limit its own future freedom of action. An assurance, of course, that the Committee would limit its intervention to the very short-term market would fall
within, not without, the boundaries of the best central banking traditions. It was
long held axiomatic that central bank portfolios should properly be confined to
very short-term bills of the highest liquidity and quality. In fact, most effective
central banks have operated within this restriction, imposed either by tradition
or by law. Traditional principles of central banking made no provision for operations in the intermediate or long maturities of any borrower.
(49) There are only two types of situation where the freedom of action of
the Federal Open Market Committee would be seriously limited by such an
assurance. In the one case, potential System intervention revoives in general
around its commitments with respect to "orderly markets." In the other, it is
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UNITED STATES MONETARY POLICY
associated mainly with the purchases and exchanges in periods of Treasury
financing.
(50) So far as the first type of intervention is concerned, the form and wording
of the directive issued by the Federal Open Market Committee with respect to
"orderly markets" assumes a particularly crucial importance. The subcommittee was much impressed with the wide differences in opinion among dealers
and nondealers as to what constitutes an "orderly market." From the discussion,
it is thoroughly apparent that the term "orderly markets" does not have a clearly
defined meaning which is generally understood and accepted.
(51) In view of these differences in concept, and particularly in view of the
narrow definition of this term held by some market elements, it seems to the subcommittee that the apprehensions of the dealers have substance. The present
wording of the directive of the Federal Open Market Committee on "maintenance
of orderly conditions" carries with it an unduly, and even dangerously strong,
implication of continuing intervention in all sectors of the market. This prospect
of intervention seriously impairs the ability of the market to stand on its own feet
or to evaluate correctly the real forces of demand and supply in the economy. It
is clearly evident that a directive to "maintain orderly markets" can mean all
things to all men, and in effect constitutes a blanket delegation of discretionary
authority which can be interpreted to cover almost any action by the Committee
in the market.
(52) In the subcommittee's view, a directive which is subject to such an interpretation by either the market, the executive committee, or the management of
the account is entirely inconsistent with the minimum role in the market which
the Federal Open Market Committee must assume if the Committee and the
market are each to perform their respective functions most effectively.
(53) The subcommittee recommends, consequently, that the wording of the
directive of the Federal Open Market Committee to the Executive Committee be
changed to provide for the "correction of disorderly conditions" rather than the
"maintenance of orderly conditions" in the market for Government securities.
The directive by the Executive Committee to the management of the account in
this regard should involve an instruction to notify the Executive Committee
whenever conditions become sufficiently disorderly to warrant the consideration
of corrective action by the Federal Open Market Committee.
(54) In making this recommendation, the subcommittee takes the position
that fluctuations resulting from temporary or technical developments are selfcorrecting in a really free money market without the necessity for intervention of
any kind. This is particularly true of a functioning market characterized by
depth, breadth, and resiliency. Of the movements that are not self-correcting,
most reflect basic changes in the credit outlook and should not be the occasion
for intervention. Of the remainder that do not fall in either of these two categories, the great preponderance, throughout all sectors of the market, will respond
readily to arbitrage induced by positive intervention on the part of the Committee
in the very short sector of the market. In other words, it is only rarely that
selling creates a sufficiently disorderly situation to require intervention in other
than the very short market. A disorderly condition created by buying is very
unlikely to occur if the Committee is in a position to absorb reserves by selling
in the short-term market.
(55) The subcommittee considers a declining market really disorderly in the
sense that it requires intervention to meet it when selling feeds on itself so
rapidly and so menacingly that it discourages both short covering and the placement of offsetting new orders by investors who ordinarily would seek to profit
from purchases made in weak markets. There are occasions when such really
disorderly reactions occur in the market. They may lead, if left unchecked, to
the development of panic conditions. These must be corrected. In the judgment
of the subcommittee, it is in these circumstances, and these circumstances only,
that the Federal Open Market Committee would be impelled, by its basic responsibilities for the maintenance of sound monetary conditions, to intervene, and intervene decisively, in other than the very short-term sector of the Government securities market.
(50) The reserve funds put into the market in such operations would complicate the smooth execution of monetary policy, but the occasions for intervention
would be infrequent. Once properly explained, consequently, this specific exception to a general public assurance that the Committee henceforth would confine
its operations to the very short maturities, preferably bills, should not impede
the development of a market with greater depth, breadth, and resiliency.
TJNITED STATES MONETARY POLICY
269
The problem of Treasury financing
(57) The Federal Open Market Committee now follows the practice of intervening in the market to support rights values on maturing Treasury securities.
So long as this practice continues, it will be impossible to give the type of assurance discussed above. These interventions are recurrent. When sales to the
Federal Reserve are appreciable, they result in the injection of reserve funds
into the market in amounts that are embarrassingly large. They impose a
pattern of yields on the market, and, consequently, are disturbing to its depth,
breadth, and resiliency.
(58) The practice of supporting Treasury financings developed during the
period of war finance, when the Treasury and the Federal Open Market Committee undertook jointly to see that lack of funds would not impede etfiective
prosecution of the war. In the judgment of the subcommittee, it would be
appropriate to sit down with the Treasury and review the practice in the light of
current experience. If any change is to be made, there would be need for
extensive consultation with the Treasury, since the Treasury's present debt management policies and its current practices in managing its cash balance would
be directly affected.
(50) The subcommittee's views on this point have been considerably influenced
by the judgment of its technical consultant, Mr. Craft, and it urges that the
Federal Open Market Committee give most serious consideration to the views
expressed in the memorandum, entitled "Ground Rules," attached as appendix C.
The conclusion presented in this document is that for the open market operation
to be successful there must be new ground rules, i. e., new methods of operation
by the Committee, known in advance, that will permit the Committee to pursue
vigorous credit and monetary policies without incurring the danger of disruption
in the market for Government securities. The principal recommendations with
respect to the most appropriate ground rules are three: (1) that the Committee
(except in the case when it is dealing with a disorderly market) confine its
operations to bills, (2) that, in the rare case of the emergence of a disorderly
market, corrective actions be deferred until the need for them is clearly indicated and then be taken only after a poll of the executive committee rather than
at the discretion of the management of the account, and (B) that the practice
of supporting directly either new or refunding issues of Treasury securities be
abandoned. The memorandum outlines in detail the considerations that have led
to these conclusions, and the specific technical operations that would best carry
them into effect.
(60) The memorandum outlines the serious operating problems that the Federal Open Market Committee will face, necessarily, if it continues to acquire
Treasury issues of new or refunding securities. The subcommittee is particularly impressed by the conclusion that the portfolio of the open market account
may become, in fact if not in theoretical composition, frozen or semifrozen. As
is pointed out, the securities which the open market account has acquired as
rights in underwriting a refunding have subsequently been exchanged for the new
issue and the Federal Open Market Committee has been hesitant to dispose of
these new issues under normal conditions in the market—a justifiable hesitation
because sale of the securities in the market before they have been held quite near
to their maturity might be disruptive.
(Gl) It is also pointed out that when these securities or, in fact any securities other than bills, however acquired, were sold into the market as they approached maturity, they have been purchased largely by corporations or other
investors who had a specific need for cash at the maturity date. They have
tended, consequently, to increase the natural and inevitable attrition connected
with any maturing Treasury issue. Consequently, the securities have tended
to be reacquired by the Committee in supporting the refunding.
(62) The persistent growth in the open market account of securities acquired
directly or indirectly in support of Treasury refundings is disquieting.
(63) The present semifrozen position of the portfolio brings out in new form
the desirability of a larger proportion of bills in the System's portfolio, and underscores the cogency of the recommendation that henceforth the Committee
operate exclusively in bills except when it is intervening in the market to correct conditions of very serious disorder. Bills, in addition to their ready market ability and other qualities that make them preferred components of the portfolio, have the unique advantage, from the point of view of the Committee's
operations, that they are marketed at auction for cash and are redeemed in cash
at maturity. Neither at issue, nor at redemption, do they raise problems of support for the Committee, nor of attrition for the Treasury.
55314—54
18
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UNITED STATES MONETARY POLICY
(64) It is clear that the Federal Open Market Committee cannot consider the
type of assurance that would contribute most to the development of depth,
breadth, and resiliency in the market until it has come to a decision on the question of whether or not the Committee should continue to buy rights or any other
securities other than bills during periods of Treasury financing. There are two
opposing viewpoints on this basic and difficult problem.
(06) If it is believed that the System's responsibilities are strictly limited to
the formulation and execution of credit and monetary policy, logic would preclude
the Federal Open Market Committee from purchasing rights or other issues to
support Treasury financing. Under this view, the Treasury, being responsible
for debt management, would be responsible also for naming such terms and
coupons on new securities that a natural-rights value in the market would be
established automatically. There would be no occasion, therefore, for intervention or support by the Federal Open Market Committee. The Committee might,
of course, engage simultaneously in open-market operations to relieve an unexpected stringency in the money market, but it would not be expected to do so,
and if it did it would operate only because of its responsibility for the general
credit situation.
