Full text of Mimeograph Letters and Statements of the Board : "The Federal Reserve System" by A. C. Miller, Member of the Federal Reserve Board, Number X-6055, Volume 28, Page 466

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X-6055

The attached a r t i c l e on "The Federal Reserve
System" i s by A. C. Miller, Member of the Federal Reserve
Board.

I t has been prepared for publication i n the

June 30th or Jubilee Number of the London S t a t i s t commemorating the F i f t i e t h Anniversary of the founding of
that paper.
I t i s issued with a release date for American
papers not e a r l i e r than evening papers of June 30th.
Suitable acknowledgment of i t s preparation for the London
S t a t i s t should be made by the American papers using the
article.




xj^osiOV.
THE PEDEEAL RESERVE SYSTEM.

The fundamentals of central-note-issue and reserve-bankirg
are few and simple.

And they are pretty widely recognized.

Some-

times d i g n i f i e d by the name of "Principles" they are in f a c t l i t t l e
more than rules of administrative expediency and working practices
developed out of experience in dealing with conditions.

As the Bank

of England i s the prototype of central and reserve banking, the
practice developed by i t in the course of i t s long h i s t o r y has
naturally supplied the general pattern a f t e r which other central
and reserve banking i n s t i t u t i o n s have been modeled with greater or
less fidelity.

Whatever their differences in structure, function

and technique, they are merely variants of the mother type.

In the

l a s t analysis a l l central and reserve banks are offspring of the Old
Lady of Threadneedle S t r e e t .
I t i s nevertheless true that in a survey of central banking
i n s t i t u t i o n s i t i s the variations from type and the d i f f e r e n c e s among
them that c o n s t i t u t e the chief matter of i n t e r e s t .

The problems that

present themselves to the management of these i n s t i t u t i o n s may be
one in the application of p r i n c i p l e s but unless the p r i n c i p l e s are
tempered in their application by considerations of l a t i t u d e and
longitude, in b r i e f by the exercise of a sound d i s c r e t i o n in dealing with the particular conditions that surround them, the r e s u l t s
do not usually prove s a t i s f a c t o r y .

Central banking i s not - cer-

tainly not yet - an exact science and the wise practice of the art
of central banking c a l l s for larger q u a l i t i e s of mind than the habit



of imitation.

That this i s appreciated i s shown in d i f f e r e n c e s to

be found i n the laws under which these i n s t i t u t i o n s are organized
in d i f f e r e n t countries, and these laws d i f f e r as do the i n s t i t u t i o n s
largely in the nature of the l i m i t a t i o n s , r e s t r i c t i o n s , safeguards
and guarantees of one kind and another to insure the exercise of
judgment in ways that are s a f e and prudent.

There are some that

allqw great l a t i t u d e for the play of d i s c r e t i o n in many d i r e c t i o n s ,
others that allow much in certain directions and l i t t l e i n others,
and others s t i l l that l i m i t i t narrowly in most ways.
The Federal Reserve System i s a conspicuous example of
an i n s t i t u t i o n permitted the exercise of wide d i s c r e t i o n i n the
handling of i t s problems and this accounts in large measure for
the great f l e x i b i l i t y i t displays whether i n the f i e l d of operation or of p o l i c y .
large experience.

Young in years i t has nevertheless had a
I t has already attained something of a d i s t i n c t i v e

quality or p e r s o n a l i t y .

I t s characteristic t r a i t i s expressive of

the genius of American i n s t i t u t i o n s .

That genius, above a l l i n the

sphere of economic relationships i s f l e x i b i l i t y and t h i s f l e x i b i l i t y
has reported i t s e l f i n the Federal Reserve as f l e x i b i l i t y of mind
and operation and has given r i s e to a d i s t i n c t f l e x i b i l i t y of creditcontrol technique.
Closely associated with this outstanding quality of f l e x i b i l i t y i s the weighting of the operation of the System at every turn
with an a c t i v e and broad sense of public i n t e r e s t .

This r e s u l t has

been achieved p a r t l y because of the clear expectation of the law but
a l s o and l a r g e l y because of a self-imposed obligation on the part of
those responsible for i t s operation and administration.



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X-6055

Looking at some of the variations of the Federal reserve
hanks from the mother type in the process of adapting i t s wajs to the
genius of the American people, i t i s noteworthy that alone among the
central note-issuing and reserve-holding i n s t i t u t i o n s of the leading
countries the Federal reserve i s not a central bank.

