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88th Congress, 2d Session

AUGUST 25, 1964

Printed for use of the Committee on Banking and Currency


For sale by the Superintendent of Documents, U.S. Government Printing Office
Washington, D.O., 20402 - Price 30 cents

W R I G H T PATMAN, Texas, Chairman
A L B E R T RAINS, Alabama
W I L L I A M B . WIDNALL, New Jersey
W I L L I A M A. B A R R E T T , Pennsylvania
E U G E N E SILER, Kentucky
P A U L A. FINO, New York
H E N R Y S. REUSS, Wisconsin
F L O R E N C E P . DWYER, New Jersey
SEYMOUR H A L P E R N , New York
C H A R L E S A. VANIK, Ohio
J A M E S HARVEY, Michigan
W I L L I A M S. MOORHEAD, P e n n s y l v a n i a
R O B E R T G. S T E P H E N S , J B . , Georgia
W. E . ( B I L L ) BROCK, Tennessee
F E R N A N D J . ST GERMAIN, Rhode Island
ROBERT T A F T , J E . , Ohio
J O S E P H M. McDADE, Pennsylvania
CLAUDE P E P P E R , F l o r i d a
J O S E P H G. M I N I S H , New Jersey
BURT L. TALCOTT, California
C H A R L E S L. W E L T N E R , Georgia
D E L CLAWSON, California
R I C H A R D T . HANNA, California
B E R N A R D F . GRABOWSKI, Connecticut
C H A R L E S H . WILSON, California
COMPTON I . W H I T E , J E . , Idaho
JOHN R. STABK, Clerk and Staff
JOHN E. BAEEIEEB, Professional Staff Member

OBMAN S. F I N K , Minority





W R I G H T PATMAN, Texas,
H E N R Y S. R E U S S , Wisconsin
C H A R L E S A. VANIK, Ohio
CLAUDE P E P P E R , F l o r i d a
J O S E P H G. M I N I S H , New J e r s e y
C H A R L E S L. WELTNER, Georgia
R I C H A R D T . HANNA, California
C H A R L E S H . WILSON, California

R O B E E T A. S C H E E M P ,



S T E P H E N D. KENNEDY, Research



W I L L I A M B . WIDNALL, New Jersey
J A M E S HARVEYj, Michigan
W. E . ( B I L L ) BROCK, Tennessee
R O B E R T T A F T , J E . , Ohio







To Members of the Subcommittee on Domestic Finance:
Transmitted herewith for the use of the Subcommittee on Domestic
Finance of the Banking and Currency Committee, and other members
of the committee and the Congress, is a staff report on the testimony
presented at the subcommittee hearings on "The Federal Reserve
System After Fifty Years."
This document also contains the subcommittee's recommendations
dated June 28.
The hearings which were held during the first 4 months of 1964
represent one of the most comprehensive inquiries into the Nation's
banking and monetary system ever conducted. The testimony, comprising three volumes, should provide a fertile source of information
and analysis for legislators and scholars for many years to com&.
Even more important, this inquiry furnishes an indisputable basis in
fact for reform of the Federal Reserve System as it exists today.
In transmitting this report to the subcommittee, it is my hope that
it will be carefully read and considered not only by the members of
the Banking and Currency Committee but also by the entire Congress
and the general public as well.
The report was prepared by staff of the Banking and Currency
Committee under the supervision of Dr. Robert E. Weintraub, senior
Sincerely yours,


Chairmcm, Barikmg and Currency Committee.


We have heard considerable testimony on the Federal Reserve System. The testimony strongly suggests that some revision of the
System is indicated to improve future monetary policy and thereby
our economy's performance, in accord with the Employment Act of
1946. A set of corrective proposals which emerges from the testimony
given before the subcommittee is presented herewith for further consideration.
We are not suggesting, of course, that these proposals cannot be
improved upon. While the subcommittee has not settled on any specific proposal, it intends to consider the entire set in public hearings
after the next Congress convenes in January 1965. The proposals,
though preliminary and tentative, are circulated at this time to allow
for full study and discussion by the Congress, the executive branch,
the Federal Reserve, and the public:
A. To emphasise the public character of the Federal Reserve
1. Provide for the retirement of the Federal Reserve stock.
2. Vest all power to conduct open market operations in the Federal
Reserve Board.
B. To increase the effectiveness of monetary policy by assuring the
recruitment of an outstanding Federal Reserve Board cmd an
adequate response to advances in economic knowledge
1. Remove the present requirement that the President, in selecting
Governors of the Federal Reserve Board "* * * shall have due regard
to a fair representation of the financial, agricultural, industrial, and
commercial interests and geographical divisions of the country." Instead require only that the Governors be men of integrity devoted to
the public interest.
2. Reduce to five the number of Governors of the Federal Reserve
3. Reduce to 5 years the terms of office of the Governors and allow
for reappointment.
4. Make the term of the Chairman of the Board of Governors coterminous with that of the President.
5. Raise the salaries of the Governors.
C. To insure public control over the expenditures of public moneys
1. Provide for a public audit by the Comptroller General of all expenditures by the Federal Reserve Board and the Reserve banks.
2. Provide for paying into the Treasury as miscellaneous receipts all
capital gains and interest received by the Federal Reserve from U.S.
Government securities.
3. Authorize appropriations by the Congress of the expenses of the
Federal Reserve banks and the Federal Reserve Board.
•Released by all the Democratic members of the subcommittee: Wright Patman,
chairman (Tex.), Henrji S. Reuss (Wis.), Charles A. Vanik (Ohio), Claude Pepper (Fla.),
Joseph G. Minish (N.J.). Charles I*. Weltner (Ga.), Richard T. Harm a (Calif.), and
Charles H. Wilson (Calif.).



D. To provide statutory guidelines for monetary policy and assure
coordination of all of the Governments
economic policies in
achieving the goals of the Employment Act of 191$
1. Require that the President set forth in his periodic economic
reports, in conjunction with his recommendations on fiscal and debt
management policy, guidelines concerning monetary policy, domestic
and foreign—including the growth of the money supply, as defined
by him—necessary to attain the goals of maximum employment, production, and purchasing power of the Employment Act of 1946.
2. Express the sense of Congress that the Federal Reserve operate
in the open market so as to facilitate the achievement of the President's monetary policy; and require that the Federal Reserve, if its
monetary views and actions diverge from those recommended by the
President, file with the President and the Congress a statement of
reasons for its divergence, in form like the President's Economic
E. To allow for greater specialisation in performing the monetary
control function
1. Permit the Federal Reserve Board to concentrate on monetary
policy by transferring its present bank supervisory functions to the
Comptroller of the Currency, the F D I C , or alternatively, to a newly
created Federal banking authority.







I n addition to the foregoing proposals, the subcommittee recommends that the following questions pertaining to Federal Reserve
operations be studied:
(a) The extension of control over reserve requirements so as to
cover all commercial banks.
(6) The opening of the discount window to all commercial banks.


Letter of transmittal to members of the Subcommittee on Domestic Finance—
Proposals for improvement of the Federal Reserve


I. Scope and background of the hearings:
A. Introduction
B. The structure of the Federal Reserve System
1. The 1913 act:
(a) Specific powers delegated
(6) Representation
2. Birth of the Open Market Committee
3. The 1933 and 1935 acts
4. Evolutionary changes
5. Structure today
C. The central banking powers exercised by the Federal Reserve
1. Functions and tools:
(a) Functions
(6) Tools

2. Impacts:
(a) On money supply
(6) A possible bottleneck
(c) On interest and thereby on national income,
employment, and prices
3. The role of the Federal Reserve: An official view
D. Purpose and theme of the hearings:
1. Purpose
2. Theme
(a) Independence and the tax cut
(6) The domination of monetary policy over
fiscal policy as a practical matter
3. Congressman Patman's bills
II. Independence:
A. The Federal Reserve's independence as a matter of language:
1. Part of Government or allied to Government
2. Independence defined as the authority to act independently and the argument for the continuation of
this authority
3. Finality of the Federal Reserve's decisions
(a) Colloquy between Representative Pepper and
President Deming
(b) Colloquy between Representative Pepper and
President Hayes
(c) The difficulty of enacting new law







II. Independence—Continued
B. Relationship of the Federal Reserve's independence to the
President's responsibilities under the Employment Act of
1. The Federal Reserve's assumption of the Employment
Act's goals
2. How independent action by the Federal Reserve makes
it impossible for the President to carry out his mandate under the 1946 Employment Act
3. Showdown not a realistic alternative to Presidential
4. The absurdity of the situation
C. Central bank independence as a matter of general theory and
1. Central bank independence and monetary stability
and instability
2. Responsibility and independence:
(a) Independence and the impossibility of assigning responsibility
(b) Independence and the possibility of evading
(c) The meaning of responsibility
3. Bad effects of not being able to assign blame:
(a) Learning made unnecessary and policy inflexible
(&) Reliance on strong personalities
(c) The sensitivity (not accountability) of independent central bankers to public opinion
and the temptation to propagandize
D. Independence and the problem of coordination:
1. The necessity of achieving coordination
2. A byproduct of not integrating monetary and fiscal
policies. _
E. Central bank independence and democracy



III. Monetary policy:
A. Bases of opposition to reform:
1. The present system said to operate well
2. Bad policy said not related to faulty structure
B. Monetary policy: Performance:
1. Chairman Patman's review
2. Federal Reserve officials' views on the recessions of
1953-54, 1957-58, and 1960-61:
(a) 1953-54_
(6) Chairman Martin on the 1957-58 episode
(c) Governors Mitchell and Daane on the 195758 and 1960-61 recessions
C. Monetary policy: Potentiality and failure:
1. The relation of monetary policy and money supply to
our economy's performance;
(a) Testimony that monetary developments have
a powerful impact on our economy
(&) Testimony that the Federal Reserve controls
the Nation's money supply
(c) Testimony on the Federal Reserve s role in
prewar economic
(d) Testimony on the role of monetary policy
from 1939 to 1952
(e) Testimony on monetary policy from 1952
until now
(/) Testimony on the interaction, if any, between
monetary developments and the balance of



III. Monetary policy—Continued
D. Some repercussions from Federal Reserve monetary policy
1. Effect of monetary stringency on private investment
and Government spending and therefore on economic
2. Effect of monetary stringency on the Government's
3. Effects of monetary stringency and monetary recessions on our economy's marginal workers



IV. The need for change:
A. The necessity of restructuring the Federal Reserve System , _
B. Our monetary failure and the Federal Reserve's structure.__
1. Structure of the Federal Reserve and its intellectual
2. An unwarranted inference
3. The defects of monetary policy and the Federal Reserve's myopia:
(a) The Federal Reserve's immediate targets
(b) The Federal Reserve's prejudices
4. The Federal Reserve's independence and its inability
to change its ways
C. Analytical conclusions


V. Audit by the General Accounting Office and other specific proposals:
A. The need for a GAO audit
B. The need for congressional appropriation
C. Other issues:
1. The tax and loan accounts—
2. Interest on demand deposits




Oh January 21, 1964, the Subcommittee on Domestic Finance of
the Committee on Banking and Currency started consideration of six
legislative proposals introduced by Chairman Patman (Texas) for
the purpose of making revisions in the structure of the Federal Reserve System. Extensive hearings on "The Federal Reserve System
After 50 Years" were held during the ensuing 3 months. This report
undertakes to analyze the testimony presented.
Testimony was given by 50 witnesses. Included among these witnesses were the 19 ranking executive officers of the Federal Reserve
System, a group consisting of the 7 Governors of the Federal
Reserve Board and the presidents of the 12 Federal Reserve banks.
The Secretary of the Treasury and two officials of the General Accounting Office also testified. In addition, the subcommittee heard 2
representatives of the American Bankers Association and 2 from the
Independent Bankers Association; the Director of Research of the
AFL-CIO; and 23 experts in the fields of economics, public administration, and law. In assembling this group of witnesses, the subcommittee was guided by two criteria: (1) professional standing, and (2)
the desirability of hearing from witnesses representing diverse schools
of thought.
In order to achieve a cross section of opinion, experts were invited
who, in addition to their scholarly achievements, have served, respectively, as advisers
to Presidents Kennedy and Truman, and Senator
Goldwater; 1 made special
studies for this committee and the Joint
Economic Committee; 2 worked as full-time employees or served3Federal Reserve banks in administrative or consulting capacities; and
participated in the preparation of the reports of the Commission on
Money and Credit
and the Canadian Royal Commission on Banking
and Finance.4 Despite the wide range of viewpoints represented,
there waa substantial agreement among the 23 experts in economics,
public administration, and law, concerning the Federal Reserve System's structure and policies.

; In the past 50 years we have become increasingly aware of the economic significance of Congress' constitutional monetary power. Al1
Professor Samuelson (MIT); Mr. Keyserling, and Professor Friedman (Chicago).
a Professors Meltzer (Carnegie Tech),, Brunner (UCLA),, and Dr. Warburton (FDIC),
Professor Gurley (Stanford).
. Professor Robertson (Indiana), Bach (Carnegie Tech), and Barger (Columbia).
* Professors Shapiro (Harvard), Reagan (Syracuse), H. Johnson (Chicago), and Gordon
(Carleton University, Ottawa).




though America's post-Civil W a r monetary history had long been
marked by financial panics due in large part to a perversely elastic
money supply, it was not until the Federal Reserve Act of 1913 that
Congress saw fit to delegate its tremendously pervasive power to regulate the Nation's money supply, interest rates, and credit.
The 1913 act created the Federal Reserve System as Congress' delegate to control the Nation's money system. The System consists of
three basic elements: 12 district or Reserve banks, the Board of Governors, and the member commercial banks. The System's initial capital was raised by a capital stock subscription to which member banks
were required to subscribe. Though the stock cannot be transferred
or hypothecated, it officially links the public elements of the Federal
Reserve, and thereby the U.S. Government itself, to the private banking community.
F o r the past 50 years the Federal Reserve System has existed,
grown, and changed—neither entirely in the Government nor out of
it, not a part of the commercial banking system but deeply rooted in
it. I t is a far different System today than it was in 1913. A brief
review of its legal and extra-legal evolution follows.
1. The 1913 act
(a) Specific powers delegated.—The Federal Reserve Act of 1913
grew out of the panic of 1907, which was caused by an acute scarcity of
currency and marked by many bank failures. The Federal Reserve
was created to prevent such panics by "furnish[ing] an elastic currency." To this end, 12 regional Reserve banks were chartered for 20
years. 5 Each regional bank was given three specific powers by the
1913 act. These were:
(1) To buy and sell * * * bonds and notes of the United
States and bills, notes, revenue bonds * * * issued * * * by
any State, county * * *
(2) To purchase from member banks and to sell * * *
bills of exchange arising out of commercial transactions * * *
(3) To establish from time to time, subject to review and
determination of the Federal Review [Reserve] Board, rates
of discount to be charged by the Federal Reserve bank for
each class of paper, which shall be fixed with a view of
accommodating commerce and business.
The power to discount was regarded by everyone at the time as the
principal power of the Federal Reserve System. By exercising this
power the Reserve banks were to encourage member banks to convert
short-term self-liquidating paper, which then constituted the bulk of
their assets, into Federal Reserve notes when needed. By furnishing
these notes (currency) the Federal Reserve would counteract the drying up of bank liquidity that had caused the panics of 1893,1904, and
The Board of Governors was given the responsibility of supervising
member banks. The Board also selected three of the nine directors of
each Reserve bank. Finally, the Board exercised limited power in the
area of monetary policy. The Board had power to review rates of dis8

The McFadden Act of 1927 gave them perpetual charters.



count set by the Eeserve banks and also to establish a rediscount rate,
This latter power could be used to induce changes in rates of discount
themselves. Thus the 1913 act created 12 regional monetary authorities, for the Eeserve banks each had the same power to set a rate of discount and operated independently of one another. But limited
authority also was vested in the Board of Governors for it had both
review and indirect policy initiating powers.
This brief summary of the economic powers delegated by the 1913
act indicates, as Dr. Easkind (professor of law and economics, Vanderbilt) told the subcommittee that—
* * * the Federal Eeserve System emerged as a response to the
unfortunate experience of narrowly regional banking systems and to the needs for a system that could provide services
for commercial banks and act as fiscal agent for the Federal
Government. * * * The principal structural features of the
1913 act further support the characterization of the system as
one concerned less with monetary control than with narrower,
technical service functions. The principal features of this act
were the creation of decentralized Federal Eeserve banks as
depositories of member bank reserves, provisions for expanding credit (and currency) on the basis of commercial obligations, and arrangements for rediscounting by member banks
with the Federal Eeserve (1671-1672).
(b) Representation.—Under
the 1913 act, the Board's seven-man
membership was entirely appointed by the President of the United
States. The Secretary of the Treasury and Comptroller of the Currency were ex-officio members of the Board of Governors and the
Secretary served as its Chairman. The other five members were
appointed for 10 years, one term expiring every 2 years. The Board
was thus a genuine public instrument.
The Eeserve banks, however, were not. The affairs of each of the
12 district banks were administered by a nine-man board of directors.
Each consisted of three class A, three class B, and three class C directors. The class A and class B directors were 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
class C directors were designated by the Board of Governors. (These
arrangements concerning the administration of the Eeserve banks are
still in force.)
By law 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 (but may be shareholders) of any bank. The
three class C directors may not be officers, directors, employees, or
stockholders of any bank. But one of the class C directors must be a
person of "tested banking experience," and this person is designated
as chairman of the bank's board of directors.
The directors each take an oath to "diligently and honestly administer the affairs of said bank fairly and impartially and without discrimination in favor of or against any member bank or banks." They
do not take the constitutional oath as Government officials representing
the public interest. The boards of directors appoint the presidents



of the Eeserve banks, subject to the approval of the Board of Governors of the System. The Eeserve bank presidents take no oath at all
on appointment to their office. (Today, those that serve on the Open
Market Committee as principals or alternates do swear "to support
and defend the Constitution of the United States against all enemies,
foreign and domestic") The Eeserve banks thus, as set up in 1913,
were quasi-public institutions.
2. Birth of the Open Market Committee
The Eeserve banks achieved effective control of monetary policy
after World W a r I. During World W a r I, the Government debt increased from less than $1 billion to over $25 billion. 6 This provided
the basis for the growth of open-market purchases and sales of Government securities by Eeserve banks. Eeserve bank domination of monetary policy was a corollary of this development, for open-market
operations are both the most useful and the most flexible instrument
available to the monetary authorities. When the Eeserve banks
whether acting alone or as a group buy Government securities the
money supply tends to increase. Conversely, when they sell Government securities the effect is to tighten money. Details of the openmarket operation are the subject of a later discussion.
F r o m October 1921 to May 1922, the Federal Eeserve banks individually purchased almost $400 million worth of Government securities to obtain earnings. These purchases disturbed the Government
securities market. I n turn, the disturbances created by these uncoordinated purchases led to the formation in 1922 of an ad hoc committee
of the presidents of five eastern Eeserve banks to coordinate open
market operations. The Committee was not explicitly sanctioned by
law. I n 1923, this system was recognized by the Federal Eeserve
Board, which named the five presidents the Open Market Investment
Committee. The individual district banks could still initiate openmarket purchases, which the Committee would execute, but these independent operations were generally very limited. 7 I n 1930, the
membership of the Committee was expanded to include representatives from all 12 Eeserve banks.
3. The 1933 and 1935 acts
I n 1933, under the pressure of widespread bank failure and the
general economic depression, Congress created the F D I C and, almost
as an afterthought, made into law the arrangements which had grown
u p for coordinating the open-market operations of the 12 district
banks. But authority for the conduct of the open-market operations
was hopelessly diffused, since each Eeserve bank could refuse to participate in operations recommended by the Committee.
^ The 1935 act vested power to initiate and enforce open-market operations in the Federal Open Market Committee, consisting of the 7
Governors and 5 of the 12 Eeserve bank presidents. This put openmarket operations partly under Government control by removing
seven of the district bank presidents from the Open Market Committee,
and replacing them with the seven presidentially appointed Governors
of the Federal Eeserve Board. The Board also was given power to
«U.S. Department of Commerce, Bureau of the Census, "Historical Statistics of the
States, Colonial Times to 1957," GPO, 1960, p. 711.
The details of the formation of the Open Market Committee are discussed more fully
in app. A of vol. III.



