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~~Ct)!W'rbENT JAL

MAR 1 1 1958

Federal Reserve Bank of St. Louis


Divisi on cf Res0arch and Sto.tistics

Oc bbe r 9 , 1939


E . A . Gc Llonweiser


E. A. Goldenweiser

It was our intention last spring , in response to the re•
quest of the Federal Advisory Council , to make a thoroughgoing
study of the so-called easy money policy;
extent it has been a policy;

to appraise to what

what its immediate and prospective

consequences may be, and whs.t the System coul°d do about it, if

Owing to heavy pressure of other work and also to the

fact that the whole situation has radically changed with the outbreak of the war, no complete study has been made.

The following

considerations and reflections are of a more general character
and are an expression of my own opinions , rather than the result
of special investigation and study of the problem by the staff.
What has caused easy money?
Extremely low interest rates on short-term money have
now prevailed for some time and longer-time money has also been
at a relatively low level.

That the low level of rates on long-

time investments has raised many problems for endowment funds,
insurance companies, and other institutions, which depend in large
part on fixed returns on long-time investments , is recognized .
It is a part of the general change and realignment of economic
forces during the past decades to which our economy must work
out an adjustment.

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It is assumed by the Council, and ther o is good authority
for the statement, that the Federal Reserve System ho.s pursued an
easy money policy since 1929 •

Tho Council, apparently, also assumes

thut the present low level of interest rates is at loast in po.rt
the direct cons equenco of this policy.
It is true that after the stock market collapse in 1929
the Federal Reserve System took several steps in the direction of
easing credit conditions .

It reduced discount rates and made sub-

stanti~l purchases of Government securities in the open market.
This policy of co.sing was interrupted , however , in September 1931 ,
when England went off the gold standard and tho country was
rapidly losing gold.

Rntes were increased at that time , accept -

ances in the System portfolio

which at first increased were

allowed to r,m off , and there was an increase in member bank
indebtedness .

After this interruption the Federal Reserve System

resumed its policy of casing conditions .

Discount rates and bill

rates were r educed and additional purchases were made in the open
mnrkot .

Open- market operations became particularly activ e o.fter

February 1932 , when the Glass - Steagall Act enabl ed the Federal
Reserv0 banks to use Government securities as collateral for
Federal Re se rv e notes.
Purcho.ses of Government securities by tho :B"'cderal Reserve banks between 1929 and the early part of 1933 unquestionably holped to eo.se the credit situo.tion.

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They did not , however,


create a substantial amount of excess reserves , but were absorbed
in meeting domestic demands for currency by hoarders and foreign
demands for gold.

This was during a. period of disastrous de -

flation when money was extromely hard to get even though rates
were relatively low .

It was not until 1933 ., a.fter be.nks ho.d paid

off their indebtedness and the demand for currency had subsided,
that excess reserves began to increase rapidly .

This was after

the Federal Reserve System discontinued purchases in the open
market .

By the autumn of 1933 member banks had excess reserves

of about $800 1 000 , 000.

From that time on thoro were no f~rther

purcho.s0s of Government socuri ties in considerable amounts u·n til
the last few weeks when purchases were mnde in connection with
stabilization of the Government security IDD.rket.
The fact that durj.ng tho period from 1933 to the present
time there was a tremendous increase in member bunk excess reserves nnd in their de~osits was no~ duo to an active policy~
. the Federal Reserve Sys tern. . but to the enormous inflow of gold
and, to a lesser extent , to the silver policy of the Governmont .
This is illustrated by the chart .

Federal Reserve policy during

that period was not actively directed towards monetary ease .


the contrary, tho only important policy actions taken by the
System during this period were in the direction of providing
safeguards aEainst possible future inflation through increasing
reserve rBquiremcnts .

A slight departure from this general

policy occurred in the spring of 1938 when the country wns

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going through a period of dis~strous contraction of activity and
tho Systom, as n part of a genorul plan of encouraging business
revival, reduced reserve requirements by one-eighth.
In tho not, Federal Reserve System policy action since
1933 has resulted in absorbing about $2,000 1 000,000 of excess
reserves, and thus reducing the potenti~l oxpQnsion of credit
of between $15,000,000,000 and $20 1 000,000,000 for the banking
system as a whole.

Easy money policy not an accurQte term
It is apparent, therefore, tha. t


ea.sy money pol icy" as

applied to the course pursued by the Federal Reserve System in
the past six years is not an accurate term.

