View original document

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.


engulfed by the economic and social problems which
grow more menacing the longer the establishment
of a firm basis for permanent peace is delayed.

Mr. Chairman and Members of the Committee:
When I testified before this Committee last November 25, I emphasized that I was speaking only
for the Board of Governors of the Federal Reserve
System. In presenting a further statement today
covering the monetary and credit situation as it has
developed in the intervening four months, I am
again speaking only on behalf of the Board.
We, of course, do not participate in the Government's military or rearmament planning or in the
formulation of programs for foreign relief. Accordingly, what the Board has authorized'me to say
with regard to the impact on our economy of military and relief expenditures is said solely from the
standpoint of the implications so far as monetary
and credit policies are concerned. We feel that in
any effort tp deal with monetary and credit problems under the situation now existing, we should
clearly recognize the alternatives before us and the
economic consequences of expanding military outlays superimposed upon the present large budgets
for military purposes and for our program of world
Never in our memories has the world been pervaded by greater fears, confusion, and discouragement, arising chiefly because of the disappointments
of the past and the uncertainties of the future. The
great hopes we had during the war for achieving a
lasting peace in a prosperous world have been
steadily diminished because a few ruthless and
despotic men hold a sword of Damocles over the
heads of free peoples throughout the world. It is
difficult, if not impossible, to plan for a rational
economic future either at home or abroad while
that sword hangs over us.


Last November the country was faced with rapidly mounting inflationary pressures. The issue
then was how to curb inflationary forces by striking
directly at the basic cause, namely, an effective
demand—composed of spending out of past savings,
current income and new credit—in excess of the
over-all supply of goods and services. As pointed
out in the Board's statement to this Committee,
correction of inflation at its advanced stage had to
be on a broad front; fiscal policy had to be our main
reliance; and monetary and credit policy was supplementary to other fundamental actions. The Board
felt then, as it feels now, that effective monetary
and credit policy would require legislation to provide the Federal Reserve System with new powers
that would serve as a partial substitute for those
traditional powers which had become largely unusable in view of the huge public debt.
The essential monetary fact in the inflationary
situation at that time was the amount of liquid
purchasing power in the hands of the public, that
is, currency, bank deposits and Government securities, aggregating in all about 254* billion dollars,
or more than three times the amount held in 1940.
This amount of cash or qish equivalent was in large
part inherited from the financing of the enormous
Federal deficits' incurred in preparation for and
prosecution of global war. Not only did we have
this huge volume of cash or cash equivalent already
available last November, but at that time, despite
the anti-inflationary influence of the Government's
large budgetary surplus, the amount of liquid funds
was being rapidly increased as a result of bank
credit expansion to finance businesses and individuals as well as State and local governments.
Because of the necessity for protecting the Government's fiscal and debt management position by

We think that the prospect of removing the threat
by peaceful means will be immeasurably enhanced
the sooner we assert our moral and physical power
to establish the foundations for peace before we are
* Presented by Marriner S. Eccles before the Joint Committee
on the Economic Report on Apr. 13, 1948.


maintaining an orderly and stable market for Government securities, the Federal Reserve System was
then and still is unable to restrain effectively further
monetary expansion. The commercial banking system held nearly 70 billion dollars of Government
securities, which were being converted into additional bank reserves through sales to the Federal
Reserve. In addition, the System was providing
reserves to banks by purchasing Government securities sold by nonbank investors. Finally, bank
reserves were being substantially augmented by a
heavy inflow of gold.
In brief, the banks at that time were in a position
to supply unlimited amounts of additional credit,
and in the face of strong demands for additional
credit from all sources further rapid monetary expansion was occurring, intensifying existing inflationary pressures. This situation was potentially
explosive because production and employment were
close to the maximum then possible.

