Full text of Economic Quarterly (Federal Reserve Bank of Richmond) : November-December 1990, Vol. 76

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The Case for Interstate

Branch Banking

David L. Mengle

l

When asked about the most important develop:
ments in banking in the decade of the 198Os, most
people are likely to point to the thrift debacle or
to losses on loans to less developed countries. But
arguably more influential has been a benign development, namely, the rise of interstate banking. In 1980,
only Maine allowed bank holding companies from
outside the state to acquire Maine banks. By 1990,
all but four states allowed out-of-state banks to enter,
although in many states there were regional limitations on entry.
Also during the 198Os,. most (but not all) states
relaxed their restrictions
on branch banking,
culminating a century-long trend toward liberalization. One hundred years ago, virtually all banking
in the United States took place through unit banks,
that is, independent banks with no branches. In the
first half of the twentieth century, banks began to
branch extensively within the cities in which they
were headquartered; by the second half of the century, statewide branching networks or holding companies had became the norm in many states. In 1980,
twelve states prohibited bank branching while twentyone allowed statewide branching. By 1990, only two
states prohibited branching while the number of states
allowing statewide branching had grown to thirty-six.
The parallel rapid growth of interstate bank holding
companies and liberalization of state branching laws
suggest the next step: interstate branch banking.
While the current practice of expanding across state
lines by acquiring an existing bank and making it a
subsidiary of the acquiring company differs little in
practice from branching, it does entail some costs
that could be eliminated by allowing the acquirer to
turn a bank into a branch. Indeed, most bank holding
companies that have been allowed to consolidate their
subsidiaries within a state into a branch network have
chosen to do so. And if banks are allowed to expand
l The
author thanks Gary Bosco of the Conference of State
Bankine Suoervisors. William E&land of Morrison & Foerster.
and M&c dken of ACNB Corp. for their helpful information:
John Walter and Marc Morris provided research assistance. The
views in the article are solely those of the author and do not
necessarily reflect the views of the Federal Reserve Bank of Richmond or the Board of Governors of the Federal Reserve System.

FEDERAL

RESERVE

by setting up de novo branches in other states, then
the potential for competition should be enhanced
even further.
This article attempts to show that interstate
branching, while not in demand in the past, is a logical
and feasible step in the evolution of the geographical
structure of American banking.1 As a preliminary, it
describes the current regulatory environment with
regard to interstate branching, as well as the evolution of attitudes toward and regulation of branch
banking. Given this background, the article outlines
the arguments for interstate branching and then
discusses ways it could be implemented,
the
likelihood of its adoption, and its possible effects on
bank structure in the United States.

THECURRENTREGULATORY
ENVIRONMENT

'.

Unique among American businesses, banks in the
United States are regulated by an interrelated set of
state and federal laws as to where they canconduct
business. A bank may choose to be chartered by the
federal government,
in which case it is called a
national bank and supervised by the Comptroller of
the Currency. Alternatively, it may choose a state
charter. If it chooses a state charter it is supervised
by its state agency, as well as by either the Federal
Reserve if the bank opts to be a Federal Reserve
System member, or the Federal. Deposit Insurance
Corporation if it does not choose Fed membership.
But whether a bank chooses a federal or a state
charter, its geographical expansion is effectively
regulated by the states.
At the state level, banks are generally chartered
to operate within the state. In addition, most states
specifically forbid entry through branching, although
some states have the option to approve an out-ofstate bank’s establishing a branch within their borders
under specified conditions. Specifically, Montana,
Nevada, New York, Oregon, Rhode Island, Utah,
r The Federal Reserve has recently gone on record as supporting changing current law to allow interstate branching
(Greenspan 1990).
BANK

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3

and Virginia might permit entry through branching
(unpublished survey, Conference of State Banking
Supervisors, 1990).2
At the federal level, the McFadden Act of 1927
(as amended in 1933) states that national banks:
may, with the approval of the Comptroller of the Currency, establish and operate new branches . . . at any point
within the State in which said association is situated, if such
establishment and operation are at the time authorized to
State banks by the statute law of the State in question by
language specifically granting such authority affirmatively
and not merely by implication or recognition, and subject
to the restrictions as to location imposed by the law of the
State on State banks. (12 U.S.C. Section 36(c))

In general, McFadden gives national banks the right
to branch to the same extent that state banks are permitted to branch. But even if a state were to allow
interstate branching for state-chartered banks, it is
not clear whether national banks could be given
interstate branching authority under current law
because the law contains the phrase “within the
State”, which would appear to limit national banks
to within state boundaries. Thus McFadden is usually
interpreted as prohibiting interstate branching by
national banks.3
Whatever the specifics of how banks are restricted
from branching across state lines, virtually all interstate bank expansion to date has taken place through
bank holding companies. The Douglas Amendment
to the Bank Holding Company Act of 1956 forbids
interstate acquisitions by bank holding companies
unless the acquired bank’s home state allows the
acquisition. Under current state interstate banking
laws and the Douglas Amendment, a bank holding
company now expands interstate by acquiring a bank
or bank holding company and then operating it as
a subsidiary rather than a branch. For example, a
bank holding company headquartered in Virginia and
engaging in full-service banking in Maryland and the
District of Columbia must under current law operate
through three separate banking organizations, one
for each jurisdiction.
One prominent wrinkle present in most but not
all interstate banking laws is a ban on expansion by
z Massachusetts allowed entry through branching in its 1983
regional interstate banking law. In September 1990, the regional
law was superseded by a nationwide interstate banking law. The
new law does not permit entry through branching.
3 One could also argue that McFadden was intended to give
national banks branching parity with state banks. If so, federal
regulators might have the discretion to allow national banks to
branch across state lines along with their state-chartered brethren
(E&land, Olsen, and Kurucza 1990).

4

ECONOMIC

REVIEW.

creating a de novo subsidiary. That is, most interstate
banking statutes allow entry only by acquiring a bank
that has been in existence a specified number of
years. It is reasonable to assume such restrictions
were necessary to secure the passage of interstate
banking laws by making the laws more palatable to
potential acquirees. Foreclosing the option of de novo
entry removed an alternative to entry by acquisition
and thereby raised premiums paid by entrants for
banks. While it is likely that most banks look first
at acquiring an existing depository institution, blocking de novo entry means that entrants are deprived
of an option they might exercise if merger premiums
seemed excessive or if no existing bank in an otherwise attractive market were a suitable candidate for
takeover.
Thrift institutions already have the legal authority
to branch interstate, although the authority has been
restricted by regulators. In Indepndent Banken &oci-

ation of Americav. Fe&al HomeLoan Bank Board (557
F. Supp. 23 (1982)), the District Court ruled that
branching by federally chartered thrifts comes under
the authority of the Federal Home Loan Bank Board
(now the Office of Thrift Supervision), whether
intrastate or interstate. The Independent Bankers
challenged the Home Loan Bank Board when it
adopted a doctrine of allowing interstate branching
to acquire a troubled thrift and then allowing branching within the acquired thrift’s state. The court made
clear that restrictions on interstate thrift branching
are administrative rules and not enshrined in the law
as is the case with banks. The implication is that the
rules could be modified at the discretion of the
Office of Thrift Supervision without any change in
the law.
There are a few interstate bank branches operating
today that had been established before either state
or federal laws forbade them. For example, since
1905 the Bank of California has operated branches
in Portland, Oregon, and Seattle and Tacoma,
Washington. All three were acquired from the British
bank that had originally established them. In addition, Midlantic National Bank in New Jersey operates
a branch across the Delaware River in Philadelphia.
Since both Bank of California and Midlantic are
federally chartered, there is no problem with state
regulatory authority over the branches. More recently, after the Bank of America acquired a failed
Arizona thrift that had operated a branch in Utah,
the Utah banking regulators allowed Bank of America
to continue to operate the office as a branch.

NOVEMBER/DECEMBER

1990

There have been other examples of interstate
branch banking (Federal Reserve Board 1933a,
~~207-9). The First and Second Banks of the United
States both had branches during their existence.
Wells Fargo and Company operated branches outside California. The branches were closed apparently
as the result of business decisions and not of legal
or regulatory actions. Finally, in 1874 the Freedman’s Savings and Trust Company, chartered by
Congress, had branches in all the Southern states and
one in New York (Chapman and Westerfield 1942).
Still, given the number of banks in the United
States, it is striking to see how little interstate
branching had occurred even before it was explicitly banned.

THEORIGINSOFCURRENTLAW
The history of banking in the United States is
characterized not simply by the lack of interstate
branching, but by the longtime lack of interest in
branching within a’ state as well. That is, while
branching has occurred throughout American banking history, it only caught on as a widespread
phenomenon in the twentieth century, and then
only in fits and starts. In contrast, the history of
Canadian banking has included branch banking from
the start and there have apparently been no serious
efforts-to emulate the American system. And while
in Canada a small number of commercial banks with
extensive branch netwoiks have been able to serve
the market, in the United States small independent
banks abound even in states with no restrictions on
branching.
Before the Civil War, there was branching at both
the federal and stati levels (Federal Reserve Board
1933a). At the,federal level, the First Bank of the
United States, which lasted from 1792 to 18 11, was
headquartered ifi Philadelphia and maintained offices
in eight-other cities. The Second Bank of the United
States, which lasted from 18 16 to 1836 and also
operated out of Philadelphia, had as many as twentyfive other offices during its life.
In addition, there were state branch banking
systems, although most of the branches that survived into the National Bank era after the Civil War
ended up incorporating as independent national
banks. Finally, “free banking” arose in the North at
the same time as branch banking in other states. Free
banking meant that specific legislative’ch&tFring of
a bank was not required; instead, anyone, meeting
specified requirements (such us initial capitalization
and depositing bonds with the chartering,state) would
FEDERAL,RESERVE

be issued a charter. Free banks were unit. banks; they
had no branches, although branch banking was not
specifically forbidden.
The last category, free banking, turned out to be
significant for the future of ‘branch banking law
because the New York free banking law contained
provisions specifying that “the usual business of
banking . . . shall be transacted at the place where
such banking association . . . shall be located . . .”
(Federal Reserve Board 1933a). The language was
apparently not aimed at branch banking per se, but
at the then notorious practice of issuing currency at
the bank’s main location, usually in a remote area
(“wildcat banking”), but only redeeming at a discount
in a city location. The provisions were significant
because they were later to be incorporated into the
National Banking Act and still later to be interpreted
as forbidding branching by national banks, even
though there is no evidence that doing so was the
original intent of the legislation (Fischer and Golembe
1976).
When the.National Bank System was established
at the efid of the Civil War, the new system was comprised entirely by unit banks, even though statechartered branch banks were sbecifically allowed to
keep their branches if they converted to national
charter. As it turned out, the grandfathering authority
for branches was not used until the first decade of
the twentieth centuti. The important point is that
branching was simply”not an important issue, not
because of specific opposition to it but because of
lack of interest. Apparently unit banks had a comparative advantage over branch .banks.
The first stirrings of renewed interest in branch
banking came during the late 1890s in the form of
proposals to encourage branching by national banks
as a means of making banking services available, to
rural areas that could not support a separately incorporated bank (Comptroller of the Currency 1895).
While such proposals did not elicit much interest from
the public, bankers were largely opposed so none
were enacted. Instead, in the Currency Act of 1900
the required capital for establishing a national bank
was reduced from $50,000 to $?5,000 (or, in 1990
dollars, from $663,500 to $33 1,750) for towns with
population of less than 3,000.4
4 In comparison, in 1990 the minimum initial capital for a
national bank was $50,000 in a town of less than 6,000 inhabitants, $lQO,OOO for a town of up to 50,000, and $200,000 for
a city of over 50,000 (12 U.S.C. 51). In practice, all regulatory
agencies have administratively adopted far higher minimums.
BANK

OF RICHMOND

5

The result was, predictably, an increase in the
number of, banks in the United States from approximately 13,000 in 1900 to about 25,000 in 1910
(Board of Governors 1959). And of the new banks,
about two-thirds were small unit banks with an
average capital base of just over $25,000 (Chapman
and Westerfield’ 1942). The resultant proliferation
of independent unit banks made for an anti-branching
force that slowed the growth of branch banking for
decades.
While the number of unit banks increased, branch
banking became more common at the state level. In
California, branch banking started as a largely rural
phenomenon, especially after branching was officially
approved for state banks in 1909 (Federal Reserve
Board 1933b). But in the rest of the country,
branching became commonplace not in rural areas
but within cities, in particular, in New York, Detroit,
Philadelphia, Boston, and Cleveland.
As both branching by state banks and the number
of unit banks grew, it is not surprising that unit
bankers attempted to contain the spread of branch
banking. The result was, first, a flurry of laws in the
1920s to ban branch banking, mostly in states where
it did not yet exist. As shown in Table I, more states
banned branching in 1929 than had done so in 1910.
Second, there were moves to keep national banks
from branching at all, with the avowed purpose of
stemming the spread of branch bar&i&in any form.
National banks in branchgmg states wanted the
same branching privileges as their state-chartered
brethren. But unit banks were adamant in opp.osing
any extension of branch banking. Further, the money
center banks of the day were largely opposed to
branch banking, since they stood to profit from
correspondent business and were not much interested
in retail customers. And apparently absent from the
debate was any consideration of interstate branching.
Regulatory policy toward branch banking varied
over time. In 19 11, the Comptroller requested that
the Attorney General issue an opinion regarding
branching by national banks. Based on the language
originally adopted from the free banking statutes, the
Attorney General opined that national banks were
not allowed to branch. But by the early 192Os, the
Comptroller allowed branching in order to meet competition by state-chartered banks in branching states.
Indeed, one Comptroller believed he could allow
branching regardless of state laws, but simply
followed state laws as a matter of policy, just as did
the Federal Home Loan Bank Board in the 1980s.
6

ECONOMIC

REVIEW,

Table

I

STATE BRANCHING LAWS,
SELECTED YEARS

Alabama
Alaska
Arizona
Arkansas
California
Colorado
Connecticut
Delaware
Florida
Georgia
Hawaii
Idaho
Illinois
Indiana
Iowa
Kansas
Kentucky
Louisiana
Maine
Maryland
Massachusetts
Michigan
Minnesota
Mississippi
Missouri
Montana‘
Nebraska
Nevada
New Hampshire
New Jersey
New Mexico,
New York
North Carolina
North Dakota
Ohio
Oklahoma
Oregon
Pennsylvania
Rhode Island
South Carolina
South Dakota
Tennessee
Texas
Utah
Vermont
Virginia
Washington
West Virginia
Wisconsin
Wyoming
KEY
Unit.banking
(branching prohibited)
+ Branching limited geographically
within
n ‘Statewide branching
No branching law
1 Not yet a state
l

state

Sources: ” Chapman and Westerfield
1942;.Federa/
Reserve
.’ Bulletin
1933,
1939; Federal Reserve Board 1933a;
White 1976; Department of the Treasury 1921; Banking
ExpansionRepotter,August 6. 1990.
‘.)

NOVEMBER/DECEMBER

1990

Finally, in 1924 in Fint National Bank in St. L&s
w. State of Missouri (263 U.S. 640), the Supreme
Court held that a state had the right to enforce its
branching restrictions for national banks unless Congress specifically said otherwise. The Court also held
that national banks did not have the right to branch.
The matter was put to’rest by the McFadden Act
of 1927, passed after three years of intense debate.
The Act allowed a national bank to branch within
its city boundaries if state banks were allowed the
same or more liberal privileges. Since most branching
at the time was within cities, the Act probably was
sufficient for most ‘banks. But in California, the
restrictions were binding on national banks so they
led to forms of corporate organization and affiliation
that served to evade the Act’s restrictions (Federal
Reserve Board 1933b).
Following the McFadden Act, anti-branching sentiment waned, largely because the extensive bank
failures of the ‘late 1920s and early 1930s showed
the weakness of unit banking ,and made branching
attractive as a means of making failures less likely.
As Table I shows, the consequence was that between
1929 and 1939 the number of states prohibiting
branches fell sharply while the number permitting
statewide branching doubled.
While the ultimate result of the rash of bank failures
was deposit insurance rather than significantly
enhanced branching powers (Fischer and Golembe
1976), there arose,during this time the first explicit
support for interstate branching. Senator Carter Glass
of Virginia, an architect of the Federal Reserve Act,
proposed in 1932 a bill that would liberalize national
bank branching powers. In particular, the bill proposed not simply statewide branching for national
banks but “trade area” branching as well. That is,
a bank located near a state line with frequent business
in the other state would be allowed to branch up to
fifty miles into the state. An obvious example of such
a trade area is the Washington, D.C.., metropolitan
area.

the 1980s. Table I- shows how the laws have
changed over time for the individual states; In 1939,
eighteen states allowed statewide branching while
nine allowed only unit banks. By 1979, the number
of states allowing statewide branching and the number
allowing only unit banking had both grown by three.
As of 1990,. thirty-six states allowed statewide
branching while only two states prohibited branching
altogether. But as mentioned earlier, by this time all
but four states had enacted laws permitting interstate
expansion by holding company acquisitions. Thus
the question is no’longer whether banks should be
allowed to expand interstate, but rather whether they
should be allowed to do so by branching.

ADVANTAGESOF
INTERSTATEBRANCHBANKING
Safety

I

From the point of view of the banking system,
interstate branching would be .beneficial in that it
would enhance safety. In general, the historical record
supports the assertion that,branch banks have a better
safety record than unit banks. In particular, during
the 1920s and early 1930s the failure rate was inversely related to bank size (Cartinhour 1931;
Chapman and Westerfield 1942). Further, during the
period 192 1-3 1, the failure rate as a percentage of
banks operating at the end of 1931 was 46.5 percent for all banks but only 26.4 percent for banks
with branches (Federal Reserve’ Board 1933a,
1933~). But the comparison understates the difference since the majority of branch banks that failed
had only one branch. For banks with over ten
branches, the failure rate. was only 12.5 percent
(Federal Reserve Board’ 1933a).

The Glass Bill was not enacted. Instead, the Banking Act of 1933 (better known as the Glass-Steagall
Act) liberalized the 1927 McFadden. provisions to
permit national banks to branch to the same extent
as was permitted to state banks. Thus national and
state banks had approximately the same branching
powers, and the law remains in force today.

There are several related reasons for the better
safety record of branch banks, reasons that apply b
&&ti
to interstate branching. First, .by its’ very
nature, a system of small unit banks is more prone
to insolvencies if funds move out of a troubled unit
bank serving an area than would a system of branch
banks in which funds simply flowed out of a
troubled branch serving the same area (Greenspan
1990). That is, events that for a unit bank would lead
to insolvency might simply lead to a loss for a branch
serving the same area. Second, runs are more likely
in a system of small banks, since small, localized
shocks are more likely to be perceived as threatening entire institutions (Calomiris 1990).

Since 1933, virtually all the action on branch
banking has occurred at the state level, although most
changes since the Depression era occurred during

‘The first two reasons for branch banking’s greater
safety imply the third: geographical diversification.
By making it less costly.for banks to expand across

FEDERAL

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BANK

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7

state lines, interstate branching would make it possible for them to diversify their. loan :portfolios to a
greater extent than is now possible. B,anks would
consequently be less subject to swings in regional
economies such as agricultural failures or declines in
regional industries, so what could mean insolvency
for .a geographically restricted set of banks might
mean only losses for one part of a geographically
diversified bank. A -fourth reason for greater safety
is that a branch bank in essence.serves as a m,utual
loss sharing,arrangement under which losses to one
part of a bank’s operation are ,diffused ‘across the
entire organization. Again, geographically limited
losses that for a geographically limited bank might
mean insolvency could be more easily absorbed by
a larger, geographically dispersed. organization.
:_
‘.
Finally, interstate branching would make it less
costly to gather core deposits, which by definition
are a more stable funding source than. purchased
funds. Despite their stated. maturity of zero, core
deposits can have effective maturities of several years
(Flannery and James 1984)., So by making core
deposits cheaper, relative to purchased funds, interstate branching ,could help increase the duration of
a bank’s li.ability side so the. bank would be. less
vulnerable to interest rate swings than if it relied
heavily -on ,purchased funds.
There would be an incidental safety benefit to interstate branching. The Federal Reserve has promulgated the “source of. strength” doctrine, which
calls upon a bank holding company to support its subsidiary banks in times of .adversity. There have been
recent cases in which a bank holding company, when
looked at as a consolidated entity, was insolvent even
though ,some subsidiary banks were technically solvent on their own (MCo+ v. Board of Gbvernorxof
the Federal Reseme S’steni, No. 89-28 16, ‘5th Cir.,
May 15, 1990). Problems arose because of disagreements as to the legal obligations between a bank
holding company and its subsidiary banks, each of
which was a distinct legal ‘entity.
If the entities involved had been branches rather
than- subsidiaries, such problems might not have
arisen (unless assets had been moved into nonbank
subsidiaries). While in the case of MCorp the reason
for the separate subsidiary banks was state law and
not the McFadden Act, the case does serve to illustrate the problems that can arise with organizations
comprised by separately chartered banks. If in the
future an interstate,bank holding company were to
face insolvency, disputes such as those arising with

8

ECONOMIC

REVIEW,

MCorp would be far less likely if regulators were dealing with one consolidated bank rather than a web
of subsidiary banks.
Consumer

.Benefits

From the point of view of the consumer, a major
advantage of interstate branching over the current
system would be convenience. For example, suppose
a bank holding company has subsidiary banks in, say,
Virginia and Washington, D.C. A customer with an
account at the Virginia bank might be allowed to cash
a check at an office of the Washington bank, but not
to make a deposit. That is, full service banking across
state lines simply does not yet exist. In contrast, if
the subsidiaries were branches a customer could do
at an out-of-state branch everything she could do at
a branch in her own state.
In addition, an interstate branch network would
be beneficial to travelers needing cash and banking
services. While such innovations as travelers’ checks
and credit cards have developed to lessen the inefficiencies associated with the current banking system,
the availability of banking services over a wider area
would add to the traveler’s options. Finally, by
adding to the number of banks able to branch into
a market, interstate branching might increase the
accessibility of banking services. Just as statewide
branching .has made banking services more available
to consumers than under unit banking, so should
interstate branching compared with the current
balkanized system (Evanoff 1988).
Efficiency

?

From the point of view of-a bank interested in
.
operating~interstate, a major argument for allowing
interstate branching is efficiency. Under the current
system,of allowing interstate expansion only through
bank holding company subsidiaries, a bank must
incur parallel costs in each state in which it chooses
to operate. First, each subsidiary must have a separate
board of directors as well as committees associated
with each board. Second, each subsidiary must
submit separate regulatory reports (for example, call
reports) and undergo separate examinations. Third,
each subsidiary must submit its own audited financial statement. Fourth, each, subsidiary requires its
own support and control functions, for example, personnel, budget, audit,’ and accounting, that for a
branch.network could be consolidated. Finally, each
subsidiary will maintain its own computer systems
and applications for such tasks as demand deposit
accounting, loans, and reserves. Even if the, bank
holding company is managed as if it were one bank,

NOVEMBER/DECEMBER

1990

the requirement that each subsidiary report separately prevents the systems from being integrated
completely.
Duplication is not the only source of costs in a
network of subsidiaries. Each subsidiary will have to
satisfy capital requirements,
so there are costs
associated with the complex treasury exercise of
balancing capital between the subsidiaries. Further,
costs incurred by the parent company must be
allocated among the subsidiaries, even though there
may be no economically meaningful way of allocating
such costs. That is, certain costs originating in, say,
the lead bank for the benefit of the subsidiaries
cannot be assigned to the subsidiaries except by some
unavoidably arbitrary method. Finally, since each
subsidiary is a separately chartered bank, moving
assets between entities must take place on an “arm’s
length” basis, meaning that internal transfers must
be treated as if the subs were not united by common ownership. As a result, internal transactions
might have tax considerations and other costs that
would not arise if the subsidiaries’were consolidated.
Despite the costs of maintaining separate subsidiaries, a bank holding company choosing to consolidate will lose at least four benefits of separation.
First, boards of directors can be a source of referrals
for loans and other business for a bank in a local area,
a source that would be lost if subsidiaries were converted to branches. Second, if a bank holding company purchases a bank that had served an area competently and profitably for years, the company might
prefer to preserve the “brand name capital” of the
acquired bank by letting it operate as a subsidiary
under its old identity instead of under the name of
the acquirer. Third, unlike their Canadian counterparts, American bankers do not have experience in
managing far-flung branch networks, so decentralized management might compensate for this lack.
The problem should lessen over time, however,
as bank holding companies develop experience in
interstate operations and develop the ability to
centrally manage more geographically dispersed
branch networks.
Finally, a bank holding company might stay decentralized to preserve the benefit of tiered reserve
requirements. When calculating the reserves a bank
is required to maintain on its transactions accounts,
the required ratio of reserve balances to deposits
increases as follows: The first $3.4 million of its
transactions accounts is exempt ‘from any requirements; the required ratio is 3 percent for $3.5 million
to $40.4. million of transactions accounts; and the
FEDERAL

RESERVE

ratio is 12 percent for all remaining transactions
accounts over $40.5 million (FederalReserveBdletitz,
August 1990). Since the cost of reserves is the
foregone interest on the funds, a bank holding company could hold down its required reserves by expanding by means of small subsidiaries rather than
branches.
Thus there is a tradeoff between costs and benefits
of maintaining separate subsidiaries. As a decentralized bank holding company growsand expands the
number of subsidiaries, one would expect the costs
of decentralization enumerated above to rise. At the
same time; at least one benefit, the lower amount
of interest foregone on reserves, becomes less significant to a banking organization as it grows larger. For
example, the deposits subject to the lower requirements would be 4 percent of assets for a bank with
assets of $1 billion but only 0.4 percent of assets for
a bank with assets of $10 billion. Thus, other things
equal one would expect consolidation to become
more likely as an organization increases in size.
Payment

Processing

One of the most obvious places for improvements.
in efficiency lies in the payment system area. For
example, consolidating a set of holding companies
into a branch network would increase the number
of “on-us” checks, that is, checks for which the payer
and payee both hold accounts in the same bank. If
so, then more clearing could take place internally
(Berger and Humphrey 1988). In addition, converting interstate subsidiaries will enable a bank to
consolidate the reserve accounts of its subsidiaries
into one account. Since banks use reserve accounts
to clear payments, there would be lower administrative costs associated with payment processing.
Indeed, even under the current system some bank
holding companies have chosen to process all their
Fedwire payments through one account regardless
of which state subsidiary they involve. Such a practice would likely become automatic under interstate
branching.
Competition

and Credit Availability

From the point of view of both banks and consumers, a major result of interstate branching would
be increased competition, especially if banks could
branch de novo. Since allowing interstate branching
would make it less costly to. enter a state, banks a
would be more likely to enter to take advantage of I,
profitable lending opportunities. This would have at
least two effects. First, it would increase the number
BANK

OF RICHMOND

.9

of competitors (or potential competitors) in a market.
Second, it could. make more and cheaper credit
available to a .market.
’
’ .
.>
With.regard to availability of credit,‘opponents of
interstate branching (and for .that matter of. branching in any form) repeatedly point to the ppssibility
that branch managers are less concerned with the
local economy than are owners and managers, of the
bank, so a branch would simply siphon funds out of
an area to be lent elsewhere. Rut such possibilities
already exist, for ,banks, as well as branches. For
example, a bank not wishing to lend in an area could
sell federal fundsupstream to a correspondent b,ank,
or could put its funds into investment securities rather
than loans.
_ Further, .a branch, that ignores profitable lending
opportunities will be vulnerable to competition-from
local institutions. Finally, the argument that branches
suck credit out, of a’region .is a two-edged sword:
The ability to draw.‘credit out of an area imfilies the
ability to inject credit into.an area, so branches may
be as likely to bring funds into an area as to take
them out. But regardless of whether objections ‘to
branching on. the basis of credit availability have any
validity,. such problems, to the extent they exists can
be .more directly attacked, through- the Community
Reinvestment Act than through branching statutes.
., ,,
.”