fix (within clearly defined limits) the reserves member banks carry
behind their deposit liabilities.
But the 1935 law, while giving more power to the public element of
the Federal Reserve, the Board of Governors, also loosened its ties
with the Chief Executive by removing the Secretary of the Treasury
and the Comptroller from the Board and lengthening a Governor's
tenure to 14 years.
4. Evolutionary
Since 1935 our country has undergone profound economic change
and development. We have experienced two wartime inflations and
five peacetime recessions. I n spite of these vast changes, however, Congress has failed to update the act in terms of modern-day, national
economic goals. I t has ignored the development of the tremendous
power exercised by the Federal Reserve in controlling the amount and
cost of money principally through open-market operations. This
power was scarcely recognized in 1913 when the act was passed. I n
fact, it was not thoroughly understood or developed until after 1935.
Because Congress has not acted, the Federal Reserve has adapted
itself to the new conditions without benefit of law or legislative standard. I t has found ways to finance itself, independent of fees collected
and Government appropriations, and still today, 50 years after it was
established, it has not been audited by the General Accounting Office.
Since 1935 the Federal Reserve also has evolved highly but perhaps
unnecessarily complex techniques for controlling the money supply.
I t has played a central role in war finance. Most importantly of all,
since 1946 it has assigned itself duties largely on its own terms deriving from the Employment Act of 1946, although that act does not
specifically mention the Federal Reserve System.
Unfortunately, as the Federal Reserve's power developed and we
began to better understand our monetary system, policy guidelines to
canalize this power failed to appear. The responsibilities of the Federal Reserve System as spelled out in the act itself testify to the almost
wholly technical and service functions envisioned for the System upon
its creation. As Dr. Warburton ( F D I C ) pointed out (1322), there are
four passages relating, respectively, to open-market operations, discounts and advances, rates of discount, and changes in reserve requirements—the first three of which refer to the "accommodation" of commerce and of business or industry and agriculture, with an additional clause (in two cases) referring to "maintenance of sound credit
conditions" or "the general credit situation of the country," and the
fourth referring to prevention of "injurious credit expansion or contraction." These passages Dr. Warburton described as having always
been ambiguous, and for many years archaic, as criteria for monetary
5. Structure today
Today the member banks still own the capital stock and elect six
of the nine directors of their respective district Reserve banks. The
district banks continue to set discount rates. The Board of Governors continues to review discount rates, and also to apply regulations
to member banks, including now the setting of reserve requirements
within the limits prescribed by law. The Open Market Committee,
operating through the System's Account Manager and the New York



Federal Eeserve Bank, continues to carry out the most important
economic function of the Federal Eeserve and still consists of the
seven Governors, serving 14-year terms that are staggered so one is
appointed every 2 years, the president of the New York Eeserve bank,
and four other district bank presidents. Thus, there has been no
significant change in the structure of the Federal Eeserve since 1935.
Concerning the statute as it now stands, Professor Miller (School of
Law, George Washington University) concluded—
* * * that Congress can, and apparently has, turned over
complete control of monetary matters to nonlegislative organs.
Congress, it seems to me has lost whatever control it may
once have had, and theoretically still retains. Thus, under
title 12, United States Code, section 263, which provides
for the creation of a Federal Open Market Committee, the
"intelligible principle" supposedly required for delegations
to administrative agencies seems to have vanished * * * this
delegation does cede complete power to the Open Market
Committee * * *. Congress, in short, has abdicated—in this,
as well as many other matters of great public importance
* * *. I t is not extravagant to say that Congress is slowly
bleeding to death—from self-inflicted wounds (1680-1681).

1. Functions and tools
(a) Functions.—The Federal Eeserve System is our country's central bank. Congress has bestowed upon the Federal Reserve System
the power to control the Nation's money supply. The fact that it was
a tacit, unintended grant in no way diminishes either its scope or
totality. I n addition, certain Federal Eeserve regulations apply to
all commercial banks operating under national charters and State
banks which have chosen to join the System. 8 Though the two functions overlap somewhat, 9 it is the monetary control function that has
the most profound effect upon the health of the Nation's economy.
Professor Lerner (Michigan State) called attention to this when he
* * * the business of the Federal Eeserve System is not the
business of banking but the management of the money supply of the country * * * (1398).
(5) Tools.—The Federal Eeserve System has three basic tools for
exercising monetary control. Each has an effect, direct or indirect,
upon commercial bank reserve positions. First, the Federal Eeserve
System has the power to set rates of discount. Increases in the rate
discourage commercial banks from borrowing from Federal Eeserve
banks and thus reduce reserve positions below what they otherwise
would be. Decreases in the discount rate tend to result in an in* As a corollary of its regulatory and supervisory function, the Federal Reserve performs
certain technical functions. It collects and clears checks, transfers funds, and also serves
as 9 the Treasury's fiscal agent.
For example, the Federal Reserve's power to require member banks to hold (within
specified limits) a certain fraction of reserves behind their deposit liabilities is both a
regulatory power and a monetary control power.



crease in reserve positions. Second, the Federal Reserve Board has
the power to increase or decrease, within certain limits, the proportion
of reserves that member banks are required to keep behind their deposit liabilities. When the required reserve ratio is lowered member banks can expand the money supply. Conversely, the money supply can be reduced through increases in reserve requirements. Third,
the Open Market Committee of the Federal Reserve has the power to
buy and sell Government securities. The open-market tool is the Federal Reserve's most flexible and useful policymaking instrument.
Purchases increase commercial bank reserves while sales reduce them.
When the Federal Reserve System buys Government securities from
a nonbank dealer in Governments, it issues officer's checks which are
deposited in a member bank. The latter in turn deposits the checks
in a Federal Reserve bank. I n this way member bank reserves increase. If the Federal Reserve buys from a bank that also is a
dealer in Government securities, the bank's reserve account is credited
directly. Conversely, when the Federal Reserve System sells securities to a nonbank dealer, it receives payment in the form of checks
drawn on a member bank. These checks are then collected by the
Federal Reserve System through debits to the member bank's reserve
account. If the sale is made to a bank that also is a dealer, that bank's
reserve account is debited directly. I n both instances, the reserve base
of the money supply is reduced.

(a) On money supply.—The effect of changes in bank reserves was
very clearly described by Governor Mitchell. Referring to the effect
of open-market purchases of securities, he informed the subcommittee:
Now the question is, W h a t will a bank do with unused
reserves? The small country banks typically carry unused
reserves because it is uneconomical for them to put them to
work. But a large bank, typically a Reserve city bank, has a
man who runs what is called the money position. His job is
to keep excess reserves in the bank at a minimum. I n other
words, his job is to put every dollar's worth of reserves to
Now this is the point. To the extent that he and his counterparts succeed in doing this, you will have additions to the
money supply * * * (1210).
(b) A possible bottleneck.—Governor Mitchell did not state that
open-market purchases by the central bank would increase the money
supply. Rather he claimed only that they could increase the money
supply, and implied that they actually would only if borrowers can
be found by the men who run commercial banks' "money positions."
I n the same vein of reasoning, Federal Reserve attempts to add to the
money supply by increasing bank reserve positions were characterized
as permissive as opposed to causative by Governor Daane (1210).
The proposition that the monetary authorities might be frustrated
in attempting to expand the money supply was first put forth by John
Maynard Keynes in the middle 1930*s. And, under circumstances
such as then prevailed, it may be correct that attempts by the Federal
Reserve to increase the money supply would fail. The history of the




1930's, however, does not allow us to determine whether monetary
policy would stimulate business in a full-fledged depression. For, as
Professor Brunner (UCLA) pointed out:
Monetary policy was not powerless, it was simply not used.
The tremendous expansion of the money supply, initiated in
1933, was perhaps the single most important factor contributing to the recovery. I t is noteworthy, however, that this
expansion was not due to policy actions but resulted from the
inflow of gold (1090).
This is not the place to debate whether monetary policy would
work in a full-fledged depression. Our view is that an adequate money
supply is necessary but not sufficient to assure both the achievement
and maintenance of business prosperity. Monetary policy cannot, of
course, revive a depressed economy nor can it maintain full employment without inflation in an economy characterized by growing labor
and capital resources if fiscal and other policies are perverse. On the
other hand, fiscal and other Government policies, no matter how enlightened, cannot achieve these goals without an adequate monetary
policy and money supply. W h a t this means is that although there
are limits to what monetary policy can accomplish by itself, it must
be used. The Federal Reserve cannot—under any circumstances whatsoever—be excused for not using its powers. Unless our monetary
tools are used, the power of fiscal and other policies to affect the economy will be greatly, and perhaps altogether, diminished. A sensible
monetary policy will not by itself bring economic growth and stability,
but it is a prerequisite for the achievement of these goals.
(c) On interest and thereby on national income, employment, and
"prices.—The mechanism which allows the men who run the "money
positions" of commercial banks to find borrowers is a fall in the rate
of interest. I t is thus immediately through bank reserve positions
and then, in turn, through a fall in interest rates that attempts by
the Federal Reserve to increase the money supply are made effective.
This was brought out by Professor Strotz (Northwestern) when he
The mechanism through which it would be effective is that
the central bank, by increasing the available reserves as a
basis for loans of the commercial banks would induce the
commercial banks to lower interest rates. A consequence of
the reduction of interest rates would be an increase in the
amount of borrowing * * * (1465).
Borrowers borrow money and resulting increases in the money
supply serve to increase spending by both consumers and investors.
By definition this involves an increase in national income; for consumption plus investment spending and national income are two sides
of the same coin. The increased spending also will tend to raise
interest rates back toward and even above initial levels. Thus increases in money supply growth serve to generate maximum employment and business prosperity or, alternatively, to cause price inflation—the result depending on whether the additional monetary growth
is injected into the economy when it is underemployed and depressed
or when it is fully employed and therefore susceptible to inflation
given a large increase in the growth of the money supply.



Conversely, decreases in the growth of the money supply can be
brought about by Federal Reserve action to reduce bank reserve positions, such as is contemplated by open-market sales or raising reserve
requirements, for example. The Federal Reserve can reduce the rate
of growth of the volume of money to zero. I n fact, it has the power
to actually decrease the volume of money, and has done so in the past.
Such action immediately raises interest rates and reduces borrowing.
Investment and other spending decline. This decline can, in turn,
generate a further decline if the Federal Reserve then fails actively
to pursue an expansionary monetary policy. I t is not enough that the
monetary authority switch to a neutral or passive policy once the
economic decline it has initiated is underway; for there is a feedback
from a decline in spending to the money supply which, if permitted,
will generate further declines in spending and money supply, etc.
If executed delicately, monetary restriction can curb an inflation—
assuming an inflation actually exists. But when the growth of the
money supply is chopped away until it approaches zero, and especially
when the stock of money falls, depression and unemployment follow.
Later the situation is aggravated by anything less than an actively
expansionary monetary policy. Probably the most important reason
that this result comes to pass is, as Congressman Reuss (Wisconsin)
concluded, that the Federal Reserve has the power to "chill off investment quite markedly by starving the money supply" (1467).
Of course, the above description oversimplifies the mechanism that
links a change in monetary policy to our economy's performance. I t
ignores such questions as which groups are the first to be affected,
and the timing of the impacts. We do not have complete knowledge
about these matters. Fortunately, however, we do not need detailed
knowledge of the transmission process. As Prof. Dudley Johnson
(Washington) pointed out:
One can be an empiricist here and say that one observes in
the real world that when there is an increase in the stock of
money there follows, with some lag, an increase in (national)
income (1466).
Further knowledge of the mechanism that links changes in the
money supply to changes in the level of business activity should be
pursued vigorously. But we cannot afford to act now as if we had
no knowledge of the matter. Empirically, the money supply and
economic activity are traveling companions, and this fact must be
a principal basis of monetary policy. I t is enough, to cite a familiar
analogous case, to know that aspirin deadens pain, diminishes fever,
and acts as an anti-inflammatory agent. Realistically, few would advise against taking aspirin even though doctors know less about the
processes involved here than economists know about the monetary
process. Decisions to act always are based on incomplete and imprecise knowledge of the link between the action and the result. Indeed, policy decisions normally are made with far less complete and
precise knowledge of the transmission mechanism than we now have
in the case of the link between the money supply and economic
3. The role of the Federal Reserve: An official view
Some persons prefer to think of the Federal Reserve as exercising
control of the flow of funds, or alternatively, credit or bank credit



rather than money. This was true of most of the Federal Reserve
officials who testified. But though they spoke in terms of the Federal
Reserve's actions as affecting bank credit rather than money in the
immediate stage of the monetary control process, they informed the
subcommittee that ultimately the actions affected economic activity.
A colloquy between Congressman Pepper (Florida) and President
Hayes (New York) brought this out clearly. Referring to the Open
Market Committee, Congressman Pepper asked,
Now, then, what I was intending to say therefore, was that
this body of 12 has the power to determine the amount of
credit available to the people of this country, does it not ?
The ensuing colloquy is instructive:
Mr. HAYES. I t has a large influence on it.
Mr. PEPPER. Well, I think it has a major influence in that
determination, does it not ?
Mr. HAYES. That is correct.
Mr. PEPPER. The amount of credit available in this country has
Mr. HAYES. I would like to insert "bank credit."
Mr. PEPPER. All right. What influence upon the economy
of this country does the amount of bank credit available in
this country have ?
Mr. HAYES. Well, it has a very powerful influence.
Mr. PEPPER. Well, how does it affect the economy ?
Mr. HAYES. The theory of it is that
Mr. PEPPER. I am not talking about the theory. How does
it affect the economy, please, sir ?
Mr. HAYES. I t affects the economy by placing purchasing power in the hands of individuals, corporations, and
institutions who presumably will use that purchasing power
to spend and to activate or to add to the activation of the economic machine. That is the essential
Mr. PEPPER. Does it affect the value of the dollar ?
Mr. HAYES. Certainly.
Mr. PEPPER. Does it affect the interest rates ?
Mr. HAYES. Yes, sir, certainly.
Mr. PEPPER. Does it affect the amount of funds that are
available for investment in the country, in capital
Mr. HAYES. Yes (655).

The point is that, whether the Federal Reserve believes and tries to
influence the supply of credit or money when it manipulates bank reserve positions, it ultimately affects the economic environment in its
entirety and its particulars as well. I n a statement of purposes and
functions, cited by Mr. Goldfinger ( A F L - C I O ) , the Federal Reserve's
Board of Governors itself put the matter plainly enough for all to
How is the Federal Reserve System related to production,
employment, and to the standard of living? The answer is
that the Federal Reserve, through its influence on credit and
money, affects indirectly every phase of American enterprises



and every person in the United States. (Board of Governors
of the Federal Eeserve System. "The Federal Eeserve System,
Purposes and Functions," p. 2.)

1. Purpose
At the outset of the hearings, the subcommittee indicated that the
last revisions of the System, concerned mostly with the open-market
function, were born in a depression atmosphere; and that since then
much has been learned about economic development, interest rates, the
money supply, and full employment. The vast Federal Reserve System, the most powerful monetary network on earth, must serve the
needs of the people and their Government, and it was to this objective
that the hearings and inquiry were addressed. In his opening statement, Chairman Patman, of Texas, stated:
We want to make sure that the public interest is the paramount consideration of the Federal Eeserve. We want to
make sure the Nation's money system is not governed by or
for the private interests of any one group.
The Chairman went on to say, in outlining the purposes of the investigation, that—
In line with this we are vigorously opposed to anything
that smacks of unsound money. We want neither inflation
or deflation. We seek prosperity and high employment
under the terms of the Full Employment Act and we want to
be sure that the Federal Eeserve System, holding as it does
the great monetary power of the United States, serves that
end (8).
Thus, the subcommittee undertook a basic examination of the Federal Eeserve in its historical development and present functioning.
2. Theme
The question of the Federal Eeserve's independence served as the
theme of the hearings. Though this question may seem to some persons to be an abstract academic issue, it raises many concrete problems. One is whether economic objectives of the administration and
the Congress can be fulfilled in the face of the Federal Eeserve's independence. The recent tax cut serves to dramatize the basic difficulty.
(a) Independence and the tax cut.—On February 26, 1964, President Johnson signed into law H.E. 8363, a bill reducing personal
and corporate taxes and aimed at stimulating labor employment and
business production. Writing in the summer of 1964, it can be said
that whether or not the economic expansion and concomitant growth
of employment which the administration and the Congress hoped to
achieve by the tax cut will be achieved depends on the future policy of
the Open Market Committee of the Federal Eeserve System. This
committee has the power to nullify the anticipated beneficial effects of
the tax cut. If the committee reverses the policy of monetary ease
which it has followed since the fall of 1962 and puts into effect a tight
money policy, the expansion will not be realized.
The Open Market Committee may fear that the tax cut is going to
generate future inflation and an increased balance-of-payments deficit
unless it is offset by monetary stringency. The committee may judge



that preventing prices and the payments deficit from rising is its
No. One priority job, more important than the job of achieving
maximum employment. Given this set of judgments, the committee
may act to tighten money, even before inflation and an increased payments deficit become realities. Such action would, in effect, nullify
the anticipated beneficial effects of the tax cut. As President Johnson
said in his economic message to Congress, " I t would be self-defeating
to cancel the stimulus of tax reduction by tightening money."
(&) The domination of monetary policy over fiscal policy as a
practical matter.—The Open Market Committee may, as a matter of
fact, decide to negate the stimulus of the tax cut because its voting
members believe—as an ethical principle—that it is evil to live above
income; that is, to run a deficit. This possibility is not as farfetched
as it might seem at first glance. Chairman Martin told the subcommittee that even though 5% percent of our labor force now is unemployed—
* * * as long as we are running a deficit in this country, we
have to finance that deficit. And I insist that the major portion of any Federal deficit should be financed out of bona fide
savings, and not out of created money (87).
Unfortunately financing the deficit out of "savings" rather than creating money would tend to nullify the effects of the tax cut. Though
many find it difficult to understand, the volume of money must grow
as population and the economy grow. Additions to the money supply are not necessarily inflationary. I n fact, some annual increase
is necessary to accommodate growth and avoid deflation and recession.
Professor Dudley Johnson (University of Washington) recognized
this when he told the subcommittee:
To the extent that the money authorities * * * force the
Government to finance its deficit from the real savings of
the community * * * the efficacy of alterations in Government expenditures and/or tax receipts in expanding aggregate demand is reduced, if not completely offset (1443).
Whatever the Open Market Committee decides, it will decide in
secret session, and, under present laws, whatever it decides will not
be subject to review and possible reversal by any authority or authorities in the country, including the President and the Congress. On
the one hand, then, the Federal Eeserve can review and reverse the
fiscal policy of the administration and the Congress. I t can do so in
one afternoon at a single meeting of the Open Market Committee.
B u t the administration and the Congress cannot, under present law,
rfeview and reverse the Federal Reserve's monetary policy. The administration and the Congress can undo what the Federal Eeserve
does only by changing the law. Enacting legislation takes much
longer than one afternoon—witness the fact that the tax cut, signed
into law by President Johnson on February 26, 1964, was proposed
initially by President Kennedy on January 24, 1963. The mere fact
that this situation exists demonstrates that the continued "independence" of the Federal Reserve raises serious questions of profound
political and economic importance.



