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Form F. TO Secretary to Secretary Snyder FROM R# 5 1 1 ( a) Governor M. S. Eccles_____ COPY R EM AR KS: I will appreciate it if you will see that Secretary Snyder personally receives this immediately in order that he may have an opportunity to read it before he goes be fore the Douglas Committee this morning. Thank you. 12/2/49 GOVERNOR ECCLES’ OFFICE Docoaber i, 1949. B eer M r. S e c r e ta r y } F or y o u r in fo r m a tio n , I a s e n c lo s in g h erew ith a cop y o f a l e t t e r w hich I have w r it t e n t o S e n a to r P au l H* D ou g las in con * n e c tio n w ith a y ap p earan ce b e fo r e h is Co*~ n i t to e on K orea b er 2 2 and in r e sp o n se t o eoase o f h is q u e s t i o n s . S in c e r e ly y o u r s , M. S. Eccles, H on orable John W* S n y d e r, S e c r e ta r y o f th e O n ited S t a t e s T r e a s u r y , ¥asaiagton, D. C. December 1, 1949 Dear Senator Douglast In connection with my testimony presented on November 22 before your Comalt t e e , I indicated that I had not attempted to include in my state ment some Important matters which may be helpful to the Committee. You granted me the privilege of filing a supplementary statement should tbat appear desirable. In the course of my testimony you asked if it would serve a use ful purpose if Congress were to instruct the Treasury further as to the policLes to be followed in debt management where they are dependent upon the monetary policies of the Federal Reserve System. You also stated that you would appreciate it if you could get some suggested standards of an instruction that might be given to the Treasury by Congress with reference to Treasury relations with the Federal Reserve. Since presenting ay testi mony I have given a great deal of thought to this subject. In reading over the record of my remarks, it was apparent to me that I had not responded as fully es I could have to some of your questions. Therefore, I should like to take advantage of the privilege of making a supplementary statement. A very fundamental dilemma confronts the Federal Reserve System in the discharge of the responsibilities placed on it by Congress. The System has by statute the task of influencing the supply, availability, and cost of money and credit. In peacetime, the objective is to do this in such a way that monetary and credit policy will make the maximum possible contribution to sustained progress toward goals of high employment and ris ing standards of living. Federal Reserve System powers for carrying out this responsibility are at present basically adequate. But the System has not, in fact, been free to use its powers under circumstances when a re strictive monetary policy was highly essential in the public interest. It has been precluded from doing so in the earlier postwar period in part be cause of the large voluae of Government securities held by banks, insurance companies and others who did not view them as permanent investments. Rea sons for supporting the market under these conditions I have already pre sented before your Committee. This policy of rigid support of Government securities should not be continued indefinitely. The circumstances that made it necessary are no longer compelling. But the Federal Reserve would not be able to change these policies as long as it felt bound to support debt-management decisions #2 - 12/1/49 - Honorable Paul Douglag. made by the Treasury, unless these were in conformity with the same objec tives that guide the Federal Reserve. The Treasury, however, is not re sponsible to Congress for monetary and credit policy and has had for a long time general e&sy-money bias under almost any and all circumstances. As long as the Federal Reserve policy must be based upon this criterion, it could not pursue a restrictive money policy to combat inflationary pressures. Decisions regarding management of the public debt set the frame work within which monetary and credit action can be teucen. As the sise of the debt ^rew through the period of deficit finance in the 'thirties and particularly over the war period, Treasury needs came to overshadow and finally to dominate completely Federal Reserve monetary wad credit policy. When the Treasury announces the issue of securities at a very low rate pat tern during a period of credit expansion, as it did lest Wednesday, the Fed eral Reserve is forced to defend these terms unless the System is prepared to let the financing fail, which it could not very well do. To maintain a very low rate pattern when there is a strong demand for credit, the System cannot avoid supplying Federal Reserve credit at the will of the market. Under these conditions it can hardly be said that the Federal Re serve System retains any effective