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89th Congress
2d Session

JOINT COMMITTEE P R IN T

THE FEDERAL RESERVE PORTFOLIO

STATEMENTS BY INDIVIDUAL ECONOMISTS

MATERIALS SUBMITTED TO THE

SUBCOMMITTEE ON ECONOMIC PROGRESS
OF THE

JOINT ECONOMIC COMMITTEE
CONGRESS OF THE UNITED STATES
LIBRARY
¡S’O C U M E N T

C O L L E C rrcrjf

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FEB 21'
UNIVERSI!-1
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Printed far the use of the Joint Economic Committee
U.S. GOVERNMENT PRINTING OFFICE
56-913

WASHINGTON: 1966

For sale by the Superintendent of Documents, U.S. Government Printing Office
Washington, D.C., 20402- Price 45 cents

JOINT ECONOMIC COMMITTEE
(Created pursuant to sec. 5 (a) of Public Law 304, 79th Cong.)
WRIGHT PATMAN, Texas, Chairman
PAUL H. DOUGLAS, Illinois, Vice Chairman
HOUSE OP REPRESENTATIVES
SENATE
RICHARD BOLLING, Missouri
JOHN SPARKMAN, Alabama
HALE BOGGS, Louisiana
J. W. FULBRIGHT, Arkansas
HENRY S . REUSS, Wisconsin
WILLIAM PROXMIRE, Wisconsin
MARTHA W. GRIFFITHS, Michigan
HERMAN E. TALMADGE, Georgia
THOMAS B. CURTIS, Missouri
JACOB K. JAVITS, New York
WILLIAM B. WIDNALL, New Jersey
JACK MILLER, Iowa
ROBERT F. ELLSWORTH, Kansas
LEN B. JORDAN, Idaho
Jambs W. Knowles, Executive Director
John R. S t a r k , Deputy Director
Marian T. Tract, Financial Clerk
Hamilton D. Gbwehr, Administrative Clerk

E c o n o m ists
W i l l i a m H. M o o r b
N elson D . M cClung

S ubc om m ittee

G eorge
D on ald

R. I d b n
A. W e b s t e r

(M in o r ity )

E con om ic P rogress

WRIGHT PATMAN, Texas, Chairman
HOUSE OF REPRESENTATIVES
SENATE
HENRY S. REUSS, Wisconsin
WILLIAM PROXMIRE, Wisconsin
MARTHA W. GRIFFITHS, Michigan
HERMAN E. TALMADGE, Georgia
WILLIAM B. WIDNALL, New Jersey
JACOB K. JAVITS, New York
LEN B. JORDAN, Idaho
Joh n R . St a r k ,

Economist

LETTERS OF TRANSMITTAL
J a n u a r y 28, 1966.
To Members of the Joint Economic Committee:
Transmitted herewith for the use of the Joint Economic Committee
and other Members of Congress are the replies received from members
of the American Economic Association in response to a letter of in
quiry sent out by the Subcommittee on Economic Progress on Sep
tember 1,1965.
The letter of inquiry was sent to all those members of the American
Economic Association who are listed as having indicated a special
interest in monetary policy. The only exceptions made were in those
cases where individuals by reason of official positions might feel con
strained in responding freely, or where they lived abroad and pre
sumptively were less likely to follow monetary affairs in this country.
The questions on the portfolio that were set forth in my letter of
September 1 were designed objectively to elicit the opinions of mone
tary experts on the present constitution and management of the Fed
eral Reserve portfolio which, of course, now exceeds $40 billion. The
statements are printed verbatim as they were received, with the excep
tion of some minor editorial changes made by the staff in the interest of
uniformity. In addition, the staff letter of transmittal contains a
general summary of the replies.
It is hoped that this volume will add measurably to the knowledge
of one of the most fundamental elements in our economic life; namely,
the open market activities of the Federal Reserve System, which are
basic in controlling the money supply in the United States. The 86
respondents who gave the committee the benefit of their judgment
and experience have made a very real contribution, which is appre
ciated.
W r i g h t P a tm a n ,

Chairman, Joint Economic Committee

J a n u a r y 27, 1966.
Hon. W r ig h t P a t m a n .
Chairman Joint Economic Committee
UjS. Congress Washington D.C
D e a r Mr. C h a ir m a n : Replies have been received from 86 monetary
economists in response to the inquiry of September 1, 1965, sent to
almost 500 economists by the Subcommittee on Economic Progress.
These are transmitted herewith along with a summary of the responses,
prepared by John R. Stark, the Deputy Director. He was assisted in
the preparation of this summary by Mrs. Eleanor H. Aeschliman
of the committee staff.
To insure objectivity, the selection of those to whom the inquiry
was to be made was based upon the directory of membership published
by the American Economic Association. In this directory the associaHI

LETTERS OF TRANSMITTAL

tion provides a listing grouping economists by their major fields of
interest as indicated by the economists themselves. The questionnaire
was sent to those members of the association who indicated a special
interest in monetary policy. The only exceptions were instances of
individuals living abroad or those whose official positions might pro
vide reason for some constraint on their part m replying. Every
effort has been made to make sure that the questionnaire itself is com
pletely objective and that the summary is as fair a representation of
the opinions of the respondents as could be prepared in view of the
wide range of responses. In addition, the full texts of the replies are
published with only such editing as was necessary to bring them into
a uniform format for publication and to arrange them alphabetically.
The staff is hopeful that these materials will prove useful to the
committee members and others in the study of the open market activi
ties of the Federal Reserve System and the management of their
portfolio.
Sincerely yours,
J am es W

now les,

Executive Director.
J a n u a r y 26, 1966.
J am es W - K

now les,

Executive Director, Joint Economic Committee.
D ear M r . K n o w l e s : Transmitted herewith is an analysis of the
replies received from 86 monetary economists in response to the Eco
nomic Progress Subcommittee’s inquiry of September 1.
The questionnaire was sent to all members of the American Eco
nomic Association who indicated a special interest in monetary theory
and policy, or in commercial banking and other short-term credit.
The only exceptions were instances of individuals living abroad and
therefore presumably more remote from the domestic monetary scene,
or those who by reason of their official positions might have felt con
strained in replying freely. Following is a summary of the opin
ions expressed by the respondents.
SIZE OF THE FEDERAL RESERVE PORTFOLIO

L How large a portfolio should the Federal Reserve System hold
in relation to the money supply, the gross national product or aggre
gate liquid assetst
Most of the respondents were of the opinion that it was impossible
to apply quantitative yardsticks to gage the adequate size of the port
folio. While an appropriate ratio of any yardstick, i.e., the money
supply, gross national product or aggregate liquid assets, to the size
of the Federal Reserve’s portfolio might be determined for any spe
cific time, they maintained that various conditions would prevent
using such a ratio as a general standard. The majority opinion was
that a minimum size necessary to carry on open market operations
was of more concern than a maximum size. The Federal Reserve/s
holdings of governments in excess of the amount needed to control the
money supply were not considered to be a serious problem by most
respondents.

LETTERS OF TRANSMITTAL

II. I f the portfolio grows too large what should be done with the
excess? How should the interest be handled?

The conclusion that the Federal Reserve holds a large amount of
governments in excess of that necessary to carry out its monetary func
tion was generally accepted. Most respondents considered interest
payments on the Federal Reserve’s holding of governments to be a
burden to the taxpayers only to the extent of the Federal Reserve’s
operating expenditures. Approximately one-third of those replying
referred to maintain the status quo; i.e., for the Federal Reserve to
old the excess, draw interest and return the unexpended balance to
the Treasury. While very few favored outright cancellation of the
excess portfolio holdings, about 30 percent indicated that some im
provement could be achieved through replacement of excess holdings
with non-interest-bearing governments which could be reconverted
to marketable securities, if needed. They expressed the opinion
that such a revision would simplify bookkeeping arrangements
between the Federal Reserve and the Treasury. Some of the
supporters of this idea pointed out that it is not now obligatory for the
Federal Reserve to return excess earnings to the Treasury.
About one-sixth of the economists replying favored subjecting the
Federal Reserve to the budgetary control applied to other Federal
agencies to solve the issue of the Federal Reserve’s earnings. A few
of these respondents suggested reinstating the requirement that excess
earnings be returned to the Treasury.
Approximately one-eighth of the group replying favored greater
reliance upon controls other than open-market operations, which would
have the result of easing the problem of secular growth in the Federal
Reserve portfolio of governments. Six respondents suggested re
ducing the reserve requirements of member banks and offsetting this
reduction with open-market sales of Treasuries. In addition to low
ering the reserve requirement on demand deposits, a few respondents
also suggested abolishing the reserve requirement on time deposits.
Other suggestions included (1) requiring financial institutions to
hold part of their reserve in governments; (2) selling excess govern
ments back to the public over a period of time (suggested by three
economists who felt open market operations were inappropriate and
favored the return to traditional central banking techniques); and (3)
expanding credit by issue and recall of currency from the Treasury di
rectly to banks rather than relying on open market operations to ex
pand and contract the money supply.

COMPOSITION OF THE FEDERAL RESERVE PORTFOLIO

I,
Should the Federal Reserve expand its operations to dealing in
private and municipal debt instruments?

About one-third of the respondents expressed the opinion that the
current policy of the Federal Reserve should be maintained. Two con
siderations were commonly raised by this group as objections to
expanded operations of the Federal Reserve in selective markets: first,
these markets tend to be narrower than the Government market, and
would involve an unnecessarily heavy burden of credit analysis for
Federal Reserve personnel; second, purchases and sales in selective
issues would subject the Federal Reserve to political pressures and
criticisms which these respondents felt should be avoided.

LETTERS OF TRANSMITTAL

Less than one-tenth of those replying preferred to give the Federal
Heserve as much flexibility as possible in this area. These respondents
¿generally felt that it might be desirable for the Federal Reserve to
deal in private and municipal securities at different times, but that the
^Federal Reserve should be free to determine its own policy in this area.
Approximately one-sixth favored extension of Federal Reserve op
erations to the private and municipal markets. The arguments of
these respondents were as follows: (1) it would increase the ability
of the Federal Reserve to directly influence the cost and availability
of credit to various classes of borrowers; (2) it would aid the objective
of stimulating given sectors of the economy or certain types of spend
ing; (3) it would provide more selective control of inflationary pres
sures by selling debt instruments of the sectors experiencing excess
demand while still maintaining credit ease in other markets; and (4)
it would prevent the Federal Reserve from obtaining too large a por
tion of governments to the detriment of private investors should the
supply of governments be insufficient to meet demand. In general,
the respondents in this group felt that purchases and sales of private
and municipal issues would speed up the impact of credit policy on
financial markets. One economist pointed out that dealings in the
private or municipal markets in addition to their monetary signifi
cance could well have the same effect as subsidies, and might be more
properlv handled in the latter fashion separate from money creation.
The balance of the respondents did not address their replies to this
point.
With respect to dealing in specific issues, the most common sugges
tions were high-grade corporates and municipals. One economist
specifically recommended dealing in certificates of deposit, as the CD’s
constitute a wide market and have to some extent replaced Treasury
bill holdings by the banks. There was no support for dealing in com
modities or commercial loans. Although most of the respondents did
not mention foreign exchange dealings, those who did felt that this
was a proper function of the Federal Reserve.
II, Should standards be laid down relative to the maturity composi
tion of the Federal Reserve's portfolio of Government bonds?
Although several economists indicated a preference for dealing in
short term (“bills only” ) or longer term issues, there was no support
for setting specific standards. The general consensus was to allow the
Federal Reserve as much flexibility as possible in this area. One
respondent was of the opinion that the maturity composition should
be determined by the Treasury Department.
The chairman’s letter of September 1, setting forth the questions
on the portfolio, is reprinted herein.
J o h n R. S t a r k ,
Deputy Director, Joint Economic Committee.

C h a i r m a n P a t m a n ’s L

etter to

c o n o m is t s

C ongress of t h e U n it e d S t a t e s ,
J o in t E c o n o m ic C o m m it t e e ,

September 1, 1965.
------------: The Joint Economic Committee solicits your
views concerning the structure and management of the rapidly grow
ing portfolio of financial assets held by the Federal Reserve System.
T e n years ago, the System held about $24 billion of Federal Gov
ernment securities in its portfolio. At latest report, their portfolio
o f “Governments” had grown to about $39 billion, an increase of about
$1.5 billion per year over the 10 years. As you know, portfolio growth
is a natural consequence of the need to expand the money supply to
meet the growth needs of our economy. But what is not so generally
recognized is that only a small fraction of this portfolio is needed
for the current, day-to-day conduct of Federal Reserve open-market
operations.
The committee believes that the growth of this portfolio and how
it is operated raise issues affecting monetary policy, debt manage
ment, and fiscal policy. The attached excerpt from a colloquy be
tween Chairman Martin and me during the July 7 hearings of the
Banking and Currency Committee will help to highlight the basic
issues about the portfolio’s size. We are inviting you, as one of a
group of experts, to comment on this situation and, especially, the
following issues:
How large a portfolio should the Federal Eeserve System hold in
relation to the money supply, the gross national product, or aggregate
liquid assets? Is any other measure more appropriate? If the port
folio grows too large compared to this standard, what should be done
with the excess? Should the assets be transferred to the Treasury
for cancellation? Should the Federal Reserve continue to hold them,
draw the interest, and return the unexpended balance to the Treasury ?
Can we design other objective standards by which to guide Fed
eral Reserve portfolio operations? Should we lay down standards
relative to the kind of assets to be held, maturity composition, private
versus public instruments ? Should the Federal Reserve supplement
its portfolio of Federal Government securities with other types of
assets such as commercial loans, foreign exchange, municipal securi
ties, corporate bonds, mortgages, commodities ?
It is the committee’s hope that these valuable expert views can be
published. With this in mind, brevity is desirable, of course. We
are more interested in the specific recommendations and reasons for
them than in elaborate argument or citation of source materials.
We appreciate your participation in this project, which will be of
assistance to the committee and the Congress in dealing with a number
of emerging issues. Kindly mail your reply to John R. Stark, Deputy
Director o f the Joint Economic Committee, G-133, Senate Post Office,
Washington, D.C.
Sincerely yours,
W r i g h t P a t m a n , Chairman.
m
D ear D r .

VIII

LETTERS OF TRANSMITTAL

C o l lo q u y B e t w e e n C h a i r m a n W r ig h t P a t m a n a n d W il l i a m
M c C h e s n e y M a r t i n , C h a i r m a n of t h e F ederal R eserve B oard

[Taken in testimony on H.R. 7601, a bill to provide
for the retirement of $30 billion of interest-bearing
obligations of the United States held by the 12 Federal
Reserve banks, on July 7, 1965, pp. 78-80 of the tran
script.]
Chairman P a t m a n . I want to clarify this for the record one more
time, Mr. Martin. How in the world can you insist that bonds that
are paid for once should continue in existence with the taxpayers hav
ing to pay interest on them after they have been paid for once ? Now,
of course, you claim that these bonds have to be there to back up Fed
eral Reserve notes. But that does not conform with your reasoning in
1959 when you presented to Congress a bill, and it was passed on by this
committee, which said that you wanted the power to lower reserve
requirements and count vault cash as reserves; and that, if you got that
power, you would transfer $15 billion of the then portfolio of $24
billion to the private banks. You further stated that the private
banks needed the income from these bonds, and that the Federal Re
serve does not need it. You do not need the $15 billion. The remain
ing $9 billion in the portfolio, as you stated in a staff report, would
provide enough flexibility for you to operate. Now, then, when the
Open Market Committee owns $38.5 billion worth of bonds—which of
course is about $14.5 billion more than it was then, you insist that it
is impossible for those bonds to be canceled, although $15 billion under
the same circumstances could be given to the private banks, after giving
them (through reducing reserves) the reserves to buy the bonds.
The Fed pays nothing for them; it merely creates new reserves.
Then it continues to get interest on those bonds and, when the bonds
become due, they can collect the principal again.
I cannot get the reasoning there at all, Mr. Martin. If that makes
sense, I am unable to comprehend it. Of course, there may be some
thing in my background—lack of knowledge—that would account for
it, but I do know this: No one should be compelled to pay his debts
more than once, but in this instance you would compel the Government
to pay its debts more than once. You would compel the Government
to continue to pay interest on bonds that have already been paid for.
When you bought these bonds, you paid for them. You will admit
that, will you not, Mr. Martin ?
Mr. M a r t in . The bonds were paid for in the normal course of
business.
Chairman P a t m a n . That is right.
Mr. M a r t in . And that is the only time they were paid for.
Chairman P a t m a n . Just like we pay debts with checks and credits.
M r . M a r t i n . E x a c tly .
Chairman P a t m a n . In

the normal course they were paid for once;
you will admit that, will you not ?
M r . M a r t in . T h e y were p a id fo r once, and th a t is all.
Chairman P a t m a n . That is rig h t.

CONTENTS
Pag«

Letters of transmittal.
.................. ...................................... ...........
Chairman Patman’s letter to economists.___ _______________ _____ . ..___
Colloquy between Chairman Wright Patman and William Me. Martin__
Statements

E conomists R esponding

Q uestionnaire

Adams, E. Sherman, vice president, First National City Bank, New
York, N .Y ., and secretary, Support Group for Progressive Banking,
Washington, D .C ___
___
_________
_______________
...
Ballaine, Wesley C., director, Bureau of Business and Economic Research,
University of Oregon, Eugene, Oreg_
____
....
Baxter, Nevins D., assistant professor of finance, University of
Pennsylvania, Philadelphia, Pa___
___ ___
____ ___
Beckhart, Benjamin Haggott, professor emeritus of banking, Columbia
University, New York, N.Y__
___
Bolster, Richard L., Longmeadow, Mass_
__
______
.
Brazelton, W. Robert, professor of economics, University of Missouri,
Kansas City, M o .
. . . __ __
_ . ___ ___
—
Brothers, Dwight S., professor of economics (on leave), Rice University,
Houston, T ex.
...
__
_____
_____
. . . ___
Brownlee, O. H., professor of economics, University of Minnesota, Minnea
polis, Minn., and Scott, Ira O., Jr., associate professor of finance, Colum
bia University, New York, N.Y_
____ __________
. _
Brunner, Karl, and Meltzer, Allan H., Graduate School of Industrial
Administration, Carnegie Institute of Technology, Pittsburgh, Pa__ _
Carr, Hobart C., chairman, Department of Banking and Finance, School
of Commerce, New York University, New York, N .Y
______
...
Cohen, Jacob, professor of economics, University of Pittsburgh, Pittsburgh,
Pa.
_____
_____________
______
Corrigan, Walter P., North Miami Beach, Fla___
___
____
Eccles, Marriner S., chairman of the board, First Security Corp., Salt
Lake City, Utah.
. . . ___
Ellis, Ira T., economist, E. I. du Pont de Nemours & Co., Inc.,
Wilmington, D el. _ _ _
_.
...
____
Fellner, William J., Sterling professor of economics, Yale University,
New Haven, C on n ...
_.
... ____
___
___
Frankenhoff, Charles A., professor of economics, College of Social Sciences,
University of Puerto Rico, Rio Piedras, P.R__
____ __ _______
Gies, Thomas G., professor of finance, Graduate School of Business
Administration, University of Michigan, Ann Arbor, Mich_______
...
Greene, J. A., Jr., dean, School of Business Administration, University
of Southern Mississippi, Hattiesburg, Miss. _____
____ ____
Gustus, Warren J., chairman, Department of Finance and Statistics,
College of Business Administration, Drexel Institute of Technology,
Philadelphia, Pa____
. ..
...
------------Hallowell, Burton C., professor of economics, Wesleyan University,
Middletown, Conn..
...
------------- -----------------Harrington, John J., Jr., assistant professor of finance, Seton Hall Univer
sity, South Orange, N.J_ _____________________________________________
Harris, Seymour E., professor of economics, University of California,
San Diego, La Jolla, Calif.
____ _______________ ___ ____
Harriss, G. Lowell, Department of Economics, Columbia University,
New York, N .Y
............- ___ _______________________ ___ . . . . ____ ____ —
Harwood, E. C., director, American Institute for Economic Research,
Great Barrington, Mass___
.....
—
—
----Hauge, Gabriel, president, Manufacturers Hanover Trust Co., New York,
N Y ___
__________ ______ _______________ ___ - ....................................

iii
vii
viii

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Hawkins, Robert G., Graduate School of Business Administration, New
York university, New York, N .Y
__
— __
------------ ....
Infinger, M . Leslie, major, associate professor of business administration,
The Citadel, Charleston, S.C--------- ---------------- -------------Johnson, Dudley W ., associate professor of finance, College of Business
Administration, University of Washington, Seattle, Wash.........................
Jordan, Carl P., Bethlehem, Pa_________
___ ___ ____
----------Kane, Edward J., Department of Economics, Princeton University,
Princeton, N.J. . . . ----------- ------- ------- ---------------------------------- ------Kane, John E., professor of banking, College of Business Administration,
University of Arkansas, Fayetteville, Ark............ ...........................................
Kerr, John C., Jr., Upper Montclair, N .J.................... - - ...................................
Lombardi, L. F., Reading, Pa—................ .......... .................................. ...............
Lounsbury, Raymond H., Vergennes, Y t ______________
_______
___62
Maloney, H. D., professor of economics, DePauw University, Greencastle,
Ind. ------- ------------------------ ------------------------------ ---------------- Masten, John T., chairman, Department of Economics, University of
Kentucky, Lexington, K y _______________ ___ ____ ________________ ___
Matthews, C. A., professor of finance, College of Business Administration,
University of Florida, Gainesville, Fla______ ______________________ 66
Mayer, Thomas, professor of economics, University of California, Davis,
Calif__________________ ___ ____ _____ ________________ _________ ____
McDonald, Stephen L., professor of economics, University of Texas, Aus
tin, Tex______ ____________________ _____ _________________________________
McKinney, George W ., Jr., Upper Montclair, N .J___ __________ __________
Meltzer, Allan H., and Brunner, Karl, Graduate School of Industrial Ad
ministration, Carnegie Institute of Technology, Pittsburgh, P a ...... ........
Metzler, Floyd A., professor of economics, University of Chicago, Chi
cago, 111-.__
___________
______
____ ___________________________ _
Miller, Ervin, associate professor of finance, Wharton School of Finance and
Commerce, University of Pennsylvania, Philadelphia, Pa_________
.
Miller, Harold W ., professor of economics, State University College at
Brockport, Brockport, N .Y ____ __ ______ ____ __________________ ____ ___
Miller, Oscar, assistant professor of economics, College of Business Ad
ministration, University of Illinois, Chicago, 111______________ _________
Minsky, Hyman P., professor of economics, Washington University, St.
Louis, M o_________ ____ __________
_____________
___ ____
Mitchell, Howard E., associate professor of economics, Western Washing
ton State College, Bellingham, Wash_________________ _____________ ____
Moore, O. Ernest, International Economic Services, New York, N .Y ____
Mueller, F. W ., chairman, Department of Finance, College of Commerce,
____________ ____ ___________ ___ DePaul University, Chicago, 111-Musgrave, Richard A., professor of economics in the Faculty of Arts and
Sciences and in the Law School, Harvard University, Cambridge, M ass-.
Ott, David J., associate professor, Department of Economics, Southern
Methodist University, Dallas, Tex__ _____ _____
________________ __ _
Patterson, Braxton I., assistant professor of economics, University of
Wisconsin, Milwaukee, Wis_______ ____ _______________________________ .
Polak, George, associate professor of economics, West Liberty State College,
West Liberty, W. Va___________________ ___ _____________________________
Porter, Richard C., associate professor of economics, Center for Research
on Economic Development, University of Michigan, Ann Arbor, M ich ..
Prager, Jonas, visiting lecturer, Department of Economics, Bar Ilan Uni
versity (Israel) and visiting economist, Bank of Israel (assistant professor
of economics, New York University, on leave). . . . ____ _________
Prather, Charles L., professor of finance, Graduate School of Business,
University of Texas, Austin, Tex_
_____ _____
_ ___________ ______
Pritchard, Leland J., professor of finance, Department of Economics, the
University of Kansas, Lawrence, Kans.....
...............
.....
Prussia, L. S., Jr_____
____ ____________ ...
________
__ _______
Robinson, Roland I., Graduate School of Business Administration, Michi
gan State University, East Lansing, Mich_____
____ ___________ ____
Rockafellow, Robert, professor of economics, College of Business Adminis
tration, University of Rhode Island, Kingston, R .I______
____
Saulnier, Raymond J., professor of economics, Barnard College, Columbia
University, New York, N .Y _____________________________________________

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CONTENTS
Scott, Ira O., Jr., associate professor of finance, Columbia University,
New York, N .Y ., and Brownlee, O. H., professor of economics, University of Minnesota, Minneapolis, Minn._
. . . ------- -----------------Shropshire, William O., associate professor of economics, School of Business
Administration, Emory University, Atlanta, Ga__________________ _____
Siegel, Barry N ., associate professor of economics, University of Oregon,
Eugene, Oreg..................................... ............. ................................... ......................
Sing, Francis P., Brooklyn, N .Y..__---- -------------- ---------------------------------------Spahr, Walter E., executive vice president, Economists’ National Com
mittee on Monetary Policy, New York, N .Y ---------- -------- --------------Sprinkel, Beryl W ., vice president and economist, Harris Trust & Savings
Bank, Chicago, 111.
...
. ____________________________ _______
Storrs, Thomas I., executive vice president, North Carolina National Bank,
Greensboro, N .C _ ,....... ...............
__............................. ....... .................
Teigen, Ronald L., assistant professor of economics, University of Mich
igan, Ann Arbor, Mich____________ _____________________________________
Terborgh, George, research director, Machinery & Allied Products Insti
tute, Washington, D .C __________ _____ ____ _______________________ _____
Thomas, Rollin G., Herman C. Krannert Graduate School of Industrial
Administration, Purdue University, Lafayette, Ind___ ____ ______ ______
Towey, Richard E., assistant professor of economics, Oregon State Uni
versity, Corvallis, Oreg____ ..
________ __ ____________________ _______
Trubac, Edward R., Department of Finance and Business Economics,
College of Business Administration, University of Notre Dame, Notre
Dame, Ind______________________________________________________ ________
Viksnins, George J., assistant professor of economics, Georgetown Uni
versity, Washington, D .C _______ ... __________________ ____ _____________
Voorhis, Jerry, president and executive director, the Cooperative League
of the U.S.A., Chicago, 111____ __ _________________ __ ___ ____ _______
Wallich, Henry C., professor of economics, Yale University, New Haven,
Conn,
______ __________ ___________ _________ ______________ ____ ______
____
_____
__________
Warburton, Clark, McLean, Va_
Ward, Richard, assistant professor of finance, University of Southern
California, Los Angeles, Calif__
__ ______ ______________
_____ ...
Weintraub, Robert, professor of economics, University of California, Santa
Barbara, Calif.
_____ ______ ___ _________________ _________________
Welfling, Weldon, professor of economics, Western Reserve University,
Cleveland, Ohio..
___
__ __________________ ___________
________
Whalen, Edward L., assistant professor, Department of Economics and
Division of Economic Research, Indiana University, Bloomington, Ind.
Whitesell, William E., Department of Economics, Franklin and Marshall
College, Lancaster, P a... ______________________ ___ _____ ______________
Whittlesey, C. R., professor of economics and finance, Wharton School of
Finance and Commerce, University of Pennsylvania, Philadelphia, Pa.
Wilde, Frazar B., chairman of the board, Connecticut General Life Insur
ance Co., Hartford, Conn____________
_______________________
Woodard, F. O., head, Department of Economics, Wichita State University,
Wichita, Kans— __ _
___________ ___ ... ___ __________________________
Wormser, Felix Edgar, consulting mining engineer, Greenwich, Conn.

Pas*
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THE FEDERAL RESERVE PORTFOLIO
S t a t e m e n t b y E . S h e r m a n A d a m s , V ic e P r e s id e n t , F ir st N a t io n a l
C i t y B a n k , N e w Y o r k , N . Y . , a n d S e c r e t a r y , S upport G roup fo r
P rogressive B a n k i n g , W a s h in g t o n , D.C.

At the outset, let me say briefly for the record that I would be
opposed to H. R. 7601, a bill to provide for the cancellation of $30
billion of Government obligations held by the Federal Reserve banks.
I fail to see how this bill would achieve any constructive purpose and
it would violate accepted principles of accounting and public finance.
Having said this, I leave it to others better qualified than myself to
deal with the broad issues it involves. There is, however, one aspect
of the subject to which I have devoted considerable thought and study
and which your committee will doubtless wish to consider because of
its direct bearing on the questions raised in your letter. I refer to the
outmoded structure of member bank reserve requirements and spe
cifically to the requirement that member banks must hold a cash re
serve against savings deposits.
There are many who hold that the entire structure of member bank
reserve requirements needs reform. Be that as it may, I shall confine
my comments here solely to the legal reserve requirement against
savings deposits because this segment of the subject can be dealt with
separately and because the issue involved is so clear cut.
The situation is indeed simple. The reserve requirement against
savings deposits of member banks makes no significant contribution
to the effectiveness of monetary policy and it obviously penalizes and
discriminates against member banks as against other types of institu
tions which compete with member banks for personal savings—notably
nonmember banks and mutual thrift institutions. There is wide
spread agreement among economists and others that this requirement
should be abolished.
The Federal Reserve authorities obviously should have an ample
period of time in which to accomplish the elimination of this require
ment, presumably in stages, so that reductions can be timed so they
will not interfere with, and may even assist, monetary policy. Excess
reserves created by the reductions could be mopped up by means o f
open market sales of Governments by the Reserve banks to whatever
extent may be regarded as desirable by the Federal Reserve authori
ties. When the requirement has been completely eliminated, the Fed
eral Reserve’s portfolio will be something like $3 billion smaller than
it would otherwise be.
From the standpoint of both logic and equity, the only reasonable
alternative to eliminating this requirement would be to impose a
comparable cash reserve requirement on other types of institutions
which compete for personal savings. This has been advocated by cer
tain economists and was a matter of some debate among academicians
l

FEDERAL RESERVE PORTFOLIO

several years ago. However, less has been heard about this proposal
since the publication of the report of the Commission on Money and
Credit in 1961. The Commission made a careful study of this proposal
and concluded that a requirement of this kind adds nothing to mone
tary policy, that such a requirement should not be imposed upon other
financial institutions, and that the existing requirement on savings
deposits of member banks should be abolished.
I can understand how someone could disagree with these conclusions
and argue that this kind of a requirement should be applied to all
financial institutions which compete for personal savings, but I do
not see how anyone could try to defend the existing situation which is
so obviously illogical and so clearly discriminatory against member
banks.
Incidentally, the alternative of imposing a comparable cash reserve
requirement on other thrift institutions would lead to a further in
crease in the amount of Government securities held by the Reserve
banks.
I realize that there may be some persons who might wonder whether
any kind of lowering of member bank reserve requirements should be
regarded as some kind of a “giveaway program” for the sole benefit
of these institutions. This would be a distortion of the true situation.
To the extent that existing requirements are much higher than they
need to be, they are inequitable and the removal of such injustice can
not fairly be characterized as being a “giveaway.” It would be a res
toration of rights of which these institutions are now unjustifiably
deprived, not a granting of special privileges. It would be a cutting
back of an unfair “takeaway program.”
Member banks would benefit some, of course, at least temporarily,
because they would be able to lend and invest a larger percentage of
their own assets—just as competing institutions are presently able to
do. But members banks would obviously not be the only beneficiaries
of this increased lending capacity. So would bank customers and, as
suming the reductions are well timed, so would the entire U.S. economy.
Sooner or later the lending capacity of the banking system is going
to have to be augmented in one way or another to meet the growing
needs for bank credit in our expanding economy. There is clearly
something to be said for accomplishing this simply by unlocking some
of the bank funds that are now unnecessarily locked up.
The alternative method of open market operations by the Federal
Reserve would result in a further enlargement of the portfolio of Gov
ernment securities held by the Reserve banks. Failure to use one of
these two alternatives could lead to an undue tightening of bank
credit.
Elimination of the reserve requirement against savings deposits
would result in a difference of something like 10 percent in the Fed
eral Reserve’s holdings of Governments. It may be that other measures
may be desirable as well. However, be that as it may, it seems clear
that there is a very strong case for the elimination of this requirement,
either as a separate action or as an item of first priority in any pro
gram in this area.

FEDERAL RESERVE PORTFOLIO

S t a t e m e n t b y W e s l e y C . B a l l a i n e , D ir ecto r , B u r e a u of B u s in e s s
a n d E c o n o m ic R e s e a r c h , U n iv e r s it y of O r eg o n , E u g e n e , O reg .

Before answering the specific questions posed in your letter to me
dated September 1, 1965, I would like to state certain aspects of my
general philosophy regarding monetary policy. I f I do not do this,
my answers might seem contradictory.
(1) Monetary policy should contribute to a high level of employ
ment, economic growth, and price stability. These objectives may
prove to be in conflict, especially the third with the first two. Should
an order of preference have to be set up, I would favor that given
above (high employment, economic growth, and then stable prices).
(2) Monetary policy and fiscal policy can both affect the quantity
of money. Of the two, monetary policy is the more easily regulated
because it can be adjusted on virtually an hour-by-hour basis. On the
other hand, monetary policy can affect output and prices only through
member bank reserves. This may be clumsy compared to fiscal policy
which directly affects spenders. Monetary policy can either augment
or tend to offset fiscal policy.
(3) With the relatively high level of employment we are now ex
periencing, I believe that a quick and substantial change in the Fed’s
portfolio (both governments and member bank borrowings) would
have an effect upon prices unless offset by fiscal policy. Bad as would
be a price rise more rapid than we are now experiencing, a sharp price
decline would have disastrous effects upon employment and output.
(4) Although you do not mention exchange rates, it is a part of the
complex of monetary policy that cannot be ignored. I believe stable
exchange rates highly desirable; however, the prioe of their continued
maintenance can become too high long before we run out of gold. I
do not know how to express quantitatively the situation which would
prevail so that it would become desirable to abandon stable exchange
rates. I have the feeling that the British may soon be making a
greater sacrifice on the altar of stable exchange rates than is merited.
Now to turn to questions listed in the fourth and fifth paragraphs of
your letter.
A. How large should the Fed's portfolio be? I do not believe any
fixed rule can be set for this. Probably the best criterion would be for
the portfolio to increase at a rate which will result in the growth of
GNP reflecting only increases in physical output with no dement of
price rise. Desirable as this criterion may be, refer to No. 1 above for
modifications that might result in a more rapid growth of the Fed’s
portfolio. It should also be pointed out that the statistical measures
of price change in the various sectors of the economy (consumer goods,
raw materials, manufactured products, labor, capital, etc.) are not
now sufficient to provide an accurate measure of deflated GNP.
B. Is any other criterion more appropriate? Answered in A above.
C I f the portfolio grows too large? I f the economy is characterized
by underemployment of resources, the Fed should create excess re
serves and no effort should be made to reduce the portfolio. On the
other hand, if an increase in the size of the portfolio has already re
sulted in higher prices, nothing should be done that might cause a fall
in prices. I f it should occur that at a time of relatively full employ

FEDERAL RESERVE PORTFOLIO

ment, not all of the portfolio (member bank reserves) had been trans
lated into deposits, it might be possible to reduce the portfolio by a
small amount. I doubt if this last situation is likely to occur fre
quently.
The above discussion has been in terms of “excess” reserves and not
whether the portfolio consists of more short-term Governments than
is essential. This question is dealt with in the next answer.
D. Should the assets be transferred to the Treasury for ccmcellaturn? Since the Fed should have an adequate short-term portfolio so
that a contraction can take place by normal maturities, there should be
a portfolio of, say, $10 billion of the sort now held. It seems to me
that it makes little difference what is done with the remaining $29
billion as long as it does not affect bank reserves. My preference
would be to have the $29 billion exchanged for Government securities
having no maturity but subject to call by the Treasury Department.
The rate of interest seems irrelevant, although I can see no reason why
it should not be zero except that this might make the interest on the
public debt appear too small.
E. Should the assets continue to be held by the Fed? Answered
in (1).
F. Should the Fed's portfolio consist of assets other than Govern
ments? From a purely monetary point of view I can see no reason
why the portfolio should not include commercial paper, municipals,
corporate bonds, and mortgages. As to foreign exchange, I thought
the Federal Reserve Bank of New York now held deposits in foreign
central banks on behalf of the 12 Federal Reserve banks. There are
practical reasons for hesitating to invest in non-Government assets.
For example, municipals already receive an artifically high price (low
interest) by virtue of their tax exemption and it is doubtful if an addi
tional stimulant is desirable by including them in the Fed’s portfolio.
Also, there is the whole question of equity among the various types of
assets that might be acquired—why pick one and not another?

S t a t e m e n t b y N e v in s D. B a x t e r , A s s is t a n t P rofessor of F in a n c e ,
U n iv e r s it y of P e n n s y l v a n i a , P h i l a d e l p h ia , P a .
t h e h o l d in g s of f i n a n c i a l

ASSETS BY

t h e fed er al reserve s y s t e m

It is generally agreed that the Federal Reserve System is presently
holding a portfolio cf Government securities far in excess of the amount
needed to conduct open market operations. This portfolio has been
expanding over time, as the Federal Reserve has purchased Govern
ments to make necessary additions to the reserve base of the banking
system. It has been proposed by Representative Patman that the
Fed transfer a portion of its portfolio to the Treasury for cancella
tion, in order to save the Government the cost of interest payments
on the debt. The reasoning behind this proposal is that since the
Federal Reserve paid for the securities when it purchased them, it is
unfair for the Treasury to continue to pay interest on the debt, and
ultimately, to redeem the principal at maturity.
I do not agree with Representative Patman’s reasoning; whether,
in fact, the Federal Reserve should turn over the securities to the

FEDERAL RESERVE PORTFOLIO

Treasury for cancellation must be decided on political rather than
economic considerations. On economic grounds, such a transaction
would have no effect. Since the Fed returns its profits to the Treasury
(after meeting its own operating costs), the Treasury is, in effect,
paying interest to itself on securities held by the System. When the
Federal Reserve decided to purchase the securities from the public,
it was, in effect, monetizing existing debt. No further interest pay
ments would be made to the public as long as these securities remained
in the Federal Reserve portfolio. It is the publicly held debt alone
which is relevant when evaluating the degree of liquidity in the econ
omy. So long as the Federal Reserve System is charged with the re
sponsibility of monetary policy, the Treasury should continue issuing
interest-bearing debt to meet its budget deficits (rather than printing
money), and Fed should buy and sell such quantities of securities as
may be necessary to achieve the desired degree of monetary restraint.
It is a matter of economic indifference whether the securities are turned
over to the Treasury for cancellation, for such a transaction would do
nothing but alter subsequent bookkeeping entries. The Treasury would
cease to credit the Fed with the interest on the securities but, by the
same token, the earnings of the Federal Reserve which are turned
over to the Treasury would be smaller by the same amount. The money
supply, interest rates, and public liquidity would all remain unaffected.
On political grounds, however, I would strongly oppose the Patman
proposal since it might lead to a reduction in the degree of independence
of the Federal Reserve. Under our system, fiscal policy is the respon
sibility of the Treasury. The Treasury sells securities to meet budget
deficits and retires debt if a surplus develops. Debt management
policies should be designed to minimize the total cost—in interest and
administration—of servicing the debt. Given the Treasury’s opera
tions, it is in the domain of the Federal Reserve to formulate monetary
policy so as to achieve the optimal level of bank reserves and the desired
degree of liquidity in the hands of the public. Such a division of
responsibility would have prevented the situation which occurred in
the late forties. At that time, the Treasury felt the need to keep
interest rates pegged at unrealistically low levels because of the cost of
servicing the large wartime debt; the Federal Reserve was prevented
from taking the steps necessary to fight inflation. I f the Federal
Reserve were to turn over the securities which it buys to the Treasury
for cancellation, pressure might develop from the latter agency for
the Fed to step up its purchases in the interest of “saving the Govern
ment money” ; also, open market sales might be criticized by Members
of Congress as “spending the taxpayers’ money.” Certainly, in the
literal sense, these transactions presently have such effects, but it must
be recognized that the economic cost involved (in terms of the in
creased “tax burden” due to servicing the publicly held debt) should
be far outweighed by the benefits of an optimal monetary policy. Polit
ically, it has always been much easier for Congress to justify low in
terest rates than high. Since the Federal Reserve is, or should be,
independent of political pressure, its members are much freer to pursue
that monetary policy which is best in the public interest.
Turning to the question of the maturity structure of the Federal
Reserve portfolio, I believe that it would be a good idea to increase the
emphasis placed on securities over 1 year. Up until 4 years ago, open

FEDERAL RESERVE PORTFOLIO

market operations were confined to “bills only,” because it was felt
these operations would be least disturbing to the money market. The
reasoning was that the bill market is the most developed and can
absorb large transactions; also given interest rate changes in short
term securities lead to smaller price changes and are thus less upsetting
to the asset holders. While these arguments still apply, the Federal
Reserve has moved into the long-term area in an attempt to “twist” the
yield curve. Because of balance-of-payments considerations, the aim
has been to keep short-term rates high; but because of the desire to
encourage private domestic investment, the goal has been to keep long
rates relatively low. Although operations in the long-term area have
been rather limited, they apparently have been successful at altering
the structure of rates. Since different institutions hold securities of
different maturities, and since the average maturity of the publicly
held debt is a relevant liquidity consideration, the Federal Reserve
might be able to increase the scope of domestic monetary policy by ex
panding its operations in the longer maturity ranges. In addition,
although the evidence is by no means conclusive on this point, it can be
argued that such operations would improve the market for longer
term securities.
It would be interesting to explore the possibility of the Federal
Reserve acquiring securities issued by the private sector. Virtually
since its inception, the Fed has dealt in bankers’ acceptances with the
expressed aim of improving the market for these instruments. Be
cause the total volume of acceptances is very small and the market is
relatively thin, the Fed cannot substantially expand its operations
here, nor can acceptances become a major vehicle for monetary policy.
It is conceivable, however, that open-market operations could be con
ducted successfully in the negotiable time certificates of deposit (CD’s)
issued by the major commercial banks. The CD market is fast be
coming a close second to the Treasury-bill market in terms of depth,
breadth, and resiliency; dealer bid-ask spreads are usually only two or
three basis points for certificates in the 90-day range and outstandings
are in the neighborhood of $16 billion. Therefore, the Federal Re
serve could probably operate in this market without being an unduly
disturbing influence. By buying and selling CD’s, the Fed could
directly influence the interest rates paid on time deposits by major
commercial banks. Since CD’s are a major source of funds, rates in
this instrument probably have a strong influence on the lending policies
of the big banks. Therefore, operations in CD’s, which ultimately
would have the same effect on bank reserves as dealing in Governments,
would have an additional effect which might reduce the lag in monetary
policy. Finally, it can be argued that the CD has replaced the Treas
ury bill as the fulcrum of the money market, that is, that various
short-term instruments are very close substitutes to the CD, and their
yields revolve around the rate on CD’s. Recently, 3-month CD rates
have averaged some 40 basis points above the Treasury-bill rate: com
mercial paper, acceptances and municipals have been offering yields
comparable to the CD. The historically high spread over Treasury
bills may reflect in part the fact that bills are appealing to a somewhat
different group of investors. Open-market operations which directly
affect rates on CD’s could perhaps alter more quickly the rates on com
mercial paper (since the two instruments are sharp competitors for

FEDERAL RESERVE PORTFOLIO

corporate short-term investment funds) than could operations directly
affecting Treasury-bill yields. In turn, lending policies of finance
companies might be more promptly influenced. In short, open-market
operations in CD’s coupled with discretionary changes in regulation
Q (which sets the maximum interest rates payable on time deposits)
could add a potentially powerful weapon to the monetary policy tool
kit. The apparent success of “operation nudge” would seem to indi
cate that institutional factors do exist which lead to a somewhat differ
ent impact when the vehicle of open-market operations is altered.
This experience tends to buttress the possibility of advantageous effects
resulting from operations in CD’s.
To summarize, I beileve that there would be no substantial economic
effects if the Federal Reserve were to turn its portfolio of Governments
over to the Treasury for retirement. I would oppose such a develop
ment on political grounds as it might reduce the independence of the
Federal Reserve. I would recommend that the Federal Reserve exand its open-market operations in the longer term issues. Finally,
suggest that serious consideration be given to conducting some openmarket operations in certificates of deposits since such a move might
increase tne effectiveness of monetary policy.

S t a t e m e n t b y B e n j a m i n H aggott B e c k h a r t , P rofessor E
of B a n k i n g , C o l u m b ia U n iv e r s it y , N e w Y o r k , N . Y

m e r it u s

In response to your letter of September 1, 1965, respecting the
open-market portfolio of the Federal Reserve System, if I may, I
should like to reply to your questions seriatim:
1. I do not believe that the open-market portfolio of the Federal
Reserve System should bear any definite or mathematical relationship
to the money supply, to gross national product or to the aggregate of
liquid assets.
2. The amount of Government obligations in the open-market port
folio of the Reserve System and the maturity distribution of those
obligations should be determined exclusively by the Federal Reserve
System in the light of its general credit policies of the moment.
3. The Federal Reserve System has on occasion used bankers’
acceptances and foreign exchange to supplement its portfolio of Gov
ernment obligations and might well do so in the future.
In fact the U.S. Treasury and the Reserve System have intimated
that they might hold substantial amounts of foreign exchange, once
the deficit in the U.S. balance of payments was eliminated. If they
were to hold, for example, as many German marks as the German
banking system has held American dollars, the total might reach the
equivalent of $2 billion.
4. The Federal Reserve System should not purchase municipal se
curities, corporate securities, mortgages, or commodities. The System
would have to pass on the credit risks involved and make compari
sons, for example, between one municipality and another. Compari
sons of this type, would soon place the Reserve System in the center
of political controversy. Similarly it should not purchase commod
ities. Action of this type would shortly involve it in price raising and
fixing operations.

FEDERAL RESERVE PORTFOLIO

The Government obligations which the Reserve banks have pur
chased over the last 5 years have been acquired to offset the effect of
gold exports and of the rise of money in circulation on member bank
reserves. The System has, in effect, pegged the long-term rate of
interest, no doubt with the full support and approval of the Treasury
Department. In my opinion, action to offset the full effects of gold
exports and of currency increases has been a mistake. The long-term
rate of interest should be permitted to rise to rectify the imbalance
in our balance of payments. Such is the policy which has been fol
lowed by other nations.
I f the U.S. Government insists on a pegged long-term rate, the
Federal Reserve System will not be able to protect the dollar in freely
functioning foreign exchange markets. Either very extensive foreign
exchange controls will have to be adopted, supplementing those al
ready in existence, or the dollar will have to be devalued.
I f one keeps in mind the fundamental accounting equation, that
assets equal liabilities plus proprietorship, one realizes that assets can
not be transferred from the Reserve System to the Treasury without
impairing the capital funds of the Reserve banks. Even if the capital
were not to be impaired, such an operation would be completely un
justified. The Reserve banks turn over the bulk of their net earnings
to the Treasury.
Statem ent

R ic h a r d L . B olster , L o n g m e a d o w , M a s s .

The question regarding transfer to the Treasury of some of the
Federal Reserve System’s portfolio as a means of debt reduction
appears as academic since that portion of the debt held by the System
is already effectively canceled in much the same way as a credit bal
ance in the cash section of a stock account offsets the debit balance
in the margin section. Moreover, the System pays over to the Treasury
its earnings after subtracting operating expenses. Since these are
very small compared to earnings they are likely to be largely covered
by discount earnings leaving most or possibly all of the portfolio in
come for the Treasury in any event.
More constructive may be the removal of reserve requirements for
time deposits since loans originating from the latter represent a con
version of saving rather than credit in the true sense as generated from
demand deposits, the latter being the proper province of credit control.

S tatem ent b y W
R obert B r a ze l t o n , P rofessor of E
U n iv e r s it y of M isso u r i , K a n s a s C i t y , M o .

c o n o m ic s ,

The question of the Federal Reserves’ “holdings of Governments”
to the extent of $39 billion is an important one. I wish to make some
comment on this subject. First, however, I would like to give my
views on a letter mailed to me and others from E. Sherman Adams
on the issue of reserves behind saving deposits.
On two points Mr. Adams is correct. The present reserve require
ments of banks in relation to savings deposits as compared to other
thrift organizations is discriminatory against banks. Also, the reserve

FEDERAL RESERVE PORTFOLIO

requirements against savings deposits serve no purpose in relation to
monetary policy. However, he errs when he maintains that since the
reserves do not serve a policy purpose, they should be eliminated. Re
serves were not instituted for purposes of monetary policy. They were
instituted for purposes of liquidity and safety. Therefore, instead of
abolishing reserves behind savings, I would urge that all savings in
stitutions have similar reserves and that these reserves need not neces
sarily be substantial.
One advantage that Mr. Adams claims for the freeing of these re
serves is an increase in credit for expansion. True. However, it seems
to me that a more effective and dynamic method of increasing long-term
credit for growth is already available to us in the effective use of mone
tary and fiscal policy. Thus, Mr. Adams will have to use another argu
ment to win my support on that issue.
The central issue of Representative Patman’s interest and that of the
Joint Economic Committee is of the substantial holdings of Govern
ments by the Federal Reserve. The total is now $39 billion. As Repre
sentative Patman pointed out, not all of this $39 billion in Government
holdings at the Federal Reserve is necessary for open-market opera
tions. From June of 1964 to June of 1965 gross sales of all U.S. Gov
ernment securities by the Federal Reserve on the open market never
exceeded $1 billion and only in November of 1964 was the net change in
U.S. Government securities held by the Federal Reserve in excess of a
billion dollars. Why then does the Federal Reserve hold $39 billion
in Governments ? The answer is obvious. The increase in the Federal
Reserve holdings has been necessary to expand the money supply so
that the growth of the economy can take place.
The debt held by the Federal Reserve, however, should not be can
celed as Mr. Patman’ desires. I do not say this from a strictly economic
viewpoint. A cancellation of the repaid debt that the Federal Reserve
owns (as is, I understand, the purpose of H.R. 7601) would lower the
outstanding debt, allow the Treasury more leeway in deficit financing
to stimulate the economy, and lower the interest payments necessary
to service the debt at its present level. It is my professional opinion
that all of these effects would be economically desirable. However, a
question must be asked. Would the cancellation of even part of the
debt held by the Federal Reserve lead to (1) the lack of confidence in
the money market oyer the safety of holding Government debt for fear
of further cancellation and/or (2) the opening of the door for the can
cellation of the public debt held by other financial institutions ? If
either or both of these developments occurred a financial panic might
be brought upon the entire money and capital market system. For this
reason and for these fears (and as an economist perhaps I understand
the importance of confidence more than a noneconomist) I am reluct
antly forced to oppose the bill for cancellation of the Federal Reserves’
holding of bonds regardless of whether they are matured or not.
There is, however, another reason for my not supporting the bill
for cancelation of the matured Government holdings of the Federal
Reserve. These holdings serve as part of the base for the entire
monetary system. Thus, any question concerning the holdings of the
Federal Reserve is not solely a question of open market policy but is
also one of the backing of the monetary system itself. This point
should hot be missed. Representative Patman’s proposal stresses the

FEDERAL RESERVE PORTFOLIO

fiscal effect of the bond holdings of the Federal Reserve as a cost to the
Treaury without considering the bond holdings of the Federal Reserve
as a significant part of our monetary backing. Therefore, even if the
present matured bonds were canceled they would have to be at least
replaced by non-interest-bearing notes on the Treasury with a firm
guarantee of repurchase by the Treasury on the demand of the Fed
eral Reserve unless we were willing to take the illogical step of weak
ening the “liquidity” of our monetary backing. Even this policy
may have problems concerning public confidence. Let us not disturb
the monetary system over a more or less minor point. We need to
concentrate on the major problem that confronts us in relation to the
Federal Reserve.
At the present time the more basic problem is not that the Federal
Reserve holds $39 billion in Government bonds of one type or another.
The actual cost of this is more of a paper accounting cost than a real
financial cost. The real problem is that the Federal Reserve has not
allowed for an increase in the liquidity of the economy so that a faster
rate of economic growth can be achieved. For example, in an article
appearing on page 1 of the October 4, 1965, issue of the Wall Street
Journal there is a report in the lead column that bankers are consider
ing an increase in the interest rate. It is further reported that several
large banks have already raised the rate which they charge to finance
companies which, of course, is not going to cost the consumer of the
final goods nothing. Furthermore, according to page 1282 of the Sep
tember 1965 issue of the Federal Reserve Bulletin, free reserves of the
banking system stand at minus $143 million as of the week ending on
August 25,1965. A further look informs one that free reserves have
been on the minus side since March of 1965 as well as in November
of 1964. This is clearly not an “easy” money policy and may indeed
be a “tight” money policy. The Federal Reserve is not making re
serves available or is absorbing any excess reserves so that interest
rates must eventually increase as there becomes a dearth of funds in
the banking system for lending purposes.
Much economic analysis based upon Keynesian analysis seemed to
prove that “money didn’t matter.” More recent Keynesian, neo-Key
nesian, and post-Keynesian analysis realizes that Keynes never made
such a statement. Keynes was talking about the special condition of
a liquidity trap but did not say that a liquidity trap was a perpetual
state of affairs. As a result, money does matter most of the time and
so monetary policy is not neutral in its effect at all times. Because
of this it is unfortunate that economists in Government and outside
of Government have paid so little attention to the proper role of the
Federal Reserve in relation to economic policy. It is proper for the
Federal Reserve to act in an anti-inflationary manner when inflation
threatens. It is not proper for the Federal Reserve to decrease growth
rates when inflation is not threatening or when they merely fear that
it might. It is true that there seems to be an upward bias in prices.
Recently, however, this upward bias has been slight and has been due
to institutional factors in our economy instead of inflationary eco
nomic policy. Some way must be found to make the Federal Reserve
more effective in maintaining higher long-term growth rates and,
when necessary, acting as an anti-inflationary agent. At present it
seems to me that the Federal Reserve’s policies are so consistently anti-

FEDERAL RESERVE PORTFOLIO

inflationary that they do decrease our long-term growth rates. I
would suggest closer collaboration with the Council of Economic Ad
visers. This, of course, is not going to be an easy task but it is never
theless the more basic problem.
In conclusion, I wish to say I do not agree with cancellation of the
Government debt held by the Federal Reserve because I fear that this
might bring about either a decrease in confidence or an excuse to ex
tend this cancellation to private held debt, as well as a diminution
of the monetary system’s backing. For long-term growth, the econ
omy needs an increase in the money supply and thus an increase in the
means to back it, not less. I feel that a more important problem is
the Federal Reserve’s policy of independently acting in such a way as
to decrease long-term growth rates by what I believe to be a too con
sistent tight monetary policy for the needs of the present times.

S tatem ent

D w ig h t S . B r o th er s , P rofessor of E c o n o m ic s ( o n
L e a v e ) , R ic e U n iv e r s it y , H o u s t o n , T e x .

The large volume of Government securities held by the Federal
Reserve System does raise a number of issues pertaining to monetary,
fiscal, and debt management policy, as you and your fellow commit
tee members well recognize. Instead of attempting to comment on
the full range of these issues I shall, as you request, restrict myself
to several specific points.
Government securities and the institutional practices which have
been developed for effecting transactions in these securities between
the Treasury, the Federal Reserve System, and the private commercial
banks—as well as between these institutions and other financial inter
mediary, industrial, and individual investors—provide a sophisticated
basis for our monetary and financial system. It would not be desirable
to radically alter present arrangements because to do so would be dis
ruptive and involve unnecessary risk. This is not to say, however, that
some alterations—well planned and gradually introduced—would not
be desirable. In the following paragraphs, three such alterations
which I believe warrant serious consideration are indicated.
First, a useful extension of the role of Government securities in the
monetary system would result from requiring commercial banks (and
perhaps, also, other types of financial intermediary institutions) to
hold some part of their reserves in this form. The advantages of such
an arrangement would be as follows:
(a) The Government would be afforded a large and stable volume o f
relatively low-cost credit;
(b) Monetary policy would be more effective because greater control
over the volume of bank holdings of Government securities would be
possible;
(c) Federal Reserve holdings of Government securities in excess o f
amounts deemed necessary for effective open market operations and
avoidance of debt management difficulties could be reduced; and
(d) Banks would be permitted to hold a greater portion of their
reserves in interest-bearing form.
A second alteration in the Federal Reserve System’s portfolio of
financial assets warranting consideration by your committee is that

FEDERAL RESERVE PORTFOLIO

of a relative increase in holdings of other than Government securities.
This could be brought about by expanding the role of rediscounting
and also by extending open market operations into additional sectors
of the securities market. The advantages of this procedure (which
would amount to a revision in the direction of practices followed
prior to establishment of the present dominant position of Govern
ment securities in the operation of the monetary system) would be
as follows :
(a) The ability of the Federal Reserve System to directly influence
the cost and availability of credit to various classes of borrowers would
be increased, thereby permitting effective selective credit control:
(b) The Federal Reserve System would be better able to foster
the development of various sectors of the securities market and the
use of various financial instruments and, thereby, promote the de
velopment of desirable financial practices ; and
(c) In general, the scope and effectiveness of both open market
operations and rediscounting would be increased.
My third and final suggestion which has a bearing on the struc
ture of the Federal Reserve System’s portfolio of financial claims
(but which relates more directly to the liability side of the System’s
balance sheet) pertains to the question of how increases in the currency
component of the money supply should be reflected in governmental
accounts. Because of the convenience which currency affords, the
public, over time, is willing to hold a growing volume of this type
of non-interest-bearing debt instrument. Under present arrangements
the Federal Reserve System is the direct beneficiary of this interestfree financing in the sense that some portion of its asset acquisitions
(and also of its operating profits) is attributable to the currency issue
function. In fact, issues of Federal Reserve notes are usually asso
ciated with Federal Reserve acquisitions of interest-bearing Govern
ment securities. While the matter is perhaps not of fundamental
importance since Federal Reserve assets are really public property
ana also because Federal Reserve earnings are largely transferred to
the Treasury, nevertheless it might be a better arrangement to have
all currency issues (as in the case of coinage) recorded as a direct
obligation of the Treasury. The advantages of such a modification
of the presently established arrangements between the Federal Reserve
and the Treasury in this connection would be as follows :
(a) With the termination of functionless transactions between the
Federal Reserve System and the Treasury associated with the currency
issue process, the risk of public misunderstanding of our monetary
svstem woul d be reduced.
(b) Instead of incremental currency issues being associated with
increases in interest-bearing public indebtedness these issues would be
in 1ieu of such additions.
(<?) The resulting reduction in the growth of interest-bearing Gov
ernment indebtedness and in the volume of Government interest pay
ments would work to make the reported figures easier to interpret
and thereby increase their usefulness as a basis for intelligent discus
sion and policy.
In conclusion, let me state that I do not believe arbitrarily deter
mined criteria should be imposed on the management of tne Fed
eral Reserve System’s portfolio of financial assets and that for this

FEDERAL RESERVE PORTFOLIO

reason I have not addressed my response to the specific questions asked
in the fourth and fifth paragraphs of your letter. However, I do
believe that some alterations in policies and practices currently being
followed might be desirable—alterations which would certainly affect
the Federal Reserve System’s portfolio of financial assets—and I have
attempted to present the cases for each of thèse in the previous para
graphs.
J o in t S t a t e m e n t b y O. H. B r o w n l e e , P rofessor of E c o n o m ic s ,
U n iv e r s it y of M in n e s o t a , M in n e a p o l is , M i n n ., a n d I ra O . S co tt ,
J r ., A ssociate P rofessor of F i n a n c e , C o l u m b ia U n iv e r s it y , N e w
Y o r k , N.Y

1. How large a portfolio should the Federal Reserve System hold
in relation to the money supply, the gross national product, or aggre
gate liquid assets?
Changes of the size of the Federal Reserve System’s portfolio may
provide the means whereby the central bank brings about changes in
the money supply. Such changes in the money supply may be effected
by other means, such as, for example, a change in reserve requirements.
Therefore, there need be no necessary connection between the size of
the portfolio and the money supply, or the GNP, or the aggregate level
of liquid assets. It is true however, as a matter of practice, that
changes in reserve requirements are employed infrequently and, as a
consequence, changes in the portfolio are regularly used to bring about
changes in the money supply and to maintain the desired relationship
between such changes in the money supply on the one hand, and the
changes in the GNP and aggregate liquid assets on the other hand.
In a growing economy, the money supply should grow in correspond
ing fashion, allowing, of course, for the growth of other liquid assets.
Such a growth in the money supply may be provided through increases
in the Federal Reserve System’s portfolio. That is to say, if the Fed
eral Reserve System increases the size of its portfolio, the money
supply and the reserve base of the money system is automatically
increased at the same time, assuming that other factors affecting bank
reserves are held constant. So long as the size of the portfolio is grow
ing, there is no particular need to have a portfolio of any particular
size. Only if the Federal Reserve System wished to induce a contrac
tion in the money supply might there be a need to reduce the size of
the portfolio. In this case, it might be useful to have securities avail
able to sell. In principle, however, it would not be absolutely necessary
to have securities on hand; for the Federal Reserve System might be
given the authority to create its own obligations which in turn could
be sold in the open market and thus used as a means of reducing or
restricting the money supply. Central banks in other countries possess
growth of such statutory authority.
2. Is any other criterion more appropriate?
As explained in question No. 1, there is no particular criterion
which is necessarily appropriate. However, given the present oper
ating practices of the Federal Reserve System, the minimum size of
the portfolio might readily be determined by taking the maximum
reduction in the size of the portfolio during, let us say, the past decade

FEDERAL RESERVE PORTFOLIO

and a half. Such a figure, with allowance for unforeseen contingen
cies, would provide a suitable standard.
3. I f the 'portfolio grows too large compared to this standard, what
should be done with the excess?
The disposition of such an excess should be determined by the de
cision of Congress with respect to the desirable degree of independence
that should be exercised by the Federal Reserve System.
b. Should the assets be trcmsferred to the Treasury for cancellation?
I f it is the sense of Congress that the Federal Reserve System should
regularly apply to the Congress for annual appropriations in order to
finance its operations, any portfolio excess should be transferred to the
Treasury for cancellation.
5. Should the Federal Reserve continue to hold them, draw the mterest, and retwn the unexpended balance to the Treasury?
If, on the other hand, it is felt that the Federal Reserve System
should, unlike the Department of Defense or other governmental agen
cies, be free to operate independently of the congressional appropri
ations system, then the current practice should be followed according
to which the Federal Reserve continues to hold and draw interest upon
its portfolio while returning any excess income to the Treasury. The
implications of this arrangement are, of course, that the taxpayer in
effect finances the operations of the Federal Reserve System although
Congress exercises no direct control over these operations via the ap
propriations system.
6. Gan we design other objective standards by which to guide Fed
eral Reserve portfolio operations?
The size of Federal Reserve portfolio operations should be thought
o f as a means to an end, not as an end in itself. In other words, these
operations should be used in whatever way is appropriate as a means
o f achieving the overall objectives of monetary and related economic
policies.
7. Should we lay down standards relative to the hind of assets to
be held, maturity composition, private versus public instruments?
Normally, the Federal Reserve System will execute monetary policy
in a way designed to provide the economy with price stability and full
employment. Its intermediate objectives will involve the level of in
terest rates and the quantity of money. These intermediate objectives
can be achieved without varying the maturity composition or privatepublic mix of its open-market portfolio. There are persuasive tech
nical reasons for limiting Federal Reserve operations to relatively
short-term obligations of the U.S. Treasury.
8. Should the Federal Reserve supplement its portfolio of Federal
Government securities with other types of assets such as commercial
loam, foreign exchange, municipal securities, corporate bonds, mort
gages, commodities?
In a period of severe economic crisis, consideration might well be
given to the possibility of open-market operations in assets other than
Government securities. Again, some central banks abroad enjoy such
statutory authority. Barring a serious crisis, however, it would prob
ably be better to restrict the central banks’ acquisitions to U.S. Treas

FEDERAL RESERVE PORTFOLIO

ury securities. The reason for this lies on the difficulty of determining
precisely which of the alternative sectors of the capital market should
be selected and for how much support.
Thank you again for the opportunity of participating in your
survey.
J o in t S t a t e m e n t b y K a r l B r u n n e r a n d A l l a n H. M e l tze r , G r ad
u a t e S ch ool of I n d u st r ia l A d m in is t r a t io n , C a r n e g ie I n s t it u t e
of T e c h n o l o g y , P it t sb u r g h , P a .