3. Congressman Patman's bills
Six bills, which have as their collective aim the remaking of the
Federal Eeserve into a genuine public instrument, were introduced
by Chairman Patman just prior to the opening of the hearings. These
bills served as the fulcrum of discussion. The bills provided a
practical framework within which witnesses could discuss the theme
of "independence." Each bill relates to a specific aspect of the overriding question of the Federal Reserve's so-called independence.
Briefly, H.E. 3783 "provides for the retirement of Federal Eeserve
bank stock." It thereby would eliminate some of what Secretary of
the Treasury Dillon called " Vestigal elements of an earlier conception
of private participation in central banking policies * * * still
visible" (1233).
H.E. 9685 "provides that interest received by Federal Eeserve banks
on U.S. Government securities shall be covered into the Treasury,"
and as a corollary, requires the Federal Eeserve to obtain such sums
as may be necessary to pay its expenses from Congress. The bill
clearly would terminate the Federal Eeserve's ability to undertake
new spending programs and even to continue many old ones without
obtaining congressional approval. But it is by no means clear that
subjecting the Federal Eeserve to the standard appropriation procedures to which most other Government bodies are subjected could
affect monetary policy.
H.E. 9631 provides for the abolition of the Federal Open Market
Committee, and in its place authorizes the Federal Eeserve Board to
conduct open-market operations by instructing the Federal Eeserve
banks. The Board would be required to govern its open-market operation, not only with a view to "accommodating commerce" and with
regard to the "general credit situation," but "in coordination with
the policy and responsibility of the Federal Government as set forth
in section 2 of the Employment Act of 1946." H.E. 9631 also sets
forth particulars concerning the size, tenure, and selection of the
Board of Governors. The set of particulars provided here is just one
of many possible sets that would, if adopted, reduce the Federal Eeserve's power to veto the policies of the Congress and administration.
In addition, H.E. 9631 provides for an audit of the expenditures of
the Federal Eeserve Board and the Eeserve banks by the General
Accounting Office.
H.E. 9749 instructs the Federal Eeserve to support Government
securities "when market yields equal or exceed 4^4 percent." This bill
limits the Federal Eeserve's freedom of action with respect to monetary policy itself. Currently the Federal Eeserve is not limited by
any instruction. Indeed no guideline or set of guidelines is now given
by the administration or Congress on monetary policy. But Congress has the power to instruct the Federal Eeserve to do certain things
under certain circumstances. Alternatively, Congress can set forth
guidelines for monetary policy or require administration formulation
of such guidelines. H.E. 9749 is just one of many possible ways in
which Congress might give instruction or guidance to the monetary
authorities. Others also were discussed during the hearings.
H.E. 9686 and H.E. 9687 are only indirectly related to the Federal
Eeserve System. The former provides for the payment of interest



on the Government's tax and loan balances in commercial banks and
for reimbursement of banks for services performed for the Treasury
as well. The link between H.R. 9686 and the Federal Reserve is that
the current way of handling tax and loan balances prevents the Treasury's operations from causing disequilibrating flows of monejr into and
out of the banking system, and the present way of handling these
balances allegedly could not be continued if the banks had to pay interest on them. Thus passage of H.R. 9686 supposedly would cause
disequilibrating flows of funds into and out of the banking system and
thereby complicate the Federal Reserve's job. H.R. 9687 also would
complicate this task. For this bill would allow banks to pay interest
on demand deposits and it is argued that if this were permitted, interbank flows of funds would rise sharply.
The scope of the hearings was not limited to these six bills. The
theme of the hearings was the System's "independence." The bills
express this important problem in concrete terms and thereby served
as the fulcrum for discussion. But witnesses were not confined to this
problem alone. The subject of the hearings was the Federal Reserve
System. Representative Charles H. Wilson (California) stressed this
point in a question he put to President Hayes (New York). He asked:
Mr. Hayes, * * * by your own words here you were invited
to participate in a series of hearings on the subject of the
"Federal Reserve System After 50 Years." Now, that's a
pretty broad subject. It does not seem you are being limited.
You were not instructed that you cannot speak about different
phases of the System, or you could not make recommendations to us, or that you were being held back in any way on
what you could bring to our attention in any way, were you ?
Mr. Hayes answered "No" (640).


1. Part of Government or allied to Government
There is some confusion about the meaning of "independence" as it
applies to the relation of the Federal Reserve to the Government. To
some Federal Reserve officials it was a question, as President Bopp
(Philadelphia) put it, of "the degree of independence within Government" (740). Others discussed the potential loss of independence in
terms of nationalization. President Ellis (Boston) did this when,
in referring to Mr. Patman's bills, he commented:
Taken as a group, these proposals amount to a nationalization of the country's central bank (269) ,1
Still other officials of the System distinguished between the Board
of Governors and the Eeserve banks and asserted that the 12 Federal
Reserve banks are, as President Hayes (New York) put it, "allied
to Government but not part of Government" (536).2 But it must
be noted that Chairman Martin disagreed with this. He told Congressman Reuss (Wisconsin) :
Let me say, Mr. Reuss, that I don't concede that the presidents of the 12 Federal Reserve banks are private individuals
2. Independence defined as the authority to act independently and
the argument for the continuation of this authority
Though Federal Reserve officials differed on whether the Federal
Reserve banks constitute a part of the Government or merely are
allied to it, there was complete agreement among them, and the other
witnesses as well, on the legal right and authority of the Federal
Reserve Board and the Open Market Committee, the two policymaking bodies of the System, to make policy independently of the
administration and the Congress. And this is precisely what independence means as it applies to the relation of the Federal Reserve to
Some indication that important segments of the commercial banking community carry
this argument to its logical conclusion and think of the Federal Reserve as a private
organization, which the Congress has hired on an eternal contract basis to help the Government achieve desired economic goals, is provided by a March 1964 pamphlet issued by
the Manufacturers Hanover Trust Co., which contains remarks of the bank's consulting
economist, Prof. Marcus Nadler (New York University) on the independence of the Federal
Reserve. The pamphlet, of course, states: "The opinions expressed are Dr. Nadler's * * *."
On the particular question at hand, Dr. Nadler remarked, "The Patman recommendations,
if enacted, would undermine the independence of the Federal Reserve System and for all
practical purposes would make the Reserve Board a branch of the Government * * *. As
a creature of Congress, the Reserve authorities must consider the broad economic policies of
the administration and assist it to achieve the desired economic objectives * * *. The
nationalization of the Reserve banks and the conversion of the Federal Reserve System into
a branch of the Government would constitute a serious blow to the economic system of the
In fact, the words are Allan Sproul's. Quoting them, Hayes said, "I agree fully * * *"




the Government. The argument for continuation of independent
authority was made by Chairman Martin when he stated:
Because money so vitally affects all people in all walks
of life as well as the financing of the Government, the task of
credit and monetary management has unique characteristics.
Policy decisions of an agency performing this task are often
the subject of controversy and frequently of a restrictive
nature; consequently, they are often unpopular, at least temporarily, with some groups. The general public in a democracy, however, is more apt to accept or tolerate restrictive
monetary and credit policies if they are decided by public
officials who, like the members of the judiciary, are removed
from immediate pressures.
There is a long-established tradition both in this country
and in other democracies that the proper exercise of reserve banking functions requires that it be insulated against
private or public pressures * * * (23).
Scholars would caution that in most other democracies central
banks currently are, literally not merely figuratively, arms of the
political authorities. This point need not be pursued here. A summary of the relations between central banks and governments in other
democracies today was submitted for the record (889-892) by President Irons (Dallas) in response to a request by Congressman Widnall
(New Jersey). Regardless, what is important here is that most would
agree with Chairman Martin that, as a matter of language, independence means insulation from public pressures, especially as these
pressures are expressed by the President. As Professor Strotz (Northwestern) stated:
By an independent central bank we mean, of course, one
whose authority is substantially independent of the executive
wing of the Federal Government (1451).
Mr. Kelly, the president of the American Bankers Association, put
it this way:
* * * the Federal Reserve is independent in the sense that
its policies and operations are not subject to direct management or determination by the President (1905). [Emphasis
The fact that monetary policy is not subject to direct management
or determination by the President is a measure of the degree of the
Federal Reserve's independence. Ordinarily, so-called independent
administrative bodies are not subject to the direct management by the
executive branch of Government but their policies are, in the final
analysis, determined by the executive or, alternatively, by clear-cut
legislative guidelines.
3. Finality of the Federal Reserved decisions
Unlike other independent decisionmaking bodies such as the F T C
and ICC, the decisions of the Federal Reserve are not subject to outside review and so cannot be reversed. This awesome fact was brought
out in colloquies between Congressman Pepper (Florida) and President Deming (Minneapolis) and President Hayes (New Y o r k ) . The
relevant questions and answers follow:



(a) Colloquy between Representative
Pepper and
Mr. PEPPER. Suppose the President would write a letter to
the Federal Reserve Board and say, "Dear Mr. Chairman, I
enclose a copy of my message recently delivered to the Congress, and I think it would be in the national interest if the
Federal Reserve System, through all the functions that you
exercise, would implement the declaration of the policy that
I have made, and I shall appreciate and look forward to your
cooperation." What would be the effect of that ?
Mr. DEMING. Well, I think in this case the Open Market
Committee, if it were to get such a letter, would reply that
this is always the policy of the Open Market Committee, to
attempt to have as strongly a growing economy as we can
have, and * * *.
Mr. PEPPER. Would not you consider it sort of an inappropriate thing, like trying to talk to a judge in the backroom ?
Mr. DEMING. I do not think the President would write
such a letter, myself. I do not have any case—I do not know
of any case in history where he has, but the
Mr. PEPPER. But it accentuates the fact that under the present system the Government does not have any direct way of
influencing the decisions of this committee that has so much
to do with the economy of the country.
Mr. DEMING. Well, the committee is fully cognizant of the
position against poverty.
Mr. PEPPER. Thank you, very much.
Mr. DEMING. And it is completely sympathetic to it (726).
(b) Colloquy between Representative
Pepper and
Mr. PEPPER. Under the law, is there any right of review of
the decisions made by the Open Market Committee ?
Mr. HAYES. I am not sure I understand, Mr. Pepper.
Mr. PEPPER. I mean you make decisions relative to the functions of the Open Market Committee. Is there any other body
which has the right of review of your decisions ?
Mr. HAYES. I think not.
Mr. PEPPER. SO, then, you are an independent body, consisting of 12 citizens of the country, chosen as provided by law,
and you exercise your discretion, not subject to review by any
other authority or authorities, in making the decisions that
you say are perhaps the most vital decisions made affecting the
economy of the country. Is that true ?
Mr. HAYES. Well, I spoke a little hastily. Obviously, the
Congress which set us u p has the authority and should review
our actions at any time they want to, and in any way they
want to. And we welcome for that reason any hearing like
this, or any other investigation that the Congress may wish to
make of us.
But we are a creature of Congress. So I certainly would not
want to



Mr. PEPPER. But while Congress, you might say, appropriates the money to provide for the U.S. Supreme Court, we
don't have any right to review their decisions
Mr. HAYES. I think there is a constitutional difference. I
am not a lawyer but obviously there are three departments of
Government. We are specifically under Congress (633).
The colloquy between Mr. Pepper and Mr. Hayes resumed a few
minutes later and this part of their dialog demonstrates the almost
total finality of the Federal Reserve's independent policymaking
Mr. PEPPER. S O to get back to the inquiry I made a few
minutes ago, this Open Market Committee, consisting of 7
members appointed by the President and confirmed by the
Senate, and 5 members elected by the Federal Reserve System
of the country, a body of 12, that Board which, as you said a
while ago, is not subject to any review by any authority or
authorities in this country
Mr. HAYES. Other than Congress, Mr. Pepper.
Mr. PEPPER. Well, excuse me. You can be abolished or new
laws can be made by the Congress but this is the Banking and
Currency Committee of the Congress, and we do not have any
right to review your committee unless we change the law.
We, for example, can abolish inferior Federal courts under
the Constitution but we have no right to review their decisions.
Now, are we not in the same relationship with the Open
Market Committee? Congress can abolish it but we have no
right to review the individual decisions which that committee
Mr. HAYES. Well, by legislation you can do anything you
Mr. PEPPER. I mean under the present law.
Mr. HAYES. Under the present law that is correct (654).
(c) The difficulty of enacting new taw.—An appropriate postscript
to the above dialogs was added by Chairman Patman (Texas) when
he observed that enacting legislation is a difficult and time-consuming
process. H e put the matter this way:
You know, in a democracy such as our own there are a lot
of people who have bottleneck positions, any one of whom
can say "No" and make it stick, but there is not one person
in the United States who can say "Yes" and be absolutely
sure. They just cannot do it.
Now, when you go to making legislative changes you first
introduce a bill that is referred to a subcommittee. The subcommittee chairman can stop it if he wants to.
Then it passes out and it goes to the whole committee, and
the whole committee chairman can have a lot of influence on
it, and it can stop there.
Then it has to go through the leadership of the House and
then the Rules Committee and those four bottlenecks—that
is not all—just those four we see every day.
And then in theSenate it is the same way. So the chances
of getting something really meaningful but opposed by an



entrenched interest in this country, that is profiting so much
by occupying a position that gives them special privileges,
are rather remote because it takes only a few to stop things
while a majority cannot always actually accomplish things.
So we have those deterrents to changes. So we should not
speak of them glibly in that we can just go to Congress and
get something done right quick. We just cannot do that

The fact that the Federal Reserve's relation to the President and
Congress has not changed since 1935 is itself extremely significant.
Totally new concepts concerning the economic functions of the President and his responsibility for the results of monetary policy were
given legislative substance in 1946 when Congress passed the Full
Employment Act and charged the President with achieving "maximum employment, production and purchasing power." This act, in
the words of Professor Miller (George Washington):
* * * is of such basic importance that it takes on the character of a constitutional amendment, is the basic charter under
which government affirmatively seeks to improve the American economy and also the economic well-being of the American people (1681).
1. The Federal Reserved assumption of the Employment AcVs goals
Congress did not redefine the relations of the Federal Eeserve to
the President when in 1946 it enacted the full employment law and
thereby profoundly changed the economic duties and responsibilities
of the President. Furthermore, it also is significant that for about a
year after passage of the Employment Act, no reference to it, not even
the fact that it had been passed, was made in the monthly publication
of the Board of Governors or in the System's annual report.
Since 1946 our understanding of the importance for achieving the
goals of the Employment Act, of Federal Reserve policy in general,
and that of the Open Market Committee in particular, has increased
significantly. The relationship of monetary policy to the 1946 law
now is well understood by most Federal Reserve officials, as well as
by professional economists. Chairman Martin put it this way:
I would subscribe fully to the view that the Open Market
Committee is concerned with maximum production, maximum employment, and maximum purchasing power—that
those are its objectives and purposes (35).
Every Reserve official agreed with the sense of this. 3 Moreover,
some expressed concern that Members of Congress, as President ScanIon (Chicago) stated—
* * * appreciate that Federal Reserve credit policy is, in
fact, carried out with a view to achieving the objectives of the
Employment Act of 1946 (527).
Some, however, tended to obscure Chairman Martin's clear-cut statement of purposes
by inserting the noncognitive term "sustainable" between "maximum" and "employment."



2. How independent action by the Federal Reserve makes it impossible for the President to carry out his mandate wader the 19Jifi
Employment Act
Federal Reserve policy is, as affirmed by official statements, determined with the goals of the Employment Act as policy targets. But
the fact that Federal Reserve policy is made independently of the
views (as well as the management) of the President makes this law
meaningless. Professor Reagan (Syracuse) recognized this when
he said:
The President is required by the Employment Act to submit an economic program, such a program must include recommendations on monetary policy to be meaningful. Thus
the President must be, as H . Christian Sonne has said, "the
coordinating agent for the whole national program." If
the Congress wishes to hold the President responsible for economic policy, and if the electorate thinks of him as responsible (as is clearly the case) then he must be given authority
commensurate with his responsibilities (1577).
This means authority to decide monetary policy or at least to nominate those who do decide it.
Professor Miller (George Washington) put it this way:
I should think that if the objectives of the Employment Act
are to be attained, as I believe they should, it is of the highest
importance that the policies of all organs of government be
consistent with each other; that, in other words, there be a
high degree of congruity in economic policy. I t is my understanding that at present such congruity, if it is reached, is
attained through a policy of consultation and coordination;
but that, however, there is no legal requirement for the Federal Reserve Board to coordinate its policies with the Treasury Department. This to me violates at least two principles:
(a) I n the first place, it makes congruity of policy a matter of accident of personality and of whether or not given
government officials get along well enough together to cooperate rather than fight (1681).
On this matter, an answer to a question put to him by Congressman Widnall, of New Jersey, by Professor Gordon (Carleton University, Ottawa) is especially relevant. Referring to the clash of
personalities which precipitated the Canadian economic crisis of
1956-61, Professor Gordon remarked:
Well, I believe, myself, sir, that a structure should always
be designed to provide for the existence in positions of authority of inappropriate personalities (959).
The second principle Professor Miller thought to be violated by the
lack of formal coordination is this:
(b) Secondly, the Federal Reserve Board, in all of its
operations, seems to be an independent organization, not responsible or accountable to any official, including the President * * *. To the extent that the Board operates autonomously, it would seem to run contrary to another principle
in our constitutional order—that of the accountability of
power (1681).