influence in its own right over the sup ply of money in the country or over the availability and cost of credit, although these are the major duties for which the System haB statutory re sponsibility. Nor can it be said that the discount rate and open market operations of the System are determined by Federal Reserve authorities, ex cept in form. They are predetermined by debt-management decisions made by the Treasury. This will be true as long as the System is not in a position to pursue an independent policy but must support in the market any program of financing adopted by the Treasury even though the program may be incon sistent with the monetary and credit policies the System considers appro priate in the public interest. The Federal Reserve System was established by Congress primarily for the purpose of determining and carrying out credit and monetary policy in the interest of economic stability and is responsible to Congress for that task. There is a seven-man Board of Governors, appointed for 14-year terms with approval of the Senate. The Board is assisted by an experienced and highly qualified staff of experts. There are twelve presidents of the Federal Reserve Banks, each with a staff of specialists, and each Federal Reserve Bank has s Board of Directors composed of leading citisens in its district drawn from professional, business, farming, banking, and other activities. There is also the Federal Advisory Council, composed of a lead ing banker from each of the twelve districts, established by Congress to advise the Board. All of these supply information and advice and many par ticipate in formulation of monetary policies appropriate to the needs of the economy. Under present circumstances the talents and efforts of these men are largely wasted. Views of the Federal Reserve Board and Open Market Com mittee regarding debt-management policies are seldom sought by the Treasury $3 - 12A/49 - Honorable Paul Douglas. before decisions are reached. The System, however, hae made suggestions on its own initiative to the Treasury in connection with each financing, but vary often these have not been accepted. Decisions are apparently aade by the Treasury largely on the basis of its general desire to get aoney as cheaply as possible. In a war period or a depression, there is reason for financing a deficit through commercial bank credit — that is, by creating new aoney. The Federal Reserve Systea has supported such financing at very low rates by purchasing governaent securities in the market at such rates, thus pump ing the needed reserves into the banking systea. In the early postwar period some support was desirable, especially for the 2^ per cent long-term bonds, but it should not have been as inflexible as it was for snort-tera rates. The outlook at the present time is for an expanding economic ac tivity with high eaployaent. We also now anticipate a government cash de ficit of over 6 billion dollars in the calendar year 1950. It would be in excusable to finance this deficit at very low rates of interest by creating new money should inflationary pressures resurge. But if the Treasury, under these conditions, insists on continuation of the present very low rates, the Federal Keserve will have to pump new money out into the economy even though it may be in the interest of economic stability to take the opposite action. In Tiaking a cheap money market for the Treasury, we cannot avoid making it for everybody. All monetary and credit restraints are gone under such con ditions; the federal Reserve becoaes simply an engine of inflation. With respect to the problem of how future monetary and credit policies are to be established, it seems to me Congress must choose from the following three general alternatives if the present dilemma confronting the Federal Reserve System is to be resolved. (1) Congress can permit the present arrangement to continue. The Treasury would control in effect the open me ricet and other credit policy as it does now by establishing such rates and terms on its securities as it pleases, with the requirement that tha Federal Reserve support them. It should be recognized that under this course, limitations over the volume of bank credit available both to private and public borrowers, and accordingly limitation over the total volume of money in the country, would be largely given up. Such credit and monetary restraint as might be required from tiae to time to promote econoaic stability would be entirely dependent upon the willingness of the Treasury to finance at higher interest rates, and in the past the Treasury has been resistant to doing this. If this alternative is followed, which is the present arrangeaent, Congress should recognize that the responsibilities for monetary and credit policies are