No critical issues of monetary policy, debt management, or fiscal
policy are raised by the size of the Federal Reserve’s portfolio of se
curities. From the standpoint of monetary policy, the most impor
tant items on Federal Reserve’s consolidated balance sheet is the
volume and rate of change of Federal Reserve monetary liabilities—
reserves plus currency, the monetary base. Unless the proposed
changes in the volume of securities held by the Federal Reserve banks
produce changes in the monetary base, they will have no important
monetary consequences for the economy. I f H.R. 7601 or similar
legislation is enacted and $30 billion of interest-bearing securities are
replaced by the same amount of non-interest-bearing, nonnegotiable
Treasury securities (or by a $30 billion reduction in the net worth of
the Federal Reserve banks), the monetary base would be unaffected.
Such legislation would have no monetary effect.
Debt management and fiscal policy also would be largely unaffected.
Since the Federal Reserve is part of the Government sector, any rele
vant measure of Government debt outstanding excludes the Federal
Reserve’s holdings. Moreover, the Federal Reserve repays to the
Treasury by far the largest part of the interest payments received
from the Treasury. The possible consequences of interest payments
by the Treasury to the Federal Reserve are, therefore, minimized.
Refunding operations that affect the portion of the debt held by the
Federal Reserve are, or can be, carried out in a routine way. In
short, the ownership of approximately $39 billion of Government debt
by the Federal Reserve reflects accounting and institutional arrange
ments that do not have important consequences for the economy.
The question of the use of objective standards to guide Federal
Reserve operations opens an important issue for discussion. Open
market operations are dominated all too frequently by so-called de
fensive operations directed toward reducing interest rate fluctuations
in a narrow comer of the securities market. It would be highly de
sirable to eliminate defensive open market operations. To acnieve
that end; to provide more stable monetary growth; and to reduce
, output, and employment, we recommend the
^ m Market Committee should decide on the ap
propriate growth rate of the money supply, currency, and demand
deposits for a 6-month or longer period.
2. The desired growth rate of the money supply should be translated
into a desired growth rate of the monetary base.
3. At each meeting, the Committee should ascertain that the Man
ager is achieving the target growth rate of the monetary base.

FEDERAL RESERVE PORTFOLIO

4. Authority and explicit responsibility for dealing with changing
money market conditions should be delegated to the Manager with
the requirement that he must maintain the desired growth rate of the
base.
5. The discount windows should be open at a penalty rate.
6. Bankers should be permitted to borrow as much as they desire
at the penalty rate, but changes in the volume of borrowing should
not interfere with the maintenance of the chosen growth rate of the
base.
The essence of the proposal is that banks would solve the problem
of distributing reserves, which is a large part of the money market or
day-to-day problem, by borrowing at a penalty rate. The Federal
Open Market Committee would devote principal attention to choos
ing the growth rate of the monetary base that is appropriate to achieve
policy objectives and would assure that the selected growth rate of
the base is maintained.
Attainment of objectives of monetary policy does not depend on the
use of a particular type of security or maturity class in the conduct of
open market operations. Determination of the securities eligible for
purchase or discount should be left to the Open Market Committee.
Their discretionary authority should not be restricted by the use of
formulas or other restrictions on the portfolio composition of the
Federal Reserve banks. Abolition of the restriction which requires
that a portion of the monetary liabilities be covered by gold or gold
certificates would be a useful step in this direction.
S t a t e m e n t b y H obart C - C ar r , C h a i r m a n , D e p a r t m e n t of B a n k i n g
a n d F i n a n c e , S ch oo l of C o m m e r c e , N e w Y ork U n i v e r s i t y , N e w
Y ork, N .Y

The series of omestions asked by the subcommittee may be classified
into three main issues:
1. The determination of the optimal size of the Government
security portfolio of the Federal Reserve.
2. The disposition of the securities in excess of this optimum or
the income on those excess securities.
3. The determination of the appropriate composition of the
Federal Reserve portfolio whatever its size both as to maturity
and the type of security.
Underlying these three issues is an unstated fourth: namely, the
issue of how much latitude the Federal Reserve policymakers should
have in determining policy in general and the three listed issues in
particular.
My position on the last, unstated but implied, issue is this: The Fed
eral Reserve should have the widest latitude possible within its field
as is consistent with broad national economic objectives. I believe
that the “ independence” of the Federal Reserve serves a useful “check
and balance” purpose and I have no fear that the Fed will use that
independence even mistakenly, to oppose an important and appro
priate national economic policy. I further believe that any confronta
tion with the administration over a specific policy will be resolved on
the merits of the case; if the Fed is right, it will win; if it is wrong,
it will lose.

FEDERAL RESERVE PORTFOLIO

I hold these and views on the first of the three issues. I suggest
that the Fed is appropriately equipped to judge what the optimal size
of its portfolio shall be. Not that there is, in my view, any single
measure, either from among those mentioned in the subcommittee’s
inquiry or from other sources, or any combination, which will yield
a correct answer on that optimum. But since all the Fed does have
the power to alter reserve requirements and since these requirements
are an important determinant of the size of the portfolio, it can be
maintained that only the Fed can judge the exact optimum, if there
is any; others may assume this part of the problem away by assuming
unchanged requirements but such an assumption is unrealistic.
Apart from the reserve requirement consideration and the attendant
consideration of public preferences as among the types of deposits—
demand or time, which carry different reserve requirements—there are
others of importance. Among these are the gold stock and other
sources and uses of bank reserves. If, for example, the gold stock
were to decline further, further purchases of Government securities
would probably be required, so as to maintain the existing volume of
bank reserve, thus enlarging the Fed’s portfolio. If, on the other
hand, the gold stock were to rise abruptly, a reduction in the security
portfolio might be appropriate.
On the first issue, then, it can be said in sum that no one, including
the Fed, can fix a formula for setting the optimal size of the Fed’s
portfolio of Government securities.
The second issue can be solved on the basis of the first. I f no one
can determine the optimal size of the portfolio, it follows that deter
mination of the excess cannot be made. This should not be taken to
mean, however, that is impossible to determine “excess” or unneeded
income accruing to the Federal Reserve. Nor should it be taken to
mean that the Fed “needs” its entire portfolio in its present form
(marketable securities). On the matter of unneeded income, it should
be pointed out that the Fed already returns substantial income to the
Treasury. (I would prefer that this capture be made through a
franchise tax and I suggest that this tax be enacted.) Alternatively,
a part of the Fed’s portfolio could be made to consist of non-interestbearing, nonmarketable securities. Certainly in the sense of having a
sufficient volume of securities for open-market sales, some large part
of the Fed’s portfolio is “excess” and from the standpoint of needed
income to the Fed, there is also an “excess.” It follows, therefore, that
the above alternative is possible, although perhaps meaningless (since
the Treasury already receives the excess income).
On the tnird issue, I again maintain that the Fed should be the
judge—not a statute—of the appropriate composition of its portfolio—
short maturities versus long, public versus private securities. This is
not to say that I have always approved of the Fed’s choice; for ex
ample, I disagreed with the so-called bills only policy. I must admit,
however, that although some harm resulted from the policy, it was
not serious, in my view.
As for my advice to the Fed on the matter, I would say that their
present choice as to maturities and as to private (banker’s acceptances)
versus public instruments are the appropriate ones. Should the sub
committee wish to recommend an expansion of the list of instruments
eligible for purchase, and the Congress wishes to put into law an

FEDERAL RESERVE PORTFOLIO

expansion, I see no great harm (or benefit). Further, if the subcom
mittee wishes to strike from the present list some securities which no
longer exist, I see no harm (or real benefit) in that step either.

S tatem ent

J a c o b C o h e n , P ro fessor o f E c o n o m i c s , U
P it t s b u r g h , P it t s b u r g h , P a .

n iv e r s it y o f

VIEWS CONCERNING THE STRUCTURE AND MANAGEMENT OF THE PORTFOLIO
OF FINANCIAL ASSETS HELD BY THE FEDERAL RESERVE SYSTEM

The Federal Reserve should manage its portfolio of assets primarily
for the purpose of influencing the level of aggregate money demand.
In pursuing this objective it should of course have an eye both to in
flationary possibilities and the monetary requirements of economic
growth. (We would give concern with the balance-of-payments prob
lem a low order of priority.)
The mechanism whereby the Federal Reserve affects ultimate eco
nomic activity is relevant to evaluating portfolio policy. The openmarket operations of the Federal Reserve accomplish several objec
tives. They have an immediate effect on the money supply insofar as
transactions take place with the nonbank public. They incrmse the
reserves of commercial bank. They affect interest rates. As far as
the choice of securities are concerned, whether the operations took place
in Government obligations or corporate securities, the effects on the
money supply and on reserves would be similar. It is with respect to
interest rates that the choice of securities exerts a unique effect. Thus
the purchase of long-term Government securities can be assumed to
have a more immediate effect on the long-term interest rate than would
the purchase of short-term Treasury securities. Similarly the pur
chase of long-term corporate bonds would be assumed to have more
of a direct effect on yields than the purchase of long-term Treasuries.
One should also make a distinction between the new issues market and
the market for outstanding securities. The effect on new borrowings
for the purpose of product expenditures should be much more direct
and immediate if the open-market transactions take place in the new
issues market rather than in the market for outstanding securities.
Given the objective of stimulating given sectors of the economy or
certain types of spending, transactions in corporate securities (bonds)
mortgages, municipal securities, should be a desirable extension of
present open-market practices. More hesitation should be exercised
about extending operations in foreign exchange beyond their present
scope because involved are questions of the relative merits of fixed
versus floating exchange rates. We should also hesitate in recommend
ing commodity transactions since this would mark an unneces
sarily sharp break with the traditional “financial” scope of monetary
policy. Open-market operations as at present constituted are suf
ficient to influence commercial bank lending in the desired direction,
without direct participation of the Fed in this market.
We can see little purpose being served by canceling “ Governments”
held by the Federal Reserve. Presumably some equivalent certificateirredeemable and noninterest bearing to be sure—would have to be
issued by the Treasury in its place. But if the excess of interest in-

FEDERAL RESERVE PORTFOLIO

come over expenses are returned to the Treasury as at present, Fed
eral Reserve holdings are already free of interest cost. As far as the
principal is concerned, the rolling over of the debt by the Treasury—
if it chooses to do so—makes it a perpetual obligation. The existing
distribution of the marketable debt among the Fed, commercial banks
and the nonbank public together with the “tailoring” features assigned
to new issues, furnishes the Federal Reserve and toe Treasury^ hope
fully acting in harmony) with a powerful and flexible weapon for
policymaking.
S tatem ent

alter

P . C o r r ig a n , N o r th M

ia m i

B each, F la.

In acknowledgement of your inquiry of September 1,1965 concern
ing the solicitation of views pertaining to the “structure and manage
ment of the rapidly growing portfolio of financial assets held by the
Federal Reserve System.” Rather than attempting to answer directly
each of your questions, I have decided to comment briefly on the
August 24,1965, progress report addressed to the “citizens interested
in returning our monetary system to the people of the United States”
from the Honorable Wright Patman, 1136 House Office Building,
Washington, D.C. I have decided to acknowledge the letter of Sep
tember 1 in this way for two reasons: (1) The material contained in
the progress report is very closely related to the subject matter
covered in the questions; (2) my views on a few of the fundamental
points raised in the progress report are a bit less vague than are those
pertaining to a few of the specific questions raised in the September 1
letter. I might add that I am somewhat pressed for time, and this,
then, enhances the importance of reason No. 2.
The Honorable Patman has distinguished himself for many years
for his knowledge of the U.S. money and banking structure and for
his courage in pressing for those reforms he has deemed necessary
to the welfare of the entire Nation. I could not possibly present a
record of experience, by way o f a letter of recommendation for my
views, that would be even within sight of Congressman Patman’s
background of accomplishments. However, for whatever little value
this may be to anyone, I should like to record my disagreement with
several of Congressman Patman’s views. I believe that these are
fundamental points and, therefore, basic to a more advanced analysis
required in answering the specific questions listed in the September 1
letter.
Because of the scarcity of time, that which follows will consist
simply of very brief comments addressed to various statements ap
pearing in the progress report and which I have selected somewhat
at random.
In statement 6 there appear the following words: “Another great
privilege enjoyed by the commercial banks is monopoly. All indi
viduals and corporations desiring checking accounts are compelled
to patronize commercial banks.”
My comment would include the following question: In a single
community why would there be greater competition between a savings
and loan association, for example, and a commercial bank (assuming,
for the moment, that both institutions have the authority to create

FEDERAL RESERVE PORTFOLIO

demand deposits (cheek book money)) than there would be between
two commercial banks %
In statement 6 there appear the following words: “The banks get
free use of the billions of dollars in Federal deposits that are main
tained in the commercial banks. * * *”
My comment would include the following: In part, this is a sendee
to the public. For example, businessmen enjoy the convenience of
depositing their withholding taxes with the same commercial banks
that they have other business to conduct with. Furthermore, it is,
in part, a payment to the commercial banks for services rendered to
the Federal Government such as the expense incurred in selling Treas
ury savings bonds. Furthermore, it is a service to the economy since
it is an effective device for maintaining the quantity of money within
the private economy at a stable level. Remember that the money
within these Federal deposits most likely come from private accounts
with the commercial banks. This is not new money for the com
mercial banks, therefore. One account is debited and another is
credited, and the quantity of money has remained at a stable level.
In statement 5 there appear the following words: “ * * * the com
mercial banking system is priviledged to manufacture money under
the fractional reserve system at a ratio of $10 for every $1 of reserves.”
My comment would include the following: This is a fallacious state
ment since it implies that only the commercial banks can create money.
Many other private financial institutions can do the same thing. For
example, consider the case of a dollar deposited in a savings and loan
association. Most of it is then lent out. The likelihood is strong that
the loan will be placed into the hands of a building contractor who, in
turn, will deposit it in his business account at a commercial bank.
Part of this can be lent out by the commercial bank, and I suppose
that you are referring to this action as the creation of money. Sup
pose, now, that the loan finds its way back into a savings and loan asso
ciation. Now the savings and loan association can do the same thing
that the commercial bank did with the exception being that the savings
and loan association can lend a greater proportion of what they have.
Now you will probably tell me that the deposit with the savings and
loan association is not considered to be a part of the money supply
whereas the demand deposit with the commercial bank is. ih is type
of definition involves some sleight of hand, but even if I should accept it
for the moment, you have overlooked one vital point: The savings and
loan association has increased the velocity of money in the same way
that the commercial bank does this; they have lent out some of the
same money a second time. And anj monetary theorist who knows his
fundamentals will tell you that an increase in velocity has the same
effect on prices, etc., as does an increase in the physical quantity of
money—remember the old equation P equals M times V ?
In statement 6 there appear the following words: “ * * * the peo
ple of the United States are captives of the commercial banks and
they must give the commercial banks free use of their money under
the law.”
My comment would include the following: The type of situation that
you are referring to here could be described in another way: The com
mercial banks, in return for a small deposit from the people, give back
to the people a much larger supply of money, and they do this for a

FEDERAL RESERVE PORTFOLIO

very low fee. Now you have argued that this fee is excessive. But if
I pay 15 cents for a check drawn on a Miami bank and use this check
to pay a bill incurred in South Bend, Ind. (when considering the serv
ice that I receive and the complex structure the check passes through),
then I call this inexpensive. However, I do recognize that this par
ticular issue does depend upon cost data (that I do not have and that
you probably do have) in order that one might make an intelligent
evaluation of it.
In statement 7 there is the following implication: Commercial banks
in the United States are relatively free to do as they please.
My comment would include the following: No private industry of
comparative size is more tightly controlled by the Government today
than is the banking industry. Commercial banks do possess significant
advantages, but also are they subject to very rigid controls. If you
propose to take away some of these advantages, would you also remove
some of these restrictions (such as the restriction on interest rates that
may be paid on savings deposits) ?
In statement 2 there appear the following words: “ * * * these three
agencies have succeeded in setting themselves up on an independent
basis whereby they are able to get their operating funds directly from
the public in the form of interest payments and fees, and bypass the
Congress. * * * Moreover, each of these three agencies conducts its
own examinations and audits of banks. * * *”
My comment would include the following: This is certainly not the
only illustration within the structure of the Federal Government of an
independent agency relying upon funds received directly from the
public. We both are aware of several successful cases of “independent”
and “semi-independent” Government corporations. Furthermore, it
is misleading to say that these entities “bypass the Congress.” Con
gress has the ultimate control over every single one of them. Their
structures have been designed in the way that they have in order that
the so-called political influence might be as far removed from their
business operations as possible. Concerning the duplication of exami
nations and audits of banks, you have supported one of the principles
lying behind this in your words appearing in statement 8. You have
said that your bill “would require that the Federal Reserve undergo
outside audits. * * * “ If one agency examines a bank twice, that is
duplication; if two agencies each examine a bank once, that is con
firmation—all of which is designed, of course, to achieve the eradica
tion of fabrication (or ought we better say simply the mitigation of
conditions that might facilitate the generation of misinformation?).
In statement 7 there appear the following words: “ * * * it is going
to take a real fight * * * to get the three supervisory agencies that
have escaped from congressional control back into the Government and
subject to Presidential and congressional control, where the Members
of Congress, elected by the people in accordance with the Constitution,
can properly review their activities.”
My comment would include the following : O f course these agencies
are subject to Presidential and congressional control. True, they
are not subject to the day-by-day operational control that are other
Government agencies, but this is desirable. To those who doubt this
and who would favor, for example, the proposal to place the central
bank under direct control of the Treasury Department, I would sug
gest a careful reading of the history of the Bank of France.
56-913— 66------ 3

FEDERAL RESERVE PORTFOLIO

In statement 6 there appear the following words: The banks “ * * *
enjoy interest on billions of dollars in Government bonds that were
purchased with the credit of the Nation.”
My comment would include the following: The U.S. commercial
banking system today is stronger than it has ever been in history. One
of several reasons for this is the availability of large blocks of safe
U.S. Government securities. As a result, the banks have invested
heavily in these securities and, therefore, are highly liquid. Of course,
they pay interest; there would be no point in the banks buying these
securities if they did not. Concerning the charge that they were pur
chased “with the credit of the Nation,” for the use of this credit the
banks, in turn, supply the Nation with several services, one of which is
the availability of checkbook money. In conclusion, if there were no
Federal securities for the banks to invest in, where would the banks
place these funds ? In whatever other direction the banks turned the
result would be a decline in liquidity. You might suggest that the
banks leave the funds on reserve, but the banks must invest for income
if they are to continue supplying the Nation with their various services.
In the 1920’s the banks placed a good deal of their funds into real
estate, and this certainly did not mitigate the evils that were to follow
in the early 1930’s.
In statement 5 there appear the following words: Speaking of the
commercial bank reserves, you say, “ * * * the reserves are not actu
ally money set aside, but only a bookkeeping entry in the form of a
credit by the Federal Reserve System.”
My comment would include the following: From the point of view
of the commercial banks, the money is there for they would use it if
their legal reserve requirements were lowered. Furthermore, the rea
son that there is not the volume of hard cash sitting inside the Federal
Reserve that many people think there ought to be is that the Treasury
Department is continually borowing from the Fed and, thus, keeping
the cash in circulation. In turn, of course, the Fed finds it has a
larger and larger volume of Federal securities on its hands—some
thing that you have expressed concern about in your statement 1.
In statement 3 there appear the following words: The banks charge
“usurious interest, excessive service charges * *
My comment would include the following: This statement may be
true; I do not have the quantitative data necessary to make a really
scientific analysis of this issue, but if it is true, why do you not initiate
or support legislation that would permit the banks to pay back to the
public some of the fruits of these excessive charges, namely, the free
dom to pay higher interest rates on savings deposits ?
In statement 6 appear the following words: “In the very depths of
the depression, when Congress was struggling to correct some of the
misery and poverty that afflicted the whole Nation, the banking lobby
slipped through a law that prohibited banks from paying interest on
demand deposits * * *, As a result, the people of the United States
are captives of the commercial banks and they must give the commer
cial banks free use of their money under the law.”
My comment would include the following: There may be some truth
in the first sentence, but surely you must know that no banking law is
violated more than (or, in fact, as often as) by the commercial banks
as section 19, statement 13 of the Federal Reserve Act. This would

FEDERAL RESERVE PORTFOLIO

seem to indicate that many bankers do not look with favor upon this
legal prohibition.
In statement 1 there appears the following argument: U.S. bonds
held by the Federal Reserve have been paid for once and will “have to
be paicl again when due. This is similar to a situation where a house
owner paid off his mortgage and was then required to continue paying
interest on it, and then pay it off again when the maturity date comes
around. It would be illegal and absurd in the case of an individual,
but that is exactly what the Government is required to do under our
present banking structure.”
My comment would include the following: I have saved this argu
ment for the concluding part of my letter for two reasons: (1) Con
gressman Patman apparently believes that this is his strongest and
most important argument—he refers back to it again and again. (2)
From my point of view, it is the most erroneous of his arguments.
Before presenting my comment, I ought to preface it with the follow
ing statement. I strongly suspect that there is something quite basic
here that I am confused on. Perhaps my chain of thought here is
even less clear that it has been in my wanderings through the previous
statements; I say this because Congressman Patman?s argument ap
pears so absurd I find it difficult to believe that the words mean what
they seem to mean. I would agree that commercial bank ownership
of Federal Reserve stock is a sleight-of-hand procedure disguising the
fact that the Federal Reserve really represents the U.S. Government,
and, therefore, bonds sold to the Fed are paid for by the Government;
but, remember that these bonds are sold to the Fed by the Treasury
which certainly represents the Federal Government as well. This is
like moving a dollar bill from my left pocket to my right. I may
certainly want to know that the dollar is now in my right and not my
left. But, if later I should move the dollar back to my left, have I lost
anything? You may complain of the left paying the right interest
while the dollar is in the right pocket. But remember that the right
will later on pay back to the left the major portion of all of its profits.
Now let us consider the issue in straightforward terms. After the
Treasury sells bonds to the Fed, it places these funds into the private
economy to pay its bills. Later it will draw money out of the economy
in the form of taxes and pay off the bonds. The Treasury and the Fed
will then be back where they began. I f you should complain that the
Treasury is not buying back all of these bonds, then this is a problem
of insufficient taxes. Refer the matter to Chairman Mills. The point
is that the Federal Reserve is simply a go-between here; the entire
operation could be handled in other ways. For example, suppose that
the Treasury printed paper money, paid its bills with these funds, later
pulled the money back out of the economy through the use of appro
priate tax rates, and then burned the money. The ultimate effect
would be the same as it is with the Treasury using the more “politi
cally” acceptable method of the Federal Reserve acting in the capacity
of a go-between. There might be one difference, however; under the
present method the Federal Reserve can act as a restraining force on
any impulsive, temporary, and extravagant acts of the Treasury—acts
that could more easily occur were the Treasury given greater freedom
in the use of its printing press.

24
S tatem ent

FEDERAL RESERVE PORTFOLIO
by

M a r r in e r S . E ccles , C h a i r m a n of t h e B
S e c u r it y C orp ., S a l t L a k e C i t y , U t a h

oard ,

F ir st

I have read your letter with interest and note you want my com
ments relative to the growth of the Federal Reserve System Govern
ment securities portfolio and also several other issues. I have just
read Chairman Martin’s statement before your committee and also
his letter to you of August 19,1965, in response to your letter of July 15
in which he answers a number of questions raised by you and other
members of the committee. I am in general agreement with the
position taken by Chairman Martin so that further comment by me
would be superfluous.
S tatem ent

I ra

T. E l l is , E c o n o m is t , E . I . d u P o n t
Co., I n c ., W il m i n g t o n , D e l .

N em ours &

It is a pleasure to give you my views on the questions raised in Mr.
Patman’s recent letter concerning Federal Reserve management of its
portfolio of Federal securities.
It is true that Federal Reserve holdings of Federal securities rose
$15 billion over the past 10 years, to $39.2 billion, but almost one-half
of this rise was related to the decline of $6.8 billion in our monetary
gold stock since 1955.
Another reason for the relatively rapid rise in Federal Reserve
holdings of Federal securities to expand bank reserves over the past
decade was that loans and investments of commercial and mutual sav
ings banks in mid-1965 were up 85 percent from their total in June
1955. The rise in “real” gross national product over this period was
only 38 percent. This situation represents true “inflation” ; i.e., ex
pansion of bank credit at a rate faster than the corresponding rise in
real output of the economy. A slower rate of expansion of bank credit
over the past 4 years would have required a lower rate of purchasing
Federal securities by the Federal Reserve System.
^I believe the size and composition of the portfolio of Federal securi
ties held by the Federal Reserve System should be determined by the
Federal Reserve authorities on the basis of their judgment of the need
to provide bank credit in the economy. Federal securities are an ap
propriate instrument for purchase by the Federal Reserve to expand
bank reserves. There is a sufficient supply of Federal securities in
existence, and the supply continues to grow by authority of congres
sional action. There seems to be no need to substitute other kinds of
securities in central bank reserves.
Certainly, there should be no suggestion that Federal securities
owned by the Federal Reserve should be returned to the Treasury
and canceled. This procedure is tantamount to “running the printing
presses.” Congress should authorize Federal tax rates. Federal
spending, and, therefore, the magnitude of the Federal debt.
An independent Federal Reserve should determine monetary policy.
Certainly, thé money-creating power of the central banks or of com
mercial banks should not be used to provide spending power for the
Federal Government in peacetime. The Federal Reserve should re
main free to buy and sell Federal securities in the market, to hold
appropriate quantities, to draw interest on them, pay its expenses and
dividends, and return the unexpended balance to the Treasury.

FEDERAL RESERVE PORTFOLIO
S tatem ent

n o m ic s ,

il l ia m

ale

J . F e l l n e r , S t e r l in g P rofessor
U n iv e r s it y , N e w H a v e n , C o n n .

I am sure all members of the economics profession consider it a
privilege to be called upon to try to clarify matters that have become
controversial between personalities prominent in the making of eco
nomic policy. My views may be expressed in the following three
paragraphs:
(1) The Government security holdings of the Federal Reserve Sys
tem should, in my opinion, give rise to no misgivings whatever, as long
as we are satisfied with the allocation of Federal Reserve profits be
tween the shareholders and the Government—as I take it we are. Un
less we should want to consider the Federal Reserve banks Government
agencies in the sense proper—and I would not suggest so considering
them—the Government cannot be said to pay for the securities at the
time when the System buys them, but the Government must be re
garded as paying for the securities on the one and only occasion when
they mature. Even on the interpretation that the Federal Reserve is
“ essentially part of the Government”—an interpretation which in this
context I find inappropriate—the conclusion would still be that the
Government pays only once, because on this interpretation the “Gov
ernment” would have to be considered as paying on the one and only
occasion when the Federal Reserve System acquires the securities.
In other words, I am in agreement with Mr. Martin’s statement, and
I feel convinced that no useful purpose would be served by imposing
on the System rules requiring the transfer of securities to the Treasury
for cancellation. I do not even see what assets the Federal Reserve
banks could carry on their books under such rules; that is to say, what
assets they could carry as against their corresponding liabilities,
which after all are not liabilities vis-a-vis the Treasury but are liabili
ties vis-a-vis the commercial banks.
(2) I feel convinced that it would be unfortunate to let the Fed
eral Reserve System buy corporate bonds, make corporate loans,
etc.—that is to say, to let the /System enter into a direct relationship
with individual users of bank credit—since the Federal Reserve banks
should not take it upon themselves to favor or to penalize various
users. The function of the allocation of bank credit should be left
to the market.
(3) I feel convinced that it would be unfortunate to lay down
rules as to the proportions in which the Federal Reserve banks
should hold the different kinds of assets they are now holding. This
proportion must be allowed to change with business conditions, and
the Federal Reserve should be allowed to use its judgment in the
appraisal of these conditions. I may add that I hope that as the
present expansion continues the money market will be sufficiently
tightened to enable the authorities to remove the measures of capitalexport control which were introduced this year, and to remove also
the earlier interest-equalization tax. These are undesirable discrim
inatory measures.
These are the views I take the liberty of submitting in response
to your inquiry.

FEDERAL RESERVE PORTFOLIO

S t a t e m e n t of C h a r l e s A. F r a n k e n h o f f , P rofessor of E c o n o m ic s ,
C ollege of S o c ia l S c ie n c e s , U n iv e r s it y of P uer to R ic o , R io
P iedr as , P .R .

In my doctoral thesis, “The Economic Independence of the United
States Monetary System,” I came to the unfashionable conclusion
that the Federal Reserve monetary authority is not the powerful, in
dependent institution it appears. As a political structure, it cer
tainly has considerable independence, especially when one considers
its freedom from congressional budget committees. Economically,
however, it is an integral part of the U.S. monetary structure.
The Federal Reserve is not, I believe, an independent variable in
the money market. It serves that market to stabilize it, to help it
grow solidly, to protect it from sudden changes in exogenous forces.
It does not rule the market. You recall very well, I am sure, the
Federal Reserve-Treasury accord in March 1951. Prior to that
time we had no monetary policy worthy of the name. In other
terms, the Federal Reserve monetary authority depends on the con
tinuing existence of a strong open market. If the Federal Reserve
foolishly seeks to dominate that market, it will immediately destroy
its freedom. The dealers will withdraw their initiative. They will
not make a market.
In the last 4 years I have been out of contact with the changes
(detailed) which have taken place in the Fed’s portfolio. My work
has been in connection with the development of an economic housing
policy which is to be found on the same spectrum with monetary
policy and fiscal policy. For this reason I shall not attempt to
answer your provocative questions.

S t a t e m e n t b y T h o m a s G . G ie s , P rofessor of F i n a n c e , G r ad u ate
S ch o ol of B u s in e s s A d m in is t r a t io n , U n iv e r s it y of M ic h i g a n ,
A n n A rbor , M i c h .

In brief, my recommendations are as follows:
1. The present system of Federal Reserve bank ownership of
Treasury issues should be continued essentially without modification.
That is, there should be no upper limit on the portfolio of the Fed
eral Reserve, despite the fact that there is evidence of substantial
secular growth in this portfolio. Such accumulation of securities
does not represent absorption of economic resources of the Nation
and, therefore, while purchase represents effective payment by an
agency of the Government for the debt, it constitutes no real burden
on the Nation. While present arrangements for financing operations
of the Federal Reserve are somewhat unique, they function very
satisfactorily and involve neither burden nor special risk to respon
sible use of public money. There is clear parallel between accumu
lation of securities by the Fed and accumulation by Federal trust
funds.
With respect to payment of interest to the Federal Reserve on
these securities, I recommend continuation of the present arrange
ment under which Federal Reserve income in excess of operating ex
pense be returned to the Treasury in the form of a special tax. My

FEDERAL RESERVE PORTFOLIO

experience with Federal Reserve budget administration convinces me
that the present arrangement has not given rise to excessive or profli
gate operating budgets by the Reserve banks or the Board of Gov
ernors.
2. With respect to the proposal to lay down standards relative
to the type of assets to be held (including quality, maturity, public
versus private issues), I recommend only general guidelines designed
to prevent gross misuse of the monetary authority. I feel that
maximum freedom and flexibility of action for the monetary admin
istration in selecting the particular issues should be preserved.
The theoretical issues involved in the area of financial markets
and types of securities—government versus private issues, short
versus long maturities, etc.—are not at this time well enough estab
lished to consider embodying instructions in statutory form. Rather,
it is of importance to leave “elbow room” from the monetary authority
to explore new methods and modify old methods in the area of open
market operations. Circumscription of operations by statute or regu
lation would be contrary to the long-run interests of good monetary
management.
S tatem ent

J . A . G r e e n e , J r ., D e a n , S ch o o l of B u s in e ss A d m i n
U n iv e r s it y of S o u t h e r n M is s is s ip p i , H attiesbu r g ,

is t r a t io n ,

M is s .

I am not concerned with the dollar amount of Government securi
ties the Federal Reserve holds. Why they must continue to build
their holdings is of more concern to me for as you know this is the most
inflationary method by which the Treasury can finance deficits. You
were concerned that in 1958 the commercial banks added $10 billion of
Government securities to their holdings. I was, too, but I would have
been more concerned if the Federal Reserve had had to purchase them.
I do not think it was ever intended that the Federal Reserve would
reluctantly wind up with more Government securities than it thought
feasible to hold. I can see nothing wrong with disposing of these
either to the public or to the banks if it can be done without upsetting
the economy or Treasury financing. I f the Treasury issues a bond
and considers it a bona fide debt of the Federal Government, then this
bond may be bought and sold freely just as the debt of General Motors.
Therefore, I think the Federal Reserve? with full cognizance of its
public responsibilities, should have the right to decide on the basis of
its knowledge of the economy, the banking system and the money sup
ply whether it should dispose of some of its holdings to the public or
to the banks.
Frankly, sir, I would be appalled at the idea of making the Federal
Reserve solely a moneymaking tool of the Treasury by removing its
independence. This I perceive to be your intention after reading
parts of “A Primer on Money.”
Since I have a great deal more confidence in the opinions of the
Board of Governors who are dealing with these matters constantly
and are less subject to political pressures than Members of Congress,
my principal recommendation is that decisions relating to monetary
matters be left up to the Federal Reserve by Congress.

FEDERAL RESERVE PORTFOLIO

I am definitely opposed to transferring the securities back to the
Treasury for cancellation. I do not think standards relative to the
kinds of assets to be held by the Federal Reserve should be imposed.
I do not think the portfolio of the Federal Reserve should be m any
proportion to another flexible criterion. In fact, as time brings
changes and crises must be met, I merely ask that the Federal Reserve
be staffed with competent people and be given the flexibility to meet
its responsibilities.
S t a t e m e n t b y W a r r e n J . G u s t o s , C h a i r m a n , D e p a r t m e n t of
F in a n c e a n d S t a t is t ic s , C ollege of B u s in e s s A d m in is t r a t io n ,
D r e x e l I n s t it u t e of T e c h n o l o g y , P h il a d e l p h ia , P a .
HOW LARGE A PORTFOLIO SHOULD THE FEDERAL RESERVE SYSTEM HOLD IN
RELATION TO THE MONEY SUPPLY?

Currently, Federal Reserve holdings of U.S. Government securities
are in excess of $39 billion. With present reserve requirements only a
fraction of this amount is necessary to insure that the Federal Reserve
has the ability to control any undesirable expansion of the money
supply. Transfer of some of these securities to the Treasury for can
cellation would reduce the administrative costs of transferring tax
collections to the Federal Reserve in the form of interest payments,
part of which is then returned to the Treasury because they are excess
earnings of the Federal Reserve.
Nevertheless, legislation to permit such transfers and cancellations
of Government securities held by the Federal Reserve would have to
define the portfolio level the Reserve would be allowed to hold. Pro
visions would have to be made for increases in this ceiling so that as
the economy grew, the Federal Reserve potential for controlling unde
sirable expansions also increased and to permit the Federal Reserve
to hold sufficient earning assets to meet secularly increasing expenses.
More important such legislation would be foreign to the popular con
cepts of the economic relations between the Federal Reserve and the
Treasury and of the economic significance of the public debt. I f the
public can be persuaded of the soundness of this legislation, then it
is worthwhile considering more deep-seated changes to achieve better
fiscal monetary coordination, the principal reasons for past rejection
of many of which has been tradition. For example, devise legislation
which would make the Federal Reserve fully responsible and fully
accountable for debt management.
CAN WE DESIGN OBJECTIVE STANDARDS BY W H ICH TO GUIDE FEDERAL
RESERVE PORTFOLIO OPERATIONS ?

Federal Reserve portfolio operations are enormously complicated,
because these are a whole series of Government agencies which are, in
effect, dealing in open market operations and whose operations have
an impact on the supply of money. Most important of these is the
Treasury. The Federal Reserve problem is further complicated by
the wide range of Government securities that are now used. One
consequence has been lumpy and sporadic refinancing by the Treasury.
The continual erratic shifts in the maturity distribution of Govern
ment debt mean that the Federal Reserve must always be engaging in

FEDERAL RESERVE PORTFOLIO

neutralizing open market operations to bring about shifts in the money
supply in order to prevent shifts in the price level. The frequently
claimed money market myopia of the Reserve is in part caused by the
policy with respect to types of Government debt instrument used.
One reason given for this policy is the need for countercyclical bal
ances. Issue short-term debt in recessions to increase liquidity, issue
long-term debt in booms to decrease liquidity. In practice, however,
such counterbalancing has not occurred. Another reason given for the
policy is that security tailoring minimizes Government interest costs.
Minimization of interest costs, however, cannot be a primary objective.
If it was, interest payments could be reduced to zero by monetizing
the debt. Nor is it clear that, in fact, tailoring will minimize total
Government costs. Thus, what if shortening the maturity of the debt
brings about an increase in all prices, including prices of all the goods
and services the Government purchases.
One way to reduce the need for devising standards to guide Federal
Reserve portfolio operations would be to drastically simplify the
Government debt structure. Limiting maturities, for example, to
several durations and providing for periodic and substantially equal
refinancings would greatly reduce the need for Federal Reserve
counterbalancing operations and the criteria for determining what and
when these counterbalancing operations should be.
SHOULD THE FEDERAL RESERVE SUPPLEMENT ITS PORTFOLIO OF GOVERNMENT
SECURITIES W ITH OTHER TYPES OF ASSETS SUCH AS COMMERCIAL LOANS
AND CORPORATE BONDS

Government debt privately held is sufficiently large—in excess of
$150 billion currently—to permit the Reserve to finance any desirable
increase in high-powered money. To empower the Federal Reserve
to acquire other types of earning assets must thus be justified on non
monetary grounds. I see no reason to suppose that the Federal Re
serve has any comparative advantage in the banking business; that is,
private lending. I f there are serious imperfections in the capital
markets, then it is better to deal directly with these by focusing on
private lending institutions and the legislation regulating them.

S tatem ent

B u r to n * C . H a l l o w e l l , P rofessor of E
U n iv e r s it y , M id d l e t o w n , C o n n .

c o n o m ic s ,

esleyan

I view monetary, debt management, and fiscal policies as a package
of methods available to implement our national economic objectives
of high employment, steady growth, and reasonably stable price levels.
I believe that the authorities who have immediate operational responsi
bility for these policies—the Federal Reserve, Treasury, and executive
branch—must not only cooperate in attaining the objectives stated, but
be provided wide discretionary powers in the uses of these policy
instruments.
The question at hand, therefore, is whether additional restraints
should be placed on the portfolio of assets which the Federal Reserve
can buy, sell, and hold in its operations. Specifically, the question is
whether the volume of Government securities now held by the Federal

FEDERAL RESERVE PORTFOLIO

Reserve should be limited in some way. To do so, in my judgment,
reduces the potential flexibility of the Federal Reserve in attaining our
national objectives without any comparable gains.
The argument that the Government would gain by reduction in
interest payments on the debt is largely obviated by the arrangement
whereby the Federal Reserve turns over to the Treasury an over
whelming share of its net profits in the form of interest on Federal
Reserve notes. The argument that fewer Government security hold
ings by the Federal Reserve would prevent further substantial reduc
tions in reserve requirements, offset in part by sales of Government
securities to the private sector, seems to settle this issue by legislation
on the assumption that it would not be settled on its own merit. The
view that the Treasury pays twice for its debt, once when the Federal
Reserve buys it from the public and again when it retires it from the
Federal Reserve, I cannot understand, much less evaluate.
I conclude that we should impose no new criteria concerning the
volume or type of assets that the Federal Reserve can buy, sell, or hold
and that we should not cancel any portion of the Federal debt now held
by the Federal Reserve.
S t a t e m e n t b y J o h n J . H a r r in g t o n , J r ., A s s is t a n t P rofessor of
F i n a n c e , D e p a r t m e n t of F in a n c e , S e t o n H a l l U n iv e r s it y , S o u t h
O r a n g e , N.J .

I do not believe that it is possible to use money supply, gross na
tional product, total liquid assets, or any other financial or economic
aggregate to measure the adequacy of the size or composition of the
assets of the Federal Reserve banks. The appropriate criterion can
only be the effectiveness of the Reserve in contributing to our achiev
ing what are generally accepted as our national goals (including
maximum employment and purchasing power, an adequate rate of
economic growth, and overall stability in our balance of payments)
within the specific framework of the Employment Act of 1946 and the
Federal Reserve Act.
Whenever there is conclusive evidence that achieving our national
goals requires that the Reserve hold different types of assets they
should be acquired. Maintaining its traditional asset structure is not
a legitimate test of the adequacy of Reserve policy and its officials are
almost certainly aware of this. During the next decade it seems likely
to me that if certain sectors of the economy have access to less credit
than is needed for a balanced achievement of our national goals, the
Federal Reserve should acquire and hold an appropriate quantity of
municipal securities, Federal agency issues, and other high-quality
debt. Clearly, authorizing legislation should be permissive and not
mandatory in nature, leaving the amounts, timing of purchases and
sales, and maturity distributions within the discretion of the System.
An advantageous time to consider legislation modifying and expand
ing the Reserve’s powers in this area will occur when the Congress
considers liberalizing the present definition of eligible paper. It makes
little economic sense that certain types of commercial bank assets (for
example, State-guaranteed bank loans to students) which make sub
stantial long-range contributions to the Nation have a second-class
status under the obsolete real-bills doctrine. Here there is a real

FEDERAL RESERVE PORTFOLIO

danger that tradition may restrain growth. However, eligibility
should not be extended to all types of commercial bank assets, but only
to those categories which make the maximum contribution to the Na
tion’s goals. At any time, there should be some assets falling outside
the definition of eligibility because of their nature, maturity, or both.
The same yardstick should be used in the discussion of changes in the
types of assets legal for holding by the Federal Reserve System, and
changes in the two areas may well be parallel.
In the future the general direction of open market operations will
necessarily be to acquire Government securities to expand commercial
bank reserves, and it is extremely unlikely that the System will ever
sell any substantial part of its present holdings of Treasury securities.
Transferring a large portion of this debt to the Treasury would result
in a nonrecurring reduction in both the gross and marketable debt out
standing and be equivalent to raising the legal debt ceiling by the same
amount. However, the real impact of this legislation would not fall
on the Reserve statement of condition but upon its income statement:
its gross income would be considerably reduced and it would become
dependent upon the Treasury for the funds needed to carry out its
responsibilities.
Since the Fed remits annually to the U.S. Treasury its net earnings
after current expenditures and certain transfers to surplus, it is tempt
ing to believe that its operations would not be affected in any impor
tant way if in exchange for the transfer of the Government securities,
it received its operating expenses from the Treasury through the ap
propriations process just as other agencies do. However, this alterna
tive seems to me to have at least two serious flaws: (1) There can be
no guarantee that the Congress will invariably give the System ap
propriations hearings that are both timely and objective; (2) there is
likely to be a serious psychological impact on the thinking of foreign
central bankers.
My first objection involves several factors. The System’s total ex
penditures, including capital losses, are difficult to project or forecast,
and a tight budget might force it to defer or fail to carry out certain
assigned responsibilities or to perform them in a perfunctory way. It
is possible that from time to time some operations might be influenced
by profit (or minimizing loss) considerations either in conjunction
with or instead of their contributions to the goals mentioned above.
While it is probable that under most circumstances the Reserve will
receive just treatment in the appropriations process, it is possible that
at the time of regular or supplementary budget hearings, the Congress
might be occupied with legislation on topics even more important than
this, and the hearings on the System’s budget might be delayed or be
too brief. An alternative would be to provide the System with author
ity to expend as needed substantial sums not earmarked for specific
areas, but large unallocated amounts here would tend to defeat the
inherent purpose of the budgetary process. And there is also a danger
that the System might deliberately and indiscriminately spend up to
the annual budget limit so as to prevent cuts in succeeding years. To
me, any of these effects, if they occurred, would be an inadequate trade^
off for eliminating the few expenditures, questionable in nature and/or
in amount, revealed in congressional hearings in the past few years.
Finally, under this first objection, there is the possibility that individ*

FEDERAL RESERVE PORTFOLIO

ual Members of the Congress may be hostile to specific expenditures in
a proposed budget even though not to the Fed’s broad courses of action,
and there may be attempts to influence or cause the Fed to rethink the
broad course of monetary policy during budgetary hearings—prob
ably the worst time to make policy. This is not to deny or restrict the
value of congressional inquiry into the System’s operations, a right
and responsibility that is unquestionable, but to suggest that question
ing and criticism should be directed to specific areas in a direct manner,
not indirectly through congressional control over the pursestrings.
Equivalent final results would be better accomplished by revisions of
specific portions of the Federal Reserve Act.
Closely related to the possible outcomes briefly described above are
the probable reactions of foreign central banks to the transfer of secu
rities to the Treasury for cancellation. Some will regard this as the
first step in our nationalizing banking here; others will interpret it
as setting the stage for annual public debates of past and future mone
tary policy, including the most delicate (and up to now, private) in
ternational negotiations; others will view this as the first step leading
to artificially low interest rates with the implications for inflation
which they associate with such rates. At this time when there are so
many other strains upon international confidence in the dollar, it is
absolutely necessary that there be no questioning of our abandoning
any of our national goals. On the other hand, since the basic targets of
governmental policy are similar throughout the Western World, a
clarification and restatement by the Congress of the Fed’s responsi
bilities, with discretion as to techniques, timing, etc., would be appro
priate.
In the discusion above, I am not necessarily stating my personal
feelings but my brief analysis of how and why foreign central banks
will react. The nature of their probable reactions must not be dis
regarded, particularly now when revisions of the international mone
tary mechanism are under active consideration. Since their reactions
might include a run on the dollar, the Congress should so act as to pre
serve the independence of the System within our democratic frame
work, never hesitating to act to increase the Fed’s responsiveness but
always avoiding the slightest hint that popularity rather than re
sponsibility may dominate its policymaking.
At this point, I must note my feeling that the proposed transfer of
securities is weakest from the viewpoint of its timing. A successful
resolution of the international liquidity problem may change the out
look of foreign central bankers enough to minimize their adverse re
actions if such legislation were enacted. Just as the change may be
premature, it also may be tardy—that is, it might have had only minor
psychological effect domestically and internationally had it been en
acted some years ago, before the role of the dollar in international
finance became such a key issue.
Beyond the comments above, there is one other that seems to me to
be important. The internal audit procedures of the System appar
ently include the same goals as those used by the General Accounting
Office in its work: the verification of all expenditures and the prepara
tion of opinions on the appropriateness and legality of some expendi
tures. GAO audited the Board of Governors’ expenditures up to 1933
when the Banking Act of 1933 removed the Board from GAO audit.

FEDERAL RESERVE PORTFOLIO

(The district banks were never under this audit.) I suggest that there
may be no valid reason why the entire System should not be covered by
GAO postexpenditure audit, assuming that GAO is directed to con
cern itself with accuracy and not policy. In such an arrangement
policymaking and the preparation of budgets would remain System
responsibilities.
S t a t e m e n t b y S e y m o u r E . H a r r is , P rofessor of E c o n o m ic s ,
U n iv e r s it y of C a l if o r n ia , S a n D iego , L a J o l la , C a l if .

First, it should be noted that the Government debt held by the
country generally in the middle of 1965 was about $318 billion. Of
this amount, $63 billion was held by Government and trust funds, and
$39 billion by the Federal Reserve banks.
Of course it has been an advantage to have public or semipublic
institutions purchase Government securities because it means the Gov
ernment has to depend on the market considerably less, and to that
extent probably gets a better price or lower rate of interest on its se
curities.
The memo raised the issue of how many or what volume of Gov
ernment securities the Federal Reserve ought to hold.
I think it is difficult to make any precise estimate here. I thjnk the
Federal Reserve banks ought to hold enough Government securities
to make sure that we get the monetary expansion we need. Congress
man Patman is well aware of the fact that open market operations
are very important if not the most important weapon the Federal
Reserve has. And if the Federal Reserve had not in the 1920’s and
early 1930’s learned how to use open market operations, we would
have had a very restrictive and a much more restrictive monetary
policy than we have had so far. The more Government securities
held by the Federal Reserve the more money is likely to be created.
I present a brief table below to give some indication of what has
happened since 1933 and 1945.
Federal Reserve operations, 1933,1945,1965
[In billions of dollars]
Public securitie^heldl fMembeifbank reserves
(plus ! currency)

1933
1 9 4 5 --. .1965 (June)..

...
-

1. 9
23. 7
39.2

2. 2
16. 0
21. 7

From 1933 to 1965, for example, the total public securities held by
the Federal Reserve banks has mcreased from about $2 billion to $39
billion. It is hard to imagine what would have happened if this in
crease had not taken place. This made possible, for example, a rise
of reserves of member banks from about $2 billion to $22 billion.
Somehow or other in these years, the Federal Reserve System had
to finance something like an increase of currency outstanding of about
$35 billion. This was partly met by a rise in gold supplies of $10 bil
lion. But the increase of currency outstanding which had to be fi

FEDERAL RESERVE PORTFOLIO

nanced, and also the rise of member bank reserves were primarily of
course financed by open market operations, that is, by the purchase of
Government securities by the Federal Reserve banks. This is what
made possible the great expansion of the supply of money since 1933.
There are, of course, some important problems raised by the holding
of Government securities by the Federal Reserve banks, and, partic
ularly, the problem of how much return the Federal Reserve banks
and, in turn, the number banks that own the Federal Reserve banks
should have.
It is my understanding that the member banks are guaranteed 6 per
cent return on their investment and the remainder of the return goes
to the Treasury. Of course, the major profits and virtually all the
profits or interest or income for the Federal Reserve comes out of the
government securities that they hold.
I would like to suggest one possible solution to this problem; namely,
that the return of member banks on their investments should not be
6 but 4 percent. After all, a member of the Federal Reserve Sys
tem has many privileges, not the least of which is the privilege of
borrowing from the central bank and being guaranteed against any
serious financial difficulties by virtue of the help that the Federal Re
serve System can give the commercial banks. It seems to me that at
the present time 4 percent is a good return on a safe investment, and
I would think that the committee might very well suggest that the
return on the investments of the member banks might be cut from 6
to 4 percent. I am of course not aware of the legal problems involved
here, but if this is legally possible, I think it would be a good move.
Moreover, there is the problem of what should be included as re
serves for member banks. I have held to the view, which Senator
Douglas and I believe Congressman Patman also presented, namely,
that the increase of reserves by counting cash as reserves, a reform of
the last few years, was an excessive windfall for the commercial banks.
It simply made it possible for them with a given amount of cash to do
much more business and increase their profits. Profits are more than
satisfactory; this is another argument for reducing the return on their
investment from 6 to 4 percent.
S tatem ent

G . L o w e l l H ar r iss , D e p a r t m e n t of E
C o l u m b ia U n iv e r s it y , N e w Y o r k , N . Y

c o n o m ic s ,

Discussion of the questions in your letter of September 1, 1965, can
serve the public interest although there may be danger of giving undue
attention to matters of little more than surface importance. My own
participation must be limited to a few points, expressed in broad terms
and without any claim to exploration of some deeper implications.
Your respondents will not agree on which are the relatively super
ficial issues and which are of more fundamental importance. Yet one
question is basic: Who is to control changes in the stock of money—and
the availability of credit to the extent that it is affected by the mone
tary authorities? Then, by whom, and how, are the controllers to be
controlled? This latter control can be exercised directly and indi
rectly, one means being through “the power of the purse.” An agency
with its own independent income, however, cannot be subjected to con
trol by this means.

FEDERAL RESERVE PORTFOLIO

The size of the Federal Reserve portfolio will influence the System’s
income. Two kinds of issues arise: (1) The amount of its income will
influence the System’s freedom to operate. No one need tell you that
the Federal Reserve has been independent of authority exercised by
Congress (or by any other agency) through control of funds to finance
operations.
(2)
I f Federal Reserve income exceeds expenses, who gets the
“profit” ? For many years, of course, System income has been vastly
reater than needed to finance its operations. The excess goes to the
Veasury. In effect, therefore, the country pays no (appreciable) net
interest on the Federal debt held by the 12 Federal Reserve banks.
This arrangement seems to me generally satisfactory. (Some tidying
of budgetary classification appears desirable. Why not show interest
as a net figure after deduction of the refund by the Federal Reserve?)
Cancellation of some or all of the Federal debt held by the Federal
Reserve would not significantly alter the realities of interest cost to
the Treasury. As regards System profits, therefore, I see no public
advantage in change and would rather deplore the prospect of debate
on an issue of so little significance.
The first point above, however, does involve a matter of real sub
stance, The cancellation of debt, along with other changes, might re
duce System income to the point where the Federal Reserve could be
compelled to go to the Congress for appropriations. This possible
result is too important to be dealt with by an indirect means. Pro
posals to subject the Federal Reserve to direct and continuing control
by elected authorities call for debate on their own merit and should
hardly be thought of as possible byproducts of portfolio change.
The literature with which I am familiar overwhelmingly favors
central bank independence of legislative and executive control. I
have agreed. Today I am “not so sure.” What do we know about
how results would differ under other arrangements reasonably pos
sible? Could not the public be better served by prompter and
franker discussion of the reasons for, and expected results of, Federal
Reserve actions? I f so, the congressional hearing process offers an
obvious forum for such discussion. Granted. But by what body?
The Joint Economic Committee seems to me to be the group—except
that under present rules you have no way to require Federal Reserve
officials to discuss what they do not wish to discuss.
Would the Appropriations Committee provide more effective
bodies? I think not, at least as they are now constituted. The back
ground, interests, focus of staff efforts, and experience of those re
sponsible for the appropriations process do not, I suggest, qualify them
for guiding monetary policy. The timing of their hearings and
scheduling of their decisions are not now geared to the very different
responsibility of “overseeing” the Federal Reserve.
Existing monetary arrangements relate the size of the System’s
portfolio to the growth in the stock of money; the System’s liabilities
(member bank deposits—reserves) depend upon its acquisition of
assets. As you know, changes in the stock of money (and in credit
which results from money creation or destruction) depend primarily
upon (a) the amount of reserves held by member banks and (&) the
ratios of required reserves. The relative roles of the two can be
altered, but (other things being the same) the portfolio holdings

FEDERAL RESERVE PORTFOLIO

which are appropriate at one time will be too small months or years
later.
A high reserve ratio coupled with high reserves will apparently
involve less profit opportunity for the commercial banking system
than if reserve requirements were lower, assuming that member banks
receive no interest on reserves. Over the long run, however, will
not the income results depend upon how the Federal Reserve creates
deposits for member banks? I f it does so without reducing bank
earning assets, then within anything like the present range of re
quired reserves, the earning capacity of the banking system can be
independent of one or the other element.
The creation of modern money (but not the operation of a banking
system which is essential to make this money effective in conducting
transactions) is essentially costless. The institution which creates
money has at its disposal something which did not exist before. I f the
institution is Government, the funds can be used to pay for current
expenses. I f the institution is a commercial bank, the funds are avail
able for lending to produce income—and for the banking system as a
whole to do so indefinitely. In essence, it seems to me, our present sys
tem deprives the Government of a potential “profit” from money crea
tion (initially). The system also gives the Treasury some of the fu
ture income because the Federal Reserve holds U.S. debt correspond
ing to the required reserves of member banks (subject to qualifica
tions) . The remainder of the interest goes to commercial banks, pre
sumably helping to cover operating expenses.
How do these conditions compare with possible alternatives ? Might
there be some method by which the money created without cost could
be used as a substitute for taxes? Time does not permit me to try to
explore such questions—including the bookkeeping which might be
necessary. And I almost shudder at the thought of public discussion
of such a possibility. Therefore, fundamental change of this sort
would be low indeed on my agenda for monetary debate and possible
legislation.
Three more points warrant brief comment: (1) The volume of assets
required by the Federal Reserve for sale if monetary restraint is called
for would seem to me very small. Any need for more than minor re
duction in bank lending capacity seems highly unlikely. Except per
haps temporarily, the practical problems will involve the rates of
increase in lending capacity and timing.
(2)
The possibility of wiping out that part of the public debt held
by the Federal Reserve seems to me likely to generate debate which
would be more diverting than helpful. The time and energy available
problems could be spent more
o
best confined to Treasury obligations, with some exceptions. The re
fund of interest on Treasury debt seems automatic, uncomplicated.
Little practical importance attaches (on this score) to the kind of debt
acquired or the interest yield. But if the Federal Reserve were to
become a holder of State-local debt, or the debt of governmental agen
cies or businesses, would not complications arise? One can easily im
agine pressures for artificially low interest rates for this or that worthy
purpose—with implications inviting, at the least, much thought before
any move in the direction. The temptations would exist, and the po
tential difficulties might take more than one form.

operations

FEDERAL RESERVE PORTFOLIO

Needless to say, other important issues warrant your attention—the
ossible payment of interest on member bank deposits at the Federal
Reserve as part of a broader program of monetary change and 100
percent reserves, to name two.

S tatem ent
for

c o n o m ic

H arw ood , D irector , A m e r ic a n I n s t it u t e
R e se a r c h , G r e a t B a r r in g t o n , M a s s .

