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Honorable M # S* Eccles, Chairman,
Board of Governors of the
Federal Reserve System,
Washington 25, D* C.


October 24, 1947.

Dear Marriner:
I have been giving a little more thought to discount rate policy in the
light of the Treasury1 s decision to adopt our views as to an appropriate and
coordinated program of credit control and debt management during the next few
First, with respect to the timing of action on our discount rate* I
had in mind that action on discount rates would follow the pattern set forth in
the draft of letter to the Treasury which I prepared, prior to the last meeting
of the executive committee of the Federal Open Market Committee* The paragraph
on discount rates read as follows:
"The discount rate of the Federal Reserve Banks is now
in approximate balance with other rates in the money market,
including the rates on Treasury bills and certificates. As
it becomes necessary, in order to maintain this relationship,
the discount rate would be increased moderately in line with
the increase in rates on bills and certificates*w
In our discussion at the meeting there was some difference of opinion
as to timing, and we finally agreed on a paragraph which left us free to take
action at any time after a further increase in the rate on certificates had been
indicated, bat which did not commit us to immediate action and retained the idea
that an increase in discount rates should be in line with market conditions* The
pertinent paragraph in the letter we finally sent to the Secretary of the Treasury
reads as follows:
"Increase the Federal Reserve Bank discount rates to
1-1/4 or 1-1/2 per cent in line with market conditions after
a further increase in the rate on certificates is indicated •*
For two reasons, and they are interrelated, I do not think we want to
get out in front of rates on certificates of indebtedness too far nor too fast*
We do not want our discount rate to carry much, if any, penalty on borrowings collateraled by certificates. Otherwise the attractiveness of certificates to the
banks, as contrasted with longer term obligations, will be diminished, or all of
the burden of adjusting reserve positions will be thrown on open market operations,
or both* This would be contrary to our aim of making the market for short-term
securities equally or more attractive than the market for longer maturities, and
to our hope that borrowing from the reserve banks might again assume such




M» S * E C C l e S


proportions that the discount rate would have some direct effect. Looking at it
from the Treasury1 s side, I think we must have regard for the continued successful refunding of its large certificate maturities, at the rates it has agreed
upon, and that tactically it would be undesirable for us to seem, or actually to
be, forcing up rates through discount rate action when we are supposed to be
getting them up by mutual agreement. On this occasion, I think, more than ever
before, the Treasury placed itself in our hands, and we should avoid doing anything which is not required by the situation and which would disturb its trust in
our judgment*
You might suggest that the answer is a restoration of a preferential
discount rate on advances collateraled by short-term Government securities. The
more I think about this, the more it seems to me that it would be a step backward;
the restoration of a wartime device which has no place in our present program.
I know that you are aware that there is no relation between the nature of the
collateral for advances and the use to which the credit is put* In this instance,
however, we should not overlook the fact that a dollar obtained from the Federal
Reserve Banks can become the basis of a credit expansion several times as large
and, what is more important in this context, the credit can flow out through the
borrowing bank to the whole banking system. That is to say, the credit will
largely find use among banks which have not borrowed and which were uninfluenced
in their investment policy by the preferential rate* It is the difference between
the impact of Federal Reserve operations on the banking system as a whole as contrasted with its impact on the individual banks*
The argument can be made, of course, that the influence of the discount
rate is largely or wholly psychological under present conditions, but I do not
think this is true when it comes to the question of the rate at which certificates
of indebtedness can be successfully refunded by the Treasury, or when it comes to
the maintenance of a satisfactory market in such securities* Right now, in this
transition period from a 1 per cent rate to a 1-1/8 per cent rate, the market is
an uncertain one, and if our discount rate were advanced prematurely, it could
expose us to such selling of certificates as might weaken our whole program of
keeping pressure on the banks* Hor do I think we want to exhaust our psychological
ammunition at a time when we already have the market off balance* The market now
knows it is on the way to a 1-1/8 per cent rate for one-year certificates of indebtedness (and maybe further), and it will feel the pressure of the retirement of our
holdings of certificates and of bills, steadily, between now and the end of the year*
Rather than rush ahead of these developments with a discount rate change,
I believe that it would be better to wait until conditions in the security markets
and in the banking situation (including the volume of member bank borrowing from
the Reserve Banks) suggest that action would be appropriate and effective* That
time may come either after the first short-term (13-month) 1-1/8 per cent note is
successfully issued as of December 1st, or after the 1-1/8 per cent one-year rate
has been actually established by announcement of the January 1st refunding, and
when we want to give an additional indication both of restraint on borrowing and
of possible further narrowing of the spread between short-term and long-term rates.
At that time an increase in the discount rates of the Federal Reserve Banks to
1-1/8 per cent would be in order, with a later increase to 1-1/4 per cent in
prospect. As the market used to say about rates on Government securities, I donft


Hon. M. S. Eccles


like the idea of dealing in "hat size" changes, but if this transition from one
rate level to another is going to be a smooth one, that is the kind of change
which is indicated. After all, we are not seeking a sledge hammer adjustment
designed to end a boom by Curtailing capital expenditures, production and employment, thus bringing downward pressure on prices. Ours is the more delicate task
of restraining a further increase in bank credit, and in the velocity of use of
existing purchasing power, while giving every encouragement to high, or higher,
production. The major attack on inflation will have to be made by means other
than drastic overall credit restrictions*

lours faithfully,

Allan S