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For release 3 p.m., Friday, December 2, 1949*
Preliminary Statement of Mr. Allan Sproul,
President of the Federal Reserve Bank of New York,
Before the Subcommittee on Monetary, Credit, and
Fiscal Policies of the Joint Committee on the
______ Economic Report, December 2, 1949._______
As I understand it, your interest at these hearings is in exploring
the various points of view developed in response to your questionnaire inquiry,
rather than in having individual witnesses try to cover all of the ground from
the beginning, by means of a long prepared statement. In any case, I have given
you my views on the general subject of your inquiry in the extended answers to
your questionnaire prepared by a special committee of the Federal Reserve Banks,
which I sent you with a covering letter of my own. Today with your permission,
therefore, I shall confine my preliminary remarks to a few brief comments on
one or two critical points which, as I see it, need fresh emphasis or elaboration,
in view of the other replies and testimony you have received.
(l)
In an inquiry as broad as that which you are conducting, there is
well-founded and proper concern with a host of questions, many of which, however
important in themselves, may tend to divert attention away from the central
problem, f In the area of monetary, credit, and fiscal policies, and under present
conditions, I believe that problem is how to combine effective monetary management
with effective debt management. There cannot be a purposeful monetary policy
unless the Federal Reserve System is able to pursue alternating programs of
restraint, "neutrality," and ease, in a roughly contra-cyclical pattern. Such
programs must, as they accomplish an increase or contraction in the volume of
credit and a tightening or loosening in the availability of credit, affect
interest rates, not only for private credit, but for Government securities. The
terms of Treasury offerings for new money, and for refunding issues, must be
affected. Yet those effects will, at times, be inconvenient and burdensome to
the Treasury in its management of the enormous public debt, and may conflict with
otherwise praiseworthy efforts to minimize expenditures for debt service*
This is an inherent conflict. It will continue to arise, in one form
after another, so long as this public debt, huge in relation to our present
national income, is with -us. It is important, therefore, that better means be
found, if possible, for reconciling potential differences between the Treasury
and the Federal Reserve System so that action in the credit sphere may be taken
promptly, as needed, in reasonable harmony with the action being taken by the
Treasury in the sphere of debt management.
The record of cooperation in the postwar years has been better than might
have been expected, and so has the record of our economy, whatever connection
there may be between the two. But agreed action, in my opinion, has most often
been too little and too late, Leo far as the aims of an effective monetary program
were concerned. For example, the System wanted to discontinue its preferential
discount rate on Government securities maturing within one year, before the end
of 1945; Treasury acquiescence, and the action, did not come until April 1946.
From the closing months of 1945 through all of 1946, the System was pressing for
discontinuance of its artificially low buying rate - 3/8 of 1$ - on Treasury bills
the action finally came, with Treasury agreement, in July 1947* From that point
on, as inflationary pressures increased, the System wished to follow a program of
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credit restraint which would have necessitated small but, perhaps, frequent
increases in short term interest rates which would have meant similar increases
in rates on Treasury bills and certificates, and some increase in the yield of
other short and intermediate Government securities. The Treasury did a large
part of the job, of course, by devoting its substantial cash surpluses to the
retirement of debt in such a manner as greatly to aid in achieving the common
objective; but the Treasury was generally several months behind in accepting the
implications of a tightening policy for the interest rates on its short term
securities.
Now, and so far as we can see into the next fiscal year, there is not
much chance of the Treasury's enjoying cash surpluses; in fact, cash deficits
with their inevitable bias toward inflationary pressure, when the economy is
already working close to capacity, seem to be in the cards. It may become all
the more important under such circumstances, and would become most important
if inflation should in fact return, that the Treasury be receptive to rising
rates — the same rising rates that would be required in attempting to hold in
check any inflationary tendencies in credit expansion to the private sector
of the economy.
It is this situation which lends weight to the suggestion that there
\ be a Congressional directive, specifying as part of the legislative framework
for debt management that the Treasury should work within the structure of interest
rates appropriate to the economic situation. The implication of such a directive
would be that the Treasury could not, as a matter of right or of superior position,
call upon the Federal Reserve System to "make a market for its securities" at
rates which the System believed to be out of line with the degree of credit
restraint considered necessary by the System. I recognize that there would con
tinue to be differences of opinion about these matters, and I realize that you
cannot legislate cooperation between people, but the Congress, as final arbiter,
might be able to provide a mandate which would charge debt management as well as
monetary management with some responsibility for the objectives specified in the
Employment Act of 1946. The country cannot afford to keep money cheap at all
times and in all circumstances, if the counterpart of that action is inflation,
rising prices, and a steady deterioration in the purchasing power of the dollar —
including the purchasing power of the dollars which the Government itself must
spend and the purchasing power of dollars invested by the public in Government
securities.
