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/ REPORT
" B S K T }
SENATE
\No. 2500
FEDERAL RESERVE POLICY AND
ECONOMIC STABILITY
1951-57
REPORT
STUDY PREPARED BY
ASHER ACHINSTEIN
LEGISLATIVE REFERENCE SERVICE
LIBRARY OF CONGRESS
TOGETHER WITH COMMENTS OF
STAFF OF FEDERAL RESERVE BOARD
COMMITTEE ON
BANKING AND CURRENCY
OCTOBER 10, 1958.—Ordered to be printed
Under authority of the order of the Senate of August 24, 1958
UNITED STATES
GOVERNMENT PRINTING OFFICE
20006
WASHINGTON ; 1968
COMMITTEE ON B A N K I N G A N D
CURRENCY
J. W. FULBRIGHT, Arkansas, Chairman
A. WILLIS ROBERTSON, Virginia
HOMER E. CAPEHART, Indiana
JOHN J. SPARKMAN, Alabama
JOHN W. BRICKER, Ohio
J. ALLEN FREAR, JR., Delaware
WALLACE F. BENNETT, Utah
PAUL H. DOUGLAS, Illinois
PRESOOTT S. BUSH, Connecticut
A. S. MIKE MONRONEY, Oklahoma
J. GLENN BEALL, Maryland
JOSEPH S. CLARK, Pennsylvania
FREDERICK G. PAYNE, Maine
WILLIAM PROXMIRE, Wisconsin
CLIFFORD P. CASE, New Jersey
J. H. YINGLING, Chief Clerk
ROBEBT A. WALLACE, Staff Director
n
CONTENTS
Page
Statement of chairman
Summary
Chapter I. The period of transition, 1951-52:
Monetary policy and debt management
The accord
Flexible monetary policy and rising interest rates
The money supply
Economic developments
Revival of the discount mechanism
Economic and financial developments in second half of 1952
Federal Reserve credit policy
Chapter II. Federal Reserve policies in 1953-54:
Appraisals of the business situation, first half of 1953
Money and bank credit, first half of 1953
The objective of a free market
The policy of bills—only
Debt management policy: The Treasury's 3^s
The midyear shift in Federal Reserve policy
The 1953-54 business recession
The policy of credit ease
Bank loans and investments
Chapter III. Federal Reserve policy, 1955-57:
The key importance of 1955 in recent economic and financial developments
The stock market and margin requirements
Credit expansion in 1955
Policy directives of the Open Market Committee
Policy decisions as viewed in retrospect by the Federal Reserve
The discount rate as a tool of monetary restraint
The discount rate and consumer credit
The shift in Federal Reserve attitude toward consumer credit controls.
Monetary policy and the growth of financial intermediaries
The tight-money policy and its critics, 1956 to mid-1957
Deliberations of the Open Market Committee in 1957
The mistaken credit policies after mid-1957
Some concluding observations
Appendix: Member bank reserves, reserve bank credit, and related items,
1950-57
Comments of staff of Federal Reserve Board:
Letter of transmittal
Comments
v
vii
1
3
6
9
11
13
14
15
19
22
26
27
28
. 29
30
34
38
41
43
44
47
52
55
58
61
64
65
67
72
74
77
81
83
I N D E X OF TABLES
Table
1. Indexes of industrial production, wholesale and consumer prices,
1950-52
2. Bond yields and interest rates, 1950-52
3. Estimated ownership of Federal obligations, 1950-57
4. Deposits and currency, 1950-52
5. Loans and investments of all commercial banks, 1950-52
6. Gross national product, seasonally adjusted at annual rates,
1950-52
7. Disposition of disposable personal income, 1950-52
8. Installment credit, 1950-52
9. Open-market transactions in United States Government securities,
July 1, 1951-September 30, 1952
10. Member bank reserves and related items, 1950-52
11. Member bank excess reserves, borrowings, and free reserves,
1950-52
ni
3
5
8
9
10
12
13
14
15
16
17
IV
CONTENTS
Table
12. Annual rate of turnover of demand deposits, 1950-52
13. Indexes of industrial production, wholesale and consumer prices,
1953-54
14. Gross transactions in Government securities by the Federal Open
Market Committee, January-December 1953
15. Bond yields and interest rates, 1953-54
16. Gross national product, seasonally adjusted at annual rates,
1953-54
17. Disposition of disposable personal income, 1953-54
18. Installment credit, 1953-54
19. Member bank reserves and related items, 1953-54
20. Member bank excess reserves, borrowings, and free reserves,
1953-54
21. Deposits and currency, 1953-54
22. Loans and investments of all commercial banks, 1953-54
23. Loans and investments of all commercial banks, 1950-57
24. Mortgage debt outstanding, by type of property and of financing,
1950-57
25. Annual rate of turnover of demand deposits, 1953-54
26. Indexes of industrial production, wholesale and consumer prices,
1955-57
27. Gross national product, seasonally adjusted at annual rates,
1955-57
28. Disposition of disposable personal income, 1955-57
29. Loans and investments of all commercial banks, 1955-57
30. Deposits and currency, 1955-57
31. Annual rate of turnover of demand deposits, 1955-57
32. Member bank reserves and related items, 1955-57
33. Member bank excess reserves, borrowings, and free reserves,
1955-57
34. Bond yields and interest rates, 1955-57
35. Installment credit, 1955-57
Appendix: Member bank reserves, Reserve bank credit, and related items,
1950-57
Page
18
20
23
25
30
31
32
32
33
34
35
37
39
40
41
42
43
45
46
47
50
51
57
59
77
STATEMENT OF THE CHAIRMAN
The Federal Reserve Board is an agency directly responsible to
the Congress. Its action or lack of action with respect to the flow of
credit may affect the stability and growth of the economy. Congress
must therefore be concerned with how the Board uses its monetary
tools and the adequacy of these tools for stabilization purposes.
The Treasury-Federal Reserve accord of 1951 restored the independence of the Federal Reserve from the Treasury, an independence
which the record shows could not have been achieved without energetic support in Congress. Since that time monetary policy has
increasingly been in the forefront of discussion in newspapers and
periodicals, in academic circles, and in Congress. The views expressed
have ranged from general endorsement of Federal Reserve policies
to fundamental skepticism which regards monetary tools as weak
reeds on which to lean in the promotion of economic stabilization.
In view of such basic differences and the likelihood that Congress
will be considering a number of measures relating to monetary policy
and economic stabilization, I considered it important to review Federal
Reserve policies since the accord. Recent events have shown that
the economy is still subject to sizable fluctuations in aggregate economic activity, and inflationary as well as deflationary developments
are ever present phenomena. I felt it desirable to have an independent analysis of Federal Reserve policies from 1951 through 1957
which would throw light on the adequacy and the use of the tools
employed by the Federal Reserve Board.
Any review of Federal Reserve policies is, of course, bound to be
controversial. Were it to be prepared by the Board itself, one would
expect it to consist mainly of explanation and justification of past
actions. I preferred to have the study prepared by an economist
uncommitted to an official or a doctrinaire viewpoint but who, nevertheless, possessed professional qualifications of a high order. For this
reason, I requested that the services of Dr. Asher Achinstein, senior
specialist in the Legislative Reference Service of the Library of Congress, be made available to prepare this report. He was assisted by
Mrs. Elizabeth M. Boswell.
Dr. Achinstein is an acknowledged expert in business cycles and has
demonstrated his scholarship, objectivity, and independence in dealing
with the problems of economic policy. He is the author of Introduction to Business Cycles, a standard textbook on economic fluctuations.
He was associated in 1953 and 1954 with Dr. Arthur F. Burns, Chairman of the Council of Economic Advisers, in the preparation of the
first two Economic Reports of President Eisenhower, and has served
as economic consultant to the Senate Banking and Currency
Committee.
While the committee and the individual members take no position
on the report, it nevertheless deserves the careful attention not only
v
VI
STATEMENT OF THE
CHAIRMAN
of the Congress but of all citizens concerned with the vital issues of
monetary policy. Not the least of its contributions is that it focuses
attention on problems requiring further research and study.
Dr. Achinstein's study was submitted to the staff of the Federal
Reserve Board for comments and many of these were incorporated.
In view of the fact that all of their suggestions were not accepted, the
Board's staff was invited to prepare a statement to be published along
with the report.
J. W .
FULBRIGHT.
SUMMARY
This report examines Federal Reserve policies in terms of the
fluctuations in aggregate economic activity from 1951 through 1957.
The following statements from the Douglas Subcommittee Report of
1950 on Monetary, Credit, and Fiscal Policies, quoted at the very
outset of the study, indicate two of the underlying basic premises for
this review.
(1) We recommend that an appropriate, flexible, and vigorous
monetary policy, employed in coordination with fiscal and other
policies, should be one of the principal methods used to achieve
the purposes of the Employment Act.
(2) The essential characteristic of a monetary policy that will
promote general economic stability is its timely flexibility. To
combat deflation and promote recovery, the monetary authorities
must liberally provide the banking system with enhanced lending
power, thereby tending to lower interest rates and increase the
availability of credit. To retard and stop inflation they must
restrict the lending power of banks, thereby tending to raise
interest rates and to limit the availability of credit for private
and Government spending. And these actions must be taken
promptly if they are to be most effective.
A corollary to these basic propositions is that appropriateness and
timeliness of monetary actions must be judged in the light of the
economic developments unfolding during the period. Not all economic
changes warrant monetary actions of a contracyclical character. Nor
is the test of successful application of the principle of timely flexibility
the complete elimination of fluctuations in general business activity.
What may be expected from the monetary authorities is a reasonably
good diagnosis of the current changes taking place in the economy
and such use of their tools as to minimize economic instability.
To be sure, they are not omniscient and are bound to make mistakes
in appraisals of current developments and in the use of their instrumentalities. One of the virtues of monetary policy, as compared to
fiscal and debt-management policy, is that the monetary authorities
are usually in a better position to minimize errors of diagnosis or of
action by more speedily steering a different course to meet changing
conditions. Whether monetary management actually exhibits the
desirable degree of flexibility is another matter.
When the Treasury-Federal Reserve accord was reached on March
4, 1951, it was hailed as an important development marking the end
of a decade during which monetary policy had been subordinated to
debt-management policy. The outbreak of the Korean war in June
1950 had touched off strong inflationary pressures and it had become
increasingly evident that credit expansion would continue to feed the
upward price spiral, so long as the Federal Reserve System purchased
large quantities of Government securities at pegged prices. It was in
the light of these developments that the Treasury finally agreed to an
TO
VIII
SUMMARY
arrangement giving monetary policy a coordinate role with debtmanagement policy.
The significance of the accord lies in the fact that it paved the
way for the Federal Reserve to exercise greater freedom in the use of
its major instruments of credit policy for promoting economic stability. So long as the rigid support of the Government security market
continued, open-market operations, the discount rate, and reserve
requirements—the three principal methods for regulating the volume
of bank credit and the money supply—could not be employed effectively.
The accord took place at a time when inflationary developments had
about reached their greatest intensity. Wholesale commodity prices,
which had risen by 16 percent during the first 9 months after the
Korean war, reached their peak in March 1951, and began to edge
downward more or less continuously until the end of 1952. The extent to which the accord was of strategic importance in weakening
inflationary pressures after March 1951 is a debatable question.
Federal Reserve officials are inclined to attribute an especially powerful role to the accord in curbing inflationary pressures; others emphasize instead the importance of the change in business conditions,
particularly the cessation of the abnormally heavy forward buying by
consumers and business firms when the anticipated war shortages did
not develop. There were also additional anti-inflation influences in
1951—perhaps of lesser importance—such as direct controls over
prices and wages by the Federal Government, and selective controls
over real-estate credit, consumer credit, and credit for the security
markets.
It was not until at least a year after the accord that the discount
mechanism began to be reactivated as a major supplement to openmarket operations as a tool for monetary control. This change
coincided more or less with the acceleration in the pace of business
activity and the intensification of the demand for bank credit toward
mid-1952. As a result of the increasing pressure on bank reserves,
bank borrowing at Federal Reserve banks rose from about $300 million in March 1952 to a record level of $1.6 billion by the end of the
year.
The revival of the use of the discount window by member banks
gave promise that the monetary authorities would henceforth be in a
stronger position than they had been for about two decades to exercise restraint on credit expansion. It was thought that they could
count on the traditional reluctance of the banks to borrow from the
Federal Reserve, on administrative regulations discouraging continuous borrowing to replenish reserves, and on making borrowing more
expensive through raising the Federal Reserve discount rate. It was
also about the time of the accord that the view began to be influential
among Federal Reserve officials that a policy of monetary restraint
which results in even small changes in interest rates would curb bankcredit expansion. With a substantial part of the portfolios of banking and financial institutions consisting of Government securities,
obese institutions were thought to be sensitive to small rises Li interest rates and to the capital losses involved in disposing of Government securities in order to switch into private loans.
The first half of 1953 is an especially instructive period, since it
brings to focus some of the major problems that continue to confront
SUMMARY
IX
monetary management in its attempt to promote economic stability.
The first relates to appraisal of the current business situation; the
second to the influence of Treasury debt-management policy on
monetary actions; and the third to the actual use made of the available
instruments of credit control. It was also in this period that the
Open Market Committee arrived at significant decisions with respect
to its most important tool of monetary policy, namely, open-market
operations.
During almost the whole of the first 6 months of 1953 the monetary
authorities based their credit policy on the assumption of continuation
of business expansion and the intensification of inflationary pressures.
There were others who pointed out early in the spring of 1953 that the
Federal Reserve Board's preoccupation with inflation resulted in its
minimizing unfavorable developments indicative of an impending
downward readjustment in business activity. With more or less the
same statistical and other pertinent data available to competent and
trained observers, such differences in appraisal of the current economic
situation must be largely interpretative and analytical in character.
However, psychological and other influences enter into these judgments. During this as well as in other periods of buoyancy in the
economy at more or less peak levels, there is a general tendency for
optimistic appraisals and the ignoring of imbalances that are building
up and which are likely to result in deflationary developments.
Another influence that appeared to have resulted in overemphasis
on the continuation of inflationary pressures was the decision of the
Treasury early in the spring of 1953 to launch a program of refunding
the debt into longer maturities. At the same time, the Federal
Reserve Board was expounding a philosophy of the "free securities
market" with open-market operations confined to the short-term
securities and no intervention in the long-term sectors. These views
of the Treasury and Federal Reserve brought forth criticism by economists and others that a free-market philosophy represented a degree
of passivity on the part of the Federal Reserve which was likely to
weaken credit policy as a tool for stabilization. Within the Federal
Reserve System, Mr. Sproul, president of the Federal Reserve Bank
of New York, opposed the "bills only" doctrine of the Open Market
Committee, contending that it placed monetary management in a
straitjacket.
By mid-1953 the Federal Reserve was moving vigorously to reverse
the course of monetary policy from one of credit restraint to credit
ease. This shift was initially made in response to a critical situation
that had been permitted to develop in the financial markets rather
than, as is sometimes asserted, to the expectation that the economy
was about to slip into a business recession. Nevertheless, extensive
midyear open-market purchases and lowering of reserve requirements
created a favorable financial environment for meeting the problems of
economic readjustment in the period immediately ahead.
The earlier restrictive monetary policy may have had some influence
in the slackening of activity, but this in no way compares with the
major importance in the 1953-54 business recession of the downward
readjustment of business inventories and the cutback in defense contracts. The liquidation of inventories occurred because production
and sales had fallen out of balance, especially in the consumer durable
X
SUMMARY
goods sector, and because of curtailment of the defense program.
These developments were independent of the tight-money policy.
Federal Reserve policy contributed substantially to moderating the
recession and supporting economic recovery. All three major instrumentalities were employed after mid-1953. There was a further
increase in open-market purchases in the last half of the year, the
discount rate was lowered from 2 to 1% percent in February 1954 and
to 1 y2 percent in April, and reserve requirements were reduced once
more around mid-1954.
The policy of active ease made credit more available and lowered
its cost considerably. With ample reserves and greater liquidity
banks sought out new business more aggressively and greatly expanded their investment portfolios. The chief beneficiaries of the
easy-money policy were the construction industry—especially housing,
commercial and public works construction—and the stock market,
with credit for trading in 1954 showing the greatest increase during
any of the postwar years. Monetary policy would not have been so
influential in recovery if the level of consumer spending had not
remained so high, if the "automatic stabilizers" had not come into
play, and if additional antirecession measures had not been undertaken
promptly by the Federal Government.
For understanding the 1955-57 business expansion and the role
played by the monetary factor, it is necessary to concentrate on 1955,
when the expansion assumed its most rapid rate of increase and the
volume of credit rose at a record rate. No single year so illuminates
the shortcomings of monetary policy when the principle of appropriate
and timely flexibility is violated. It also focuses attention on some of
the limitations inherent in the existing tools of monetary control.
Between the third quarter of 1954 and the first quarter of 1955 the
gross national product advanced at an annual rate of over $22 billion;
about two-thirds of the increase was due to the sharp expansion in
outlays for consumer durable goods, continued advances in purchases
of new homes, and a shift from liquidation to accumulation in business
inventories. The speedy economic recovery, which received its main
impetus from these sectors, was accompanied by a substantial rise
in credit and by a considerable easing in financial terms, especially
longer maturities and lower downpayments on mortgage and installment credit. In the second quarter of the year, installment credit
outstanding expanded by nearly $2 billion, a record rate in so short a
period. The mortgage debt on 1- to 4-family homes increased by
$6.5 billion during the first 6 months of the year. The upsurge in
consumer expenditures for durable goods and housing was a major
stimulus to the acceleration of business investment in plant and
equipment during the latter half of 1955. In all of these developments the commercial banks played a powerful role through a $12
billion expansion of loans in 1955.
The first restrictive credit move by the Federal Reserve Board was
the raising of margin requirements from 50 to 60 percent in January
1955. Since stock prices and stock-market credit had each risen by
about 50 percent since September 1953, and speculative activity was
increasing during the latter half of 1954, the 10-point rise in margin
requirements could hardly succeed in checking the flow of credit to
the market. In April, a month after the widely followed stock market
hearings of the Senate Banking and Currency Committee were completed, margin requirements were raised from 60 to 70 percent. It
SUMMARY
XI
was only after this action was taken that the rate of increase in stockmarket credit began to slacken considerably.
The record of the meeting of the Open Market Committee at the
beginning of March 1955 shows that it was concerned that relaxation
of terms for the rapidly expanding volume of consumer and mortgage
credit represented a potential threat to stability. At the beginning
of May, and even more so by the end of June, it noted that overall
economic activity was reaching boom proportions with the likelihood
of prices moving upward and that business, financial, and consumer
confidence was extraordinarily high. It was therefore surprising, even
in financial circles, that the Reserve banks waited until mid-April
and early May to raise the discount rate from
to 1% percent. The
Federal Reserve waited another 4 months before it made a similar
feeble attempt at monetary restraint when it raised the discount rate
to 2 percent in August.
While open-market operations were conducted during the months
of March through June so as not to increase bank reserves, it would
seem to have been more appropriate, in view of the swelling demands
for credit, if there had been direct intervention by the System to
reduce bank reserves.
Federal Reserve officials have recently admitted that they should
have moved faster and more vigorously in 1955. One reason for the
failure to do so given by the presidents of the Reserve banks was that
the economic data available in the first half of 1955 understated the
speed of the recovery. This explanation for the inadequacy of monetary policy leaves much to be desired. If the monetary authorities
failed to act more vigorously, it was much more a matter of judgment
and interpretation than limitations inherent in the data. The Chairman of the Federal Reserve Board, in accounting for the tardiness and
lack of vigor of the restrictive actions taken in the upswing, has
acknowledged an important element ignored by the bank presidents,
namely, the human factor of hesitancy to exercise curbs that might
check the pace of business expansion.
Additional explanations for the inadequacy of monetary policy
in 1955 may be found in the theory of credit control that seemed to be
influential among officials of the Federal Reserve System as well as in
the limitations of general monetary controls.
From the degree of pressure exerted in 1955 it would appear that
the monetary authorities were still under the influence of the view
propounded around the time of the accord that small increases in
interest rates inhibit bank disposal of Government securities, thereby
curbing bank-credit expansion. This theory received little support
from actual financial developments in 1955 and the first half of 1956.
Throughout this period interest rates were moving upward; the discount rate was raised 6 times from April 1955 to August 1956—from
IK to 3 percent. In order to meet demands of their customers the
banks disposed of more than $12 billion of Government securities in
1955 and up to mid-1956. It was not until the latter period that
considerations of bank liquidity caused the shifting out of Government
securities to cease. The Federal Reserve appeared to underestimate
considerably the lag between the adoption of its policy of monetary
restraint and the time when it could take effect.
The ineffectiveness of monetary policy was particularly evident in
the case of consumer durable goods purchases. The rise in interest
rates neither inhibited users nor lenders of installment credit. The
XII
SUMMARY
Federal Reserve had no authority to exercise selective controls over
downpayments and maturities with which to check excessive expansion of consumer credit. It had such powers under temporary
authority during 1941-47, 1948-49, and in 1950-52. Nor did it request
the Congress for authority to regulate consumer credit at any time
since the expiration of regulation W in mid-1952.
Despite the evidence that the rapid expansion of consumer credit
in 1955, with its accompanying secondary impacts on capital investment, contributed to subsequent inflationary developments, the Federal
Reserve Board arrived at the conclusion, on the basis of a six-volume
study published in the spring of 1957, that authority for regulating
installment credit was inadvisable and that the use of general controls
was adequate to deal with unstabilizing credit developments. This
is in contrast to the views of the Board expressed in a more comprehensive statement submitted to the Patman committee 5 years
earlier, that consumer credit is relatively unresponsive to general
credit instruments and for this reason selective regulation provides
a helpful supplement to general monetary controls.
An additional factor reducing the effectiveness of Federal Reserve
policy which has been stressed in recent years is the growth of financial
intermediaries, such as life-insurance companies, building and loan
associations, savings banks, investment companies, and pension funds.
In 1955 life-insurance companies, savings and loan associations, and
mutual savings banks acquired over two-thirds of the more than $16
billion increase in the non-farm-mortgage debt. Accordingly, some
students of monetary policy have argued for selective control over
housing credit as well as over installment credit.
The monetary authorities had a difficult course to steer with respect
to credit policy in 1956. Once they had failed to adopt stronger
measures in 1955, they were in the proverbial position of holding a
bear by the tail during the following year and a half. On the one hand,
there was the risk that a more liberal policy with respect to the availability of bank reserves might accelerate price rises, especially in
"bottleneck" sectors of the economy. On the other hand, if the policy
became much more restrictive, there was the danger of initiating a
downward spiral in business activity since certain of the key sectors
which had ushered in the boom had been showing considerable weakness for some time. Nevertheless, with the economy continuing to
operate near capacity levels—despite some uncertainties about its
general direction—and with prices1 and
wage rates moving upward,
11
the Open Market Committee felt t J
I T
relax in its efforts at restricting
Open-market operations were so conducted that the security holdings
of the System had increased by only $160 million during 1956. The
money supply grew at the rate of only 1 percent as compared to a
2.8 percent rise in 1955. However, the rate of turnover of demand
deposits in centers outside of New York City increased 8 percent in
1956.
One may justifiably view with favor the determination of the
Federal Reserve not to relax restraints in 1956 and in the first half of
1957, but there is much less justification for regarding favorably the
policies pursued through the summer and fall of 1957. In public
statements by Federal Reserve officials, in testimony at congressional
hearings, and through policy decisions such as raising the discount
SUMMARY
XIII
rate one-half of 1 percentage point, i. e., to 3% percent in August, the
monetary authorities appeared to show little concern about the increasing signs that the boom might end in the not-too-distant future.
In the fall and almost up to mid-November, when the discount rate
was lowered from 3% to 3 percent, giving public notice that the Federal
Reserve regarded the immediate problem ahead as not inflation but
business contraction, presidents of the Reserve banks and members of
the Board of Governors of the System were making speeches that
inflation was still the No. 1 economic problem and it would be a great
mistake to relax credit restraint.
In the light of the vehemence and the frequency with which Federal
Reserve officials publicly stressed during the first 10 months of 1957
the necessity for continuing monetary restraint, it comes as a surprise
to read the record of the 1957 meetings of the Open Market Committee.
During almost all of the 18 meetings held throughout the year there
appeared to be an absence of that confidence in the business outlook
and in the continuation of inflationary pressures which was manifested in public statements by top spokesmen for the System. The
contrast between the record of the deliberations of the Open Market
Committee and the public statements and actions of the Federal
Reserve requires explanation. Similarly, the relatively sharp rise in
the discount rate in August, when business expansion was grinding to
a halt, is also in need of a more satisfactory explanation than has been
thus far advanced by the monetary authorities. It is safe to predict
that long after the events of 1957 have passed, economists will still
seek the answer to these two questions.
In explaining the August 1957 rise in the discount rate, the Chairman of the Federal Reserve Board recently stated that the change
was necessary for technical reasons, but what he appeared to ignore
was the fact that the sharp hike in the rate was widely interpreted as
indicating that the monetary authorities regarded the intensification
of inflationary pressures and the need for continuation of monetary
restraint as the immediate issue facing the country. That a change
in the discount rate is regarded as a signal to the public of a shift in
Federal Reserve policy was expressly stated by the Board of Governors of the System when it lowered the rate in November. If it
was a public signal in November, it must also have been one in August.
If the inadequacies of the Federal Reserve in 1955 may justifiably
be said to have encouraged subsequent inflationary developments, the
miscalculations in the summer and fall of 1957 may be said to have
contributed to the sharpest business decline in the postwar period.
The misunderstanding with respect to the unusually sharp rise in
the discount rate in August, and the fact that meetings of the Open
Market Committee are publicly reported as late as a year after they
have taken place, call for exploration of improved methods for providing the public with a clearer understanding of Federal Reserve
policy changes through prompt publication of explanatory statements.
The 1955-57 boom, followed by the sharpest recession in the postwar period, and the current signs of resumption of expansion with the
probable renewal of inflationary pressures, all emphasize the necessity of a fundamental reexamination of our financial system with a
view to increasing the effectiveness of monetary policy in a stabilization program.
8 5 T H CONGRESS
)
M Session
J
SENATE
J
REPORT
1
No. 2500
FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
1951-57
OCTOBER 10, 1 9 5 8 . — O r d e r e d t o b e p r i n t e d under a u t h o r i t y of t h e order of t h e
S e n a t e of A u g u s t 24, 1958
Mr.
FULBRIGHT,
from the Committee on Banking and Currency,
submitted the following
REPORT
CHAPTER
I.
THE
PERIOD
OF T R A N S I T I O N ,
M O N E T A R Y POLICY A N D D E B T
1951-52
MANAGEMENT
When the Treasury-Federal Reserve accord was reached on March
4, 1951, it was hailed as an important development marking the end
of a decade during which monetary policy had been subordinated to
debt management policy. Freed from the necessity of supporting the Government security market at fixed or pegged prices, the
monetary authorities would henceforth be in a position to use more
effectively the tools of credit policy for promoting economic stability.
There had been mounting criticism for several years prior to the
accord on the extent to which debt management considerations by
the Treasury continued to dominate Federal Reserve monetary
policies. These views were thoroughly aired during the hearings of
the Douglas Subcommittee on Monetary, Credit, and Fiscal Policies
which opened in September 1949, and in the collection of statements
submitted to the subcommittee by Government officials, bankers,
economists, and others, published in November 1949. There followed
in January 1950 the subcommittee's report which recommended that
"an appropriate, flexible, and vigorous monetary policy, employed in
coordination with fiscal and other policies, should be one of the principal 1methods used to achieve the purposes of the Employment
Act." It went on to state:
Timely flexibility toward easy credit at some times and
credit restriction at other times is an essential characteristic
of a monetary policy that will promote economic stability
rather than instability. The vigorous use of a restrictive
1
Monetary, Credit, and Fiscal Policies: Report of the Subcommittee on Monetary, Credit, and Fiscal
Policies, Joint Committee on the Economic Report, 81st Cong., 2d sess., 1950, S. Doc. No. 129, p.l.
1
2
FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
monetary policy as an anti-inflation measure has been inhibited since the war by considerations relating to holding
down the yields and supporting the prices of United States
Government securities. As a long-run matter, we favor
interest rates as low as they can be without inducing inflation, for low interest rates stimulate capital investment.
But we believe that the advantages of avoiding inflation are
so great and that a restrictive monetary policy can contribute so much to this end that the freedom of the Federal
Reserve to restrict credit and raise interest rates for general
stabilization purposes should be restored even if the cost
should prove to be a significant increase in service charges
on the Federal debt and a greater inconvenience to the
Treasury in its sale of securities for new financing and refunding purposes.2
The subcommittee rejected, for the reasons given below, the notion
held by some groups that for stabilization purposes "little or no
reliance should be placed on monetary policy and that we should
rely exclusively on other measures, such as fiscal policy
(1) It is highly doubtful that fiscal policy would be powerful
enough to maintain stability in the face of strong destabilizing
forces even if monetary policy were neutral, and a conflicting
monetary policy could lessen still further the effectiveness of
fiscal policy. (2) Monetary policy is strong precisely where
fiscal policy is weakest; it is capable of being highly flexible.
It can be altered with changes in economic conditions on a
monthly, daily, or even hourly basis. (3) It is a familiar
instrument of control and thoroughly consistent with the
maintenance of our democratic government and our competitive free-enterprise system. It is certainly much to be
preferred over a harness of direct controls. (4) Our monetary history gives little indication as to how effectively we
can expect appropriate and vigorous monetary policies to
promote stability, for we have never really tried them.3
The report stressed that, to be effective, monetary management
must be characterized by timely, vigorous, and flexible actions:
The essential characteristic of a monetary policy that
will promote general economic stability is its timely flexibility. To combat deflation and promote recovery, the
monetary authorities must liberally provide the banking
system with enhanced lending power, thereby tending to
lower interest rates and increase the availability of credit.
To retard and stop inflation they must restrict the lending
power of banks, thereby tending to raise interest rates and
to limit the availability of credit for private and Government
spending. And these actions
must be taken promptly if they
are to be most effective.4
a Ibid., p. 2.
s Ibid., p. 18.
< Ibid., p. 19.
16 F E D E R A L
RESERVE
TABLE 1 . — I n d e x e s of industrial
Month
1950—Januar y
February
March
April
May...
June.
July
August
September...
October.
November.
December-..
1951—Januar y
February
March
April
May
June
POLICY A N D
production,
wholesale
[1947-49=100]
Industrial pro-1
duction
Wholesale
prices
Consumer
prices
100
99
102
106
97.7
98.3
98.5
98.5
99.6
100.2
103.0
105.2
107.1
107.7
109.3
100.6
100.4
100.7
100.8
101.3
101.8
102.9
103.7
104.4
105.0
105.5
106.9
108.6
109.9
110.3
110.4
110.9
110
112
115
120
120
121
120
122
122
122
122
122
122
121
112.1
115.0
116.5
116.5
116.3
115.9
115.1
ECONOMIC
110.8
STABILITY
and consumer
Month
1951—July.
August.
September-.
October
November.. .
December.
1952—Januar y
February
March
AprilMay
June.
July
AugustSeptember...
October
November...
December...
Ind ustrial pro-1
duction
119
118
118
118
119
119
121
121
121
120
119
118
115
123
129
130
133
133
prices,
1950-52
Whole- Consumer
sale
prices
prices
114.2
113.7
113.4
113.7
113.6
113.5
113.0
112.5
112.3
111.8
111.6
111.2
111.8
112.2
111.8
111.1
110.7
109.6
110.9
110.9
111.6
112.1
112.8
113.1
113.1
112.4
112.4
112.9
113.0
113.4
114.1
114.3
114.1
114.2
114.3
114.1
i Seasonally adjusted.
Source: Board of Governors of the Federal Reserve System and U. S. Department of Labor.
Fourteen months elapsed between the publication of the Douglas
committee report and the accord. During this period, the outbreak
of the Korean war in June 1950 touched off strong inflationary
pressures. The abnormally heavy buying by consumers and business
firms in anticipation of possible future shortages resulted in a sharp
increase in prices. Between June 1950 and March 1951, wholesale
commodity prices rose by about 16 percent. During these 9 months,
the Federal Reserve System increased its holdings of Government
securities by over $4 billion, thus increasing bank reserves which
facilitated the unusual expansion of bank loans by nearly $10 billion.