The extremely low

level of short-time interest rates which has developed is due
to tho unprecedented inflow of gold caused by o.n excess of ex·ports over imports and by a c~pital flight from Europe.


System's policy in the matter has boon largely passive, and
such po 1 icy action o. s the System has taken ho.s b cen with



to providing snfeguards for tho future.
Why has the Syctem not reduced its portfolio?
The question may be raised why the System has not disposed of some of its holdings of Government securities,

It is

quite apparent tho.t sales from the System's portfolio would have
only to.ken up a rGlatively small portion of the of'fects of the
gold inflow and would have depriv~d the Syst:m both of ammunition

Federal Reserve Bank of St. Louis



for cont ending with an inflationary situ~tion in tho future and
of its source 8f earnings out of which t o m0et expenses.


to meet expenses is important for tho Federal Reserve System in
order to be able to maintain its independence, but even more important has boon the nocessity of mn.intn.ining a portfolio which
would make the System an important factor in the mon0y market
when the need should nrise.

Tho possible effects of sales from

the System's portfolio on th0 price of Government bonds is referred to later.
Moro fundamonto.l causes of low money rates
There are other more lusting factors than the inflow of
gold that have worked in the directi on of low monoy rates.


fact that the United States is now a creditor country and that
it not only docs not have to mnke net payments of interest and
principal nbroad, o.s it did befo re 1914, but on the contrary
c on stantly rec e ive s payments fr om abroad, has worked towards a
lower level of interest rat os .

Another factor ho.s been the re-

lative inactivity of busin0ss and the srru.111 effective demn.nd for

With savings accumulating at a rapid rate there has been

a dearth of outlets for these ~o.vings, ~nd this also hQs depressod
interest re.tes.
It ma.y very well be that this country has ent0r0d an ero.
of much lower returns on capitnl over o. long period thn.n were
e.vo.ilablc while the country was still in n pioneering or dovelopmont~ l stage.

Federal Reserve Bank of St. Louis

Lower rates of inter e st arc usual inn more mature


economy, and the fact that the process of mo.turing ho.s been rapid
in this country is attributable t o tho war, the world dopres~i on,
and disturbed political conditions throughout the world .


developments have accelerated the coming of age of the American

it has been obliged to pass in a short period fr om

financial dependence on foreign countries to the responsibility
of world financial leadership, backod by immense resources.


trend, however, in the direction of lower money rates was definite
even before the outbreak of the first World War.
Government deficits and growth of doposits
An additional reason for the low long-time money rates
has be e n the large volume of Government deficit financing through
the banks.

Without discussing at this time the policy of deficit

financing and .tho uses t o which the money has boon put, it is
apparent that the fact that great oxpendi tures by the Government
were necessary and were made, nnd that tho bo.nks have purchased
a large volume of Government securities, has increased deposits
to the largest level in history .
There are now available for inv e stment and othor use
vast r0serves of funds n.lroa ~1y create d , and the presence of
those fun ds, which seek investment outlets whenever the opportunity pr e sents itself, is a powerful forc e for l~eeping longtime money rates at low leve ls.

Government activity in vc.rious

lines, such as the agricultural n.nd urban rncrtgn.go fiel~, havo
contributed t o establishing l owe r money rnte standar ds.

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In the



main they have only tended to overcome some of the artificial barriers which hud provontod the abundanc0 of money from oxpressing
itself in lower interest costs for certain groups of borrow0rs.
The fundamental forces for low rates wore deeper than the special
actions taken by the Government .
Position of the banks
Many ba.nks are greatly disturbed by the fact that · interest
rates on loans have declined .
been discussed .

The reason for those declines have

All money rates have participated


tho decline,

but customer rates on loans to ordinary borrowers have declined
considerably loss than open- market rates and rates to preferred
customers who are in a position to shop for their loans.


general run of borrowers who do not have a national credit
standing still pay from 6 to 8 per cent on their loans .
The desire of banks t o have a lnrge number of applicants
willing to pay high rates for loans is natural, but the fact is
that it is a completely unattn.inn.ble desire, a nostalgia for tho
good old times that have passed.

With tho abundance of existing

funds and with ample reserves for additional credit expansion ,
the situation wished for by many bankers olmnot come about .
It is also true that the banks are not making full use
of the funds that they already ho..ve , indicating that it is not
rates alone that disturb them, but inability to find an adequate
volume of acceptable loans or safe investments .