Whether or not a directive is possible or may be forthcoming, there
seems to me to be a clear need to study this question of how to bring about a
more regular relationship for consultation between the Treasury and the Federal
Reserve System than that now temporarily provided through fortunate personal
relationships. One suggestion along these lines which may deserve your con
sideration is that there be created a national advisory council on domestic
financial policy, a consultative body which would bring together the heads of
the four or five principal agencies whose activities affect, directly or
indirectly, the areas of prime responsibility of the Treasury and Federal Reserve
System. Such a council might also extend its scope to include within its purview,
on a purely consultative basis, the lending and loan guarantee activities of all
other Federal financial agencies
in the interests of frequent consideration
of overlapping mutual problems. This suggestion is open to the criticism that it
might be just another piece of machinery, delaying decision but not leading to
3
harmonious action. Nevertheless it is worth exploring. Another suggestion is
that the Secretary of the Treasury be made a member of the Board of Governors of
the Federal Reserve System. I have a latent distrust of these ex officio rela
tionships and it didn't work well in the early years of the System, but the idea
should at least be re-examined in the light of present conditions.
(2)
If a suitable permanent framework for the relations between debt
management and monetary policy can be established, the tasks of monetary control
and debt management will not be impossible. While the money market is not so
sensitive to slight changes or disturbances as it was from 1946 through much of
1948, when large segments of the swollen public debt had not yet settled into
firm hands, it is still sensitive to relatively small changes in the interest
rate structure, and to any uncertainty concerning the future direction of rates
created by such changes, in terms of its readiness to make funds available for
expansion. Through judicious use of discount rates and flexible open market
operations, it should be possible to make monetary policy reasonably effective
without such abrupt and such wide changes in interest rates as used to be
considered a necessary part of central banking technique. Such a monetary
program would be consistent with very moderate fluctuations in the cost of
servicing the debt, and would not contemplate (nor require) large changes in
the prices of outstanding Government securities.
In this context, the question of par support of Government securities,
to which considerable attention has been given at past hearings and which has
evoked some comment by witnesses before your committee, would shrink to a
relatively minor issue. With the market susceptible to and habituated to
small rate changes, any slight and probably temporary decline in prices below
par would not be a matter of major concern. The likelihood that we shall be
operating in this sort of climate is strengthened by the fact that we have
already passed through the postwar period of most extreme capital demand, in
excess of current savings, and an early recurrence of that kind of disparity,
with the great upward pressure it exerts upon long term rates, is improbable.
Moreover, the maturity of the Government debt now outstanding is being shortened
automatically by the passage of time, a factor which exerts a mechanical downward
pressure on the market rates for these issues (i.e., a rise in their price, over
time), allowing more and more leeway, each year, so far as outstanding issues
are concerned for fluctuations to occur above the par level.
This does not mean, however, that there has been or can be a commitment,
express or implied, to support all Government securities at par at all times.
Such a commitment would make any pretense of credit policy over the long run
rather ridiculous, since the essence of credit control is fluctuating rates,
reflecting credit availability. And just as the pretense of credit policy would
be made ridiculous, the present forms of debt management would be made obsolete.
If all Government securities of all maturities can be liquidated at par at any
time, they become, in effect, demand obligations and need only bear varying rates
of interest if we want to reward various kinds of holders in various ways. And
again I say it would be a spurious gain to support all Government securities at
par or better, ad infinitum. There may be extreme situations, which we cannot
now perceive, when there would be greater losses and damage to the economy by
reason of unbridled inflation, unrestrained by monetary action, than would result
from allowing the price of Government securities to go below par.
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(3)
I favor the extension of rational reserve requirements to al
at least all insured) commercial hanks; I also favor the uniform reserve plan,
relating reserve requirements to type of deposit, and abandoning the outmoded
geographical classification. But both of these are essentially matters of im
proved housekeeping, they do not affect the real fundamentals of monetary control.
I do not apologize for them on that account. I think it is unfortunate that
needed improvements, which will add to efficiency and remove burdensome inequities,
are often dismissed for lack of glamor or lack of urgency. But it is equally un
fortunate if, in order to attain these improvements, they are "oversold" — being
offered as powerful remedies for problems that can better be solved in other ways.
As I see it the case of these proposals rests on simple grounds. So
far as the application of reserve requirements to state chartered commercial
banks is concerned, it is important to remember that these banks are exercising,
by the acquiescence of Congress, a constitutional Federal function — the power
to add to or subtract from the money supply. While no one is more anxious than
I to preserve those characteristics of local responsibility and initiative which
are fostered by the state chartering of banks, I do question whether the arrange
ments which permit these advantages should also be used to avoid a proper share
in the responsibilities of national monetary policy. To say that it would strike
at the foundation of the state banking system to make nonmember banks subject to
national reserve requirements seems to me to be putting the cart before the
horse and then belaboring the horse.