Public hearings and committee reports helped to focus attention
on the desirability of greater Federal Reserve independence. But it
was not until developments after the Korean war made it especially
evident that credit expansion would continue to feed the upward
price spiral, so long as the Federal Reserve System purchased large
quantities of Government securities at pegged prices, that the Treasury finally agreed to an arrangement giving monetary policy a
coordinate role with debt management policy.
THE
ACCORD
The Treasury and the Federal Reserve System announced on
March 4, 1951, that they had—•
reached full accord with respect to debt-management and
monetary policies to be pursued in furthering their common
purpose to assure the successful financing of the Government's requirements and, at the same time, to minimize
the monetization of the public debt.
In accordance with this agreement, holders of the 2% percent restricted bonds of 1967-72 in the amount of $19.7 billion were to be
given the opportunity to exchange them for a nonmarketable 2%percent 29-year bond, convertible at the option of the holder into a
1^-percent 5-year marketable Treasury note. This was designed to
encourage the holding of long-term bonds and thus curb debt
monetization.
H. Kept. 2500, 85-2
2
4
FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
The most important phase of the agreement directed toward minimizing the monetization of the debt was that the Reserve System
would immediately discontinue purchases of Government securities at
pegged prices at the option of the market. It was agreed, however,
that a limited volume of open-market purchases would be made while
the long-term bonds were being exchanged. This meant that disposal
by banks and other investors of such securities would be governed by
the demand in the market without Federal Reserve open-market
support. In response to market forces, short-term interest rates were
expected to fluctuate around the Federal Reserve discount rate which,
except for unforeseen developments, would remain at 1% percent for
the rest of the year. Under these circumstances, the Federal Reserve
expected to influence the availability of credit because individual
member banks would have to come to the discount window and borrow
at the discount rate to maintain or increase their reserves.
Finally, it was agreed that there would be more frequent conferences
between the Treasury and Federal Reserve officials and staff to work
more closely on a joint program of Government financing as well as in
the maintenance of orderly markets for Government securities.
The significance of the accord lies in the fact that it paved the way
for the Federal Reserve to exercise greater freedom in the use of its
major instruments of credit policy for promoting economic stability.
So long as the rigid support of the Government security market continued, open-market operations, the discount rate, and reserve requirements—the three principal methods for regulating the volume of bank
credit and the money supply—could not be employed effectively.
They could only operate effectively in an inflationary period if they
were free to restrict the availability of bank reserves. But the initiative in changing member bank reserves when the Government security market is pegged rested largely with the holders of these securities.
In a period of a great rise in the demand for credit, commercial banks
and nonbank investors, a large part of whose assets were in the form
of Government securities at low yields, found it more attractive to
dispose of substantial amounts of these securities and place their funds
in higher-earning loans.
From the end of June 1950 to the end of February 1951, commercial
banks sold United States Government securities in the amount of $6.7
billion, insurance companies $1.1 billion, and mutual savings banks
nearly $1 billion. The Federal Reserve banks purchased about $4
billion. During the 8-month period, member bank reserves increased
by over $3 billion despite a loss in gold of nearly $2.5 billion. About
$2 billion of member bank reserves were absorbed by the Federal Reserve increasing requirements in January and February 1951 by 2
percentage points on demand deposits and 1 percentage point on time
deposits.
TABLE 2 . — B o n d yields
and interest
rates,
1950-52
[Percent per annum]
U. S. Government securities
Period
1950—January.__
FebruaryMarch
April
May
June
July
August
September.
October. __
November.
December.
1951—January _..
FebruaryMarch
April
May
June
July
August
September.
October.
November.
December .
1953—January...
FebruaryMarch
April
May.
June
July
August
September.
October-..
November.
December .
1
2
3-month
Treasury
bills
1.090
1.125
1.138
1.159
1.166
1.174
1.172
1.211
1.315
1.329
1.364
1.367
1.387
1.391
1.422
1.520
1. 578
1.499
1.593
1.644
1.646
1.608
1.608
1. 731
1.688
1.574
1.658
1.623
1.710
1.700
1.824
1.876
1.786
1.783
1.862
2.126
9 to 12
month
issues 1
1.12
1.15
1.16
1.17
1.18
1.23
1.23
1.26
1.33
1.40
1.47
1.46
1.47
1.60
1.79
1.89
1.85
1.79
1.74
1.70
1.71
1.74
1.68
1.77
1.75
1.70
1.69
1.60
1.66
1.74
1.89
1.94
1.95
1.84
1.89
2.03
Taxable
bonds (long
term) 2
2.20
2.24
2.27
2.30
2.31
2.33
2.34
2.33
2.36
2.38
2.38
2.39
2.39
2.40
2.47
2.56
2.63
2.65
2.63
2. 57
2.56
2. 61
2.66
2.70
2.74
2.71
2.70
2.64
2.57
2. 61
2.61
2.70
2. 71
2.74
2.71
2. 75
Includes certificates of indebtedness and selected note and bond issues.
2H percent bonds, 15 years and over prior to April 1952 and 12 years and over beginning
April 1952.
Corporate bonds
(Moody's)
Aaa
2. 57
2.58
2.58
2.60
2.61
2.62
2.65
2.61
2.64
2. 67
2.67
2.67
2.66
2.66
2.78
2.87
2.88
2.94
2.94
2.88
2.84
2.89
2.96
3.01
2.98
2.93
2.96
2.93
2.93
2.94
2.95
2.94
2.95
3.01
2.98
2. 97
Baa
3.24
3.24
3.24
3.23
3.25
3.28
3.32
3.23
3.21
3.22
3.22
3.20
3.17
3.16
3.22
3.34
3.40
3.49
3.53
3. 51
3.46
3.50
3.56
3. 61
3.59
3.53
3. 51
3.50
3.49
3.50
3.50
3. 51
3.52
3.54
3.53
3. 51
Common
stock
yields,
200 stocks
(Moody's)
6.28
6.24
6.16
5.98
5.79
6.17
6.17
6.39
6.22
6.49
6.80
6. 57
6.32
6.27
6.40
6.18
6.35
6. 55
6.20
5.86
5.91
6.02
5.78
5. 55
5.53
5.73
5.49
5.77
5. 65
5. 45
5.39
5.46
5.56
5.56
5.28
5.13
HighAverage
Prime
grade
rate on
municipal short-term commerbonds
bank loans cial paper,
4 to 6
(Standard to business,
months
& Poor's)
selected
cities
2.08
2.06
2.07
2.08
2.07
2.09
2.09
1.90
1.88
1.82
1.79
1. 77
1.62
1. 61
1.87
2.05
2.09
2.22
2.18
2.04
2.05
2.08
2.07
2.10
2.10
2.04
2.07
2.01
2.05
2.10
2.12
2.22
2.33
2.42
2.40
2.40
2.60
2.68
2.63
2.84
3.02
3.07
3.06
3.27
3.45
3. 51
3.49
3. 51
1.31
1.31
1.31
1.31
1.31
1.31
1.31
1.42
1.65
1.72
1.69
1. 72
1.86
1.96
2.04
2.11
2.16
2.31
2.31
2.26
2.19
2.22
2.25
2.30
2.38
2.38
2.38
2.35
2.31
2. 31
2.31
2.31
2.31
2.31
2.31
2.31
Federal
Reserve
bank
discount
rate
1.50
1.50
1.50
1.50
1.50
1.50
1.50
3 1.75
1.75
1. 75
1. 75
1.75
1.75
1.75
1.75
1.75
1.75
1.75
1.75
1.75
1.75
1.75
1.75
1.75
1.75
1.75
1.75
1.75
1.75
1. 75
1. 75
1.75
1. 75
1. 75
1. 75
1. 75
3 Effective Aug. 21, 1950.
Source: Board of Governors of the Federal Reserve System, Treasury Department,
Moody's Investors Service, and Standard and Poor's Corp.
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6
FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
F L E X I B L E M O N E T A R Y POLICY A N D R I S I N G I N T E R E S T
RATES
As was expected, abandonment of the rigid support policy resulted
in an increase in bond yields and in interest rates. The yields on
Federal securities rose moderately from April 1951 to mid-1952—a rise
that was much less than was anticipated in some quarters. During
this period yields on long-term bonds ranged from 2.56 to 2.61, 90-day
bills from 1.52 to 1.70, and Aaa corporate bonds from 2.87 to 2.94.
Could a rise of interest rates of these magnitudes have any significant effect on the expansion of bank credit? The monetary authorities
who argued for a more flexible credit policy maintained that even
moderate increases in interest rates would serve to curtail the volume
of bank credit. This view is explained at length in statements prepared by the Federal Reserve for the Patman Subcommittee
on General Credit Control and Debt Management.5 According to this
theory, the monetary authorities can limit bank reserves by selling
Government securities or by limiting the amount of securities purchased and permitting their prices to adjust to investor demands in
the market. A rise in yield occurs in either case. The increasing
yield checks the tendency of banks and other financial institutions
who are inclined to sell Government securities from switching to such
other investments as business loans or mortgages. They are reluctant
to sell Government securities because of the capital loss involved.
Moreover, institutional rigidities which keep rates on other assets
from rising while the yield on Government securities increases make
the holding of Governments relatively more attractive. Then too, in
an unpegged market, banks and financial institutions become more
cautious in disposing of Federal securities because of the increasing
uncertainty about future security prices and yields. As a result of
these reactions by lending institutions, there is a reduction in the
volume of credit extended to borrowers, even though the latter may
not be disposed to lessen their demand for funds because of increasing
interest rates. In short, according to this theory, a more flexible
of credit
monetary policy can succeed in limiting the availability
even without an appreciable rise in interest rates.6
To what extent did developments in the money market after the
accord support this viewpoint? In the first place, it is essential to
establish whether the sale of Government securities by lending institutions was curtailed. Secondly, even if this occurred, did the change
take place because the price of Governments fell below par, i. e., the
rise in interest rates, or because of other factors that influenced the
demand and supply of credit?
Examination of data on changes in Government security holdings
since the accord does not indicate uniformity of reaction to rising
interest rates by lending institutions. For example, from mid-1951
to mid-1952, insurance companies and mutual savings banks continued to dispose of large amounts of Government securities while
5
Monetary Policy and Management of the Public Debt: Replies to questions and other material for the
use of the Subcommittee on General Credit Control and Debt Management, Joint Committee on the
Economic Report, 82d Cong., 2d sess., 1952, S. Doc. No. 123, pt. I, p. 368 ff. and especially pp. 371-373 and
380-383.
• The view that under modern conditions even small changes in interest rates can have a considerable
restrictive influence on bank loans has been expounded by Robert V. Roosa, now vice president of the
Federal Reserve Bank of New York. His article, Interest Rates and the Central Bank, has become the
standard reference for the exposition of this viewpoint. See Money, Trade, and Economic Growth, in
honor of John Henry Williams, pp. 270-295. The Macmillan Co., New York, 1951.
7 FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
commercial banks increased their holdings of short-term securities
substantially. It would seem that supporters of the view that
a more restrictive monetary policy, accompanied by a moderate increase in interest rates and culminating in a lessening of the availability of credit, cannot obtain comfort from the fact that institutional holders of long-term Government securities, such as insurance
companies and savings banks, did not stop sales from their portfolios.
However, they can point out that the rate of disposal of Governments
by these institutions did definitely slacken after the accord, a change
that was presumably influenced by the fact that sales had to be made
at market and not at pegged rates.
TABLE 3.—Estimated ownership
of Federal obligations,
1950-57
00
[Par values 1 in billions of dollars]
End of month
1950—June
December.
1951—June
December.
1952—June
December.
1953—Jun e
December.
1954—June
December.
1955—June
December.
196fr-June
December.
1957—June
December.
Total
Federal
securities
outstanding 2
U. S. Government
investment
accounts
257.4
256.7
255.3
259.5
259.2
267.4
266.1
275.2
271.3
278.8
274.4
280.8
272.8
276.7
270.6
275.0
37.8
39.2
41.0
42.3
44.3
45.9
47.6
48.3
49.3
49.6
50.5
51.7
53.5
54.0
55.6
55.2
Held by banks
Total
83.9
82.6
81.4
85.4
84.0
88.1
83.6
89.6
88.7
94.1
87.1
86.8
80.8
84.2
78.9
83.2
Commercial banks8
65.6
61.8
58.4
61.6
61.1
63.4
58.8
63.7
63.6
69.2
63.5
62.0
57.1
59.3
55.8
58.9
Held by private nonbank investors
Federal
Reserve
banks
18.3
20.8
23.0
23.8
22.9
24.7
24.7
25.9
25.0
24.9
23.6
24.8
23.8
24.9
23.0
1
United States savings bonds, series A-F and J, are included at current redemption
value.
2
Securities issued or guaranteed by the U. S. Government, excluding guaranteed securities
held by the Treasury.
3
Consists of commercial banks, trust companies, and stock savings banks in United
States and in Territories and island possessions.
* Includes partnerships and personal trust accounts. Nonprofit institutions and
corporate pension trust funds are included under "Miscellaneous investors."
Total
135.6
134.9
132.9
131.8
130.8
133.4
135.0
137.3
133.3
135.1
136.7
142.3
138.5
138.5
136.2
136.6
5
6
Individuals4 Insurance
companies
67.4
66.3
65.4
64.6
64.8
65.1
66.0
64.8
64.8
63.6
65.4
65.6
67.5
67.1
67.4
19.8
18.7
17.1
16.5
15.7
16.1
16.0
15.8
15.3
15.0
14.8
14.3
13.3
12.8
12.3
12.0
Mutual
savings
banks
11.6
10.9
10.2
9.8
9.6
9.5
9.5
9.2
9.1
8.8
8.7
8.5
8.4
8.0
7.9
7.6
Corporations 5
18.4
19.7
20.1
20.7
18.8
19.9
18.7
21.6
16.6
19.2
18.7
23.3
17.4
18.6
15.7
16.9
State and Miscellalocal govneous
ernments • investors7
8.7
8.8
9.4
9.6
10.4
11.1
12.0
12.7
13.9
14.4
14.7
15.1
15.7
16.1
16.9
17.0
9.7
10.5
10.7
10.6
11.6
11.7
12.8
13.2
13.7
13.9
14.4
15.6
16.3
16.1
16.1
16.5
Exclusive of banks and insurance companies.
Consists of trust, sinking, and investment funds of State and local governments and
their agencies, and Territories and island possessions.
7 Includes savings and loan associations, nonprofit institutions, corporate pension trust
funds, dealers and brokers, and investments of foreign balances and international accounts
in this country.
Source: Treasury Department,
3
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FEDERAL
RESERVE
POLICY
AND
T H E MONEY
ECONOMIC
STABILITY
9
SUPPLY
The rise in interest rates did not appear to have any deterrent effect
on the money supply. The volume of money, measured by demand
deposits and currency outside banks, which had risen by $3.2 billion
from June 1950 to March 1951, increased by $5.8 billion in the comparable period of 1951-52. The increase in money supply took place
despite a slackening in the expansion of bank loans. Total bank loans
which had risen by $10 billion during the 9 months prior to the accord
increased by less than one-third in the 9 months ending March 1952,
due largely to the slackening in business, real estate, and consumer
loans. Two factors were mainly responsible for the change in the
relationship between bank loans and the money supply. In the earlier
period the expansion of bank loans was accompanied by a very substantial drop in the holdings of Government securities by the banking
system and by a sizable outflow of gold from the country; in the later
period the rise in bank loans was accompanied by an increase in bank
holdings of Government securities and by an inflow of gold into the
country.
TABLE 4 . — D e p o s i t s and currency,
[Billions of dollars]
1950-52
Deposits and currency
Demand deposits and currency
End of period
Total i
Total
1950—January.
February
March
April
May
June
July
August
September
October
November
December
1951—January
February...
March
April
May
June
July
August
September
October
November
December
1952—January
February
March
AprilMay
June
July
August
September
October
November
December
__
169.7
168.2
167.1
168.4
169.2
170.0
170.2
171.0
171.6
172.8
173.9
176.9
175.2
174.2
172.5
173.3
173.7
174.7
175.8
177.0
177.9
181.6
182.7
186.0
185.2
183.4
182.9
183.8
184.4
184.9
185.8
186.2
187.4
190.2
191.6
194.8
110.9
109.2
107.8
108.9
109.7
110.2
110.9
111.9
112.5
113.8
115.2
117.7
116.2
115.2
113.4
114.1
114.4
114.7
115.8
116.7
117.4
120.7
122.1
124.5
123.5
121.3
120.5
121.0
121.3
121.2
121.9
122.1
123.0
125.3
126.8
129.0
Demand
deposits
adjusteda
Currency
outside
banks
86.4
84.5
83.2
84.3
85.0
85.0
86.5
87.4
88.0
89.2
90.3
92.3
91.6
90.6
89.0
89.5
89.5
89.0
90.7
91.4
92.0
95.0
96.3
98.2
97.9
95.7
94.8
95.1
95.3
94.8
95.7
95.8
96.4
98.6
99.4
101.5
24.5
24.7
24.6
24.6
24.7
25.2
24.4
24.5
24.5
24.6
24.9
25.4
24.6
24.6
24.4
24.6
24.9
25.8
25.1
25.3
25.4
25.7
25.8
26.3
25.6
25.6
25.7
25.9
26.0
26.5
26.2
26.3
26.6
26.7
27.4
27.5
Time deposits 3
58.7
59.0
59.3
59.5
59.5
59.7
59.4
59.1
59.0
59.0
58.7
59.2
59.0
59.0
59.1
59.2
59.3
59.9
60.0
60.3
60.5
60.9
60.6
61.5
61.7
62.0
62.4
62.7
63.0
63.7
63.8
64.1
64.5
64.9
64.8
65.8
12 Includes holdings of State and local governments, but excludes U. S. Government deposits.
Includes demand deposits, other than interbank and U. S. Government, less cash items in process of
collection.
3
Includes deposits in commercial banks, mutual savings banks, and Postal Savings System, but excludes
interbank deposits.
Source: Board of Governors of the Federal Reserve System.
10
FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
Total member bank reserves had increased by $3.1 billion from
June 1950 to March 1951, but the raising of reserve requirements in
January 1951 resulted in only $1.1 billion increase in the reserves
available for credit expansion by March 1951. In the year ending
March 1952 the reserves available for credit expansion had increased
by $1.3 billion. The difference between the two periods was that
prior to March 1951, very large Federal Reserve purchases of Government securities more than offset a substantial outflow of gold to
increase bank reserves, while during the year ending March 1952
Reserve bank holdings of Government securities showed little net
change with additional reserves being supplied by a gold inflow.
TABLE 5 . — L o a n s and investments
of all commercial
banks,
1950-52
1
[Billions of dollars]
End of period3
1960—January
February
March
April
May
June
July
August
September
October
November
December-1951—January
February
March
April
May
June
July
August
September
October
November
December1952—January
February
March
April
May
June
July
August
September
October
November
December
Total
loans
and investments
121.2
120.6
120.3
120.3
121.2
121.8
122.3
123.3
123.6
124.5
125.4
126.7
125.1
125.0
125.7
125.4
125.1
126.0
126.1
127.0
128.6
130.5
131.9
132.6
132.8
132.2
132.5
132.3
133.1
134.4
136.8
136.6
137.1
139.4
141.7
141.6
Loans
Total«
42.9
43.1
43.7
43.8
44.1
44.8
46.0
47.3
48.9
49.9
51.5
52.2
52.7
53.5
54.4
54.4
54.5
54.8
54.6
55.2
56.0
56.8
57.3
57.7
57.5
57.6
57.8
58.2
58.5
59.2
59.7
60.2
61.2
62.4
63.4
64.2
Investments
Business 4
17.2
17.2
17.1
16.8
16.7
16.9
17.3
18.3
19.4
20.0
21.1
21.9
22.3
23.1
23.7
23.6
23.5
23.7
23.4
23.9
24.5
25.0
25.3
25.9
25.6
25.6
25.8
25.2
24.9
25.3
25.1
25.5
26.2
26.9
27.5
27.9
Total
78.3
77.5
76.6
76.5
77.1
77.0
76.4
76.0
74.6
74.6
73.8
74.4
72.4
71.5
71.4
71.1
70.6
71.2
71.5
71.8
72.6
73.8
74.6
74.9
75.3
74.7
74.7
74.2
74.5
75.2
77.0
76.4
75.9
77.1
78.3
77.5
U.S. Government
obligations
68.0
67.1
65.8
65.5
66.1
65.8
65.0
64.2
62.5
62.5
61.7
62.0
60.0
59.1
58.8
58.5
58.1
58.5
58.7
59.1
59.7
60.9
61.6
61.5
62.0
61.3
61.1
60.5
60.7
61.2
62.9
62.0
61.6
62.9
64.1
63.3
Other
securities
10.3
10.4
10.8
11.0
11.0
11.2
11.4
11.8
12.1
12.1
12.1
12.4
12.4
12.4
12.6
12.6
12.5
12.7
12.8
12.7
12.9
12.9
13.0
13.3
13.3
13.4
13.6
13.7
13.8
14.0
14.1
14.4
14.3
14.2
14.2
14.1
1
Excludes mutual savings banks.
' June and December figures are for call dates. Other monthly data are for the last Wednesday of the
month.
3 Data are shown net. Includes commercial and industrial loans, agricultural loans, loans on securities,
real estate loans, loans to banks, and "other loans," some of which represent consumer credit.
* Data are shown gross, i. e., before deduction of valuation reserves. For months other than June and
December data are estimated on the basis of reported data for all insured commercial banks and for weekly
reporting member banks.
Source: Board of Governors of the Federal Reserve System.
In considering monetary policy after the accord, it is necessary, of
course, to refer to the underlying business conditions that were influencing the demand for funds as well as the factors influencing their
supply. The accord took place at a time when inflationary develop-
11
FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
ments had about reached their greatest intensity. Few would deny
that continuous support purchases of Government securities at pegged
prices had made the Federal Reserve System an "engine of inflation"
during the 9 months after the outbreak of the Korean war. But the
extent to which the removal of continuous support purchases of
Government securities was of strategic importance in the weakening
of inflationary pressures after March 1951 is a debatable question.
There are those who emphasize the importance of the change in
business conditions, particularly the cessation of the abnormally
heavy forward buying by consumers and business firms when the
anticipated shortages did not develop. To be sure, they grant that
the shift in monetary policy exerted some anti-inflation influence in
1951, as was the case also with direct controls over prices and wages
by the Federal Government, and of the selective controls over7 real
state credit, consumer credit, and credit for security markets.
ECONOMIC
DEVELOPMENTS
That inflationary pressures had lessened after March 1951 is
evident from the indexes of industrial production and of wholesale
prices. The former which had climbed from 112 in June 1950 to
122 by December continued at the same level through May 1951,
dropped to 118 by August and more or less remained at this level for
the rest of the year. The latter rose from 100.2 in June 1950 to 116.5
in March 1951, declined to 113.7 in August, stabilized at this level for
the remainder of the year, and continued to drift downward in 1952.
The gross national product which rose from an annual rate of
$274.4 billion in the second quarter of 1950 to $317.8 billion in the
first quarter of 1951—an increase of 15.8 percent—reached $341
billion in the first quarter of 1952—-an increase of only 7.3 percent
during the year. In the earlier period the pronounced increase in
GNP was due primarily to the sharp rise in consumer expenditures
and in business inventories; in the later period defense expenditures
showed a very marked rise while the rate of accumulation of business
inventories fell off sharply and consumer spending at first declined
and then moved upward gradually. The relative influence of the
various sectors of the economy on the changes in the pace of total
national output before and after the accord can be seen from the
figures for the major components of GNP from quarter to quarter.
7 In support of their position that the accord played a more powerful role in curbing inflationary pressures
than their critics have been prepared to grant, Federal Reserve officials have argued that the mere fact
of ceasing to support long-term Governments had the effect of shrinking considerably the liquidity of the
economy. As was expected, this decrease in the general liquidity resulted in the banks enlarging their
holdings of short-term United States securities and of nonbank institutional holders greatly decreasing the
rate of their disposals of long-term Government securities. For the same reason, there was an increase
in the demand for cash balances—as the rise in the money supply after the accord appeared to indicate.
The critics, on the other hand, who question the substantial influence ot the accord in curbing inflation,
cite in support of their view the fact that bank loans continued to grow, insurance companies and savings
banks continued to dispose of Government securities in favor of other assets, and the expansion of currency
and deposits was more rapid after the change in policy than before. For the latter view, see Charles R.
Whittlesey, Old and New Ideas on Reserve Requirements, Journal of Finance, May 1953, pp. 193-194;
also James Tobin, Monetary Policy and the Management of the Public Debt: The Patman Inquiry,
Review of Economics and Statistics, May 1953, p. 124.
For an interpretation of the period which indicates that general market conditions were chiefly responsible
for the downward movement of wholesale prices since early in 1951, see Bert G. Hickman, The Korean
War and United States Economic Activity, 1950-52, Occasional Paper 49, National Bureau of Economic
Research, Inc., 1955.
12
FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
TABLE 6.—Gross national
product,
seasonally
adjusted
at annual
rates,
1950-52
[Billions of dollars]
1951
1950
I
II
III
IV
I
II
1952
III
IV
I
II
III
IV
Gross n a t i o n a l
product
265.8 274.4 293.2 304.3 317.8 326.4 333.8 338.1 341.0 341.3 347.0 358.6
Personal consumption expenditures
Durable goods
Nondurable goods
Services
185.7 189.9 204.4 200.1 211.5 205.5 208.8 213.4 214.6 217.7 219.6 227.2
26.8 27.9 35.5 31.2 33.0 28.0 28.5 28.4 27.7 29.1 27.5 32.1
96.2 97.7 103.3 102.0 110.2 108.1 109.5 112.7 113.3 113.9 115.9 117.2
62.6 64.3 65.7 66.9 68.3 69.4 70.8 72.3 73.6 74.7 76.2 77.9
Gross private domestic
investment
New construction
Residential nonfarm
Other
Producers' durable
equipment
Change in business
inventories: total
Nonfarm only
Net foreign investment.
Government purchases of
goods and servicesFederal
National security.
Other,..
Less Government
sales..
State and local
39.8
21.6
46.9
23.6
51.1
25.6
61.4
25.3
56.9
25.7
61.6
25.0
56.3
24.5
51.0
24.5
52.2
25.2
45.6
25.4
49.1
25.4
52.6
26.1
12.2
9.4
13.8
9.8
15.4
10.3
14.4
10.9
14.1
11.6
12.5
12.5
11.8
12.7
12.1
12.4
12.4
12.8
12.7
12.7
12.8
12.6
13.4
12.7
15.7
18.4
20.6
21.1
20.7
21.3
21.6
21.5
21.9
22.4
19.4
21.2
2.5
2.2
4.9
4.2
4.9
3.8
15.0
13.8
10.5
9.3
15.2
14.0
10.2
9.1
4.9
3.8
5.1 - 2 . 2
4.0 - 3 . 3
4.3
3.4
5.3
4.7
- . 9 -2.3 -3.0 -2.7 -2.3
-.6
1.9
1.9
2.0
41.2
21.9
17.0
5.2
39.9
20.6
17.1
3.8
40.6
20.8
17.8
3.2
45.5
25.2
22.2
3.3
51.6
30.8
27.6
3.5
59.9
38.4
34.8
3.9
66.8
44.9
41.1
4.4
71.8
49.7
45.3
4.9
72.2
49.6
45.3
4.7
77.1
54.0
49.0
5.4
80.0
56.7
50.0
7.0
80.7
57.0
51.3
6.0
.3
19.3
.2
19.3
.2
19.8
.3
20.3
.3
20.9
.3
21.6
.6
21.9
.5
22.1
.4
22.5
.4
23.1
.3
23.2
.3
23.7
.9 - 1 . 7 - 1 . 9
Source: Department of Commerce.
One of the immediate effects of the outbreak of the Korean war was
the marked rise in consumer expenditures and the sizable drop in
personal savings. From the second to the third quarter of 1950
personal consumption expenditures increased at an annual rate of
$14.5 billion, or 7.1 percent. More than one-half of the increase was
in consumer durable goods. This pronounced rise was followed by
a sharp increase in business inventories in the last 3 months of the
year, a change from an annual rate of $4.9 billion in the third to $15
billion in the fourth quarter.
In the first quarter of 1951 consumer expenditures increased by
$11.4 billion over the final quarter of 1950. During the next 3 months
they dropped by $6 billion with most of the decline in expenditures for
consumer durables. Spending for consumer durables continued at
the sharply reduced second quarter level through the first 3 months of
1952. Investment in business inventories which reached a record
annual rate of $15.2 billion in the second quarter of 1951 dropped to
$4.9 billion in the
fourth and to minus $2.2 billion by the second
quarter of 1952.8
Residential nonfarm construction expenditures which had reached
an annual rate of $15.4 billion in the third quarter of 1950 dropped to
a rate of $11.8 billion a year later.
8 Federal Reserve officials stress the view that the accord played a major role in changing the climate of
expectations in the money market and in general market conditions. The flight of "hot money" from the
dollar before the accord, and reflected in gold exports, was followed by the cessation of the flight of gold after
the accord. Moreover, it was an important factor in changing inflationary psychology with a consequent
shift in consumer expenditures and business inventories.
13 F E D E R A L
RESERVE
POLICY A N D
TABLE 7 . — D i s p o s i t i o n of disposable
ECONOMIC
personal
income,
STABILITY
1950-52
[Seasonally adjusted quarterly totals at annual rates]
[Billions of dollars]
Period
1950—1st quarter
2d quarter
3d quarter
4th quarter
1951—1st quarter
2d quarter
3d quarter
4th quarter
1952—1st quarter
2d quarter
3d quarter
4th quarter
Disposable
personal
income
Personal
consumption
expenditures
200.9
201.7
210.2
217.7
219.8
226.4
229.5
233.8
232.1
235.6
241.1
245.6
Personal
saving
185.7
189.9
204.4
200.1
211.5
205.5
208.8
213.4
214.6
217.7
219.6
227.2
15.2
11.8
5.8
17.6
8.3
20.9
20.7
20.4
17.5
17.9
21.5
18.4
Saving as
percent of
disposable
personal J
income
7.6
5.9
2.8
8.1
3.8
9.2
9.0
8.8
7.5
7.6
9.0
7.4
Source: Department of Commerce.
Thus, while outlays for consumer durable goods and housing together with inventory investment were major stimuli in the inflationary developments during the second half of 1950 and in early
1951, by mid-1951 these sectors were a restraining influence upon
inflationary pressures. At the same time that these contractive forces
were operating, defense outlays had stepped up sharply. National
security expenditures which were at an annual rate of $22.2 billion
in the final quarter of 1950 more than doubled by the final quarter of
1951. Most of the rise in gross national product during this period
originated from this source.
REVIVAL OF THE DISCOUNT
MECHANISM
If we must largely attribute the subsidence of inflationary pressures
during the first year after the accord to the reduction in spending by
consumers for durable goods and to the downward adjustment of
business inventories, this does not signify that the more flexible credit
policy was not a salutary development. While there are differences
of opinion as to how much of an anti-inflationary influence the monetary authorities actually were or could be after March 1951, it can
hardly be questioned that with the turning away from the rigid
support of Government security prices the way was paved for openmarket operations and the discount mechanism to become more
effective complementary tools of monetary policy.
It was not until a year after the accord that it had become apparent
that the member banks were resorting increasingly to borrowing at
the Federal Reserve banks in order to obtain additional reserves for
supporting credit expansion. The discount mechanism had fallen
more or less into disuse for two decades and could not be reactivated
until a flexible open-market policy had been restored. When the
monetary authorities deem it desirable to exercise restraint on credit
expansion, less reserves are made available to the banks through restrictive open-market operations. In order to obtain additional reserves to meet temporary deficiencies in their legal reserves, the jnember banks turn to the discount window of the Federal Reserve banks.