Last November we expected some abatement of
inflationary pressures in the first quarter of this
year. Such a situation developed. It was recognized
that there would be a large volume of funds drawn
from the banks by business and individuals in order
to pay taxes which would result in a large cash
surplus available to reduce the public debt. It was
also recognized that the existing and contemplated
program of monetary and credit policy would have
some restrictive effect. The program, which was
carried out, included the statement by the bank
supervisory agencies, urging the banks to be more
restrictive, the lowering of Federal Reserve support
levels for Government securities late in December,
a slight rise in rediscount rates early in January,
and some increase in reserve requirements for
banks in New York and Chicago in February.
The banking fraternity, recognizing the dangers
in rapidly expanding bank credit and thfc need
for restraint, undertook a nation-wide educational
program to bring about restriction by voluntary
means. Finally, there was a widespread belief
that the supply of goods in many fields was gradually catching up with deferred demands and that
favorable crop developments would combine to
lessen inflationary pressures by the spring of this
Monetary developments since November have

accorded generally with expectations held at that
time. Fiscal and monetary operations together effectively offset factors increasing bank reserves during
the period, such as the inflow of gold, return of
currency from circulation and purchase by the
Federal Reserve of Government securities from
nonbank investor^. During the four-month period,
December through March, the Federal Reserve purchased 8.6 billion dollars of Government securities,
largely bonds, and sold in the market 6.3 billion
of securities, chiefly bills and certificates. The Government retired 3.9 billion dollars of its securities
held by the Reserve System. The net result of these
operations was to reduce Federal Reserve holdings
by 1.6 billion dollars and thus to keep the bank
reserve positions under pressure during this period.
The combined effect on the money supply of
Treasury and Federal Reserve operations, which
were.only made possible by the large budgetary
surplus, was strongly anti-inflationary. The money
supply was contracted by nearly 4 billion dollars.
Commercial bank loan expansion was sharply curtailed, partly reflecting fiscal and monetary developments, partly reflecting the effectiveness of warnings
by banking supervisors and the success of the
bankers' own program of voluntary restraint, and
partly reflecting the usual seasonal slack in business
loan demand during the first quarter.
Concurrently with these developments, the world
crop outlook has become more promising and prices
of farm products and foods have declined. In addition, productive activity generally has held close
to maximum levels. These developments have exerted an anti-inflationary influence.

Notwithstanding these salutary developments, it
cannot be said that inflationary dangers have been
removed. Farm prices, though lowerthan they were,
still continue firm, even though at present levels
they are much higher relatively than prices of most
other commodities. Current and backlog demands
for many goods continue to be very strong. Prices of
industrial products, wages, rents, transportation and
some other services are still advancing. The money
supply, though contracted by an estimated 4 billion
dollars, remains excessive in relation to total product. Public holdings of cash or cash equivalent
available for spending are nearly as large as last
fall—250 billion dollars compared with 254 billions

—and continue to be broadly distributed among
holders. Commercial banks, though obliged to sell
some securities to offset shrinking deposits, still hold
66 billions of Government securities, which are
readily convertible at the banks' discretion into reserves. Upon these reserves a six-to-one expansion
of bank credit and deposits can be built. To the
extent that the monetary gold stock is increased and
Government securities are sold to the Federal
Reserve by nonbank investors, still more reserves
would be created. These additional reserves could
also support an inflationary six-to-one expansion
of bank credit.
On the basis of the monetary situation alone,
there would still be a dangerous inflationary potential, even if no further impetus were given
to inflationary pressures by other forces. However,
upward pressures are now in prospect as a result
of several important new factors. One of these is
the tax reduction bill. This bill will add about
5 billion dollars to the purchasing power of the
public and take away a like amount from Federal
revenues in the next fiscal year. The international
financial obligations which we have now accepted
are another factor likely to add many billions to
Government expenditures in the future. The expanding program of military preparedness will
further increase the budget burden for next year
and future years by still more billions. Stemming
from these developments, on top of existing inflationary conditions, is a rapidly changing public
psychology with respect to the inflationary outlook.
Businesses and consumers will be more.disposed
to use existing liquid resources and to expand their
borrowings to finance current expenditures. The
prospect is that the demand for new financing,
aside from Government requirements, will exceed
the supply of available savings. This would mean
that many in need of financing will turn to the
banks for credit. A growth in the total volume of
bank credit and money, under such a situation,
can only add to inflationary pressures. Moreover,
these pressures would be aggravated if the demands
of the defense and foreign aid programs for goods
which are already in short supply further reduce
the quantities available to the public.
The Government's fiscal operations for the balance of the calendar year 1948 are likely to show a
budgetary deficit which would eliminate the only
remaining important anti-inflationary influence*