Scientific research on money-credit problems conducted by Amer
ican Institute for Economic Research for more than three decades
has provided the evidence that is the basis for the assertions and
recommendations that follow.
The excessively large Federal Reserve bank holdings of U.S. Gov
ernment securities is one of the consequences of the unsound banking
practices that have been followed in the United States during the
past few decades. Those practices were the result of a departure from
a basic principle of commercial banking included in the original
Federal Reserve Act but long since abandoned.
In attempting to deal with the monetary problems associated with
financing two great wars and with speculative booms and marked
contractions of business activity, many individuals including legis
lators and other responsible authorities seem to have forgotten the
basic principle of sound commercial banking. When followed, that
principle confined the creation and lending of purchasing media by
banks to the amount necessary for representing gold and things en
route to and offered in the markets.
In recognition of that principle, the original Federal Reserve Act
authorized the Federal Reserve banks to rediscount only short-term,
self-liquidating loans made by the commercial banks to those process
ing things soon to be offered in the markets. During World War I
the act was amended to permit Federal Reserve bank rediscounting
of U.S. Government securities in order to finance deficit expenditures
for war. Thus, the basic principle of sound commercial banking,
which had been rediscovered after years of research by a monetary
commission and by the Members of Congress concerned with Fed
eral Reserve legislation, was abandoned.
Monetary theorists and bankers have made many attempts to dem
onstrate that commercial loans are an inadequate basis for a modern
banking and money-credit system. The assertion is unwarranted,
but discussion and refutation of the arguments presented in those
attempts is not feasible here.
After World War I, Federal Reserve authorities sold and forced
the commercial banks to sell much of the U.S. Government securities
held, thereby forcing removal from circulation of most of the excess
purchasing media that had been created. Subsequently, during most
of the 1920’s however, those authorities acquiesced in the disregard of
sound banking by the commercial banks, which created and loaned
purchasing media to private borrowers for purposes other than the
short-term financing of processing activity. Both the Federal Re
serve and commercial banks bought large amounts of U.S. Government
securities during the mid-1930’s, when the spend-for-prosperity notion
was tried, and they bought unprecedented amounts of such securities
during World War II, again to finance deficit expenditures for war.
56-913— 66-------4

FEDERAL RESERVE PORTFOLIO

After the war, commercial banks again began to create a large amount
of purchasing media for noncommercial purposes, which they loaned
for purchases of real estate, securities, and consumer goods and used
for investments in obligations of corporations and State and local
governments.
At the end of World War II, Federal Reserve bank holdings of U.S.
Government securities totaled about $24 billion. The total had de
creased to about $19 billion at the end of 1949 but subsequently had in
creased to nearly $26 billion at the end of 1953 and to more than $27
billion at the end of 1960. During the past 5 years such holdings have
increased about $12 billion to a total of about $39 billion.
The Federal Reserve banks have purchased unusually large amounts
of U.S. Government securities during recent years, apparently in order
to offset the contraction of total purchasing media in use that resulted
from large withdrawals of U.S. gold by foreign claimants, and in
order to make available to the commercial banks additional reserves
required for the increasing volume of loans necessary for expanding
business activity.
During the past several years the large volume of savings made
available to the commercial banks has enabled them to make noncom
mercial loans and to acquire investments without creating inflationary
purchasing media. However, Federal Reserve purchases of U.S. Gov
ernment securities totaling $12 billion during the past 5 years involved
the creation of that amount of purchasing media. These purchasing
media were turned over to and spent by the Government without plac
ing on the market things of equivalent value; consequently, such pur
chasing media are inflationary.
When Federal Reserve purchases of U.S. Government securities
are evaluated with reference to the principle of sound commercial
banking described above, such purchases clearly are revealed to consti
tute inflation. Moreover, the practice prevents the stabilizing influ
ences on the amount of purchasing media in use and on prices that
ordinarily result from outflows of gold. Consequently, international
payments imbalances remain uncorrected and seem to require the
imposition of restrictions on economic activity, including a tax on the
purchasing of foreign securities and restraints on lending and direct
investment abroad.
Federal Reserve authorities attempt to regulate the amount of pur
chasing media in use by buying and selling U.S. Government securities,
thus altering the reserves of the commercial banks and the amounts of
purchasing media that these banks can originate for lending. This
method of attempting to provide a flow of purchasing media appropri
ate for representing things being processed and placed on the market
evolved after the basic principle of sound commercial banking was
overlooked in amendments to the Federal Reserve Act.
In abandoning the practice of rediscounting only short-term, selfliquidating (commercial) loans, Federal Reserve authorities discarded
the essential guide for providing an appropriate flow of purchasing
media. Thus, the relatively small number of monetary authorities now
attempt to make decisions regulating the flow that formerly were
made much more effectively by the collective judgment of thousands of
commercial bankers.

FEDERAL RESERVE PORTFOLIO

The money-credit problems of the United States will not be resolved
until the practice of sound commercial banking is restored. That
restoration can be accomplished by the following steps:
1. Amending pertinent legislation to (a) coniine rediscounting by
the Federal Reserve banks to short-term, self-liquidating commercial,
industrial, and agricultural loans; and (b) prohibit Federal Reserve
bank purchases of U.S. Government and other securities in excess of
their capital fimds available.
2. Separating the commercial banking function from the investment
functions of the commercial banks (the latter including lending for in
stallment buying, term loans, and longer term investments in mortages and real estate and in securities of corporations and of Federal,
tate, and local governments). Such a separation could be effected by
appropriate accounting and examination procedures, rather than by
performing each function in separate banks.
3. Requiring each commercial bank to work toward and reach,
within a period of 10 to 15 years, a condition such that its investmenttype assets did not exceed its sayings and capital liabilities. Satisfac
tion of this requirement would insure that all purchasing media (cur
rency and checking accounts) in use would represent either gold or
things being processed and offered in the markets.
4. Reducing the gold content of the dollar to the extent necessary
for reestablishing the previous equilibrium between the gold-exchange
value of purchasing media and that of commodities. Commodity
prices are about 160 percent of their previous equilibrium; therefore,
a reduction of a little more than one-third of the gold content of the
dollar, to a so-called price of about $60 per ounce, would appear to be
scientifically warranted and would approximately reestablish the
equilibrium mentioned above. (Although commodity prices probably
have been influenced by disproportionate changes in the human-effort
cost of processing gold and other things, the relative magnitudes of
such changes and methods of measuring them are not ascertainable.
Therefore, the influence of such changes must be ignored.)
5. Requiring the U.S. Treasury to (a) use the so-called profit result
ing from reduction of the gold content of the dollar to retire U.S.
Government securities held by the Federal Reserve banks; and (b)
use any accretion of monetary gold to retire U.S. Government securi
ties held by the Federal Reserve banks. The latter action would in
volve Treasury provision of gold certificates to those banks in exchange
for the securities, and selling of the securities to the public, thus
obtaining purchasing media for paying the seller of gold.
6. Requiring the Federal Reserve banks to sell, within a period of
10 to 15 years, all U.S. Government securities in excess of the banks’
capital liabilities less real estate.
fey implementing the steps outlined above, the United States could
reestablish a sound money-credit system and unilaterally lead the way
toward the establishment of such a system in and among the leading
industrial nations. Those who chose to follow that lead would benefit;
those who did not would continue to suffer the consequences of
depreciating currencies.
I do not suggest that the foregoing proposals would solve all the
Nation’s economic problems. However, solution of our money-credit
problems is essential for future growth and may even be necessary to

FEDERAL RESERVE PORTFOLIO

sustain the economy while scientifically warranted solutions for other
problems are being developed.
S tatem ent

G a b r ie l H a u g e , P r esid e n t , M a n u f a c t u r e r s H
T r u st Co., N e w Y o r k , N . Y

an o ver

Representative Wright Patman has asked me to communicate to you
my views on H.R. 7601 which would provide that the 12 Federal
Reserve banks shall transfer to the Secretary of the Treasury U.S.
Government securities in an aggregate principal amount of $30 billion
for cancellation, and to offset this loss of assets the Treasury would be
directed to relieve the Federal Reserve banks of the same amount of
liability with respect to Federal Reserve notes outstanding.
I note in the sixth paragraph of Mr. Patman’s letter that he is
“more interested in the specific recommendations and reasons for them
than in elaborate argument or citation of source materials.” With this
request in mind, I submit the following comments on the questions
asked in the letter:
1. There is no clear reason why the size of the Federal Reserve
System portfolio of U.S. Government securities should bear any fixed
ratio to the money supply, gross national product, or aggregate liquid
assets. Its size should be determined by the judgment of the Federal
Reserve Open Market Committee on the basis of the credit needs of
the national economy. Such needs should be appraised on the basis
of economic information available to the committee. Any attempt to
fix ratios by legislation would negate the function of the Federal
Reserve authorities to “ lean against the wind” and prevent excesses
in credit expansion and contraction. This policy has generally worked
well over the last half century.
2. The expression, “if the portfolio grows too large,” is not clear
in that no standard or criterion is stated by which one could judge
whether it were too large or too small. I f the portfolio is to large
for the credit needs of the national economy, the proper remedy would
seem to be to sell some of the securities in the open market.
3. Transfer of such assets (U.S. Govrenment obligations) to the
Treasury for cancellation would not appear to accomplish any con
structive purpose. The Treasury would save the interest paid on such
obligations but it would lose an equal amount of income by the reduc
tion in Federal Reserve payments to the Treasury. Such payments in
the year 1964 exceeded the interest received on its portfolio ot Govern
ment securities. (Federal Reserve Bulletin, February 1965, at p. 322.)
On the other hand, cancellation of the Government securities which
now back the outstanding Federal Reserve notes would mean that the
notes would be converted, in effect, into “greenbacks.” While the
American public may not distinguish between the two kinds of cur
rency, the act of cancellation of some three-fourths of the Government
securities held by the Federal Reserve banks could be interpreted
abroad as a sign of monetary weakness and could precipitate a run
on the dollar; that is, a rush to convert dollar exchange into gold,
with consequent needless loss of our specific reserve.
4. In my opinion, the Federal Reserve should continue to hold U.S.
Government securities purchased in the open market and return the
excess earnings to the Treasury as now provided by law.

FEDERAL RESERVE PORTFOLIO

5. It would not be practicable to legislate “ objective standards” to
guide Federal Reserve portfolio operations. Such restrictions would
hamper the Federal Reserve authorities in their supremely important
task of smoothing out swings of the business cycle.
6. I see no reason to direct the Federal Reserve to purchase private
obligations or commodities. The Federal Reserve banks from the very
beginning have been authorized to rediscount certain types of com
mercial loans held by their member banks when such member banks
require additional funds. Prior to World War I the rediscount of
“eligible paper” held by member banks was the principal, if not the
sole, function of the Reserve banks. Acquisition by the Reserve banks
of private obligations should be limited to such rediscounting for
members. Open market purchases of private obligations could not
perform any financial or economic function not already performed by
such purchases of U.S. Government securities, and in many cases
would mean a sacrifice of liquidity.
7. In the colloquy between Mr. Patman and Mr. Martin I do not
understand the reference to “compelling the Government to pay its
debts more than once.” The Treasury received payment for its obli
gations when they were issued, and will redeem them at maturity, re
gardless of whether the owner at that time is the Federal Reserve or
some private citizen.
S t a t e m e n t b y R obert G . H a w k i n s , G r a d u a t e S ch o o l of B u s in e s s
A d m in is t r a t io n , N e w Y o r k U n iv e r s it y , N e w Y o r k , N . Y
THE FEDERAL

reserve’s

PORTFOLIO

The size of the portfolio
1. The size of the Federal Reserve’s portfolio of securities should
be considered from two basically separate points of view. The first
is with respect to the conduct of monetary policy. The Federal Re
serve needs a minimum amount of securities which could be sold in
the event that renewed inflation or other factors make it necessary
to significantly contract money and credit. What this minimum
amount should be depends on the contingencies to be met, but certainly
$10 billion in securities would be sufficient for almost any in the present
economic environment. Any holdings beyond this minimum, while
acquired through past monetary policy operations, would be irrele
vant for the satisfactory conduct of future Federal Reserve monetary
operations. However, it would be advisable that the minimum abso
lute amount held by the Fed rises as the economy grows, since the
amount of open market sales necessary to obtain a given relative con
traction in money and credit will be larger the larger is the money
supply. Thus, the minimum amount of security holdings should l>e
based on a relatively fixed ratio between these holdings and other rele
vant economic variables such as the money supply, GNP, liquid assets
or the like. But the other variable in the relationship is largely a
matter of indifference, since an appropriate ratio at the outset, regard
less of which variable is used, will yield roughly the same growth in
the minimum as the economy expands.
2. The second point of view from which the size should be con
sidered is essentially political and administrative. Should the Fed

FEDERAL RESERVE PORTFOLIO

eral Reserve be allowed to hold securities in excess of the minimum
amount needed for open-market operations? At the outset, the
Federal Reserve, even though legally owned by member banks, must
be considered an arm of the Federal Government, and with respect
to broad matters of economic policy, hopefully subject to its control.
As such, the case can be made that under a democratic governing
system, all Federal Reserve revenues should accrue to the Treasury
and Federal Reserve expenditure should be authorized and appro
priated by the Congress. This could be partially achieved by trans
ferring Federal Reserve security holdings in excess of the “minimum
amount” to the Treasury so that they could be retired. This would
eliminate the funneling of interest payments through the Fed, and
back to the Treasury as unexpended income as is now the practice.
If the Fed’s income from their remaining securities was insufficient
to meet operating expenses and various contingency reserves, the
remainder would be made up from appropriated funds. This would
involve a transfer of potential power over the Fed to the Congress
rather than an increase in the extent of the control of the Fed by the
executive. The latter is probably the more desirable to facilitate
the coordination of economic policies.
A lesser consideration involves the potential loss of an independent
source of operating expenses by the Fed which might result should
the excess in the portfolio be transferred. Heretofore, the Fed has
had highly efficient operations and has accumulated competent staffs
of economists who have produced valuable research. To the extent
that a loss of independence from Congress in income would impinge
on administration and research activities, the result would be un
fortunate.
On balance, it seems unlikely that much would be gained while
some unfortunate results could occur from a removal of the excess
securities of the Fed.
The composition of Federal Reserve assets
1.
In general, the composition of the asset portfolio should be
determined solely on the grounds of the effectiveness and equity of
monetary policy. Open-market operations in a broad range of
financial instruments, including Government and private across the
maturity spectrum, would provide a number of advantages relating
to the effectiveness of monetary policy. Selective operations among
various types of securities would provide monetary policy with the
potential to alter relative interest rates and credit conditions among
various capital and money markets. Since the transmission of the
effects of monetary policy is not perfect among capital markets,
these imperfections could be used to affect the allocation of credit
while the volume would continue to be controlled by the usual means.
This would allow (1) more selective control of inflationary pressures
by selling debt instruments of the sectors experiencing excess de
mand while retaining easier credit conditions in sectors where prices
are stable; and (2) selective permissiveness of credit expansion to
allocate demand and production for specific purposes such as eco
nomic growth, State and local expenditures, etc. It is not suggested
that a broadening of the Fed open-market powers should be adopted
forthwith, but careful examination and discussion of the possibility

FEDERAL RESERVE PORTFOLIO

is needed. Furthermore, the extent to which individual interest
rates and credit supplies could be effected differentially is probably
small, due to available alternatives on both the demand and supply
sides. While markets are not perfect, neither are there great
imperfections.
2. More specifically, open-market operations at all maturities of
Federal Government securities should be continued. The relative
success of “operation twist” is sufficient testament. Likewise, Fed
operations in the foreign exchange market is desirable, and should
be accomplished for its own portfolio. The coordination of the
monetary impact of such operations with that arising from domestic
security operations can best be accomplished from the same portfolio.
As for other portfolio candidates, such as State and local govern
ment bonds and private debt instruments, the problems are some
what more complicated. Although the possibilities here for affecting
the distribution of credit exist, the risk of default of such instru
ments must be contended with. Sufficient contingency reserves and
selective purchasing would make the problem manageable but it
must be emphasized that the default risk is a difference in kind as
between Government and non-Government securities and not a matter
of degree. Certainly the contemplation of operations in such instru
ments would exclude commodities and many kinds of bank and
other loans. Perhaps high grade corporate bonds, certain com
mercial mortgages, and State and local bonds offer sufficient ground
to experiment on a small scale with open market operations.
There remains a final aspect of extending open market operations
to non-Government securities which should be made explicit. Opera
tions in Federal debt issues do not affect the spending of the ulti
mate borrower while operations in other types of debt issues would
presumably be for that specific purpose. Furthermore, operations
would be for the purpose of making it more costly (and harder) for
some borrowers to borrow than others. This may be viewed as an
indirect means of extending limited subsidies to some and taxing
others. Would it not be more rational, within the democratic
processes which presumably control our economy, to make these in
direct taxes and subsidies the responsibility of the Treasury rather
than of the monetary policymakers.
Even if such wider open market operations were introduced, they
should not be for the purpose of merely diversifying the Fed port
folio, but only for monetary policy objectives. Thus, objective
criteria as to the percentage of the portfolio consisting of each type
of assets has no place. Rather, the widest discretion should be
available to the account managers to use shifts in the composition
to influence the allocation of credit, if indeed such is to occur which it
should not without considerable analysis.

S t a t e m e n t b y M . L eslie I n f in g e r , M a j o r , A ssociate P rofessor
B u s in e s s A d m in is t r a t io n , T h e C it a d e l , C h a r l e s t o n , S .C

Briefly, my views are as follows :
1. I am somewhat surprised that such a bill has been conceived,
since no constructive purpose could be served by retiring the bonds
held by the Federal Reserve banks.

FEDERAL RESERVE PORTFOLIO

2. There may be some minor arguments for broadening portfolio
policy to include the other securities listed by Congressman Patman,
but the difficulties encountered in such a program would multiply
the complexities of the Open Market Committee’s operations without
really adding any significant advantages.
3. It seems to me that Congressman Patman is spending entirely
too much time—and the taxpayers’ money—fighting Mr. Martin and
“the bankers.”
4. In order to do their job effectively the members of the Board
of Governors must be kept relatively free from political pressures;
therefore, nothing should be done to further weaken the “independ
ence” of the Board of Governors.
5. In order to attract and retain the high-caliber men needed on
the Board of Governors, the Congress should not only protect them
from political pressures but also see to it that the salary scale is
kept relatively high.
S tatem ent b y D udley W
C ollege of B u s in e s s A
S eattle, W a s h .

J ohnson , A

ssociate

d m in is t r a t io n ,

P rofessor of F i n a n c e ,
W a s h in g t o n ,

n iv e r s it y of

The Structure a/nd Portfolio Mcmagement of the Feedral Reserve
System
I. INTRODUCTORY REMARKS

Mr. Chairman and members of the Joint Economic Committee, I
am honored and I greatly appreciate the opportunity to take part
in your important study concerning the structure and management
of the portfolio of financial assets held by the Federal Reserve System.
It will be well worthwhile at the outset to spend a few moments
establishing some terminological ground rules. This is needed be
cause in order to discuss alternative approaches to the management
of the Federal Reserve’s portfolio it is necessary to take a position on
two fundamental matters, both of which can be considered “practical”
questions, though in different ways. These are the nature of central
banking, and what constitutes “sound” monetary policy.
II. THE GENERAL NATURE OF CENTRAL BANKING

As is well known, we can view a commercial bank as attempting to
maximize its assets subject to certain constraints. Less elegantly, a
bank is in the business to make a profit. This is not true of a central
bank (the Federal Reserve System for the United States), A central
bank is any banking institution which does not attempt to maximize
its assets; i.e., has a credit policy independent of earnings. A central
bank acts to influence the financial environment of the country in the
national interest. Such was not always the concept of central banking
in the United States or elsewhere. One will look in vain in the Fed
eral Reserve Act of 1913 for statements asserting that the major
goals of monetary policy are to help promote full employment, eco
nomic growth, and price level stability—the generally agreed-on goals
of modem monetary policy. It was not until 1923 that the Federal
Reserve recognized explicitly the weakness in using reserve ratios as

FEDERAL RESERVE PORTFOLIO

criteria for monetary policy.1 Since 1923 the Federal Reserve, as is
the case for all central banks, has broadened slowly its functions and
goals so that the essential nature of central banking is to conduct
monetary policy in a manner which contributes to the attainment of
domestic economic objectives. How can a central bank best promote
the national interest? In the opinion of the present writer, this can
be done by managing properly the money supply; i.e., the business of
the Federal Reserve System is not the business of banking, but the
management of the money supply. The money supply should be
managed in a manner such that it contributes to the attainment of the
domestic economic goals of full employment, economic growth, and
price level stability.2 Therefore, as I point out later, the size and
composition of the central bank’s portfolio of securities should be
governed by considerations related to the money supply. With the
exception or certain unique economic circumstances, there exists a close
association between changes in the Federal Reserve’s portfolio and
the money supply. The proper way the latter should be managed is
discussed next.
“Sound” monetary 'policy3
Because open market operations are the major instrument through
which monetary policy is conducted, any evaluation or recommenda
tions for improvement of the Federal Reserve’s portfolio policies is
conditioned by what one considers to constitute “sound” monetary
policy. It is necessary to take a position not only on what can rea
sonably be expected of the Federal Reserve, but also on what monetary
control can be expected to achieve. This necessitates a general view
of how monetary policy affects the economy, as well as what consti
tutes sound money supply management.
At the risk of saying too much by saying too little, it seems to me
that two conflicting views emerge with respect to the shortrun economic
stabilizing role of monetary policy that has resulted from recent re
search and thinking on the role of money in influencing economic
activity.
One view is that monetary policy cannot perform a shortrun stabili
zation rtfle. Within this view, two variations appear. First, some
experts conclude that money is of negligible importance in influencing
or determining the course of shortrun economic activity and that what
matters for shortrun economic stabilization is not control over interest
rates and credit institutions, or even over the volume of particular
types of lending, but control over the volume of aggregate spending.
Since it is difficult, if not impossible, to establish that monetary policy
has a reliable, speedy, and quantitatively significant influence on final
aggregate demand—i.e., the links between changes in the money sup
ply and aggregate demand are tenuous and weak—shortrun monetary
policy is considered of little importance.
1 The Federal Reserve Board, Annual Report, 1923, pp. 30-38.
2 It should be pointed out that some would disagree with my proposition that the Federal
Reserve controls the money supply or its rate of change, except in some irrelevant longrun
sense. To analyze the validity of this view would lead us too far astray, but one could
substitute for management of the money supply the power of the banking system to carry
earning assets as the job of central banking and not change the substance of my analysis,
assuming nonliquidity trap situations.
8 In writing this section, I have benefited from reading Harry G. Johnson’s Alternative
Chiiding Principles for the Use of Monetary Policy (Essays in International Finance, No.
44, November 1963), pp. 7 -8 ; Eli Shapiro’s “ Structural Changes in Central Banking”
(pp. 7-8), and Franco Modigliani’s “Discussion,” pp. 25-26, both of which are in the 1964
Annual Report of the Federal Reserve Bank of Boston.

FEDERAL RESERVE PORTFOLIO

The other negative view toward using discretionary monetary policy
as a tool for shortrun economic stabilization is best represented by
Prof. Milton Friedman. As is well known, Prof. Friedman argues
that variations in the money supply are one of the most important
sources of economic instability. But because we know so little about
what causes shortrun economic stability, he believes that the use of
discretionary monetary policy for shortrun stabilization purposes
creates the risk aggravating instability rather than stabilizing eco
nomic activity. However, since the money supply is such a powerful
determinant of economic activity, a fixed rule calling for a steady
rate of growth in the money supply should be substituted for dis
cretionary monetary policy. Thus, it is argued that this rule will
provide a stable long-run monetary policy for the economy producing
the optimal environment for the attainment of growth, price level
stability, and full employment. Moreover, Friedman argues that
open market operations should be the sole tool used to conduct mone
tary policy, and the size of the central bank’s portfolio would be that
amount needed to produce the sought-after rate of growth in the
money supply.
Another view of monetary policy is that it can be usefully employed
as a shortrun stabilization tool. Central bank operations through the
reserve base have a direct influence on interest rates, the money supply,
and changes in these variables produce an effect on the volume of final
aggregate demand. In spite of the fact that our knowledge of the
magnitude of this effect on final expenditures or the time required to
make it effective is imperfect, shortrun stabilization should not be
abandoned as a primary objective of monetary policy.
I support the view of using discretionary monetary policy. My
criterion of a “ sound” monetary policy is one in which the central bank
varies the money supply in a way opposite to shortrun movements in
the volume of final output and employment. Such a monetary policy
should not be affected by disturbances in the banking system. Ad
mitting that there does not exist a scientifically correct answer to the
question of how low the unemployment rate should be before an
economy can be considered to be fully employed, I will arbitrarily
define a fully employed economy as one in which the annual average
of unemployment does not exceed 3.5 percent. My values are such
that any level of unemployment above this rate is socially undesirable.
When aggregate demand is insufficient as measured by less than a
fully employed economy, and if the monev supply either contracts or
does not increase at an appropriately rapid pace, monetary policy is
too tight, no matter how loose it might be as measured bv some abso
lute standard. And if aggregate demand is excessive so that the level
of unemplovment is so low that inflation develops, then aggregate de
mand is excessive. A monetary policy which does not restrict the
money supply is too loose, irrespective of how tight it might be judged
in terms of some absolute standard. Since individuals’ value judg
ments pertaining to what constitutes a fully employed economy differ,
bv definition of one would not be acceptable to all and, therefore, rela
tive measures of monetary ease or restriction by individuals will differ.
But the validity of relative criteria of monetary policy is not changed.
An illustration used bv Prof. Franco Modigliani mav be useful to
illustrate the above distinction between absolute and relative criteria
of monetary policy:

FEDERAL RESERVE PORTFOLIO

“ Consider the case of a motorboat in a channel whose task it is to be
at all times lined up with some landmark, but where the channel is
swept by a current of varying speed. In this case an absolute, measure
of performance might be the amount of gas given to the motor. The
relative and relevant measure would be what is happening to the boat
relative to its target* no matter how much (or how little) gas is being
supplied, we must still say that it is insufficient (or excessive) if the
boat fails to gain ground with respect to its target.” 4
My views on the importance of money do not stem from any belief
that there is a simple and highly predictable relation between the
money supply and the level of .aggregate spending. This relation is
very complex and needs much more studying. But my view of what
constitutes “sound” monetary policy is based on the notion that, by and
large, containing the money supply will contain aggregate spending,
while increasing the money supply will normally—though not in all
circumstances—tend to increase aggregate demand.
III. VIEWS ON SPECIFIC QUESTIONS

The size of the Federal Reserve's portfolio in relation to the money
supply, GNP, or aggregate liquid assets
It is well known that the Federal Reserve does not directly control
the money supply. To attempt to alter the money supply, the Federal
Reserve operates on the reserve base through open market operations,
changes in reserve requirements, and other policies. This behavior of
the central bank influences the decisions of commercial bankers and
the public. From an interaction of their decisions, the actual money
supply is determined. In consequence, there exists a close association
between changes in the reserve base and changes in the money supply.
It is, therefore, appropriate to look at Federal Reserve policy in terms
of how it affects the money supply.
Basically, the extension of Federal Reserve credit (the reserve base)
emerges through open-market purchases of securities, purchases of ac
ceptances in the market, or discounting of paper for member banks.
Open-market purchase of government securities is dominant in its
effect on the Federal Reserve’s portfolio. Moreover, since the central
bank determines the size of open-market operations, the amount of
reserves created or destroyed is precisely determinable, which is not
true with discounting, as the initiative to rediscount or abstain is in
the hands of the member banks.
How large a portfolio should the Federal Reserve System hold in
relation to the money supply, GNP, or total liquid assets ? I know of
no economic model (theory) from which we could derive any “ ideal”
portfolio/variable ratio that should be used as a goal or rule to follow
in conducting monetary policy. All that one can say is that the
“ideal” portfolio emerges from conducting monetary policy in such a
manner that the money supply moves in a way opposite to short-run
movements in output and employment. I f it is desired to expand the
money supply in order to contribute to an expansion of aggregate
demand (GNP), the portfolio should be increased (assuming no de
crease in the required reserve ratio) until the money supply expands
*Ibid., pp. 25-26.

FEDERAL RESERVE PORTFOLIO

to the desired level. I f aggregate demand is too large, the portfolio
should be reduced until the money supply is contained sufficiently to
reduce total spending. The extension of Federal Reserve credit is a
means to an end.
Therefore, as stated before, the size and, more importantly, the
direction of change, plus or minus, of the central bank’s portfolio,
depends on the volume of total expenditures. If the latter is too low
to give us a fully employed economy, Federal Reserve credit should
be expanded, i f the opposite, the portfolio should be reduced. Any
absolute criteria for portfolio or monetary policy are useless; only
relative criteria of monetary posture are relevant.
An evaluation of recent Federal Reserve portfolio policy
The above makes it clear that in order to evaluate the recent port
folio policies of the Federal Reserve, data pertaining to the money
supply and the real side of the economy are needed—e.g., data on
employment and GNP.
Since World War II no major depression has occurred in the United
States. We have experienced only minor cycles. This is shown in
table 1 below. In the contraction of 1948-49, unemployment rose to
7 percent of the labor force for one quarter; the average rate during
the recession was 5 percent. Although unemployment did not exceed
5 percent in the recession of 1953-54, the 1957-58 unemployment was
more serious. During 1959, a 5.5 percent unemployment rate pre
vailed; in 1960, 5.6 percent; in 1961, 6.7 percent; in 1962, 5.6 percent;
in 1963, 5.7 percent; in 1964, 5.2 percent; and as of June 1965, 4.7
percent.
T a b l e 1.—Percentage

change from peak to trough in gross national
product for several selected business cycles in the United States
Business cycle
Peak

November 1948________
July 1953___ __ ________
July 1957______________
May 1960______________

Trough

October 1949________
August 1954_________
April 1958....................
February 1961______

Months from
peak to trough

Gross national
product (percent
age change from
peak to trough)

11
13
9
9

— 3 .2
-2 .0
-3 .4
-1 .1

Source: Adapted from table 2 in Geoffrey H. Moore’s “ Measuring Recessions,” Journal of the American
Statistical Association, LIII (June 1958), p. 261. Data on 1960-61 contraction added.

During 1959, the annual percentage change in the money supply
was 0.5 percent. From 1960 to December 1963, the money supply
increased at an annual average rate of 2.9 percent; for the December
1963 to May 1964 period, the annual rate of change was 2.1 percent.
These rates of increase are low by historical standards, although in
various periods since May 1964 the money supply has increased more
rapidly. This period from 1959 to 1964 has seen a slow rate of growth
in income, a high unemployment rate, and relative stability in the
price level. But the rate or change in the supply of money has not
been uniform throughout the period, and it is useful to observe the
changing pattern.
The actual history of the money supply and of postwar recession
in output in the United States is shown in figures (1) and (2). It can
be seen at once that in every postwar recession the rate of growth of the

FEDERAL RESERVE PORTFOLIO

money supply—I might add that this also holds true for every recession
since the establishment of the Federal Reserve—has slowed down
during the declining phase of the recession, sometimes becoming an
absolute decline. When economic activity reaches boom proportions,
the growth of the money supply typically slows down.

FEDERAL RESERVE PORTFOLIO

T ab l e 2. —Changes

in total holdings of Government securities by the
Federal Reserve from peak to trough in postwar business cycles

-------------

1.........

-- - Business cycle

Peak
. .

November 1948-.
July 1953..
July 1957..
May 1960___

_
_

■ -

Ii
I
1

Trough

October 1949.
August 1954.
April 1958____
February 1961.

i
Holdings of Govern-1
ment securities
(percentage change .
from peak to trough) |
i
- ........
■ 11

- 2 4 .3 3
-3 .1 8
+ 1 .1 4
+ 3 . 92

Source: Computed from various Federal Reserve bulletins.

As the major vehicle for supplying reserves to the commercial banks
in order to increase the money supply is the central bank’s open market
operations, it appears to me that the postwar experience suggests that
the portfolio policies conducted by the monetary authorities during
recessionary periods have been of little aid in contributing to the elimi
nation of recessions. The data in table 2 show this, especially for the
earlier recession periods. Moreover, when the troughs of the cycles
have reached their lowest levels and output and employment have
failed to expand back to full employment levels, which has been gen
erally the solution since 1959, the portfolio policies of the Federal Re
serve have been such that the increase in the money supply has been
insufficient to expand aggregate demand so that we achieved full em
ployment. Therefore, given the high levels of unemployment prevail
ing in the economy from 1959 to shortly after 1965, the portfolio pol
icies followed by the central bank were suboptimum. This phenome
non is not typical only to this period. For example, from January
1953 to January 1961, there occurred only a $2 billion increase in Fed
eral Reserve credit. Since the creation of reserves by the central bank
entails no cost—they are created at zero real social cost—the Federal
Reserve System apparently has conducted its open market operations
within a constraint imposed by the balance-of-payments situation, or
by its fear of inflation, or by both.
What criterion should be used for Federal Reserve portfolio policy?
In effect, my previous observations already answer this question.
I think portfolio policy should be determined by how the monetary
authorities want to vary the money supply. In the absence of a cen
tral bank endowed with the powers of a Santa Claus so thait needed
increases in the money supply can be injected into the system via
“ chimneys,” the money rein must be implemented primarily through
open market operations.
The disposition of “ excess” securities
The specific question raised is: I f the portfolio grows too large com
pared to some standard, what should be done with the excess? Then,
the following alternatives are mentioned: Should the assets be trans
ferred to the Treasury for cancellation ? Should the Federal Reserve
continue to hold them, draw the interest, and return the unexpended
balance to the Treasury ?
Before answering the major issue implied by these questions—viz:
Does the holdings of Government securities by the Federal Reserve

FEDERAL RESERVE PORTFOLIO

System raise substantive issues independent of money supply consid
erations?—I would like to make the following point: Since my major
theme is that there exists no absolute standard by which to measure
monetary policy, hence, the size of the central bank’s portfolio, an
excess amount of securities held by the Federal Reserve can only
mean that the money supply is increasing in the face of excess aggre
gate monetary demand. Under such conditions, the Federal Reserve
should not have purchased the securities in the first place; rather it
should have sold securities in the market. Increases in earning assets
of the Federal Reserve banks cause the money supply to increase and,
given an excess volume of total spending, the damage to society of
additions to the central bank’s portfolio appears when the money sup
ply increases and higher prices result. How the Federal Reserve and
the Treasury handle this excess between themselves is absolutely of no
significance.
Are there substantive issues, independent of general credit condi
tions, resulting from the Government debt held by the Federal Reserve
System ? No. The Government debt held by the Federal Reserve Sys
tem is a direct consequence of the open market operations undertaken
by the System, which are the major tool it employs in implementing
monetary policy. The System might be viewed as a depository for
fictitious Federal debt. The fictitious nature of this debt is evidenced
by the fact that, although interest is paid by the Treasury on its debt,
a large portion of Federal Reserve bank earnings are transferred to
the Treasury. Moreover, when the Treasury sells securities to the
central bank, this is, in an economic sense, no sale at alL This is an
internal bookkeeping operation within the Government incidental to
the creation of money for the Government’s use.
Maturity composition of the Federal Reserve's portfolio
Open-market operations have three distinct, though related, facets:
(1) the creation or extinction of member-bank reserves; (2) the influ
encing of the absolute level of interest rates; and (3) influencing the
structure of interest rates—the relationship between various interest
rates, like long term and short term. In consequence, when the central
bank undertakes open-market operations, it can do so in a variety of
ways, each of which will produce a different effect on the structure as
well as upon the level of interest rates. If, for example, the central
bank decides to trade in Government securities, it can do so by confin
ing its operations to the short-term sector, and long-term sector, or a
combination of both. And, of course, the structure of interest rates
can be altered without, on balance, creating or destroying memberbank reserves. The central bank can sell a given amount of short-term
securities while simultaneously buying an equal amount of intermedi
ate and long-term securities.
Monetary policy analysis draws heavily upon general interest theory
in order to define both its function in the economy and its specific imlementation. Since monetary policy is largely concerned with the
uying or selling of Government securities, the question immediately
arises, “Which securities, short-term, long-term, or various combina
tions?” I f any one of these alternatives is chosen, why? And, can
we as Chairman Patman asks, lay down any objective standards for
the Federal Reserve to follow in managing the maturity composition
of its portfolio?

FEDERAL RESERVE PORTFOLIO

In my view, it is impossible to lay down absolute criteria regarding
the maturity composition of the central bank’s portfolio. Once again
it depends on the prevailing economic environment, although, I do feel
that the Federal Reserve often puts too high a value on socially trivial
objectives like the technical health of the bond market. Such concern
like the bills-only doctrine, a doctrine whose economic rationale I was
never able to understand, often limits the size of interventions in the
market to amounts less than that current monetary policy needs would
justify. But Chairman Patman’s question raises a substantive issue,
viz., the general economic significance of altering the structure of in
terest rates via changing the maturity composition of the central
bank’s portfolio. My direct answer to this question is that how much
securities the Federal Reserve buys (or sells) is far and away more
important than what issue it chooses to deal in. In what follows I
attempt to justify this view. In analyzing this question, we shall focus
on two broad effects of manipulating the structure of financial assets
held by the Federal Reserve. They are: relative interest rate and
liquidity effects.
In order to simplify the analysis, let us assume that the Federal
Reserve, in changing the maturity composition of its portfolio, on
balance neither creates nor destroys member bank reserves. Admit
tedly this is highly unrealistic, given stabilization goals, but it enables
us to ignore money supply changes and isolate the relative interest
rate and liquidity effects.5
Interest rate effects.—The traditional view is that various debtmanagement policies can influence the level of private expenditures
The orthodox theory, as related to Treasury debt management, im
plies that during periods of prosperity the Treasury should attempt to
sell long-term securities and buy short-term securities; that is, lengthen
the average maturity of the debt in the hands of the public. Let us
assume that the central bank does this, although, as stated above, the
central bank in such a possible inflationary situation would probably
not offset the reserve loss by buying short-term securities. The reason
ing underlying this debt-management system policy is that such sales
will reduce the volume of long-term funds available for investment,
long-term interest rates will mcrease and liquidity will be reduced.
Presumably, investment spending will be reduced. The counterpart
of Treasury debt-management theory (in our discussion, central bank
debt management) is that in times of recessions short-term securities
should be sold ana long-term securities bought, that is, the outstand
ing debt should be shortened. Liquidity will be increased, and the
long-term rate of interest will be lowered and presumably investment
spending will be stimulated. But such a stabilization theory of debt
management is too simple; the reasoning underlying this orthodox
theory is not obvious. Let us explore it further by first examining the
interest rate effects of debt-management techniques; we then will look
at the impact of these interest rate effects on private spending.
Assume the Federal Reserve or, for that matter, the Treasury under
takes an anti-inflationary debt management policy, that is, sells long
term securities (borrows in the long-term market) and uses the* funds
5 In writing this section, I have drawn extensively from Warren Smith’s “Debt Manage
ment in the United States” (Joint Economic Committee Study Paper No. 19), U.S. Printing
Office, I960.

FEDERAL RESERVE PORTFOLIO

to retire (buy) short-term debt—the average maturity of the out
standing debt is lengthened. Now, simultaneously two things happen
the long-term rate rises, which presumably exercises a restrictive effect
on investment undertakings, but the short-term rate falls, which affects
certain types of spending decisions in an expansionary manner: there
occurs a change in the structure of interest rates. Thus, when funds
are drawn from the long-term sector and injected into the short-term
sector, we have two forces working simultaneously—one expansionary
and one restrictive. The net result of this debt-management technique
depends on which one of these two effects is greater. The impact on
private expenditures depends on the responsiveness of spending to
changes in long-term rates. Not only are the relative interest elastici
ties of investment demand with respect to long and short-term invest
ment rate charges relevant here, but also the interest elasticities of the
supplier of funds in the two sectors.
Obviously, an extremely important (if not the most significant) fac
tor in all this is the investment interest elasticities. Not only is it dif
ficult to form a judgment on the impact of changes in the level of
interest rates on investment expenditures, but even more so to evaluate
the effects on such expenditures of changes in the structure of interest
rate«. The whole question of the impact of changes in interest rates
on investment expenditures is complex, both at the theoretical and
empirical levels. The empirical evidence, such as it is, suggests (does
not prove, however) that both long-term and short-term mvestment
are relatively insensitive to alterations in interest rates. It would
appear, then, that debt-management techniques that alter the compo
sition of the debt produce negligible effects on investment expenditures
as a result of the changes in the interest rates. In all probability, the
interest-rate effects on long-term investments are more important then
such effects on short-term investments. Thus, there might be some
restrictive effects of shifting funds from the long-term sector (selling
bonds) to the short-term sector (buying short term)—that is, length
ening the debt, and some stimulating effects from shifting funds from
the short-term sector to the long-term sector (that is, shortening the
debt). But the order of magnitude is an empirical question, on which
the present writer has no evidence.
Of course the effects of various debt-management techniques on
private demand depend not only on the elasticities of the investment
demand functions m the various markets^ but also upon the elastici
ties of supply in the various markets. Little, if any, evidence exists
regarding the elasticities of supply in these markets. One might
expect on a priori grounds that the elasticity of supply in the short
term market exceeds that in the long-term market because short-term
securities are better substitutes for money than long-term securities.
Regarding then an overall evaluation or relying on relative interest
rate effects as a tool for so-called debt-management operations, it
would appear that they serve as a weak foundation for stabilization
policy.
Liquidity effects.—Alterations in the term structure of interest
rates are not the only effects resulting from changes in the composi
tion of the publicly held debt. There is a liquidity effect. Almost a
complete theory of debt management has been constructed on the
basis of the liquidity argument. The analysis runs somewhat as
56-913— 66--- 5

FEDERAL RESERVE PORTFOLIO

follows. Assume the Federal Reserve or Treasury sells long-term
securities and with the proceeds purchases short-term debt. Those
who bought long-term securities are much less liquid than before,
whereas those who sold short-term securities for cash are only a
little bit more liquid than before. Those whose liquidity is reduced
will substantially decrease their demand for goods and securities,
while those whose liquidity increased only slightly will increase
their spending only slightly. The net result is deflationary. I f the
Treasury or central bank were to buy long-term securities and sell
short-term securities the result would be just the opposite—that is,
expansionary. Please note that we are dealing here with the direct
liquidity effect, which is not dependent on interest rate changes.
The argument here is presumably an extension of the idea that the
level of aggregate monetary demand is affected by the size of the
stock of cash balances or other liquid assets held by households and
business firms. As far as the direct liquidity theory of debt manage
ment goes, the level of private expenditures is not only influenced by
the absolute size of the stock of liquid claims, but on how liquid this
stock is.
There is no doubt about the important theoretical role played by
the stock of accumulated wealth on influencing the level or expendi
tures, especially on the part of the consumers. But the empirical
evidence is mixed regarding the importance of changes in the stock
of liquid assets on spending. Some investigations have shown that
liquid assets appreciably affect consumer expenditures, while others
have obtained predictive relationships that are quite satisfactory
without using liquid assets. Thus, if there exists some doubt on the
empirical importance of the size of the stock of liquid assets, it is
more doubtful that changing the composition of such a stock exerts
any important influence on spending.
In the view of the author it does not seem possible to specify any
precise rules to govern debt management, whether it is undertaken
by the Treasury or the Federal Reserve—enough is not known about
the effects of alternative debt management techniques to be specific.
Secondly, it would appear that we should not take too seriously the
economic stabilization effects of altering the maturity composition
of the Federal Reserve’s portfolio, assuming that the total amount
of Federal Reserve credit remain the same. All the effects are of
secondary importance—when some people are made more liquid,
some are made less; when some interest rates rise, some fall. Given
the fact that there exists considerable doubt regarding the impacts
of changes in the level of interest rates and liquidity on private
spending, it is not surprising that changes in the structure of in
terest rates and liquidity on spending are more difficult to determine.
Of course, this does not mean that the composition of the debt is of
no significance. If there exists a large stock of highly liquid debt
during an inflationary situation the task of the monetary authorities
can become more difficult.
The addition of non-Federal Government securities to the Federal
Reserve's portfolio
Another question raised is, “Should the Federal Reserve supple
ment its portfolio of Federal Government securities with other types
of assets such as commercial loans, foreign exchange, municipal se

FEDERAL RESERVE PORTFOLIO

curities, corporate bonds, mortgages, commodities?” Of course, the
Federal Reserve, through the discounting process, does buy commer
cial paper, acceptances, and foreign exchange, but they constitute a
negligible fraction of its portfolio which consists almost exclusively
of Federal securities. I see no economic reason for the system to
purchase non-Federal Government securities. The reasons are as
follows:
Under current arrangements, the ultimate limit to money supply
increases that open market operations per se would produce is de
termined by the amount of Federal Government securities available
for the Federal Reserve to purchase, although its gold reserve re
quirements might set a lower limit. (From an economic view such
gold requirements are senseless and should be repudiated.) The total
amount of money which the Federal Reserve could destroy exclu
sively through open market operations is determined by the amount
of securities the Federal Reserve could sell. Given the large size
of the outstanding marketable Federal debt, the Federal Reserve’s
open market policies are not restricted in any way. If it were to
purchase all this debt, the money supply would increase by an
astronomical amount; and if the Federal Reserve sold all the securi
ties in its portfolio, the money supply would more than be cut in
half. For these reasons, I see no need for the Federal Reserve to
supplement its portfolio with non-U.S. Government securities.

S tatem ent

C ar l

P- J o r d a n , B e t h l e h e m , Pa.

In brief, I am absolutely opposed to the bill introduced by Rep
resentative Patman, H.R. Y601. To be sure, the portfolio and openmarket operations of the Fed were not perfectly conceived, nor have
they been perfectly executed. But given our present knowledge of
monetary variables and their effects, the existing framework is ap
propriate. Thus, the crucial problem is the lack of understanding of
monetary phenomena: demand and supply variables, asset elastici
ties, and interaction lags.
The understanding of these problems is not an easy task, and will
require a great deal of concentrated professional attention. Perhaps
the committee could encourage such research through dissertation
grants or through the special residence arrangements which some
of the executive departments are now trying.
In short, it is the present state of economic sophistication, not the
present institutional arrangements, which has limited the effective
ness of monetary management. Therefore, my opinion is that H.R.
7601 is not only a detrimental piece of proposed legislation, but also
serves to badly obscure the real problems.

S t a t e m e n t b t E dw ard
P r in c e t o n U

ane,

n iv e r s it y ,

D epartment
P r in c e t o n ,

c o n o m ic s ,

N.J.

In discussing external regulation of Federal Reserve portfolio
policy, one must distinguish between two classes of economic effects :
those relating to the aggregate economy and those applying to the

FEDERAL RESERVE PORTFOLIO

various sectors thereof. Restrictions on the composition (or struc
ture) of the Federal Reserve portfolio have effects mainly of the latter
sort. On the other hand, restrictions on the aggregate size of this
portfolio, since they tend to dilute the System’s fiscal self-sufficiency,
may change the very ground rules under which aggregate monetarypolicy decisions are made. Because of this possibility, portfoliopolicy reform is an inextricable part of the much larger question of
the optimal curtailment of Federal Reserve autonomy. This memo
randum contends that this is simply too important and many-faceted
a question to be treated in so inadvertent and piecemeal a fashion.
1. EFFECT ON MACROECONOMIC POLICY PERFORMANCE

Except in combination with more general revisions in the Federal
Reserve’s legislative mandate, the restrictions envisaged are, with
respect to the level of aggregate economic activity, not critical ones.
By themselves, limitations on central bank portfolio activity are apt
to influence the tactics—but not the strategy—of future monetary
policy.
Under current provisions of the Federal Reserve Act, even a rela
tively careful specification of the goals of monetary policy and of
the state of the economy implies no unique menu of Federal Reserve
action. A great many Federal Reserve portfolios, of differing size
and composition, are consistent with any overall policy stance. Hence,
whatever restrictions Congress might impose on the composition of
the open market account, Federal Reserve officials would remain free
to vary the pressure on bank reserves so as to determine the money
supply. Evidence of this is provided by Federal Reserve performance
under such self-imposed constraints as (1) bills only (or preferably),
(2) operation nudge (or twist) and (3) governments and bank ac
ceptances only.
Similarly, at least so long as the open market account remains
large enough both to cover expenses and to accommodate potential
sales, restrictions on the size of this portfolio are equally unimportant.
To take an extreme case, if the Federal Reserve were allowed to
issue Treasury securities on tap and to cancel (say, for gold certificate
credit) its purchases of Treasury debt, it could get along with no
portfolio at all.
Getting along without a portfolio need not, however, mean getting
along otherwise exactly as before. In particular, such an arrangement
would make it impossible for the Fed to continue to finance its own
operations. Instead, like most other Government agencies, it would
have to rely upon congressional appropriations. Having to push a
budget through Congress would drastically modify the environment
within which Federal Reserve decisions are made. Each year, Con
gress would have an opportunity to make its pleasure and displeasure
felt and felt strongly. As a result, Federal Reserve policy would fall
more closely under the influence of the Congress and, quite likely,
become even less responsive to the will of the executive. Because of
its overriding importance, we return to this issue in sections 3 and 4.

FEDERAL RESERVE PORTFOLIO
2. DISTRIBUTIONAL

EFFECTS: SECTORAL SHARING OF
BENEFITS OF POLICY ACTION

THE

COSTS AND

While it makes little difference to aggregate economic perform
ance, the particular mix of tactics whereby the Fed chooses to wield
monetary control does affect the relative economic welfare of various
individuals and firms. Any policy measure is bound to weigh more
heavily on certain groups and sectors in the economy than on others.
In the perennial choice between lower reserve requirements and open
market purchases, for example, the tradeoff is between the interest
cost of the national debt and the level of bank profits. Similarly, by
dealing in bank acceptances, the Federal Reserve fosters this market.
In contrast, issuers of and dealers in instruments like certificates of
deposit, commercial paper, and municipal bonds are left quite on
their own.
While they need not, on occasion composition-of-portfolio restric
tions can influence policy performance in the aggregate as well. Con
sider, for example, the impact of eligibility and gold cover require
ments on the monetary policy of the critical early thirties. This
experience suggests that, when they are written into enabling legis
lation, compositional restrictions are slow to change and provide
authorities with too ready a scapegoat. Whereas even today eligi
bility and gold cover requirements remain somewhat of an embarrass
ment, in response to emerging pressures on the balance of payments,
the Fed has lurched rather easily from bills only to operation nudge.
Unlike their aggregate effects, the distributional effects of compo
sitional requirements operate day in and day out. In a representa
tive democracy, therefore, disadvantaged groups or sectors may be
expected to protest their lot, and, via the political process, to bring
pressure for change. Ultimately, then, the committee’s raising these
questions is a reflection of past protests and an attempt to establish
whether criteria exist for reconciling such conflicts once and for all.
3. THE BROADER PROBLEM

Viewed in this fashion, the issues raised go far beyond those on
which the committee has attempted to focus. The problem is to de
termine what would constitute the optimal legislative curtailment
of Federal Reserve freedom of action. This is a herculean question,
one which extends simultaneously both (1) to tactical dimensions
other than portfolio policy (for example, to discount policy, to the
level and structure of reserve requirements, and to deposit rate regula
tions) and (2) to lines of authority connecting the Federal Reserve
with various agencies of the executive and legislative branches.
To deal with even a part of this problem, one must first introduce
extensive assumptions about, and analysis of, these other matters.
Since possible alternatives are so diverse (consider, for example, how
differently Friedman, Smith, and Tobin would treat the discount
rate), one can only list a number of alternative packages of reforms
(“programs for monetary stability” ), designating one of these as his
own personal favorite.

FEDERAL RESERVE PORTFOLIO
4. A SECOND-BEST APPROACH

Alternatively, one can view the committee’s task rather more
broadly than we have so far: specifically, as a search for “better”
arrangements, whether or not these happen also to be demonstrably
the “ very best.” Along these lines, one can venture this much. Any
decision to reduce the size of the Federal Reserve portfolio increases
the chance that, sooner or later, the Federal Reserve will lose its fiscal
independence. Once this occurs, in and out of season congressional
pressures will carry more force. Hence, if something is to be done,
the vital question becomes whether or not the newly operative pres
sures will be better directed, on balance, than those they deflect.
Although it has theoretical overtones, this is essentially an em
pirical question and one which should be thoroughly researched before
new legislation is introduced. Past Federal Reserve policies are a
matter of record. Lacking a channel for full and regular expression,
contemporanous congressional pressures are essentially undocumented.
Still, by examining such remarks on economic policy as appear in
the Congressional Record and various committee hearings and taking
into account differences in the individual legislators’ probable intent,
committee memberships, and general influence, one could construct
a rough statistical index of just which modifications in monetary be
havior Congress would have supported through time. Comparing dis
crepancies between this index and actual Federal Reserve policies with
actual and potential macroeconomic achievements would allow us to
shape an informed judgment about the existence and direction of
alleged policymaking biases.
Lacking such a study, I would oppose codifying changes of the
variety envisaged here. Even with such a study, I would prefer to
see the question of Federal Reserve independence considered on a much
broader basis.
S t a t e m e n t of J o h n E. K a n e . P rofessor
B u s in e s s A d m in is t r a t io n , U n iv e r s it y
v il l e , A r k .

of
of

B a n k i n g , C ollege of
A r k ansas, F ayette

This is in response to your recent letter asking for comments relative
to Federal Reserve System holdings of U.S. Treasury securities and
to certain other matters.
I will comment first on the proposal that a substantial amount of
the U.S. Treasury securities presently owned by the Federal Reserve
System be transferred to the Treasury for cancellation. There is no
compelling objection to cancellation. For example, if $30 billion of
Treasury securities were canceled, Congress could authorize the Fed
eral Reserve System to list on its combined balance sheet, in lieu there
of, an account entitled “Fiduciary Authorization” in the amount of
$30 billion. Thus, the needs of double entry bookkeeping can be met
very easily. Furthermore, cancellation would not require any change
in the operation of our money and banking system. (I am assuming
that the extent of cancellation would not be so great as to eliminate
entirely the annual net profit of the Federal Reserve banks.)
It should be recognized, however, that the term, “Fiduciary Au
thorization,” is a pleasant sounding account title which actually means

FEDERAL RESERVE PORTFOLIO

“ deficit.” Thus, the objection may be raised that cancellation would
constitute another substantial step toward a completely fiat money
system (i.e., a system in which money is without asset backing). It
is possible that this would produce a loss of confidence in our money
and banking system. But under present conditions it seems doubtful
that the public would take any sharp notice of, or feel any concern
about the matter. However, if at some future time confidence in our
banking system should falter for some other reason, and if liabilities
of the Federal Reserve banks were not fully matched by assets, this
might have an adverse psychological effect.
There may also be some justification for the belief that a fiat money
system lends psychological encouragement to irresponsible monetary
management. But the degree of responsibility with wThich our money
system is managed depends primarily upon the dedication of the en
trusted members of our legislative and executive governmental
branches and agency officials, rather than upon the form of the sys
tem. Nevertheless, the principle of full asset backing of Federal
Reserve System liabilities may be an important symbol of financial
responsibility.
As the atiove comments suggest, I am not aware of any clearly
serious objection to cancellation. On the other hand, neither am I
aware of any possible benefit to be derived from cancellation. Can
cellation would not, of itself, result in any change in the operation of
our money and banking system. And there would be no gain for the
Treasury, inasmuch as Federal Reserve System excess profits are paid
to the Treasury from time to time.
The question has been raised as to the most appropriate size of the
Federal Reserve System portfolio of U.S. Treasury securities “in re
lation to the money supply, the gross national product, or aggregate
liquid assets.” I believe that within broad limits, at least, the size of
these three relationships is not important. As suggested above, it is
preferable for the total assets of the Federal Reserve System to be at
least equal in value to the total liabilities. A substantial part of the
assets should be in the form of international reserves o f unquestioned
international acceptability, or at least of unquestioned usefulness to
the Federal Reserve System in its international operations. With
respect to the remainder of the assets, it should be noted that lending
to member banks is an appropriate activity for Federal Reserve banks;
and so it may be assumed that (properly secured) loans to member
banks will be found among Federal Reserve assets. However, in
recent years, Federal Reserve assets have been acquired largely as a
result of open market operations. Thus, the question arises as to the
most desirable type of asset for Federal Reserve open market opera
tions.
Under present conditions there is no asset as suitable as U.S. Treas
ury securities. The advantages which these securities have over other
assets, in differing degrees, include the following :
1. There is a relatively broad market for U.S. Treasury securities,
with the result that purchases and sales by the Federal Reserve Sys
tem do not have as great an effect upon market price as would likely
be encountered with many other assets. Thus, the possibility that
Federal Reserve open market operations will have a disturbing effect
on security, real estate, or commodity markets is rather well mini
mized.

FEDERAL RESERVE PORTFOLIO

2. The quality of U.S. Treasury securities is above question, with
the result that the Federal Reserve System does not need to direct its
energies to an analysis of the credit worthiness of such securities.
Also, there is a minimum of storage, preservation, etc., problems con
nected with ownership of U.S. Treasury securities. This leaves a
maximum of Federal Reserve energies available for the major func
tion of monetary management.
3. The use of U.S. Treasury securities minimizes the possibility that
favoritism and even corruption will become involved in Federal Re
serve open market operations. If the Federal Reserve System were
to begin buying and selling corporate bonds, for example, there is a
possibility that favoritism, or even outright corruption, would be the
basis for the purchase of bonds of a particular corporation. It is true
that a very high level of integrity that has always characterized the
Federal Reserve System suggests that such an unfortunate develop
ment is unlikely. But in any case, the motives of Federal Reserve
officials would always be subject to suspicion. This, in itself, would
be a handicap.
There is some plausibility to the propostion that the economy’s
liquidity would be increased if the Federal Reserve System were to
reduce its holdings of U.S. Treasury securities through open market
sales while purchasing a like amount of other assets. Thus, a greater
amount of U.S. Treasury securities would be held by other financial
institutions or by the general public. However, if a greater amount
of U.S. Treasury securities is desirable for holders other than Federal
Reserve banks, there is a better method of achieving this goal; and it
is unnecessary for Federal Reserve banks to resort to the purchase of
less desirable assets.
It might be suggested that the Federal Reserve System should
select assets for open market purchase and sale on an ad hoc basis, in
such a way as to exert a stabilizing effect on various security, real
estate, or commodity prices. Such a program should be most ear
nestly avoided. Aside from the relative disadvantages indicated
above, of open market operations in assets other than U.S. Treasury
securities, it should be stressed that managing the monetary system is
job enough for one agency. If we are to have direct market interven
tion for the purpose of stablizing the price of any item (other than
the foreign price of the dollar), it is better that such intervention be
carried on by some agency that does not also have the responsibility
of managing the monetary system. Incidentally, the Federal Reserve
System would encounter a special technical problem should it attempt
to make its open market operations serve the dual role of influencing
the money supply and also influencing the price of some particular
item. This problem would arise from the fact that the purchase and
sale of assets by the Federal Reserve System normally has a multiple
effect on the money supply.
S tatem ent

Jo hn C. K

err ,

J r ., U

pper

o n t c l a ir .

N .J .

I would like to say that the Congress should not legislate new port
folio requirements for the Federal Reserve System, but should instead
seek to maximize the Federal Reserve Board’s flexibility over its
open market operations. Any points about specific aspects of the

FEDERAL RESERVE PORTFOLIO

portfolio of Government securities can, I believe, be adequately pointed
out at the sessions of your committee to which the FRB Chairman and
the other members of the Board are asked to testify.

Statem ent

L. F

L o m b a r d i , R e a d in g ,

Pa.

In response to the kind invitation of Chairman Patman, it is a
pleasure for me to submit my views and suggestions for the improve
ment and the operation of effective monetary and fiscal policy. It is
hoped that they will prove useful in discussion of these important
topics by the Congress.
It is my personal impression that the supply of money (liquidity)
has been markedly tight in the United States for over a decade.
Considering the rate of growth which we are stimulating by fiscal
measures, I view the current trend toward restriction of liquidity as
quite alarming. I am speaking particularly of tightness in the loan
market and that element of the financial market which comprises and
influences the stock market.
The fact that the Federal Reserve System is engaged, through its
intermediary, the Federal Reserve Bank of New York and other media,
in an effort to counteract some undesirable aspects of our gold outflow
has required actions to maintain high domestic rates of interest. I am
worried about the extension of these responsibilities within the present
Federal Reserve System.
It is my view that many policies presently implemented through the
Federal Reserve System would be more effectively handled by the
Treasury Department. In particular, the use of Government securities
as a tool of monetary policy deserves special attention. Would it not be
far more effective, and admit of more exact influence and closer regu
lation, if the money supply were influenced in a direct manner through
the issue and recall of suitable currency to all banks on an equitable
ratio based on assets ? The term “banks” is used here in its broadest
possible meaning: commercial banks, national banks, State banks, per
haps some financial intermediaries. Government securities could then
resume their rightful place as instruments of national debt. An or
derly market in these securities could be maintained by the Treasury,
This program would, of course, require that all banks which are
members of the FDIC would have to be members of the Federal Re
serve System. The problems of regulating State banks in this manner
are beyond the scope of my investigation. I believe in increased in
spection, tighter banking regulations, and Government audits on an
annual basis for all banks, National and State. This area seems to me
the legitimate concern of the Congress which bears the responsibility
for the creation of the currency.
The suggestions presented here are based on my belief that the
present “ dual” system of banking has a definite tendency to bypass
the fact that the public or Government sector of our constitutional
government has the prerogative of creating the money supply and
regulating it. I f this prerogative is to be placed in more private than
public hands for implementation, it should be done by changing the
compact rather than by a gradual erosion of the public sector. These

FEDERAL RESERVE PORTFOLIO

are the fundamentals which deserve serious consideration and choice.
Under the choice already made we require only to give direct control
a more firm implementation to assert the public interest and right in
a money supply responsive to the will of the majority of our citizens.