(CG) This view rests on the doctrine that the governmental structure must
provide that responsibility for public decision be clearly fixed and that public
officials be held strictly accountable for their decisions. It, therefore, leaves
little scope for purchases to support a new issue by the Federal Open Market
Committee during the period of subscription. In this view, the Federal Open
Market Committee would buy no rights on a maturing issue, with the result that
all attrition would fall on the Treasury if the issue were not attractively priced.
(67) This would be expected under the logic of the doctrine of responsibility.
Since decisions with regard to debt management are unquestionably a prerogative
of the Treasury, the Treasury, under that doctrine, would expect to accept the
consequences of an erroneous decision. If attrition were large, the Treasury
would be expected to replenish its cash balance with a second offering on terms
more in tune with the market.
(OK) In contrast to this view is the position which holds that debt-management
and reserve-banking decisions cannot be separated. While the Treasury is primarily responsible for debt-management decisions, that responsibility under this
second view is shared in part by the Federal Reserve System, and while the
Federal Reserve is primarily responsible for credit and monetary policy, that
responsibility must also be shared by the Treasury. According to this position, the problems of debt management and monetary management are inextricably intermingled, partly in concept but inescapably so in execution. The
two responsible agencies are thus considered to be like Siamese twins, each completely independent in arriving at its decisions, and each independent to a considerable degree in its actions, yet each at some point subject to a veto hy the
other if its actions depart too far from a goal that must be sought as a team.
This view was perhaps unconsciously expressed by the two agencies in their
announcement of the accord in March 1951. In that announcement they agreed
mutually to try to cooperate in seeing that Treasury requirements were met
and that monetization of debt was held to a minimum.
(CO) In the view of the subcommittee, it would be wise to avoid pushing either
of these positions to the full logical extreme. Neither position exactly fits the
immediate situation facing the money market, the Treasury, or the Federal Open
Market Committee.
(70) The Federal Open Market Committee has only recently abandoned its
previous policy of continuous control of prices and yields throughout the list of
Government securities. During periods of refunding, it is still purchasing rights,
and on occasion interfering with market arbitrage by supporting issues whose
maturity approximates the maturity of new Treasury issues. The object of these
transactions is to shield the cash balance of the Treasury from the attrition that
might otherwise occur when maturing issues are not presented for exchange.
(71) The Treasury, faced with enormous financing problems both for new
money and refundings, has modified to a considerable degree the debt-management
techniques developed during the war. Maturing certificates, however, are usually
rolled over into a similar issue and when projections are made of needs for new
money it is assumed that only moderate attrition will fall on the Treasury in
connection with these refunding operations.
(72) The market, too, is in a period of transition. It is confused with respect
to the occasions when it should expect intervention from the Federal Open TCIarket
Committee, and it is uncertain with respect to the sectors in which this intervention might occur. It is hesitant, therefore, and lacks the depth, breadth,
UNITED STATES MOKETARY POLICY
271
and resiliency that would be desirable. It is in the interest of the Treasury as
well as of the Federal Open Market Committee that every effort be made to
improve these characteristics of the market.
(73) It is in the context of this situation that the subcommittee is formulating
its recommendations. It has found (1) that the Federal Open Market Committee
can promote the well-being of the market for Government securities by an assurance that henceforth it will avoid unnecessary intervention in the market, and
will confine that intervention as much as possible to the very short maturities,
preferably bills, (2) that the ability of the Federal Open Market Committee to
give such an assurance is blocked by the present practice of purchasing rights
and certain issues during periods of Treasury financing, and (3) that, in addition
the portfolio of the open market account is becoming unduly weighted with the
securities that have been acquired in these support operations.
(74) The subcommittee recommends, therefore (1) that the Federal Open
Market Committee ask the Treasury to work out promptly new* procedures for
financing, and (2) that, as soon as practicable, the Federal Open Market Committee abstain, during periods of Treasury financing, from purchasing (a) any
maturing issues for which an exchange is being offered, (b) any when-issued
securities, and (c) any outstanding issues of comparable maturity being offered
for exchange.
(75) Should the Federal Open Market Committee adopt the recommendations
of the subcommittee with respect (a) to the type of situation justifying intervention to correct disorderly market conditions, and (l>) to the kinds of transactions appropriate during a period of Treasury financing, it would be in a position to give a public assurance to the market that henceforth, with two exceptions, the Committee will intervene in the market only to absorb or release reserve funds to effectuate its monetary jDolicies, and that it will confine its intervention to the shortest sectors of the market, preferably bills.
(76) The two exceptions should be carefully explained to the market. They
would occur (1) in a situation where genuine disorderly conditions had developed to a point where the executive committee felt selling was feeding on
itself and might produce panic, and (2) during periods of Treasury financing. In
the first case, the Federal Open Market Committee would be expected to enter
more decisively in the long-term or intermediate sectors of the market. In the
second case, intervention, if any, would be confined to the very short maturities,
principally bills. The subcommittee recommends most strongly that the Federal
Open Market Committee adopt the necessary measures and give this assurance.
Judgments of System market techniques
(77) The whole Federal Reserve System can take pride in the prestige enjoyed
by the Federal Reserve Bank of New York, and by the management of the open
market account in their relations with the Government-securities market. The
subcommittee in its discussion made every effort to provide an atmosphere where
the market participants would feel encouraged to talk freely with the understanding that their comments would be considered impersonally and objectively.
In most cases, the participants in the discussions responded to this atmosphere
and discussed their problems objectively, including problems that have arisen
in dealing with the Federal Open Market Committee. Without, in any sense,
diminishing the importance of these problems and the urgent necessity of taking
actions recommended below to eliminate their recurrence, the subcommittee
found that by and large the market personnel which participated in the discussions had confidence in the integrity of the personnel of the Federal Reserve
Bank of New York, and respect for the competence of its management.
(7S) At the same time, the subcommittee was surprised to find extensive criticism of many of the technical operations of the Committee, especially in its relations with the dealer organization. As was anticipated, it found that the drawing of a rigid line between "recognized" and "non recognized" dealers was resented by the latter. In addition to this, however, there were evidences, even
among the recognized dealers, of irritation with the dealer-Federal Open Market
Committee relationship, and some doubt and confusion as to exactly what function the relationship now serves under conditions of unpegged markets.
(79) It is the view of the subcommittee that these two sources of dissatisfaction and irritation cannot be brushed off lightly or viewed complacently as
inevitable accompaniments of the difficult and broad operations that are performed by the Committee in the market for the huge outstanding Government
debt. The complaints are specific and relate to specific techniques of operation.
Unless corrected, they will continue to fester and rankle.
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UNITED STATES MONETARY POLICY
(80) In all too many cases, the criticisms ate interrelated; that is, the technical operations of the Federal Open Market Committee most broadly criticized
in the market are the very types of operations which require for their effectuation
a sharp differentiation between dealers who are recognized and others who are
not. If these technical operations of the Committee were abandoned in accordance with the suggestions of the bulk of the participants in the discussions, there
would seem to be less need or justification for the present rigid system of dealer
recognition. The subcommittee proposes, therefore, (1) to examine the technical
operations to which objection has been raised in its discussions, (2) to come to a
judgment as to whether or not the objections are valid, (3) to recommend alternative procedures if they are considered valid, and (4) to consider what form of
relationship between the Federal Open Market Committee and the dealers would
be most appropriate to a situation of unpegged markets.
(81) "Reluctant buying"—The "reluctant buying" technique employed on frequent occasions by the Federal Open Market Committee during the period of
pegging, and apparently still used in more limited extent and in modified form
during certain refunding operations since March 1951, furnished the most prevalent and active target for criticism on the part of dealers, both recognized and
unrecognized, as well as of nondealers. This criticism was practically unanimous on the part of all who referred to the subject in their discussion.
(82) Reluctant buying is the term used to refer to the practice followed by the
Committee of limiting its purchases of securities to only a portion of the amounts
offered while at the same time requiring that dealers not lower their quotations.
This practice involves the exercise of judgment as to whose securities will be
taken. The technique is premised on the theory that failure to secure prompt
execution will discourage offerings and give time to the dealers to shop around
and find market lodgment for securities pressed for sale. It requires a tight
Committee control over the major trading elements in the market—maintained
through the recognized dealer mechanism—in order to enable the Committee to
prevent changes from being made in quoted dealer prices without having to use
reserve funds to clear the market of securities being offered for sale at those
prices.
(88) Criticisms of the technique (and these were more or less tied together
with all the arrangements under which the System took control of the market
under the pegs) relate in part to the effects it has on market institutions. It
precludes proper functioning of the dealer mechanism, both recognized and
unrecognized. It makes brokers of recognized dealers and prevents their taking
positions and making markets. Unwillingness to deal with unrecognized dealers,
or even to permit recognized dealers to split commissions, makes unrecognized
dealers refuse business and turn their customers away since they cannot cover
costs. When first applied, it automatically eliminated the auction market for
Government securities on the stock exchange, since the specialist, unlike the recognized dealers, could not cover his bids through the Federal Open Market
Committee.