During the last three quarters of the year, it is
estimated that.the budgetary deficit may exceed
3 billion dollars. (In view of large tax receipts in
the first quarter of 1949, however, there may be
a small budgetary surplus for the twelve-month
period beginning with April 1 of this year.) It is
also estimated, that continued sales of savings bonds
and other public debt receipts will approximately
cover voluntary redemptions of public debt by
holders of maturing issues. The current deficit will
need to be financed by drawing on Treasury deposits which have been built up by tax receipts
during recent weeks, or by borrowing in the market.
Under these circumstances, there can be no net
retirement of Government securities held by the
Federal Reserve System. To the extent that the
Treasury may need to borrow new money, it probably will have to be obtained largely from the
banking system.
During the next few months Treasury use of
accumulated balances with Federal Reserve Banks
will add to bank reserves, which will also continue
to be augmented by the inflow of gold and possibly
by further Federal Reserve purchases of Government securities from holders wanting funds for
other uses. These last two factors may operate for
a long time in the future. If the international outlook does not improve, Government deficits may
continue and even increase substantially, and banks
may be called upon to purchase additional Gdvernment securities. Under these conditions, the Federal
Reserve would find it difficult, and perhaps impossible, to sell Government securities in order to absorb bank reserves without seriously upsetting the
market for such securities.
Prospects are, therefore, that in the future gold
inflow and Federal Reserve purchases of securities
in maintaining an orderly market for long-term
Treasury bonds will further increase bank reserves,
panks would thus be in a position to expand loans
and investments for private purposes and this would
mean still more inflationary expansion of the money
supply. To restrain such potential expansion, the.
Fdderal Reserve would have to take action' to absorb any excessive volume of reserves. Two types
of measures should be adopted: ( 1 ) Interest rates
on short-term Treasury securities and discount rates
should be permitted to rise to the extent possible
without raising rates on long-term bonds; and
( 2 ) To the extent that this action is not adequately

restrictive, the Federal Reserve should have the
power to increase reserve requirements substantially to cover at least any growth in the total supply
of reserves.
The first of these measures, which could be
adopted by the Federal Reserve and the Treasury
without any new legislation, would be designed
to induce banks to purchase short-term Government
securities and to discourage extension of credit to
private borrowers. Policies > during the past year
have moved in that direction about as fast as is
feasible without unduly upsetting the market.
There are limits, however, to such a course. Shortterm rates probably cannot be raised much more
without unsettling the 2 54 per cent rate for longterm Treasury bonds. Moreover, it is doubtful how
much any rate that is feasible will deter banks from
making loans to private borrowers or purchasing
higher rate securities.

properly be limited to 25 per cent of aggregate
demand deposits and 10 per cent of time deposits.
To be effective and equitable, it should apply to
all commercial banks. A detailed description and
analysis of the Board's .special or optional reserve
proposal was submitted to the House Committee
on Banking and Currency and has been published
in the Federal Reserve B U L L E T I N .
To the extent that it may become necessary to
rely upon the banks for any new Government financing operations, the optional reserve requirement
would be an especially valuable instrument. And
in the case of large-scale deficit financing, it would
be essential. In such financing, it would be advisable to make available to banks only short-term
securities. Application of the optional reserve requirement would have the effect of immobilizing
these securities so that they could not be used to
obtain reserves to pyramid new bank assets upon
them on a six-to-one ratio. In other words, securities
issued in new Treasury financing through baftks
/ Accordingly, the Board believes that the System would be tied to the deposits created by their pur/should be given authority to increase the reserve chase. A ready market for short-term Governments
requirements of all commercial banks. For the pres- would be assured and the Treasury would be helped
ent this authority should make it possible for the in successfully carrying out both its refunding operSystem to require all commercial banks to maintain ations and its deficit financing. At the same time,
primary reserves with the Reserve System amount- the Federal Reserve would be enabled to exercise
ing to 10 per cent of aggregate demand deposits and some restraint upon the money market for private
4 per cent of time deposits in addition to present credit.
The dominance of public debt in the present
requirements. This would give to the Reserve System power to increase bank reserves in the aggre- credit situation has rendered the System's tradigate by a maximum of about 12 billion dollars. tional powers generally unusajble for purposes of
An authority of this amount would enable the restraining further inflationary credit expansion.
System to absorb the reserves that ar? likely to The Reserve Board is not now seeking additional
arise from gold acquisitions or from necessary power beyond what it formerly possessed; it is
System purchases of Government securities sold merely pointing out that the System has little or
no authority to deal with the credit situation as it
by nonbank investors over the next few years.
In case banks should persistently follow the prac- currently exists and seems likely to develop. If the
tice of selling Government securities to the Federal Congress wants! the Federal Reserve System to perReserve in order to expand private credits, not- form the 'functions for which it was established,
withstanding higher short-term interest rates and the System must have a substitute or at least a
increased primary reserve requirements, then the partial substitute for those powers that have beSystem should be granted supplementary authority come unusable. The Board feels that it would be
to impose a special reserve requirement along the remiss if it failed to bring this matter to the attenlines proposed by the Board last November. This tion of Congress.
There is no simple way of holding in check bank
type of authority may be described as an optional
reserve requirement because it could be held, at the credit expansion in excess of essential public and
option of the individual bank, in specified cash private need. The problem should be met in a combination of ways—by general credit controls and
assets or in short-term Government securities.
The maximum requirement under this plan could in particular areas by selective controls, such, for

