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THE

FEDERAL RESERVE SYSTEM

Its Purposes and Functions

BOARD OF GOVERNORS
OF THE FEDERAL RESERVE SYSTEM
WASHINGTON 25, D. C.
1947

FIRST EDITION, 161,000 COPIES

First printing May 1939
Second printing June 1939
Third printing December 1939
Fourth printing January 1941
Fifth printing December 1941

SECOND EDITION

First printing November 1947

PRINTED I N U. S. A.
BY THE NATIONAL PUBLISHING COMPANY
WASHINGTON, D. C.

FEDERAL RESERVE BUILDING, CONSTITUTION AVENUE AT 20TH STREET, WASHINGTON, D.

TABLE OF CONTENTS
CHAPTER
I

PAGE

PURPOSE OF THE FEDERAL R E S E R V E

SYSTEM

The principal purpose of the Federal Reserve is to
regulate the supply, availability, and cost of money
with a view to contributing to the maintenance of a
high level of employment, stable values, and a rising
standard of living.
II

FUNCTION OF BANK RESERVES

In the regulation of the supply of bank credit, or
money, the Federal Reserve depends chiefly on its
ability to increase or decrease bank reserves, which
constitute the legally required basis of bank credit,
or money.
III

GENERAL METHODS OF REGULATION

The principal Federal Reserve methods of general
regulation of the volume of bank credit, or money, are
discounts for member banks, purchases and sales of
securities in the open market, and changes in reserve
requirements.
IV

SELECTIVE METHODS OF REGULATION

In addition to general methods of regulation the
Federal Reserve has special powers to regulate the
terms on which transactions in stock market securities
are financed and for a period during and immediately
after the war it had authority to prescribe terms on
which consumer credit could be extended.
V

STRUCTURE OF THE F E D E R A L R E S E R V E SYSTEM

All national banks and many State banks are members
of the Federal Reserve System. There are twelve
Federal Reserve Banks, each serving one of the
districts into which the country is divided. The
functions of the Federal Reserve are entrusted to the
Board of Governors of the Federal Reserve System,
the Federal Reserve Banks, and the Federal Open
Market Committee.

CONTENTS
CHAPTER

PAGE

RELATION OF FEDERAL RESERVE TO CURRENCY . 62
The Federal Reserve pays out currency in response to
public needs and absorbs redundant currency. Its
operations result in making the entire currency supply
elastic.

VII

RELATION OF FEDERAL RESERVE TO GOLD

Gold and Federal Reserve credit are the principal
sources of member bank reserves. Consequently gold
movements are reflected in changes in the demand for
Federal Reserve credit. Gold certificate holdings of
the Federal Reserve Banks set the limits of Federal
Reserve credit expansion.

VIII THE MONETARY EQUATION

Gold movements, currency in circulation, and Federal Reserve credit are the principal factors that
influence the volume of member bank reserves—the
basis of the money supply. The relationships among
these factors may be called the Monetary Equation.
IX

SERVICE FUNCTIONS OF THE FEDERAL R E S E R V E
BANKS

The twelve Federal Reserve Banks hold the legal
reserves of member banks, furnish currency for circulation, facilitate the collection and clearance of checks,
exercise supervisory duties with respect to member
banks, and are fiscal agents of the United States
Government.
X

BALANCE SHEET OF THE FEDERAL RESERVE BANKS 89
The credit operations of the Federal Reserve Banks
are reflected in their balance sheet. Comparisons for
different dates reflect changes in fundamental monetary
conditions.

BANKING AND MONETARY AGENCIES OTHER THAN
THE FEDERAL RESERVE
101
There are several agencies other than the Federal
Reserve with functions and responsibilities in the
same general field but no other that has the primary
responsibility for regulating the money supply.

CONTENTS
CHAPTER

XII

PAGE

W A R SERVICE OF THE FEDERAL RESERVE

105

During the war the primary duty of the Federal
Reserve was to facilitate the financing of military
requirements and of production for war purposes.

XIII

111

SUMMARY

The Federal Reserve as it operates at present is
the product of constant adaptation to changing conditions. It has to deal today with monetary problems
that are far different from those that occasioned its
establishment.
PUBLICATIONS OF THE BOARD OF GOVERNORS
OF THE FEDERAL RESERVE SYSTEM
116
INDEX

119

vii

FOREWORD

Central banking is essential to the economic stability
and progress of any modern country. The central
banking organization may be a single bank, as in
England, or a system of regional banks with a national
governing body, as in the United States. The main
central banking function, however, is similar in all
countries. It is to endeavor, within the powers granted
by law or vested by custom, to see that the money
supply is neither too large nor too small for the maintenance of stable economic progress. In the United
States the long-run objective of the Federal Reserve
System is to do its part in fostering monetary and
credit conditions favorable to sustained high employment, stable values, and a rising level of consumption.
Federal Reserve operations are subject to constant
adaptation to changing conditions; in their daily routine they are rather complex and replete with technicalities that cannot be presented fully in brief compass.
Nevertheless it is believed that no essentials have been
neglected in this short and simplified account of purposes and functions.
This revision of the initial 1939 edition undertakes
to bring the original text up to date. While Federal
Reserve policy continues to be affected by the aftermath of war finance, this edition is primarily concerned
with the System's responsibilities and functions in

FOREWORD

peacetime. In so far as possible discussion of special
wartime functions has been reserved for one chapter
near the end of the book.
E. A. Goldenweiser, for many years Director of the
Division of Research and Statistics of the Board of
Governors and now a member of the Institute for
Advanced Study at Princeton, New Jersey, is primarily
responsible for the preparation of this volume. Bray
Hammond and other members of the staff of the Board
of Governors, who prepared the first edition, have also
contributed to the revision.
T H E BOARD OF GOVERNORS OF THE
FEDERAL RESERVE SYSTEM

Washington, D. C.
November 21, 1947

CHAPTER I
PURPOSE OF THE FEDERAL RESERVE SYSTEM
The principal purpose of the Federal Reserve
is to regulate the supply, availability, and cost
of money with a view to contributing to the
maintenance of a high level of employment,
stable values, and a rising standard of living.

N December 23, 1913 President Woodrow Wilson
signed the Federal Reserve Act establishing the
Federal Reserve System. Its original purposes, as conceived by its founders, were to give the country an
elastic currency, to provide facilities for discounting
commercial paper, and to improve the supervision of
banking. Over the years the System has developed a
broader objective, namely, to help prevent inflations
and deflations, and to do its share in creating conditions favorable to sustained high employment, stable
values, and a rising level of consumption. This broader
objective was well stated by President Roosevelt when
the new Federal Reserve Building was opened in
October 1937: "I dedicate this building to progress
toward the ideal of an America in which every worker
will be able to provide his family at all times with an
ever-rising standard of comfort." The Federal Reserve
System is dedicated to this ideal.
The reader may wonder what connection there is
between employment, wages, the standard of living,
and the Federal Reserve System. The Federal Reserve
may seem to be a remote institution, dealing exclusively with bankers, and serving them in some mysterious way. If this is the reader's frame of mind, he

THE FEDERAL RESERVE SYSTEM

needs only to look in his pocketbook to see whether
he has a Federal Reserve note, or, for that matter, any
other piece of money. Seven-eighths of the country's
currency is in the form of Federal Reserve notes and
the Federal Reserve System, through its influence on
the money supply, has an influence on every person
in the country. The influence of the Federal Reserve,
however, is not limited to its power to issue Federal
Reserve notes. It extends to the money supply as a
whole, by far the larger part of which consists of bank
deposits. It is clear that an institution which can
influence the money supply is of importance to everyone. This book is written for the purpose of describing the ways in which the Federal Reserve System influences changes in the money supply and how it
carries out its other functions.
Before the establishment of the Federal Reserve
System the supply of money was limited and did not
respond to changes in the country's needs. Banks in
smaller cities and rural regions maintained balances
with banks in larger cities, which they were permitted
to count as reserves. A very large volume of these
reserve balances was maintained in New York and
Chicago. Many banks, furthermore, as a matter of
convenience and custom and as a means of utilizing
idle funds, kept balances in the financial centers over
and above their legal requirements. New York,
Chicago, and St. Louis were designated as central
reserve cities, and national banks in these places were
required to maintain all their legal reserves in the
form of cash in their own vaults.
Under these circumstances, when banks throughout
the country were pressed for funds by their depositors and borrowers, the demand converged on a

PURPOSE OF THE FEDERAL RESERVE

few banks situated in the financial centers. In ordinary times the demand was not excessive, for while
some out-of-town banks would be drawing down their
balances, others would be building theirs up. But at
times when business was unusually active the demand
became widespread and intense. It was particularly
acute during the crop-moving season. At such times
banks all over the country would call on banks in the
financial centers for funds, which the city banks were
to supply and charge to the reserve balances of the
country banks. Because no facilities for obtaining
additional funds were available to the city banks, the
situation would become very tight. To meet the outof-town demand the banks in the financial centers
would sell securities and call loans or refuse to renew
existing loans or make new ones, with the result that
security prices would fall, interest rates would rise
sharply, loans would have to be liquidated, and borrowing would become difficult.
Panics and crises of this kind were apt to occur
every few years. The problem had been under public
discussion and study for a long time when, following
a crisis of unusual severity in 1907, Congress appointed a National Monetary Commission for the purpose of determining what should be done. There was
active and thorough consideration of the question for
several years and Congress, though it greatly modified
the plan recommended by the Commission, eventually adopted legislation embodying the results of study
both by the Commission and by other authorities inside and outside Congress. This legislation is the
Federal Reserve Act, which became law on December
23, 1913 and provided machinery by which varying
demands for money by the public could be met.

THE FEDERAL RESERVE SYSTEM

Practically every modern country has a central
bank for the performance of functions corresponding
to those performed by the Federal Reserve System.
In England it is the Bank of England, which has been
in existence since the end of the seventeenth century;
in France it is the Bank of France, established by
Napoleon I; and in Canada it is the Bank of Canada,
which began operations in 1935. In the United States
there is a regional system of twelve Federal Reserve
Banks, and the coordination of their activities is
effected through the Board of Governors in Washington.
The duties of the Federal Reserve, in addition to
the regulation of the money supply, include functions
that relate primarily to the maintenance of regular
services for the member banks of the Federal Reserve
System, the United States Government, and the public. These services are principally the following: holding member bank reserve balances; furnishing currency
for circulation; effecting telegraphic transfers of funds;
facilitating the clearance and collection of checks;
examining and supervising State member banks and
obtaining reports of condition from them; collecting
and interpreting economic information bearing on
credit problems; and acting as fiscal agents, custodians,
and depositaries for the Treasury and other governmental agencies.
Since the principal function of the Federal Reserve
is to regulate the money supply, the following three
questions should be answered in general terms at the
outset: (1) What constitutes the money supply? (2)
How do changes in this supply affect the lives of the
people? and (3) By what means does the Federal Reserve regulate this supply?

PURPOSE OF THE FEDERAL RESERVE

(1) What constitutes the money supply? From the
point of view with which this book is concerned the
money supply consists of all kinds of paper money
and coin that are in circulation and of deposits held
by the banks for their depositors. That paper money
and coins (currency) are a part of the money supply
needs no elaboration or explanation. A statement of
the composition of our currency will be given later.
The reason that bank deposits are also included in the
money supply is not far to seek. When a person has
$10 in his pocket and $100 in the bank he is in a position to spend $110 at any time. These two kinds of
money represent his cash resources; they serve the
same general purpose and they can be converted into
each other at any time; that is, currency can be converted into a bank deposit by taking it to a bank, and
a bank deposit can be converted into currency by taking it out of a bank. The amount of currency and of
deposits in June 1947 is shown below (in billions of
dollars):
Paper money and coin (currency)
Bank deposits:
Demand
Time

28
83
56

It will be seen that the amount of bank deposits is
much greater than the amount of currency. We have
long since acquired the habit of keeping most of our
money in the banks and of making most of our payments by drawing checks on our deposits with the
banks. Our habits in this respect, however, change
from time to time. Sometimes we keep more cash and
sometimes less. Such changes in money habits have
certain technical consequences to be referred to later.
For a general idea of the functions of the Federal

THE FEDERAL RESERVE SYSTEM

Reserve, however, the two kinds of money, pocket
money and bank money, should be considered together, because both kinds originate in bank credit,
over the volume of which the Federal Reserve exerts
a regulatory influence. Because bank deposits constitute the major part of our money supply, and because
both deposits and currency are closely related to loans
and investments of banks in a manner described later,
the phrases "money supply" and "volume of bank
credit" as used in this study generally mean the same
thing, namely, the means of payment owned by the
people of the country.
(2) How do changes in the supply of money affect
the lives of the people? Everyone believes that he is
better off financially if he has more money. But more
concretely the question of whether the supply of
money is adequate depends on whether the manufacturer has or can get enough money at a reasonable
cost to buy his raw materials and pay the wages of
his employees, whether the farmer has enough
money or can borrow enough to finance his operations, whether the merchant has or can get enough
money at a nonprohibitive rate to lay in a stock of
goods, whether consumers as a group have enough
money to buy what they require and what is produced. When money is scarce or hard to get, or costs
too much, factories and stores may curtail operations and lay off employees. Diminished wages cause
hardship to workers, who curtail their purchases; this
makes it still more difficult for the merchants, who reduce their orders for goods. Manufacturers in turn
find it necessary to lay off more workers. A serious
depression, unemployment, and distress may follow.
The course of events leading to the reverse of these

PURPOSE OF THE FEDERAL RESERVE

developments is similar. If consumers possess and
are prepared to spend so much money that they try
to buy more goods than the manufacturers can
produce by manning their plants to capacity,
an increase in the supply of money in the hands of
consumers cannot add to the country's output. It can
only bid up prices, that is, make purchasers pay more
for the same amount of goods. If merchants and
others tried to buy more goods than usual, so as to
profit by the rise in prices, manufacturers might be
induced to try to expand their plants, thus bidding
up the prices of construction materials and wages. No
one profits by these advances because production costs
go up as much as consumer prices and the cost of
living as much as wages. In the end, the spiral breaks
at some point, perhaps because prices get so high that
consumers, even though many of them receive higher
wages, can no longer buy the goods produced. Then a
downward spiral develops, and the higher values have
risen on the upswing, the more abruptly and lower
they are likely to fall on the down turn. Unemployment and distress will follow.
These are the ways in which excessive changes in
the money supply can affect the lives of the people. The story is oversimplified in that it does not
include all the factors that affect the level of economic
activity, but it serves to indicate the tendencies that
may develop if money is too plentiful, too cheap, or
too easily obtainable, or if it is too scarce, too dear, or
too hard to get. It is by influencing the supply, cost,
and availability of money that the Federal Reserve
has an influence on the lives of the people.
(3) By what means does the Federal Reserve influence the money supply? This is the principal subject

THE FEDERAL RESERVE SYSTEM

of this book and the main points should be stated
briefly at the outset. Practically all of the money we
use reaches us, directly or indirectly, through the
banks. We may receive our pay in cash in an envelope,
but the firm which pays us will have cashed a check
at the bank before making up its pay roll. Therefore,
the supply of money in the country depends almost
entirely on the ability of banks to meet the monetary
requirements of industry, trade, agriculture, and other
sectors of economic life. The ability of banks to meet
the money needs of the people depends in turn on
the amount of reserves they hold. This amount is
affected by Federal Reserve operations. Banks can
lend and invest money only in proportion to the
reserves at their disposal. The way the system of
reserves works, and the fact that under it our banks
can lend in the aggregate several times as much
as they have in reserves, will be discussed later.
What needs to be understood from the beginning is
that the Federal Reserve, through the determination
of the cost and other conditions on which banks can
obtain additional reserves, can influence the amount of
money that they may pass on to the public through
loans and investments. The Federal Reserve thus has
the power to influence the country's money supply.
In an economy like ours, where practically all transactions are settled in money, regulation of the money
supply gives the Federal Reserve great powers and
places on its management a grave responsibility. There
are serious limitations on this power and many factors
that affect the flow of money, as distinguished from
its supply. The Federal Reserve alone cannot assure
the maintenance of satisfactory economic conditions.
These depend, in addition to the supply of money, on

PURPOSE OF THE FEDERAL RESERVE

the demand for it, over which the Federal Reserve can
exert only an indirect and limited influence. They also
depend on a great variety of other things, including
governmental policies in regard to expenditures, taxes,
and debt; the distribution of income among different
groups of the population; the bargaining strength and
policies of management and labor and of agriculture
and other sectors of the economy; the power of monopolies; the course of foreign trade and foreign investment; and the prospects for peace. The Federal Reserve has little power to influence the flow of money
into particular channels or to insure that it will be
used at all. But the money supply, which the Federal
Reserve can influence, is of itself an important factor
in the people's economic life. The country relies on
the Federal Reserve for such regulation of the money
supply as will facilitate the maintenance of stable economic conditions, high employment, and a rising
standard of living.

CHAPTER II
FUNCTION OF BANK RESERVES
In the regulation of the supply of bank credit,
or money, the Federal Reserve depends chiefly
on its ability to increase or decrease bank reserves, which constitute the legally required
basis of bank credit, or money.

OMMERCIAL banks, like other business organiC
zations but unlike the Federal Reserve Banks, are
in business for the purpose of making money. When
investors put their money in the capital stock of a
bank they expect to earn a return on their investment
and look to the managers of the bank to make this
return as large as possible within the limits of safety.
The bulk of a bank's earnings comes from the returns
it receives from loans to customers and holdings of
securities. Consequently it is usually a bank's policy to
put as much as possible of the money it receives as
capital and as deposits into loans and investments.
Every bank is required by law, however, to hold as
reserves an amount of uninvested funds equal to a
designated portion of its deposits.
Historically, reserve requirements were imposed by
law for the purpose of protecting depositors—to assure
that banks did not expand credit to the point that
they could not meet their depositors' withdrawals.
This was before establishment of the Federal Reserve
System when there was no central bank at which a bank
could discount paper in order to obtain additional
reserves in time of temporary need. Consequently
reserve requirements, although they restrained credit
expansion, did not protect depositors; the banks could

FUNCTION OF BANK RESERVES

not pay out to their depositors the funds they were
required to keep as reserves. Other ways of protecting
depositors have since been developed and bank reserves
have come to be considered primarily as the medium
through which the money supply can be regulated.
It is because the Federal Reserve can influence the
volume of reserves available to banks that it can
influence the money supply.
If a bank is a member of the Federal Reserve System, at the present time (June 1947) it is required to
keep the following percentages of its deposits as
reserves:
Time deposits, all member banks
Demand deposits:
Reserve and central reserve city banks
Other member banks

6
20
14

On the average these percentages work out for all
member banks at about 15 per cent. As will be explained later, reserve requirements are subject to
change by the Board of Governors of the Federal
Reserve System within certain limits. Banks that are
not members of the Federal Reserve System are subject
to reserve requirements that vary from State to State.
Bank reserves are the basis of our money system.
Their operation is described below in general and somewhat simplified form. When a member bank receives a
deposit of $100, in currency or in the form of a check on
another bank collectible through clearing, it must
deposit $15 with a Federal Reserve Bank as required
reserves against the deposit and is free to lend or
invest the remaining $85. This percentage of reserves
represents the general average required under existing
law and regulation, taking all member banks and all
types of deposits into consideration. When there is

THE FEDERAL RESERVE SYSTEM

an adequate demand for loans from customers or a
supply of suitable securities in the market, the bank
will invest practically all of the $85 and will keep as
reserves only the $15 prescribed by law. In practice
the bank will keep a little more than the $15 because
the law requires it to keep its entire legal reserve with
the Federal Reserve Bank, and in addition the bank
needs some cash in its till to meet the demands of
customers without delay. But since currency can
always be obtained promptly from the Federal Reserve
the amount kept in bank tills is relatively insignificant.
For purposes of exposition it may be assumed, therefore, that all of the money above the required 15 per
cent is lent or invested by the banks. In practice this
was not the case during the depression and the period
prior to our entry into the war, largely because gold
imports were providing reserves and the business
situation was not conducive to the expansion of loans.
More recently banks once more tend to make use of
nearly all their available funds.
It is on the relationship between the volume of reserves and the amount of bank lending that the Federal Reserve chiefly depends for regulating the supply
of money. Methods possessed by the Federal Reserve
for influencing the amount of bank reserves will be
described in the next chapter. The present chapter
attempts to describe how changes in bank reserves
affect the volume of money.
Assume that a bank has $8,500 of loans and investments, $1,500 of reserves with the Federal Reserve,
and $10,000 of deposits, leaving out for the present
other items in the balance sheet. The bank's ratio
of reserves to deposits is at the legal minimum of 15
per cent. Consequently, if a customer wants to borrow,

FUNCTION OF BANK RESERVES

the bank cannot meet his needs out of its own resources because it has no funds available for lending.
It must obtain additional funds if it wishes to make
additional loans.
For the purpose of describing the operation of the
banking system, let us assume that there is only one
Bank and that all the people keep their deposits with
this Bank and go there to obtain all their bank loans.
Let us give the Bank enough resources to make it
possible to think of it as representing all the banks
in the country. Let us assume that the relevant items
in its balance sheet are as follows (in billions of
dollars):
Loans and investments
85
Reserves with the Federal Reserve Banks
15
Deposits
100
Ratio of reserves to deposits
15 per cent

The Bank would not be in a position to make any
additional loans or investments: its funds would be in
use up to the limit permitted by law. Let us assume
that the Federal Reserve believes that additional
loans will be in the public interest and that it adds
10 billion dollars to the Bank's reserves in a manner
that also increases the Bank's deposits by the same
amount (using one of the methods described in the
next chapter). Then the simplified balance sheet of
the Bank would be (in billions of dollars):
Loans and investments
Reserves
Deposits
R a t i o of reserves to deposits.