State chartering and state supervision (the real essence of a "dual
banking system") would not be disturbed by the extension of the System1s reserve
requirements to all banks. We have nearly 2,000 state-chartered banks, at present,
as voluntary members of the Federal Reserve System. Their aggregate earning
assets are nearly twice those of the more than 7>000 state-chartered nonmember
banks — the reserve requirements of membership have apparently not prevented
the state-chartered members from thriving, nor has their membership destroyed
their essential state character. And yet monietary policy can't be fully effec
tive unless all parts of the banking system, the whole banking community, have
some understanding of lit and play the game. There should be some direct contact
between the Federal Reserve System and all banks .('or all insured banks) of the
country.
If wider access to the discount privilege on the part of nonmember banks
is necessary to make this palatable, it might not be too great a price to pay,
suid would have collateral advantages in strengthening the emergency liquidity of
the banking system. I must confess to some lingering feeling, however, that if ‘
banks want (or if in the national interest they should have) all or most of the
advantages of membership, they ought to pay their dues. As a counter-weight
to possible concern that System control over all reserve requirements places too
wide a range of authority in a distant Washington body, it should be pointed out
that a transfer of authority over reserve requirements from the Board to the
Federal Open Market Committee would assure a representation of regional banking
experience in the determination of these requirements.
The type of deposit vs. geographical location reserve proposal also
rests on considerations of equity among banks, and on the desirability of
modernizing a control apparatus in order to permit the System to carry out its
general mandate from Congress in the most efficient, practicable manner.
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(4)
No change in the System’s power over reserve requirements sh
be presented, however, as an alternative to facing head-on the actual and
potential conflicts between monetary control and debt management. It has been
argued, for example, that increases in reserve requirements (whether primary or
secondary or what not) provide a way of tightening up on the availability of
credit, without affecting interest rates and, therefore, without trespassing
on Treasury prerogatives of debt management. We tried that approach in 1948,
without appreciable results. Following the increases in reserve requirements
in that year, the banks sold Government securities to the market in a volume
roughly equal to the dollar amount of their increased reserve requirements;
the market in turn unloaded an equal volume upon the Federal Reserve Banks.
That result was inevitable, I believe, so long as the Federal Reserve held
its buying rates (that is, held interest rates) virtually unchanged.
We saw the reverse operation this past summer. Reserve requirements
were lowered, and the banks used most of the proceeds to buy Government secu
rities from the market, while the Federal Reserve Banks sold (or redeemed) a
roughly corresponding volume. There were other factors at work, to be sure, in
both of these periods but full review of the statistical record, making allowance
for these other factors, still shows that the 1948 increases and the 1949 reduc
tions in reserve requirements resulted mainly in shifts of Government securities
between the Federal Reserve Banks and the commercial banks.
The inescapable fact, in my opinion, is that moderate changes in reserve
requirements, up or down, will have no appreciable effect upon the availability of
credit to the general economy, if rates have to be held constant. And if rates
can vary, changes in reserve requirements are a crude way to do a job that the
discount rate and open market operations can accomplish with much greater flexi
bility and precision. The proper role for changes in reserve requirements is in
making long run ’’strategic” alterations in the banking structure, in resjjpnse to
sustained gold flows, for example, or shifts in the public's habitual use of
currency. The one exception might be a period of runaway inflation, of an extreme
form such as has not occurred in the history of the Federal Reserve System. Under
such circumstances, when all traditional control instruments have been outdistanced
and crude but drastic measures become necessary, it might be effective to make
temporary, emergency use of very high reserve requirements, perhaps as high as
100 per cent, against new deposits, in order to Immobilize for a time the moneycreating" capacity of the commercial banking system. Short of that, given the
environment created by the present large national debt, changes in reserve require
ments seem to me to have no significant role to play in the day-to-day adaptation
of credit policy to the changing business situation. They cannot be substituted
for rate flexibility, in influencing the availability of bank credit to the
economy.
I have given you my views on what seems to me to be a central point of
your inquiry, with some collateral comments. I shall be glad to try to answer
questions raised by this presentation, or questions related to other aspects of
your studies if you so desire.
Remarks on the Organization of the Federal Reserve System
by Mr. Allan Sproul, Supplementing His Preliminary Statement
Before the Subcommittee on Monetary, Credit, and Fiscal Policies
of the Joint Committee on the Economic Report, December 2, 1949.