The heart of the matter is that the Federal Reserve's structural
independence and so insulation from the President and, under today's law, from the Congress as well, means that the Employment
Act of 1946 is simply not enforceable. The President cannot, as he
is required to do by the Employment Act, submit a program that is
likely to be effective in achieving the goals of the law unless the Federal Reserve is willing to cooperate. There is no assurance that the
required cooperation will be forthcoming. Moreover, the President's
program will not have even the proverbial "ghost of a chance" if the
Federal Reserve decides upon a perverse monetary policy. Thus the
President's program is really not a working program but a vision, the
fulfillment of which depends on the policy of the independent Federal
3. Showdown not a realistic alternative to Presidential authority
Leon H. Keyserling pointed out that Federal Reserve executives
"take policy steps clearly in conflict with the policies of the administration when they so desire" (1843). There is no assurance that the
President could compel the Federal Reserve to do what he thought
was in the public interest if the Chairman and a majority of the other
11 members of the Open Market Committee, or simply a majority
without the chairman, did not want to do so. Moreover, it could be
politically inexpedient for a President to force a public showdown
with the Federal Reserve's Chairman over anything, except a "life
and death" issue. An article appearing in the Wall Street Journal,
which was put into the record by Congressman Brock (Tennessee),
indicates that a showdown between President Johnson and the Chairman would be politically very risky:
If he [Martin] were forced out of his post—or just irritated into indignant resignation—the impact upon this administration could be profound * * *. Republicans would
be handed on a platter their first convincing evidence that this
Democrat [Johnson] has no sense of economic responsibility
Past experience teaches that even strong disagreements tend to
evaporate rather than to be resolved. On this, Secretary Dillon's
answer to a question by Congressman Brock (Tennessee) is enlightening. Mr. Brock asked:
Is it really possible for you to have a violent disagreement?
I mean, these are not black and white decisions in most cases.
Are they not mostly a gray area? You have a number of
experts that disagree within the Treasury, as they do within
the Fed?
Secretary Dillon answered:
I think that is correct. I think it would be unusual to
have—certainly in the spirit in which we have been working
in the 3 years that I have been here I have not seen any—real
black and white basic differences of opinion.
However, if you had strong-minded individuals on either
side, even if it were gray area issue, they might strongly differ with each other. We have not had that sort of a situation
in the last 3 years.



I think there have been some differences of opinion in the
past. I think there were some differences of opinion on a number of occasions—probably on one or two occasions during the
preceding administration—that were quite strong, but after
a time they evaporated (1264).
The hard truth is that unless the administration is willing to force
a showdown it cannot change Federal Eeserve policy. I t s spokesmen
may nag privately and for a time even disagree publicly, as Secretary
Humphrey and Mr. Burgess did in 1956 and 1957. But it is not likely
to make a major issue over monetary policy if it is a question of reducing unemployment 1, or even 2, or possibly 3 percentage points.
Monetary economics is a complex subject and it would be difficult to
explain to the general public how a slightly more expansive policy
could achieve a 1,2, or even 3 percent fall in the rate of unemployment.
I n essence, then, structural independence of the Federal Reserve
from the President and the President's responsibilities under the Full
Employment Act are both logically and practically inconsistent.
Congress must decide which of the two it wants. We can't have both.
W h a t we have now is independence of the Federal Reserve and lipservice to the proposition that the President is responsible for coordinating "all plans, functions, and resources" to achieve "maximum
employment, production, and purchasing power."
added.] H e is simply not responsible for what the Federal Reserve
does with the monetary powers of the Nation.
4. The absurdity of the situation
Since what the Federal Reserve does is perhaps the most important
determinant of levels of employment, production, and purchasing
power, the President cannot in any meaningful sense be held responsible for achieving the objectives of the Employment Act as long as
the Federal Reserve's independence of his views is preserved. The
absurdity of the situation was pointed out by many witnesses. Prof.
Dudley Johnson (Washington) put it this way:
To argue that the control over the money supply should be
independent of the values of certain representatives of the
citizenry in a democracy strikes me as ludicrous. I t is as if
Congress were to create a Department of W a r and Peace and
the President of the United States would appoint a Board
composed of seven members for terms of 14 years, with the
terms arranged so that one expires every other year. Now
this Board would have the exclusive jurisdiction to decide
whether or not the United States would or would not go to
war (1444).
I n a similar vein, Professor Raskind (Law and Economics, Vanderbilt), commented as follows:
When the President, who is authorized in the limit, to
make decisions involving nuclear war, is barred by statute
from responsibility from the monetary component of economic stabilization policy, the need for change is apparent



Mr. Keyserling put the matter in terms of both our current economic
policy and traditional political philosophy. He observed:
The President and the Congress, in the Nation's interest
as they see it, have recently undertaken a contrived Federal
deficit of unparalleled size. This tax action, for all practical
purposes, is irreversible for many years to come. I t will
confront the Government with many thorny problems for
many years to come. Can it be argued with any rationality,
under the circumstances, that the Government has no direct
and proximate interest in the extent to which the management
of the people's money—which in fact is created by the Government—advances or impedes the objective of this momentous
step in tax and fiscal policy ? Can a deflationary monetary
policy be permitted to cancel out, in whole or in part, an expansionary fiscal intent ?
I submit, in conclusion, that we have moved far beyond the
point when any one impregnable citadel of policy formulation, affecting profoundly the totality of our objectives as an
economy, a nation, and a people, can remain "independent"
of that ultimate responsibility to the people through their
Government which is the very hallmark of our democracy and
our free institutions (1761).

1. Central bank independence and monetary stability and instability
The case for making a nation's central bank independent of the
political representatives of its people is that insulation is necessary to
prevent abuse of the money-creating powers of government and resulting monetary and economic instability. But this hypothesis was not
supported by decisive empirical evidence or logical deduction by
Chairman Martin or any other witness who asserted its validity.
As it was set forth by Chairman Martin and its other proponents as
well, the proposition appears one-sided. Simply stated the contention is that if the System were to lose its independence from public
pressures there would be excessive creation of money and resulting
inflation. I t is not contended that insufficient money creation and
persistent unemployment would result, though this is logically an
equally likely result.
Case histories of hyperinflation were cited by Federal Reserve officials, Mr. Kelly ( A B A ) , and Secretary Dillon by way of attempting
to demonstrate that the money-creating powers of Government can
be abused. No one would deny the possibility of such abuse. The
question, however, is which sort of institutional arrangements are apt
to lead to abusing the money-creating powers of Government. More
often than not, severe or hyperinflation have occurred in countries run
by dictators, not in democracies. Thus a central bank which is insulated from the public would appear more apt to generate hyperinflation than a truly public monetary authority. Certainly the 1950 inflation in Paraguay, which both Governor Daane and Secretary Dillon



referred to, illustrates the danger of insulating Government in general
and the money-creating powers of Government in particular, from
the pressures of the people; for, as Chairman Patman pointed out,
Paraguay is governed by a dictator and is not a democracy. Paraguay has been governed by one political party with the army's support
since 1943. Elections have been formalities wherein the people can
only vote "yes," affirming the party's (and the army's) candidate.
The 1945-55 Argentine inflation cited by Secretary Dillon is another
example of the danger of insulating the money-creating powers of
Government from the people; for these were the years of Peron.
Cases in which an insulated, and so independent, monetary authority
abused its powers by following the deflationary policies to excess also
have occurred. Canada in the 1956-61 period provides an example.
During this period the independent Bank of Canada was pursuing a
tight money policy; even though 10 percent of the labor force was
unemployed. Eeferring to that occasion, Professor Gordon (Carleton
University, Ottawa) stated:
The Minister of Finance was questioned in the House concerning the policy and he denied that he had anything to do
with the policy or was responsible for it (959).
Other examples could be cited. Indeed, Professor Friedman (Chicago) stated that in the case of the independent Federal Keserve—
The chief defect in Federal Reserve policy has been' a
tendency to go too far in one direction or the other, and then
to be slow to recognize its mistake and correct it. Contrary to widely held views, the major mistakes of this kind
in peacetime have all been in a deflationary direction * * *
Thus, as Prof. Harry Johnson (Chicago) pointed out, the assumption that an independent central bank will govern monetary policy
flexibly and efficiently and in the best interests of the country—
is not consistent with the historical evidence of the behavior
of monetary authorities; the evidence is rather that central
banks have done little if anything to restrain inflation in wartime * * * while in peacetime they have displayed a pronounced tendency to follow deflationary policies on the
average (970).
Insulated central banks, in short, do not protect against but in fact
have caused both inflations and depressions. Professor Friedman put
Experience shows that independent monetary authorities
have introduced major elements of monetary instability, and
analysis suggests that they can be expected to continue to do
so (1134).
2. Responsibility and independence
{a)' Independence and the impossibility of assigning resppn^ii
bility.^—As indicated, Professor Friedman also argued tliat logic, or
as he puts it, analysis, suggests that an independent monetary authority can be expected to produce economic instability. In an article
submitted for the record he wrote:



One defect of an independent central bank * * * is that
it almost inevitably involyes dispersal of responsibility * * *.
I n the past few years, I have read through the annual reports of the Federal Reserve System from 1913 to date, seriatim. One of the few amusing dividends from that ordeal
was seeing the cyclical pattern that shows up in the potency
that the authorities attribute to monetary policy. I n years
when things are going well, the reports emphasize that
monetary policy is an exceedingly potent weapon and that
the favorable course of events is largely a, result of the skillful handling of this delicate instrument by the monetary
authority. I n years* of depression, on the other hand, the
reports emphasize that monetary policy is but one of many
tools of economic policy, that its power is highly limited, and
that it was only the skillful handling of such limited powers
as were available that averted disaster. This is an example
of the effect of the dispersal of responsibility * * * no one
assumes or is assigned the final responsibility (1170-1171).
Professor Lerner (Michigan State) put the argument this way
when he observed:
Independence of the monetarv authority from the Executive in matters of policy, even if both do the best they can in
the public interest, leads to fiscal and monetary policies working at cross purposes, defeating each other's objectives. I t
enables both the Executive and the monetary authority to
blame each other for whatever happens to the economy
(b) Independence and the possibility of evading
An independent central bank can, of course, benefit an inept political
administration. Such an administration can shirk its responsibility
because, as Prof. H a r r y Johnson observed:
The monetary authority can easily be cast as a scapegoat * * * (972).
This is certainly a disadvantageous byproduct of central bank independence. But the primary defect of insulating the central bank
from the political processes and assuring that its officers do not have
to pay for failing to perform well is that the central bank itself can
shirk its responsibilities. Thus, independence raises the specter of
major mistakes being committed},, such as those that were committed
in the early 1930's by the then completely independent Open Market
Committee. The danger of such a catastrophe occurring in the future
was brought into common view by Representative Vanik (Ohio) and
Secretary Dillon. Mr. Vanik asked:
But can you conceive of a situation where the Fed may take
some very, very tremendous action and the barn would burn
down, and we would be pretty powerless to do anything about
it except to try to correct it on the next go around ?
Mr. Dillon answered:
I t is theoretically possible, yes. (1250).
History, of course, warns us that the theory in question is, unhappily, valid.



(c) The meaning of responsibility.—Because insulated central
bankers can shirk their responsibility it is important, as Chairman
Patman recognized, to link the central bank to the political administration. If something goes wrong the people then are assured of "being able to blame somebody they had something to do with putting into
office." Professor Gordon (Carleton University, Ottawa) in commenting on Chairman Patman's remarks also indicated the necessity
of achieving a political tie. He stated:
We mistake the question of responsibility very often. We
think of the responsibility of a public official in terms of his
personal integrity. However, responsibility really means being responsible to some other body and eventually to the
people at large (960).
The powers of a central bank may be exercised by men of the highest integrity, but the bank cannot be said to be responsible unless its
officers, or alternatively, their nominators, are subject to the election
process. "Power under a constitutional order," Professor Miller
(School of Law, George Washington University) pointed out, "means
accountable, i.e., responsible power." (1684.)
3. Bad effects of not being able to assign blame
(a) Learning made unnecessary cmd policy inflexible.—The problems created by institutional arrangements which fail to assign responsibility for error are familiar to all students of comparative economic systems. One of the great weaknesses of Socialist political economies is that they have no way of assigning accountability where it
belongs. Thus, for example, a few years ago Soviet Premier Khrushchev complained about the production of cars without tires. But he
did not know whether to blame automobile factory managers for exceeding their quotas, tire plant managers for not meeting theirs, or any
of the several suppliers of materials to tire plants. In our profit system a mistake like this would occur, but whoever was responsible for
it would be detected quickly by impersonal market forces and punished by these same forces. He certainly would lose money and perhaps he would even be compelled to seek new employment for himself and his capital. But this is the very strength of the profit system.
For by fixing responsibility it insures that adherents of once fashionable dogma and also incompetents will either learn their business and
jobs or give way to those who can and will learn. And thus our profit
system succeeds by what is essentially a learning process.
An independent central bank is heir to weaknesses similar to those
of a socialistic economy. For by virtue of the central bank's independence, central bankers do not have to bear final responsibility. I t
is not enough to say, as Chairman Martin did:
Now we do bear the slings and arrows of the public. You
are in the position of being able to blame us if it goes wrong
Kecent history proves otherwise, however. Insulated central bankers
can terminate all inquiry simply by saying, as Chairman Martin so often does when someone tries to clarify the role of the Federal
Keserve in particular historical episodes, "You and I don't read economic history the same way."



Because they do not have to worry very much about being blamed
and paying for their mistakes, insulated central bankers are not apt
to learn from them. In practice this means that independent central
bankers are not likely to acquire knowledge of the processes on which
they are acting; and so, they are not likely to develop sound operating
methods. It also means that central bank policy will be inflexible, and,
in turn, that bad policies are likely to be perpetuated. These structural flaws were recognized by Prof. Harry Johnson (Chicago) when,
referring to the economic instability misguided monetary policies
have generated, he observed:
These defects are in my judgment inherent in the conception * * * of an independent monetary authority, and are
unlikely to be modified greatly * * * on the basis of accumulated experience and research (970-971).
Failure to do substantive research in monetary economics is still
another flaw of the Federal Eeserve which derives from its independence. Many witnesses complained about this failure. To quote Professor Bach (Carnegie Tech)—
The Fed deserves criticism for its failure to push more
actively on the fundamental research that must be done to continue to improve further our monetary policy (1390).
(b) Reliance on strong personalities.—This tendency for deleterious policies and misguided methods to persist is reinforced by the
tendency for central bank independence to produce a "cult of personality." Professor Friedman brought this out when he observed:
Another defect of the conduct of monetary policy through
an independent central bank that has a good deal of leeway
and power is the extent to which policy is thereby made highly dependent on personalities. In studying the history of
American monetary policy I have been struck by the extraordinary importance of accidents of personality * * *. A
similar situation prevails today. The actions of the Reserve
System depend on whether there are a few persons in the
System who exert intellectual leadership (1171-1172).
The dependency of an independent central bank's policies on personalities together with the fact that insulation means that responsibility won't be affixed in the event of error tends to perpetuate inappropriate policies and operating methods. For there are no compelling reasons for insulated authorities to admit error, and it always
is difficult for men, especially strong personalities, to admit that a
specific institutional decision they made was wrong. Of course, in a
democracy it doesn't matter whether those in error will admit being
wrong. As Chairman Patman put it, in a democratic Republic like
the United States—
The politicians have responsibility. If they don't carry out
the will and wishes of the people, they are defeated (62).



But an independent, politically insulated central bank, by definition,
is not a democratic institution. Its officers, are insulated from, and so
need not be responsive to, the public will. Its intellectual leaders need
not learn from mistakes. Thus inappropriate policies and actions
tend to be perpetuated. There is nothing in the structure of independent central banks that1 compels or impels correction.
(o) The sensitivity (not accountability) of independent central
bankers to public opinion and the temptation to propagamdize.—The
fact that independent monetary authorities need not be responsive to
public opinion does not mean that central bankers are insensitive to
public opinion. They are sensitive. But as Prof. Harry Johnson
(Chicago) put it, an independent central bank's—
position as the one agency of economic policy formation outside the normal political structure both exposes it to subtle and
sustained political pressures and forces it to become a political
animal on its own behalf, devoting considerable effort, either
to justifying its policies * * * or to denying responsibilities
*** (971).
In other words, independence permits central bankers to substitute
linguistic acrobatics for actual flexibility. A truly flexible policy,
one that responds quickly to changes in economic conditions, requires
that decisions be made by men who must pay some sort of penalty for
monetary and economic instability. Unless this condition is met, and
it is not likely when the central bank is independent, policy and operating methods will tend to be inflexible and errors to be perpetuated.