14
FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
An expanding volume of discounts enables the Federal Reserve System to exercise greater control over bank credit expansion. The
banks are said to be traditionally reluctant to borrow from the Federal Reserve banks and are also subject to administrative regulations
that discourage continuous borrowing. Moreover, replenishing of reserves through the discount window may be made more expensive
through the raising of the Federal Reserve discount rate. As a result
of these pressures, member banks readjust their loans and investments
to meet their obligations to repay promptly. In other words, the
discount mechanism acts as a brake in bank credit expansion, and
serves as a major supplement9 to open-market policy as a tool for
promoting economic stability.
TABLE 8 . — I n s t a l l m e n t credit,
1950-52
[Millions of dollars]
End of month
Total outstanding
1950—January.
February..
March
April
May_
June
July
August
September.
October...
November.
December.
1951—January.. _
February..
March
April
May
June
July
August
September.
October. _.
November.
December.
1952—January.._
February..
March
April
May
June
July
August
September.
October. _ .
November.
December.
11,599
11,669
11,888
12,136
12,534
13,030
13.578
14,045
14,452
14, 570
14,492
14,703
14,564
14,409
14,382
14,321
14,376
14,437
14,369
14,622
14, 766
14,826
14,946
15,294
15,121
15,030
15,032
15,234
15, 834
16, 588
17,044
17,329
17,669
18,216
18.579
19,403
Automobile
paper
Other consumer goods
paper 1
4,613
4,717
4,868
5,024
5,220
5, 504
5,825
6,032
6,191
6,212
6,133
6,074
5,984
5,910
5,875
5,873
5,932
5,996
5,992
6,108
6,157
6,095
b, 048
5,972
5,881
5,848
5,824
5,916
6,249
6,662
6,878
6,946
7,055
7,293
7,504
7,733
3,671
3,643
3,690
3,760
3,887
4,004
4,159
4,349
4,546
4,611
4,588
4, 799
4,727
4,639
4, 591
4,502
4,445
4,393
4,289
4,354
4,389
4, 178
4, 572
4,880
4, 776
4,683
4,647
4, 667
4,812
5,001
5,133
5,252
5,400
5,626
5,712
6,174
Repair and
moderniza-2
tion loans
887
872
872
897
922
945
971
996
1,014
1,021
1,016
1,001
988
987
989
1,002
1,003
1,012
1,029
1,045
1,064
1,082
1,0!
1,074
1,073
1,071
1,091
1,132
1,174
1,216
1,254
1,297
1,345
1,374
1,385
1
Represents all consumer installment credit extended for the purpose of purchasing automobiles and
other consumer goods, whether held by retail outlets orfinancialinstitutions. Includes credit on purchases
bya individuals of automobiles or other consumer goods that may be used in part for business.
Represents repair and modernization loans held by financial institutions; holdings of retail outlets are
included in other consumer goods paper.
Source: Board of Governors of the Federal Reserve System.
ECONOMIC
AND F I N A N C I A L
DEVELOPMENTS
IN
SECOND
HALF
OF
1952
Toward mid-1952, there was a quickening in the pace of business
activity with accompanying increase in the demand for credit. The
index of industrial production rose from 119 in May to 133 in December, except in June and July during the steel strike. The gross
9
For the most recent Federal Reserve statement on the role of the discount mechanism in monetary
policy, see the Forty-fourth Annual Report of the Board of Governors of the Federal Reserve System.
1957, pp. 7-18.
15 FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
national product rose at an annual rate of $17.3 billion, or 5.1 percent
from the second to the final quarter of 1952. Virtually all of the
increase arose from the expansion of business inventories and from
consumer spending. The rise in consumer spending was facilitated
by the rapid expansion of installment credit, especially after the
lifting of consumer credit controls. In addition, there was the discontinuance around the middle of the year of direct regulation of real
estate credit and of the voluntary credit-restraint program. Defense
spending considerably slackened its rate of expansion after the second
quarter of the year. The leveling off of defense expenditures in the
last half of the year and the substantial growth of production in the
civilian sector were accompanied by a decline in wholesale prices and
by consumer price stability.
Total loans of all commercial banks increased by $5 billion from
June to December 1952 with most of the expansion in consumer and
business loans. Total bank investments rose by over $2 billion with
practically all of the acquisition in United States Government securities. Despite the greater increase in bank credit in the last half of
1952 as compared to the corresponding period of 1951, the rise in
the money supply (adjusted demand deposits and currency in circulation) was about $2 billion less in the second half of 1952 than in
the last half of 1951.
FEDERAL RESERVE CREDIT POLICY
With the intensification of the demand for bank credit as business
activity accelerated and with a large increase in the demand for funds
by the Treasury to finance a Government deficit, there WSLS increasing
pressure on bank reserves. In the absence of offsetting open-market
operations, the member banks turned increasingly to discounting at
the Reserve banks to replenish their reserves. In March 1952 discounts and advances of the Federal Reserve System averaged $314
million; in June the monthly average rose to $585 million; during
the next 4 months it was around $1 billion; and in December it reached
$1.6 billion.
TABLE 9.—Open-market transactions in TJ. S. Government securities}l
Sept. 80, 1952
July 1,
1951-
[Millions of dollars]
During periods
of
refunding2
Total
Other than periods
of refunding
Class of security
Maturing issues (rights) _ _
Other securities maturing:
Within 91 days
91 days to 14 months
14 months to 5 years
5 years to 10 years
Over 10 years
Total
3,059
1, 568
594
1
3
23
5,248
Sales
Purchases
Sales
Purchases
Sales
2,206
2,277
3,059
541
341
372
1,154
too
Purchases
1,834
1,123
5
4,488
6
3,947
3
1,529
1,301
2
2,959
1
Excludes repurchase agreements with dealers and brokers and purchases and sales of special certificates
from
and to Treasury.
3
Commitments from date of announcement to closing of books, plus all transactions in new securities on a
when-issued basis.
Source: United States Monetary Policy: Recent Thinking and Experience: Hearings, Subcommittee on
Economic Stabilization of the Joint Committee on the Economic Report, 83d Cong., 2d sess., 1954, p. 265.
16
FEDERAL RESERVE POLICY AND ECONOMIC
TABLE 1 0 . — M e m b e r bank
reserves
and related
STABILITY
items,1950-52
[Averages of daily figures, millions of dollars]
Period
1950—January. . .
February—
March
April.
May
June.
July
August
September.
October...
November.
December.
1951—January...
February. .
March
April
May.
June
July
August
September.
October...
November.
December.
1952—January.
FebruaryMarch
April
May
June
July
August
September.
October. _.
November.
December.
Federal Reserve credit
18,649
18,310
18,242
18,136
18,005
18,325
18.703
18,877
19,610
20,044
20,159
21,606
21,839
23,286
23.663
23,983
23,686
23,913
24.285
24,264
24.664
24,982
24.785
25,446
24,444
23,826
23,890
23,726
23.704
24,144
24.786
24,824
25,055
25,681
26,172
27,299
Gold stock
24,420
24,346
24,311
24,247
24,236
24,231
24,192
23,927
23,560
23,366
23,157
22,879
22,523
22,249
21,909
21,806
21, 757
21,755
21,757
21,790
21,906
22,104
22,298
22,483
22,824
23,039
23,278
23,293
23,297
23,308
23,348
23,346
23,343
23,340
23,338
23,276
Currency in
circulation
27,220
27.008
27,043
27,062
27,022
27,026
27,117
27.009
27,154
27,233
27,380
27,806
27,304
27,145
27,171
27,179
27,324
27,548
27,859
27,951
28,213
28,387
28,612
29,139
28,637
28,406
28,437
28,459
28,557
28,843
29,028
29,088
29,343
29,555
29,904
30,494
Total
reserves
16,520
16,146
16,081
15,898
15,941
16,194
16,253
16,273
16,602
16,731
16, 742
17,391
18,088
18,907
19,207
19,324
18,892
19.309
19,229
19,174
19,396
19,868
19,794
20.310
20,469
19,995
20,207
19,777
19, 767
20,140
20,535
20,306
20,514
20,611
20,744
21,180
Source: Board of Governors of the Federal Reserve System.
From June to December the required reserves needed to support
the increase in bank deposits amounted to $1 billion, and about $1.6
billion of reserve funds were needed to offset the outflow of currency
in circulation. The additional reserves were supplied as follows:
About $1 billion originated from borrowing from the Federal Reserve,
$1.3 billion from outright purchases of Government securities by the
Open Market Committee, and about $400 million
through the acquisition of securities under repurchase agreements.10
The Federal Reserve did not change its preaccord directive "to
maintain orderly conditions" in the Government securities market
until March 1953 when the present wording "to correct disorderly
conditions" was approved. In the interval it underwrote Treasury
refunding operations through open-market purchases of the maturing
issues for which an exchange was being offered and at times of the
new security on a when-issued basis. During the period between
July 1, 1951, and September 30, 1952, the Treasury entered the
market 9 different times to refund about $49 billion of maturing
securities. During these 15 months, purchases of the Open Market
Committee amounted to $5.2 billion and were concentrated almost
wholly in short-term securities, i. e., issues less than 14 months.
About three-fourths of the total purchases were made during periods
of refunding and only one-fourth were made between refunding
periods. The $3.9 billion of support purchases during refunding
10
See appendix, p. 78.
17 F E D E R A L R E S E R V E
POLICY A N D ECONOMIC
TABLE 1 1 . — M e m b e r bank excess reserves,
borrowings,
STABILITY
and free reserves,
1950-52
[Averages of daily figures, millions of dollars]
Borrowings at
Federal
Reserve
banks
Period
1950—Januar y
February
March.
April
May
June
July
August
September. __
October
November...
December.
1951—Januar y
February
March
April
May
June
737
783
694
704
767
746
647
765
842
731
1,027
825
627
713
833
590
35
123
128
101
80
68
123
164
96
67
145
142
212
330
242
161
438
170
Free
reserves
901
614
655
593
624
699
623
483
669
775
586
885
613
297
471
672
152
664
Period
1951—July
August
SeptemberOctober
November.
December.
1952—January. __
February..
March
April
May.
June.
July
August
September.
October
November.
December.
Excess
reserves
756
704
721
915
729
695
885
650
628
709
609
649
778
648
657
723
Borrowings at
Federal
Reserve
banks
194
292
338
95
340
657
210
365
307
367
563
579
1,077
1,032
683
1,048
1,532
1,593
Free
reserves
562
412
723
330
578
283
65
130
-468
-383
95
-400
-875
-870
Source: Board of Governors of the Federal Reserve System.
periods were offset at the same time by $1.5 billion of sales of other
securities in the portfolios of the Reserve banks. Nearly $3 billion
of sales by the Open Market Committee were made between periods
of refunding in order to withdraw funds supplied during support
operations. However, since total purchases for the 15-month period
amounted to $5.2 billion and total sales were nearly $4.5 billion, this
meant that offsetting sales fell short of purchases by $700 million.
This additional Federal Reserve credit occurred during the sizable
August and September 1952 Treasury refunding operations when a
large part of the substantial increase in open-market purchases was
not offset by sales transactions.
The decision not to withdraw funds supplied in support of the
August and September 1952 refundings reflected the tightening
situation in the money market, a condition that was becoming more
apparent since the spring of 1952. The increasing pressure on member
bank reserves is evident from an examination of table 11 showing
the member bank reserve balances and the amount of rediscounting
at the Federal Reserve banks. Particularly significant for indicating
stringency of credit conditions is the difference between excess reserves
(i. e., total reserves less legal required reserves) and member bank
borrowings at the Federal Reserve banks. This difference is known
as free reserves.
There was a downward trend in free reserves since the spring of
1952, becoming negative in the latter half of the year. In November
and December free reserves were minus $900 million.
Tightness in the money market was reflected in the rise in the
yields of securities, particularly the Treasury bill rate. The monthly
average of Treasury 3-month bills rose from 1.57 in February 1952
to 2.12 in December. The last half of the year the bill rate was
above the 1% percent discount rate of the Federal Reserve. When
the bill rate is above the discount rate, there is some encouragement
for banks to borrow from the Federal Reserve banks rather than to
dispose of bills, but it was not until January 1953 that the Federal
18
FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
Reserve banks attempted to bring the discount rate more nearly in
line with short-term market rates by raising the discount rate to 2
percent. Another factor in the growth of member bank borrowing
was the excess-profits tax which made it profitable for potentially
affected banks to borrow during this period. As table 11 shows, total
member bank borrowing and net borrowed reserves grew rapidly.
They would have grown even more rapidly, however, had it not been
for purchases of the Open Market Committee.
TABLE 1 2 . — A n n u a l rate of turnover
of
demand
its, 1950-52
1
[Ratio of debits to deposits]
Period
1950—Januar y
February
March
April
May
June
July
August
September...
October
November. __
December. __
1951—Januar y
February
March..
April
May
June
New
York
City
29.0
29.0
30.1
28.4
30.0
31.6
29.0
34.5
32.8
30.6
32.3
36.1
32.5
30.1
35.1
32.5
31.0
33.7
1
3
6 other
centers2
338 other
reporting
centers
20.9
20.9
23.5
22.0
21.7
23.2
21.5
16.3
15.8
22.2
23.5
23.0
24.0
25.2
24.7
23.5
26.4
25.6
24.2
24.0
16.0
15.7
16.2
17.0
17.1
17.1
18.4
18.3
19.1
19.2
19.0
18.3
18.5
18.5
18.3
18.4
Period
1951—Jul y
August
SeptemberOctober
NovemberDecember _
1952—January _ __
February..
March
April
May
June
July
August
September.
October
NovemberDecember.
New
York
City
31.1
27.6
30.6
31.2
32.1
35.9
31.2
32.3
33.6
34.0
32.8
37.4
34.4
29.6
35.4
36.4
34.1
41.8
6 other 338 other
centers3 reporting
centers
23.3
22.1
23.6
23.1
24.4
24.3
23.0
23.4
25.7
24.6
22.8
24.9
24.0
20.8
24.3
25.0
24.1
26.9
18.0
17.3
18.3
18.4
19.6
19.0
18.3
18.5
18.2
17.8
17.9
18.8
18.1
17.0
18.9
18.7
19.3
19.8
Does not include interbank and U. S. Government deposits and is given without seasonal adjustment.
Boston, Philadelphia, Chicago, Detroit, San Francisco, Los Angeles.
Source: Board of Governors of the Federal Reserve System.
CHAPTER I I .
FEDERAL RESERVE
POLICIES IN
1953-54
The first half of 1953 is an especially interesting period to the
student of monetary policy. It posed a series of issues to the Federal
Reserve Board and the Open Market Committee which have been
discussed ever since not only in the academic literature but by the
Congress itself, particularly at committee hearings where monetary
and fiscal problems affecting economic stability are under consideration. On some of these questions there have been sharp differences
of opinion within the Federal Reserve System, in the Congress, and
among economists. Some of the issues are quite technical and on
the surface appear to be concerned only with the operating techniques
of what has come to be the most important tool of monetary policy,
namely, open-market operations. But they cannot be readily dismissed on the grounds that the issues involve only considerations of
the technical operations of the System's open-market account. They
raise important questions of credit policy which have a significant
bearing on the objective of promoting the stability and growth of the
economy through the use of the powers of the Federal Reserve System.
The issues referred to in the preceding paragraph all came to the
fore at the March 1953 meeting of the Open Market Committee and
are reported in the record of its policy actions in the Federal Reserve
Board's Annual Report for 1953. The first of the policy decisions
was concerned with the longstanding directive to the Executive Committee to continue, as it had done since August 1951, to operate
"with a view to exercising restraint upon inflationary developments."
The second, involving a change from previous directives, provided
that the Executive Committee should arrange for transactions in the
System open-market account with a view "to correcting a disorderly
situation in the Government securities market/' rather than as
previously, "to maintaining orderly conditions in the Government
securities market." The third action instructed the Executive Committee that "operations for the System account should be confined
to the short end of the market (not including correction of disorderly
markets)." In practice, this meant confining operations to Treasury
bills. The System account was also to refrain from support purchases
in the market during periods of Treasury refinancing.
A P P R A I S A L S OF T H E B U S I N E S S S I T U A T I O N , F I R S T H A L F OF 1953
Let us first consider the early March directive which instructed the
Executive Committee to continue to operate "with a view to exercising
restraint upon inflationary developments." The assumption that the
economy was likely to be dominated by inflationary developments
explains in large measure the controversies about Federal Reserve
policy and Treasury debt management policy that flared up in the
Congress and in the financial and business community during the
first half of 1953. Particularly important for the purposes of this
19
H. Rept. 2500, 85-2
3
FEDERAL
20
RESERVE
POLICY A N D
ECONOMIC
STABILITY
report is that the controversies bring to the fore certain limitations
in the use of the tools of monetary policy (and fiscal and debt management policy) for promoting economic stability. As we shall see in the
next chapter, these limitations are not only apparent in a review of
the first half of 1953; they become even more apparent in the review
of later Federal Reserve actions. The limitations referred to relate
to the difficulties involved in appraisals of changes in the business
situation, currently and for the near future.
As the Open Market Committee saw it, economic activity which
had been expanding at a rapid rate in the second half of 1952 was
continuing to expand further in the early months of 1953. Industrial
production, the gross national product, and business inventories were
increasing, and unemployment was exceptionally low. At the same
time the demand for capital and credit continued strong, especially
mortgage and consumer credit, despite the raising of the discount
rate from 1% percent to 2 percent around the middle of January.
There were some observers who did not anticipate continuation of
inflationary pressures. Typical of those who were critical of the Open
Market Committee's concern with further inflationary developments
was Mr. Marriner Eccles, former Chairman of the Federal Reserve
Board, who argued that the signs pointed rather to deflationary developments. The wholesale and consumer price levels had stabilized.
It was also pointed out that the production of automobiles and other
consumer durable goods and the construction of housing were reaching
a point of saturation in relation to demand, and that Government
expenditures
were scheduled to reach a peak and start declining during
the year.1 These appraisals of current developments were publicly
expressed at the same time that spokesmen for the Federal Reserve
and the Treasury were publicly stressing the predominance of inflationary pressures calling for monetary and debt management policies
of an anti-inflationary character.
TABLE
1 3 . — I n d e x e s of
industrial
production,
1958-54
wholesale
and
consumer
prices,
[1947-49=100]
Month
Industrial production 1
Wholesale
prices
134
134
135
136
137
136
137
136
133
132
129
109.9
109.6
110.0
109.4
109.8
109.5
110.9
110.6
111.0
110.2
109.8
110.1
1953—January
February
March
April
May
June
July
August
September—.
October
November. _.
December.
126
Consumer
prices
113.9
113.4
113.6
113.7
114.0
114.5
114.7
115.0
115.2
115.4
115.0
114.9
Month
1954—January
February
March
April
May
June
July
—
August
September-.
October
November...
December.
Industrial production 1
Wholesale
prices
125
125
123
123
125
124
123
123
124
126
128
130
110.9
110.5
110.5
111.0
110.9
110.0
110.4
110.5
110.0
109.7
110.0
109.5
i Seasonally adjusted.
Source: Board of Governors of the Federal Reserve System and U. S. Department of Labor,
i Washington Post, April 15, 1953.
Consumer
prices
115.2
115.0
114.8
114.6
115.0
115.1
115.2
115.0
114.7
114.5
114.6
114.3
21 FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
To be sure, at any given time, analysts of business conditions differ
in their appraisals of current economic developments. In view of the
fact that more or less the same statistical and other pertinent data are
available to competent and trained observers, such differences must
be largely interpretative and analytical in character. Since even in
periods of general high and expanding levels of activity there are
sectors of the economy that are contracting rather than expanding,
there are bound to be differences in judgment as to the relative influence of the diverse movements that are taking place. Unfortunately,
psychological and other biases enter into these judgments, especially
during periods of prosperity, which result in minimizing the unfavorable influences that appear on the business horizon and the neglect
of which may result in faulty policy decisions. Fortunately, however,
one of the virtues of monetary policy, as compared to fiscal and debt
management policy, is its greater flexibility. The monetary authorities are generally in a better position to minimize errors of diagnosis
by more speedily steering a different course to meet changing conditions. As we shall see, this was the case in 1953; it may have been
less so in 1957.
Let us examine some of the statisticaFseries which measure the
behavior of the economy during this period. The index of industrial
production, which rose from 115 in July 1952 to 133 in November and
December, climbed to 137 in May 1953. This would appear to indicate that the rate of expansion in production was slackening in the
earlier part of 1953. The gross national product, which increased at
an annual rate of $11*6 billion between the third and fourth quarters
of 1952, rose by $5.9 billion in the first quarter of 1953, and by an
annual rate of $4.3 billion in the second quarter. To some observers
at the time, the slackening in the rate of economic activity, as indicated
by such broad-gaged measures as the index of industrial production
and the gross national product, meant that the economy was approaching the peak in the expansion phase of the business cycle and would
soon turn down. To others, especially the monetary authorities,
whose daily activities in the area of credit indicated continuing strong
pressures for additional funds, the slackening in the rate of economic
expansion—even if it could be so gaged at the time—might only be
temporary, to be followed by a further upward surge of activity in the
months ahead. Officials of the Federal Reserve have pointed out that
business inventories were rising at the time, and they interpreted this
rise as an indication of the intensification of inflationary pressures.
However, a rise in inventories could also signify that production and
sales were growing out of balance, a condition that could culminate
in readjustments of a deflationary character. Toward midyear,
when inflation was still the dominant theme, it was becoming more
apparent that such readjustment was in process.
When one turns from general measures of business activity and
examines the behavior of specific areas, there were a number of signs
early in 1953 which indicated impending change in a downward
direction. It is sufficient to cite only a few of such indicators. Industrial stock prices, which in the past have manifested a definite tendency
to lead at cyclical turning points of business activity, moved downward during each of the first 6 months of 1953. Orders for manufacturers' durable goods and the average length of the manufacturing
workweek started to decline in the spring. The rise in retail sales
22
FEDERAL RESERVE POLICY AND ECONOMIC
STABILITY
was halted in February, while business inventories continued to
expand through the summer. It is precisely at the time when aggregate measures of business conditions indicate increasing buoyancy in
the economy at more or less peak levels that there is intensification
of concern about inflationary pressures. It is at such times also that
there is a tendency to ignore imbalances that have been building up
in certain sectors for a number of months but which only become
visible later on in the general measures of business activity. With
retail sales sluggish since the early months of 1953, while inventories
were piling up, a downward adjustment in the economy rather than
a further upward push was the more likely prospect.
MONEY AND BANK CREDIT, FIRST HALF OF 1953
Turning from the industrial sector, where production was at peak
levels while key individual sectors were manifesting signs of weakness, to the financial sector, let us examine briefly the changes in the
money supply and some of the major influences affecting bank reserves.
Demand deposits and currency, which usually move downward
during the first half of the year and rise substantially in the second
half, declined more sharply in the first 6 months of 1953 than in the
corresponding periods of 1950-52. The relatively greater decline in
the money supply largely reflected a shrinkage in bank holdings of
Government securities in the amount of $4.2 billion during the first
half of 1953. The commercial banks not only sold Government securities to meet the large demands for credit; they also continued to rely
heavily on borrowing from the Federal Reserve banks. In January
their discounts and advances were nearly $1.4 billion and in April
they were close to $1.2 billion.
There is little doubt that the reserve positions of the banks were
under pressure. This pressure was exerted by foreign gold withdrawals starting in December and by restrictive Federal Reserve openmarket operations. The latter may be seen from table 14 showing
open-market transactions for 1953. Jn the first part of the year there
were no outright purchases of Government securities and over $200
million of sales. There was also substantial reselling of securities
which had been purchased in December under repurchase agreements
with dealers in short-term Government securities. As a result of
these operations, there was a net reduction in Federal Reserve holdings of Government securities and to that extent an absorption of
member bank reserves. Free reserves, i. e., excess member bank reserves less borrowings by member banks, were minus at least $600
million in each of the first 4 months of 1953.
The pressures on credit resulted in a general firming of interest rates
to mid-April and a sharp advance to early June. Between January
and June, the monthly averages of Treasury bill rates rose from 2.04
percent to 2.23 percent, prime commercial paper from 2.31 percent to
2.75 percent, and long-term Governments from 2% to 3% percent.
TABLE 14.—Gross transactions
in Government
securities
by the Federal Open Market
Committee,
January-December
1953
[In millions of dollars]
Market transactions (gross)
Net change
in Federal
Reserve
holdings
Outright transactions 1
Total
Purchases
Purchases
January—
February, _
March
April
May_
June
July
August
September .
October
November.
December. .
-753.4
-68.3
-69.2
+74.0
+366. 3
+499. 8
+217. 5
+99.5
+171. 5
+113 0
2-252. 5
+820 4
Total.
+1, 218. 6
1
2
Purchases
2,801. 6
477.5
414 1
384.0
138.0
144.9
646.4
57.0
1,102.0
1,981. 3
75.5
225.0
687.1
245 5
25.0
263 7
113.0
165.0
375.0
2 520.0
50.0
478.2
242.9
119.0
476 0
555.4
196.7
110.0
219.4
554.2
57.0
684.5
2, 426. 6
8, 294.7
7,076.1
2,174. 8
890.4
6,119. 9
478 2
242.9
119 0
551.5
780 4
883 8
355.5
244.4
817.9
170.0
849.5
Includes runoff of Treasury bills at maturity.
Includes 2^-percent notes of December 1953, redeemed with gold certificates.
Repurchase agreements
with dealers
1, 231. 6
311.2
188.2
145.7
35.3
46.2
75.5
17.7
Sales
Special
certificates
purchased
Exchange of
directly from maturing
Treasury
certificates,
(largest
notes, and
amount outbonds
standing
in month)
350.1
3,886. 9
270.5
1,085. 9
275 9
142 0
402 0
414.1
384.0
138.0
144.9
628.7
57.0
582 0
1,931. 2
1,172.0
6,185. 7
1, 505 0
281.3
1,152 8
503.0
710.9
1,398. 2
702.7
591.0
7,978 4
17,825. 8
Source: Hearings on January 1954 Economic Report of the President, Joint Committee on the Economic Report, 83d Cong., 2d sess., February 1954, p. 133.
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24
FEDERAL
RESERVE
POLICY
AND
ECONOMIC
STABILITY
Around mid-February the Federal Reserve Board reduced margin
requirements on stock market credit2 from 75 to 50 percent. In explaining its action the Board stated:
The margin requirements had been increased from 50 to
75 percent in January 1951 as a preventive measure and as
a supplement to the steps previously taken in the credit and
monetary area to lessen inflationary pressures. By February 1953 inflationary pressures had moderated and, with the
margin requirements fixed at 75 percent, there had been no
substantial increase in the total amount of credit in use in
the stock market. Accordingly, the Board concluded that
margin requirements of 50 percent would be adequate to
prevent the excessive use of credit for the purchasing and
carrying of securities and that a reduction to that level would
be in harmony with the System's overall credit and monetary policy under current conditions.
To be sure, inflationary pressures in early 1953 were certainly not as
strong as in early 1951, but they were apparently regarded as sufficiently strong for the System to raise the discount rate in January
1953 and to restrict bank reserves through open-market operations.
Consequently, critics pointed out at the time that the Board's action
in lowering margin requirements was inconsistent with its concern
about "inflationary developments" and with its restrictive general
monetary policy.
2
Fortieth Annual Report of the Board of Governors of the Federal Reserve System, 1953, p. 83.
TABLE 1 5 . — B o n d yields
and interest
rates,
1953-54
[Percent per annum]
U. S. Government securities
Period
1953-^-January _ _.
February..
March
April
May
June
July
August
September
October
November.
December.
1954—January. _.
February..
March
April
May
June
July
August
September.
October....
November.
December.
1
2
3-month
Treasury
bills
2.042
2.018
2.082
2.177
2.200
2.231
2.101
2.088
1.876
1.402
1.427
1. 630
1.214
.984
1.053
1.011
.782
.650
.710
.892
1.007
.987
.948
1.174
9-to-12month
Taxable bonds
10 to 20
years2
1.97
1.97
2. 04
2.27
2.41
2.46
2.36
2.33
2.17
1. 72
1.53
1. 61
1.33
1.01
1.02
.90
.76
.76
.65
.64
.89
1.03
.94
1.10
Corporate bonds
(Moody's)
2.80
2.83
2.89
2.97
3.09
3.09
2.99
3.00
2.97
2.83
2.85
2. 79
2.67
2.58
2.50"
2.45
2.52
2.53
2.45
2.46
2.50
2.52
2.55
2.57
3.26
3.29
3.25
3.22
3.19
3. 06
3.04
2.96
2.90
2.85
2. 73
2. 70
2. 72
2.70
2.62
2.60
2.64
2. 65
2.68
2.68
Includes certificates of indebtedness and selected note and bond issues.
2^> percent bonds, 15 years and over prior to April 1952 and 12 years and over beginning
April 1952
3 3H percent bonds of 1978-83, 1st issued May 1, 1953.
4
Effective Jan. 16, 1953.
Aaa
Baa
20 years
and over 3
3.02
3.07
3.12
3.23
3.34
3.40
3.28
3.24
3.29
3.16
3.11
3.13
3.06
2. 95
2. 86
2.85
2.88
2.90
2. 89
2. 87
?. 89
2.87
2.89
2.90
3. 51
3.53
3. 57
3. 65
3. 78
3.86
3. 86
3. 85
3.88
3. 82
3. 76
3.74
3. 71
3. 61
3. 51
3.47
3.47
3.49
3.50
3. 49
3.47
3.46
3.45
3.45
Average
Common High-grade
Prime
rate on
stock
municipal short-term commeryields,
bonds
bank loans cial paper,
200 stocks, (Standard to business,
4 to 6
(Moody's) & Poor's)
selected
months
cities
5.15
5. 22
5.34
5.49
5. 51
5.58
5.46
5. 75
5. 73
5. 59
5.53
5. 55
5.33
5.32
5.14
4.94
4.88
4.82
4.61
4. 75
4.46
4. 57
4. 39
4.20
2.47
2.54
2.61
2.63
2. 73
2.99
2.99
2.88
2. 88
2. 72
3.54
3. 73
3^74
2.62
2.59
2.50
2.39
2.38
2. 47
2.49
2.48
2.31
2.23
2.29
2.32
2.29
2.33
3. 76
3.72
3. 56
3. 55
2.31
2.31
2.36
2.44
2. 67
2. 75
2. 75
2. 75
2.74
2. 55
2.31
2.25
2.11
2.00
2.00
1.76
1.58
1.56
1.45
1.33
1.31
1.31
1.31
1.31
<2.00
2.00
2.00
2.00
2.00
2.00
2.00
2.00
2.00
2.00
2.00
2.00
2.00
s 1. 75
1.75
6 1.50
1.50
1.50
1.50
1.50
1.50
1.50
1.50
1.50
s Effective Feb. 5, 1954.
6 Effective Apr. 16, 1954.
Sources: Board of Governors of Federal Reserve System, Treasury Department,
Moody's Investor Service, and Standard and Poor's Corp.
§
K|
to
Oi
26
FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
THE OBJECTIVE OF A FREE
MARKET
One cannot fully understand monetary and debt management
policy as well as conditions in the money market during the first half
of 1953 without consideration of the March directives of the Open
Market Committee other than that of "exercising restraint on inflationary developments." Since these directives, mentioned at the
beginning of this chapter, have also played an important role in Federal
Reserve3 policy ever since, it is essential that we examine them more
closely.
The change in the directive to the Executive Committee from
"maintenance of orderly conditions" to that of "correction of disorderly conditions in the Government securities market" was designed
to make more explicit the commitment of Federal Reserve policy to a
philosophy of a "free securities market." It was intended to reassure
dealers and professional buyers and sellers of Government securities
that the forces of supply and demand would determine the prices and
yields of Government securities and that in such a market they would
not be subject to the hazards of unpredictable intervention by the
Open Market Committee. The Federal Reserve would confine its
operations to releasing and absorbing reserve funds in order to effectuate its general credit policies. Only in extreme circumstances
would the Open Market Committee step in to correct a market that
was clearly disorderly.
To reinforce the goal of a "free market" there were the additional
directives: (1) Open-market operations would be confined to the short
end of the market; (2) support of the market during periods of Treasury refinancing would be discontinued; (3) the policy of the Committee was not to support any pattern of prices and yields in the
market.