with the Treasury and not with the Federal Reserve Systea and that the principal purpose of the #4 - 12/1/49 - Honorable Paul Douglas. Federal Reserve System is then to supply additional bank re serves on the demand of any holder of Government securities at rates of interest in effect established by the Treasury. (2) The Congress could provide the Federal Reserve System with a partial substitute for the open market and discount powers which debt-management decisions of the Treas ury have rendered and can continue to render largely useless for purposes of credit restraint. Some measure of control over the availability of credit under inflationary circum stances could be regained if the System were given substan tial additional authority over basic reserve requirements of the entire commercial banking system. With such authority, the System could, if necessary, immobilize new bank reserves arising from a return of currency from circulation, gold in flows, and System purchases of securities from nonb&nk inves tors and thereby prevent the multiple expansion of the money supply. In addition, the System would need authority to re quire banks to hold a special reserve in Government bills and certiricates. This would be necessary in case banks entered upon an inflationary credit expansion through the sale of Government securities to the Federal Reserve or in the event it wes necessary to assist the Government to finance large deficits without creating additional bank reserves which serve as a basis for multiple credit expansion. (3) Congress, if it wishes credit and monetary policy to be made by the Federal Reserve System in accordance witJh the objectives of the Federal Reserve Act and the Employment Act of 194&» could direct the Treasury to consult with the System in the formulation of its debt-management decisions in order that these decisions may be compatible with the gen eral framework of credit and monetary policy being followed by the System in the interest of general economic stability. It is obvious, of course, that Government financing needs must be met end the responsibility of the Federal Reserve to insure successful Treasury financing must continue to be fully recog nized. But Treasury financing can be carried out successfully within the framework of a restrictive credit policy, provided the terms of the securities offered are in accordance with that policy. To sum up briefly my views, I believe th£t Congress should fix clearly the responsibility for national monetary and credit policy. Although the Federal Reserve System was established as an agency of Congress for de termination of monetary and credit policy, as it must function now it is re sponsible both to Congress and to the Treasury for that policy. These two responsibilities are often conflicting, and both cannot be satisfactorily discharged. The responsibilities and authority of the System need clarifica- #5 - 12/1/49 - Honor®ble Paul Douglas• t io n and fo r t h « t pu rpose one o f th r e e a l t e r n a t i v e a c t io n s m i^ht be tafcen by C o n g r e ss: ( 1 ) R eco gn ize in th e s t a t u t e t h a t r e s p o n s i b i l i t y fo r mone ta r y and c r e d i t p o l i c y i s w ith th e T re a su ry and r e c o g n iz e th e F e d e ra l R eserve f o r v h a t i t i s to d a y — an a ^ e n t f o r a d v is in g th e T re a su ry r.nd c a r r y in g ou t a o n e ta r y rmd c r e d i t p o lic y d e t e r a in ed by th e T r e a s u r y ; ( 2 ) G ive th e F e d e ra l R eserve S y s te a such a d d it io n s 1 a u th o r i t y o v e r bank r e s e r v e req u ire m e n ts a s would a d e q u a te ly se r v e a s a p a r t i a l s u b s t i t u t e fo r d is c o u n t end open m arket pow ers; ( 3 ) G ive th e S y s te a a mandate to d eterm in e a o n e ta r y and c r e d i t p o l i c i e s on th e b a s is o f g u id e p o s ts s ta te d in te r n s o f th e la n gu age o f th e F u ll E a p lo y a en t A c t o f 1 9 4 6 , w ith th e T re a s u ry r e q u ir e d to a d v is e snd c o n s u lt w ith th e F e d e ra l R eserve and ta k e in t o acco u n t th e aan d ate o f C on gress in c o n n e c tio n w ith i t s deb t-aan ageraen t d e c i s i o n s . I r e c o g n iz e t h a t a o n e ta r y o r c r e d i t p o l i c y by i t s e l f can n ot assura e c o n o a ic s t a b i l i t y . I t should be a cco ap an ied by a f i s c a l p o l i c y , a s w e ll a s a bank s u p e r v is o r y p o l i c y , in harmony w ith i t . I a p p r e c ia te v e ry much h avin g th e o p p o r tu n ity to e x p r e s s 3jy v ie v s on t h i s m a tte r . S in c e r e ly y o u r s , M. S . E c c le s . H on orable P au l H. D o u g la s , U n ited S t a t e s S e n a te , W ?sh in ,- t o n , D. C .
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