1. The necessity of achieving coordination
Another weakness inherent in an independent central bank i? that
monetary and fiscal policies are not coordinated. Every economist who
testified saw the necessity for coordination. Said Professor Barger
Coordination of monetary policy with the general economic
policy of the President obviously is necessary * * * (1354).
Of course no FederalKeserve official denied this. In fact, all claimed
the desired coordination was currently being achieved at informal
luncheons and the like. But for many this sort of arrangement is not
enough. Prof. John Gurley (Stanford) put it this way—
"Independence" is a good word, and so many people think
that the independence of the Federal Eeserve is a good thing.
But it is not a good thing. I t is like having two managers ,
for the same baseball team, each manager independent of the
other. The managers could get together for lunches once a
week; that might help. Or one of them could try to offset
the actions of the other—that might work a bit. Nothing of
this sort, really, would correct the basic situation, the intolerable arrangement of having two managers (1309).
Thus limited informal advisory efforts to coordinate policy aren't
enough to assure coordination. The Chairman of the Federal Eeserve
may meet with administration officials. They may even agree—though



they need not and often have not. But most important, the Chairman
of the Federal Reserve cannot commit the system to a course of action.
H e has only one vote on the 12-man Open Market Committee. This
crippling limitation on the "lunch meeting" method of coordinating
monetary and fiscal policies was brought into common view by a colloquy between Eepresentative Minish (New Jersey) and Secretary
Dillon. The dialog is as follows:
Mr. M I N I S H . * * * Mr. Secretary, on page 3 of your testimony it says that Presidents Kennedy and Johnson have continued the practice of meeting from time to time with the top
financial officials of the administration.
Chairman Martin, it says, has participated fully in these
discussions. How fully can he participate if he has to go back
to the Board and the Open Market Committee for directions ?
Secretary DILLON. Well, he can participate fully from the
point of view of explaining the considerations that are topmost in the minds of both the Board and the Open Market
Committee, because he meets with the Board and Open
Market Committee every 3 weeks. And, therefore, it is not
at all difficult for him in this sort of a meeting to either explain very clearly what he thinks their views would be or to
take back to them the views of the President. * * *
So, I think it has been a very useful two-way thing, so
that the President and the other financial officers of the Government understand what is motivating the Open Market
Committee and the Board and what they are thinking about,
and they, in turn, get absolutely straight first hand from the
President himself his own desires in the field of economic and
monetary policy.
Mr. M I N I S H . So that he can only get the views of the people that he is dealing with until he gets further directions
from the Open Market Committee ?
Secretary DILLON. Well, yes, as I pointed out in my prepared statement, he cannot commit the Open Market Committee or the Board to any specific action.
He can commit himself to trying to obtain action, if he
wishes to, and at times I think that has been the case. But he
cannot commit the Board (1255-1256).
Professor Gurley proceeded to point out one of the many unreasonable situations that result from the separate formulation of monetary
and fiscal policy. H e stated:
That we have a separate manager for monetary policy
gives rise to unreasonable situations, such as the President of
the United States trying to use moral suasion on the Federal
Reserve, hoping that it will not nullify the good effects of the
tax reduction. * * * (1309)
I t was precisely this problem of assuring a coordinated economic
policy that led Professor Villard (CUNY) to assert,
I am prepared to compromise the independence of the Federal Reserve in order to achieve overall coordination of economic policy (1022).



Dr. Warburton (FDIC) put it this w a y Proper administration of monetary policy is so vital to national welfare and the success of other Government policies
that it should be a responsibility of a top-ranking official and
appropriately coordinated with the executive branch of the
Government (1319).
Professor Strotz (Northwestern) used an especially colorful imagery to project the need for coordinating monetary, fiscal, debt, and
other national economic policies when he stated:
Thus, from every limb of the puppet go many strings held
by different authorities, all of whom may have different intentions as to how the puppet is actually to perform—and in
the midst of a windstorm. In such a situation, who can dispute the need for coordination of the many different puppeteers? The notion of an independent monetary authority
set up to achieve a particular goal, such as price level stability, is, in any practical context, very unrealistic (1453).
#. A byproduct of not integrating monetary and fiscal policies
Failure to coordinate monetary and fiscal policy, then, can lead
to negation of one set of fiscal policies, and thereby the substitution
of a less desirable set of fiscal policies; for no administration can allow
its overall economic policies to fail and long endure. Prof. Eli
Shapiro (Graduate School of Business, Harvard) called attention to
this possible byproduct of not coordinating monetary and fiscal policy.
The point is that an independent monetary authority can create an
insufficient money supply and thereby impel, if not compel, the adoption of fiscal deficits. Professor Shapiro put it this way:
Since policy decisions are made by different agencies and
since these decisions require trade-offs to be made among the
various goals, our stabilization strategy requires coordination
among the agencies to insure the pursuit of a common end.
For if one agency takes price stability to be the critical goal
and pursues policies appropriate to the attainment of that
goal, while other agencies deem full employment or economic
growth to be the more important objective of policy, we will
observe conflicting policies which may indeed prevent the attainment of any of these goals.
For example, if the central bank, in its interest in price
stability, maintains a monetary policy which dampens demand, the fiscal policy of the Government in attempting to
offset this policy will be forced to run larger deficits (10991100).
The point which Professor Shapiro made also was stressed by several
Congressmen. Representative Hanna (California), in a dialog with
Professor Samuelson (MIT) pointed out:
* * * is it not basic here that one of the reasons that we
cannot have members of the Board (and OMC) too independent is that their actions are in no sense independent of
politics? * * * I was not speaking of politics in a petty
sense * * * but * * * in the fact that no matter for what
reason they did it, what they did would have an effect upon
the political situation (1120).



Implicit in Mr. Hanna's remarks is the fact that, whether they like
it or not, legislators and the President are held accountable by the
people for the economy's performance. Thus, if the Federal Reserve
causes or contributes to severe price inflation, Congress may be impelled to enact price controls. Alternatively, if the Federal Reserve
causes or contributes to rising unemployment and business recession,
Congress may try to generate economic expansion through a variety
of deficit spending and welfare programs. Certainly past economic
stagnation and recessions provided impetus for the growth of Government in general and Government welfare spending in particular.
"Those who oppose the trend toward more Government spending
should ask why we have had so much monetary restriction. With
greater monetary ease, private investment activity would not be stifled.
Hence, the need for easy fiscal policy would be eliminated."

An independent central bank is essentially undemocratic. It is
the very antithesis of democracy to give so much power to men who
are insulated from the elective process. In a democratic republic, the
central bank must be a truly public body. Thus, "the central bank,"
said Professor Samuelson (MIT)—
like the House of Lords, it should be able to delay innovations
to smooth down the volatile changes of public opinion and of
thin majorities. But the central bank should never be
thought of as an island of isolated power, as a St. George
defending the economy against the "dragon" of inflation and
frenzied finance * * *. "The age of chivalry is dead—that
of responsible, democratic government has succeeded" (1110).
Traditionally, Americans have been against ideas and institutions
which smack of government by philsopher kings. As Mr. Goldfinger
pointed out:
The persistent inference that representative government
means runaway inflation, unless some superboard made up
almost excusively of technicians or bankers filters out all such
possibilities, is offensive in a democratic society * * * (1474).
The point was brought out also in a dialog between Representative
Brock (Tennessee) and Professor Villard (CUNY). Representative
Brock asked:
Is it not true that you would create more political pressures
for changes in monetary policy overall, economic policy, with
the change in the administration, with the advent of some new
pressure on the President ?
Are you not subjecting yourself to some rather drastic shift
according to the winds if you take this position ?
Professor Villard answered as follows:
Well, I do not believe so, because it seems to me that—perhaps I should answer it the other way around and say that
obviously the President will be subject to political pressures,



but what I am concerned with is that he should be the one
who makes the basic economic decisions.
Now, in making these decisions he will undoubtedly be subjected to pressures, pressures on the one hand, for example, to
reduce the level of unemployment, pressures on the other
hand, to prevent an increase in prices.
I think both of these alternatives generate political pressures. I sometimes worry about the fact that the pressure
on the President to prevent an increase in prices may be more
powerful politically because everybody is subjected to price
increases but there are only a relatively small percentage of
the population who are unemployed, so that it may well be that
he will give too much weight from my point of view to preventing price increases.
But I do not see, in a democracy, any alternative except to
give the power to make decisions on basic economic policy to
the Executive. This does not guarantee that he will make the
right decisions all the time, but I do not think there is any
possibility of setting up a group of experts who should have
this power.
In fact, I agree with Professor Johnson's point that you
would really have to have a fourth arm of the Government
composed of experts if you do not want to give the power to
the President.
In short, it seems to me that, to the extent that power can
be appropriately delegated by the Congress, must be given to
the President (1043).
Thus, our democratic tradition alone will be enough to make many
thoughtful people demand a politically accountable central bank. But
if this were the only argument, many might still prefer an independent central bank, basing their preference on the oft-heard assertion
that independence has economic advantages. In the hearings, however, those who supported independence on this ground failed to
develop substantial logical or empirical evidence for this position. On
the contrary, testimony presented at the hearings brought into common
view some important economic weaknesses and disadvantages of an
insulated independent central bank, and, as demonstrated in the foregoing, those who cited these developed powerful analytical and historical reasons for them. The case against central bank independence is
strong, whether viewed from the standpoint of achieving economic
responsibility, flexibility, and coordination, or from the standpoint of
making our institutions truly representative of the people.


1. The present system said to operate well
Federal Reserve officials, the witnesses representing the American
Bankers Association and Independent Bankers Association, and Professor Bach (Carnegie Tech) did not favor changing the System's
organization at this time. But many of these witnesses admitted the
existing structure is, to use Chairman Martinis term, "cumbersome."
Professor Bach, the only university economist who was against change
at this time, put it this way:
The organization of the Federal Eeserve System today still
reflects the outdated regionalism and fears of 50 years ago
when the System was established.
Bach also stated:
* * * there has been clear evidence of some conflict and inefficiency arising out of the present complex Federal Reserve
structure*** (1388).
Still, Professor Bach was against major reorganization such as contemplated by Representative Patman's bills at this time. He was
against reorganization now because "* * * the present system operates,
on the whole, well" (1388). Therefore, Professor Bach did not think
there was much to be gained from major reorganization.
This was basically the view of Chairman Martin. He put it this
And I think it has been fairly well done. I don't say that
it could not be done in different ways. But I want to emphasize the fact that by and large the Federal Reserve Board
as such has the control—we have had a decentralized central
bank. It has been the wonder of a good many of our foreign
friends, and to their amazement it has worked surprisingly
well despite its cumbersome nature (40). [Emphasis supplied.]
Other Federal Reserve officials also felt there was no need to change
because things were going well. President Clay (Kansas City) put
the matter as follows:
Well, now, you have a system I believe that works pretty
well as it is right now. Maybe there are some modifications
that might be advisable but I think they should be taken in
small steps rather than great big chunks so that we know
where we are going on this. I think this is a matter of safety
to the whole economy (785).




President Hayes made essentially the same point when he observed:
While change may be inevitable, Mr. Chairman, it should
come about as the result of the play of natural forces; it should
not be forced simply because it may seem to be logical.
Samuel Johnson once said: "He is no wise man who will quit
a certainty for an uncertainty." To be sure, one might quit
a badly operating "certainty" for an untried "uncertainty"
that offered the promise of betterment. But when, as here, the
system sought to be replaced is operating well, Dr. Johnson's
counsel seems to me to be pertinent (532).
2. Bad policy said not related to faulty structure
Pragmatism then was the System's first defense. "It works. Why,
therefore, change it?" If the premise is accepted the conclusion
follows. But the premise is not, as will be demonstrated in this part
of the report, acceptable. The second line of defense was that changing the System's structure along lines contemplated by Mr. Patman's
bills would do little, if any, good for it would not bring a better
monetary policy. Professor Bach put it this way:
The major policy failures of the Federal Reserve—and there
have been some, notably in the 1930's—have not been attributable to the organizational structure of the System (1388).
Eeferring to Mr. Patman's bills, President Deming (Minneapolis)
stated the argument as follows:
What is being considered here is whether a differently organized or structured Federal Eeserve System would have
turned out, or will turn out, a better monetary policy. It is
this that I very much doubt. If monetary policy has at times
been inappropriate, it is not, I submit, because of faulty
organization or structure (688).
Witnesses from outside the Federal Eeserve were not so willing to
accept the present structure. A substantial portion of their testimony
indicated, first, that the Federal Eeserve System is not operating
well, and second, that its bad policies stem inevitably from its structure. It follows that the System must be restructured if we are to
avoid future monetary mistakes and resulting economic instability.
This topic is pursued in part IV.

1. Chairman Patman's review
The Federal Eeserve is our monetary authority. All of the 19
ranking personnel of the System who testified before the subcommittee
agreed that, in meaningful terms, the goals of monetary policy are
"maximum employment, maximum production, and maximum purchasing power"—the goals of the 1946 Employment Act. It is a fair
question to ask whether the Federal Eeserve's policies have contributed to our achieving these objectives or, alternatively, whether these
policies have caused labor to l>e unemployed, factories and equipment
to be idle and the dollar to be unstable.



On February 11, Chairman Patman charged in his opening statement that the Federal Reserve's monetary policy was in fact an important root of our recent economic instability. H e stated:
Almost everyone will agree the Federal Reserve's record
in the 1929-33 depression was bad. This is not a partisan
opinion. President Hoover wrote in his memoirs (p. 212)
that the Federal Reserve "was indeed a weak reed for a nation
to lean on in time of trouble."
Since Hoover's time we haven't had a great depression.
But we have had five recessions and two inflations in the
30 years since 1933, and this is not a record anybody ought
to brag about.
Of course, the Federal Reserve's officials will tell you these
episodes weren't its fault, but reflect the failure of other policies. This is at best a half-truth. Recognizing that other
policies, especially fiscal policy, influenced past economic
trends and turns in no way whatever absolves the Federal
Reserve from responsibility for these trends and turns.
Let's look at the five recessions and two inflations we've
had since 1933. Between the summer of 1936 and the spring
of 1937 the Federal Reserve doubled bank reserve requirements. The price we paid for this was the sharp 1937-38
business and employment decline.
Inflation was unavoidable during the Second World W a r
and immediately thereafter. But the Federal Reserve was
not completely blameless in this episode. I n 1942 reserve requirements at central city banks were reduced from 26 to 20
percent. I t was 1948 before this inflationary action was reversed and reserve requirements at central city banks increased back to 26 percent.
During the 1948^19 recession the Federal Reserve reduced
its holdings of Government securities by $5 billion. These
sales decreased bank lending and investing power, and thereby aggravated the 1948-49 recession.
During the sharp inflation that followed the invasion of
South Korea, the Federal Reserve did nothing until January-February 1951 when reserve requirements on demand
deposits were raised by 2 percent and on time deposits by
1 percent. The Korean war inflation slowed down almost
to zero immediately.
From the spring of 1951 until now our great and essentially
healthy and venturesome free enterprise economy has three
times been throttled by the Open Market Committee of the
Federal Reserve System. The Open Market Committee's decisions affect the money supply and interest rates. I will let
the facts speak for themselves. The recession of 1953-54
began in J u l y 1953. The growth of the money supply fell
steadily beginning in January 1953, and by July was at an annual rate of less than 1 percent.
The next recession began in July 1957 and lasted until
April 1958. Interest rates started to rise in the middle of
1956. The growth of the money supply fell below 2 percent
during 1956 and by the spring of 1957 the money stock was



actually decreasing. It continued to decrease until the beginning of 1958, long after the recession began.
The most recent recession began in May 1960 and lasted
un^il February 1961. Once again we find interest rates rising
and the growth of the money supply falling just before the
downturn. The money supply fell from $142.8 billion at the
end of September 1959 to $139.4 billion in June 1960 (925926).
2. Federal Reserve officials' views on the recessions of 1953-54, 195758, and 1960-61
(a) 1953-54,.—Neither Chairman Martin or other ranking Federal
Eeserve personnel volunteered opinions on the causes of the 1953-54
recession and they were not questioned about this episode. Hence,
there is no way of knowing whether they are willing to bear any of the
onus for the economic downturn of July 1953 to August 1954. But
whether they would be or not, the staff is concerned that Federal Eeserve policies brought on that recession. The Federal Eeserve Board's
December 1954 "Bulletin" indicates that in the July to December 1952
and January to April 1953 periods, just before the downturn began in
July 1953, open-market policies were intentionally restrictive, The
relevant materials from the "Bulletin" are reproduced below.
Use of Federal Reserve instruments, July 1952 to October 195k1



July-December 1952

Limited net purchases of
U.S. Government securities in open market to

January-April 1963

Sold in open market or redeemed $800,000,000 net of
U.S. Government securities.

Intent with
respect to
effect on
credit and


Restrictive-. To meet seasonal and other reserve
drains only in part, requiring
banks to borrow some of the
reserves needed so as to restrain
bank credit and deposit expansion at a time when credit demand was very large and the
economy was fully employed.
Purchases in August and September were made primarily at time
of Treasury refunding operations
and were offset in part by subsequent sales.
To offset seasonal changes in factors
affecting reserves and thus to
maintain pressure on member
bank reserve positions.

i Board of Governors of the Federal Reserve System, Federal Reserve Bulletin (Washington), December
1954, p. 6.