(84) However, the most striking criticism, in the opinion of the subcommittee, was that the technique failed in its basic purpose of pegging prices with
a minimum of Federal Open Market Committee purchases. It was the general
conclusion of most discussants that the theory underlying the entire "reluctant
buying" technique rests on an incorrect judgment of market reactions. It was
the consensus that the response of investors to this technique is perverse in
that holders are induced to attempt to force a greater volume of securities on
the market than they otherwise would. Failure to secure prompt execution of
sales at quoted markets, instead of reducing sales, heightens uncertainty, encourages further offerings, and in the case of the restricted bonds seems to have
stimulated attempts to dispose of bonds to the Federal Open Market Committee
through resorting to various types of "blinds." For example, the Committee was
believed to have been less reluctant to buy restricted bonds from recognized
dealer banks (because of the $500,000 limit on their portfolios) than from
nonbank dealers.
(85) It was the almost universal recommendation that, should an occasion
ever arise again that justified support operations, a policy of aggressive rather
than reluctant buying on the part of the Committee would reduce uncertainty
among investors as to their ability to sell and to that extent diminish the volume
or offerings. The subcommittee finds this technical judgment persuasive.
Certainly the technique of "reluctant buying" should be avoided. In the execution of an aggressive technique, moreover, purchases should not be confined to'
recognized dealers. If the objective is to engender confidence and remove uncertainty from the market by a show of bids, the desired effect will be achieved
UNITED STATES MONETARY POLICY
273
more readily and with less nionetization of debt by spreading the bids among all
dealers with whom the public is accustomed to trade rather than by raising
•questions in the minds of investors as to whether or not they can secure execution through accustomed channels.
(86) The "reluctant buying" technique is perhaps merely the ultimate development in a series of arrangements for controlling the market that had their genesis
during the war period. These were further strengthened in the postwar period.
The principles and theory underlying these arrangements were that control over
the market could be achieved with a minimum outlay in reserve funds if the final
effort at matching off private transactions were narrowed to a small group of
dealers, provided that the Committee could control these dealers by various
devices and could confine its buying to the residual transactions. It is tlfe view
of the subcommittee that with the passing of the pegging operation the need
for such arrangements, if it ever existed, has also passed. Fortunately the
circumstances which give rise to most of the serious criticisms directed against
the operations of the Committee revolve about the arrangements made to control
the market under pegs. By dispensing with these arrangements, no longer
needed, these sources of criticism can be corrected.
(87) Trading on an agency basis.—Dissatisfaction was general throughout
the group of recognized dealers with respect to agency transactions on behalf
of the Federal Open Market Committee. This dissatisfaction was expressed
most openly and acutely with respect to the commissions allowed by the Committee. These were claimed to be too small in many cases to cover costs. It
was also alleged by some, but not all, that the commissions allowed by the
Committee have been a factor in the narrowing of spreads in the market to the
point where it has weakened the dealer organization.
(88) Dissatisfaction was expressed with the rule that prohibits a recognized
dealer from selling from his position when engaged in an agency transaction for
the Federal
Open Market Committee. Whenever the Committee is the major
buyer1 of a particular issue, the rule has the effect of freezing the recognized
dealer's position in that issue, precluding him from making a market in that
issue, and turning him, in effect, into a broker for the Federal Open Market
Committee. It constitutes a strong inducement not to make markets and thus
acquire positions if the dealer thinks the account may enter the market; it raises
the specter of losses on positions previously acquired; and in some circumstances
it creates a situation where the Committee is subsequently under moral compulsion to absorb dealer positions to protect them against loss.
(89) Nonrecognized dealers resent the fact that they have to absorb all handling costs themselves or refuse customer business when the Committee is the
sole buyer in the market, since recognized dealers are not allowed to split commissions on agency transactions. The unrecognized dealers also suspect or are
aware that recognized dealers have been "bailed out" on occasion.
(90) These are problems that arose most acutely during the pegging operations,
but they did not end with the accord. They still arise during periods of Treasury
refundings and, in fact, whenever the Federal Open Market Committee operates, as it customarily does, on an agency basis. One recognized dealer was
troubled by the fact that in many instances he is put in a morally indefensible
position of acting as agent for both buyer and seller, i. e., for the Committee as
well as for his customer.
(91) In the judgment of the subcommittee, this bundle of problems and irritations all stem from a common source, i. e., the emphasis on agency transactions
in operations of the Federal Open Market Committee, and would be corrected
by willingness to transact business at the market with dealers as principals.
This would eliminate the problem of inadequacy of commissions and allow competition in the market to establish spreads adequate to support an efficient and
functioning dealer organization. It would remove the problem of frozen positions and permit dealers to make markets by building up and reducing positions
in accordance with market considerations. It would end the problem of "bail
outs."
(92) From the point of view of operations to effectuate Federal Reserve credit
policy, reserve funds are put into or absorbed from the market just as effectively
when securities are bought from dealers as principals as when dealers are used
as agents. From the point of view of promoting a strong self-reliant Government securities market characterized by intelligent pricing, alert arbitrage,
depth, breadth, and resiliency, the Committee's purposes are better served by
techniques of operation which avoid the freezing of positions, always at the
hazard of loss, on the part of those whose professional attitudes toward the mar-
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UNITED STATES MONETARY POLICY
ket are probably most influential in hour-to-hour and day-to-day shifts in market
situations.
(93) It is the subcommittee's conclusion, therefore, that agency transactions
should be abandoned and that the Federal Open Market Committee should enter
into transactions with dealers as principals on a net basis. Such transactions
should, of course, be made at the best market available. It is very doubtful
whether they should be confined as a matter of procedure to the presently recognized dealers. A case may perhaps be constructed for rigid rules of dealer qualification where agency relationships with the Federal Open Market Committee
are involved, but there is little basis in public policy for such discrimination
among dealers in transactions where dealers are principals.
(94) Use of the repurchase facility.—The role occupied by repurchase agreements and the terms of settlement in the technical operations of the Federal
Open Market Committee is a subject of considerable controversy within the
dealer organization, and many conflicting points of view are present. Recognized
nonbank dealers are quick to point out that their bank-dealer competitors have
direct access to the Federal Reserve banks and therefore are in a position to
borrow at the Reserve banks at the discount rate in order to carry portfolios
when money is tight. Nonbank dealers, on the other hand, borrow at the money
market banks at rates that frequently rise above the bill rate. A negative
"carry" thus develops which makes it expensive and at times prohibitively costly
to maintain adequate portfolios. This problem is particularly acute when money
is tight over a period of weeks or months, and also when a holiday falls on
Friday or Monday, necessitating a 4-day carry. In these circumstances the nonbank dealers are at a serious competitive disadvantage in their ability to make
markets. In the endeavor to mitigate this situation, they try to borrow from
out-of-town banks and also use credit accommodation from corporations on
repurchase agreements.
(95) Bank dealers, in part because of their access to Federal Reserve credit,
are readily able to service customers on a cash, rather than the usual regular
delivery basis. There has been an increasing use of cash transactions which has
constituted an increasingly serious competitive disadvantage to nonbank dealers.
Except when the repurchase facility at the Federal Reserve bank is available,
the only way they can meet the competition is by buying Federal funds, which
is costly when money is tight.
(96) All of the recognized nonbank dealers felt strongly that the Federal
Open Market Committee should alleviate these difficulties by a more liberal
policy with respect to the extension of Federal Reserve credit on repurchase
agreements. Their proposals ranged from the suggestion that each nonbank
dealer be given what would be in effect a line of credit for repurchase contracts
by the Federal Open Market Committee to be used at his own discretion, to the
more modest suggestion that repurchase facilities be extended freely over weekends, particularly over weekends lengthened by a holiday. They complained that
frequently they are not informed until the last moment whether or not repurchase facilities would be available. They also desired a change in the policy
of the Committee under which it now refuses to buy bills, either outright or on
a repurchase basis, which dealers have bought for cash delivery. Some even
suggested a change in policy by which the Committee would be willing to buy
bills outright with payment in immediate funds.
(97) Most bank representatives, but not all, opposed the availability of repurchase agreements to nonbank recognized dealers. They maintained that
the advantage enjoyed by a member bank of direct access to Federal funds
at the rediscount rate was an inherent advantage of membership. The equivalent
extension of facilities to dealers on repurchase contracts would constitute, in
effect, the opening up of membership privileges to nonmembers. They also
maintained that the competitive advantage they enjoyed over the nonbank
dealer in their access to Federal funds merely offset the competitive advantages
enjoyed by the nonbank dealer in being able (1) to take positions in excess of
$500,000 in restricted bonds, and (2) in being permitted to enter large subscriptions for attractive Treasury issues, such as the 2%s of 1958. They further
claimed that free extension of repurchase facilities to nonbank dealers would have
the effect of pegging the bill rate.
(98) Nonbank unrecognized dealers complained that they worked under a
double competitive disadvantage. They enjoyed neither the full access to Federal funds of the bank dealers nor the occasioned access to repurchase facilities
of the recognized nonbank dealers. Nonbank dealers, both recognized and unrecognized, stated that they were forced to bid to miss in the weekly bill auction
when the impact of these competitive cost disadvantages was too severe.