85
25
110
. . . . . . . 22.7 per cent

The Bank would have a higher ratio of reserves to deposits (22.7 per cent) than is required by law (15 per
cent). Therefore, it could make additional loans and
investments. A little figuring will show that the Bank

THE FEDERAL RESERVE SYSTEM

has the 16.5 billion dollars of reserves required for
its deposits of 110 billion dollars and also has 8.5 billion
dollars of reserves above requirements, or excess reserves. Let us assume that the public is eager to get
additional money and wants to borrow as much as the
Bank will lend. Let us assume also that the proceeds
of the loans will be kept on deposit with the Bank.
This is not a far-fetched assumption, because borrowers
most likely want the money in order to pay other
depositors in the Bank. While there will be transfers
from one deposit to another, no deposits will be withdrawn from the Bank, and the total of deposits will
remain at the higher level made possible by the increase in reserves. Another calculation will show that
on the basis of the 8.5 billion dollars of excess reserves
the Bank can add 56 billion dollars to its loans and
investments. The Bank's balance sheet would then be
(in billions of dollars):
Loans and investments
Reserves
Deposits
Ratio of reserves to deposits

141
25
166
15 per cent

This simplified picture of bank transactions indicates
that a deposit of 10 billion dollars of reserve money
with the Bank gave rise to a growth of 56 billion dollars
in loans and investments and of 66 billion in deposits.
This calculation, which leaves out of account many
complications, shows what a powerful instrument Federal Reserve action can be. It can provide the basis
for an increase in the money supply not merely by the
amount that it adds to the Bank's reserves, but by
about six times that amount. This is true because
there can be a multiple expansion of deposits on the
basis of the additional reserves.

FUNCTION OF BANK RESERVES

Consider now the course of events in case the Federal
Reserve decides that there is too much money and that
the amount should be diminished. Suppose that it
reduces the Bank's reserves by 5 billion dollars, using
a method that will reduce deposits by the same
amount. The balance sheet will then read (in billions
of dollars):
Loans and investments
Reserves
Deposits
Ratio of reserves to deposits

85
10
95
10.5 per cent

The Bank would be deficient in reserves to the extent
of 4.5 per cent of deposits, or more than 4.2 billion
dollars. In order to comply with the law the Bank, if
it were not able to call on the Federal Reserve, would
have to call loans or sell investments, and thus absorb
deposits to the extent of about six times its deficiency
in reserves, that is, by 29 billion dollars. If its depositors repaid loans or repurchased 29 billion dollars of
investments by drawing on their deposits, the result
would be (in billions of dollars):
Loans and investments
56
Reserves
10
Deposits
66
Ratio of reserves to deposits
15 per cent
(the legally required minimum)

Once more we see the powerful effect of Federal
Reserve action, this time in the direction of contraction. By reducing the Bank's reserves by 5 billion
dollars the Federal Reserve caused a liquidation of 29
billion of loans and investments and a reduction of 34
billion in deposits, or money.
It is because of the fact that the Federal Reserve
by adding to the Bank's reserves can enable it to in

THE FEDERAL RESERVE SYSTEM

crease its loans and its deposits by several times the
amount added that Federal Reserve dollars are often
called "high-powered" dollars as compared with ordinary deposit dollars or "low-powered" dollars.
In our exposition so far we have considered one
Bank, large enough to represent all the banks in this
country, as doing all the banking business. We have
assumed that the Bank will lend or invest as much
money as the law will permit. This has often been
true of the banking system in the past, and is approximately the situation at the present time (June 1947).
We have also assumed a uniform reserve requirement
of 15 per cent, which represents the current average
of the requirements on both types of deposits, time
and demand, in all groups of banks, and we have
assumed that all the money lent by the Bank will be
kept on deposit. To the extent that the public chooses
to withdraw some of the money in currency, this will
not be the case. In a later chapter, changes in the publics demands for currency from time to time will be described. It is sufficient for the purposes of this chapter
to know that the people's demand for currency changes
in response to business conditions and is not affected
directly by the amount of loans made by the banks.
It is, therefore, proper to disregard currency withdrawals in a description of the way bank credit expands
and contracts.
The process of reserve operation in the simplified
situation in which one Bank does all the banking business may now be transferred to the more complex
situation in which thousands of banks make loans and
investments and hold deposits.
It has been seen that our consolidated Bank can
expand its loans and investments by as much as 56

FUNCTION OF BANK RESERVES

billion dollars if the Federal Reserve adds 10 billion
dollars to its reserves. No individual bank can do that
because borrowers may wish to take the money out
of the lending bank. In fact, a borrower is more likely
than not to use the deposit created by his loan to write
checks to pay various people. He has borrowed the
money presumably for the purpose of making payments; he would not ordinarily undertake to pay interest on a bank loan for the purpose of carrying an
unused deposit account. Consequently, a bank does
not lend more than it has in free funds; if it did, it
would not be able to honor its depositors' checks. How,
then, can the banking system lend at least six times
as much as it obtains from the Federal Reserve if each
individual bank of which the banking system is composed cannot lend any more than it receives? Is this
not a paradox?
What appears to be a paradox is really a simple
and understandable matter. In substance what happens is similar to what happens when a given amount
of money, by being passed from hand to hand, buys
several times as much as its face value. In order to
establish a parallel between the two, let us assume
that all of the people through whose hands the money
passes will put aside 15 per cent of all their receipts as
savings and immediately spend the other 85 per cent.
The first person receives $100; in accordance with the
condition just laid down, he puts aside $15 and spends
$85—let us say to buy clothing. The tailor who
receives the $85 puts away 15 per cent of it and
spends $72.25—let us say to buy furniture. The furniture dealer saves 15 per cent and spends $61.41.
This process continues, as is indicated in the accompanying table, until in the end the entire original

THE FEDERAL RESERVE SYSTEM

$100 has been put aside as savings and articles to the
total value of $566 have been bought. The amount
received by all the people in the aggregate was $666,
the value of the articles bought was $566, and the
savings were $100. This corresponds closely to what
happens in the case of the banking system. On the
basis of $100 added to reserves the total amount of
deposits increases by $666, total loans and investments
THE MULTIPLYING CAPACITY OF MONEY IN BANK OR COMMODITY
TRANSACTIONS

Amount received Amount spent Amount set
or deposited
or lent
aside
Transaction

1
2
3
4
5

$100.00
85.00
72.25
61.41
52.20

$ 85.00
72.25
61.41
52.20
44.37

$ 15.00
12.75
10.84
9.21
7.83

6
7
8
9
10

44.37
37.71
32.05
27.24
23.15

37.71
32.05
27.24
23.15
19.68

6.66
5.66
4.81
4.09
3.47

11
12
13
14
15

19.68
16.73
14.22
12.09
10.28

16.73
14.22
12.09
10.28
8.74

2.95
2.51
2.13
1.81
1.54

16
17
18
19
20

8.74
7.43
6.32
5.37
4.56

7.43
6.32
5.37
4.56
3.88

1.31
1.11
.95
.81
.68

Total for 20

$640.80

$544.68

$ 95.12

25.86

21.98

4.88

$666.66

$566.66

$100.00

Additional transactions
Grand total

by $566, and reserves by $100, the original amount
received. The power of money to do business in a total

FUNCTION OF BANK RESERVES

amount several times as large as the sum used to
transact the business is due to the fact that money
passes from hand to hand and in so doing continues
to pay for purchases.
There is one difference between bank transactions
and commodity transactions. In the case of commodities the net result is final. The purchasers own the
articles bought and their savings and have no further
obligations. In the case of banks, the transactions result in loans and investments, which represent obligations due to the banks, and also in deposits, which
represent bank liabilities to the public. Aside from
the fact that banking transactions create two sets of
obligations that cancel each other, while commodity
transactions do not, the two cases are parallel. The
multiplying capacity of money arises from the fact
that it is universally acceptable and passes from hand
to hand, each time paying for a transaction. In principle, the bank case does not differ from the commodity case. The arithmetic applicable to both cases is
presented in the table on the opposite page.
This analysis has an important bearing on the question of the source of power to create money. It is
sometimes maintained that, since the banking system can lend several times as much as it obtains in
reserves, it creates money by a stroke of the pen. In
the light of the preceding description it is clear that
this statement is not correct in relation to any single
bank. An individual bank can lend only such money
as it acquires from its stockholders, its depositors, or
the Federal Reserve. In the meantime the money,
after it leaves the hands of the first bank, continues
to do business as it passes from bank to bank or from
person to person.

THE FEDERAL RESERVE SYSTEM

What is important to Federal Reserve operations
is that the issuance of a given amount of what has
been termed high-powered money by the Federal Reserve may create a volume of ordinary money that is
several times as large as the amount issued, and that,
on the other hand, Federal Reserve withdrawal of a
given amount of high-powered money may result in
liquidation of several times that amount of loans and
investments and of deposits, that is, of ordinary
money. It is this leverage which our banking procedure and law give to the Federal Reserve that results
in its power to cause large changes in the total money
supply by undertaking much smaller operations.
These are the principles on which our banking system operates. In practice an individual bank does not
match one transaction against another. There is a
continuous flow of funds into the bank from its depositors, who bring checks on other banks and currency
to be added to their deposits. And there is a continuous outflow of funds as depositors write checks on
their own accounts or cash checks drawn on other
banks. The bank must constantly watch its deposits
and its reserves to make sure that its reserves are sufficient to comply with legal requirements. The occasion
to borrow from the Federal Reserve Bank usually
arises, not from a desire to make an additional loan
when the bank has no funds to spare, but from the
need to replenish reserves which have declined below
the required level as the net result of all the transactions that have gone through the bank.
There is another point that needs to be clarified.
While in the practical workings of the banking system
the bulk of deposits originates in the granting of loans
or the purchase of investments by banks, each indi-

FUNCTION OF BANK RESERVES

vidual banker knows from day-to-day experience that
deposits are brought to him by his customers, and his
ability to make loans and investments arises largely
from the receipt of his depositors' money. This is
another apparent banking paradox which causes much
confusion. The fact is that deposits originating in
loans and investments move from one bank to another
in the course of business and seldom stay with the
bank of origin. The series of transactions is as follows:
when a banker makes a loan he credits the amount to
the borrower's deposit account; the depositor writes
checks against it in favor of various people who deposit
them at their banks. Thus the lending banker is likely
to retain or receive only a small portion of the deposits
he creates, while a portion of the deposits created by
other banks is brought to him by his customers. Hence
both statements are generally speaking true; taking
the banking system as a whole the bankers originate
deposits by making loans and investments, but each
individual banker's ability to lend or invest arises
largely from deposits brought to him by his customers.
While a bank must watch its reserve balance with
the Federal Reserve Bank to make sure that it is
large enough, this does not mean that the balance
remains unused. Under Federal Reserve rules reserve
requirements are related to reserve balances maintained on the average over a period (a week for central
reserve and reserve city banks and half a month for
other member banks). While maintaining his average
reserve balance at or above the required minimum, a
banker may make constant use of his account.
Through it he can settle adverse balances with
other banks through the clearings and transfer funds
to other cities. He uses his reserve account with the

THE FEDERAL RESERVE SYSTEM

Federal Reserve Bank in much the same way that a
depositor uses his checking account. But he must be
careful to see that over the reserve period the account
averages at or above the amount required in relation
to his deposits.
MEMBER BANK RESERVE BALANCES

It has been stated that banks as business organizations endeavor to use all their available funds in
profitable ways and keep as reserves only the minimum required by law. During most of the life of the
Federal Reserve, member banks have used practically
all their funds and have had practically no excess reserves. During the depression and the war period,

FUNCTION OF BANK RESERVES

however, conditions were different, as is brought out
by the accompanying chart.
In the thirties there was a large movement of gold
into the country which increased the reserves of
member banks. At the same time there was only a
limited demand for loans acceptable to banks. Consequently, the banks had a considerable volume of
reserves in excess of requirements, or excess reserves.
As credit expanded during and after the war, as currency demand increased rapidly, and as reserve requirements were increased in a manner described in
the next chapter, excess reserves declined and at the
present time (June 1947) they once again constitute
a relatively small proportion of total reserves.

CHAPTER III
GENERAL METHODS OF REGULATION
The principal Federal Reserve methods of general regulation of the volume of bank credit,
or money, are discounts for member banks,
purchases and sales of securities in the open
market, and changes in reserve requirements.

T has been shown how changes in bank reserves
influence the volume of bank credit or money. It is
the purpose of this chapter to describe the three
methods by which the Federal Reserve may influence
the amount of bank reserves. These methods are discounts, open market operations, and changes in reserve requirements.
Discounts
When a bank has lent or invested all of its available
funds and has no reserves above legal requirements, it
may obtain additional reserves by turning over a part
of its portfolio to a Federal Reserve Bank. It may
rediscount one or more of its customers' notes with a
Reserve Bank, or it may give its own note to a Reserve Bank, using paper from its own holdings as
collateral. The second procedure, known as an advance, differs from the first in form only, not in substance. In either case the Reserve Bank gives the
member bank credit in its reserve account for the
amount of the accommodation and thereby increases
the legal reserves of the member bank. For this service
the Reserve Bank charges interest at a rate which is
known as the discount rate.

GENERAL METHODS OF REGULATION

Originally the Federal Reserve Act prescribed rigid
limitations on the kind of paper that was eligible for
obtaining Federal Reserve credit. All obligations of
the United States Government were eligible, and such
commercial paper as represented loans of limited maturities to meet the current needs of commerce, industry, or agriculture. Loans made for investment or speculative purposes, that is, for carrying or trading in
investment securities other than bonds and notes of
the United States Government, were not eligible. Experience showed, however, that these limitations were
not in themselves effective in preventing too much
lending in prosperous times, when eligible paper was
plentiful, and that they hindered adequate assistance
by the Federal Reserve to member banks in times of
depression, when eligible paper was scarce. Consequently, the limitations were in effect removed by law
and at present a Reserve Bank may make an advance
to a member bank on its note secured by any collateral
satisfactory to the Reserve Bank. In case the collateral
is not of the kind described as eligible, however, the
Reserve Bank must charge an extra 1/2 per cent or
more of interest.
When a member bank applies for accommodation,
a Federal Reserve Bank is under no obligation to
grant the credit; its decision is expected to rest on its
judgment concerning the applicant's need and the use
to be made of the additional funds. In the language of
the law: "Each Federal Reserve Bank shall keep itself
informed of the general character and amount of the
loans and investments of its member banks with a
view to ascertaining whether undue use is being made
of bank credit for the speculative carrying of or trading in securities, real estate, or commodities, or for any

THE FEDERAL RESERVE SYSTEM

other purpose inconsistent with the maintenance of
sound credit conditions; and, in determining whether
to grant or refuse advances, rediscounts or other credit
accommodations, the Federal Reserve Bank shall give
consideration to such information."
A member bank with satisfactory collateral can
usually obtain the desired accommodation from a
Federal Reserve Bank. The policy of the Federal
Reserve in encouraging or discouraging borrowing by
member banks expresses itself principally not in granting or refusing loans but in the rate charged for discounts and advances. Traditionally, when the Federal
Reserve was of the opinion that expansion of the
money supply would be desirable in the public interest,
it set its discount rate at a low figure in relation to
prevailing market rates. When it believed that further
expansion would be harmful, it raised the discount
rate. Hence the discount rate in effect at the Federal
Reserve Banks, and particularly a change in this rate,
has at times been an important indication of Federal
Reserve policy; a high rate or an advance in rate indicated that there appeared to be danger of too much
money and inflation; a low rate or a reduction in the
rate indicated that in Federal Reserve opinion an
increase in the supply of money would be in the
public interest. The discount rate, therefore, not
only has represented the cost of accommodation at
the Federal Reserve Banks but has reflected Federal
Reserve judgment as to whether there was too much,
too little, or the right amount of money for doing the
country's business.
In many periods since the establishment of the
Federal Reserve System the discount rate has been the
principal method of expressing Federal Reserve policy

GENERAL METHODS OF REGULATION

with respect to the money supply. For a number of
more recent years, however, first as the result of an
inflow of gold from abroad, which gave member banks
additional reserves without recourse to borrowing from
the Reserve Banks, and later as the result of wartime
developments to be discussed later, discounts for
member banks have been relatively small and the
discount rate has been of relatively minor importance
in Federal Reserve policy. Nevertheless, discounts and
the discount rate can have an important bearing on
the money supply. Their influence is increased by the
customary reluctance of member banks to show indebtedness on their balance sheets.
Open Market Operations
Open market operations as a method of influencing
the money supply differ from discount operations
primarily because they are undertaken at the initiative
of the Federal Reserve, not at the initiative of the
member banks. In the case of discounts the Federal
Reserve can do no more than establish a discount
rate until a member bank applies for credit accommodation. In the case of an open market operation the
Federal Reserve decides of its own accord that there
is too little or too much money and proceeds to buy
or sell in the open market—i.e., from or to any one
who is in the market—such obligations as it is permitted by law and chooses to acquire. Obligations of
the United States Government are the principal kind
of paper thus bought or sold.
The process through which open market operations
by the Federal Reserve are reflected in the volume of
member bank reserves may be briefly described as
follows: if the Federal Reserve decides to buy 100

THE FEDERAL RESERVE SYSTEM

million dollars of United States Government securities,
it notifies the dealers in such securities and they supply the securities to the Federal Reserve; in payment the dealer receives a Federal Reserve Bank's
check. The dealer deposits the check with a member
bank, which in turn deposits it with a Federal Reserve
Bank. The result is that the Reserve Bank has added
100 million dollars to its holdings of United States
Government securities, and has added the same
amount to the reserve deposit of some member bank.
How this amount of additional reserves may result
in a growth of about six times that amount in the
money supply has been described in the preceding
chapter.
If the Federal Reserve decides that it wishes to
reduce the amount of member bank reserves, and
through them the money supply, it sells Government
securities to a dealer. In payment the dealer draws a
check on a member bank in favor of a Federal Reserve
Bank, and the Reserve Bank deducts the amount from
the reserve deposit of the member bank. If the amount
is 100 million dollars, the result is a decrease by that
amount in Federal Reserve holdings of United States
Government securities and a corresponding decline in
the member bank's reserves. As has been indicated in
the preceding chapter, such a decrease in reserves, if
not met in some other way, would necessitate a reduction of about six times that amount in member bank
deposits and hence in the money supply.
Member banks, however, would be reluctant to call
enough customers' loans or sell enough securities to
cause an extreme contraction in bank credit, and
the Federal Reserve would hesitate to insist on a
radical reduction in the money supply. What would

GENERAL METHODS OF REGULATION

probably happen is that member banks, finding themselves short of legally required reserves, would try to
replenish them at least in part by obtaining discounts
or advances from the Reserve Banks. The Reserve
Banks would generally grant such loans, at the discount rate. As a result, the Federal Reserve would
hold a smaller amount of Government securities and
a larger volume of discounts than before, while member banks would have a smaller volume of deposits
(because of the dealer's check) and would be in debt
to the Federal Reserve. For the sake of simplicity this
leaves out of account the reduction in required reserves
that would result from the decrease in member bank
deposits.
In this connection the member banks' reluctance to
show indebtedness, which has been mentioned before,
has an important bearing on the effects of open market
operations. If purchases by the Federal Reserve are
made at a time when member banks are substantially
in debt to the Federal Reserve, it is probable that
member banks will use at least part of the reserves
they acquire as the result of the purchases to reduce
their debt. On the other hand, as has already been
stated, the loss of member bank reserves resulting
from sales by the Federal Reserve in the open market
will probably be made up at least in part by additional
borrowing from the Federal Reserve.
Federal Reserve action in the open market, therefore, is not likely to result in a rapid multiple expansion or contraction of member bank deposits. Instead,
under ordinary conditions, it is likely to result in a
decline or an increase in member bank indebtedness,
with no immediate substantial change in member
bank reserves. But this does not mean that the action

THE FEDERAL RESERVE SYSTEM

would have no effect on the money supply. When
member banks are out of debt to the Federal Reserve
they are much more willing to make loans and investments and thus to increase their deposits; when they
are heavily in debt they not only are less willing to
make additional loans but are inclined to reduce the
volume of their loans and investments. They may
not call loans, but they will probably be less willing
to make new loans or to renew old ones as they come
due. And the Federal Reserve is in a position to
encourage this process by raising the discount rate.
Open market operations, therefore, work more
gently than would be the case if additions to or subtractions from member bank reserves through Federal
Reserve purchases or sales led to an immediate multiple expansion or contraction of bank deposits. They
are nevertheless a powerful influence on the money
supply because, by decreasing (or increasing) member
bank indebtedness, they tend to encourage (or discourage) expansion of deposits at member banks.
The accompanying chart shows how increases in
Federal Reserve holdings of United States Government obligations (that is, open market purchases) in
the past have been accompanied by declines in holdings of discounts, and, on the other hand, how decreases in security holdings (that is, open market sales)
have been reflected in increased holdings of paper discounted for member banks. In the past, the Federal
Reserve has tended to make complementary use of
these two instruments of credit policy.
Brief reference should be made to another element
in Federal Reserve credit which has not been important in recent years but was of considerable moment
in the past, namely, dealings in bankers' acceptances.