The Federal

Reserve;-System consists of twelve tanks to each of which i s assigned
a d e f i n i t e area of territory known as a Federal Reserve D i s t r i c t .
Bach of the twelve banks i s autonomous within i t s province and each
i s independent of the others.

This framework represents an adapta-

tion of the structure of reserve banking to the analogies of the
p o l i t i c a l , s o c i a l and economic organization of the United S t a t e s .
That organization, as i s well known to students of America, has much
of a d i s t i n c t l y regional character - more e s p e c i a l l y on the economic,
f i n a n c i a l and s o c i a l s i d e s .
The problem of reserve banking even in a country as large
as the United States with d i f f e r e n t sections of i t in d i f f e r e n t stages
of economic and f i n a n c i a l development, however, requires attention
to more than regional conditions.

Ample provision was, therefore,

made in the Federal Reserve Act for giving e f f e c t to the indispensable viewpoint of the national economic i n t e r e s t and i t s paramountcy at times in deciding the course of p o l i c y and operations of the
Federal reserve banks.
In order to give adequate expression to the national viewpoint and to provide a means of coordinating at times the a c t i v i t i e s
of the Federal reserve banks toward the attainment of objectives of
national i n t e r e s t an agency, governmental in character and designated The Federal



Reserve Board, was set up.

Through t h i s means i t

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X-6055

L ^7(
was sought not only to weight the administration of the Reserve System
with a sense of national i n t e r e s t but also to give to the a t t i t u d e of
the Federal Reserve System and i t s larger determinations the aspect
and quality of public p o l i c y .
I t may he claimed for the i n s t i t u t i o n of the Federal Reserve
Board that i t constitutes a d i s t i n c t i v e element in reserve banking.
Certainly no understanding and appraisement of the Federal Reserve
System can be undertaken without an appreciation of the position*
r e s p o n s i b i l i t i e s # powers, Amotions and viewpoint of the Board.
Standing at the apex of the System i t i s clothed with general power
$

of supervision of the Federal reserve banks.

Their actions are subject

to i t s review and revision; i t has the f i n a l say in the determination
a
of discount rates; i t has a voice in their open market operations and
in matters a f f e c t i n g their international relations - to mention only
some of the more important matters a f f e c t i n g the current operation
of these banks.

The Board a l s o has ultimate authority in the matter

of federal reserve note i s s u e s ; i t has the power within l i m i t s to
change the reserve requirements of i t s member banks; i t has authority
to suspend on occasion the l e g i s l a t i v e l y - p r e s c r i b e d minimum reserve
requirements both of the Federal reserve banks and of the member banks
of the Federal Reserve System.

I t i s , in b r i e f , without carrying the

s p e c i f i c a t i o n s further, the repository of broad and varied d i s c r e t i o n ary authority such as the framers of the Federal Reserve System believed
to be e s s e n t i a l to the e f f e c t i v e practice of reserve banking in the United
States,
I t i s t h i s vast grant of authority, exercised under the control
of a governmentally constituted Board representative



of the public

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X-6055

,
L %
i n t e r e s t and r e s p o n s i b l e to the nation* t h a t makes the F e d e r a l r e s e r v e
banks unique among the g r e a t "banks of the world f o r f l e x i b i l i t y of
operation.
The F e d e r a l Reserve Board i s , however, more than an agency
of s u p e r v i s i o n and a d m i n i s t r a t i o n .

I t i s a symbol - a symbol of the

broad p u b l i c i n t e r e s t and r e s p o n s i b i l i t y w i t h which the r e s e r v e banks
from the American p o i n t of view a r e i n v e s t e d .

The dependence of

economic w e l l - b e i n g upon the manner i n which i n s t i t u t i o n s of the cent r a l banking type a r e o p e r a t e d i s p ro b ab l y nowhere more k e e n l y a p p r e c i a t e d than i n t h e U n i t e d S t a t e s ; nowhere i s more demanded or e x p e c t e d .
The i n s t i t u t i o n of the F e d e r a l Reserve Board may, t h e r e f o r e , be regarded
as the method by which the American l e g i s l a t o r a t the time t h e F e d e r a l
Reserve Act was drawn u n d e r t o o k to surround the o p e r a t i o n of the F e d e r a l
r e s e r v e banks w i t h a c o n s t a n t atmosphere of broad p u b l i c i n t e r e s t and
t o g i v e to the a d m i n i s t r a t i o n of c r e d i t under the a u s p i c e s of t h e s e
¥

banks a wider o u t l o o k and a t r u e r sense of d i r e c t i o n than might have
been expected i f t h e i r management had been more d i s t i n c t l y and exc l u s i v e l y of a " b u s i n e s s " t y p e .