(6) Chairman Martin on the 1957-68 episode.—The hearings show
unshakable reluctance on the part of today's officials to admit that
the Federal Reserve's monetary policy played a causal role in 1957-58.
Congressman Reuss-, of Wisconsin, asked Chairman Martin:
Isn't it true in retrospect that the Federal Reserve System
put on the brakes and tightened money at a premature time,
at least once or more in the last 5 or 6 years? (84)
Chairman Martin asserted, with respect to the 1957-58 recession:
* * * I am not willing to concede that the Federal Reserve, by its policy in 1957, brought on that downturn; I
think that the causes were much more fundamental than that



Chairman Martin gave no supporting argument for his denial of
Federal Reserve responsibility for the 1957-58 recession, nor did he
discuss the 1960-61 recession.
It is a matter of historical record that Chairman Martin and the
Federal Reserve did in fact show an unwarranted preoccupation with
inflation at that time. Chairman Martin's own testimony on August 13, 1957, which was after the downturn had begun, reflects this
preoccupation. As reported in the New York Herald-Tribune for
August 14, 1957, Martin told the Senate Finance Committee, "Inflation is the most critical problem facing the country." It is noteworthy
that this opinion was not shared by administration officials. This, too,
was noted by the Tribune:
Where Mr. Humphrey and Mr. Burgess in their appearances before the committee had held out the hope that inflation may be coming to an end, Mr. Martin gave no indication
that he would agree with their appraisal.
Chairman Martin's testimony in 1957 will be enough for most
people to conclude the Federal Reserve erred at the time. It adds
support to the powerful evidence that the Federal Reserve's "inflation
neurosis" caused the 1957-58 recession, which is provided by the data
on the stock of money preceding and just after the downturn in July
1957. As was noted earlier, Chairman Patman called attention to the
relevant facts when h&stated :
* * * by the spring of 1957 the money stock was actually
decreasing. It continued to decrease until the beginning of
1958 * * * (926).
Mr. Patman also pointed out that the same pattern, wherein the
downturn in economic activity is both preceded and surrounded by a
fall in the stock of money, held for the start of the 1960-61 recession.
(c) Governors Mitchell and Daane on the 1957-58 and 1960-61 recessions.—Congressman Reuss explored the question of the Federal
Reserve's role in the 1957-58 and 1960-61 recessions with Governors
Mitchell and Daane. The dialog follows:
Mr. REUSS. I want to pursue with you gentlemen the theme
that we were discussing * * * whether the money supply was
an important factor in economic growth. I think it is.
Mr. Mitchell says, quoting from page 13: "It has not even
been established in times like these whether changes in money
supply precede change in economic activity or vice versa."
I gather Mr. Daane agrees with that, and I emphatically
Let me ask Mr. Mitchell this. In the year from February
1957 to February 1958 the Federal Reserve actually decreased
the narrowly defined money supply. It decreased from $137
billion to $136 billion. In the middle of this 1-year period, in
July 1957, there was the start of a serious recession and enhanced unemployment.
* * * In saying as I do that the Federal Reserve's decrease
in the money supply had something, and an unfortunate something, to do with the unemployment and recession that followed, am I guilty of McCarthyism, of guilt by association, or



is there not a causal connection between this strangulation of
the money supply and the unemployment and recession which
followed ?
Mr. MITCHELL. I think you put it beautifully. This is
guilt by association; yes.
Mr. RETTSS. I am guilty of monetary McCarthyism?
Mr. MITCHELL. Yes; that is right, because we don't know
which comes first. If you have a decline in business activity,
it will of itself result in a decline in velocity and/or a decline
in the money supply. Free reserves rise * * * (1214).
Governor Daane also argued that Federal Reserve policy had not
strangled the money supply, but rather that the volume of money fell
because business activity declined. H e stated, "You [do] have a substantial increase in excess reserves * * *" (1215).
The answers of Governors Mitchell and Daane raise a theoretical
possibility, not a factual point. Conceivably, velocity could fall and
free and excess reserves rise as a result of a decline in business activity.
But this possible bottleneck to effective monetary control was not a
problem in the 1957-58 recession. I t is a fact that in addition to the
money stock, both excess and free reserves actually fell between December 1956 and December 1957, the year in which the business recession started. Using the 6 months immediately preceding the downturn in July 1957, excess reserves were constant and free reserves fell.
Indeed, at no time in the past 10 years was the theoretical bottleneck
to which Governors Mitchell and Daane alluded an operational problem. The Governors recognized this when, in a supplementary answer
to a question put by Congressman Reuss, they observed:
Over the past 10 years member banks have on the average
made almost full utilization of the supply of
reserve funds made available to them by the Federal Reserve
(1933). [Emphasis supplied.]
Moreover, it is important to recognize that even if excess and/or
free reserves were to rise and velocity to fall, the adverse effect of such
changes on total spending could be offset by a proportionately greater
rise in the volume of money. Thus, from a theoretical, as well as an
empirical, standpoint, the argument raised by Governors Mitchell and
Daane is invalid. Factually, the bottleneck alluded to was not an operational problem. Theoretically, the argument fails to take into account that monetary policy can be used to offset changes in velocity in
the event that velocity behaves perversely.
Governors Mitchell and Daane also argued that, since the rate of
growth of the broadly defined money supply (including time deposits)
did not fall off significantly until after the economy turned down in the
summer, it would be difficult to attribute the downturn in the economy
to monetary developments in 1957 (1516). The question of whether
the money supply should include time deposits is beyond the scope of
this report. However, it can be stressed here that the Federal Reserve
acts directly on currency and demand deposits, and only indirectly on
time deposits. Thus, the staff is not convinced that a broad definition
of the money supply is justifiable when considering the impact of
Federal Reserve policies. Moreover, the official position of the Federal
Reserve on the matter is that the money supply does not include time
deposits. Money is defined in the monthly Bulletin of the Board of



Governors to include only currency plus demand deposits. Also, as
witness the following colloquy, Governor Mitchell agrees that this is
the appropriate definition.
Mr. REUSS. But let me see if we can't find one area of agreement here. I n that same paragraph on page 13, when you
were talking about Professor Friedman you talk about the
Federal Reserve formulating monetary policy with "a more
logically defined money supply."
The dialog continues as follows:
Mr. MITCHELL. Narrowly defined.
Mr. REUSS. Good for you. You think that currency outside banks and demand deposits is a more sensible view of the
money supply.
Mr. MITCHELL. That is right.
Mr. REUSS. S O do I (1216).

The relevant data then are the statistics on the narrowly defined volume of money. These data show that the Federal Reserve either acted
to deliberately decrease the stock of money or passively allowed it
to fall prior to and just after the start of both the 1957-58 and the
1960-61 recessions. We do not know which is true. But judging by
Chairman Martin's remark that "inflation was the crucial problem" as
late as mid-August 1957 it would appear that the Federal Reserve's
errors were errors of commission. I t is interesting that Governor
Mitchell despite his earlier attempt to deny the role played by monetary development in bringing on the 1957 recession was critical of the
failure of the Federal Reserve to reverse its policy after the recession
had started. On this he stated:
* * * my feeling was that the Federal Reserve did not
switch policy early enough in 1957, and I think the facts warranted an earlier switch, and if I had been a member of the
Board, I would have voted for an earlier switch than the one
which occurred (1217).
Governor Mitchell's argument is to the effect that monetary policy
did not introduce the disturbance but affected its length and depth.
Chairman Martin appears to agree; he was not willing to admit monetary policy brought on the 1957 recession; he thought "the causes were
much more fundamental than that." On the other hand, he was at
times willing to concede the Federal Reserve's policy has been less
than perfect, in reversing trends brought on by these unspecified
"fundamental" causes. Regardless, the facts definitely suggest that
monetary policy not only prolonged and aggravated the 1957-58 recession, but also brought it on.
Concerning the 1960-61 recession, Governors Mitchell and Daane
did not disagree with the contention that a restrictive monetary
policy brought on that episode. Clearly, the volume of money fell
prior to as well as immediately after the downturn began. I n a supplementary reply to a question put by Congressman Reuss, Governors
Mitchell and Daane recognized this when they observed:
From mid-1959 to mid-1960, demand deposits and currency contracted by $3.2 billion, or 2 percent. Whatever
significance is attached to the money supply measure, this



performance reflects a highly restrictive monetary policy,
which many observers have charged with partial responsibility for the economic downturn that began in the spring
of 1960(1948).

1. The relation of monetary policy and money supply to our economy's
(a) Testimony that monetary developments have a powerful impact
on our economy.—No witness claimed that our knowledge of the
mechanism that links monetary policy and monetary developments to
our economic performance is complete. At the same time it was the
overwhelming consensus of the witnesses that money definitely matters and that monetary policy is causally related to national income,
prices, international payments, employment, production, etc. Federal
Reserve officials agreed that a causal relationship exists from the
Nation's monetary developments to its economic performance. As
Governor Mitchell pointed out:
If it didn't there would be no argument for the existence
of any type of monetary authority (1188).
The historical evidence for the theory that money matters is what
most impresses economists. Professor Meltzer (Carnegie Tech) told
the subcommittee:
Evidence from a large number of countries and many different time periods suggests that money and national income
are closely associated (928).
He testified further that:
Monetary policy is not a matter of "pushing on strings"
as the Board and others have so often suggested. I t is a
powerful force in our economy * * * (928).
Prof essor Brunner (UCLA) noted first that:
* * * substantial increases in the money supply are
typically associated with every major inflation ever observed.
A moment later he looked at the other side of the coin and observed:
* * * that receding activity levels typically occurred after
the growth rate of the money stock fell below a barrier of 3
percent per annum (1051).
Professor Brownlee, too, noted that our "principal" economic difficulties "have been with the variability of the rate of change in the
supply of money" (1063).
Dr. Warburton (FDIC) who has studied the question for nearly
half a century analyzed the data for the 1919-63 period and concluded that there was—
* * * a typical though not invariable, time sequence in the
occurrence of the crucial turning points, or cyclical peaks and
troughs. Money supply leads, followed by final product expenditures, and then by rate of use of money. This sequence
gives stanch support to the principal theory of the origin of



severe business fluctuations * * * they originate in maladjustments in money supply (1315).
In addition, Dr. Warburton told the subcommittee that he had
done some exploratory work for the period 1781 to 1919, and that—
The results of this exploratory work tend to support the
hypothesis that serious business fluctuations are led by serious
irregularities in money supply (1316).
The evidence is clear. The supply of money plays a strong causal
role in the economy. It is not all that matters but it clearly is an
important determinant of our economy's long-term growth and shortterm stability and freedom from recessions and inflations. This report is about the Federal Reserve—our Nation's monetary authority—
and we majr appear to be saying that money supply is all-important.
Obviously, it is not. But clearly, monetary policy is important, far
more important than many believe.
(~b) Testimony that the Federal Reserve controls the Nation*s money
supply.—Since irregular growth of the money supply is a strategic
and perhaps the dominant factor underlying business fluctuations, it
is important to know how the growth of the Nation's money supply is
controlled. The tools the Federal Reserve has to control the volume
of money were described in part I-C of this report. It will be recalled
that the Federal Reserve has power to change the proportion of the
reserves banks are required to keep behind their deposit liabilities, to
vary the rate at which banks can discount eligible paper, and most important, to buy and sell Government securities on the open market.
By means of these three policy instruments it can manipulate bank
reserve positions and thereby control the Nation's money supply and
ultimately national economic performance.
There is, of course, full agreement that the Federal Reserve has the
technical power and knowledge to control the money supply if it
chooses to do so (although there is considerable evidence, too, that its
techniques for so doing are inadequate). When Representative Reuss
asked whether the Federal Reserve can change the money supply, Governor Mitchell responded that "it is at times difficult" but it could be
done—"ignoring all other consequences" (1198-1199). If we can
judge by official publications et al., the "other consequences" pertain
to such Dank phenomena as the quality of credit, free reserves, who is
borrowing, and most importantly, the availability of bank credit.
Judging by the erratic behavior of the money stock, these other consequences have not been ignored. Indeed they seem to have received
an unwarranted amount of attention and at the expense of adequate—
in the sense of sound and prudent—monetary control.
Furthermore, though their day-to-day policies belie this, Federal
Reserve officials agree that what they do is aimed first at affecting
bank reserves and ultimately the economy's performance.
Vice Chairman Balderston, in a speech at Georgia State College on
February 13, 1964, which was referred to several times during the
hearings, put it this way: "The role of general monetary policy is to
regulate the reserves available to commercial banks so as to promote
economic growth, high levels of employment, reasonable stability in
prices, and to aid in achieving equilibrium in our balance of payments.



It is this responsibility so vital to the protection of integrity of the
dollar that has been delegated by Congress to the Federal Reserve
System." The evidence summarized and assembled^ in this report
demonstrates that the Federal Eeserve has not met this responsibility
(c) Testimony on the Federal Reserve's role in prewar economic
-fluctuations.—There was little specific testimony on economic turns and
trends before World War II. The testimony of Professor Friedman
(Chicago), who is the coauthor of a comprehensive study of our monetary history ("A Monetary History of the United States 1867-1960"),
contained a brief, specific reference to the interwar period. He stated
that the Federal Eeserve had three times made major mistakes during
this period, and that all three errors were "in a deflationary direction."
Professor Friedman told the subcommittee—
"These major mistakes include the sharp deflation enforced
on the country in 1920-21; the contraction in the quantity of
money by one-third from 1929 to 1933; the doubling or reserve requirements in 1936-37 and the subsequent shift from
a rapidly rising to a declining quantity of money * * *
Dr. Warburton (FDIC) in a memorandum submitted for the
record gave a somewhat more detailed description of monetary policy
before the war. He wrote:
When the Federal Eeserve banks were opened, their operations were directed to issuance of currency in the form of
Federal Eeserve notes. During World War I, and for a
year after the armistice in 1918, their policies were focused
primarily on financing the Government debt. The consequent monetary expansion produced a rapid rise in prices,
and led the Federal Eeserve Board and banks, toward the end
of 1919 and during 1920, to their first attempt at control of
the circulating medium through substantial increases in discount rates. The impact of this restrictive policy on business
activity and employment, in the depression of 1920-21, was
greater than had been anticipated.
Throughout most of the 1920's Federal Eeserve officials
spent much time and effort in attempting to develop guidelines for their future policies. Under the leadership of the
Federal Eeserve Bank of New York, attempts were made to
reverse the direction of policy with sufficient frequency to
maintain a substantial degree of economic stability. However, no attention appears to have been given to the need for
growth in the money supply, although the policies pursued
did not prevent such growth during most of the 1920's.
In 1929 and the early 1930's Federal Eeserve policy shifted
from an emphasis on the state of business and employment to
concentration on reduction of bank loans used in speculative
markets or based on securities. The measures taken drastically reduced member bank reserves, relative to the growth
needed for economic stability, with disastrous results on the
supply of money. The great depression was the consequence.
In the middle and late 1930's, after the change in the price



of gold and its impact upon gold holdings of the Federal Reserve banks, Federal Reserve authorities were primarily concerned with preventing such holdings from resulting in an
undue expansion of the money supply (1322).
The 1929-33 episode was the worst monetary and economic catastrophe in our history. But even today, many people believe the
"Great Depression" was born suddenly and fed by nonmonetary forces.
I t is useful, therefore, to review briefly the Federal Reserve's role in
the period. Early in 1928, before the "crash" of the stock market, the
Federal Reserve adopted a policy of monetary stringency which weakened many of our financial, mercantile, and industrial enterprises and
thereby made the economy extremely vulnerable to depression. On
May 18,1928, Gustav Cassel, a Swedish economist, testified before the
House Banking and Currency Committee and warned that the Federal Reserve's policy of monetary restrictions "may have an effect on
the general level of prices that will result in a depression. * * *"*
Cassel's warning went unheeded.
As noted by Professor Friedman, between 1929 and 1933 the volume
of money fell by one-third. Thus, the Federal Reserve, which controls
the supply of money compounded its error of 1928 and turned what
might have been a short though deep recession into a catastrophe.
Many persons, as the hearings brought out, blame the Hoover administration for the disastrous monetary policy of 1929-33. They
base this on the fact that the Secretary of the Treasury then was
Chairman of the Federal Reserve Board. However, neither the Secretary nor any other public representative was on the Open Market
Committee, and it was this Committee's policies that were the major
factor underlying the one-third contraction of the money supply between 1929 and 1933. Moreover, as Professor Friedman testified, the
Congress and administration officials (especially Mr. Ogden Mills,
Under Secretary of the Treasury) urged the Open Market Committee
to reverse course and follow expansionary policies. I n early 1932, the
Committee heeded this advice and the economy actually perked up
somewhat. B u t as soon as Congress adjourned, the restrictive policy
was resumed and followed until the collapse of the banking system in
1933. Small wonder, therefore, that President Hoover wrote in his
"Memoirs" (212) that the Federal Reserve "was indeed a weak reed
for a Nation to lean on in a time of trouble."
Errors committed more than 30 years ago would not cause us serious
concern today if we could be sure that those in authority today
had learned something from the errors of those in charge in 1929-33.
But as already noted, there is cause for concern that there is no
feedback mechanism in the structure of the Federal Reserve to assure that past errors are analyzed and insight and knowledge of the
monetary process thereby achieved. A study by Professor Meltzer
(Carnegie Tech) and Professor Brunner (UCLA) bears this out. On
this Professor Meltzer testified:
Our detailed study of the Federal Reserve's procedures reveals that their knowledge of the monetary process is woefully inadequate, unverified, and incapable of bearing the
heavy burden that is placed upon it. After 50 years, the Fed1

Cited in Gustav Cassel, "The Crisis in the World's Monetary System," p. 73.



eral Reserve has little verified knowledge to form the basis
for its policy actions. Equally important, the dominant
views expressed by Federal Reserve officials [today] are
founded on notions that were responsible for major errors in
1929-33, 1936-37, and at other crucial points (927).
I t was precisely because of the danger of future major mistakes
that Professor Friedman (Chicago) expressed a preference for congressional control of monetary policy. Answering a question by
Congressman Harvey (Michigan) Professor Friedman observed:
So far as the minor short-term movements are concerned,
ou may well be right that Congress would have been worse.
do not know, it might have been better or worse.
My preference for Congress derives from a different consideration. As I see it, the major problem of monetary policy
is to have a system which is not subject to major mistakes.
What I am convinced of, on the basis of the record, is that
Congress is less likely to make a major mistake than a Reserve
Board is, although it may make more minor mistakes.
You may be right that in terms of the minor fluctuations
Congress would have been worse. What I am impressed
with is that Congress would never have permitted the decade
of the thirties to develop as it did and would not do so again
in the future (1152).
(d) Testimony on the role of monetary policy from 1939 to 1952.—
World War I I was financed in several ways: by taxes; the sale of
Government securities in exchange for money that was in circulation
before the war; and the sale of Government securities in exchange for
newly created money. To facilitate the creation of new money,
reserve requirements at central city banks were reduced from 26 to 20
percent in 1942 and not raised back again until 1948. In addition, in
1943 the Federal Eeserve Act was amended so that for the duration
plus 6 months member banks did not have to keep reserves behind deposits "payable to the United States by any member bank [and] arising solely as the result of subscriptions made * * * for United States
Government securities * * *" (82). Thus member banks did not sacrifice any alternative in subscribing to Government securities, and
hence it is clear that the interest on the debt which banks accumulated
during the war (they cannot be said to have bought this debt) has and
continues to represent an outright subsidy to banks and a burden on
the general taxpayer.
Mr. Jerry Voorhis, a former Congressman from California, and
currently executive director of the Cooperative League of the United
States, testified on the cost of linking the creation of money to the
creation of debt. Mr. Voorhis (and Chairman Patman concurred in
this both during the war and the current hearings) would have had
the Federal Eeserve print the money that had to be created during
the war in order to finance that part of the Government's budget not
paid for by taxes and funds raised by the sale of Government securities in exchange for money previously in circulation. Mr. Voorhis'
plan would not have generated any more inflation than was actually
generated by wartime bond sales in exchange for newly created bank
money. The magnitude of inflation under Mr. Voorhis' plan would




not have differed from what occurred because the increase in the
money supply would have been the same. The advantage of Mr.
Voorhis' plan is that it would not have involved the creation of interest-bearing debt and thus it would not have saddled us with interest
payments on this debt which continue to this day. Probably $50 billion of Government interest-bearing debt which was issued during the
war need not have been created. Unfortunately, the practice of linking money creation to debt creation continues. Still today, as Mr.
Voorhis testified:
[A major] way in which we now bring about increases in our
money supply is by increases in our debt, either public or
private (1592).
During the period 1939-45, Mr. Leon H. Keyserling, told the subcommittee that—
* * * with all of our productive resources strained, total
national production grew at an average annual rate of 9.1
percent in real terms, and industrial production grew at an
average annual rate oi 11.8 percent. To generate this phenomenal expansion of output, the nonfederally held money supply
grew at an average annual rate of 15.7 percent, Federal budget
expenditures measured in uniform dollars grew at an average
annual rate of 49.4 percent, and the Federal deficit measured
in 1957 dollars averaged about $60 billion annually. Under
these circumstances, there was a substantial amount of price
inflation, * * * (1755).
^ The wartime inflation ended in 1947. In fact, it really ended earlier
since the rapid rise in reported prices immediately alter price controls were lifted in June 1946 was merely legal recognition of the
earlier rise in black market prices. From 1947 until the outbreak of
the Korean war in June 1950, there was no advance in consumer prices
and very little in wholesale prices.
Contrary to popular belief, the Federal Reserve followed a deflationary policy after the war, especially after 1947. It was a net seller
of Government securities from V-J Day to the invasion of South
Korea. Its deflationary policy was in fact instrumental in producing
the 1948-49 recession. Prior to and just after the downturn in November 1948, the Federal Reserve sold $5 billion of Government securities.
Some witnesses apparently forgot what happened during this period.
In their zeal to condemn H.R. 9749, which provides for Federal Reserve support of Government bonds when yields equal or exceed 4 ^
percent, they overlooked the fact that the postwar deflationary policy
took place at a time when the Federal Reserve supposedly was dominated by the Treasury. For example, President Hickman (Cleveland) , referring to the period when the peg was in force on the bond
market, stated:
And during that period, of course, after the war, we had a
very great inflation. From the end of the war, 1947 to 1951,
bonds were sold to the Federal Reserve System in very large
volume. And this became part of the monetary reserves of
the banking system. And the banks loaned the^ money out,
inflated the money supply, and this caused prices to rise.
Actually, wholesale prices in that period went up about 70
percent, or something like that (185).