GENERAL METHODS OF REGULATION

A banker's acceptance is a draft, usually drawn by a
seller of goods against the buyer, which is "accepted"
by a bank so that the bank becomes primarily liable
SYSTEM HOLDINGS OF DISCOUNTS AND
UNITED STATES GOVERNMENT SECURITIES

on the instrument and lends its own credit to that of
the buyer. In this country most acceptances arise out
of exports or imports. A seller of cotton, for example,
may draw a draft payable in ninety days on a buyer
in Liverpool. The buyer may have an arrangement
with a bank in New York whereby the bank will accept
the seller's draft on the buyer, thus enabling the seller
to negotiate the draft, and the buyer will reimburse
the accepting bank upon maturity of the instrument. These instruments, known as acceptances
or bills, bear three signatures, those of the seller, the
buyer, and the accepting bank. They usually are
secured by goods in the process of shipment, and may
be accompanied by shipping documents. They are
considered to be paper of the highest quality.

THE FEDERAL RESERVE SYSTEM

The Federal Reserve Banks generally stand ready
to buy acceptances at a slight discount, that is, at a
discount rate slightly higher than the rate prevailing
in the open market. Such purchases are a form of
credit expansion intermediate between discounts for
member banks and open market purchases. They are
similar to discounts in that the initiative for their sale
to the Reserve Banks comes from member banks or
dealers, the Reserve Banks merely announcing the
rate at which they are willing to buy. On the other
hand, the purchase of acceptances is similar to open
market purchases in two respects: in both operations
the Federal Reserve will buy not only from member
banks but also from others, and neither operation
places the seller in debt. There is no indebtedness
added to the condition report of a member bank when
it sells an acceptance to a Reserve Bank. The member
bank has sold a bill, endorsed by it, which is reported
merely as a contingent liability. Consequently purchases of acceptances by the Reserve Banks do not have
the effect of borrowing by member banks; they do not
put the banks in debt and therefore do not make them
less willing to extend credit to their customers.
In recent years the volume of acceptances has become relatively small and the Reserve Banks have
purchased them only in minor amounts. Their place
in the financial system has been taken by three-month
Treasury bills. These bills are issued weekly by the
United States Treasury, usually at rates determined
by competitive bids. During the war the Federal
Reserve adopted the policy of purchasing all Treasury
bills offered at a fixed rate of % per cent, and of
allowing banks an option to repurchase bills sold at
the same rate. Member banks, particularly those in

GENERAL METHODS OF REGULATION

financial centers, tended to treat their Treasury bill
holdings as equivalents of cash, selling and repurchasing them to adjust their reserve positions in
response to current movements of funds. In the summer of 1947 the wartime policy of the Federal Reserve
with regard to Treasury bills was discontinued and
bill rates were once more permitted to find higher levels
in response to conditions in the market.
Source of Federal Reserve Lending Power

As has just been described, when the Federal Reserve makes a discount for a member bank or buys a
United States Government security in the market, it
gives credit for the proceeds to a member bank in its
reserve account. The member bank may use such
additions as reserves for its deposits or, if it happens
to be in need of additional currency to meet a public
demand, it may withdraw them in Federal Reserve
notes or other currency.
The question arises as to the source and the limits
of the Federal Reserve's lending power. The limits
are set by the legal requirement that Federal Reserve
Banks must hold a 25 per cent reserve in gold certificates against their notes in circulation and their deposits. Their combined liabilities for notes and deposits consequently must not exceed four times their
gold certificate holdings. Only in emergencies can
this requirement be suspended and only for short
periods and at penalty rates.
The source of Federal Reserve lending power is in
the System's authority to issue Federal Reserve notes
and to create bank reserves in an amount exceeding the
Federal Reserve Banks' holdings of gold certificates.
At present the authorized ratio is four to one. The

THE FEDERAL RESERVE SYSTEM

issue of notes is an act of creating money. It is for
this reason that, as will be explained later, notes are
issued to the Federal Reserve Banks by the Federal
Reserve Agent, a representative of the Federal Government. When a Federal Reserve Bank gives a
member bank credit in its reserve account for a discount, the basis is laid for the creation of additional
money through loans and investments by the banking
system. Member banks also give deposit credit to
customers who have obtained loans, but Federal Reserve transactions differ from member bank operations in two important respects: (1) member banks
are required by law to keep deposits with the Reserve
Banks, while depositors of member banks are legally
free to withdraw their deposits at any time, and (2)
the Reserve Banks can issue notes, while the member
banks cannot.
The answer to our question, therefore, is that the
lending power of the Federal Reserve Banks arises
from the authority given to them by law to create
money, and the limits of this power are set by the
requirement that their liabilities on notes and deposits
must not be in excess of four times their holdings of
gold certificates.
Changes in Reserve Requirements
Discounts and open market operations by the Federal Reserve Banks, as has been seen, result in changes
in the volume of member bank reserves. Changes in
reserve requirements, which are the third method of
regulating the money supply, have no direct influence
on the total of member bank reserves but affect the
amount of reserves that member banks must hold as
deposits with a Federal Reserve Bank, and conse-

GENERAL METHODS OF REGULATION

quently the amount available for lending or investing.
For example, when the reserve requirement is 15 per
cent, a member bank must keep in its reserve account
with a Federal Reserve Bank $15 out of every $100
of its own deposits, and has $85 left to lend or invest.
If reserve requirements were raised to 20 per cent,
the member bank would have to keep $20 uninvested
and have only $80 to lend, and if requirements were
reduced to 10 per cent, it would need to keep only $10
uninvested and would have $90 to lend or invest. Thus
a change in reserve requirements changes the rules
under which member banks must operate.
These are the effects of changes in reserve requirements on an individual member bank, but in addition
they change the rate at which multiple expansion will
operate. On a 15 per cent reserve requirement $100
of reserves will support bank deposits of $666, as was
shown in the table on page 18. On a 20 per cent basis
$100 will support $500 of deposits, and on a 10 per
cent basis it will support $1,000 of deposits. It will be
seen that changes in reserve requirements are an extremely powerful instrument for reaching the volume
of money through bank deposits.
Originally the Federal Reserve Act prescribed certain reserve requirements and made no provision for
changes by the Federal Reserve. The percentages in
effect on June 21, 1917, were:
Time deposits, all member banks
Demand deposits:
Central reserve city banks
Reserve city banks
Country banks

3
13
10
7

Central reserve cities now are New York and Chicago ;
in June 1947 there were about sixty reserve cities,
including most of the larger cities of the country; banks

THE FEDERAL RESERVE SYSTEM

outside of these cities are known for purposes of
determining reserve requirements as country banks.
Banking legislation empowering the Federal Reserve to change reserve requirements was enacted first
in 1933 and has not been changed extensively since it
was revised in 1935. As the law stands today (June
1947) the Federal Reserve has authority to increase
reserve requirements to twice the ratios stated in the
law and subsequently to reduce them to any level
that is not below these ratios. The range of discretion
and the requirements in effect at present are as follows
(in percentages):
Range
3 to 6

Time deposits, all member banks..
Demand deposits:
Central reserve city banks.... 13 to 26
Reserve city banks
10 to 20
Country banks
7 to 14

In effect,
June 1947
6
20
20
14

Changes in reserve requirements may be made applicable to any or all the groups of banks shown above
but must be uniform for all banks within a group.
Federal Reserve Bank lending power is in no way
affected by changes in member bank reserve requirements, even though they may change the demand for
Reserve Bank credit. They are reflected in changes
in the distribution of Federal Reserve Bank deposits
between the required and the excess reserves of
member banks.
Because changes in reserve requirements are a very
powerful instrument they are used only on infrequent
occasions. When changes are made they apply to all
the banks in a group, regardless of the reserve position
of the individual banks. As a matter of fact, even
when banks in the aggregate have a large volume of
excess reserves, there are sure to be some banks that

GENERAL METHODS OF REGULATION

have none. An increase in requirements makes it
necessary for such banks to acquire additional reserves either by reducing their loans and investments or by borrowing. Because of this effect on
individual banks, increases in reserve requirements
have been made only at times when the total
of excess reserves was so large that such deficiencies as resulted in individual cases were small. For
example, when requirements were raised by 50 per
cent in August 1936, member banks as a group had
excess reserves of more than 3.0 billion dollars; after
the increase in requirements they still had an excess of
over 1.8 billion dollars. In the spring of 1937, before
the first of a series of increases in requirements, member banks had more than 2.0 billion dollars of excess
reserves, and they still had about 0.9 billion after
requirements had been increased to the maximum
permitted by law.
Action on reserve requirements is not adapted to
day-to-day changes in banking and monetary conditions. It expresses itself in changes in percentages,
which generally result in large aggregate inroads on
the available reserves of member banks. Frequent
changes in requirements by small percentual amounts
would be disturbing to member banks and would complicate their bookkeeping and their customary way of
doing business. For these reasons this method of influencing the volume of available bank reserves and
the supply of money is usually employed only for the
purpose of adjusting the banking structure to largescale changes in the country's supply of monetary
reserves. It is not employed to make frequent delicate
adjustments to current changes in the supply of
money. For this purpose the Federal Reserve depends
principally on discount and open market operations.

CHAPTER IV
SELECTIVE METHODS OF REGULATION
In addition to general methods of regulation the
Federal Reserve has special powers to regulate
the terms on which transactions in stock market
securities are financed and for a period during
and immediately after the war it had authority
to prescribe terms on which consumer credit
could be extended.

HE instruments of credit policy so far discussed,
discounts, open market operations, and changes in
reserve requirements, relate to the volume and cost
of bank credit in general, without regard to the particular field of enterprise or economic activity in which
the credit is used. Thus they are distinct from the
two instruments of control, now to be discussed, which
are particular or selective. These two are applicable
to stock market credit and consumer credit, respectively. Selective instruments of Federal Reserve regulation do not, as do general regulations, approach the
problem through influencing bank reserves. Instead
they prescribe the terms on which certain kinds of
loans may be made, or credits granted, regardless of
whether the banks have abundant or scanty reserves.
These methods are supplementary to methods of general regulation, and their merit is that they make it
possible to restrain the flow of money into certain
fields at times when conditions in the economy as a
whole are such as to make general restraints on the
growth in the volume of money undesirable. For example, an unhealthy stock market speculation may
develop and call for restraint at a time when credit

SELECTIVE METHODS OF REGULATION

for production and trade is not expanding and when
the application of general instruments of regulation
might do harm to the country's over-all economic
activity. At such a time the Federal Reserve could
decide to employ its power to regulate margin requirements.
Margin Requirements
The Federal Reserve authorities have long been
enjoined by law to restrain the use of bank credit for
speculation; they are to keep themselves informed,
in the language of the law, as to "whether undue use
is being made of bank credit for the speculative carrying of or trading in securities, real estate, or commodities" and they are authorized to take certain restrictive action to prevent undue use of credit in these
fields. Since 1934, the Board of Governors of the
Federal Reserve System has also had the specific power
to curb the excessive use of credit for the purpose of
purchasing or carrying securities by limiting the
amount which holders of securities may borrow upon
them for this purpose either from banks or from securities brokers and dealers.
This amount is always less than the current market
value of the securities, and the difference between the
two is called the margin. Thus if a loan of $7,500 is
secured by stock worth $10,000, the margin is $2,500
or 25 per cent of the value of the stock. The Board's
regulations may be thought of as prescribing either
minimum margin requirements or maxium[maximu ]loan values;
for the greater the margin required, the less the
amount that can be borrowed.
The Board's regulations apply to the margin that
must be required at the time the security is pur-

THE FEDERAL RESERVE SYSTEM

chased. If the collateral security for the indebtedness
subsequently declines in value, the regulations do not
make it necessary for the borrower either to put up
additional collateral or to reduce the indebtedness.
The limitations apply only to credits obtained for the
purpose of buying or carrying securities registered on
national stock exchanges;1 they do not apply to any
loan for commercial purposes, even though the loan
be secured by stocks. In any case the bank or broker
making a loan may require additional collateral if he
deems it necessary.
For several years before the war, the Board's regulations required margins of 40 per cent, but during the
war requirements were raised first to 50 per cent, then
to 75 per cent, and in 1946 to 100 per cent. When the
margin required was 40 per cent, one could borrow for
the designated purpose 60 per cent of the value of his
collateral security; when it was 50 per cent, he could
borrow 50 per cent; when it was 75 per cent, he could
borrow only 25 per cent; and when it was 100 per
cent, he could borrow nothing. To require a margin
of 100 per cent was in effect to forbid loans for the
purpose in question. The reason for so drastic a requirement was that inflationary pressures were very
strong and any growth whatever in stock market
credit would increase them. The 100 per cent requirement was in effect from January 1946 to February
1947, when it was reduced to 75 per cent, making it
possible for banks and brokers to lend 25 per cent
of the value of the collateral.
1

The provisions of the law make some distinctions between
brokers or dealers and banks; brokers or dealers cannot extend credit
on unregistered securities except temporarily in connection with
cash transactions; banks are not restricted by margin requirements in
making loans on securities other than stocks.

SELECTIVE METHODS OF REGULATION

The control effected by margin requirements, though
bearing directly on the lender, puts restraint upon
the borrower and dampens demand. It can be used
accordingly to keep down the volume of stock market
credit even though lenders are abundantly able and
eager to lend. The extent to which margin requirements may restrain borrowers can be illustrated very
simply. Before the regulation was authorized, a person
having, say, $1,000 to put in the market could arrange
with a broker, if the broker was willing to accept the
risk, for the purchase of 100 shares of stock at $100
a share—that is, $10,000 worth—the stock being held
by the broker as collateral for the $9,000 he was lending and giving him a margin of 10 per cent. If the
stock rose or fell $5 a share, the borrower would have
a profit or loss of $500. Customary margins in preregulation days ranged from 10 to 25 per cent. Under
the present requirement of a 75 per cent margin, the
buyer could arrange to purchase only about 13 shares
at $100 each, and a rise or fall of $5 a share would
bring him a profit or loss of only $65. It is obvious
that high margin requirements greatly reduce the
gains or losses to be realized by buying with borrowed
funds, and cut down the amount of credit which can
be obtained for this purpose. Furthermore, with high
margins the pressure of forced selling to bolster accounts during market declines is reduced.
Another effect of high margin requirements is in
restricting the amount of pyramiding that can take
place in a rising market, that is, the extent to which
traders may add to their holdings, when the market
is rising, without putting up additional money or
additional securities but merely by borrowing against
the additional market value of securities already held

THE FEDERAL RESERVE SYSTEM

in their accounts. In case 100 shares of stock purchased for $10,000, for example, should rise in value
to $15,000, the increase of $5,000 would suffice, under
a 10 per cent margin requirement, not only to margin
the increase in value of the original 100 shares but in
addition to margin an additional purchase of 300
shares. Under a 50 per cent margin requirement, however, the increase of $5,000 market value would suffice,
after allowing for the increased margin of $2,500 on
the original 100 shares, to permit the purchase of only
about 33 shares. Restriction of pyramiding is an
important restraint on rising stock prices as well as on
the growth of credit employed in the stock market.
By the control of margin requirements excessive use
of credit in the stock market, which has caused serious
disturbances to the economy in the past, has been
placed under control. The danger of a stock market
boom financed by credit and followed inevitably by a
disastrous collapse has been largely eliminated. A
boom and a collapse in the stock market is still possible—on a cash basis, but without the use of credit
it is not likely to assume the proportions it had in the
past, as for example in 1929. At that time credit
extended by brokers alone had increased to at least
10 billion dollars, a peak from which it fell to threequarters of a billion by the middle of 1932. This rise
and fall in stock exchange loans was accompanied by
an advance in prices of common stocks to an index
number of 238 in the autumn of 1929 followed by
a drop to 36 in the middle of 1932. This boom and
bust in the stock market caused a great deal of damage
and contributed to the development of depression in
the thirties. With the inauguration of control of credit
going into the stock market the likelihood of an episode

SELECTIVE METHODS OF REGULATION

like the one that culminated in 1929 has become
remote.
Aside from having to do with a specific use of
credit, the authority with respect to security loans
differs from other Federal Reserve powers in reaching
outside the Federal Reserve System to banks that are
not members of the System and to brokers and dealers
in securities. It is closely related, however, to other
regulatory powers of the Federal Reserve authorities,
because the use of credit for purchasing or carrying
securities has an important bearing upon its use for
business purposes in general.
Consumer Credit
Temporary control of consumer credit was established in 1941 by Executive Order of the President
under authority of an act of Congress (enacted
October 6, 1917, and subsequently amended) giving
him certain emergency powers. The purpose was
to curb the use of credit for the purchase of automobiles, electric refrigerators, radios, washing machines, vacuum cleaners, household furniture, and
other consumers' goods and services. Consumers' goods
and services were becoming scarce because the equipment, materials, and labor required for their production were being transferred to the war effort. At the
same time, since employment was general and pay
rolls were large, the purchasing power of consumers
was increasing. In this situation, with decreased supply
and increased demand, there was every reason for
expecting prices to rise exorbitantly. The President,
accordingly, under authority of his emergency powers,
instructed the Federal Reserve authorities to regulate

THE FEDERAL RESERVE SYSTEM

the use of consumer credit so that it would not be
used to accentuate the demand.
In compliance with the Executive Order, the Board
of Governors issued Regulation W, prescribing terms
upon which credit might be granted. At the outset it
applied only to instalment credit, including both instalment sales and instalment loans, in which form
the great bulk of consumer credit was being generated.
The restraints imposed by Regulation W on instalment credit were twofold: they limited the amount of
credit that might be granted for the purchase of any
article listed in the regulation, and they limited the
time that might be agreed upon for repaying the
obligation. Instalment loans not related to the specifically listed articles were subject only to limitation
on the time of repayment. Thus, for example, a person buying an automobile had to make a down payment of at least a third of the purchase price, and
agree to pay the balance within eighteen months. This
was a larger down payment than had generally been
demanded by dealers and a shorter allowance of time
than had been permissible. The result was a reduction in the aggregate amount of credit currently extended for the purchase of automobiles and in the
time it was allowed to run. But a more fundamental
economic result was reduction of the demand for
automobiles at a time when they could not be produced in volume, when prices were tending to rise,
and when the nation needed all the money its citizens
could refrain from spending. What was true of automobiles was true of other goods and services bought
with credit funds.
The scope of the regulation was later broadened to
include a larger number of articles requiring down

SELECTIVE METHODS OF REGULATION

payments and to cover charge accounts and singlepayment loans. Requirements were made more restrictive as to down payments and maturities on
instalment credits; charge accounts were closed against
further purchases (of listed articles) unless paid by
the tenth day of the second calendar month following
the purchase date; and single-payment loans of defined
categories were limited to ninety days with limited
renewals.
The regulation of consumer credit went much further than the regulation of stock market credit in
extending responsibilities of the Federal Reserve authorities outside the field of banking. It applied to the
operations of sales finance companies, personal loan
companies, department stores, dealers in automobiles,
electrical appliances, household furnishings, musical
instruments, dry goods, and many others. These credit
grantors, if engaged in instalment business, were required to register with the Federal Reserve Bank of
the district in which they were situated and if not so
engaged were given a blanket license. They were furnished instructions and information about the procedure to be followed in extending consumer credit, their
records were subject to inspection, and they could be
penalized for violating the regulation.
In the two-year period immediately following the
war, regulation of consumer credit was continued,
though some of the terms were relaxed and the
scope of the regulation was contracted to about
what it was at the outset. The reason for continuing
it was that the supply of goods was at the time altogether inadequate relative to the demand, in which
circumstances the danger of an inflationary rise in
prices was extreme. Restraint upon the use of credit

THE FEDERAL RESERVE SYSTEM

in purchasing scarce articles was intended to lessen
the pressure for a rise in prices and help to restrain it.
In addition, fixing minimum down payments for important consumers' durables and the maximum lengthof-contract for consumer instalment financing in general tended to cause competitive business forces to
take the direction of lowering prices instead of keeping, them up by means of offering easier and easier
credit terms.
One reason why consumer buying on instalments
was subjected to special regulation is that variation
in the volume of such buying has a disturbing influence on business stability. Purchases on an instalment
basis are likely to be large at a time of general prosperity when the demand for goods is pressing on the
supply and consequently prices are likely to rise. At
such a time instalment purchases are likely to increase
still further a demand for goods that is already larger
than can be easily supplied. On the other hand, at a
time of depression and unemployment, when the demand for goods is low relative to the supply and is
declining, the necessity for many purchasers on instalment to meet their payments tends to reduce still
further the amount of money available to consumers
for current purchases. This tends to intensify the depression. It is believed by many that regulation of
instalment purchases, prescribing stiffer terms in a
boom period and permitting easier terms in a depression, would tend to reduce somewhat the swings from
prosperity to depression and would therefore support
the main purpose of Federal Reserve policy.
Resting as it did on an Executive Order of the President and not on explicit legislation by Congress, the
regulation of consumer credit by the Federal Reserve

SELECTIVE METHODS OF REGULATION

authorities was a temporary form of credit control.
It has been terminated as of November 1, 1947, after
having been in effect a little over six years. Such a
control could be made permanent only in case Congress should decide to give it that status by specific
statutory authorization.
Selective instruments of national credit policy,
though used in their modern form for less than fifteen
years, have been developed far enough with respect to
stock market credit and consumer credit to show that
such instruments can be a useful complement to
the older and more general instruments—discount
rates, open market operations, and reserve requirements. They are flexible in themselves and can help
to make credit policy in general more flexible. Their
distinguishing characteristics are that they are applicable to parts of the economy instead of to the economy
as a whole and that they can be used to restrain the
demand for credit without operating, as general instruments do, through the stiffening of money rates.