S tatem ent

R a y m o n d H . L o u n sb u r y , V ergennes, Y

In his letter of September 1, 1965, Congressman Wright Patman
has raised questions concerning the operations of the Federal Reserve
System.
How much of the portfolio of Federal Government securities held
by the Federal Reserve System are excess holdings?
The System must add to its holdings if our country is to realize its
maximum economic growth. Once the securities are acquired, how
ever, the System does not need to retain ownership of them in order to
have them available for sale in the open market at a later date. This
is so because the occasion for their sale will not arise if maximum
economic growth is to be maintained. Their sale in the open market
could stunt our economic growth and, if on a sufficiently large scale,
cause recession or even depression. Our goal should be an expanding,
not a contracting, economy. However, if, because of a very large
growth in the Nation’s monetary gold stocks, the excess reserves of
member banks should become needlessly large in relation to the legiti
mate credit requirements of their customers, the System could reduce
excess reserves by raising legal reserve requirements instead of selling
securities in the open market. Therefore, as far as the performance
of the functions of the System is concerned, all Federal Government
securities held by the System are excess holdings.
What should be done with excess holdings of Federal Government
securities by the Federal Reserve System?
The securities should be transferred to the Treasury for cancella
tion. As part of the transfer the System should acquire Federal Re
serve notes in exchange or the right to demand them from the Treas
ury at any time in order to meet the public demand for hand to hand
currency that will arise from the growth of the economy.
The basis for this recommendation is the fact that it is not the
function of the System to make profits. The Congress, o f course, should
make provision for meeting the legitimate expenses of the System as
it does for any other department of Government.
Should the Federal Reserve System supplement its portfolio of
Federal Government securities with other types of assets?
The System should rely mainly on the acquisition of Federal Gov
ernment securities to promote maximum economic growth.
This
policy and the transfer of the securities to the Treasury for cancella
tion will reduce the size of the Federal debt and ease the interest burden
on taxpayers. However, since the effect of open market operations
on member bank reserves may be unevenly distributed, it would seem
desirable for the Federal Reserve banks to stand ready at any time to
acquire sound private instruments from any member bank whose legal
reserves are inadequate to meet the legitimate credit needs of its
customers.

FEDERAL RESERVE PORTFOLIO
S tatem ent

D . M a l o n e y , P rofessor of E c o n o m ic s , D e P atjw
U n iv e r s it y , G r e e n c a s t l e , I n d .

Total Federal Eeserve holdings of Government securities are the
cumulative result of Open Market Committee operations. The abso
lute level of these holdings does not, as far as present economic
research is aware, reflect any particular relationship to economic
conditions at any given time. The level of these holdings, as dis
tinguished from changes in this level, has no known or necessary or
desirable relationship to such variables as gross national product, na
tional income, or levels of employment and prices. Present holdings
of approximately $40.5 billion are the net result of several decades of
buying and selling activities by the Federal Eeserve. The growth of
these holdings is simply the outcome of an excess of purchases over
sales extending over a period of several years. With rare exceptions,
the Federal Reserve has not been concerned with the absolute level of
these holdings, but rather with the impact of changes in these holdings
on bank reserves and other monetary variables, such as interest rates.
In a growing economy in which increases in bank reserves are pro
vided principally through such operations, it is obvious that these hold
ings will rise over time.
As these holdings increase, there necessarily occurs an increase in
federally budgeted interest payments to the Federal Eeserve. These
“payments” are, of course, ultimately in the nature of intragovernmental transfers. Furthermore, the interest income from Govern
ment securities accruing to the Federal Eeserve is, in effect, largely
retransferred to the Treasury in accordance with the longstanding
policy and practice regarding the disposition of Federal Eeserve
System earnings. The essential point is that these transactions do
not constitute a real cost or burden to the economy or to taxpayers,
aside from their incidental contribution to the operation expenses of
the Federal Eeserve banks. They have a trivial effect on Federal
revenue requirements compared with other Treasury requirements.
In my view, Federal Eeserve open market operations should, aside
from temporarily and essentially technical daily or other short-term
requirements, be guided solely by the bank reserve situation in rela
tion to potential credit expansion, and by considerations of interest
rate level and structure. With regard to the level of bank reserves
the instruments to be used should be those most immediately available
and convenient; e.g., Treasury bills. Other securities with longer ma
turities should, on occasions, be utilized when it is desirable to influ
ence the term structure of interest rates. The Federal Eeserve should
continue to be free to use short-, intermediate-, and long-term securi
ties in such operations. Foreign exchange operations are a special
case and should be left completely to the discretion of the appropriate
Federal Eeserve and Treasury officials.
Finally, in my view, the Federal Eeserve should not in its opera
tions become involved in the very complicated problem of discriminat
ing among the various types of commercially acceptable assets of a
private nature, with the exception of bank acceptances, which occupy
a special position of longstanding nature. The view here is that in its
open market operations the Federal Eeserve should maintain neu
trality among liquid assets other than Government securities and, in
special cases, foreign exchange and bank acceptances. It should

FEDERAL RESERVE PORTFOLIO

under no circumstances engage in the most difficult practice of eval
uating and trading in municipal or corporate securities or commod
ities. The central bank must remain essentially aloof from the
movements of demand and supply for particular goods, services, and
securities of a private nature. Its essential task is to oversee and
regulate the reserve base for commercial bank credit expansion.

S tatem ent

n o m ic s ,

J o h n T M a s t e n , C h a i r m a n , D e p a r t m e n t of E co
U n iv e r s it y of K e n t u c k y , L e x in g t o n , K y ,

This is written in reply to your letter of September 1, which solicits
my views concerning the structure and management of the portfolio
of financial assets held by the Federal Reserve System. I give you
my views with considerable reservation for I recognize that I may not
be fully aware of all of the complex factors which may be involved
and that, in the light of a give and take of ideas and facts, I might
alter the position which I shall take.
1. I think that much of the additional bank lending power could
have been made available by a reduction in required bank reserves and
that this avenue should be explored more fully in formulating mone
tary policy. Bank reserves may provide individual banks with tem
porary funds but they do not provide liquidity for the total banking
system. The liquidity of the banking system depends upon the proper
implementation of monetary policy. By reducing bank reserve reuirements, the Federal Reserve System would have less of a reason
or adding to its portfolio of Government securities.
2. The portfolio holdings of the Federal Reserve System, given the
level of required bank reserves, should be large enough to provide an
adequate supply of money to accommodate the desired level of gross
national product. Since the velocity of money is not subject to con
trol, the exact size of the portfolio, and thus the supply of money,
cannot be predetermined. Monetary policy must be flexible, adjust
ments must be made to changes in velocity and to accommodate eco
nomic growth at the desired level. I do not believe that there is any
fixed relationship that can exist between the portfolio holdings of the
Federal Reserve System and the supply of money, gross national
product or aggregate liquid assets. What might be regarded as a
satisfactory ratio under one set of conditions might prove to be en
tirely unsatisfactory under another set of relationships. Flexibility
and competent monetary management are necessary, not rigid and
static guidelines.
3. The best criterion for monetary policy is whether it accomplishes
its objective. Before we can do this, we must agree on our objective
or objectives and determine to what extent they are attainable. In
a democratic society, objectives should be decided by the will of an
informed public; but it is highly important that the public be given
all of the facts and that they understand their significance. This
could and should be regarded as a plug for more economic education.
I would not, however, establish a criterion in terms of the size of the
Federal Reserve portfolio but rather in terms of whether it has suc
cessfully achieved its objective. I f it does not do this, then we are en
titled to ask, why: and to take such steps as may be necessary to

FEDERAL RESERVE PORTFOLIO

remedy the situation. Possibly we may find that we have demanded
too much of monetary policy in expecting it to solve all of our eco
nomic problems.
4. I fail to see how it is possible to transfer Federal Reserve assets
to the Treasury for cancellation without a corresponding reduction in
Federal Reserve liabilities. A reduction in required member bank
reserves would make a reduction in the size of the Federal Reserve
portfolio possible. A reduction in Federal Reserve notes and an in
crease in Treasury currency (possibly additional U.S. notes) would
also make a reduction in the Federal Reserve portfolio possible; but
I fail to find any substantial advantage in such a policy at this time.
In reality, all forms of currency are a debt of the Federal Govern
ment. The Federal Reserve is, in the issuance of notes, merely an in
strumentality of the Government.
5. I do not think that it is necessary for the Federal Reserve to
draw interest on all of its portfolio holdings. Some portion of the
total portfolio could be represented by special noninterest bearing
issues. At the same time, the present policy does not seem too unsatis
factory unless it can be shown that the Federal Reserve is imprudent
in its expenditures. Even if this can be demonstrated, there are other
ways of meeting the problem. The denial of interest income to the
Federal Reserve should not be used as a means of penalizing or
crippling the System. To repeat, I do not regard it as essential for the
hard core of U.S. security holdings of the Federal Reserve to carry
interest. It should, however, have a sufficient volume of public issues
to conduct normal open market operations. These issues should have
the same qualities as all comparable issues available in the open mar
ket. In fact, they should be open market issues.
6. The Federal Reserve portfolio of marketable Government issues
should be large enough to enable it to engage in open market opera
tions throughout the range of the maturity schedule. Any special
non-interest-bearing issues that it might hold should be convertible
into marketable issues under predetermined conditions. The impor
tant consideration should be the preservation of flexibility in the im
plementation of monetary policy. I am skeptical of inflexible prede
termined standards which serve to inhibit action when it is needed.
7. I do not favor open market operations or purchases by the Fed
eral Reserve of municipal securities, corporate bonds, commercial
paper, or commodities. The Federal Reserve should not be subjected
to the political and other pressures that would develop as a result of
trading in these areas. Foreign exchange dealings are justifiable if
they serve to stabilize the flow of funds internationally and thus have
a direct impact upon the domestic monetary system.
In summary, I wish to remind the Subcommittee on Economic
Progress that nearly all money used internally in the United States is
debt. It is not convertible directly into anything of intrinsic value.
The real value of money depends upon what it will buy in the way of
goods and services. Thus, proper monetary management is of the
utmost importance for the welfare of the people.
We need to find a way of coming to an agreement upon the objec
tives for monetary policy. Then, assuming that the people who must
implement policy are honest and competent, we need to give them the
tools adequate to the task. Change is inevitable but change for the

FEDERAL RESERVE PORTFOLIO

sake of change should be avoided. Evolutionary change is also pref
erable to sudden and disruptive change. I trust that your survey
will provide the basis for constructive and considered changes that
are undoubtedly needed and I wish to thank you for inviting me to
express my views.
S t a t e m e n t b y C . A . M a t t h e w s , P rofessor of F in a n c e , C ollege of
B u s in e s s A d m in is t r a t io n , U n iv e r s it y of F lo rid a , G a in e s v il l e ,
F la.
size a n d m a n a g e m e n t of t h e federal reserves portfolio of
g o v e r n m e n t sec u r it ies

Questions related to the size and management of the Federal Re
serve’s portfolio of Government securities must be considered within
the context of the objectives of central policy and of the instru
ments available to the central bank to accomplish or implement policy
decisions. The following comments will be based on the assumption
that the objectives of policy will be essentially those set forth in the
Report of the Commission on Money and Credit ; namely, low levels
of unemployment, a relatively stable price level, and adequate rates
of economic growth. It will also be assumed that the available policy
instruments will be essentially the same as those possessed by the Fed
eral Reserve authorities at present. The question of primary consider
ation is how to instruct the authorities in the use of open market opera
tions. This leads to further questions concerning the disposition of
securities held and of earnings received.
Principles To Be Applied
In formulating instructions concerning the use of any policy in
strument, Congress should consider certain basic principles. Obvi
ously, the instrument should be strong enough so that its use will make
significant contributions to achieving the objectives of monetary policy.
In addition, use of the instrument should be sufficiently flexible to en
able it to be adapted to changing needs of the economy and to changing
conditions. And finally, the nature of the instrument should be such
that its use will interfere as little as possible with the market process
and subject the authorities to the minimum pressure from specialinterest groups.
If these principles are applied to the instructions which are written
into the law concerning open market operations, they would require
that the Federal Reserve be given the authority to buy and sell securi
ties in sufficient quantities to achieve its objectives. The framers of
the original Federal Reserve Act placed considerable faith in the
acquisition and redemption of eligible commercial paper as an auto
matic guide to monetary policy. While the Federal Reserve banks
were permitted to acquire Government securities, they were not per
mitted to use these as collateral for the issuance of Federal Reserve
notes. Consequently, when a shortage of eligible commercial paper
coincided with a desire to convert demand deposits into currency, the
authorities were limited in their ability to issue Federal Reserve
notes in the amounts necessary to maintain liquidity of the financial

FEDERAL RESERVE PORTFOLIO

system. Considering the size of the Federal debt at the present time,
there is little danger that a shortage of this media for open market
operations, nor of collateral for Federal Reserve notes will exist in
the near future, but the lesson of our past monetary experiences should
not be lost.
The principles set forth above would also require that open market
operations should be conducted in those securities which have the
“deepest and broadest” market. I f this principle is followed, open
market operations in a volume sufficient to accomplish the System’s
objectives will have the least impact on the price of securities traded
and on the price differentials between these and other securities. Free
dom to enter the market to buy and sell securities as necessary without
specification as to type or maturity date would result in the least
interference with the free market processes and the allocation of
resources. Such freedom would also provide the flexibility needed to
permit open market operations to adjust to changing economic condi
tions. It follows that Congress should refrain from specifying too
rigidly the types or maturities of securities to be bought and sold
in open market operations.
While permission to engage in open market operations should
extend to a sufficiently broad definition of securities so as not to limit
the authorities’ ability to achieve given objectives, the composition
of the Federal Reserve’s portfolio should not be specified nor should
the Federal Reserve be required to buy or sell any particular type of
securities. To specify that the Federal Reserve authorities should
execute open market operations in State and local securities, would
open the gates to pressure from issuing governmental units to buy
specific issues or to refrain from the sale of specific issues when impact
of such transactions would be beneficial or harmful to the govern
mental unit concerned. Furthermore, the market for the issues of
most of the individual States and localities is probably too narrow to
permit open market operations without causing undue fluctuations
in the price of the security being bought or sold.
Open market operations in commodities would also subject the
monetary authorities to continuous pressure to purchase selected com
modities, to refrain from purchase, to dispose of its stocks, or to refrain
from sales as the self-interest of different groups might be served by
these alternative courses of action. Such pressure would support open
market operations designed to influence prices of individual commodi
ties—not the welfare of the economy in general—and would under
mine the very foundation of a free-enterprise economy, the market
place. However imperfect the marketplace is and however limited
it may be in scope, to require open market operations in commodities
would only serve to limit it further.
Open market operations in commodities are subject to two other
objections which should be mentioned. One of these objectives stems
from the problem associated with the storage and preservation of
commodities. While these problems might not limit the purchase of
commodities, if the commodities should be perishable they might not
be available for sale when and if the need arose to restrict or contract
the money supply. Consequently, open market operations in com
modities could result in an inflationary bias as it might provide the
basis for an expansion of the money supply without the ability to
subsequently force a contraction should the need arise.

FEDERAL RESERVE PORTFOLIO

Closely related to this is the problem of confidence. Should it be
necessary to write off substantial quantities of commodity assets,
what capital account would they be charged against ? Such a situa
tion could give rise to unlimited rumors which could result in the
loss of confidence in the money supply. (If some type of convert
ibility were maintained, it could also result in runs on the commodity
held tor conversion.)
OPTIMUM SIZE OF PORTFOLIO DIFFICULT TO DEFINE

It is difficult to define the optimum size of the Federal Reserve Sys
tem’s portfolio of Government securities (or of any other asset or
group of assets). Since we are opposed to instructing the Federal
Reserve to acquire other types of securities and commodities either
separately or collectively, we will direct our comments to the desira
bility of limiting or defining the size of holdings of Government
securities. Here, one must recognize and be ever cognizant of the
objective of open-market operations which is to assist in achieving
the country’s economic objectives through controlling or influencing
the money supply. One must also realize that open-market purchases
provides the basis for a multiple expansion of the money supply,
whereas, sales tend to cause a multiple contraction.
I f the money supply is to be varied through open-market operations,
then it follows that the size of the portfolio to be accumulated by the
Federal Reserve System cannot be defined in relationship with the
money supply. To use this means of control would be to assume
that the money supply adjusts, in some way, to the needs of the econ
omy and that this adjustment should determine the optimum size of
the Reserve System’s portfolio. While correlation analysis will show
a positive relationship between changes in the money supply and
changes in Federal Reserve ownership of Government securities, the
change in the former does not cause the change in the latter. It is
more logical and accurate to have the causal relationship run from an
increase in the Federal Reserve’s portfolio to an increase in com
mercial bank reserves to an increase in the money supply.
Even if the time sequence seems to run for an expansion of the
money supply to an increase in Federal Reserve ownership of securi
ties, the significant causal relationship is the reverse. The commer
cial banking system may be able to effect an expansion of the money
supply as a result of continuously increasing discounts at the Federal
Reserve banks, or as a result of more efficient utilization of existing
reserves.
I f the former is the route taken, then a subsequent acquisition of
securities is probably necessary for the expansion to be maintained
since the banks do not like to remain continually in debt to the Fed.
Such is not the case, however, if the banks are able to more efficiently
utilize reserves. In the latter case, the past acquisition would have
provided the reserves and present innovations enabled the reserves
to support a larger money supply. But this case does not need the
Federal Reserve to acquire additional securities to provide a base for
the larger money supply.
There is a possibility, of course, that in addition to more efficient
utilization of reserves, commercial bank reserves may be increased
from sources other than increases in Federal Reserve bank credit

FEDERAL RESERVE PORTFOLIO

outstanding. For example, the public may permanently alter the
ratio in which it holds currency and demand deposits so as to decrease
the proportion of the former, or the gold supply of the United States
may increase. Either of these changes would permit an expansion
of the money supply which, if accompanied by an increase in Federal
Reserve holdings of Government securities would permit even further
increases if the basic objectives required restraint on the expanding
money supply.
These relationships and possible effects serve to illustrate the danger
inherent in instructing the monetary authorities to maintain any fixed
proportion between Federal Reserve holdings of Government securi
ties and other economic series. Fundamental changes may occur in
the relationship between the money supply and the level of economic
activity, between the selected series and the money supply, and, there
fore, between the optimum size of the Federal Reserve s portfolio and
the level of economic activity. I f the assumed relationships do not
exist, then the attempt to maintain a fixed relationship between the
Federal Reserve’s portfolio and any selected guide may lead to policy
which prevents rather than contributes to the achievement of economic
objectives; that is, may contribute to instability rather than stability.
WHEN ARE FEDERAL RESERVE HOLDINGS EXCESS?

I f it is decided that the optimum size of Federal Reserve holdings
of Government securities cannot, or should not, be defined by law, then
it follows that it is equally difficult or impossible to define what is meant
by “excess holdings.” But even if it is possible to arrive at some
concept of excess, it would not necessarily follow that those securities
in excess should be returned to the Treasury for cancellation. To do
so might interfere with the Federal Reserve’s ability to contract bank
reserves should they experience a substantial growth from other fac
tors such as the tremendous gold inflow during the 1930’s and 1940’s.
It is also conceivable that such action could interfere with the Federal
Reserve’s ability to issue Federal Reserve notes should the public de
cide to increase the proportion of assets it desires to hold in the form
of currency as opposed to demand deposits or other assets. It is dur
ing emergency periods such as these that the monetary authorities
find it most difficult to fulfill their responsibilities. Regulations and
guides directed toward normal conditions and problems prove inade
quate. Only by providing authority and resources sufficient to the
exceptional problem can the authorities be expected to meet their re
sponsibilities. It is impossible to determine when or to what extent
the periods of crisis may develop in the future. In the meantime, it
would be unwise to transfer “excess holdings of Government securi
ties” to the Treasury for cancellation and thus limit the ability of the
Federal Reserve to cope with future emergencies.
WHAT SHOULD BE DONE W ITH EXCESS EARNINGS ?

It does not follow, however, that the excess earnings of the Federal
Reserve System should not be transferred to the Treasury. Since the
Federal Reserve System has been established as a means of implement
ing powers granted by the Constitution to Congress, it follows that
profits from such operations should accrue to the people as a whole—
56-913— *56-------6

FEDERAL RESERVE PORTFOLIO

or to the Treasury. The only question is how to achieve this transfer
as efficiently as possible. The present method is to invoke a clause of
the Federal Reserve Act which was originally included for a different
purpose. In general, it is undesirable to achieve desirable objectives
through illegal means.
It would be preferable to provide for the transfer of excess earnings
by statute. Such an objective could be accomplished by requiring the
Federal Reserve banks to pay a franchise tax based on their earnings
similar to that included in the original Federal Reserve Act. An
other possibility would be to have the Treasury issue special securi
ties—at very low rates of interest or noninterest bearing—in exchange
for those acquired through open market operations. The securities
acquired by the Treasury would be held for reverse exchange should
the Federal Reserve need them for open market sales. This procedure,
however, would be more cumbersome and the simpler method of a
franchise tax is preferred.
The question relating to the disposition of excess earnings implies
that some measure of excess exists. It opens a whole series of related
questions such as who should be responsible for determining and re
viewing expenses of the Federal Reserve System, who owns and should
thus receive the “profits” from the operation of the System; and who
should own the System. These are questions which were not raised
for discussion and to which we have not addressed our remarks. They
are, however, germane to any discussion of the disposition of Federal
Reserve earnings.
S tatem ent

T h o m a s M a y e r , P rofessor of E c o n o m ic s , U
of C a l if o r n ia , D a v is , C a l if .

n iv e r s it y

I feel that the level of the Federal Reserve’s portfolio at any one
time is not nearly as important a factor as the changes occurring in
the portfolio. One can treat the level of the portfolio as a relatively
unimportant outcome of these changes. Hence, the problem really
becomes one of finding criteria for changes in the Federal Reserve’s
holdings of Government securities. These changes can be looked at
as the resultant of the following factors: (1) the increase in the money
stock, (2) the proportion of the increase in the money stock which is
brought about by open market operations rather than by other factors,
such as currency holdings or changes in reserve requirements, and (3)
the distribution of earnings and assets between the Federal Reserve
and the Treasury.
The criteria for the optimal growth of the money stock are full
employment and price stability, and if we insist on sticking to fixed
exchange rates, balance-of-payments equilibrium. (Obviously these
criteria need not be consistent.) On a more concrete level I would
advocate increasing the money stock at a fairly stable (but not rigid)
rate determined by the growth of (full employment) output and major
changes in velocity. The second factor, the extent to which the money
supply should be increased by open market operations centers around
the choice between open market operations versus the lowering of
reserve requirements. Your committee has discussed this issue exten
sively in the past and has done yeoman service in bringing this issue to
the public’s attention. I lean toward the position that, on the whole,
it is better to increase the money supply via open market operations.

FEDERAL RESERVE PORTFOLIO

This implies that the Federal Reserve’s holdings of Government
securities are growing over time, unless there is a redistribution of
assets between the Federal Reserve and the Treasury. Since the
Federal Reserve is a part of the Government such a redistribution has
little potential either for good or for evil. I can see only the follow
ing three minor advantages in turning over $30 billion of securities
to the Treasury. First, having the Federal Reserve hold public debt
exaggerates the size of the national debt, and hence, may cause some
unnecessary concern to some people. But this is probably only a minor
point since the public appears to be less concerned nowadays with
the size of the debt than it was earlier. Moreover, people who are
worried about the size of the debt would probably be just as worried
about a $280 billion debt as they are about a $310 billion debt. A
second possible advantage is that a smaller cushion of net earnings
may cause the Federal Reserve to work harder at keeping down ex
penses. But this is only a hypothetical effect, and in case it appears,
at least on the basis of my rather casual and quite limited observation,
that the Federal Reserve is not spendthrift. Third, turning over
Government securities to the Treasury would prevent the possibility
that the Federal Reserve at some future time may decide not to sur
render its net earnings to the Treasury. But this is a rather unlikely
contingency. Moreover, if this were to happen the Treasury could
increase its deficit spending by an equivalent amount without being
inflationary, so that the failure to receive the Federal Reserve’s earn
ings would really involve no significant cost to the Treasury.
The second point raised in your letter is the composition of the
Federal Reserve’s portfolio. With regard to the maturity structure,
like most economists I was glad to see “bills preferably” abandoned.
Since the long rate reacts only sluggishly to changes in the short
rate, the Federal Reserve should stand ready to operate in all ma
turity segments of the market if it wants to bring about a change in
interest rates.
The purchase of private securities in place of Government securities
raises another issue. It may be worth noting at the outset, that the
Federal Reserve through its purchase of banker’s acceptance and the
provision of business loans is already operating in the private market,
and hence, that there is little room for the ideological argument that
operating in the private market is against Federal Reserve tradition.
Under normal circumstances I see little need for the Federal Reserve
to buy or sell private securities. But in a very severe depression, if
rising risk premiums prevent rates on corporate securities from falling,
Federal Reserve purchases of private securities would be helpful.
Admittedly, there is no imminent danger of such a severe depression,
but giving the Federal Reserve the power to purchase corporate and
municipal securities, (without compelling it to do so) would be a
useful safeguard. Support of mortgages in a severe depression could
perhaps be handled better by one of our numerous specialized housing
agencies. This leaves business loans. I believe that the Federal Re
serve should not be in the market for two reasons. First, the granting
of business loans requires an intimate knowledge of business, and the
Federal Reserve is not equipped with this knowledge, except perhaps
in the case of large firms. Second, granting business loans brings
the Federal Reserve into competition with the banks it has to super

FEDERAL RESERVE PORTFOLIO

vise, and this creates trouble. Apparently, one of the European cen
tral banks has been hindered in its monetary policy by the fact that
banks are reluctant to rediscount (and thus reveal their customers)
for fear that the central bank will attempt to capture these customers
for itself.
Statem ent

S t e p h e n L. M c D o n a ld , P rofessor
U n iv e r s it y of T e x a s . A u s t i n , T e x .

c o n o m ic s ,

c o m m e n t s o n issu e s r e l a t in g to t h e federal reserve s y s t e m ’ s
portfolio

of g o v e r n m e n t

securities

I, General.
Given the tools of monetary management available to the Federal
Reserve System and the various factors not subject to System control
affecting the availability of reserves to commercial banks, growth of
the System’s portfolio of Government securities is closely linked with
growth of the Nation’s money supply. Purchase of securities is the
only means by which the System may directly and on its own initiative
supply additional reserves to commercial banks and thereby enable an
expansion of the money supply. Additions to reserves through dis
counts and advances, while influenced by the discount rate and System
permissiveness, depend on the initiative of member banks. The Sys
tem may enable an expansion of the money supply by reducing the
required reserve ratios of member banks, but the limitations on this
tool of monetary management, imposed by law, and the need always
to leave some room for emergency reductions, make it an unsuitable
means of providing for orderly growth of the money supply over the
long run.
Several factors other than Federal Reserve policy actions affect
commercial bank reserves: variations in the monetary gold stock,
changes in currency in circulation, growth of Treasury currency out
standing and fluctuations in the float, in nonmember deposits with
Federal Reserve banks and in other System accounts. Chief among
these are variations in the monetary gold stock and changes in cur
rency in circulation. To manage the Nation’s money supply appro
priately the Federal Reserve System must supplement, offset or pas
sively permit the effects of these other factors influencing commercial
bank reserves, depending on the size and direction of their net effect.
In recent years a substantial decline in the monetary gold stock and a
similar increase in currency in circulation, both tending to reduce com
mercial bank reserves, have required compensatory expansive actions
by the System, principally enlargement of its portfolio of governments
through open market purchases.
II. How large should the System 'portfolio be in relation to other
economic variables?
There is no simple rule that can be stated concerning the appropriate
or best relationship of the System portfolio to the money supply, the
gross national product, aggregate liquid assets or any other such
variable. Given the System’s powers and depending on the concurrent
net effect of the several nonpolicy factors affecting commercial bank
reserves, it may be appropriate for the System portfolio to grow at

FEDERAL RESERVE PORTFOLIO

the same rate, at a higher rate, or at a lower rate than other economic
variables; ana there are no specifiable critical ratios at which relative
growth or deecline of the portfolio should cease. The important thing
is that the System have adequate and efficient means of increasing
the money supply at a rate conducive to sustainable growth, minimal
involuntary unemployment and stable prices, regardless of the in
fluence of nonpolicy factors on commercial bank reserves.
It is conceivable that System accumulation of governments over
the years might so reduce the supply available to the private sector
as to affect adversely the quality of private portfolios, particularly
if the Federal debt snould grow at a markedly lower rate than private
debt. The development of such a problem in the foreseeable future
seems most unlikely. In any case, there is no basis in economic theory
or experience for specifying some unique ratio between System hold
ings of governments and total available financial assets (of any degree
of liquidity) at which private portfolios would begin to experience
significant deterioration. The best way to insure against such problems
is to give the System wide latitude in its choice of means to affect the
money supply, including the types of assets purchased and sold.
/ / / . What types of assets should be eligible for the System port
folio?
For several reasons, Government securities are the preferred type
of asset for that portion of the Federal Reserve System’s portfolio
acquired through open market purchases. Governments are eligible
collateral for Federal Reserve notes; they are traded in well developed,
highly active markets in which transactions costs are low and quantity
purchases have minimum impact on price; they may be bought and
sold without directly influencing the relative borrowing costs of
individual businesses or industries.
For the simple purpose of supplying additional reserves to commer
cial banks, however, the type of asset purchased by the System is im
material. It may be real or financial, a claim issued by a public or
a private entity and, if a debt instrument, of any maturity. Conse
quently, the System should be free (and willing) to acquire assets
other than governments and instruments of any maturity when such
action would tend to enhance the effectiveness of monetary manage
ment, whether by increasing the selectivity of policy actions or by
minimizing such unwanted side effects as private portfolio deteriora
tion. Since the desideratum is sufficient System flexibility to cope
with any likely set of circumstances in pursuing the aims of mone
tary policy, it would be undesirable to try to prescribe the composition
of the System portfolio.
IV What should be done with any “excess” in the portfolio ?
The Federal Reserve System’s portfolio of governments may be
“excessive” in the sense that it contains more securities than the
System is likely ever to wish to sell as a matter of policy, or in the
sense that it yields more current income than is necessary to finance
the legitimate operations of the System. I f the portfolio is exces
sive in both senses, or in the latter sense only, two remedies are readily
available. First, the System may be required to exchange the excess
portion of its portfolio for non-interest-bearing obligations of the
Treasury, the latter being eligible collateral for Federal Reserve notes

FEDERAL RESERVE PORTFOLIO

and reexchangeable, as required for open market sales, for interestbearing Treasury obligations. The non-interest-bearing obligations
might, indeed, take the form of legal tender notes which could be
placed in circulation as demanded by the public in lieu of Federal
Reserve notes. Second, the System may be required simply to re
turn any excess earnings on governments to the Treasury, as it now
does.
The second remedy is simpler and equally effective in reducing the
net cost to the Treasury of debt held by the Federal Reserve System.
The variant of the first remedy involving legal tender Treasury notes
would reduce the gold certificate reserve requirements of the System
(by reducing the issue of Federal Reserve notes); but this reserve re
quirement, which is domestically functionless and internationally det
rimental, should be eliminated in any case.

S tatem ent

G eorge

M cK

in n e y ,

Jr.,

pper

o n t c l a ir ,

N.J.

In specific comment on the colloquy between you and Federal Re
serve uhairman Martin, enclosed with your letter, I oppose H.R. 7601
or any other measure which would cancel legal obligations of the U.S.
Government. I feel Mr. Martin’s position is both clear and correct.
The free market principle is an important aspect of effective central
banking. To require the Federal Reserve to hold nonmarketable
Government securities, or to cancel or otherwise renounce any part
of the public debt of the United States, would involve a subversion
of the principles of central banking and a debasement of the credit
of the Nation which would be intolerable. Cancellation of outstand
ing obligations of the Federal Government, whether or not they were
held by the Federal Reserve, would pose a threat of partisan manipu
lation of central bank assets or forced acquisition of assets by the
central bank. It would be considered by foreign governments and
individuals to be a serious threat to those monetary policies necessary
to preserve the value of the dollar. The prestige of the U. S. dollar
abroad would suffer damage of incalculable significance. The damage
to foreign and domestic confidence in the integrity of our Government
would be considerable.
The following comments are in specific answer to the questions
raised in the body of your letter. The size of the portfolio held by the
Federal Reserve should not be determined by the money supply, the
gross national product, aggregate liquid assets, or any similar quanti
tative measure; the appropriate criterion is the well-being of the
economy. Under no circumstances should these assets be returned to
the Treasury for cancellation. The Federal Reserve should continue
to hold them and draw the interest on them as does any other
properly constituted owner of Government debt instruments. This
interest, as such, should not be returned to Treasury, although the
present substantial tax paid by the Federal Reserve is reasonable and
appropriate. Standards set by the Congress to guide Federal Re
serve portfolio operations generally should not be quantitative. They
should be subjective in nature and should relate only to achieving
the most effective execution of the responsibilities given to the Fed
eral Reserve by the Congress. In general, additional standards

FEDERAL RESERVE PORTFOLIO

relative to the kind or maturity of assets held by the Federal Reserve
are not now necessary.
These replies to your questions should be considered only in the con
text of the central banking functions of the Federal Reserve System.
The Federal Reserve’s total portfolio of assets should be determined in
the first instance by the needs of the economy. Because other con
siderations should be subordinate to this one, the appropriate size of
the Federal Reserve’s portfolio of Government securities cannot be dis
cussed in isolation. Alternatives must be considered: it is feasible for
the Federal Reserve to reduce its average portfolio of Government
securities only if the contractionary effects of the related open market
operations are offset by some equivalent expansionary influence. To
consider whether the Federal Reserve should hold a smaller average
portfolio of Government securities, it is essential to simultaneously
consider whether reserve requirements should be reduced, or member
banks should be encouraged to increase their borrowings from the
Federal Reserve, or some other asset should be increased in an amount
commensurate with the reduction in the Government securities
portfolio.
The Federal Reserve should be attentive to arguments of those who
feel the “mix” of these variables should be changed in any specific
situation, but the responsibility and authority should be left to the
System. The range of discretion the Congress has seen fit to grant
to the Federal Reserve in managing its asset holdings should not now
be further restricted. It would be appropriate, though, to permit or
require the Federal Reserve to reduce reserve requirements, especially
against time deposits. Such a reduction, of course, would be accom
panied by an offsetting sale of Government securities or other assets
from the Federal Reserve’s portfolio.
It is important to bear in mind the fact that a relationship between
the Federal Reserve’s portfolio and any other single economic aggre
gate which might be appropriate at one time or under one set of cir
cumstances would be inappropriate at another time or set of condi
tions. The Federal Reserve needs the maximum possible freedom of
action to formulate effective credit policies tailored to economic cir
cumstances as they change from day to day. Positive efforts should
be made to avoid unnecessary restraints on the mechanics by which
these policy objectives are accomplished.

Statem ent

F lo yd

n iv e r s it y of

M e t zle r , P rofessor
C h ic a g o , C h ic a g o ,

c o n o m ic s ,

III.

In answer to Mr. Patman’s question, I do not believe there is any
hard and fast rule concerning the amount of Government bonds which
the Federal Reserve System should hold in its portfolio. Canceling
the Government bonds held by the Federal Reserve would indeed re
duce the Government debts, but it seems to me that this effect would
be small. A much more important consideration than the asset
ortfolio of the Federal Reserve System is the fiscal policy followed
y the F ederal Government.
I f we want to expand the demands for goods and services, I believe
that except for its effect on the balance of payments, it is a matter of

FEDERAL RESERVE PORTFOLIO

indifference whether we try to manipulate the quality and availability
of money or the relation between the Government taxes and its re
ceipts; fiscal policy, in fact, is likely to be more effective and more
rapid than monetary policy. Until now, the Government debt has
not increased substantially relative to the national income. For this
reason, I am not greatly concerned about the asset portfolio of the
Federal Reserve System. What is more important, I believe, is an
extension of our ideas concerning the Government debt. I f the Fed
eral Reserve System were considered a part of the Federal Govern
ment, Treasury bonds held by the Federal Reserve would be an asset
from the point of view of the banking system and a liability from the
point of view of the Treasury. The net effect would be zero so far as
the Federal Government as a whole is concerned. Canceling the debt
would thus write down the Treasury liability and the Federal Reserve
asset to the same degree, leaving the net debtor position unchanged.
There is another point, however, which argues in favor of giving the
Reserve System more latitude in its portfolio. The balance of pay
ments is not, now, a pressing issue but it may become so in the future.
In this situation the Federal Reserve System might have to sell bonds
to prevent a capital outflow. If so, it would be important for the Fed
eral Reserve have enough bonds in its portfolio to carry out its
responsibilities.
S t a t e m e n t b y E r v in M iller , A ssociate P rofessor
W h a r t o n S c h o o l of F in a n c e a n d C o m m e r c e , U
P e n n s y l v a n i a , P h il a d e l p h ia , P a .

F in a n c e ,

n iv e r s it y

It seems to me that it is not feasible to stipulate just what should be
the quantitative relationship of the Federal Reserve portfolio to the
money supply, gross national product, or aggregate liquid assets of the
economy. Although it is certainly true that the portfolio of Govern
ment securities has been growing rapidly, it should be borne in mind
that this rise has been in the period 1958 to date, while for the 6 pre
vious years the portfolio was relatively stable. Indeed, one can go
back still further and find that at year ends 1945 and 1957 the holdings
of Government securities were almost identical. The recent period
of rapid growth has coincided with adverse gold movements and with
increases of currency in circulation and thus the growth in the Federal
Reserve portfolio has been necessary largely to offset them. This
serves to demonstrate that in a world of rapid change, freedom of
action to move vigorously and decisively is essential to the success of
central bank policy. Quantitative restrictions on acquisitions of Gov
ernment securities in recent years would have hampered Federal Re
serve’s ability to move vigorously and decisively.
However, there is one relationship of the Government security hold
ings of the Federal Reserve that should be watched carefully ; namely,
the ratio of Federal Reserve holdings to the marketable Federal debt
by the public and the Federal Reserve combined. Circumstances can be
envisioned in which this ratio might impinge on the needs of the rest of
the economy for the uniquely riskless asset that Federal debt provides.
In such a situation, it miirht be desirable for the Reserve authorities
to consider acQuirin^ other a^«ets. Here it would seem best to avoid
private securities in open-market operations owing to possible political

FEDERAL RESERVE PORTFOLIO

charges that may be made concerning the choices of securities and the
impacts of the purchases. It would seem best also to avoid commod
ities for a variety of reasons; e.g., political complications, the imping
ing on other governmental programs which deal with price and/or
income stabilization in agriculture, etc. The most suitable additional
assets for the Reserve authorities to consider would probably be the
highest grade of readily marketable municipal and State securities.
These are in substantial and growing supply and probably give reason
able insulation from political pressures. Foreign exchange offers the
highly desirable quality of being an impersonal medium, and can be
used successfully at times. On the other hand, its availability is re
lated to the state of the balance of payments. Thus open-market
market operations in foreign exchange—especially if large scale—
might at times be in conflict with foreign and other economic policies
or be hampered by the state of the balance of payments. In short,
foreign exchange does not offer the possibility of flexible open-market
operations at all times.
If private assets are to be considered, open-market commercial paper
is a logical possibility, given its impersonal character and short lifespan. Existing operations in bankers’ acceptances could be stepped
up, with the Reserve authorities taking an active role in acquiring or
disposing of such assets.
The fiscal impact of Federal Reserve holdings of Government se
curities is handled reasonably well at present, since nearly all the inter
est flows back to the Treasury under current policies. However, im
provement is clearly possible, and a strong case can be made for having
the Federal Reserve exchange a substantial part of its portfolio for
special non-interest-bearing issues of the Treasury. This would make
the recorded budget level of interest payments correspond more closely
to the facts; i.e., some of the present overstatement of interest charges
in the Federal budget could be removed and the overall budget total
correspondingly reduced.
S t a t e m e n t b y H arold W M il l e r , P rofessor o f E c o n o m ic s , S t a t e
U n iv e r s it y C ollege a t B r ock po r t , B r ockport , N.Y

It would be very handy to have some formula for arriving at port
folio need of the System, however I fear it might not serve too well.
To look back over the years to note portfolio change we may observe
a swell from 2.2 billion in December of 1941 to 23.7 billion in 1945
was accompanied by a near comparable change in the money supply
from 10.9 to 28.4 billion. Naturallv the Fed was playing a central
bank’s role in financing the war while politicians were content not to
levy the necessary tax.
From what I can observe this was the beginning of a large port
folio and the swell is now 39 billion as you point out while money
supply is now about 163 billion. To me these relationships are quite
interesting.
I would judge the “prime” purpose of having any portfolio at all
is for OM operations. They wouldn’t need a bundle of stock in order
to buy more to expand reserves. However, to tighten up on things
they would need something to sell—you must admit we wouldn’t
want the Fed to be caught without highly salable securities just in
case we need to cool off the economy.

FEDERAL RESERVE PORTFOLIO

Your question—How much do they need? A review of OM sales
of the past tells us past needs but -the future might require something
more. Of course, the needs would have some kind of relationship to
GNP, total credit, etc. However, any relationship that might be
established wTould not be constant for any length of time. I appreci
ate your efforts to simplify monetary theory but I fear it isn’t a
1,2,3 kind of thing.
It appears your real worry is the level of efficiency of the System.
The Fed spends what it needs and turns the rest back to society. Per
haps this is an odd arrangement but I feel it might very well be con
sidered better than to have a central banking system that has to go
to Congress for operating funds; regardless of the party in power,
politics can become sticky.
Somehow I feel you would agree we want a central bank to have
operating funds adequate for the:
(1) hiring of top flight, well-trained individuals,;
(2) expense of providing for visitors from abroad;
(3) publication and destribution of education materials;
(4) servicing of money in general; and
(5) currency exchange activity
As for the backing of Fed notes with securities one might hesitate
to give it too much weight. Actually the true backing of the note is
the availability of goods and services in the country at competitive
prices. This also applies to the dollar when on foreign soil.
Mr. Patman, I appreciate your concern and even if I thought the
system was perfect I would still value your interest in monetary theory.
In the past you have worried about the source of new money. With
expansion of the stock of money some loyal citizen pays someone else
interest on money today that did not exist yesterday. Naturally this
usually happens with an expansion of the economy and an increase in
loans. Contraction of the economy with fewer loans would contract
the money as you know. The real question then centers on the down
right efficiency of our commercial banking system.
Perhaps this correspondence does not answer your question to your
satisfaction. Let me say the situation is far from simple and does not
lend to simple answers.
S t a t e m e n t b y O scar M il l e r , A ssis t a n t P rofessor of E c o n o m ic s ,
C ollege of B u s in e s s A d m in is t r a t io n , U n iv e r s it y of I l l in o is ,
C h ic a g o , I I I .

It is my opinion that the only important relevant criteria in regard
to size of the Federal Reserve portfolio is the ability of the Open Mar
ket Committee to affect the monetary supply and thus affect price-level
stability and the volume of employment in our economy. More ex
plicitly, I feel that the size of the portfolio should be large enough
so that the reserves of the member banks could be significantly altered
to provide price-level stability and full employment. I see no necessity
for stating a maximum level of assets to be held by the Federal Re
serve, but rather a minimum level, namely, enough to significantly
effect changes in the supply of money in the economy. I see no reason
for the Federal Reserve transferring assets to the Treasury, inasmuch
as the interest payments merely represent a transfer of ownership,

FEDERAL RESERVE PORTFOLIO

but do not place a greater real burden upon the economy when being
held by the Federal Reserve or being held by the Treasury. I f the
Federal Reserve did not draw the interest and use it to pay their ex
penses, they would have to obtain their expense money elsewhere (via
taxes or other charges) and although a different distribution (as
among citizens) of the burden might be achieved, the burden to the
whole economy would be the same.
With regard to the types and maturities to be held, I feel that so
long as U.S. Government securities are available, they should be held
as the major kind of asset in the open market portfolio—with long
term maturities being preferred so that long-term interest rates may
be significantly affected by the Federal Reserve (again toward the ob
jective of full employment and price-level stability) so as not to
cause the the possibility of undue embarrassment to the Treasury of
an overzealous board attempting to reduce a large part of their hold
ings at inconvenient times (recessions), Commercial and foreign
assets should be permitted to be held by the Federal Reserve only if
and when the supply of U.S. Government securities is too small for
the Federal Reserve to achieve the increase in bank reserves necessary
to affect price-level stability and full employment. I do not see the
latter condition as a real condition in the near future.
The questions of combining the Treasury and Federal Reserve into
a single monetary authority under some form of congressional control
and membership on the Board of the Federal Reserve and on the Open
Market Committee are left for another time. In general, I find my
self sympathetic to Representative Patman’s views in these areas.

S t a t e m e n t b y H y m a n P . M i n s k y , P rofessor of E
W a s h in g t o n U n iv e r s it y , S t . L o u is , M o .

c o n o m ic s ,

The Federal Reserve System really is a department of the Federal
Government that has been granted some independence in policymak
ing. Within what is normally a small range of variation, the liabilities
of the Federal Reserve System determine the reserve base and hence
the deposit liabilities of the member banks. I take it that the con
tinued existence of fractional reserve commercial banking is not at
issue. What is at issue is whether the “posture” of the Federal Re
serve System as a bankers bank is to be maintained.
I f we consolidate the books of all the Government agencies, then
the Treasury debt held by the Federal Reserve banks would appear as
both an asset and a liability of the Government. Such internal finan
cial arrangements are usually ignored—the debt to all practical pur
poses does disappear once it enters the Federal Reserve System’s portThe present arrangements make the reserve base of the commercial
banks reflect either loans or investments by the Federal Reserve or the
Treasury’s holdings of gold. In principal there is no reason why the
Federal Reserve System should be a;ble to cast up a conventional bal
ance sheet. It could like the Treasury have only half a balance sheet.
In principal the erasing of some $30 billion of Federal Reserve hold
ings of Government debt or equivalently the substitution of some $30
billion of a special zero interest rate Treasury debt for the standard

FEDERAL RESERVE PORTFOLIO

debt now held—should have no effect upon the operation of banks or
the central bank.
Because something makes no difference in principal it does not fol
low that it does not in fact matter. The transformation of conven
tions into matters of principal is not an unknown phenomena, witness
the recent controversy over the kind of metal on which coins are to be
printed. The convention that the Federal Reserve System have assets
equal in value to its liabilities can blunt the willingness and ability of
the Federal Reserve System to fulfill its responsibilities as the lender
of last resort in a time of crisis. On the other hand, there is no reason
to take the myth about the Federal Reserve seriously if the Federal
Reserve does not take it seriously. Under these circumstances we
might just as well let well enough alone.
A central bank does not need any stock of interest-bearing Govern
ment debt in order to engage in contractionary open market opera
tions. It could decrease the reserve base of the commercial banks by
borrowing from banks in the Federal funds market. The distinction
between Treasury debt management and Federal Reserve open market
operations is trivial. In principal the Federal Reserve System could
own the entire Federal debt and emit its own interest-bearing debt to
keep the reserve base of the commercial banks on target.
Much of what is called the defensive operations of the Federal Re
serve System are really unnecessary in the sense that they could be elim
inated by some slight changes in usages. Two changes that would
help to this are (1) to allow member banks to issue currency on exactly
the same terms as they now issue demand deposits; and (2) to open the
discount window to money market institutions such as Government
bond dealers and consumer credit houses.
The essential function of the Federal Reserve is to act as a lender of
last resort to the financial markets of the economy as they are rather
than as the Federal Reserve thinks they ought to be. The Federal Re
serve—or the Government—by implicitly insuring the nominal price
of private liabilities against the possibility of a general pressure to
liquidate prevents the development of a cumulative crisis and makes
such liabilities more attractive.
When tested the Federal Reserve System failed not only as a lender
of last resort to the market but even as a lender of last resort to the
commercial banks. As a result of the distrust of the Federal Reserve
which followed the central banking function was decentralized. Par
tial central banks such as FDIC, FHA, HOLC, FNMA, etc. have
arisen with responsibility to maintain orderly conditions in particular
markets. However, because the Federal Reserve controls the quantity
of money, it might be necessary for the Federal Reserve System to back
up these specialized institutions. Unless the Treasury intervenes, the
Federal Reserve System, using bankers ideas of eligible assets might
not find the intruments offered by these specialized institutions to be
of high enough quality.
The Federal Reserve’s broad reponsibility is not to allow tangible
asset prices to get far out of line with their costs of production. In
order to do this it must stand ready when a deflationary crisis threatens
to buy all “ assets” at a price that is close to their nominal or book value.
It follows that the view that the Federal Reserve System must main
tain a conventional balance sheet, and that the Federal Reserve System

FEDERAL RESERVE PORTFOLIO

should hold a risk averters portfolio, can get in the way of the Federal
Eeserve System doing the correct thing. I f the aim is to expand the
reserve base you buy assets, any assets will do. I f you want to peg a
price you buy the assets or a closely related asset ; you do not depend
upon a “perfect” oozing relationship among assets. If you want to
abort a deflationary process you acquire the assets under pressure.
The other function of the Federal Eeserve System, the maintenance
of conditions for economic stability and growth is fulfilled with the
proper change in the reserve base. There is no reason why the subse
quent substitution of a special Treasury instrument for whatever the
Fed acquires in this process need lead to any repercussions.
On the other hand, it may very well be that the public’s direct and
indirect holdings of Government liabilities is the really relevant de
terminant of income. If this is so, merely increasing the size of the
conventional money supply may not be sufficient to maintain income
and employment. Eather what is needed is a correct rise in the pub
lic’s secure outside asset, the Government debt. Thus a chronic deficit,
rather than the substitution of one Government liability for another in
private portfolios is what is needed.

S t a t e m e n t b y H ow ard E . M it c h e l l , A ssociate P rofessor of E co
n o m ic s , W ester n W a s h in g t o n
S t a t e C ollege , B e l l i n g h a m ,
W ash.

A review of the questions raised in your letter suggests that there
are two general areas for consideration. The first has to do with the
amount of Federal Government debt held in the portfolio of the
Federal Eeserve System; the second raises questions relative to the
composition of the portfolio of the Federal Eeserve. I shall consider
them in this order.
Although the original intent of the legislation creating the Federal
Eeserve System was to provide for a flexible money supply through
the device of discount operations and to improve the regulation of
commercial banks, later modifications have delegated to the Federal
Eeserve System along with other agencies a responsibility for assisting
in the establishment of sustained high employment, production, and
purchasing power in our economy. The major instrument used by
the Fed in pursuing this latter objective is its open market opera
tions. The sizable portfolio of Federal Government debt instruments
has accumulated over time as a result of open market sales and pur
chases. As the gross national product of the Nation has grown, the
Federal Eeserve has continued to be a net purchaser of Federal debt
instruments and thereby has provided the additional supply of money
needed to facilitate the exchange transactions. Additional amounts
of reserves have been provided since 1960 to assure that inadequate
supplies of money would not interfere with a continued growth in
output and employment. The portfolio of Federal Government debt
accumulated over time by the Federal Eeserve System reflects the con
sequences of its continued action in pursuit of its assigned
responsibilities.
In view of these responsibilities, then, it would appear that primary
concern should be directed toward whether the operations of the Fed-

FEDERAL RESERVE PORTFOLIO

oral Reserve have furthered its accomplishment of these responsibili
ties or have in some way detracted from their accomplishment. The
size of the portfolio should be, in this sense, of secondary importance.
It would be quite inappropriate to allow the size of the portfolio to in
any way affect current operating decisions of the Federal Reserve
authorities.
While it may be unnecessary and perhaps undesirable for this port
folio to reach extreme size, there is at least some indication that a mini
mal level might be desirable. Proper fulfillment of its responsibilities
may, from time to time, require that the Fed sell Federal debt instru
ments. The portfolio should be adequate both in size and in maturity
distribution to allow the Open Market Committee optimum latitude
in its sales operation. Reference might be made to Federal Reserve
operations undertaken in 1960, popularly referred to as “ Operation
Switch,” as an illustration of the need for an adequate and diversified
portfolio.
It is difficult to visualize any particular criterion such as money
supply, grogs national product, or aggregate liquid assets, which might
serve as a guide to the proper size of the portfolio of Government debt.
While recognizing that for any given gross national product a certain
level of money supply might be desirable, changes in the rate of
expenditure or the intensity of utilization of the given money supply,
changes in the sources, availability, or use of credit, and other circum
stances could render different recommendations as to the proper
amount of money, and the size of the portfolio itself. In view of the
very large near-liquid obligations of the commercial banking system
in the form of time and savings deposits, a great degree of latitude
would be needed by the Federal Reserve should depositors decide to
change the structure of their asset holdings so that it included a
smaller proportion of commercial bank time deposits. Statistics indi
cate that time deposits have risen as a percent of personal financial
assets since 1959 and approach the proportion they represented in
1945 and 1952.
The question of the desirable size of the portfolio of Government
bonds, interesting as it is, is completely subsidiary to the problems as
sociated with the transfer of a sizable segment of it to the Treasury for
cancellation. The proposed transfer fails to deal with both the sol
vency position and the monetary control responsibility of the Federal
Reserve. Since the greater portion of the Federal Reserve’s assets
are offset by current liabilities in the form of currency and commercial
bank reserves—neither of which can be cancelled—the debt instru
ments would have to be replaced by U.S. notes (as suggested
in sec. 2 of H.R. 7601,89th Cong., 1st sess.). This would be comparable
to replacing the debt with non-interest-bearing permanent debt of the
Federal Government, or alternatively of rendering permanent that
increase in money associated with Federal Government deficits orig
inally financed by interest-bearing debt.
The Federal Reserve does not stand in the same position as the
Treasury. Notes issued by the Treasury and declared to be money are
acceptable and will circulate without discount. Thus in the event that
all or a large part of the present portfolio were to be returned to the
Treasury for cancellation, conditions might arise which would present
the Federal Reserve System with a dilemma. One might imagine a

FEDERAL RESERVE PORTFOLIO

condition of high liquidity and inflationary pressure which needed to
be counteracted by the Federal Reserve. Lacking an adequate port
folio of Federal Government securities, the Federal Reserve would
have to develop a new instrument, probably an instrument of its own
which it might sell to the banking community or to the public. It
is quite apparent that this instrument would not carry the same rating
and status as Federal Government securities and hence would be dif
ficult to sell. Since the Federal Reserve has no taxing authority nor
could it always be assured of adequate earnings through the discount
window to sustain interest and principal repayment on these obliga
tions, the market acceptance would probably be nil. It is in this sense
that there is some necessary minimal portfolio of Government bonds
nat must be held. There appears to be no evidence that the size of
the portfolio of Federal Government securities has affected either the
ability or the willingness of the Federal Reserve to pursue its obliga
tions to the society. In view of the difficulties associated with the trans
fer of the securities to the Treasury and their cancellation I see no
reason to recommend any change in present operating procedures.
The second area of discussion has to do primarily with the composi
tion of the asset portfolio of the Federal Reserve System. The con
stitution of this portfolio should reflect the unique characteristic of
central banking, which is the primary function of the Federal Reserve
System. The importance of proper conduct of the central banking
operation to the total society is so overriding and the management
problems involved are so extensive that it would be unwise to further
complicate its role and responsibility.
The United States has, through the course of time, developed par
ticular institutions—commercial banks, savings and loan associations,
the Small Business Administration, the Federal National Mortgage
Assocation, etc.—to serve various special needs of the society. It
would appear that these institutions are adequate at the present
time, or if believed to be inadequate to serve special needs, could be
modified or supplemented in such fashion as to meet new goals or
responsibilities associated with their area of operation. It has been
the trend historically to divest central banks 01 many operations not
directly connected with the central banking function rather than to
add to their role and responsibility. This would appear to be a very
wise policy in the present situation.
In summary, my recommendations would be as follows :
First, that the Federal Reserve System continue to hold in its
portfolio those Federal Government debt instruments that it acquires
m the normal course of its operations. The present procedure gives
a maximum of latitude to its operations and adds little cost except
that associated with tax collection and transfer payment. No sig
nificant benefit would accrue to the Federal Government by the pro
posed procedure.
Second, under present circumstances, I would not recommend the
extension of the authority of the Federal Reserve to deal in debt or
equity instruments of other institutions than those of the Federal
Government. It would be more desirable to modify the authority and
power of existing institutions to meet special needs. The Federal
Reserve can, and presently does, assist these institutions by providing
additional reserves or liquidity when this action will assist in main
taining economic stability and growth.

84
S tatem ent

FEDERAL RESERVE PORTFOLIO
by

O. E r n e s t

M oore, I n t e r n a t io n a l E
N e w Y or k , N.Y.*

c o n o m ic

S ervices ,

The size of the Federal Reserve System’s portfolio of U.S. Gov
ernment securities should not be related to such factors as the money
supply, the gross national product, or aggregate liquid assets. Since
the purpose of open market operations is the day-to-day, seasonal, and
cyclical control of member bank reserves, the size of the portfolio
should be guided by a single criterion: the amount of securities which
the System must acquire in order to stabilize or raise the level of mem
ber bank reserves, or which it must dispose of in order to lower that
level. This is subject to the reservation that the portfolio does not,
and need not consist exclusively of U.S. Government securities. Never
theless, so long as U.S. Government securities make up the overwhelm
ingly largest part of the money market’s instruments, they will nec
essarily continue to be the backbone of the open market portfolio.
By this reasoning, there should never be an “excess” of U.S. Gov
ernment securities in the System’s open market portfolio, and conse
quently no need to make the suggested transfers to the Treasury for
cancellation. Such transfers would, in any event, have a highly dis
ruptive influence on our monetary system, in at least two ways: (1)
They would result in two types of currency; namely, a fiat Government-issued currency without any gold-certificate backing, and a Fed
eral Reserve currency with a gold-certificate reserve. Under present
legislation, and as a matter of practical necessity, the Government is
obliged to maintain all forms of U.S. currency at a parity with one
another. How this could be done if we had two such diametrically
different currencies in circulation is far from clear. (2) They would
add greatly to existing doubts abroad of the soundness of the U.S.
dollar and would probably impel foreign central banks to convert
into gold all or most of their existing dollar balances and their future
acquisitions of dollars. This would be a serious blow to our present
efforts to restore the U.S. balance of payments and might well make
the balance-of-payments problem insoluble, with the ultimate danger
of a dollar devaluation and world monetary chaos. The Federal
Reserve System should therefore be allowed to hold onto all of the
U.S. Government securities which it has acquired. Moreover, the
time may very well come when a drastic change in overall credit con
ditions will make it desirable for the System to liquidate a substantial
part of this portfol io by sales to the market.
As to the interest which the System now earns on its holdings of
U.S. Government securities, for all practical purposes this money is
already being returned to the Treasury in the form of so-called in
terest on Federal Reserve notes in circulation. The procedure, while
in general satisfactory, could in my opinion be changed so that, in lieu
of paying interest on the note issue, the Federal Reserve would simply
pay into the Treasury each year an amount equivalent to the interest
received on its holdings of U.S. securities. In this way, it would be
clear to everyone that the System derives no pecuniary advantage
from such holdings.
♦The views expressed by Mr. Moore are his own. This statement does not
in any way purport to express the opinions of International Economic Services.

FEDERAL RESERVE PORTFOLIO

It would be unwise for Congress to lay down standards relative to
the kinds of assets to be held by the System, their maturity composition,
or the relative proportions of private and public instruments. In the
constantly changing conditions of the money market, the System needs
flexibility in these matters if it is to do a good open market job—a job
which is difficult enough even with the present degree of freedom. In
deed, if a change were to be made, it should be in the direction of
somewhat greater flexibility, so that the System could have a wider
range of assets to choose from, at least in times of emergency. While
I do not think the System should have power to acquire such dubious
and possibly illiquid assets as commercial loans and commodities, it
might well be authorized to acquire high-grade corporate bonds that
are quoted on one or more organized security markets, and perhaps,
also, guaranteed and insured mortgages on residential property. Such
authorization could be limited to emergency or other unusual cir
cumstances and should, in any event, be a discretionary authorization,
not a legal compulsion.
S t a t e m e n t b y F . W M u e l l e r , C h a i r m a n , D e p a r t m e n t of F i n a n c e ,
C ollege of C o m m e r c e , D e P a u l U n iv e r s it y , C h ic a g o , III.