~M~DELSOF~,INT~~RSTATEBANKII$G
:
The United States follows’s dual~banking system;
which means that banks may’be chartered either
federally or by the states: When developing a plan
for interstate branching,- one’.must be cognizant ‘of
the interaction of state and’federal laws regarding
banking structure; The following.paragraphs describe
three possible means of implementing interstate
branching.
., .’
National

Bank Branching

Interstate
branching could be instituted
by
simply allowing federally chartered banks to establish
branches without regard to the laws of the states in
which the branches would be located. That is, the
national bank system would become a national banking system in-the- sense, of a nationwide system and
not simply a federally chartered one. Such a system
could be put.into place by repealing the McFadden
Act and changing the language of current law to grant
a national bank the authority to establish branches
freely without regard to state laws. The main.requirement would be specific Congressional authorization.

10

ECONOMIC

REVIEW,

The advantage of using the national-bank system
to bring about interstate branching is that it would
be relatively simple. That is, it could be accomplished
through federal legislation and would not require consent at the individual state level. Further, the approach would not involve overlapping or conflicting
regulatory agencies, ,since all national banks are
supervised by. the Office of the Comptroller of the
Currency. Such a .system is already in. place in
Canada, where’bank chartering and regulation have
been federal functions since the British North
America.Act .of 1867.
The, disadvantage of the national bank approach
to interstate branching is that it would put statechartered’ banks at a competitive disadvantage to
national banks, at least in those states that do not
grant interstate branching privileges to state-chartered
banks. Within the Federal Reserve System, there
would be an additional problem: All national banks
are members of the Federal Reserve System, but
state-chartered banks.mayelect to join. or not to join
the System. In a system of unlimited interstate
branching by national banks, there would be a disparity between the powers of national banks and state
member banks. Of course, there would be a simple
solution: States could grant interstate ‘branching
powers to the banks they charter.
I .,
_.
:
Host-State

Regulation
:
The .first alternative, concerns itself. only with
national banks, and in effect, overrides any state
powers over national bank expansion. An alternative
that preserves the authority.of the states would be
to permit state-chartered banks to branch interstate
provided they abide by the regulations of the state
into which the bank wishes to expand. Such an alternative would most likely retain state authority over
bank ‘structure by allowing. national banks .to enter
a state only if the state ,consents.
.

., ,Utah in effect agreed to a scheme of host-state
regulation when, as previously mentioned, it permitted a state-chartered bank in Arizona.to maintain
a Utah office as a branch. The Arizona bank had
previously been a thrift, which was taken over by
the Resolution Trust Corporation, then purchased
by BankAmerica Corp., and. then. converted to a
state-chartered commercial bank (AmericanBanker,
July 12, 1990). Consistent with thrifts’ more liberal
interstate branching powers, the thrift had operated
a branch in Utah. When.BankAmerica converted the
thrift to a.bank, however, it- had to seek permission
from Utah to continue to ,operate the office. as a

NOVEMBER/DECEMBER

1990

branch instead of convert it to a subsidiary. Utah
assented, and under the agreement Utah will be
responsible for examining the branch (American
Banker, September 4, 1990).
Leggett (1989) has put forward a more comprehensive proposal involving host-state regulation of
interstate branching. The proposal would allow bank
holding companies with interstate subsidiaries to consolidate their banks as branches. It belongs in the
host-state taxonomy because a branch of a statechartered bank could not exercise any powers in the
host state that were not granted to banks chartered
in that state, although the proposal also provides that
the out-of-state branch could not exercise any powers
not granted by its home state. While the state bank’s
own regulators would examine the entire bank, they
would be required to apply the host state’s laws and
standards for out-of-state branching applications. In
order to ensure that such laws and standards are
followed, the host-state regulator would have the
authority to approve or disapprove applications for
entry.
There has been legislation recently introduced in
Congress that follows the host-state regulation principle (H.R. 5384 and S. 2922). The bills would
(1) repeal the Douglas Amendment to the Bank
Holding Company Act; (2) amend the Federal
Deposit Insurance Act to specifically authorize outof-state branches unless a state specifically forbids
them; and (3) amend McFadden to allow establishment by national banks of out-of-state branches
unless a state specifically forbids it as in (2). The
activities allowed the branch would be governed by
host-state law.
Since states would have the opportunity to pass
laws that block interstate branching, it is not clear
how far such a bill would go toward facilitating
nationwide branch systems. Still, two points are
significant. First, by repealing Douglas the bill would
permit nationwide interstate banking by the holding
company acquisition route, as well as eliminate all
geographical restrictions on interstate entry. That
alone is the most extensive nationwide banking
initiative to arise at the federal level to date. Second,
states would only be able to opt out of permitting
interstate branching. And since states would be
required to specifically pass laws that forbid interstate
branching rather than laws that permit it, branching
would be allowed if a state simply did nothing.
FEDERAL

RESERVE

Home-State

Regulation

A third alternative for interstate branch banking
is based on an analogy with the European Community’s Second Banking Directive, to take effect
at the end of 1992 (Golembe 1989,199O). The
effect of the Directive will be to create a “single
banking license” for a depository institution in any
European Community nation to provide banking services. The license is based on two concepts. The
first is mutual recognition by each member country
that every other country’s laws and regulations are
equal to its own and that no country will use its laws
and regulations to restrict access to its market. The
second is home country control, so even if laws and
regulations differ between countries, those of the
home country will govern the operations of a branch
in another country (Key 1989). In certain areas such
as consumer protection, however, host-state regulators retain authority.
As applied to the United States, the European
Community approach would involve authorizing a
bank chartered in one state to branch into any other
state. Whatever the host state’s laws, the branch
would be governed by the laws of the state in which
the parent bank is located. Thus within such a
framework, a bank located in a state with statewide
branching would be able to expand into a limited
branching state but still branch throughout the state
regardless of what the local banks could do. And to
take the analogy further, if a bank located in a state
that permits banks to sell life insurance branches
into a state that does not, the branch would be able
to exercise the more liberal insurance powers even
within the restrictive state’s boundaries.
There are advantages to both the host-state and
home-state regulation alternatives. Given the dual
banking tradition of the United States, host-state
regulation is likely to be more consistent with current practice. That is, by deferring to host states it
is less likely that states would oppose entry from
another state than if control over the branch were
to lie entirely in the home state. Further, even if hoststate regulation were the norm, there would be no
reason why host states could not agree to defer in
specific cases to home state regulators. In such an
environment, host states would have the option rather
than the obligation to accept another state’s laws and
regulations.
Home-state regulation would probably lead the
laws and regulations of the various states to become
more similar and consistent. Since banks in a restrictive state would be at a disadvantage relative to
BANK

OF RICHMOND

11

branches of banks from liberal states, there would
arise pressure in the more restrictive states to loosen
the rules. In the European Community, such a
tendency toward “regulatory convergence” is fully
expected to occur and is consistent with the goal of
“harmonization” of rules, regulations, and standards
between member countries (Key 1989).
Depending on one’s views concerning the dual
banking system, regulatory convergence may or may
not be an advantage. If one believes that an advantage of the American dual banking system is that it
fosters diversity and allows some states to experiment
while others are more conservative, then regulatory
convergence might be less attractive than it would
be to one who considers the tension between state
and federal regulation to be an obstacle to progress.
More important, while convergence toward liberal
branching laws among states would have salutary
effects on safety, convergence toward, say, liberal
real estate investment laws for banks might not.

INCENTIVESTOPERMIT
INTERSTATEBRANCHBANKING
Having presented the case for interstate branching
and outlined three ways it could be structured, the
next matter for consideration is the likelihood of its
adoption. As mentioned previously, many of the
benefits of interstate branching will accrue to consumers in the form of convenience, increased competition for deposits, and more efficient payment
clearing. But consumers are by their nature a’diverse
and unorganized group, and the benefits to any individual consumer are not likely to be so large as to
excite him to lobby his state legislature to allow
interstate bank subsidiaries to convert to branches.
And while the experience of Utah in allowing an outof-state thrift branch to operate in the state as a bank
branch suggests that sales of insolvent thrift institutions might require some loosening by states of
restraints on entry by branching, it is not clear that
such liberalization would be necessary in most states.
Thus it is logical to ask: Whence will come the
pressure for interstate branching?
As described earlier, interstate branching would be
more efficient than maintaining separate subsidiaries.
Banks with interstate operations might therefore be
expected to support permitting interstate branching.
But because it would make it less costly for a bank
to move across a state line, interstate branching would
likely increase the number of potential competitors
in a market. Consequently, other (and probably most)

12

ECONOMIC

REVIEW.

banks at the state level might have incentives to
oppose interstate branching, or at least to refrain from
actively supporting it.
Further, competition could be even more intense
if de novo interstate branching were permitted, since
banks that are now deterred on the margin from
expansion into another state by the merger premium
cost of acquiring a bank might find it less costly to
enter a state by establishing a new branch. In the
past, interstate banking laws have been crafted in a
way that limits competition. In particular, most states
restrict de novo entry in favor of entry by acquisition, which tends to make merger premiums higher
than would be the case were the de novo option
available. Thus potential acquirees might have
reasons to oppose permitting alternatives to entry by
acquisition.
The lineup of potential winners and losers from
interstate branching brings to mind the long opposition by unit bankers to branching within a state. In
particular, it illustrates Anthony Downs’s (1957) principle that when a small group has much to gain and
a far larger group has about the same amount to lose
from a specific measure, the gainers have the incentive to devote more resources to having the measure
enacted than would the losers, each of which would
stand to lose a small amount as individuals. The same
idea was expressed by the Federal Reserve Board
(1933a):
That the opposition of the bankers should have been overwhelming, in the absence of any real public interest in favor
of branch banking, is not strange. Nor is it strange the
bankers, pursuing, as in the main they were, a thriving and
profitable business, should have been more moved by the
probability that branching would affect them individually
than by the possibility that the economic system as a whole
would profit from it.

With regard to interstate branching today, the
question is whether there exist the same incentives
to fight it as there were to fight branching within a
state in the first decades of this century.
At first glance, one might be pessimistic regarding
the chances for interstate branching because of the
relative influence of interstate and in-state banks on
the state legislature. That is, in states with both types
of banks, both will have influence on the legislature,
and reform may in such a state originate in state
legislation. But in states with banks that are not likely
to expand into other states, legislative pressure might
more likely be for protection rather than enhanced
entry. Consequently, it might seem improbable that
any large-scale initiative for interstate branching could
originate at the state level.

NOVEMBER/DECEMBER

1990

Still, it should be recalled that the current crop of
interstate banking laws, that is, those that allow bank
holding company expansion across state lines, did
originate at the state level. While the prevalence of
laws that block de novo entry probably reflects the
incentives of potential acquirees to protect their
interests, banks apparently did not see fit to devote
a great deal of resources to blocking interstate banking in toto. Thus the success of efforts to introduce
interstate banking suggests that incentives to oppose
interstate branching are not as strong today as were
the incentives in the 1920s to oppose branching.
Whatever the interplay of interests at the state
level, the incentives might well be different at the
federal level. While both regional interstate banks and
those seeking to limit competition
are wellrepresented, the balance is probably less tilted in
favor of protection. In addition, the banking committees of both the House and Senate are by their
nature more likely to reflect a national perspective
than that of individual state interests, so public
interest arguments might get a more sympathetic
hearing. Finally, consumer interests (such as they
exist) may be better represented at the federal level
than in the legislatures of fifty states.
The upshot of incentives at both the state and
federal levels seems to be as follows. It is probably
more likely that interstate branching would be
approved at the federal level than in the legislatures
of all fifty states. Further, if Congress follows the
H.R. 5384 approach of authorizing interstate
branching unless states pass legislation specifically
&-bidding it, the result is likely to be interstate
branching in more states than if it were left to the
states to pass laws specifically awiocizing it. The
reason is that it is easier for either side to block legislation than to get it passed, since a law can be
bottled up or killed in committee without ever
getting it up for a vote.
There is some probability that branching laws in
the United States could be liberalized in response
to the developments in the European Community
cited above. Prior to the adoption of the Second
Banking Directive, there was some sentiment in
the European Community in favor of adopting
reciprocity, under which American banks would be
allowed to do in the European Community whatever
European Community banks could do in America.
American banks preferred national treatment, under
which American banks could do in Europe whatever
European Community banks were allowed to do
there (and similarly for EC banks in America). If
FEDERAL

.RESERVE

reciprocity had been adopted, American banks might
have come under severe restrictions relative to their
European counterparts. In the end, national treatment prevailed, although there have been repeated
urgings that American banking laws be reformed to
give European banks the same access to the
American market as American banks now have to
the European market.5

EFFECTSONBANKSTRUCTURE
As of the end of June 1990, there were 12,321
banks operating in the United States. Because of
mergers, consolidations, and failures, this number is
widely expected to fall even if the current laws on
branching remain in effect. Interstate branching may
cause the number to fall still more. What is not clear
is how much interstate branching will contribute to
the fall in the number of banks.
The obvious candidates for consolidation are, of
course, the bank subsidiaries of interstate bank
holding companies. At the time of this writing there
are 160 interstate bank holding companies operating
at least 46.5 bank subsidiaries in different states. If
the law is changed to allow interstate subsidiaries to
be consolidated into branches, and assuming all
interstate bank holding companies decide to consolidate, then the number of separately chartered
banks in the United States could fall by at least 305.
And assuming that regional restrictions on interstate
banking are removed, the number could fall even
more by means of end-to-end mergers between banks
that had been restricted to separate regional compacts such as those in the Southeast and New
England.
At the other end of the spectrum, in June 1990
there were 11,724 small banks, that is, banks with
$500 million of assets or less. The effect of interstate
branching on small banks would ,largely depend on
the laws of the various states. In states with restrictive branching laws, it is reasonable to assume that
some banks have remained in business because of
the laws and would be absorbed by another organization if the laws were liberalized. So if interstate
branching were enacted in such a way as to either
override state branching laws or to induce states to
liberalize their branching restrictions, then the
number of small banks would probably fall.
5 Such calls for reform routinelv cite the McFadden Act as an
obstacle to foreign bank expansion. See, for example, “Time
to Ooen Non-EC Markets. Brittan Tells Bankers’ Grouo.” BA!I~
Banking Report, February’lz,
1990; and “U.S. Urged’to End
Banking Barriers,” AmeriGan Banker, March 26, 1990.
BANK OF RICHMOND

13

But in states with liberal branching laws, there
might be little if any effect on the number of small
banks. For example, all states in the Fifth Federal
Reserve District allow statewide branching. Table II
shows there are substantial numbers of banks with
$500 million of assets or less in each of the Fifth
District States. Except perhaps in West Virginia,
which did not allow statewide branching until 1988,
the number of small banks cannot be attributed to
branching restrictions. The survival of small banks
in such a legal environment suggests that the vast
majority would remain in business even if interstate
branching were permitted. To the extent that reductions in the number of small banks occur in states
already permitting statewide branching, they are
likely to be the result of acquisitions of banks in
markets previously divided by state lines.
Another way to consider the probable effect of
interstate branching is to take the number of banks
per capita for countries with no limitations on
branching and project the same ratio on the United
States. Canada, for example, has eight major banks,
of which six operate nationwide, serving its population of 26.3 million. If the United States had the same
ratio of banks to population, it would have about 75
banks, of which about 56 would operate nationwide.
At first blush, 75 banks (much less 56) seems small
compared with the current 12,321. But 56 banks
competing with each other in markets across the
United States does not seem small, especially when
one realizes that the vast majority of American banks
operate in one market. Only if the 56 banks operated
in separate, balkanized markets would there be cause
for concern. More important, even if most of the
l&32 1 were to cease to exist as separate firms, they
would not simply vanish into thin air. Most would
likely be converted into branches of one of the
nationwide banks. Consequently, while there would
be fewer banks in each market there would not
necessarily be fewer banking facilities.
But Canada might not provide a relevant comparison. First, Canadian banking policy differs from
that of the United States in that it has been and
remains a strictly federal function despite the provinces’ high degree of autonomy in other areas (such
as securities regulation). Unlike the United States,
there was no conflict between the provinces and the
federal government over banking structure. Second,
while banking policy in the United States has at times
encouraged the spread of small, local banks, Canadian policy seems to have favored larger banks.
Specifically, while in the United States in 1900 a
14

ECONOMIC

REVIEW.

Table II

Banks with Assets below $500 Million
Fifth Federal Reserve District
Number of
Banks

State

Banks below
$500 Million

108

96
68

South Carolina
Virginia

78
84

180

West Virginia

162

168
159
20

Maryland
North Carolina

District

of Columbia

Source:

Consolidated

Reports

26
of Condition

and Income,

78

June 1990.

national bank could be chartered with as little as
$25,000 in capital, in Canada the Bank Act of
1871 required a minimum of $500,000 in capital
(Breckenridge 1910).
Finally, a structural outcome similar to the Canadian system is unlikely because small banks in the
United States may have advantages over entrants into
their markets simply by virtue of being there first.
If a larger bank wishes to enter, it has to incur costs
to buy its way in either de novo or by acquiring
the incumbent. If the incumbent is earning above
normal returns, the costs of entry might be worth
incurring. But if the incumbent is simply earning a
normal return, the entrant would have to have an
advantage over the incumbent in order to make the
costs of entry worth incurring. The advantage could
occur on the supply side in the form of more efficient operations, or on the demand side in the form
of enhanced services and credit availability that would
make consumers willing to pay more. The point is
that the eventual structure of American banking will
depend to a large extent on the structure that is in
place now and will not inevitably converge to that
of Canada.
A more realistic comparison might be with California, which has explicitly allowed branching since
1909. California has 431 banks serving its 29.1
million population. The California banks per capita
ratio applied to the entire United States implies about
3,700 banks. Still, such projections are precarious
because they do not take into account advantages
of incumbent banks in markets. At best, they represent an upper limit to what one might expect to
happen. Given the divergence between the number
of banks predicted by the ratios for Canada and
California, the only prediction one can safely make
is that the number of banks in the United States will
fall but not by much.

NOVEMBER/DECEMBER

1990

Suppose, however, that the drastic reductions in
the number of banks implied by the ratio for California or even for Canada were to come to pass. What
would be the implications for consumer welfare? A
rough idea of the answer may be inferred from a
simulation of the potential for mergers in local banking markets in the United States (Burke 1984). The
analysis simulated the maximum extent of concentration and minimum number of firms remaining in
a market after the consummation of all possible
mergers that did not violate the Department of Justice
Merger Guidelines. 6 No matter how many banks a
market started with, the number of banks remaining in the market after all mergers were consummated
averaged from four to six, assuming no entry from
out-of-market competitors or de novo banks. In some
markets, the number could fall as low as three before
triggering an antitrust challenge.
The implication of the simulation results is that
the number could fall substantially within most local
markets before constituting undue concentration
under the Department of Justice Merger Guidelines.
Thus it could be that the 56 nationwide banks suggested by the analogy with Canada might be more
than sufficient to preserve competition. Even if all
56 banks do not overlap in all markets, it is only
necessary that some overlap in each market. So long
as one accepts the Guidelines as a valid delineation
of levels of concentration that might harm consumer
welfare, one may infer that there is plenty of room
for consolidation before the number of banks falls
to levels with which regulators should be concerned.

More generally, Table III is a contingency table
showing the frequency of consolidated and decentralized banks by size class in a sample of twelve
states that have adopted statewide branching
sometime during the last twenty years.7 As the
analysis of an earlier section implied, the larger the
bank holding company, the more likely it is to consolidate its subsidiaries into branches. Indeed, that
is exactly what the frequencies in each column of
Table III imply. The purpose of the analysis is to
test whether the tendency to consolidate is statistically independent of size, since it is mostly larger
organizations that operate on an interstate level and
might therefore be likely to take advantage of interstate branching authority.
The strength of the association, measured as a x2
statistic, just fails the test of statistical significance
at the 5 percent level of confidence. Thus while the
numbers in the contingency table point to an increasing percentage of consolidation as organization size
grows, the relationship is not strong in a statistical
sense. As a result, the experience of bank holding
companies within states that have liberalized their
branching laws does not provide a strong basis for
predicting that all interstate bank holding companies
will automatically convert their subsidiaries to
branches if the law so allows, at least in the short
term. Despite the compelling arguments for consolidation of subsidiaries into branches, there are
apparently sufficient benefits to decentralization to
make the outcome vary widely across companies.

Having considered the banks likely to be affected
by interstate branching powers, the possible results
of consolidation, and the implications for competition, one question remains: How likely are bank
holding companies to consolidate their subsidiaries?
One way to predict the likelihood of consolidation
if interstate branching laws are liberalized is to look
at the experience of bank holding companies in states
that have liberalized their branching laws, since
they would provide a situation analogous to the repeal
of McFadden. At least one case study of Virginia
showed that when state branching restrictions were
liberalized, the majority of banks converted their subsidiary banks to branches (Kyrus 1982).

7 The states are Florida, Louisiana, Massachusetts, Michigan,
New Jersey, New York, Ohio, Oklahoma, Tennessee, Texas,
Virginia, and West Virginia. Bank holding companies with
combined bank assets of less than $1 billion are excluded in order
to limit the sample to companies with statewide operations
instead of operations limited to one local area.

6 According to the guidelines, mergers in unconcentrated markets
(Herfindahl index below 1000) would not be challenged, those
in moderately concentrated markets (Herfindahl index between
1000 and 1800) might be challenged if they raised the Herfindahl by at least 100 points, and those in highly concentrated
markets (Herfindahl index above 1800) might be challenged if
they raised the index by at least 50 points (Feder/ Register,
June 29,1984).
FEDERAL

RESERVE

Table III

Consolidation vs. Decentralization
Banks Larger than $1 Billion in Assets
$1-5
Billion

$5-10
Billion

Over $10
Billion

Branches

25
(46.30%)

13
(59.09%)

25
(71.43%)

63

Subsidiaries

29
(53.70%)

9
(40.91%)

10
(28.57%)

48

54

22

35

111

Column

Total

Summary

statistics:

Note:
BANK

Numbers

OF RICHMOND

$ = 5.526

in parentheses

(Critical
denote

Row
Total

x1,os,2 .,r, = 5.99)
column

frequencies.

15

There are some qualifications to the results. First,
most of the decentralized bank holding companies
are operating in states that have liberalized their
branching restrictions in the last five years, for
example, Michigan, Ohio, and Texas. Second, at the
time of this w&g there appears to be a trend toward
consolidation that may not yet have ‘finished. For
example, five of the bank holding companies in the
sample announced or completed consolidations since
June 1990. As a result, the numbers may reflect more
consolidation over time, especially among the larger
organizations. Finally, consolidation seems irreversible, since there are apparently no cases of consolidated banks that elected to spin off branches
into subsidiaries. The implication of the qualifications is that at this time the contingency tables might
not yet reflect long-run results.

CONCLUDINGCOMMENTS
The liberalization of geographical restraints on
banking and other depository institutions has been
a prominent feature of banking in the United States
since the failures of the late 1920s and early 1930s.
The liberalization has picked up momentum during
the 198Os, during which barriers fell to both statewide branching and interstate bank holding company
expansion. Given all that has happened, it would
seem logical for the next step to be to relax restrictions on branching across state lines.
Despite
branching,

the arguments in favor of interstate
it is not likely that permitting it would

immediately revolutionize the banking structure of
the United States; Assuming all interstate,, bank
holding companies were to consolidate, the number
of large banks, most of which do not combete directly
with each other,, would fall. J3ut while interstate
branching could lead to some interstate expansion
that had not occurred before, it would not likely have
much effect on the number of small banks, at least
those that have survived the competition in states
with liberal branching laws. And given that some bank
holding companies have chosen to retain a decentralized structure within their states, it is possible that
some interstate organizations could remain decentralized as well.
Still, a long-term benefit of permitting interstate
branching is that .it could pave the way for the
development of a truly nationwide banking system
with geographically diversified lending and funding
sources. Since interstate branching would enable
interstate organizations to operate at lower cost than
under the current system, it could facilitate the
development of expertise in interstate operations.
While nationwide organizations might not develop
immediately because of capital constraints,and limited
knowledge of markets outside of banks’ local areas,
the ability to expand in a sound manner will increase
as bankers’become accustomed to operating branch
networks over wider areas. In the end, the result
could be a mixture of large banks with nationwide
branch networks and markets and smaller banks
specializing in local markets.

REFERENCES
Berger, Allen N., and David B. Humphrey. “Interstate Banking
and the Payments System.” Journalof FinamiaLServim Research 1 (Ianuary 1988): 131-145.

Breckenridge, Roeliff M. Th Habty of Banking in Canada.
National Monetary Commission. Washington: Government
Printing Office, 1910.
Burke, Jim. “Antitrust Laws, Justice Department Guidelines,
and the Limits of Concentration in Local Banking Markets.”
Staff Studies 138. Washington: Board of Governors of
the Federal Reserve System, 1984.
Calomiris, Charles W. “Is Deposit Insurance Necessary?: A
Historical Perspective.” Journa/ of EconomicHhtory 50 dune
1990): 283-295.
ECONOMIC

REVIEW.

and Chin Banking. New

Chapman, John M., and Ray B. Westerfield.
New York: Harper & Brothers, 1942.

Board of Governors of the Federal Reserve System. AL-Bank
statr’stiw, UnitedStnm, 1896-f 9%. Washington: Government
Printing Office, 1959.

16

Cartinhour, Gaines T. Branch, G&p
York: Macmillan, 193 1.

Bran& Ban&g.

Clair, Robert T., Paula K. Tucker, and Thomas F. Siems.
“Removing the Remaining Barriers to Interstate Banking.”
Th Bankm Magazine, January/February 1991, pp. 11-17.
Comptroller

of the Currency.

Downs, Anthony. An Ihnomic
Harper & Row, 1957.

Ann.& Report, 1895.
Thory of Lhnocracy. New York:

E&land,
William S., Robert K. Olsen, and Robert M.
Kurucza. “Recent Developments
in Interstate Branch
Banking.” Memorandum, Morrison & Foerster, Washington,
D.C., June 18, 1990.

NOVEMBER/DECEMBER

1990

Evanoff, Douglas D. “Branch Banking and Service Accessibility.” Journalof Money, CreditandBanking 20 (May 1988):
191-202.

. “The McFadden Act: The Next Landmark to
Go.” BonRing .!@an.ribn Reporter 9, April 16, 1990,
pp. 3-4.

Federal Reserve Board. Brat& Banking in tke United States.
Federal Reserve Committee on Branch, Group, and Chain
Banking, 1933a.

Greenspan,
Alan. Testimony
before the Committee
on
Banking, Housing, and Urban Affairs, United States Senate,
July 12, 1990.

Bran& Banking in Cahjhzia. Federal Reserve
Committee on Branch, Group, and Chain Banking, 1933b.

Key,

. Bank Suspensins in tke United States, 1892-l 931.
Federal Reserve Committee on Branch, Group, and Chain
Banking, 1933~.

Leggett, Mark. “A Proposal: Interstate Consolidation of Bank
Holding Company-Controlled
Banks.” NCNB Corp.,
October 30, 1989.
U.S. Department of the Treasury. Geographical
Resthions
ComtnenGl Banking in tke United States, 198 1.