UNITED STATES MONETARY POLICY
275
(09) The subcommittee feels that this testimony reveals unsatisfactory aspects
of the bill market. In some degree these basic frictions are inevitable in a
market structure that is shared by bank and nonbank dealers. No problem
would exist, for example, if all dealers were also member banks. Then the dealer
organization would price securities and develop competitive patterns in an
environment in which access to immediate funds to carry portfolios and to buy
for immediate cash were available at the discount rate to all dealers alike.
There would be no call for repurchase contracts since the member bank discount
window would meet the need.
(100) Similarly, there would be a less difficult problem if there were no bank
dealers. Then all dealers alike would have to pay the market money rate to
carry portfolios and likewise would have to buy Federal funds in the Federal
funds market if they bought securities for cash delivery. In that case, the
Federal Open Market Committee could confine its consideration of whether or
not to make repurchase facilities available to the effect of such facilities on the
rate structure and to the desirability of mitigating the sudden development of
very tight conditions in the money market over periods of temporary strain.
(101) The problems created by the presence of both bank and nonbank dealers
as indispensable components of the market structure must be recognized by the
Federal Open Market Committee. Little comfort can be derived from the fact
that the competitive disadvantage of nonbank dealers with respect to direct access
to Federal funds is alleged to be compensated by a competitive disadvantage that
prevents bank dealers from freely competing in the market for restricted securities. Both disadvantages react adversely on the structure of the Government
securities market. Both impair the market's ability to perform efficiently under
all conditions. Certainly a serious situation is revealed when the nonbank dealer
component in the weekly auction for bills bids to miss at times of stringency, not
because the bills acquired could not be marketed but because the necessary risks
and costs of carrying the bills prior to resale is higher for nonbank dealers than
for their bank competitors.
(102) The subcommittee feels that these fissures in the structure of the market can be alleviated somewhat by changes in the technical operations <>f the
Federal Open Market Committee. They should not be accentuated by the Committee's operations. The subcommittee sees no purpose served by a procedure
under which the Committee first divides the bills bought by a dealer into two
categories, according to whether or not they were acquired for immediate cash,
and then confines its purchases to those which have been acquired on a regular
delivery basis. It may be that the original consideration back of this discrimination was to discourage deals for immediate cash and encourage market transactions on the basis of regular delivery in order to achieve a more effective control over the New York money market. If so, the maneuver has lost utility and
should be dropped. Sales for cash are increasing and will probably continue to
do so as long as banks use this medium for adjusting reserve positions and dealer
banks with ready access to immediate cash are in a position to service them.
(103) The subcommittee likewise sees no consideration sufficiently relevant
to justify overlong delay in letting dealers know whether or not repurchase
agreement facilities will be extended. If the facilities are to be made available,
the dealers should be informed in sufficient time to perform their market functions efficiently.
(104) The subcommittee doubts whether our experience with operations in a
free market has yet developed to the point where it is possible to lay down
definitively all the situations in which the availability of repurchase facilities
would or would not be advisable. The testimony, however, has presented a clear
case for the more ready availability of repurchase facilities to nonbank dealers
over weekends as well as in periods of acute credit stringency. It recommends
that they be made available regularly to nonbank dealers over weekends. Any
tendency to abuse the privilege should be subject to control by variations in the
rates on these facilities.
(105) These moves should go some distance toward alleviating structural impediments which have acted to prevent the nonbank dealers from carrying their
full load in the bill market. They should make it more possible for all nonbank
dealer participants in the weekly bill auction to gage their bids at each auction
on their evaluation of the demand for bills rather than on their lack of access
to credit facilities enjoyed by competitors.
(106) In addition, the subcommittee feels it would be worth while to see
whether or not a call-money post could be reactivated where nonbank dealers
could borrow for portfolio purposes. It is anomalous to find money-market banks
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UNITED STATES MONETARY POLICY
maintaining over a considerable period of time a portfolio of bills t h a t yields
t h e m a lower return than the rates a t which they are willing to lend on call an
equivalent collateral. Normally one would expect the opposite relationship to
p r e v a i l ; provided the m a r k e t were truly impersonal the loan with less risk exposure should carry the lower rate. I t is disturbing to find a money m a r k e t so
unorganized t h a t dealers, to counteract this situation, cultivate both out-of-town
banks and corporations individually on a customer basis as sources from which
to borrow money. Revival of an effective call-money post for dealer loans such
as existed in the 1920's would go far to correct this condition. A more detailed
discussion of this problem is given in appendix D of this report.
(107) The restrictions against bank ownership on most of the remaining restricted issues will expire by 1054 and this will go far to restore equal competitive relationships between bank and nonbank dealers in t h a t sector of the market. These restrictions may be removed a t any time by the Treasury.
(108) The subcommittee sees no public purpose served by limiting repurchase
facilities to the present restricted list of recognized nonbank dealers. The market structure would be better served by equal extension of the privilege to all
nonbank dealers of integrity who participate effectively in the bill market. It
recommends t h a t in the future when repurchase contracts are made available
by the Federal Open Market Committee, they be offered fairly and impartially
to all nonbank dealers who participate regularly in the weekly bill auction, and
in amounts related to t h a t participation, say, in some relationship to the average
of the dealer's bill a w a r d s over the preceding 3 months.
(100) Operations (hiring Treasury financing.—The techniques applied by the
Federal Open Market Committee during Treasury refunding operations were
subject to some criticism, but the more important conclusion t h a t emerged from
the discussion of this phase of the Committee's operations was the fact t h a t
neither the committee nor the dealer organization h a s yet come to well-defined
and consistent positions on this difficult technical problem. Because the subject
dealt with the placement of new Treasury issues, t h e discussion inevitably
touched on problems t h a t fall also in the a r e a of debt management. For example,
the view was unanimous t h a t the dealers cannot function effectively as secondary
underwriters unless the coupon and terms placed on new issues a r e sufficiently
attractive to establish a natural rights value in the market. There were other
suggestions t h a t may minimize the problem of attrition, as, for example, t h a t
refundings be conducted through new issues for both cash and exchange r a t h e r
than solely on the basis of exchange. The subcommittee h a s not considered
problems of debt management and the following comments and recommendations
deal solely with technical procedures which the Federal Open Market Committee
h a s followed during periods of Treasury financing.
(110) All of the criticisms of the dealers t h a t relate to the technical practices
of the Federal Open Market Committee during periods of refunding stemmed
basically from the agency relationship of the Committee with the recognized
dealers. Nonrecognized dealers complained t h a t they were forced out of the
market during periods of refunding. They had no outlet t h a t would cover costs
for issues they might take from their customers since the Federal Reserve
refused either to deal with them directly or to permit recognized dealers to split
commissions with them.
(111) Recognized dealers for their p a r t complained t h a t the commissions
allowed by the Federal Open Market Committee on agency transactions barely
covered clearing, telephone, and other current costs and made little or no contribution to carrying overhead costs. They also complained t h a t because of the
agency relationship their own holdings of t h e maturing issues were frozen so
long as the books were open or the Committee was operating since under this
relationship dealers are uot allowed to sell to the Federal Reserve from their
own position. The practical result is t h a t in the case of any offering t h a t
requires Committee support dealers a r e frozen into any maturing'securities they
had in position at the time the Committee started supporting operations. In
their capacity as dealers they feel obligated to tender such securities in exchange.
Under these circumstances they avoid making markets in order not to add to
their positions. They become, temporarily, merely brokers for the Federal Open
Market Committee. They resent losses they sustain when the rights value established by the Committee is high in relationship to the market, and thev feel t h a t
the Committee should feel morally obligated to bail them out.
(112) Recognized dealers also complained (1) t h a t the Committee h a s been
slow on occasions in deciding w h a t rights value to pav when the books are
opened on refinancings, and (2) t h a t a t times i t has operated for short periods
"UNITED STATES MONETARY POLICY
277
with different rights values to different dealers, thus giving the dealers' customer
the idea that some dealers can secure better execution than others.
(113) Most of these problems will disappear if the Federal Open Market
Committee decides to abandon agency transactions as recommended by the subcommittee. All, of course, would disappear if the Committee should decide to
refrain from purchases of rights. Presumably the emphasis on the agency relationship stems from the period of general pegs when it was feared that dealers,
if permitted to operate as principals, would canvass investors to stimulate
market activity and persuade them to sell rather than exchange maturing issues.
This apprehension may have been justified when the Committee was operating
with more or less continuous pegs, but has no substance in a free competitive
market. In a free market, any dealer who solicited customer business merely
to create activity would soon find himself with fewer customers.
(114) It is the subcommittee's recommendation, therefore, that if the Federal
Open Market Committee decides to purchase rights during a period of Treasury
refinancing, it purchase them from dealers as principals without regard to
whether or not the securities come from a dealer's own position. This will
eliminate the problems of frozen positions, of the bailing-out of losses on those
positions, and too narrow commissions. It will also free the dealers to perform
their function of making markets at all times.
(115) The subcommittee also recommends that these transactions be conducted
without regard to whether or not a dealer is on the recognized list. It is hard to
see how a refunding operation, accompanied as it must be by a very general
turnover of securities in the market, is aided by a technique that either eliminates some dealers from the market or forces them to trade exclusively off
other dealers' markets.