CHAPTER V
STRUCTURE OF THE FEDERAL RESERVE SYSTEM
All national banks and many State banks are
members of the Federal Reserve System. There
are twelve Federal Reserve Banks, each serving
one of the districts into which the country is
divided. The functions of the Federal Reserve
are entrusted to the Board of Governors of the
Federal Reserve System, the Federal Reserve
Banks, and the Federal Open Market Committee.

O far we have spoken of the Federal Reserve as a
unit without reference to its structure or to the
distribution of duties and responsibilities among its
component parts. This presentation has the advantage of emphasizing that from the point of view of
regulating the money supply the responsibility rests
on the System as a whole and that all of its parts perform their allotted functions in accordance with policies directed toward accomplishing a common objective. Consideration of the System's structure, however,
is now in order.
Membership
The Federal Reserve System at the end of 1946 had
6,900 member banks. This number included all banks
with national charters, which are required to belong,
and such banks with State charters as voluntarily
chose to belong, were qualified for membership, and
were accepted by the Federal Reserve. While in number
member banks were somewhat less than one-half
of all banks in the United States, they held more than
three-fourths of the country's bank deposits. The
different kinds of banks in this country at the end of

STRUCTURE OF SYSTEM

1946 and the amount of their deposits are shown in
the accompanying table. It will be noted that this
table does not include Federal Reserve Banks, which
are fundamentally different from commercial banks.
ALL BANKS IN THE UNITED STATES, DECEMBER

Kind of bank

Member bank
Nonmember bank
Total
Classes of member banks:
National
State 2
Classes of nonmember banks:
Commercial
Mutual savings
1
2

Number

1946

Deposits1
(In millions of dollars)
Demand

Time

6,900
7,685

78,920
13,526

27,190
23,610

14,585

92,446

50,800

5,007
1,893

52,194
26,726

18,412
8,779

7,147
538

13,526

6,756
16,854

Excluding interbank deposits.
Includes three mutual savings banks.

It will be noted that of demand deposits, which are
the closest equivalent to currency in serving as means
of payment, member banks hold over 85 per cent.
Consequently Federal Reserve policies have a direct
influence on institutions holding about nine-tenths of
the country's more active bank deposits.
Obligations and Privileges of Member Banks
By becoming members of the Federal Reserve System, banks become eligible to use all of the System's
facilities and, in return, undertake to abide by certain
rules that have been developed by law and regulation
for the protection of the public interest. National
banks are chartered by the Comptroller of the Currency, a Federal Government official, and are subject

THE FEDERAL RESERVE SYSTEM

in their operations to the National Banking Act as
well as to the Federal Reserve Act. State-chartered
banks that choose to become members of the Federal
Reserve System retain their charter privileges but
agree to be subject to the general requirements of the
Federal Reserve Act. Since these banks join the System voluntarily they have the privilege of withdrawing from membership on six months' notice.
Principal among the obligations assumed by member banks are: (1) to subscribe to the capital of the
Federal Reserve Banks an amount equal to 6 per cent
of the member's capital and surplus. (Of this, one half
must be paid-in and the other half is subject to call.
No part of the second half has been called.) (2) To
comply with the reserve requirements of the Federal
Reserve and to keep the required reserves without interest with the Federal Reserve Banks. (That this is
a much more important obligation than the first is
clear from the fact that late in June 1947 the total
paid-in capital of the Federal Reserve Banks was about
190 million dollars, while required reserves of member
banks were in excess of 15,000 million, or nearly eighty
times as large as the capital.) And (3) to be subject to
various requirements of the Federal Reserve Act with
respect to branch banking, holding company regulation, interlocking directorates, and other matters, and,
in the case of State member banks, also to general
supervision and examination by the Federal Reserve.
In return, member banks are entitled to the following
principal privileges, among others: (1) to borrow from
the Federal Reserve Banks when in need of additional
funds; (2) to use Federal Reserve facilities for collecting checks, settling clearing balances, and transferring
funds to other cities; (3) to obtain currency whenever

STRUCTURE OF SYSTEM

required; (4) to receive a cumulative dividend of 6
per cent on the paid-in capital stock of the Federal
Reserve Banks; and (5) to participate in the election
of six of the nine directors of each Federal Reserve
Bank.
Federal Reserve Banks
For purposes of administering the Federal Reserve
System the country is divided into the twelve districts shown in the map on page 52. The district
boundaries do not always follow State lines and States
in many instances form parts of more than one district. There is a Federal Reserve Bank in each district
and some of the Reserve Banks have branches. A list
of the districts and branches is given below:
Federal Reserve Bank of Boston
Federal Reserve Bank of New York
Branch at Buffalo, New York
Federal Reserve Bank of Philadelphia
Federal Reserve Bank of Cleveland
Branches: Cincinnati, Ohio
Pittsburgh, Pennsylvania
Federal Reserve Bank of Richmond
Branches: Baltimore, Maryland
Charlotte, North Carolina
Federal Reserve Bank of Atlanta
Branches: Birmingham, Alabama
Jacksonville, Florida
Nashville, Tennessee
New Orleans, Louisiana
Federal Reserve Bank of Chicago
Branch at Detroit, Michigan
Federal Reserve Bank of St. Louis
Branches: Little Rock, Arkansas
Louisville, Kentucky
Memphis, Tennessee

District Number 1
District Number 2
District Number 3
District Number 4
District Number 5

District Number 6

District Number 7
District Number 8

52
THE FEDERAL RESERVE SYSTEM

FEDERAL RESERVE SYSTEM

STRUCTURE OF SYSTEM
Federal Reserve Bank of Minneapolis
Branch at Helena, Montana
Federal Reserve Bank of Kansas City
Branches: Denver, Colorado
Oklahoma City, Oklahoma
Omaha, Nebraska
Federal Reserve Bank of Dallas
Branches: El Paso, Texas
Houston, Texas
San Antonio, Texas
Federal Reserve Bank of San Francisco
Branches: Los Angeles, California
Portland, Oregon
Salt Lake City, Utah
Seattle, Washington

District Number 9
District Number 10

District Number 11

District Number 12

Each of the twelve Federal Reserve Banks is a corporation organized and operated in the public service.
The Federal Reserve Banks differ essentially from privately managed banks in that profits are not the
object of their operations, and their stockholders,
which are the member banks of the Federal Reserve
System, do not have the powers and privileges that
customarily belong to stockholders of privately managed corporations.
Each Federal Reserve Bank has nine directors, three
of whom are known as Class A directors, three as Class
B directors, and three as Class C directors. Class A
and Class B directors are elected by member banks,
one director of each class being elected by small banks,
one of each class by banks of medium size, and one of
each class by large banks. The three Class A directors
may be bankers. The three Class B directors must be
actively engaged in the district in commerce, agriculture, or some other industrial pursuit, and must not be
officers, directors, or employees of any bank. The three

THE FEDERAL RESERVE SYSTEM

Class C directors are designated by the Board of Governors of the Federal Reserve System. They must not
be officers, directors, employees, or stockholders of any
bank. One of them is designated by the Board of
Governors as Chairman of the Reserve Bank's board
of directors and as Federal Reserve Agent.
Under this arrangement, business men and others
who are not bankers constitute a majority of the directors of each Federal Reserve Bank. The directors are
responsible for the conduct of the affairs of the Reserve
Bank, subject to the supervision of the Board of Governors. They choose the Reserve Bank officers, but the
law requires that their choice of President and First
Vice President be approved by the Board of Governors.
The salaries of all officers and employees are also subject to the approval of the Board of Governors. Each
branch of a Federal Reserve Bank has its own board
of directors, a majority of whom are selected by the
Reserve Bank and the remainder by the Board of
Governors. The provisions of law circumscribing the
selection of Reserve Bank directors and the management of the Reserve Banks indicate the public nature
of the Reserve Banks.
Decentralization is an important characteristic of
the Federal Reserve System. Each Reserve Bank and
each branch office is a regional and local institution as
well as part of a nation-wide system. Its officers and
employees are residents of the Federal Reserve district, and its transactions are with regional and local
banks and businesses. I t gives effective representation
to the views and interests of the particular region to
which it belongs and at the same time helps to administer nation-wide banking and credit policies.
The income earned by the Federal Reserve Banks

STRUCTURE OF SYSTEM

from their operations is used to cover their expenses,
including the expenses of the Board of Governors in
Washington, to pay 6 per cent dividends to members,
and to make additions to surplus. In case of liquidation of the Reserve Banks the surplus would go to the
United States Government.
While the Federal Reserve Banks earn an income,
their operations are not carried on for this purpose
but are determined by Federal Reserve credit policies,
which are discussed in other chapters. For many years
the System's net earnings were turned over in large
part to the Government as a franchise tax. At a time
when these earnings were small and after the Congress
had directed the Reserve Banks to contribute half of
their surplus to the capital of the Federal Deposit
Insurance Corporation, the provision for the franchise
tax was repealed. Recently, however, earnings of the
Reserve Banks have once more been large, as the
result of war financing. The Federal Reserve has,
therefore, adopted a procedure by which it turns over
to the Treasury nine-tenths of its earnings above expenses and dividends. The Federal Reserve makes
these payments on the basis of authority contained in
a section of the law dealing with Federal Reserve
notes. This is another illustration of the public character of the Federal Reserve.
From the point of view of credit policy the Federal
Reserve Banks make the decisions regarding what
loans and discounts to individual member banks will
be in harmony with the objectives of the Federal Reserve System. The Reserve Banks also establish the
discount rate, but it must be approved by the Board
of Governors, which also has authority to make
changes in the rate on its own initiative. In connec-

THE FEDERAL RESERVE SYSTEM

tion with open m a r k e t operations t h e Federal Reserve
Banks, in groups prescribed by law, elect five of the
twelve m e m b e r s of t h e Federal Open M a r k e t Comm i t t e e — t o be described later.

Board of Governors

The Board of Governors of the Federal Reserve
System is a governmental institution with offices in
Washington, D. C. It consists of seven members appointed by the President of the United States and
confirmed by the Senate. Members are appointed for
terms of fourteen years, so arranged that one term
expires every two years. No two members of the
Board may come from the same Federal Reserve district. The Board's expenses are paid out of assessments upon the Reserve Banks.
It is the Board's duty to supervise the workings of
the Federal Reserve System. As already indicated, the
Board appoints three of the nine directors of each
Federal Reserve Bank, including the Chairman, who
is also the Federal Reserve Agent, and the Deputy
Chairman. Appointments of the President and First
Vice President of each Federal Reserve Bank are subject to the Board's approval. The Board also issues
regulations that interpret the provisions of law relating to Reserve Bank operations. It directs the System's activities in bank examinations and in economic
research and publications. The Board represents the
Federal Reserve System in most of its relations with
executive departments of the Government and with
congressional committees. It is required to exercise
special supervision over foreign contacts and international operations of the Reserve Banks. It issues an
annual report to Congress and publishes weekly a

STRUCTURE OF SYSTEM

statement required by law of the assets and liabilities
of the Federal Reserve Banks. It issues a monthly
Federal Reserve Bulletin and other periodic or occasional publications.
Of the principal monetary actions of the Federal
Reserve the Board has full authority over changes in
reserve requirements and margin requirements. It
also has authority to establish the maximum rates of
interest that member banks may pay on time deposits.
It "reviews and determines" discount rates established
by the Reserve Banks. While the terms of consumer
credit were being regulated, the Board had sole responsibility for their determination and enforcement.
In general, the Board of Governors is responsible for
formulating national credit policies and for supervising
their execution. The members of the Board are also
members of the Federal Open Market Committee.
Federal Open Market Committee
This Committee, comprising the seven members of
the Board of Governors and five representatives elected
by the Federal Reserve Banks, has the responsibility
of deciding when and how much to buy or sell in the
open market and under what conditions. The Federal
Reserve Banks, in their operations in the open market,
are required by law to carry out the decisions of the
Open Market Committee. The Committee meets in
Washington four times a year, or oftener if necessary,
and reviews the business and credit situation with the
help of its staff, which is drawn from the staffs of the
Board of Governors and the Reserve Banks. In view
of the importance of open market operations as instruments of Federal Reserve policy the Federal Open
Market Committee is a vital organ of the System. In

THE FEDERAL RESERVE SYSTEM

meetings of the Committee representatives of the Reserve Banks bring to the council table their knowledge
of regional conditions and members of the Board
present the national aspects of the current situation.
Decisions about open market policy are made in the
light of such discussion.
Advisory Committees
The Federal Reserve Act provides for a Federal
Advisory Council of twelve members, one from each
Federal Reserve district, selected annually by the
Federal Reserve Bank through its board of directors.
Council members are usually selected from among
representative bankers in each district. The Council
meets in Washington at least four times a year. It
confers with the Board of Governors on business conditions and makes advisory recommendations regarding
the affairs of the Federal Reserve System. It constitutes a link between the Board and representatives
of banking in the twelve districts.
In addition to the Federal Advisory Council the System has a number of conferences and committees that
help in reaching understanding on common problems.
Of these the most important is the Conference of
Presidents of the Federal Reserve Banks, which meets
by itself and with the Board at least three times a year.
The Money Market
In order to understand the functions of the Federal
Reserve System, the structure of which has been outlined in the preceding pages, it is necessary to place it
in the country's financial organization. For Federal
Reserve influence reaches beyond the confines of membership in the Federal Reserve System.

STRUCTURE OF SYSTEM

For many of the most important responsibilities of
the Federal Reserve System, the point of contact with
the banking and financial organizations of the country
is what is customarily called the "money market."
The "money market" has no formal organization or
specific place of business as stock markets and commodity markets have, but it is none the less a reality.
As far as large transactions are concerned, modern
means of communication make the country practically one money market. Well-established borrowers
with high credit ratings can negotiate bank loans on
much the same conditions in one city as in another;
for if money is scarce and dear in one center, the supply tends to be replenished at once from other centers
where it is more abundant. Relatively small transactions originating from local needs and represented by
loans based on close contact with local conditions are
handled by many regional money markets in which
rates charged and other conditions vary considerably
from place to place. Contacts of these local money
markets with the national money market are chiefly
through balances kept by local banks with city correspondents. Funds of these regional banks are likely
to flow into the financial centers when not required for
local use and to be recalled when local demand develops. Through this flow of funds, banks in all parts
of the country maintain a degree of contact with the
national money market. Their actions have an influence on conditions in that market and they are in
turn influenced to some extent by developments in the
financial centers. The movements of funds in and out
of the national money market are no longer disruptive
as they frequently were before the organization of the
Federal Reserve System. The Reserve Banks now

THE FEDERAL RESERVE SYSTEM

stand ready to supply additional funds to money market banks when needed and to absorb redundant funds.
Money market transactions take place through
banks and related institutions, but the market comprises the customers of banks as well as the banks
themselves. Thus, when the United States Treasury
borrows by the sale of its obligations in the money
market, the lenders—that is the buyers of the obligations—will be not only banks, but insurance companies, investment trusts, private individuals, and
other holders of funds for investment. The money
market derives much of its character as a market
from the operations of dealers who specialize in buying and selling acceptances and securities. Being the
principal financial center, New York City is the heart
of the American money market.
As in any other kind of market, demand will sometimes exceed supply, and supply will sometimes exceed
demand; rates of interest and discount will sometimes
rise and sometimes fall. It is the responsibility of the
Federal Reserve authorities to watch over the market,
to prevent fluctuations from becoming violent, and
through purchases or sales and rate policies to endeavor to maintain orderly credit conditions. Most
of the measures taken by the Federal Reserve authorities have their most direct influence on the money
market through the medium of bank reserves.
The functions exercised by the Federal Reserve
are directed for the most part to the money market
as a whole and not to the individual banks. Indeed,
the individual banker may not be aware of Federal
Reserve action save indirectly. His bank's operations
by themselves may disclose only that his customers
are bringing in more deposits than they are checking

STRUCTURE OF SYSTEM

out, or checking out more than they are bringing in,
or are increasing or decreasing their demand for loans.
Federal Reserve policies, however, also affect the attitude of banks toward prospective borrowers and
toward investment opportunities. When funds are
abundant banks lend and invest more freely than when
their funds are limited as the result of Federal Reserve
action. Nonmember as well as member banks, in fact
all financial institutions, are affected by Federal Reserve operations in the money market that make money
more or less abundant and more or less costly to
borrowers.

CHAPTER VI
RELATION OF FEDERAL RESERVE TO CURRENCY
The Federal Reserve pays out currency in response to public needs and absorbs redundant
currency. Its operations result in making the
entire currency supply elastic.

