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J o in t C o m m itte e on th e E co n o m ic R e p o rt H e a rin g s u pon t h e 1951 A n n u a l E co n o m ic B e p o r t o f th e P r e s id e n t , F e b ru a ry 2 , 1 9 5 1 S ta te m e n t upon M o n e ta ry F o l ic / John B . C la r k , V ic e C h a irm a n C o u n c il o f E co n o m ic A d v is e r s by- The d iv e r s it y o f v ie w o f m o n e ta ry p o lic y w h ic h h a s been e x h ib it e d in r e c e n t d is c u s s io n and h e re to d a y i s n o t s u r p r is in g * in g w it h t h e p ro b le m i n We a r e now d e a l an e n v iro n m e n t w h ic h h a s n e v e r b e fo re bean e x p e r ie n c e d . The p o lic ie s and t h e o r ie s d e v e lo p e d in a p e r io d w hen, a s D r, S e lt z e r s a id , b u s in e s s lo a n s c o n s t it u t e d th e b u lk o f in v e s tm e n t o f th e b a n k s . T oday i t e x is t s i n a s it u a t io n w h e re th o b a n k s h o ld b i l l i o n s o f d o lla r s o f G overnm en t s e c u r it ie s w h ic h , w h a te v e r p r ic e m a n ip u la tio n may ta k e p la c e , w i l l a lw a y s be li q u id and can b e tu rn e d in t o c a s h u p on a m om ent’ s n o t ic e . I t e x is t s in a p e r io d w hen g reax, i n s t it u t i o n a l le n d e r s lik e w is e h o ld b illio n s o f d o lla r s o f th e s e l i q u id a s s e t s a n d when b u s in e s s i t s e l f i s a s o u rc e o f c r e d it f a r beyond a n y s it u a t io n t h a t e x is t e d b e f o r e . B u sin e ssm e n do n o t h a ve t o go t o b a n k s in th e y can i n i t i a t e th e y m.j want to o r d e r t o g e t lo a n s b e fo re a p r o je c t e ve n th o u g h l a t e r in th e c o u rs e o f th e p r o je c t r e s o r t t o b a n k s f o r p a r t o f th e fu n d s . T hese a re new s it u a t io n s w h ic u h a ve g r e a t ly u p s e t th e a s s u m p tio n s upon w h ic h m o n e ta ry p o lic y h a s b e e n d e v e lo p e d in q u a rte r. We a ls o h a v e th e new s it u a t io n b e c a u se i t h a s b e e n h a n d le d s u c c e s s f u lly , th e p a s t c e n tu r y and a o f an enorm ous p u b lic d e b t w h ic h , seem s now to b e lo o k e d upon b y ijsany p e o p le a s a tam e d o m e s tic a n im a l w h ic h d o e s n o t h o ld w it h in it th e s e e d s o f v io le n t d is tu r b a n c e t o th e econom y, a n d t h e r e f o r e we do n o t have to do m uch a b o u t i t . - th a t is 2 - n o t t h e c h a r a c t e r o f t h e n a t io n a l d e b t. p ru d e n tly * i f If it is n o t h a n d le d we ta ic e su ch a c t io n t h a t some im p o r ta n t o f f e r in g o f G o v e rn m ent s e c u r it ie s i s a f lo p on t h e m a rk e t, we w i l l so o n le a r n t h a t th e G o ve rn m ent c r e d it can b e d e s tr o y e d b y im p ru d e n t d e b t m anagem ent. T h e se a r e th e tw o new s it u a t io n s w h ic h h ave t o b e c o n s id e r e d in c o n s id e r in g m o n e ta ry p o lic y to d a y . O b v io u s ly we h a v e an opportunity t o c o s e t o d if f e r e n t c o n c lu s io n s a b o u t p r o p e r m o n e ta ry p o lic y . o f t ie in p a s t h a ve v e r y l i t t l e a s it u a t io n w h ic h i s to g u id e u s in C e r t a in ly th e le s s o n s d e te rm in in g w h a t we a r e t o d o so g r e a t ly d if f e r e n t fro m t h a t o f o t h e r y e a r s . The b re a d th o f t h i s d iv e r i s t y o f v ie w i s il lu s t r a t e d b y a c o u p le o f s ta te m e n ts v h ic h h ave b e e n b ro u g h t t o th e a t t e n t io n o f th e C o m m itte e . I am n o t c e r t a in t h a t y o u h a v e h a d . I t is One a s ta te m e n t is s u e d t h i s week by some o f th e m ost im p o r ta n t mm h&ta o f th e f a c u lt y o f C h ic a g o U n iv e r s it y , o f th e d e p a rtm e n t o f e c o n o m ic s . a u t h o r it ie s s u p p o rt th e m To snow how s t r o n g ly th e s e r e s p e c t a b le .s t r ig o r o u s v ie w o f m o n e ta ry p o lic y , I w ant t o re a a j u s t a fe w lin e s ; "T he p r ic e r i s e o f th e la s t s i x m onths c o u ld a lm o s t c e r t a in ly h a ve be e n la r g e ly o r m o ll y a v o id e d b y e f f e c t iv e m o n e ta ry a c t io n . ” A p p ro a c h in g th e s o b je c t fro m t h a t s ta n d p o in t th e y come t o t h i s co n c lu s io n o f w h a t t h e p o lic y s h o u ld be to d a y ? wThe F e d e r a l R e s e rv e S ystem s h o u ld a t once an noun ce t h a t i t w i l l co n d u ct i t s o p e r a t io n s n it h an eye s in g le t o t h e ir e f f e c t s on th e s u p p ly o f m oney a n d c r e d it and o n th e le v e l o f p r ic e s * n I n dem anding 11a n e y e s in g le * upon one an d o n ly one o b j e c t iv e , t h e y e x c lu d e a l l id e a o f m o n e ta ry p o lic y b e in g r e la t e d t o th e p ro b le m s o f d e b t - m anagem ent in 3 - t h i s p e r io d if t e a t h e p u b lic d e b t c e r t a in ly i s m a tte r o f d a ily c o n c e r n . " I t s h o u ld c u r i t ie s to w h a te v e r m o u n t i s at on ce b e g in n e c e s s a ry t o b r in g th e c u r r e n t ly s w o lle n c r e d it b a s e , a n d i t t o th e p o in t t h a t th e i n f la t io n c id e n t a l a f f e c t s i s a r is e in L a s t w eek y o u h e a rd M r. is to sell about g o in g to be G o ve rn m e n t s e a c o n t r a c t io n in s h o u ld p e rs e v e re in c h e e k e d , e ve n th o u g h a one t h is p o lic y o f it s in th e in t e r e s t r a t e on G overnm ent s e c u r it ie s * ” c c le s s t a t e a v e ry s im p le th e o ry o f m o n e ta ry p o lic y b a s e d upon th e id e a o f t iie d ir e c t r e la t io n b e tw e e n th e vo lu m e o f n o n e /— in c lu d in g c u r r e n c y a n d b a n k d e p o s it s and s a v in g s d e p o s it s — and p r ic e s * A s I u n a e rs o o d h im , h is v ie w w as t h a t y o u c o a ld in f lu e n c e p r ic e s in e it h e r d ir e c t io n by c h a n g in g th e v o lu ra e o f m oney, v ie w e x p re s s e d b y th e C h ic a g o e c o n o m is ts . in That seems The s im p le f a c t i s t o b e th e t h a t p r ic e s J u ly , A u g u s t a n d th e f i r s t p a r t o f S e p te m b e r h a d t h e ir raost r a p id p r ic e a d v a n ce w hen th e re w as a lm o s t no ch a n g e i n th e v o lu m e o f m oney, a n d h a d s lo w e d down and t h e r e w a s r e l a t i v e l y l i t t l e p r ic e a d va n ce fro m th e m id d le o f S e p te m b e r u n t i l th e end o f N ovem ber when th e re w as a v e r y r a p id in c r e a s e in b a n k lo a n s and i n t h e vo lu m e o f money o u t s t a n d in g . That is In 1939 th e v e r y r e v e r s e o f th e s it u a t io n th e F e d e r a l R e s e rv e A m e ric a n p e o p le a s in g le of the Board made a m o n e ta ry t h e o r ie s h e ld s h o r t s e n te n c e w h ic h w as re p e a te d i n **The B o a rd f in d s i t b y ch an g es in im p o s s ib le im p lie d by th e s e t h e o r ie s . very frank statement to the by the b o a rd * I t h a t r e p o r t m ore w i l l re a d than o n ce : to b e lie v e t h a t p r ic e s ca n be c o n t r o lle d th e v o lu rae an d c o s t o f m o n e y.* B e fo re y o u s u g g e s t t h a t t h a t w as a t a tim e w hen we w e re in t e r e s t e d in b r in g in g a b o u t p r ic e in c r e a s e s , and t h a t t h e v e r y g e n e r a l an d u n iv e r s a l •li te ra ls u se d b y th e B o a rd a t t h a t tim e m u st be in t e r p r e t e d a s a p p ly in g o n ly to e f f o r t s to c o s e o u t o f a d e f la t io n a r y c o n d it io n , l e t me h u r r y to y o u t h a t th e i l l u s t r a t i o n th e y u s e d , o u t o f e x p e r ie n c e , to j u s t i f y t e ll t h is c o n c lu s io n , was th e e v e n ts fro m 1926 to 1929 w h ic h a s y o u may r e c a ll w as n o t a d e f la t io n a r y p e rio d * The C h a irm a n . M r. C la r k . Was t h a t a B o a rd s ta te m e n t? Y e s , s ir * The C h a irm a n . M r. C la r k . R e s e rv e B u lle t in N o t th e s ta te m e n t o f a n y in d iv id u