The letter of inquiry, under date of September 1, 1965, from the
Joint Economic Committee Subcommittee on Economic Progress
poses four principal questions as follows:
I. How large a portfolio should the Federal Reserve System hold—
A. In relation to the money supply?
B. In relation to the gross national product ?
C. In relation to aggregate liquid assets ?
II. I f the portfolio grows too large (relative to some standard),
what should be done with the excess—
A. Transferred to the Treasury for cancellation ?
B. Continue holding by the System, with unexpended interest
income returned to the Treasury ?
III. Should different criteria be designed for the System’s port
folio operations such as—
A. Different kinds of assets.
B. Maturity composition.
C. Public and/or private obligations.
IV Should the System’s Government portfolio be supplemented by
other types of assets such as—
A. Commercial loans.
B. Private capital paper.
C. Foreign exchange.
D. Commodities.
The common problem running through all of these questions is:
How can central bank credit be appropriately administered ? It is to
this larger question that the following comments are directed.
Central banks like their counterparts in the private sector, com
mercial banks, operate on the principle of fractional reserves. This
provides the central bank with the opportunity to increase or decrease
the volume of its bank credit outstanding, in relation to its ultimate
reserve (however defined). Sudh increases or decreases have far56-913— 66--- 7

FEDERAL RESERVE PORTFOLIO

reaching effects, directly upon the monetary structure, and indirectly
upon the economy.
The two principal instruments through which changes in the volume
of central bank credit are effected are rediscounts and open-market
operations. (The variable reserve ratio does not change the volume
of central bank credit, but rather the effectiveness of the existing
amount. It is therefore not considered a policy instrument, espe
cially in the short run.) While repurchase agreements and float
alter the volume of central bank credit, any change in either is more
the result of policy rather than a determinant.
Rediscounts, by member banks at their Reserve banks at some rate,
are a means of varying the volume of commercial bank credit through
its cost. The lower the rate the lower the cost; the higher the rate, the
higher the cost for an equivalent volume of funds. Presumably over a
period of time and under normal circumstances, the lower the rate the
more deliberate will be the borrower’s adjustment, while the higher
the rate the more rapid will the adjustment be, since at a low rate the
cost is small, while at a high rate the cost can be substantial. The ad
justment, of course, will be in the borrowing bank’s portfolio and
lending rates, the speed of adjustment being determined by the cost
of the borrowed reserves, and the cost being determined by tine amount
of the debt and the rate.
Three circumstances surround the mechanism of rediscounting.
First, recourse to central bank credit can be had only on the initia
tive of the prospective borrower. Secondly, the cost of borrowing is
borne by the borrowing bank. Finally, the rediscounting operation
is highly selective, since only those institutions “out of step” with the
System will be required to react to such a means of adjustment. While
such circumstances may not be entirely persuasive to many, they are
of sufficient significance to have their day in court. At any rate, re
discounting on the terms of the central bank is a means of varying the
volume (at differing speeds) of commercial bank credit through its
cost.
Open-market operations, on the other hand, are a means of influenc
ing the cost of commercial bank credit through its volume. For rea
sons not necessary to detail here, the expansion of central bank credit
eventuates in part as an addition to the existing legal reserves of the
commercial banking system. Assuming existing full expansion in the
latter, any net addition generates “excess reserves,” upon which addi
tional commercial bank credit may be expanded by some multiple (de
pending upon the existing required reserve ratio). Under “normal”
circumstances, were interest rates tending to rise they would, at least
temporarily, be restrained; if they were stable there would be a tend
ency for them to fall. A reduction in the central bank open-market
portfolio will have reverse effects since, for reasons not detailed here,
the elimination of such assets will in fact reduce the aggregate reserves
of the commercial banks and, in the process, if commercial bank rates
were rising they would tend to rise further, as if falling they would
tend to level off. This assumes that there is a sufficient number of
interest-sensitive borrowers, either to absorb the additional expansion
made possible in case of central bank increases in its holdings, or in
case holdings are reduced, enough borrowers can be induced to curb
their request for accommodation or actually discharge an existing loan

FEDERAL RESERVE PORTFOLIO

without the benefit of renewal. Such sensitivity is not as acute as was
once supposed. Under any circumstances, operations on the part of
the central bank in the open market are able to affect significantly the
terms upon which commercial bank credit is made available.
It is essential to observe certain qualifications surrounding openmarket operations. First, unlike rediscounting, the initiative in openmarket operations lies principally with the central bank. (An excep
tion is currency in circulation.) In the second place, open-market
operations provide reserves without any explicit cost to the commer
cial banking system. Third, because of this latter aspect, and if the
commercial banks are in debt to the central bank under expansion, the
debtor banks will first retire their debt at the central bank before any
further expansion of commercial bank credit eventuates. Conversely,
a reduction of the central bank portfolio may force the commercial
banks into the debt of the central bank, thus imposing a cost upon the
former, which if persisted in will result in a rise in rates and a contrac
tion in commercial bank credit. Fourth, a final qualification of the
effectiveness of open-market operations involves the fact that a reduc
tion in the central bank’s portfolio can force a reduction in aggregate
available reserves and thus ultimately in the volume of commercial
bank credit, whereas an increase in holdings can in no way force ex
pansion ; the additional reserves may merely eventuate as “excess.” In
open-market operations, therefore, the cost of commercial bank credit
may be varied by making differing amounts of commercial bank credit
available through changes in the aggregate reserve base.
It is important to emphasize the functioning of the evidences of
central bank credit, which for present purposes may be defined prin
cipally as central bank deposits and central bank currency. From
shortly after the beginning of the Federal Reserve System until late
1959, all legal reserves of member banks were required to be held in
the form of deposits at their respective Reserve banks. These de
posits had their origin principally (but not exclusively) as a result of
open-market operations of the Reserve banks. Being defined as good
legal reserve, they formed the basis for subsequent expansion on the
part of the member banks. In this process borrowers of all types—
personal and corporate, public and private—are enabled to exchange
their own unacceptable debt for the more convenient and acceptable
debt (deposits) of the commercial banking system. In this manner,
commercial bank debt (deposits) permeate the economy, the latter hav
ing access to this process by virtue of the reserves made available by
the central bank in conjunction with the commercial bank’s expansion
coefficient. Thus every facet of economic activity has come to be
dependent upon the clearance provided for the economic structure,
through the banking system. Any shifts in the terms (interest
rates) or availability of bank credit thus have far reaching and fre
quently an unpredictable impact.
The other principal evidence of central bank credit is Federal Re
serve currency. Such currency—as in the case of all currency—has
the same object as deposits; namely, as a means to accommodate the
indirect exchange of values. The subject matter of exchange accom
plished by currency may be, and frequently is, the same types of values
as are subject to exchange by bank deposits. However, for reasons
not detailed here, currency is used principally to effect exchanges of

FEDERAL RESERVE PORTFOLIO

values for which currency is the preferred means compared to de
posits. But this great difference exists between the two evidences,
that the volume of deposits may be unilaterally modified by the cen
tral bank, whereas the volume of currency is determined by the re
quirements (real or supposed) of the public. Since currency in any
amount is now eligible to be counted as legal reserve, variations in the
amounts dishoarded or hoarded by the public may change the aggre
gate reserves of the banking system requiring offsetting action by the
central bank if it desires no change in its existing monetary policy.
The upward trend in the holding of currency in relation to bank
deposits could pose a difficult problem for monetary management if
disgorged in significant amounts, either in terms of commercial bank
reserves or the value of money, or both. As a matter of fact it is sur
prising that currency in circulation continues its relative increase as
reflected in the past decade in spite of the increased dependence of the
economy on the commercial banking system and the proliferation of
other financial institutions whose objects are to substitute for much ex
change previously accomplished by the use of currency. This leads to
the conclusion that hoarding may be involved to an extent not sus
pected.
Since the central bank is the point of origin for our exchange media
in the form of central bank deposits and currency, a major question
arises as to the criteria which may be used to vary the accessibility to
central bank credit in terms of both amount and cost. Historically,
three main criteria evolved which served as tolerable guides, i.e., for
eign exchange rates, currency convertibility, and changes in the value
of money. Each of these criteria were oriented to particular prob
lems. The criterion evidenced by the appreciation or depreciation of
the defined rate of exchange vis-a-vis other countries was used as a
device to determine any imbalance in the balance of payments, and the
“Transmission of the Precious Metals” occupied a leading place in
early monetary policy. Currency convertibility into the standard also
was an early criterion relating to excessive note issues with a distinct
domestic orientation. Changes in the value of money had both a
domestic as well as an international impact. With all of the implicit
limitations, these objective criteria provided a means to measure both
the need for and the effects of monetary policy. In addition, such
objective criteria possessed the quality of nonmanipulability, which
provided an anchor against which the need for and effects of changes
m monetary policy could be measured.
Recent years have witnessed either a disavowal or modification of
each of these criteria. Pressures on exchange rates have commonly
come to be relieved by devaluation or exchange rationing, merely
masking in effect the causes^ in an effort to avoid the consequences.
Internal currency convertibility has nearly everywhere been aban
doned, thus relieving most monetary authorities from previously im
posed disciplines. The “protection” or security for currency in circula
tion by the pledging of government securities in no way provides any
dependable objective criterion for such issues, since not only is the
availability of collateral ever present, but it can be expanded unilater
ally ad libitum.
Especially since World War II, one historical criterion, the value of
money, has been linked with two other relatively new criteria, economic

FEDERAL RESERVE PORTFOLIO

growth and employment, to form the new standards for m o n e ta ry
policy. While our own central banking authorities have never, to this
writer’s knowledge, explicitly avowed growth and/or employment to be
unqualified criteria, there is no reason to suppose that they are against
either, and every reason to assume that they are in favor of both, as is
everybody else. The real problem lies in the orderliness with which
either or both could be accomplished and the contributions which mone
tary policy may be expected to make.
The criterion of the value of money has itself undergone modifica
tion. Without detailing the adverse effects implicit in designed wind
fall gains and losses, shifting of real burdens and the misdirection of
resource allocation resulting from changes in the value of money
a conviction on the part of many assumes that a designed annual fall
in the value of money anywhere from 2 to 5 percent annually, is not
only tolerable but also essential to provide “incentive” for industry.
These intentional resulting inequities are largely justified on the basis
that “growth” will not occur in the absence of such a policy. Doubt
less some growth will be stimulated, but the grave risk is that resource
allocation may take on unsustainable patterns, and above all only the
sum of windfall gains will be counted, windfall losses being conven
iently overlooked. Much of this growth therefore is illusory.
There have been three major factors contributing to the growth
of the economy, since World War II. The first of these was the ac
cumulated deficiencies of the economy during the years 1930 to 1946.
The second has been the nearly 40-percent increase in population since
1942. The third factor has been the fall in the value of money,
especially since 1946. The “ raw” national income figures show a
substantially different rate of growth than the deflated figures; and
the per capita figure reflects a lower growth rate than either of the
former. As a matter of fact the deflated growth rate from 1900 to
1930 is not much different than the growth rate from 1930 to 1960.
Monetary policy in each period was vastly different, which raises
the question as to whether or not growth occurs from the needs of the
economy accompanied by an accommodating monetary policy, or
whether a monetary policy itself can induce or force a sustainable
accommodation on the part of the economy. The latter assumes that
through some conditioning process, and with great reliance on an en
vironmental philosophy, that the economy can be made to respond in
a predetermined manner. Such consequence does not always follow
however and the “ease” in monetary policy may find an outlet in direc
tions other than expected. One such current area, in the writer’s
opinion, is reflected in the stock market. The “yield” criterion has
long since been replaced almost exclusively by the “capital gains”
criterion. But capital gains depends upon favorable price changes.
Emphasis upon favorable price changes is itself the essence of specu
lation. Witness the price of many stocks selling on a yield basis
below the yield basis upon which the same corporation’s senior debt
may be had. Such a reversal of criteria makes no appeal to reason,
and has been aided by the fear of a continued fall in the value of
money.
Growth does not have to be at the expense of a fall in the value of
money. At some relatively high level of production, say 85 percent,
further output will tend to be at the expense of a fall in the value of

FEDERAL RESERVE PORTFOLIO

money. Such pressures on the value of money may be relieved by
absorbing such costs through an easing of monetary policy and thus
spreading its impact by diffusion, or by maintaining some modest re
straint and thus providing an incentive for innovation and technology.
Only from the latter can permanent growth occur. Even if monetary
policy could assure “real” growth, the “leapfrog” nature of its impact
makes growth an unreliable guide. The impact of an easy money
policy takes time to permeate the economy. After its effects have
gradually appeared, successive industries are “ squeezed” as the value
of money declines, which calls for additional infusions. Thus each
new infusion is apt to be the basis for subsequent infusions in leap
frog manner. Monetary policy to be equitable should be an “ accom
modating factor” in preference to a motivating factor.
A second modem criterion is employment—or its converse, unem
ployment. Unfortunately either term lacks precision. Unemploy
ment shows up in various guises—technological or functional, struc
tural, frictional, and seasonal, all complicated by under- or over-em
ployment. In addition actual employment will be the result of a con
sideration of all of these factors and this latter in varying degrees.
Exactly how structural unemployment for instance can be used as a
guide for monetary policy leaves more to be desired than gained, since
an exhausted ore mine can never be revived by such a measure. Any
new industry will not develop there if there is a more favorable
“least-cost combination” location: and if the latter is not true, alterna
tive activities would already have made this deprived location its first
choice and the area would not be “depressed” in the first instance.
Likewise with “ frictional unemployment” which is always with us.
No monetary policy is able to eradicate the changing of jobs—nor
should it. If, as it is frequently argued, some minimum percentage
is allowable, say 2 percent, this is a function mainly of definition. I f
a period of 1 week is defined as the point beyond which frictional
unemployment is measured, the rate could presumably be higher than
2 percent. I f the period is lengthened to 6 months we could doubtless
eliminate frictional unemployment altogether. In either case mone
tary policy is largely irrelevant, and the size of the figure is determined
bv definition. The imprecision of such figures therefore as an objec
tive criteria for monetary policy makes unemployment a slender reed
upon which to lean, the other types being different only in degree.
Other fixations of a different character have also in the past been
used as criteria for monetary policy. Thus operations by the central
bank to correct “ disorderly markets” were carried on principally to
stabilize the market for Federal Government securities. While cen
tral bank authorities are correctly concerned with the state of Govern
ment credit, it is doubtful if the latter should be used as a criterion for
monetary policy. I f the Government debt is as “riskless” as is fre
quently assumed, it should be able to hold its own in the open capital
market without resort to leaning on central bank credit. Even clearer
is the case of the “pegged market” from 1942 to 1951. Policy imple
mentation was carried on solely for the benefit of the Government,
rather than for the economy as a whole. Nor is it surprising to find
the most rapid postwar decline in the value of money to occur within
this period.

FEDERAL RESERVE PORTFOLIO

Since a leading tool of monetary policy is its ability to unilaterally
influence the value of money through changes in the rate of interest,
the question arises as to what considerations are dependable. Interest
rate levels have long been used to protect a country’s international cur
rency value. Changes in the ratefs) have long been used to dampen or
encourage the flow of current production into capital formation. Such
changes have long been used in an attempt to preserve parity between
the circulating media and the standard. These changes in monetary
policy have largely paralleled or followed changes in the value of
money in the open market, being more “ corrective” than motivating
in nature.
In recent years many have embraced the notion of an “engineered”
rate(s) of interest, on the basis that a “low” rate will stimulate growth
and reduce unemployment. Both of these criteria have been com
mented upon earlier. It is admitted that if expectations anticipate
$1 million from an undertaking to become available to support the
necessary capital formulation, the latter, in a 5-percent market would
amount to $20 million. I f on the same expectations, the rate was
forced down to 4 percent, the same anticipated revenue would support
$25 million of capital formation. Further the recapitalization of ex
isting assets would result in a 25-percent increase in their value. But
it is this shift in rates which may well induce a misapplication of re
sources in the hope—not so much to increase production for the social
income stream but principally for windfall gams. In addition, if such
general rate changes permit, as they have (although not exclusively)
a fall in the value of money, new problems arise. I f prices should
double, as they have since 1941, the required capital formation would
amount to $40 million which at 4 percent would require $1,600,000 to
justify the expansion, which corrected for price distortion would
amount to only $800,000 to the undertakers of the enterprise. This
raises therefore the question as to how “cheap” the rate actually is.
Since most of the earlier criteria, i.e., foreign exchange rates, parity
between the circulating media and the standard and a relative stability
in the value of money, have either been abandoned, modified or admin
istered in a fashion to avoid any unwelcome restraint, the question
arises as to which major goals central bank policy should be oriented.
A stable society requires order, and order requires self-discipline,
and self-discipline requires individual responsibility. Within the
framework of our cultural and philosophical heritage, this assumes
that each individual will discharge his current as well as his future
responsibilities. The latter however cannot even be measured, let
alone attained, unless the future needs can be at least presently ap
proximated. In order for the current approximation to reflect the
measure of these future responsibilities, wide fluctuations in the value
of money must be ruled out. What remains therefore is a relatively
stable value of money, irrespective of growth (which will occur any
way) , or unemployment (which is not responsive to monetary policy).
Such a relatively stable value of money could do considerable by con
taining speculation and bring continuing order to the economy through
the proper allocation of resources.
Within the framework of the problems discussed in the preceding
pages, it is now possible to answer the questions posed.

FEDERAL RESERVE PORTFOLIO

I
There is no way of determining any absolute measure of portfolio
size. It should be “ adequate,” but adequacy will result in varying
amounts at different times and under differing circumstances.
Attempts to measure this adequacy in terms of the “ money supply,”
gross national product or “liquid assets” will themselves fail because
these concepts are themselves imprecise and also because emphasis
upon such measure could readily compound the problem from which
an escape is sought. Thus a continual fall in the value of money may
indeed be due to previous infusion on too large a scale. But the main
tenance of some proportion between the portfolio and the “money
supply” would presumably require an increase in the portfolio. This
would of course only tend to magnify the original problem. But in
addition, how is the “money supply” to be defined? Only formal
exchange media, i.e. Treasury and central bank deposits and cur
rency? or are time deposits of commercial banks to be added?, and if
so why not other “ available” claims to exchange media? And what is
to be clone with what many refer to as “near money?” Furthermore,
what is to happen to changes in “ cash-balances,” and the hoarding
and dishoarding which are known to occur? Are “ idle” balances to
be abstracted from the money supply, and only “active” balances in
cluded, which would change the measure considerably ? There are as
a matter of fact a whole host of factors which influence the behavior
of money, which rank far ahead of any quantification of the money
supply. The latter would thus be a most inappropriate measure for the
objectives sought.
The gross national product is equally devoid of merit. In the first
place this is an unstable estimate. According to some, it has an error
of ± 15 percent. ^Secondly, even those who compile this measure rec
ognize its limitations, hence the need to “ deflate” the measure, and this
correction by admission is only minimal. Since the availability of and
the terms upon which “ funds” may be acquired at different times may
be the permissive factors which tend to augment or diminish this mag
nitude, increases (or decreases) in the portfolio could conceivably be
the principal basis for increasing (or decreasing) the standard by
which policy was determined. With its many pitfalls the GNP would
be an inadequate guide.
Aggregate liquid assets are not defined, but presumably this means
such assets as are reversible in the market. Since all assets are re
versible in the market at some price, given the proper time, all assets
thus become “liquid.” This is surely not what the questioner had in
mind, and it is assumed that reference was made to those assets which
can be shifted “ without too much loss,” in accordance with common
parlance. But what is “too much” for one holder may be acceptable to
another, which if true makes “liquidity” a function of who holds the
asset. Further, an asset which is “illiquid” one day may turn out to be
“liquid” at a later day. “Liquidity” in the economic system (not dis
cussed here), is something quite different than the naivete implicit in
the question. For these, and many other reasons, such a measure as
“aggregate liquid assets” holds no promise as a means to measure the
appropriate size of the central bank portfolio.

FEDERAL RESERVE PORTFOLIO

II
I f some absolute measure of optimum portfolio size could be devised
(which is doubtful), there would be no troublesome “excess.” Since
the question assumes that there can be an excess, with which this writer
agrees, and on the supposition that the excess can be identified, the first
question arises as to how the “excess” came into existence in the first
place. It must have been due either to a previously faulty monetary
policy, unilaterally imposed, or externally imposed, most probably by
fiscal policy. Given the modem intellectual syndrome of growth,
employment, and low interest rates, many would account for the
“excess” portfolio, as being an accommodation to forces that did not
understand the consequences of their actions; and which differs prac
tically not at all from the same forces which dictated similar monetary
actions in the thirties, and particularly from 1942 to 1951, during the
era of “ pegged markets.” Central bank authorities being forced into
these compromises, are now criticized for having too large a portfolio.
Regardless of the equities in the matter, if the portfolio is now too
large, what should happen to the “excess,” supposing it can be
measured?
Access to the central bank portfolio shows up principally in two
types of liabilities: currency and central bank deposits. Since the
beginning of World War II when central bank currency amounted
to approximately $5% billion, it has grown in volume to about $40%
billion, an increase approaching eight times. This growth has been
in the face of increasingly widespread use of bank credit for exchange,
and the mushrooming of financial intermediaries. Some of the growth
has been due to population changes, much to a fall in the value of
money. Such need has been moderated, however, by easy access to
credit facilities and continued industrial integration. This tre
mendous growth would tend to support the conclusion, as has earlier
been stressed, that there exists widespread hoarding. Currency and
demand deposits being nonearning debts, it can be presumed that such
holdings on the part of the uninitiated, may be induced by increasing
suspicion of the future. Such an outpouring of currency could not
occur, except that the monetary authorities have been relieved of the
discipline of limiting its issue. But since this currency has found its
way into our system, attempts to reduce it, as a consequence of port
folio reduction is possibly only by inviting catastrophe.
So far as central bank deposits are concerned, they have increased
from about $7% billion required as reserves in 1941, to about $22 billion
today, or an increase of about three times. It is quite clear from this
that currency has expanded nearly three times as much as deposits.
In the latter case however, such central bank deposits represent the
principal reserves upon which the commercial banks have expanded.
But this latter has precluded any large reduction in the central bank
portfolio, unless a proportionate reduction in required reserve accom
panies such action. This in turn would tend to increase the expan
sion coefficient which could ultimately augment instability in the com
mercial banking system.
It has been suggested in some quarters that a removal of the reserve
requirement against commercial bank time deposits could free a por
tion of the reserves and thus permit a reduction in the portfolio. This
writer has the same objection as expressed in the previous paragraph;

FEDERAL RESERVE PORTFOLIO

namely, that this is in effect a reduction in the effective ratio which
would simultaneously increase the expansion coefficient.
To the argument that these securities have already been paid for
(it is presumed by the expansion of central bank credit in the form of
deposits and/or currency), it is claimed there would be no harm in
their cancellation. This, however, would be no different than fiat
money. Instead of acquiring Government securities, the central bank
might as well credit the Treasury’s account in the first place. At this
junction only the “needs of the Treasury” would restrain expansion.
As it now stands, since no reserve is required against central bank
deposits, expansion in this manner could theoretically be infinity.
And this author ventures a hazardous prediction, that unless our
balance-of-payments position is brought into equilibrium, as our gold
position deteriorates, the gold requirement against our notes will be
reduced and/or ultimately eliminated. We would be then on a pure
fiat basis.
The trouble invited by considering central bank holdings “paid for,”
stems from a failure to recognize the difference between a legal dis
charge and an economic extinguishment—of vital importance. The
debt originated because the public sector withdrew from the private
sector at particular periods more values than it contributed, the dif
ference amounting to the debt. Equilibrium can only be reestab
lished by correcting this imbalance, by developing a surplus, a hardly
likely prospect at this juncture. Elimination of any “excess” port
folio, however, hinges on this vital distinction.
This writer can see no solution to the problem of “excess,” sup
posing it can be measured. Central bank credit has become so closely
entwined in the economy, that its reduction in the amounts proposed
($20 billion) would be unthinkable in terms of the readjustments
required. To merely “charge off” such amount would be a gargantuan
step toward fiat money. Since we have erected this behemoth (against
the advice of many), a good, solid first step would be to at least stabi
lize the holdings.
The revenues of the Reserve System in the form of interest on its
holdings is enormous. This could be avoided by the issuance of
special non-interest-bearing paper, in order to reduce such earnings.
This, however, raises again the specter of fiat money. Furthermore,
if all such holdings were in this category, open-market operations
would be impossible, since the tie with the money and capital markets,
which deal only in interest-bearing obligations, would be destroyed,
Open-market operations as we now understand them would cease to
exist. #The present method of “recapture,” does not pose a problem,
since it is only a paper transfer payment, and well adapted to the
system as it now stands. It should therefore be retained.
I ll
It is not clear from the question whether the different criteria for the
System’s portfolio operations as outlined, refers to additions to present
Government holdings or as a substitute for them. I f it refers to addi
tions, the question of the present “ excess” becomes moot, since it is
the alleged current excess which is supposed to be the object of
reduction.

FEDERAL RESERVE PORTFOLIO

I f the question refers to substitutions for present holdings, this
introduces a whole new set of problems. If different kinds of assets
refers to real assets, i.e., office buildings, farmland, etc., while this
would gladden the heart of such owners, the type of assets involving
entrepreneural risk and lack of any continuous market, makes such
assets flatly ineligible, even for consideration. Nor does maturity com
position in money and capital market instruments bear much weight.
In open-market operations there is an initial impact on the price of the
security in which shifts are carried out which either tend to raise the
particular yield through depressing the price, or tend to lower the yield
by increasing the price, depending upon the operation. In the long
run however this is not significant, for except during changes in policy,
holdings are customarily “rolled over,” thus leaving the maturity dis
tributions as before. And there is added danger, that if maturity be
comes a major criterion, stabilizing at some preconceived yield level
may take precedence over monetary policy, as it has in the past. The
burden of substituting or mixing holdings between public and private
paper on the unilateral decision of the central bank would pose more
problems than it would solve. Since the span of operating in all private
obligations is entirely too broad, even for the central bank, the problem
as to what private obligations should be eligible arises. Even if such
a choice could be made equitably, particular segments would be
prejudiced, either favorably or unfavorably, depending upon policy,
in relation to the segments whose paper was not eligible. This would
surely skew the flow of capital and could well induce a misallocation of
our resources. Furthermore, even if it could be accomplished without
prejudice, it could make no contribution to the problem of the “excess”
portfolio. To the latter problem a redefinition of the kinds of eligible
assets, the maturity distribution or the substitution or additions of
private obligations contributes nothing.
IV
The acquisition of commercial loans on the part of the central
bank, on the initiative of member banks, was of course—together with
the original currency provisions—one of the leading functions of the
Reserve System. The desuetude into which rediscounting fell, begin
ning in the early thirties and lasting until its renaissance in 1951, is
well known. This power of supplementing the portfolio has been con
tinuous however, but has largely been replaced by the “availability”
theory. The function of controlling the volume of commercial bank
credit expansion through its cost, with all its limitations, still has much
merit, which has been previously discussed. Because of its selectivity,
pressures due to imbalance can be imposed at their point of origin. To
the extent that the emission of central bank credit takes this form, just
by so much is the size of the portfolio reduced, and by so much would
the “excess” portfolio be reduced. Regulation A could well be revised,
cutting out the minuscule criteria, and admitting all paper with a ma
turity of, say a year or less, without resort to the test of “having been”
or “to be used” for “ working capital purposes.” There is no reason
why a particular bank, having expanded beyond the current limits of
monetary policy, should not be expected to bear the costs of its action.
Such action would place the burden where it originated, reduce the

FEDERAL RESERVE PORTFOLIO

need for expanding open-market holdings, and bring a selective dis
cipline to those banks responsible for the costs involved.
(Private capital paper has been discussed in the preceding section.)
The use o f foreign exchange as a supplemental device does not
appear promising. Such a device is used chiefly by smaller countries
where international trade forms a large proportion of their GNP.
In this country such proportion is modest. In addition, because of
the volatility in acceptances in this country, to maintain order in
monetary policy, the influx and efflux would of necessity have to be
offset with compensating actions, doubtless through the portfolio. As
a consequence, as an aid in solving the portfolio problem, its inclusion
has little to offer.
The use of “commodities” as a supplementary device is no clearer
than the different “kinds of assets” discussed above. This writer
shudders at what might have happened to monetary policy, if since
1933, com, wheat, and cotton haa been used as a supplement, or an
alternative, to the portfolio. The inclusion of commodities is in
supportable.
Frankly, the question is not whether the portfolio is too large. It
obviously is the right size for what we have been attempting to accompplish. The real question is: have we aimed at the right objective(s) ?
During periods of relatively full utilization of the factors of pro
duction, as at present, the interest rate and a fall in the value of money
are largely alternatives. The unadministered interest rate acts as a
means to determine the amount of current production which social
choice makes available for capital formation. At any rate below this
level, the magnified demands for current production can only be met
by augmenting the “ funds” through which diversion will be accomlished by expanding credit. This will require, once excess reserves
ave been used up, an increase in central bank credit through increasing
the latter’s portfolio. This must inevitably bring on a fall in the value
of money, which in turn not only requires more central bank credit to
suppress any rise in the interest rate, but also to finance an increased
volume of production. This latter, due chiefly to a lag in costs, sets
up increasingly refined processes, which require both time and a more
roundabout process. This latter also requires more credit, and in
order to keep rates from rising, new infusion of central bank credit
are necessary. In addition, continued fiscal deficits require financing,
thus making further drafts on credit availability. It is this imbalance
that has given rise to the enormous portfolio carried by the Reserve
system. So long as this policy continues, the portfolio will continue
to grow. But in these holdings, there is no “excess,” since the amount
has been necessary in view of the policy followed. It is therefore, not
the size of the holdings which are to be criticized but rather the policies
which required the accumulation for their effectuation. Thus it isn’t
the holdings which should be changed, but the policy.

S t a t e m e n t b y R ic h a r d A . M u sg r ave , P rofessor of E c o n o m ic s i n
t h e F a c u l t y of A rts a n d S c ie n c e s a n d i n t h e L a w S ch o o l ,
H arvard U n iv e r s it y , C am b r id g e , M a s s .

If one starts with the proposition that the Federal Reserve System
after all is a public organization responsible to Government (be it

FEDERAL RESERVE PORTFOLIO

Congress or Executive) rather than to the shareholders, it really
makes little difference how large the System portfolio is. If receipts
from the portfolio exceed the requirements of the System, they will
merely be returned to the Treasury. Thus the cost to the taxpayers
is the same as it would be if the System did not hold earning assets,
and its cost was covered through the budget.
At the same time I recognize that this is an oversimplified view.
More likely than not the independence of the System is increased by
having a larger volume of earnings. Similarly, the smaller the in
come of the System, the closer one comes to a situation where the
finances of the System are subject to budgetary control. As far as
these considerations are concerned, I think it makes more sense to keep
System earnings more or less within the limits of what is required to
sustain the cost of operating the System. Since in an expanding
economy the System portfolio grows over time, it may well be that the
built-in increase in earnings exceeds the required needs for funds,
which might then suggest that there should be a periodic turning back
of securities to the Treasury in exchange against paper bearing no
interest.
While these considerations are of some importance, they should not
be exaggerated. Certainly they should not be permitted to influence
the way in which monetary expansion is to be provided for. Thus the
Fed could provide for monetary expansion through reduction in re
serve requirements rather than open market purchases, which would
decrease the acquisition of earning assets. At the same time it would
mean that commercial banks hold more earning assets. Since the lat
ter involves a true cost to the Treasury, to the extent that these assets
take the form of Treasury paper, this would of course be a bad bargain
for the taxpayer. In other words, the acquisition of commercial bank
earning assets is a much more important factor than that of Federal
Reserve bank earning assets.
One other aspect of the matter might be mentioned, although it may
not be very important in the current setting. During a penod when
the Federal Reserve wishes to engage in open market safes and com
bine these with an active policy of debt management, it may not hold
the particular issues whicn it would like to offer for sale in order to
push up a particular part of the rate structure. This might make a
case for having the Fed portfolio large enough so that a wide variety
of issues will be on hand when needed. At the same time this would
be a rather silly solution arising from the unnatural separation be
tween debt management and monetary functions. It would make
more sense to let the Fed hold Treasury debt “in general,” say special
issues furnished to the Fed by the Treasury, with or without interest,
depending on how Fed finances are to be handled. Whenever the Fed
wishes to engage in open market sales, it would then trade in these
special issues, and the Treasury would give it whatever specific type
of debt instrument the Fed wants to sell in the market. Thus the
qualitative purpose of debt operation on the part of the Fed would
not be subject to any arbitrary limitations imposed by the particular
issues that it happens to have on hand.
From a theoretical point of view, the proper solution to this prob
lem thus lies in letting the Fed hold special issues with or without
interest, issues which could be exchanged with the Treasury against

FEDERAL RESERVE PORTFOLIO

the specific public issues desired for open market sale. At the same
time I would not advocate that the earning portfolio of the Fed be
sharply limited in the absence of such an exchange arrangement, be
cause then the Fed might be limited in its ability to influence the rate
structure through open market sales.

S t a t e m e n t b y D a v id J . O t t , A ssociate P rofessor , D e p a r t m e n t
E c o n o m ic s , S o u t h e r n M et h o d ist U n iv e r s it y , D a l l a s , T e x .

in its purchases and sales of financial assets the Federal Reserve
System basically operates to affect (1) the structure of assets in the
combined balance sheet of the private sector; and (2) the amount
of gross assets and liabilities in the combined balance sheet of the
private sector. When the Fed purchases Government securities, it
causes a substitution of a highly liquid asset (claims on the Fedmember bank deposits or currency) for a less liquid asset (Govenment bonds, notes, or bills) in the balance sheets of private sector. To
induce the private sector to hold more “demand debt” (to use Tobin’s
phrase) and less Government securities, yields on Government must be
reduced. There ensues a general reshuffling of private portfolios with
prices of earning assets (including tangibles) being bid up until the
private sector has achieved portfolio equilibrium with less Government
securities and more Government “ demand debt.” Part of this process
will be an expansion of deposit money and bank lending made possible
by the increased reserves. From both the wealth effects (increase
in the value of claims on Government) and the price effects (excess of
capital goods demand prices over supply prices) will come a stimulus
to aggregate private demand. Federal Reserve sales of Government
securities will cause a rise in yields on assets, a decrease in the value of
Government securities outstanding, and a capital goods supply price
exceeding the demand price. The effects will reduce aggregate private
demand.
The size of the System’s portfolio is relevant only to the amount of
sales the Federal could make, i.e., to the magnitude of inflationary
pressures or balance-of-payments surplus it could be called upon to
offset.
It can always buy assets regardless of the size of its existing port
folio (ignoring any gold reserve requirements). And in theory it
could conduct open market sales by issuing its own security if it had
no stocks of assets to sell. In practice, however, limiting the size of
the Fed’s portfolio by canceling inter-Government debt would restrict
the ability of the System to substitute debt for money in private bal
ance sheets—when everything was sold there would be no more to sell
since (to my knowledge) the System cannot sell its own debt.
This seems an unwise restriction on the open market operations of
the central bank. We may, in fact, someday need drastic open market
sales, and unless the bank has assets to sell, it would be forced to turn
to changing reserve requirements or perhaps selective controls, both
of which have disadvantages when compared to open market opera
tions. I would not favor canceling a large proportion of the System’s
portfolio without giving it the power to sell its own debt.

FEDERAL RESERVE PORTFOLIO

In my view, the proper size and composition of the System’s port
folio cannot at present be simply related to GNP, the money supply,
or total liquid assets. We simply do not know enough about the im
pacts of open market operations at this point to formulate any firm
rules of thumb. From period to period, the amount of Government
demand debt required to produce the levels of asset prices consistent
with full employment, a modicum of price stability, and international
equilibrium will vary.
I f the central issue is really whether the Fed should finance its
expenses out of interest earned on its portfolio and remain outside the
normal budgetary process, it would seem to me that this could be
handled separately. The operation of a central bank is a govern
mental function and there is no reason why any governmental activity
should not have its operating expenditures controlled by Congress.
Congress could require the Fed to return all interest income to the
Treasury and submit its own budget for congressional action. This
would keep the System outside the executive branch in drawing up its
budget but would submit its expenses to congressional control.
S t a t e m e n t b y B r a x t o n I. P a t t e r s o n , A s s is t a n t P rofessor
E c o n o m ic s , U n iv e r s it y of W is c o n s in , M il w a u k e e , W is .

Comments on Questions Raised by Representative Patman by
Braxton I. Patterson, University of Wisconsm
In a letter dated September 1, Representative Patman raises several
questions about the Federal Reserve portfolio. Simplifying some
what, he raises three fundamental questions: How large should the
portfolio be? What should be done about (or with) the excess of
Federal Reserve revenue over expenses and dividends? Should the
composition of the portfolio be changed? I will comment on each
of these, and on the related question of reserve requirements.
SIZE OF THE PORTFOLIO

The main objective of the portfolio must be to provide sufficient
room for flexibility in open market operations. To provide downward
flexibilty, the portfolio must be large enough to cover all expenses even
if substantial sales are made. A situation similar to that following
our devaluation in 1934, when a heavy inflow of gold created more bank
reserves than the Federal Reserve could offset through open market
sales, could occur again. I f it does, it would not necessarily be during
a serious depression or during a period when banks want to hold
substantial excess reserves. The resulting expansion of bank loans
and our money supply could be seriously inflationary. The present
portfolio is probably larger than will ever be needed for this pur
pose, but even a remote possibility that substantial sales would be
required in the future suggests that the portfolio should not be
reduced unless other reasons for this are quite important.
In the other direction, it is extremely important that the Federal
Reserve be free to acquire whatever additional securities may be
needed to provide an orderly expansion of money and credit. On a

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FEDERAL RESERVE PORTFOLIO

few occasions in the past, the gold reserve requirement or the collateral
requirement against Federal Reserve notes has imposed restraint on
the Federal Reserve System’s actions. On two occasions, the result
was more monetary contraction than could be justified on the basis of
prevailing economic conditions. Any ceiling on the Federal Reserve’s
portfolio, even one tied to capacity gross national product, could be
equally dangerous under some conditions.
I do not anticipate that we will soon experience conditions that
would require either substantial open market sales or open market
purchases at a rate much faster than the growth in gross national
product. However, both are possible. It would be better not to force
the Federal Reserve to wait for congressional action if they do occur.
Although Congress can act quickly under emergency conditions, a few
days could make a substantial difference. Also, a request for emer
gency legislation could have an adverse effect on business confidence.
FEDERAL RESERVE EARNINGS

The present practice of having the Federal Reserve collect full inter
est on its portfolio, and then return about three-fourths of the money
to the Treasury, is unnecessary but creates no serious problems.
Simply canceling some of these securities would create some account
ing and legal difficulties, which have been amply discussed by Chair
man Martin. After the recent transfer achieved through a reduction
in the Federal Reserve banks’ surplus, there is not enough left to
achieve any important changes in this manner. It would be neces
sary to transfer some of the liabilities also, and so no substantive
change would occur. More important, cancellation would also reduce
the ability of the Federal Reserve to prevent an excessive monetary
expansion. There might be one psychological benefit. By reducing
the nominal Federal debt, such action might leave some Congressmen
less reluctant to vote for deficit spending at times when that would be
beneficial. This hardly justifies any action that might be taken.
The one liability that could be shifted to the Treasury would be the
Federal Reserve notes. The Government would still oe obligated to
pay, by redeeming these notes, just as much as it is now obligated to
pay for the debt. The Treasury would not pay interest, but the pay
ment from the Federal Reserve banks would be reduced by essentially
the same amount, so that the budget would not be affected. A trans
fer of the obligation to redeem Federal Reserve notes, except for those
issued so long ago that they may be presumed to have been destroyed,
also involves a conceptual difficulty. A note issued by a Federal Re
serve bank should remain an obligation of the issuer. Of course, the
same result could be achieved more slowly by a new issue of Treasury
notes to replace womout Federal Reserve notes. Conceptually, there
would be no problem as long as the Treasury limits the issue to the
amount needed in circulation. It would be grossly inappropriate to
permit the Treasury to use the note issue as a substitute for borrowing.
Our money supply should be adjusted to the needs of our economy, and
not the Treasury’s need to raise funds. Indeed, the larger the deficit,
the smaller the increase in the money supply that is consistent with
stability.
One possible change would create no senous technical difficulties
while reducing the amount of money making the round trip between

FEDERAL RESERVE PORTFOLIO

101

the Treasury and the Federal Reserve banks. About half of the Fed
eral Reserve’s portfolio could be exchanged for nonmarketable, noninterest-bearing-perpetual bonds. At any time that substantial open
market sales become necessary? these could again be exchanged for
marketable issues. The securities provided at that time would be de
termined by the Treasury, after consultation with the Federal Reserve.
Provision could be made for further exchanges of this type as the
Federal Reserve’s portfolio and income grow in the future. There
would be some side Denefits from this arrangement. Both the Federal
Reserve and the Treasury would avoid the costs of redeeming matur
ing securities and replacing them with new issues. In addition, the
reduction of the excess of Federal Reserve earnings over needed income
might create some additional discipline over expenditures. However,
the net gain would probably be negligible.
RESERVE REQUIREMENTS

While Representative Patman did not raise the question of reserve
requirements, I would like to comment on this subject for three rea
sons : First, I believe that the present system involves serious weak
nesses. Second, E. Sherman Adams has raised this question, par
ticularly for time deposits, in a reply which was distributed by the
Support Group for Progressive Banking. Finally? the Federal Re
serve’s earnings will depend on the extent to which bank lending
power is created by reducing reserve requirements instead of by open
market purchases.
There are several factors that should be considered in setting reserve
requirements. In order to provide effective and predictable monetary
control, the requirements should remain above the level that banks
would ordinarily want to hold. For flexibility, the requirement should
be near the middle of the range permitted by law. Aside from changes
needed to achieve these two objectives, or to achieve greater equity, I
believe that changes in reserve requirements should be made only in
extreme circumstances. Since conditions that would require drastic
action are possible but not probable, I would prefer to see the present
power to change requirements retained, but very seldom exercised.
Another consideration is the benefit from the interest on the public
debt. The taxpayers benefit by having the interest paid to the Federal
Reserve, and then returned to the Treasury. Banks, and indirectly
their customers, would benefit from having lower reserve requirements.
With the same money supply, lower reserve requirements would mean
less in the Federal Reserve portfolio, but a larger portion of commer
cial bank assets would earn interest. Competition can be relied upon
to force the banks to pass part of this on to their customers in the form
of lower interest changes, lower service charges, and higher interest on
time deposits. I do not believe that present conditions are such that
any substantial net benefit to our society would be achieved by changes
in the present reserve requirements in either direction.
Finally, as Dr. Adams quite properly emphasizes in his reply, equity
requires that the same requirement should apply to the same type of
account, regardless of the class of financial institution involved. The
1959 amendment to the Federal Reserve Act was a step in this direc
tion, since it permits vault cash to be counted as part of a bank’s re
56-913— 6«--- 8

102

FEDERAL RESERVE PORTFOLIO

serves. Some banks need to keep much more currency on hand than
others, and I know of no real difference in the type of banking involved
that would justify a difference in the reserve requirements. However,
both equity and the degree of effectiveness of monetary controls require
three further adjustments. First, the requirements imposed on mem
bers of the Federal Reserve System should be extended to all com
mercial banks. Secondly, the present classification of banks for pur
poses of reserve requirements should be abandoned in favor of a system
that will more adequately differentiate between different types of
banking. Finally, the requirement now in effect for time deposits at
member banks should be extended to mutual savings banks, savings
and loan associations, and credit unions.
At present, less than half of our commercial banks are members
of the Federal Reserve System. The remaining banks are subject to
State requirements which vary widely. Equity requires that the same
reserves should be held by competing banks unless there is a clear
difference in the type of business. Furthermore, since most States
permit banks to count some Government securities and correspondent
balances, a shift of deposits from member to nonmember banks will
increase the lending power of the banking system. These two weak
nesses can be corrected fully only by extending reserve requirements
to all commercial banks.
Subjecting nonmember banks to the same reserve requirements as
member banks would also make it easier to eliminate the notion that
the member banks own the Federal Reserve banks by retiring the
stock. The stockholding is now the major tie between member banks
and the Federal Reserve, and, in contrast to 40 or 50 years ago, is
probably an attraction. Retiring the stock would necessitate finding
another guide for the level of Federal Reserve bank capital and sur
plus. The volume of deposits would probably be the best one. All
present services for member banks should be available for all com
mercial banks. Membership in the system might be retained by count
ing as members those banks that indicate that they intend to take
advantage of the privilege of borrowing from the Federal Reserve,
however rarely they do so. I believe that the banks should continue
to have some voice in the Federal Reserve System, both through the
Federal Advisoiy Council and by continuing to elect the class A direc
tors of the district banks. The class B directors should be appointed
rather than elected, providing a majority of directors are appointed
by the Board of Governors.
Because there are important differences in the type of business done
by commercial banks, some differences in reserve requirements can
be justified. The present two-way classification of member banks
does not seem to be the best way of accomplishing this. Since those
banks that can justifiably be required to hold larger reserves than
other banks generally have a substantial volume of funds deposited
by other banks and thrift institutions, the logical differentiation
would be to impose higher reserve requirements on interbank de)osits than on individual, partnership, and corporate accounts. So
ong as nonmember banks and thrift institutions can count these
balances as part of their reserves, monetary policy is not likely to
be fully effective unless the reserve requirement against such de
posits is 100 percent. This would make it more difficult for smaller

FEDERAL RESERVE PORTFOLIO

103

banks and thrift institutions to obtain the services now provided by
the larger banks, so it would be better to require them to hold reserves
in forms equivalent to deposits at the Federal Reserve banks. I f
this is accomplished, a differential of from 5 to 20 percent for inter
bank deposits would seem appropriate on the basis of the existing
difference between the requirements for Reserve city banks and coun
try banks. For flexibility, a third class of deposits, those of the U.S.
Government, could be subject to a requirement between the other
two. While I feel that the classification by depositor provides the
best method of distinguishing between banks, a supplementary re
quirement on the total of all demand deposits above a certain level
may also be useful, particularly if the differential for interbank
deposits is small. If this is done, I would suggest no more than an
additional 1 percent on deposits between $10 million and $100 mil
lion, 2 percent on deposits between $100 million and $1 billion, and
3 percent on deposits above $1 billion. Time deposits should not be
included in this computation.
I am in general agreement with Dr. Adams that the present treat
ment of commercial bank time deposits and accounts at other thrift
institutions is not equitable, but do not agree with his remedy. There
are two reasons for preferring to impose cash reserve requirements
on mutual savings banks, savings and loan associations, and credit
unions. One reason is that any financial institution with accounts
subject to withdrawal will hold some cash in the absence o f any
requirement. A study I did a few years ago for savings and loan
associations in the Midwest indicates that these associations general
ly maintain a ratio of cash to share accounts that is quite close to
the cash requirement imposed on member banks for savings deposits.
Thus, the existing requirement is not as inequitable as it might appear.
Furthermore, the present reserve requirements for demand deposits
are higher than the banks would choose to hold, and should remain
so. Thus, in the absence of a reserve requirement for time deposits,
commercial banks would probably hold little additional cash to
cover time deposits. Eliminating the requirement might create an
inequity that reverses the present one. My second reason for pre
ferring to apply the same requirement to the other institutions is that
it would give the Federal Reserve a somewhat greater degree of con
trol over the availability of credit. Currently, when funds flow into
the thrift institutions, most of the money is lent or invested, with the
same effect as bank lending. Most o f the rest, retained as reserves,
is placed in demand deposits at nearby banks. Thus the increase in
lending by the thrift institutions is not offset by a decrease in bank
lending. The potential for shifts of this sort is large enough that
I would favor requiring all financial institutions of a depository
nature to hold cash reserves of the same type required for member
banks—currency and deposits at the Federal Reserve banks. Fed
eral home loan bank deposits could be counted if revisions were made
to insure that any increase in these accounts would automatically
be offset by a reduction in deposits at the Federal Reserve banks. Im
posing a 100-percent requirement on the deposits at commercial banks
that are counted as reserves would be an acceptable, but inferior,
alternative.

104

FEDERAL RESERVE PORTFOLIO
COMPOSITION OP THE PORTFOLIO

I do not believe that any change in the present law concerning
the composition of the Federal Reserve’s portfolio would be helpful.
Most of the influence of open market transactions is felt indirectly,
via the impact on bank reserves. Essentially, the same results can
be achieved by buying (or selling) anything—Government securities,
corporate stocks and bonds, real estate? or commodities. Under some
conditions, purchase of certain securities may be more effective than
the purchase of others. The Federal Reserve should be free to shift
its portfolio if these conditions arise, but should not be forced to do
so in the absence of these conditions. The system should also be free
to return to a greater reliance on corporate securities (mainly com
mercial paper) if the ratios of Government debt to total debt and to
gross national product continue to decline.
There are two considerations that make the present concentration
of open market operations in the Government security market particu
larly appropriate at the present time. First, it is desirable for the Fed
eral Reserve to affect bank reserves with a minimum of disturbance
to the market. The relatively broad market for Government securi
ties, particularly Treasury bills, enables the Federal Reserve to make
substantial purchases or sales with less disturbance than would be
created in most other markete. Any shift in commercial bank second
ary reserves and residual investments toward municipal and cor
porate securities could call for a similar shift for open market opera
tions.
The second consideration is the amount of risk involved. Figures
in the August 1965 Federal Reserve Bulletin show that the Federal
Reserve banks have a very narrow capital margin. For the System as
a whole, capital accounts amount to less than 2 percent of total liabili
ties, ranging from below 1.4 percent for the Federal Reserve Bank of
Atlanta to nearly 2.7 percent for the Federal Reserve Bank of Dallas.
The ratio of capital accounts to U.S. Government securities owned
outright (the one portfolio component that could readily be shifted
elsewhere) is over 3 percent for the System as a whole, ranging from
2.3 to 4.2 percent. With any substantial portion of these holdings in
common stocks, recent stock market declines would have wiped out any
equity. With the Treasury having the residual claim against both
income and assets, the loss would ultimately be borne by the taxpayers.
The present level of capital is quite adequate with the existing asset
structure of the Federal Reserve banks. It might not be adequate if
any appreciable portion of the portfolio were shifted to corporate
bonds, and certainly would not be adequate if common stocks became
important. The risk factor should not be permitted to deter the Fed
eral Reserve from acquiring corporate issues if substantially greater
effect could be obtained. I do not believe that these conditions exist
now, so the risk factor should be considered.
SUMMARY

With respect to most of the questions raised by Representative Patman, no change is required. I f anything, changes should be in the
direction of providing more flexibility. One change influencing Fed
eral Reserve earnings is suggested, although it would make little dif-

FEDERAL RESERVE PORTFOLIO

105

ference in actual operations. About half of the Federal Reserve
portfolio could be replaced by a special issue that would not earn inter
est, and would be retained by the Federal Reserve banks unless and
until future conditions require that they 'be exchanged for marketable
issues.
For reserve requirements, I am proposing substantial changes. All
demand deposits of the same type should be subject to the same reserve
requirement, regardless of the location of the bank or whether it
chooses to be a member of the Federal Reserve System. Differentia
tion between banks should be achieved by classifying depositors, rather
than banks, with interbank deposits subject to higher reserve require
ments than other deposits. All thrift accounts should be subject to
the same reserve requirements, whether they are deposits at commercial
banks or accounts at other thrift institutions, and only items that are
equivalent to currency and deposits at the Federal Reserve banks
should be counted as satisfying the requirement.

S t a t e m e n t b y G eorge P o l a k , A sso ciate P rofessor o f E c o n o m ic s ,
W est L ib e r t y S t a t e C ollege , W e s t L ib e r t y , W . Ya.

The growth in the portfolio of financial assets held by the Federal
Reserve System, as stated in your letter, “is a natural consequence of
the need to expand money supply to meet the growth needs of our
economy.” Despite the fact that the portfolio of “Governments” had
increased by about $1.5 billion per year over the 10-year period from
1955 to 1965, the ratio of the Federal Reserve portfolio of Government
securities to gross national product remained at approximately 6
percent in 1965 and 1955.
While it is true that only a small fraction of this portfolio is needed
for the current day-to-day conduct of Federal Reserve open market
operations, the letter fails to mention that the Federal Reserve Act
provides that before a Reserve bank may obtain Federal Reserve notes
for issuance it must tender “collateral m an amount equal to the sum
of the Federal Reserve notes thus applied for.” Consequently, at the
end of July 1965, about $33 billion of the Federall Reserve banks’
portfolio of Government securities was pledged in the collateral
account.
What is even more important is the fact that any attempt on the
part of the Congress to set a criterion for the disposition or manage
ment of the Federal Reserve financial assets could be construed as a
serious interference with the independence of the Federal Reserve
System. Such action, in my opinion, could have serious repercussions
both at home and abroad. Cancellation of the $30 billion of the Gov
ernment securities held by the Federal Reserve System would, in effect,
raise the debt ceiling by an equivalent amount. This fact in itseli
would bring about suspicion and speculation as to the intent of the
Congress and revive the doubts that have been expressed concerning
the fiscal responsibility of the Government. It cannot be too often
emphasized that lack of confidence in the dollar could do a serious
damage to our financial position.
As long as we like to think that we have an independent Federal
Reserve System, and that such a System is quite capable of protecting

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FEDERAL RESERVE PORTFOLIO

the dollar, rather than one dominated by political interests, the Fed
eral Reserve System should be allowed to manage its own portfolio.
After all, interest on Government securities paid to the Federal Re
serve is repaid to the Treasury as interest on Federal Reserve notes,
and the cancellation of the Government securities held by the Federal
Reserve System would serve no useful purpose.

S t a t e m e n t b y R ic h a r d C . P orter , A ssociate P rofessor of E co
n o m ic s , C e n t e r for R e se a r c h o n E c o n o m ic D e v e l o p m e n t , U n i
v e r s it y of M i c h i g a n , A n n A rbor , M i c h .
r e c o m m e n d a t io n s c o n c e r n in g t h e federal reserve s y s t e m ’ s asset
portfolio

I believe that monetary policy is, along with other Government
policies, an important means by which more stable economic condi
tions can be maintained. Traditionally, especially recently, monetary
policy has meant in this country open-market operations; therefore, I
believe that some responsible Government agency should have the
power to conduct open-market operations with stabilization and growth
as its objective. In order to do this, the agency must either own a sufcient quantity of Government securities or have the power to create
such securities when the economic situation requires open-market
sales. Once such an agency has a sufficiency of Government securities
and is responsibly concerned with open-market operations, whether it
has too many and what to do with the surplus are not very important
questions.
What may be important is the fact that by holding such a large
asset portfolio of Government securities, the Federal Reserve System
is able to determine its annual budget without recourse to Congress.
To the extent that it is disturbing for Government agencies to become
independent of Congress, something should be done to alter this situa
tion. The obvious solution would be to introduce some non-interestbearing securities into the Federal Reserve System’s asset portfolio
or require it by law to present its budget to Congress (and return its
excess interest earnings to the Treasury). While I am, in general, fa
vorable to the idea that Congress should review agency budgets each
year, in this case I feel somewhat ambivalent since I would not like
to see the many useful research functions which the Federal Reserve
System conducts, and is currently expanding, be cut apart by the
overly pragmatic scissors of a congressional committee.
As to the composition of the Federal Reserve asset portfolio, I see
no reason why the maturity structure of its Government securities
should be determined by law. There are too many potential advan
tages to “twist” operations to justify removing the possibility of their
being used in the future. But I do think that for the remainder of
this century at least, the Federal Reserve can manage its open-market
operations by dealing only with various maturities of Government se
curities. I do not think that the Federal Reserve System, the Con
gress, the public, or even the economics profession is quite ready to
watch the Federal Reserve operate in corporate bonds, mortgages, or
commodities.

FEDERAL RESERVE PORTFOLIO

107

I am very much in favor of any action which would make the
Federal Reserve System more responsive to national needs, more re
sponsible to our stated policy goals and more daring in its conduct of
monetary policy, but I do not feel that the size or composition of its
Government security holdings are a key to any of these changes.
Certainly insistence that the Federal Reserve gain approval from
Congress of its annual expenditures would make the System more
responsive to the Congress, but it is not clear that this in itself would
mean an improvement in the quality of our monetary policy.

S t a t e m e n t b y J o n a s P rager , V is i t in g L e ct u r e r , D e p a r t m e n t op
E c o n o m ic s , B ar I l a n U n iv e r s it y ( I s r a e l ) a n d V i s i t in g E c o n o
m i s t , B a n k of I srael ( A s s is t a n t P rofessor of E c o n o m ic s , N e w
Y o r k U n iv e r s it y , o n L e a v e ) *
a . t h e s ize of t h e federal reserve portfolio of se c u r it ie s

Changes in Federal Reserve asset holdings accomplished through
purchases and sales of Government securities on the open market affect
the economy in a number of ways. Open market operations exert
an expansionary on contractionary influence on commercial bank
reserves, bank deposits, and ultimately national income flows. Such
operations also influence the revenues of the Federal Reserve System
and the commercial banking community as well as the actual interest
cost of the Federal debt. Both sets of influences are explored in this
section. The reply to the question concerning the relationship between
Federal Reserve portfolio holdings and money supply, GNP, and
liquid assets (No. 1) deals primarily with the macroeconomic impact
of changes in the central bank’s portfolio. Other policy objectives,
on the microeconomic level, which might be achieved by legislating
regulations concerning the size of the portfolio of the Reserve System
are examined in the answer to question No. 2.
1. Question: How large a portfolio should the Federal Reserve
System hold in relation to the money supply, the gross national prod
uct, or aggregate liquid assets?
Answer: The Federal Reserve System should not be forced to com
ply with any mechanical limitation of its discretionary powers. Its
ability to act flexibly should not be compromised.
Some economists believe that the only tool necessary and proper for
the implementation of monetary policy is open market operations.
Moreover, they see a clear-cut pattern and a casual relation between
changes in the supply of money and economic activity. As a result,
they believe that through changes in the Federal Reserve’s portfolio
of marketable assets, the economy’s progress can be controlled easily
and effortlessly. A “rule” can be devised, and if the monetary authori
ties but heed its prescriptions, the economy will achieve, as Voltaire’s
Dr. Pangloss never tired of repeating, “the best of all possible worlds.”
A second group of economists greets this view with considerable
skepticism. To be sure, this second school agrees that the supply of
♦Mr. Meir Chart, of the Bank of Israel, read an earlier draft of this paper and
made some valuable suggestions for which I am indebted.

108

FEDERAL RESERVE PORTFOLIO

money influences economic activity and that through the control of
money supply the authorities can help shape the economy’s growth.
However, these economists believe that the relationship between money
and economic activity is not simple, nor is it direct, and neither is it
stable. At times changes in money supply can exert strong pressures
on economic activity and do so speedily. At other times the influence
will be weak and will work slowly. An inflexible rule cannot cope
effectively with changing circumstances; active intervention based on
a sound prognosis of economic conditions and a sure understanding of
the nature and consequences of action must be permitted. When the
road is hilly and curvy, the topography constantly changing, an auto
matic driving mechanism could prove fatal to the occupants of the
vehicle. A sure hand backed by a knowledgeable mind is demanded.
Moreover, even if one agrees with the “rule” theory of monetary
policy, it does not follow that open market operations provide the only
methoa for achieving its goals. A decrease in reserve requirements
by “X ” percent per year can give the same impetus to growth in money
supply as some “ Y ” percent per year increase in open market pur
chases.1 To be sure, if the objective of the rule is to sterilize totally
the discretion of Federal Reserve officials, then the fewer the tools,
the smaller is the area of discretion. If, however, the objective of the
rule is simply to assure adequate noninflationary growth of the money
supply, and if other criteria of monetary policy are admitted as well,
disarming the monetary authorities of all weapons but one would
hinder the authorities from performing their duties. An example may
not be improper here. In order to hold down the interest cost of the
wartime debt during the Second World War, interest rates were pegged
and open market operations of the Reserve System were but passive
responses to the demands of the public. Had the Federal Reserve
not been provided with the right to increase reserve requirement ratios,
that little control over money supply which was achieved would have
been absent. I f the rule had required a decrease in the rate of growth
of money supply, as we suspect it would have, and if open market
operations were devoted to other goals, the rule could not have been
made effective without alternative weapons.
Thus, it may be concluded, first, that discretionary monetary author
ity is not only desirable, but necessary for assuring a stable, yet grow
ing economy. An inflexible, mechanistic relationship between money
supply or liquid assets and GNP cannot be acceptable. Consequently,
it makes little sense to tie open market operations to money supply,
GNP, or liquid assets. Furthermore, even if a rule concerning money
supply is thought acceptable, a rule relating open market operations
and money supply, GNP, or liquid assets does not follow. In both
cases, a flexible response to changing conditions is desired. Discretion
is needed.
1 The well-known equation of multiple expansion of money supply reads :
Total deposits= Initial deposits x

ratio

Thus, if initial deposits = $100 and the reserve ratio is 20 percent of deposits, the total
createable money supply is $500. (To expand total deposits to $1,000, the central bank
can buy $100 worth of outstanding securities, thereby increasing initial deposits to $200.
The identical amount of total deposits, $1,000, can be realized by lowering the reserve
requirement ratio to 10 percent of deposits. While this example is very simple, the
principle applies to more sophisticated cases as well.