The problem of dealer recognition
(116) There is no room for complacency on the part of the Federal Open
Market Committee over the problem of dealer recognition. That fact emerged
more and more vividly as each of the unrecognized dealers discussed his problems before the subcommittee. The unrecognized dealers showed up well as
individuals both in terms of personality and integrity, and in terms of professional grasp of the business and ability to evaluate the impact of credit and
monetary problems on the money markets. It would be hard for anyone sitting
through all the hearings to reach the conclusion that this group of unrecognized
dealers differed significantly, on the average, from those who represented the
recognized dealers with respect to training, integrity, professional capacity, or
ability to analyze problems. The fact is that they made a very good impression
as a group.
(117) These were the dealers who fell outside the line when the Federal Open
Market Committee, at the same time that it was pegging the prices of Treasury
securities and was frequently tlie only source of demand, established formal
criteria to distinguish the dealers with whom it would deal from those with
whom it would not. That line seriously impaired the ability of unrecognized
dealers to function and survive in the Government securities business. Of that
fact there can be little question. The impairment came, not only through loss
of prestige, which was bitterly resented, but also through loss of customer contacts because of inability to function in rough markets, i. e., when the Committee was operating in the market. This impairment is not so serious now
that the Committee has stopped pegging but it still persists to some degree.
Curiously, it has not seemed to impair the credit standing of the unrecognized
dealers at the banks. All stated they had no difficulty in securing the financing
necessary for their business.
(118) There was practically unanimous agreement on the part of dealers,
recognized and unrecognized alike, that character, integrity, and professional
grasp of the business are the essential prerequisites to effective operation as a
Government securities dealer. All seemed to feel that capital, though important,
is secondary. Even some of the recognized dealers who defended the practice
of formally designating the dealers with whom the Federal Open Market Committee would do business, indicated that capital is not the first essential for
successful dealer operation. Since additional capital can apparently lie attracted
when justified by the scope and profitability of the business, a determining factor
in success and growth of a securities dealer is the ability to gain customers, to
hold them, and to service them at a profit.
(119) The lines drawn by the Federal Open Market Committee, therefore,
struck the unrecognized dealers in a most vulnerable spot, namely, in their ability
to service their customers. It cut down the range of their customer potentialities
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UNITED STATES MONETARY POLICY
and thus reduced their ability to attract or earn capital to meet the minimum
capital requirements of the Federal Open Market Committee. It acted in the
same way to impair the ability of a nonrecognized dealer to earn recognition by
developing customer relations that were nationwide in scope and that extended
to all sectors of the list. In short, once the lines were drawn and recognition
was accorded to some dealers and not others, a hurdle of some magnitude was
imposed on the unrecognized dealers which impaired their ability to develop
their business to the point where it would be able to meet the standards imposed
by the committee.
(120) The subcommittee probed both recognized and nonrecognized dealers
alike to ascertain whether there were not also special responsibilities imposed
upon the recognized dealers that might be considered to offset in some degree
the privilege of direct contact with the Federal Open Market Committee, but
this line of inquiry enlisted only feeble response. The unrecognized dealers
professed a willingness to submit reports to the Federal Open Market Committee.
In fact, many do report now even though they are unrecognized. In general,
the dealers, both recognized and unrecognized, did not seem to feel that the
responsibilities to the Federal Open Market Committee imposed on the recognized
group operated seriously to their disadvantage in competition with the nonrecognized group. It is clear that the unrecognized dealers would be only too willing
to accept such burdens in return for recognition.
(121) The Federal Open Market Committee cannot afford to be complacent
about this situation. It has explosive potentialities. Privilege as such is
repugnant to the spirit of American institutions. The privilege of dealer recognition, if it is to be continued, must be justified on grounds of high public policy
as essential and necessary to the effective conduct of open market operations. It
is not suflicient to aver that dealer recognition was once useful or that it should
be maintained because it is already in existence, in the absence of a positive
reason for change. The fact that privilege exists by virtue of actions of the
Federal Open Market Committee is in itself a positive reason for its eradication
unless there are necessary and compelling considerations to require its perpetuation.
(122) The present system of official dealer recognition instituted by the
Federal Open Market Committee in 1944 was an element in a technique of open
market operations designed to peg the yield curve on Government securities
and at the same time minimize the monetization of public debt. This technique
was based on the hope that the yields on Government securities could be pegged
with only a few securities monetized by the Federal Open Market Committee if
all offers to the committee had to pass first through a very limited number of
dealers with whom the committee would maintain intimate and confidential
relations, and who would be required by the committee to make strenuous efforts
to find other buyers for securities in the market place before they looked to
the committee for residual relief.
(123) The inexorable march of events on which that hope foundered is now a
matter of history. The facts are that debt was monetized in volume and that
the country suffered a serious inflation until the Federal Open Market Committee abandoned the pegs. The basic reason, therefore, that seemed to justify a
small privileged dealer group no longer exists. The technique of which it
was an integral part did not work out according to expectations and failed of
its purpose.
(124) The subcommittee has already recommended that the Federal Open
Market Committee discontinue the technique of reluctant buying and abandon
agency relations in its transactions with dealers. It has recommended that
the Committee enter into transactions with dealers outside the recognized list
if it is operating to support markets, e. g., to peg rights during periods of Treasury refunding. It has also recommended that in its dealings in the bill market
both on an outright and on a repurchase basis, it enter into transactions with all
dealers who perform a responsible and continuous role in the weekly bill auction.
If these recommendations are adopted by the Federal Open Market Committee
the competitive importance of recognition in the market place would diminish
greatly. It would become a matter of less importance, therefore, whether the
fiction of a recognized list of dealers was maintained or dropped. For its own
part, the subcommittee feels it advisable to drop the relationship completely
and so recommends.
(125) If the Federal Open Market Committee decides to maintain the recognized dealer relationship, on the other hand, the subcommittee recommends most
earnestly that it proceed promptly to revise the present list of dealers who enjoy
•UNITED STATES MONETARY POLICY
279
the privilege of recognition. It is difficult to justify exclusions that have been
made from the select group when comparison is made with some that are within.
There are bank dealers within the recognized group that do not take positions
or make markets, that do not attempt a nationwide coverage, that do not operate in volume in all segments of the list, and that are clearly motivated in their
conduct of operations by a desire to attract and hold correspondent banks for
their institutions rather than by a desire to earn a competitive return on the
capital at their disposal as dealers. If the relationship is continued, it is urgent
that the Federal Open Market Committee draw the lines for recognition on bases
that can be justified as impartial and objective.
Reports and information
(126) The Federal Open Market Committee faces no problem of lack of access
to market information available to dealers. The Committee has been too powerful a market factor for its requests for information to be easily challenged. It
has frequently been the determining factor in hour-to-hour and day-to-day trading in the market for Government securities, i. e., the market in which dealers
risk their capital on a relatively thin margin of equity in continuous, almost
split-second, trading operations. Despite the dropping of the pegs and smaller
intervention in the current market, the potential power of the Federal Open Market Committee, backed by the power to create bank reserves, remains. Under
these circumstances, dealers will continue to cultivate contacts with the Committee since no single quality is more important to their ability to survive than their
ability to forecast correctly (1) the probabilities of intervention in the market
by the Federal Open Market Committee, (2) the direction of that intervention,
either on the bid or the offered side, if it occurs, and (3) the sectors in the market to which it may be directed.
(127) Under these circumstances, also, dealers tend to seek orders from the
Committee, not because of the profit potentialities of business involved but because they may indicate the direction of the Federal Open Market Committee's
thinking. Receipt of an order from the trading desk, in fact, acquires a significance out of all proportion to the actual commission involved. In addition, the
dealer endeavors to cultivate access to the Committee and to its staff representatives. He readily accepts the obligation to give information on his activities and to make reports. He welcomes hour-to-hour contact with the trading
desk, both to submit quotations and to tender market reports. The responses,
however guarded, may provide clues to the state of the market. Even when
the Committee is pursuing a neutral policy and is out of the market, the trading
desk has business to do, orders to execute for agency and foreign accounts. As
npted earlier, this amounted to $2.4 billion in the year ending June 1952. The
dealer does not necessarily know whether or not these represent market intervention on the part of the Federal Open Market Committee, but he is likely to feel
that continuous and close contact with the trading desk helps him to come to a
judgment on whether they do or not. Under the present arrangements the
trading desk has probably more knowledge of the sources of demand and supply
in the market as well as the money position than any other element.
(128) This situation places a heavy responsibility upon the Federal Open
Market Committee. It cannot, in this instance, rely on the customary reluctance
of respondents to furnish information to act as a check on its own curiosity. It
must decide for itself not only what information should properly be supplied
to the market so that it can function effectively but also the limits of what the
Committee can, with propriety, ask from the dealers in the way of informaion.
(129) The fundamental rule is that no general information should be furnished a dealer that is not equally available to others. It is unavoidable that
dealers executing orders for the Federal Open Market Committee gain special
knowledge wTith respect to that particular transaction, but every effort should
be made, as in fact the subcommittee believes it is, to be close-mouthed with
respect to these transactions. It goes without saying, of course, that no member
or representative of the Federal Open Market Committee should indicate an
attitude toward the prices which dealers quote and at which they do business in
the market.