Banking Expansion

ECONOMIC

REVIEW
(Volume

Federal
January/February

March/April

Reforming

Deposit

1990

76)

Bank of Richmond

Lessons from the Savings

Robert

Interest

Michael Dotsey &
Anatoli Kuprianov
Jeffrey M. Lacker &
John A. Weinberg
Robert L. Hetzel
Robert L. Hetzel

Price Volatility

for Price Stability
Price Stability: A Proposal

Reflections on the Strategy of Monetary
The EMU: Forerunners and Durability
A Yankee Recipe for a EuroFed Omelet
Fifth District Bank Performance
and Unit

Rate Expectations

Thomas M. Humphrey
Robert L. Hetzel
William E. Cullison

Countries

Robert P. Black
Robert F. Graboyes
Robert F. Graboyes
John R. Walter &
Donald L. Welker
Yash P. Mehra

Policy

Labor Costs as Predictors

of Inflation

and the Slope of the Money

Market

Yield Curve

Response

to Supply

Timothy Cook &
Thomas Hahn
Ching-Sheng
Mao
David B. Humphrey

The Macroeconomic
Effects of Government
Spending
Why Do Estimates of Bank Scale Economies Differ?
November/December

The Case for Interstate Branch Banking
Ricardo Versus Thornton on the Appropriate
Credit Controls: 1980
FEDERAL

RESERVE

Monetary

BANK

OF RICHMOND

P. Black

James Parthemos
Michael D. Bordo

and Loan Crisis

Fisherian and Wicksellian
Price-Stabilization
Models in the
History of Monetary Thought
Free Enterprise and Central Banking in Formerly Communist
Is Saving Too Low in the United States?

Real Output
September/October

Insurance:

and Stock

A Mandate
Maintaining

July/August

INDEX

In Support of Price Stability
The Federal Reserve Bank of Richmond:
Governor Seay and the
Issues of the Early Years
The Lender of Last Resort: Alternative
Views and Historical Experience

Takeovers

May/June

Reserve

on

White, Roger S. “The Evolution of State Policies on Multi-Office
Banking from the 1930’s to the Present.” In U.S. Senate,
Compendium of Issues Re/ating to Branching by Financial
Znstifutionr, pp. 43-82. Subcommittee on Financial Institutions, Committee on Banking, Housing, and Urban Affairs.
94th Congress 2d Session. Washington: Government
Printing Office, 1976.

Flannery, Mark J., and Christopher M. James. “Market Evidence on the Effective Maturity of Bank Assets and
Liabilities.” Joucval of Money, C&it and Banking 16
(November 1984, Part I): 435445.
Carter H. “Notes on ‘1992.”
Reporter 8, August 7, 1989, p. 2.

of the
Fedwal

Kyrus, Nicholas C. “Branching Laws and Banking Structure:
Banker, September
The Virginia Experience.” South
1982.

Fischer, Gerald C., and Carter H. Golembe. “The Branch
Banking Provisions of the McFadden Act as Amended:
Their Rationale and Rationality.” In U.S. Senate, Cornpendium of Isrues Reiating to Branching by Financzbl Insti~tions,
pp. 1-42. Subcommittee on Financial Institutions, Committee on Banking, Housing, and Urban Affairs. 94th
Congress 2d Session. Washington: Government Printing
Office, 1976.

Golembe,

Sidney J. “Mutual Recognition:
Integration
Financial Sector in the European Community.”
Re.wve Bulhin 75 (September 1989): 591-609.

Shocks

David L. Mengle
Thomas M. Humphrey
Stacey L. Schreft
17

Ricardo Versus Thornton
Monetary

Response

on the Appropriate
to Supply Shocks

Thomas M. Humphmy

David Ricardo (1772-1823)

Henry Thornton (1760-1815)

Introduction:
Supply Shocks and Policy Choices
Exogenous supply disturbances such as the recent
Iraqi oil shock deliver a double blow to the economy.
By rendering material or energy inputs scarcer and
dearer, they raise production costs per unit of output. In so doing they discourage production and raise
product prices. The resulting rise in the general price
level shrinks the buying power of spenders’ money
balances, thus reducing the aggregate demand for real
output. Real activity slackens as prices rise.
Of course the adverse price and output effects of
a supply shock would hardly be expected to last
forever. For the depressed levels of output and
employment would put downward pressure on wage
rates. And the resulting fall in wages would tend to.
countervail the impact of dearer energy and material
inputs on production costs, thereby restoring aggregate prices, output, and. employment to their .preshock levels. If wages are downwardly sticky,
18

ECONOMIC

REVIEW,

however, such adjustment cannot be instantaneous.
During the interim the economy feels the effects of
the shock.’
Because supply shocks are painful, they raise the
question of the appropriate monetary response. What,
‘if anything, should the central bank do to counter
the adverse price and output effects of a shock?
Essentially the policymakers’ choices are three. They
can leave monetary policy unchanged and do nothing
to mitigate the shock. Alternatively they can accommodate the shock with expansionary policy in an
effort to dampen its depressive output effects.
Finally, they can employ contractionary policy to
reverse the price rise caused by the shock. Of these
alternatives, expansionary policy runs the risk of
.’ For more on the conventional sticky wage analysis of supply

shocks and their policy implications see Bruno and Sachs (1985),
DornbuSch and Fischer (1984), Feldstein (1990), Fischer (1985),
Gordon (1981), Mishkin (1989), Shapiro (1987), and Solow
(1980). The present section draws heavily from these sources.

NOVEMBER/DECEMBER

1990

putting further upward pressure on prices. By
contrast, contractionary policy risks worsening the
recession caused by the shock. A policy of holding
the money stock constant of course avoids these
risks, albeit at the cost of ameliorating neither of the
shock’s adverse effects.
Which of the foregoing alternatives will the
policymakers select? Their choice will depend to
some degree on their belief in the neutrality or nonneutrality of money stock changes on real output and
employment. Those believing in money’s short- as
well as long-run neutrality will opt for contractionary
policy. They will reason that if money has no real
effects, then expansionary policy is powerless to
stimulate real activity whereas contractionary policy
can stabilize prices at their pre-shock level at the cost
of no additional lost output and employment. Since
stable prices reduce business risk and uncertainty,
contractionary policy will be judged the best.
Contrariwise, policymakers believing in money’s
short-run non-neutrality will opt either for expansionary or constant money-stock policies. Expansionary
policy will be selected if its beneficial output and
employment effects are judged to exceed its inflation costs. Only if those costs are seen to outweigh
the benefits will expansionary policy be rejected in
favor of constant money-stock policy. Seldom will
contractionary policy be chosen by believers in
money’s non-neutrality.
Given that such policy
produces additional output losses on top of those
already caused by the shock, it will be regarded as
too costly to conduct.
That supply shocks may require different monetary
responses depending on the neutrality or nonneutrality of money is hardly a new idea. It was
thoroughly established in the writings of David
Ricardo and Henry Thornton in the first decade of
the nineteenth century. Ricardo, a strict believer in
money’s long- and short-run neutrality with respect
to output and employment, argued that supply shocks
should be countered with monetary contraction.z
2 Ricardo was not always consistent on the neutrality proposition. In certain isolated passages (for example, WWS, III, 94)
he remarked that sudden and sharp contraction can bring painful real effects which only gradual contraction can avoid. His
remarks have been interpreted as a rejection of the short-run
neutrality proposition [Ahiakpor (1985), Hollander (1979)J. More
likely they are mere exceptions or minor qualifications to it
[de Vivo (1987), p. 189), O’Brien (1981, p. 371), Peake (1978)].
Generally he adhered to the neutrality proposition and made no
distinction between the short run and the long. The proposition’s prevalence in the bulk of his monetary writing supports
O’Brien’s (1975, p. 164) judgment that “Ricardo, focusing as
usual on successive periods of long-run equilibrium, denied the
damage of deflation and the stimulating effect of rising prices.”
FEDERAL

RESERVE

Thornton,
a believer in money’s short-run nonneutrality, opposed monetary contraction and argued
instead that the money stock should be held constant in the face of supply shocks. Both parties agreed
that money has no long-run (permanent) real effects.
On this matter Thornton was every bit as much a
strict classical quantity theorist as Ricardo. At issue
was the short-run (temporary) non-neutrality of
money. The following paragraphs show how this
issue influenced the respective policy prescriptions
of Ricardo and Thornton just as it undoubtedly continues to influence the Fed’s response to oil shocks
today.
David Ricardo’s

Analysis

Textbook allegations to the contrary, economic
analysis of supply shocks and the appropriate policy
response did not begin with the OPEC price hikes
of 1973-74.3 As early as the first decade of the nineteenth century, David Ricardo (1772-1823) and
Henry Thornton
(1760- 18 1S), the preeminent
monetary theorists of the English Classical School,
analyzed such shocks in the form of harvest failures.
They were particularly concerned with how to deal
with external gold drains triggered by the impact of
bad harvests on domestic monetary requirements and
the balance of payments. At issue was whether such
drains should be allowed to contract the money
supply and bring prices back to their pre-shock level.
Ricardo argued that they should. Assuming a given
initial money stock, his argument was that English
harvest failures would, by reducing real output and
thus raising general prices, lower money’s purchasing
power in England relative to its purchasing power
abroad. Traders would then find it advantageous to ship
monetary gold abroad to where its value was highest.
Ricardo maintained that the resulting gold drain should
be allowed to contract the English money stock until
prices fell to their pre-shock level. In terms of the equation of exchange P = MVIQ, with velocity V constant,
the shock-induced fall in real output Q requires an
equiproportionate reduction in money M to stabilize
prices P at their pre-shock level4 As Ricardo put
3 See Barro (1990, p. 114) and Gordon (1981, p. 17) for textbook statements identifying 1973 as the year when supply-shock
analysis became important to macroeconomists.
4 Ricardo’s use of the exchange equation to analyze aggregate
price determination is well known. In his notes on Jeremy
Bentham’s manuscript “Sur Les Prix” he wrote: “May we not
put the mass of commodities of all sorts on one side of the
%&--and the amount of money multiplied by the rapidity of
its circulation on the other. Is not this in all cases the regulator
of prices?” (K&r, III, 3 11) Here is a precise verbal statement
of the equation P = MVIQ.
BANK

OF RICHMOND

19

it in the Appendix to the fourth edition of his Tire
H&h Priceof But&n, A Proofof the Depreciationof Bank
Notes:

In short, wage-price flexibility renders monetary
stimulus powerless to cushion real shocks.

England, in consequence of a bad harvest, would come
under the case . . . of a country having been deprived of
a part of its commodities,
and therefore requiring a
diminished amount of circulating medium. The currency
which was before equal to her payments would now become
superabundant and relatively cheap, in . . . proportion . . .
of her diminished production; the exportation of this sum,
therefore, would restore the value of her currency to the
value of the currencies of other countries (Wok, III, 106).

Ricardo

In prescribing monetary contraction,
Ricardo
assumed money’s output and employment effects
were negligible so that contraction would not amplify
the depressive impact of the shock. His policy
prescription manifested his belief in the neutrality of
money.
That same belief led him to reject expansionary
remedies. Such remedies purport to stimulate production thereby counteracting, wholly or partially,
the output losses due to the shock. In Ricardo’s view,
however, monetary accommodation could no more
relieve the real effects of a shock than contraction
could exacerbate them. “Money,” he said, “cannot
call forth goods” (J#%& III, 301). Likewise, when
asked to give his opinion on the output stimulus provided by “fictitious
capital,” a then-current
euphemism for monetary expansion, Ricardo replied:
“I believe that on this Subject I differ from most other
People. I do not think that any Stimulus is given to
Production by the Use of fictitious Capital, as it is
called,” arising from extra issues of money (K&r,
V, 446).
To be effective, such overissue must inflate
product prices faster than it does money wages with
the resulting fall in real wages and corresponding rise
in real profits inducing employers to hire extra labor
to expand production.
According to Ricardo,
however, money wage flexibility prevents this outcome. Indeed, wages adjust virtually as rapidly as
prices to monetary change so that lags of wages
behind prices are but fleeting phenomena. In his own
words:
There is but one way in which an increase of money no
matter how it be introduced into the society, can augment
riches, viz at the expense of the wages of labour; till the
wages of labour have found their level with the increased
prices which the commodities will have experienced, there
will be so much additional revenue to the manufacturer
and farmer; they will obtain an increased price for their
commodities, and can whilst wages do not increase employ
an additional number of hands, so that the real riches of
the country will be somewhat augmented. A productive

20

ECONOMIC

REVIEW,

labourer will produce something more than before relatively to his consumption, but this con be otdy of monmtory duration (WorRr, III, 318-19, emphasis added).

Diagrammed

Writing more than sixty years before the invention of supply and demand curves, Ricardo expressed himself in words and numerical examples
rather than in geometrical diagrams. Nevertheless
it may be useful to illustrate his analysis with the
aid of conventional aggregate demand and supply
schedules
located in price-output
space (see
Figure 1). Drawn for a given nominal money stock,
the aggregate demand schedule slopes downward
because of a real balance effect on expenditure: a fall
in prices raises real cash balances thereby increasing the quantity of goods demanded. The vertical
aggregate supply schedule reflects Ricardds assumption of the neutrality of money: given perfect wageprice flexibility, the quantity of output supplied is
invariant to changes in money and hence prices.
Starting from initial demand-supply equilibrium at
point A, a harvest failure shifts the aggregate supply
schedule to the left. Equilibrium moves to point B
along the initial demand schedule yielding lower
output and higher prices. Monetary contraction then
shifts the aggregate demand schedule downward.
Equilibrium moves to point C where prices are
restored to their pre-shock level. Monetary contraction has no effect on output but stabilizes prices at
their pre-shock level.
By the same token, monetary expansion and the
resulting rightward shift in the demand curve would
do nothing to counter the output loss of the shock.
It would merely move the price level to a higher point
along the shock-displaced
supply curve with no
corresponding rise in output. Since price stability in
the face of the shock can be costlessly attained
whereas monetary expansion and inflated prices yield
no benefits, contractionary policy is preferred.
Henry Thornton’s

Analysis

Opposed to Ricardo was Henry Thornton, banker,
member of Parliament, philanthropist who before his
marriage donated six-sevenths of his considerable
income to charity and at least one-fourth thereafter,
and author of the classic An Enpiry into the Nature
and Effects of the Paper Cmdt of G-eat Britain ( 1802).
Thornton
objected to Ricardo’s prescription of
NOVEMBER/DECEMBER

1990

Figure

1

RICARDO’S ARGUMENT
Price
Level

0

I

AS’

if

AS (Aggregate

Supply)

and adjusted sluggishly in response to price falls such
that when those falls occurred real wages would rise
to inhibit economic activity. For this reason he maintained that monetary contraction risked the danger
of disrupting markets and causing further falls in
output and employment. As he put it in his Paper
Cmdit, monetary contraction and the resulting
diminution in the priceof manufactures . . . may also, if
carried very far, produce a suspension of the labour of
those who fabricate them. The masters naturally turn off
their hands when they find their article selling exceedingly
ill. It is true, that if we could suppose the diminution of
bank paper to produce permanently a diminution in the value
of all articles whatsoever, and a diminution, as it would
then be fair that it should do, in the rate of wages also,
the encouragement to future manufactures would be the
same, though there would be a loss on the stock in hand.
The tendency, however, of a very great and sudden
reduction of the accustomed number of bank notes, is to
create an WUSUO~
and temporary
distress, and a fall of price
arising from that distress. But a fall arising from temporary
distress, will be attended probably with no correspondent
fall in the rate of wages; for the fall of price, and the
distress, will be understood to be temporary, and the rate
of wages, we know, is not so variable as the price of goods.
There is reason, therefore, to fear that the unnatural and
extraordinary low price arising from the sort of distress of
which we now speak, would occasion much discouragement
of the fabrication of manufactures (1802, pp. 118-19).

I

output

Along the aggregate demand curve, rising prices shrink
real cash balances and thus the quantity of goods demanded. Perfect wage-price flexibility fixes the aggregate
supply curve at the actual (and potential) level of output.
Point A denotes initial supply-demand equilibrium. A crop
failure shifts the supply curve leftward. Equilibrium moves
to point B with lower output and higher prices. Monetary
contraction
then shifts the demand curve downward.
Equilibrium moves to point C where prices are stabilized
at their pre-shock level with no additional loss of output.
Ricardo’s conclusion:
Since price stability can be costlessly attained, crop failures should be countered with
monetary contraction.

monetary contraction. He argued that at a very
minimum the money stock should be held constant
in the face of real shocks. He agreed that harvest
failures and raw material shortages would, by boosting
production costs, act to raise prices. “[B]ad harvests,”
he wrote, “by raising the price of bread, have in some
degree lifted up that of labour, and of all commodities.
Our prices may have also been partly augmented by
the enhancement of the cost of raw materials brought
from other countries” (1802, p. 263).
Besides raising prices, crop failures, Thornton
noted, would necessitate extraordinary imports of
food paid for by exports of monetary gold. But he
did not agree with Ricardo that the gold drain should
be allowed to contract the money stock. Believing
as he did in the short-run non-neutrality of money,
Thornton was convinced that monetary contraction
was hardly the, proper way to deal with adverse supply
shocks, He thought that money wages were sticky
FEDERAL

RESERVE

To avoid this danger, he favored offsetting or
sterilizing the gold outflow with compensating note
issues by the Bank of England. The additional paper
would go to replace the departed gold, thus maintaining constancy in the money stock. He was even
willing to risk temporary suspension of the gold
standard rather than contract the money supply in
the face of supply shocks. To him, inconvertibility
and the consequent inability to redeem paper in gold
at a fixed price on demand was preferable to monetary
contraction. Particularly so when such contraction,
by disrupting real activity, would impair the
economy’s ability to generate export surpluses that
would be paid for by specie inflows upon the postshock return to gold. To put the economy through
the wringer of monetary contraction, he said, is to
compel
the manufacturer, on account of the unusual scarcity of
money . . . to slacken, if not suspend, his operations. To
inflict such a pressure on the mercantile world as necessarily causes an intermission of manufacturing labour, is
obviously not the way to increase that exportable produce,
by the excess of which, above the imported articles, gold is
to be brought into the country (1802, p. 118).

Sources

of Non-Neutrality

Although Thornton opposed monetary contraction, he did not go to the opposite extreme and
BANK

OF RICHMOND

21

recipients. Owing to these forced saving effects he
concluded that “It has thus been admitted that paper
possesses the faculty of enlarging the quantity of
commodities by giving life to some new industry”
(p. 239).

advocate expansionary monetary policy to accommodate supply shocks. To be sure, he admitted that
such expansion could stimulate output and employment temporarily, thus dampening the real effects
of the shocks. These stimulative effects, he said,
came from three sources.
First were sellers’ efforts to maintain fixed
inventory-to-sales ratios. Their efforts, which ensured
that any money-induced
rise in sales would be
matched by a corresponding rise in production for
inventory, were described by Thornton as follows:
It may be said . . . and not untruly, that an encreased issue
of paper tends to produce a more brisk demand for the
existing goods, and a somewhat more prompt consumption
of them; that the more prompt consumption supposes a
diminution of the ordinary stock, and the application of
that part of it, which is consumed, to the purpose of giving
life to fresh industry; that the fresh industry thus excited
will be the means of gradually creating additional stock,
which will serve to replace the stock by which the industry
had been supported; and that the new circulating medium
will, in this manner, create for itself much new employment
(1802, p. 237).

Thornton

Third was the shift in real income from wage
earners to profit recipients caused by the lag of wages
behind prices. Because profit recipients tended to
save and invest more than wage earners, this income
shift would encourage capital formation thus increasing actual and capacity real output. Here is the origin
of the famousJbrcedsaGngdo&~e
according to which
the redistributive effects of inflation divert resources
from consumption to investment. Of these forced
saving effects, Thornton (1802, p. 239) wrote:
It must be also admitted, that, provided we assume an
excessive issue of paper to lift up, as it may for a time, the
cost of goods though not the price of labour, some augmentation of stock will be the consequence; for the labourer,
according to this supposition, may be forced by his necessity to consume fewer articles, though he may exercise the
same industry (1802, p. 239).

Thornton likewise alluded to the possibility of “a
similar defalcation of the revenue of the unproductive members of the society,” namely fixed-income
ECONOMIC

REVIEW,

D&rammed

Thornton’s analysis, like Ricardo’s, can be depicted
with aggregate demand and supply schedules (see
Figure 2). Thornton’s aggregate supply schedule,
however, differs from Ricardo’s. As noted above,
Ricardo’s supply schedule is vertical throughout its
range, reflecting his assumption of complete wageprice flexibility such that changes in aggregate demand have no influence on output and employment.

Second was lagged wage adjustment which ensured
that a monetary stimulus would temporarily raise
prices relative to wages. As pointed out by Jurg
Niehans (1990, p. 108), Thornton held that wages
were set for extended periods of time whereas prices
related to instantaneous transactions. This meant that
wages were less volatile than prices and thus less
responsive to monetary impulses. Consequently
monetary expansion would produce a larger initial
rise of prices than wages. The resulting fall in real
wages would spur real output and employment.

22

Nevertheless, he opposed pursuing these expansionary real effects because of the high inflationary
costs of doing so. Indeed he condemned all forced
saving and the accompanying price inflation as
“attended with a proportionate hardship and injustice”
(p. 239). To him, inflation was an unmitigated evil
to be avoided at all costs, even if it meant giving up
the associated gains in output and employment.
These gains, he thought, could never compensate
for the uncertainty, injustice, and social discontent
generated by inflation. In short, he favored a policy
of holding the money stock constant on the grounds
that an accommodative policy’s inflationary costs
would far exceed its output and employment benefits.

By contrast, Thornton’s supply schedule slopes upward to the point of full employment, reflecting his
assumption that higher prices operating through wage
lags and forced-saving effects induce higher levels of
output and employment. In his own words:
. . . additional industry will be one effect of an extraordinary emission of paper, a rise in the cost of articles will be
another.
Probably no small part of that industry which is excited
by new paper is produced through the very means of the
enhancement of the cost of commodities (180’2, p. 237).

In short, money-induced inflation stimulates output along the positively sloping portion of the
supply schedule. Provided the economy operates in
this range, output gains are possible. Only at the
economy’s absolute full-capacity level of output are
these gains impossible to obtain. There Thornton’s
supply schedule becomes vertical (perfectly inelastic).
At that point:
. . . it is obvious, that the antecedently idle persons to
whom we may suppose the new capital to give employ, are
limited in number; and that, therefore, if the encreased
[monetary] issue is indefinite, it will set to work labourers,

NOVEMBER/DECEMBER

1990

a new equilibrium at point B with higher general
prices and lower real output. Monetary contraction
could, by shifting the aggregate demand curve down
and to the left, restore prices to their pre-shock level
at point C. But output would be depressed below
its already low level produced by the shock. Because
of this depressive effect, monetary contraction should
be avoided.

Figure 2

THORNTON’S ARGUMENT
Price
Level
1
1

AS’
I8..-

I 8’
@

AS

/ (Aggregate
-,’
SUPPlY)

Alternatively, monetary expansion could, by shifting the demand curve up and to the right, stabilize
real output at its pre-shock level. But such output
stabilization would involve a costly further price
rise to point D. If the price rise generated additional uncertainty, injustice, and social discontent
whose costs exceeded the benefits of output stabilization then accommodative policy should not be
undertaken.

AD”
AD

I
0

AD’

output

Aggregate
supply becomes perfectly inelastic at full
employment. Point A denotes initial equilibrium. A harvest
failure shifts the supply curve to the left. Equilibrium moves
to point B with lower output and higher prices. Monetary
contraction would shift the demand curve downward with
equilibrium
moving to point C. There prices would be
stabilized at their pre-shock level at the cost of extra
output losses. Alternatively,
monetary expansion would
shift the demand curve upward. Equilibrium would move
to point D. There output would be stabilized at its pm-shock
level at the cost of a further rise in price. To Thornton, the
costs of monetary contraction and expansion rendered
both actions unacceptable.
His advice: Hold the money
stock constant when supply shocks occur. Then rely on
wage adjustment and/or self-reversal of the shocks to
restore equilibrium
to point A.

Since neither monetary contraction nor monetary
expansion are desirable alternatives, it follows from
Thornton’s analysis that the money stock should be
held constant in face of the shock. In the long run,
equilibrium will in any case return to point A as the
shock proves to be temporary and/or wages and
prices fully adjust to clear the markets for labor and
output. A policy of maintaining a constant money
stock allows this self-equilibration process to occur
naturally without intervention. It does not exacerbate the temporary price or output effects of the
shock. True, it does not ameliorate these effects
either. But they will be relatively small and shortlived if the wage-price adjustment mechanism works
reasonably smoothly as Thornton thought it would.
Conclusion

of whom a part will be drawn from other, and, perhaps, no
less useful occupations. It may be inferred from this consideration, that there are some bounds to the benefit which
is to be derived from an augmentation of paper; and, also,
that a liberal, or, at most, a large encrease of it, will have
all the advantageous effects of the most extravagant emission
(1802, p. 236).

To summarize,
for Thornton
the classical
neutrality-of-money proposition holds only at absolute
full employment. Short of that point non-neutrality
prevails. Note also that the positively sloped portion
of Thornton’s supply schedule is drawn for a given
price of food and raw materials: rises in these particular prices shift the curve upward and to the left.
Thus starting from initial equilibrium at point A,
suppose a harvest failure or other real shock shifts
the supply schedule to the left thereby establishing
FEDERAL

RESERVE

The Ricardo-Thornton
exchange taught that
policymakers can respond to supply shocks either
with monetary contraction, with accommodative
monetary expansion, or with a constant money-stock
policy. These alternatives define the set of feasible
policy choices to this very day. Given their relevancy, which alternative should the Fed choose to
counter the effects of any future oil shock?
Clearly it should respond with Ricardian monetary
contraction if money affects only prices and not real
output. Conversely it should respond with monetary
expansion if money temporarily stimulates output
and the resulting social benefits exceed the costs of
higher prices. Lastly it should respond with Thornton’s constant money-stock policy if the beneficial
output effects of expansion would be exceeded by
its inflationary costs.
BANK

OF RICHMOND

23

probably narrow to Thornton’s constant money-stock
or accommodative policies. Of these, Thornton’s
policy appears to be the more prudent choice.
Especially so as oil shocks may prove to be selfreversing and monetary accommodation today could
generate expectations of similar accommodation in
all future episodes contrary to the Fed’s goal of
achieving long-run price stability. These considerations strongly suggest the advisability of Thornton’s
neutral or constant money-stock response to supply
shocks.

Since, contrary to Ricardo’s belief, money-stock
changes always seem to entail temporary real output and employment effects,5 the Fed’s choice would
s In addition to the sources of non-neutrality identified by
Thornton in his Pazxr Credit. such real effects mav stem (1) from
lags in nominal inierest rates behind inflation so that real rates
change, (2) from imperfect information and the resulting confusion of monetary shocks for relative price ones calling for real
adjustments, and (3) from long-term contracts that prevent the
private sector from responding to disturbances as quickly as the
policymakers. Of these, Thornton mentions the first in his
y3ay$) 18 11 parliamentary speech on the Bullion Report (pp.

REFERENCES
O’Brien, D. P., 198 1. “Ricardian Economics and the Economics
of David Ricardo,” OxfbdEGonomic Papers, 33 (November),
352-86.