In my reply to your questionnaire, I suggested that the responsibility
for all major instruments of Federal Reserve policy should be lodged in the group
now called the Federal Open Market Committee. Other monetary controls must be
integrated with open market operations, and there is certainly strong logic on the
side of unified direction over all of them. Such a change would also assure the
regular representation of actual operating experience, and an awareness of differ
ing regional problems, in the formulation of the interrelated aspects of a national
monetary policy. It is not an ideal arrangement, nor even good administrative
procedure, to place open market operations under a broadly representative committee,
and to place the power over reserve and margin requirements, and the review and
determination of discount rates initiated by the Reserve Banks, solely under the
Board of Governors. The Federal Open Market Committee has worked well in guiding
the most important instrument of Federal Reserve policy. The next step should be
the transfer of other closely related powers of monetary control to that Committee.
This is a question on which men in the System may differ, displaying a
bias, perhaps, toward the side they know best. As a Reperve Bank President, it is
probably natural that I should see advantages in this proposal, while members of
the Board may react against it, as an intrusion upon their authority. On this
question, just as on the substantive questions of credit policy, both views deserve
a hearing. My own view is that we shall do well to retain, wherever we can, the
regional characteristics of the System, both in the matter of decentralized opera
tion and, more important, in the natter of System national policy. No one would
deny the need for coordination of general credit policy, but we now have, in the
Federal Open Market Committee, the statutory means of achieving this while retain
ing some regional participation and responsibility. This Committee is composed,
as you know, of the seven members of the Board of Governors and five of the
Presidents of the Federal Reserve Banks. Here are brought together, under statu
tory auspices and with statutory responsibilities, men who are devoting their full
time to the problems of the Federal Reserve System and who are in touch with
governmental policies and private views and opinions, in Washington and throughout
the country. It is the best expression which we have of the Federal character of
the System, a character which is in tune with our political organization, with the
continuously expressed intent of the Congress, and with the desires of our people.
And let me nail right here one or two arguments which have been advanced
on the other side. First, there is the argument that the Presidents on the Federal
Open Market Committee iexercise authority without having responsibility. In the
first place, as I have stated, membership on the Federal Open Market Committee, and
the duties and responsibilities of the Committee are now fixed by statute. Every
man who accepts a place on that Committee derives his authority from the Congress
and assumes a responsibility to the Congress and, through it, to the public. These
Presidents are mostly men who have devoted their lives to the Federal Reserve
System - they are career men in the public service. It comes with ill grace for
anyone who has ever served on the Committee to hint that they are swayed by private
interests to compromise public duty. You do not plant honor and integrity in a
nan by bringing him to Washington and giving him an official position in the
Government.
2
Second, there is the argument by threat; by posing a wholly unacceptable
solution as the only alternative to the giving of additional powers to the Federal
Open Market Committee. This is the argument that if you are going to give additional
powers to the Committee, you should abolish the Board of Governors. Such an argument
seems to me to miss the whole point of the original suggestion. The essential and
unique characteristic of the Federal Open Market Committee is its blend. The Board
retains all of its existing duties, but exercises its principal powers through majority
membership in the Federal Open Market Committee. The Presidents, with their experi
ence gained through carrying out policy in the field, sit as minority members of the
Committee. All participate in policy making discussions, and conflicting views are
given the test of thorough debate. You are protected from being blown off your
course by either the political winds of Washington or the financial winds of Wall
Street.
The compromise solutions which have been brought forward do not impress me. It is not enough, I am sure, to bring the Presidents of the Reserve Banks into
the discussion of these matters of credit policy as advisers. Occasional requests
for comments are not enough, nor is it enough to provide for attendance at meetings
without membership or vote. You'have to "belong" to be able to insist on considera
tion of your point of view. Similarly, I do not believe that the suggestion that two
of the Reserve Bank Presidents come to Washington each year for full-time service on
the Board of Governors is practical. Such men would bring valuable lessons of past
experience to the Board, but they would have divorced themselves from the insight
produced by close contact with current operations. They would be cut loose from
their own staffs, their directors, and their districts, and transplanted to the
somewhat unfamiliar Washington scene, while their institutions would be deprived
of chief executive officers for a year at a time, one year out of six.
This is a case where the whole cannot adequately be replaced by either
of its parts. In my view, we have developed through the Federal Open Market Com
mittee a unique contribution to the processes of democratic administration. The
System will best meet its responsibilities if this successful pioneering experiment
is expanded to embrace all of the major policy determination of the System.
Nor am I frightened by the express or implied threats that to insist on
placing more powers in the Federal Open Market Committee is to hasten the national
ization of the Federal Reserve System, and the removal of any taint of private
participation in its affairs. I think we shall do well to retain the modest measure
of private participation in the affairs of the System which we now have, to make
effective use of thpse public spirited men who are willing to serve as directors
of the Federal Reserve Banks. And I believe the Congress will feel that way if
and when it examines the situation. We are a successful working example of Govern
ment functioning in the economic field, with the aid and support of private
business. Our experience in Govemment-business cooperation - with Government
having the dominant and deciding voice - may be one signpost along the way to
solution of that major ^problem - the relation between Government and business in
our whole economy.
@FedFRASER