(130) So far as additional information to be supplied to the market in the
weekly condition statement is concerned, the subcommittee recommends (1)
that securities held under repurchase agreement by the Federal Open Market
Committee be segregated from the balance of the System portfolios; (2) that the
amount of special certificates of indebtedness outstanding be regularly indicated,
either in the text or on the stub of the statement; (3) that weekly averages of
member bank borrowing be shown in addition to the actual yolume of member
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UNITED STATES MONETARY POLICY
bank borrowing at the close of business on statement days, as is now done for
excess reserves*
(131) The extent of the limitations which the Committee should impose on
itself and its representatives in seeking information from the dealers poses a
more serious problem. In the discussions with the dealers, expressions of irritation, dissatisfaction, and resentment were confined to three quite specific points:
One, they did not like the tone or content of the morning meeting when different
dealers report individually to the manager of the open market account before
market opening. They stated they got little out of the contact and some suggested that it would be better to drop the meeting and substitute a more general
type of meeting from time to time between the manager of the account and all the
principal dealers together as a group. They felt that they might be given a
chance to ask questions at such a meeting and to receive helpful enlightenment
on the attitude of the Federal Open Market Committee toward the market. Two.
the dealers did not like it when they were questioned so closely by the trading
desk on the geographical source of current customer orders as to reveal indirectly
the identity of their customer. While the great bulk of the dealers did not object
to disclosing the general source of their customer orders, they did feel that it was
morally wrong to be asked a series of indirect questions so pointed as to permit
identification of the source of their business. Some felt that incorrect use of this
information may have been made by the Committee, either by direct approach to
sellers, thus revealing that the dealer had not maintained secrecy on a confidential relationship, or by discrimination between offerings, buying some securities
pressed for sale by a particular customer but not all. Three, they were apprehensive lest the disclosure of their individual positions to the personnel of the
trading desk might tend to affect the decisions of that personnel in subsequent
dealings with them.
(132) AVith respect to these three specific points, the subcommittee recommends: (1) That the individual morning dealer conference be abandoned. It
recognizes that there may be merit in the more general type of conference
suggested by some of the dealers as a substitute for these meetings but feels
that any information furnished by the Federal Open Market Committee at such
a meeting should he such as might properly be given to any other segment of the
public, (2) that disclosure of the source of customer orders be so limited that
there will be no possibility of identification, direct or by inference, of the individual source of customers to the trading desk, and (3) that the Federal Open'
Market Committee discontinue its present practice of collecting statistics ondealer positions and activity, and substitute for this practice the regular collection of dealer position and activity reports by an officer of the System not connected with the Federal Open Market Committee. This officer would furnish
aggregate summaries to the trading desk that did not reveal the position or
activity of any individual dealer.
(133) The subcommittee feels that the furthest its representatives can go
with propriety in soliciting or accepting information from individual dealers
with respect to the source of their orders, is to receive only information as to
the general type of customer, the volume of the business, and the sector of the
market involved. It questions seriously the propriety of the present practice in
which its representatives on the trading desk are free to press dealers for quite
specific information on customer transactions and on the basis of this information proceed to compute transaction sheets currently during the trading day,
such sheets being subject to later verification against the dealers' statistical
reports. It recommends that this practice be dropped.
Housekeeping
(134) In many respects, the Federal Open Market Committee is unique both
in the form and the substance of its organization. In form, it is a completely
independent organization, specifically set up by statute, with exclusive power
of decision with respect to the matters delegated to it. Its composition is designed to insure, to the full extent that legislation can insure, that its members
will not only be fully competent, but will also be immune to outside pressure.
It is neither nn appendage of the Federal Reserve Board nor a creature of the
Federal Reserve banks, but a completely independent body, each member of
which, as an individual, whether he be a Governor from the Board or a president
from a Federal Reserve bank, reports to no one. His actions are a matter of
public record but each member sits as an individual, bound only by his oath to
execute the law. The responsibilities delegated to the Committee are of almost
incomparable import.
UNITED STATES MONETARY POLICY
281
(135) The statutory individuality of the Federal Open Market Committee and
its separation both from the Federal Reserve Board and the Federal Reserve
banks is expressed in its chart of organization. It has its own staff, and when it
gathers it meets as a separately organized and staffed body. Its sessions are not
joint sessions of the Federal Reserve Board and the Federal Reserve banks, but
statutory meetings of the Federal Open Market Committee.
(13G) In a very general sense, the Federal Open Market Committee stands in
the relation of a fiduciary to the Federal Reserve banks. It, and it alone, has the
decision with respect to the amount, as well as the issues, of their open market
portfolios. They hold, at the moment, nearly $24 billion of securities, the greatest
investment portfolio by far in the history of the world. It is wholly in the discretion of the Federal Open Market Committee to direct the investment of large
additional amounts.
(137) In an even more general sense, the Federal Open Market Committee
stands in a fiduciary relationship to the whole American economy. It could be
called special trustee for the integrity of the dollar, for the preservation of its
purchasing power, so far as that integrity can be preserved by its operations.
It is especially charged, also, to use its powers to provide an elastic currency
for the accommodation of agriculture, commerce, and business, i. e., to promote
financial equilibrium and economic stability at high levels of activity.
(138) This unique structure of the Federal Open Market Committee was
hammered out after long experience and intense political debate. Like other
components of the Federal Reserve System, it exemplifies the unceasing search
of the American democracy for forms of organization that combine centralized
direction with decentralized control, that provide ample opportunity for hearing to the private interest but that function in the public interest, that are government and yet are screened from certain governmental and political pressures
since even these may be against the long-run public interest
(139) When the substance, rather than the form, of the Federal Open Market Committee is analyzed against this background, certain possible anomalies
arise. It has no individual budget, nor does the act provide for one. There
is no single person on its operating staff who is responsible to the Committee
alone. Each of its officials is paid either by the Federal Reserve Board or by a
Federal Reserve bank. Each would automatically cease to have any relationship
with the Federal Open Market Committee the moment that connection was
severed. No member of the Committee, nor of its staff, is charged to give exclusive attention to its concerns. Everyone connected with it wears also another hat. Even the manager of the open market account, who comes nearest
to devoting his full time to its functions, has heavy independent responsibilities
in connection with the fiscal agency and other operations of the Federal Reserve
Bank of New York.
(140) The Federal open market account is not managed by the Federal Open
Market Committee. This function has been delegated to the Federal Reserve
Bank of New York, subject to policy directives that provide discretionary leeway within which the management operates. The manager of the account is
selected by the directors of the Federal Reserve Bank of New York and approved
by the full Federal Open Market Committee each year. In his day-to-day operations, he is subject to the authority of the Federal Reserve Bank of New York,
and not to that of the Federal Open Market Committee.
(141) The subcommittee urges that the Committee take the initiative in reexamining and reviewing this structure of organization. There has been much
experience since the arrangements were first established. In the light of that
experience, is the structure well designed to carry out the Committee's important
functions? For example, should the Federal Open Market Committee operate
under a budget of its own? This might require legislation, but if a separate
budget would improve its operations, the Committee is morally obligated to
suggest such legislation to the Congress.
(142) Should all or part of the staff of the Federal.Open Market Committee
be separate and distinct from the staffs of the Federal Reserve Board and the
Federal Reserve banks? However paid, should they wear one hat, and one
hat only, devoting all their time exclusively to the operations of the Federal
Open Market Committee? There are both advantages and dangers in this suggestion which must be weighed. The Federal Reserve System is a family, and
the Federal Open Market Committee urgently needs the knowledge, the judgment,
and the skill of all the members of that family. It would be extremely difficult to build up a new and independent staff as qualified as the personnel which
it now enlists to work on its problems. It would be equally unfortunate to
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UNITED STATES MONETARY POLICY
lose the contributions of that staff to System problems t h a t fall outside the
limited area of responsibility of the Federal Open Market Committee. Yet
there are equal dangers in a situation where the time of no one person on the
whole staff of the Committee is wholly devoted to i t s responsibilities, where
everyone wears two hats, and where each must fulfill duties separate and distinct from those imposed by the Federal Open Market Committee.
(143) Should the present situation, which delegates the management of the
open-market account to the Federal Reserve Bank of New York, be retained,
or should the manager of the open-market account be made directly responsible
to the Federal Open Market Committee? The present arrangement has the
advantage t h a t the mechanical operations of the account, the keeping of its
books and records and the handling of its funds, are under the immediate
supervision of the Federal Reserve Bank of New York with its superb facilities.
More important, it has the advantage t h a t the president of the Federal Reserve
Bank of New York, situated as he is in the center of the Nation's money market,
with his personal insight into problems of monetary policy and his immediate
access to financial information not so readily available to anyone else, can
supervise on the spot the execution of the general policy directives of the
Federal Open Market Committee and the executive committee and thus determine t h a t t h a t policy is made effective in operations.
(144) I t has the disadvantage that the president of t h e Federal Reserve Bank
of New York sits at meetings of the Federal Open Market Committee and of the
executive committee necessarily in a somewhat different role from t h a t of his
colleagues. He comes not only as a contributor to the discussion on policy
formation, but, also necessarily, as a protagonist for the actual day-to-day
operations of the account. These operations a r e his responsibility. H e cannot
criticize them without criticizing his own staff. The committee, therefore, in
some part loses contact with the critical insight of its best informed member.