FEDERAL RESERVE PORTFOLIO

109

2. Question: Is any other criterion more appropriate?
Answer: There is no compelling reason why Congress should limit
the Federal Reserve’s portfolio of Government securities. Such a
limitation would impose an unnecessary restraint on the System’s abil
ity to react to changing conditions. Other policy objectives can be
handled best through specific measures directed at these goals.
Justification for limiting the quantity of Government securities in
the Federal Reserve’s portfolio may come from a direction quite dif
ferent from that discussed in answer to the first question. Since the
monetary authorities possess a variety of weapons—open markets op
erations, reserve requirement changes, discount rates—would it really
matter if the Reserve System is limited to some maximum portfolio of
securities ? After all, cannot the same impact on say, money supply,
be achieved via reserve requirement changes as through operations in
the open market? The answer is “ Yes,2but * *
One reason for hesitating to suggest such a policy—a policy which
implies that Federal Reserve holdings of securities should be limited
to $700 million or less3—has been mentioned already. Any loss or
even the partial destruction of its weaponry would entail a reduction
in flexibility. One does not discard a rifle even though another iden
tical to the first is available, for the two weapons can cover two fronts.
So, too, is it with changes in reserve requirements and open market
operations.
A second objection to limiting the Reserve’s portfolio involves the
magnitude of the ceiling. Federal Reserve holdings of less than $700
million would be inadequate for Federal Reserve operations of a
“defensive” nature. Such actions occur when some exogenous cause
changes the reserves of the commercial banking system. For example,
when the public increases its demand for cash, banks lose reserves and
if money is not to become tighter, the Reserve System will offset this
currency drain by open market purchases. Federal Reserve actions
of this sort are aimed at preventing the external cause from upsetting
the status quo; they are not implemented in order to modify the exist
ing degree of ease or restraint. It is difficult empirically to differ
entiate between “defensive” and “ dynamic” actions of the Open Mar
ket Committee, for the authorities often combine the two goals in a
single action. Data on open market operations in December, the
seasonal peak for currency demand, and January, when a sharp drop in
* This has been shown in footnote 1.
8 This number is derived as follows. During the years 1953-59 (unfortunately, data for
later years was not available to me), four “policy periods” can be distinguished. (“Policy
period” is defined as the time between a change in the directive to the manager of the
open market account from the Open Market Committee signifying tightening or loosening
and its discontinuation.) The four are identified below and the change in the Federal
Reserve portfollio during the period is added.
Billiona
1. June 1953 to May 1955, loose_________________________________________ — $1. 08
2. August 1955 to August 1957, tight____________________________________
—0. 7(2
3. September 1957 to July 1958, loose___________________________________
+ 1 .8 9
4. January 1959 to July 1959, tight_____________________________________
+ 0 . 65
During both periods of ease, reserve requirements were reduced. In period 3, the
reductions were aided by net purchases on the open market, while during period 1, open
market operations prevented excessive case resulting from decreases in the required reserve
ratio. During periods of tightness legal reserve ratios were not increased; the + $0.65 in
period 4 represents purchases to prevent undue tightness resulting from exogenous factors.
The only years of tightness in which open market operations actually restrained the growth
of money supply occurred in period 2. In this period the authorities could have chosen
to raise reserve requirement ratios. Consequently one may infer that had the System’s
security holdings been less than $720 million, Reserve officials would have been forced to
increase the legal reserve ratio.

110

FEDERAL RESERVE PORTFOLIO

currency demand occurs, are illuminating, however, for operations in
these months are primarily of a defensive nature. While not all port
folio changes in December and January reach $700 million, some do
and some exceed this limit.4
A policy which would force upon the Reserve System more active
use of the reserve ratio has still additional consequences. These stem
from the requirement that, in the long haul, there must be a sufficiently
large stock of money to grease the wheels of the growing American
economy. I f the portfolio of the System is to be limited, then new
money must result from continuous reduction in the legal reserve ratios
of the banking system. First of all, this action would tend to increase
the profits of commercial banks, as a smaller share of their assets would
be kept idle. Secondly, actual interest payments on the Federal debt
would increase. Creating new money via open market purchases brings
Government securities held by private holders into the hands of a
Government agency, viz., the Federal Reserve System. For all prac
tical purposes, securities held by the Reserve System cost the
Government little, the bulk of the payment being merely an intragovemmental transfer. Reducing reserve requirements instead means
that the outstanding securities remain with the public, and they receive
the interest. Thirdly, substituting reductions m reserve requirements
for open market purchases reduces the income of the Federal Reserve
System.
All these consequences, if desired, can be achieved by direct action
rather than by limiting the powers of the Federal Reserve. ^I f Con
gress wishes to increase the profitability of commercial banking—and
without going into the merits of such action, let it be stated that profit
rates of commercial banks have not been significantly different from
those of industrial firms5—it can do so, for example, through subsidies
or tax reductions. I f the objective of the limitation proposal is to in
crease the actual cost of the Federal debt—why Congress should want
to act in this manner is difficult to comprehend—this result could be
achieved by reducing Federal taxes and issuing additional Government
securities to cover the increased budgetary deficit. Finally, if Con
gress wishes to control Federal Reserve income, let it accept the pro
posals of Mr. Patman embodied in H.R. 9685 (88th Congress), that
the Federal Reserve System be deprived of independent sources of
income.
4 The changes in the portfolio for the period from December 1953 to January 1959 for
Decembers and Januarys are as follows :
Millions
1953: December__________________________________________________________
+$467
1954.
_________
—376
January_______________________________________________ _
December____________________________________________________________
+244
1955:
January___________________________________________________ _________
—717
December_____________________________________________ ____
______
+605
1956:
January______________________________________________ _____ _______
—705
December__________ ___________________ __________________ _ _______
+741
1957:
January______________________________________________________________
—673
December_____________________________________________ _______________
+ 656
1958:
January______________________ _____________________
_________
—374
December_________
___________________ ___________ ___
..
+'662
1959 : January_______ ____ ______________________________
___
—536
5 According to Fortune’s annual survey of the 500 largest industrial firms and 50 largest
commercial banks, median returns as a percentage of invested capital were roughly 9.3
percent for the former and 10.3 percent for the latter (1960-64).

FEDERAL RESERVE PORTFOLIO

111

Actually, limiting Federal Reserve income is not an objective per se,
but a means of obtaining control over Federal Reserve expenditures.
For without an independent income, the System would have to turn
to Congress for appropriations. Of course, this aim could be achieved
without forcing the System to disband open market operations. All
that would be necessary is a limitation on its portfolio such that the
income therefrom (and from other sources such as rediscounting)
would not exceed a specified amount. Even such a proposal is inferior
to that of submitting the Federal Reserve’s budget to the Congressional
budgetary mechanism which would result from Mr. Patman’s H.R.
9685. Whether the Patman proposal itself is desirable is a question
which has been explored by the Subcommittee on Domestic Finance of
the House Committee on Banking and Currency and published in its
“The Federal Reserve System After 50 Years: Hearings” (1964),
Congress surely has the right of allocating appropriations among the
various branches of Government—including the Federal Reserve—as
well as the right to order that revenues of the various governmental
bodies should be turned over to the general fund of the Treasury.
Two sources of difficulty which might result from Congressional
supervision of the Reserve System’s budget should be mentioned.
First, Congress might use the power of the purse as a means of
interfering with the day-to-day execution of Federal Reserve policy.
While there is no convincing reason for preserving the independence
of the Federal Reserve System and there is some reason for believing
that Congress ought to assert itself in the determination of general
monetary policy, Congress should not intervene in its execution.
Congress is not institutionally equipped for daily supervision. Sec
ondly, the possibility exists that the level of staff excellence might be
lowered should Congress be niggardly in its appropriations to the
System.
In any case, these various objectives could be obtained by direct
legislation aimed at the specific goal. To attain them circuitously
through limitation of the Reserve System’s portfolio involves im
posing an unnecessary and unwarranted rigidity into the choice of
the Federal Reserve weapon-mix.
3-5. Questions: If the portfolio grows too large compared to this
standard, what should be done with the excess? Should the assets
be transferred to the Treasury for cancellation? Should the Federal
Reserve continue to hold them, draw the interest and return the
unexpended balance to the Treasury ?
Answer: While discretion over the size of the portfolio should
remain with Reserve System officials, no strong objections can be
raised if all income therefrom is transferred directly to the Treasury.
The assets, however, should remain with the System.
It was emphasized previously that the freedom of the Federal
Reserve System in manipulating its holdings of securities ought not
be impaired. Changes m the portfolio provide the System with a
tool for influencing aggregate economic activity, and such operations
should remain undisturbed. To be sure, some undesired side effects
may occur from the open market policies pursued by the authorities,
but these evils may be remedied by appropriate legislation.
The disposition of the earnings from the Reserve System’s port
folio, however, does not affect the general economy. The question

112

FEDERAL RESERVE PORTFOLIO

of the System’s income is not an economic problem but a political
one. In the American system of democracy, Congress controls the
purse strings of the Government. There is no strong reason for
exempting the Federal Reserve from this requirement. In order
to accomplish this end, the System’s independent sources of income
must be removed. Mr. Patman’s H.R. 9685 would accomplish this,
and would force the System to come to Congress for appropriations.
However, the assets of the System’s portfolio should not be trans
ferred to the Treasury, since such a move could limit the ability of
the monetary authorities to operate in the open market. Similarly,
it must be emphasized that Congress should not interfere with the
Reserve System’s freedom of operation.
B.

THE COMPOSITION OF THE FEDERAL RESERVE PORTFOLIO OF SECURITIES

6-8. Questions: Can we design other objective standards by which
to guide Federal Reserve portfolio operations? Should we lay
down standards relative to the kind of assets to be held, maturity
composition, private versus public instruments? Should the Fed
eral Reserve supplement its portfolio of Federal Government securi
ties with other types of assets such as commercial loans, foreign
exchange, municipal securities, corporate bonds, mortgages, com
modities?
Answer: The Federal Reserve System should be permitted, indeed,
urged to include all sorts of financial assets in its portfolio but should
be prevented from purchasing commodities. Further study is re
quired to determine a nondiscriminatory method of enlarging its
portfolio.
The channels through which a change in monetary policy finally
brings about a modification of the spending flow are numerous.
Open-market purchases by the authorities affect the availability of
and charges on credit and market interest rates in general. Com
mercial bank free reserves will be increased (or negative free re
serves decreased) as the securities bought by the Federal Reserve
are paid for by the creation of reserves. With this increase in bank
reserves, borrowers who were previously turned away can now be
accommodated. As this source of lending has begun to dry up, and
perhaps even before, banks will seek to make additional loans, bor
rowing will have to be made more attractive, and consequently rates
on loans, short- and long-term, will be reduced. And those would-be
borrowers who were deterred by the high cost of credit can now
borrow more cheaply. In both cases, namely, the increased avail
ability of credit and its reduced cost, new borrowing will be under
taken and new spending will result. A looser monetary policy ac
complished by Federal Reserve open market purchases will raise
aggregate demand and gross national product. Needless to say,
the opposite reactions may be expected from a tightened monetary
policy, through open market sales.
Open market purchases can bring about an increase in spending
in another manner as well. The increased demand for Government
securities by the Reserve System will raise their prices and lower
their yields. Portfolio holdings of all sorts of securities by financial
and nonfinancial institutions and individuals, based upon the previous

FEDERAL RESERVE PORTFOLIO

113

level and structure of yields, will now be reexamined and modified
in accordance with the new market information. Security holders
will tend to reduce their demands for the lower yielding Government
and increase their demands for a somewhat more risky but more
remunerative private security, say AAA corporate bonds. Natu
rally, this action will drive up the prices of AAA bonds, and thus
the profit seekers will switch to the next best security, and so on.
Ultimately, the new issue market will become looser and issuers of
debt instruments will find improved opportunities and lower charges
on their obligations. Simply stated, open market purchases by the
Federal Reserve have opened a gap in the market which private
borrowers can now fill by supplying their own securities. Again,
borrowing will increase, spending will rise, and so will GNP.
Now, insofar as the Federal Reserve’s impact on commercial bank
reserves is concerned, it matters little what type of asset the central
bank purchases or what its maturity is. Reserves are created by
payments to the seller whose check ultimately finds its way into the
commercial banking system and from there to the Reserve banks.
However, insofar as specific interest rates and the availability of
funds in the new issue market is concerned, the type of security does
matter. The location of the gap is important, for interest rates do
not fall quickly and portfolio adjustment takes time. There is at
least a 6-month lag from the time that the Federal Reserve changes
its policy until the impact is felt on aggregate spending. And the
lag may be even longer. Needless to say, this lag hinders the ability
of the monetary authorities to achieve their objectives, and renders
monetary policy less effective than it could be. This lag ought to be
reduced.
On the basis of this reasoning, it follows that the Reserve System
should be applauded for abandoning its “bills only” policy. If
interest rates are to be reduced speedily, the System ought to operate
throughout the yield spectrum.
Moreover, since the objective of the loose monetary policy is to
increase private spending, the relevant interest rates are the ones the
reduction of which will lead to the strongest and fastest increase
in spending. It follows that the Federal Reserve ought to purchase
evidences of debt issued by others than the Federal Government
and equities as well. This emphasis on opening a gap in the market
leads one still further. The Federal Reserve ought to underwrite
securities. And carrying out the implications of this “open gap” theory
to the logical end, the System ought to buy commodities, too; even
go so far as place orders for new goods. In this final instance, the
Federal Reserve will be pushing purchasing power directly into the
spending stream. GNP will be increased immediately.
Intuitively, one feels something is wrong here. Is not the purchase
of commodities properly called fiscal policy? Have we not left the
financial sphere and moved into that of Government purchases of
goods and services for purposes of stabilization and growth? It
seems to me that if Congress does not deem it wise to place respon
sibility for fiscal and monetary policy under one roof by giving
the President discretionary monetary and fiscal powers—a plan of
great merit—then it ought to divide these powers completely. The

114

FEDERAL RESERVE PORTFOLIO

Federal Reserve should have only monetary powers, and thus should
not be given the option of purchasing commodities. (As a corollary,
the Federal Reserve and not the Treasury should determine the type
of securities sold by the Federal Government, although not the
quantity issued.)
Different problems arise with respect to permitting the Federal Re
serve to intervene in private security markets. Whose securities ought
the Federal Reserve buy ? Those of the giants or those issued by small
businesses ? Those of rapidly growing firms, who have shown prom
ise, or those of slowly growing ones, who need aid? Those of firms
engaged in export activities or those concerned primarily with the
domestic market? Industrial companies or agricultural ones? Cali
fornia, Kansas, or Massachusetts firms ? Is not discrimination inher
ent in such a proposal ? The critics of monetary policy have claimed
that even open-market operations in Government securities have a
discriminatory impact. Federal Reserve operations in specific pri
vate securities will strengthen and perhaps justify this criticism. If
shares of stock are purchased, the question of Government infiltra
tion into private enterprise surely will be raised.
To some extent, the choice of securities from a specific category
might be made at random. For example, should the Reserve officials
decide to intervene by $6 million in the AAA bond market, a random
choice from existing AAA securities might be made. Alternatively,
some sort of proportional allocation might be suggested. Thus, if
1,000 securities appeared on the AAA list, 0.001 of the total alloca
tion would be purchased of each listing. Some combination of these
two methods might also be adopted.
Another objection that could be raised is that the broadening of the
Reserve System’s portfolio to include non-Federal Government securi
ties would change the nature of the Federal Reserve System from
that of controller of money supply and lender of last resort to that
of a plain and simple lending institution. Thus, the Federal Reserve
would supplement and perhaps take over some of the functions of the
SBA, FHA, FNMA, not to mention those of private financial agen
cies. This would not be too serious an objection if the random pro
cedure suggested above is adopted? for then no consistent bias would
occur. It could be justifiable criticism, however, if the Federal Re
serve, consciously or not, favored a specific type of borrowing.
As for the implications of stockownership, the Federal Reserve could
be prohibited from voting or otherwise interfering in the affairs of the
corporations in which it owns equities.
To conclude, then, it makes good sense to permit the expansion of
the Federal Reserve’s portfolio to include non-Federal evidence of
indebtedness and ownership. Some practical problems remain, how
ever, as to the proper method of implementation. I would suggest,
therefore, that Congress request Federal Reserve officials, representa
tives of the academic and financial communities, and other interested
parties to investigate the most practicable manner of implementing an
expanded open-market policy. The Joint Economic Committee itself
might wish to commission detailed studies. The Joint Economic
Committee then should act in the light of the results of these studies.
Alternatively, the Joint Economic Committee might recommend
the amendment of the Federal Reserve Act to give the Federal Reserve

FEDERAL RESERVE PORTFOLIO

115

System the right to intervene in State, local, and private security
markets at the System’s option. It is to be expected that the Federal
Reserve will not exercise this option without careful investigation and
serious consideration of the consequences of such action.

S tatem en t b y C harles L . P rath er , P rofessor of F in a n c e , G radu
ate S chool of B usiness , U n ive rsity of T exas , A u st in , T e x .

Instead of cancellation of $30 billion of U.S. Government obliga
tion, as proposed in H.R. 7601, it seems to me there are better ways
of handling this problem. There is no reason why the securities
should not be retained for accounting and psychological reasons but
they may be made noninterest bearing. The public seems to want
backing for their currency and the withdrawal of $30 billion in assets
from the Federal Reserve System could be disturbing.
At numerous times, it has been suggested that all legal reserve re
quirements against savings and time deposits be eliminated, which
would reduce the need of the Federal Reserve System’s liabilities and
its holding of assets. As a depositor, I object to this change until the
assets and liabilities of the time and savings departments of com
mercial banks are segregated. Not before banks protect their time
and savings banks are they entitled to have their legal reserve require
ments against them eliminated. Under present banking policies, the
effect would be about the same as lowering the percentage reserve
requirement for demand deposits.

S tatem en t b y L eland J. P ritchard , P rofessor of F in a n c e ,
D epartm ent of E conomics , t h e U n iversity of K an sas , L a w
rence , K a n s .
portfolio holdings of t h e federal reserve b a n k s

The proper volume should be entirely determined by the decisions of
the monetary authorities, for it is only through adding to or sub
tracting from this portfolio that the Reserve authorities can supple
ment or offset the many other factors affecting commercial bank re
serves so as to bring about a net effect in keeping with credit manage
ment objectives. This is the only way in which nonmember as well as
member bank reserves and excess and free reserves can be properly
determined.
Now whether or not this determination should be made by the Open
Market Committee and executed through the decisions of the Manager
of the Trading Desk at the Federal Reserve Bank of New York is
another matter. I am inclined to the opinion that this decisionmaking
process should lie entirely with the Board of Governors, and that the
Board should be reconstituted to include the Secretary of the Treasury,
the Comptroller of the Currency, the Chairman of the Federal Home
Loan Bank Board and perhaps the Director of the Federal Deposit
Insurance Corporation.
I believe your objections to allowing the Reserve System to utilize
excess earnings on their Government portfolio could be met by: (1)

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FEDERAL RESERVE PORTFOLIO

eliminating stock ownership (and dividends) of the Reserve banks;
and (2) having the books of the Feds audited by the General Account
ing Office and all funds in excess of current expenses returned to the
Treasury, and not just approximately 90 percent as at the present
time. The latter should be accomplished by the reenactment of the
old franchise tax and not accomplished in the devious manner now
employed.
As you know the Reserve banks do not need to issue common stock
or have this stock held by the commercial banks, or any other party
or group. The Reserve oanks are central banks. They do not need
an owners’ equity to protect depositors. Furthermore they do not
need capital in any form in order to finance their operations. The
Reserve banks, as you know, acquire all earning assets through the
creation of deposits, and these deposits are the reserves of the banking
system. Incidentally, the legal reserves of all commercial banks should
consist of deposits in the Federal Reserve banks, that and nothing
more. I f this were so the job of controlling the size and expansibility
of the banking system would be made easier and more responsive to
the monetary authorities.
S ta te m e n t b y

L. S. P ru ssia, J r.

With regard to your direct questions regarding the appropriate size
of Federal Reserve System portfolio of Government securities in rela
tion to money supply, gross national product, and liquid assets, I do
not believe that any firm measure or rule of thumb can be applied.
The relationship depends upon many considerations that are con
stantly changing. Institutional relationships, the interplay of fiscal
and monetary policies, developments in the private sector, and inter
national considerations all have a bearing on this important question.
Generally speaking, I believe that overall monetary policies should
provide our Nation with a growing supply of money and credit at the
lowest possible level of interest rates to promote continuous, maximum,
long-term economic growth. Monetary policies always should seek
to be promotive but, equally important, they should encourage stable
growth. This means that the monetary authorities should avoid poli
cies that would promote excessive general price level movements that
might jeopardize continuous maximum growth. Consequently, this
means that the authorities might have to take steps, when the occasion
warrants, to make adjustments in policy consistent with fiscal policies
and developments in the private sector that will either restrict or en
large the availability of money and credit. In sum, the monetary
authorities should remain continuously cognizant of the overall eco
nomic needs of the Nation and adjust policy accordingly. Moreover,
I believe they should have a reasonably wide degree of freedom to set
policies with these objectives in mind.
The most important consideration is the ultimate objectives of mone
tary policy. The means of achieving these ends seem less important in
relation to these primanr objectives. The basic aim of policy should be
to provide an optimum now of credit resources and the Federal Reserve
has several alternative means of achieving these objectives. However,
the particular policy mix chosen to achieve these ends can have an
important influence on the banks and financial relationships generally.

FEDERAL RESERVE PORTFOLIO

117

As you noted in your letter, the Fed has chosen to provide bank reserves
in recent years through open market acquisitions of Governments.
Although this may have been appropriate m the early sixties, the con
tinued pursuance of this policy orientation has raised serious questions
more recently. To understand this it is necessary to review briefly the
history of the sixties to make my point.
As you well know, our Nation has been involved in a serious balanceof-payments problem for a number of years. The grave importance of
this problem became painfully apparent in the early sixties in the midst
of a domestic recession. Because of this recession, domestic monetary
policy obviously required a promotive orientation, lower interest rates,
and rapid credit expansion to encourage domestic growth. On the
other hand, this policy orientation was not consistent with our interna
tional financial relationships which required a monetary policy that
would hold domestic interest rates at levels high enough to prevent
excessive outflows of dollars and gold.
Given this dilemma of policy objectives, our Government selected a
mix of monetary and fiscal policies that would promote internal
growth but that would simultaneously protect our international pay
ments position. In the financial area the Federal Reserve and Treas
ury cooperated in a policy mix that has come to be known as Operation
Twist. The objective of these policies was to sustain or raise domestic
short-term rates that were sensitive to international money flows and
simultaneously maintain or lower domestic long-term rates to stimu
late domestic investment and internal growth.
The Treasury took part in Operation Twist by adopting debt man
agement policies which saw outstanding marketable issues due within
1 year rise from $70 billion in mid-1960 to $95 billion at the present
time. The rising supply of short-term issues tended to sustain or raise
short rates. Simultaneously, the Fed adopted promotive credit poli
cies in 1960 by enlarging available free reserves. During the last 5
years the Fed has supplied reserves largely through open market acqui
sitions of U.S. Government securities, as you point out. Equally im
portant, the Fed abandoned its bills-only policy in the early sixties,
and acquired intermediate and long-term Government securities to
support their prices and to hold down long-term rates.
The Fed also has pursued Operation Twist objectives by raising the
discount rate and liberalizing regulation Q which governs the rates
member banks can pay on savings and time deposits. These moves
have raised short-term rates and bank expenses. As a consequence,
these moves have helped to sustain short rates at levels consistent with
the foreign rate structure and have also forced the banks to move
funds into longer-term commitments such as term loans, mortgages,
and long-term investment to justify the rapidly rising interest expense.
This latter move has been effective in helping to hold down long-term
rates.
It seems to me that the authorities employed an imaginative new
approach to monetary control under difficult circumstances during
this period. The Fed operated on bank balance sheets to increase the
flow of credit, but the authorities also successfully influenced the
yield curve of maturities by open market purchases and by operating
on bank costs. The resulting impact of Operation Twist proved to be
successful.
56-913— 66--- 9

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FEDERAL RESERVE PORTFOLIO

In line with this policy orientation, it appears that it was necessary
to offset gold outflows by means of open-market acquisitions of gov
ernments rather than by reductions in reserve requirements. Openmarket purchases, particularly long-term issues, helped to sustain
the overall effect of Operation Twist. This approach simultaneously
reduced long-term rates and provided banks with increased reserves
to expand credit. It provided easy money without necessarily reduc
ing short-term rates. The cost impact of higher regulation Q limits
did the rest by forcing the banks into longer term commitments. On
the other hand, provision of reserves by reduced reserve requirements
in the early sixties would have worked against this policy objective
because it would have allowed the banks to offset rising costs more
easily by greater investment in earning assets.
Although you cautioned against elaborate argument in your letter,
I believe this review of history is essential to an understanding of the
Fed’s rapid accumulation of U.S. Government securities in the last
few years. This was a necessary adjunct of this policy orientation;
however, this approach has had other important effects on our financial
system. Moreover, the economic environment has changed markedly
and it is now doubtful whether this same policy orientation is
appropriate.
The huge acquisitions of governments by the Fed have substantially
changed the role of the monetary authorities in recent years. Where
the Fed held 14.1 percent of the marketable Federal debt in 1959, it
now holds 18.7 percent. Because of these acquisitions, the authorities
have absorbed 45 percent of the increase in total Federal debt in this
period. As a consequence, the Fed has become an important engine
for financing Federal deficits. This naturally raises a question as to
whether it is appropriate to have an arm of the Government finance so
large a part of its indebtedness. This type of internal financing be
comes relatively cheap because the Fed regularly remits about 90 per
cent of its net earnings to the Treasury.
Heavy acquisition of Federal debt by the Fed also has changed the
market environment. Continuous market support operations lulled
investors into a false sense of security. The breadth, depth, and resil
iency of the market narrowed as it came to rely on Fed support, par
ticularly at the long end. Investors assumed that the Fed would
continue to support prices in a narrow range with the result that
trading tended to decline and investors became complacent. Conse
quently, the market received a severe shock when the Fed recently
withdrew its support. Hence, this whole episode of Fed operations
has tended to discourage a broadened ownership of Federal debt which
presumably is a prime objective of debt management policy.
Large-scale operations on the cost structure of commercial banks
have raised other questions. As indicated, efforts to increase expenses
have forced the banks to seek new ways to justify these higher costs
to continue to earn an adequate return on capital. This has forced
the banks to seek higher yielding, long-term commitments, but it
also has required the acceptance of greater risk and reduction of
liquidity. Therefore, the safety of depositors has been affected by
the Fed’s policy orientation. Although the policy has encouraged a
rapid growth o f credit, it also has affected the quality of credit and the
nature of financial relationships. So far, this policy orientation has

FEDERAL RESERVE PORTFOLIO

119

worked to achieve the desired ends, but it also has increased the vul
nerability of the banking system to economic reversals and raises im
portant questions regarding the future health of our whole financial
mechanism.
The policy orientation of the Fed during the recession-dominated
period and during the earlier stages of acceleration appears to have
been desirable. However, the character of the challenge facing the
Nation now has changed. We have passed through this difficult
recession stage and the economy is now operating close to full employ
ment. The expansion has lasted nearly 5 years, and without the
recent stimulation of the escalation of the Vietnam action, there would
be questions about sustaining the advance. Given the increased vul
nerability of the banking system, it now seems appropriate to con
sider a basic change in policy orientation to insure continued sustain
able growth.
It no longer seems acceptable for the Fed to support credit growth
entirely through open market acquisitions of governments. Increased
demand for credit accompanying economic growth has raised interest
rates to levels that are consistent with our balance of payments re
quirements. Moreover, the interest equilazation tax and the recently
instituted voluntary restraint program have limited the outflow of
dollars. It might also be observed that the banks have been required
to assume a large share of this burden, again with the result that bank
earnings will be squeezed by reduced opportunities for attractive for
eign lending. Then, too, bank earnings have been held down this
year because the Fed increased regulation Q limits in late 1964 for the
third time in 3 years.
Overall, the Fed’s policy orientation in recent years has had an im
portant impact on bank earnings. Between 1960 and 1964 memberbank revenues increased $3.5 billion (38.7 percent), but expenses in
creased $3.2 billion (57.3 percent) largely because of increased interest
expense. After other adjustments, net income before taxes, at $2.9
billion, has shown no growth whatsoever during this 4-year period.
Net after-tax income has risen $200 million or by only 13.9 percent
during the period, but this was aided by the 1964 tax cut. During
this same period, by comparison, total U.S. corporate profits increased
30.4 percent, and after-tax profits of the U.S. corporations increased
39.2 percent—three times the percentage increase in member-bank
profits. As a result of this poor bank profit showing, the return on
capital declined from 10.1 percent in 1960 to 8.8 percent last year.
However, during the same period, the return on equity of U.S. manu
facturing corporations increased from 9.2 percent in 1960 to 11.6 per
cent last year. Clearly, although earning assets of banks have grown
sharply in recent years, this has not been translated into profits because
of Fed policies which have substantially increased bank costs.
Given this situation, I agree with you that the Fed should change
its policy orientation. It is no longer necessary or desirable for the
authorities to support credit expansion entirely by open-market ac
quisition of governments. Indeed, the present policy orientation, if
pursued, could have undesirable effects on our economy.
However, it is necessary for the Fed to continue to support credit
growth. Therefore, it would seem desirable for the Fed to shift its
expansionary policy emphasis from open-market acquisitions to reduc

120

FEDERAL RESERVE PORTFOLIO

tions in bank reserve requirements. At present member banks are
required to hold over $21 billion in cash reserves against their deposit
liabilities. As in the case of the Fed’s U.S. Government security hold
ings, this amount of reserves seems to be altogether too large.
Responsible scholars have repeatedly advocated a thoroughgoing
revision of these requirements because they are inequitable and per
petuate an anachronism of another period. They no longer serve the
necessary ends of monetary policy and are positively damaging with
regard to competitive relationships. The most serious deficiency of
present reserve regulations is the 4-percent cash requirement against
savings and time deposits. Commercial banks are the only type of
financial institution that is required to meet such a rigid requirement.
At present member banks must hold $4.6 billion m required cash
reserves against savings and time deposits. Orderly elimination of
this requirement would serve to support necessary credit growth and
could also serve to reduce Fed holdings of governments if it is deemed
inappropriate to provide the banks with this amount of free reserves
over a short period. With the consent of Congress, gradually reduced
requirements could be offset by sales of governments out of the Fed’s
portfolio to maintain the overall policy posture desired.
Furthermore, a reduction in requirements against demand deposits
also appears appropriate. The present high level of required reserves
is a holdover from the inflation-dominated war period. They pres
ently appear to be unnecessary and should also be reduced. Each 1*
percent reduction here would, if fully offset by sale of governments,
reduce the Fed’s portfolio by an additional $1.3 billion.
A carefully designed program of reduced reserve requirements would
achieve your objective and simultaneously improve the overall opera
tion of our financial mechanism. Such a program would provide for
the necessary growth in credit, improve the equity of competition be
tween financial intermediaries, and also reduce the Fed’s holdings of
U.S. Government securities in line with your views.
This approach to the problem appears to be eminently more desir
able than your proposal to turn Fed-held securities back to the Treas
ury for cancellation. This proposal appears to be unworkable and
perhaps dangerous. I f the Fed were to turn $30 billion in governments
back to the Treasury for cancellation, how would its books be bal
anced? Reported Federal Reserve capital amounts to only slightly
more than $1 billion. Clearly, an asset cancellation of the proposed
magnitude could not be written off against this. The contraction in
other liabilities necessary to offset such a massive decline in Federal
Reserve assets would be catastrophic because it would mean a sharp
decline in credit availability.
But perhaps more important, cancellation of Federal debt suggests
repudiation. No matter how adroitly this might be accomplished, and
surely it would require an act of Congress, it would have serious reper
cussions on confidence in the dollar. Wholesale cancellation of Fed
eral debt would cast serious doubts on the Government’s sense of re
sponsibility to meet its obligations. Therefore, confidence in the dol
lar would be seriously damaged around the world.
I share your concern with the present orientation of monetary pol
icy. Ingeniously devised methods to cope with serious problems
worked well when they were needed; however, we live in a dynamic

FEDERAL RESERVE PORTFOLIO

121

and ever-changing environment. We must constantly be aware of this
and adapt our policies to this changing environment if we are to insure
the continued health of our Nation. The time for change appears to be
overdue and, hopefully, steps will be taken shortly to improve the
vital influence of our money and credit policies for the benefit of all.
S ta te m e n t b y R o la n d I. R o b in so n , G r a d u a te S c h o o l o f B u sin ess
A d m in is tr a tio n , M ic h ig a n S t a t e U n iv e r s ity , E a s t L a n sin g ,
M ic h .

I believe the present laws governing this portfolio and recent Fed
eral Reserve administrative policies in managing it have been entirely
satisfactory; I see no excuse for any change in this regard. As long
as the Treasury recaptures the excess of Federal Reserve earnings over
operating costs (which seem emminently reasonable to me) the public
interest is being served.
May I respectfully suggest, however, that by focusing your atten
tion on this matter, you are losing an opportunity to press forward on
more important matters. For example, Federal banking regulation
has become increasingly splintered with the Justice Department and
the SEC more involved. Regulatory policies of the various agencies
have frequently been at odds with one another. On a point closer to
youi! own long-run interests, the organization for decisionmaking
within the Federal Reserve System often seems to become bogged
down by its own weight. These matters are important; far more im
portant than the channel through which the Federal Reserve—one
branch of the Government—funnels its earnings back into the Treas
ury. In these areas there is a great opportunity for you to serve not
only present public policy but the future; structural organization does
not have the glamour that is found in current economic policy but in
the end it may be more important.

S ta tem en t b y R obert R ockafellow , P rofessor of E conomics , C ol
lege of B usiness A dm in istra tion , U n ive rsity of R hode I sland ,
K ingston , R .I.

How large a portfolio of “Governments” should the Federal Reserve
System hold in relation to the money supply, the gross national prod
uct or aggregate liquid assets? Is any other criterion more appro
priate?
The $39.2 billion of Government bonds have mostly been acquired
by the Federal Reserve System as a result of open market operations
with buying predominating over selling and only secondarily have
Government bonds been bought with the purpose of securing earning
assets. Since the Federal Reserve System pays back to the Treasury
most of its income and at the same time keeps a surplus twice that
of its capital account and assuming that its expenses are reasonable,
I see no great harm in the present policy and can suggest no objective
criterion or rule, such as a GNP -Government securities holdings ratio,
for example. Such a criterion would not be especially significant in
my opinion. I am more concerned with the broader problems: have

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FEDERAL RESERVE PORTFOLIO

the “money managers” allowed the Nation’s money supply to expand
sufficiently “so as to assume an adequate rate of economic growth
and sustained high levels of production and employment.” We still
have unused resources of labor and capital and I believe that the
policy followed since World War II by the Federal Reserve has been
too conservative. But I think the Federal Reserve should continue
to hold its “ Governments.” I see no immediate crisis like that of
the 1929-33 deflation necessitating sharp changes in our central bank
ing structure and practice. Legislation to compel cancellations of
some $25 billion of “ Governments” might upset confidence at this
time in the conservative world of financial institutions.
Should we lay down standards relative to the kinds of assets to be
held, maturity composition, private versus public instruments?
I certainly am not in favor of a “bills only” policy such as character
ized the period 1951-60 with its three recessions, preceded in each
case by a deliberate “tight money” policy with net deficit reserves.
(I do not like the present prolonged “net deficit reserves” position as
it is currently maintained.)
Bankers acceptances supplement the Federal Reserves’ portfolio
now, but since they are limited in supply in our commercial practice,
they are not very important.
S tatem en t b t R aym o n d J. S au ln ie r , P rofessor of E conomics ,
B arnard C ollege , C olum bia U n ive rsity , N e w Y ork , N .Y

Responding to your request for comments on H.R. 7601, I would
advise strongly against its enactment. My reasons are as follows:
(1) Unless a non-interest-bearing security were substituted for
the income-earning securities now held by the 12 Federal Reserve
banks, it would be impossible to cancel $30 billion o f Federal Reserve
holdings of securities without either (a) wiping out the capital of the
Federal Reserve banks (which would b>e an expropriation of member
bank property); (b) wiping out the reserve balances of member banks
(which would be not only an expropriation of property but would
create havoc in the banking system); and (c) greatly reducing Fed
eral Reserve note circulation (which would be a disaster for the
economy).
(2) To substitute non-interest-bearing securities for those the 12
Federal Reserve banks now hold, not at the option o f the banks but at
the option of the Congress and against the wishes and better judgment
of the banks, would set a precedent for arbitrary debt cancellation
that would destroy confidence in the U.S. dollar and the word of the
U.S. Government.
S ta te m e n t b y W i l l i a m O. S h ro p s h ir e , A s s o c ia te P r o fe s s o r o f
E co n o m ics , S c h o o l o f B u sin ess A d m in is tr a tio n , E m o ry U n i
v e r s ity , A t l a n t a , G a .

Assuming that the Federal Reserve is only responsible for monetary
policy, i.e., measures designed to effect changes in the money supply, the
only reason the System has for owning any Government securities at
all is to have something to sell when it wants to reduce the money supply
through open-market operations.

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FEDERAL RESERVE PORTFOLIO

The answer, then, to the question of how large the bond portfolio
should be hinges upon the possible size of future security sales by the
Federal Reserve. This amount is, of course, uncertain, but a review of
the data on security sales for the last 15 years suggests the order of
magnitude of open-market operations. Since 1950, the largest reduc
tion in security holdings during a 12-month period occurred between
1956 and 1957. During this interval of credit restraint the Federal
Reserve reduced its holdings by $783 million. It is possible that this
net figure for the year fails to reveal very large sales in 1 week that
were offset by purchases in the following week. Therefore, it is useful
to look at the data for periods shorter than 1 year. The largest net
reductions for monthly intervals appear to have been in the neighbor
hood of $0.5 billion to $1 billion; the largest net reductions during 1
week appear to have been in the same range. One further observation
is suggestive of the possible magnitude of open-market sales. Dur
ing the interval that has been described by one critic as “viciously
restrictive,” the largest net reduction in the System’s holdings of
securities amounted to about $2 billion. This reduction occurred be
tween December 9, 1959 and March 2, 1960. These data suggest that
the present Federal Reserve holdings of U.S. securities are far greater
than the amount necessary to carry out monetary policy.
This does not necessarily mean, however, that the debt should be
canceled. From an economic point of view, it is a matter of indifference
whether the debt is canceled or held in the Federal Reserve portfolio.
That is, neither taxpayers, consumers, nor businessmen would detect
the difference if the debt were canceled tomorrow. The choice be
tween cancellation and continuance of the present arrangement seems
to me to be a political one. Because of its large holdings of Govern
ment securities, the Federal Reserve is not dependent upon congres
sional appropriations for its operatiig income. I f the debt were can
celed, its earnings might be reduced to the extent that tax money
would have to be appropriated to finance the System. Under present
arrangements, Congress levies taxes to cover debt service, part of which
accrues to the Federal Reserve to cover its expenses. I f the debt were
canceled, Congress would probably have to provide tax money to finance
the Federal Reserve. This latter method of finance would mean, of
course, that the Federal Reserve would be directly dependent upon
Congress for operating funds. Whether this increased control by
Congress is desirable is another question, which cannot be answered
on economic grounds.
S ta tem en t

B arr y N . S iegel , A ssociate P rofessor
U n iversity of O regon , E ugene , O reg.

E conomics ,

This is in response to your letter of September 1, 1965, requesting
my opinions on the subject of Federal Reserve portfolio policy. As
stated in your letter, the Federal Reserve holdings of governments
have grown to almost $40 billion, partly in response to the need for
rowth in the money supply. I might also add that the external gold
rain plus the internal drain of a rapid increase in currency in circu
lation since 1960 together more than account for the increase in Fed
eral Reserve holdings of U.S. securities. Both the defense of the
existing money supply and the need for monetary growth appear to

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FEDERAL RESERVE PORTFOLIO

have influenced Federal Reserve portfolio policy. The growth in the
deposits during this period could have been met by relatively small
reductions in reserve requirements. The external and internal drains
upon bank reserves, however, would have required an approximate
50-percent reduction in reserve requirements if the Federal Reserve
had chosen this particular route to offset the two drains.
Should the internal and extenral drains upon bank reserves con
tinue unabated in the future, they will probably be met by further
increases in Federal Reserve holdings of U.S. securities. Under exist
ing arrangements, the only other way of offsetting the impact of such
drains upon the money supply is to lower continuously member bank
reserve requirements. The enect of this would be to substitute mem
ber bank holdings of United States and perhaps privately issued se
curities for Federal Reserve holdings of U.S. securities. While con
tinuous reductions in reserve requirements are technically feasible,
within the lowest legal limit of reserve requirements, I would prefer
meeting member bank reserve drains by the method of Federal Reserve
open-market purchases. This method at least has the virtue of re
ducing the net interest cost of the Federal debt to the public. More
over, the second method would open the Federal Reserve to the charge
of feathering the nest of the banking system, since member banks, not
the Federal Reserve System, would be receiving the interest earnings
on the debt purchased to meet the reserve drains.
The above remarks should indicate that I know of no mechanical
rule or criterion which should dictate the size of the Federal Reserve’s
portfolio. The size of that portfolio is dictated by the rate of desired
growth in the money stock and, more importantly, by the direction and
size of gold and currency movements. How these influences are met
is as much a political and ethical problem as it is an economic problem.
The same is partly true of the question of what should be done with
the enlarged portfolio of the Federal Reserve. Technically, the Fed
eral Reserve could continue to hold its additional stocks of U.S. se
curities until maturity, turning over to the Treasury the interest it
earns in excess of its expenses and dividend payments. Alternatively,
the excess portfolio could be sold to the Treasury in exchange for non
interest bearing certificates issued by the Treasury. The only tech
nical advantage I can see in this latter alternative is a possible negli
gible reduction in bookkeeping costs.
I do not wish to comment upon the standards which guide the ma
turity composition of the Federal Reserve’s holdings of governments,
except to say that such composition ought to be guided by the principles
imposed by the theory of debt management. These principles should
be exercised to meet the Federal Reserve System’s responsibilities in
the area of economic stabilization and in defense of the dollar.
I would, however, like to comment upon the standards by which
the Federal Reserve System distributes its assets among public and
private instruments. In recent years the marketable portion of the
Federal debt has been declining. In the meantime, the volume of
marketable Federal debt available to the public as liquid and/or de
fault free assets has been declining even more rapidly. Since Decem
ber 1962, the decline in the Federal marketable debt held by the public
has been over $5 billion. Moreover, there is a strong possibility
either that this trend will continue or that, at best, the amount of debt

FEDERAL RESERVE PORTFOLIO

125

available to the public will increase only very slowly. This is because
of the rapid potential growth in the social security trust funds result
ing from schedules increases in social security taxes and because of
the possibility (mentioned above) of continued increases in the Fed
eral Reserve’s holdings of Federal debt.
The public’s demand for Federal debt is not likely to grow as slowly
as the supply available to it. Commercial banks are the principal
holders of marketable Federal debt. Since 1962 their holdings have
dropped from $58 billion to about $48 billion. In the meantime their
earning assets as a whole have continued to increase, so that the ratio
of Governments to total earning assets in their portfolios has fallen
from 0.29 in December of 1962 to below 0.20, a postwar low. It is
doubtful that banks will continue to allow the ratio to fall as rapidly
in the future. In the same period, State and local governments in
creased their holdings of Federal marketable securities by over $5
billion. The prospects for a continued rapid increase in demand
from this, the second most important source of “public demand” for
Federal debt, is quite good. Indeed, corporations are the only im
portant “public sector” institutions to reduce their holdings of Federal
marketable debt. They have sold off about $3 billion of their hold
ings since 1962. (Most of these data come from the August 1965 Fed
eral Reserve Bulletin, p. 1141.)
In general, then, I expect a continued strong growth in the demand
for Federal debt relative to the growth in supply available to the
ublic. I f a recession occurs in the near future, this gap between
emand and supply may even widen, since both banks and nonfinancial corporations may hasten to put their assets into Government
securities as other investment opportunities fall off. I might also add
that there is some evidence in the behavior of the structure of interest
rates in recent years which is at least consistent with the view I have
been expressing. The yield differential upon U.S. Government’s
versus State and local securities has ¡been narrowing, indicating that
investors may be substituting such securities in their portfolios for
the relatively scarce governments. The recent upsurge in popularity
of negotiable certificates of time deposits may also be an indication
that investors are substituting such instruments for relatively short
supplies of short term Treasury instruments.
What does all this have to do with Federal Reserve portfolio policy ?
Perhaps nothing at the moment. However, for the future, the Federal
Reserve may have to widen its portfolio to include all sorts of private
instruments. As the economy grows, so also will its wealth. Wealth
holders will wish to balance their portfolios with both liquid and lowrisk securities. A failure of growth in the marketable Federal debt
available to the public will cause the public to substitute private for
Federal instruments. The Federal Reserve System is a guarantor of
the liquidity only of the Federal debt and a limited class of private
paper. If, in the future, the public comes to hold a large volume of
privately issued securities as liquid assets, the Federal Reserve may
be well advised to think now of changing its procedures in order to
buttress the liquidity of those assets.
Let me stress that the above is only a very tentative suggestion, based
upon a tentative analysis. At present, I see the liquidity problem as
only a small cloud in the sky. The political and ethical ramifications

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FEDERAL RESERVE PORTFOLIO

of Federal Reserve support for private instruments are such that I
would want to be sure of myself before recommending that the Fed
eral Reserve provide a supplementary market for privately issued
securities. I do think, however, that the situation bears further
analysis and, perhaps, some planning.

S ta tem en t by F ran ces

P. S in g , B r o o k l y n , N.Y

The following are my comments on the topic you raised in your
letter:
(1) The current holdings of about $39.8 billion of U.S. Govern
ment obligations by Federal Reserve banks are large in relation to
that is required for open market operations. However, they are not
large with regard to money supply, especially in view of future need
of money as our economy keeps expanding. Money supply is here de
fined as currency outside banks plus demand deposits adjusted. The
ratio of Federal Reserve banks’ holdings of U.S. Government securi
ties to money supply ranged from the low of 70.7 percent in June of
1950 to the high of 113 percent currently. (My calculation is based
upon quarterly figures of selected years 1946, 1950, 1955, 1960, 1965.)
However, if we include time deposits in the money supply concept,
then the ratio would be 10.5 percent in June 1950 to 14.9 percent in
March 1946 (and currently 11.2 percent). The relatively rapid
growth of time deposits in the postwar period and the ease of con
verting them into cash and demand deposits warrant a close study
of the behavior of this item while considering the relationship of the
Federal Reserve’s holdings of governments to money supply. In fact,
the conversion of time deposits into demand deposits would be en
couraged when and if H.R. 9687 is passed.
Since increase in gross national product is closely related to increase
in money supply, enlarged holdings of U.S. Government securities by
the Federal Reserve are essential to economic growth, unless the Fed
eral Reserve authorities choose to lower member banks’ reserve re
quirements to achieve the same goal. From March 1946 to March 1965,
gross national product rose by 233.5 percent, while money supply
increased only by 55.1 percent. (One compensatory factor here is the
rate of turnover of demand deposits which, during the period, went
up about four times in New York City and slightly more than twice in
other maj or cities across the country.) However, if we use the broader
concept of money supply; that is, money in circulation plus time de
posits, then the rate of increase would be 266 percent within the same
period. Therefore, the current holdings of U.S. Government obliga
tions by the Federal Reserve are not large in view of the increasing
need for money supply in years to come.
(2) With respect to the problem of paying interest on those govern
ments held by the Reserve banks, I do not consider the cancellation
of a major portion of those securities a good solution to the problem
of saving taxpayers’ money. As mentioned above, a growing economy
needs a rising money supply. So if those securities are canceled, the
Federal Reserve authorities should be permitted, by enacting new law,
to purchase other types of obligations, say municipal and/or cor
porate bonds to back up Federal Reserve notes in circulation and

FEDERAL RESERVE PORTFOLIO

127

member banks’ deposits at the Reserve banks, unless the Federal Re
serve Act is amended to eliminate the requirement of putting up any
collaterals, except gold, to secure notes in circulation and deposit
liabilities. According to the latest figures I have gathered, on Oc
tober 6, 1965, Federal Reserve banks’ holdings of U.S. Government
obligations amounted to $39,791 million, and $26,879 million of which
had to be used to back up Federal Reserve notes outstanding, leaving
$12,912 million to secure total deposit liabilities of $19,548 million.
Even though there was an excess of $4,900 million in gold reserve
which could be used to replace the same amount of governments held
against Federal Reserve notes in circulation, total Federal obligations
held by the Reserve banks cannot be considered excessive unless the
Congress is willing to abolish the reserve requirements which Federal
Reserve banks have to keep against both note issuance and deposit
liabilities. Accordingly, I am not in favor of canceling a major part
of the U.S. Government obligations held in the Federal Reserve’s
portfolio. I f the Congress considers interest payments on the gov
ernments held bv the Reserve banks are not in the public interest, one
of the two remedies may be adopted: (a) to require the Reserve banks
to turn over all interest received on the governments to the Treasury;
or (b) to convert the present holdings of U.S. securities by the Reserve
banks into non-interest-bearing debt. I believe any one of the two
methods is far better than that of canceling governments held in
the Federal Reserve’s portfolio for the sake of saving interest cost.
(3) It may be made permissible for Federal Reserve banks to buy
corporate and/or public obligations other than U.S. Government
securities for the purpose of controlling money supply and for backing
up notes in circulation and deposit liabilities. However, I believe
that by confining open market operations to the governments, the
Congress in fact broadens the outlet for U.S. securities, and thus pre
venting interest rates on the governments from rising further.
(4) As to the composition of securities held in the Reserve banks’
portfolio, I consider it wise to leave that at the discretion of the Fed
eral Reserve authorities. Any law requiring the Federal Reserve to
hold a certain percentage of securities in a given term, say 40 percent
in short-term issues, would put the authorities in a straitjacket. For
this reason (and also others) I was opposed to the bills-only policy
adopted by the Federal Open Market Committee in the 1950’s.
I hope that my statement serves some purpose, and I would be glad
to do further studies concerning the operations of the Federal Reserve
System for you and your committee.

S ta tem en t b t W alter E . S p a h r , E xecutive V ice P resident , E con
omists ’ N a tio n a l C om m ittee on M on etary P olicy , N ew Y ork ,
N .Y

1.
“How large a portfolio [‘of Federal Government securities’]
should the Federal Reserve System hold in relation to the money
supply * * *?”
Answer: As a basic principle, debt of the Central Government
should not be monetized. The National Government should not create
money for itself; it should obtain it by taxation and by borrowing

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FEDERAL RESERVE PORTFOLIO

from savers and investors. The U.S. Government should not use the
Federal Reserve banks as a means of creating money and deposits
for Government use against Government securities. It is appropriate
for these banks to receive Government deposits and to act as Govern
ment fiscal agents provided these banks are compensated for the
service rendered.
The Reserve banks should make loans and investments in accord
ance with the nature of the functions which these banks should
perform. In brief, these banks, fundamentally, should be rediscount
institutions for their member banks and their notes and derivative
deposits (those arising from loans and investments) should expand
and contract in general harmony with productive activity. The
capital funds of Federal Reserve banks should be invested, not loaned,
because of the nature of capital accounts. To the extent that the cash
assets represented by capital accounts are in excess of investments in
real estate, buildings, equipment, Federal Reserve stock, and other
necessary items, investments may appropriately be made in Govern
ment securities and other debt obligations provided the Government
securities are not purchased from the Government,
Because of the nature of the deposits of Federal Reserve banks—
demand deposits—the offsetting assets should consist of cash reserve
and automatically self-liquidating short-term loans, arising from the
rediscount of commercial, agricultural, and industrial paper.
Only gold certificates as reserve and short-term commercial, agri
cultural, and industrial paper eligible for discount should be held as
assets against Federal Reserve notes.
The expression “money supply” is not defined in the question asked.
But if it means Treasury currency, Federal Reserve bank deposits
and notes, and time and demand deposits of commercial banks, there
would not be any valid reason, in my opinion, for attempting to
state how large a portfolio of U.S. Government securities the Reserve
banks should hold in relation to the money supply for the reasons
given above—the considerations of appropriate procedure for the
Federal Reserve banks—and because of the varying velocity with
which the different varieties of money and credit circulate.
2. In relation to the gross national product? Because of the nature
of the figures on the gross national product, and for reasons stated in
item 1, there would not be any valid reason, of which I am aware, to
suppose that any appropriate relationship between gross national
product and the volume of U.S. Government securities held by the
Reserve banks could be stated.
3. “ Or aggregate liquid assets” ? I f the Reserve banks were run
on correct principles, as indicated in part in item I above, the rela
tionship between the Government securities held and other liquid
assets could be expected to vary widely from time to time.
4. “Is any other criterion more appropriate” ? That was stated
in general in my reply to item 1.
5. “I f the portfolio grows too large compared to this standard,
what should be done with the excess” ? I f the principle stated in
item 1 were followed, “the portfolio” probably would not become
too large. But considering the volume of such securities now held
by the Reserve banks, they should be sold as rapidly as possible—that
is, without shaking the market for Government securities unduly—to
savers and investors.

FEDERAL RESERVE PORTFOLIO

129

6. “Should the assets be transfered to the Treasury for cancella
tion” ? Excessive holdings of Government securities should be sold
to savers and investors for cash. I f the Government becomes in
volved, it should of course buy them at the market rate.
7. “ Should the Federal Reserve continue to hold them, draw the
interest, and return the unexpended balance to the Treasury” ? The
Reserve banks should move persistently toward the principle stated
in item 1, selling a large proportion of its Government securities to
savers and investors.
It should draw the interest specified on the securities it holds.
The Federal Reserve Act, in section 7, quite properly does not au
thorize the Reserve banks to pay any of its earnings to the U.S.
Treasury.
8. “ Can we design other objective standards by which to guide
Federal Reserve portfolio operations” ? These were stated in sum
mary form in item 1.
9. “ Should we lay down standards relative to the kind of assets to
be held, maturity composition, private versus public instruments?”
Yes, provided this would involve returning the Federal Reserve banks
to their proper functions. Thè Federal Reserve banks should be
bankers’ banks—rediscount institutions financing commercial, agricul
tural, and industrial activities (and fiscal agents for the U.S. Govern
ment) , but not chiefly institutions investing largely in that Govern
ment’s securities and creating deposits and money against such
securities.
The right of the U.S. Government to sell its securities directly to
the Reserve banks should be repealed, a possible exception being in
respect to so-called on-day Treasury certificates since a purchase of
these by the Reserve banks during periods of Government financing
could act as a stabilizing factor in what otherwise might be an unduly
disturbed money market.
10. “ Should the Federal Reserve supplement its portfolio of Fed
eral Government securities with other types of assets such as com
mercial loans, foreign exchange, municipal securities, corporate bonds,
mortgages, commodities?” The financing of such activities is in
general the proper functions of other types of banks—those which can
be close to their customers. The Federal Reserve banks should be
bankers’ banks, holding the reserves of member banks, acting as
rediscount banks for eligible paper, providing a clearing mechanism
for the credit items of their member and nonmember clearing banks,
and acting as fiscal agents for the U.S. Government.

S tatem en t b y B ekyl W S p r in k e l , V ice P resident and E conomist ,
H arris T rust & S avings B a n k , C hicago , I I I .
Y o u are quite correct in pointing out that “portfolio growth is a
natural consequence of the need to expand the money supply to meet
the growth needs of our economy.” As you well know, there are essen
tially two means by which the growth in the money supply can occur.
Oneis by purchase of assets, at present Government securities, by the
Federal Open Market Committee. An alternative which will accom
plish the same objective would involve reduction in required reserve

130

FEDERAL RESERVE PORTFOLIO

ratios of commercial banks. I find it very difficult to indicate how
large a portfolio the Federal Reserve should hold, but I do have a
strong conviction that the Federal Reserve should permit and en
courage moderate continuous growth in the money supply month after
month and year after year. I know of no magic figure which is just
the right amount of money, but experience would suggest that a growth
in the money supply of about 3 to 4 percent per year would be about
right. Although it might be unwise to specify an exact rate as an
objective, nonetheless, great volatility in monetary growth clearly
should be avoided.
It has been the view of many commercial bankers, including myself,
that Reserve ratios for commercial banks have been too high and that
the present method of variable ratios between country banks and
Reserve city banks leaves much to be desired. Furthermore, it is clear
that commercial banks work under a distinct handicap resulting from
the requirement that they maintain reserves in the form of noneaming
assets against time money. Our competitors have no such restriction
and it is my belief that financial institutions should be on an equal
basis with respect to their ability to compete in the marketplace for
funds. It would therefore be my view that somewhat greater reliance
should be placed on reduction in Reserve requirements as a means for
encouraging growth in the money supply and hence a lesser emphasis
upon increasing the size of the portfolio of financial assets held by the
Federal Reserve System.
I would be very much against laying down “standards relative to
the kind of assets to be held, maturity composition, private versus
public instruments.” It would seem to me that the Federal Reserve
should have the power to purchase assets other than Government
securities in the event a severe crisis made this move advisable. How
ever, I see no need at present for them to purchase assets other than
Government securities. It would seem that Federal open-market
acquisition of assets should be as neutral with respect to price effects as
possible. The usual confinement to Government securities achieves a
high degree of neutrality as contrasted to the situation where they are
encouraged to acquire varying kinds of assets.
You raised the question as to whether assets should be transferred to
the Treasury for cancellation. The real difficulty with this proposal
so far as I am concerned would be that it would tend to reduce or even
eliminate the independence of the Federal Reserve System from the
existing administration. I f there were clear evidence that the Federal
Reserve was not coordinating its activities both with the administra
tion and the desire of Congress, and if there were evidence that they
were clearly doing a poor job in administering their monetary respon
sibilities, then I would probably be inclined to favor such a proposal.
However, it appears to me that the opposite is the case. In my opinion,
monetary policy in the past 4 or 5 years has been the best ever achieved
by the Federal Reserve System. They have clearly learned from the
mistakes committed in earlier periods and they have adopted a mod
erately expansive monetary policy which has contributed greatly to
the long span of continuous economic growth without inflation. Fur
thermore, there is clear evidence that their policies have been closely
coordinated with those of the administration and with the desire of
Congress. Therefore, I would oppose any attempt to further reduce

FEDERAL RESERVE PORTFOLIO

131

their independence. It is conceivable to me that under some future
administration it will be very helpful to have a central bank with the
power to arrive at an independent evaluation of current financial
policies and that they might well make an independent contribution
to the achievement of the objective of the Full Employment Act.
S t a t e m e n t b y T h om a s I. S to r r s , E x e c u t iv e V i c e P r e s id e n t,
N o r t h C a r o lin a N a t i o n a l B a n k , G re e n sb o ro , N .C.