The view that yields on Government securities should be determined
by a free money market was vigorously expounded in speeches in the
spring of 1953 by the Chairman of the Board of Governors and by the
Secretary of the Treasury. This view was regarded with much less
enthusiasm by a number of critics, among whom were distinguished
economists.4 They pointed out that the Federal Reserve System
came into existence precisely because the country had learned from
the bitter experience of the past that it was dangerous to the stability
3
These directives which were adopted at the March meeting of the Open Market Committee are based
on recommendations of an ad hoc subcommittee appointed in 1951 to study methods of improving the
effectiveness of open market operations. The full text of the report of the ad hoc subcommittee on the
Government securities market, which was submitted to the Open Market Committee in November 1952,
was first made public 2 years later in United States Monetary Policy: Recent Thinking and Experience:
Hearings before the Subcommittee on Economic Stabilization, Joint Committee on the Economic Report,
83d
Cong., 2d sess., 1954, pp. 257-307.
4
Among the critics of the "free market philosophy" was Prof. Lester V. Chandler of Princeton University:
* * High officials in the Treasury Department have at times suggested that interest rates should be
determined by the market forces of demand and supply, and the Chairman of the Board of Governors made
a memorable speech describing the transition to 'free markets,' which was to include a 'free money market.'
This was, in my opinion, an unfortunate choice of words. * * * But to allow the total supply of money and
loans, and the price of loans, to be determined by private demand and private supply would negate the
very idea of central banking. Central banks exist because we are not willing to allow the total supply of
money and credit, and the cost of credit, to be determined by the unregulated forces of private supply and
demand. The basic function of a central bank is to regulate the total supply of money and credit and the
terms on which they are made available. It should be clear that the Federal Reserve can make its maximum
contribution to economic stability and growth only by recognizing its continuous responsibility for money
market conditions, and by taking whatever positive actions that may appear conducive to the attainment
of its objectives. * * * A successful policy of economic stabilization cannot be a passive policy * * *
(United States Monetary Policy: Recent Thinking and Experience, cited in footnote 3; pp. 45-46).
For this and the next section see Alvin H. Hansen, The American Economy, McGraw-Hill, 1957, ch. 4.
Also Paul A. Samuelson, Recent American Monetary Controversy, The Three Banks Review, March 1956;
also Deane Carson, Recent Open Market Committee Policy and Techniques, Quarterly Journal of Economics, August 1955; and C. R. Whittlesey, Monetary Policy and Economic Change, Review of Economics
and Statistics, February 1957.
27
FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
of the economy to permit the unregulated forces of supply and demand
to determine the total volume of credit and its cost. Strict adherence
to the "free-market" philosophy, instead of making open-market operations more effective, represented a degree of passivity on the part of
the Federal Reserve which was likely to weaken credit policy as a tool
for stabilization. It was incompatible with economic developments in
recent decades in which so high a proportion of total indebtedness had
come to be represented by Government debt. According to the
critics, there are periods when it is highly desirable in the interests of
promoting economic stability and growth that the monetary authorities take an active role in influencing the course of interest rates.
This may be accomplished at times through regulating the volume of
bank reserves; at other times it may be necessary to operate directly
in the long-term sector of the Government security market.
According to its proponents, the free market promotes "market
depth, breadth, and resiliency." In such a market dealers are active
in buying and selling not only as brokers for institutional investors
but also for their own account. In operating in the latter capacity,
they rely heavily on the use of borrowed funds. To such dealers a
very small change in bond prices and yields may make all the difference between a profitable and an unprofitable transaction. They
may be prepared to take risks in a free market. But when it is subject to uncertainties originating from Open Market Committee intervention, dealers are reluctant to take trading positions that involve
sizable amounts of borrowed funds.
THE POLICY OF BILLS-ONLY
If the free market is to provide depth, breadth, and resiliency,
then, according to the Committee, it is desirable that open-market
operations be confined to short-term securities, and there should be
no intervention in the intermediate and long-term sectors. The
Government securities market has "depth" when there are orders to
buy and sell above and below the current market price; it has
"breadth" when orders are large in volume and come from widely
divergent investor groups; it has "resiliency" when there are small
fluctuations in price due to speedy investor reactions to small changes
in market conditions. These conditions are more nearly fulfilled in
the market for Treasury bills and when dealers are assured that the
Open Market Committee will limit its operations to this sector.
When the Committee enters the short end of the market with a view
either to increasing or decreasing bank reserves, it has relatively the
smallest effect on price changes and on the asset value of investor
portfolios. On the other hand, if it were to operate directly in the
long-term bond market, dealers would find the risks of sharp fluctuations in bond prices much too great.
Mr. Allan Sproul, President of the Federal Reserve Bank of New
York and Vice Chairman of the Open Market Committee, agreed
with his colleagues that the Committee should avoid continuously
intervening in the market to influence the structure of interest rates
and thus permit the free market to govern. But he strongly opposed
adoption of the "bills only" approach to open-market operations.
While voting for the March 4 directive to substitute for the "maintenance of orderly conditions" the clause "correction of disorderly
28
FEDERAL
RESERVE
POLICY
AND
ECONOMIC
STABILITY
situations in the market," he thought the emphasis should be on the
"avoidance of disorderly
situations rather than their correction after
they happened." 6
* * * One of the virtues of credit control is supposed to be
its ability to take prompt action to head off financial disturbances which might otherwise have harmful repercussions
throughout the economy. If open-market operations in
longer term Government securities can be used to this end,
I would use them rather than wait until a disorderly situation
or a crisis has developed, and only then depart from operations solely in Treasury bills * * *.6
Mr. Sproul contended that to confine open-market operations to the
short end of the market was to place monetary management in a
straitjacket; that there were circumstances when credit policy
would be more effective if it operated directly in the long-term sector.
The Federal Reserve Bank of New York questioned the view that it is
fear of Federal Reserve intervention that produces uncertainty and
therefore thin markets.
* * * Clearly it is the appraisals of the outlook for interest
rates and security prices by dealers and investors, much
more than any fear (or hope) of intervention by the System
in the market for particular securities, that determine the
"depth, breadth, and resiliency" of the market at any given
time. Fear of adverse trends, or uncertainty as to what the
trend is likely to be, is the predominant reason for thin markets, rather than apprehensions concerning System inter-7
vention in particular sectors to limit price movements * * *.
Mr. Sproul questioned the majority view that operations in very
short-term securities are transmitted speedily to the longer sectors
of the market through arbitrage transactions by dealers. For example,
in a period of business recession when monetary authorities pursue a
policy of credit ease by increasing bank reserves through purchase of
Treasury bills, their yields may go down substantially, while longterm rates may not be lowered much or soon enough to stimulate
business investment. If there were direct intervention in the longer
sector of the market, Federal Reserve credit policy would be more
effective in achieving its objective of promoting economic stability.
DEBT MANAGEMENT
POLICY: T H E
TREASURY'S
At the same time that the Federal Reserve was stressing the importance of the free market with noninterference by the System, the
Treasury was even more emphatically expounding the virtues of a free
market for Government securities and of a debt management policy
that aimed at refunding the debt into longer maturities. It was
maintained that stretching out the debt through issuance of long-term
bonds was essential to curb inflationary pressures. Moreover, borrowing from nonbank investors rather than from commercial banks
did not result in an increase in the money supply during a period
when it was considered important to reduce spending.
8
United States Monetary Policy: Recent Thinking and Experience, cited in footnote 3; p. 225.
• Ibid, p. 225.
* Ibid., p. 310.
29
FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
Early in April 1953, the Treasury announced the offering of $1
billion of 30-year bonds at 3% percent. Although the issue was
heavily oversubscribed, these bonds quickly declined below par even
before the May 1 issue date. About the same time banks increased
their prime commercial loan rate from 3 percent to 3% percent. The
yields on municipal, State, and corporate bonds also advanced sharply.
In early May, maximum interest rates on FHA-insured and VAguaranteed mortgages were increased from 4% and 4 percent respectively, to 4K percent.
The 3% percent bond issue brought forth considerable criticism in
the Congress and in the editorial pages of influential financial papers
and weeklies. Criticism was directed not only at the Treasury for
its decision to launch its program of stretching out the debt at this
time and for the excessive rate of interest fixed for the issue, but it
was also directed at the Federal Reserve for continuing its policy of
monetary restraint. The tight monetary policy was being overdone
with the consequence that prices of seasoned Government and industrial bonds were slumping badly and interest rates were climbing
rapidly along a wide front. Moreover, it had become apparent that
the Treasury would have to borrow in much greater amounts because
of the sizable budget deficit that was expected in the latter half of
the year. Tension in the money market in May increased further
when the Treasury offered 1-year 2%-percent certificates in exchange
for $5 billion 1%-percent maturing certificates and for $700 million
of 2-percent bonds. Greater apprehension on the part of lenders as
to the future of interest rates and fear that the Federal Reserve would
continue its restrictive credit policy increased investor reluctance to
commit funds at existing rates. On June 1-2, the Government
securities market became demoralized, as evidenced by the fact that
there were practically no bids for United States Treasury securities.
Only a few days earlier it had also become clear that reception of
the new 2%s was disappointing.
T H E MIDYEAR
S H I F T IN
FEDERAL
RESERVE
POLICY
In the second week of May, the System began to take some cognizance of the growing tensions in the money market by supplying reserves to member banks through a moderate amount of open-market
purchases. But the release of Federal Reserve credit in May was
inadequate to meet a situation in which there were large private demands for credit, in part the result of the fear that funds would be
difficult to obtain later on and would command higher interest rates,
and increasing demands for funds by the Government. With the
demoralization of the bond market and the tensions in the financial
markets generally at the beginning of June, the Federal Reserve began
to move much more vigorously to ease the financial situation. It
greatly stepped up purchases of Treasury bills. Between early May
and early July the System increased its holdings of United States Government securities by $1.2 billion. And even more aggressive acrossthe-board action was taken when the Federal Reserve Board announced on June 24 a reduction of reserve requirements on demand
deposits from 24 to 22 percent in central Reserve city banks, from 20 to
19 percent in Reserve city banks, and from 14 to 13 percent in country
banks, The release of reserves in May and June through open-market
30
FEDERAL RESERVE
POLICY A N D
ECONOMIC
STABILITY
operations was accompanied by a sharp decline in borrowings at
Federal Reserve banks, so that the amount of discounting in June was
down to one-third the average for the first 4 months of the year.
Free reserves which were minus at least $600 million in these months
became plus $364 million in June.
TABLE 1 6 . — G r o s s national
product
seasonally
adjusted
at annual
rates,
1953-54
[Billions of dollars}
1953
I
II
1954
III
IV
I
II
III
IV
Gross national product
364.5
368.8
367.1
361.0
360.0
358.9
362.0
370.8
Personal consumption expenditures
Durable goods
Nondurable goods
Ser vices
230.9
33.2
118.1
79.6
233.3
33.4
118.6
81.2
234.1
33.6
117.8
82.8
232.3
31.2
117.4
83.7
233.7
31.2
117.9
84.6
236.5
32.2
118.8
85.5
238.7
32.3
119.6
86.9
243.2
33.9
121.0
88.3
52.0
26.9
13.7
13.2
22.5
2.5
3.0
52.9
27.8
14.0
13.8
22.0
3.1
4.0
51.1
27.7
13.8
14.0
22.6
.7
1.5
45.2
27.9
13.7
14.2
21.9
-4.6
-4.3
46.6
27.8
13.7
14.1
21.4
-2.6
-2.8
47.2
28.9
14.7
14.2
20.9
-2.7
-3.2
48.8
30.2
15.8
14.4
20.7
-2.1
-2.8
52.3
31.6
17.0
14.6
19.9
.8
.2
- -2.1
-2.6
-2.0
-1.4
-1.0
-.4
-.9
.7
85.2
60.9
53.0
8.3
.4
24.3
83.8
58.9
51.3
8.0
.4
24.9
84.9
59.2
49.8
9.7
.3
25.7
80.8
54.2
46.6
8.0
.4
26.5
75.5
48.3
43.1
5.6
.4
27.3
75.5
47.3
41.9
5.8
.4
28.2
74.6
45.9
40.6
5.6
.3
28.7
Gross private domestic investment
New construction
Residential nonfarm
Other
Producers' durable equipment
Change in business inventories: total
Nonfarm only
Net foreign investment
Government purchases of goods and services _
Federal
National security
Other
Less Government sales
State and local
83.7
59.2
52.1
7.6
.5
24.4
Source: Department of Commerce.
The May shift in Federal Reserve policy from credit restraint to
credit ease was not due primarily, as is sometimes asserted, to the
expectation by the monetary authorities that the economy was about
to slip into a business recession which it was deemed desirable to
counteract. The measures designed to ease credit were initially undertaken rather in response to a critical situation that had been permitted
to develop in the financial markets—a situation that was frequently
described at the time as reaching nearly panic proportions. As a
result of the Federal Reserve moving vigorously in June to reverse
the course of monetary policy, the rise of interest rates came more
or less to an abrupt halt and the strained condition in the credit
markets quickly eased.
T H E 1953-54 BUSINESS
RECESSION
Apart from the question as to whether the extensive open-market
purchases and the lowering of reserve requirements in June were the
result of Federal Reserve prevision of a change in business conditions,
there can be little doubt that these actions created a favorable financial
environment for meeting the problems of economic readjustment in
the period immediately ahead. For it was only a matter of weeks
after the system moved aggressively to ease credit conditions that the
general level of business activity began to move downward. The
index of industrial production dropped from a peak of 137 in July to
123 in March 1954 and more or less remained at this level through
31
FEDERAL
RESERVE
POLICY A N D
ECONOMIC
STABILITY
August. The gross national product declined from an annual rate
of $368.8 billion in the second quarter of 1953 to $360 billion in the
first quarter of 1954.
TABLE 1 7 . — D i s p o s i t i o n of disposable
personal
income,
1953-54
[Seasonally adjusted quarterly totals at annual rates]
[Billions of dollars]
Period
1953--1st quarter
2d quarter
3d quarter
4th quarter
1954--1st quarter
2d quarter
3d quarter
4th quarter
Disposable
personal
income
250.0
252.8
253.8
253.8
254.6
254.8 j
256.8
260.9 ,
Personal
consumption
expenditures
230,9
233.3
234.1
232.3
233.7
236.5
238. 7
243.2
Personal
saving
19.0
19.6
19.7
21.6
21.0
18.3
18.0
17.7
Saving as
percent of
disposable
personal
income
7.6
7.8
7.8
8.5
8.2
7.1
7.0
6.8
Source: Department of Commerce.
How much of an influence did the restrictive monetary policy and
the tight money market have in bringing on the recession? There is
little doubt that in the spring months builders found it more difficult
to secure funds for construction, and it was also the case that the peak
of housing starts was reached in April and moved downward during
the remainder of the year. There was also some evidence of postponement of other capital ventures because of unfavorable credit
conditions. To some extent, then, the tight money policy was an
influence contributing to a slackening in economic activity but its
effect in no way compares with the impact of two other factors that
were of major importance in the business recession. The first, and
initial factor, was business inventory adjustments, and the second was
the cutback in defense contracts.
Businessmen were adding to their inventories at an annual rate of
$3.1 billion in the second quarter of 1953, and at the very moderate
rate of $®.7 billion in the third quarter; by the fourth quarter of the
year they were reducing their inventories at a rate of $4.6 billion.
National security expenditures, which were at an annual rate of
$53 billion in the second quarter—the peak of such expenditures since
the beginning of the Korean war—dropped to $49.8 billion in the
fourth quarter and moved downward throughout 1954 to a rate of
$40.6 billion in the last quarter of the year. The tight money policy
can hardly be said to have contributed to the reduction either of
investment in inventories or of defense expenditures. The liquidation
of inventories occurred because production and sales had fallen out of
balance, especially in the consumer durable goods sector, and because
of curtailment of the defense program.
32
FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
TABLE 1 8 . — I n s t a l l m e n t credit,
1953-54
[Millions of dollars]
End of month
Total outstanding
Automobile
paper 1
Other consumer goods
paper 1
Repair and
moderniza-a
tion loans
7,899
8,093
8,397
8,693
8,996
9,241
9,514
9,677
9,772
9,875
9,898
9,835
9,650
9,497
9,403
9,416
9,459
9,604
9,722
9,769
9,781
9,768
9,720
9,809
6,145
6,070
6,100
6,124
6,200
6,287
6,337
6,369
6,379
6,422
6,485
6,779
6,622
6,490
6,331
6,296
6,256
6,261
6,234
6,214
6,218
6,280
6,377
6,751
1.380
1.381
1,392
1,412
1,441
1,472
1,500
1,524
1,557
1,585
1.609
1.610
1.595
1,581
1,571
1,575
1,594
1.596
1,604
1.615
1,622
1,628
1,626
19,586
19,720
20,150
20,551
21,016
21,467
21,887
22,146
22,317
22,503
22,654
23,005
22,638
22,365
22,160
22,207
22,268
22,501
22,658
22,740
22,803
22,881
22,983
23,568
1953—January
February..
March
April
May
June
July
August
September.
October.. _
November.
December.
1954—January...
February—
March
April
May
June
July
August
September,
October...
November.
December.
1.616
Personal
loans
4,162
4,176
4,261
4,322
7,629
7,565
7,371
7,402
7,466
7,588
7,618
8,238
7,688
7,283
7,152
7,402
7.633
7,699
7.634
7,587
7,676
7,834
8,000
8,724
i Represents all consumer installment credit extended for the purpose of purchasing automobiles and other
consumer goods, whether held by retail outlets or financial institutions. Includes credit on purchases by
individuals
of automobiles or other consumer goods that may be used in part for business.
3
Represents repair and modernization loans held by financial institutions; holdings of retail outlets are
included in other consumer goods paper.
Source: Board of Governors of the Federal Reserve System.
From the second to the fourth quarter of 1953, consumer expenditures for durable goods declined by $2.2 billion and for nondurables
$1.2 billion, while expenditures for services rose by $2.5 billion.
During the same period, personal saving as a percent of disposable
TABLE 19.—Member bank reserves and related items,
1953-54
[Averages of daily figures, millions of dollars]
Period
1953—January...
February.,
March
April
May
June
July
August
September.
October-..
November.
December.
1954—January. __
FebruaryMarch
April
May.
June
July
August
September.
October...
November.
December.
Federal
reserve
credit
Gold
stock
23.101
22,797
22,606
22,562
22, 557
22, 514
22,366
22,226
22,176
22.102
22,057
22,028
22,015
21,957
21,963
21,966
21,971
21,927
21,926
21,871
21,809
21,787
21,724
21,711
Source: Board of Governors of the Federal Reserve System.
Currency
in circulation
29,920
29,718
29,752
29,782
29,870
30,012
30,165
30,167
30,328
30,366
30,555
30,968
30,282
29,903
29,800
29,755
29,773
29,856
29,968
29,896
29,991
30,078
30,287
30,749
Total
20,958
20,520
20,416
20,007
19,897
20,287
19,653
19,526
19,552
19,536
19,718
19,920
20,179
19,557
19,573
19,392
19,533
19,670
19,164
18,478
18,403
18,893
19,207
19,279
Required
reserves
20,251
19,882
19,828
19.472
19,306
19,499
18,882
18,834
18,784
19,034
19,227
19,243
18,925
18,881
18.627
18,817
18,813
18,329
17,638
17.628
18,173
18,393
18,576
33
FEDERAL
RESERVE
POLICY A N D ECONOMIC
STABILITY
income rose from 7.8 to 8.5 percent. In the first quarter of 1954
consumer expenditures for commodities continued at the reduced
level of the previous quarter, while national security expenditures
dropped by more than $3 billion. By March 1954 the index of industrial production declined 10 percent from its July 1953 peak and nearly
6 percent of the civilian labor force was unemployed in March as
compared with 3 percent a year earlier. Despite these and other
deflationary pressures which have been known to exert a cumulative
downward push on the economy, the gross national product reached its
low in the second quarter, advanced moderately in the third, and rose
sharply in the last quarter of the year.
TABLE 2 0 . — M e m b e r bank
excess reserves,
borrowings,
and free
reserves,
1953-54
[Averages of daily figures, millions of dollars]
Period
1953—January
February
March.
April
May
June
July
August
September
October...
November
December
1954—January
February
March
April
May
June
July
August
September
October
November
December
Excess
reserves
—
707
638
588
535
591
787
784
643
718
752
684
693
936
632
692
765
716
858
836
839
775
720
814
704
Borrowings
at Federal
Reserve
banks
1,347
1,310
1,202
1,166
944
423
418
650
468
363
487
441
100
293
189
139
155
146
66
115
67
82
164
246
Free
reserves
-640
-672
-614
-631
-353
364
366
-7
250
389
197
252
836
339
503
626
561
712
770
724
708
638
650
458
Source: Board of Governors of the Federal Reserve System.
There were various influences originating in the private and the
governmental sectors of the economy that contributed to the relative
mildness of the 1953-54 business recession. In the private sector
there were such favorable factors as the maintenance of consumer
spending at a high level. After dropping at the annual rate of nearly
$2 billion in the fourth quarter of 1953, personal consumption expenditures rose at an annual rate of $1.4 billion in the first quarter of 1954,
$3 billion in each of the next 2 quarters, and $4.5 billion in the last
quarter. Personal saving, which was at its highest in the last 3 months
of 1953 and in the first 3 months of 1954, dropped substantially during
the remainder of the year with a fourth-quarter level that was $4
billion less than the peak reached a year earlier. Another factor in
the private economy that exerted a stabilizing influence and hastened
business recovery was the pace of residential construction which
stepped up with each succeeding quarter of 1954. Both the reduction
of the personal income tax that became effective in January 1954 and
the decision of consumers to maintain a lower rate of saving contributed to the rise in consumer expenditures. Apart from the offsetting
effect of the "automatic stabilizers," such as unemployment insurance
34
FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
and the decline in taxpayments, there was also the favorable influence
of the rise in State and local government expenditures all through the
period of contraction. In addition to these and other factors of a
contracyclical nature that might have been listed, there was the
significant contribution of the monetary factor. Let us now turn to
the role which credit policy played during this period.
TABLE 2 1 . — D e p o s i t s and currency,
1958-54
[Billions of dollars]
Deposits and currency
Demand deposits and currency
End of period
Total i
1953—January
February
March
April
May
June
July
August
September
October
November
December
1954—January
February
March.
April
May
June. ___
July
August
September.
October
November
December
_
193.3
191.6
191.0
192.2
192.1
192.6
193.0
193.4
194.3
197.3
197.4
200.9
199.8
197.4
195.2
197.3
198.0
198.5
200.4
200.3
202.5
204.7
205.8
209.7
Total
Demand
deposits
adjusted 2
Currency
outside
banks
100.5
98.3
97.4
98.0
97.5
96.9
97.4
97.5
97.7
100.3
100.2
102.5
102.3
99.6
96.7
98.6
98.7
98.1
100.0
99.4
101.2
103.1
104.0
106.6
26.8
26.9
26.9
27.0
27.0
27.4
27.2
27.3
27.5
27.4
27.9
28.1
26.9
26.9
26.9
26.7
26.8
27.1
26.8
26.9
26.9
26.9
27.5
27.9
127.3
125. 2
124.3
125.0
124.5
124.3
124.6
124.8
125. 2
127.7
128.1
130. 5
129.2
126. 5
123.6
125. 3
125. 5
125.2
126. 8
126.3
128.1
130.0
131.5
134.4
Time
deposits3
66.1
66.4
66.8
67.2
67.6
68.3
68.4
68.7
69.1
69.6
69.3
70.4
70.6
71.0
71.7
72.0
72.5
73.3
73.7
74.0
74.4
74.8
74.3
75.3
1
Includes holdings of State and local governments, but excludes U. S. Government deposits.
2
Includes demand deposits, other than interbank and U. S. Government, less cash items in process of
collection.
3
Includes deposits in commercial banks, mutual savings banks, and Postal Savings System, but
excludes interbank deposits.
Source: Board of Governors of the Federal Reserve System.
T H E P O L I C Y OF C R E D I T
EASE
We have seen that the Federal Reserve authorities shifted from a
policy of restraint to credit ease shortly before the general business
contraction had begun
and that this change was not initiated as an
antirecession move.8 Nevertheless, in increasing their holdings of
Government securities by $1 billion between May and July and then
lowering reserve requirements in July, commercial banks entered the
recession without the fears of uncertainty about Federal Reserve policy
that seemed to be created by official pronouncements of a noninterventionist philosophy of the free market. The actions taken by the
Federal Reserve also had the immediate tangible effect of greatly
reducing member bank borrowing so that by January 1954 all mem8
The 1953 Annual Report of the Board of Governors of the Federal Reserve System records only 2 meetings of the Open Market Committee during the first half of the year, March 4-5 and June 11. It was at the
June meeting that the credit policy directive was changed from "exercising restraint upon inflationary
developments" to "avoiding deflationary tendencies without encouraging a renewal of inflationary developments."
35 FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
ber bank indebtedness at the Reserve banks was virtually eliminated—
a condition that continued during most of the year. This was accompanied by a sharp decline in interest rates until at least mid-1954.
TABLE 2 2 . — L o a n s and investments
of all commercial
banks,
1953-54
[Billions of dollars]
End of period *
Total
loans and
investments
1953—January
February
March
April..
May
June,.
July
August
September..
October
November--December
1954—January
February
March
April
May
June
July
August
September
October
November
December
140.8
140.1
140.0
138.5
138.1
138.0
143.2
143.1
143.0
144.0
145.5
145.7
145.3
144.9
142.8
144.1
145.7
146.4
147.3
149.5
150.6
154.0
155.7
155.9
Investments
Loans
Total 2
63.9
64.1
65.2
65.3
65.4
65.0
65.6
66.0
66.3
67.1
67.3
67.6
66.5
66.9
67.1
66.8
67.1
67.3
67.3
66.5
67.3
67.7
69.5
70.6
Business
loans 3
27.5
27.4
27.9
27.8
27.6
27.4
27.5
27.7
27.9
27.9
27.8
27.2
26.6
26.4
26.7
26 2
26.0
26.1
25.8
25.8
26.1
26.2
26.6
26.9
Total
77.0
76.0
74.8
73.3
72.7
72.9
77.5
77.1
76.7
76.8
78.3
78.1
78.9
78.0
75.8
77.3
78.6
79.0
80.0
83.0
83.3
86.3
86.3
85.3
U. S. Government
obligations4
62.8
61.9
60.5
58.9
58.3
58.6
63.2
62.6
62.2
62.3
63.7
63.4
64.2
63.0
60.7
62.1
63.3
63.5
64.3
67.3
67.3
70.2
70.1
69.0
Other
securities
14.2
14.1
14.3
14.4
14.4
14.3
14.3
14.5
14.5
14.5
14.6
14.7
14.7
15.0
15.1
15.2
15.3
15.5
15.7
15.7
16.0
16.1
16.2
16.3
1 June and December figures are for call dates. Other data are for the last Wednesday of the month.
2
Data are shown net, i. e., after deduction of valuation reserves. Includes commercial and industrial,
agricultural,
security, real estate, bank, consumer, and other loans.
3
Data are shown gross of valuation reserves. For months other than June and December data are estimated on the basis of reported data for all insured commercial banks and for weekly reporting member
banks.
4
Figures are based on book values and relate only to banks within the continental United States.
Source: Board of Governors of the Federal Reserve System.
In pursuing a policy of active ease after mid-1953, all three major
instrumentalities of Federal Reserve credit policy were employed to facilitate economic recovery—open-market operations, the discount rate
and reserve requirements. Between July and December 1953, there
was an additional increase of nearly $700 million in Federal Reserve
holdings of Government securities. At the beginning of February
1954 the discount rate was lowered from 2 percent to 1% percent and
in April-May the rate was lowered to 1% percent. In June-July, reserve requirements against demand deposits were reduced 2 percentage
points at central Reserve cities; in July, 1 percentage point at Reserve
city "banks and a similar reduction in August at country banks; there
was also a reduction in June of 1 percentage point on time deposits
at member banks. These reductions released approximately $1.6
billion of reserves. Since member banks were supplied with more
reserves than were needed at the time, the freed reserves were offset
in part by a reduction in Federal Reserve holdings of Government
securities of about $1 billion during the next 2 months. However, for
the remainder of the year, open-market purchases of nearly $1 billion
provided the banks with additional reserves for credit and monetary
expansion. The progressive easing of the reserve position of member
H. Kept. 2i500, 85-2
4
36
FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
banks is evidenced by the fact that their free reserves averaged $279
million in the fourth quarter of 1953, $559 million in the first quarter
of 1954, $633 million in the second and $734 million in the third
quarter.
The policy of active ease resulted in a marked decline in interest
rates. The average rate on Treasury bills dropped from a peak of
2.23 percent in June 1953 to a low of 0.65 percent in June 1954. The
rate on prime commercial paper fell from its peak of 2.75 percent in
1953 to 1.33 percent in August 1954 and remained at this level for
the rest of the year. In contrast to these sharp declines was the sluggish movement of the average rate on short-term bank loans to business
firms. Customer loan rates moved fiom a peak of 3.76 percent in
December 1953 to 3.60 percent in June 1954 and to 3.55 percent at
the end of the year.
TABLE 2 3 . — L o a n s and investments
of all commercial
banks,
1950-57
[Millions of dollars]
Call date
Total loans
and investments
(excluding
interbank)
Dec. 30, 1949.
June 30, 1950.
Dee. 31,1950.
June 30, 1951.
Dec. 31,1951.
June 30, 1952.
Dec. 31, 1952.
June 30,1953.
Dec. 31, 1953.
June 30, 1954.
Dec. 31,1954.
June 30,1955.
Dec. 31, 1955.
June 30, 1956.
Dec. 31, 1956.
June 6, 1957..
Dec. 31, 1957.
120,099
121,665
126,585
125,890
132,461
134,284
141,467
137,802
145, 525
146,208
155,676
154,846
160,307
159,344
164,471
163, 514
169,346
Total loans
(excluding
interbank)
42,867
44, 694
52,159
54,666
57,597
59,080
64,006
64,870
67,431
67,162
70,379
74,765
82,027
86,223
89,650
90,027
93,177
Business
17,060
16,947
21,927
23,651
25,879
25,312
27,870
27,418
27,204
26,120
26,867
28,872
33,245
36, 111
38,720
39,020
40,526
Agriculture
3,051
2,896
2,905
3,122
3,408
3, 651
3,919
3, 675
4,965
5,143
5,200
4,391
4,475
4,254
4,161
4,077
4,066
Loans 1
Investments
Securities
U. S. Government
securities
2,637
2,804
2,859
2,644
2,561
3,078
3,163
2,793
3,563
3,718
4,454
4,471
5,037
4,433
4,281
3,908
4,221
1
Figures for various loan items are shown gross (i. e., before deduction of valuation
reserves); they do not add to the total. Total loans are shown net.
Real estate
11,542
12,412
13, 541
14,144
14,580
15,019
15, 713
16,231
16,694
17,227
18,418
19,779
20,809
21,787
22,509
22,530
23,110
Consumer
5,777
6,613
7,374
7,425
7,455
8,256
9,368
10, 597
10,897
10,760
10,892
12,129
13,236
14,168
14, 550
15,100
15,809
All other
3,357
3,613
4,228
4,395
4,528
4,616
4,877
5,096
5,068
5,185
5,619
6,247
6,492
6,819
6,990
6,630
7,219
Total
77,232
76,972
74,426
71,224
74,863
75,204
77,461
72,932
78,094
79,046
85,297
80,081
78,280
73,122
74,821
73,487
76,169
Source: Board of Governors of the Federal Reserve System.
67,005
65,751
62,027
58, 521
61,524
61,178
63,318
58,644
63,426
63,508
68,981
63,271
61,592
56,620
58,552
56,642
58,239
Other
securities
H
©
H
S3
>
t*
10,227
11,221
12,399
12,703
13,339
14,026
14,143
14,287
14,668
15,538
16,316
16,809
16,688
16,502
16,629
16,845
17,930
W
H
W
H
W
<J
O
E
o
£
O
W
o
§
c
1
0
i—i
§
Kj
00
38
FEDERAL RESERVE POLICY AND ECONOMIC
STABILITY
In the long-term sector of the market, the yield on the 3^-percent
Treasury bond issued May 1, 1953, dropped to 2.6 percent in August
1954. High-grade municipal bonds moved downward from 2.99 percent in June 1953 to a low of 2.23 percent in August 1954, and Moody's
Aaa corporate bonds declined from 3.40 percent in June 1953 to a low
of 2.85 percent in May 1954. Apparently, in this period at least,
proponents of the view that Federal Reserve credit policy should concentrate on the short-term sector of the market and that its influence
would soon be felt in the long-term sector can point to the decline of
yields on long-term securities in the 1953-54 period as supporting their
position. It should be noted, however, that from high to low, the
percentage decline of yields in the long-term sector was generally less
than half the decline in the short-term sector. Relatively smaller
fluctuations of yields in long-term as compared to short-term markets
has characterized other periods when interest rates moved downward
during business contractions.