The fact that the policy of supporting the bond market in the
postwar period did not bring inflation does not mean it has no inflationary potential. I t may not be able to cause inflation but can feed
one, as the Korean war experience proved. The outbreak of war in
Korea led many to try to hoard goods. They sold Government securities to obtain the funds they needed to build up inventories. By supporting the price of Government securities the Federal Reserve made
it comparatively easy to hoard. I n the second half of 1950 the Federal
Reserve bought $2.4 billion of Government securities, and the money
supply rose more than 3 percent by March 1951. This greatly added
to the inflationary pressure from wartime hoarding. Wholesale prices
rose about 14 percent by March 1951. Of course, the Federal Reserve
could have at least partly offset the inflationary pressure by raising
bank reserve requirements. I t finally did this in the J a n u a r y February period of 1951. The price rise was halted, but by this time
the horse was out of the barn.
(e) Testimony on monetary policy from 1952 until now.—The testimony of non-Government witnesses on monetary developments after
1952 was, on the whole, highly critical of Federal Reserve policies.
The criticisms concentrated on (1) the Open Market Committee's
deflationary bias, or "inflation neurosis" as Prof. Dudley Johnson
(Washington) put it, which was the root of our low rate of economic
growth in the 1953-62 period, and (2) continuation of the Committee's history of over-reacting to changes in the economy and thereby
aggravating the problem of unemployment and that of periodic inflation as well.
I t is as easy to magnify the Federal Reserve's recent errors as it is to
understate them. I n the staff's opinion, the testimony neither exaggerated nor understated the facts. The criticisms were based on two problems. One problem arose because our monetary growth was not large
enough to permit our economy's production and employment to accommodate the improvement of our technology and the growth of our
savings and labor force. The growth of the money supply was especially low from January 1956 to August 1962. During this nearly
7-year period, the volume of money increased from $135.2 billion to
only $144.8 billion; this is only 1.1 percent per year. 2
The second problem arose because there were three business cycles
in the period since 1952. We have had the same problems in earlier
decades, and they have been more critical in the past. But this does
not justify their existence in the most recent decade of our history,
and, more important, unless changes are made, their future existence.
Dr. Warburton ( F D I C ) put the problems of the post-1952 period in
their proper historical perspective. H e stated:
During the past decade Federal Reserve policy, as described
by officials, has been focused on three objectives: provision of
a money supply adequate for growth; countercyclical variations superimposed upon the rate of growth; and particular
situations, notably the balance of international payments.
Federal Reserve actions in pursuit of these objectives have
resulted in a more stable money supply, with some growth,
than in any other period in the Nation's history for which
All figures on the money supply used in this report are those available from Federal
Reserve sources through May 1964.



adequate data are available, except for several years of the
1920's. Business fluctuations have also been less severe than in
any other period of equal length. However, serious questions
continue about the adequacy of Federal Reserve policy, particularly with respect to the rate of growth of the money supply and with respect to business fluctuations resulting from
the emphasis on countercyclical policy (1323).
Listed below are excerpts from the testimony of the experts on our
Nation's money system on the two problems which continue to
plague us.
First, on the inadequacy of growth of the money supply and the Federal Reserve's "inflation neurosis"
Chairman Martin:
But one thing I am certain of is that inflation creeps up
on you (83).
But let me point out that people are always asking: "Where
is the inflation ?" And then all of sudden you have it. And
our job is to try and prevent this, try to keep it in its incipient
stages from getting out of control. And to go back to the
1957-58 period we are talking about, we then had an inflation
psychology. And I think it was essential that we stop it
(87). [Emphasis supplied.]
Prof. Dudley Johnson (Washington):
Now, if one examines the behavior of the Consumer Price
Index, especially since 1953, or after the first 6 months of the
Korean war, I think you will see a general upward drift in
this index.
Now, my statistician friends tell me that a significant part}
if not all, of this rise in the CPI can be explained by the
upward bias which is structured in this price index. As I
mentioned earlier, this results from certain technical characteristics in the construction of price indexes—the constant
repricing of a frozen basket of goods as well as the inability
to measure the quality improvements in the goods and services which make up the index, what this means is that the past
inflationary problem in the United States has been greatly
overexaggerated. In fact, I don't think we have had that
much, if any inflation, since 1953. This leads me to conclude
that we have been paying a very dear price in terms of foregone production and unemployment to fight a nonexistent
inflation (1460-1461).
Prof. Harry Johnson (Chicago):
* * * while in peacetime they have displayed a pronounced
tendency to allow deflationary policies on the average. Moreover—I refer here particularly to the behavior of the United
States and Canadian central banks in the past decade * * *
Professor Gurley (Stanford):
Since 1950, the ratio of the money supply to GNP has fallen
from 40 to 25 percent. This has raised interest rates across



the board which in turn has been a factor in the slowdown of
our output growth rate. Monetary policy has been a tightwad, doling out money in driblets when more was caJLied
for (1311).
Professor Lerner (Michigan State):
I would agree that during most of the period a lower rate
of interest would have been desirable * * *. I think so,
because of the effect on the economy in increasing the level of
economic activity and giving us more employment and prosperity (1404).
Professor Strotz (Northwestern):
We can think of ourselves as regulating the quantity of
money. Then the interest rate will be determined by the
technical terms under which we can exchange present goods
for future goods, and the desires of the community to consume now or to consume later. These forces, I think, ought
to be allowed to find their equilibrium position.
So I think the interest rate will achieve a proper level if we
determine that the quantity of money shall be maintained at
a proper level (1461-1462).
Professor Bach (CarnegieTech):
The Fed's action on the investment boom in 1957 was, I
think, a debatable one in the strength of the action it took. I
think reasonable men can differ on this. My own taste is that
it was somewhat too restrictive at that point and my own
taste has been that it has been on the whole slightly too restrictive over the past 5 or 6 years (1402).
Professor Eobertson (Indiana):
The greatest restraints were placed on the economy by
the monetary policy in effect from 1955 to 1960. Taking the
period since the accord we find that the rate of growth of the
money supply from 1951 to 1963 was approximately 2.2 percent per annum. That the recession of 1957-58 was not necessarily induced but was brought on more sharply by an unnecessary tightening of interest rates in the late summer and
early fall of 1957.
Kepresentative Vanik (Ohio) then asked: "You assign error to
Federal Reserve's policy?"
Mr. Robertson replied:
Yes; I would, especially in 1959 and 1960. In these years,
although we were Tbeginning to feel some international constraints, the international gold flow problem was not yet a
major problem. I feel that the Fed was bringing about high
rates in that period for purely domestic reasons, and I don't
think that we can let the Fed off the hook by saying they were
required at that time to put a stopper on the gold flow (1370).
Professor Brownlee (Minnesota):
Since the "accord" between the Treasury and the Federal
Reserve (1951), the average annual rate of growth in the


money supply has been about 2 percent * * *. If increases
in the money supply were the only demand expanding device, an annual average rate of increase of 2 percent is too
small to keep the price level constant with real output growing at 3 percent or more per year (or to keep output growing at 3 percent per year at a price level which cannot be
reduced). Federal cash payments to the public exceeded receipts, thereby increasing the Federal debt arid adding to aggregate demand. State and local borrowing1 also increased
substantially. The result is a level of interest rates higher
than would have prevailed had there been smaller increases
in debt and larger increases in the money supply.
I believe that the money supply could have been expanded
faster than it was, given the fiscal situations of the various
governmental units, without significant price increases.
Many persons believe that the real gros^national product has
been from 3 to 5 percent below that which could be produced
without inflation for nearly 7 years (1065).
Professor Villard (CUNY):
Once? again to put a quite complicated matter in the baldest
possible terms, as I see it, in order to reduce the rate of increase in prices by hardly more than 1 percent a year we have
recently been,wasting perhaps 5 percent of our productive
potential. When I take into account that continuing unemployment has caused labor leaders to question seriously the
value of automation and is turning niany of the unemployed
into, unemployables, I find what I estimate to be the recent
"trade off" between unemployment and inflation a very poor
bargain indeed (1021).
Mr. Keyserling:
* * * let us take a quick look at the unsatisfactory trends
in pur economic performance since the beginning of 1953.
The most characteristic feature of this poor performance has
been the chronic rise of unemployment and idle plant * * *.
While total national production expanded at an average
annual rate of only 2.9 percent during this period, the nonfederally held money supply expanded at an average annual
rate of only about 1.8 percent (1746 and 1747).
Prof. Eli Shapiro (Harvard):
With respect to the tradeoffs, the question that you posed
earlier, I think my response to your comments would be, as
fairly as I can do it—I would think that the Federal Reserve
authorities are preoccupied with stability of the price level
in such a way that when compelled to make a choice they
tend to err in the direction of price stability, whereas I
would personally regard getting to the utilization of our full
capacity as a primary goal in our society * * *.
So that, moreover, I think that we have enjoyed a remarkable period of price stability under the circumstances with
widespread unutilized capacity (1122).



Prof. Dudley Johnson (Washington) :
One did not hear the term "structural unemployment" during World War I I , since there was a sufficient flow of aggrefate spending to employ the then existing labor force. Nor
id one hear much talk about "structural unemployment," or
"technological unemployment" in 1952, or in 1953, periods
in which there occurred a rapid increase in the rate of technological change. Aggregate monetary demand was sufficiently high in these two periods so that unemployment was
only 3.1 percent in 1952, and 2.9 percent in 1953, even in the
face of rapid technological change (1436).
Mr. Goldfinger (AFL-CIO):
For a decade, unemployment has been in a rising trend.
Even last year, when the real volume of national output rose
nearly 4 percent, unemployment increased. This key domestic problem of unemployment and underemployment is
poisoning race relations and creating difficulties in labormanagement relationships, as well as wasting manpower
resources. Moreover, for the unemployed, underemployed,
and their families the lack of gainful job opportunities causes
obvious distress.
The Nation's monetary policy during the past decade has
contributed to this condition. During much of the past
decade, monetary policy has been relatively tight and interest
rates have been relatively high—discouraging the needed expansion of demand for goods, services, and manpower.
Moreover, monetary policy decisions were factors in setting
off the three recessions since 1953 (1472).
And there is a history of the Federal Reserve tilting
with the windmills of overall demand inflation in the 1950's
with the resultant trend of rising unemployment.
The Federal Reserve's continuing fear of inflation is notorious. Prof. Dudley Johnson has called this inflation
fear a Federal Reserve "neurosis." On the other hand, there
is a constant displeasure with, but no real fear of persistent
high unemployment, which has continued in this country for
over 6 years (1477).
Professor Samuelson (MIT), in a column published in the Washington Post, November 25, 1963, which he submitted for the record, had
this to say on the deflationary bias of the Federal Reserve:
An index number of scholar's confidence in the Fed, using
1928 as a base of 100, showed a steady postwar rise from 3
in 1945 to 73 in late 1952. The incompetent handling of
matters in early 1953 sent this index confidence plunging down
toward 50; there followed what technical chartists call a
head-and-shoulders topping out, until the disastrously biased
tight-money capers of 1956-60 created a crash in the index.
Since then the index of confidence in the probity of the Federal Reserve has been painfully climbing back toward the level
of 50.



How to improve the image? Sending Board members'
speeches to the complete mailing list of the American Economic Association is perhaps not the most constructive move
!>ossible at this time. Institutional advertisements in the
eading economic journals is probably too crude. You can't
buy love; you have to earn it. The therapy must be fundamental and drastic.
Professor Samuelson then urges the monetary authorities t o :
Stop being jockeyed into the underdog position of last defender of stability of the price index. The universe was not
created with a basic division of powers; the Government being under obligation to use its fiscal policies to produce high
and growing real output; the Federal Reserve being under
obligation to use its monetary policy to insure stability of the
price level.
Such logic leads—indeed it did lead, even in the days before gold was a problem—to credit policies that are too tight
and fiscal policies that have thereby to be so much the looser.
The result, even at full employment, will be a bias against
capital formation and a bias toward present consumption.
The founders of the Federal Reserve really didn't know
what they were doing. But surely none of them thought they
were designing an engine that would be a bulwark against
growth (1125-1126).
Second, on the recessions of 1953-5^ 1957-58,1960-61 and the Federal
Reserved tendency to overreact
Mr. Keyserling:
The thesis that the movements in the money supply were
merely responsive to the business cycle, and not causal factors
in themselves, cannot be supported upon analysis of the yearby-year trends * * * extraordinarily drastic restraints upon
the nonfederally held money supply * * * gave much force
to the economic downturns of 1957-58 and late 1960-early
1961 (1747).
Professor Friedman (Chicago) :
Taken altogether, the period from 1957 to mid-1962 was
characterized by unduly wide swings in the rate of growth
of the money stock and also by a somewhat lower average rate
of rise in the money stock than in earlier postwar years. The
swings in the money stock contributed to the too-frequent ups
and downs in the economy. The low rate of rise in the money
stock contributed to the generally high level of unemployment but also, on the favorable side, to relative stability in
wages and prices.
September 1962 saw another change of course. The change
was in a desirable direction, but too great in magnitude.
Since then, the quantity of money, defined narrowly, has risen
at a rate of nearly 41/2 percent a year; and defined more
broadly at over 8 percent a year. These are rates of rise
that cannot be long maintained without producing a substantial increase in prices (1138).



Professor Friedman, it should be noted, urges that the monetary
authorities be instructed to increase the narrowly defined money
supply (currency plus demand deposits) at a rate of 2 to 4 percent
per annum. This, he contends, would minimize both unemployment
and inflation.
Professor Brunner (UCLA):
During the recession of 1948-49, the Board lowered the
legal reserve ratios in successive steps. This action was effectively designed to raise the extended [monetary] bpse by a
substantial amount, and was thus properly planned to increase the money supply an<d counteract the prevailing
deflation. Unfortunately, the Federal Reserve authorities
also engaged in large-scale open-market sales which lowered
the extended [monetary] base. These sales dominated the
effect of the changes in the legal reserve ratios, a fact clearly
revealed by the growth rate of the extended [monetary] base.
Contrary to the Federal Reserve's assertions, the open-market
sales did not modify a prevailing "policy of ease"; neither did
the Federal Reserve actually exert a "countercyclically
stimulative" policy. Policy was deflationary at the time,
because the positive effect of lower requirement ratios was
overwhelmed by the negative effect of open-market sales.
A somewhat different constellation was observed in the
recession of 1953-54. Once more, the release in required reserves, accomplished by the reductions in legal reserve ratios,
contributed to raise the extended [monetary] base. But, this
effect was again offset by a contraction of Federal Reserve
credit. This contraction was reflected simultaneously in the
Federal Reserve's portfolio of discounts and advances, and its
portfolio of Government securities. Thus, both discount
policy and open-market policy explains the deflationary direction in the movement of the extended [monetary] base during
the recession of 1953-54. Inspection of pertinent data for
1957-58 and 1960-61 would again reveal that both openmarket and discount policy shaped the deflationary trend * * *
During 1961, policy became decisively expansionary, hesitated seriously for some months in 1962, and moved further
to generate a growth rate of the base in the late fall of 1963
not achieved since 1952. This prolonged and decisively expansionary policy is quite likely one of the single most important reasons explaining the length and vitality of the
current upswing in economic activity (1073).
Dr. Walker (executive vice president, ABA) also agreed that recent
policy was far from tight. He pointed out that for the past 3 years,
"Credit policy, in 3hort, has been and continues to be essentially easy"



Whether considered in terms of money supply or credit availability,
policy has been expansionary in recent years, viewed as a whole.
Many, like Professor Brunner, are persuaded these monetary developments are an, important cause of the recent business upswing. But
many also are apprehensive that recent developments won't continue,
and, in fact, many believe that the recent growth of the money supply
was the result of a "happy accident," as Professor Bach (Carnegie
Tech) put it.
Our recent business upswing began in the spring of 1961, following
moderate monetary expansion beginning in the fall of 1960. The
upswing, as Professor Brunner (UCLA) noted in testimony cited
above, hesitated in 1962 following a sharp decrease in the growth of
the money supply. Since August 1962, the money supply has increased at the rate of 4.1 percent per year. The economy has bloomed
with this expansion. And given the rosy monetary developments, the
takeoff of the economy was not unexpected.
The current economic expansion, however, will last only if the
Federal Reserve acts in the appropriate way. Testimony before the
subcommittee gives cause for concern that because of its "inflation
neurosis" the Fed may brake the growth of the money supply too
hard whehever it "senses" that inflation is creeping up, like some
unseen tijger stalking an innocent prey. In fact, the Federal Reserve—
as this is written in early June 1964—may again be turning about
to tilt with real or imagined "incipient" inflation, for since late last
year the growth of the money supply has decreased steadily. Hopeiully, this trend will be reversed.
There was some testimony that the Open Market Committee believes
that it has been following an anti-inflationary or a progressively less
easy policy for over a year, which means that the current upswing of
employment and business activity has been a "happy accident." Certainly this is the impression obtained from reading the instructions
of the.Committee as reported in the Federal Reserve's Annual Report
for 1963 and 1962 as well. At the end of 1961 the account manager
was instructed to provide reserves "but with a somewhat slower rate
of increase in total reserves than in recent months." In early 1962
the instruction called for "maintaining a supply of reserves adequate
for further credit expansion" and also "maintaining a steady money
market." In March the instruction continued to call for supplying
reserves "adequate for further credit expansion" but now the account
manager was warned to avoid "undue downward pressure on shortterm interest rates." In June 1962 the instruction called for "providing a somewhat smaller rate of reserve expansion." In December
1962 the instruction called for "maintaining a firmer tone in money
*Qn July 10, when this report was in galleys, the Federal Reserve released money supply estimates for June showing a rise of $1.3 billion for the month. If continued for a
year the June developments would generate an 8.5 percent rise In the Volunie of money
by July 1965. Thus the June developments definitely buck the downtrend that began
in January, and in fact almost fully corrects for Its deficiencies. But 1 month's
developments do not constitute a trend. June might mark the resumption of monetary
expansion on the order of what we had since August 1962. On the other hand the
monetary expansion In June may denote onty an attempt by th$ Federal Reserve to
maintain an orderly Government securities market—traditionally the Federal Reserve
increases the money supply before large Treasury refundings, and in July the Treasury
refunded nearly $42 billion of Government securities. In future months we will learn
which of these two hypotheses is correct.