N important purpose of the establishment of the
A
Federal Reserve Banks in 1914 was to provide an
elastic currency. Prior to that time the currency had
consisted principally of Treasury notes secured by
gold or silver and of national bank notes which had to
be secured by specified kinds of United States Government obligations that were extremely limited in
amount. As a consequence, additional paper money
could not be easily supplied when the nation's business so required and currency would become hard to
get and command a premium. Currency shortages,
together with other related developments, caused several financial panics. It was one of the tasks of the
Federal Reserve to prevent such panics by providing
a kind of currency that would respond in volume to
the needs of the country. The Federal Reserve note is
such a currency.
Federal Reserve notes are paid out by the twelve
Federal Reserve Banks to member banks on request
and are charged to their reserve accounts. Any Federal
Reserve Bank can obtain the notes from its Federal Reserve Agent, a representative of the Government, upon
pledging gold certificates, so-called eligible paper,
or United States Government obligations. Consequently, whenever the public needs more currency,
member banks can obtain it from a Federal Reserve

RELATION TO CURRENCY

Bank, which in turn can secure it from a Federal Reserve Agent on the pledge of practically any Reserve
Bank asset. The only limitation is that the Reserve
Banks must have, in their own hands or pledged with
a Federal Reserve Agent as part of the collateral for
Federal Reserve notes, gold certificates amounting to
not less than 25 per cent of the Federal Reserve notes
in circulation, in addition to having in their own
possession gold certificates amounting to not less than
25 per cent of their deposit liabilities. (Prior to 1945
the required percentage was 40 for notes and 35 for
deposits.) Under this system the volume of currency
increases when the public's needs become larger, and
declines when they become smaller. In the latter case
member banks, on receipt of currency from their depositors, redeposit it with the Federal Reserve Banks,
which turn it over to their Federal Reserve Agents
and redeem the assets previously pledged as collateral
for the notes.
As has been stated earlier, Federal Reserve notes
constitute about seven-eighths of all the currency in
circulation. The other kinds of currency are United
States notes (a remnant of Civil War financing), various issues of paper money in process of retirement,
silver certificates, silver coin, nickels, and cents. Federal Reserve notes are not issued in denominations
smaller than $5, and so all of the $1 and $2 bills (as
well as some bills of larger denominations) are in other
forms of paper money, chiefly silver certificates and
United States notes. At the end of June 1947 the
total amount of currency in circulation was 28.3
billion dollars, of which 24.0 billion were Federal Reserve notes. Of the remainder the largest amount
consisted of silver certificates. All of the kinds of

THE FEDERAL RESERVE SYSTEM

currency in circulation in the United States are legal
tender and the public makes no distinction among
them. It may be said that the Federal Reserve has
endowed all forms of currency with elasticity since
they are all receivable at the Federal Reserve Banks
whenever the public has more currency than it needs,
and they may all be paid out by these Banks when
demand for currency increases. Therefore, in the subsequent discussion reference will be made to the total
of currency in circulation rather than to any particular kind.
It has already been stated that the amount of currency in circulation changes in response to changes in
the public's needs. These changes are substantial and
frequent. The demand varies for different days of the
week, for different days of the month, and for different
seasons. It increases before holidays such as Memorial
Day, Independence Day, and Labor Day, when many
people take trips and need more ready cash. There is
an extraordinary increase in the demand before Christmas, when cash is used for Christmas shopping or as
gifts. After the holidays, the currency is promptly
deposited in the banks by the merchants, hotel keepers,
and others with whom it has been spent, and the
banks send it to the Federal Reserve Banks.
In addition to seasonal changes in the demand for
currency, there are changes that reflect variations in
business conditions. When business is good, the demand for currency increases, and when business declines the demand also declines. While most payments
in this country are made by check, some types of payments are made principally in currency. The most
important of these are pay rolls and retail trade, and
statistics show that the amount of currency in circula-

RELATION TO CURRENCY

tion fluctuates in response to changes in t h e volume of
these two kinds of p a y m e n t s . T h e r e h a v e been occasions, as in 1930-32, when t h e d e m a n d for currency increased because numerous b a n k failures caused people
to withdraw their deposits from other banks. D u r i n g
the war the a m o u n t of currency in circulation increased
greatly in response t o a variety of influences: t h e
growth of p a y rolls, retail trade, a n d t r a v e l ; removal of
m a n y people from their usual places of residence; p a y ments t o members of t h e armed forces; larger incomes
of people n o t in t h e h a b i t of using b a n k s ; and no
doubt hoarding of currency for various reasons. T h e
demand for additional currency subsided after t h e
war, b u t t h e volume in circulation is still extraordinarily large.
F r o m t h e point of view of t h e Federal Reserve a n d
member banks, changes in t h e d e m a n d for currency
have a special significance t h a t arises o u t of our system of reserve requirements. As has been explained,
reserve requirements of m e m b e r banks are expressed
as percentages of their deposits. If t h e public borrows,
say $1,000, from a b a n k and leaves it on deposit t o be
transferred from b a n k t o b a n k b y check, t h e a m o u n t
of reserves t h a t t h e banking system m u s t hold increases by only $150. If, however, t h e public wishes
to withdraw the proceeds of t h e loan in currency, t h e
member b a n k m u s t obtain t h e currency from a R e serve Bank, which will charge t h e full a m o u n t withdrawn t o t h e member bank's reserve account. Consequently t h e reserves of t h e b a n k — a n d of t h e banking
system as a whole—will diminish b y t h e full $1,000.
If t h e banking system h a d n o excess reserves, it
would have to obtain additional reserves. I n either
case, t h e Federal Reserve could m a k e it unnecessary

THE FEDERAL RESERVE SYSTEM

for the member banks to borrow from the Reserve
Banks, if it thought it desirable to do so, by buying
an equivalent amount of Government securities in the
open market. Whichever procedure was followed, the
demand for Federal Reserve credit and Reserve Bank
holdings of discounts and securities would increase;
but the increase would be $150 in the case of the demand for $1,000 of deposits and $1,000 in the case of
demand for an equal amount of currency. Because the
increase in the demand for Federal Reserve credit is
so much greater when the public withdraws its funds
from banks in currency than when it leaves them on
deposit, the volume of discounts and securities held by
the Federal Reserve Banks is greatly influenced by
changes in the demand for currency.
One effect of the fact that a demand for currency
results in a greater demand for Federal Reserve credit
than does a similar demand for deposits is that the Federal Reserve Banks' need for reserves to meet their own
requirements increases much more when currency is
flowing out to the public than when bank credit expansion takes the form of a growth in deposits. The
Reserve Banks are required to hold the same ratio of
reserves in gold certificates against their Federal Reserve notes in circulation and against their deposits,
(25 per cent) but when the public demand is for $1,000
in currency, the Federal Reserve Banks pay out that
amount of Federal Reserve notes—and their reserve
requirements increase by $250. If, however, the public's demand is for $1,000 in deposits, member bank
reserves, which are the deposits against which the
Reserve Banks must hold reserves, increase by only
$150 and the reserves needed by the Reserve Banks
by only $37.50 (25 per cent of $150). Consequently

RELATION TO CURRENCY

an increase in currency ties up more than six times as
much of the Reserve Banks' reserves as does an identical increase in bank deposits.
It is principally because of the great growth in currency in circulation during the war that the Federal
Reserve Banks' ratio of reserves to combined note and
deposit liabilities declined to a point where Congress
deemed it wise to reduce the reserve requirement of
the Reserve Banks from 40 per cent for Federal Reserve notes and 35 per cent for deposits to 25 per cent
for each kind of liability. The amount of reserves that
the Reserve Banks actually hold, however, is always
considerably larger than the minimum required by
law. This is because the Reserve Banks are not operated for the purpose of making a profit and consequently do not extend additional credit simply because they have enough reserves to enable them to do
so. The volume of Federal Reserve credit to be extended is decided on the basis of demand of the public
for currency and bank deposits and of the policies
pursued by the Federal Reserve to encourage or discourage this demand. As has already been stated, these
policies are determined by considerations of the public
interest rather than by the availability of unused
reserves at the Federal Reserve Banks.

CHAPTER VII
RELATION OF FEDERAL RESERVE TO GOLD
Gold and Federal Reserve credit are the principal sources of member bank reserves. Consequently gold movements are reflected in
changes in the demand for Federal Reserve
credit. Gold certificate holdings of the Federal
Reserve Banks set the limits of Federal Reserve
credit expansion.

HERE is a dual relationship between the Federal
Reserve and gold. It may be said that gold is both
the basis and the principal competitor of Federal
Reserve Bank credit. It is the basis of Reserve Bank
credit because the power of the Reserve Banks to
create money either through adding to their deposits
or issuing Federal Reserve notes is limited by the
requirement of a 25 per cent reserve in gold certificates
against both kinds of liabilities. Consequently, the
total of Federal Reserve notes and deposits must not
exceed four times the amount of gold certificates held
by the Reserve Banks. Thus gold sets the limits of
Reserve Bank credit expansion.
Gold is a competitor of Federal Reserve Bank credit
for the reason that, when the United States acquires
more monetary gold, additional reserves become available to the member banks without their having to
resort to a Reserve Bank for credit. Except to the
extent that there is a more than temporary decline in
the amount of currency in circulation, gold and Reserve
Bank credit are by far the most important sources of
member bank reserves. The more gold comes to the
country from abroad or from domestic mines, the less
demand there is for Reserve Bank credit. These rela-

RELATION TO GOLD

tionships require more detailed explanation and description.
It should be mentioned first that what the Federal
Reserve Banks hold is not gold but gold certificates.
By the terms of the Gold Reserve Act of 1934 all the
monetary gold in the country, that is all the gold that
is not used in industry and the arts, must be turned
over to the Treasury, which pays $35 an ounce for it.
The Treasury pays for the gold by check and issues an
equivalent amount of gold certificates to the Reserve
Banks. The Treasury must hold gold at the rate of $35
an ounce for all the gold certificates it issues.2 Consequently, while the title to the gold is in the Government, the greater part of it is held as cover for the gold
certificates in the possession of the Reserve Banks and
may not be used for any other purpose. The Reserve
Banks are the only institutions permitted by law to
hold gold certificates, which are no longer permitted to
circulate. Except for a small amount that has not been
turned in and that may have been lost, destroyed, or
sent abroad, gold certificates are used exclusively as
reserves of the Federal Reserve Banks. In practice the
Reserve Banks hold only a relatively small amount of
the certificates; most of them are represented by a
credit in a gold certificate account on the books of the
Treasury. This serves the same purpose and saves the
unnecessary expense of printing and shipping the notes.
At the end of June 1947, the Treasury held gold in
the amount of 21,266 million dollars: of this amount
20,087 million was cover for gold certificates, 156 million was held as the statutory reserve against United
States notes, and the remainder, 1,024 million, was in
2
The amount of gold that the Treasury must hold as cover for each
dollar of gold certificates can be changed only by an Act of Congress.

THE FEDERAL RESERVE SYSTEM

the general fund of the Treasury. Only the gold in
the general fund is at the free disposal of the
Treasury.3
The process by which gold produced in the United
States or imported from abroad reaches the Treasury
and is reflected in additions to the reserves of member
banks and Federal Reserve Banks is not difficult to
follow. The gold is taken to an assay office of the
United States Treasury, which pays for it by check.
The seller of the gold deposits this check with a member
bank, which in turn deposits it with a Reserve Bank,
where it is added to the reserve balance of the member
bank and charged to the account of the United States
Treasury. The Treasury replenishes its account by
issuing an equivalent amount of gold certificates to the
Reserve Bank. Assume that the gold is worth a million
dollars. Then the gold stock of the Treasury, the
gold certificate holdings of the Reserve Bank, the
reserve balance of the member bank, and the bank
deposit of the seller of the gold will all increase by a
million dollars.
On the other hand, if a member bank has the required license from the Treasury to export a million
dollars in gold, the member bank draws a check for
a million dollars on its reserve deposit, the Federal
Reserve Bank turns over a million dollars of gold certificates to the Treasury in exchange for gold, and the
Treasury furnishes the gold to the member bank.
The result is that gold holdings of the Treasury, gold
3
When gold was revalued from $20.67 to $35.00 an ounce in 1934,
there accrued to the Treasury 2.8 billion dollars, of which 2 billion
was placed in a Stabilization Fund. Most of the remainder was used
indirectly to retire national bank notes. In 1947 part of the
2 billion dollars in the Stabilization Fund was used to pay the gold
portion of the United States subscription to the International
Monetary Fund, and the balance was added to Treasury cash.

RELATION TO GOLD

certificate holdings of the Reserve Bank, and the
reserve balance of the member bank have all been
reduced by a million dollars. It should be mentioned
that gold movements in recent years have been handled
almost exclusively by governments and central banks,
so that gold transactions proceed through official channels. Sometimes gold transactions with foreign countries are effected without a physical movement of gold
into or out of this country. A foreign central bank
may purchase gold in the United States and have it
"earmarked," or segregated, for its account at the Federal Reserve Bank of New York, or it may sell some of
its earmarked gold to the United States Treasury.
Movements in and out of earmarked accounts have the
same effect on our banking system as exports and
imports of gold. "Earmarked" gold belongs to foreign
authorities and is not a part of the monetary gold
stock of the United States.
These processes are essentially the same as they
were when gold itself was held by the Federal Reserve
Banks and when circulation of gold coins was permitted. The only difference is that the title to the gold
is in the Treasury and the Reserve Banks hold claims
on it in the form of gold certificates. The effects of
gold movements on the reserves of Federal Reserve
Banks and member banks and on bank credit and the
total money supply are unchanged by the altered
procedure.
It has been shown that gold imports (or exports)
increase (or decrease) the reserves of Federal Reserve
Banks and, therefore, their ability to issue notes and
create deposits. The effect of gold movements on
member bank reserves is the same as that of Federal
Reserve discount or open market operations. When

THE FEDERAL RESERVE SYSTEM

gold comes in, it increases member bank reserves in
the same way as would an equivalent amount of discounts or open market purchases by the Reserve
Banks; when gold goes out, it diminishes member bank
reserves in the same way as would the paying off of a
discount by a member bank or the sale of a security
by a Reserve Bank. It is for this reason that the demand for Reserve Bank credit diminishes when gold
comes in and increases when gold goes out. Sometimes the Federal Reserve makes loans on gold to
foreign authorities and this has the same effect on
credit conditions in this country as any other advance
by a Reserve Bank.
Movements of gold from one country to another are
the ultimate means by which international balances are
settled. On one side of the balance sheet are all the
goods, services, and securities the United States, for
example, has sold to foreigners, and on the other side
are all the goods, services, and securities the United
States has bought from foreigners. There are other
items that enter into one or both sides of the balance
sheet such as expenditures of tourists abroad, remittances by immigrants to their mother countries, and
gifts to foreign countries. If, after all of these items
have been taken into account, there is still a balance
due to the United States from abroad, it can be met by
foreigners broadly in one of two ways: by borrowing
in the American market, or by sending gold to the
United States. Shipment of gold is usually the last
resort employed to cover the balance. In recent years,
owing to the world-wide demand for American goods
and securities and the scarcity of exportable commodities abroad, the balance due to the United States by
foreign countries has been very large. It has been

RELATION TO GOLD

covered by public and private loans to foreign countries and by large imports of gold. These gold imports
have been an important factor in credit conditions in
the United States.
Disregarding currency movements in and out of the
Federal Reserve Banks, which follow the independent
pattern explained in the preceding chapter, gold and
Federal Reserve Bank credit are the two principal
sources of member bank reserves, which in turn are
the basis of member bank credit and of the total money
supply. It is for this reason that large gold imports
make it more difficult for the Federal Reserve to regulate the supply of money. When member banks receive
reserves through gold imports they can expand their
loans and investments and thus increase the money
supply without being obliged to apply for accommodation to the Federal Reserve Banks. Furthermore, they
can increase it by several times the amount of the
addition to their reserves through gold imports, just
as they can on the basis of any other growth in
reserves. At times the Federal Reserve has been able
to offset the effects of gold imports by equivalent sales
of securities in the open market, and at other times
by raising member bank reserve requirements. But
there have been times when the Federal Reserve has
lacked the means of offsetting the effects of gold
imports. At such times its ability to influence the
volume of money in the domestic economy is restricted
by gold imports. The maintenance of international financial stability, under which gold movements usually
remain moderate in amount, is consequently of great
importance to the effective execution of central banking functions.

CHAPTER VIII
THE MONETARY EQUATION
Gold movements, currency in circulation, and
Federal Reserve credit are the principal factors
that influence the volume of member bank
reserves—the basis of the money supply. The
relationships among these factors may be called
the Monetary Equation.

EMBER bank reserves, the basis of the money
supply, and all the principal factors that affect
their volume have now been discussed separately and
may be brought together in what may be called the
monetary equation. The four factors in this equation
represent the channels through which all the numerous forces in the country's economic life affect the
position of the Federal Reserve Banks and the member banks. It has been shown that gold imports, decreases in currency in circulation, and extension of
Federal Reserve credit add to member bank reserves;
that gold exports, increases in currency in circulation,
and contraction of Federal Reserve credit diminish
member bank reserves.
Of the four factors, gold movements are largely
independent of Federal Reserve regulation. They depend on international financial conditions. For many
years they have not been responsive to relative levels
of interest rates, as they were in the past, but have
been determined by official policies of central banks
and governments. Currency movements in and out
of circulation are likewise largely independent of Federal Reserve regulation. They follow their own course
in response to business conditions and the public's

THE MONETARY EQUATION

habits and preferences. Federal Reserve credit is the
balance wheel between these two more or less independent factors and member bank reserves. It is the
chief means by which the Federal Reserve, through
influencing the volume of member bank reserves, can
discharge its responsibility to regulate the volume of
bank credit and the total money supply. The Federal
Reserve can use its credit powers either to initiate
changes in the volume of member bank reserves or to
modify changes caused by gold or currency movements. Action to offset the effects of gold and currency movements will or will not be taken, depending
on whether these effects are in harmony with current
Federal Reserve monetary policy.
Member bank reserves, although affected by the
operations of the three other factors in the monetary
equation, are not themselves an entirely passive element. They respond to economic forces that are not
necessarily reflected in gold or currency movements
and their independent responses are subject to regulation by the Federal Reserve. For instance, at times
of vigorous demand for bank credit by the public and
a consequent growth in bank deposits, member banks
need more reserves. The need for additional reserves
expresses itself in a demand for additional Reserve
Bank credit, which may be met by the Federal Reserve through additional discounts or open market
purchases. Also, within limits specified by Congress,
the Federal Reserve may change the reserve requirements of member banks.
The course of the four factors of the monetary equation since January 1934, when gold was revalued, is
indicated in the chart on page 76. It will be seen
that from 1934 through 1941 the principal movement

THE FEDERAL RESERVE SYSTEM
MAJOR FACTORS IN THE MONETARY EQUATION

was in gold, and that the monetary gold stock of the
United States was increasing rapidly. This was a
period of depression when the Federal Reserve
authorities were pursuing a policy of monetary ease
in order to encourage economic recovery. Consequently, they did not tighten Federal Reserve credit
in order to moderate the expansionary effects of the
gold inflow on member bank reserves. Reserve Bank
credit remained stable at 2.5 billion dollars. The effect
of the gold movements was in part offset by an increase of currency in circulation but in the main it was
reflected in a growth of member bank reserve balances.
Gold shipments to this country stopped after we entered the war and our Allies began to receive our
exports under lend-lease. In fact, gold flowed out of
the United States, reflecting chiefly our large-scale

THE MONETARY EQUATION

purchase of goods from South American countries.
Currency in circulation went up rapidly and was the
principal factor in reducing member bank reserves.
In response to increasing demand, Federal Reserve
Bank credit expanded tenfold, from 2.5 to 25.0 billion
dollars. In 1946, the first year after the war, all the
four factors remained relatively stable, and in 1947,
with some decrease in currency in circulation and in
member bank reserve balances, and a resumption of
gold imports, Federal Reserve Bank credit showed a
substantial decline.
In a simplified way, the foregoing analysis indicates
how the factors of the monetary equation are interrelated, and how ups and downs in any of them are
reflected in appropriate changes in one or more of the
others. Behind all of the movements shown on the
chart is the impetus of innumerable economic forces.
Other factors enter into the monetary equation, but
for the most part they are of either minor or transitory
importance. Silver purchases by the Treasury, for example, have the same kind of effect on member bank
reserves as have imports of gold. These purchases are
made by the Treasury in accordance with a policy laid
down by law and they are paid for in effect by the
issuance of silver certificates. These certificates, issued
in accordance with the silver policy and independently
of the demand for currency, result in a redundant
supply. The surplus currency is returned to the member
banks and is deposited for credit to their reserve accounts with the Federal Reserve Banks. The silver
operations of the Treasury, however, have a relatively
minor effect on monetary conditions. Silver certificates
in circulation at the end of June 1947 amounted to
about 2 billion of the total of more than 28 billion dol-

THE FEDERAL RESERVE SYSTEM

lars of currency in circulation, and should be compared
with 16 billion of member bank reserve balances.
Furthermore, changes in the volume of silver certificates are relatively slow.
For the most part, the remaining factors that affect
the volume of member bank reserves reflect various
operations of the United States Treasury. Usually
they are either temporary in character or minor in
amount, but at times they have been of great importance. The financing of World War II, discussed in
Chapter XII, is a good example of the far-reaching
effects of Treasury operations under abnormal conditions.

CHAPTER IX
SERVICE FUNCTIONS OF THE FEDERAL RESERVE
BANKS
The twelve Federal Reserve Banks hold the legal
reserves of member banks, furnish currency for
circulation, facilitate the collection and clearance
of checks, exercise supervisory duties with respect to member banks, and are fiscal agents of
the United States Government.