Ahiakpor, James, 1985. “Ricardo on Money: The Operational
Significance of the Non-neutrality of Money in the Short
Run,” History of Pohtical Economy, 17 (Spring), 17-30.
Barro, Robert, 1990. Macroeconomics, 3rd edn.
John Wiley.

, 1975. Tire Classicaf Economists. Oxford, Oxford
University Press.

New York,

Bruno, Michael, and Sachs, Jeffrey, 1985. Economics of WXdwide Stagflation. Cambridge, Mass., Harvard University
Press.

Peake, Charles, 1978. “Henry Thornton and the Development
of Ricardds Economic Thought,” History of Politicl Economy,
10 (Summer), 193-212.

de Vivo, G., 1987. “Ricardo, David.” In The Nm Pa&awe: A
Dictionaty ofEconomics, ed. John Eatwell, Murray Milgate,
Peter Newman, volume 4. New York, Stockton Press.

Ricardo, David, 1951-1955. Th Wbrh and Correspondence of
David Ricardo. Edited by Piero Sraffa. Eleven volumes.
Cambridge, Cambridge University Press.

Dornbusch, Rudiger, and Fischer, Stanley, 1984. Monoeconwnics,
3rd edn., New York, McGraw-Hill.

Shapiro, Matthew, 1987. “Supply Shocks in Macroeconomics.”
In The New Pa/grave: A Dictionary of Economics, ed. John
Eatwell, Murray Milgate, Peter Newman, volume 4,
New York, Stockton Press.

Feldstein, Martin, 1990. “The Fed Must Not Accommodate
Iraq,” Th Wall Street Journal, August 13, p. A-10.

Solow, Robert, 1980. “What to Do (Macroeconomically) When
OPEC Comes.” In Rational Expectations and Economic
PO&J, ed. Stanley Fischer, chapter 8. Chicago, University
of Chicago Press.

Fischer, Stanley, 1985. “Supply Shocks, Wage Stickiness, and
Journal of Money, Credit and Banking,
Accommodation,”
17 (February), l-15.
Gordon, Robert, 1981. Monoeconomics, 2nd edn.,
Little, Brown and Company.

Boston,

Thornton, Henry, 1802. An Enquiry into the Nature and Effects
of the Paper Credit of hat
Bri>ain. Reprinted Fairfield,
New Jersey, Kelley, 1978.

Hollander, Samuel, 1979. The Economtis of David Ricardo.
Toronto, University of Toronto Press.
Mishkin, Frederic, 1989. Th Economics of Money, Banking, and
FinancialMa~ts, 2nd edn., Glenview, Ill., Scott, Foresman.

1811. Two Speeches on the Bullion Report, May
1812. Reprinted as Appendix III of his Paper Credit.
Fairfield, New Jersey, Kelley, 1978.

Niehans, Jurg, 1990. A History of Economic Thory: Ciak
Contributions, f720-1980. Baltimore, Johns Hopkins University Press.

24

ECONOMIC

REVIEW,

NOVEMBER/DECEMBER

1990

Credit Controls:

1980

Stacq L. Schreft*
I.
Government price control programs in the U.S.
began over two hundred years ago. More recently,
credit controls, which are a special case of price controls, entered the arsenal of policy instruments. Credit
control programs involve regulation of either the price
of credit-interest
rates-or the quantity of credit extended for various purposes.a Credit controls can
be S&?&W or general. Selective controls affect the
price or quantity of specific types of credit, whereas
general controls are designed to affect the aggregate
amount of credit used.b
The most recent implementation of credit controls
in the U.S. was in the spring of 1980, under the
Carter Administration. Surprisingly, to date there has
been no comprehensive study of the 1980 experience. To fill this gap, this article focuses on the
(1) 1980 credit control experience, (2) history of the
legislation that made those controls possible, and
(3) economic and political motivation for using such
controls. The 1980 episode warrants close scrutiny
because it teaches three lessons. First, credit
NOTE:

Footnotes are indicated by lettetx Endnotes are indicated
by numben and arz located befoorethe References. In
general, endnotes contain oniy bibliographical information.

l I would
like to thank Robert Black, Kathryn Combs, Tim
Cook, Marvin Goodfriend, Bob Hetzel, Tom Humphrey, Jeff
Lacker, and Ray Owens for valuable comments on an earlier
draft. They along with my other colleagues in the Research
Department at the Richmond Fed, the library and statistics staffs
of the Richmond Fed, the staff of the Jimmy Carter Library,
the Freedom of Information Office of the Federal Reserve Board,
Jeremy Duffield, Paul O’Brien, and Tom Simpson provided
suggestions and assistance in locating essential research materials.
Marc Morris deserves special mention for his diligent research
efforts. The views expressed in this paper are the author’s and
do not necessarily reflect the views of the Federal Reserve Bank
of Richmond or the Federal Reserve System.

a Restrictions on the quantity of credit are a form of price control in that they are usually implemented through changes in the
terms of lending that alter the effective interest rate.
b The term “credit control” is sometimes used synonymously
with “credit allocation.” “Credit control” as used in this oaoer
refers only to policies that directly allocate credit, as in the case
of selective credit controls. In contrast, “credit allocation” is more
general, encompassing selective credit controls, but also referring to any policy that affects interest rates and thus indirectly
alters the distribution of credit..
FEDERAL

RESERVE

controls may not deliver the desired results. Second,
they may have unintended and unforeseen adverse
effects. Third, political realities may tempt policymakers to impose credit controls again despite unfortunate previous experiences with such policies.
Section II provides a brief review of credit control
experience before 1980. Selective credit controls
were first imposed in 194 1 and were used twice more
before 1952. These programs were all similar in that
they set minimum downpayments
and maximum
maturities for credit purchases of various consumer
durables. Congress repealed the legislation that permitted the use of such credit controls in 1953 and
reinstated the legislative authority in 1969 with the
passage of the Credit Control Act that year. Section
III examines the legislative history of the 1969 Act,
which conferred upon the President the authority to
direct the Board of Governors of the Federal Reserve
System (hereafter, the Board) to control “any or all
extensions of credit.” The sole upe of this authority
occurred in March 1980, when President Carter
invoked the Act. Section IV attempts to reconstruct,
using internal Administration
memoranda,
the
political and economic factors motivating Carter’s
decision to impose credit controls. The evidence
suggests that Carter’s advisers supported the use of
selective credit controls focusing on consumer credit
for political reasons.
Details of the Board’s 1980 credit control program
appear in Section V. Unlike the programs used in
the 1941 to 1952 period, the Board’s 1980 program
left decisions regarding credit allocation to individual
lenders. Section V argues that the program’s scope
and intent were not clearly communicated to the
public and thus caused considerable confusion.
Section VI documents the economy’s response to the
program, while Section VII argues that the control
program might have made the 1980 recession more
pronounced than it otherwise would have been,
largely because of its effect on consumers’ buying
psychology. Congressional debates over repeal of the
Credit Control Act in 1982 and subsequent repeated
attempts to reenact the legislation are described
in Section VIII. Finally, Section IX concludes by
considering the likelihood of credit controls in the
future;
BANK

OF RICHMOND

2.5

II.
THE U.S. EXPERIENCEWITH

CREDITCONTROLSBEFORE~~S~
America’s experience with price control programs
began while the country was in its infancy. The
New England colonies used wage and price controls
as early as 1630. After winning independence from
Great Britain, the Continental Congress and many
of the states also experimented repeatedly with wage
and price control programs. However, these policies
all failed to meet their goal of checking the inflation
generated by the printing of paper currencies to
finance federal and state expenditures. In response
to these failures, Congress passed a resolution on
June 4, 1780, recommending that the states repeal
all price controls because
it hath been found by experience that limitations upon the
prices of commodities are not only ineffectual for the purposes proposed, but likewise productive of very evil consequences to the great detriment of the public service and
grievous oppression of individuals.’

These early attempts at price controls did not
involve credit. In fact, America waited almost 150
years for its first taste of credit controls. In October
1917, to assist with the mobilization for World War
I, Congress enacted the Trading with the Enemy Act
(40 Stat. 415) that, under section 5(b), gave the
President the authority to regulate credit during wartime. However, credit controls were not imposed
during World War I, although wage and price controls were. President Roosevelt was the first. to use
the Presidential authority to regulate credit. On
August 9, 1941, he issued Executive Order #8843
directing the Board to regulate consumer credit to
ease the transition to a wartime economy. Presumably, by restricting consumer credit, overall credit
use and consumer spending would be reduced, freeing resources for a military buildup while restraining
inflationary pressures. Credit controls were viewed
as necessary for fighting inflation because the Federal
Reserve System (hereafter, the Fed) was committed to maintaining low interest rates, which made
its standard tools unavailable for controlling inflation.
The Board responded to Roosevelt’s executive
order by issuing Regulation W on September 1,
1941.2 Among its provisions, Regulation W set
minimum downpayments and maximum maturities
on credit purchases for consumer durables and semidurables. Regulation W (revised effective May 6,
1942) included anexpanded list of commodities and
covered all types of consumer credit (e.g. singlepayment loans, installment loans and sales, and
26

ECONOMIC

REVIEW,

charge account purchases). Total consumer credit
outstanding dropped by 50 percent over the first two
years that Regulation W was in use. This reduction
may in part have been caused by the unavailability
of many consumer durable goods, rather than the
credit control program. On August 8, 1947, while
the controls were in place, Congress passed legislation (61 Stat. 92 1) removing as of November 1 the
President’s authority to impose credit controls unless
the U.S. were again at war or a state of national
emergency were declared.
On November
17, 1947, President Truman
asked Congress for the authority to reinstate consumer credit controls to deal with the postwar
inflation. This authority was granted on August 16,
1948 (62 Stat. 92 l), and controls were imposed again
under Regulation W from September 20, 1948
until June 30, 1949, when the authority expired. This
was the first and only peacetime use of credit controls before 1980.
Selective credit controls also were imposed during the Korean War. Congress granted the Board
emergency authority for temporary controls through
section 601 of title VI of the Defense Production Act
of September 8, 1950 (89 Stat. 810).3 Under this
authority, the Board reestablished Regulation W,
instituting minimum downpayment
requirements
ranging from 10 percent to 33% percent of the
purchase price and a maximum maturity of 18 to 30
months. These restrictions had fairly broad public
support; 400 economists signed a letter to Senator
Joseph O’Mahoney, dated January 2 1, 195 1, urging
the use of selective credit controls on consumer and
real estate credit and loans for securities as a “first
line of defense against inflation.“4 On May 7, 1952,
the control program was lifted.
While the controls were in place, however, a
congressional subcommittee studied the economic
effects of the selective credit controls used between
1948 and 19.5 1.5 A majority of the subcommittee
found that these controls had allocated credit inefficiently. The subcommittee’s findings resulted in
congressional repeal in 1953 of the President’s
authority to invoke mandatory controls under the
Defense Production Act.6 Congress did not grant the
President this authority again until 1969.’

III.
THE CREDITCONTROLACTOF

THEBASISFORTHE~~~O

1969:

EPISODE

From 1953, when the authority for standby credit
controls expired, until 1969, House Representative

NOVEMBER/DECEMBER

1990

Leonor K. Sullivan was a driving force in the movement to reenact credit control legislation. She
repeatedly argued that such authority would be
needed in wartime. In 1966, with the U.S. mobilizing for the Vietnam War and inflationary pressures
building, Sullivan and Representative Henry S. Reuss
sponsored H.R. 14025, an amendment to the
Defense Production Act that would reinstate the
President’s standby authority. The House defeated
the bill, presumably in part because hearings were
not held on the amendment.8
Congressional defeat of H.R. 14025 apparently did
not weaken Sullivan’s resolve to achieve passage of
credit control legislation. She raised the issue again
in August 1967, during congressional subcommittee
hearings on the Consumer Credit Protection Act, and
yet again in June 1969, during hearings on the increase in the prime interest rate. Finally, in late 1969,
Sullivan and Reuss attached an amendment to H.R.
15091, a bill extending the authority of financial
regulatory agencies to set interest rate ceilings on
savings accounts, time deposits, and certificates of
deposit.9 A House report (from the Banking and Currency Committee) set forth the motivation for the
amendment:
The majority of the committee . . . believe[s] the present
administration is about to achieve at one and the same
time continuing inflation and a recession. By its monolithic
super-tight-money attack on inflation, it is not only failing
to cure inflation, on savings institutions, on small business,
and [those] . . . who are now kept from gainful employment
by the administration’s policies. . . ..
. . . [The amendment to] H.R. 1509,l would help correct
this situation by providing discretionary authority to the
President to authorize the Federal Reserve Board to control
extension of credit, particularly con.wner credit and unnecessary
bank business lending. This will enable specific attacks on
inflationary areas, and thus make unnecessary the present
across-the-board supertight money which threatens unemployment and recession.iO [emphasis added]

The economic reasoning behind the legislation
was the same as that for the ,earlier Sullivan-Reuss
amendments. As explained in a Joint Economic Committee report,
The use of general interest rate increases to fight inflation
is not neutral in its’effects on the economy. It tends to
fall most heavily on small businessmen and on construction
and other long-term investment and is not particularly
effective in curbing speculative excesses.
When businessmen begin to accumulate excess inventory
because of anticipated price rises, or to overinvest in plant
and equipment, their profit expectations are so high that
only very large interest rate increases will deter them. In
these sectors of the economy, interest rate increases may
have an inflationary rather than a deflationary effect. On
FEDERAL

RESERVE

the other hand, residential construction, .which we do not
want to discourage, is hit much harder by higher rates.
This committee believes that it would be preferable to
concentrate on a prudent and limited ‘restriction of consutner
credit as an ahniative to general rredit restraint. Consumer
credit, we know; is not dependent on interest costs because
consumers think primarily in terms of the periodic payment
they are required to make and, within broad limits, are not
deterred or encouraged by interest rate changes.” [emphasis added]

Congress never determined whether the economic
rationale for the amendment was sound. Time was
not available for committee hearings on the amendment because the House was scheduled to consider
the bill less than a week before December 2 1, 1969,
the expiration date of the original authority to set
interest rate ceilings. Sullivan argued that the issue
of standby credit controls had been the subject’ of
several hearings by the Committee on Banking and
Currency, so the House should not postpone judgment on the amendment until,further hearings could
be arranged. Further support for the bill came from
the Fed.‘2 Apparently, Sullivan’s argument was persuasive. What congressional debate did occur focused
on the growth of consumer credit, its inflationary
potential and the possible need for credit controls
of the type Regulation W ‘imposed.‘3 The House and
Senate passed a compromise version of the bill on
December 19 without formal hearings, and President
Nixon signed the legislation on December 24, 1969,
making it Public Law 91-151.’ ‘.
The Sullivan-Reuss amendment is Title II of P.L.
91-151 (-12 U.S.C. 1901-1909 (1969)), commonly
known as the Credit Control Act.(CCA)., Section 205
of Title II states that
whenever the President determines that such action is
necessary or appropriate for the purpose of preventing or
controlling inflation generated by the extension of credit in
an excessive volume, the President may authorize the
Federal Reserve Board to regulate and control any or al
extensions of credit. [emphasis added]

The CCA granted the President and the Board
almost dictatorial power over credit use. As described
by the minority view,
’ Conference Report No. 91-769 explains that the Senate’s version of the interest rate ceiling legislation (S. 2577) contained
a provision to permit the use of voluntary credit control
agreements like those used during the Korean War. P.L. 91-151
granted standby credit control authority of the type included in
both the House and Senate bills. -The conference report states
that both types of controls were included in the legislation so
that “the President would be afforded the broadest possible spectrum of alternatives in fighting inflation, curbing unnecessary
extensions of credit,-and channeling credit into housing and other
essential purposes.” See “Banking-Interest
Rate CeilingsCredit Control: P.L. 91-151;” p. 1522.
BANK

OF RICHMOND

27

GNP rose 4.9 percent, the unemployment
rate
averaged 7 percent, and real per capita disposable
income was up 4.9 percent. Consumer installment
credit outstanding, which consists of most short- and
intermediate-term credit extended to individuals that
is scheduled for repayment on at least two payment
dates, grew 19 percent. The.major failure in the
economy’s performance was the 6.4 percent annual
inflation rate (December to December).i6

Title II. of the bill . . . would give the Federal Reserve
Board power to regulate and control afly or a// extensions
of credit including maximum amounts, terms and conditions,
and maximum rates of interest which of course. would
establish a national usury law. The authority could.only be
activated by the President to the extent and for such period
of time as he might determine.
This is far broader credit control authority than has ever
before been granted. . . .
If fully invoked, it would be heady power for the Fedcomplete credit control over all of our economy, nonbanking as well as banking institutions, whether.creatures
of
State or Federal government,’ and all individuals. It would
establish a.complete credit police ,state.i4 [emphasis as in
original]

The Nixon Administration had made clear that it
did not want standby authority for consumer credit
controls. ‘President Nixon signed the legislation
only because he wanted to,’extend the Board’s authority to impose interest rate ceilings. In, fact, he
described ttie legislation as “unnecessary
and
undesirable” and warned that its use would move’the
country ‘dangerously close to a centrally planned
economy.i5
IV.

WHYDIDPRESIDENTCARTER'I~OKE
198OP
THECREDITCONTROLACNN
Credit controls were discussed as a possible policy
tool throughout Jimmy Carter’s presidency, although
they were not imposed until ‘March 1980. The
economic and political factors leading to Carter’s
imposition of selective credit controls under the
CCA date back to, January 1977, when he was
inaugurated.d
Carter’s

First

TWO Years in.Offce

Carter’s first year in office was the economy’s third
consecutive year of expansion. The Administration’s
stimulative programs increased government spending,
which contributed to the mildness of a temporary
mid-year slowdown. For the year & a whole, real
~
d The Jimmy Carter Library does not yet have available the
Presidential Handwriting Files that contain material written by
Carter, including memoranda written to his advisers regarding
policy proposals. The files are not exaected to be available
until’Janu&y 1992 at the earliest: Consequently, this article
presents material sent from Administration officials and others
to Carter or his advisers. Some memos written by Carter’s
advisers contained space for him to check his approval or disapproval of a proposal; these memos, if returned to and filed
by their authors, provide evidence of his position on the proposed action. Sometimes memos sent among Carter’s advisers
summarize his position. Whensuch memos are not available,
his position must be inferred from the historical record of his
Administration’s economic policies.
28

ECONOMIC

REVIEW.

The economic expansion continued at an uneven
pace throughout
1978, although the long-run
economic outlook dimmed. Inflation became the
country’s major economic concern, as the annualized inflation rate rose to over 9.4 percent in the
second quarter. I7
In May, Carter received a letter from George
Meany, president of the AFLCIO, expressing concern over the inflation problem and urging action:
The AFL-CIO shares the concern that you and [Fed]
Chairman Miller have expressed on the need to curb inflation: We are equally concerned about the pursuit of policies
which have repeatedly led the country down the path of
recession and unemployment. . . .
. . . [we urge you to give serious consideration to
authorizing the Federal Reserve to implement the Credit
Control Act of 1969 . . . . If you authorized the use of that
authority, the Federal Reserve Board could exercise selective credit regulation measures. Such policies would not
entail ever-higher interest rates, with a concentrated impact
upon housing which is in short supply, that would bring
serious unemployment, along with continued inflation in
housing prices and rents.
I believe that selective credit
tially useful alternative to the
money/high interest rates, or
which you have wisely rejected
failure. is

regulation offers a potenextremes of either tight
wage and price controls,
because of their record of

Carter responded that, although he shared Meany’s
concerns, he believed credit controls to be “inefficient, inequitable and costly to administer.“19
Despite Carter’s aversion to credit controls, the
Administration was said to have conducted an informal review of the Credit Control Act in the early fall
of 1978 to appease the AFLCIO.ZO In addition,
Carter told the United Steelworkers
in midSeptember that he would soon announce a new antiinflation program that might include voluntary wageprice standards .*l Shortly after that, Meany’s
preference for selective credit controls was made
public by Th Was/lington Post.** In late October,
Carter officially announced his program. It consisted
of the voluntary wage and price standards’ to which
he had alluded, along with Federal spending restraint
and regulatory reform. Under the voluntary standards,

NOVEMBER/DECEMBER

1990

firms were asked to restrict their price increases to
one-half percent less than their average rate of increase over 1976 and 1977.23

debt to discourage the use of credit and reduce interest
rates. The practical problem is that while the Fed can limit
the terms on which banks extend credit, would such limitations apply to Sears and Roebuck and every retail merchant
in the country? Likewise, it has been privately suggested
that the Fed might prohibit financial institutions from
extending credit to companies that violate the wage/price
guidelines. The difficulty is that the sanction-the
denial
of credit-could.put
companies out of business or choke off
desirable business investment. In short, the denial of credit
to those violating our wage/price guidelines probably constitutes overkill. Most importantly, ifcmdit cont&s were eflective,
and credt demand in some or a/l sects of the economy were
reduced, the result woukf be to heaghten the chances that our
sought afrer ‘sol?landing’ would become a harder ctzzsh. , . .
[P]ast history with such controls has usually produced unintended and undesirable consequences,
and the subject
should be addressed with extreme caution, if at all.25
[emphasis as in original]

Talk of credit controls continued. Bamm’s reported
on November 13, 1978 Townsend-Greenspan
&
Co.‘s opinion on the likelihood of such controls, given
that the President could implement the CCA:
“At this stage, it is difficult to envisage any major move
towards credit controls, certainly of a rigid type.. However,
it is not inconceivable to us that some restrictions on loans
for mergers and acquisitions, and other, not necessarily
definable ‘non-productive’ purposes, could be initiated.“z4

A few weeks later, on December 4, Th wall
Stt-iet Journal quoted Alfred Kahn, chairman of the
Council on Wage and Price Stability (COWPS), as
endorsing credit controls as an anti-inflation device
and planning to raise the prospect of controls with
Charles Schultze, chairman of the Council of
Economic Advisers (CEA), and G. William Miller,
Federal Reserve Board Chairman. In response to Th
WallStmtJoumal’s report, Orin Kramer, Associate
Director for Housing and Urban Development, sent
a memo to Stuart Eizenstat, ‘Carter’s Assistant for
Domestic Affairs and Policy, warning that he
(Kramer), Robert.Carswell of the Treasury and Lyle
Gramley of the CEA, were concerned about the
effect Kahn’s statement would have on the financial
markets and thought that it should be retracted:
/W/he&f of not contr& are a good idea, it is ext7wnely bad
policy to talk izbout them publicly before the. Adminrjrration
&i made a jnn decision to introduce them. The President
has standby authority to permit the Federal Reserve Board
to impose a wide range of credit controls. There is fear in
the business and financial community that the President
will use this p.ower: Kahn’s statement, with the itnpliiation
that the President might consider exer&ing thrisauthority, will
induce some corporations and sophistiicated individuals to
acceleratetheir bming
out offear that the ‘window’wih’close.
This increased bomxoirig wiil increase interest rates, increase
credit aggrzgata, andgive the Feds hawks an argument to raise
Fed rate! &n&r. If the Fed failed to respond to higher
money market rates by tightening up, the Fed would risk
signalling ‘weakness’ to the international bankers, thereby
jeopardizing the strength of the dollar.
From Kahn’s viewpoint, it would be best if he were to be
the one to indicate ‘that his statements wempure/y h@othe&ai,
and credit controls are not under active conrideati~n. In any
event, thfi should be the Administration’s position-and quickly,
befwe thepmssum buif& up. [emphasis as in original]

Kramer also warned that the desirability of credit
controls was “highly questionable”:

With rumors of credit and mandatory wage-price
controls still circulating, 1978 ended. For the year
as a whole, real GNP grew 4.5 percent, slightly under
the ‘1977 rate, and the. inflation rate was 9 percent,
up over 2 percent from 1977. The Board attributed
the behavior of economic activity in part to the continuing high inflation. The personal saving rate was
extremely low by postwar standards, and consumer
spending on durable goods was strong, ,perhaps
because consumers anticipated future price rises.
This spending behavior contributed to the ratio of
aggregate household indebtedness
to disposable
personal income reaching a record level; consumer
installment credit outstanding grew 19.4 percent.
Business investment apparently slowed because of
the greater uncertainty associated with rising inflation.z6 The Board found long-run economic prospects
to be mixed and expected further weakening in consumer sentiment. Consumer spending and real GNP
growth would slow accordingly. Inflationary pressures
were predicted to remain strong.*’
Should the Credit Control Act Be Used
or Repealed?: The 1979 Political Debate
Debate over whether credit controls might be
imposed continued into 1979. Financial analyst Don
Conlan thought there was a 40 percent chance of
credit controls being instituted, while Bamn’s editor
Robert Bleiberg thought the’probability was 60 percent.28 Throughout the first half of the year, the
Senate debated bill S. 35, legislation introduced.by
Senator Jesse Helms of North Carolina that would
have repealed the CCA. In addressing the Senate
in January, Helms expressed his opinion of the CCA:

Beyond the obvious credit market distortions created by
controls, it is difficult to create a control system which is
effective. For example, Kahn suggested the possibility of
limiting the amount of time consumers have to pay back
FEDERAL

RESERVE

I find . . . that there remains on the books in the Federal
Code an onerous piece of legislation which purports to be a
means of “combating inflation.” In fact, it is little more than
BANK

OF RICHMOND

29

‘zation, but you cannot order them to do so. The Board will
have to be persuaded of the wisdom of this action. [emphasis as in original]
We request your approval for us to meet with Chairman
Miller and the other members of the Federal.Reserve Board
to discuss these matters.

a means of providing total Federal control of the financial
system of this country. I speak of. . . the Credit Control
Act of 1969.29

On March 28 Helms added,
Only repeal of this onerous law can quiet this unrest [in
financial markets]. Indeed, failure to repeal the law will
accelerate speculation about control implementation. . . .
. . . [An] obvious objection to the Credit Control Act is
political. The statute is so loosely drawn and confers such
vast powers on the President and-through
him-on the
Federal Reserve Board that no credit transactions would be
outside the purview of this law, once the authority is
invoked by the President. The invocation of virtually unlimited power by the President is hardly consistent with the
post-Watergate mood .of Congress. . . .30

Carter gave his approval for preliminary discussions
only.31
Apparently, the Administration was still debating
use of the CCA in mid-May, when Kahn sent a memo
to Carteis key advisers on credit controls as part of
an anti-inflation strategy:

Just two days later, Treasury Secretary W. Michael
Blumenthal sent a memo to Carter urging him to
invoke the CCA and impose ‘consumer credit
controls:
It is the unanimous opinion of your economic advisors ‘that
our anti-inflation program needs the strengthening of a
somewhat more restrictive monetary policy., Although
growth in the money supply has been sluggish for several
months, banks have been intensively exploiting other
sources of funds to sustain a very rapid rate of expansion in
bank credit. In the context of rising inflationary expectations, the overly-ample availability of credit is fueling a
business scramble for inventories and adding to pressures
on prices of materials.
Your advisors also agree unanimously that action should
be taken to limit the most liberal terms on consumer credit.
Such action would require you to invoke the Credit Control
Act of 1969 and to request that the Federal Reserve Board
take steps to put consumer credit controls into effect.
The Federal Reserve has’been reluctant to increase restraint on the banking system; their analysis suggests more
current and potential weakness in the economy than we
perceive. Our concern is that much further delay in exercising restraint will permit and encourage a surge in both
business and consumer spending that will add significantly
to the already poor prospects for prices in’the next few
months. . . .
Given the Board’s reluctance to take the initiative in
restricting credit growth, it will be important that we convey
not only our concern, but yours as well. . . .
A useful adjunct to a tightening of monetary policy would
be to impose a modest tightening. of terms on consumer
credit. Since the effects of such controls on consumer
spending are uncertain, a heavy-handed action would be
inadvisable. Putting limits on the terms of credit can be
justified, however,. because competitive pressures are
’ pushing,lenders to move steadily toward moie’liberal terms.
In the process, some consumers may be overextending their
debt positions to an extent that is not desirable. Our tentative thinking is to limit the maximum matu$y on new car ioqns
to. 42 mqnths, and to inqease the minimum month/y fqpayment
on revolving cr&t (chargecar& to 10 percent of the outstanding
balance att&utab/e to new Loam. [emphasis added]
The Credit Control. Act of 1969 permits the Federal
Reserve Board to impose such controls on your authori30

