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Federal

reserve

Ba n k

of

N

ew

York
N E W YO RK 45. NEW YORK

November 5, 1954
Professor Blm vw « ood,
University of Missouri,
Columbia, Missouri.
Dear Professor a oo^:
f
For scktjb tiow I have oeen intending to write! to you
about your paper an 'ftecent Monetary Policies** wtucii came to roe
‘
about two month# ago.
1 a m delighted, of cours*, that you are enough interested
in the recent views and actions > the * ederal Reserve System to study
i
and writ* about them, anti pleased that your general iceas about a
T
*free*‘lxsoa^y market appear to be similar to mine.
^
i £ raise ona or two questions a eout your paper,
f
t
ths re Core, i is withiu the frame at any delight and any pleasure that
t
you wrote i at ail. First, I think your interpretation of the historical
t
record suffers from compression, ana ivom luraping together ail
officials of the federal Reserve Systeal. This thought of mine is
affected, 1 know, by personal considerations, but i believe a reading
of the annual reports of the Federal Reserve Bask of N e w York and
of .»r, Roosa'a and asy papers in the John Williams' assays, would
giv«? you a same what different picture from the one you have sketched.
One specific point 1 would mention here is that I have not blamed the
inflation which occurred after the war on "continued heavy Government
spending" , but 1 have blazn-d i on the swollen money supply created
t
during the war which 1 did not think we could shrink without grave
risk oi deflating the economy at the wrong tlaae. ('IV.on«tary contraction
is such a terribly lethal weapon, i should be us^ct with great maceration* u)
t
another point which you do not mention, is the fact that our support
operations during the postwar 40‘ not only gave the commercial hank©
s
automatic or seuQi*autoinatic access to reserve funds, but also gav^
others such as insurance companies and savings banks the same sort
ot access*, which •did present a aanger outside o i the ordinary operations
of central hanks.




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P ro fesso r Wood

11/5/54

These sad s im ila r s m a lle r points a re not why I am
w ritin g you, ho w ever. I am w ritin g because Z th in k , th at a fte r exposing
the lim ita tio n s and inconsistencies of present m a jo rity thinking in the i /
jt edtsral R es erve, you have proposed an o v e r*s im p lifie d a lte rn a tiv e .
n
I do not believe we can enjoy the lu xu ry ot a fixed fo rm u la o f m onetary
m anagem ent in our com plicated m oney econom y.
It seem s to me to be n e ith e r possible n o r d esirab le
to tr y to reduce a ll o f the co n flictin g considerations w hich have to be
reco nciled in fo rm u latin g m onetary p o licy to the selection of a single
rate c u rv e . I a g re e , of co u rse, th at in te re s t ra te s a re a m ost im p o rtan t
guide to policy and its execution, and th at open m a rk e t operations a re
lik e ly to be the m ost effec tive tool of the F e d e ra l R eserve System ,
m ost of the tim e , in re la tio n to ra te s . But 1 als o think th at th ere a re
guides to po licy other than in te re s t ra te s , and th at the discount ra te
|
and bank borrow ing have th e ir uses as w e ll as open m a rk e t o p eratio n s. |
M ost often the discount ra te and open m a rk e t operations can be used
together; the discount ra te to sym bolize the p o licy adopted, and open
m a rk e t operations to keep m a rk e t ra te s and m em ber bank borrow ing
in ap p ro p riate re la tio n to the discount r a te . A t tim e s of c re d it ease,
this would m ean sensitive m oney m a rk e t ra te s below the discount
ra te and in frequ ent and m in o r borrow ing in response to tem p orary
needs of individual banks. /;t tim es of c re d it re s tra in t, it would m ean
sensitive m oney m a rk e t rates (except F e d e ra l funds) a t o r maybe
above the discount ra te , w ith m em b er banks having to borrow fa irly
freq u en tly and in re la tiv e ly la rg e am ounts so th a t, in the ag gregate,
^
they would be in debt m ore o r l«ss continuously. Th ere a re d iffe re n t
kinds of rese rv e d o lla rs and d ifferen ces in tha response of the banking
system to th ~ ir a v a ila b ility . We should take advantage of these d iffe re n c e s .
S im ila rly , 1 think you go too fa r when, a fte r dem olishing
the iciea oi leaving in te re s t ra te s to "n atu ral fo rc e s " you condemn un­
n e c e s s a rily "fortuitous changes" in rate s - the '’continual m in o r changes
in ra te s w hich serve no purpose w hatever fro m the standpoint of c re d it
re g u la tio n ." H e re , too, 1 see a m iddle ground. Rate changes in the
m a rk e t can serve a useful purpose, as a guide to d is trib u tio n and uses
of funds w ith in each secto r of the m a rk e t as w e ll as between secto rs
of the m a rk e t. It m akes a d iffe re n c e , fo r exam p le, w hether the T re a s u ry
b ill rats is 1/4 o r 1/2 of I p er cent below tins discount ra te , and w hether
d e a le r loan rate s a rc above o r below the T re a s u ry b ill ra te , o r w hether
the F e d e ra l funds rate is above o r below the b ill r a te , and where the tim e
deposit rate is in re la tio n to o ther short te rm ra te s . We need to watch
rates and rate m ovem ents, and the varyin g in te rre la tio n s among d iffe re n t
ra te s , as indications of the p re v a ilin g response to general p o lic y , and as
guides to w hether m ore o r le ts re s e rv e s a re needed to c a rry out the




3

P ro fe s s o r Wood

1 1 /5 /5 4

lateotloiui o f c re d it po licy* but we do not need to tr y to pick out a single
set of ra t*a fo r each phase o f c re d it p o lic y .
F in a lly , 1 think you dism iss "u n certain ty" too re a d ily
as a le g itim a te in flu en ce. You m ay be rig h t in saying th at fo r every
"change in un certainty*’ th e re is a sp ecific change in rats* w hich would
achieve the sam e e ffe c t, but m ust our effects alw ays be achieved in the
sam e way ? Is th ere not room fo r u n certain ty as a substitute fo r actu al
rate change? If th ere is - if u n certain ty a t tim e s re in fo rc e s c u rre n t
p o licy - need we re je c t it? P erhaps 2 am too m uch im bued w ith the idea
of c e n tra l banking as an a r t , but when you re fe r to the need fo r gauging
po licy in te rm s of degrees of p re s s u re , a re you not also w ritin g of an
a r t which cannot alw ays express its e lf in one way and w hich could take
advantage, at tim e s , o i a little uncertainty?
W Ufa ap p reciatio n o f your paper and its stim u lating
presentatio n of yo ur view s concerning recent m onetary p o licy,
Y ours fa ith fu lly ,

A lla n op ro u l,
P re s id e n t.

P .S .




I am looking fo rw a rd to seeing you a t P rin ce to n on
N ovem ber 21 when the C om m ittee on the H is to ry o f the
F e d e ra l R eserve System w ill be m eeting w ith you and
Bopp and C h an d ler.
A« .


Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102