I t i s doubtless for t h i s reason that

the a l l e g a t i o n of s e l f i s h n e s s has seldom been made a g a i n s t , F e d e r a l
r e s e r v e banks; and, c o n s i d e r i n g how s e n s i t i v e the American temperament
i s i n m a t t e r s touching currency and b a n k i n g , i t i s a l s o no doubt
because of t h e e x i s t e n c e of such an i n s t i t u t i o n as the F e d e r a l Reserve
Board t h a t h o s t i l e c r i t i c i s m of the System has had so l i t t l e e f f e c t .
In consonance with the p o s i t i o n of p u b l i c r e s p o n s i b i l i t y
thus emphasized by t h e c r e a t i o n of the F e d e r a l Reserve Board the System
has from the beginning of i t s o r g a n i z a t i o n p u r s u e d to an u n u s u a l degree




-5-

X-S055
.

-

•*'

a p o l i c y of p u b l i c i t y with regard to i t s a f f a i r s .

The Board i n i t s

Animal Report and even more currently through i t s

monthly p u b l i c a t i o n ,

the Federal Reserve B u l l e t i n , and the "banks t h r o u g h t h e i r current
Monthly Letters have undertaken to give to the public not only a
comprehensive view of current tanking and f i n a n c i a l developments
"but a l s o d e t a i l e d data i n s c i e n t i f i c a l l y organized form of important
movements i n the f i e l d s of production, trade, a g r i c u l t u r e , employment,
p r i c e s , together with other relevant f a c t o r s hearing upon the i n t e r p r e t a t i o n of the regional and national problems of c r e d i t c o n d i t i o n s and
needs.

Through a Division of Research and S t a t i s t i c s the Board has

done pioneer work in the organization and development of f a c t - f i n d i n g
surveys and economic a n a l y s i s of a highly s c i e n t i f i c and i n t e r p r e t i v e
character.

Taken i n the aggregate t h i s work supplies the has i s of the

economic r a t i o n a l e of Federal Reserve p o l i c y and i s l a r g e l y to be
credited with whatever merit may be a t t r i b u t e d to i t *
In thus preparing and educating i t s e l f f o r the work of
credit administration the Federal Reserve has a l s o done much to
educate the p u b l i c .

Indeed, i t s a c t i v i t i e s i n the f i e l d of economic

research have given impulse to similar undertakings by p r i v a t e
agencies and by organized research in some of the leading u n i v e r s i t i e s
of the United S t a t e s .

Supplemented by the p r o d i g i o u s l y expanding

work of the United States Department of Commerce i n t h i s same general
f i e l d , tine American business and banking p u b l i c today i s probably the
most f u l l y informed of any i n the world regarding the changing condition
of the national economy and i t s various elements.

I t would be hard in

any estimate of the good working of the Federal Reserve System i n recent
years to exaggerate the contribution made by the business p u b l i c through



.

X-6055

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i t s cooperation "based upon knowledge and i n t e l l i g e n c e with regard TO

the functioning of the System and. the underlying c o n d i t i o n s a f f e c t i n g
i t s good operation.
Because of a l l this the p o l i c i e s of the System, p a r t i c u l a r l y
in the domain of credit p o l i c y , have been more consciously p u b l i c i n
character, more widely conceived from the point of view of national
economic i n t e r e s t and, on occasion at l e a s t , more nearly r a i s e d to
the l e v e l of economic statesmanship.

They have a l s o been more

confident i n character and go f a r to explain the f l e x i b i l i t y which
the c r e d i t - c o n t r o l technique of the System d i s c l o s e s .

I t seems

doubtful for instance whether the economic p o t e n t i a l i t i e s of open
market p o l i c y would have been as quickly discovered and a technique
developed for making i t an e f f e c t i v e instrument and a leading r e l i a n c e
i n credit administration without the f u l l n e s s of information and
understanding r e q u i s i t e in the application of a type of p o l i c y requiring
such p o s i t i v e n e s s and d e f i n i t e n e s s of a t t i t u d e as does the open market
operation on a broad s c a l e .