a l m em bers? T h a t w as a B o a rd s ta te m e n t, p u b lis h e d in in A p r il 1939* so e a s ily d e te rm in e d . th e F e d e r a l The F e d e r a l R e s e rv e p o s it io n to d a y i3 not They h a ve n o t made a n e q u a lly c a n d id s ta te m e n t o f th e t h e o r ie s b e h in d t h e ir o p e r a t io n s . A s w e ll a s I h ave b e e n a b le to a s c e r t a in th e t h e o r e t ic a l p o s it io n o f th e B o a rd a t t h is tim e , i t is t h is : T hey s t i l l h o ld to th e v ie w e x p re s s e d in 1939 t h a t y o u c a n n o t c o n t r o l p r ic e s b y b r in g in g a b o u t ch a n g e s i n volu m e o f m oney o r i n m oved in t o th e c o s t o f m oney, th e c o s t o f c r e d it . th e t h e o r y o f r e s t r i c t in g th e T hey f i r s t a v a i l a b i l i t y o f b a n k c r e d it , w h ic h has b e e n m e n tio n e d h e re to d a y , b y f in d in g m ethods w h ic h w i l l in d u c e b an ks to h o ld t h e ir G o ve rn m e n t s e c u r it ie s . You se e i t a re d e a lin g w it h , on e th e y d id n o t have i n is a new p ro b le m th e y 1939 to a n y la r g e d e g re e . T hey w o u ld in d u c e b a n ks to h o ld t h e ir G o ve rn m e n t s e c u r it ie s b y g iv in g them a b e t t e r y ie ld th e re o n , a p o lic y w h ic h P r o f e s s o r M u sg ra v e in h is r e p o r t to y o u — w h ic h h as b e e n p u b lis h e d — sp e a k s o f a s b u y in g o f f th e b a n ks fro m u s in g t h e ir c r e d it m a c h in e ry to e n d a n g e r th e p u b lic w e lf a r e . The d i f f i c u l t y w it h t h a t i s , a s h as b e e n p o in te d o u t b y some o f th e s e g e n tle m e n to d a y , t h a t e v e ry b a n k i n s e c u r it ie s w h ic h i t A m e ric a h a s p le n t y o f G overnm ent c a n d is p o s e o f in th e m a rk e t w it h o u t b e in g much co n c e rn e d a b o u t th e s e ch a n g e s i n y ie ld s . The b a n ks h o ld a la r g e p r o p o r t io n o f s h o r t- te r m s w h ic h a r e n o t v e r y much a f f e c t e d b y th e m o d e ra te ch a n g e s in .y ie ld s w h ic h y o u c a n b r in g a b o u t* The R e s e rv e B o a rd now h a s a much m ore s o p h is t ic a t e d th e o r y o f con t r o llin g b a n k c r e d it u n d e r t h is G overn m en t li q u i d s e c u r it ie s . c o n d it io n of la r g e b a n k h o ld in g s of I t is t h a t th e y w i l l p e rh a p s be a b le t o d is s u a d e th e b a n k e r fro m d is p o s in g o f t h is G overn m en t s e c u r it ie s i f to ta k e a b o o k lo s s th e re o n . I c a n n o t qi*>te a n y th in g o f f i c i a l l y b u t t h is is he h a s fro m th e B o a rd i t s e l f on t h a t , th e e x p la n a t io n g iv e n b y Ifr* Louis B row n, a d ir e c t o r o f th e F e d e r a l R e s e rv e S an k o f Hew Y o rk , when he u n d e rto o k to e x p la in th e r e c e n t p o lic y m an eu vers o f th e F e d e r a l R e s e rv e System * By u s in g op en m a rk e t o p e r a t io n s to b r in g a b o u t an in c r e a s e in th e y ie ld — w h ic h means a d e c lin e i n t ie s , in c lu d in g s h o r t te rm s , b o o k lo s s i n s e ll in g th e m a rk e t p r ic e — o f th e G overn m ent s e c u r i th e b a n k e r w i l l be p e rs u a d e d n o t to ta k e a some G ove rn m e n ts to b u ild make some b u s in e s s lo a n w h ic h i s up h is r e s e r v e i n o r d e r to o f f e r e d to h im . The s u g g e s tio n h a s b e e n made h e re t h a t b a n k e rs do n o t t h in k t h a t m y and do n o t a c t t h a t w a y. B u t q u it e ir r e s p e c t iv e o f th a t, t h a t th e b a n ks o f th e c o u n tr y ca n p o s s ib ly be p u t in lit t le b a n k t h a t s u p p o rts me when th e G o ve rn m e n t i s n o t e n t ir e ly I t is t y p ic a l in th a t re s p e c t, b u t i t one t h a t I h ap p en to know a b o u t* is 1 do n o t t h in k th a t sq u e e ze . The n o t e m p lo y in g me i s n o t su ch a b ad e x a m p le . E v e r y w eek, we s u b s c r ib e f o