BANK LOANS AND INVESTMENTS
Both the decline in business activity and the more ample bank reserves resulting from the easier Federal Reserve credit policy caused
commercial banks to turn to the purchase of Government securities.
In the last 6 months of 1953 they acquired $4.8 billion, in contrast to
the sale of $4.7 billion in the first half of the year when they were
under pressure to meet credit demands. Their holdings of Government securities changed little in the first half of 1954 but during the
last half increased by $5.5 billion. The United States Government
obligations of over $10 billion acquired since mid-1953 were partly
from purchases of new Treasury securities and partly from nonbank
holders. Thus, these acquisitions by the commercial banks provided
funds to other financial institutions facilitating their expansion of
loans for investment activity. This was especially the case with
mortgage credit for housing, an area that contributed substantially
to the mildness of the 1953-54 recession. Moreover, the absorption
by commercial banks of Federal securities, especially during the second
half of 1954, resulted in a sharp rise in demand deposits.
Another category of commercial bank investment which was a
stimulus to recovery was the $2 billion increase in the holdings of
"other securities/' mainly State and local, between mid-1953 and the
end of 1954. The long-term borrowing by State and local governments was largely for construction of highways, schools, and other
community facilities.
Total commercial bank loans in the second half of 1953 increased
less than in any corresponding 6-month period since 1950. During
the next 9 months they remained lower than at the end of 1953, but
in the last quarter of 1954 they expanded by over $3 billion. Two
categories of loans showed a marked rise in 1954 and played a significant role in investment activity; namely, loans on real estate and for
purchasing and carrying securities to brokers and dealers and to others.
FEDERAL
RESERVE
POLICY AND
TABLE 24.—Mortgage debt outstanding,
ECONOMIC
STABILITY
by type of property and of
financing,
39
1950-57
[Billions of dollars]
Nonfarm properties
Period
All
properties
1- to 4-family houses
Government underwritten
Total
Total
1950—March
June
September
December. _
1951—March
June
September _ .
December. _
1952—March
June
SeptemberDecember. _
1953—March
June
September. _
December - _
1954—March
June..
September..
December. _
1955—March
June
September. _
December-.
1956—March
June
September. _
December. _
1957—March
i
June 1
September 1
December -
72.8
75.0
77.8
79.9
82.3
84.1
86.4
88.9
91.1
93.4
96.1
98.7
101.3
103.1
106.2
109.7
113.8
117.2
121.8
126.1
130.0
133.6
137.6
141.4
144.8
147.2
150.2
153.4
156.3
66.7
69.1
71.6
73.6
75.6
77.4
79.5
81.8
84.0
86.0
88.6
91.1
93.6
95.3
98.2
101.6
105.5
108.8
113.2
117.2
120.9
124.2
128.0
131.6
134.9
137.1
129.9
143.0
145.8
39.0
41.0
43.3
45.2
46.9
48.7
50.4
51.9
53.3
55.1
57.0
58 7
60.3
62.4
64.3
66.1
67.6
69.9
72.6
75.7
78.5
82.2
85.5
88.2
90.8
93.7
96.6
99.1
101.1
103.3
105.6
107.6
Total
15.6
16.5
17.6
18.9
20.0
21.0
22.0
22.9
23.5
24.0
24.7
25.4
26.1
26.7
27. 5
28.1
28.8
29.7
30.7
32.1
33.5
35.3
37.0
38.9
40.2
41.3
42.4
43.9
45.1
45.9
46.5
47.2
FHA
insured
VA
guaranteed
7.3
7.6
8.2
8.6
8.9
9.2
9.5
9.7
9.9
10.1
10.4
10.8
11.1
11.4
11.7
12.0
12.2
12.4
12.6
12.8
13.2
13.5
13.9
14.3
14.7
15.0
15.2
15.5
15.7
15.9
16.1
16.5
8.3
8.9
9.4
10.3
11.1
11.8
12.5
13.2
13.6
13.9
14.3
14.6
15.0
15.3
15.8
16.1
16.6
17.3
18.1
19.3
20.3
21.8
23.1
24.6
25.5
26.3
27.3
28.4
29.4
30.0
30.4
30.7
Multifamily
and
commerConvencial
proptional
erties
23.4
24.5
25.7
26.3
26.9
27.7
28.4
29.0
29.7
30.8
31.7
33.1
34.2
35.7
36.8
38.0
38.8
40.2
41.9
43.6
45.0
46.9
48.5
49.3
50.6
52.4
54.1
55.1
55.9
57.4
59.1
60.4
21.6
22.2
23.0
23.3
23.9
24.1
24.4
24.9
25.3
25.7
26.2
26.7
27.5
27.7
28.4
29.0
29.8
30.3
31.0
31.8
32.7
33.4
34.3
35.1
35.8
36.1
36.6
37.4
38.2
Farm
properties
6.1
6.0
6.2
6.3
6.7
6.7
7.0
7.1
7.1
7.3
7.5
7.6
7.8
7.8
8.0
8.1
8.3
8.4
8.7
8.8
9.1
9.4
9.6
9.8
9.9
10.1
10.3
10.4
10.5
1
Preliminary.
Source: Board of Governors of the Federal Reserve System.
Heal estate loans rose by $1.7 billion, more than one-half the rise
of total bank loans in 1954. This was in response to the expansion
in housing construction which started its upward climb in the fall of
1953 and accelerated its pace during the following year. There is
little doubt that the easy money policy was a major factor in the 1954
housing boom. Both the greater availability of credit and the more
liberal financing terms on FHA and VA mortgages spurred builders
to increase the volume of home building. From September 1953 to
December 1954 the total mortgage debt outstanding on nonfarm 1- to
4-family houses increased by $11.4 billion—a rise that was made
possible by the adequacy of funds for mortgage investment by insurance companies, mutual savings banks, savings and loan associations,
as well as by commercial banks.
The second largest 1954 increase in bank loans—nearly $1 billion—
was for the purchase and carrying of securities. The expansion in the
volume of stock market credit accompanied as well as stimulated
increased stock market activity. Common stock prices began to rise
in September 1953 and continued their uninterrupted upward course
until January 1955—an increase of 50 percent with the most rapid
40
FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
rise in the later months of 1954. The ample supply of bank credit
spilled over into the stock market so that credit for trading showed
the greatest increase during any of the postwar years. The buoyancy
of the stock market, even while business activity was moving downward, was regarded by the investing public as indicating that the
business recession would be mild ana of short duration.
TABLE 2 5 . — A n n u a l rate of turnover
of
demand
its,1
1953-54
[Ratio of debits to deposits]
Period
1953—January
February
March
April
May
June
July...
August
September. __
October
November. . .
December-..
New
York
City
34.3
35.1
37.1
35.4
35.6
38.9
36.0
32.2
40.2
35.8
38.4
43.1
6 other 338 other
centers3 reporting
centers
23.9
24.4
28.7
26.7
26.2
26.5
25.7
23.6
25.9
23.9
26.4
26.8
18.4
18.9
19.4
18.4
18.8
19.2
19.2
17.8
19.3
18.4
20.2
19.7
Period
1954—January...
February..
March
April
May
June
JulyAugust
September.
October
November.
December _
New
York
City
42.7
42.7
44.6
41.3
41.9
44.2
41.6
40.0
40.4
39.3
42.2
48.1
6 other 338 other
centers* reporting
centers
24.1
25.5
29.2
27.6
25.5
26.8
24.9
24.8
25.3
23.6
26.3
28.1
18.6
19.2
19.7
18.8
18.8
19.7
18.8
18.5
19.4
18.6
20.7
21.0
1
2
Does not include interbank and U. S. Government deposits and is given without seasonal adjustment.
Boston, Philadelphia, Chicago, Detroit, San Francisco, Los Angeles.
Source: Board of Governors of the Federal Reserve System.
Our review of economic and financial developments since mid-1953
indicates that Federal Reserve credit policy contributed substantially
to moderating the recession and supporting economic recovery. The
shift to a policy of active ease played an important part in making
credit more available and in lowering its cost. With more ample
reserves and greater liquidity banks sought out new business more
aggressively and greatly expanded their investment portfolios. The
chief beneficiary was the construction industry—especially housing,
commercial and public works construction. Toward the end of 1954
even credit for the consumer durable goods industry, which had
declined during the first half of 1954, began to move up sharply.
Monetary policy would not have been so powerful an influence in
recovery if the level of consumer spending had not remained so high
and if other antirecession measures had not been undertaken promptly
by the Federal Government. It has been said that monetary policy
was too liberal in this period and created difficult problems after the
business upswing in the fall of 1954 gathered much greater momentum
in the following year. This and related questions concerning the role
of monetary policy in economic stabilization are discussed in the next
chapter.
CHAPTER
THE
III.
KEY IMPORTANCE
FEDERAL
RESERVE
POLICY,
1955-57
O F 1955 I N R E C E N T E C O N O M I C A N D
DEVELOPMENTS
FINANCIAL
For understanding the character of the business expansion from the
fall of 1954 to the summer of 1957 and of the role of monetary policy in
these developments, no single year is so illuminating as 1955. It was
in this year that the expansion assumed its most rapid rate of increase
and the amount of private indebtedness rose at a record rate. The
acceleration in the pace of production and in the volume of credit
posed a series of problems for the monetary authorities that are central
in any consideration of the role of monetary policy in economic
stabilization.
The rapidity of the expansion in economic activity in 1955 is indicated by the index of industrial production which moved from a low
of 123 in August 1954, to 130 in December and advanced to 144 by
December 1955. Only during 1 month of 1956 and 1 month of 1957
did the index generally exceed the December 1955 level by 2 points.
The gross national product increased by nearly $35 billion in 1955,
$22 billion in 1956, and $15 billion in the first 9 months of 1957.
TABLE 2 6 . — I n d e x e s of industrial
production,
wholesale
and consumer
prices,
1955-57
Industrial
production 1
Wholesale
prices
Consumer
prices
136
143
144
146
146
147
146
146
145
143
143
144
144
145
144
141
139
135
114.0
114.7
115.5
115.6
115.9
116.3
116.9
117.0
116.9
117.2
117.1
117.4
118.2
118.4
118.0
117.8
118.1
118.5
[1947-49=100]
Month
1955—Januar y
February
March
April.
May
June
July
August
September...
October
November.
December...
1956—Januar y
February
March
April.-.
May
June
Industrial
production!
Wholesale
prices
132
133
135
136
138
139
139
140
142
143
143
144
143
143
141
143
141
141
110.1
110.4
110.0
110.5
109.9
110.3
110.5
110.9
111.7
111.6
111.2
111.3
111.9
112.4
112.8
113.6
114.4
114.2
Consumer
prices
114.3
114.3
114.3
114.2
114.2
114.4
114.7
114.5
114.9
114.9
115.0
114.7
114.6
114.6
114.7
114.9
115.4
116.2
Month
1956—July
August
September.
October
November.
December.
1957—Januar y
February. _
March
April
May
June
July
August
September.
October
NovemberDecember.
117.0
116.8
117.1
117.7
117.8
118.0
118.2
118.7
118.9
119.3
119.6
120.2
120.8
121.0
121.1
121.1
121.6
121.6
1
Seasonally adjusted.
Source: Board of Governors of the Federal Reserve System and U. S. Department of Labor.
The main impetus to the speedy pace of the economic recovery after
the summer of 1954 came from residential construction and automobile production. Between the third quarter of 1954 and the first
quarter of 1955 disposable personal income rose at an annual rate of
$7 billion, while consumption expenditures increased at the rate of
$10.7 billion. Personal saving as a percent of disposable income fell
41
42
FEDERAL RESERVE
POLICY A N D
ECONOMIC
STABILITY
from 7.0 to 5.5 percent. During this 6-month period consumer expenditures for durable goods rose by $5.9 billion. Expenditures on
nonfarm residential construction, which began to rise in the second
quarter of 1954, advanced to a level that was $4.2 billion higher by the
second quarter of 1955. Thus, the consumer played a powerful role
in the speed of business recovery. The liberality of credit terms and
the rise in the volume of credit for the purchase of homes and automobiles were also powerful influences in the economic expansion. The
mortgage debt on 1- to 4-family houses, which had risen by $9.6
billion in 1954, increased by $12.5 billion in 1955. Consumer installment credit rose by about $5.5 billion during 1955.
TABLE 2 7 . — G r o s s national
product,
seasonally
adjusted
at annual
rates,
1955-57
[Billions of dollars]
1955
I
II
1956
III
IV
I
II
III
1957
IV
I
II
III
IV
Gross national
product
384.3 393.0 403.4 408.9 410.8 414. 9 420.5 430. 5 436.3 441.2 445.6
438.9
Personal consumption expenditures
249.4 254.3 260.9 263.3 265.2 267.2 269.7 275.4 279.8 282.5 288.3
Durable goods
38.2 39.1 41.4 39.8 38.7 37.8 37.5 39.5 40.2 39.5 40.4
Nondurable goods
121.2 123.7 126.1 128.1 129.6 130.9 131.6 133.4 135.5 137.1 140.5
Services
90.0 91.6 93.4 95.3 96.9 98.6 100.6 102.5 104.1 105.9 107.4
287.2
39.6
138.8
108.7
Gross private domestic investment
58.8
New construction
33.9
Residential nonfarm
18.5
Other
15.4
Producers' durable
equipment
20.5
Change in business
inventories: total
4.4
Nonfarm only
3.8
63.1
34.9
65.4
35.4
67.6
35.4
68.0
35.2
67.7
35.8
68.1
35.8
68.8
36.2
65.9
36.1
67.0
36.1
66.7
36.6
61.5
37.1
18.9
16.0
18.9
16.5
18.4
17.0
17.8
17.4
17.7
18.1
17.6
18.3
17.7
18.4
17.2
18.9
16.5
19.6
16.9
19.7
17.6
19.6
22.1
24.4
25.4
25.9
26.6
27.3
28.2
28.7
28.1
28.0
26.7
6.1
5.7
5.7
5.5
6.7
6.7
6.9
7.4
5.4
6.2
4.9
5.3
4.4
4.6
1.1
.6
2.9
2.0
2.2
1.3
-2.3
-3.1
-.8
.1
-.5
-.5
1.3
2.0
2.8
4.2
4.2
3.6
1.9
76.5
47.0
41.9
5.5
76.4
46.2
41.1
5.6
77.0
46.5
41.0
5.8
78.5
47.5
41.2
6.8
78.1
46.1
41.2
5.4
78.7
46.0
41.4
5.0
80.8
47.4
43.0
4.7
83.4
49.1
44.5
5.0
86.4
50.5
45.8
5.1
87.5
51.5
47.4
4.5
87.0
50.9
46.9
4.5
88.3
50.5
46.0
5.0
.4
29.5
.4
30.2
.4
30.5
.4
31.0
.4
32.0
.4
32.7
.4
33.4
.4
34.4
.4
35.9
.4
36.0
.5
36.1
5
37.8
Net foreign investment. _. - . 5
Government purchases of
goods and services
Federal
National security.
Other
Less Government
sales
State and local
Source: Department of Commerce.
The continuous business upswing in 1955 was associated with an
increasing accumulation of inventories, from an annual rate of less than
$1 billion in the last 3 months of 1954 to $6.7 billion in the last 3 months
of 1955. Another major stimulus to the 1955 expansion was the rise
of business investment in plant and equipment, beginning in the
second quarter and accelerating in the latter half of the year. To a
considerable extent the sharp rise in business investment was induced
by the upsurge in consumer demand for durable goods and housing.
The marked expansion of business activity in 1955 was accompanied
by very little rise either in the index of wholesale prices or the index
of consumer prices. While industrial prices in wholesale markets rose
3K percent in the second half of 1955, this rise was largely offset by
the decline in farm prices. If the increasing exuberance of the
43 F E D E R A L
RESERVE
POLICY A N D
ECONOMIC
STABILITY
economy since the fall of 1954 was not reflected in the general level of
commodity prices at wholesale or retail during 1955, it was registered
in the acceleration in the rise of common stock prices in the last 3
months of 1954—a rise that had been continuing for a year. Stock
prices climbed upward with a few interruptions all through 1955,
although at a slower pace than in the preceding year.
TABLE 2 8 . — D i s p o s i t i o n of disposable
personal
income,
1955-57
[Seasonally adjusted quarterly totals at annual rates]
[Billions of dollars]
Disposable
personal
income
Period
1955—1st quarter
2d quarter
3d quarter
4th quarter
1958—1st quarter
2d quarter
3d quarter
4th quarter
1957—1st quarter.
2d quarter
3d quarter
4th quarter
__ __
_ __ _ ___
Personal
consumption
expenditures
263.8
272.0
277.7
283.0
283.1
288.8
292.1
297.2
300.0
305.7
308.7
306.8
249.4
254.3
260.9
263.3
265.2
267.2
269.7
275.4
279.8
282.5
288.3
287.2
Personal
saving
14.4
17.8
16.8
19.8
17.9
21.6
22.4
21.7
20.3
23.2
20.4
19.6
Saving as
percent of
disposable
personal
income
5.4
6.6
6.0
7.0
6.3
7.4
7.7
7.3
6.8
7.6
6.6
6.4
Source: Department of Commerce.
T H E STOCK M A R K E T AND MARGIN
REQUIREMENTS
We have seen in the previous chapter that the monetary authorities
pursued a liberal credit policy which encouraged banks to lend more
freely. One sector that took advantage of the increasing credit
opportunities was the stock market. During 1954 bank credit extended to brokers and dealers increased by nearly $1 billion. Loans
on margin accounts by brokers and dealers to their customers increased
by about the same amount, with the greatest rise taking place in the
second half of the year.
The first restrictive credit move by the Federal Reserve Board was
the raising of margin requirements from 50 to 60 percent at the beginning of January 1955. As measured by Standard & Poor's index of
500 stocks, their average price rose by more than 50 percent between
September 1953 and January 1955. In addition to about a 50-percent
rise in stock-market credit, there was increasing evidence of speculative activity in the market during the latter half of 1954. It was
these developments which led the Federal Reserve Board to act on
January 4, as well as the Senate Banking and Currency Committee
to decide on January 14 upon a study of the stock market. Past
experience has shown that continuously rising stock prices generate
an optimistic psychology that is transmitted to other areas than the
stock market, resulting in widespread overconfidence and to excesses
that can jeopardize economic stability. The Banking Committee's
public hearings were held during the first 3 weeks in March and were
widely reported in the daily press. Practically every one of the 21
prominent witnesses who testified expressed some concern about 1 or
more of the speculative tendencies that had appeared in the stock
44
FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
market. On the basis of its hearings, the Committee "was of the view
that conditions in January warranted more vigorous action to curb
stock-market credit by the Federal Reserve Board" than the 10-point
rise in margin requirements.1 It is also significant to note that the
Committee pointed out that the liberality of credit in other areas than
the stock market might be a potential threat to economic stability: 2
* * * A number of witnesses stressed the dangers in overextension of credit in the mortgage market and the possibility
that the recent rate of housing construction may not be
sustainable for very long. Likewise, concern was expressed
about the high level of consumer credit and the ability of the
automobile industry to maintain current levels of production
during the second half of the year * * *
On April 23, 1 month after the close of the Senate Banking Committee's hearings, the Federal
Reserve Board raised margin requirements from 60 to 70 percent.3 After the second action was taken, the
rate of increase in stock-market credit declined substantially.
CREDIT EXPANSION IN
1955
Between the third quarter of 1954 and the first quarter of 1955 the
gross national product advanced at an annual rate of $22.3 billion;
about two-thirds of the increase was due to the sharp expansion in
outlays for consumer durable goods, continued advances in purchase
of new homes, and a shift from liquidation to accumulation in business
inventories. The speedy economic recovery which received its major
impetus from these sectors was accompanied by a substantial rise in
credit and by a considerable easing in financial terms, especially longer
maturities and lower downpayments on installment and mortgage
credit. Business loans of commercial banks which usually decline in
the first half of the year increased by $2 billion in the first 6 months
of 1955. In the second quarter of the year, installment credit outstanding expanded by nearly $2 billion, a record increase in so short a
period. The mortgage debt outstanding on 1- to 4-family homes
increased by $6.5 billion during the first 6 months of 1955 as compared
to $3.8 billion in the corresponding period of 1954.
1
Stock Market Study: Report together with the individual views and minority views of the Committee
on Banking and Currency, Senate, 84th Cong.. 1st .sess., May 26, 1955, p. 7.
2 Ibid., p. 13.
» It is of interest to note that when Mr. Martin, Chairman of the Federal Reserve Board, testified on
March 14,1955, at the hearings on the stock-market study he was questioned at considerable length about
the adequacy of the January change in margin requirements by Mr. Fulbright, chairman of the Senate
Banking and Currency Committee.
ML>EFTAL R E S E R V E
POLICY A N D
TABLE 29.—Loans and investments
ECONOMIC
STABILITY
of all commercial banks,
45
1955-57
[Billions of dollars]
Total loans
and investments
End of period 1
1955—January
February
March
April
May
June
July
August.
September
October 8
November
December
1956—January
February
March
April
May
June
July
August
September
October
November
December
1957—January
February
March
April
May
June.
July___
August
September.
October.
November
December
-
156.3
154.8
153.5
155.5
155.6
155.3
157.0
156.7
157.3
158.9
159.4
160.9
159.4
158.4
159.9
160.1
159.7
160.0
159.6
161.0
162.0
162.5
164.0
165.1
162.8
162.5
162.9
165.1
165.1
165.6
165.4
165.9
166.3
167.9
167.3
> 170.1
Loans
Total 2
70.6
71.2
72.3
72.9
73.9
75.2
76.6
77.3
78.4
79.2
81.4
82.6
82.0
82.5
84.7
85.3
86.0
86.9
87.1
87.5
88.5
88.8
89.5
90.3
88.9
89.3
90.6
91.0
91.2
93.3
92.3
92.8
93.4
93.0
92.9
93.9
Investments
Business 3
26.6
26.8
27.4
27.6
28.0
28.9
29.1
29.9
30.5
31.1
32.3
33.2
32.7
32.9
34.5
34.8
34.8
36.1
35.8
36.4
37.0
37.2
37.8
38.7
37.6
37.8
39.0
39.0
38.9
40.5
39.6
39.9
40.3
39.7
39.6
40.5
Total
85.7
83.6
81.2
82.6
81.7
80.1
80.4
79.4
78.9
79.7
78.0
78.3
77.4
75.8
75.2
74.8
73.7
73.1
72.5
73.6
73.6
73.8
74.5
74.8
73.9
73.1
72.2
74.2
73.9
72.3
73.1
73.1
73.0
74.9
74.3
76.2
U. S. Government
obligations4
69.0
66.8
64.2
65.6
65.0
63.3
63.7
62.5
62.0
62.9
61.4
61.6
60.9
59.2
58.6
58.2
57.3
56.6
56.2
57.2
57.0
57.5
58.2
58.6
57.7
56.8
55.7
57.5
57.1
55.5
56.3
56.2
55.9
57.3
56.9
58.2
Other
securities
16.7
16.8
17.0
17.0
16.7
16.8
16.7
16.9
16.9
16.8
16.6
16.7
16.5
16.6
16.6
16.6
16.4
16.5
16.3
16.4
16.6
16.3
16.3
16.3
16.2
16.3
16.5
16.7
16.8
16.8
16.8
16.9
17.1
17.6
17.4
17.9
1
June and December 1956, and December 1957, figures are for call dates. Other data (including those
for2 June 1957) are for the last Wednesday of the month.
Data are shown net, i. e., after deducting valuation reserves. Includes commercial and industrial,
agricultural, security, real estate, bank, consumer, and other loans.
3 Data are shown gross of valuation reserves. For months other than June and December data are
estimated on the basis of reported data for all insured commercial banks and for weekly reporting member
banks.
*8 Figures are based on book values and relate only to banks within the continental United States.
For October 1955 certain loan items are available on 2 bases because of a reclassification resulting from
reporting errors. The business loans figure shown above is after reclassification. The figure before reclassification is $30.8 billion.
Source: Board of Governors of the Federal Reserve System.
Commercial banks played a powerful role in the speedy economic
recovery in the first half of 1955 through their expansion of credit for
housing and consumer durables. Bank loans increased by $4% billion—
a record for the January-June period since World War II. During
these 6 months, there was an increase of $1.3 billion in real-estate loans,
$1.2 billion in consumer loans, and $2 billion in business
loans of which
a substantial part was for sales finance companies.4 In order to meet
the increasing demands for loans, the banks reduced their holdings of
United States Government securities by $5.7 billion in the first half of
the year. There was also some rise in bank borrowing from the Federal Reserve banks—an increase from a monthly average of $160 million in the last quarter of 1954 to an average of about $400 million in
the first half of 1955.
* See table 23, p. 37.
46
FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
TABLE 3 0 . — D e p o s i t s and currency,
1955-57
[Billions of dollars]
Deposits and currency
Demand deposits and currency
End of period
Total i
Total
1955—January
February
March
April
May
June
July..
August
September
October
November
December
1956—January
February
March
April
May
June
July
August
September
October
November
December
1957—January
February
March
April... __ .
May
June
July
August
September
October
November
December
. . .
209.2
206.9
205.3
207.4
206.7
207.7
208.1
208.6
209.7
211.3
212.2
216.6
214.4
211.6
210.8
212.4
211.2
213.6
213.3
212.8
214.1
216.6
217.2
222.0
219.9
218.0
217.2
219.6
218.4
219.7
221.0
220.0
220.9
223.0
223.3
227.7
133.8
131.3
129.1
131.2
130.1
130.6
131.0
131.2
132.1
133.4
134.8
138.2
136.0
132.8
131.6
133.1
131.6
133.0
132.6
132.0
132.8
135.1
136.3
139.7
136.9
134.4
132.6
134.7
132.7
133.4
134.4
132.9
133.3
135.0
135.7
138.6
Demand
deposits
adjusted2
107.0
104.5
102.4
104.5
103.3
103.2
103.9
103.9
104.9
106.1
106.9
109.9
108.9
105.6
104.4
106.1
104.2
104.7
105.2
104.5
105.4
107.4
108.3
111.4
109.5
107.0
105.2
107.3
104.8
105.6
106.6
105.1
105.5
107.2
107.2
110.3
Currency
outside
banks
26.8
26.8
26.7
26.7
26.8
27.3
27.1
27.4
27.2
27.3
27.9
28.3
27.1
27.2
27.2
27.0
27.4
28.3
27.4
27.5
27.4
27.7
28.0
28.3
27.4
27.4
27.4
27.4
27.9
27.8
27.8
27.8
27.8
27.8
28.5
28.3
Time
deposits 3
75.4
75.7
76.2
76.2
76.5
77.1
77.1
77.4
77.7
77.9
77.4
78.4
78.4
78.8
79.3
79.3
79.6
80.6
80.7
80.9
81.3
81.5
80.9
82.2
82.9
83.6
84.6
84.9
85.7
86.4
86.7
87.1
87.7
88.1
87.6
89.1
1
2
Includes holdings of State and local governments, but excludes U. S. Government deposits.
Includes demand deposits, other than interbank and U. S. Government, less cash items in process of
collection.
3
Includes deposits in commercial banks, mutual savings banks, and Postal Savings System, but excludes
interbank deposits.
Source: Board of Governors of the Federal Reserve System.
In the second half of the year, bank loans increased by $7.4 billion
with three-fifths of the advance occurring in the category of business
loans. The rise in consumer loans was the same as in the first part of
the year, and real estate loans advanced at a somewhat slower pace
than during the first 6 months. As a result of the pressure for funds,
bank borrowing at the Federal Reserve
banks during the last quarter
of the year averaged $900 million.5
A $12 billion increase in bank loans in 1955 was offset by the sale of
Government securities in the amount of $7.4 billion. Commercial bank
sales of United States Government obligations were absorbed by nonfinancial corporations, pension and trust funds, State and local govern5
It is of some interest to note that the amount of borrowing during the latter part of 1955 and right through
1957 did not reach the level of the earlier 1952-53 period of tight credit. Part of the explanation lies in the
fact that in recent years the banks turned increasingly to the Federal funds market for adjusting
their reserves. More intensive use was made of existing reserves since banks with a deficiency of reserve
balances borrowed from those with excess reserves. Another explanation is that Federal Reserve borrowing
in 1952-53 could be included with other borrowed capital in calculating a bank's excess profits tax liability.
In June 1953 the excess profits tax expired.
47 FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
ments, and individual investors. Largely because of the contrary
movement of bank loans and investments, there was a rise in demand
deposits of only $3.4 billion.
Although the money supply increased moderately during 1955, the
velocity of circulation rose substantially. Demand deposits and
currency outside banks increased at the rate of 2.8 percent as compared
to a 3 percent rise in 1954. However, the average annual rate of
turnover of demand deposits outside New York City increased by
nearly 7 percent between 1954 and 1955.
TABLE 3 1 . — A n n u a l rate of turnover of demand deposits,
1955-57
1
[Ratio of debits to deposits]
Period
1955—January
February
March.
April
May
June
July
August
September___
October
November. __
December.. _
1956—January. __
February
March
April
May
June
New
York
42.0
41.9
41.7
37.3
42.7
44.7
40.7
38.2
43.5
44.7
45.4
51.3
45.7
41.1
47.2
45.4
46.0
47.0
6 other
centers 2
25.4
26.4
30.2
27.1
28.4
28.3
26.6
25.9
27.4
26.5
29.0
28.1
29.5
27.5
29.7
30.1
28.7
28.9
337 other
reporting
centers 3
19.6
19.6
20.0
19.2
20.6
20.8
20.4
19.9
21.1
20.3
22.0
21.6
21.7
21.0
20.8
21.5
21.7
21.6
Period
1956—July
August. ___
September. __
October
November. __
December
1957—January. _ _
February
March
April..
May
June...
July
August.. __
September.. _
October
November. _.
December
New
York
45.9
44.4
44.8
45.2
48.3
51.8
48.3
48.9
48.7
46.9
47.1
51.4
49.5
44.7
52.2
49.9
51.2
58.9
6 other 337 other
centers 2 reporting
centers 3
22.4
21.3
22.0
22.1
23.6
23.3
22.9
23.0
22.5
22.4
23.2
23.1
23.6
22.1
24.1
22.7
23.5
24.7
29.6
27.4
27.4
28.4
31.0
29.9
30.0
30.2
32.0
30.3
30.5
30.4
30.6
28.5
31.4
29.6
30.5
32.2
1
Does not include interbank and U. S. Government deposits and is given without seasonal adjustment.
2 Boston, Philadelphia, Chicago, Detroit, San Francisco, Los Angeles.
3 Before April 1955, 338 other reporting centers.
Source: Board of Governors of the Federal Reserve System.
The increase in the demand for funds and the growing pressure on
bank reserve positions was reflected in the rise of interest rates. The
yield on Treasury bills, which averaged 0.65 percent in June 1954 and
rose to 1.17 percent by December, advanced to 2.6 percent in December 1955. The rate on 4-to-6 months' prime commercial paper rose
sharply during 1955, from 1.47 percent in January to 3 percent in
December. Long-term rates in 1955 advanced much less than shortterm rates. Between December 1954 and December 1955, yields on
Government 10- to 20-year taxable bonds rose from 2.57 percent to
2.88 percent, and Moody's Aaa corporate bonds advanced from 2.90
percent to 3.15 percent.
POLICY DIRECTIVES
OF T H E
OPEN MARKET COMMITTEE
6
In view of the pace of economic and credit expansion during 1955,
let us see how the Open Market Committee regarded the changing
situation and how it dealt with it. On January 11 it revised its directive to the Executive Committee from "maintaining a condition of
ease in the money market" to "maintaining conditions in the/money
market that would encourage recovery and avoid the development of
unsustainable expansion." However, the change in directive "did not
6 The policy actions of the Open Market Committee referred to in this section are recorded in the Fortysecond Annual Report of the Board of Governors of the Federal Reserve System, 1955, pp. 89-111.