HE reserve accounts which member banks mainT
tain with their Reserve Banks are kept in active
use. The member banks are constantly drawing on
them and replenishing them in day-to-day transactions. The banks are required to maintain their reserve
balances at a level determined in relation to their deposits, but these deposits constantly change. Member
banks are permitted to draw on their reserve accounts,
but must maintain an average level equal to the legal
requirements. Central reserve city and reserve city
member banks are permitted to average their reserves
over a weekly period and country banks over a semimonthly period. Transactions in member bank reserve
accounts entail a heavy amount of continuous work
for the Federal Reserve Banks, which includes:
Furnishing coin and paper money for circulation;
Receiving and sorting deposits of currency;
Receiving, sorting, collecting, and clearing checks.
How Currency is Distributed
There are two principal ways by which any individual gets paper money and coin. Either he draws it
out of his bank and has it charged to his account; or

THE FEDERAL RESERVE SYSTEM

he is paid for his labor, his services, or his merchandise
with money that has been drawn out of a bank by
someone else. Practically all money, therefore, passes
into and out of banks at one time or another.
There are times when banks are called on to pay out
more currency than they receive and there are times
when they receive more than they pay out. In agricultural regions there is a heavy demand for currency at
times when crops are being harvested; in cities there is
a heavy demand for currency at certain times in the
summer. Moreover, the demand varies for different
kinds of currency. Some communities use more coin
than others and less paper money, and some use more of
certain denominations than others do.
In accordance with this demand, banks provide
themselves with the amounts and kinds of currency
that the people in their communities want. Member
banks depend upon the Federal Reserve Banks for replenishment of their supply, ordering what they require and having it charged to their reserve accounts.
Nonmember banks generally get their supplies from
member banks.
The twelve Federal Reserve Banks in turn keep a
large stock of all kinds of paper money and coin on
hand to meet this demand. This includes both Federal
Reserve notes, which are their own liabilities, and coin,
silver certificates, and United States notes, which they
obtain from the Treasury, giving the Treasury credit
in its checking account for the amounts obtained.
Before establishment of the Federal Reserve Banks
in 1914, the means of furnishing currency for circulation were unsatisfactory. A gap existed between the
Treasury and the banking system, and demand for increased circulation could not always be met promptly.

SERVICE FUNCTIONS

This was the case in the panic of 1907, and as already
indicated the experience of that year was one of the
things that led to formation of the Federal Reserve
System. The currency mechanism provided under the
Federal Reserve Act has worked satisfactorily—currency moves into and out of circulation automatically
in response to increase or decrease in the public demand. The Treasury, the twelve Federal Reserve
Banks, and the thousands of local banks throughout
the country form a system of currency distribution
that reaches every community, that enables currency
to be furnished promptly where it is needed, and that
also enables surplus currency to be retired from circulation at times when the public demand subsides.
Collections, Clearances, and Transfers of Funds
Currency is indispensable, yet it is used only for the
smaller transactions of present-day economic life. A
hundred years ago it was used much more generally.
Since then the use of bank deposits has increased to
such an extent that payments made by check are now
many times greater than payments made with paper
money and coin.
The use of deposits is facilitated by the service of
the Federal Reserve Banks in clearing and collecting
checks through the reserve accounts of member banks.
For example, suppose that a manufacturer in Hartford, Connecticut, sells $1,000 worth of electrical equipment to a dealer in Sacramento, California, and receives in payment a check on a bank in Sacramento.
The check is an order on the Sacramento bank to pay
the Hartford manufacturer $1,000. Obviously, the
Hartford manufacturer does not want to make a trip
to California to collect the $1,000, nor does he want to

THE FEDERAL RESERVE SYSTEM

pay postage and insurance on a shipment of currency.
He does not ordinarily want currency at all. What he
wants is to have $1,000 placed to his credit in his
checking account. Accordingly, he deposits the check
in his Hartford bank. The Hartford bank does not
want currency for the check; it wants credit in its reserve account at the Federal Reserve Bank of Boston.
Accordingly, it sends the check to the Federal Reserve
Bank of Boston. The Federal Reserve Bank of Boston
sends it to the Federal Reserve Bank of San Francisco.
The Federal Reserve Bank of San Francisco sends it
to the bank in Sacramento. The bank in Sacramento
charges the check to the account of the depositor who
wrote it, and either remits the amount to the Federal
Reserve Bank of San Francisco or authorizes the San
Francisco Reserve Bank to charge the amount to its
reserve account. The Federal Reserve Bank of San
Francisco thereupon credits the Federal Reserve Bank
of Boston. The Federal Reserve Bank of Boston in
turn credits the account of the Hartford bank. Thus
the check effects the transfer through the Federal Reserve Banks of $1,000 of deposit credit from the checking account of the dealer in Sacramento to the checking account of the manufacturer in Hartford.
Since promptness is important in collecting checks,
the Federal Reserve Banks extend to member banks
having a substantial volume of checks payable in other
Federal Reserve districts the privilege of sending such
checks direct to other Federal Reserve Banks for collection. The Hartford bank might, therefore, have
forwarded the $1,000 check direct to the Federal Reserve Bank of San Francisco for collection, at the same
time informing the Federal Reserve Bank of Boston
of its action. Credit would then have been given to

SERVICE FUNCTIONS

the Hartford bank's reserve account by the Federal
Reserve Bank of Boston on the basis of this information just as if the check had been sent through Boston.
The Federal Reserve Banks and the American
Bankers Association cooperate closely in improving
check collection practices. Together they have developed the practice now followed of reporting by wire
the nonpayment of any check for $1,000 or more.
Therefore, if the $1,000 check received by the Hartford manufacturer had been dishonored for any reason,
he would have been notified promptly of this fact by
wire. Another practice similarly sponsored is that of
using a check routing symbol. This is the denominator
of the fractional number printed in the upper righthand corner of many checks. This symbol tells transit
clerks at a glance where each check should be sent to
facilitate its prompt presentation. The check routing
symbol makes it possible for checks to be routed more
accurately and more speedily.
Even though a bank is not a member of the Federal
Reserve System, it may nevertheless arrange to maintain with the Federal Reserve Bank what is called a
"clearing balance." Checks drawn on other banks
which are received by the nonmember bank and forwarded by it to the Reserve Bank may be credited to
this clearing balance, and checks drawn against the
nonmember bank and deposited in other banks may be
paid with funds from the balance.
Checks which are collected and cleared through the
Federal Reserve Banks must be paid in full by the
banks on which they are drawn, without deduction of
a fee or charge. That is, they must be paid "at par."
The Federal Reserve Banks have greatly shortened
and simplified the process of clearing and collecting

THE FEDERAL RESERVE SYSTEM

checks. By doing so, they have improved the means
by which goods and services are paid for and by which
monetary obligations are settled; they have also reduced the cost to the public of making payments and
transferring funds. The Federal Reserve Banks also
handle other items for collection besides checks, such
as drafts, promissory notes, and bond coupons.
In order to make transfers and payments as promptly
and efficiently as possible, the twelve Federal Reserve
Banks maintain a gold certificate fund in Washington
called the Interdistrict Settlement Fund, in which each
Reserve Bank has a share. Through this fund money
is constantly being transferred by telegraphic order
from the account of one Reserve Bank to that of another. Many millions of dollars of transfers and payments are made every day, including large transfers for
member banks and for the United States Treasury.
Supervisory Functions
Each of the Federal Reserve Banks has an examining staff for the examination of State member banks
in its district. The Federal Reserve Banks themselves
are examined by the examining staff which the Board
of Governors maintains.
Among other supervisory powers exercised by the
Federal Reserve authorities with respect to banks are
the following:
1. The power to take disciplinary action, including
the following specific powers: to remove officers and
directors of member banks—after citation in the case
of national banks by the Comptroller of the Currency
and in the case of State member banks by the Federal
Reserve Agent—for continued violation of banking law
or for continued unsafe or unsound banking practice;

SERVICE FUNCTIONS

and to suspend member banks from recourse to the
credit facilities of the Federal Reserve System if it is
found that they are making undue use of bank credit
for speculation in securities, real estate, or commodities.
2. The power to grant permits to national banks to
exercise trust powers.
3. The power to grant permits to holding companies
so that they may vote the stock of member banks controlled by them. Such companies are usually corporations which own a majority of the stock of one or more
member banks.
4. The power to permit member banks to engage in
banking abroad by establishing branches in foreign
countries and by investing in the stock of corporations
organized under the provisions of State laws or of
Section 25(a) of the Federal Reserve Act (so-called
Edge Act corporations) to engage in international or
foreign banking. With the Board's permission, seven
large banks situated in New York, Boston, and San
Francisco were maintaining foreign branches in June
1947, about seventy-five in all, situated in twenty-one
different countries; four of the corporations were operating six branches and two fiduciary affiliates in four
foreign countries; and two corporations were conducting their foreign banking business in New York.
Fiscal Agency Functions
The twelve Federal Reserve Banks carry the principal checking accounts of the United States Treasury,
handle much of the work entailed in issuing and redeeming Government obligations, and perform numerous other important fiscal duties for the United States
Government.

THE FEDERAL RESERVE SYSTEM

The Government has an enormous amount of banking business to do. It is continuously receiving and
spending funds in all parts of the United States. Its
receipts come mainly from taxpayers and purchasers
of Government securities and are deposited in the
Federal Reserve Banks to the credit of the Treasury.
Its funds are disbursed mostly by check, and the
checks are charged to the Treasury's account by the
Federal Reserve Banks.
The Federal Reserve Banks also perform important
services for the Treasury in connection with the public
debt. When a new issue of Government securities is
sold by the Treasury, the Reserve Banks receive the
applications of banks, dealers, and others who wish to
buy, make allotments of securities in accordance with
instructions from the Treasury, deliver the securities
to the purchasers, receive payment for them, and credit
the amounts received to the Treasury's checking account. The Reserve Banks also redeem securities as
they mature, make exchanges of denominations or
kinds, handle transfers and conversions, pay interest
coupons, and do a number of other things involved in
servicing the Government debt. They issue and redeem
United States savings bonds and upon request hold
them in safekeeping for the owners. For the convenience of the Treasury and also for the convenience of
investors in Government securities, it is necessary that
there be facilities in various parts of the country to
handle such transactions, and the Federal Reserve
Banks furnish these facilities. Since the Federal Reserve authorities are constantly in touch with the
money and investment markets, the Treasury follows
the practice of consulting them for their advice as to
the terms and conditions that will affect the sale and
the refunding of Government obligations.

SERVICE FUNCTIONS

Under instructions from the Treasury, each Federal
Reserve Bank manages the war loan deposit accounts
of banks in its district. These accounts are so called
because they were authorized during World War I to
expedite the Government's wartime financing; they
continued to be used during peace years, and during
World War II the Treasury's financing program again
made them very important. Nonmember banks as
well as member banks of the Federal Reserve System
may become "special depositaries" of the Treasury
and carry war loan deposit accounts by complying
with the Treasury's requirements. The principal requirement is the pledge with a Federal Reserve Bank,
as fiscal agent of the Treasury, of Government securities or other acceptable collateral that will fully secure
the balance in the account. A bank designated as a
war loan depositary credits to the war loan account the
proceeds of its customers' and its own subscriptions
to Government securities issued by the Treasury from
time to time. As the Treasury calls for the funds, they
are transferred to a Treasury account at a Federal
Reserve Bank and become available for disbursement.
War loan deposit accounts are a convenient and practically indispensable device for the sale of Government
securities in large volume. They greatly facilitate
the payments for the securities purchased and the
Treasury's receipt of the payments.
In connection with the lending and other financial
activities of such Government agencies as the Reconstruction Finance Corporation and the Commodity
Credit Corporation, the Federal Reserve Banks act as
custodians of collateral and securities. This involves
not only safekeeping but disbursement of funds upon
receipt of proper documents and maintenance of accu-

THE FEDERAL RESERVE SYSTEM

rate records of large quantities of securities, warehouse
receipts for commodities, and other valuable papers
which are constantly in process of being received,
transferred, and returned, as loans are granted, as
partial payments are made, and as maturing obligations are paid off or renewed.
The Federal Reserve Banks are reimbursed by the
United States Treasury and other Government agencies for much of the expense incurred in the performance of fiscal agency functions.
Because of its situation in one of the principal financial centers of the world, the Federal Reserve Bank of
New York acts as the agent of the United States Treasury in gold and foreign exchange transactions. It acts
as depositary for the International Monetary Fund
and the International Bank for Reconstruction and
Development; it receives deposits of foreign governments and central banks and performs certain incidental services as their correspondent. These services
include handling their short-term investments in this
market and holding gold under earmark for them in
the United States. All the Federal Reserve Banks
participate in the foreign accounts carried on the books
of the Federal Reserve Bank of New York, which, in
these matters, acts as agent for the other Federal Reserve Banks. The Board of Governors in Washington
exercises special supervision over all relationships and
transactions of Federal Reserve Banks with foreign
banks and governments and with the International
Monetary Fund and the International Bank.
The service functions that have been described absorb the attention and time of the greater part of the
Federal Reserve Bank personnel.

CHAPTER X
BALANCE SHEET OF THE FEDERAL RESERVE
BANKS
The credit operations of the Federal Reserve
Banks are reflected in their balance sheet. Comparisons for different dates reflect changes in fundamental monetary conditions.

HE major credit functions described in the preceding chapters are reflected in the balance sheet
of the twelve Federal Reserve Banks, which is made
public every Friday and shows the condition of the
Reserve Banks on the Wednesday immediately preceding. The statement appears in the Friday issue of the
principal daily newspapers of the country and is usually
accompanied by explanatory comment, particularly as
to changes in member bank reserves and related factors.
The statement as of December 31, 1946, in condensed form for the most part but with a few items
that are not included in the statement published regularly, is given on the following page. Only the most
important items are shown separately.
Explanation of Asset Accounts
1. GOLD CERTIFICATES on hand and due from the
United States Treasury. The law does not permit the
Federal Reserve Banks to own gold and forbids the use
of gold or gold certificates in circulation, but it authorizes the Treasury to issue gold certificates to the Federal Reserve Banks for the gold it acquires. In exchange for these certificates the Treasury obtains credit
in the checking accounts it maintains with the Federal
Reserve Banks. The Federal Reserve Banks do not

THE FEDERAL RESERVE SYSTEM

hold any large amount of gold certificates, however,
their actual receipt being unnecessary and cumbersome; instead the Reserve Banks and the Treasury
keep a book record of gold certificates due the Federal
BALANCE SHEET OF THE RESERVE BANKS, DECEMBER 31, 1946

Millions
of
dollars
1. GOLD CERTIFICATES on hand and due from U. S. Treasury 18,381
2. Other cash
268
ASSETS

3. U. S. GOVERNMENT SECURITIES
4. DISCOUNTS FOR MEMBER BANKS

5.
6.
7.
8.
9.

Acceptances purchased
Loans on gold
Other earning assets
Uncollected items
Miscellaneous assets

23,350
16

147
1
2,763
80

TOTAL ASSETS

45,006

LIABILITIES
10. FEDERAL RESERVE NOTES

24,945

11. Deposits:
a. RESERVES OF MEMBER BANKS

b. U. S. Treasurer's account
c. Other deposits
12. Deferred availability items
13. Miscellaneous liabilities
TOTAL

LIABILITIES

16,139

393
822
2,020
9
44,328

CAPITAL ACCOUNTS
14. Capital stock
15. Surplus .
16. Other capital accounts
TOTAL LIABILITIES AND CAPITAL ACCOUNTS

187
467
24
45,006

Reserve Banks. This account includes both the
relatively small amounts of certificates actually delivered to the Federal Reserve Banks and the much
larger amount due them from the Treasury. The procedure is a method by which the Government makes
monetary use of its gold; instead of putting the gold
itself in circulation, the Treasury pledges it while re-

BALANCE SHEET OF RESERVE BANKS

taining physical possession of it. The arrangement gives
the Reserve Banks an asset in the form of a claim on
the United States Treasury, evidenced on the books
of the Treasury.
To meet the requirements of the law, a portion of
the gold certificates due the Reserve Banks is set aside
as a redemption fund for Federal Reserve notes; the
amount of this fund, which was 794 million dollars on
December 31, 1946, is included in the total shown on
the statement.
2. Other cash is coin and paper money (excluding
gold certificates and Federal Reserve notes) in the
Reserve Bank vaults.
3. UNITED STATES GOVERNMENT SECURITIES

com-

prise Treasury bills, Treasury certificates, Treasury
notes, and United States bonds. Since Reserve Bank
purchases of securities, as explained in earlier chapters, are a means of creating Reserve Bank credit—
and in recent years the most important means—the
amount of securities held also measures the amount
of Reserve Bank credit created by such purchases.
Accordingly, it is one of the most significant items of
the Reserve Bank statement and reflects one of the
most important aspects of the central banking function. Open market transactions are authorized by the
Federal Reserve Act, Sections 12A and 14.
All United States securities owned by the Reserve
Banks on December 31, 1946, had been purchased by
them from previous owners—banks, dealers in securities, and others. The law authorizes the Reserve Banks
to hold at any one time as much as 5 billion dollars of
Government obligations acquired directly from the
Treasury. Such direct transactions are infrequent,
however; during the year 1946 they did not occur at all.
4. DISCOUNTS FOR MEMBER BANKS. This item shows

THE FEDERAL RESERVE SYSTEM

the amount of Federal Reserve Bank credit created by
lending to member banks.
5. Acceptances purchased. These are prime bankers'
acceptances purchased by the Federal Reserve Banks
at the established buying rate when offered for sale by
bankers, dealers, and others. At the date of this statement the Federal Reserve Banks held no acceptances.
These purchases are authorized by the Federal Reserve
Act, Section 14, paragraph 1.
6. Loans on gold. These are loans made to foreign
central banks and foreign governments on the security
of gold owned by them. These loans are authorized by
the Federal Reserve Act, Section 14, paragraph 2.
7. Other earning assets in recent years have comprised loans to provide working capital for industry,
as authorized by Section 13(b) of the Federal Reserve
Act, and advances to individuals, partnerships, and
corporations on the security of direct obligations of
the United States, as authorized by Section 13, paragraph 13 of the Act.
8. Uncollected items are checks and other cash
items deposited with the Federal Reserve Banks and
still in process of collection at the time the statement
is made up.
9. Miscellaneous assets consist of several items, of
which the principal are the bank premises owned by
the Federal Reserve Banks, the premium on securities
owned, and accrued interest receivable.
Explanation

of Liabilities

and Capital

Accounts

10. FEDERAL RESERVE NOTES, which constitute the
principal part of currency in circulation, have been
described in previous chapters.
11. Deposits consist mainly of the RESERVES OF

BALANCE SHEET OF RESERVE BANKS

They also include checking accounts
of the United States Treasury and other governmental
agencies, deposits of foreign banks, and clearing accounts maintained by nonmember banks authorized by
Section 13 of the Federal Reserve Act.
12. Deferred availability items are of technical significance. The account arises from the fact that Federal Reserve Banks do not give immediate credit for
all checks deposited with them for collection, the
credit being deferred according to a time schedule
which allows for the time taken by the checks in
going through the mail to the banks upon which they
are drawn. Since the time actually taken is often
greater than allowed in the schedules, the result is
that some credit is given before the checks are collected. This is reflected in the fact that "uncollected
items," shown among the assets (No. 8), is generally
considerably larger than "deferred availability items."
The difference represents an amount of credit being
extended by the Federal Reserve Banks and is usually
referred to as Federal Reserve Bank "float."
13. Miscellaneous liabilities consist of several items,
the principal ones being discount on bills and securities, miscellaneous accounts payable, and accrued
dividends.
14. All of the capital stock of the Federal Reserve
Banks is owned by banks that are members of the
Federal Reserve System. See Chapter V.
15. Surplus is governed by Sections 7 and 13b of
the Federal Reserve Act. Section 7 surplus is
accumulated from the earnings derived by the Reserve Banks from their loans and investments. Ordinarily these earnings are adequate to cover the expenses
of the Reserve Banks, the 6 per cent per annum
MEMBER BANKS.