If the banks

were able to invest all the funds at their disposal, even at

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existing low rates, annual returns would bo considerably bettor
than they are.

But, even as it is, the bnnks arc making reason-

able returns on their capital funds.

In the absence of other

acceptable outlets for investment this is due in part tc the
banks' ability to invest large amounts in Government securities.
It would seem that banks will ha.ve to be r econciled to
th0 lower level of rates that has become established and that
they will have to use their knowledge and ingenuity to find
other ways than in the past for doing a profitable business.
Much has already been done in the direction of pers onal loans,
of instalment financing, of increased long-time lending.


will nlso need to hold more securities, perhaps with l onger
maturitios, than they have been accustomed to in the past, and
to adopt policies of ignoring paper profits and losses on highgrade securities caused by fluctuations in interest rates.
Recent modifications in regulations and examination procedure
will work in that direction.

It is probably fair to say thnt,

while banks have been eagor to find loans and investments,
many banks have been reluctant to depart from habits and customs which suited conditions ten or twenty years ago , but which
are not adapted to conditions at the present time.
Prospects for money rates
Predictions as to the future behavior of money


Nevertheless, it seems probable that rates wl_,l~ .

tinue low, even though rates on sh ort-time money may ndvan t ;,,

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from their extremely,low level .


Thero has recently been a sub-

stantial increase in commercial loans in r0sponse to tho violent
spurt in business that accompanied the outbr eak of the war.
Yields on Government and high-grn.de corporate bonds have advancoc
somewhat .

It is difficult to predict whether the commercial

credit demand is going to grow rapi dly , but it is likely that
any growth that will occur will fall far short of available resources and that., even though we experi_once a considerable wartime boom, a return of interest rates t o who.t the brmk0rs are
inc 1 ine d to cons i :le r normal, becnu se it oxi s ted in tho pa.st,

is not likely to occ ur.

A growth of $300 1 000 1 000 or so in

commercial loans in the past six weeks has been due partly to
seasonal influences but largely to inventory buying.


growth may occur, but it is not like ly to be of sufficient
volume to m11k0 a serious dent in the o.vnilo.ble funds and avail able lend ing co.po.city,
Money rates in the United States are l i kely to remain
low, as compe.red with tho past , for a. l~mg time if not perme..nently .
Consequently, there seems to be no s olution for th0 pr oblems that
confront the banks, except ~n adjustment of their business ton
changed :national and world situution.
Federal Reserve policy
As already indicated, the Federal Reserve System f or the
past six years has pursued a policy of neutrality in roe;ard t o

Federal Reserve Bank of St. Louis

It has not intervened in tho money market, except f or




the purpose of exerting a stQbilizing influence at times when disorderly c onditions have developed•

This is what the System did in

the spring of 1937 and on a min0r sen.le in the autumn of that year .
This is what it did also nnd on a substnntial scale during tho
month following the outbreak of the war.
If the System were to decide that higher inte~cst rutes
were ns desirable as is the view of some of the Council, it might
be able to contribute somewhat to thnt end by lQrge-scnle sales
from its portfolio.

It is doubtful whether such sales woul d r e-

sult in a general rise of interest rates, but it is beyond
question thn.t they would result in great disturbance in the
Government security mnrkot and in consequent severe losses of
principal by the banks in their bond portfolio .
' During last summer the System permitted its maturing
bills to be repuid without replacement in ordor to nvoid constantly facing the difficulty of replacing at u no-yield level

or worse, and to incrense tho volume of short-time securities
ava ilable to the banks and other investors.

This policy had no

noticeable effect on money rntes.

It is a fair summary of System policy us it looks today
to say that the System consi ders it n. pa.rt of its function to
prevent violent and speculative changes in the prices of United
States Government securities which are the dominant fnctor in
the capital market. _

Federal Reserve Bank of St. Louis



The System does not consider it its function to maintain
Government security values at a fixed level against economic forces
pulling the other way.

At the same time the System feels that in

the absence of compelling reasons for a generally restrictive
credit policy, banks and other investors are entitled to the mn.intenance of u market in which they can liquefy their Government
security holdings.

For this purpose the System stands ready to

discount paper secured by Government oblig~tions at par ut a
discount rate of l per cent.

With these provisions in effect

and with the instructions that examiners are not to require banks
to carry high-grade bonds at market prices in computing their net
position, the System is affording the banks such protection as
thoy may require in connect ion with their bond portfolio.

Federal Reserve Bank of St. Louis