48
FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
call for pursuit at this stage of a program of credit restraint or of firmness in the money market." At its meeting of March 2, the Committee noted "that expansive forces had continued generally strong,
both domestically and abroad," but concluded that the "situation
did not appear to call for a generally restrictive credit policy." It is
interesting to note that the record of this meeting states that—
concern was indicated with respect to the relaxation of
terms for, and the volume of expansion in, mortgage and
consumer credit, and there were some fears that in a few industries, including building, activity was reaching levels
that could not be sustained.
In the light of this recognition of the potential dangers arising from the
two sectors of the economy that played so significant a part in the
rate of economic expansion during the rest of the year, one may be
puzzled at the Committee's conclusion that "further measures toward
restraint should be deferred until the effects of the shift in operations
that had taken place since the beginning of the year were more
apparent." The credit restraint referred to was the reduction in
January and February of Federal Reserve holdings of United States
Government securities by $1.3 billion. But this reduction was primarily for the purpose of absorbing reserve funds that normally become
available to commercial banks by the seasonal return of currency from
circulation and by the seasonal decline in deposits. The sale of Government securities by the Federal Reserve banks may have been
larger than usual in recognition of the increasing demand for bank
credit. But the amount of such sale in excess of the seasonally "normal" was small and could exert—as it was intended to do—only a
very moderate influence in tightening bank reserves.
It was not until its meeting of May 10 that the Open Market Committee revised its January directive by deleting the words "encourage
recovery." Since "recovery now was an accomplished fact," the
credit policy was to aim at "maintaining conditions in the money
market that would avoid the development of unsustainable
expansion." Among the various developments in the economy, it
noted that the gross national product had risen substantially since its
1954 low and had exceeded its mid-1953 peak; a number of industries
were operating at or close to capacity; business, financial, and consumer
confidence was extraordinarily high; there had been no seasonal
contraction in business loans, and the rapid expansion of real estate
and consumer loans had continued. In its meeting of June 22, the
Committee referred to new record levels in economic activity, but
expressed some concern that the high level of production and employment had been supported by rapid expansion in consumer and mortgage credit on easy terms and that there was the likelihood of prices
moving upward.
There appeared to be little leeway for further increases in
production, and it was doubtful that productivity could be
increased rapidly enough to counteract cost-price influences.
In view of the fact that the monetary authorities recognized around
the beginning of May, and even more so by the end of June, that overall economic activity was reaching boom proportions, it was surprising
even in financial circles that the Reserve banks waited until mid-April
49
FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
and early May to raise the discount rate from l){ to 1% percent.7 The
new 1% rate was below the discount rate at the beginning of 1953, and
it was not until early in August that the 2 percent rate established in
January 1953 was reached. Since the gross national product in the
second quarter of 1955 was about $28 billion above the first quarter
of 1953, an increase of about 8 percent, one could hardly accuse the
Federal8 Reserve of having moved vigorously in its restrictive credit
policy. Moreover, after the initial reduction in Government security
holdings of the System open-market account in the first 2 months,
open-market operations were so conducted as to produce no net change
in Reserve bank holdings during the months of March through June.
To be sure, failure to provide reserves through open-market operations
may be regarded as a restrictive action. But in view of the swelling
demands for credit, direct intervention of the System to reduce bank
reserves would appear to have been more appropriate.
Apparently, the Open Market Committee counted on the stronger
credit demands to drive the commercial banks to the discount windows
of the Federal Reserve banks for their additional reserves. With the
traditional reluctance of the banks to augment their indebtedness to
the Federal Reserve and the rise in the discount rate in April, credit
would be more costly and less available and thus undue credit expansion would be discouraged. However, the banks did not rush to
borrow in any great amount from the Federal Reserve during the
first half of the year. Between December 1954 and June 1955, bank
borrowings from the Federal Reserve increased by less than $200
million. They relied on the disposal of their substantial holdings of
Government securities, which they had accumulated under the
influence of the easy money policy of 1953-54, to obtain funds to take
care of the heavy demands for private credit. As we have seen,
$5.7 billion of United States Government obligations were sold or
redeemed during the first half of the year by all commercial banks.
i The following quotation from the First National City Bank Monthly Letter of May 1955, p. 53, is of
interest: "* * * In light of the resurging strength of business, the only surprise was that the Federal Reserve
had waited so long to act. As far back as January possibilities of a rate advance became a common topic
of discussion. As it was, the Federal Reserve authorities limited their actions at that time to raising stock
margin requirements and paring down idle loan funds among the banks while the Treasury reentered the
long term market with an issue of 40-year 3-percent bonds. At the end of February, after the Treasury
bond issue had been placed, talk of imminent action on discount rate spread about the financial community.
The authorities contented themselves with suspending open market operations, permitting the business
rise to carry forward on its established momentum, and letting the related credit demands absorb slack
of excess reserves and compel banks to come in as borrowers from the Federal Reserve at the discount rate."
s As financial editor Edward H. Collins of the New York Times noted in his column of August It, 1955:
"There is at least a budding tendency to ask today * * * whether the Reserve, recalling the severe criticism
towliich it was subjected (in 1953), isn't, consciously or unconsciously, proceeding somewhat overcautiously
in this, its second bout with incipient inflation."
50
FEDERAL RESERVE POLICY AND ECONOMIC
TABLE 32.—Member bank reserves and related items,
STABILITY
1955-57
[Averages of daily figures, millions of dollars]
Period
1955—January
February
March...
April
May
June
July
August
September
October
November
December
1956—January
February
March
April
May
June
July
August
September
October
November
December
1957—January
February
March
April
May
June
July
August
September
October
November
December
Federal
Reserve
credit
25,449
25,021
24,989
25,070
24,924
24,958
25,497
25,450
25, 525
25, 792
26,089
26,853
25,879
25,183
25, 517
25,411
25,237
25, 516
25, 599
25,357
25, 737
25,698
26,097
27,156
25,905
24, 912
24, 968
25,411
25,041
25,189
25,466
25,166
25,489
25,326
25,373
26,186
Gold stock
21,714
21,715
21,718
21,680
21,673
21,676
21,680
21, 682
21, 682
21, 685
21, 687
•21,689
21,692
21,694
21,711
21,735
21,768
21, 795
21,826
21,855
21,880
21,906
21,910
21, 942
21,989
22,279
22,305
22,313
22,358
22,621
22,625
22,626
22,627
22,660
22, 743
22,769
Currency
in circulation
30,110
29, 784
29, 790
29,807
29,861
30,050
30,284
30, 289
30, 420
30, 532
30, 791
31,265
30,620
30,214
30,256
30,245
30,322
30, 536
30,751
30,650
30,803
30,864
31,198
31, 775
31,040
30, 595
30, 568
30,614
30,645
30,902
31,116
31,035
31,143
31,109
31,335
31,932
Total
reserves
19,114
18,819
18,635
18,800
18, 746
18, 715
18,825
18, 728
18, 711
18,870
18, 902
19,240
19,138
18, 709
18,924
18,847
18, 735
18,933
18,836
18, 783
19,024
18,939
19,169
19, 535
19,295
18,816
18,884
19,087
18,827
18,982
19,129
18,834
18,956
19,040
18,958
19,420
Required
reserves
18,432
18,195
18,050
18,210
18,166
18,146
18,205
18,152
18,148
18,345
18,378
18, 646
18, 586
18,177
18,340
18,320
18,268
18,359
18,237
18,224
18,446
18,419
18, 579
18,883
18, 773
18,302
18,366
18, 580
18,362
18,485
18, 595
18,300
18,434
18, 573
18,447
18,843
Source: Board of Governors of the Federal Reserve System.
At its meeting of August 2, the Open Market Committee changed
its directive from "maintaining conditions in the money market that
would avoid the development of unsustainable expansion" to "restraining inflationary developments in the interest of sustainable economic
growth." A few days later the Federal Reserve increased the discount
rate from 1% to 2 percent.
Recent statements by top officials of the Federal Reserve with
respect to the monetary policies pursued in 1954 and 1955 make it
desirable to quote at length from the record of the August 2 meeting
of the Open Market Committee indicating the basis for their decision
to change their directive "to restraining inflationary developments":
The shift to a policy of restraining inflationary developments resulted from the Committee's review of the economic
situation and its conclusion that the supply of money and
credit was a more stimulating force at the time than was
desirable in the interest of sustainable economic growth.
Information that had become available for June and July
indicated that industrial production had increased to a new
high level, with fairly general advances in durable and nondurable goods lines as well as in minerals. Unfilled orders
had continued to rise. In addition, a renewed upsurge of
consumer buying appeared to be developing. Buying of
FEDERAL
RESERVE
POLICY A N D
TABLE 3 3 . — M e m b e r bank excess reserves,
ECONOMIC
borrowings,
STABILITY
and free reserves,
51
1955-57
[Averages of daily figures, millions of dollars]
Period
1955—January
February.
March
April
May
June
July
August
September
October
November
December,
1956—January.
February
March
April
May...
June
July
August
September
October
November
December.
1957—January.
February
March
April
May
June
July
August
September
October
November
December,
Excess
reserves
___
...
.
..
-
..
-
-
682
625
585
590
580
569
619
577
564
524
525
594
552
533
585
527
467
575
599
559
579
520
590
651
523
514
518
506
465
496
534
534
522
467
512
577
Borrowings
at Federal
Reserve
banks
Free reserves
313
354
463
495
368
401
527 ;
765
849
884
1,016
839
807
799
993
1,060
971
769
738
898
792
715
744
688
407
640
834
1,011
909
1,005
917
1,005
988
811
804
710
Source: Board of Governors of the Federal Reserve System.
automobiles in July continued at record levels, and sales of
appliances and other goods at department stores showed
remarkable gains from the preceding month and a year ago.
This upsurge in consumer demand reflected a further marked
rise in consumer installment credit and an increased willingness of consumers to draw on liquid asset accumulations.
It also suggested consumer expectations of higher prices later
on. Numerous industries appeared to be producing at near
capacity, and overall productivity gains had virtually disappeared in recent months. The situation was one in which
a given percentage in output called for about an equal percentage gain in man-hours, and in which too easy access to
bank credit was likely to result in increased prices rather
than in increased production. There had been a substantial
and contraseasonal rise in bank loans during the first half of
the year, and in July all banking reports confirmed a continuing strong demand for bank credit.
The Committee believed that, with increased costs pushing
upward on industrial prices, the general price level might
well move upward with accompanying speculative increases
in inventories. It also took into account discussions relating
to a probable increase in the discount rate at the Federal
H. Rept. 2500, 8 5 - 2
5
369
271
122
95
212
168
92
-188
—285
-360
-491
-245
-255
-266
-408
-533
-504
-194
-139
-339
-213
-195
-154
-37
117
-126
-316
—505
-444
-508
-383
-471
-467
-344
-293
-133
52
FEDERAL RESERVE
POLICY A N D
ECONOMIC
STABILITY
Reserve banks early in August, based on observations of
economic and financial developments in the respective
Federal Reserve districts, and it agreed that the wording of
its directive should be changed, as indicated above, to show
that increased monetary restraint on credit expansion was
now clearly appropriate.9
In view of the Committee's current and more or less similar appraisals since early May of the pace in economic activity, waiting
4 months before changing the discount rate and then raising it by
only one-fourth of 1 percent was rather a feeble attempt at restrictive
monetary action. By September there was greater realization within
the Federal Reserve System that a larger increase was justified and
the rate was advanced from 2 to 2% percent.
P O L I C Y D E C I S I O N S AS V I E W E D I N R E T R O S P E C T BY T H E F E D E R A L R E S E R V E
Officials of the System have recently admitted that they should
have moved more vigorously, as the following 10
statement by the
presidents of the Federal Reserve banks indicates:
There is some question, however, whether the policy of
ease was carried too far in 1954, when a combination of openmarket operations and reductions in discount rates and
reserve requirements pushed available reserves of member
banks to high levels and short-term interest rates to exceedingly low levels. As noted above, commercial banks utilized
a large portion of the available reserves to purchase Government and other securities. While this action cushioned the
recession and provided a basis for recovery by promoting
growth in the money supply, it also contributed to the
growth of liquidity in the banking system. Consequently,
when policy was shifted toward restraint in 1955, and
gradually became more restrictive through 1955 and in 1956,
commercial banks were in a position to meet demands of
consumer and business borrowers by liquidating Governments and extending loan credit.
There also is some question whether the System moved fast
enough in exercising restraint in the early and intermediate
stages of the boom. Granted that a somewhat less easy policy
in 1954 would have reduced commercial bank purchases of
securities at that time, even the excessive liquidity existing at
the beginning of 1955 might have been absorbed more quickly,
and credit expansion thereby restrained further, had policy been
tightened faster in 1955 * * * [Italic supplied.]
One reason given by the presidents of the Reserve banks for^not
moving more vigorously was that the economic data available
in the
first half of 1955 understated the speed of the recovery:11
* * * The recovery from the recession of 1953-54 moved
much faster than was generally expected; there were still
doubts in early 1955 that the recovery was firmly established,
9
Forty-second
10
Annual Report of the Board of Governors of the Federal Reserve System, 1955, p. 102.
Investigation of the Financial Condition of the United States: Joint and supplemental comments of the
presidents of the Federal Reserve banks in response to the questionnaire of the Committee on Finance,
U. S. Senate, 85th Cong., 2d sess., ch. 1, April 1958, p. 44.
" Ibid., p. 45.
53
FEDERAL
RESERVE
POLICY A N D
ECONOMIC
STABILITY
and there was considerable apprehension that a move toward
tighter credit at a faster pace might halt the recovery short of
its full potential. Much of the economic data available
currently in the first two quarters of 1955 seriously understated the extent of the recovery up to that time. It was
only later, when revisions of statistics became available, that
the rapidity of the upturn became apparent. Moreover, it
should be recalled that, at various times during the boom
period, forces emerged that seemed to indicate a leveling off
in business activity, or even an imminent decline. It is only
through hindsight that the need for a more restrictive policy
in the early stages of the boom seems clear.
Unfortunately, the Reserve Board presidents failed to indicate which
of the many statistical series employed by their research departments
in analyzing current business conditions misled them because they
"seriously understated" the magnitude of the recovery. To be sure,
there are limitations in currently published data that purport to
reflect monthly and weekly changes in business conditions, and there
is little doubt that Government officials would be greatly aided in
arriving at sounder policy decisions if they were supplied with improved and more currently available statistical information. There
were undoubtedly some statistical series, such as the quarterly estimates of the gross national product, that were revised upward after
mid-1955, but understatement of these series during the first half of
the year is hardly a justification for the implication that because of it
monetary policy moved too slowly. There was an abundance of
statistical information to indicate that the economy was moving
upward at a rapid pace during the first 6 months of 1955, and that
certain sectors were developing at a rate that could threaten economic
stability. Apparently, the Open Market Committee was convinced
by this evidence, since at the beginning of May it dropped the phrase
"economic recovery" and its credit policy directive concentrated on
"avoiding unsustainable expansion." By the summer of 1955, it was
concerned with restraining inflationary developments. If the monetary authorities failed to act more vigorously, it was much more a
matter of judgment and interpretation of the economic data than of
the limitations inherent in the data. We must look in other directions
for an explanation of the inadequacy of monetary policy in 1955. In
this connection the following quotations from the testimony of Mr.
Martin, Chairman of the Federal Reserve Board, before the
Senate
Finance Committee in August 1957, is of special interest: 12
Senator M A R T I N . I would now like to ask you some questions about the present, current inflation. When did this
current inflation begin?
Mr. M A R T I N . Well, I cannot state it precisely, Senator.
It is pretty difficult to say that it began at any precise point.
I think those of us in the System—and mind you, the
System is not a one-man operation, for we have many varying views—I think we began to get worried about the current
aspect of inflation in the middle of 1955. * * * Let me go
back just a little bit if I may. In the inventory recession of
1953-54, we pursued a policy, and I think we were quite
18
Investigation of the Financial Condition of the United States: Hearings before the Committee on
Finance, U. S. Senate, 85th Cong., 1st sess., pt. 3, 1957, pp. 1304-1305.
54
FEDERAL RESERVE POLICY AND ECONOMIC
STABILITY
correct in our policy, in the early stages, of adjusting
promptly, to make the inventory adjustments as orderly as
possible, by easing money.
By the end of 1953 and the early part of 1954,1 personally
think that we were overdoing it a bit. We were using the
phrase "active ease."
One thing you find out about this is that while your
weapons may be more effective in inducing restraint than
they are in galvanizing the economy, nevertheless it is more
difficult to get people to recognize the need for action when
it comes to restraint.
And I think in retrospect that one of the errors we made
was that, in 1954, when the adjustments that were being
made by the market were culminating and the base was being
laid for the recovery that we had, we got a little bit enthusiastic about increasing the money supply, and we lowered
our discount rate in February 1954 from 2 to 1% percent;
and then we lowered it again to 1% percent in April of that
year. * * *
The trouble in 1955, the place where I began to get concerned, was when it took us from April of 1954 until April
of 1955 to move back from IK to 1% percent in the discount
rate—a whole year—because the constant discussion in the
System was, "Well, better not take a step, you had better
not do anything to slow things down." You see, everybody
likes expansion. Then we went up to 1%. We later moved
up successively during 1955 in four notches. * * *
Senator M A R T I N . D O you feel you acted soon enough, and
do you feel those actions were strong enough to stave off
inflationary pressures then present?
Mr. M A R T I N . N O ; I do not think we did. But there are
differences of opinion on that within the System. I would
think we would have been more effective if we had acted a little
bit quicker and a Utile bit sharper in our movements * * *.
[Italic supplied.]
Mr. Martin and the Federal Reserve bank presidents are in agreement that the System overdid the policy of credit ease in 1954, thus
making it more difficult later for the monetary authorities to control
credit expansion. However, the Chairman of the Federal Reserve
Board, in accounting for the tardiness and lack of vigor of the restrictive actions taken in the upswing, stressed an important element
ignored by the bank presidents. This is the human factor of hesitancy
to exercise curbs w^hen business expansion is underway. There is
little doubt that the record of the past, as well as of the more recent
period in monetary history, furnishes plenty of illustrations of the
monetary authorities yielding to the weakness referred to by Mr.
Martin. Since proper timing is of the essence of effective monetary
policy, this limitation cannot be ignored in any evaluation of tools
for promoting economic stability.
The tardiness and lack of vigor shown in 1955, however, was more
than a matter of hesitancy by those responsible for decisions with
respect to general credit policy to exercise restraints that might check
the pace of business expansion. Part of the explanation may be found
55
FEDERAL
RESERVE
POLICY A N D
ECONOMIC
STABILITY
in the theory of credit control that seemed to be influential among
officials of the Federal Reserve System, as well as in the limitations
of the tools that were actually employed.
T H E D I S C O U N T R A T E AS A TOOL OF M O N E T A R Y
RESTRAINT
All through the 1955-57 period, the discount rate was a major
weapon employed by the Federal Reserve to limit bank credit expansion. The use of the discount mechanism is based on the view that
member banks are traditionally reluctant to borrow funds from the
Reserve banks or to remain in debt to them for any length of time.
For the discount mechanism to act as a brake on credit expansion, it
must be preceded by restrictive Federal Reserve open market operations that will put pressure on the reserves of the banks. From the
degree of pressure exerted in 1955 it would seem that Federal Reserve
officials were still under the influence of the theory propounded
around the time of the accord that small changes in interest rates
could have a significant influence on the decisions of lenders to curtail
the expansion of private credit.13 Since a substantial part of the
portfolios of banking and financial institutions has come to consist of
Government securities, these institutions are sensitive to small rises
in interest rates and to the capital losses involved in disposing of
Government securities in order to switch into private loans. This is
a comfortable theory for those who have the responsibility for decisions
with respect toflexiblemonetary policy. If one could be fairly successful in curbing excessive credit expansion without much of an increase
in interest rates, one could avoid the unpopularity associated with
such diverse criticisms as high interest rates result in sizable increases
in interest payments by the Treasury on the large public debt, cause
disturbances in the capital market through sharp fluctuations in
capital values, enrich the banks through increased earnings, and have
an adverse discriminatory effect on small businesses, homebuilders,
and municipalities. Unfortunately, the view that a policy of monetary restraint which results in small rises in interest rates curbs credit
through locking in securities of financial institutions received little
support from the developments in 1955 and the first half of 1956.
The banks disposed of $5.7 billions of United States Government
obligations during the first half of 1955, nearly $2 billion during the
second half, and an additional $5 billion by the summer of 1956.
Throughout this period interest rates were moving upward, and the
rise was accompanied by the sale of more than $12 billion of both shortterm and long-term securities in order for the banks to meet their credit
demands. The discount rate was increased 6 times between April
1955 and August 1956—from 1% percent to 3 percent. Bank loans
increased $4.5 billion in the first 6 months of 1955, $7.4 billion in the
second half of the year, and nearly $5 billion in the first 6 months of
1956.
Why did the view that small increases in the interest rate inhibit
bank disposal of Government securities, thereby curbing bank credit
expansion, not find support in the financial developments of 1955?14
13 See Chapter I, p. 6.
" The theory might have had a more realistic basis if there had been effective consumer and mortgage
credit controls in the first half of 1955.
H. Rept. 2500, 85-2
6
56
FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
One answer given by some critics of the theory is that it is based on a
mistaken interpretation of the behavior of lending institutions during
a period of rapidly increasing demand for loan funds. The anticipation of a rise in interest rates, instead of checking the disposal of securities because of fear of capital losses, acts for a considerable time to
hasten such disposals. Even before the April change in the discount
rate the banks sharply reduced their holdings of Government securities—a reduction of nearly $5 billion between January and March.
They had been expecting a rise in the rate for some months, as was
indicated on page 49. Such expectation increases the incentive to
dump securities at a time when capital losses are minimal, and there
appear to be ever-widening opportunities for profitable lending. The
banks sold another $3 billion between April, the month of the first
hike in the discount rate, and August, the month of the second hike.
Since their portfolios contained large quantities of short-term United
States Government securities, the banks were prepared to take the
relatively small losses from the sale of these securities and switch into
more profitable areas such as mortgages, installment credit, and industrial and commercial loans. This was largely the case in 1955; later
the banks sold mainly longer term Government securities on which
they incurred heavier losses. After a time, to be sure, rising interest
rates did have a noticeable influence in checking disposals. But it
was not until mid-1956 that bank holdings of United States Government obligations stabilized and more or less continued at this level
with relatively minor fluctuations through 1957. If for no other
reason, a point is reached where considerations of bank liquidity cause
the shifting out of Government securities to cease. In short, the
Federal Reserve appeared to considerably underestimate the lag between the adoption of a policy of monetary restraint and the time
when the policy takes effect.
U. S. Government securities
Period
3-month
Treasury
bills
1955—January...
February..
March
April
May
June
July
August
September.
October....
November.
December.
1916—January
February..
March
April
May
June
July
August
September.
October
November.
December.
1957—January
February..
March
April.,
May
June
July
August
September.
October
November.
December.
1.257
1.177
1.335
1.620
1.491
1.432
1.622
1.876
2.086
2.259
2.225
2.564
2.456
2.372
2.310
2.613
2.650
2.527
2.334
2.606
2.850
2.961
3.000
3.230
3.210
3.165
3.140
3.113
3.042
3.316
3.165
3.404
3. 578
3. 591
3.337
3.102
9- to 12month
Taxable bonds
10 to 20
years *
1.36
1.41
1.49
1.71
1.72
1.71
1.88
2.12
2.14
2.19
2.28
2.56
2.50
2.38
2.43
2.83
2.83
2.69
2.62
3.01
3.17
3.07
3.15
3.33
3.17
3.23
3.35
3.41
3.37
3.55
3. 71
3.93
4.02
3.94
3.52
3.09
2.66
2. 72
2.72
2.77
2.76
2. 77
2.88
2.91
2.88
2.82
2. 85
2.88
2.86
2.82
2.90
3.05
2.94
2.89
2.97
3.15
3.19
3.18
3.30
3.43
3.33
3.20
3.25
3.30
3.39
3.61
3.63
3.63
3.72
3.84
3. 61
3.28
20 years
and over 8
2.77
2.92
2.92
2.92
2.91
2.91
2.96
3.02
3.00
2.96
2.96
2.97
2.94
2.93
2.98
3.10
3.05
3.19
3.25
3.24
3.30
3.36
3.34
3.26
3.27
3.35
3.42
3.54
3.58
3.64
3. 61
3.63
3.50
3.33
»Includes certificates of indebtedness and selected note and bond issues.
/
Percent bonds, 15 years and over prior to April 1952 and 12 years and over beginning
April 1952.
3
3H percent bonds of 1978-83,1st issued May 1, 1953.
Sources: Board of Governors of Federal Reserve System, Treasury Department,
Moody's Investor Service, and Standard and Poor's Corp.
Corporate bonds
(Moody's)
Aaa
2.93
2.99
3.02
3.01
3.04
3.05
3.06
3.11
3.13
3.10
3.10
3.15
3.11
3.08
3.10
3.24
3.28
3.27
3.28
3.43
3.56
3.59
3.69
3.75
3. 77
3.67
3.66
3.67
3.74
3.91
3.99
4.10
4.12
4.10
4.08
3.81
Baa
3.45
3.47
3.48
3.49
3.50
3.51
3. 52
3.56
3.59
3.59
3.58
3.62
3.60
3.58
3.60
3.68
3.73
3. 75
3.80
3.93
4.07
4.17
4.24
4.37
4.49
4.47
4.47
4.44
4. 52
4.63
4.73
4.82
4.93
4.99
5.09
5.03
Average
Common High-grade
rate on
stock
municipal short-term
yields, 200
bonds
bank
stocks
(Standard
loans to
(Moody's) <fc Poor's)
business,
selected
cities
4.22
4.21
4.21
4.12
4.14
3.87
3. 78
3.91
3.93
4.12
4.09
4.06
4.21
4.09
3.86
3.87
4.13
4.01
3.87
4.02
4.24
4.23
4.25
4.13
4.31
4.44
4.35
4.16
4.05
4.05
4.01
4. 21
4.50
4.68
4.58
4. 77
2.39
2.42
2.45
2.43
2.41
2.48
2.62
2.67
2.63
2. 56
2. 55
2. 71
2.64
2.58
2.69
2.88
2.86
2. 75
2.78
2.94
3.07
3.14
3.38
3.44
3.40
3.26
.3.32
3.33
3.52
3. 75
3.75
3. 91
3.90
3.79
3.76
3.47
3.54
3.56
3.77
3.93
3.93
4.14
4.35
4.38
4.38
4.40
4.83
4.85
Prime
commercial paper,
4 to 6
months
1.47
1.68
1.69
1.90
2.00
2.00
2.11
2.33
2.54
2.70
2.81
2.99
3.00
3.00
3.00
3.14
3.27
3.38
3.27
3.28
3.50
3.63
3.63
3.63
3.63
3.63
3.63
3.63
3.63
3.79
3.88
3.98
4.00
4.10
4.07
3.81
Federal
Reserve
bank
discount
rate
1.50
1.50
1.50
*1.75
1.75
1.75
1.75
•2.00
•2.25
2.25
r
2.50
2.50
2.50
2.50
2.50
•2. 75
2.75
2.75
2.75
•3.00
3.00
3.00
3.00
3.00
3.00
3.00
3.00
3.00
3.00
3.00
3.00
3.50
3.50
3.50
» 3.00
3.00
EFFECTIVE DATES
«Apr.
15.
5
Aug. 5.
« Sept. 9.
' Nov. 18.
« Apr. 13.
• Aug. 24.
«
W
>
W
M
U1
H
W
<1
tei
hj
O
i—i
o
H
«
W
Q
O
O
Q
W
£
w
Kj
w Aug. 23.
» Nov. 15.
Oi
58
FEDERAL
RESERVE
POLICY AND
ECONOMIC
T H E D I S C O U N T R A T E AND C O N S U M E R
STABILITY
CREDIT
The ineffectiveness of monetary policy in checking credit expansion
was particularly evident in the case of consumer durable goods purchases, which played so important a role in the 1955 boom. The rise
in interest rates neither inhibited the users nor the lenders of installment credit. The recent studies of installment credit prepared under
the auspices of the Board of Governors of the Federal Reserve System
indicate that users of consumer credit appear to be much more concerned with the amount of the downpayment and the maturity of the
loan than with the interest rate.15 They are frequently unaware of
the actual financial rate they are being charged. The important
consideration seems to be the amount of the monthly payments to be
made. Under increasingly liberal financial arrangements, especially
the lengthening of maturities, there was little change in the size of
monthly payments during 1955.
Lending institutions were also not deterred by the interest rate from
greatly expanding the volume of installment credit. Well over half
of the $5.4 billion increase in installment credit during 1955 was
supplied directly and indirectly by commercial banks. They were
reluctant to curtail so profitable a source of earnings as consumer
credit loans. They had become the largest supplier of installment
credit so that by the end of 1955 they held 37 percent of the total outstanding installment loans. About 32 percent was held by sales
finance companies with 4 of these companies doing three-fifths of the
business. These large companies had little difficulty in obtaining
funds either through borrowing from the banks at lower interest rates
than were paid by all other bank borrowers, or direct placement of
their commercial paper with nonfinance companies and large institutional investors, or through sale of their long-term notes and
debentures.
15
Consumer Instalment Credit: A study by the Board of Governors of the Federal Reserve System, 6 vols.
1957. Pt. I: Growth and Import, 2 vols. Pt. II: Conference on Regulation, prepared under the auspices
of the National Bureau of Economic Research, 2 vols. Pt. Ill: Views on Regulation, 1 vol. Pt. IV:
Financing New Car Purchases, a national survey for 1954-55,1 vol.
59 FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
TABLE 3 5 . — I n s t a l l m e n t credit,
1955-57
[Millions of dollars]
End of month
1955—January. __
February..
March
April
May
June
July
August
September.
October...
November.
December.
1956—January. __
FebruaryMarch
April
May
June
July
August
September.
October...
November.
December.
1957—January. __
FebruaryMarch
April
May
June
July
August
September.
October...
November.
December.
Total outstanding
23,512
23,604
24,046
24, 591
25,204
25,969
26, 509
27,154
27, 653
27,913
28,211
28,958
28,849
28,896
29,101
29,424
29, 779
30,114
30,366
30, 743
30,841
30,985
31,240
31,827
31,568
31,488
31.524
31,786
32,158
32,608
32,968
33,303
33,415
33, 504
33, 596
34,105
Automobile
paper 1
9,861
10,028
10,410
10, 796
11,254
11, 794
12,235
12, 718
13,075
13,246
13,327
13,472
13, 488
13, 582
13, 750
13,898
14,065
14,261
14,389
14, 539
14, 547
14,498
14, 469
14,459
14,410
14,432
14,528
14,691
14,883
15,127
15,329
15,490
15,556
15, 579
15,542
15,496
Other conRepair and
sumer goods
modernipaper 1
zation loans 2
6,668
6, 563
6, 554
6,596
6,665
6, 770
6,810
6,888
6,962
7,029
7,176
7,634
7, 517
7,429
7,376
7,434
7, 578
7, 554
7, 590
7,697
7,733
7,872
8,066
8, 510
8,305
8,160
8,043
8,017
8,081
8,165
8,189
8,229
8,228
8,236
8,300
8,687
1, 574
1, 552
1, 533
1,538
1, 552
1, 572
1, 585
1, 612
1,639
1,664
1,678
1,689
1,662
1, 656
1,662
1,680
1,718
1,748
1, 768
1,799
1,832
1,865
1,890
1,895
1,872
1,859
1,856
1,862
1,886
1,905
1,921
1,954
1,969
1,988
1,996
1,984
i Represents all consumer installment credit extended for the purpose of purchasing automobiles and
other consumer goods, whether held by retail outlets or financial institutions. Includes credit on purchases
by2 individuals of automobiles or other consumer goods that may be used in part for business.
* Represents repair and modernization loans held by financial institutions; holdings of retail outlets are
included in other consumer goods paper.