I t has the disadvantage also that other members of t h e Federal Open Market
Committee, reluctant to seem critical of a colleague, may hesitate to scrutinize
adequately the technical operations of the account. This is a serious deficiency
because the other bank president members of the Committee are usually scattered
and out of intimate touch with one another as well a s with the market. They
must depend on give and take discussion a t Committee meetings and a t t h e
meetings of the executive committee to sharpen their appreciation of the Committee's operating problems.
(145) The present arrangement makes one major contribution of paramount
concern to effective operations. There must be confidence throughout t h e market
and throughout the financial community generally t h a t open-market operations
a r e immune from political pressures. This confidence is undeniably strengthened
by the fact that the Federal Reserve Bank of New York actually conducts open
market operations for the Committee. Under the present management arrangement, the actual contacts of the market are contacts with personnel of the
Federal Reserve Bank of New York, subject to the discipline of its directors.
(146) There is, of course, the equal necessity of maintaining the confidence
of the public generally t h a t the Committee's operations a r e immune from banker
domination. This consideration is reflected in the general structure of the
Federal Reserve System with the Board of Governors and the regionally decentralized Federal Reserve banks. I t is also reflected in the actual statutory
composition of the Federal Open Market Committee. From this point of view r
the present arrangement by which the management of t h e open-market account
is delegated to the Federal Reserve Bank of New York requires t h a t the individual members of the Federal Open Market Committee maintain close contact
with all important aspects of its operations,
(147) Throughout its consideration of the recommendations it is making in
this report, the subcommittee has had this problem in mind. These recommendations do not stop with the evaluation of technical practices of the Committee, originated during the period of the pegs, t h a t now handicap t h e development of a free market. The subcommittee has been a w a r e also of t h e urgent
necessity of simplifying as much as possible the operating procedures of the
committee and the points of impact which its operations have on the market
mechanism. The problem has been to work out procedures (1) t h a t wTill provide
more effectively for the execution of the Committee's monetary policies in the
open market, (2) t h a t will do this in a way t h a t will minimize confusion in t h e
m a r k e t with respect to the committee's purposes, and (3) t h a t will enable
individual members of the Federal Open Market Committee to maintain more
intimate contact with i t s technical operations. The subcommittee feels t h a t
operations under i t s recommendations will not only make for greater depth.
UNITED STATES MONETARY POLICY
283
breadth, and resiliency in the market, with less misunderstanding, but will also
enable each member of the Federal Open Market Committee to carry out more
effectively his individual statutory responsibility as a committee member.
(148) T h e subcommittee desires to raise one aspect of the problem for special
consideration. I t urges t h a t the full Federal Open Market Committee take
a definite position with respect to the suggestion advanced above t h a t the manager of the open-market account be employed by the Federal Open Market Committee as a whole, rather than by the Federal Reserve Bank of New York.
(149) The subcommittee is not proposing this shift. I t is recommending,
however, t h a t the change be most seriously considered. The operations of the
account would continue to be located in the Federal Reserve Bank of New York,
as a t present, and the Federal Open Market Committee would continue to avail
itself of the personnel, wisdom, and experience of the whole Federal Reserve
System, as a t present. The only change would be t h a t the manager of the openmarket account would be employed by the Federal Open Market Committee as
a whole, that he would be solely responsible to the Federal Open Market Committee, and t h a t he would have no responsibilities other than those imposed on
him by the Federal Open Market Committee.
(150) Should the Committee decide to make such a move, certain details of
organization.would have to be solved. They are not of concern a t this point.
The immediate concern is whether such a move would be in the public interest,
whether it would improve the functioning of the Federal Open Market Committee.
Certain features of the proposed arrangement stand out as crucial. Since the
manager of the open-market account would be directly responsible to the whole
Federal Open Market Committee, the individual members of the Committee
might feel less reluctant to make direct contact with him and thereby familiarize
themselves with details of the Committee's operations. The manager of the
account also would no longer occupy the dual role of manager of the account
and also of vice president of the Federal Reserve Bank of New York. He would
be relieved of responsibility to its directors with respect to any of his activities.
Finally, he would no longer participate in transactions originating in the fiscal
agency or foreign correspondent relationships of the Federal Reserve Bank of
New York.
(151) Some duplication of facilities would result from this change but there
would be offsetting advantages. For example, the money market might be less
confused with respect to the significance of orders transmitted through the
trading desk. The execution of an order for the Treasury, or for a foreign
correspondent, could not then give rise to rumors t h a t the Federal Open Market
Committee had entered the market.
(152) The chief change, of course, and the one which requires the most serious
consideration would be the change in the relationship of the president of the
Federal Reserve Bank of New York to the account. As Vice Chairman of the
Federal Open Market Committee, he would have, as he now has, full access to
all the operations of the account and continuing responsibility for maintaining
a vigilant scrutiny over them. He would continue to be in the same building
with the manager of the open-market account, and would be as continuously
available for consultation as a t present. The line of responsibility between the
whole Committee and the manager of its account, however, would be direct and
undivided. I t would not impose upon the president of the Federal Reserve Bank
of New York the added individual responsibility which he now bears for operational and discretionary decisions within the directives laid down by the whole
Committee or its executive committee.
Relations with the Treasury
(153) There is one final recommendation the subcommittee would like to
make. I t falls in the difficult and delicate area that deals with problems of
debt management and Treasury relationships. Specifically, the subcommittee
recommends t h a t the Federal Open Market Committee inform the Treasury that
in the future it will keep the Secretary continuously informed as to its credit
and monetary policies but that it will refrain as an official body from regularly
initiating specific proposals with respect to details of individual Treasury offerings. T h a t is, it will no longer on its own initiative regularly write formal
letters or seek official interviews to lay before the Secretary of the Treasury its
suggestions as to issues, coupons, etc., that in its judgment would be appropriate
for particular debt management operations. The Federal Open Market Committee would, on the other hand, be prepared to* respond to a request of the Secretary for the committee's judgment as to whether the terms he had in mind for a
new issue were appropriate in the light of market conditions, i. e.( whether the
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UNITED STATES MONETARY POLICY
committee would expect them to develop a sufficient rights value, and also
whether they would create complications for monetary management or would
conflict with or run into difficulties because of credit operations in contemplation bv the Federal Open Market Committee.
(154) The subcommittee urges this change in procedure in order to establish
formal official communications with the Treasury on a more correct basis than
prevails at present. The Secretary of the Treasury is primarily responsible for
decisions in the area of debt management. In coming to those decisions, he
should feel free to consult and talk over his problems with anyone he wishes,
commercial bankers, investment bankers, security dealers, etc., and also with anyone he chooses within the Federal Reserve System, either in or out of the
Federal Open Market Committee. So far as system personnel is concerned, however, it should be wholly understood that he consulted them as individuals.
The decision he arrives at should be a decision for which he, as the responsible
official, takes full responsibility. Neither the Federal Open Market Committee
nor the executive committee should take responsibility, as it now does, for
initiating a recommendation as to coupon and terms in the area of debt management.
(15r>) In the judgment of the subcommittee, the present practice under which
the Federal Open Market Committee convenes itself and. after consideration and
vote, writes a letter outlining its official recommendation with respect to debt
management policies is improper and unwise, in view of the clear location of
responsibility for debt-management decisions in the Treasury. It is just as
unwise and improper as the converse would be, namely, that the Secretary of
the Treasury should regularly and officially, as a member of the President's
Cabinet, write the Board of Governors and the Federal Open Market Committee
his considered views with respect to future credit policies and open-market
operations.
(15G) Such formalized action by either, however well intended, trespasses
upon the statutory responsibility of the other. It tends to complicate rather
than to facilitate that adjustment of views and of official decisions which is
essential to the achievement of their common objectives in the public interest.
S U M M A R Y OF CONCLUSIONS AND RECOMMENDATIONS
a
A* Relations mitJi the market
The subcommittee finds that a disconcerting degree of uncertainty exists
among professional dealers and investors in Government securities with
respect both to the occasions which the Federal Open Market Committee might
consider appropriate for intervention and to the sector of the market in which
such intervention might occur, an uncertainty that is detrimental to the development of depth, breadth, and resiliency of the market. (35-43) In the judgment of the subcommittee, this uncertainty can be eliminated by an assurance
from the Federal Open Market Committee that henceforth it will intervene in
the market, not to impose on the market any particular pattern of prices and
yields but solely to effectuate the objectives of monetary and credit policy, and
that it will confine such intervention to transactions in very short-term securities, preferably bills. (44-48) The subcommittee feels most strongly that it
would be wise to give such an assurance.
The subcommittee finds two outstanding commitments that may require intervention by the Federal Open Market Committee in other than the very shortterm sectors of the market, and that may add to or subtract from reserve funds
available to the market for purposes other than the pursuit of monetary policies
directed toward financial equilibrium and economic stability. (49) These commitments are, first, the directive to the management of the open-market account
to "maintain orderly conditions" in the market for United States Government
securities, and, second, those arising from the practice of purchasing rights on
maturing issues during periods of Treasury financing, and also on some of these
occasions of purchasing when-issued securities and outstanding securities of comparable maturity to those being offered for cash or refunding.