ECONOMIC

REVIEW,

It is amazing to me how often these [direct controls on
‘credit, especially consumer credit] continue to be suggested
from both the right and the left. I recognize that the case
for these on short-term macroeconomic grounds is weak:
it is unclear that we need additional consumer credit
restraint right now. . . .
I think the case is clearer as part of a longer-term policy
of discouraging excessive consumption. There is widespread
public acceptance of the notion that consumers are taking
an excessively cavalier attitude toward incurring debt, and
that the government ought to do something directly to
discourage it. Certainly the imposition of direct credit
controls would be widely perceived as a serious step to
combat inflation.32

While the White House debated implementing
credit controls, the Senate Committee on Banking,
Housing, and Urban Affairs held hearings on S. 35,
Helms’s bill to repeal the CCA, and S. 389, a bill
introduced by Senator John Tower, that would
require the President to report to Congress when
invoking the Act and require a concurrent resolution
by Congress before the Fed implements the controls.
Alan Greenspan, then president of TownsendGreenspan & Co., gave testimony typical of those
favoring repeal:
Curbing the growth of credit expansion is, in my view, the
key to defusing the strong underlying inflationary forces
which threaten the stability of our economy. However,
rationing credit through statute or regulation is unlikely to
be successful and to the extent that it is, would probably
allocate credit in an undesirable manner.33

Witnesses testifying for the Administration and the
Board, however, wanted to retain standby authority
for credit controls. For example, a letter from CEA
chairman Charles Schultze to Senator Proxmire was
presented as evidence at the hearing; It read,
[R]epeal of [the CCA] would not be in the national interest.
The authority. . . is very broad and general. At the same
time, the language of the Act provides safeguards that
would effectively prevent it from being used in inappropriate
ways. First, the Act specifically provides that the President’s
authority is limited to cases in which inflation is generated
by an excessive volume of credit. . : .
NOVEMBER/DECEMBER

1990

Although the authority granted in that Act has been in
existence for ten years, no Administration has sought to use
it, and properly so, in my judgment. The sources of inflation
during the past decade have been many and varied. . . .
Nevertheless, there has been no time in the past decade
when the expansion of credit could not have been controlled appropriately by the more general instruments of
monetary policy. . . .
Under almost all conditions, selective credit controls are
not a substitute for the general instruments of monetary
policy, nor, indeed, can these two types of instruments
complement one another effectively. But one can certainly
conceive of circumstances in which resort to selective credit
controls might be necessary. . . . [W]e might find that
strong inflationary pressures were being generated by a
substantial relaxation of terms on consumer credit, and that
the resulting increase in consumer borrowing was threatening to put many consumers in a precarious financial position, as well as to heat up inflation. . . . A similar need for
selective controls might arise if inflation were being generated by a wave of credit-financed scare buying by consumers
because of threatening international developments, as was
the case immediately following the beginning of the Korean
war.34

The Board’s stand on the CCA was similar to the
Treasury’s. Federal Reserve Board governor Nancy
Teeters presented the Board’s position to the Banking Committee:
Credit controls as an instrument of anti-inflationary policy
have most appeal at times when fiscal and monetary policies
cannot, for one reason or another, be employed flexibly.
During World War II and for a while thereafter, monetary
policy was constrained by a pledge to maintain a low interest
rate on U.S. Treasury securities. As a result, the Federal
Reserve could not effectively control growth in the monetary
and credit aggregates since it had to supply as much bank
reserves as needed to maintain an unchanged level of
interest rates. Regulating nonrate terms of credit extensions
seemed to be one of the few ways to discourage borrowing
in such an environment. Thus, regulations limiting consumer credit were used on three occasions in this period.
. . .
. . . . If credit controls are to be used, it would require
circumstances when the need is clear and obvious-a
national emergency, such as war, or a clearly perceived
imbalance in the distribution of available credit. . . .
Selective credit controls might be effective in holding
down a narrow category of spending and might be appropriate if there were shortages of particular goods, such as
automobiles and other consumer durable goods during World
War II. However, even if such shortages occurred, rationing
or excise taxes might be a more effective and equitable
means of treating the problem. . . .
. . . [A] large bureaucracy would probably have to be
created to administer controls. In the absence of a national
consensus as to their necessity, detection of violations
would depend almost entirely on the regulators, since both
the borrowers and the lenders may have an incentive to
circumvent the controls. Regulatory staff also would be
needed to decide on exemptions to the controls, as obvious
inequities arose. Their cost also would include the paperwork and compliance burden borne by the lenders and the
borrowers. These direct costs would likely escalate with
the duration of the controls as they were extended to
counter the ingenuity of the private sector. . . .
FEDERAL

RESERVE

All these factors suggest that under most circumstances
policies other than credit controls would have superior
results with fewer undesirable side effects. . . .
There may be situations in the future, however, in which
mandatory credit controls could be a useful component of
national economic policy. One such circumstance could
occur if it were necessary to undertake a major and rapid
redirection of resource allocation in response to a national
emergency, like an outbreak of war. . . .
The Credit Control Act of 1969 is useful to the extent
that it provides a means for dealing with such contingencies
promptly. . . .
. . . . Thus, if the act is to be retained, the changes
suggested by S. 389 would seem unwise. . . .
The Federal Reserve position is basically that it sees no
reason to repeal it.35

Neither S. 3.5 nor S. 389 ever reached the Senate
floor, and Carter did not invoke the CCA then,
although a May 1979 Gallup poll found most of the
public supporting government control programs.36
By October, the economy was well on its way to
attaining an annual inflation rate of 13.3 percent
(measured by the change in the consumer price
index, December to December).s7 On October 6,
the Board announced several policy actions.3* First,
a shift in operating methods was undertaken. The
Board in conducting monetary policy would in the
future focus less on controlling the federal funds rate
and more on controlling bank reserves. Second, it
raised the discount rate, the rate at which it lends
funds to commercial banks, from 11 percent to 12
percent. Third, the Board imposed upon domestic
member banks and branches and agencies of foreign
banks a marginal reserve requirement of 8 percent
on increases in their managed liabilities above a
specified base. The managed liabilities subject to the
reserve requirement were time deposits of $100,000
and over with maturities of less than one year,
Eurodollar
borrowings,
repurchase
agreements
against U.S. government
and federal agency
securities, and federal funds borrowings from
nonmember institutions. Because such managed
liabilities financed approximately 50 percent of the
growth in bank credit between June and October,
they were viewed as contributing to the inflation
problem, even though they attracted credit mainly
from other uses. When the reserve requirement was
imposed, member banks were estimated to be
holding $240 billion in managed liabilities.e
e The Board previously imposed supplemental marginal reserve
requirements on managed liabilities in 1973. Its objective was
to curb credit growth and moderate inflationary pressures without
inducing tight credit conditions. Non-member banks were
asked to cooperate with the program by holding special marginal
reserves themselves. The supplemental requirements were
gradually lifted. See FederalReseme BulLetin, vol. 59, no. 5 (May
1973) pp. 375-376.
BANK

OF RICHMOND

31

The Board’s October 6 actions were prompted by
the rapid growth rates of money and credit
throughout 1979, the rise in inflation and upward
revisions in inflationary expectations,
and the
speculative activity in the markets for gold, silver,
and other commodities.39 According to Paul Volcker,
Chairman of the Federal Reserve Board, the actions
were to signal an “unwillingness to finance an accelerating rate of inflation.“40
Events in Early 1980
Preceding Carter’s Action
Concern over the record inflation rates and the
threat of recession made the economy a dominant
issue in the 1980 presidential campaign. The year
began with Senator Edward Kennedy predicted to
be Carter’s major opponent for the Democratic
nomination. Kennedy, unlike Carter, endorsed the
use of mandatory wage and price controls. In a campaign speech on January 28, Kennedy said,
The time has come for a frank admission that under this
President, the voluntary guidelines have run their course
and failed.
Inflation is out of control. There is only one recourse:
the President should impose an immediate six month freeze
on inflation-followed
by mandatory controls, as long as
necessary, across the board-not
only on prices and wages,
but also on profits, dividends, interest rates, and rent.4i

The public seemed to share Kennedy’s position.’
A mid-January N?w York Times/CBS News poll
showed that “6.5 percent of adult Americans were willing.to ‘have the Government enforce limits on both
wage and price increases’ to slow the inflation rate.“42
By mid-February inflation data was available for
January. The producer price index for finished goods
rose at an annual rate of 19 percent, and the CPI
climbed 18 percent .43 On February 15, the Fed
raised the discount rate from 12 to 13 percent.44 The
markets responded quickly. Banks raised the prime
rate to 1S3/ percent .45 Precious metals prices fell,
while financial futures prices rose.46
Also on February 15, T’e Nm York Times quoted
Alfred Kahn as saying that the Administration was
considering the use of selective credit controls. Kahn,
who opposed wage and price controls, favored
Regulation W-type restrictions on loan downpayf Leonard Silk, “Uncertainty on Controls,” Th New Yod Times,
February 2’2, 1980. Silk reports that Kennedy’s position did not
contribute much to his popular support. Although Kennedy was
the only presidential candidate favoring wage and price controls,
survey results found that 62 percent of-the public was unaware
of his position, while 8 percent believed that he opposed controls.

32

ECONOMIC

REVIEW,

ments and maturities.47 Four days later, Kahn,
Eizenstat, and White House Staff Director Al
McDonald sent a memo to Carter stating that
[i]t is essential that we move again onto the offensive on
the inflation front. The economic situation is critical and
the public recognizes this. Working against us are the
continuing bad reports, the growing support for controls,
widening business assumptions that high inflation is with us
indefinitely and public expectations that increased defense
spending will fuel it more.
To date the public has been reasonably understanding of
your position. They recognize that you are not to blame
for the high inflation rate, but they correctly demand to
know what you plan to do about it. As soon as the international crisis recedes, this will be the nation’s number
one preoccupation.
We have no time to lose. We must move out forcefully
and visibly to reinforce the importance of the voluntary
effort and to reemphasize your priority to bring this aspect
of the economy under control.48

On February 21, Henry Kaufman, economist and
general partner at Salomon Brothers, suggested
restrictions on bank credit growth as part of a seven
point plan to reduce inflation.49
Talk of control programs heated up in Congress
in late February. Mandatory wage-price controls had
vocal support. Nevertheless, they were unlikely to
receive congressional
authorization;
Democratic
Senator Bennett Johnston threatened to filibuster any
Senate effort to enact such legislation.s0 Support for
credit controls was somewhat stronger, primarily
because the CCA allowed for their imposition without
congressional consultation or approval. The Administration feared, as did many in Congress, that the
mere request for authorization of wage and price
controls would induce firms to borrow heavily and
increase prices in anticipation of future restrictions
on their ability to do so. In fact, rumors that credit
controls might be imposed were having the same
effect. A report in Th Wah’Street Journal on such
borrowing activity quoted Donald DeLuca, treasurer
of Pittsburgh-based Copperweld Corp., as saying that
“he could ‘smell’ credit controls coming. He . . .
phoned his New York bankers to accelerate agreement on a $50 million revolving credit.“51
The issue of credit controls arose again on
February ‘25, when Chairman Volcker was on Capitol
Hill giving his semi-annual report on monetary policy
as required by the Humphrey-Hawkins Act. Volcker
was perceived as a forceful opponent of credit controls, arguing that credit was already slowing because
of general market conditions and the restrictive actions the Fed had taken.52 While testifying, Volcker

NOVEhiBERlDECEMBER

1990

was questioned by Senator Proxmire about his position on selective credit controls. The following exchange ensued:

Pm Restraint on growth of consumer credit would
directly carry the message to the American public of the
need for restraint. Many credit card issuers might welcome
official sanction for pulling back from business that is currently unprofitable, and there could be minor effects on
consumer saving.

Volcker: ‘&.. . . I just don’t know how they would be workable. . . . I m no enthusiast of using direct controls in this
area and think they can be counterproductive in that they
lead to anticipation of inability to raise money and thereby
actually increase demand.”

Con: The Federal Reserve Board considers such action of
relatively little importance substantively (depending on
coverage, only $70 to $200 billion of credit is involved and
borrowing would take different forms.)’ It would be administratively highly cumbersome because tens of thousands of
individual lenders are involved (many of which would have
to be exempted).ss

Proxmire: “Then you are opposed to invoking the Credit
Control Act which is on the books now which the President
could of course invoke? . . .”
Volcker: “Yes.“s3

The Federal Reserve nevertheless
chose to
cooperate with the Administration. Volcker met with
Carter on February 20 and 24.g After these meetings, on February 28, Carter received a memo from
Treasury Secretary G. William Miller outlining possible components of the intensified anti-inflation program under discussion. s4 The memo listed several
options to restrain credit growth:
The Federal Reserve is considering actions which it will
take independently (but with coordinated timing) to reinforce credit restraint consistent with already announced
targets. These will be within the general framework of the
October 6 actions, but, to the extent feasible, designed to
maximize “awailabiky”
rather than “interest rate” effects.
They could include:
1. Action to tighten existing marginal reserve requirements on liability expansion. These requirements, im osed
in October, are not “binding” on most banks now. R
2. A more visible program of voluntary credit restraint,
with reporting requirements,
aimed primarily, but not
entirely, at banks. This program will emphasize restraint on
total lending, but with special accommodation of small
business and mortgage lending to the extent feasible.
Emphasis would be placed on discouraging “take-over” or
“speculative” financing.

Also described in the memo were several actions that
the Board might take if the CCA were invoked, along
with the pros and cons of each:
JT]he Federal Reserve would constrain credit not tied to
autos, home repairs, or mobile homes . . . by a system of
special reserve requirements of say, 10 percent, on any
increase in outstanding amounts.
g According to the Presidential Diary Office Files at the Jimmy
Carter Library, the latter meeting, which concerned the
economy, lasted just under two hours and was also attended by
Energy Secretary Charles Duncan, Jr., Stuart Eizenstat, Alfred
Kahn, Office of Management
and Budget Director James
McIntyre, Jr., G. William Miller, Press Secretary Jody Powell,
Charles Schultze, and the First Lady. See President’s Daily
Diary, “Z/24/80 Backup Material,” Box PD-73, Presidential Diary
Office, Jimmy Carter Library.
h See Section VI below for a discussion of the effectiveness of
the Board’s October 6 marginal reserve requirements on managed
liabilities.
FEDERAL

RESERVE

The Board, however, did not suggest to the Administration the use of consumer credit controls.56
Internal Fed memos confirm that the Board was
preparing to undertake the actions described in
Miller’s correspondence. The dates and content of
the memos suggest that the Board made the major
decisions regarding which actions to take during
February and had decided on all but a few details
of its program by March 5. Actions that could be
undertaken without the CCA appear to have been
planned for at the Board’s own initiative, rather than
at the Administration’s request. Where the initiative
for the other actions originated is unclear.57
Word began spreading during the first week of
March about the anti-inflation program the Administration was considering. Media attention turned away
from whether credit controls would be imposed and
toward what form they would take. Although business
borrowing accounted for the bulk of total credit
growth, the consensus view was that businesses could
too easily evade credit controls through use of the
bond and commercial paper markets, making controls on consumer credit more practical. A Washington specialist at an investment firm was quoted
as saying that Volcker “ ‘may be prepared to acquiesce on consumer measures in return for Carter’s
people staying out of his hair on commercial lending
restraints.’ ‘3*
The possibility of consumer credit controls did not
please bankers, who publicly expressed their concern. The N~~QJYo& Times quoted a Citibank
newspaper advertisement as reading “ ‘There may
be policy makers who believe this [credit controls]
to be in the national interest but it is doubtful that
many citizens will find it to be in theirs.’ “59 Less
than a week earlier, though, the Administration had
i With credit for automobiles and housing excluded from a
control program, only about a quarter of total consumer credit
would be subject to regulation.
BANK

OF RICHMOND

33

received telephone calls from senior executives at two
of the country’s largest banks, stating that their banks
“would be adversely affected by consumer credit controls. However, both agreed that the financial markets
(bond markets) expect and would react favorably”
to such controls.60 And on March 6, Carter’s counsel,
Lloyd Cutler, forwarded to Carter’s key advisers excerpts from a memd he had received from “the head
of one of our largest financial institutions.” The
banker argued for mandatory restrictions on the annual growth rate of consumer credit, except credit
for housing and automobiles. Such restrictions closely
resembled the voluntary restrictions that the Board
was considering.61
By Monday, March 10, information was circulating
regarding meetings the Carter Administration had
held with congressional leaders to discuss the President’s economic policy. Carter was said to be planning a program whose economic costs would be
borne primarily by consumers. Bank and retail credit
cards and checking account overdrafts were rumored
to be likely targets of a control program. The Board
was thought to be preparing Regulation W-type
restrictions that would set minimum downpayments
and maximum maturities, limit the size of credit lines,
and perhaps reduce grace periods.jp62 Administration
sources also hinted at a possible tightening of the
marginal reserve requirement on managed liabilities.
A program with rigid quantitative restrictions on the
amounts of various types of credit extended was,
however, definitely ruled out by both the Board and
the White House.63

Economic data released March 10 did not help
matters. The Fed announced that all major components of consumer credit grew more slowly in
January than December, with consumer installment
credit growing at an annual rate of 5.3 percent. For
January and December combined, the installment
credit growth rate was the lowest since the expansion began in 1975. These credit conditions were
accompanied by the first decline in retail sales in
four months. Commerce Department data showed
February’s retail sales 0.7 percent lower than
January’s.65
j Recall that the memo from Treasury Secretary Blumenthal to
Carter in March 1979 recommended credit controls of this form.
ECONOMIC

REVIEW,

On Friday, March 14, Th Nm York Timesreported
the opinions of several economists regarding consumer credit controls.68 Otto Eckstein, a Harvard
professor and president of Data Resources Inc.,
described such controls as “ ‘a symbolic gesture.’ ”
Henry Kaufman thought the controls would have “ ‘at
best . . . some marginal impact.’ ” S. Lees Booth,
economist and senior vice president of the National
Consumer Finance Association, wondered why controls would be placed on consumer credit, which is
a small part of total credit in the economy. Another
economist, former Board Chairman Arthur Burns,
spent March 14 testifying before the Senate Banking Committee, at which time he gave his opinion
of the CCA:
I think it’s one of the worst pieces of legislation ever written
by the Congress. I hope that you [Sen. Proxmire] . . .
would think seriously about having the piece of legislation
rescinded.@

The markets did not respond well to this news as
traders upped their expectations of a recession in the
near future. Precious metals prices, which had begun
falling three weeks earlier, all fell sharply, as did other
commodities prices, while financial futures prices
rose.64

34

On March 12, Treasury Secretary G. William
Miller sent.Carter a memo consisting of a checklist
of policies that could be part of the President’s fourth
anti-inflation program. 66That afternoon, Carter held
a meeting with his advisers in the Cabinet Room.67
Carter chose to invoke the CCA to control consumer
revolving credit (except credit for home mortgages
and automobiles), credit extensions by depository and
non-depository
financial intermediaries,
and the
managed liabilities of banks that were not members
of the Fed. Reporting by affected institutions would
be required.

At 4:30 p.m. that day, in the East Room of the
White House, Carter made a prepared statement
announcing the fourth anti-inflation program of his
presidency, and issued Executive Order 12201 invoking the CCA.‘O
V.
ANATOMY OF THE 1980
CREDIT RESTRAINT PROGRAM
An Overview of the Board’s
Credit Restraint Program
In his address from the White House on
March 14, Carter announced his imposition of credit
controls under the CCA:
Just as our governments have been borrowing to make
ends meet, so have individual Americans. But when we try
to beat inflation with borrowed money, we just make the
problem worse.
Inflation is fed by credit-financed spending. Consumers
have gone into debt too heavily. The savings rate in our
nation is now the lowest in more than 25 years. . . .

NOVEMBER/DECEMBER

1990

The traditional tools used by the Federal Reserve to
control money and credit expansion are a basic part of the
fight on inflation. But in present circumstances, those tools
need to be reinforced so that effective restraint can be
achieved in ways that spread the burden reasonably and
fairly.
I am therefore using my power under the Credit Control
Act of 1969 to authorize the Federal Reserve to impose
new restraints on the growth of credit on a limited and
carefully targeted basis.”

Executive Order 12201, invoking the CCA, stated
that the credit controls would be “in effect for an
indefinite period of time and until revoked by the
President.“72 Carter’s political advisers hoped that the
anti-inflation program would be accepted by the
public, thus giving the President an advantage over
the other presidential contenders for the Democratic
nomination.73
After Carter announced his economic program,
Volcker introduced the Board’s Credit Restraint
Program (CRP):
[T]he Federal Reserve has . . . taken certain further actions
to reinforce the effectiveness of the measures announced in
October of 1979. . . .
One consequence of strong demands for money and credit
generated in part by inflationary forces and expectations has
been to bring heavy pressure on credit and financial markets
generally, with varying impacts on particular sectors of the
economy. At the same time, restraint on growth in money
and credit must be a fundamental part of the process of
restoring stability. That restraint is, and will continue to
be, based primarily on control of bank reserves and other
traditional instruments of monetary policy. However, the
Federal Reserve Board also believes the effectiveness and
speed with which appropriate restraint can be achieved
without disruptive effects on credit markets will be facilitated
by a more formal program of voluntary restraint by important
financial intermediaries . . . .74

As Board Vice Chairman Schultz later said of the
program,
. . . [T]he overspending in the economy, . . . if there are
excesses, appears to have been on the Government side and
on the consumer side in terms of open-end credit. . . .
So, are we going to slow this economy down. . . ? The
answer to that is yes; I think we must.75

The Board’s program consisted of six restrictive
measures:
1. a voluntary credit restraint program under which
all domestic commercial banks, bank holding
companies, finance companies, and U.S. agencies and branches of foreign banks were expected
to limit their total annual loan growth
2. a special deposit requirement of 15 percent for
all lenders on increases in certain types of consumer credit
FEDERAL

RESERVE

3. an increase from 8 percent to 10 percent in the
marginal reserve requirement on managed liabilities of large banks
4. a special deposit requirement of 10 percent on
the additions to the managed liabilities held by
non-member banks
5. a special deposit requirement of 15 percent on
any additional assets held by money market
mutual funds
6. a surcharge on the discount window borrowings
of large banks.
The special deposit requirements were simply reserve
requirements applied to institutions not otherwise
subject to such regulation. For example, the special
deposit requirement on consumer credit mandated
that lenders hold 15 cents with the Fed as noninterest-bearing reserves for each dollar of consumer
credit extended over some predetermined amount.
The Federal Reserve Act grants the authority for
actions 3 and 6, while the CCA confers authority for
the others.k Failure to comply with the regulations
could result in a maximum civil penalty of $1,000
(12 USC 1908), and a maximum criminal penalty
of $1,000 and a year in jail (12 USC 1909). The
Board informed the public of these potential
penalties.76
The CRP bore little resemblance to the credit
controls imposed previously and described in Section II. Consequently, a more detailed description
of the program’s components is warranted before proceeding to analyze its effects.
The Voluntary

Credit Restraint

Program

The first component of the Board’s program
restricted total loan growth by affected financial
institutions (primarily banks) to a range of 6 percent
to 9 percent over the period from December 1979
to December 1980. Other lenders, not specified in
the program, were also requested to participate. To
monitor the program, the Board required affected
institutions to file reports of lending activity besides
those normally required. All affected lenders with
total assets of at least $1 billion filed monthly reports.
Into this category fell 170 domestic commercial
banks, 139 U.S. branches and agencies of foreign
banks, 161 domestic affiliates of bank holding companies, and 15 finance companies.77 In addition,
banks with assets totalling at least $300 million but
k Board of Governors, Press Release, March 14, 1980. The
inclusion of finance companies in action 1 required the CCA.
BANK

OF RICHMOND

3.5

less than $1 billion filed quarterly reports, and smaller
banks were exempt from the filing requirement. The
base over which loan growth was calculated was the
average for December 1979 for banks that normally
filed weekly reports with the Fed, the average from
the November and December reports for finance
companies that typically reported monthly, and the
level as of December 3 1 for non-member banks. All
reports were filed with the lenders’ district Federal
Reserve Banks. 7*
The 6 percent to 9 percent growth range for total
bank lending was thought to be consistent with the
announced target ranges for growth of the monetary
aggregates. The 9 percent upper bound was considerably lower than the growth rate of 13 % percent
for the previous year, December to December, and
the accelerated rate of 173/4 percent for January and
February of 1980.79 According to the Board, these
growth rates
could not continue without threatening achievement of the
restrained growth in money and credit in 1980 which was
deemed necessary to help curb inflation. . . . [A] supplemental program to restrain loan growth seemed appropriate,
so long as the burden of the restraint did not fall on those
classes of borrowers least able to bear itW

No quantitative rules were given for how lenders
should allocate available credit. Rather, the Board
simply set forth a few broad qualitative guidelines.
It discouraged banks from making unsecured loans
to consumers, financing corporate takeovers or
mergers, lending for speculative purposes (e.g.
speculative purchases of commodities or precious
metals), and approving back-up credit lines in support of credit raised with commercial paper. In
contrast, funding for small businesses, farmers,
homebuyers, and automobile buyers and dealers was
strongly encouraged. 81 Board Vice Chairman
Frederick Schultz explained,
. . . [T]he Board expects that, in setting interest rates and
other lending terms banks will, where possible, take account
of the special needs of these borrowers. . . .
, . . Large businesses are on notice that they should not
turn to the commercial paper market to replace other credit,
as such a shift would reduce the residual credit available for
other borrowers.
. . . [T]hese measures can not prevent small, and indeed
all, businesses from encountering strains in coming monthssz

Lenders were expected to ensure a continued flow
of credit to borrowers without access to other forms
of financing. The Board required reports on such
activities to monitor the lenders’ progress and would
consult with those whose efforts were inadequate.
Further, the nation’s 36.5 nonfinancial corporations
36

ECONOMIC

REVIEW,

with at least $30 million of outstanding commercial
paper or total annual revenue of at least $2 billion
filed monthly reports on their commercial paper
issues and their foreign borrowings.83
Consumer

Credit Restraint

To restrain consumer credit growth, the Board
imposed a special deposit requirement (SDR) on all
increases in certain types of consumer credit. The
SDR required that lenders hold with the Fed in noninterest-bearing accounts reserves equal to 15 percent of the amount of consumer credit extended over
the amount of covered consumer credit outstanding
on March 14, 1980.’ Credit subject to the SDR
included all open-end credit, secured or unsecured,
and closed-end consumer credit either unsecured or
secured by collateral not purchased with the credit.
Open-end credit consisted of credit card, bank overdraft and revolving credit.m For calculating the
required deposit, all open-end credit was presumed
to be used for non-business purposes. Closed-end
credit included unsecured personal loans, loans for
which the borrower already owned the collateral,
travel and entertainment card plans, retail merchant
credit, and credit secured by financial assets other
than savings deposits. Thus, car, mobile home, and
mortgage loans were exempt from the SDR because
the proceeds of the loans financed the purchase of
the car or home.84
Any lender extending at least $2 million in covered
credit was subject to the regulation. The $2 million
cut-off exempted 1.7 million retail firms and 36,595
other firms from the SDR. There were 10,108 firms
remaining, of which about 6,000 were banks; these
firms extended about 85 percent of all covered
credit.85
All non-exempt lenders based on their covered
credit outstanding on March 14 had to file monthly
reports with the Federal Reserve (the Federal Home
Loan Bank Board for thrifts and the Federal Credit
Union Association for credit unions). The reports
determined the lenders’ covered credit outstanding
during the previous month based on the daily average
amount outstanding or the amount outstanding
on a date approved by the Board.86 For multi’The base was later changed;

see Section VI.

m Credit card credit includes credit arising from purchases on
retail credit card plans and from cash advances extended through
such plans. Revolving credit includes special installment overdraft credit and revolving credit arising from arrangements with
travel and entertainment charge cards and other nonbank credit
plans.