THE FEDERAL RESERVE SYSTEM

dividend payable to member banks, and additions to
surplus. Around the year 1920 and again in very recent years the net earnings of the Federal Reserve
Banks were large; but at other times they have been
relatively small. Some of the Federal Reserve Banks
in certain years have operated at a loss. The surplus
can be drawn on to meet deficits and pay dividends in
years when operations result in loss, but it cannot be
distributed otherwise to the stockholding member
banks. The law provides that, if the Reserve Banks
are dissolved, any surplus is to be paid to the United
States.
Section 13b surplus represents funds received from
the Secretary of the Treasury for the purpose of making
loans to industry in accordance with Section 13b of
the Federal Reserve Act, plus or minus the net earnings
or net loss arising from using such funds. This surplus
amounted to 27 million dollars at the date of the
statement.
16. Other capital accounts at the date of this
statement comprised only reserves for contingencies
amounting to 24 million dollars. At other times it will
include also unallocated net earnings for the year to
the date of the statement.
Historical Comparison
It is plain from a glance at the statement that four
accounts are by far the largest, namely, gold certificates
and Government securities, (1) and (3) among the
assets, and Federal Reserve notes and reserves of member banks, (10 and 11a) among the liabilities. These
accounts are also the most significant, for they reflect
the essential central banking operations of the Federal
Reserve Banks, as described in preceding chapters. In

BALANCE SHEET OF RESERVE BANKS

the course of years these accounts have undergone important changes in volume resulting from changed
economic and monetary conditions generally; and to
indicate these changes the figures at the end of 1920,
1930, 1940, and 1946 are tabulated as follows:
COMPARISON OF BALANCE SHEETS OF FEDERAL RESERVE BANKS IN
FOUR DIFFERENT YEARS

(In millions of dollars, as of December 31)
Account

1920

1930

1940

1946

ASSETS

1. Gold certificates on hand and 1
due from U. S. Treasury. . . 2,060
2. Other cash
264
3. U. S. Government securities. .
287
4. Discounts for member banks. . 2,687
5. Acceptances purchased
260
6. Loans on gold
7. Other earning assets
8. Uncollected items, etc
668
9. Miscellaneous assets
28

2,941 19,760
220
275
729
2,184
251
2
364

18,381
268
23,350
16

147

8
607
81

8
944
88

1
2,763
80

6,254

5,201

23,262

45,006

2
3,553
10. Federal Reserve notes
11. Deposits
a. Reserves of member banks. 1,781
b. U. S. Treasurer's account. .
57
c. Other deposits
23
519
12. Deferred availability items. . .
13. Miscellaneous liabilities
19

1,663

5,931

24,945

2,471
19
28
564
11

14,026
368
1,732
833
2

16,139
393
822
2,020
9

5,952

4,756

22,892

44,328

100
202

170
275

(3)

139
157
27
47

187
440
27
24

6,254

5,201

23,262

45,006

Total assets
LIABILITIES

Total liabilities
CAPITAL ACCOUNTS

14.
15.
16
17.

Capital . .
Surplus, Sec. 7. . .
Surplus Sec 13b
Other capital accounts
Total liabilities and capital accounts

Includes gold owned by Federal Reserve Banks.
Includes 217 million dollars of so-called Federal Reserve "Bank
notes," which are no longer issued.
3
Included in "miscellaneous liabilities."
2

THE FEDERAL RESERVE SYSTEM

The first thing to be noted in this tabulation is that
a number of items, including several of the most important, have greatly increased since 1920. On the
other hand, one important account, discounts for member banks, is much smaller than it used to be.
GOLD CERTIFICATES. The increase in the amount of
gold certificates reflects the enormous increase in this
country's stock of gold that occurred principally in the
decade between 1930 and 1940. It also reflects the revaluation of gold in terms of dollars. In 1934, by the
terms of the Gold Reserve Act the value of gold was
changed from $20 an ounce to $35 an ounce and thereby
the value of the stock of monetary gold in the United
States was raised from 4 billion to about 7 billion
dollars. Domestic production of gold also increased the
stock, but by far the greatest factor was the shipment
and sale of foreign gold to this country. Between January 31, 1934 and December 31, 1940, imports of gold
exceeded exports by more than 14 billion dollars. The
Treasury purchases all gold produced in the United
States or imported. By issuing gold certificates to the
Federal Reserve Banks, as has been explained earlier,
the Treasury obtains credit in the checking accounts
it maintains with those Banks.
During the war the country's stock of gold declined
somewhat but more recently it has been growing
rapidly. The sale of gold by the Treasury entails
reduction in the amount of gold certificates issuable
by it to the Federal Reserve Banks.
GOVERNMENT SECURITIES and DISCOUNTS FOR MEMBER BANKS. The increase in United States Govern-

ment securities reflects several important developments. In 1920, Federal Reserve Bank credit was
being furnished mainly in the form of discounts for

BALANCE SHEET OF RESERVE BANKS

member banks, but a few years later member banks
had to a great extent ceased to borrow at the Reserve
Banks. At the same time, open market purchases of
Government securities had become important as a
means of supplying member banks with the reserves
they had previously obtained by rediscounting.
Between 1930 and 1940, member banks borrowed at
the Reserve Banks less than in the decade before, and
the Federal Reserve authorities purchased more Government securities. The increased purchases occurred
mainly in the years 1931, 1932, and 1933, when the
Reserve Bank holdings rose from 729 million dollars
at the close of 1930 to 2,437 million at the close of
1933. This was the period of economic depression and
banking weakness that culminated in the crisis of
March 1933, and the Reserve authorities bought securities for the purpose of easing the money market and
offsetting the decline in the volume of money that resulted from liquidation of bank loans. The Reserve
Bank portfolio of Government securities remained
close to 2,500 million dollars till the end of the decade.
The more recent increase between 1940 and 1946
in the amount of Government securities held occurred
principally in the years of United States participation
in the war, 1942-1945. In this period the public debt
grew from 58 billion to 278 billion dollars, Government securities were regularly offered in the market,
and the Reserve authorities were under obligation to
keep the market orderly and stable. The principal
drain on member bank reserves during this period
arose from the extraordinarily large demand for currency. Federal Reserve Bank holdings of Government
securities became very large during this period, reaching a high point of nearly 25 billion dollars in the
latter part of 1945.

THE FEDERAL RESERVE SYSTEM

FEDERAL RESERVE NOTES. The volume of Federal
Reserve notes outstanding was unusually high in 1920.
In that year, which was one of high prices, the amount
of currency in circulation was larger than ever before,
and Federal Reserve notes made up by far the
greater part of total circulation. For the remainder
of the decade the volume of notes was substantially
less. But in 1931, 1932, and 1933 it greatly increased
as a result of the banking weakness of that period and
the general withdrawal of deposits from banks in currency. Thereafter the amount rose steadily until
1940. In 1940 the volume of Federal Reserve notes began to increase far more rapidly than at any previous
time, in response to accelerated demand for currency.
At the end of the war in 1945 the total currency in
circulation was over 28 billion dollars. This wartime
increase arose from several causes, the most important
of which were that employment was general, wages
were high, and a relatively large number of persons
kept more money on hand than usual. The volume of
Federal Reserve notes is directly affected by the public
demand for currency. When more currency is wanted,
the public obtains it through the banks, and the
amount of Federal Reserve notes increases; when the
public wants less it returns the surplus through the
banks and the amount decreases.
RESERVES OF MEMBER BANKS. Increases that have
occurred since 1920 in the country's gold stock and in
the amount of Reserve Bank credit have tended
directly to augment the volume of member bank reserves. On the other hand, member bank reserves are
directly reduced when depositors withdraw currency
from banks. Hence, roughly speaking, bank reserves equal the total of monetary gold and Re-

BALANCE SHEET OF RESERVE BANKS

serve Bank credit, less the amount of currency
in circulation. Since all three of these formative
elements reflect in some way the basic economic and
political conditions of the whole world, so too do member bank reserves. For instance, the tremendous
growth in the monetary gold stock between 1930 and
1940 reflected the unsettled conditions that were driving gold to the United States from other countries; the
great expansion in Reserve Bank credit that resulted
chiefly from purchases of United States Government
securities during World War II reflected the immense
increase in the public debt necessitated by participation in a global war; and the expansion of currency
in circulation during the war reflected the magnitude
of the war effort on the home front. The volume of
member bank reserves, therefore, is not the product
of domestic policy alone; indirectly it is also the
product of conditions arising from developments all
over the world.
The relation of member bank reserves to the other
accounts in the Federal Reserve Bank statement may
be illustrated by adding together gold certificates and
Federal Reserve Bank credit and subtracting from the
total the amount of Federal Reserve notes. The remainder, as shown in the following examples taken
from statements for the years indicated, is not greatly
different from the amount of member bank reserves.
Gold certificates, etc
U. S. Government securities
Discounts for member banks

1920
2,060
287
2,687

1930
2,941
729
251

1940
19,760
2,184
2

1946
18,381
23,350
16

Total
Federal Reserve notes

5,034
3,553

3,921
1,663

21,946
5,931

41,747
24,945

Remainder
Reserves of member banks

1,481
1,781

2,258
2,471

16,015
14,026

16,802
16,139

100

THE FEDERAL RESERVE SYSTEM

To account for differences between the actual
amount of member bank reserves and the remainder
shown by addition and subtraction of the other items
would require the introduction of numerous items not
otherwise relevant to this discussion. It is sufficient
for present purposes that the existence of a close relation between member bank reserves and the other
accounts be understood.
The principal other changes in the Federal Reserve
Bank statement over a period of years have occurred in
items 8 and 12 ("uncollected items" and "deferred
availability items"). The recent great increase in
these accounts, which reflect the volume of bank checks
deposited with the Federal Reserve Banks and in process of collection, is a consequence of the greatly increased volume of monetary payments in recent years.

CHAPTER XI
BANKING AND MONETARY AGENCIES OTHER THAN
THE FEDERAL RESERVE
There are several agencies other than the Federal Reserve with junctions and responsibilities
in the same general field but no other that has
the primary responsibility for regulating the
money supply.

INCE the Federal Reserve System is not the only
official agency in the monetary and banking field,
its operations cannot be fully understood without
some reference to certain other agencies. The most
important of these are the Treasury Department, the
Office of the Comptroller of the Currency, the Federal
Deposit Insurance Corporation, the State bank supervisors, certain Government agencies that make loans
and that guarantee loans made by banks, and certain
international lending organizations. These are described briefly in the following paragraphs.
The Treasury is the Government department with
which the Federal Reserve System* is most closely
related. The reason for this is twofold. In the first
place, a great part of the work of the Federal Reserve
Banks is performed by them as fiscal agents of the
Treasury; and in the second place, the Federal Reserve authorities have the responsibility of regulating
credit conditions in general and particularly those in
the money market, where the 'Treasury constantly
goes to borrow money. It is important to the Treasury
that Government financing be facilitated by the
maintenance of a stable and orderly market for Government securities and it is important to the Federal
101

102

THE FEDERAL RESERVE SYSTEM

Reserve that the nature and timing of Treasury offerings and redemptions be in harmony with current
monetary policies. The Treasury also has special
or occasional operations—for example, the purchase
and sale of gold and silver—that affect bank reserves
and hence the responsibilities of the Federal Reserve
authorities. The close relationship of Treasury and
Federal Reserve functions makes necessary a constant
cooperation between the two organizations, apart from
the fact that the Federal Reserve Banks are fiscal
agents of the Treasury.
The Office of the Comptroller of the Currency is a
bureau of the Treasury Department. It was established
in 1863 to supervise the system of national banks
whose organization under Federal charter was authorized that year. When the Federal Reserve System was
established fifty-one years later and national banks in
the continental United States were required to become
members of the System, they became subject to regulations of the Federal Reserve authorities also.
The Federal Deposit Insurance Corporation was
established in 1933. Deposits in national and State
bank members of the Federal Reserve System are insured up to $5,000 for each depositor, as are the deposits
of nonmember banks that voluntarily qualify for insurance. At the present time most of the nonmember
banks are qualified. Banks whose deposits are insured
by the Corporation are in certain respects subject to
its regulations and insured nonmembers are subject to
examination by it.
In addition to the two Federal agencies just mentioned, each of the forty-eight States supervises banks
incorporated under its law. In this situation, it is
necessary for the various agencies with supervisory

OTHER BANKING AND MONETARY AGENCIES 103

responsibilities to cooperate and consult with one another for the development of consistent standards and
procedures in bank examination.
Congress has given certain powers to make loans,
largely with public funds, to a number of Federal
agencies. These agencies are principally the Reconstruction Finance Corporation, which under certain
conditions is authorized to lend to business enterprises,
financial institutions, municipalities, and public agencies and corporations; a group of agricultural credit
agencies under the Farm Credit Administration, which
make various types of agricultural loans; the Rural
Electrification Administration, which makes loans to
encourage the use of electricity in rural areas; and the
Export-Import Bank, which makes loans, mostly foreign, to promote the export and import trade of the
United States. The Federal Reserve Banks are authorized to act as fiscal agents of many of these organizations. The loans made by these and other agencies are
intended to supplement the lending activities of commercial banks, particularly in fields where the latter
are inhibited from making loans by law, custom, or the
nature of the risk. Besides making loans, some of the
foregoing Federal agencies and certain others have
been authorized by Congress to guarantee and insure
loans made by banks and other financial institutions.
In particular, the Veterans' Administration has been
authorized to guarantee and insure loans (so-called
"G.I." loans) that may be obtained from banks and
other institutions by veterans of World War II, and
the Federal Housing Administration, under certain
conditions, can insure home mortgage loans made by
banks and other financing institutions.
Two international institutions, the International

104

THE FEDERAL RESERVE SYSTEM

Monetary Fund and the International Bank for Reconstruction and Development, which have offices in
Washington, D. C, have functions that relate them
closely to the Federal Reserve System. They are not
part of the American banking and monetary system,
but they affect the domestic money market through
their operations in gold and through the influence they
have on the demand for credit in this country. The
United States shares with other nations the ownership
and control of these two institutions and has representatives on their directing bodies appointed by the
President with the Senate's approval. In order to coordinate the policies and operations of these representatives and of all agencies of the Government that
make foreign loans or engage in foreign financial
transactions, Congress has established the National
Advisory Council on International Monetary and
Financial Problems, whose members are ex officio the
Secretary of the Treasury, who is Chairman of the
Council, the Secretary of State, the Secretary of Commerce, the Chairman of the Export-Import Bank, and
the Chairman of the Board of Governors of the Federal Reserve System. Any Federal Reserve Bank,
upon request of the International Monetary Fund and
the International Bank, may act as the depositary and
fiscal agent of these institutions.

CHAPTER X n
WAR SERVICE OF THE FEDERAL RESERVE
During the war the primary duty of the Federal
Reserve was to facilitate the financing of mili
tary requirements and of production for war
purposes .

N time of war the duty of the Federal Reserve, as
of everyone, is to support the country’s war effort.
The Federal Reserve provides machinery for aiding
the Government to finance the enormous expenditures
necessitated by war. The United States has partici
pated in two world wars since the establishment of the
Federal Reserve, and in both wars the Reserve Sys
tem has taken an active part in helping to finance the
requirements of the Government. The amount of
money to be spent to fight a war is determined by
Congress, which also has the responsibility of decid
ing how much of the money shall be raised by taxation.
The difference between the revenue raised by taxes
and total expenditures has to be met by borrowing. It
is the responsibility of the Treasury Department to
determine the character of obligations on which the
Government will borrow and the rate of interest it
will pay to investors. In these matters the Federal
Reserve is consulted and makes recommendations,
particularly with respect to how the war needs may
be met with as little inflationary effect as possible.
After policy decisions have been made, it is the duty of
the Federal Reserve to see to it that the banking system
is in a position to absorb any public debt essential for
war expenses that is not purchased by investors other
than banks.

105

106

THE FEDERAL RESERVE SYSTEM

It was the policy of the Treasury and the Federal
Reserve during the war to make every effort to en
courage nonbank investors to absorb as much as possi
ble of the public debt, and to leave as little as possible
for the banks. The reason for this is apparent from
preceding chapters. When an individual or a corpora
tion pays taxes or buys a Government bond, the Treas
ury comes into possession of money that was already
in existence and owned by the taxpayer or bond pur
chaser. There is no addition to the money supply and
no additional upward pressure on prices, except to the
extent that funds previously held idle may have been
put to use, or to the extent that the bond buyer or tax
payer borrows from a bank to pay taxes or to buy Gov
ernment securities. As the Treasury acquires more
money with which to buy war goods, someone else has
correspondingly less money to spend on civilian goods.
When, however, a bond is bought by the banking sys
tem, no one gives up his money to the Government;
new money is created in the form of a bank deposit to
the credit of the Government. As the Government
spends this money and it passes into the hands of the
public, it is added to the general money supply and
becomes available for the purchase of such civilian
goods as are in the market.
Since production for civilian use is limited in war
time by the concentration of the nation’s effort on
production for war purposes, the additional money
arising from bank purchases of Government bonds
may result in more money for civilian purchases than
there are goods and services to be bought at existing
prices. The extra money cannot lead to increased out
put, since the industrial plant and manpower are
already in use to their full capacity. Consequently, if

WAR SERVICE OF FEDERAL RESERVE

107

the extra money is used, it results in an upward pres
sure on prices. It becomes an inflationary influence,
which during the war is held in check by direct con
trols over prices, by rationing, and by allocation of
materials.
In order to avoid or minimize this inflationary pres
sure during the war, many things were 'done to chan
nel Government bonds into the hands of individuals
and corporations; in other words, to have the bond
purchases absorb existing and current savings rather
than bring additional money into existence. Cam
paigns to place War Savings bonds, drives to sell war
bonds, and other measures were actively pursued by
the Treasury and supported by the Federal Reserve.
But the Federal Reserve had the responsibility for see
ing that the banks had enough funds to absorb the
Government securities that were not taken by non
bank purchasers. Prevention of inflation had to be
come secondary to providing the sinews of war. The
Federal Reserve was able to regulate security loans
and consumer credit by methods which did not inter
fere with the total supply of money and to use its
influence to discourage speculative purchases of Gov
ernment securities by the use of bank credit. But it
had to suspend the use of general methods of restrain
ing the growth in the money supply.
At the outbreak of the war the Federal Reserve de
clared its determination to see to it that banks had
adequate funds for war needs. This undertaking was
carried out throughout the war period. For the pur
pose the Federal Reserve established a low rate for
discounts based on short-term Government securities.
It agreed to purchase, at a fixed rate of % per cent,
all three-month Treasury bills offered in the market,

108

THE FEDERAL RESERVE SYSTEM

and by open market purchases supported all Treasury
issues that needed support. With this assistance from
the Federal Reserve, the Treasury was able to meet
the enormous war needs of the Government at ex
tremely low rates and to maintain at all times a
strong market for United States Government obliga
tions.
In addition to this the Federal Reserve acted as the
agent of the Government in its undertaking to guar
antee or provide bank loans to contractors who could
not otherwise have financed production for the war
effort. This service, which employed the organization
and contacts of the Federal Reserve in efficiently
directing many billions of dollars into war production,
made an important contribution to the war effort.
By cooperation of the War Department, the Navy
Department, and the Maritime Commission with the
War Production Board and the Federal Reserve
authorities, an arrangement was developed, and author
ized by Executive Order of the President, for insuring
or guaranteeing loans that were needed to finance
essential war production. The loans were made by
commercial banks or other lending institutions which,
to protect..themselves from excessive risk, often ob
tained guarantees covering portions of loans. The
guarantee was given by the War Department, the
Navy Department, or the Maritime Commission, de
pending on which was primarily interested in the
contract which the loan was to finance. The Federal
Reserve Banks acted as their agents.
For example, a manufacturer may have had ma
chinery for the production of cartridges but not money
enough to buy the necessary materials or to pay the
necessary wages. A commercial bank may not have

WAR SERVICE OF FEDERAL RESERVE

109

felt justified in lending him the amount he needed
unless it had a guarantee. In such a case the War
Department, in order to obtain the cartridges, would
be willing to give that guarantee, and the bank would
be willing to pay a fee for it. An agreement would
accordingly be made by which the War Department
obligated itself to purchase 75 per cent or another desig
nated portion of the loan upon the bank’s demand.
The manufacturer would then be granted the loan
and could begin making the cartridges ordered by the
War Department. Such guarantees were authorized
for 8,771 loans aggregating 10.3 billion dollars.
Aggregate results of financing the war may be sum
marized as follows: from the middle of 1940 to the
end of 1945 the United States Government had to
raise the incredibly large sum of 380 billion dollars,
chiefly for war purposes. Of this amount, 153 billion
was raised by taxation, 132 billion came from sales of
securities to nonbank investors, and 95 billion was
financed by bank credit. As a consequence, and not
withstanding the efforts to minimize bank participation
in war finance, the total of bank deposits and currency
increased 112 billion dollars, that is, about threefold,
during the war. In addition, the public (including
Federal and State government agencies and trust funds,
insurance companies, other businesses, and individuals)
holds 130 billion dollars of United States Government
obligations, which it is in a position to sell or cash
at any time and thereby to acquire more money with
which to purchase goods and services. The inevitable
heritage of war is an enormous expansion of money
and a grave threat of inflation.
With the termination of the war the Federal Re
serve must once more direct its policies toward regula

110

THE FEDERAL RESERVE SYSTEM

tion of the money supply. Its task is made extremely
complex and difficult by the great financial dislocation
caused by the war. The vast amount of Government
securities held by individuals, corporations, endow
ments, and savings institutions, including insurance
companies, makes it desirable to continue to protect
these securities from wide variations in price. Further
more, a rise in the cost of money would increase the cost
of the debt to the Government, that is, to the taxpayers.
While the interest rate at which the Government was
able to borrow was low, the annual cost of the debt
is nevertheless 5 billion dollars. If the general level of
interest rates went up, the cost of the debt, as it came
due and was refunded, would increase further. In
these circumstances the Federal Reserve must rely in
part on selective rather than general methods of con
trol and must also develop new techniques adapted to
new domestic and world conditions.
These serious problems are before the Federal Re
serve at the present time and it is too early to describe
the methods that it will be able to devise and be
authorized to use in meeting the new situation. But,
whatever changes in technique the Federal Reserve
may have to adopt, its general objective remains un
changed. T o repeat what has been said before, this
objective is to contribute to the maintenance of stable
production and values, high employment, and a rising
standard of living.