For open market operation i s an i n s t r u -

ment of i n i t i a t i v e in c r e d i t administration and can not be undertaken
i n an atmosphere of doubt or h e s i t a t i o n . To be competent i t must be
based upon conviction as to i t s economic j u s t i f i c a t i o n and i t s acceptance
by at l e a s t the i n t e l l i g e n t p u b l i c .
In the post-war h i s t o r y of the Federal Reserve technique
no s i n g l e item i s of greater i n t e r e s t than the development of i t s open
market procedure.

Such prominence as the open market operation has i n

recent years a t t a i n e d was probably not a n t i c i p a t e d at the time the
Federal Reserve System was organized.




The Federal reserve banks were

then conceived of as banks of discount to which member banks would
turn as they needed additional supplies of currency or reserve
credit - in b r i e f , as i n s t i t u t i o n s i n which the i n i t i a t i v e in
creating new credit would r e s t with the borrowing member -bank, the
Federal reserve bank playing i t s part in the process mainly through
the establishment of discount rates designed

either to encourage

or to discourage the use of i t s f a c i l i t i e s as the s i t u a t i o n might
seem to require.
Following the disastrous revulsion of 1920 and the depression of 1921 rediscounting with Federal reserve banks f e l l
into some d i s f a v o r .

The public at l e a s t in certain sections of

the country showed some misgiving with regard to member banks
heavily or continuously in debt to their Reserve banks.

In con-

sequence member banks showed reluctance to borrow except under
the pressure and J u s t i f i c a t i o n of seasonal or other transitory
requirements.

In these circumstances i t appeared advisable to

the Federal Reserve in order that the recovery of trade might be
f a c i l i t a t e d and l a t e r in order continuously to maintain a favorable
economic s i t u a t i o n to take the i n i t i a t i v e at times, i n supplying the
country with an enlarged basis of credit.
an open market p o l i c y .

Thus was begun in 1922

I t was organized and further developed in

1923 as a System matter and in the l a s t f i v e years has been perhaps
the most d e c i s i v e factor in the credit-control technique of the Federal
Reserve System,
By p.n open market operation i s , of course, meant the purchase
or sale by Federal reserve banks of s e c u r i t i e s in the open money market



L ^

-9of the country.

X-6055

The purchase of s e c u r i t i e s has the e f f e c t of enlarging

the credit base; the sale of s e c u r i t i e s of contracting i t .

The e f f e c t

so far as the public i s aware i s very similar to that of an inflow
or outflow of gold.

Indeed, as open market p o l i c y has been operated

in the United S t a t e s , for example in the autumn of 1927 when an outflow
of gold was in process the Federal Reserve has sometires intervened to
prevent the firming e f f e c t s on money rates that might normally be expected from such outflow by making o f f s e t t i n g purchases of s e c u r i t i e s ,
thus releasing money to the market.

Similarly in the reverse case on

one or two occasions s a l e s of s e c u r i t i e s have been made to o f f s e t the
e f f e c t s of gold i n f l u x where easing of money conditions to be expected
from such i n f l u x did not seem at the moment to be desirable.
In reviewing the course of money rates in the United States
in recent years, at any rate so far as influenced by Federal Reserve
p p l i c y , the foremost influence must be assigned to open market operations .

While the discount rates of the Federal' reserve banks have

undergone change from time to time, such changes more frequently than
not have been made either in recognition of a credit s i t u a t i o n brought
about by antecedent open market operations or to accompany and reenforce
a change of a t t i t u d e assumed by the Federal Reserve through i t s open
market p o l i c y tfoward the trend of business and credit conditions and needs.
,

As revealing.the f l e x i b i l i t y of the Federal Reserve the history

pf i t s open market p o l i c y in the l a s t f i v e years constitutes the mostf"
interesting chapter of i t s post-war development.

The manner in which

this instrument has been used, the general procedure with reference to
credit administration of which i t constitutes the heart, and the degree
of reliance placed in i t make of i t i f not exactly a new expedient in



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X-6055

the technique of reserve banking at l e a s t one of new and enlarged

:
L.