1. “ How large a portfolio should the Federal Reserve System hold
in relation to the money supply, the gross national product, or aggre
gate liquid assets? Is any other criterion more appropriate?
Categorical answers cannot be given to such questions. The mini
mum level depends in part upon the System’s need for earnings and in
ppxt upon the volume of trading in the various types of Government
securities that would be necessary, under all conceivable conditions,
to secure desired effects in bank reserve positions and to maintain or
derly conditions in the Nation’s financial markets. At times massive
sales of securities may be necessary, either to accommodate large
changes in market factors affecting reserves or to compensate for the
reserve effects of System trading undertaken to restore orderly condi
tions in one or more sectors of the Government securities market. Re
strictions on the size of the Federal Reserve portfolio should not be
such as to hamper the effectiveness with which the System can dis
charge its important statutory responsibilities. Standards based on
some relationship between the Federal Reserve portfolio and the
money supply, the gross national product, or total liquid assets could
prove particularly hazardous since our knowledge concerning proper
relationships among such variables is so imperfect. A far more sensi
ble criterion, it seems to me, would be the amount of securities the Sys
tem acquires in conducting the responsibilities assigned it by Congress.
Under this standard the System would not have “excess securities” in
the sense that Chairman Patman implies.
2. “I f the portfolio grows too large compared to this standard, what
should be done with the excess? Should the assets be transferred to
the Treasury for cancellation? Should the Federal Reserve continue
to hold them, draw the interest, and return the unexpended balance to
the Treasury?”
Nothing at all would be gained by transferring a portion of the
System’s Government security holdings to the Treasury even if one
judges that the System portfolio exceeds some minimum necessary for
System operations. The only two tangible effects would be two book
keeping entries: (a) A reduction in a liability (bonds and other types
of Government debt) of the Federal Reserve and (6) a decline in the
Federal Reserve’s liability for Federal Reserve notes and an equal rise
in the Treasury’s liability for the notes (if the transfer were made in
the manner described in H.R. 7601). The taxpayer would gain noth
ing at all by the cessation in interest payments on the canceled debt
since the Federal Reserve is already transferring to the Treasury all
the income it now receives except that used to cover expenses, pay
statutory dividends, and make small additions to surplus. Treasury
interest payments would decline, but its income would drop a like

132

FEDERAL RESERVE PORTFOLIO

amount. Even more important, however, a retirement of Government
debt in such a manner would provide a severe jolt to confidence in the
dollar both here and abroad. It would also be quite confusing to the
public to have the Federal Reserve responsible for some of the notes
it issues but not for others. Consequently, I see every reason for sim
ply continuing the present practice of returning the unused portion of
the System’s earnings to the Treasury.
3. “Can we design other objective standards by which to guide Fed
eral Reserve portfolio operations? Should we lay down standards
relative to the kind of assets to be held, maturity composition, private
versus public instruments?”
I would not favor specifying any sort of maturity patterns or simi
lar restrictions for the System portfolio. Monetary policy requires
that the System be left free to vary the types of its permissible security
holdings in accordance with the needs of the economy.
4. “Should the Federal Reserve supplement its portfolio of Federal
Government securities with other types of assets such as commercial
loans, foreign exchange, municipal securities, corporate bonds, mort
gages, commodities?”
I see no need for expanding the System’s authority to acquire ad
ditional types of assets for three reasons:
(a) The markets in which the System now has authority to act—
the Government security market, the foreign exchange market, and
the bankers’ acceptance market—are sufficiently inclusive to accom
modate any foreseeable volume of System open market operations.
Domestic markets other than the Government security market are
simply not broad enough to accommodate any sizable volume of open
market transactions and, consequently, could be used very little even
if the System were free to operate in additional markets.
(b) The necessity for making additional decisions as to what types
of securities to buy would complicate somewhat the task of the Open
Market Committee.
(c) Third, an increase in the proportion of private securities bought
would likely increase Government interest payments to some extent
since open market purchases of private securities exert relatively more
downward pressure on yields of private securities than upon those
on Government securities. In contrast, purchases of Government se
curities exert relatively more downward pressure on yields of Gov
ernment securities.
S ta te m e n t b y R o n a ld L. T e ig e n , A s s is t a n t P r o fe s s o r o f E c o
n om ics, U n iv e r s it y o f M ic h ig a n , A n n A r b o r , M jo h .

Statement on the Structure and Management of the Federal Reserve
System Portfolio of United States Government Securities
In the statement which follows, the factors responsible for the stabil
ity of the Federal Reserve System’s portfolio of U.S. Government
securities during the 1950’s, and its relatively rapid rise during the
1960’s, are first discussed against the background of the monetary policy
mechanism as it is presently constituted. The purpose of this review
is to show that secular growth in the portfolio is almost inevitable
under existing policy arrangements and that special conditions were

FEDERAL RESERVE PORTFOLIO

133

responsible in both periods for the portfolio behavior which was
observed. Whether or not a huge Federal Reserve portfolio of gov
ernments constitutes a meaningful economic burden is then taken up.
It is concluded that the portfolio as such does not impose a burden of
any consequence; however, a case can be made for changing the present
procedure of financing the operations of the Federal Reserve System,
and such a change might logically include a change in the size or com
position of the portfolio. The statement concludes with a discussion
of some alternative plans along these lines.
RECENT PORTFOLIO HISTORY

The growth of the Federal Reserve System’s portfolio of U.S. Governmeiit securities from $24.2 billion at the end of 1957 to its June
1965, level of $39.1 billion, compared with the stability of the port
folio at or near a value of $24 billion from 1951 through 1957, is not
surprising. It is generally agreed that monetary policy was excessive
ly tight during much of the decade of the 1950’s, whereas during the
1960’s, monetary policy has generally been as easy as the balanee-ofpayments situation would permit. Under the present monetary
policy system, the Federal Reserve buys Government securities in the
open market in order to generate claims against itself (member bank
reserves). Thus the System portfolio would be expected to grow
relatively slowly during a period of monetary restraint such as the
1950’s; on the other hand, relatively rapid portfolio growth would be
expected during a period of ease such as the 1960’s. There were addi
tional factors at work which heighten the contrast between these two
periods. Substantial reductions in member bank reserve require
ments between February 1951 and January 1958 freed reserves for the
expansion of money and credit and substituted to some extent for open
market purchases. Nonbank public currency holdings grew from
$26.3 billion at the end of 1951 to only $28.3 billion at the close of 1957,
and the gold stock was virtually unchanged during this period. In
contrast, the burden of supplying reserves to the banks fell upon open
market operations after 1957. In addition to providing the reserves
appropriate for a relatively easy monetary policy, open-market pur
chases were required to offset substantial reserve drains which would
otherwise have led to serious monetary contraction. The most impor
tant of these drains were the gold outflow, represented by a decrease
in the gold stock from a level of $22.8 billion at the end of 1957 to
$14.3 billion in June 1965, and an increase in currency in the hands of
the nonbank public of over $6 billion, from $28.3 billion in 1957 to
$35 billion in June 1965. There was also a substantial diversion of
reserves to cover the rapid growth of member bank time deposits; time
deposit required reserves increased from $2.3 to $4.5 billion over this
period even though the member bank reserve requirement on time
deposits was reduced from 5 to 4 percent late in 1962. These reserve
drains accounted for most of the growth in the System portfolio dur
ing 1957-65.
Under the present monetary policy arrangements, in which openmarket operations constitute the chief policy instrument, long-run
growth of the System portfolio is almost inevitable in a growing
economy. The only alternative methods of allowing for monetary
56-913— 66------ 10

134

FEDERAL RESERVE PORTFOLIO

expansion are through increased member bank borrowing from the
Federal Reserve, or through the lowering of reserve requirements.
As a systematic way of supplying new reserves, borrowing is counter
to Federal Reserve System philosophy (although it is important in
the monetary policy setups of other countries, notably Great Britain).
Reserves can also be made available by further reductions in reserve
requirements. Such action would not only facilitate monetary ex
pansion directly, but would retard the rate at which the System
portfolio grows for a given degree of reliance on open-market opera
tions, since the lower are reserve requirements, the greater is potential
monetary expansion for a given open-market purchase or the less
purchases are needed for a given desired expansion. However, re
serve requirement changes are generally considered to be too inflexible
to be relied upon for short-run reserve adjustments; more generally,
reserve-requirement reduction will tend to increase the Treasury’s
net interest costs (because debt will be shifted from the System port
folio, where the net cost is practically zero as will be shown below,
to the public) and increase commercial bank earnings. Also, the
larger credit expansion multiplier resulting from lower reserve reuirements introduces added instability into the financial system to
lie extent that the Federal Reserve misjudges the size of open-market
operations needed to achieve particular policy goals. Some or all
of these effects may be judged to be sufficiently undesirable to rule
out exensive reductions in reserve requirements. Even if some reduc
tions are made to facilitate long-run monetary growth, continued
reliance on open-market operations as the dominant policy instrument
for achieving both cyclical and secular goals seems advisable, implying
that, as the economy grows, the Federal Reserve System will be a net
buyer o f securities and its portfolio will continue to expand.
To summarize the above discussion, the recent growth of the System
portfolio occurred as a normal response to special circumstances which
the System was largely unable to control, based on the monetary policy
mechanism which has developed over a long period of time and which
has been fully operative since 1951. The portfolio is likely to continue
to grow secularly under the present system. I f it can be shown that a
large portfolio constitutes a serious economic burden, means should be
found not only to reduce its present size but to prevent it from growing
in the future. The question o f the nature and extent of this burden
is discussed in the following section.

IS THE SYSTEM PORTFOLIO A BURDEN?

Interest payments by the Treasury on the'huge and growing Fed
eral Reserve portfolio are viewed in some quarters as a burden im
posed on the economy by the operations of the Federal Reserve System.
These payments are the source of most System revenue, and they have
exceeded System expenses by substantial amounts for many years
(including the entire postwar period). In 1964, for example, interest
earnings were $1.32 billion while System expenses were about $200
million. While there has been no legal requirement for transfer of
the System’s excess revenue to the Treasury since 1933, when such a
requirement in the Federal Reserve Act was repealed, the System
has voluntarily repaid most of such revenue over the years as interest
on outstanding Federal Reserve notes.

FEDERAL RESERVE PORTFOLIO

135

The Federal Reserve System, as a holder in due course of Govern
ment securities, is entitled to receive interest payments on these secu
rities as such payments become due, and it is true that the Treasury
must levy taxes or borrow to meet these interest payment obligations.
Because of the repayment procedure outlined above, however, the large
System surplus—and by extension, the System’s large portfolio—
constitutes no significant burden beyond that imposed by the neces
sity to operate the Federal Reserve System itself. The net effect of
the transactions described above is that the Treasury must finally
raise only enough net new revenue to cover the operating expenses of
the System (these include the statutory dividend payments to mem
ber banks on Federal Reserve stock and, by decision of the Board of
Governors, a transfer to surplus of the amount needed to make surplus
equal to paid-in capital). In the interim between interest payments
by the Treasury to the System and the end-of-year repayment to the
Treasury by the System, however, the Treasury may find it necessary
to borrow more short-term funds than would otherwise be the case.
The System portfolio consists of a variety of issues and maturities,
so that there isprobably no systematc pattern to such short-term bor
rowing by the Treasury. To the extent that it occurs and is not offset
by other measures, the System portfolio can be said to be responsible
for some undesirable random variation in short-term interest rates
which would not otherwise be present. This appears to be the only
“burden” imposed by the present procedure of interest payments and
1 T'
J*
i 11 * ’gnificant,"although it
,
x
„ em does not present
__ AA__ ,
serious problems or constitute an excessive burden compared with
some alternative arrangement in which the Federal Reserve’s annual
interest revenue was reduced substantially. The real issue, I believe,
is deeper and is concerned with the way in which the Federal Reserve
System is organized and administered. The real cost to society is not
the total interest revenue which the System receives in any given
period, but is measured by the resources which are required to run it.
An attempt to reduce the System portfolio in a once-for-all fashion
does not come to grips with the basic question: is the present Federal
Reserve System organized and controlled in such a way that its goals
are achieved with reasonable efficiency ? This is surely not the place
to suggest or discuss radical reorganization, and it may be that the
operations of the Federal Reserve are conducted with a high degree
of efficiency. On the other hand, it is troublesome that the System
has the power to establish its own budget without formal outside con
trol, thus effectively determining (for a given portfolio) the amount
of its revenue which is returned to the Treasury, and that there is no
legal requirement that any revenue be returned. At the least, legisla
tion should be reenacted requiring that the Federal Reserve banks
repay their excess earnings to the Treasury, even if this is only a
matter of form. It would be more desirable, in my judgment, to sub
ject the System to the same budgetary procedures and restrictions
which apply to other Government agencies. Its operations would then
come under regular scrutiny in the process of determining appropri
ations, and it could simply be required by law to repay all revenues—
both from interest payments on its portfolio and from other sources—

136

FEDERAL RESERVE PORTFOLIO

to the Treasury (note that this proposal is consistent with either port
folio reduction or with retention of the present portfolio by the
System). This is not meant to imply that operation of the System
should be curtailed; in fact, it would be necessary, in the approprations
process, to assure that important System activities—including its am
bitious program of research on monetary problems—were not cur
tailed, and it is conceivable that the net result might even be a larger
budget than would be the case under the present procedure.
SOME APPROACHES TO RESTRICTING THE SYSTEM PORTFOLIO

Reforms of the type suggested above might or might not be accom
panied by structural changes in the.System portfolio; on the other
hand, it may seem desirable to reduce the portfolio without other
reforms in order to reduce the amount of short-term borrowing done
by the Treasury. It is true, after all, that while no serious problem
is raised under existing arrangements, the System does not need a
portfolio of securities as large as its present holding, either for reve
nue or for use in open market operations.1 The purpose of this sec
tion is to consider alternative ways of changing the size or composi
tion of the portfolio so as to bring it closer into line with the System’s
operating needs while at the same time reducing the short-term
finance burden on the Treasury. Three such plans will be discussed;
each is consistent either with present System organization or with
reorganization along the lines suggested previously.
1.
Cancellation of part of the portfolio against the System's lia
bility for Federal Reserve notes.—-Under H.R. 7601, on which hear
ings are now being held, $30 billion of the System portfolio would be
retired, to be offset by an equal reduction in Federal Reserve liability
for Federal Reserve notes. The advantage of the plan is that it would
achieve the goal of portfolio reduction without disturbing repercus
sions on the monetary sector directly or on public confidence. How
ever, there are several disadvantages. Even if portfolio reduction is
taken to be a desirable end in itself, this approach will not result in
a permanent reduction and portfolio stability at, say, $10 billion.
Unless the mechanical aspects of monetary policy are changed, the
portfolio will tend to grow secularly. Of course, its rate of growth
can be reduced by lowering reserve requirements as discussed above:
this would not only free reserves now but would result in greater
potential monetary expansion per dollar of open, market purchases
in the future. However, the tendency will be toward continued sec
ular growth, and further portfolio reductions may seem desirable.
Under this proposal, potential reductions are severely limited by
1 While precise quantitative estimates of the portfolio size, needed for these purposes are
difficult to make, it would probably be adequate for the System to hold $10 billion or even
less, or marketable, interest-bearing securities at present yields, assuming that reserve
requirements will remain unchanged and that monetary policy will continue to be about as
important relative to the other instruments of stabilization policy as it has been in the
past. The $200 million needed for expenses in 1964, for example, could have been earned
on a portfolio of approximately $5.25 billion, based on the rate of return of 3.82 percent
actually earned by the System on its entire portfolio in 1064. As far as open market
operations are concernedt System gross sales of securities have not exceeded $1.5 billion
in any month at least since the beginning of 1956, while annual gross sales (excluding
repurchase agreements) have not exceeded $6.7 billion, the level they attained in 1962.
Note, however, that the conclusion that $5 or $6 billion of securities will be adequate for
open market needs does not take account of the maturity distribution required for this
function. Data are from various annual reports of the Board of Governors of the Federal
Reserve System.

FEDERAL RESERVE PORTFOLIO

137

the greatly reduced stock of Federal Reserve notes which remain as
liabilities of the System. Unless such notes are issued in substantial
quantities in the future, further reductions comparable in scope to
the present proposal will be impossible. Secondly, this proposal does
not take account of the maturity distribution needed in the portfolio
for open market operations. It is important not only that the System
have enough elbow room in the aggregate, but also that there are
enough securities in its holdings in each maturity class to accom
modate potential sales. This is a consideration which must be borne
in mind in evaluating any proposed change.
2. Cancellation of part of the portfolio against the System surplus
account.—Under this proposal, the immediate goal of portfolio reduc
tion would be achieved, and further reductions could be made without
difficulty under this procedure whenever they seemed advisable. How
ever, the large negative System surplus which would result would
undoubtedly cause some concern in the public mind, even though such
concern would be without foundation. The Federal Reserve System
itself seems to feel that a substantial positive surplus is needed as a
“protective shield against risks” (51st Annual Report of the Board
of Governors of the Federal Reserve System, 1964, p. 50). These
considerations are perhaps important enough to rule out this proposal
as a practical alternative.
3. Conversion of part of the portfolio into non-interest-bearing
debt.—The true goal of the proposals discussed above is not to reduce
the System portfolio, but to reduce the gross interest payments by the
Treasury to the System. This goal could easily be achieved by the
simple device of exchanging part of the existing portfolio for a new
security issued by the Treasury. This security would be noninterest
bearing and nonmarketable. Its use would avoid the limits on future
reductions and the potential damage to public confidence which are
associated with the proposals for reduction in the size of the portfolio
which are reviewed above. There is also a degree of flexibility asso
ciated with this proposal which is not characteristic of the others.
Under it, the portfolio could be reduced to the minimum necessary to
provide for System expenses and for immediate open market needs.
Any doubts concerning the adequacy of the reconstituted portfolio for
open market purposes could be resolved simply by providing for re
conversion of some of the new, non-interest-bearing debt back into
marketable debt of any maturity desired at the request of the Federal
Reserve System (in practice, it should be noted that the tendency for
the portfolio to grow will provide a certain degree of flexibility which
would apply to all of these proposals). Furthermore, as new surplus
marketable debt is acquired by the System, it could be continuously
converted into nonmarketable debt by the Treasury without limit.
The above proposals are discussed in the context of a System port
folio composed only of securities of the U.S. Government. I believe
that this should continue to be the rule. Among other reasons, open
market operations, because of the size of the individual transactions,
require a market of exceptional depth and breadth; the U.S. Govern
ment securities market possesses these characteristics to a greater ex
tent than any market in private securities. It should be emphasized
that within the portfolio of governments, there must be adequate
quantities—or the possibility of access to adequate quantities—of se

138

FEDERAL RESERVE PORTFOLIO

curities in each maturity range in which transactions are conducted.
Drawing 011 the experience of the recent past, this would mean that
relatively large quantities of securities in the l-to-5-year maturity
range should be available, as well as securities with less than 1 year
to maturity.
S tatem en t b y G eorge T erborgh, R esearch D irector, M a ch in ery
& A l l i e d P r o d u c ts I n s t it u t e , W a s h in g to n , D.C.

Let me say first of all that I have read the attachment to the chair
man’s letter, consisting of a colloquy with William McChesney Martin
of the Federal Reserve Board. As to this, I must confess myself
baffled by Mr. Patman’s position, that in paying interest on Govern
ment obligations held by the Federal Reserve Board the Treasury is
somehow “paying on its debts more than once.” I f the payment of
interest on obligations is “paying debts more than once,” this is some
thing all debtors do, whether public or private, and is in no way unique.
I do not presume to take a position here on the proper level of
member bank reserve requirements, which apparently is not at issue.
I should like to insist, however, that whatever the liabilities of the
Federal Reserve System may be, they should be covered by equivalent
assets. As to what these assets should be, this is a matter of cir
cumstance and convenience, but in view of the enormous dimensions
of the market for Government obligations* I see no reason why the
System should be required to go beyond this category. It is tech
nically adequate for the purpose of credit control. Moreover, I see
no point in congressional prescriptions requiring portfolio diversifi
cation by the inclusion of other types of obligations. The whole
matter should be left to the discretion of the Board.
In view of the fact that excess earnings of the Federal Reserve
System are recaptured by the Treasury anyway, it seems to me absurd
to gag over the fact that the Treasury pays interest on the Reserve
portfolio. In short, I conceive the issue raised here, if I correctly
understand it, to be a false one.

S tatem en t b y R o llin G . T hom as , H erm an C. K rannert G raduate
S chool of I ndustrial A dm inistration , P urdue U niversity ,
L afayette , I nd .

As I interpret the inquiry, the questions raised fall into two cate
gories : First, is the total portfolio of the Federal Reserve banks ex
cessively large in relation to the total money supply and the gross
national product? Second, should the portfolio be comprised of
money market assets other than U.S. Government securities?
The first question seems to involve the inference that the present
portfolio of $39 billion is excessive. This question can only be an
swered in the light of the origins of the portfolio and the underlying
reasons for its existence:
1. Given legal reserve requirements against member bank deposits,
comprised of vault cash plus deposits in the Federal Reserve banks,
and any additional cash which member banks may wish to carry as

FEDERAL RESERVE PORTFOLIO

139

excess reserves, it is necessary that the reserve funds available to
banks be maintained and, over time, be increased sufficiently to per
mit the increase in the money supply needed to accommodate the
growth of the GNP.
2. Because gold exports and increases in money circulation outside
of banks reduce bank reserves by equal amounts, such reductions must
be restored or replaced if a deflationary money and credit shortage
is to be avoided. Between December 1955 and July 1965, our gold
stock declined by $7.7 billion, and during the same period the domestic
requirements for money in circulation outside of oanks rose by $5.1
billion. Altogether these developments reduced member bank re
serves by $12.8 billion. At the same time member banks required
reserves increased by $2.9 billion. Therefore, pressures on member
bank reserve positions rose by the total amount of $15.7 billion. This
was met mainly by an increase in the Federal Reserve holdings of
U.S. Government securities of over $14.5 billion and by some modest
reductions in member bank reserve requirements.
3. As is well recognized, the Federal Reserve bank purchase of U.S.
securities in the open market results in an equivalent increase in
member bank reserves. Bond sellers receive drafts (or cashiers’
checks) on the Federal Reserve bank and deposit them in their com
mercial bank accounts. These checks are sent in by member banks to
the Federal Reserve bank for deposit in members’ reserve accounts.
4. Thus, in the ordinary course of business the Federal Reserve
banks are able to replenish or increase member bank reserves by pur
chasing securities in the open market or, alternatively, by lending to
(or discounting for) member banks. The purchase of securities is
generally preferred to lending to member banks inasmuch as the
latter process involves the distasteful (to banks) process of going
into debt to obtain necessary reserve funds. Any large scale depend
ence upon member bank borrowing as the method of obtaining reserves
discourages the rise in bank credit and tends to be deflationary.
5. The Federal Reserve banks’ portfolio, therefore, arise directly
out of the process of increasing the reserves available to member banks
as their needs increase. Because bank reserves, as well as paper cur
rency in circulation, are mainly in the form of deposits in the Federal
Reserve banks and Federal Reserve notes, both liabilities of the banks,
they must be matched by equivalent assets, following: ordinary busi
ness practices. These assets are gold certificates ana Treasury cur
rency holdings, plus the Federal Reserve portfolio of U.S. securities
and loans to member banks. To meet member bank needs for in
creased reserve funds the Federal Reserve banks must either pur
chase securities or make loans to member banks; i.e., their portfolios
must increase.
To be sure, there is an alternative way to provide relief for reserve
shortages of member banks. The percentage reserve requirement
against bank deposits may be reduced. Such an action would of
course be a cause for rejoicing among bankers, but is beside the point
in the current discussion.
6. It is difficult to visualize any objective test of an excessively large
asset portfolio for the Federal Reserve banks. Because both bank
reserves and money in daily circulation are mainly in the form of Fed
eral Reserve bank liabilities such liabilities seem destined to expand
more or less continuously as our economy grows.

140

FEDERAL RESERVE PORTFOLIO

Therefore, the portfolio under consideration will continue to grow
just as the portfolios of commercial banks must grow to provide the
necessary increase in money and credit. Therefore, it seems that the
central banks’ (Federal Reserve banks) portfolio will continue to
grow during the foreseeable future. The suggestion is raised that
part of the Federal Reserve bank security portfolio might be trans
ferred to the Treasury for cancellation. Presumably this suggestion
is made as an alternative to the present practice of returning excess
earnings (after expenses) to the Treasury. The primary objection
to the gift of the U.S. security holdings to the Treasury by the Federal
Reserve banks is that technically this would make the Federal Reserve
banks bankrupt. That is, their liabilities would no longer be matched
by equivalent assets. In one sense of the word this might be unimpor
tant if concealed from the general public but it would involve a fiat
form of central bank liabilities, the foundation of the whole currency
and banking system, having less than 100 percent asset backing. Fur
thermore, it would certainly complicate the bookkeeping operation of
the Federal Reserve banks and involve the necessity of inventing some
fictitious asset to replace the securities transferred to the Treasury.
Perhaps a better plan might involve the exchange of part of the U.S.
interest bearing securities for noninterest bearing obligations of the
Treasury.
7, Finally, as to the makeup of the Federal Reserve portfolio, there
seems no reason to dictate that any given proportions of particular
types of loans or securities be maintained. It is important that the
Federal Reserve banks be permitted freely to discount paper for mem
ber banks. Some proposals would extend the privilege of discounting
at or borrowing from Federal Reserve banks to nonmember banks.
This might fairly and beneficially be adopted, especially if member
bank reserve requirements were applied to nonmembers. Further
more, the rules of eligibility of assets upon which member bank may
borrow at the Federal Reserve might well be broadened to escape some
of the rigidities of the old “self-liquidating commercial paper rules”
still remaining in the discount regulations. However, the question
raised seems to imply that the Federal Reserve banks be permitted or
even required to include some given proportion of private credit paper
(corporate bonds, commercial loans, municipal securities, mortgages).
Such a suggestion is difficult to understand unless it is the purpose that
the Federal Reserve banks should be given the task of encouraging
specific segments of the economy by purchasing credit paper arising
therefrom. You will recall that during the depression of the 1930’s
the Federal Reserve banks were permitted to make direct loans to busi
ness and industry to aid in the rehabilitation of business working
capital depleted by the depression. This emergency provision, now
expired, was invoked at a time when the private banks and the other
sources of loan funds were unable or unwilling to assume normal
credit business risks. This is certainly no longer true. Furthermore,
the central banks’ (the Federal Reserve) basic functions of providing
currency and needed bank reserves for the growing economy are in
compatible with the credit analysis and lending to local borrowers on
the local level.
There is another aspect of the questions posed by your committee
which deserves attention. House bill 7601 proposes to retire $30 mil

FEDERAL RESERVE PORTFOLIO

141

lion of interest-bearing U.S. obligations out of the Federal Reserve
banks’ portfolio. The ostensible reason given for this proposal is that
“no one should be compelled to pay his debts more than once.” It is
charged that opponents of this proposal “would compel the Govern
ment to pay its debts more than once.” It “would compel the Gov
ernment to continue to pay interest on bonds that have already been
paid for.” But it should be entirely clear that the U.S. Treasury,
when it first issued these obligations, obtained funds from the money
market and spent them for governmental purposes. In other words,
savers and investors and financial institutions that purchased these
obligations at the time of their issue surrendered monetary funds in a
way exactly as they do when making loans to private borrowers.
When the Federal Reserve banks purchased these U.S. obligations
from previous holders for the purpose of increasing the money supply,
Federal Reserve funds (deposits and notes) were given in exchange.
It is absurd to say that this process, in any way, constituted a repay
ment by the U.S. Government. The taxpayers have not been Iburdened by the transaction and will not be until taxed to retire the obli
gations. To be sure taxes are collected to pay the interest on the debt,
including that part held by the Federal Reserve banks, but that is a
separate question.
Behind the proposals of H.R. 7601 there appears to be another
motive not directly revealed in the questions submitted. This motive
is to abolish the independent responsibility of the Federal Reserve
System to provide suitable amounts of bank reserves and currency
needed for the proper functioning of the money and banking system.
The skill of the managers of the System has sometimes been less than
perfect. This, I think, will be readily admitted. But because one of
the avowed policies of the System has been to avoid excessive and in
flationary increases in money and credit and the minimizing of eco
nomic instability, it has been and is being attacked as being excessively
cautious, to the detriment of business and economic growth. There
fore, some opponents of independent central bank control over money
and credit would strip the Federal Reserve of its present prerogative
of paying its operating expenses out of operating income, mainly in
the form of interest on U.S. obligations held in its portfolio, by re
quiring such income to be paid to the Treasury (or as here proposed,
extinguished by canceling the major part of such securities). This
would compel the Federal Reserve System to obtain annual budgeted
funds of operating expenses through congressional approval. Such
a situation would be intended to transfer monetary and credit policy
decisions out of the hands of the Federal Reserve authority into the
hands of congressional committees. For, should the committee con
clude that the Federal Reserve policy of the preceding period was
too tight or too easy, it could bring the Federal Reserve to heel by
withholding operating funds. Such a situation would, to my mind,
create an intolerable barrier to the establishment of effective monetary
policy. There is no good reason for doubting the good faith of the
Federal Reserve authorities. (The accusation that any tightness of
the money supply to impose restraint on inflation is really designed to
enrich private bankers scarcely deserves notice.) Monetary policy, as
everyone knows, is complex and difficult and is constantly being
studied by the Federal Reserve and by academic scholars. That it

FEDERAL RESERVE PORTFOLIO

142

should become a matter of determination by a congressional committee
seems unthinkable.
Finally the argument that the holding of $35 billion of U.S. securi
ties in the Federal Reserve portfolio constitutes an unfair burden on
the U.S. taxpayers is difficult to substantiate. There would be no such
accusation made so long as the securities are held by private institu
tions and individuals. But, as is well known, the Federal Reserve
banks transfer the bulk of their earnings after operating expenses
to the U.S. Treasury, in the form of interest on Federal Reserve notes,
so that the combined surplus accounts of the Federal Reserve banks
shall not exceed their paid-in capital. For example, the earnings on
portfolio holdings of U.S. Government securities and the amounts
transferred to the U.S. Treasury during the last 3 years were:
Earnings on U.S. securities:
196 2
196 3
196 4

Millions

$1,039.2
1,138.2
1, 323.7

Transferred to the U.S.
Treasury:
196 2
196 3
196 4

Millions

$799.3
879.6
1,582.1

S t a tem en t b y R ichard E . T ow ey , A ssistant P rofessor of
E conomics , O regon S tate U n iversity , C orvallis , O reg.

In my opinion, there is no cause for alarm merely because the Treasury security holdings of the Federal Reserve System have become much
larger in absolute terms. As Congressman Patman’s letter recognizes,
all of the Federal Reserve’s income after necessary expenses reverts to
the Treasury. Any suggestion that the Federal Reserve might abuse its
functions by reason of the size of its income does not merit consideration.
It is possible that savings in handling, bookkeeping, etc., could be
effected by the conversion of a sizable part of the System’s portfolio
into a non-interest-bearing Treasury security. The amount to be con
verted should be entirely at the discretion of the Federal Reserve, how
ever, and it should have the right of reconverting at par or other ac
ceptable terms into interest-tearing securities of any outstanding
maturity it specifies at any time. The amount retained in interestbearing securities should be enough to provide sufficient income for
Federal Reserve functions and to conduct open-market operations effi
ciently. The Federal Reserve should also be permitted to err moder
ately on the “ safe” side by overestimating its needs for interest-bearing
securities without question from the Congress as long as the policy of
repaying the balance after expenses to the Treasury is continued.
This plan is offered solely in the interest of efficiency in administer
ing the portfolio; it definitely should not be used as a device to control
the amount of Federal Reserve expenses, particularly those associated
with the implementation of monetary and credit policy. Of necessity
the Federal Reserve must often conduct open-market trading at the
“ wrong” time as far as income is concerned: It is a buyer when prices
are relatively high and a seller when they are relatively low. It has
not experienced a net annual loss on security sales in recent years, but
this may become necessary in the future since presumably the “bills
only” doctrine has been abandoned. The System should not be de-

FEDERAL RESERVE PORTFOLIO

143

terred from taking losses on security sales which are in the interest of
sound monetary policy.
The Federal Reserve should also explore the feasibility of conducting open-market operations with instruments other than Treasury se
curities and bank acceptances. The most likely candidates would ap
pear to be high-grade corporate and municipal bonds and Governmentbacked mortgages. The impact of credit policy on the financial
markets would be speeded up as a result and this would be in keeping
with the departure from “bills only.”

S t a te m e n t b y E dw ard R. T r u b a c, D e p a r tm e n t op F in a n c e a n d
B u sin ess E con om ics, C o lle g e o f B u sin ess A d m in is tr a tio n , U n i
v e r s ity o f N o tr e D am e, N o tr e D am e, In d .

My comments will pertain to only two of the items of concern to the
Joint Economic Committee: the optimum level of Government security
holdings by the Federal Reserve and the desired mix of short- and
long-term securities held in the Fed’s portfolio.
With respect to the initial point, my position is simply that the
Fed should hold as many securities as it needs to pursue an effective
monetary policy. It has been suggested that other criteria should be
applied in determining the long-term level of security holdings; for
example, the notion that the Fed’s security holdings should rise pro
portionately to increments in economic activity. The merit of this
proposal, however, is closely tied to the validity of three propositions:
(1) A secular rise in income should be accompanied by a pro
portionate increase in the money supply.
(2) An increase in the money supply should be generated by
Federal Reserve purchases of Government securities instead of
lowering reserve requirements.
(3) Security holdings of the Fed should not be retired by re
deeming them with the Treasury.
The validity of each proposition can be disputed.
Regarding the first point, I feel that economic growth can be
sustained by a less-than-proportionate increase in the money supply
since investment is relatively insensitive to the narrow range over
which interest rates have fluctuated during the last decade. Rela
tively small gains in interest rates reflect the response of firms to an
improved economic outlook. A large part of the corporate demand
for money balances stems from a desire for protection against the
variance of the difference between cash inflows and cash outflows.
During a business advance this variance probably declines because of
the reduced uncertainty about when customers and debtors will make
payments. This decline in uncertainty, therefore, results in a reduced
demand for money which, in turn, is reflected in a lower level of in
terest rates than would otherwise occur.
The second proposition primarily revolves around the issue of
whether bank earnings or Treasury interest costs should be given
greater weight in arranging for a secular growth in the money supply;
the method chosen would have a significant impact on both variables.
Recent empirical studies indicate that bank profits have compared
favorably with those attained by other industries in the last few years,

FEDERAL RESERVE PORTFOLIO

144

although the recent advance in bank profits has been purchased at the
expense of a declining ratio of capital accounts to risk assets. While
this increase in risk exposure suggests that some reductions in reserve
requirements could be justified, I would prefer that the bulk of the
money supply be generated by open-market purchases.
Turning to the third pointy I see no reason why all of the Fed’s
Government security holdings in excess of the minimum amount needed
for an effective monetary policy could not be canceled by redeeming
them with the Treasury; this policy, of course, would not be incon
sistent with continued security purchases by the Fed. The result
would be a smaller public debt (as it is currently measured), thereby
easing some of the problems associated with debt limit extensions.
It was noted above that, apart from considerations of short-term
monetary policy, Treasury interest costs are an important variable
affecting the size of Federal Reserve security purchases. To some
extent, Treasury interest costs should also influence the maturity
preference of these purchases, since long-term securities usually carry
a higher rate and their acquisition, therefore, by the Federal Reserve
would result in greater interest cost savings. But recent discussions
concerning the Fed’s role in promoting economic growth have instead
focused on the impact of its maturity preference on the structure of
interest rates.
I personally would favor a continuation of the bills-only policy,
for although short- and long-term securities are not perfect substitutes
they are sufficiently close substitutes for a large group of investors so
that changes in relative supplies will have little effect on the structure
of rates. Empirical studies suggest, for example, that the effect on
long-term rates will be approximately the same, regardless of whether
the Fed buys $10 million in bonds or $10 million in bills. Since there
is little difference in rate impact, my preference for the bills-only
policy stems from the fact that bond dealers would be reluctant to take
a position in Government bonds if the Fed was directly involved in
the long-term market because of the sharp fluctuations that would
occur in bond prices.
S t a t e m e n t b y G e o r g e J . V i k s n i n s ,1 A s s i s t a n t P r o fesso r o f
E c o n o m i c s , G e o r g e t o w n U n i v e r s i t y , W a s h i n g t o n , D.C.

I am honored by Congressman Patman’s invitation to comment on
the problems raised by the growth in the Federal Reserve System’s
portfolio of U. S. Government securities.
I have tried to follow your suggestions regarding brevity and hope
that the enclosed comments will be useful.
the

s i z e 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 ’ s p o r t f o l io o f g o v e r n m e n t
s e c u r it ie s

On June 30, 1965, the Federal Reserve System owned $39.1 bil
lion in U.S. Government securities—$38.9 billion having been bought
outright and the remainder being held under repurchase agreements.
Total System assets as of that date were $60.5 billion, with $13.7 billion
i At the time of this writing, the author is a consultant to the House Republican confer
ence. The views expressed in this statement are not necessarily those of the conference.

FEDERAL RESERVE PORTFOLIO

145

in total gold certificate reserves being the other major asset category.
On the other side of the balance sheet, of course, the principal liabili
ties were Federal Reserve notes of $34.9 billion and member bank
reserves of $18.2 billion.
My purpose in recounting these familiar statistics is simple—under
present law, a “floor” exists under the total portfolio of U.S. Govern
ment securities which must be held by the Federal Reserve System.
Since there must be a 25-percent gold certificate “backing” for Federal
Reserve notes, $8,725 billion of gold certificates is required for this
purpose. The rest of System asset holdings can be used as a backing
for the remaining 75 percent of the value of the notes. Of course,
“ Governments” are the major type of asset and, therefore, at present
$21.2 billion in Governments is the legal minimum. The economic
minimum is more difficult to establish, as is discussed below, but it is
likely to be $5 to $10 billion above the legal minimum. Of course, this
legal requirement might be changed, if the problems associated with
System ownership of this amount of Government securities exceed the
benefits to be gamed from maintaining this 25 percent relationship.
These benefits are exceedingly difficult to define, let alone measure, but
they have something to do with domestic and international “ faith in
the dollar.”
Since the March 1965 change in gold reserve requirements, member
bank deposit liabilities can be backed 100 percent by Governments.
The size of these deposit liabilities is linked, of course, to the existing
level of commercial bank reserve requirements, which vary from 16%
percent for demand deposits (checking accounts) in “Reserve city”
banks and 12 percent for demand deposits in “country” banks to 4
percent for time deposits in both bank classifications. These require
ments have been decreasing in the postwar period—the maximum re
quirements of 26 percent for demand deposits in central Reserve city
banks (this classification was eliminated as of July 28,1962); 22 per
cent for Reserve city and 16 percent for country bank demand deposits
as well as 7% percent for time deposits (the latter two figures exceed
ing—for a temporary period—the maximums established by the
Banking Act of 1935) were in force at the end of 1948. These values
have been decreased in reasonably orderly steps since that year—how
ever, the last decrease took p]ace in 1960.
The Federal Reserve Act, as amended in 1935, provides minimum
reserve requirements of 10, 7, and 3 percent for the three classes of
deposits. (The first two are demand and the last a time deposit).
These levels could easily be reached in an orderly fashion by a simul
taneous decrease in reserve requirements and System sales of U.S.
Government securities, if it is our judgment that the size of the present
portfolio of Governments is too large. Furthermore, let me express
the heretical opinion that even the minimums mentioned above are
rather useless vestiges of the era of “wildcat banks.” It is quite true
that reaching the legal minimums would eliminate a part of the Fed’s
“kit of policy tools”—downward revision of reserve requirements as a
policy of easing credit would no longer be feasible. Nevertheless,
there seems to be general agreement that reserve requirement varia
tions are a crude, “meat-axe” sort of monetary policy, and open-market
purchases of Governments—no longer linked to a gold cover on mem
ber bank reserves—can be every bit as large as necessary. Since this

146

FEDERAL RESERVE PORTFOLIO

problem is completely trivial, the decrease in reserve requirements
seems a simple and desirable answer to the committee’s question—in
fact, it is particularly attractive, due to the opinion, held by many of
our colleagues, that the member commercial bank has been overregu
lated. The reserves required of all other financial intermediaries are
usually much smaller and, furthermore, as an example, the Federal
Home Loan Bank Board even pays interest to its member depositors
(in addition to other subsidies).
However, the basic question still remains—what is wrong or un
desirable about the Fed’s portfolio of Governments? Congressman
Patman quite correctly points out its considerable postwar increase—
it has risen by slightly more than 6 percent per year in the past 10-year
period, faster than either the money supply or GNR There are two
factors mainly responsible for this rate of growth—the need for a
larger money supply to finance our expanding economy, including
increases in both Federal Reserve notes and member bank deposits,
and the decrease in gold certificate reserves, which the Fed needed to
neutralize. In this latter connection, if the administration’s program
of “voluntary coercion” has been successful in eliminating our balanceof-payments deficit, this source of Fed-held Governments’ portfolio
further increase would be eliminated.
Yet, of course, expanded money supply needs will continue to lead
to further increases in the value of U.S. Government securities held
by the Federal Reserve System. Thus, the committee raises a very
interesting question—should the Fed’s portfolio be permitted to in
crease without limit? In general, we might consider this in light of
some simple cost-benefit analysis. The cost of this portfolio involves
basically two factors—first, commercial banks hold required reserves,
which are a form of interest-free Government debt and, thus; to an
extent subsidize this debt. As I have argued above, this cost might be
minimized by a reduction in reserve requirements. The second ele
ment involves the “ double-payment” idea so often mentioned by Con
gressman Patman—the Fed, which is part of the Government (at least
philosophically) pays for these securities once by creating either Fed
eral Reserve notes or member bank reserves (the latter, for all prac
tical purposes) and then the Treasury pays interest on the Govern
ments to the Fed. The question at issue is what happens to these
interest payments—if the Fed provides free services to the banking
system or spends lavishly, an objection can be raised to the size of
the portfolio. Otherwise, of course, it is only a bookkeeping trans
action in which the Government borrows from itself.
In reference to the latter question, the answer can be given only by
an accountant or an auditor—however, having been in the employ of
the Board of Governors for three summers, I would be willing to offer
a lay opinion that the Fed is inherently incapable of lavishness. Or,
it is difficult for me to believe that System expenditures are meaning
fully out of line with those made by comparable Government agen
cies, private banks, foundations, universities, or business firms. Bank
ing services are indeed provided by the System “ free” of explicit
charges. Nonetheless, one can easily argue that such services are
but a partial repayment for the interest earnings forgone on a large
volume of required reserves, and, furthermore, the provision of such
services permits commercial banks to remit at par and clear checks

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147

quickly and efficiently—thus, satisfying the goal of the Federal Re
serve Act of furnishing an elastic supply of the medium of exchange.
In general, the charge that the Federal Reserve System subsidizes
banks out of earnings on its portfolio of Governments is a relatively
unimportant one—particularly since the subsidy has the elements of
a payment in kind due to the high level of reserve requirements.2
The benefits associated with the Fed’s portfolio are basically those
of monetary policy flexibility, but it is, of course, highly unlikely that
any significant proportion of the present $40 billion would have to be
sold for monetary management purposes. The main benefit is prob
ably that of holding basically an interest-free form of public debt in
this form. The Fed normally earns slightly more than a billion dol
lars and pays to the Treasury about $900 million as “interest on Fed
eral Reserve notes.” My main objection to this procedure cannot
really be fitted into the cost-benefit approach: it is that continued Fed
eral Reserve System purchases of virtually unlimited quantities of
Governments understate the cost of our large and rising national debt.
This is done by lowering the total interest cost of any given volume of
borrowing by credit creation (and continually assured reextension).
My proposal, therefore, for this problem area is quite simple: the
Fed should be limited to a maximum percentage of the total public
debt or a maximum amount, to be established by the Congress. Prac
tically speaking, the rate of increase in the System’s portfolio of Gov
ernments could, of course, be linked to the rate of increase in GNP,
national income, or any convenient macroeconomic magnitude. How
ever, in my opinion, the basic undesirable feature is the relationship of
the size of this portfolio to the public debt and, therefore, if a ceiling
is to be established, it would be preferable to link the portfolio to the
size of the total debt. This would limit infinite monetization of the
debt, which is certainly possible under present law. Twenty percent
of the total marketable debt or $50 billion, whichever is reached
sooner, might be such a ceiling—although no particular “scientific”
limit can be said to exist. After this ceiling is reached, further ex
pansion in the money supply should take the form of either regular
decreases in member bank reserve requirements or possible acquisi
tions of other credit instruments (meanwhile established as desirable
social investments), such as foreign exchange of underdeveloped na
tions, mortgages on public housing, and the like.
In closing, I would not consider this a “burning issue” of national
economic policy at the present. The Board of Governors and the
FOMC have traditionally been dominated by cautious and prudent
men—as a partial offset, perhaps, to the built-in inflationary bias of
politicians. Thus, it is likely that the debt will be monetized and held
m this interest-free form only with considerable reluctance on the part
of the Fed. Yet, times change and so do men—we may well see an
end to the “leaning against the wind” philosophy at 21st Street and
Constitution Avenue and the purchase of an outboard motor.
2 We might also mention in this connection that this is by no means the only subsidy
granted to business in general or financial institutions in particular. The subsidy granted
to savings and loan associations is considerably more favorable than that given commercial
banks— the Federal Home Loan Bank System makes long-term advances to member asso
ciations at rates often below those needed to raise funds through the market and pays
interest on reserves that the associations have on deposit.

148

FEDERAL RESERVE PORTFOLIO

S ta te m e n t b y J e r r y V o o r h is , P r e s id e n t a n d E x e c u t iv e D ir e c t o r ,
T h e C o o p e ra tiv e L ea g u e o f t h e USA, C h ic a g o , III.

I agree entirely with the point which you have been so effectively
making to the effect that under the present scheme of things the people
of the United States through their Government are actually called
upon to retire the Government securities held in the portfolio of the
Federal Reserve System twice over. For the Federal Reserve System
creates the money using the national credit for this purpose when it
purchases Government bonds in open market operations. At this
point those bonds should properly be retired with no further obliga
tion on the people or the Government. But this is not the case.
Instead, those bonds continue to draw interest, and even the principal
must ultimately be paid off a second time out of taxes.
My own suggestion would be that if it is deemed necessary for the
Federal Reserve System to hold Government securities as backing for
Federal Reserve notes, then at the very least whenever it does so, those
bonds which the System has purchased with newly created money
should be replaced by non-interest-bearing securities of the Govern
ment bearing no due date. This would relieve the taxpayers of the
necessity of continuing to pay interest on such securities and would
give them, as they should have, the benefit from the use of the moneycreating power by the Federal Reserve System.
Another way of getting at the same end would be the one suggested
in the fourth paragraph of your letter; namely, to let the Federal Re
serve continue to hold the bonds and draw the interest but to return
all the unexpended balance from the interest to the Treasury of the
United States.
In my judgment, a still better way of dealing with the matter would
be to carry out your own proposed program for making the Fed
eral Reserve System a true agency of our Government so that any
interest paid to the Federal Reserve System on Government securities
held by it would automatically be the property of the people as a whole
and net income to the Treasury of the United States.
I do not feel myself competent to judge how large a portfolio the
Federal Reserve ¡System should hold in relation to the money supply,
but if this could be determined with fair accuracy, then still another
alternative to solve the problem which you so properly pose might be
to say that any Government securities purchased over and beyond the
necessary amount fixed by Congress tor the portfolio should upon
purchase be transferred to the Treasury for cancellation.

S tatem en t

b y H e n r y C. W a l l ic h , P rofessor of E conomics ,
Y ale U n ive rsity , N ew H aven , C o n n .

My response can best be given under three headings: (1) How often
is the portfolio paid for? (2) How large should it be? and (3) Of
what securities should it consist?
(1)
I believe that it is correct to say that the portfolio is paid for
by the Government only once. This is true whether we regard the
Federal Reserve as a part of the Government, or treat it as a separate
entity. In the former case, the securities are paid for when the Fed-

FEDERAL RESERVE PORTFOLIO

149

eral Reserve buys them. The second payment, by the Treasury to the
Federal Reserve, is washed out by the receipt of these funds by the
Federal Reserve from the Treasury. This is simply an intra-Government transaction. In the latter case, treating the Federal Reserve
separately from the Government, the securities are paid for when the
Treasury pays the Federal Reserve.
The appearance of a double payment could arise if the Federal
Reserve is regarded as part of the Government when it makes the
purchase, and as a separate entity when the bond matures and is paid
off by the Treasury. Of course, it is necessary to be consistent in the
treatment of the Federal Reserve with respect to both purchases.
(2) Since the Federal Reserve channels back to the Treasury a
large part of its interest receipts, I see no loss to the Government from
the maintenance of a large Federal Reserve portfolio. There is, on
the other hand, an advantage for the public in knowing that Federal
Reserve liabilities are backed by assets that have a value in the market
place. If part, of the portfolio were removed from the Federal Re
serve, the Federal Reserve would have to receive some generalized
claim on the Government to make its books balance. Insofar as this
had any effect, it probably would be one of reducing confidence in our
monetary arrangements. The alternative course, to allow the Fed
eral Reserve to show liabilities greatly in excess of assets, strikes me as
even less desirable.
Cancellation of some part of the pubic debt, even though held by
the Federal Reserve, might in itself raise serious questions. It would
open the doors to public spending through pure money creation. It
might also raise fears in the minds of savings bond holders and other
less sophisticated investors that their securities might be canceled.
I conclude that the Federal Reserve portfolio should be lange
enough to cover its liabilities and capital accounts to the extent that
they are not covered by gold certificates and miscellaneous assets.
(3) I believe that in normal times we are wise in limiting the
Federal Reserve portfolio to Government obligations and short-term
loans to member banks and the money market. In times of emer
gency, the centml bank should be free to lend on any assets its chooses,
and perhaps to acquire directly a wider range of assets than normally.
These might well comprise corporate and municipal bonds.
To allow the central bank to acquire mortgages, commodities, com
mercial loans, and perhaps common stocks outright strikes me as un
desirable even in an emergency. I f the circumstances require it, some
intermediary can always be employed that would be financed by the
central bank and would shield it against the adverse possibilities of
direct ownership. The same applies with greater force in normal
times. The outright purchase of any asset is a form of subsidy. If
the Government decides to extend subsidies, it should keep that act
as separate as it can from money creation. Otherwise there is danger
that the volume of money will be determined by the amount of sub
sidies to be given.
Purchase of Government obligations by central bank also is a form
of subsidy. However, given the large size of the public debt, its
homogeneity, and the fact that creation of public debt is not greatly
affected by its interest cost, I see no serious disadvantage.
56- 913-

66-

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FEDERAL RESERVE PORTFOLIO

150

S ta te m e n t b y C l a r k W a r b u r to n , M c L e a n , V a .

Total assets of the Federal Reserve banks, as implied in your letter,
should grow at a rate relevant to the expansion of the money supply
needed as an accompaniment of the growth of the economy. In view
of the complexity of the forces which influence the quantity of money
needed for this purpose and the amount of Federal Reserve bank
assets needed in connection with that quantity of money, no general
rule, I think, can be given the Federal Reserve banks with respect to
their aggregate assets, either in relation to the money supply, gross
national product, aggregate liquid assets, or any other statistical mag
nitude in the economy. However, it would be desirable to replace the
criteria for Federal Reserve operations in the Federal Reserve Act
(including whatever modification of them may be implied from the
Employment Act of 1916) by a more specific directive to the Federal
Reserve authorities to orient their operations on the objective of sup
plying the economy with the quantity of money consonant with its
growth needs and maintenance of reasonable stability in the level of
prices.
Formal cancellation of a portion of the U.S. Government obliga
tions held by the Federal Reserve banks would not really change the
essential character of Federal Reserve bank assets nor reduce the obli
gations of the Treasury associated with the operations of the Federal
Reserve System. Liabilities of the Federal Reserve banks, such as
member bank reserve balances, not matched by other types of assets,
would be obligations of the Government- -simitar to the situation with
respect to Federal Reserve notes, which have always been obligations
of the Treasury (as well as obligations of the Federal Reserve banks)
and with respect to U.S. notes (“greenbacks” ) held by Federal Re
serve banks or their member banks and now counted in their legal
reserves.
A change in the form of Government obligations held by Federal
Reserve banks would not, so fa,r as I can see, have any appreciable
effect on the income of the U.S. Government or on the net interest
paid by the Federal Government—so long as the earnings of Federal
Reserve banks in excess of their expenses and appropriate additions
to surplus are returned to the Treasury. On this point, it seems to
me the Federal Reserve Act might well be amended to restore its
original provision regarding disposition of the earnings of the Federal
Reserve banks after specified additions to surplus.
In regard to replacement of the Federal Government securities in
the asset portfolio of the Federal Reserve banks by other types of as
sets, such as those mentioned in your letter, I see no reason for making
any substantial change in the present arrangements. However, some
of the suggestions that have been made for alterations in the conditions
attached to rediscounting by member or nonmember banks might well
be accepted.

FEDERAL RESERVE PORTFOLIO

151

S t a t e m e n t b y R i c h a r d W a r d , A s s i s t a n t P r o fesso r o f F i n a n c e ,
U n i v e r s i t y o f S o u t h e r n C a l i f o r n i a , L os A n g e l e s , C a l i f .
THE PUBLIC DEBT AND THE CENTRAL BANK

A central bank is not at all necessary for the functioning of the
monetary system as it exists today. The Government could do di
rectly what it now does through the Federal Reserve, which functions
chiefly as a means of separating monetary policy decisions from the
executive branch of Government. Abolishing the central bank would
introduce no fundamental change in the technical process of the main
tenance of the monetary system.
The intragovemmental nature of central bank transactions is of
fundamental importance in assessing the role of the central bank port
folio, and it thereby merits elaboration. I illustrate with a simple
description of the monetary process as it would appear without the
central bank. In this system, as today, the Government has two means
of financing a Federal budget deficit: The issuance of interest-bearing
obligations or the creat ion of money; i.e., the issuance of non-interestbearing obligations. Its guide for deciding between the two is the
general state of the economy and the public’s need for liquid assets.
Money provides the most liquidity, and at the other end of the spec
trum long-term Government securities are the least liquid of the Gov
ernment’s liabilities. When it creates money, the Government pays
for goods and services by checks, which when deposited in banks are
claims on the Government which serve as legal reserves. Under the
fractional reserve system the banks can expand the money stock by a
multiple of reserves, so that only a portion of total money creation
finances Government debt. In addition to deposit claims the Govern
ment also creates currency claims. To the extent that the public draws
currency, the Government merely substitutes one type of liability for
the other.
In the opposite case of a budget surplus the Government initially
receives deposits from the public in the form of taxes. These deposits
then extinguish bank reserve deposits, but if this result is not desired,
the Government may buy up an equivalent amount of its own secu
rities, thus returning the reserve money to the public and the banking
system. I f the Federal budget is in balance, there is no tendency for
Government monetary or nonmonetary liabilities to change. The
Government can instigate change if it desires by buying its securities
with monetary liabilities, thus increasing the public’s holding of
money and decreasing its holdings of Government securities. This is
not the procedure used today, but this is the effect of what is done now
through the Federal Reserve.
The fact that we have set up a central bank which “holds” Govern
ment securities as an intermediary in the monetary process does not
change this sketch of the fundamentals of the monetary process. If
we chose at some time to do away with this intermediary, the currency
and deposit liabilities of the Federal Reserve would become the liabil
ities of the Treasury. No meaningful valuation of Government assets
could be assigned to the Treasury, but then it is not meaningful to call
Government securities assets of the Federal Reserve, since the Federal
Reserve is itself an arm of the Government. In the same way social

152

FEDERAL RESERVE PORTFOLIO

security obligations to claimants are liabilities of the Treasury. It is
all right for the fund to “hold” Government securities, but that need
not give social security claimants any more or less reason to expect
that the Government will honor these claims than if there were no
special funds set up.
DEBT MANAGEMENT

In the foregoing analysis, which stresses Government liabilities and
the real assets acquired in their creation, it makes little difference what
sort of securities the Federal Reserve holds in its portfolio. The
really important decision is what the public holds—both the amount
of money and securities and the maturity of securities. It is all part
of the same process of deciding in accord with economic conditions
how liquid the public’s claims on the Government should be. If the
Federal Reserve holds all bills or all 20-year bonds, the maturity of
publicly held issues need not thereby be affected.
Though it can be done, I do not think it desirable to divorce the eco
nomic decision of financing the Government from the economic de
cision of deciding how much financing is necessary, i.e., the size of
surpluses or deficits incurred. All of these are decisions to be made by
the administration in power, and I would prefer that the machinery
be so established. I f this were done, the problem of central bank port
folio management disappears, and the issue emerges in its true nature
as the problem of managing the Government’s monetary and non
monetary liabilities.
On the assumption that such sweeping change is not forthcoming, I
offer, within the same framework, some less drastic suggestions. As
stated earlier, it is not what the Federal Reserve holds in securities
that counts, but what it buys from and sells to the public. If we
assume that the decision with respect to the size of the money stock
remains exclusively with the Federal Reserve, then the remaining de
cision is the maturity of the public debt outstanding. The pmicymaking authority for this decision is not clear. The Federal Reserve
can change the maturity distribution of the publicly held debt by,
say, buying bonds and selling bills. I f it wished, however, the Treas
ury could always undercut this by selling bonds and using the pro
ceeds to buy up some of its own bills. Or, it can do the same thing, a
little more slowly, by refinancing all maturing issues by issuing bonds.
Even though we have given the Federal Reserve control over the
money stock and the mechanism to enforce it, the management of the
publicly held debt is not so well defined.
To clear the matter up Congress should assign responsibility to one
agency or the other. Although a good case can be made for turning
this function over to the Federal Reserve, my preference is the Treas
ury. The Treasury should have the exclusive right to determine the
maturity of the securities involved in Federal Reserve dealings with
the public. For monetary purposes the Federal Reserve need specify
only the amount of transactions. The Treasury should decide the
issues to be traded. My principal reason for advocating this proce
dure is that the alternative of transferring the power to the Federal
Reserve would decrease the area of control exercised by the adminis
tration. Centralizing such decisions in the Federal Reserve involves
far more than just the Federal Reserve’s portfolio, which is equal to
only 18 percent of the Government debt held by the public and the

FEDERAL RESERVE PORTFOLIO

153

Federal Reserve combined. To control the maturity distribution of
the Government debt the Federal Reserve would then have to be
charged with all Government security sales. There are also other
intragovernmental holdings to consider, which together are much more
than Federal Reserve holdings, though most of these are now in special
nonmarbetable issues. It would seem necessary for the Federal Re
serve to control acquisitions of these special funds if it is to control the
distribution of public holdings with a minimum of market activity.
Monetary policy requires only that the money managers decide the
volume of securities they buy or sell in order to affect reserves. The
actual participation on the market is more properly a function of the
Treasury, which issues debt far in excess of Federal Reserve holdings.
It might even be desirable that the Treasury be in charge of the open
market desk, which as a side benefit would prevent the Federal Re
serve from using such vague guides for monetary policy as the “feel of
the market.”
The case has sometimes been made that the Federal Reserve could
more effectively distribute securities than does the Treasury. It
would be possible to assign this function to the Federal Reserve, even
if the Treasury retained the basic decision over what is to be issued.
I do not see any reason, however, why the Federal Reserve can do
a better job than can the Treasury or that it has any inclination to do
it differently. The Federal Reserve conducts its open market opera
tions through the same securities dealers with which the Treasury
consults. The Treasury and the Federal Eeserve have no difficulty
cooperating on technical matters. It is the policy matters in which
Congress must be specific in delegating authority.
There is, however, one desirable procedural change, which is for
the Federal Reserve to purchase securities directly from the Treasury.
This would eliminate some turnover in the market and avoid some
payment or dealer margins. It is not feasible, however, for all pur
chases to be direct, since the timing and amount of the Federal Re
serve’s need to supply reserves do not necessarily coincide with the
timing and amount of the Treasury’s borrowing and spending. Alter
natives might be worked out through greater use of Treasury balances
in private banks, but this seems less desirable than the Federal Re
serve’s continuing some market purchases.
The Federal Reserve should explore devices to minimize the neces
sity of its entry into the market. Others have suggested such devices.
“Float” could be eliminated by the simultaneous debiting and crediting
of the banks involved in a check clearing. Increasing banks’ reserve
settlement periods would allow time for banks to make up reserve
deficiencies and reduce the necessity for defensive operations by the
Federal Reserve to keep reserve levels stable. Uniform reserve re
quirements would reduce the reserve changes necessitated by shifts of
deposits between banks of different reserve classes. Much of the Fed
eral Reserve’s transactions are offsetting over a period of time because
of such defensive operations. In the first half of this year, for in
stance, the System purchased $11.4 billion of securities (including
repurchase agreement transactions) in excess of what was necessary to
replace maturing issues. In the same period it sold $9.4 billion, for a
net change of only $2.1 billion. (The discrepancy is due to rounding.)