example, as reimposition of consumer instalment
credit regulation, and the continuation of existing
margin requirements on stock market credit.

thus prevent the serious inflationary effects brought
about by strikes.



The Congress is currently considering continuance of easy mortgage credit for housing. Easy
mortgage credit is one of the most inflationary
factors in the domestic credit picture. At the very
most Government mortgage credit programs at this
time should be limited to relatively low cost housing,
particularly for rental housing, and should be accompanied by some restriction on other less essential types of housing. The housing shortage cannot be overcome by increasing the competitive
pressures on scarce supplies of materials and manpower. They are the limiting factors on the volume
of cohstruction. I t is one thing to provide easy
credit facilities to encourage special types of residential construction activity under a system of allocations and permits. It is quite another thing to
provide such encouragement in a free market already characterized by heavy accumulated demands
and by strategic shortages in supply that are likely
to be intensified by the defense and world aid
In restraining inflationary pressures under present and prospective conditions, monetary and credit
policies must be combined with fiscal and other
governmental policies. The public should be given
every possible assurance that the Government will
protect the purchasing power of the dollar so that
the public would be more willing to defer the
satisfaction of wants, particularly for houses and
durable goods.
Wherever possible, Government expenditures that
will add to pressures on the labor and capital goods
markets should be deferred, and State and local
governments should be requested likewise to defer
nonessential expenditures of this type. There should
be early action to close loopholes in our tax laws
and to strengthen the tax collection machinery.
If the stage is reached at which Government expenditures again threaten to create large budgetary
deficits, then a reimposition of wartime levels of
taxation and direct economic controls along the
lines proposed by Mr. Baruch, for example, should
be undertaken. If young men are to be drafted into
the military forces, then a way should be found
to keep men at work in essential industries, and



The Board believes that any realistic appraisal
of the economic outlook from the standpoint of
monetary and credit policy must take account of
the underlying facts of the international situation.
During the war there was no doubt about the ultimate victory. The country looked forward confidently to an era of stability and peace following
the hostilities. Nearly three years after the end of
fighting, however, we seem to be farther away from
these goals than ever. Our national debt still exceeds 250 billions, or more than five times the prewar total. Federal budgets have never fallen under
37 billions a year and we are confronted now with
ti«s prospect of an expanding debt and budgets.
During the war we expected the peace to bring an
end to these enormous drains on our resources.
Today, there is no end point in sight. Threatening as the inflationary potential was at the end of
the war, it is worse today. When we embarked
upon the defense program in 1940 we had a tremendous slack in the labor force, with nearly
12 millions fewer employed then than now. We had
surpluses of most raw materials, of unused industrial capacity, of housing, of foodstuffs, and of
countless other things. The impact of our heavy
armament expenditures was not inflationary so long
as the total demand on our resources did not exceed
capacity* It rapidly became inflationary as civilian
purchasing power created by the expenditures began
to exceed the available supplies of goods and
We held the excess purchasing power fairly well
in check while the war was on. We have now seen
the consequences of premature removal of the
harness of wartime controls. Even the one remaining anti-inflationary force, that is, a large budgetary surplus used to reduce our money supply* is no
longer in prospect.