r -6- $200,000 of bills which mature in 13 weeks* $200,000 happens to be just 10 per cant of our required reserve* So every week we hare £200,000 of bills maturing* All we have to do in any week to increase our reserve by 10 per cent is simply not to sub scribe for new bills that week* reserve by 30 per cant* s h o r t- te r m And in three weeks we can increase our The Treasury is going to continue to use these securities in our total debt structure* They will always be available to the banks* You could not possibly drop prices on the financial markets lew enough— unless you are reacfer to completely destroy the debt structure— so that any banker is going to be under any particular difficulty of meeting requests that he make attractive loans* We are caught in this trap and we can not get out of it, by these methods* The bankers do have liquid assets vtiich they are able to turn into reserves and you cam not stop them by market manipulation* The view of the Council upon this tough problem has been presented under two of the three groups of circumstances kith *feich your committee has been concerned during the past year* Last February Mr* Keyserling and I, as the surviving maabers of the Council of Economic Advisers, in response to your request for a report upon a number of questions, in cluding monetary policy, furnished you our views which you hacve published in the hearings on the 1950 Economic Report of the President* In November we again made a report in response to the request of the staff that we contribute to this very valuable staff report that has been published within the last few ds$rs* The first time we were dealing with problems of monetary policy in a period of peacetime inflation# We told the covdttee that our approach to the problem is not and can not be limited to the monetary aspect, nor to the obvious need to proteet the treasury in managing the public debt* Under the Employment Act of 19U6 our approach has to be much broader to consider thetotal problem of stabilization and not merely the monetary problem and the debt-manageaaent problem* We are continually concerned with the problem of economic growth* We look upon the cost of capital as being no different from any other cost of production and we believe that it is always desirable to hare costs of production, Including the cost of capital, held at as low a point as social policy will permit or will bring about* Therefore, we were not in favor of monetary policies that were directed to increasing the cost of capital and thereby limiting economic expansion* But in a period of inflation, under ordinary peacetime con ditions, a period which is bound to come to an end either through effective policies being applied to it or through the crash which otherwise is the normal result of inflation, we think that it is entirely permissible to ti hten credit* And for that reason, ever since the Federal Reserve Board presented the proposal in 19U7, we have rigorously supported the plan for a special reserve, to be held at the option of the bank in short-term Government securities o In November the committee was considering the situation that then was dominated by the needs of the defense program following the attack in Korea, a very long tern program, so far as we can tell. The one change - 8- that we then made, and for that reason made, in our recommendation was to tell you that under toe conditions following the Korean attack we looked upon the continued expansion of the economy as being far more important than it would have been in another period of inflation* For that reason we were not in favor of tightening credit, although we did believe that it was still true that the Federal Reserve Board always should have among the tools in its armory of anti-inflationary policy, the right to establish the special reserve requirement when con ditions called for such action* Mowie are in the third situation* The Chinese attack has aggravated the problem of preparedness and has accelerated the defense program* ¥0 immediately shifted from the original