FEDERAL RESERVE PORTFOLIO

154

MONETIZATION OF NONGOVERNMENT DEBT

The monetary analysis which I have employed emphasizes the role
of Government securities in the monetary process. Though other
assets are employed for money creation, Government securities are the
most desirable for this purpose. Their acquisition by the central bank
means that the Government, rather than private interests, derives the
benefits of reserve money creation. It would be undesirable for the
central bank to enlarge its portfolio to include additional private or
State and local government debt. I f the Government wishes to enact
special programs for such borrowers, it can do so directly, as it has in
many cases, without the subsidy being administered by the central
bank. Any program which is financed by money creation simply cuts
down the amount of money creation that can be used to finance the
remainder of the Government’s expenditures.
Programs enacted by Congress and administered by the appropriate
Government agency are kept under public scrutiny. A program fi
nanced by money creation and administered by the Federal Reserve
is not. Congress oversees loans to small business and farmers; it has
no say over loans to multibillion-dollar banks, which can borrow from
the Federal Reserve discount window and their name will not even
become known to the public, nor so far as I know to Congress. Such
a program, financed through the central bank and automatically mone
tized, is not even subject to the appropriation process. Federal Re
serve acquisitions of bankers’ acceptances provide preferential treat
ment to a particular segment of the market. The Federal Reserve
should discontinue their purchase.
Similar objections hold with respect to central bank acquisition
of foreign exchange. I f the central bank is charged with the program,
foreign currency holdings are automatically monetized, a method
which obscures to the public the true cost. The real resources required
to acquire foreign assets become more apparent if the Government
must tax or borrow to acquire them. There is no reason why foreign
exchange should be singled out for special treatment any more than
farm surplus acquisitions should be financed through the central bank.
The foreign exchange program rests in the central bank in many
countries because it evolved from the pure gold standard, in whicn
balance-of-payments deficits and surpluses had an automatic tendency
to affect the money stock. In the absence of such a standard, monetary
policy is discretionary and no longer is directly connected to the bal
ance of payments. I might add that under present international
arrangements, with the dollar the only gold convertible currency, I do
not favor the United States holding foreign currencies as international
reserves through any agency. Negotiations now underway may lead
to changes which would make such holdings desirable, but there is no
necessity for the central bank to assume this function, which is closely
involved in foreign policy. The Federal Reserve’s present foreign
currency program involves it not only in spot holdings but in the as
sumption of liabilities for future delivery of foreign currencies. The
size of these liabilities, which complicate assessment of the Nation’s
international reserve position, is not made known to the public. This
is an example of the way such activities can enlarge in scope.
The Federal Reserve no longer holds gold, but it does hold gold
certificates w^hich were deposited by the Treasury as a means of mone

FEDERAL RESERVE PORTFOLIO

155

tizing the gold stock, i.e., creating money with which to purchase gold.
This decision is up to the Treasury, which so far has chosen to mone
tize most of its gold. It makes little difference whether this arrange
ment is continued. I f the Treasury did not deposit gold certificates,
more Government securities could thereby be monetized, but more Gov
ernment securities would have to be issued—to pay for the gold—
with no net effect. This again emphasizes the central bank as an
intergovernmental, bookkeeping arrangement.
An historical incident illustrates how the Treasury can bypass the
central bank. Normally Government gold purchases add to the cen
tral bank’s gold certificate holdings and increase bank reserves by an
equivalent amount. I f total reserve levels are to remain unchanged,
the Federal Reserve must sell an equivalent amount of Government
securities. In the late 1930’s gold inflows from abroad were too large
relative to the central bank’s security holdings to use this procedure.
Consequently the Treasury sold securities to the public and used the
proceeds to buy gold, which it did not monetize. There is no umbilical
cord connecting central banks and gold.
THE PORTFOLIO SIZE

In the present system the size of the Federal Reserve s portfolio
must vary directly with the desired money stock and the reserve ratio.
There is no reason to believe that the money stock need ever to contract
as long as it is not excessively expanded in some period. Thus, except
for the possibility of reducing reserve requirements, the central bank
portfolio will likely grow. Under these assumptions it would be pos
sible to periodically “retire” Federal Reserve Government security
holdings, the only practical effect of which is that interest payments
on these from the Treasury to the Federal Reserve cease. Alternatively
Congress could simply discontinue interest payments on a portion of
Government securities held by the Federal Reserve. Unless the Fed
eral Reserve becomes subject to the appropriation process, which I
favor, I would consider either of these courses undesirable. The
procedure is meaningless unless it is carried far enough for the Federal
Reserve to feel the restriction on earnings. I f it goes that far, it may
lead the Federal Reserve to actions to protect its earnings, even
though these actions are contrary to its desired monetary policy. As
long as the central bank exists, the public should have no doubt about
its earnings ability.
In summary, in the absence of virtual elimination of the Federal
Reserve as a separate entity, there are few changes in portfolio policy
that are desirable. The major suggested change is to shift to the
Treasury the determination of the maturity of the securities the Fed
eral Reserve buys and sells. Federal Reserve holdings other than
Government securities should be strictly limited. Such assets would
be acquired as a result of automatic money creation, removing them
from public scrutiny and involving the central bank in affairs not
directly related to monetary policy.

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FEDERAL RESERVE PORTFOLIO

S t a t e m e n t b y R o b e r t W e i n t r a u b , P r o fe sso r o f E c o n o m i c s ,
U n iv e r s it y of C a l if o r n ia , S a n t a B a r b a r a , C a l i f .

The subcommittee’s inquiry into the growth of the Federal Re
serve’s portfolio of U.S. Government securities is important and
timely.
1. On the importance of the Fed's portfolio
The Fed is the Nation’s monetary authority, and hence whether its
ranking executives like it or not, the Fed is responsible for the growth
of the Nation’s stock of circulating media. The significance of the
quantity of money to the economy’s performance is widely recognized,
if it is not already a commonplace, and need not be detailed here. It
is enough to point out that all our recessions and depressions were
preceded by sharp decreases in the growth of the money stock (to less
than 1 percent per year), all our recoveries from these episodes often
were ignited by sharp increases in the growth of the money stock, and
most important all periods of economic growth without inflation have
been sustained by monetary growth in the 2% or 3-6 percent per year
range—the present expansion being a case in point.
The growth of the money stock (currency plus demand deposits) is
determined by many forces including, in the direct or immediate sense,
the required and desired reserve ratios of member banks to their
deposit liabilities, the public’s preferences for holding (a) cash and (&)
time deposits relative to demand deposits, and the monetary liabilities
of the Government. These liabilities consist of (1) Federal Reserve
notes or currency; (2) Federal Reserve deposit liabilities to member
banks; and (3) Treasury currency and coin outstanding; the Federal
Reserve’s liabilities comprising about 90 percent of the total.
At any given time, the stock of money (S) equals the product of
the sum of the Government’s liabilities (L) and a multiplier (m) which
is determined by the required and desired reserve ratios and the
public’s preferences among cash, demand, and time deposits. Mathe
matically, S = L m.
The growth of the Fed’s portfolio of Government securities is of
extreme importance because it is the principal source of the Federal
Reserve’s monetary liabilities, today equaling nearly 75 percent of
these liabilities and hence more than two-thirds of the total of all of
the Government’s monetary liabilities (L ). Inasmuch as the Fed’s
power to add to or subtract from its portfolio is limited only by the
gold reserve requirement (which itself is not immutable as recent his
tory proves), it is clear that the Fed can control the size of the mone
tary liabilities of the Government (L) and thereby the money stock
(S) merely by controlling its portfolio of Government securities.
Whatever else happens to change (L ), for example a gold drain, can
be more than offset easily and immediately merely by adjusting the
size of the portfolio. Thus the Feds control over (L) is absolute. As
a corollary of this control the Fed can make the money stock behave
very nearly precisely as it wants. Insofar as (m) is continually
jiggling small deviations from target money stocks must be expected.
But it may be reasonably urged that large persistent deviations cannot

FEDERAL RESERVE PORTFOLIO

157

occur unless the Fed is misusing or not using its power to adjust the
size of its portfolio of Government securities.1
2. On the size of the Fed's 'portfolio
Manifestly, the size of the Fed’s portfolio must be governed so that
the stock of money grows at least 2y2 and perhaps as much as 6 percent
per year. The precise growth of the money stock in any given year
must be whatever it takes in view of labor force and technological de
velopments, to achieve the goals of the 1946 Employment Act. As a
corollary, the precise growth of the Fed’s portfolio must be whatever
it takes to achieve the desired monetary growth. Both the money
supply target and the corollary portfolio policy can be revised as the
year passes. Sharp revisions are not likely to ue necessary in years in
the near future if the Fed begins each year with a monetary growth
target midway between 2*/2 and 6 percent and a portfolio growth
target 1.1 or 1.2 times as large in percentage terms. As a first ap
proximation, this policy implies that over the long haul the Fed’s
holdings of Government securities will grow at about 5 percent per
year. But this rate of growth assumes no longrun change in the mone
tary multiplier (m) or in other sources of the Government’s monetary
liabilities (L ). If the multiplier falls, as it has since 1961 reflecting
the public’s shift to time deposits with the periodic increases in the
interest paid on each dollar of these deposits, the Fed’s portfolio will
have to grow at more than 4 percent per year to achieve a 4.25 percent
rate of growth of the money stock. Similarly, if other sources of the
Government’s liabilities fall over time, as they have in recent years
reflecting largely the gold drain, the Fed will have to additionally
increase the annual rate at which it adds to its portfolio of Government
securities. Probably we can expect a continuing shift to time deposits
and hence a continuing decline in (m). Also we can expect a con
tinued gold drain, and moreover, we have to expect a future decrease
in the Treasury’s currency and coin outstanding. Thus (L) also will
tend to decrease in the long run if not controlled. This means that
the size of the Fed’s portfolio must increase relatively more rapidly
in distant than in near years. In the distant future it will have to
grow at more than 5 percent per year to achieve a 4.26 percent per
year growth in the money stock. The precise relationship between
the growth of the Fed’s portfolio and the growth of the money stock
cannot be forecast. But it can be stated with confidence that today
it is greater than unity and it will tend to rise over time.
Finally, in this connection, it is useful to recognize that the Fed
need not passively accept the observed existing relationship between
required portfolio growth and desired monetary growth. The Fed
can exercise direct control over the relationship between its port
folio and the money supply by increasing or decreasing required bank
deposit reserve ratios. Such changes, respectively, would decrease and
increase the monetary multiplier (m). Because the overwhelming
bulk of the interest income (about 85 percent today) which the Fed
1 Viewed in a purely arithmetic context, it may be objected that the effect on (S) of
an increase in (L), which results from the Fed’s purchases of Government securities, can
be exactly offset by a decrease in (m), which results from a rise in desired free reserves.
This objection is, however, unreasonable since the Fed’s purchases are made in the open
market and the money stock (S) is directly increased when the Fed buys from nonbank
holders of Governments. Thus the objection contemplates banks calling loans when the
Fed buys in the open market. This could occur but not in sufficient amount and duration
to prevent the Fed from increasing the money stock (S) if it was really intent on achieving
such an increase.

158

FEDERAL RESERVE PORTFOLIO

derives from its portfolio of Governments is returned to the Treasury
it follows that any policy change that increases the Fed’s portfolio
(and, given interest rates, its interest income), will decrease the an
nual transfer payment from taxpayers in general to Government secu
rities holders in particular. Assuming only that it is desirable to reduce
the cost to the taxpayers of carrying the debt, it would be appropriate
therefore for the Fed to raise bank reserve requirements. This could
be done gradually. Such a policy will achieve the desired decrease in
debt cost to taxpayers by reducing the monetary multiplier (m ). For
reductions in (m) necessitate larger increases in (L) and hence in
the Fed’s portfolio of Government securities to achieve the same
growth of the money stock (S ).
3. On the question of whether bulh of the Fed's portfolio should be
transferred to the Treasury
The usual argument for not transferring the major part of the
Fed’s portfolio of Governments back to the Treasury is that this
would in some unspecified way undermine confidence in the dollar.
Perhaps the transfer would be interpreted to mean the United States
will not honor its financial obligations. But, in fact, debt instru
ments held outside the Fed are honored by payment of currency and/
or deposits in Federal Reserve banks. Debt instruments held by the
Fed already have been honored. Thus this fear is groundless. More
likely the motivating fear is that the transfer (somehow) would be a
license to the United States to run continuing fiscal and balance-ofpayments surpluses. That this is the underlying fear is a deduction
from the fact that the Treasury can redeem debt from the Fed only
if it first accumulates dollars, bank balances, or gold; these are the
only “coin” the Fed will take. But the notion that transferring the
bulk of the Fed’s portfolio to the Treasury would have the slightest
effect on future U.S. fiscal and balance-ox-payments transactions is
simply farfetched. Moreover insofar as the balance of payments is
stressed the argument confuses money and credit. People, including
foreigners, hold dollars because its value (measured in purchasing
power) is relatively stable not because of the collateral (gold) back
ing on hand.
The Treasury’s debt has economic significance only because it in
volves an annual transfer of money income from taxpayers in general
to debt holders in particular. But, as noted above, the overwhelming
bulk of the debt held by Fed involves no such transfer, the interest
income received being returned to the Treasury. Therefore, today,
it is downright silly to think of the Government securities held by the
Fed as the obligations (i.e., debt) of U.S. taxpayers, beyond a mini
mum amount of at most $10 billion which is required to pay the Fed’s
operating expenses and provide a reservoir of marketable instruments
that the Fed can sell in the unlikely event of a sudden burst of velocity
induced inflation in order to quell same quickly. To end the illusion
that the $30 billion residual securities in the Fed’s $40 billion portfolio
are part of the debt, today’s residual securities should be transferred
to the Treasury immediately and any residual acquired in the future
as a result of the necessity of providing fuel (i.e., base or highpowered money) for required monetary growth should be transferred
as soon as it is acquired.

FEDERAL RESERVE PORTFOLIO

159

4- Opinions on miscellaneous matters
(a) As long as there is Government debt outstanding there is no
reason for the Fed to buy other financial assets. Giving the Fed
power to do so would make it possible to influence prices and yields
of specific debt instruments, i.e., to favor one company or economic
sector against others. Hence I would not want to see the Fed supple
ment its portfolio of Governments with commercial loans, municipal
securities, corporate bonds, etc.
(b) I believe strongly that Congress should require the Fed to
state biannually, after formal consultation with other Government
economic bodies, the percentage rise in the money stock that is re
quired to achieve the goals of the 1946 Employment Act this half year
and the percentage rise in its portfolio of Government securities that
will be required to generate the desired increase in the money stock.
Deviations from either the immediate or ultimate targets should be
explained in a report to the Congress within 3 months of the end of
the 6 months target period.
Statem ent

W eldon W
R eserve U

e l f l in g ,

P r o fe s s o r o f E c o n o m i c s , W
C l e v e l a n d , O h io

estern

n iv e r s it y ,

The increase in the Reservre System’s holdings of securities since
1955 represents, of course, an increase in currency in circulation of
about $8 billion, a decrease in the gold stock of about $7 billion, and
an increase in bank reserves of about $2.5 billion.
The System’s holdings of Federal securities, per se, are less im
portant than the resulting changes in the money supply and interest
rates. Between 1940 and 1951 System purchases increased the money
supply above and depressed interest rates below equilibrium levels,
a condition which contributed to rising prices and costs until 1958.
Of an increase of Federal debt of about $45 billion since 1957, $14.5
billion has been absorbed by the Reserve System, over $7 billion by
Government agencies and trust funds, and $23 billion by the public.
The net effect has been an increase of $2.3 billion in bank reserves and
an increase in the money supply of about $26 billion, or an average of
$3.25 billion per year.
Assuming the need for an expanded money supply over a period of
time, there are numerous methods of providing it. Monetizing interest-bearing Federal debt is only one way. Taking the currency com
ponent alone, the $8.3 billion increase since 1955 could have taken
the form of non-interest-bearing Treasury notes instead of Federal
Reserve notes. If the public’s demands for currency had been trans
lated into demands on the Treasury for notes, the Federal Reserve
System would have had no need to restore this amount of bank re
serves through open market purchases. The technical gold reserve
position of the System would be improved by the absence of $8 billion
of total liabilities.
By the same token, if the machinery of the Reserve System is used
to provide the annual increases in currency, there is no sound objection
to the System taking non-interest-bearing obligations from the Treas
ury in exchange for Federal Reserve notes, which could then be de
posited in tax and loan accounts.

160

FEDERAL RESERVE PORTFOLIO

Similarly, required increases in bank reserves could be supplied in
the same manner. Either new non-interest-bearing debt could be
issued or open market debt could be made noninterest bearing to the
Eeserve banks.
Needless to say, any such shift to use of non-interest-bearing debt
should be limited to increments in the money supply deemed appro
priate by the monetary authorities. It should not reflect budget defi
cits but be a way of financing such part of a deficit as would be mone
tized as a matter of monetary policy under present arrangements.
Essentially, the question of whether the Treasury should pay interest
to the System, as to any other holder (including Federal agencies and
trust funds), is one of determining the source of the System’s income,
rather than a question of monetary policy. Considered purely as a
monetary mechanism, the present arrangement works as well as would
one monetizing non-interest-bearing Federal debt.

S t a t e m e n t b y E d w a r d L. W h a l e n . A s s i s t a n t P r o fe s s o r , D e p a r t
m e n t o f E c o n o m i c s a n d D i v i s i o n of E c o n o m i c R e s e a r c h , I n d i a n a
U n iv e r s it y . B l o o m in g t o n , I n d .
THE STRUCTURE AND MANAGEMENT OF THE FEDERAL RESERVE SYSTEM’S
PORTFOLIO

The existing Federal Reserve portfolio of U.S. Government securi
ties is a byproduct of past open-market operations . The appropriate
ness and effectiveness of the monetary policy which initiated these
open-market operations constitute a really substantive issue for evalu
ation. The size of the Federal Reserve portfolio is a matter of lesser
importance representing as it does the results of past decisions and
actions whose effects for good or ill already have transpired. Never
theless, the question regarding the size of the Federal Reserve’s port
folio relative to the money supply, gross national product, or aggre
gate liquid assets has been raised and deserves an answer.
The Federal Reserve 'portfolio relative to other economic variables
Figures for the Federal Reserve’s holdings of U.S. Government
securities, the money supply, gross national product and aggregate
liquid assets for the 10-year period from 1955 to 1964 are shown in table
1. The last three columns of the table present the ratio of the money
supply, gross national product and aggregate liquid assets to the Fed
eral Reserve’s portfolio. A decrease in these ratios indicates that the
Federal Reserve’s holdings have increased relative to the economic
magnitude involved, and this phenomenon has occurred only in the
case of the money supply. Federal Reserve holdings of Government
securities have declined relative to gross national product and the
liquid assets included in the table. Thus, according to two of the
three standards suggested by the question, the size of the Federal
Reserve’s portfolio is less of a problem now than it was 10 years ago.

FEDERAL RESERVE PORTFOLIO

161

T a b le 1.—Federal Reserve portfolio relative to the money supply gross

national product, and selected liquid assets (amounts in billions of
dollars)

Year

U.S. Gov
ernment
securities
held by
Federal
Reserve
banks1

Money
supply2

Gross
national
product

Selected
liquid
assets8

(1)

(2)

(3)

(4)

(5)

135. 2
136. 9
135. 9
141. 1
142. 1
141. 1
145. 5
147.6
153.2
159.4

397.
419.
442.
444.
482.
502.
518.
556.
583.
622.

19551956.
19571958.
1959.
1960.
1961.
1962.
1963.
1964.

. .

24. 8
24. 9
24. 2
26.3
26. 6 .1
27. 4
28. 9
30. 8
33. 6
37. 0

332. 5
5
2
343. 2
8
356. 0
2
373. 1
1
393. 9
6 1 399.2
1 424. 6
7 |
2 1 459. 0
9
495. 3
6
529.9

Ratio:
Ratio:
Ratio:
column 34- column 4-r- column 5-fcolumn 2 column 2 column 2

(6)
5.
5.
5.
5.
5.
5.
5.
4.
4.
4.

(7)
45
50
62
37
34
15
03
79
56
31

16. 0
16. 8
18. 3
16. 9
18. 1
18. 3
17. 9
18. 1
17.4
16. 8

(8)
13.4
13. 8
14.7
14. 2
14. 8
14. 6
14. 7
14. 9
14. 7
14.3

* U.S. Government securities held by all Federal Reserve banks at the end of the month of December.
2 Averages of daily figures, seasonally adjusted.
3 The selected liquid assets held by the public include demand deposits and currency less demand deposits
held by mutual savings banks and savings and loan associations, time deposits at commercial banks, mutual
savings banks, Postal Savings System deposits, savings and loan shares, U.S. Government savings bonds
and U.S. Government securities maturing within 1 year.
Source: Board of Governors of the Federal Reserve System, Federal Reserve Bulletin.

Even if all three ratios had moved in the same direction, the re
sults would be difficult to interpret. Many factors affect the ratios
between the size of the Federal Reserve System’s portfolio and the
three economic magnitudes appearing in the table. Take, for in
stance, the money supply. Decreases in the ratio between the money
supply and the Federal Reserve’s portfolio may be the result of at
tempts to offset the contractionary effects of a deficit balance of pay
ments, an increased public preference for currency instead of demand
deposits, a growth in excess member bank reserves, or increases in
reserve requirements.
The relationship between gross national product and the Federal
Reserve’s portfolio is complicated not only by all the factors in
fluencing the money supply relative to the Federal Reserve’s port
folio, but also by an additional variable: the velocity of money.1
The velocity of circulation of money itself is a very complex variable
whose fluctuations may reflect separately or in combination changes
in the demand for money or structural and institutional changes in
the economy. Similarly, the ratio between a measure of liquid
!The ratio between gross national product and the Federal Reserve's portfolio can be
expressed as the product of the velocity of money and the ratio of the money supply to the
Federal Reserve’s portfolio. This relationship can be demonstrated through a few simple
equations. Let Rm be the ratio between the money supply and the Federal Reserve System’s
portfolio, so that Rm = M / B
where M stands for the money supply, and B represents the portfolio balance. Gross
national product, Y can be expressed as the velocity of money, V. times the money
supply Y = V M
Dividing both sides of this equation by B gives the ratio between gross national product
and the portfolio balance Y/ B — V' M/ B
which is equal to Y/ B= zV'Rm
Thus, gross national product relative to the Federal Reserve’s portfolio is influenced
multiplicatively by the factors determining the velocity of money and the factors determin
ing the ratio of the money supply to the Federal Reserve’s portfolio.

162

FEDERAL RESERVE PORTFOLIO

assets and the Federal Reserve’s portfolio is influenced by a wide
variety of factors which makes the significance of changes in this
ratio subject to question.
Thus, interpreting changes in any one of these three ratios is ex
ceedingly difficult. Harder still is the task of establishing the mini
mum level for a particular ratio at which the Federal Reserve’s port
folio would be judged excessive. And, since the Federal Reserve
System has little control over these ratios, imposing such a standard
would only add to the political and institutional impediments to
vigorous monetary policy. Therefore, the Federal Reserve’s holdings
of U.S. Government securities relative to the money supply, gross
national product or aggregate liquid assets do not seem to provide
appropriate criteria for judging the size of its portfolio.
Other standards
Is any other criterion more appropriate? Two possible standards
for evaluating the size of the Federal Reserve’s holdings of U.S.
Government securities are suggested. First of all, because of the
>rimary importance of monetary policy, its portfolio should be
arge enough to insure flexible open-market operations. Second,
ranting the existing financial independence of the Federal Reserve
ystem, its portfolio should be large enough to cover all of its
necessary expenses.
By either of these two standards, the present portfolio of the
Federal Reserve System is larger than necessary. Legislation be
fore the Banking and Currency Committee suggests that $30.0 bil
lion of the $88.5 billion of U.S. Government bonds held by the
Federal Reserve banks could be eliminated without limiting the
flexibility of open-market operations. In 1964, a portfolio of
slightly more than $5.5 billion in U.S. Government securities would
have generated interest income sufficient to cover not only the ex
penses of the Federal Reserve System but also the dividends it paid
to member banks in that year.2 Although disagreement may arise
over the exact amount of the surplus in the Federal Reserve’s port
folio, both standards indicate that it is substantial.
Disposal of the surplus balance
What should be done with the surplus? Two alternative courses
of action are possible. The surplus portion of the Federal Reserve’s
portfolio could be transferred to the Treasury for cancellation, or
the Federal Reserve could continue to hold the securities, draw in
terest on them, and return the unexpended balance to the Treasury.
In spite of the evidence that the Federal Reserve’s portfolio is larger
than necessary, the latter alternative seems preferable. The economic
consequences of the present arrangement are not serious, and the
arguments for retirement and cancellation of Government debt held
by the Federal Reserve are not convincing.

2 A minimum portfolio balance of $5,513 million was computed for calendar year 1964
as follows: Total expenditures for the year, consisting of net expenses and dividends paid
to member banks, amounted to $228 million. The difference between this figure and $21
million of income from all sources except interest income on U.S. Government securities is
$207 million, the expenses which had to be covered by interest income on Government
securities. A rate of return of 3.76 percent was computed on the portfolio held by the
Federal Reserve banks by dividing current earnings on U.S. Government securities by an
average of total U.S. Government securities held by the Federal Reserve on Dec. 31, 1963,
and Dec. 30, 1964. At this rate, the balance necessary to cover the remaining expenses
of $207 million is approximately $5.5 billion.

FEDERAL RESERVE PORTFOLIO

163

One of the arguments for retirement and cancellation implies that
the Federal Government is forced to repay the principal on Gov
ernment securities held by the Federal Reserve twice instead of once*
The first time it pays for them is when the Federal Reserve System,
an agency of the Government, purchases Government securities from
the public. It pays for them a second time when these securities
are redeemed by the Treasury. The confusion in this argument lies
in the fact that for the first transaction the Federal Reserve is con
sidered to be part of the Federal Government; in the second trans
action, it apparently is not. I f the Federal Reserve were properly
seen as part of the Government in the second transaction, then the
Treasury’s redemption of the securities held by the Federal Reserve
would correctly be seen as an internal bookkeeping transaction.
The argument is clouded by an additional observation that the
Federal Reserve really doesn’t pay for the Government securities
it buys; it merely creates member bank reserves or issues Federal
Reserve notes. However, a Treasury redemption of Government
securities held by the Federal Reserve has the same effect on the
public’s money supply and bank reserves as a Treasury redemption
of Government securities held by the public. In either case, if the
Treasury chooses to retire part of its indebtedness, the public’s hold
ings of Government securities is reduced; if the Treasury refunds
part of its debt with the proceeds of a new issue, the new issue re
places the public’s holdings of the retired securities. In both situa
tions, the money supply and bank reserves remain unchanged, and the
equivalence of the net effects of Treasury redemption demonstrates
that the principal on the Government debt in either case is paid for
only once.
Sometimes the impression is given that the Federal Reserve some
how bilks the public in its open market purchases of Government
securities. It trades non-interest-bearing bank reserves and Federal
Reserve notes for income-earning U.S. Government securities. How
ever, since the public is not coerced into selling its Government securi
ties, the transaction presumably is a reflection of individual or com
mercial bank preference for cash or bank reserves. And, in order
to induce the sellers to part with their securities, the Federal Reserve
has to make its offering price sufficiently attractive to compensate the
owners for the future income they anticipate receiving from these
income-producing financial assets.
Another argument for retirement and cancellation of part of the
Federal Reserve’s portfolio implies that taxpayers continue to pay
interest on Government securities held by the Federal Reserve.
True, the Federal Reserve does receive income from its holdings
of Government securities, but a large portion of these earnings is
returned to the Treasury. The real cost to the public is not the in
terest paid on the Government securities; rather, the expenses of the
Federal Reserve, in excess of its income from other sources, constitute
the real burden to taxpayers.
Choosing between the present arrangement or retirement and can
cellation of part of the Federal Reserve’s portfolio essentially is a
choice between two sets of bookkeeping transactions. The rationale
for a change from one to the other should be on grounds of admin
istrative convenience and efficiency but not on their economic effects,

164

FEDERAL RESERVE PORTFOLIO

which are virtually nonexistent. On grounds of administrative de
sirability, the proposal to retire and cancel part of the Federal Re
serve’s portfolio is lacking in several important respects.
A transfer of part of the Federal Reserve’s portfolio to the Treasury
for retirement fails to correct a tendency for the Federal Reserve’s
portfolio to grow in excess of its needs. As the Federal Reserve
expends credit in response to economic growth, open market purchases
in the long run will tend to exceed open market sales, and the portfolio
balance again will increase. Thus, under present institutional ar
rangements, future adjustments are likely.
Not only is the tendency for the Federal Reserve’s portfolio to be
come excessively large not corrected, but also the procedures suggested
by the proposed legislation will not be satisfactory for future adjust
ments. In order to maintain the accounting integrity of the Federal
Reserve’s balance sheet, a debit entry is required to offset the credit
entry removing a portion of the Government securities from its port
folio. Under the proposed legislation, the required debit entry would
be accomplished by relieving the Federal Reserve banks of their liabil
ity for Federal Reserve notes outstanding, and this liability would
be transferred to the Treasury. At the end of December i964, the
Federal Reserve note liability amounted to $34.7 billion; the proposed
legislation would reduce its liability by $30 billion. But, if Federal
Reserve holdings of U.S. Government securities grow more rapidly
than Federal Reserve note liabilities, as it has in the recent past, how
are future adjustments to the Federal Reserve portfolio to be
effected ?*
Finally, the proposal to retire and cancel U.S. Government securi
ties held by the Federal Reserve is not consistent with accounting
practices applied to other Government agencies. The Federal Reserve
System is not the only Government agency holding U.S. Government
securities. At the end of the month of December 1964, U.S. Gov
ernment agencies and trust funds, exclusive of the Federal Reserve
banks, held $60.6 billion in U.S. Government securities; this is well
over 1y2 times the amount held by the Federal Reserve banks. Should
not a policy of retirement and cancellation of Government debt held
by the Federal Reserve be applicable to these other Government agen
cies also ?
Retention by the Federal Reserve of its present holdings of U.S.
Government securities does not necessarily imply that nothing should
be done, however. The Federal Reserve policy of returning its un
expended earnings to the Treasury should be made obligatory, and for
the sake of consistency in Government accounting practices the ex
penses of the Federal Reserve should be subjected to annual audit
by the General Accounting Office. A substantial reduction in Federal
Reserve expenditures could be achieved by retiring the capital stock
of the Federal Reserve banks, thus eliminating annual dividend pay
ments to member banks. In other words, retention of the present
arrangement makes more imperative guarantees that the unexpended
income returned to the Treasury is maximized.
8 The Federal Reserve note liability increased $7.8 billion, from $26.9 billion at the end
of 1955 to $34.7 billion at the end of 1964. During the same period, the Federal Reserve’s
portfolio of U.S. Government securities increased $12.2 billion, from $24.8 to $37 billion.
Thus, the Federal
™te HaMi Itv
cicely to be inadequate to compensate for future
adjustments to the Federal Reserve’s portfolio.

FEDERAL RESERVE PORTFOLIO

165

Management of the Federal Reserve 'portfolio
Advice to the Federal Reserve on its portfolio management is rough
ly equivalent to recommendations concerning its open-market opera
tions. The types of financial assets and their maturities which the
Federal Reserve Open Market Committee buys and sells are vitally
important for effective monetary policy. When conditions warrant,
the Federal Reserve should seek to alter not only the general level but
also the structure of interest rates through open-market purchases and
sales of longer term financial instruments. Since 1961 Federal Re
serve behavior indicates that the “bills only” policy has been aban
doned and that open-market operations have been appropriate to the
U.S. domestic and international situation.
Extension of the spectrum of the Federal Reserve’s portfolio to in
clude private as well as public evidences of debt appears to offer an op
portunity to make open-market operations a selective as well as a gen
eral instrument of credit control. Generally, Federal Reserve policy
has shied away from direct interference in credit markets, and prob
ably from the standpoint of overall economic efficiency this inclina
tion has been a wise one. However, conditions in which selective cred
it control would be necessary are not inconceivable, and in such situa
tions the Federal Reserve snould be encouraged to participate in the
markets for private obligations of the maturities. For ordinary long
term operations, however, such broad participation is probably un
necessary. Open-market operations in short-term Government se
curities appear adequate to compensate for cyclical credit needs and
technical adjustments.
The search for objective standards by which to guide the Fed
eral Reserve’s portfolio management—which is equivalent to guidance
on its open-market operations—is likely to be a will-o’-the-wisp. The
multitude of possible situations and the variety of combinations of
equivalent actions dooms an attempt to formalize open-market reac
tions to changing credit conditions to probable failure. Fortunately,
the Federal Reserve System has been able to insulate itself from this
type of outside interference in normal times. However, in the ab
sence of outside interference, the Federal Reserve sometimes imposes
its own rules of thumb, as the “bills only” episode indicates. All com
mitments to such objective standards which may inhibit adoption of
novel but effective and appropriate monetary policies are better dis
couraged than promoted.
S ta te m e n t b y W il li a m E . W h i t e s e l l , D e p a r tm e n t o f E con om ics,
F r a n k l i n a n d M a r s h a ll C o lle g e , L a n c a s te r , P a .

The Portfolio of the Federal Reserve System
The Federal Reserve System occupies a unique position in the Amer
ican economy, and therefore its policies and procedures should con
stantly be subjected to the closest scrutiny. Past System operations
have given rise to a huge portfolio of the U.S. Government securities,
and additions are regularly made to this portfolio as the Federal Re
serve increases the money supply through open market operations.
The very presence of the System’s large portfolio presents a number
of questions: What should be the size and composition of the Federal
56—913— 66—•— 12

166

FEDERAL RESERVE PORTFOLIO

Reserve’s portfolio? What should be done with the securities not
needed by the Federal Reserve System in the discharge of its respon
sibilities as a central bank? Can we design objective standards by
which System portfolio operations may be guided, including questions
of the maturity composition of securities in the portfolio and the types
of assets the portfolio should contain? The following discussion is
designed to direct thinking toward solutions to these and closely re
lated questions.
GROWTH OF THE MONEY SUPPLY *. OPEN MARKET OPERATIONS AND
REDUCTION OF RESERVE REQUIREMENTS

The Federal Reserve may meet the need for a secular growth of
the money supply either by employing open market operations or
reducing member bank reserve requirements. The choice between the
two is not solely a matter of individual preference even though either
method will allow for the needed growth of the money supply, but
the intricate theoretical issues raised by the choice need not detain
us. The important point here is that while the Federal Reserve has
made use ox gradual reductions in reserve requirements since 1951
without any offsetting increases it is presently using open market
operations to provide for further increases in the money supply. This
naturally results in an increase in the size of the Federal Reserve’s
portfolio of Government securities.
Under most circumstances the effects of expanding the money supply
through the use of open market operations will be different from the
effects of an equivalent expansion through reduction in reserve re
quirements. The spending units induced to increase spending will
be different in each case as will the types of expenditures consequently
affected. On the one hand, imprecise knowledge in the area prevents
us from making specific predictions as to the ultimate effects of using
either alone or a mix between the two. On the other hand, however,
we do know something about the consequences of choosing one over the
other in terms of effects upon Treasury interest costs and bank
earnings.
Federal Reserve purchases of Government securities in the open
market for the purpose of increasing member bank reserves has an
immediate and direct benefit to the Treasury since most of the reve
nues accruing to the System are turned over to the Treasury. Open
market operations absorb Government securities into the portfolio
of the Federal Reserve, and this reduces the carrying costs of the
debt to the Treasury. Lower reserve requirements, on the other hand,
are favored by the commercial banks because of the effects on their
profit positions.
It would be a mistake to assume that the interest costs to the
Treasury involved in the different choices open to the Federal Reserve
are negligible. While the absolute dollar amounts for 1 or 2 years
may seem relatively small when compared to total interest costs, one

FEDERAL RESERVE PORTFOLIO

167

should not overlook the fact that interest savings are cumulative and,
over time, appreciable in absolute dollar amounts.1
A final consideration involves the effects of various levels of reserve
requirements on the position of leverage given to the Federal Reserve.
Lower reserve requirements increase the amount of money which can
be created per dollar of additional reserves as well as increasing the
amount which the money supply will have to contract per dollar of
reduction in reserves available to the banking system.
THE SIZE OF THE PORTFOLIO OF THE FEDERAL RESERVE SYSTEM

The portfolio of the Federal Reserve is currently at about $39 bil
lion. The present size of the System’s portfolio and the promise of an
increase in that size if the Federal Reserve follows the practice of
providing reserves for the banking system through open market op
erations suggest the need for consideration of policy questions with
respect to the System’s management of its portfolio of Government
securities.
The absolute size of the portfolio of the Federal Reserve is not
significant as an abstract entity. It is meaningful only when one con
siders the size of the System’s portfolio in relation to some set of
economic objectives which he envisions for the Federal Reserve. From
the point of view of the responsibilities with which the Federal Re
serve is presently charged, it could probably hold a considerably
smaller portfolio and still discharge fully its obligations as a central
bank under various likely situations which one might assume. The
absolute size, above this required minimum, becomes significant only
as it relates to semipolitical decisions with respect to Federal ReserveTreasury relationships or Federal Reserve-commercial banking sys
tem relationships.
It would, therefore, be a mistake to attempt to tie the size of the
Federal Reserve portfolio to some other economic aggregate such as
gross national product, aggregate liquid assets, or even the money sup
ply. A substitute proposal for the type of discretionary monetary
policy which we now have would most likely have as its key feature
some kind of formula for increases in the money supply over a given
period of time at a given rate adjusted perhaps for the secular trend
m velocity. The increase in the money supply under such a proposal
would presumably be tied to some economic aggregate or aggregates
which reflect the growth or the level of economic activity. Under
such a proposal one might expect to find increases in the size of the
System’s portfolio tied in some more or less close fashion to an economic
aggregate such as gross national product or aggregate liquid assets.
The suggestion has a certain appeal not only to the quantity theorist
in economics but to individuals who have observed monetary policy
1 See the calculations made for the Joint Economic Committee by John Kareken in “The
Government’s Management of Its Monetary, Fiscal, and Debt Operations,” pt. 6A, hearings
before the Joint Economic Committee, 86tn Cong., 1st sess., 1959, pp. 1252-1253. Also,
see the note on bank profits. Ibid., pp. 1254-1255.
Professor Kareken has pointed out another difference between open-market operations
and changes in reserve requirements and that is the effect of the system’s choice of method
on the structure of interest rates. Open-market operations have the effect of changing the
ratio of Treasury debt to total outstanding debt instruments and a new ratio of a particular
maturity of Treasury securities to total outstanding securities. While this may be assumed
to have some effects in the market, it is not clear that these effects will be so great as to
unduly influence the Federal Reserve’s decision as to which method to use. See John H.
Kareken, “On the Relative Merits of Reserve— Ratio Changes and Open-Market Operations,”
Journal of Finance, vol. 16, No. 1, March 19.61, p. 70,

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FEDERAL RESERVE PORTFOLIO

in action and long for something “less personal” and hopefully less
fallible to substitute for the sometimes ill-timed and/or improper or
inadequate actions of the Federal Reserve. The evidence in support
of such a position is subject to contradiction; and despite its appeal,
it is by no means clear that such a policy would result m an improve
ment over discretionary policy as now practiced.
Suggestions to tie the growth of the Federal Reserve System’s port
folio of Government securities to GISTP or the establishment of a
hoped-for optimum ratio between aggregate liquid assets and System
holdings are likely to prove to be quite inadequate as a substitute for
discretionary monetary policy in which the portfolio size is related
only in a very imprecise way to GNP or some other economic aggre
gate. Changes in the velocity of money or shifts in portfolio prefer
ences among holders of financial assets or any combination of other
factors could in a very short time render even more complex mechani
cal arrangements inadequate to cope with the situation. Unsustainable
booms could develop and then be encouraged to reach proportions
which demanded severe readjustments simply because of the permis
sive increases of the money supply some formulas might allow. Thus,
in spite of the appeal of such policies, the Federal Reserve should be
reluctant to adopt them without refinements and provisions not yet
suggested by their advocates.
The exact rate of growth of the money supply must depend on con
siderations of the strength of private demand and the nature of fiscal
policy since these two factors affect the demand for money. This may
require different rates of growth of the money supply at different
times, and situations may arise when more than one method of encouraging growth of the money supply should be used.
THE FEDERAL RESERVE’S PORTFOLIO AND THE COMMERCIAL BANKS

The Federal Reserve was not designed as a profitmaking institution
of the Federal Government. We have already noted, however, that
by the very nature of its operations the Federal Reserve affects both
the profitability of the commercial banking system and the interest
costs to the Treasury. Thus, while there exists no economic need to do
anything with the securities held by the System, there may be some
requirement for action to stem pressures for moves which might not
be deemed beneficial to the longrun interest of the country as a whole.
The Treasury recoups a large proportion of the interest costs on the
securities held by the Federal Reserve because of the high “ tax” on
System earnings. On the other hand, considerable “political” pres
sures may be generated by the banking community in the direction of
persuading the Federal Reserve to turn over income producing assets,
m effect, by reducing reserve requirements. The argument would
probably follow the lines o f: (1) the Federal Reserve is not a profitmaking institution ; (2) the System does not need the securities held in
its large portfolio; (3) reserve requirements are at unusually high
levels in terms of equity as between commercial banks and other non
controlled institutions and in historical terms; and (4) therefore, the
Federal Reserve should gain the advantages of greater leverage by
lowering the reserve requirements for the member banks.2 Most
8 Since the American Bankers Association has pushed the adoption of a planned reduction
in reserve requirements in the past it is not illogical to expect a renewal of interest in the
plan at the next favorable opportunity, most likely the next recession.

FEDERAL RESERVE PORTFOLIO

169

bankers, viewing the operation of the System from the position of
their individual bank, tend to view reserve requirements as sterile
investment of “their” earning assets. This creates continual pressure
from the banking community for a reduction in required reserves,
although it is true that substantially all of member bank reserves have
been created by the Federal Reserve System.
The Federal Reserve has not raised reserve requirements since
1951 although it has lowered them several times during recession
periods since that date. This continual movement in only one direc
tion suggests that the Reserve officials view reserve requirements as
being too high and that the successive moves downward are designed
to bring the requirements to more nearly satisfactory levels. The
Federal Reserve has never formally stated its position with respect
to where reserve requirements should eventually come to rest, if
indeed they should be lowered only to a certain level. This gradual
reduction of reserve requirements during periods of recession without
offsetting increases during periods of prosperity may perhaps give
some clue as to the receptiveness of the Federal Reserve to the sug
gestion by the commercial banks that reserve requirements are at
levels which are “too high.” The creation of additional reserves by
open market operations has the dual effect of reduction in interest
costs to the Treasury while providing relatively less profit to the com
mercial banks than would be the case if reserves were supplied through
lowering reserve requirements. However, there is no clear evidence
that the Federal Reserve should lower reserve requirements.
The problem of pressure on the Federal Reserve to lower reserve
requirements as the System’s portfolio of Treasury securities becomes
relatively larger could be met by legislative action which would with
draw the Federal Reserve’s ability to further reduce reserve require
ments. This suggestion has been made in other contexts,3 but it is
equally applicable as a means of reducing the political pressures on
the System from private interests.
It has been suggested that the System could, as another alternative,
return its “excess” securities to the Treasury for cancellation. Any
such suggestion would in the future, as it has in the past, almost surely
meet with strong political opposition by those who cite the danger
of what they choose to call in disparaging terms “fiat money/5 Op
ponents of such a proposal would almost surely point out the possi
bilities of envisioned international repercussions and domestic suspi
cions of the soundness of the Government in the management of its
finances. These claims may have contained some truth in the early
postwar years, but today the validity of such claims is of secondary
importance to the potential political and perhaps psychological impact.
The Federal Reserve System presumably has no incentive to spend
more money simply because it receives more in interest payments
from the Treasury. Therefore, if it were decided that changes in
legislation concerning reserve requirements would be unwise and if
it were also decided that there should be a reduction in the size of
•Jh.e System’s portfolio, consideration could be given to still another
8 See the suggestions of Warren L. Smith in “Reserve Requirements in the American
fonetary System,” Monetary Management, Englewood Cliffs : Prentice HalL 1963, p. 216 ;
nd Milton Friedman, in his statement in “Employment, Growth, and Price Levels,” pt. 9A,
earings before the Joint Economic Committee, 86th Cong., 1st sess., 1959, p. 3022.

170

FEDERAL RESERVE PORTFOLIO

alternative. A certain portion of the securities now held by the
Federal Reserve represents a permanent monetization of Federal debt.
This fact could be recognized by a simple and convenient intragovernmental memorandum of debt; interest could be paid at a nomi
nal rate or even entirely excluded from consideration. The Federal
Reserve would thus become the Government’s underwriter, not unlike
the case with the Bank of England.
Policy implications.—At least two policy implications emerge from
the foregoing discussion: (1) Until it is convincingly demonstrated
that the Federal Reserve has to supply subsidies to the banking sys
tem, it would be preferable to increase the money supply through the
use of open market operations rather than through further reductions
in reserve requirements. I f it were decided that it is necessary to
subsidize the banks because of the peculiar position they occupy with
respect to their opportunities for profit in competition with the finan
cial intermediaries of the economy, then an argument can be made for
providing that financial subsidy through congressional appropriation
rather than by reductions in reserve requirements. Congress would
then periodically have an opportunity to review the profitability of
this unique industry, and there would be little question as to the cost
of the subsidy provided. (2) The interest savings to the Treasury
are substantial enough to recommend open market operations in
preference to reduction in reserve requirements as a method of sup
plying the needed increases in the monetary stock of the economy.
DEVISING OTHER OBJECTIVE STANDARDS FOR FEDERAL RESERVE OPERATIONS

There is an undoubted appeal to the idea that objective standards
can be devised for the operations of the Federal Reserve with respect
to its conduct of operations in the Government securities market. It
seems quite probable that one of the advantages seen for a policy of
“bills only” was that it largely eliminated the difficulties inherent
in the decision of what market sectors to enter to effect monetary
decisions. A rather mechanical response in one sector of the market
even though that sector be the one most often appropriate for the
usual open market operations of the System, did not prove to be satis
factory in the case or bills only; and we are unlikely to discover simple
rules or objective standards which should be followed by the Federa
Reserve as it conducts its open market operations. Some genera
guidelines can be handed down, but one should be careful to allow fo
needed flexibility in System operations because of the range of prob
lems which it currently faces and because of the unforeseen problem
it will surely face in the future. For example, one may indicate
preference that the Federal Reserve, according to its judgment, de?
in its open market operations in the various securities that are out
standing but at the same time not attempt to impose a precise formul
or measurement on such dealings. One may also direct the Feder*
Reserve to use open market operations to expand the money suppl
without specifying exactly what securities are to be bought in tl
open market to accomplish this end. In short, the need is for a flexib
attitude as opposed to the inflexibility exhibited during the bills oh
period.
Standards relative to the assets held by the Federal Reserve Sy
tern.—Some individuals have suggested the possibility of supplemer

FEDERAL RESERVE PORTFOLIO

171

ing the present holdings of the Federal Reserve with other ty{>es of
assets such as commercial loans, mortgages, commodities, municipal
securities, corporate bonds, and foreign excnange. The Federal Re
serve, by discounting commercial paper and through the execution of
its other normal functions, now deals in a relatively small way in some
of these. However, it would be unwise for the System at this time
to attempt larger operations in the areas indicated because of the
multitude of troublesome details which would have to be worked out.
For example, direct control of corporate and State and local securities
issues would raise serious questions with respect to the constitutionality
of such action, and it appears that attempts at control over these
issues by Federal Reserve purchases or sales of them would likewise
raise questions about the legitimate functions of the System.
Furthermore, there appears to be little or no need for significant
System operations beyond what is now being done in these areas. A
substantial reduction in the Federal debt in the hands of the public
could conceivably weaken the effectiveness of monetary controls. The
smaller size of Government debt held by the public relative to the
larger and growing private debt might mean that transactions of
sufficient size to accomplish monetary aims would be difficult to achieve
or that the connections between Government and private debt mar
kets might be appreciably weakened. This situation, if it should
arise, might call for a reevaluation of the desirability of System
dealings m private debt instruments on a relatively large scale; but
there appears to be no necessity for such considerations at the present
time. Debt holders who prefer Government instruments might con
ceivably have to make some small shifts in their portfolios as a result
of relative declines in the availability of Government securities, but
the growing importance of Government guaranteed debt and the
demonstrated flexibility of the financial system are likely to mini
mize the seriousness of any relative decline in available direct Gov
ernment debt. In short, any problems here are likely to be very
longrun ones.
A further consideration relative to System dealings in the types
of assets suggested is that such operations have direct implications
for the question of resource allocation. Should the Federal Reserve
as a matter of normal policy extend its operations into these other
areas when the effect would almost surely be that of bidding up the
rates on these various types of loans. Inis would place the System
not only in a position of direct competition for such loans with other
sectors of the financial community, But depending on which securities
or loans it chooses to buy, would have the effect of encouraging ex
pansion of some sectors sometimes at the expense of others. At best,
such a policy would have little beneficial effects; and at worst, it could
create severe destabilizing pressures in the areas in which it chose
to operate.
Assets held by the System and velocity considerations.—Perhaps one
of the implicit questions with respect to an expansion of System hold
ings of other assets is that of whether or not changes in velocity are
able to appreciably affect the ability of the Federal Reserve to achieve
its goals of credit restraint during periods when it may seem advisable
to apply restraint in the economy. There can be little doubt that the
development of financial intermediaries in the economy has resulted

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FEDERAL RESERVE PORTFOLIO

in some slippage in monetary controls, as has the existence of non
member banks outside of direct System control; and this slippage has
probably been rather significant. Serious consideration should be
given at the present time to extending controls of some kind over the
operations ox both financial intermediaries and nonmember banks.
There are questions here which relate to matters other than stabiliza
tion alone—questions of equity, efficiency of allocation of resources, and
the proper scope of governmental authority—but these are matters
which simply must be dealt with.
I f the aim of Federal Reserve holdings of assets other than Govern
ment securities is in general that of controlling the perverse variability
of velocity, there would seem to be surer and certainly less complex
means of accomplishing this goal. The imposition of reserve re
quirements on financial intermediaries, for example, would give the
authorities the power to control the growth of intermediary claims
directly should this prove to be necessary. Such action would avoid
the difficulties involved with a rather tenuous relationship between
some marginal amount of Federal Reserve holdings of other financial
assets and control of velocity changes. After all, it may not even be
desirable to give the Federal Reserve complete control over changes in
velocity even if that were a real possibility. It can reasonably be
argued that the increased leverage of monetary action which results
from the growth of intermediaries may strengthen the monetary au
thority in the sense that the effects per dollar of action are thus in
creased. On the other hand, it can be argued with equal vigor that
such developments weaken the monetary authority because of the dif
ficulty of getting finer adjustments. I f the restraints on the scale of
Federal Reserve operations were to become significant, there would be
a greater reluctance to use monetary action. Additional reluctance
on the part of the monetary authorities may be induced by the corollary
fact that the increased leverage caused by a growth of intermediary
claims tends to produce some uncertainty concerning the short-run
impact of monetary operations. On balance, there does appear to be
a strong case for extending controls to financial intermediaries, but
these controls should take the form of more, not less, direct controls
than the supplementing of Federal Reserve holdings of other assets.
Even though it is admitted that the presence of financial inter
mediaries and nonmember banks does affect the degree of control
exercised by the monetary authority, this does not mean that the
monetary authorities’ attempts at control are empty gestures. Mone
tary policy is not so impotent that variations in velocity offset its
intended effects entirely, but some potentially serious problems are
present.
SUMMARY

This brief examination of questions relating to the Federal Reserve’s
management of its portfolio has emphasized the following key points:
1. The secular growth of the money supply should be provided by
System open market operations rather than further reductions in
reserve requirements.
2. The absolute size of the Federal Reserve System’s portfolio is
important not as an abstract entity but as it relates to the economic
objectives of System operations. The analysis indicates that the Fed-

FEDERAL RESERVE PORTFOLIO

173

eral Reserve should not adopt proposals which tie the size of the
portfolio inflexibly to a specified ratio between itself and GNP, ag
gregate liquid assets, or the money supply.
3. I f it were deemed necessary for the Federal Reserve to reduce
its holdings of securities in excess of those which are needed for the
execution of essential central bank functions, consideration could be
given to the use of an intragovernmental memorandum of debt with
interest at a nominal rate.
4. There is undoubted appeal to the idea that impersonal, objective
standards can be set for guiding System portfolio operations, but there
is presently no convincing evidence that this is possible.
5. It would probably be unwise for the System at the present time
to extend its operations to include other types (or greater amounts in
a few cases) of assets such as commercial loans, mortgages, commodi
ties, municipal securities, corporate bonds, and foreign exchange.
6. This does not imply that the Federal Reserve should not consider
extensions of controls over financial intermediaries and over non
member commercial banks. In fact, analysis suggests just the
opposite.
The Federal Reserve should be flexible enough to consider all of
the ideas put forth by its critics, but this does not in any way imply
that certain suggestions cannot be rejected without a trial period of
operations.
S t a tem en t b y C. R. W h ittle se y , P rofessor of E conomics a n d
F in a n c e , W harton S chool of F in a n c e an d C ommerce , U niver
s it y of P e n n sylvan ia , P h ila d e lp h ia , P a .

In the first place, I feel much as my friend Seymour Harris does
with respect to the contribution which you have made in the area of
monetary policy over a great many years. You may be interested to
know that I was one or the six or eight economists (Paul Douglas
among them) who joined with Irving Fisher in attracting attention
to the 100 percent Reserve plan for effecting a relative basic reform
of the banking system. I cannot say that I thought that the plan
had any prospect of adoption but I was convinced of its logical merit.
I mention it here in the hope that it will absolve me from appearing;
particularly deferential to the status quo.
Secondly, it would seem to me to be wiser from a tactical standpoint
to concentrate on issues which are as clear cut as possible and where
the action that should be taken is least open to doubt. Also, instead
of identifying the Fed with bankers generally it would seem better
to assume that they recognize as well as others that they are quite
different and that the whole justification for there being a central
bank lies in that fact. Moreover, as far as possible reform should be
effected within the framework of existing institutions. It is the
last observation that brings me directly to the questions presented in
your letter.
There is no optimum ratio for the Fed’s portfolio in relation to
money supply, gross national product, or any other specific criterion.
One can argue that there is some amount below which the portfolio
should not fall. It can readily be shown that there is some amount

174

FEDERAL RESERVE PORTFOLIO

above which it need not rise. But it does not follow, nor is it true,
that either figure can be determined with any degree of exactness.
To repeat, there is no criterion of the sort asked for.
No senous harm is done by holding securities in excess, even
greatly in excess, of the amount that is really necessary. (Various
means could be suggested for eliminating the excess.) As matters
now stand the Treasuiy passes money out to the Federal Reserve in
interest on these securities and gets it back again out of excess earn
ings. This arrangement, which was adopted as an expedient and
without having been planned, may strike one as untidy. To the un
sophisticated it may even be misleading. But it does not make
enough difference to justify the effort and exacerbations that would
result from trying to change it.
I am opposed to laying down arbitrary (if this is the meaning o f
“objective” ) standards for portfolio operations. The unlamented
bills only policy was such a rule and any other measure of a signifi
cantly restrictive character could similarly obstruct the attainment of
desired central banking goals. In principle it would be much better
to move in the direction of greater freedom, as proposed in the final
query. There is little prospect that such powers would be exercised
to any great extent in the foreseeable future; and even less that they
would be abused.
S tatem en t b y F razar B . W ilde, C h a ir m a n of t h e B oard,
C onnecticut G eneral L ife I nsurance C o., H artford , C o n n .

Since 1913 our monetary system has been based upon the com
petency and good judgment of the Board of Governors of the Federal
Reserve System. I f we are to have a successful result, the Board must
have maximum flexibility both by tradition and by law in exercising
its enormous responsibility.
There can be no perfect performance in a business of such size and
complexity. Any kind o f formula restriction or interference with
the Board’s freedom of judgment will inevitably work to the Nation’s
disadvantage. This is the evidence of history throughout the world
when countries have tried to use automatic formulas, such as a rigid
gold standards in monetary management, rather than rely upon the
] udgments of highly skilled individuals.
Under a system which relies basically upon human judgment, it
follows that the man or men appointed require talents of an unusual
nature. They must be highly intelligent and economically literate as
well as possess an extraordinary degree of objectivity and strength
of character. Any monetary manager is subject to continuous daily
pressures, not only from those of us who don’t understand monetary
management but also from those who may have some understanding
but whose judgment is often based upon short-term reasoning. The
best possible test of the competency and integrity of a central bank
is evidence that many times the operation is proceeding somewhat con
trary to what popular opinion and judgment think it should be.
The reason the Congress set up the Federal Reserve System as a
semiautonomous institution, definitely not subordinated to the admin
istration and answerable only to the Congress on the basis of its per
formance, was that the Congress recognized the risk of making a po-

FEDERAL RESERVE PORTFOLIO

175

litical football out of monetary policy and the institution charged with
administering it. The basic responsibility of the Board is to play a
major role in the progress and stability of our economy. It does this
through the operation of the monetary system in providing adequate
credit for trade and commerce. It must not provide too much or too
little. It must avoid at all times the risk of rapid changes in the price
level. In other words, it is a major instrument in the successful growth
and stability of the economy. O f course, it cannot do it alohe. Na
tional fiscal policy must operate in harmony with monetary policy to
assure success.
Bearing these principles in mind—and they are fundamental—the
specific questions in your letter are largely answered. The Board, to
be successful, must be guided by the collective judgment of its members
in assessing the situation, the outlook, and need at a given time. The
position they take will reflect the total circumstances of the country
and in the world at the time a decision is made. They will have to
weigh especially trend indications because it is not the situation of the
day which requires action on their part so much as the trend lines
and direction in which the economy is moving.
They should not be asked to follow a formula. They should decide
on the size and composition of the portfolio needed as their judgment
dictates. The kind of assets and the maturity composition have to
be determined in light of the problems of the time. The portfolio,
while still open to their judgment, should be largely Federal Govern
ment securities. Special assets, such as municipal securities, cor
porate bonds, mortgages, and commodities, would not be appropriate
under any circumstances that I could foresee.
Your letter indicates some concern about the interest earned on
Federal Reserve assets. Since the interest received by the Federal
Reserve finds its way almost entirely back to the Nation, it doesn’t
seem as though this is a problem. I f there is an excess of assets, I
presume that the Board in its judgment would sell the excess in the
marketplace. Cancellation could be misunderstood.
In view of the enormous problems which our country faces both
domestically and internationally in the monetary field, I hope that it
will be the continued judgment of the Joint Economic Committee
and of the Congress that no significant changes should be recom
mended in the structure or rules o f the present System.

S tatem en t

by F. O. W oodard, H ead , D epartm ent of E conomic » ,
W ic h it a S tate U n ive rsity , W ic h it a , K a n s .

A recent letter from the Honorable Wright Patman, chairman o f
the Joint Economic Committee, relative to the Federal Reserve’s ac
quisition and ownership of Government securities, is both timely and
vital. At the very least, the antiquated methods used in this area are
expensive and time consuming. I agree with Congressman Patman
that a change is necessary. However, I am not so concerned, as is Con
gressman Patman, with the double purchase of the debt by the Gov
ernment, but rather with the turnover procedure necessary under the
present system. This refunding procedure involves an unnecessary
expense to the Treasury.

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FEDERAL RESERVE PORTFOLIO

My suggestion is a simple one. Replace the very large amount of
permanently monetized securities now held by the Fed (perhaps 25
or 30 billion) with special Treasury issues bearing no maturity date.
This will eliminate the need for the Treasury to periodically refund
this portion of Federal debt. The chances of the Fed needing this
portion of the debt for monetary control purposes is very slight, but,
should a need arise, a reconversion of the special issues into marketable
issues could be easily arranged.

S tatem en t b y F e l ix E dgar W ormser, C onsulting M in in g E ngineer ,
G ree nw ich , C o n n .

I am of the opinion that the Federal Government should be prepared
to obtain the funds it needs through taxation, or borrowing from the
citizenry. I question whether it was the intent of the originators of
the Federal Reserve System to monetize public debt with the conse
quent serious monetary implications that lead to questions of monetary
policy as noted in your letter.
In any event I think that all governmental bodies, Federal, State,
county, and municipal, should always be prepared to pay interest on
the money they borrow. The Federal Government, as is well known,
happens to be in a unique governmental position in that it can print
and issue money, if it so desires, to pay its debts—fiat money—but
that does not mean it is desirable to do so although our history records
periods when it was done.
I am in hopes that someday your distinguished committee will come
to grips with the grave question of the quality of our dollar. I be
lieve you would wish, as I do, that our great Nation use the finest
kind of currency that has ever been devised through centuries of ex
perience. That being a reasonable premise, should we not return to the
use of a dollar redeemable in gold which obviously is superior to one
that is not redeemable ?
Moreover, I am tempted to ask, is any monetary system based upon
Government compulsion, such as the one we use today, consonant with
the basic American tradition of freedom ?
I hope you will excuse my emphasis on these monetary fundamentals
rather than supplying answers to your questions on monetary manage
ment.
O

Full text of The Federal Reserve Portfolio : Statements by Individual Economists: Materials Submitted to the Subcommittee on Economic Progress of the Joint Economic Committee, Congress of the United States

FRASER