On the basis of present trends, we believe that
the country, sooner or later, has to choose between
three broad alternatives.
First, we can continue on the present course of
providing essential foreign aid and of carrying ojit
a military program on a scale of9 as yet, undeter5

mined size and cost, while at the same time we
have no effective checks on the free play of economic forces. This is the certain road, if followed
long enough, to a ruinous inflation. Surely no one
would seriously contend that we can go on adding
more and more pressure in the boiler of inflation
without an ultimate explosion. Those who view us
with a hostile eye no doubt hope that we will
wreck our economy on the shoals of inflation. It
would be a cheap way to defeat us.
Secondly, the country could be subjected to a
full harness of direct economic controls—for example, allocations, construction permits, rationing,
price and wage controls, as well as taxation at
higher levels. Without such a harness, amounting
to a regimentation of the economy in peacetime,
there is no sure protection against inflationary dangers that may lie ahead. They cannot be successfully combated by any single means or on any
single front. There is no power that the Board now
possesses or that the Congress could give us in the
monetary and credit field that would be adequately
effective by itself.
Beyond that, we must ask ourselves whether the
public would be willing in peacetime to submit to
the sacrifices and rigid restraints of a wartime
economy. If our preparedness program calls for a
military draft upon our young men, should it not
call also for control of the profits arising from that
We may well ask for how many years must we
maintain enormous and probably expanding military expenditures. The question is, how long, to
what end, and at. what consequences to our economy? We do not have the inexhaustible supplies of
manpower and resources to support indefinitely,
with no end point in sight, programs of the magnitude which we now are shouldering or contemplate
ing. We cannot go on year after year bearing these
crushing costs without jeopardizing what we seek
to save. If we were confident of the early establishment of peace, we could tolerate a tightly controlled
economy. We believe that the time element is the
very essence of this grave problem.
Our nation sought neither territory nor reparations in either World War. We seek neither now.
We ask only for the earliest possible establishment
of the foundations for enduring peace. To that
end, our third and best course may be to choose
a combination of alternatives; that is to say, sic6

ceptance of such controls as may become necessary
to prevent inflation at home while abroad we lay
at the earliest possible moment the foundations for
peace. Surely an informed public would be ready
to accept even burdensome controls and taxation if
convinced they are essential to safeguard our economy against a ruinous inflation, and that there is
an early end point in sight which will enable us
to maintain our system and our institutions in a
peaceful world.
To sum up the situation as the Board sees it, we
are faced with the possibility that still further upward pressures will be added to the tremendous
inflationary potential generated by war financing
and intensified by subsequent developments. We
should do everything possible within the existing
authority of the Government to moderate and
counteract these forces. Federal, State and: local
governments should practice the»strictest econom)
and defer all public works and similar expenditure
that can be postponed until there is a surplus o ;
manpower and materials instead of the shortage
that now exist. Every effort should be made noi
only to preach but to practice economy and savings
at this time. The need still is urgent' to spend less
and save more—to invest in Government Savings
Bonds. Every assurance should be given that the
purchasing power of these savings will be protected,
So far as the monetary and credit field is concerned, we have tried to make clear that action]
on these fronts alone cannot guarantee stability.
Nevertheless, we believe that the Reserve System
should be armed with requisite powers, first to
increase basic reserve requirements of all commercial banks and, later on, if the situation requires
it, to provide that all such banks hold an additional
special reserve. Both of these would be protective
measures. The first could be used to offset gold
acquisitions and purchases of Government securities by the Federal Reserve, and thereby restrict
continued expansion of our already excessive money
supply. The second would be essential in case banks
embark upon an inflationary credit expansion
through the sale of Government securities to the
Federal Reserve or to assist the Government in
case of large-scale deficit financing.
We believe it is the part of prudence to recognize
clearly that the underlying cause of the continuing
inflationary dangers arises from the disappointment
of our great hopes for the early establishment of

world peacc. Surely we must summon all our human and material resources needed to assure that
peace. If necessary to protect our economy at home
so that we shall not lose by inflation what we seek
most of all to save, we should be willing and prepared to reimpose to whatever extent the situation
demands a harness of controls, including higher
levels of taxation. Nobody wants such regimentation
but in the hard choices before us it is infinitely
preferable to economic chaos and possible collapse
of our. system, to which all free men look for deliverance from,the evils of war and misery that
feed on economic distress.

We are aware that the questions of policy designed to achieve the cardinal purpose of assuring
an enduring world peace are outside the domain of
those charged with responsibilities in the monetary
and credit field, but we feel that such responsibilities
have to be exercised in the light of the burdens
which the economy must bear. The earliest attainable settlement of the issues that now stand in the
way of lasting peace offers the best hope for the
preservation of our institutions and our freedoms.
Meanwhile, they must not be jeopardized either by
uncontrolled inflation or long continued regimentation at home.