With respect to the first of these commitments, the subcommittee recommends
that the Federal Open Market Committee amend its present directive to the
executive committee by eliminating the phrase "to maintain orderly conditions
1
For the convenience of readers, the numbers of the paragraphs in the report specifically
clfaliiiff with- each recommendation have been inserted opposite to the same recommendation as it appears in this summary*
UNITED STATES MONETARY POLICY
285
in the Government securities market" and by substituting therefor an authorization to intervene when necessary "to correct a disorderly situation in the Government securities market." It has indicated in its report the conditions it would
consider sufficiently disorderly to require correction. (50-56) The subcommittee recommends also that such intervention be initiated by the executive
committee only on an affirmative vote after notification by the manager of
account of the existence of a situation requiring correction.
With respect to the second, the subcommittee recommends that the Federal
Open Market Committee ask the Treasury to work out new procedures for financing, and that as soon as practicable the Committee refrain, during a period of
Treasury financing, from purchasing (1) any maturing issues for which an
exchange is being offered, (2) when-issued securities, and (3) any outstanding
issues of comparable maturity to those being offered for exchange. (57-74)
The subcommittee feels that such qualifications as are implicit in these two
recommendations would not seriously impair the constructive effect of a general
assurance from the Committee that its intervention henceforth will be limited
to the effectuation of monetary policies and will be executed in the very short
sector of the market. It recommends most strongly that such assurance be given
as soon as its existing commitments have been appropriately modified. (75-70)
B. Relations with dealers
The subcommittee finds no present or prospective justification for continuing
the present system of rigid qualification for dealers with whom the account
will transact business, and recommends that the system be dropped. (116-124)
In the event the Federal Open Market Committee, contrary to the subcommittee's basic recommendation, decides to maintain the system of recognized dealers
the subcommittee recommends:
(a) that the present list of recognized dealers be revised, both by eliminations from and additions to the list (125)
(b) that repurchase agreements be extended impartially to all dealers who
participate regularly in the weekly bill auction, irrespective of whether or
not they are on the recognized list. (108)
(c) that if rights are acquired in support of Treasury refundings they be
purchased as freely from nonrecognized as from recognized dealers. (115)
(d) that transactions to correct disorderly conditions in the Government
securities market be made with unrecognized as well as recognized dealers.
(85)
C. Operating techniques
The subcommittee finds that many of the present operating techniques of the
account are -upsetting to the smooth functioning of the market. In general,
these techniques were prescribed by the Federal Open Market Committee at a
time when it was attempting to peg market prices and yields of United States
Government securities. With respect to market techniques, the subcommittee
recommends specifically:
(a) that "reluctant buying** be completely abandoned, and that supporting
operations in the market, if undertaken at all, be executed through a technique of aggressive rather than reluctant purchasing. (81-80)
(&) that agency transactions be abandoned and that the account conduct
its transactions with dealers as principals on a net basis. (87-93, 110-113)
(o) that if rights are acquired during refundings they be purchased from
dealers without regard to whether or not they come from the dealers* positions. (114)
((7) that refusal to buy bills acquired by dealers on a cash basis be discontinued. (102)
(c) that nonbank dealers be informed adequately in advance when repurchase facilities will be made available. (103)
(/) that repurchase facilities at an appropriate rate and with appropriate
limitation as to volume be made regularly available to nonbank dealers
over weekends. (94-104)
The subcommittee finds that relations between the open market account and
the dealers are not as impersonal as is desirable now that the Committee is no
longer trying to peg prices and yields on Government securities by maintaining
a tight rein on the activities of dealers. It recommends:
(a) that the Open Market Committee make known to the dealers the
"ground rules" which henceforth will govern the occasions for its transactions with dealers. (59, 75-76)
55314—54
19
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UNITED STATES MONETARY POLICY
(b) t h a t the individual morning dealer conference he abandoned. (131-132)
(v) that the information obtained by the trading desk from dealers be
so restricted as to eliminate the possibility of identification, directly or by
inference, of individual customers. (131-132)
((/) that reports on individual dealer positions and activity be collected
by an officer of the System other than the manager of the account, that the
individual reports be kept confidential, and t h a t only aggregates compiled
from the individual dealer reports be disclosed to the manager of the
account. (131-132)
(c) that the present practice of asking dealers to report transactions currently during the trading day in sufficient detail to permit the computation
of current individual dealer transactions sheets be discontinued. (131,133)
The subcommittee finds that there is a serious gap in the structure of the money
market as it affects the functioning of the market for Government securities.
Continuously in recent months, funds available to dealers to carry portfolios
have been inadequate in volume and available only a t rates higher than the
yield of their portfolios. This deficiency could not exist so continuously in a
central money market equipped (1) to a t t r a c t temporarily idle funds from over the
country to New York, and (2) to make these funds available on call to dealers
in the money market. The subcommittee recommends t h a t the feasibility of reestablishing a central call-money post for dealers be explored. (100)
D. Federal Reserve reports
The subcommittee finds that the Federal Reserve System can inprove the data
which it makes available to inform the market on its operations. I t recommends
t h a t the following information be shown henceforth on the weekly condition statement of the Federal Reserve b a n k s :
(a) securities held on repurchase agreement;
(b) special certificates of indebtedness held by the system ;
(c) weekly averages of member bank borrowing. (130)
E. Organization of the Open Market
Committee
The subcommittee finds many anomalies in the structure and organization
of the Federal Open Market Committee, particularly (a) the absence of a sepa r a t e budget covering its operations, (b) the absence of a separate staff responsible only to the Committee, and (c) the delegation of the management function
to an individual Federal Reserve bank. I t recommends t h a t the Committee reexamine and review its present organization, and in particular t h a t it consider the advantages and disadvantages t h a t would ensue, were the manager
of the open market account made directly responsible to the Federal Open
Market Committee as a whole, and not, a s a t present, responsible through the
Federal Reserve Bank of New York. (139-152)
F. Relations with the Treasury
The subcommittee finds t h a t the Federal Open Market Committee is frequently placed in an inconsistent position by its present practice of initiating
advice to the Secretary of the Treasury with respect to decisions in the area of
debt management. I t recommends t h a t the Committee inform the Secretary
of the Treasury that henceforth it will refrain, a s an official body, from initiating regularly proposals with respect to details of specific Treasury offerings,
and will confine itself officially to providing information currently on its monet a r y policies and to counseling on the credit and monetary implications of debtmanagement suggestions advanced for its consideration by the Treasury. (153-
15G)
An*^dix
/j
(1) Outline of Study prepared by ad hoc subcommittee on the Government securities market
(2) Letter dated May 28, 1052, from Chairman Martin to individuals and organizations receiving the Outline of Study for informational purposes
(4) List of recipients of Outline of Study for informational purposes
(4) Letter dated May 28, 1052, from Chairman Martin to individuals who re, r , * . c e i v e ( 1 ' a s addressees, t h e explanatory letter and Outline of Study
(5) List of recipients of Outline of Study a s addressees
UNITED STATE§ MONETARY/POLICY
" • • 7 T ' . •:.
287
li'.lr',V-M
I . FUNCTION OP DEALERS I N TREASURY OBLIGATIONS^"
A. W h a t are the essential functions performed by dealers in Treasury obligations? Discuss their functions in relation to the operations of banks and financial
institutions, of the Treasury, and of the Federal Reserve banks, particularly t h e
open-market account. How were these functions affected by the maintenance of
pegs by the Federal Open Market Committee?
B. W h a t are the essential attributes which a dealer must possess to perform
these functions efficiently (capital, borrowing facilities, moral and technical
qualifications, etc.) ? Were these affected by the maintenance of pegs? How a r e
these attributes affected by specialization : {a) geographical (with respect to location of customers; (b) structural (with respect to types of securities); (c)
types of customers (e. g., banks as against insurance companies, etc.)?
I I . EFFECT ON DEALERS OF OPERATIONS OF FEDERAL OPEN-MARKET ACCOUNT
A. How have the operations of the open-market account affected the ability
of dealers to perform their essential functions? Discuss with relation to amount
of capital required, credit availability, adequacy of commissions, effect on spreads,
willingness and ability of dealers to take positions, etc. Distinguish between
open-market-account operations during maintenance of pegs and the effects since
the discontinuance of pegging operations.
B. From the point of view of successful dealer functioning, what are the advantages and disadvantages of qualification? Distinguish between conditions
prior to and following t h e discontinuance of pegs.
C. Either as a qualified or nonqualified dealer, have you any suggestions or
criticisms of the effect of the operations of the open-market account on your
own operations? Do you feel that the standards for qualification a r e appropriate and a r e applied objectively?
D. Is disclosure to the Federal Reserve by qualified dealers of the general
sources of customer orders a justifiable aid to the orderly functioning of the
market?
K. Do you feel t h a t the operations of the account are, or have been, discriminatory and, if so, that the discrimination was not justified by overriding
considerations? Distinguish between operations of th
@FedFRASER