4'

p o t e n t i a l i t i e s in situations c a l l i n g for an authoritative a t t i t u d e
and active i n i t i a t i v e toward the money market, such as have obtained
more or l e s s constantly during the past f i v e years*

The acute

transitions and readjustments incident to the economic movement during
this period called for a credit-control device l e s s l e i s u r e l y in
character and l e s s openly deliberate than that of the discount rate
and gave impetus to the extraordinary development which the open
market operation attained.
Whether open market p o l i c y w i l l continue to hold i t s present
place of importance in the credit procedure of the Federal Reserve
seems doubtful.

There have been some indications that i t was l o s i n g

i t s hold on the esteem of a considerable s e c t i o n of the business and
banking p u b l i c .

I t s quality of arbitrariness has exposed i t to the

c r i t i c i s m of being un-American.

I t seems not improbable, therefore,

that with the return of the United States to a more s e t t l e d economic
basis and with the world in general well advanced to complete
recovery and the gold standard as an international s t a b i l i z i n g
mechanism p r e t t y nearly restored to i t s old-time e f f i c a c y , the primary
reliance in the credit-control technique of the Federal Reserve in the
future w i l l be the discount rate fcather than the open market operation.
Not that the open market operation w i l l be discarded but that i t w i l l
|ease to be an habitual expedient and take i t s place as an occasional
expedient in the credit mechanism of the Federal Reserve - an expedient
to be resorted to in s i t u a t i o n s of acuteness where prompt intervention




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X--6C55
i
'-itf 6,

i s necessary to e f f e c t i v e handling.

l i t h the probability that such

situations w i l l be of l e s s frequent recurrence in the future than in
the recent past however the more orderly and l e s s d r a s t i c form of
credit regulation provided by the discount rate promises to play
the role of leading importance in Federal Reserve p r a c t i c e .
An added and more immediate impulse to this s h i f t i n g of
emphasis in Federal Reserve procedure i s l i k e l y to r e s u l t from the
serious impairment of p r e s t i g e wh^ch thy open market p o l i c y of the
Federal Reserve has recently sustained, because of untoward developments in connection with i t s adventure in the autumn of l a s t year
in undertaking to ease and s t a b i l i z e the international s i t u a t i o n .
The American stock market on that occasion took advantage of the
Federal Reserve's p o l i c y of cheap and easy money.

The volume of

credit involved in speculative loans grew rapidly and i n the early
part of the year 1328 attained such magnitude as to awaken widespread
concern in the United States and to place the Federal Reserve inaa
p o s i t i o n of uncomfortable r e s p o n s i b i l i t y .

The lesson of t h i s

experience w i l l not soon be forgotten and i s l i k e l y to r e g i s t e r i t s e l f
in the f l e x i b l e mind of the Federal Reserve as a change of f r o n t . For
the circumstances which have occasioned the p a r t i a l miscarriage of
Federal Reserve p o l i c y i n the coarse of the l a s t ten months are of the
kind that are l i k e l y to repeat themselves.

The exuberant temper of

the American speculative community can u s u a l l y be counted on to respond
to a s u f f i c i e n t stimulus in the way of cheap and easy money.

This

recent experience suggests the hazard to which a p o l i c y of cheap and
easy money i s always exposed i n the United S t a t e s .



Unless and u n t i l

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X-6055
I

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therefore some e f f e c t i v e method can t o devised for preventing the
diversion of the flow of Federal Reserve credit into speculative
loans, open market p o l i c y w i l l be handicapped and at a disadvantage.
But whatever the outcome of the differences developing between the adherents of discount p o l i c y and those of open market p o l i c y
may "be, the future i s not l i k e l y to see any change of general outlook
on the part of the Federal Reserve or i t s major r e s p o n s i b i l i t i e s toward
the economic and credit s i t u a t i o n s .

Nor any weakening of i t s f a i t h

in the i n d i s p e n s a b i l i t y of the economic approach to i t s problems.

The

credit system i s envisaged by the Federal Reserve as a v i t a l influence
i n the economic process.

The f u l l c a p a b i l i t i e s of a wise dispensation

of credit, however, have not yet been f u l l y realized in the United States
even though conditions here have been so unprecedentedly favorable
to their e x p l o i t a t i o n .

That credit i s an energizing influence and an

integrating force of vast p o t e n t i a l i t i e s in ..the Modern economic system
i s coming to be more and more deeply appreciated on this side of the
Atlantic.

But the f u l l measure of i t s economic potency has not yet

been taken even in the United States.

I t remains for the future to

v i s i o n credit as the elan v i t a l of the modern body p o l i t i c and economic.