NOVEMBER/DECEMBER

1990

subsidiary firms, the parent company filed a single
report that combined the covered credit issued by
all its subsidiaries.87
The SDR was designed to raise the cost of credit
extensions and thus discourage credit growth. At the
end of 1979, $38.4 billion in credit was available to
Mastercard
holders, of which 3 1.6 percent was
used, and credit lines totalling $27 billion were
available to Visa cardholders, with 48 percent outstanding. Though the growth in consumer installment
credit outstanding slowed considerably during the last
half of 1979 and the first two months of 1980, the
Board was concerned that the record inflation rates
being experienced might induce credit card holders
to make greater use of their cards’ credit lines.
Limiting credit use through price rationing was not
possible because state usury ceilings prevented card
issuers from raising credit card interest rates in
response to inflation.s8
Although the SDR was only one part of the Board’s
program, it probably had the broadest reach, touching
almost every American consumer. Many economists,
however, questioned the SDR’s usefulness. They
viewed it as a cosmetic measure because it applied
only to a small fraction of total credit in the economy.
In terms of credit use at the end of 1979, covered
credit was 48 percent, or $184 billion, of the $38 1
billion of total consumer credit outstanding,n and
total credit was measured to be approximately $4
trillion.89 As a result, the SDR was not expected to
have any effect on inflation.90 There was also concern that consumers would be unduly harmed by the
requirement because they had few alternative funding sources. Volcker shared that concern but believed
that the requirement was needed:
[T]hey do bite at the consumer, at certain types of consumer lending, but ultimately at consumer spending because
that is considered under present conditions not to be an area
of high priority, given that credit has to be restrained
overall. . . .
. . . . [The Board is] trying to get at uses of credit that
are less immediately relevant to the problems of the economy today.9r

nThe $381 billion of total consumer credit consisted of all
covered open- and closed-end credit plus credit for home
improvement loans, automobiles, mobile homes, service credit
(unpaid bills to providers of services), and purchases secured
by the goods purchased with the loan proceeds. Mortgage debt
is not included. See Memo from Axilrod, Kichline, and
Petersen to the Board of Governors, “Proposed Consumer Credit
Regulation.”
FEDERAL

RESERVE

Marginal Reserve Requirements
Managed Liabilities

on

As described in Section IV, on October 6, 1979
the Board imposed a marginal reserve requirement
(MRR) on managed liabilities in addition to the
reserve requirements already in place. The MRR
was levied on domestic member banks and U.S.
branches and agencies of foreign banks and applied
to any increases in their managed liabilities over their
bases. The base was the larger of $100 million and
the average amount of managed liabilities held as of
the two statement weeks ending September 26.
Institutions with managed liabilities exceeding 48100
million had to report their bases to the Fed and were
subject to the program.
The objective of the MRR was to slow bank credit
growth by raising the cost of funds used to finance
lending activity. Bank credit growth had slowed considerably during the fourth quarter of 1979; however,
the slowdown was attributed primarily to the drop
in credit demand that accompanied an increase in
the cost of funds and growing concern over recession prospects. As demand fell, banks subject to the
MRR reduced their managed liabilities. When their
managed liabilities fell below their bases, they became
able to increase their lending without holding marginal
reserves. This made the MRR less effective. Loan
demand rose in January and February of 1980, but
marginal reserves responded
considerably
less
because many banks could finance their credit extensions without going over their bases.
The MRR also failed to restrain credit growth
because of several loopholes. One loophole allowed
large domestic commercial banks and U.S. agencies
and branches of foreign banks to circumvent the
MRR because it applied to net Eurodollar borrowings, borrowings net of balances due to a bank’s own
non-U.S. branches. This loophole worked as follows.
Consider a financial institution using Eurodollar borrowings to directly fund a loan. The MRR required
reserves be held against such borrowings. To avoid
holding reserves, however, a bank would switch its
loan customers to a foreign affiliate and provide its
affiliate with the funds to make the loan. This type
of indirect funding created Eurodollar loans to offset Eurodollar borrowings, reducing net borrowings
and required reserves.92
A second loophole existed because the MRR
applied to large time deposits with maturities of less
than one year; thus, banks could issue deposits with
longer maturities without increasing their marginal
BANK OF RICHMOND

37

reserves. In addition, federal funds purchases from
small member banks and agencies and branches of
foreign banks that were belay their bases, and so
not subject to the MRR, were exempt from the requirement.93 Banks apparently recognized these
methods for evading the reserve requirement; as a
chief financial officer of a major New York bank
explained, “ ‘If someone really doesn’t want to carry
the extra reserves, he doesn’t have to.’ “94
As part of its March 14 credit restraint efforts, the
Board tightened the MRR on member banks and
U.S. agencies and branches of foreign banks and,
under the CCA, extended its coverage to include
non-member banks. The Board raised the MRR from
8 percent to 10 percent and reduced the base by the
greater of either 7 percent or the decrease in a bank’s
domestic office loans to foreigners plus the gross
balances due from foreign offices of other institutions
that occurred between the original base period and
the week ending March 12. A bank’s base would be
reduced even further by future drops in foreign
lending.95 The Board expected holdings of marginal
reserves to increase by about $1.3 billion as a result
of these changes.96
For non-member banks, the base was the greater
of $100 million or marginal liabilities over the twoweek period ending March 12. As for member banks,
the base would decrease by the amount of future
reductions in foreign loans. The reserve requirement
was 10 percent.97
Restraint

on Money Market Mutual Funds

As part of its credit restraint program, the Board
required money market mutual funds (MMMFs) and
other similar creditors to maintain a non-interestbearing deposit with the Federal Reserve. The
deposit was equal to 15 percent of a fund’s increase
in assets over its March 14 base level. The 15 percent requirement was expected to reduce the return
on a brand new fund by approximately 2 percent.
All managed creditors had to report their bases to
the Board and, on a monthly basis, their daily average
asset levels.98
The reserve requirement on MMMFs was designed to slow the outflow of funds from thrift institutions and smaller banks. The percentage change
in the growth of consumer savings from January to
September, 1979 relative to the same period in 1978
was 184.2 at MMMFs, - 13.3 at commercial banks,
- 14.9 at savings and loan associations, -49.0 at
credit unions. By slowing the flow of funds into
MMMFs and thus the national money market, the
38

ECONOMIC

REVIEW.

Board hoped to reduce the supply of credit available
for large borrowers while easing credit availability for
borrowers with few alternative funding sources.99
The legality of the Board’s regulation of MMMFs
was questioned from the moment the program was
announced. House Representative Reuss argued that
the public’s transfer of funds from thrifts to MMMFs
did not contribute to an “extension of credit in
excessive volume” as required for use of the CCA.100
The Investment Company Institute, a trade association of mutual funds, considered filing a lawsuit
against the Fed, charging that the CCA did not
authorize the Board to hinder individuals’ attempts
to manage their savings wisely and that the deposit
requirement, which was essentially a tax on the return
to MMMF deposits, was unconstitutional because
only Congress could impose taxes. The Institute
ultimately decided against filing the lawsuit because
it did not want “ ‘to disrupt the government’s overall
economic program and because the precise effects
of the [Bloard’s action’ ” were unclear. Instead, the
Institute formally petitioned the Board to lift the
deposit requirement.iOi The Board responded by
exempting certain MMMFs from the regulation,
although it began requiring weekly, rather than
monthly, rep0rting.O
Discount

Rate Surcharge

Acting on requests from the directors of the twelve
Federal Reserve Banks, the Board added a 3 percent surcharge to the rate of 13 percent charged on
discount window borrowings. The surcharge applied
only to borrowing by banks with at least $500 million
in deposits when the borrowing occurs in at least two
consecutive weeks or more than four weeks in a
quarter. Of the 5,459 Federal Reserve member
banks, 270 had deposits of at least $500 million.iOz
The surcharge was imposed to discourage frequent
discount window borrowing by the largest and most
active users of the discount window. According to
the Board, because the surcharge applied only to a
segment of banks, it would have a smaller effect on
short-term interest rates than would a general increase
in the basic discount rate. It was not meant as a
device for guiding market interest rates.io3
o Board of Governors of the Federal Reserve System, Press
Release, April 11, 1980. Exempted were “bona fide” personal
trusts, pension, retirement, and other tax-exempt accounts
invested in MMMFs; tax-exempt assets of MMMFs that invested
at least 80 percent of their assets in short-term tax exempt
obligations; and funds with a base of under $100 million. Unit
investment trusts were allowed to be “rolled over” without
satisfying the deposit requirement.

NOVEMBER/DECEMBER

1990

VI.

THEECONOMICEFFECTS

OF

THE

1980 CREDIT RESTRAINT PROGRAM
The Immediate

Market Response

The Board’s announcement of its CRP ,was followed immediately by turmoil in the financial
markets.ro4 On Friday, March 14, the day of the
announcement, the prime rate was 18% percent. It
rose to 19 percent Monday, March 17, the third increase in four business days. The rise was attributed
to the increased cost of funds caused by the Board’s
modification of the marginal reserve requirement on
managed liabilities. 10sThe same day, Henry Kaufman predicted that “ ‘the peaks of credit stringency
and of interest rates are still ahead of us.’ “lo6 A
Fed official was reported as admitting that the CRP
would affect the allocation of credit. “He added that
‘rationing by price in the marketplace hasn’t been well
distributed, and demand for credit has been a lot
stronger than we [the Fed] thought it would be.’ “lo7
Between the end of February and the middle of
March, the rate on 90-day Treasury Bills rose 150
basis points. Announcement of the CRP and heavy
government supply caused it to rise another 120 basis
points before the end of .March. According to Donald
Maude, a senior vice president at Merrill Lynch
Government Securities, Inc., “ ‘[T]he appetite of
investors for anything with a maturity longer than two
years is negligible at best. ’“‘0s By April, two weeks
after the CRP began, the prime rate reached 20
percent, up 350 basis points in one month, and the
federal funds rate exceeded 19 percent. The rise in
the funds rate equalled about two-thirds of the discount rate surcharge on large banks and was not expected by the Board.P
Complying With the
Program’s Requirements
There was considerable confusion among consumers and businesses over how to comply with
the program. Although the Board tried to keep the
p Many banks offered small businesses a below-prime interest
rate to satisfy the Board’s request for special programsfor these
borrowers. In addition, the Board announced on April 17, a
“temporary seasonal credit program” for banks with less than
$100 million in deposits. Aggregate credit lines of $113 million
were arranged under the program for 129 banks, primarily from
the Midwest. A total of $1.5 million was actually borrowed by
five banks. This low borrowing level is attributed to the steep
decline in the federal funds rate after April 17. See Board of
Governors, “Federal Reserve Credit Restraint Program,” p. 17;
Letter from Volcker to Chairman Nowak, August 20, 1980, in
U.S. House, Hearings on FederrolMonetary Pohy And Its Effect On
Small Basimxs (Part 3-Credit Conttvk and Avaiiabihy of Credit),
p. 329:
FEDERAL

RESEdVE

control program simple by letting lenders independently develop policies to allocate credit in ways
consistent with the regulations, creditors required
much more detailed instructions regarding reporting
requirements, maintenance of special deposits, and
monitoring of compliance with supposedly “voluntary” restrictions. As a result, the Board issued 9
press releases over 8 weeks, providing answers to
commonly asked questions about all factors of the
program. Daily conference calls were made by
the Board to the Federal Reserve Banks, providing
the latest interpretation of the regulations so that
the regional Reserve Banks could handle the
thousands of phone calls they received for additional
information. lo9
On March 17, Chairman Volcker was in Washington, D.C. briefing 65 of the leading bankers on
the CRP. According to Th Nm York Times, he told
them that the Board expected their cooperation with
the program, and he drove home his point by suggesting that other government agencies “would be
involved in assuring compliance with the program.”
After the meeting, the bankers expressed concern
over having responsibility under the program for
allocating credit among their customers.*10
By mid-March, when the voluntary credit restraint
program was imposed, loan growth at many .banks
was already close to, if not exceeding, the maximum
9 percent annual rate. Banks were especially concerned about their ability to comply with the voluntary credit restraint program because of their loan
commitments. Unused commitments at large banks
rose from $235.6 billion at the end of December
1979 to $248.4 billion at the end of February 1980,
and rose even further before March 14. As of midMarch, business loans outstanding totalled $157.3
billion.111 If businesses made full. use of the committed funds, bank lending would increase much
more than 9 percent, the maximum under the CRP.
When banks expressed concern over this possibility, the Board suggested that the banks decide
which prospective. borrowers had legally binding
commitments and encourage them to postpone
takedowns or find alternative financing.“*
Bankers, especially those from banks with a strong
consumer -orikntatidn, were upset that the Board
imposed the surcharge instead of raising the basic
discount rate.113 At the time, federally chartered
banks were permitted to charge one percentage point
more than the prevailing.discount rate on loans made.
Thus, an increase in the basic discount.rate would
have provided banks some relief from usury laws that
BANK

OF RICHMOND

39

made consumer lending unprofitable given the federal
funds rate of over 16 percent on March 14. 114
The immediate effect of the tightening of the
marginal reserve requirement on managed liabilities
was an increase in the number of member banks with
covered managed liabilities in excess of their base
levels from 115 to 199 between February 27 and
March 26. The number of U.S. branches and agencies of foreign banks having to hold such reserves
rose from 19 to 44 over the same period; 43 nonmember banks were also affected by the program as
of March 26. Overall, covered managed liabilities in
excess of affected institutions’ base levels rose from
$4.0 billion to $21.2 billion between February 27
and March 26.q
As stated in Section V, the Investment Company
Institute decided against filing a lawsuit over the
15 percent special deposit requirement levied on
MMMFs. One factor behind this decision was the
realization that the regulation, along with the
Securities and Exchange Commission’s corresponding requirement that MMMFs disclose the effects
of the CRP on their funds, would not be as onerous
as first thought.“5 James Benham, chairman of
Capital Preservation Fund, was quoted as saying
“ ‘At first, this [the CRP] looked very messy for all
of us, but now I think the fund business is going to
continue booming.’ “116 Many MMMFs initially
responded to the program by stopping their advertising so as not to attract new investors. Many
stopped accepting new accounts altogether but continued accepting deposits from existing shareholders.
Existing funds expected that staying below their base
level, and thus avoiding the 15 percent special
deposit, would be easier than originally thought
because the CRP coincided with income tax season,
which could increase redemptions.117 Managers of
existing funds accepted that they would have to keep
at least small amounts on deposit because of the
normal errors in predicting weekly asset levels.
During the first four weeks following the CRPs
announcement,
MMMF assets declined over $1
billion.lis The Board’s March 28 exemption of certain funds from the special deposit requirement
contributed to a resurgence of asset growth in the
second half of April, as did the creation of new funds,
called “clones.” Clone funds were developed to allow
MMMFs to accept new deposits without lowering
q Board of Governors, “Federal Reserve Credit Restraint
Program,” pp. 40, 42. A few other non-member banks later
became subject to the program.

40

ECONOMIC

REVIEW,

the return to incumbent shareholders, and possibly
exposing the mutual funds to legal challenges by these
shareholders. The clones held portfolios resembling
those of the first generation funds from which they
derived. By late April, approximately 96 moneymarket funds were operating, of which 1.5were clones
with assets of about $329 million.119 Of the 70 older
funds sold to individual investors, 32 were still
accepting additional investments. During their first
few weeks of operation, the clones offered higher
yields than the older funds. For example, as of
April 16, clone funds offered a 30-day average
yield of 17 percent while older funds offered only
15.3 percent.120 This differential arose, despite the
special deposit requirement, because clones that were
set up quickly were invested heavily at the higher,
post-controls interest rates. By the end of May, the
older funds had a slight yield advantage. Special
deposits by MMMFs with the Board peaked at $8 17
million and were $573 million, or 0.72 percent of
assets, when the controls were lifted.‘*’
Besides MMMF assets, increases in consumer
credit were also subject to a 15 percent special
deposit. Announcement of the deposit requirement
on lenders of certain types of consumer credit brought
complaints that the regulation was unfair and difficult
to comply with because of existing state and federal
laws. Specifically, creditors argued that the choice
of March 14 as the base ignored the seasonality in
their sales, and thus credit extensions.122 Also, the
Truth in Lending Act required that customers be
notified of any changes in the terms of credit card
agreements. Each state had its own notification laws,
requiring between 15 and 10.5 days’ notice. 123Credit
card issuers complained that these laws made changing card terms difficult. Moreover, changes that were
made could not be applied only to new extensions
of credit without great expense and delay; consequently, outstanding balances would be affected
also.124
In response to these complaints, the Board made
several technical changes in its consumer credit
restraint regulations on April 2. First, the Board
established a uniform national requirement that
written notice of changes in charge account terms
be given to account holders at least 30 days in
advance. Second, account holders had to be given
the option of paying their outstanding balances under
the original account terms. Although the Board
superseded state notification requirements, it chose
not to waive state interest rate ceilings. Later on
April 14, the B.oard did waive conflicting federal
regulations on finance charges for oil company credit

NOVEMBER/DECEMBER

1990

programs.125 Third, to adjust for the seasonality in
sales, creditors were’given an BIternative method of
calculating their bases. They could use either
March 14 or the amount of .outstanding covered
credit for March 1979, scaled up by ‘a factor based
on the increase in.the firm’s covered credit between
March 1979 and March 1980. The scaling factor
would be, reduced .by one;twelfth each month to
make the SDR applicable by March 198 1 to any yearover-year increase in covered credit over the base
level. Finally, responding to a petition by the Consumer Federation of America, the Board said that
it would try, but could not promise, to give the public
an opportunity to comment on rule changes before
making a final decision.126
Lenders had reduced their issuing of credit cards
for several months before the CRP because high
market interest rates were bumping against usury ceilings.127 Once the uniform 30-day notification requirement was imposed, they began modifying their
charge account terms. A congressional subcommittee survey of 59 creditors offering 96 distinct charge
cards found that the most frequent change in terms
made in response to the CRP was the imposition of
an annual fee. This change was made on 49 percent
of the cards surveyed. Creditors stopped accepting
credit card applications for 42 percent of the cards.
Forty-one percent raised the standards for qualifying for credit; 4 1 percent changed the finance charge
calculation method; 3.5 percent increased the annual
percentage rate; and 23 percent increased the
minimum monthly payment. Eighty-six percent of
the cards had their changes applied retroactively to
the account holder’s outstanding balance. Among the
most stringent actions were Exxon’s announcement
of a 50 percent increase in its minimum monthly
charge and that, effective August 1, single purchases
under $40 would be included in the minimum
monthly payment. Even in 1980, a tank of gas cost
less than $40.128 To discourage credit card use more
generally, a television advertisement ran in which
Russell Hogg, president of the Interbank Card
Association,
which franchises
MasterCards,
discouraged use of MasterCards for anything other
than “ ‘necessities and emergencies.’ ‘Qua
The

Big Surprise

On March 24, just ten days after the CRP began,
the Administration saw the first sign of recession: an
increase in unemployment benefit applications. 130
As the Administration later explained,
Early in 1980 there were few signs of recession. If anything,
activity seemed to be picking up. The evidence available
FEDERAL

RESERVE

at the time hinted that households . . . were on a buy-inadvance spending spree. ; . .
By early March there was fear that inflationary pressures
. . . were mounting . . ., and that without some additional
action these would . .. . lead to an explosion of prices. . . .
It was in this environment that . . . . the President authorized . . . selective controls on credit.131
In retrospect, it appears that . . . interest rates finally had
reached levels in late February and early March which were
sufficient to discourage borrowing. However, data [available
when the credit controls were planned] . . . did not show
‘this development. . . .’[N]ew home sales fell slightly in
February and plunged in March, although the only information available in early March had shown that sales
advanced in January.r3*

Additional evidence of recession soon followed the
unemployment data. Statistics for March indicated
that the narrow money aggregates fell sharply in late
March; the Board attributed this to the increased
opportunity cost of holding money caused by the
reserve requirements on managed liabilities and.the
start of a recession.133 Weekly data for large banks
showed loan growth remaining strong through early
March, but slowing considerably over the rest of the
month. As a result, total bank loan growth for March
fell to an adjusted annual rate of 2% percent from
rates of 15 percent to 20 percent earlier in the year.
Consumer installment credit rose only 5 percent in
March and 7 percent for the first quarter.134 Housing starts suffered their largest fall in twenty years. 135
By April 11, market analysts were speculating that
the Board would ease its credit controls soon because
of the accumulating evidence suggesting that a severe
recession was underway.136
One month after credit controls were imposed
interest rates began a sharp decline. The prime rate
was 19.5 percent on April 18, while the federal funds
rate was 18.3 percent and the 3-month commercial
paper rate was 16.2 percent. The 3-month Treasury
bill rate, which had peaked at 16.5 percent at the
end of March, was down to 13.8 percent, its lowest
level since the beginning of March.lJ7 Traders rejoiced that the corporate bond market was reborn
because companies once again began seeking longterm financing. Market analysts attributed the bond
market’s revival to anticipations that inflation would
not be allowed to get out of control and to firms’
attempts to replace bankloans with fured-cost market
financing.138
The consumer credit controls were largely symbolic and without teeth; however, they induced consumers to alter their buying behavior. Consumer
spending, especially credit-financed expenditures,
fell off dramatically. The country’s major retailers
BANK OF RICHMOND

41

(e.g. The J.C. Penney Company, Sears, etc.) experienced declines of about 20 percent in charge account
applications and 10 percent in credit sales during
March and April. I39Retail sales fell at the fastest rate
in twenty-nine years. 140 According to economist
S. Lees Booth, the program “ ‘may have been symbolic, but it was shocking.’ ” A Nm Yo& Times/CBS
News poll taken in April showed “58 percent of
Americans . . . using credit cards less than they did
. . . in [ 19791, while only 5 percent were using them
more.“141 As President Carter described the situation, “(Mlany [credit] card holders began to believe
that it was almost unpatriotic to buy items on
credit.“14* Typical of the letters Carter received from
the public regarding the controls was one from
Dennis Gordon of San Francisco, California. It read,
We are supporting you sir, one-hundred percent. Your
inflation fighting program has forced us into alternatives
that we are not finding hard to live with. We are spending
with more wisdom and not as frequently. We are drawing
closer to each other during this fight against inflation.
An evening once ‘[spent] going “out on the town” is
now enjoyed gathering in our home or the homes of
friends. We have once again discovered parlour games,
sing songs, lengthy walks and other means of “old
fashioned” entertainment.
I believe myself and my group of friends are not unique.
I believe all across America we are pulling together to
survive, and will do so quite nicely and to our surprise,
comfortably.i43

An informal New York Times survey of consumers in
Ridgewood, New Jersey revealed similar attitudes. 144
The decline in consumer spending, however, concerned the Federal Open Market Committee at its
April 22 meeting. According to the Board’s description of the meeting,
The contraction in activity was projected to be somewhat
larger than had been anticipated a month earlier and to be
accompanied by a substantial increase in unemployment. . . .
The degree of prospective weakness in consumer spending was viewed as a major source of uncertainty. The antiinflationary measures announced on March 14 appeared to
have curbed considerably spending in anticipation of price
increases. It was noted in this connection that a rise in the
saving rate from the abnormally low levels of the most
recent two quarters to a more normal rate would imply a
marked cutback in consumer spending. . . . However, it
would be premature to conclude that inflationary attitudes
and behavior had been fundamentally altered, especially
in view of the prospect that the rapid rise in the consumer
price index would persist for a number of months. . . .
Several members noted their concern that if a large decline
in interest rates were to occur over the next few weeks, it
was likely to be perceived by some market participants . . .
as an easing of monetary policy and could have very undesirable repercussions on inflationary psychology . . . .145
42

ECONOMIC

REVIEW,

For the month of April, the narrow money aggregates again fell sharply, hitting below the lower end
of the Federal Open Market Committee’s long-run
target range. Only three banks still had annual loan
growth rates exceeding 9 percent. Total bank loans
outstanding fell 5 percent (annualized). 146
In May, interest rates plummeted, falling about one
percentage point each week.147 Bank loan growth
declined further. The slowdown in bank loan growth
in April and May reduced by over 100 the number
of financial institutions having to hold reserves against
managed liabilities.’ By May 5, market analysts
speculated that the end of the CRP was near because
“the measures weren’t needed in the first place,” and
the program was “ ‘scaring people away from the
stores.’ ” The consumer controls were expected to
be lifted within six weeks.14a
The Board’s first step toward easing the controls
was elimination on May 7 of the 3 percent discount
rate surcharge. While the surcharge was in place, few
banks had to pay it because it had been imposed only
two weeks before the first quarter ended. Consequently, at most seven banks paid the surcharge in
any statement week, and almost all that did borrowed in two consecutive weeks. The surcharge was
lifted just days before any banks could be subject to
the surcharge for borrowing four weeks in any
quarter.S
On May 14, Volcker announced that the Board
could “ ‘legitimately look forward to dismantling’
[the CRP]. . . . ‘We have not wanted to move
prematurely, we will not. . . . But equally, we are
not interested in fostering any impression that credit
allocation, formal or informal, can be any part of the
basic, continuing armory of monetary policy.’ “149
The Board eased the credit restraint measures considerably on May 22, the day lenders of consumer
credit were to make their first special deposit. It cut
the deposit requirement on consumer credit and
MMMFs from 15 percent to 7.5 percent, cut the
reserve requirement on managed liabilities from 10
percent to 5 percent, and revised its lending
guidelines to make credit more available for certain
I Board of Governors, “Federal Reserve Credit Restraint
Program,” pp. 40,42. The excess of covered managed liabilities
over base levels dropped by $11.1 billion over this period.
’ Peter Keir, “Impact of Discount Policy Procedures on the
Effectiveness of Reserve Targeting,” in Neee,Monetary Cm& Proc&m, pp. 158-159 and Table 2. Those paying the surcharge
borrowed an average of $80 million.

