Full text of Easy Money Policy
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'_ - 1 ;::··· ~~Ct)!W'rbENT JAL MAR 1 1 1958 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis BOARD OF r; Oi/ERNORS OF THE FEDERAL nESERVE S1STEM ,. Divisi on cf Res0arch and Sto.tistics Oc bbe r 9 , 1939 EASY UONEY POLICY By E . A . Gc Llonweiser EASY MONEY POLICY By 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 anything. 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. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 2 - 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. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis They did not , however, 3 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 . On 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 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis SOURCES OF MEMBER BANK RESERVES MONTHLY AVERAGES OF DAILY FIGURES BILLIONS OF DOLLARS BILLIONS OF DOLLARS 18 18 16 / ~ 14 /' 1 ~ t . . ..----,· , 8 ~ / J I _/ _/ MEMBER BANK RESERVE BALAN~ - -- / - ... -... - ~ _.-.,j ,,,,,~- i'v' t--' ~·--- ------- -------· ~--.i, _, ~ ~~ - 12 / ✓- 6 2 16 MONETARY GOLD STOCK 14 4 ,F ~ 10 _/ -- ----- - ..._. 6 - - -----i I I - - -- - - - - - - - 4 RESERVE BANK HOLDINGS . OF U. S. GOVT. SEGI RITIES ·------■ -------··------■ ■-----♦ 2 _. ------- 1932 1933 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 1934 1935 1936 1937 8 - - -- 0 --- 1938 1939 1940 - 4 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 11 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. The 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 o. view 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 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis - 5 for cont ending with an inflationary situ~tion in tho future and of its source 8f earnings out of which t o m0et expenses. Ability 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. The 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 credit. 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. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis Lower rates of inter e st arc usual inn more mature 6 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 . These developments have accelerated the coming of age of the American economy; 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. The 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. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis In the 7 - 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 in 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. The 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 https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 8 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. They 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 hazardous. r~1~.f.ft~1"~ Nevertheless, it seems probable that rates wl_,l~ . tinue low, even though rates on sh ort-time money may ndvan t ;,, https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis ·•........ ) 1 : li .·, ,1,1' ·_IBRAR 9 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, 1 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. Further 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 rates. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis It has not intervened in tho money market, except f or - 10 - 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. _ https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis 11 - 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. https://fraser.stlouisfed.org Federal Reserve Bank of St. Louis