Source: Board of Governors of the Federal Reserve System.
We have seen that concern was expressed about consumer credit
expansion during almost every one of the 1955 meetings of the Open
Market Committee. But the Federal Reserve had no authority to
exercise selective controls over downpayments and maturities with
which to curb excessive expansion of consumer credit. It had such
powers under temporary authority during 1941-47, 1948-49, and in
1950-52. Nor did it request the Congress for authority to regulate
consumer credit at any time since the expiration of regulation W in
mid-1952.
The January 1956 Economic Report of the President had pointed
out that installment credit accentuates swings in consumer durable
goods purchases, "thereby exposing
the rest of the economy to the
hazard of widened fluctuations." 16 The report appeared to regard
favorably standby controls over installment credit as a supplementary
stabilization device and recommended study of the problem:17
* * * Experience during the recent past suggests that the
authority to set, if and as circumstances may require, mini16
Economic
17
Report of the President, January 1956, p. 94.
Ibid., p. 94.
60
FEDERAL
RESERVE
POLICY A N D
ECONOMIC
STABILITY
mum downpayments and maximum maturities on installment
credit for the purchase of consumer durables would be a
useful adjunct to other stabilizing measures. Its availability
as a standby measure, to be used only when the economic
situation demands it and under proper administrative safeguards, would increase the Government's ability to fulfill its
responsibilities under the Employment Act. Although present conditions do not call for the use of such authority to
regulate the terms of installment credit, this is a gpod time
for the Congress and the executive branch to study the
problem. * * *
About the time of the release of the President's report, Mr. Martin,
Chairman of the Federal Reserve Board, was appearing before the
Senate Banking Committee which was concerned with his nomination
for a full term of 14 years. During 2 days of hearings he was questioned at length about the monetary policies pursued by the Federal
Reserve during the preceding year and on the influence of the Treasury
on the Board's actions. Mr. Fulbright, chairman of the committee,
closed the hearings by reading a statement on consumer credit which
indicated his readiness to schedule hearings on the question of18granting
standby authority. The statement in part read as follows:
I have been greatly concerned about the tremendous
growth of consumer credit for some time now. During the
stock-market hearings last year, I and other members of
this committee called attention to the potential dangers in
the marked rise of installment credit. The President's
economic report states that in the second quarter of 1955
consumer installment debt expanded by nearly $2 billion,
the largest on record over so brief a period. While members
of the Committee on Banking and Currency cautioned the
public on the dangers of excessive credit in this area, as well
as in the stock market, the administration's concern seems
belated. * * *
If the administration wants standby authority over consumer credit, I shall be glad to schedule hearings on their
proposal. The staff of the committee has been gathering
data and opinions on this subject for some time.
Generally, I prefer indirect credit regulations to direct
controls, but the indirect methods did not stop an unhealthy
increase in consumer credit last year. Whether this was
because general credit instrumentalities were not effectively
employed or whether they were simply inadequate, I am not
prepared right now to say. If consumer credit controls had
been in existence in 1955, prospects for consumer durable
goods this year might well be brighter. It now appears that
a great part of the boom of 1955 was borrowed from the
future, in the form of great increases in private debt for
consumer durables.
In any event, however, we should not permit a recurrence
of excessive borrowing which can only result in violent
fluctuations in so important an industry as automobiles.
18
Nomination of William McChesney Martin, Jr.: Hearings before the Committee on Banking and Cur*
rency, U. S. Senate, 84th Cong., 2d sess., January 20 and 27,1956, pp. 68-69.
61
FEDERAL
RESERVE
POLICY A N D
ECONOMIC
STABILITY
Insofar as the 1955 prosperity was based on an unusually
rapid expansion of consumer debt, there is a real question
whether the high level of activity was not achieved at the
expense of substantially lower levels of production in 1956.
T H E SHIFT IN FEDERAL RESERVE ATTITUDE TOWARD CONSUMER CREDIT
CONTROLS
In mid-February 1956 the President, through the Council of
Economic Advisers, requested the Board of Governors of the Federal
Reserve System to undertake "a broad study of the role of consumer
installment credit in a growing economy, including arguments for and
against renewal in some form of governmental authority to regulate
credit, in this field." This 6-volume, 2,000-page study, which was
published by the Board in the spring of 1957, contains a vast mass of
factual and analytical materials pertaining to consumer installment
credit, and widely varying viewpoints are represented on the question
of regulation of consumer credit.
On May 24, 1957, the Board of Governors, after studying these
reports, transmitted a two-page statement to the chairmen of the
Senate and House Banking and Currency Committees, the Joint
Economic Committee, and the Council of Economic Advisers,19 giving
its views on the regulation of consumer installment credit.
The
principal conclusion of the Board of Governors was that—
a special peacetime authority to regulate consumer installment
credit is not now advisable. The Board feels that the broad
public interest is better served if potentially unstabilizing credit
developments are restrained by the use of general monetary
measures and the application of sound public and private fiscal
policies.™ [Italic supplied.]
It is of interest to record the third, fourth, sixth, and eighth findings of the Board: 21
(3) Though of recognizable importance as a factor of
instability, fluctuations in consumer installment credit have
been generally within limits that could be tolerated in a
rapidly growing and dynamic economy.
(4) A possible exception to the third finding occurred
during the 1954-56 upswing in economic activity. The rapid
expansion of consumer installment credit in 1955, with its accompanying secondary impacts on capital investment, contributed to the emergence of inflationary pressures. This
expansion, however, combined with real estate mortgage and
other types of credit expansion in producing this sequence of
developments.
(6) Liberalization of installment credit terms and standards
from mid-1954 through 1955, which was particularly marked
in connection with the purchase of new automobiles, contributed to the further widening of the practice of installment
buying and borrowing and to the very great expansion in installment credit outstanding that occurred. Some of the
» Federal Reserve Bulletin, June 1957, pp. 647-648.
»Ibid., p. 648.
«Ibid., p. 648.
62
FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
forces making for this rapid widening of the market for consumer credit were temporary. Also, this drastic liberalization of credit terms and standards exposed consumer lenders
to increased risks. On both counts, the forces making for
credit liberalization in that period were to an extent transient
and self-limiting.
(8) Under peacetime conditions, special regulation of consumer installment credit would inevitably present problems
of compliance to the financing and business firms subject to
it, and of administration and enforcement to the agency of
Government responsible for the regulation.
It is important to note that the Board of Governors had expressed
itself with much greater vigor on the contribution of consumer
credit to economic instability 5 years earlier in a more comprehensive
statement on the subject submitted for the Patman committee report.22
The Board had also regarded selective regulation of this area as a
helpful supplement to general monetary controls. Let us quote from
the earlier Federal Reserve statement:
Expansion in consumer credit adds directly to the growth
of bank credit and by this means to the money supply. A
substantial part of the consumer credit outstanding is financed either directly or indirectly by bank loans. In addition to the consumer loans made directly by banks, a large
part of the funds of sales finance and personal loan companies
is obtained from bank sources, and a great many retail establishments finance their receivables partly through borrowing
at banks. Thus, a substantial part of every dollar of additional consumer credit ordinarily stems from bank credit
expansion and represents a direct addition to the total number of dollars competing for an existing supply of goods and
services. To the extent that nonbank lenders sell Government securities to finance an expansion of their consumer
credit balances, this also affects the money supply directly or
indirectly. Of equal importance from the standpoint of
monetary stability is the fact that the operations of bank
and nonbank lenders in this credit area influence the activity
or turnover of money. An expansion of consumer credit,
accordingly,
affects both the money supply and its circulation.23
The general role of consumer installment credit in economic
fluctuations can be described briefly as follows: When incomes
rise in the upswing of the cycle, demand for and extensions
of installment credit increase, with the result that the expenditures of people increase more rapidly than their income.
When incomes shrink in the downswing of the economic
cycle, demand for and extension of credit decreases and
outstanding installment balances contract. In order to pay
off debt, people are forced to cut back their expenditures more
than if they had not incurred debts in the upswing. This
32
Monetary Policy and the Management of the Public Debt: Their Role in Achieving Price Stability
and High-Level Employment: Replies to questions and other material for the use of the Subcommittee on
General Credit Control and Debt Management, Joint Committee on the Economic Report, 82d Cong..
2d sess., 1952, pt. I, pp. 410-418.
23 Ibid., pp. 411-412.
63
FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
expansion and contraction of consumer debt * * * is a
significant factor in fluctuations in bank credit and the
money supply.
The generalization to which this description leads is that
fluctuations in installment credit accentuate cyclical swings
in consumer expenditure and hence in economic activity.
This cause and effect role of consumer credit in economic
fluctuations is in many respects similar, of course, to that
of other credit, producer credit included, but, as pointed out
later, continued expansion of consumer credit in periods of
strong inflationary boom has a significance
somewhat different from that of producer credit. * * * 24
Consumer credit functions at a point in the economy and in
a manner that tends to make it relatively unresponsive to the
effects of general credit instruments. For this reason selection
of this credit area for regulation provides a helpful supplement to
the general measures * * * 25 [Italic supplied.]
Thus, the unregulated expansion of consumer credit adds
to general inflationary pressures and might actually require
a more aggressive use of general credit instruments than
would otherwise be necessary. That is to say, in the absence
of selective regulation of consumer credit, other means of
credit restraint might have to be exercised more restrictively in order to bring about sufficient restraint on the
overall expansion of private credit. This emphasizes the
desirability of being able to use selective credit measures to
complement, but not to substitute for, overall or general
credit measures, the extent of such use depending on prevailing economic circumstances. One of the primary justifications for the selective regulation of consumer credit is that
it helps to avoid too strong effects on segments of the
economy that are more sensitive to general credit actions.26
It should be noted that there was at least one top official of the
Federal Reserve System who spoke out vigorously in 1955 for giving
the System authority over installment credit. Mr. Allan Sproul,
president of the Federal Reserve Bank of New York, in an important
address before a joint meeting of the American Finance Association
and the American Economic Association in December 1955, declared:27
* * * I know that there are those who believe that
selective credit controls are a dangerous step on the road to
general overall planning, and I have no desire to become a
fellow traveler on that road. But I do believe that there is a
temptation to abuse consumer credit in boom times, that it
2* Op. cit., pp. 411-413.
« Op. cit., p. 413.
26 Op. cit., p. 414.
27 Allan Sproul, Reflections of a Central Banker, Journal of Finance, March 1956, p. 12. This address
also challenged economists to take the lead in assisting monetary authorities to reexamine the basic problems
in the field of central banking. He stressed the necessity of independent analysis of these problems by
persons not connected in any official capacity with the System. His remarks in this connection were as
follows:
"We have excellent research staffs in the Federal Reserve System: able economists and statisticians and
devoted students of money and banking problems. But their work needs more cross-fertilization and
critical analysis by thoughtful and disciplined minds outside the System who can apply their talents to
this special field without the bias of an organizational viewpoint. Not enough work has been done, I would
say, on the monetary problems of a mixed Government-private economy, on the functioning and form
of a fractional reserve banking system in such an economy, on the growing importance of other financial
institutions, which crisscross both the fields of commercial banking and investment banking, and on the
performance and characteristics of our money and capital markets. These are subjects which are becoming
critical in the development of central banking * * *" (pp. 13-14).
64
FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
can thus become a serious source of instability in our
economy, and that we would not jeopardize our general
freedom from direct controls by giving the Federal Reserve
System permanent authority to regulate consumer
credit. * * *
MONETARY POLICY AND THE GROWTH OF FINANCIAL
INTERMEDIARIES
We have seen that the ineffectiveness of monetary policy resulted
in part from a reluctance to move vigorously to restrict credit when
business confidence was high and activity was rapidly expanding.
Apart from the limitation of this human factor, the nature of the boom
was such that areas which were making the greatest demands on
credit in 1955—housing and consumer durables—were those that
were not particularly sensitive to the restrictive tools actually employed by the Federal Reserve.
There is an additional limitation on monetary policy which has
been stressed in recent years, namely, the greatly changed institutional and financial environment in which the banking system operates.
In particular, what is referred to is the vastly increased importance of
the role played by financial intermediaries, such as life insurance
companies, building and loan associations, savings banks, investment
companies, and pension funds, in the field of credit. Since World
War II the increase in the assets of nonbank financial intermediaries
was at least three times that of commercial banks. The acceleration
in the flow of savings to nonbank financial institutions raises many
problems with respect to the functioning of our capital markets.
Here we are concerned, however, only with the contention that the
growth of these institutions has rendered monetary policy less effective
in restricting credit during the recent boom.
Life insurance companies, savings and loan associations, and mutual
savings banks invested heavily in mortgages in 1955. During the
year these 3 groups acquired over two-thirds of the more than $16
billion increase in the nonfarm mortgage debt. Life insurance companies and savings banks not only financed mortgages through savings
that were channeled to them, but also obtained additional funds for
such loans by borrowing heavily from the commercial banks. Under
"warehousing" arrangements they either sold mortgages to the banks
which they agreed to buy back or they obtained forward commitments
from the banks in order to make good on their own forward commitments to lend. Savings and loan associations expanded their mortgage activity by greatly increasing their borrowing from the Federal
home-loan banks.
From one point of view, it would seem that the growth of financial
intermediaries should have made the capital markets more sensitive
to a restrictive monetary policy. These institutions hold a considerable proportion of the public debt. Since their portfolios contain the
longer term Government securities they should be especially sensitive
to capital losses arising from increasing interest rates. Critics of
general monetary controls, however, have argued that the financial
intermediaries have reduced the effectiveness of Federal Reserve
policy. Their spectacular growth has signified greater efficiency in
assembling idle funds and putting them to work. In a period when
monetary policy seeks to restrict the money supply, these institutions
65
FEDERAL
RESERVE
POLICY A N D
ECONOMIC
STABILITY
increase the velocity of monetary circulation by increasing the proportion of the money supply that is actively spent at the expense of
the portion that is held idle. By selling their Government securities
to nonbank investors they take—
up idle balances which they transfer to active spenders by
making mortgage or other loans or by buying newly issued
corporate securities. In this case idle balances become
active, passing through financial
institutions in the process,
and velocity is increased.28
The critics have argued that the monetary authorities have placed
excessive emphasis on the money supply and on the volume of bank
reserves and have 29not given sufficient attention to the change in the
velocity of money.
In the minds of some students of Federal Reserve policy, the growth
of financial institutions raises the question whether, in the interest of
promoting economic stability, it is not desirable to supplement general monetary controls with selective control over housing credit as
well as over installment credit.30
T H E T I G H T M O N E Y P O L I C Y A N D I T S CRITICS, 1956 T O MID-1957
Once the monetary authorities failed to adopt stronger measures in
1955, they were in the proverbial position during the following year
and a half of holding a bear by the tail. The great increase of consumer and mortgage credit which stimulated the production of nearly
8 million cars and the construction of more than 1.3 million homes in
1955 sparked the expansion of plant and equipment expenditures.
These expenditures rose 7 percent in 1955, and in 1956 they advanced
to record levels with a 22-percent rise over the preceding year. The
increasing pressure on resources and manpower culminated in an
upward movement of wholesale industrial prices starting in mid-1955.
By the end of 1956 these prices rose 8 percent. During the year the
index of industrial production, however, hovered more or less around
the advanced level reached in December 1955. Despite a 16-percent
decline in housing starts and more than a 20-percent drop in production of automobiles in 1956, the sharp rise in plant and equipment
expenditures was a major factor in the continuation of the high level
of business activity. The rate of economic expansion slackened with
about one-half of the advance in the gross national product accounted
for by higher prices.
The monetary authorities had a difficult course to steer with respect
to credit policy in 1956. On the one hand, there was the risk that a
more liberal policy with respect to the availability of bank reserves
might accelerate price rises, especially in "bottleneck" sectors of the
economy. In these sectors production could not readily advance, or
if output were expanded it would be at substantially higher costs.
On the other hand, if the policy became much more restrictive, there
was the danger of initiating a downward spiral in business activity
since certain of the key sectors which had ushered in the boom had
been showing considerable weakness for some time.
38 Warren L. Smith, On the Effectiveness of Monetary Policy, American Economic Review, September
1956,
p. 602.
a
® Ibid., pp. 600-604. On the influence of the growth offinancialintermediaries see also: Arthur F. Burns,
Prosperity
Without Inflation, Fordham Universty Press, 1957, ch. 3.
M
See Irwin Miller, Monetary Policy in a Changing World, Quarterly Journal of Economics, February
1956, p. 3411; Alvin H. Hansen, The American Economy, McGraw-Hill, 1957, ch. 3.
66
FEDERAL
RESERVE
POLICY A N D
ECONOMIC
STABILITY
The Open Market Committee directives during 1956 reflected the
uncertainties resulting from the mixed trends of the various sectors of
the economy. From late January to late March, the credit policy
directive read that transactions in the System open market account
were to be with a view "to restraining inflationary developments in
the interest of sustainable economic growth" but should also take
"into account any deflationary tendencies in the economy." This
supplementary clause "gave consideration to the view that the
domestic economy after a year and a half of expansion might be
nearing31 a cyclical peak and that a reaction might be in prospect before
long."
At the end of March, however, the clause to take into account
deflationary tendencies was deleted, since the balance of evidence was
believed32 to indicate a further advance in the economy. The record
stated:
* * * Among the general factors leading to this conclusion
were the much greater than expected plans of business concerns in all major lines for plant and equipment expenditures,
the widespread optimism of consumers as to the economic
outlook and their own financial position and income prospects, and evidence of an exceptionally heavy demand for
bank credit in the current month. The committee also
noted that common stock prices had risen sharply further.
Growing pressures for increases in prices and wages were
evident, and there was danger that if supported by further
credit expansion pressures would engender an inflationary
spiral. * * *
Consideration was also given to possible action by the Federal
Reserve to increase the discount rate to "prevent undue credit expansion for financing capital outlays through the banking system." 33
In April the Board of Governors raised the discount rate from 2%
percent to 2% percent in 10 of the Reserve banks and to 3 percent for
the 2 others. By the end of May, however, the directive once more
added the additional clause of taking into account deflationary tendencies as well as pursuing a policy of restraining inflationary developments. This directive was continued until early in August. In this
month the Board of Governors raised the discount rate from 2% to 3
percent. For the remainder of the year the directives called for
restraining inflationary developments in the interest of sustainable
economic growth. During the last month, there was a supplementary
clause that "recognition should be given to additional pressures in
the money, credit, and capital markets
resulting from seasonal factors
and international conditions." 34
With the economy continuing to operate near capacity levels—
despite some uncertainties about its general direction during the first
part of the year—and with prices and wage rates moving upward, the
Open Market Committee felt that as a general policy it could not
relax in its efforts at restricting the availability of bank reserves.
Despite mounting criticism of the "tight money policy"—what with
interest rates advancing in all sectors of the money and capital markets
31 Forty-third Annual Report of the Board of Governors of the Federal Reserve System, 1956, p. 20.
32 Ibid., p. 26.
33 Op. cit., p. 27.
Op. cit., p. 43.
67
FEDERAL
RESERVE
POLICY A N D
ECONOMIC
STABILITY
and especially long-term rates because of the increased business demand for investment funds—the determination of the Federal Reserve
to resist pressures for relaxation during 1956 and the first half of 1957
was applauded in many quarters. Open market operations were so
conducted that the security holdings of the System had increased by
only $160 million during 1956. The money supply had risen by $1.5
billion, representing a rate of increase of only 1 percent, as compared
to a 2.8 percent rise in 1955. However, the rate of turnover of demand
deposits in centers outside of New York City increased 8 percent in
1956.
To be sure, there was also increasing criticism that while business
firms were able to obtain funds for capital expansion from the banks
and through the security markets—over 70 percent of the $7.6 billion
increase in bank loans in 1956 was in the category of business loans—
residential builders, small business firms, and State and local governments were adversely affected by the restrictive monetary policy.
Other critics pointed out that neither open-market operations nor
further rises in the discount rate accomplished the objective of the
restrictive credit policy since plant and equipment expenditures—the
major influence in the intensification of inflationary pressures—were
not inhibited from continuing their rapid rise throughout 1956. During the year more than four-fifths of corporate outlays for plant and
equipment was derived from depreciation and amortization allowances
and retained profits. Toward the first of these criticisms, officials of
the Federal Reserve took the position that in a free economy the
market was35the regulator of the flow of credit and not the monetary
authorities.
With respect to the second criticism, the Federal Reserve recognized that liberal depreciation and amortization provisions
in the tax law and large corporate earnings contributed to the capital
boom, but it was pointed out that were it not for its restrictive
policy, capital expenditures would have been greater and inflationary
pressures in other areas would have been intensified.36 In support of
this position they cited the large volume of scheduled offerings in
the capital market that were canceled or postponed.
DELIBERATIONS
OF T H E
OPEN MARKET COMMITTEE
IN
1957
One may justifiably view with favor the determination of the monetary authorities not to relax restraints in 1956 and in the first half
of 1957, but there is much less justification for regarding favorably
the policies pursued through the summer and fall of 1957. As critics
have pointed out, in holding onto a policy of restraint too long, the
Federal Reserve may have contributed to accelerating the pace of the
downswing in business activity. The monetary authorities had become
so preoccupied with the increase in inflationary pressures since mid1955 that they ignored the cumulative evidence which pointed to the
likelihood of the boom ending in the not-too-distant future. At least
so it seemed from the public statements by Federal Reserve officials,
their testimony at congressional hearings, and policy decisions such
as raising the discount rate one-half percentage point, i. e., to 3%
percent, in August. At his appearance before the Senate Finance
35 Hearings on January 1957 Economic Report of the President, Joint Economic Committee, U. S.
Congress,
85th Cong., 1st sess., 1957, p. 591.
a0 Investigation of the Financial Condition of the United States: Hearings before the Committee on
Finanee, U. S. Senate, 85th Cong., 1st sess., pt. 3, August 1957, p. 1399.
68
FEDERAL
RESERVE
POLICY A N D
ECONOMIC
STABILITY
Committee during that month, the Chairman of the Federal Reserve
Board stated that credit restraint is "required at present, for clearly
the most critical economic problem now facing the country is that
of inflation." 37 In the fall and almost up to mid-November, when the
discount rate was lowered from 3% to 3 percent giving public notice
that the Federal Reserve regarded the immediate problem ahead as
not inflation but business contraction, presidents of the Reserve banks
and members of the Board of Governors of^the System were making
speeches that inflation was still the No.f lfeconomic|problem and it
would be a great mistake to relax credit restraint.
In the light of the vehemence and the frequency with which Federal
Reserve officials publicly stressed during the first 10 months of 1957
the necessity for continuing monetary restraint, it comes as a surprise
to read the record of the 1957 meetings of the Open Market Committee
published in the annual report of the Board of Governors and released
in April 1958. During almost all of the 18 meetings held throughout
the year there appeared to be an absence of that confidence in the
continuation of the upward movement of business activity and in the
intensification of inflationary pressures which was manifested in public statements by top spokesmen
for the System. Even as early as
January the record indicates: 38
There were * * * developments that suggested that the
economy might be losing some of its upward momentum.
While these data were not sufficient to support a forecast of
a downward turn as a clear, nearby prospect, they suggested
that the economy might be entering a period of sidewise
movement. For example, a tendency for total capital expenditures to level off was evidenced by recent figures for
factory construction contracts, new machine tool orders, and
freight car orders, together with scattered announcements of
postponements of plant construction projects. There were
cross currents in the area of prices with higher costs showing
up in increased prices for finished goods, both at wholesale
and at retail, in contrast with a softening trend in prices of
a number of primary products. Business loans at all reporting member banks after a fourth quarter rise of $1.6 billion
declined by more than $700 million in the 3 weeks to midJanuary, a postwar record decline for the period that compared with a drop of $355 million a year earlier. A rapid
decline in security loans had also occurred and about threefourths of the total rise in loans during the fourth quarter
of 1956 had been wiped out. * * *
In February it was noted that there was some easing of inflationary
pressures.
It was too early to tell, however, whether this was but a
temporary lull, the beginning of a downturn, or the attainment of high-level stability.
During the first 2 months of the year there was no change in the
credit policy directive that open-market operations were to be conducted with a view—
37
Investigation of the Financial Condition of the United States: Hearings before the Committee on
Finance,
U. S. Senate, 85th Cong., 1st sess., pt. 3, August 1957. p. 1262.
38
Forty-fourth Annual Report of the Board of Governors of the Federal Reserve System, 1957, p. 37.
69
FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
to restraining inflationary developments in the interest of
sustainable economic growth, while recognizing unsettled
conditions in the money, credit, and capital markets and in
the international situation.
At the beginning of March, the wording was changed. While calling
for a continuation of restraint on inflationary developments, the
directive took recognition of "uncertainty in the business outlook, the
financial markets, and the international situation."
This change in wording * * * was not an indication of
a shift in direction of policy but was designed to emphasize
the factor of uncertainty in the current business outlook.
The general direction of policy continued to be one of restraining inflationary developments.
In its review of conditions, the committee found evidence
of the slowing down of expansionary forces in many sectors
of the private economy but no indication that a pronounced
downturn had begun. Rather, there were many underlying
forces tending to hold activity at a high level. * * * 39
While it was apparent that a sidewise movement was taking
place in the economy, there was uncertainty as to which way
the economy would go. In any event, however, since the
economy's upward momentum had definitely slackened and
since the rise in finished goods prices seemed likely to level
off in the near future, it was not believed appropriate that
overt action be taken toward increasing credit restraint,
although maintenance of about the degree of restraint that
had existed for some time seemed to be called for. * * * 40
The March policy directive of the Open Market Committee was renewed without change at each of its subsequent meetings until the
revision of November 12.
Around mid-year and during the month of August when the discount
rate was raised from 3 to 3% percent, the Open Market Committee
continued to note that business activity manifested a sidewise movement and that divergent trends in various sectors "provided no clue
as to the direction
and intensity of the next major change in economic
activity." 41 The increase of one-half percentage point in discount
rates "was regarded as primarily a technical move made at a time
when market interest rates were considerably above discount rates".42
The Board of Governors of the Federal Reserve System, at its August
8 meeting approving the relatively large hike in the discount rate, also
noted the general sidewise movement of the economy but stressed
the upward trend of prices and wages and the 43
vigorous demand for
credit which was pushing interest rates upward:
* * * With the upward movement of interest rates, the
discount rate of the Federal Reserve banks, which had stood
at 3 percent since the fall of 1956, fell further behind the
rate structure generally. The disparity became even more
pronounced in early August when the commercial banks inIbid.,
Ibid.,
«Ibid.,
«Ibid.,
«Ibid.,
p. 42.
p. 43.
p. 49.
p. 50.
p. 68.
70
FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
creased from 4 to 4% percent the rate charged on loans to
prime business borrowers.
The increase in the Federal Reserve bank discount rates,
which brought them into better alinement with money market rates, raised the cost to member banks of operating on
borrowed reserves and thus diminished incentive on the part
of the member banks to borrow from the Reserve banks.
At the September 10 meeting, the Open Market Committee found
no material change in business activity for the past several months.
It was noted that bank credit had expanded less rapidly in the previous
5 weeks than in other recent years and some slackening in money turnover had appeared. On October 1 the Committee took note of the
fact that—
an increasing number of business observers were suggesting
that the major expansive forces had been spent, that pressure
of inflationary forces was in process of lessening and even of
dispersing, and that the prospective movement in activity
was a decline. Business sentiment * * * appeared to be
developing into a psychology of gloom in some places and was
much more cautious about prospects than for some
months * * * On the other hand, the reports to the Committee at this meeting did not present a picture of a settling
or declining economy. There was considerable feeling that
while inflationary clouds might be breaking up, it would be44
premature to conclude that they had been scattered. * * *
On October 22, 3 weeks before the Federal Reserve had signaled a
definite shift in its position through the reduction of the discount
rate from 3% to 3 percent, the Open Market
Committee still appeared
uncertain as to how the economy would 45
* * * breakout from the sidewise movement that had been
characteristic of business for some months. In a searching
reexamination of the economic situation, the Committee
found that the latest quarterly and monthly figures showed
continuation through the third quarter of 1957 of many
features prevailing earlier in the year, with production
steady at a high level, price movements in wholesale markets
mixed with the average up, and consumer prices generally
continuing upward. September industrial production was at
144, down a point from August but within the narrow 143 to
146 range prevailing so far this year. The economy as a
whole showed basic strength, but there was uncertainty as to
what combination of demands would prevent recession in
activity, or, on the other hand, make for an advance in total
output and employment from present levels.
In analyzing the implications of recent business and credit
developments for monetary and fiscal policy, it appeared
that there had been short-run abatement in inflationary
pressures, and questions were raised about potential declines
in important sectors of activity. Business sentiment had
turned more pessimistic than the current indicator picture,
and attitudes of common stock investors appeared to reflect
«Ibid., pp. 51-52.
«Ibid., pp. 53-54.
71 FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
a growing disbelief in the extension of inflationary trends.
Business loan expansion was continuing to run behind the
preceding year. As a result of the increasing uncertainty
as to the business situation * * * the environment for
monetary policy was beginning to look quite different from
the boom conditions that initially justified the current restrictive policy. * * *
The Committee concluded, after reviewing the data, that
there was no immediate occasion to reverse its policy of
restraint in credit expansion or to make a change in the
policy directive. While it was clear that the Committee at
this juncture did not wish to make any move which would
signal a change in policy, it wished to supply seasonal needs
reasonably freely. It did not wish to increase restraint from
what it had been. There was some feeling that the Committee should actually diminish restraint a little, but more
of the members believed that the Committee should resolve
doubts on the side of ease. Thus, in renewing the directive
without change, the Committee agreed that although general policy was not to be changed appreciably, it should tend
on the easier side from where it had been in recent weeks.
On November 12 the Open Market Committee decided "that action
should now be taken to recognize the change in the general economic
situation away from the sidewise movement that had prevailed during
most of 1957." It had46finally become convinced that a business
recession was underway:
* * * there was no longer much doubt that at least a
mild downturn in business activity was underway, and there
was widespread belief that it would probably continue well
into 1958. The major question seemed to be not whether a
further business decline would occur, but for how long and
in what degree. In terms of credit policy, the question presented was how far the Committee should go at this time in
recognizing the change in the economic situation and outlook,
and by what means. * * *
Its policy directive was changed from that of restraining inflationary
developments to "fostering sustainable growth in the economy without
inflation, by moderating the pressures on bank reserves." Two days
after this revision, the Board of Governors of the System approved the
reduction of the discount rate to 3 percent, with one member (Mr.
Robertson) dissenting on the ground that the "economic situation did
not call for an overt act that
could be interpreted as a drastic move
toward monetary ease."47 In mid-December the Open Market
Committee revised its credit policy directive to provide that openmarket operations were to be conducted with a view "to cushioning
adjustments and mitigating recessionary tendencies in the economy."48
The economic and financial data presented at this meeting
confirmed rather clearly the developing recession that had
been indicated by reports at earlier meetings at which the
Committee acted to moderate the pressures on bank re«Ibid., p. 56.
«Ibid,, p. 70.
«Ibid., p. 61.
H. Kept. 2500, 85-2
7
72
FEDERAL RESERVE
POLICY A N D
ECONOMIC
STABILITY
serves. The recession was still of moderate intensity, and
inasmuch as the Committee actions taken since midNovember to lessen pressures on reserves, together with the
reduction in Reserve bank discount rates, had signaled an
effective change in policy toward less severe credit restraint,
it did not appear to the Committee that additional major
actions were necessary at the moment. The change at this
meeting in wording of the Committee's policy directive was
adopted with the understanding that reserves would continue
to be made somewhat more available, but the particular
reason for this change was to recognize that the economy had
encountered a recession and that the Federal Open Market
Committee's policies were being molded accordingly. * * *
T H E MISTAKEN CREDIT POLICIES AFTER
MID-1957
In defending the tight monetary policies of 1956 and 1957 before
congressional committees, Government officials frequently quoted in
support of their actions from the 1950 report of the Douglas Subcommittee on Monetary, Credit, and Fiscal Policies. But they generally
failed to refer to those sections of the report which stressed that to be
effective, monetary management must be characterized by timely,
vigorous, and flexible actions. We have seen that officials of the
Federal Reserve System stated in retrospect that they fell short of
satisfying these criteria in 1955. Although they have not yet admitted to shortcomings in the application of these criteria in the second
half of 1957, it is not unlikely that, after allowance of a longer period
for hindsight, the violation in the summer of 1957 of the principle of
timely flexibility in monetary policy will also be admitted. If mistakes in 1955 may justifiably be said to have encouraged subsequent
inflationary developments, the errors in 1957 may be said to have
contributed to the sharpest business decline in the postwar period.