CHAPTER XIII
SUMMARY
The Federal Reserve as it operates at present is
the product of constant adaptation to changing
conditions. It has to deal today with monetary
problems that are far different from those that
occasioned its establishment.

HE basic powers of the Federal Reserve authorities relate to money and banking. They are monetary in that they deal with the means of payment,
which consists in part of currency and in part of
deposit credit.
Before the Federal Reserve System was organized,
the outstanding defects of American banking were
diagnosed as "inelastic currency" and "scattered bank
reserves." Establishment of the System promptly
cleared the way for the anticipated improvements.
Elasticity of the currency was achieved. The machinery for note issue proved adequate for the purpose
and in time was found to work almost automatically.
For many years, including the war period, the volume
of currency in circulation has expanded and contracted
smoothly and efficiently in accordance with the varying requirements of the public, and the currency function of the Federal Reserve Banks has become a matter
of routine, virtually free from uncertainties and difficult administrative problems.
The reserve function, on the other hand, has assumed
far greater importance. It has come to be recognized
as much more than a matter of "pooling" or "mobilizing" scattered reserves and making available to banks
in need of funds the surplus reserves of banks that
111

112

THE FEDERAL RESERVE SYSTEM

have more than they need. It involves a power to create
reserve funds and to extinguish them. If the funds lent
by a Federal Reserve Bank, or paid by it for securities,
were merely the funds deposited with it by its member
banks, the loans and the purchases would not enlarge
the total volume of reserve funds. In fact, however,
they do enlarge the total volume of reserve funds. By
acquiring the obligation of a member bank or other
obligor and in exchange crediting an equivalent amount
to the reserve balance of the member bank, a Federal
Reserve Bank expands its assets and its liabilities,
and these continue expanded so long as the obligation
is held. The action is creative.
This does not mean that the power of the Federal
Reserve authorities is unlimited. The law limits their
power to expand their deposits—that is, the reserve
balances of member banks—and to expand their note
issue by requiring that these liabilities not exceed
four times their holdings of gold certificates. Moreover, Federal Reserve action does not result in an increased use of bank credit unless there is a demand
from the public for the credit. The Federal Reserve
authorities are able to expand bank reserves to meet
almost any conceivable demand for credit once that
demand comes into existence and also to discourage a demand for credit when it shows signs of
developing speculative excesses. They possess no
means, however, of impelling bank customers to borrow or of impelling bankers to lend.
The powers of the Federal Reserve to regulate the
volume of bank credit, or money, are one of the important factors in determining economic conditions. The
purpose of Federal Reserve functions, like that of
governmental functions in general, is the public wel-

SUMMARY

113

fare. Federal Reserve policy must be viewed in the
light of its objective—which is to maintain monetary
conditions favorable for an active and sound use of the
country's productive facilities, a high level of employment, and a rate of consumption reflecting widely diffused well-being. In carrying out their policy, the
Federal Reserve authorities take into account the factors making up the prevailing situation and use their
powers in the way that seems to them best calculated
to contribute, with other agencies, to economic stability
and progress.
In review, the principal means through which the
Federal Reserve authorities may exercise their powers
over bank credit are the following:
DISCOUNTS. Through the power to raise or lower
Reserve Bank discount rates and the power to discount
and make advances, the Federal Reserve authorities
are able to influence both the cost and availability of
bank credit and to supply individual banks with additional reserve funds.
OPEN MARKET OPERATIONS. These operations directly affect the volume of reserves: purchases of securities by the Federal Reserve authorities supply banks
with additional reserve funds, and sales of securities diminish the volume of such funds. As a means of credit
expansion, these operations are limited by the reserve
position of the Federal Reserve Banks, and at the
commercial bank level by the demand for bank credit.
As a means of credit contraction, they are limited by
the amount of securities held by the Reserve Banks.
RESERVE REQUIREMENTS. Raising or lowering requirements as to the reserves which member banks
maintain on deposit with the Federal Reserve Banks
has the effect of diminishing or enlarging the volume of

114

THE FEDERAL RESERVE SYSTEM

funds that member banks have available for lending.
Under existing law, the requirements may be raised
from the present level for New York and Chicago
member banks but not for other member banks; they
may be reduced by one-half at banks outside New
York and Chicago and by about one-third at banks
in those cities.
SELECTIVE CONTROLS. AS has been stated in earlier
chapters, the foregoing powers directly affecting the
volume of member bank funds have no immediate effectiveness with respect to the utilization of those funds.
In the field of stock market speculation, however, the
Reserve authorities exercise direct control. During the
war and early postwar period they also exercised direct
control in the field of consumer credit. The Reserve
authorities may also exercise limited influence over
the credit practices of banks through bank supervision
and examination.
In addition to the credit functions described, the
Federal Reserve Banks perform certain services of
which the most important are: holding member bank
reserve balances; furnishing currency for circulation;
facilitating the clearance and collection of checks and
the transfer of funds; and acting as fiscal agents, custodians, and depositaries of the United States Government.
In recent years the most important problems affecting Federal Reserve policy have arisen from war. The
country's war effort had to be financed, and the share
of the Federal Reserve in that task called for the most
careful and extensive use of its powers. A stable market had to be maintained where the credit needs of
the Government and of industry could be satisfied
promptly and at low cost. The Federal Reserve

SUMMARY

115

authorities maintained such a market by ready purchases of Government obligations at par, by low money
rates, by arranging guaranteed credit for war production, and by restraint upon the use of credit for speculating in securities and for financing civilian consumption. But war financing, a part of which had to be
met by selling Government obligations to the banks,
left the country in possession of a supply of money
far greater than needed in peacetime and potentially
inflationary in its influence. Furthermore, the size and
distribution of the public debt greatly complicate the
task of regulating the money supply.
The Federal Reserve System was established in an
era when the monetary problem was one of scarcity
and rigid limitation on expansion; it has come to
operate in an era when the problem is instead one of
superabundance and of rigidities in the way of contraction.

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Comprising 17 papers on banking and
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Statistics of banking,
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116

PUBLICATIONS

117

(8 pamphlets)—No. 1. Jobs,
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Private Capital Requirements; No. 6. Housing, Social Security, and Public Works; No. 7. International Monetary
Policies; No. 8. Federal Reserve Policy.

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Services, Board of Governors of the Federal Reserve System,
Washington 25, D. C.

INDEX
PAGE

Acceptances:
Bankers', as element in Federal Reserve credit
31
Item in condition statement of Federal Reserve Banks.... 92
Affiliates, holding company, permits granted by Federal Reserve authorities
85
American Bankers Association, cooperation with Federal Reserve in check collection practices
83
Assets and liabilities of Federal Reserve Banks:
Balance sheet
89
Definition of items in statement of condition
90
Balance sheet for the Federal Reserve Banks:
Assets and liabilities
90
Description of items
89
Bank credit:
Regulation of
24
Relation of gold to
68
Relation of reserves and deposits to
66
Reserves of banks as basis for
10
Bank examinations: (See Examinations.)
Bank supervision by Federal Reserve authorities
84
Banking and monetary agencies other than Federal Reserve.... 101
Board of Governors of Federal Reserve System:
Annual report to Congress
56
Building, dedication of
1
Duties of
56
Expenses assessed on Federal Reserve Banks
55
Members of
56
Publications of
57,116
Branch banks:
Federal Reserve System:
Directors
54
List of
51
Foreign, power of Federal Reserve authorities to permit
establishment of
85
Brokers and dealers in securities, margin requirements
39
Capital accounts of Federal Reserve Banks
94
Capital stock: (See Stock, capital.)
Central banking functions of Federal Reserve authorities
4
Central reserve cities
35
Charts:
Federal Reserve System
52
Major factors in the monetary equation
76
Member bank reserve balances
22
System holdings of discounts and United States Government securities
31
Check routing symbols, use of
83
Clearing and collection:
Checks, as function of Federal Reserve System
4
Collections, clearances, and transfers of funds
81
Service function of Federal Reserve Banks
81

119

120

INDEX
PAGE

Coins, circulation of
63, 80
Collateral for loans from Federal Reserve Banks
25
Commodity transactions compared with bank transactions
19
Comptroller of the Currency:
Examination of national banks
84
Relation with Federal Reserve System
... 102
Condition statements of Federal Reserve Banks, description
of items
90
Conference of Presidents of Federal Reserve Banks
58
Consumer credit:
Authority of Board of Governors to control
43
Termination of control
47
Country banks, reserve requirements of
36
Credit: (See Bank credit.)
Credit policies, authority of Board of Governors to formulate
and supervise execution of
57
Currency:
Amount in circulation, influence on volume of member
bank reserves
74
Changes in amount in circulation, reasons for
64
Coins, circulation of
63, 80
Distribution by Federal Reserve Banks
79
Elasticity achieved by Federal Reserve System
62, 111
Federal Reserve notes: (See Federal Reserve notes.)
Furnishing for circulation as function of Federal Reserve
System
4
Influence of Federal Reserve System on supply of
2
Relation of Federal Reserve System to
62
Relation of supply to bank deposits
5
Silver certificates
63
United States notes
63
Deferred availability items, definition of term in statement of
condition
93
Deposits:
All banks in United States
49
Insurance by Federal Deposit Insurance Corporation
102
Liability item in condition statement of Federal Reserve
Banks
92
Relation to loans and investment of banks
14
Reserve requirements at Federal Reserve Banks reduced
to 25 per cent
67
Reserve against: (See Reserves.)
War loan accounts, management by Federal Reserve Banks 87
Directors:
Federal Reserve Banks, classes of
53
Federal Reserve branch banks
54
Member banks, power of Federal Reserve authorities to
remove
84
Discount rate:
Authority of Board of Governors to review and determine 57
Changes as indication of Federal Reserve policy
26
Establishment by Federal Reserve Banks
55

INDEX

121
PAGE

Discounts:
Asset item in statement of condition of Federal Reserve
Banks
91, 96
Influence on bank reserves
24
Power of Federal Reserve authority to influence cost and
availability of bank credit
113
Dividends of Federal Reserve Banks
55
Earnings of Federal Reserve Banks, purpose of
55
Eligible paper
25
Examinations:
Federal Reserve Banks
84
National banks by Comptroller of the Currency.,
84
Nonmember insured banks by Federal Deposit Insurance
Corporation
102
State member banks
84
Executive Orders:
Consumer credit, giving Board temporary control over
44
War loans, insuring or guaranteeing loans needed to finance
war production
108
Federal Advisory Council, members and duties of
58
Federal Deposit Insurance Corporation:
Examination of nonmember insured banks
102
Relation with Federal Reserve System
102
Federal Open Market Committee:
Composition of
57
Duties of
57
Federal Reserve Act, date of passage
1
Federal Reserve Bank of New York, agent of Treasury in gold
and foreign exchange transactions
88
Federal Reserve Banks:
Balance sheet of
89
Branches of
51
Capital stock of
53, 90, 93
Collections, clearances, and transfers of funds as function of 81
Currency distribution as function of
79
Custodians of collateral and securities for Government
agencies
87
Directors, classes of
53
Earnings of
55
Examination of
84
Fiscal agency functions
85
Income
54
Lending powers, sources and limitations of
34
List of
51
Relations with Treasury
101
Service functions of
79
Summary of services performed
114
Supervisory functions
84
Surplus of
55, 90, 93
Federal Reserve districts:
List of
51
Map of
52
Federal Reserve lending power, sources of
33

122

INDEX
PAGE

Federal Reserve notes:
Circulation of
62
Interest charge paid to Treasury
55
Power of Federal Reserve System to issue
2
Reserve in gold certificates required against
33
Reserve requirement at Federal Reserve Banks reduced to
25 per cent
67
Review of circulation since 1920
98
Federal Reserve System:
Functions relating to member banks, United States Government, and the public
4
Influence on supply and availability of money
7
Map of . . . . : . . . .
52
Means of influencing money supply
7
Membership in
48
Purposes of
1
Relation to employment, wages, and standard of living
1
Structure of
48
Summary of powers and functions
111
War service of
105
Fiscal agents, function of Federal Reserve System acting for
Treasury and other governmental agencies
4, 85
Float, term used in connection with condition statement of
Federal Reserve Banks
93
Foreign banking corporations, authority to establish
85
Foreign banks, Federal Reserve Bank of New York as agent for 88
Foreign branches, establishment of
85
Foreign exchange, Federal Reserve Bank of New York as agent
of United States Treasury
88
Franchise tax, payment by Federal Reserve Banks
55
Gold:
Amount held by Treasury
69
Loans on, asset item in condition statement of Federal
Reserve Banks
92
Movement of, effect on volume of member bank reserves. 23, 74
Relation of Federal Reserve System to
68
Transactions with foreign countries
71
Gold certificate fund
84
Gold certificates:
Amount held by Federal Reserve Banks
69
Asset item in statement of condition of Federal Reserve
Banks
90, 96
Legal requirement against notes in circulation and deposits. 33, 67
Government agencies, relation to Federal Reserve System.... 103
Government securities:
Asset item in statement of condition of Federal Reserve
Banks
91, 96
Buying and selling as means of influencing money supply.. 27
Issuance and redemption as function of Federal Reserve
Banks
85
Services performed by Federal Reserve Banks in connection with issuance
86
Guarantees covering war loans
108

INDEX

123
PAGE

Holding company affiliates, power of Federal Reserve authorities to grant voting permits
85
Instalment buying, control of Board of Governors over
44
Insurance of deposits
102
Interdistrict Settlement Fund
84
International Bank for Reconstruction and Development:
Federal Reserve Bank of New York as depositary for
88
Functions as related to Federal Reserve System
104
International Monetary Fund:
Federal Reserve Bank of New York as depositary for
88
Functions in relation to Federal Reserve System
104
Legislation:
Federal Reserve Act, passage of
1
Reserve requirements, empowering Federal Reserve to
change
36
Liabilities of Federal Reserve Banks
90
Loans:
Governmental agencies, power given by Congress to
103
Member banks, authority of Federal Reserve Banks over. . 55
Paper eligible for rediscount at Federal Reserve Banks. . . .
25
Relation of reserves and deposits to
8, 14
Securities, regulation by changes in margin requirements. . 39
War, guaranteed by War and Navy Departments and Maritime Commission
108
Loans and investments, capital and deposits of banks as
basis for
10
Map of Federal Reserve System
52
Margin requirements, regulation by Board of Governors
39, 57
Maritime Commission, guarantee of war loans by
108
Member banks:
Loans and discounts, authority of Federal Reserve Banks
over
55
Number of
49
Obligations and privileges of
49
Officers and directors, power of Federal Reserve authorities
to remove
84
Membership in Federal Reserve System:
Number and classes of members
48
Obligations and privileges of
49
Monetary equation, factors affecting volume of member bank
reserves
74
Money: (See also Currency.)
Effect of supply on lives of people
6
Function of Federal Reserve System regulating supply....
4
Influence of discounts and discount rate on supply of
27
Money market, responsibility of Federal Reserve System in
connection with
59
National Advisory Council on International Monetary and
Financial Problems
104
National banks:
Chartered by Comptroller of the Currency
49
Number of
49
Supervision by Comptroller of the Currency and Federal
Reserve System
102

124

INDEX
PAGE

National banks—Continued.
Trust powers, authority of Federal Reserve to grant permits 85
National Monetary Commission, appointment to devise new
banking system
3
Navy Department, guarantee of war loans by
108
Nonmember banks:
Clearing balance, maintenance with Federal Reserve Banks 83
Examination of
84
Number of
49
Operations of Federal Reserve in the money market,
effect on
61
Open market operations:
Influence on money supply
27
Summary of Federal Reserve authority over
113
Par clearance of checks
83
Presidents of Federal Reserve Banks:
Appointment of
54, 56
Conference of
58
Public debt:
Annual cost of
110
Policy of Treasury during war to encourage nonbank
investors
106
Services performed by Federal Reserve Banks in connection with
86
Publications of the Board of Governors
57, 116
Pyramiding of stocks, effect of high margin requirements o n . . . .
41
Rates, discount: (See Discount rate.)
Reconstruction Finance Corporation:
Federal Reserve Banks as custodians of collateral and
securities for
87
Functions as related to Federal Reserve System
103
Rediscounts, eligible paper to obtain Federal Reserve credit. ...
25
Regulations, Board of Governors:
Reserve requirements
36
Securities loans, by changes in margin requirements
39
W, Consumer Credit, restraints imposed by
44
Reserve cities
35
Reserve requirements:
Authority of Board of Governors over
57
Changes in, as method of regulating money supply
34
Deposit liabilities of Federal Reserve Banks, reduction to
25 per cent
67
Effect on demand for currency
65
Federal Reserve notes, reduction to 25 per cent
67
Legislation empowering Federal Reserve to change
36
Percentages now in effect
36
Percentages originally prescribed
35
Power of Board of Governors in
fixing
11
Summary of Federal Reserve authority over
113
Reserves:
Accounts maintained by Federal Reserve Banks for member
banks
79
Effect of changes on volume of money
12
Effect of open market operations on
27

INDEX

125
PAGE

Reserves—Continued.
Excess, effect of movement of gold on
23
Excess of member banks with Federal Reserve Banks. . . .
22
Functions of
10
Holding for member banks by Federal Reserve System
4
Holdings of banks, influence on supply of money
8
Maintenance of reserve balances by banks prior to passage
of Federal Reserve Act
3
Member banks:
Increase or decrease, effect on deposits and loans and
investments
15
Review of changes since 1920
98
Ratio to combined note and deposit liabilities
67
Regulation of
24
Summary of functions and powers of Federal Reserve
112
Volume of, influence of gold movements, currency in circulation and Federal Reserve credit
74
Roosevelt, President Franklin D., statement at dedication of
new Federal Reserve Building
1
Safekeeping of securities, Federal Reserve Banks as custodians
of collateral and securities for Government agencies. . . .
87
Securities loans, regulation by changes in margin requirements.
39
Service functions of the Federal Reserve Banks
79
Silver, purchases by Treasury, effect on member bank reserves. 77
Silver certificates:
Amount in circulation
77
Denominations and amount of
63
Stabilization fund, amount of
70
State member banks:
Examination of
84
Number of
49
Obligations and privileges of
49
Stock, capital of Federal Reserve Banks:
Amount of
90
Dividends on
51, 55
Ownership of
53, 93
Stock market credit, authority of Board of Governors to control 39
Surplus of Federal Reserve Banks
-.
55, 90, 93
Treasury bills, place in financial system
32
Treasury Department:
Earnings of Federal Reserve Banks, portion paid to
55
Relations with Federal Reserve System
101
Trust powers, authority of Federal Reserve to grant permits to
national banks
85
United States Government, relation of Federal Reserve
System to
4
United States Government securities: (See Government securities.)
Voting permits, power of Federal Reserve authorities to grant..
85
War Department, guarantee of war loans by
108
War financing, summary of efforts of Federal Reserve System. . 114
War loan deposit accounts, management by Federal Reserve
Banks
87
War loans, Executive Order for insuring and guaranteeing loans 108
War services of the Federal Reserve
105

Full text of The Federal Reserve System : Its Purposes and Functions, (1947)

FRASER