NOVEMBER/DECEMBER

1990

types of loans.‘50 Treasury Secretary Miller, meanwhile, encouraged consumers to return to the
stores.isl
The May easing of the CRP did not slow the flow
of bad economic news in June. Early in the month,
data was released showing that unemployment rose
1.6 percentage points to 7.8 percent over April and
May; it was the largest two-month increase ever.15*
In addition, consumer installment debt fell 8 percent
in April, with the decline greatest for personal loans.
This was the first decrease in consumer debt since
May 1975.1s3 On the bright side, producer prices rose
only 0.3 percent in May. Economist Lawrence
Chimerine,
chairman of Chase Econometrics,
called the credit controls “ ‘overkill,’ ” and saw the
recession as being “very severe,” with little chance
of a quick recovery. ls4 By the end of June, the National Bureau of Economic Research declared that
the economy was in a recession that had begun in
January. I55
The economy was so weak by late June that the
controls were nonbinding.156 As a result, on July 3
the Board announced the phase-out of the CRP, and
President Carter removed the Board’s authority under
the CCA except as needed to end the program.
Carter warned that he retained the authority to
impose controls and would invoke the CCA again
if signs of excessive credit use reappeared.’ Retailers
were concerned that the psychological effect the controls had on consumers might not be reversed by
simply lifting the controls.157 They immediately
began planning credit promotions in hopes of
revitalizing charge sales, although they retained many
of the more stringent credit policies they had adopted
while the controls were in place (e.g. annual fees and
higher minimum monthly payments) because they
were “good business practices.“158
Data released July 9 showed that consumer installment credit fell a record 13 percent in May. New
consumer credit extensions were 25 percent lower
than the September 1979 peak. These declines were
attributed to the effect the CRP had on consumers.
Between January and May, output of consumer goods
fell 3.7 percent, while retail sales fell 10.3 percent.
From April through June, preliminary data showed
an 8.5 percent (annualized) decline in GNP. Inflation, however, was down to 11 percent by July, as
was the prime rate.ls9
t Board of Governors, Press Release, July 3, 1980. Also “White
House Credit Text,” Th Nz-w Yod Zhes, July 4, 1980. The
reserve requirement on managed liabilities would be lifted
July 10; the special deposit on consumer credit, July 23; and
the deposits by MMMFs, July ‘28.
FEDERAL

RESERVE

The Aftermath of the Controls
Another Surprise

Program:

After the precipitous drop in economic activity
during the second quarter, economists generally
expected the recession to last through the end of
1980 and be almost as severe as the 1974-75 recession. In reality, however, private sector demand
“rebounded with surprising alacrity.” The sharp drop
in interest rates was a driving force in the recovery,
stimulating housing and consumption. Housing starts
rose 70 percent between May, their low point, and
September; car sales also rebounded dramatically,
increasing 28 percent between May and October.
Although outstanding consumer installment credit
experienced its largest decline in the postwar period
during the second quarter, it began rising as soon as
the controls were lifted, albeit at a slower pace than
early in the year. The rise in credit use was accompanied by an increase in consumer spending. Real
retail sales rose 17.8 percent in June and 27.3
percent in July. In the third quarter, real personal
consumption expenditures rose 5.1 percent, compared with a record 9.8 percent second quarter
decline.
The drop in interest rates in the spring was shortlived. As the economy strengthened and inflationary
pressures intensified, the demands for money and
credit increased and interest rates rose. The prime
rate climbed from 11 percent in July to 2 1.5 percent
in December. The federal funds rate hit 19.8 percent as the three-month commercial paper rate
reached 19.5 percent.
Looking at 1980 in its entirety, the economy
experienced a short but severe recession during the
first half of the year and quickly recovered during
the second half. Real GNP remained essentially unchanged, while the money aggregates were close to
the upper end of the Federal Open Market Committee’s fourth quarter-to-fourth quarter target ranges.
Disposable income rose only 0.5 percent, but personal consumption fell 0.3 percent. Consequently,
saving rose one percentage point over the previous
year, fourth quarter to fourth quarter, to 5.7 percent.
The CPI, excluding food, energy, and home purchase
and finance, rose 9.0 percent between April and
November, slower than the 12 percent rate during
the first quarter, but higher than the 7.2 percent rate
for the year ending November 1979.i60 In retrospect,
the credit control program appears to have lowered
interest rates and inflation only while it was in
effect, and did so by worsening a recession that was
already underway.
BANK

OF RICHMOND

43

Data Resources,
Incorporated
conducted
a
preliminary study in 1980 of the CRP’s overall
economic impact.161 DRI found that
“the March 14 Credit Controls had some negative impact
on the economy in the second quarter. . . . The credit
controls did make the fall off in economic growth more
severe.”

In addition, DRI concluded that the CRP reduced
real output, but not inflation; other factors accounted
for the lower inflation rate during the second and third
quarters.U DRI’s simulations indicated that the
CRPs total, long-run cost to society would be losses
of $23 billion of GNP, $19 billion of total consumption, 300,000 man-years, 50,000 housing starts, and
500,000 new domestic car sales.
VII.

WHATWENTWRONG?
Although the 1980 recession was underway before
the CRP was imposed, the Board, the Administration, and the financial markets believed that the
program contributed to the steep fall-off in economic
activity beginning in March. This slowdown is
apparent in the time series of the key macroeconomic
variables, as Figures l-10 show. This section addresses two questions: To what extent did the controls accomplish the Boards objectives? To what
extent did they contribute to the recession?
Each component of the CRP had a different
effect on the economy. Some accomplished what
they were designed to do; others did not. Some were
too effective at reducing credit use.
The reserve requirements on managed liabilities
and the discount rate surcharge were not expected
to affect market interest rates, but they did. The
imposition of these measures immediately raised the
cost of funds to large banks. This increased cost
quickly led to increases in the prime and federal funds
rates. Loan growth slowed as the rising interest rates
priced borrowers out of the credit markets.
Also contributing to the decline in bank lending
was the voluntary credit restraint program. According to the Board,
It is difficult, if not impossible, to say how much of the
weakness in bank loans [under the program was] . . . due
to the recession, how much to reaction to fiscal announcements and general credit conditions (including expectational
effects), how much to the cumulative effects of earlier
” The Chamber of Commerce’s summary of DRI’s results does
not specify what these other factors might be.
44

ECONOMIC

REVIEW,

overall restraints, and how much to the credit restraint
programs. But the timing and abruptness of the change in
loan growth trends suggest that announcement of the programs played a significant role. Indeed the immediate effect
of the programs on bank lending may have been exaggerated
by the initial reactions of lenders to these restraints, as
they sought to evaluate what the Federal Reserve actionsespecially the 6 to 9 percent limitation-would
mean in
their particular case . . . .162

In contrast, the special deposit requirement on
MMMFs was designed not to reduce credit use but
rather to alter the disintermediation from financial
institutions. It did not accomplish its objective
because, as explained in Section VI, it had a negligible effect on fund yields. Although assets at
MMMFs fell during the first four weeks of the CRP,
they quickly recovered, growing over 30 percent
between mid-March and late J~1y.l~~
Similarly, the consumer credit restraint program
was not expected to have a major impact on credit
use or consumer behavior because it focused primarily
on charge card credit and personal loans and was imposed on lenders, rather than directly on consumers.
Consequently, the declines in consumer installment
credit, personal consumption expenditures, and retail
sales were a big surprise. This surprise may have been
caused in part by the response of charge card issuers
to the restraint program. Despite the Boards announcements that the CRP would be in place only
temporarily,164 many of the changes in charge card
terms made under the program were not designed
for temporary use. The most effective, least costly,
and easiest ways for creditors to temporarily reduce
the growth of charge card use were to stop accepting card applications and reduce credit lines while
the program was in place. These were not the steps
most commonly taken in response to the controls.
Rather, creditors more often introduced annual fees
and changed the methods of calculating the minimum
balance and finance charge, changes that were more
costly to implement and inconsistent with the program’s temporary nature. These changes also applied
retroactively, thereby penalizing charge account
holders generally rather than only those who used
their cards while the controls were in force.” Because
creditors decided individually how to respond to the
CRP, the changes made in credit terms varied greatly
across charge cards. The diversity in charge term
changes, together with the failure of creditors to communicate these changes clearly, contributed to consumers’ confusion over the impact of the program
on their finances.165
” Many of these changes are still in place today.

NOVEMBER/DECEMBER

1990

Real GNP

Fig. 1

Annualized

MarketInterest Rates

Fig. 6

Percent Per Annum

Percent Change

1679

’

1980

Total Consumption Expenditures
Fig. 7

Fig. 2
Annualize!?e%!?t

Fig. 3

Fixed Investment and Change
in Business Inventories (NIPA)
Annualized

Treasury Interest Rates

Change

Percent Per Annum

Fig. 8

Unemployment Rate
Percent lor Month

Percent Change

60

7.8

0
6.0

-40
1979
Fig.4

1980

ConsumerInstallmentCreditOutstanding
Annualized

1979
Fig. 9

i 980

Consumer Price Index
Annualized

Percent Change

Percent Change

8
5

-15
-18

1
1979

Fig.5

1980

RetailSales ExcludingAutomotiveGroup
Annualized

Percent Change

1980

1979
Fig. 10

Ml and M2
Annualized

Percent Chanae

30

Figures 1, 2, and 3 use quarterly data, all others
use monthly data. Data points are centered over
their respective
time periods, those periods
represented
by segments between tick marks.
Data for Figures
adjusted.

1-5, 8, and 9 are seasonally

Gray shading indicates period of Credit Controls:
March 14,198O . July 3, 1980.

-20
1979

1980

i 980

45

As the preceding discussion indicates, the CRP led
to an immediate rise in short-term interest rates and
affected consumers’ buying psychology. The rise in
interest rates was only temporary; within a month
after the CRP began, rates started falling. This suggests that the CRP resulted in an immediate decrease
in the supply of credit, followed by a larger decrease
in the demand for credit. The drop in demand was
in addition to the decline that would have occurred
even in the absence of credit controls because of the
recession that was already underway.
Looking back on the CRP, Board Vice Chairman
Schultz explained why it did not work as planned:
We [the Board] learned in 1980 that it is exceedingly difficult to assess in advance the impact of controls on economic
activity. When the Board enacted its program, we did not
anticipate, and we had no reason to anticipate, the market
impact it would have. G&n t/re limited coverage of the
program, it woaki have been eqected to have had a moderate
effect on amgate
demand; however, we did not reckon
comxtLy the dimensions of the pqhoLogka1 impact of the
prvgrom on homers
and lends. To be sure, some of
this impact owed in part to a misunderstanding, especially at
the beginning, about the scope and intent of the program,
but beyond this, there was [a] remarkable shift in attitudes
that led to a sudden contraction of credit flows. This contraction involved even those sectors that were explicitly
exempted from the controls, and . . . contributed to a sharp
economic recetion. Then, when we removed the controls
in the early summer, we were surprised once again by how
quickly the economy snapped back.166 [emphasis added]

VIII.

THEFATEOFTHECREDITCONTROLACT

Two events increased uncertainty concerning labor
income in the first half of 1980. First, rumors began
spreading in late 1979 that a recession was imminent, but its length and severity were unknown.
This led to a slowdown in consumer credit use in
late 1979 and. early 1980. Second, the imposition
of credit controls in mid-March increased consumers’
uncertainty about their ability to use their charge
cards and obtain personal loans. For consumers,
charge cards and personal loans are a source of
liquidity ,and a means to smooth their consumption expenditures over time because they enable
consumers to access their future income. Consequently, the controls raised consumers’ uncertainty
about the amount of income accessible in the present, causing consumers to reduce current consumption even more sharply than they had before the
controls became effective.‘”
w Why would consumers alter their buying behavior as they did
in response to restrictions on credit card use and extensions
of personal loans? The economics literature shows that when
faced with greater uncertainty regarding labor income increases
(i.e. increases in the variance of expected future income), a riskaverse consumer will reduce current consumption and plan to

46

ECONOMIC

REVIEW.

Table I presents evidence supporting the claim that
the 1980 recession was “ ‘the worst consumer recession since World War II.’ “167 The table, which is
patterned after one by Barro,r6* shows the shortfall
in real GNP for each recession since World War II
and the percentage of the shortfall attributable to
personal consumption and investment. The shortfall is calculated as the average over all quarters in
a recession of the deviation of actual GNP from its
trend level. For the 1980 recession, personal consumption accounted for 79.4 percent of the shortfall in real GNP; this is more than twice the average
34.8 percent contribution for all postwar recessions
and is 36 percentage points greater than that for the
1973-1975 recession. The contribution of expenditures on durable goods alone is 37 percent, 3.3 times
the average of 11.2 percent. In contrast, investment,
defined as gross fixed investment plus the change
in business inventories, contributed 64.9 percent of
the shortfall in real output, compared with an average
of 69.5 percent for all recessions considered.x Thus,
this evidence suggests that the CRP contributed to
the 1980 recession by inducing a greater reduction
in consumption, especially consumption of durable
goods, than that in the typical postwar recession.Y

Senator Helms’s attempt to repeal the CCA in
1979 was not the last such attempt. In fact, while
selective credit controls were in place in 1980,
another effort was made at legislative repeal. In May
1980, Senator William Armstrong proposed an
amendment,to Senate bill S. 2352, which would extend authorization for the Council on Wage and Price
Stability. The amendment would end the President’s
authority under the CCA as of July 1, 1981. According to the amendment’s supporters,
increase future consumption. That is, the consumer behaves
more prudently, saving more in the current period as a precaution against possible future misfortune. See Olivier jean
Blanchard and Stanley Fischer, Lectrrfes on Macnzconomics (The
MIT Press, 1989) pp. 279291; Stephen P. Zeldes, “Optimal
Consumption with Stochastic Income: Deviations from Certainty
Equivalence,” Th Qaartdy Journal of Economics, vol. 104,
no. 2 (May 1989) pp. 275298.
’ For some recessions, the percentage contributions of consumption and investment to the GNP shortfall sum to over 100
percent. This occurs when government purchases and net
exports combined had a stimulative effect, contributing to a
reduction (i.e. a negative percentage change) in the GNP
shortfall.
y There are methods, other than those used in Table I, for
calculating the shortfall in real GNP. They result in consumption making an even greater contribution to the shortfall than
shown here.

NOVEMBER/DECEMBER

1990

Table I

Breakdown of Shoiffall

in. Real GNP During Postwar Recessions

Time Period of Recession
Quarterly*

48: IV-’
49:lll

:
Monthly

53:ll.54:11
53:754:5

48:11-

49:lO
Average Quarterly
of Real GNP**

Shortfall

Average Quarterly

Real GNP

9.56
1114.53

accounted for by:
Expenditures.

75:l

28.03

69:1270:11-.

22.08

13.61

’

73:1175:3

38.17

8O:l-

81:lll

8O:ll .’
80:180~7

82:~‘.
81:782: 11

Mean for
Postwar
Recessions

41.20

ha.29

27.32

plus Change

0.91

.1.40

1.51

1.29

1.23

‘1.24

1.83

0.82

26.15

20.66

26.24.

37.43

26.26

43.35

79.38

18.51

.34.75

,4:70

10.15

16.33

19.57,

37.02

0.59

11.24

17.54

12.88

19.22

4.67

16.02
21.98

24.66

9.41

16.23

1.88

2.02

5.36

17.71

8.50

107;99

38.36

72.02

64.94

67.50

69.51

14.00

-4.26

21.08

Services

Other*

73:IV-

,7O:IV

0.86

19.52

,,’

Gross Fixed Investment
Business Inventories

7O:l-

61:1
60:461:2

1429.13 1534.97 1665.15 2417.53 2720.47 3195.25 3191.28 2158.54

-14.45

Durables
Nondurables

6O:ll-.

58:l
57:858:4

;.

Average Shortfall’as
a % of
Average Trend Real GNP
% of Real GNP Shortfall
Personal Consumption

17.66

57:lll-

- 1.58

3.21

7.27

in

129.41
- 55.56

l l

27.86

48.03

51;48

25.73

-45.41

”

35.39

- 15.38

-44.32

* Barre studies the period 1929-1982and uses annual data; consequently,
he combines the 1980 and 1981-82 recessions.
used. In determining.the
first and last,quarter
in a recession, we include quarters with at least two months of recession.

Here, .quarMy,

data are

* The shortfall, measured in billions of 1982dollars, is the’average difference between trend GNP and actual GNP for each quarter in the recession,
GNP is determined ,by multiplying the actual GNP for the previous quarter by the trend quarterly growth rate of 0.8% + for the period studied,’
l

l l l

“Other”

consists qf government

purchases

Trend

and net exports.

Having suffered the inevitable inequities, costs and frustrations inherent in . . . [selective credit controls], a coalition
of business and consumers want the March 14th program
stopped and the Act repealed. . . .
On paper, the credit control program was simple: direct
bankers to restrain credit lending, allowing each. to say
how. In reality, the program has been.a nightmare.169

During Senate debate of the. amendment,
argued that
_‘.

Helms

The committee amended the Senate bill to sunset
the CCA on June 30, 1982, a year later than originally proposed. The Senate approved the Armstrong
amendment and S. 2352 by votes of 43-40 and
72-11, respectively,
and the House gave its
unanimous consent to S. 2352 as amended.172 Carter
signed the, bill into law on December 9, 1980,’
stating,

[b]y leaving the Credit Control Act on the books, we make
it almost mandatory that the President use it when he has a
seemingly good, excuse to use it: In other words; if he
neglected to use it, some m’ight say that he was not”doing
all he could” to fight inflation: By leaving such an act, on
the books, we make the President more subject to pressures
to “do something” even though “doing something” using
credit controls is the wrong thing to do.*‘0

I believe that abolishing the authorization granted to the
President,under the [C,CA] . . . is highly unwise, because
many of the act’s provisions can be extremely helpfuI,at
critical periods in the fight against inflation. This is no time
to strip a President of inflation-fighting powers. At the same
time, I recognize that certain improvements to the Credit
Control Act may be desirable. It is my hope that during the
next 18 months Congress will enact a new Credit Control
Act that saves the essential inflation-fighting powers that
the act makes availabler

The House considered its version of the bill in
September. This bill did not include ,an amendment
for sunsetting the CCA. In debate ‘of the; bill,
Representative Annunzio suggested that the Senate’s
amendment was politically motivated to detract
attention from the success of President Carter’santiinflation program and’hurt his chances &Ithe upcoming election.r7r

Thirteen days after’the’sunsetting of the CCA, the
House held hearings on H.R. 6 124, a bill “to reduce
interest rates, control inflation, and ensure the
availability of credit for productive purposes, and
promote economic recovery by extending the Credit
Control Act.” Specifically, the bill would repeal the

A conference committee met to. arrange a compromise between the House and Senate versions.

’ See Act of December 8, 1980, 94 Stat. 2748-9. Section 9
amends the CCA by adding to it Section 2 11, terminating the
authority conferred by the CCA on June 30, 1982.

FEDERAL

.

RESERVE

i

BANK

OF RICHMOND’

47

termination of the CCA (Sec. 2 11) and amend Section 205(a) to read

cruel deception. This is why I oppose having credit controls available even on a standby basis, for emergency
situations.177

“Whenever the President determines that such action is
necessary or appropriate to reduce high leve.k of unemp&wwnf
in any sector of the economy, of to pfewent of conhal inflatim of
recession,the President may authorize the Board to regulate
and control any wallextensions
of credit.” [emphasis added]

On behalf of the Reagan Administration, Manuel
Johnson, Acting Assistant Secretary for Economic
Policy, reported that

‘.

the Administration strongly opposes the use of credit controls, or any controls for that matter. . . .

It also allowed for limiting credit for nonproductive
purposes. 174
Typical of the arguments given in support of H.R.
6 124 were those by J. Morton Davis, president of
D. H. Blair & Co., Inc., and J. C. Turner, general
president of the International Union of Operating
Engineers and chairman of the National Council for
Low Interest Rates. Davis called the CCA a “spare
tire” and wondered why anyone would not want to
have a spare tire available. Turner argued that high
interest rates were the “quicksand” of the 1981-1982
recession and that the CCA provided “the only
avenue available for removing the crushing burden
of high and volatile interest rates.” He also supported
the addition of unemployment and recession as “triggers” to allow use of the Act.17s
The Board and the Reagan Administration opposed
H.R. 6124. Preston Martin, Board Vice Chairman
in 1982, testified,
[The Board does not] believe that credit controls are an
effective, .efficient, or fair method to deal with [unemployment, recession, high interest rates or] . . . inflation when
the more general instruments of monetary and fiscal policy
can be used. Our experience with the administration of
controls for a brief period‘in 1980 amply demonstrated
the difficulties encountered in the application of credit
controls.r76

Former Board Vice Chairman
concurred:

Frederick

Schultz

Now; with the benefit of 20/20 hindsight . . ., I am convinced that controls were not the right way to address the
economic problems we experienced in early 1980. . . .
One reason some people have proposed that credit controls be used today is that they feel this would help to
lower interest rates and aid the economy. . . . Certainly
one does not lower interest rates by reducing credit supplies! So the lowering of rates must be achieved by reducing effective credit demands, which in the aggregate is
not consistent with higher rates of spending and economic
activity. . . .
. . . . We still found oursehks at the end of. . . 1980 with
the need to deal with inflation, high interest rates, and
languishing productivity. ‘Indeed, I think that there is a
considerable risk that the underlying problems of the
economy will be found to be even more intense once a
period of credit controls has been ended. . . . The quick-fix
or ‘the bandaid policy always looks attractive, but that is a
48

ECONOMIC

REVIEW,

The recent experience with credit controls in 1980
exemplifies virtually all of the undesirable consequences of
controls. . . . Key industries targeted for relief, such as
housing and autos, collapsed under the weight of credit
scarcity. Interest rates were temporarily reduced but the
cutoff of credit at the lower rates produced rising unemployment and a general weakening of the economy that
subsequently turned into a full scale recession from which
we still have not fully recovered. And, instead of declining,
inflation continued strong throughout the year. 1’s

H.R. 6124 died in committee, but its fate and the
testimony given opposing it did not prevent an extended version of the bill from being introduced as
H.R. 1742 just one. year later. In June 1983, the
House Subcommittee on Economic Stabilization held
a hearing on the bill, called the Credit Control Act
of 1983. The bill amended the CCA of 1969 as H.R.
6 124 would have and included a provision for the
Board to review the financing of corporate acquisitions and mergers. I79 At the subcommittee hearing
on the bill, Representative
Norman Shumway
asserted,
I have read the bill. Certainly no one can quarrel with the
stated purposes of it: to reduce interest rates, to control
inflation, to ensure the availability of credit for productive
purposes and to promote economic recovery.
But I would suggest [that] . . . there is no evidence
whatsoever that explicit control by the Federal Government
of credit availability and allocation will contribute to the
achievement of any of these objectives.
In fact, the most recent experience we have had with
credit controls under the past administration proved to be a
disaster. It depressed an economy which was already
headed for a period of lesser growth as a result of existing
trends and policies. . . .
Mr. Chairman, you know as well as I that although the
bill before us provides the President standby authority only,
this President neither wants nor needs such authority.
He has indicated, in fact, that he will veto the legislation
if sent to him. This, of course, is highly unlikely because
the Senate has no intention whatsoever of considering the
measure.
I can only conclude, therefore, that the introduction of
H.R. 1742 and today’s hearing are both rather desperate
attempts to embarrass the administration.
In the face of the increasingly bright signs of a healthy
recovery, I can perhaps understand the-desire of my friends
on the majority side to score partisan political points, but I
don’t understand why this senseless and rathermeaningless
proposal was chosen as the vehicle.rEO

NOVEMBER/DECEMBER

1990

The hearing was brief, and the bill never got out of
committee.

thus proved to be a blunt .policy instrument whose
economic impact was impossib1.e to manage.

No bills have been introduced subsequently to
reenact the CCA of 1969. .For now, the Presidential authority for selective credit controls conferred
under the Act remains repealed.
’

At present, there -is no- legislative authority for
selective credit controls like those2used in- 198.O.rsr
The only Presidential authority to regulate credit is
grantedunder
section S(b)(l) of the Trading With
The Enemy Act of October 6, 1917, (40 Stat. 415).
This act allows for the investigation, regulation, or
prohibition of “transfers of credit or payments between, by, through; or to any banking institution”
during wartime.‘*2

IX.

COU~DCREDITCONTROLS
BEPARTOFOURFUTURE?
The Carter Administration apparently decided to
impose credit controls to signal that it was actively
fighting inflation. The Board and the Administration
designed the credit restraint program to have minimal
economic impact on real production and employment. Contrary to their expectations, however, the
program’s immediate effect was to raise, not lower,
short-term interest rates and to dramatically reduce
consumer c,onfidence. Interest rates started down
within a month after the program began as a decline
in consumer spending worsened the developing
recession. The economy’s recovery after ‘the credit
controls were lifted.‘was as fast and sharp as its
decline when they were imposed. Credit controls

Although no legislative’authority
now exists for
credit controls, the U.S. experience with such controls probably has not come to a close. This experience suggests that in times of rising prices and
interest rates, there are always voices advocating the
use of credit controls. And in such times, Congress
grants the authority for such controls, despite its own
earlier recognition
of the ineffectiveness
and
economic harm that credit controls have caused. The
1980 experience makes clear the dangers involved
in using credit’ controls, to fight inflation. This
article has reconstructed the details of that experience
in the hope that policymakers will be more aware
of the dangers of credit controls in the future.

ENDNOTES
1. The discussion of price controls in Revolutionary America is based on
Margaret Myers, A Fimmial Hirtory of the United States (Columbia
University Press, 1970), pp. 24-29, and Robert L. Schuettinger and
Eamonn F. Butler, Foq cnrnrriw of Wage and price Gwrmlr (The Heritage
Foundation, 1979), pp. 38-41.
‘2. The di$cussion of Regulation W that.follows is based on Myers, AFimm&/
H&my of tkc United Stans, pp. 355-356, 379-388; Paul Smith, “A Review
of the Theoretical and Administrative History of Consumer Credit Controls,”
in ha Kaminow and James M. O’Brien, eds., &u&s in sc/ccriw Cndt Poli&
(Federal Reserve Bank of Philadelphia, 1975). pp. 138-143; and David
Fand “On Credit Allocation ” in U.S. Senate, Committee on Banking,
Hous’ing, and Urban Affairs, ‘Hearings on Amending tk Cmfit Cmtml Act,
96 Gong. 1 Scss. (Government Printing Office, 1979). pp. 130-134.
3. Section 602 of title VI provided the legislative basis for the Board’s
Regulation X, pertaining to controls on real estate construction credit.
4. Letter from Richard A. Lester to Senator Joseph O’Mahoney, January 2 1,
1951, Submitted to the Joint Committee on the Economic Report, Mutt-n&
pnpond on Gmcml Cndt Gmnvl, aCbt Management, and Emmmic Mobiliaotitm, 82 Gong. 1 Sess. (GPO, 1951), pp. 54-55.
5. U.S. Congress, Joint Committee on the Econqmic Report, Subcommittee
on General Credit Control and Debt Manage&x,
Heating on Monetary
PO& andtk Management of tk pub/icDebr, 82 Gong. 2 Sess. (GPO, 1952).
6. Section 116(a) of Act of June 30, 1952 (66 Stat. 296, 305).
7. Credit controls have not been used often in the U.S., although they are
common in Western Europe. See Donald Hodgman, “Credit Controls in
Western Europe: An Evaluative Review,” in Ctrdit Alhzion Techniquesand
Macr~ry Pohy, Federal Reserve Bank of Boston Conference Series No. 11
(September 1973), pp. 137-161..
8. “Banking-Interest
Rate Ceilings-Credit
Control: P.L. 91-151,” Uniad
States Code Gnzgnxionai and Adminismtive News, 91 Cmg. I Sm., vol. 1,
St. Paul: West Publishing Co., 1970, pp. 1479-82, 1490.

11. “Banking-Interest

Rate Ceilings-Credit

Control: P.L. 91-151,” p. 1475.