The successful application of the principle of timely flexibility
depends on a reasonably good diagnosis of the current changes that
are taking place in the economy. The monetary authorities are, of
course, not omniscient, and are bound to make mistakes. They are
not only engaged in practicing the difficult art of prevision but, unlike
many other forecasters, they have the responsibility for making
decisions with respect to the flow of credit, based on their judgments
of the prospective business situation, which can seriously affect the
entire economy. Recognizing both the limitations arising from the
uncertainties attached to prompt discernment of economic changes
and from a definite inclination on the part of the monetary authorities
to unduly delay in taking the necessary steps, there are those who look
with a dim view on the potentialities of monetary policy for promoting
economic stability. Some skeptics advocate the use of impersonal
devices which would signal both the need and time for action, thus
minimizing errors originating in human psychology. Others place
major reliance
on the stabilizing power of different tools, such as
fiscal policy.49 Those, however, who regard monetary policy as an
essential tool, among a variety of measures required in a stabilization
« John K. Galbraith, The Affluent Society, chs. 16 and 17, Houghton-Mifflin, 1958; testimony of Seymour
E. Harris, Investigation of the Financial Condition of the United States: Hearings before the Committee
on Finance, U. S. Senate, 85th Cong., 2d sess., April 1958, pt. 6, p. 1992 £f.
73 FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
program, need not entertain illusions that human limitations can be
overcome by the adoption of mechanical formulas, either in forecasting
or in decision making. There are no mechanical substitutes for diagnoses based on the fullest use of the available evidence—often conflicting in character—nor can the necessity for the exercise of the
age-old virtues of sound judgment, wisdom, and courage be eliminated
from decisions for action. As a consequence, the process of identifying
past errors and ascertaining the source of the miscalculations must be
an ever-continuous one if we are to make progress in learning how to
cope more effectively with the problems of economic instability.
The contrast between the record of the deliberations of the Open
Market Committee, which stressed the sidewise movement of the
economy during most of the year, and which expressed considerable
uncertainty as to the business outlook, and the public statements and
actions of the Federal Reserve, which emphasized that the central
problem during the first 10 months was inflation, requires explanation.
Similarly, the relatively sharp rise in the discount rate in August when
business expansion was grinding to a halt is also in need of a more
satisfactory explanation than has thus far been advanced by the
monetary authorities. It is safe to predict that, long after the events
of 1957 have passed, economists will seek the answer to these two
questions.
If in the eyes of the Federal Reserve officials, inflation was the No.
1 problem, it would appear that, in part, it was because the main
focus of their attention was on the continuous rise of consumer prices
and interest rates. Insufficient attention was given to the fact that
the underlying forces which were responsible for the boom and for
inflationary pressures were fast becoming contractive influences—if
due recognition were given to the time-lags that are operative in these
sectors of the economy. This is not a matter of hindsight since there
was cumulative evidence that the sidewise movement was more likely
to tilt downward rather than upward. The index of industrial production had reached its peak in December 1956 at 147, slipped to 144
in April and May, and remained at 145 from June to August. New
orders of manufacturers had been declining ever since the beginning
of the year and unfilled orders dropped $6 billion between January and August. The average weekly hours of work in manufacturing was moving downward from 41 hours in December 1956 to 39.7 in
July and employment in manufacturing industries was drifting downward in the same period. The index of spot prices of raw materials
dropped steadily from 100.4 in December 1956 to 92.1, or a decline of
8 percent in 7 months. Corporate profits had been declining since
the fourth quarter of 1956; exports were dropping since March of
1957; and Government contracts were being cut back by midyear.
Above all, a number of the before-mentioned indicators and other
signs pointed to the tapering off of the boom in the capital goods
industries—a boom that had been a major influence in the inflationary
pressures of 1956 and early 1957. In view of a rate of expansion of
physical plant capacity, especially by manufacturing industries, that
was much higher than that of output or sales since the beginning of
1956, this disparity could not continue indefinitely. In the words
of the Federal Reserve Bank of New York, "the pace of current and
planned business investment in capital equipment and in. inventory
had already reached such proportions, by 1956, that an eventual
74
FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
slowing down for consolidation and reassessment could be considered
inevitable." 50 To be sure, there was 51uncertainty as to "the timing
and dimensions of such a slackening."
But in view of the fact that
heavy commitments for capital outlays were made 1 to IK years
earlier and that downward revision of investment programs was becoming increasingly evident by mid-1957, the fact that current capital
outlays were at peak levels did not signify that a sharp decline in such
expectations was not a near prospect.
In the light of these developments, the August rise in the discount
rate remains inexplicable. When pressed on this point, the Chairman
of the Federal Reserve Board insisted that the change was "necessary
for technical reasons." 52 But what Mr. Martin appeared to ignore
was the fact that a sharp hike in the rate was also widely interpreted
as indicating that the monetary authorities regarded the intensification of inflationary pressures and the need for continuation of monetary restraint as the immediate issues facing the country. That a
change in the discount rate is regarded as a signal to the public of a
shift in Federal Reserve policy was expressly stated by the Board
of
Governors of the System when it lowered the rate in November.53 If
it was a54 public signal in November, it must also have been one in
August.
SOME C O N C L U D I N G
OBSERVATIONS
The sharp contrast between the deliberations of the Open Market
Committee as revealed in the 1957 Annual Report of the Board of
Governors of the Federal Reserve System and the public interpretations of their actions, as well as the misunderstandings with respect
to the meaning and significance of the August hike in the discount rate,
raise the question of the necessity for the secrecy surrounding the
decisions of our monetary authorities. This question was raised by
Senator Fulbright, Chairman of the Senate Banking and Currency
Committee, during the course of interrogating Mr. Martin at the
stock market hearings in March 1955. The chairman of the committee asked whether the Board of Governors gives any explanation
for its actions when it announces changes in margin requirements.
Mr. Martin replied that "Our actions should speak louder than our
words. In this particular field, as in most central bank moves, it is
by action rather
than by announcement and statement that we get
our results." 55 Mr. Fulbright then pointed out that failure to furnish
an explanation for
their moves results in misunderstanding of Federal
Reserve policies.56 If the absence of a forthright statement of policy
changes resulted in faulty interpretations of Federal Reserve decisions
60
Annual Report, 1957, Federal Reserve Bank of New York, p. 7.
«Ibid.,
p. 7.
82
Federal Reserve Monetary Policies: Hearings before a subcommittee of the Committee on Banking
and Currency, U. S. Senate, 85th Cong., 2d sess., February 1958, pp. 24r-25. Senator Douglas' interrogation
of Mr. Martin on the necessity for raising the discount rate at the very time when the economy had
begun
to slip is contained on pp. 20-28.
83
Forty-fourth Annual Report of the Board of Governors of the Federal Reserve System, 1957, p. 70.
The sign-aspect of the discount rate is also indicated in the following quotation from the 1957 Report of
the Federal Reserve Bank of New York, p. 12: "By mid-November, it was decided to give all sections of
the84 economy an unmistakable sign that the direction of credit policy had changed."
It is interesting to note that tnere were differences within the System on the advisability of the August
rise in the discount rate. "As was to be expected, when the underlying forces of the boom were beginning
to wear out, there were differences of view, even within the central bank, over the need for this final overt
step in the long sweep of the System's restrictive policy." Annual Report, 1957, Federal Reserve Bank of
New
York, p. 11.
88
Stock Market Study: Hearings before the Committee on Banking and Currency, U. S. Senate, 84th
Cong., 1st sess., March 1955, p. 571.
««Ibid., p. 572t
75
FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
with respect to margin requirements at the beginning of 1955, there
were more serious misunderstandings of the more general monetary
controls that were exercised after mid-1957. The problem of providing the public with a clearer understanding of Federal Reserve
policy changes through prompt publication of explanatory statements
is of sufficient importance to warrant serious exploration in the near
future.
There are other matters of an informational character relating to
monetary policy that need strengthening. There have been numerous
complaints recently by Federal Reserve officials concerning the adequacy of the statistical tools employed in arriving at policy decisions.
The shortcomings of existing data and the need for additional and
more timely statistical information essential for the appraisal of changing business conditions have been stressed in recent years by the
Joint Economic Committee of57the Congress and by the President's
Council of Economic Advisers.
Progress toward filling the gaps in
our knowledge of the operations of our economy through improvement
of the Federal statistical programs depends upon more liberal appropriations for economic statistics. But this does not mean that even
with their present resources Government agencies cannot initiate
beneficial changes in their statistical programs.58
Our review of the financial and economic developments between
1950 and 1957 has discussed the successes and the inadequacies of
monetary policy in promoting economic stability. The shortcomings
have been of two kinds: (1) The actual use that was made of the
available tools for monetary control; and (2) the limitations inherent
in the existing tools. The recent boom followed by the sharpest
recession in the postwar period has emphasized once more the necessity
of a fundamental reexamination of our financial system with a view
to increasing the effectiveness of monetary policy in a stabilization
program. The setting up of a National Commission on Money and
Credit for a period of 3 years under the auspices of the Committee for
Economic Development should result in valuable information and
analyses. But the committees of the Congress must continue to
inquire into the operations of the Federal Reserve System in the more
immediate context of the problems that face the country as the
economy moves from expansion to contraction and to resumption of
expansion with the probable renewal of inflationary pressures. In the
light of the latter eventuality it is well to keep in mind the limitations
revealed in the present report with respect to our existing monetary
controls and the necessity for considering in the near future methods
for strengthening our credit instrumentalities for the promotion of
economic growth and stability.
®7 Economic Statistics: Hearings before the Subcommittee on Economic Statistics of the Joint Committee
on the Economic Report, 83d Cong., 2d sess., July 1954, 363 pages; Economic Report of the President,
January
1958, pp. 91-96.
58
In the field of banking and monetary statistics, for example, it is essential to have easily available compilations of monthly data going back over extended periods of time. The latest extensive compilation in
this area published by the Federal Reserve Board in 1943 was Banking and Monetary Statistics, statistics
f banking, monetary, and other financial developments, November 1943, 979 pages.
APPENDIX
MEMBER
BANK
RESERVES,
RESERVE BANK
CREDIT,
AND R E L A T E D ITEMS,
1950-57
[Averages of daily figures, millions of dollars]
Reserve bank credit outstanding
U. S. Government securities
Period
Total
1950—January,
February
March..
April. ..
May
June
July....
August.
September...
October
NovemberDecember
1951—January.
February
March..
April...
May
June
July...,
August.
September
October
November...
December
See footnotes at end
Bought
outright
18,082
18,082
17,705
17,705
17,682
17,682
17,608
17, 571
17,486
17, 486
17,800
17,800
18,129
18,129
18, 328
18,291
18, 946
18,931
19,365
19,364
19,381
19,373
20,345
20,336
20,682
20,699
21,733
21, 703
22,316
22, 333
22,975
22, 970
22,438
22, 395
22,783
22, 797
22,996
23,059
23,035
23,123
23,259
23,171
23,834
23,826
23,364
23,364
23,409
23,310
of table, p. 79
DisHeld counts
under
and
repuradchase vances
agreement
37
37
15
1
8
9
17
30
17
5
43
14
63
88
88
8
99
101
178
170
140
116
84
140
172
96
67
145
142
213
330
242
162
438
170
194
292
338
131
343
657
Float
464
425
386
385
400
437
431
375
565
611
631
1,117
924
1,219
1,084
842
806
940
1,026
843
1,062
1,012
1,074
1,375
Total
18,649
18,310
18.242
18,136
18.005
18,325
18,703
18,876
19, 610
20,044
20,159
21, 606
21,839
23,286
23, 663
23,983
23,686
23, 913
24,285
24,263
24, 664
24,982
24 785
25,446
Gold
stock
24,420
24,346
24, 311
24,247
24,236
24,231
24,192
23,927
23, 560
23,366
23,157
22,879
22,523
22, 249
21,909
21,806
21, 757
21, 755
21, 757
21,790
21,906
22,104
22,298
22,483
TreasTreasury
cur- Currency ury
rency in circu- cash
holdoutlation
ings
standing
4.597
4.598
4.600
4.601
4.602
4.605
4.606
4,609
4,613
4,618
4,622
4,629
4,635
4,637
4.639
4.640
4,643
4,647
4,656
4,666
4,674
4,682
4,688
4,701
27,220
27.008
27,043
27,062
27,022
27,026
27,117
27.009
27,154
27,233
27,380
27,806
27,304
27,145
27,171
27,179
27,324
27, 548
27,859
27,951
28,213
28,387
28,612
29,139
1,314
1,310
1, 307
1,313
1.302
1,299
1,305
1, 307
1.303
1,305
1,290
1,290
1,297
1.290
1,289
1,292
1.291
1,286
1,291
1,288
1,284
1,283
1,286
1,280
Deposits, other than
member bank reserves, with Federal
Reserve banks
Nonmember 1
Treasury
472
585
638
695
563
512
549
668
749
590
450
615
368
842
603
632
640
280
405
483
576
451
436
271
Member bank reserves
Other
Federal
Reserve
accounts
Total
Required
Foreign Other
1,420
1, 478
1,331
1,250
1,299
1,372
1,481
1,404
1,235
1,367
1,331
1,273
1,199
1,255
1,212
1,252
1,243
1,162
1,158
1,104
1,055
977
867
719
728
752
764
717
759
796
752
740
803
746
739
742
734
730
750
696
731
756
719
721
802
776
796
16,520
16,146
16,081
15,898
15,941
16,194
16,253
16,273
16,602
16, 731
16,742
17,391
18,088
18, 907
19,207
19,324
18,892
19, 309
19,229
19,174
19,396
19,868
19,794
20,310
15, 585
15, 409
15,298
15,204
15, 237
15,426
15,507
15,626
15,837
15,889
16,009
16,364
17,263
18,279
18,494
18,491
18,302
18, 475
18,473
18,470
18, 675
18,952
19,065
19,484
Member bank reserves, reserve bank credit, and related items,
1950-57—Continued
oo
[Averages of daily figures, millions of dollars]
Reserve bank credit outstanding
U. S. Government securities
Period
Total
-January
February
March
April
May
June
July
August
September...
October
November. . .
December...
-January
February
March
April
May
June
July
August
SeptemberOctober.
November. __
December.
-January
February
March
April
May
June
July
August
September—.
23,206
22,552
22,634
22,448
22,308
22, 617
22, 798
23,027
23,471
23,657
23,638
24.400
24,202
23,918
23,892
23,861
23,973
24,748
24,955
25,000
25,168
25,344
25,172
25,639
25,263
24,770
24,633
24,635
24,689
24,998
24, 771
23,989
23,941
Bought
outright
23,195
22,552
22,626
22,448
22,308
22,505
22, 617
22,983
23,433
23,644
23, 527
23,876
24,011
23,875
23,878
23,806
23,881
24,729
24,943
24,974
25,097
25,341
25,078
25,218
25,149
24,729
24,620
24,632
24,680
24,960
24, 761
23,930
23,928
DisHeld counts
and
under
repuradchase vances
agreement
11
8
112
181
44
38
13
111
524
191
43
14
55
92
19
12
26
71
3
94
421
114
41
13
3
9
38
10
59
13
200
365
314
365
573
585
1,092
1,059
723
1,093
1, 577
1, 633
1,372
1,336
1,220
1,184
955
433
428
658
468
367
494
448
118
308
205
151
172
166
104
210
170
Float
1,034
904
937
908
818
936
890
734
856
927
954
1,262
1,008
822
909
843
750
776
737
660
771
800
744
1,018
861
667
712
696
640
710
695
654
725
Total
24,444
23,826
23,890
23, 726
23,704
24,144
24, 786
24,824
25,055
25,681
26,172
27,299
26, 586
26,080
26,025
25,892
25,682
25,960
26,123
26,322
26,410
26,514
26,413
27,107
26,243
25, 746
25, 553
25,483
25,503
25,876
25,571
24,855
24,838
Gold
stock
22,824
23,039
23,278
23,293
23,297
23,308
23,348
23,346
23,343
23,340
23,338
23,276
23,101
22, 797
22,606
22, 562
22, 557
22, 514
22,366
22,226
22,176
22,102
22,057
22,028
22,015
21,957
21,963
21,966
21,971
21,927
21,926
21,871
21,809
Deposits, other than
member bank reTreasserves, with Federal
Other
ury
Reserve banks
TreasFederal
cur- Currency ury
Reserve
rency in circu- cash
Nonmember 1
outlation
holdacings
standcounts
ing
Treasury
Foreign Other
4,709
4,719
4,728
4,737
4,740
4,751
4,756
4,765
4,778
4,788
4,796
4,806
4,814
4,821
4,825
4,832
4,843
4,851
4,853
4,860
4,867
4,873
4,878
4,885
4,891
4,904
4,920
4,941
4,954
4,956
4,959
4,960
4,967
28,637
28,406
28,437
28,459
28, 557
28,843
29,028
29,088
29,343
29, 555
29, 904
30,494
29,920
29, 718
29, 752
29,782
29,869
30,011
30,165
30,167
30,328
30,366
30,555
30,967
30,282
29,903
29,800
29,755
29,773
29,856
29,968
29,896
29,991
1,281
1,294
1,283
1,278
1,281
1,282
1,270
1,276
1,275
1,276
1,278
1,271
1,280
1,299
1,296
1,281
1,279
1,273
1,264
1,273
1, 273
1,274
915
767
778
811
813
825
830
815
810
806
796
109
352
333
549
553
328
306
501
326
550
591
569
552
500
244
395
356
52
545
656
537
557
497
602
201
568
490
584
486
602
498
591
541
J37
601
681
785
766
688
689
745
611
526
530
563
552
566
537
548
538
463
434
466
453
470
494
481
531
553
632
536
522
799
845
875
i£8
242
279
259
231
253
297
290
405
336
378
397
350
203
239
376
354
406
424
390
422
429
352
427
412
321
409
464
431
744
738
790
818
745
767
791
720
721
876
803
832
775
800
841
861
779
933
939
861
871
889
805
908
834
870
913
926
864
941
973
916
929
Member bank reserves
Total
20,470
19,995
20,207
19,777
19,767
20,140
20, 535
20,306
20, 514
20,611
20, 744
21,180
20,958
20,520
20,416
20,007
19,897
20,287
19,653
19, 526
19, 552
19, 536
19, 718
19,920
20,179
19,557
19,573
19,392
19,533
19,670
19,164
18,478
18,403
Required Excess
19,537
19,300
19,322
19,127
19,139
19,431
19,926
19,657
19, 736
19,963
20,087
20,457
20,251
19,882
19,828
19,472
19,306
19,499
18,869
18,882
18,834
18,784
19,035
19,227
19,243
18,925
18,881
18,627
18,817
18,813
18,329
17,638
17,628
933
695
885
650
628
709
609
649
778
648
657
723
707
638
588
535
591
788
784
644
718
752
683
693
936
632
692
765
716
857
835
840
775
October
November--December
1955—Januar y
February
March
April
May
June
July
August
September.
October—.
November- - _
December
1956—Januar y
February
March
April
May
June
July
August
September.
October
November.._
December
1957—Januar y
February
March
April
May
June
July
August
September...
October
November. __
December
24,485
24,661
24,917
24, 200
23,838
23,619
23,632
23, 666
23,598
23,967
23,886
23, 709
23,951
23,997
24,602
23,897
23,401
23,522
23,410
23,322
23, 522
23,580
23,530
23, 728
23.781
24,024
24,765
24,092
23, 111
23,061
23,239
23,041
22, 989
23,351
23,146
23, 325
23, 348
23,417
23, 982
24,472
24,654
24,888
24,182
23,787
23,604
23,604
23,617
23, 596
23,925
23,870
23, 668
23,881
23, 963
24,318
23,824
23,375
23,449
23,393
23,262
23,486
23, 573
23,488
23,695
23,742
23,951
24,498
24,056
23, 083
22, 997
23,121
22,996
22,917
23,198
23,129
23, 302
23,252
23,276
23, 615
13
7
29
18
51
15
28
49
2
42
16
41
70
34
284
73
254
345
407
444
473
566
585
445
465
576
803
872
895
1,018
840
26
73
17
60
36
7
42
33
39
73
267
36
118
45
72
153
17
23
96
141
367
1,060
971
770
738
898
792
715
745
706
432
665
859
1,036
931
1.009
917
1.010
994
818
810
716
720
769
992
805
710
804
838
798
878
940
746
1,055
1,389
1,152
965
987
925
928
1,206
1,263
910
1,198
1,182
1,300
1,633
1,343
1,106
1,024
1,110
1,046
1,170
1,175
989
1,147
1,143
1,126
1,443
25,459
25,776
26,317
25.449
25,021
24,91"
25,070
24,924
24,958
25,497
25.450
25, 525
25, 792
26,089
26.853
25,879
25,183
25,517
25,411
25,237
25,516
25,599
25,357
25, 737
25,698
26,097
27,156
25, 905
24,912
24,9"
25,411
25,041
25,189
25,466
25,166
25,489
25,326
25,373
26,186
i Nonmember deposits, January 1950-June 1952, represent total of foreign and other.
4,973
4,979
4,982
4,985
4,990
4,996
4,997
4,999
5,001
5,003
5,004
5,006
5,008
5,008
5,008
5,008
5,011
5,013
5,018
5,028
5,033
5,032
5,038
5,043
5,048
5,056
5,064
5,067
5,071
5,081
5,090
5,098
5,106
5,108
5,115
5,121
5,129
5,137
5,144
30,077
30,287
30,749
30,110
29,784
29, 790
29,807
29,861
30,050
30,284
30,289
30,420
30,532
30, 791
31,265
30,620
30,214
30,256
30,245
30,322
30,536
30, 751
30,650
30,803
30,864
31,198
31,775
31,040
30, 595
30, 568
30, 614
30, 645
30, 902
31,116
31,035
31,143
31,109
31,335
31, 932
797
800
805
819
826
823
816
818
825
801
801
797
781
778
777
787
796
783
783
785
778
771
774
772
776
774
772
794
817
812
803
792
782
769
764
763
780
793
768
610
492
443
341
477
690
501
421
329
461
569
540
509
538
434
356
480
532
545
556
485
521
504
523
487
456
463
335
336
423
429
521
490
480
490
547
495
464
385
455
416
439
477
420
363
370
389
412
423
431
386
390
394
459
404
364
349
338
331
315
300
318
356
337
308
372
323
335
316
348
361
393
377
349
378
338
322
345
444
393
365
383
473
442
481
432
345
423
398
392
403
444
394
354
351
350
338
322
304
280
275
237
299
313
247
276
294
216
339
276
290
279
273
271
258
337
186
944
883
929
903
927
960
973
928
959
962
918
968
1,000
937
983
921
973
1,048
1,067
982
991
999
946
946
950
845
998
896
1, 071
1,135
1,195
1,075
1,077
1,048
1,163
1,180
1, 097
1,044
1,063
18,893
19,207
19, 279
19,114
18,819
18,635
18,800
18, 746
18,715
18,824
18,728
18, 711
18,870
18,902
19,240
19,138
18, 709
18,924
18,847
18, 735
18,933
18, 836
18,783
19,024
18,939
19,169
19,535
19, 295
18,816
18,884
19, 087
18, 827
18,982
19,129
18,834
18, 956
19,040
18, 958
19,420
18,173
18,393
18, 576
18,432
18,195
18,050
18,210
18,166
18,146
18,205
18,152
18,148
18,345
18,378
18,646
18,586
18,177
18,340
18,320
18,268
18,359
18,237
18,224
18,446
18,419
18,579
18,883
18, 773
18,302
18,366
18, 580
18, 362
18,485
18,595
18,300
18,434
18, 573
18,447
18,843
720
814
703
682
624
585
590
580
569
619
576
563
525
524
594
552
532
584
527
467
574
599
559
578
520
590
652
522
514
518
507
465
497
534
534
522
467
512
577
Source: Board of Governors of the Federal Reserve System.
£
KJ
CO
COMMENTS OF STAFF OF FEDERAL RESERVE BOARD
LETTER OF TRANSMITTAL
B O A R D OF G O V E R N O R S
OF T H E F E D E R A L R E S E R V E S Y S T E M ,
Washington, September 15, 1958.
Hon. J. W .
FULBRIGHT,
Chairman, Senate Committee on Banking and Currency,
United States Senate, Washington 25, D. C.
D E A R S E N A T O R F U L B R I G H T : Thank you for your letter of August 2 6
inviting comments by the Board's staff on the revised draft of the
paper, enclosed with your letter, prepared by Dr. Asher Achinstein of
the staff of the Legislative Reference Service of the Library of Congress
under the heading, "Federal Reserve Policy and Economic Stability,
1951-57."
Because we ourselves are continually studying and reviewing
System experience to search out the lessons it may hold in guidance
for the future, the Board and its staff welcome efforts by others to
review System policies and actions critically in development of
standards for a more perfect execution of monetary responsibilities.
As the attached comments by our staff indicate, however, it is
disappointing that this paper, while fully explicit as to the personal
evaluation of the author, fails to state what monetary actions may or
may not be expected to accomplish in economic stabilization or to
set forth any standards for measuring the performance of monetary
policy. This omission deprives the reader of a basis for judging either
the validity or objectivity of the author's conclusions.
The Board will appreciate having the attached comments published
in the printed report along with this letter.
Sincerely yours,
WM. M c C . MARTIN, J r .
81
C O M M E N T S BY T H E S T A F F OF T H E B O A R D OF G O V E R N O R S O F T H E
F E D E R A L R E S E R V E S Y S T E M ON T H E R E P O R T " F E D E R A L R E S E R V E
P O L I C Y AND E C O N O M I C STABILITY, 1 9 5 1 - 5 7 / '
BY D R .
ASHER
A C H I N S T E I N OF T H E L E G I S L A T I V E R E F E R E N C E S E R V I C E O F T H E
L I B R A R Y OF C O N G R E S S
The report has been reviewed with care in recognition that critical
evaluation may help toward perfecting the application of monetary
policy. From this point of view, the paper suffers from three major
defects.
First, its economic analysis envisages a more drastic recession in
1958 than actually developed. The author's views were formulated
before it was generally realized that the 1957-58 recession had come
to an end. Hence, the paper reflects, both explicitly and implicitly,
the general foreboding of early last spring that the recession of 1957-58
would be long and severe. The same forebodings were prevalent
during the downturn phases of the recessions of 1948-49 and 1953-54.
Happily, in all three cases forebodings proved wrong. For the third
time in the postwar period, recessionary tendencies in this country
have proved to be short-lived adjustments and have been followed
by renewed and vigorous expansion.
Much of this paper—and particularly the discussion of 1957—
would now need revision. For example, from a reading of this
document anyone would be surprised to learn that, even before it
had been published, the recession of 1957-58 was regarded as among
the shortest and mildest (in terms of total man-hours of work lost
in the economy as a whole) in American history. Surely, this fact
is relevant to any judgment on the precautionary policies pursued by
the Federal Reserve System in 1957.
There is, and has been, practically no informed opinion among
economists that fluctuations in business activity can be entirely
eliminated from a free market economy. Accordingly, it is out of
focus to concentrate, as does the author, on the fact that fluctuations
occurred. The ideal, and aspiration, has been that instability be
minimized. The question for objective appraisal is whether or not
Federal Reserve policies since 1951 have tended to mitigate or to
accentuate economic instability. This question, moreover, must be
considered in relation to the actual situation when monetary actions
were taken, including any concurrent actions of a stabilizing or destabilizing nature by other Government agencies. Thus considered,
a judicious view would surely be that without the monetary actions
taken by the Federal Reserve since 1951 the booms would have been
more exuberant and the recessions more severe.
Second, the author attempts to evaluate the effectiveness of monetary policies without adequate recognition of the principles and guides
on the basis of which these policies have been determined, or presentation of an alternative set of standards. As a result, the paper has
serious limitations for a reader seeking a balanced appraisal of the
effects of Federal Reserve policy. What, for example, should be the
83
84
FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
relation of monetary actions to stability or instability in the economy?
Also, are Federal Reserve actions the sole factor for stability on the
side of public responsibility, or is economic stability also affected by
taxing and spending policies, by agricultural policies, and by other
public policies such as those that govern the terms and conditions in
the insurance and guaranty of home mortgages? If other public
policies also influence economic stability, is it not incumbent upon the
author to state concretely and definitely his concept of the relative
role of monetary policy in the years discussed and to analyze the extent
to which monetary policy was aided or vitiated by other public actions?
Third, the paper fails to deal adequately with the most persistently
grave threat to economic stability during the postwar period—inflation. At some points, it ignores inflation as a problem, and at others
it plays down the problem.
For example, the paper evaluates Federal Reserve policy actions in
1956-57 as though the economy were not in the grip of an active
wage-price spiral. It ignores the growing tendency throughout the
economy after mid-1956 to hedge against inflation by incorporating in
longer term contracts escalator clauses for higher wage and other
costs, and the consequent speeding up of the wage-price spiral. It
also ignores the growing tendency on the part of business management
in this period to anticipate future construction needs in an effort to
avoid expected future increases in construction costs, and the effects
of these anticipatory decisions on construction costs and surplus plant
capacity. As a result the paper gives inadequate recognition to the
effect of the developing inflationary psychosis on the prices of fixedinterest securities, and on the level of long-term interest rates.
Expectations of renewed inflation are at least as widespread today
as they were in the early summer of 1957. They constitute the major
current threat to the continued progress of our recovery. Investors
are being urged on all sides to shift their holdings to common stocks as
hedges against inflation. This is illustrated by the growth and formation of investment trusts and by the decisions on the part of private
pension trusts to increase the proportion of common stocks to bonds
held in their portfolios. The sale of bonds—which constitutes the
only means for raising market funds to finance public expenditures,
State and municipal as well as Federal, and a principal means of
financing industrial growth—is being seriously handicapped. Today,
prices of common stocks have risen to a point where their average
yields are below the yields of senior bonds of the same corporations
and at approximately the same level as average yields on United
States Government securities.
Additional points which may be helpful in reading the paper are:
(1) In its criticism of monetary actions through open market and
discount operations, no account is taken of the complications caused
by Treasury debt management problems and the relation of Treasury
refinancing and financing operations to the timing of monetary actions.
(2) Unfavorable comments on the use of available instruments for
monetary policy are frequently accompanied by favorable comments
on the possible revival of regulation of mortgage credit and of consumer credit, the authority for which, as supplementary instruments
of credit control, has been discontinued by the Congress. And yet
the paper offers no analysis of the problems or limitations of the latter
type of instrument.
85
FEDERAL RESERVE POLICY AND ECONOMIC STABILITY
(3) In his detailed comments on restrictive Federal Reserve policy
in 1952-53, 1955, and 1957, the author appears to favor a sledgehammer approach of sharper and more rapid actions on the basis of
forecasts presumed to be accurate. Perhaps preoccupation with the
sledge-hammer approach in applying monetary actions accounts for
the author's surprise that the Federal Open Market Committee
through the first three quarters of 1957 was weighing meticulously all
aspects of the current economic situation in order to detect promptly
any evidences of downturn. The Federal Open Market Committee's
record was entirely consistent, of course, with the System's public
posture of monetary restraint during the period in view of the
evidence that the economy was in the grips of a demand-pull cost-push
inflation and of the danger that speculative excesses would lead to
serious liquidation and severe economic recession.
(4) The paper suggests some avenues of inquiry that afford promise,
as for example when it takes up in critical vein what it terms certain
limitations in the use of the tools of monetary policy, and fiscal and
debt management policy, for promoting economic stability. However, the inquiry does not go beyond recognizing that the fallibility in
foreseeing the future that attends all forms of human endeavor extends
to monetary policy. Indeed, the author makes the point that monetary policy has unusual virtues, at least in comparison with fiscal
policy and debt management policy, in that its flexibility enables the
monetary authorities to minimize errors of diagnosis by more speedily
steering a different course to meet changing conditions.
o
@FedFRASER