position we had taken that it was not necessary to have wage and price controls* necessary to have wage and price controls* How we thought it was And a second change which that new condition makes in my mind is that if now business loans, the exten sion of bank credit, are creating a dangerous situation, there is no sense in trying to attack the danger by the use of the awkward, indirect, mid indiscriminate control of credit* ¥e should do idth respect to credit what we are doing with respect to other sectors of the economy, and that is to apply direct control of the volume o f credit* And when it is suggested, as Mr* Eccles argues with me, that the problems of direct control of the volume of loans i&ich banks may make is an administrative impossibility, I have to say that we certainly are wasting our time in talking about such things as controlling prices of i*,000,000 business institutions and fixing the wages of 60,000,000 workers if th e p ro b le /a s o f c o n t r o llin g lU , 000 b a n k s , to c o n t r o l th a n a n y o t h e r s i n That is a p e r s o n a l v ie w . I say * if i t is o u r n a t io n , is th e in s t it u t io n s r ie d s i& j e c t to o b ig a jo b f o r us to h a n d le . The C o u n c il has n o t had o c c a s io n to p a s s upon i t . n e c e s s a ry to a c t . * L a s t w eek, w hen th e c o s j& itte e h a d an e x e c u tiv e h e a r in g , I s t a t e d a y v ie w t h a t th e re i s le m i n imre t h is m a tte r o f b a n k c r e d it , p r o b a b ly no g r e a t p ro b t h a t th e s it u a t io n h a s a lr e a d y b e e n c a r in t o a p a t t e r n w h ic h w i l l n o t o n ly s to p th e in c r e a s e i n b a n k c r e d it b u t w i l l so o n c r e a te a p le t h o r a o f fu n d s s e e k in g in v e s tm e n t. T w d a y s a f t e r I made t h a t f o r e c a s t to y o u th e p r e s id e n t o f a b u ild in g a n d lo a n a s s o c ia t io n , i n a n a d d re s s a t one o f t h e ir c o n v e n tio n s , b e s o u g h t them n o t t o e s t a b lis h li m i t s upon d e p o s it s w h ic h th e y w o u ld a c c e p t . th e p ro b le m a ro s e b e c a u s e th o s e in s t it u t io n s a lr e a d y a r e f in d in g i t And im p o s s ib le to f in d o u t le t s f o r s a v in g s an d f o r new in v e s tm e n t fu n d s . I f y o u lo o k e d a t th e s c h e d u le t h a t B on Woodward g ave y o u a t y o u r h e a r in g th e f i r s t o f th e w eek y o u may h a ve n o t ic e d t h a t lie came to th e c o n c lu s io n t h a t i n con su m e rs to f in d b e in 1 9 5 1 , w it h o u t a n y ch a n g e s i n p r ic e s , of goods to b u y w o u ld mean t h a t c o n s m a e rs 1 s a v in g s w o u ld e x c e s s o f $25? b i l l i o n th e m oney? th e i n a b i l i t y t h is y e a r . I t w i l l n o t be p u t in t o o r a m ethod o f s a v in g . W hat a re th e y g o in g to do w it h h o u ses. T hat is a k in d o f a s a v in g W hat a re th e y g o in g to do w it h th e fu n d s ? W hat w i l l b e done w it h th e fu n d s o f th e s e c o r p o r a t io n s w h ic h a r e g o in g t o b e g in to e s t a b lis h r e s e r v e s f o r th e s e h ig h e r ta x e s t h a t th e P r e s id e n t h a s p ro p o se d to d a y , and w h ic h w i l l n o t b e p a y a b le u n t i l th e b e g in n in g o f n e x t w in t e r ? - 10 T h ey w i l l n o t l e t th o s e fu n d s l i e - id l e in th e b a n ks* I am s t ic k in g b y a y f o r e c a s t , M r. C h a irm a n , t h a t b y th e m id d le o f th e y e a r y o n a re n o t o n ly n o t g o in g to h a re a n y p ro b le m o f e x p a n s io n o f b a n k c r e d it , b u t y o u a r e g o in g t o h a ve s u c h a d r iv e upon th e G o ve rn m e n t s e c u r it y m a rk e ts b y th o s e s e e k in g th e o n ly o u t le t a v a ila b le f o r t h e ir fu n d s , t h a t i t m i l be a b s o lu t e ly im p o s s ib le th ro u g h a n y r a t io n a l open m a rk e t o p e r a t io n s to p re v e n t in t e r e s t r a t e s fro m g o in g down*
@FedFRASER