12. Federal Reserve Chairman Martin testified in support of standby authority
for Regulation W in June 1969. See “Banking-Interest
Rate CeilingsCredit Control: P.L. 91-151,” pp. 1500-04.
13: Prepared &tement
by Robert Morris Associates
Hmings on Amending tk Cm&t Gmtmi Act, p. 32 1.
14. “Banking-Interest

Rate Ceiling&&dit

in U.S.

Senate.

Control: P.L. 91-151.” p. 1516.

15. Wee& hnpihion
of Prw’dtwial Documnu, vol. 5, no. 52, December 29,
1969 (GPO, 1980). p. 1785.
16. L&no& Rqm-t of-tk -t,
J anuary 1978 (GPO, 1978), pp. 35-39,
and Board of Governors of the Federal Reserve System, Annual Statitical
LXg6.s: 1970-79 (March 1981), p. 286.
17. Board of Governors of the Federal Reserve System. 65th Anwal Rcpon,
1978 (Board of Governors, 1979). pp. 5-13.
18. Letter from George h+any to President Carter, S/19/78, “Anti-hiflation
[O/A 6338][3],” Box 143, Stuart Eiinstat’s
Files, Jimmy Carter Library.
19. Letter from President Carter to George Meany, 6/S/78, “Anti-Inflation
[O/A 6338][2],” Box 143, Stuart Eizenstat’s Files, Jimmy Carter Library.
20. Robert J. Dowling, “Credit Controls are Haunting Wall Street,” Busims
Wed, November 27, 1978, p. 30.
21. Robert M. Bleiberg, “Lurch to Controls: The U.S. Is Getting There in
Not-So-Easy Stages,” editorial commentary, Bmmn’s, vol. 58, Septcmber 25, 1978, p. 7+.
22. Hobart Rowen, “Meany Suggests Mandatory, Not Voluntary, Wage-Price
Plan,” Tk Wmhingm Post, October 11, 1978.
23. Board of Governors,

65th Annmzl Report, 1978, p. 13.

9. ‘Banking-Interest
1490. 1497.

Rate Ceilings-Credit

Control: P.L. 91-151,” pp. 1467,

24. Robert M. Bleiberg, “For Whom the Bell Tolls: The Drop. in the Stock
Market Probably Has Further to Go,” editorial qxmnentaty, Bomm’s,
vol. 58, November 13, 1978, p. 7 +.

10. “Banking-Interest

Rate Ceilings-Credit

Control: P.L. 91-151,” p. 1468.

25. Memo from Orin .Kramer to Stuart Eizenstat, 12/4/78, “Anti-Inflation
[O/A 63381[11,” Box 143, Stuart Eizenstat’s Files, Jimmy Carter Library.

FEDERAL: RESERVE BANK OF RICHMOND

49

“Proposed
Governors;
Governors,
Governors;
Actions on
Governors.

26. Board of Governors, 65th Amwal Report, 1978, pp. 5-7, and Board of
Governors, Ann& Stotihal L&wt: 1970-79, p. 286.
27. Board of Governors,

65th Annual Rcpmt, 1978, pp. 7, 13.

.28. Remarks of Senator Jesse Helms,
March 28, 1979, p. S2750209.

Gmgrtx&@

Ret&

(daily edition),

29. Remarks ‘of Senator’ Jesse Helms,
January 15, 1979, p. SZ750010.

&@&om~l

Recoil (daily edition),

30. Remarks of Senator Jesse Helms,
March 28, 1979, p. S2750209.

Congressitul Record (daily, edition),

3 1. Memo from W. Michael Blumenthal to President Carter, 3/30/79, “Monetary Policy [CF, O/A.S38J,” Box 234, Stuart Eizenstat’s Files, Jimmy
Carter Library.
32. Memo’ from Alfred Kahn to Walter Mondale,. et al., 5/17;79, “BE 4-2
8/18/78-l/20/81,” Box BE-16, WHCF-Subject File, Jimmy Carter Library.
33. Testimony of Alan Greenspan
Cndt Gnmvl Act, p. 17.

in U.S. Senate, Hcoriogs on Amending tk

Voluntary Credit Restraint Program,” 311180, ‘Board of
Memo from Axilrod, Kichline, and Petersen to the Board of
“Proposed Consumer Credit Regulation,” 311180, Board of
Memo from Axilrod to the Board of Governors, “Possible
Marginal Reserves and Credit Controls,” 3/4!80, Board of

58. “Credit-Control
Any Rules.”

Rumors Spur Borrowing, Concern Over Effectiveness of

59. Robert A. Bennett, “Bankers Oppose
Emu, March 4. 1980.

fk

Credit Contrdls,”

Nm

Yor#

60

Memo from Orin Kramer to Stuart Eizenstat, 2/28/80, “FI-2 2/l/801/4/81,” Box FI 4, WHCF-Subject File, Jimmy Carter Library.

61

Memo from Lloyd N. Cutler to Secretary Miller, et al., 316180, “Inflation
9179-2180,” Box 80, Lloyd Cutler’s Files, Jimmy Carter Library.

62

Clyde H. Farnsworth, “Credit Card Controls Are Studied,” Tk NEW Yorff
Times, March 10, 1980.

34. Letter from Charles Schultze to Senator Proxmire in U.S. Senate, Hcaringr
on Amending tk Credit G~ntml Act, pp. 14- 15.

63. Richard J. Levine, “White House Maps Fiscal Policy: Carter Economic
Advisers Rule Out Common Forms of Credit Controls as Part of Battle
Against Inflation,” Tk WalI Strwt Jottmul, March 4, 1980.

35. Testimony of Nancy Teeters in U.S. Senate,
C&it ~omnd Act, pp. 255-260.

64. “Fears of Credit Controls Depress
March 11, 1980.

Heoriings it Amending tk

36. E. J. Dianne, Jr., “The People Want Controls,”
February 3, 1980.
37. Economic Rep&f of tk Pmridmt, January 1981 (GPO,

Tk New Yti

Times,

1981), p. 264.

38. Board of Governors of the Federal Reserve System,
Btdletitr, vol. 65, no. 11 (November 1979). pp. 915-918.

Fedeml Reww

39. Statement of Frederick H. Schultz before the U.S. House, Subcommittee
on Access to Equity Capiial and Business Opportunities of the Coinmittee
on Small Business, Heuriqy on Fedeml Monetary Policy And Its Effect On
Small Burimxr (Port 3-Credit Gwtmls and Avoi/obility of Credit), 96 Cong.
2 Sess. (GPO, 1980). p. 3.
40

Remarks of Paul Volcker before the U.S. Congress, Joint Economic
Committee, Hearing a Tk I980 EconomicReport of the Fkident, 96 Cong.
2 Sess., Part I (GPO, 1980). p. 77.

41. Address by Edward Kennedy at Gaston Hall, Georgetown University,
1128180, “Kennedy (Sen Ed M.) [Speech],” Box 7, Kathryn Bernick’s Files,
Jimmy Carter Library.
42. E. J. Dianne, Jr., “The People Want Controls.”
43. Peter S. Nagan and Kenneth A. Kaufman, “Fed Moves Will Boost ShortTerm Rates, But Longer Yields May Drop,” ABABonRingJoumul, vol. 72,
no. 4 (April 1980). p. 17.
44. John M. Godfrey, “Credit Controls: Reinforcing Monetary Restraint,”
Federal Reserve Bank of Atlanta, Economic R&t-w, vol. 65, no. 3
(May/June 1980), p. 16.
45. Leonard Silk, “Uncertainty

on Controls.”

46. “Financial Futures Rally: Precious Metals Down,”
February 23, 1980.

Tk Nero Yorff Times,

47. Clyde H. Farnsworth, “Kahn Calls Credit Curb Possible in New Plan,”
Tk NW Yr& Tieres, February 15. 1980.
48. Memo from Alfred Kahn, Stuart Eizenstat, and Al McDonald to President
Carter. 2/19/80. “BE 4-2 l/1/80-2/29/80.” Box BE 19. WHCF-Subiect
, Fife.
Jinuny Carter Library.
49. Henry Kaufman, “America’s Economic and Financial Dilemma,” Transcript
of speech given before the American Bankers Association.in Los Angeles,
February 21, 1980.
50. David fgnatius and Dennis Farney, “Frustration Moves Congress Democrats
to Contemplate Wage and Price Controls,” Tk Wall Strzet Joumol,
February 25, 1980.
51. “CreditControl
Rumors Spur Borrowing, Concern Over Effectiveness of
Any Rules,” Tk Wall Smet Journal, March 3, 1980.
52. Clyde H. Farnsworth, “Consumer
7&.r, March 11, 1980.

Debt Rise Slim Again,” Tk Nnm Yo&

53. Testimony of Paul Volcker before the U.S. Senate, Committee on Banking, Housing, and Urban Affairs, Htztiings on tk F&ml Re.ww? I&t Moo&y
Po/iq Repmtfm 1980, 96 Gong. 2 Sess. (GPO, 1980). p. 20.
54. Memo from G. William Miller to President Carter, 2/28/80, “inflation
9/79-2/80,” Box 80, Lloyd Cutler’s Files, Jimmy Carter Library.
55. Memo from G. William Miller to President Carter, Z/28/80, “Inflation
9/79-2180,” Box 80, Lloyd Cutler’s Files, Jimmy Carter Library.

65. Clyde H. Farnsworth,

Metals Prices,” Tk Naz Yd

7ima,

“Consumer Debt Rise Slim Again.”

66. Memo from G. William Miller to President Carter, 3/12/80, “Inflation
9/79-2180,” Box 80, Lloyd Cutler’s Files, Jimmy Carter Library.
67. President’s Daily Diary, 3/12/80, “3/12/80-3/22/80,” Box PD-75, Presidential
Diary Office, Jimmy Carter Library.
68. Steve Ldhr, “Consumer
March 14, 1980.

Credit:

inflation

Key?” Tk Ncno Yet+ 7&,

69. Testimony of Arthur Burns before the U.S. Senate, Committee on
Banking, Housing, and Urban Affairs, Heunrzgson tk &tension of tk Council
on Wage,and Isicc Stability and Rev+ of tk pnsidmr’sAnti+&m
Poli&s,
96 Cong. 2 Sess. (GPO, 1980). p. 150.
70. Text of the President’s Address on Economic Policy at the White House,
March 14, 1980, in U.S. Congress, Joint Economic Committee, Hearings
on tk Raidmt’s Nne, ,Anh'-hfikh'rm
hgmm,
96 Gong. 2 Sess. (GPO,
1980). p. 5.
7 1. ‘Text of the President’s Address on Economic Policy at the White House,
March 14, 1980, in U.S. Congress, Joint Economic Committee, Heoringr
a tk pnsidmt’s Now Anti-Inflation Rogrum, pp. 7-8.
72. Executive Order 12201 of March 14, 1980, Fcdetol Rcgirtor, vol. 45,
no. 54, March 18, 1980, p. 17123.
73. Tercnce Smith, “Political Aspect of Carter’s Plan,” Tk Nm Yo& 7&s,
March 15, 1980.
74. Board of Governors
March 14, 1980.

of the Federal

Reserve

System,

75. Testimony of Frederick Schultz, U.S. House;Heuhgs
Policy And Its E&t On Small Bo.huss (Port 3-Cndt
obiliq of C&it), p. 8.

Press

Release,

on Fcdcol Monetary
Gmtmh and Avail-

76. Roger May, “Q&A: Here’s How Lenders Must Meet New Fed Rules on
Loans to Customers,” Tk Wall Shwt Joumol, March 19, 1980.
77. Board of Governors of the Federal Reserve &stem. “Federal Reserve
Credit Restraint Program,” Interim Staff Rep&, July 21, 1980, Tables
IAl, IfAl, IIfAl, fVAI.
78. Board of Governors of the Federal
March 14, 19, 26, 1980.

Reserve

System,

Press Releases,

79. Testimony of Frederick Schultz,. U.S. House, Hcorings On Fcdcal Mommy PO& And Irr L.@ect on Small Basinas (Pan 3-C&it
Cotztm~ and
Availobifity of Credit), p. 17.
80. Board of Governors, “Federal Reserve Credit Restraint Program,” pp. 2-3.
81. Board of Governors,

Press Release, March 14, 1980.

82. Testimony of Frederick Schulta, U.S. House, Hearings on F&ulMomtmy
Pole And Its &@ct On Smut1 Bunnw (Putt 3-Cmdit Connol and Avaihbili~
of Cndit), p. 4.
83. Board of Governors, “Federal Reserve Credit Restraint Program,” Table
VAl. Also, Letter from Robert P. Black accompanying reporting form
FR2062e, March 28, 1980, Federal Reserve Bank of Richmond.
84. Board of Gover&,

Press Release, March 14, 1980.

85. Memo from Axiirod, Kichline, and Petersen
“Proposed Consumer Credit Regulation.”

to the Board of Governors,

56. Testimony of Paul Volcker before the U.S. Senate, Committee on
Banking, Housing, and Urban Affairs, Hearing on Imphmmtotioo of tk
C&it CmhdAct, 96 Chg. 2 Sess. (GPO, 1980), p. 17.

86. Board of Governors,

57. The following memos were obtained from the Federal Reserve Board:
Memo from the Reserve Requirement Policy Group to the Board of
Governors, “Possible Reserve Requirement Action,” 2/22/80. Board of
Governors; Memo from Corrigan and Ettin to the Board of Governors,

87. For mcrre on the CRPs effects on multi-subsidiary hrms, see William N.
Koster and Timothy D. Marrinan, “The Credit Restraint Program: A MultiSubsidiary Creditor’s Perspective,” Jownro/ ojRetui1 Bun&g, vol. 2, no. 2
r.June 1980), pp. 11-18.

50

ECONOMIC REVIEW, NOVEMBER/DECEMBER

1990

Press Release, March 14, 1980.

88. Board of Governors, “Federal Reserve Credit Restraint Program,” p. 32.
Also, Clyde Farnsworth, “Credit Card Controls Are Studied.”

119. Tom Herman, “Growth of Money-Market Funds Resumes Following
Decline Prompted by, Fed Rule,” Tk Wol/ S@zr Jounrol, April 26, 1980.

89. Memo from AxiIrod, Kichline, and Petersen to the Board of Governors,
“Proposed Consumer Credit Regulation.” Statement of Senator Proxmire,
U.S. Senate, Heating MI Impknzentation of rk &dir Gmtml Act. p. 35.

120. Rosalyn Retkwa, “The Second-Generation
7Fmes. April 27, 1980.

90. Steve Lohr. “Consumer Credit: Inflation Key?
91. Testimony of Paul Volcker, U.S. Senate, HeariingMI Itn#emmtatim of tk
Cndit Cmtnd Act, p. 15.
92. Memo from the Reserve Requirement Policy Group to the Board of
Governors, “Possible Reserve Requirement Actions.”
93. Memo from the Reserve Requirement Policy Group to the Board of
Governors, “Possible Reserve Requirement Actions.”
94. Sanford Rose, “Random Thoughts,” Amen&n E&z&r, February 11, 1980.
.95. Board of Governors,

97. Board, of Governors, Press Release, March 14, 1980, and Board of
Governors, “Federal Reserve Credit Restraint Program,” p. 39.
98. Board of Governors, cress Release, March 14, 1980, and Testimony of
Paul Volcker, U.S. Senate, Heating a Itnpknmtaion oftk &dit.carm/Act,
p. 47.
99. Board of Governors, “Federal Reserve Credit Restraint Program,” p. 46.
Also Statement of Lawrence Connell before the U.S. Senate, Committee
on Banking, Housing, and Urban Affairs, Heutings on Monq Mu&t MUIWI
Funds, 96 Gong. 2 Sess. (GPO, 1980). p. 260.
100. Statement by Henry Reuss, Hearing a tk Pnsident’s New Anti-Infatim
f’mgmt, p. 85.
101. Manorama C. Gotur, “Experiment in Credit Control: Review of the
March Credit Restraint Program,” Report prepared for the American
Council of Life Insurance, September 1980, p.4; “Funds’ Group Says It
Won’t Sue Fed Now But Will Ask for Withdrawal of New Rule,” Tk Waf/
StncfJournol, March 20, 1980; and Steve Lohr, “Money Funds to Contest
Reserve Rule,” Tk NecmY& 7imes, March 21, 1980.
102. Board of Governors, Press Release, March 14, 1980; and Clyde Farnsworth,
“3-Point Rise to Cut Lending,” Tk Neao Y& fimes, March 15, 1980.
103. Peter Keir, “Impact of Discount Policy Procedures on the Effectiveness
of Reserve Targeting,” in NeonMonetary Con& Pmccdunq Federal Reserve
Staff Study, vol. 1 (Board of Governors, February 1981), p. 159; also
Peter S. Nagan and Kenneth A. Kaufman, “Fed m&es will boost shortterm rates, but longer yields may drop.”
104. Chamber of Commerce of the United States, Economic Policy Division,
“A Review of the March 14, 1980 Implementation of the Credit Control
Act of, 1969,” September 1980, Presented in support of David Meiselmads
testimony before the U.S. House, Subcommittee on Consumer Affairs and
Coinage of the Committee on Banking, Finance and Urban Affairs, Hea&gs
lo &tend tk Credit Control Act, 97 Gong. 2 Sess. (GPO, 1982), p. 304.
105. Edward P. Foldessy, “Some Banks Lift Their Prime. Rate To a Record
19%,” Tk Wall Snvcr Journal, March 18, 1980.
Bills As Demand

Mamy FunbRepwt,

Monday, August 1;. 1980, #243.

122. Isadore Bannash, “Creditors Tighten Their Terms,”
March 27. 1980.
123. Board of Governors
March 26, 1980.

of the Federal

Reserve

Tk New Yen’ 7Gw.r.

System,

Press

Release,

124. Testimony of.Nancy Teeters before the U.S. House, Subcommittee on
Consumer Affairs of the Committee on Banking, Finance and Urban Affairs,
Heating MI tk Cash L&count ActlTk Fair Cm&t RacdcccssAct. 96 Cong.
2 Sess. (GPO, 1980), p. 11.
125. Board, Press Release, April 18, 1980.

Press Release, March 14, 1980.

96. Memo from the Office of Staff Director for Monetary and Financial Policy
to the Board of Governors. “Marginal Reserve Requirements,” March 1,
1980, Board of Governors of the Federal Reserve System.

106. “Rates Plummet On Treasury
Jmmrol, March 17, 1980.

121. Daog&‘s

Mbney Funds,” Tk Ncpo Yor)

Rises,” Tk Wal/ Smet

107. Robert S. Greenberga,
“Reserve Board, in New Attack on Inflation, Is
Stressing Restraint on Debt Rather Than Higher Interest Rates,” Tk
Wall Smt Journal, March 17, 1980.
108. Phil Hawkins, “Prices Pushed Into Further Steep Decline By Vast Supplies
of U.S. Issues, Inflation,” Tk Wa// Stmet Jounra/, March 20, 1980.
109. Board of Governors, “Federal Res&ve Credit Restraint Program,” p. 110.
110. Robert A. Bennett, “Volcker Gives Bankers Credit-Allocating
Tk NW Yw4 Times, March 18, 1980.

Role,”

126. Board of Governors
April 2, 1980.

of the Federal

Reserve

System,

Press

Release,

127. Susan Harrington, “Small and Medium-Size Bank Aides Call New Curbs
on Credit Costly and Needless,” Tk Wa/I Strwt Jown&, March 18, 1980.
128. U.S. House, Subcommittee on Consumer Affairs of the Committee on
Banking, Finance and Urban Affairs, Cndt Cant&r: An Evukati~n, Staff
Report, 96 Gong. 2 Sess. (GPO, 1980), pp. 2, 7, 12, 15.
129. Steve Lohr, “Buying Habits Found Unexpectedly
Credit,” Tk Ncpn Y& 7imes, May 9, 1980.
130. Steven Rattner! “Debate Over Carter’s
Tk New Ym+ Tunes, June 9, 1980.
131. Emnomic Repot
pp. 134-136.

of tk

Curbed By Controls on

Economic

Policy Intensifies,”

F%i&nt, January 1981, Washington:

132. Emnomic R~pmr of tk R-t&&r,

GPO,

January 1981, pp. 160-161.

133. Board of Governors, 67th AnnuofRq~~~?, 1980 (Board of Governors,
p. 16.
134. Board of Governors.

1981.

67th Annual Rqnw,

1981),

1980, pp. 11-12. 33.

135. Chamber of Commerce of the United States, “A Review of the March 14,
1980 Implementation of the Credit Control Act of 1969,” in U.S. House,
Hearings to Ezrmd tk Cmfit Cmtml Act. p. 3 19.
136. Edward P. Foldessy, “Fed May Cut Credit Curbs Soon, Analysts Say, as
Economy and Money Growth Slow,” Tk WaN &wet Jo~mul, April 1 I,
1980.
137. Board of Governors, Amnul Statiuical D&t:

1980.

138. Daniel Hertzberg and Richard F. Janssen, “Bonds Reborn: Firms’ Debt
Offerings Suddenly Arc Reviving As Interest Rates Drop,” Tk Wall Street
Jornno/, April 25, 1980.
139. Isadore Barmash. “Credit-Card Applications And Use Off at Big Stores.”
Tk Ncpn Yo4 7imes, April 24, 1980.
140. Chamber of Commerce of the United States, “A Review of the March 14,
1980 Implementation of the Credit Control Act of 1969,” in U.S. House,
Heatiqs m &tend tk Cmiit Gmml Act, p. 3 19.
141. Steve Bohr, “Buying Habits Found Unexpectedly
Credit.”
142. Jimmy Carter, Keeping Faith: Memoin
p. 528.

of a

Curbed By Controls on

pnsidct

(Bantam Books, 1982),

143. Letter from Dennis Gordon to President Carter. 3/27/80, “BE 4-2 4/l/804/15/80,” Box BE 20, WHCF-Subject File, Jimmy Carter Library.
144. Steve Bohr, “Suburb Copes With Credit Curb,”
.May 19, 1980.

Tk New YGT+Times,

145. Board of Governors of the Federal Reserve Board, “Record of Policy
Actions of the Federal Open Market Committee,” Fe&& Reserve BuIfetin,
vol. 66, ,“o. 6 uune 198O),.pp. 486-487.

111. Richard F. Janssen, “Loan Commitments Made Prior to Curbs By Fed
Could Result in Trouble for Banks,” Tk Wa/lStreet Jouma/, April 1, 1980.

146. Board of Governors,

112. Board of Governors
April 9, 1980.

148. Edward P. Foldessy, “Fed Relaxes Money-Market Credit Curbs As Pressures Mount for End to Restraints,” Tk WaI~SnwJoumai~ May 5, 1980.

of the Federal’ Reserve

System,

113. John H. Allen, “Fed Puts Surcharge On Discount
Em-s, March 15, 1980.

Press Release,

Rate,” Tk New Yor+

67th AnnualRq+

1980, pp. 11, 12, 16.

147. Board of Governors, Annual Staistic~/ LXgat: 1980.

149. Steven Rattner, “Volcker, Citing Economy,
Tk Ncap YonOlimes, May 15, 1980.

Backs Credit Curb End,”

114. Robert A. Bennett, “Volcker Gives Bankers Credit-Allocating Role.” Also,
Board of Governors, “Federal Reserve Credit Restraint Program,” p. 17.

150. “Fed Eases the Credit Restraints It Imposed in March; Move Likely Will
Accelerate Decline in Prime Rate,” Tk Wall Strzet Journal. May 23, 1980.

115. Judith Miller, “Volcker ‘Impressed’ By Budget. Harmony,”
7hq
March 19, 1980.

151. S&en
Rattner, “Control bf &edit Is Reduced
Reserve,” Tk NEW Yor;Q7imer, May 23, 1980.

Tk New Ym;t

116. Tom Herman, “Money-Market Funds’ ‘Messy’ Outlook Brightens as Fed’s
Curbs Are Evaluated,” Tk Wall Strzet Journal, March 20, 1980.
117. Steve Lohr, “Money Funds Meet Fed Curb: Managers Devise Shields
Against Set-Aside Ruling,” Tk Nenn Yor+ 7ima, March 24, 1980.
118. Board of Governors,

“Federal Reserve Credit Restr&t

Program,” p. 46.

152. Steven Rattner, “Debate Over Carteis

Sharply

By Federal

Economic Policy Intensifies.”

153. “Consumer Debt Down Sharply,” Tk Nepo Yw4 7&r,

June 7. 1980.

154. Steven Rattnef, ,“Debate Over Carter’s Economic Policy Intensifies.”
155. N&&m B. Tu&, “What Money Supply Doesn’t Do,” Tk Waif Snwt
JamaI, June 20, 1980.

FEDERAL RESERVE:BANK

OF .RICHMOND.

51

156. Emnonri Report

of tk

presidmt, January 1981, p. 137.

157. Isadore Barmash, “Retailers and Banks Hail Lifting of Credit Controls,”
Tk New Yorft Times<July 4, 1980.

170. L&&ivc
H&my, Public Law 96-508 (S. 23.52). compiled by Judith M.
Weiss and Jan D. Reagan, (Board of Governors, 1983), p. S 6047.
171. L&dative

Histmy, Pub12 Los 96-508 (S. 2352),

p.

H 9598.

158. Isadore Barmash, “Retailers Promoting Credit Use,” Tk Nclm Yor+ 7&s,
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Tk New Ymff 7imes. July 26, 1980.

172. L@&ivt- Hiany,
H 10162-3.

159. Board of Governors, “Federal Reserve Credit Restraint Program,” p. 33;
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hei, July 10, 1980.

173. Jimmy Carter’s Statement on Signing S. 2352 Into Law, December 9,
1980, from U’ceHy Compilation of l’nvidmtial Documents, vol. 16,
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(S. 2352).

160. Board of Governors, 47th Annual Rcpwt, 1980, pp. 3, 4, 16, 22; Ecaonic
Report of tk Praident, January 1981, pp. ‘137-138: Board of Governors,
Alinual Stati&al Digest: I980.
161. Chamber of Commerce of the United States, Economic Policy Division,
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Act of 1969,” in U.S. House, Hcorings to fitend tk Credit Cmhvl Act,
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162. Board of Governors, “Federal Reserve Credit Restraint Program,” p. 11.
163. Donoghue’sMay

Fund Rep&iv Monday, August 11, 1980, #243.

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174. U.S. House, Hearings to &tend tk Q&it Cmtnd Act, pp. 9-10.
175. Testimony of J. C. Turner,
ControlAct~ p. 61.

U.S. House,

Hearings to &tend tk

Cndit

176. Testimony of Preston Martin, U.S. House, Hearings m .&auf tk Credit
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177. Testimony of Frederick Schultz, U.S. House, Heunqs to Ewendrk
Conno/Act, pp. 227-228, 231.

G&it

164. Robert S. Greenberger, “Reserve Board, in New Attack on Inflation, Is
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178. Testimony of Manuel Johnson, U.S. House, Heatingx m &tend tk Cndit
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165. House Subcommittee on Consumer Affairs of the Committee on Banking,
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179. U.S. House, Subcommittee on Economic Stabilization of the Committee
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166. Statement of Frederick H. Schultz. in U.S. House, Hwiings m l&&d
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167. Clyde H. Farnsworth,

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tk

180. St&ement of Norman Shumway, U.S. House, Hcutingmr Tk Cm/it conno/
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169. Minority Views before the U.S. Senate, Committee on Banking, Housing,
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182. Federal Rune Act and Other Statumty &w&ions Aficting tk Fe&& Resnw
System, Rc Amended TAmugh August 1988 (Board of Governors, 1989).
pp. 299, 367-375.

168. Robert J. Barre, Monocronomics, 2d edition, &hn
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-FEDERAL

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OF RICHMOND

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