markets while continuing to provide moderate reserve expansion."
Not once during 1962 did the instruction call for stepping up the
pace of reserve expansion or for achieving lower interest rates or an
easier money market tone. On the contrary, as noted, the last instruction in 1961 called for slowing down the expansion of reserves. In
mid-1962 the account manager was told to further brake the rate of
increase in reserves. In December, he was told to achieve a firmer
money market.
There was no real change in the instruction after December 1962
until May 1963 when the account manager was told to achieve "slightly
greater firmness * * * while accommodating moderate reserve expansion." In July the instruction called for achieving still "a slightly
greater degree of firmness" and at the same time continuing to accommodate "moderate expansion in aggregate reserves." This instruction
remained in force through the end of the year.
Clearly, anyone who assumes that the instructions of the Open
Market Committee are followed by the System's account manager at
the New York Reserve Bank must be hard put to explain the monetary
expansion we had from August 1962 to mid-January 1964.
Attention now is called to the tendency of the Federal Eeserve to
overreact, especially to the threat of inflation. On this problem and
its implications for monetary developments now and in the near
future, witnesses made these comments:
Prof. Harry Johnson (Chicago) :
* * * in the short-run conduct of policy they have tended
to overreact to changes in the economy and to reverse their
policy with a substantial delay, thereby contributing to the
economic instability that their policies are intended to combat (9T0).
Professor Meltzer (Carnegie Tech):
What we find is that the Federal Eeserve permits a larger
rate of growth in the money supply during the periods when
they should be controlling inflation, and a smaller rate of
growth in the money supply during periods when they should
be preventing unemployment (941).
Professor Friedman (Chicago):
If the Eeserve System waits until the inflationary effects of
its present policies become clearly manifest and only then
curtails the rate of monetary expansion, it will be months
thereafter or perhaps a year or more before the inflation is
stemmed. In the interim, it will understandably be tempted
to step on the bra*ke too hard (1139).
Prof. Dudley Johnson (Washington):
* * * whether such monetary ease will continue is problematical, given the recent statements by the monetary authorities on the possible inflationary effects and payments
effects of the recent tax cut (1448).


Professor Strotz (Northwestern) :
As for present Federal Eeserve policy, I would voice the
following complaints. I am disturbed to find the Board of
Governors already so concerned about the possible inflationary effects of the recent tax cut as to consider moving in a
direction that nullifies the intended expansionary effects on
employment motivating the cut in the first place (1454).
Mr. Goldfinger ( A F L - C I O ) :
During the past 3 years, the Federal Reserve—the Nation's
monetary manager—has fortunately been more positive in its
role. But interest rates—the price of money—which were
pushed upward during the 1950's are at high levels and unemployment remains about 5% percent of the labor force.
Yet it is not monetary ease that is now the primary concern of
the Chairman of the Federal Eeserve.
I n 1964, America once again faces a potential threat from
the Federal Eeserve—monetary policy may be used to negate
the demand-generating and job-creating impact of the tax cut.
Once again, the Nation's monetary policy may be tilting with
the windmills of overall demand inflation or ineffectively responding to a balance-of-payments deficit, leaving persistent,
high levels of unemployment in its wake (1472).
I t is not unreasonable, then, for those of us who criticize the
Federal Eeserve for its recession-preceding, money tightening actions of 1957 and 1959 to wonder how much additional
damage can result from mistaken inflation fears in the 1960's
Just as Chairman Martin is certain that "inflation creeps
upon you," with a memory of the past, I fear that he will see
"inflation" where it is not, and quite honorably attempt to
destroy it. The result will be disastrous at a time of already
tight money and high unemployment. We cannot afford
such loss again—with a 5^/2-percent jobless rate and unemployment rates two to three times that level for Negroes and
young people (1478).
Professor Bach (Carnegie Tech) :
On the issue of current monetary policy, I shall be brief.
In my judgment, the results of monetary policy have turned
out to be about right for 1963—in part, I suspect, because of
a happy accident. The stock of money has grown at an annual rate of about 4 percent during 1963, and at an annual rate
of 5 percent during the last half of the year. This compares with more like 2 percent over a period of several years
before 1963, in spite of the fact that the Federal Eeserve
announced a movement to a policy of "less active ease" at
mid-1963, raised the discount rate from 3 to &y2 percent, and
apparently reduced its target level of free reserves (1391).
Professor Meltzer (Carnegie Tech) :
1963 is a very good year to discuss, 1962-63. I mentioned
in my statement, in my earlier remarks, that it was precisely at the time that the Federal Eeserve indicated that they




had moved to a policy of slightly less ease that the money
supply began to grow at a much more rapid rate. Their indication of a change in policy toward less ease was published
in the Federal Eeserve Bulletin by the manager of the account, Mr. Stone. Slightly less ease should mean that the
money supply is going to be compressed, that growth in the
money supply is going to slow down. But it is just at that
time that the money supply began to grow faster.
Judged by free reserves that Mr. Hayes at these hearings
and that Mr. Martin and others have used over and over
again as the indicator of their policy—their policy has been
tight. But judged by appropriate indicators, that adequately
summarize Fed policy operations on the money supply, their
policy has been easier since late 1962. So they misjudged
the meaning or content of their policy, and I think there is
a strong case to suggest that they do not understand, in any
reasonable detail, the operations that they are conducting or
their effect (951).
I n summary, the staff is convinced that recent monetary policy has
been excessively concerned with inflation and has tended to overreact to the threat of inflation. Thus it produced and nursed three
recessions. The annual rate of growth of the money supply fell to
less than 1 percent before the 1953-54 episode, and before the 1957-58
and 1960-61 recessions the volume of money actually fell.
Monetary developments have been expansionary since the fall of
1961, and the rate of increase in the money supply has been just about
right to achieve growing employment without inflation. The economy, in consequence, now is experiencing an upswing in business activity and declining unemployment, and without rising prices. But so
great is the Federal Reserve's fear of inflation that the growth of the
money supply at rates sufficiently close to what has obtained since
1961 are not likely to continue. Moreover, there is evidence that the
Federal Reserve never meant for as much ease to obtain as we have
had, and that therefore the period of expansion we have been experiencing has been an accident.
(/) Testimony on the interaction, if any, between monetary developments and the balance of payments.—Nearly every witness testified
that since 1956 the Federal Reserve's policies have been formulated,
at least in part, in response to our balance-of-payments difficulties.
Most witnesses, however, were disturbed by this. They felt we had
sacrificed domestic employment and growth in trying to achieve
balance-of-payments equilibrium. Moreover, they were doubtful
that the policy of monetary stringency which had increased our domestic problems was the appropriate one for solving our international
difficulties. Mr. Goldfinger ( A F L ^ C I O ) put it this way:
Resultant high unemployment and yearly losses of billions
of dollars of potential output from economic slack are ineffective "solutions" to the balance-of-payments problem.
The administration and the Congress and, indeed, the Federal
Reserve Board, have already used more direct and more effective means of treating the payments problem.



Money tightening efforts have not resulted in much lowering of the deficit, but they have slowed domestic economic
progress (1478).
Professor Lerner agreed. He observed:
As to the level of interest rates and the money supply, it
is my feeling that lower interest rates and a greater money
supply would have done much more good than harm, and
possibly no harm at all. The higher income level would have
increased demand for imports and the lower interest rate
would have induced more idle money to be held abroad, but
the higher level of employment would have made investment in the United States more attractive compared with investment abroad and thus might very well have offset or
more than offset the first two influences on the balance of payments.
This cannot be known with any certainty, but in any case
the loss from national income from higher interest and lower
money supply is almost certainly much greater than any real
cost that would have been involved in a larger gold drain
Precisely because we know that tight money policies create domestic economic problems and do not know whether they decrease or
increase our international payment problems we can find fault with
the Federal Reserve for attempting to solve our payments difficulties
with tig;ht money policies. The fact is that following 7 years of monetary stringency (January 1956 to August 1962) our payments deficit
continued to run at an annual rate of more than $3 billion. Only since
the money supply has been growing at a rate large enough to generate
an upswing has our payments position improved. Until the Federal
Reserve can demonstrate the power of monetary stringency to equilibrate a payments deficit without causing substantial domestic unemployment they should not follow a restrictive policy for the purpose
of trying to eliminate our payments deficit. Rather, they should take
the chance that a policy of adding to the money supply in proportion
to the growth of our productive resources will underwrite "maximum
employment, production, and purchasing power" at home without increasing our payments problems. As Professor Bach put it:
I have the feeling that we could afford to take a bit more
risk, if you want to put it that way, with our gold stock * * *
I n the above connection, a letter from Chairman Martin to Senator
Douglas, of Illinois, which was inserted into the record on pages
1381-1383, reveals that our gold reserves could fall to $8 billion (or
by $7 billion from the present level) and all that would occur, under
the law, is that the Federal Reserve System would have to pay a tax
of $300 million a year because of the resulting deficiency in gold reserves. But this tax would be meaningless, for as the letter points
out, "Payments on these taxes would diminish net earnings on the
Federal Reserve banks and reduce by an equal amount their payments
to the Treasury £ts interest on Federal Reserve notes, which amounted
to $800 million in 1962. I t should be understood that the total pay



ment to the Treasury would not change; it would simply be divided
into two parts adding to the same total, one part labeled 'tax on reserve deficiencies' and the other labeled 'interest on Federal Reserve
notes.' I n the example, the total payment would still be $800 million,
but $300 million would be in the form of a tax and $500 million would
represent interest on notes" (1383).
Professor Barger (Columbia), alone among university economists
who testified, felt that the Federal Reserve had steered a middle course
between gold and jobs successfully. He testified:
I t seems certain that our employment rate would be lower
today, and our gross national product larger,, had monetary
policy been somewhat easier during the past 2 or 3 years. But
I also believe that the Federal Reserve has shown extraordinary skill in keeping money just tight enough to bring gold
losses to a practical halt, without doing any more damage to
domestic employment and the growth of the gross national
product than proved absolutely necessary (1356).
Professor Barger also testified that—
The position of the administration is that the gold flow
and balance of payments should take priority * * * (1370).
Congressman Vanik (Ohio), asked where it had been indicated
by the administration that the Federal Reserve should give priority
to stemming the gold outflow over curbing unemployment. I n a
tripartite colloquy, among Representative Yanik and Professors Barger (Columbia) and Robertson (Indiana) it developed that the Federal Reserve did not have legal authority or administration approval
to do this. More important, the dialog also indicates, as others testified, that monetary stringency is simply not an effective way of equilibrating balance-of-payments problems. The dialog follows:
Mr. V A N I K . I have not seen that written down anywhere. I have not seen it anywhere where the administration said when it comes to deciding between full employment or curbing unemployment and limiting the gold
flow that we are going to favor limiting the gold flow. If
you had seen it I would like to have you spell it out for me.
Mr. BARGER. I would quote the statement of the late President Kennedy if you like, at the time that Telstar was
first launched, when he said that the one thing, whatever else the United States did, the one thing that it would
never do, would be to devalue the dollar. If that is not a
categorical statement of priority, I don't know what is, sir.
Mr. ROBERTSON. * * * I think both Professor Barger and
I agree with the overwhelming majority of the economics
professors in our views that domestic matters should take
precedence over foreign in any handling of the money markets and in any engineering of interest rates, and I certainly would want to be on record as saying this. * * * I
am afraid, sir, that monetary policy alone can never, never
adjust gold flows. I give you as one example the effectiveness of the so-called interest-equalization tax, which did
more at one stroke to stop international gold flows than



raising the interest rate by 2 full percentage points would
have done,
Mr. V A N I K . That is correct. I want to say that I see
nothing in the Full Employment Act that relates anything, any of its objectives, to the gold flow. Perhaps
at the time the act was adopted in 1946 this was not comprehended as a problem.
But the law still stands. Also, I want to say I don't think
the Telstar statement Professor Barger mentioned meant
President Kennedy gave priority to stemming the gold outflow over achieving full employment. I think he meant
we'd defend the dollar with policies like the interest equalization tax (1371).
Professor Barger did, in fact, suggest that our payments deficit
reflects a "fundamental disequilibrium" which cannot be corrected
by monetary stringency. To correct the situation he stated:
I think that a realinement of exchange values, particularly with Western Europe and the F a r East through the
agency of the International Monetary Fund, would be the
proper procedure (1365).
P u t otherwise, Professor Barger urged devaluation.
agreed. Still other economists urged that we simply free the price
of the dollar and let market forces determine its value. This would
have the virtue of preventing deficits and surpluses though it
might cause other problems.
Regardless of whether one favors freely fluctuating exchange rates,
devaluation, or policies such as the interest equalization tax as the
appropriate means of solving our payments problems, it is clear that
monetary stringency is the most costly way of attacking the problem, and moreover, also the least likely to be effective. Secretary
Dillon, in a recent speech quoted in the Washington Post, June 1
(20), expressed precisely this point of view when he stated:
All of us recognize the need to improve the process of
balance-of-payments adjustments among free industrial
nations. We have found that the old "rules of the game"—
whatever their value in the past—are no longer adequate.
For instance the classical presumption that balance-of-payments deficits call for the restriction of domestic activity
has had little relevance to the situation facing the United
States in recent years.
The Federal Eeserve's restrictive policy from 1956 to 1962
may have been aimed at solving our payments problem without
dwarfing our domestic economic growth and causing unemployment, but if it was, it clearly failed. Monetary stringency, by itself,
actually may have aggravated our payments deficit, and has certainly
stunted our growth and caused unemployment.

The political, social, and economic repercussions of monetary
mismanagement these past 50 years are both numerous and vital.
This report outlines only the most important effects of the Federal
Reserved recent errors.



Between January 1, 1956, and August 1962, our economy had to
adjust to an extremely miserly monetary policy. The money supply—whether deliberately or because the Open Market Committee
did not know what it was doing—grew from $135.3 to $144.8 billion
or by only 1.1 percent per year during this period. During this
same period, we had two recessions, one from July 1957 to August
1958 and the second from May 1960 to February 1961. Long-term
yields on Government bonds reached 4.37 percent just before this
latter recession.
Population and knowledge, the human resources of our economy
grew much faster than 1.1 percent per year during this nearly 7year period. Thus we were compelled to find ways of making dollars do more work or to suffer the strains of unemployment. We
found some ways of making our dollars work harder. But these were
not enough to prevent a significant rise in long-term unemployment.
Moreover the ways we found to compensate for monetary stringency
were detrimental to our economy's growth.
1. Effect of monetary stringency on private investment and Government spending and therefore on economic growth
This report earlier pointed out that politicians are held responsible for achieving full employment (without inflation, of course)
whether they like it or not. Thus, if monetary policy fails, fiscal
policy will be used to do the job. Professor Shapiro (Harvard)
put the argument this way:
* * * if the central bank * * * maintains a monetary
policy which dampens demand * * * [then] with a deficit
of sufficient size, it may be possible to offset this restrictive monetary policy (1099-1100).
Professor Brownlee (Minnesota) was one of those who pointed
out that we have followed this course. H e told the subcommittee:
F o r a given desired gross national product, we have a
choice between easy money and a tight budget (a surplus)
or tight money and an easy budget (a deficit). We have
chosen the latter policy (1066).
Expansion of Government spending, then, was the principal
way which we found to substitute for the adverse effects of the
Federal Eeserve's policy of monetary stringency during the 1956-62
period.- Monetary policy strangled private investment during these
years. Private borrowers (investors) found that funds were too
costly or simply not available. So spending was increased at all
levels of government by way of trying to make up the gap. From
1956 through 1962 net private investment fell from 8.4 percent of
G N P to 6.7 percent, or by one-fifth of the initial rate. I n the
same period, Government expenditures rose from 25 percent of G N P
to 29 percent. Moreover, Government transfer payments, which constitute a good measure of welfare spending, rose from 23 percent of
all Government expenditures to 27 percent.
I t is not at all clear that the President and Congress, acting for the
electorate, would have chosen to sacrifice private investment to Government spending, and especially welfare spending, if they had been
allowed to choose. But the President and Congress have not been al



lowed to choose. Our elected officials could only react—to counterpunch—with an expansionist fiscal policy when the Federal Reserve
throttled private investment with a policy that deliberately or accidentally held the average annual growth of the money supply to 1.1
percent for almost 7 years. Professor Samuelson ( M I T ) spoke of
the consequences when he observed:
* * * we have gone along with the image of an adversary
procedure, where it is the business of the Federal Reserve, the
central bank, to worry about the price level, as if that was its
brief, and its mandate; while it is supposed to be the business
of somebody else, I suppose the executive branch—you cannot
call it the Treasury because the Treasury does not decide these
things—to determine what the unemployment rate will be and
what the rate of growth will be.
You cannot divorce these two.
But if you try to, you will get something like what we have
had in recent years; namely, a biasing of policy toward fiscal
ease which means a low-capital-formation economy, because
we keep tighter money and we offset it by a looser fiscal
policy. * * * W h a t we see in the tax bill is an example of
that. We are encouraging the use of resources by tax reduction in the direction of current consumption, even though it
is true that there are aspects of the tax bill which have a bearing upon capital formation. And the Federal Reserve is
prepared to—in fact, it has warned us that it is prepared to—
mop up any inflation that may result from that by tightening
money and credit, which means putting the tourniquet around
capital formation.
Well now, under such a procedure, where I can only move
the white man in chess and you can only respond with the
black man in chess, you are not going to get the optimum from
anybody's point of view (1121).
Representative Hanna (California) made a similar analysis the day
before Professor Samuelson appeared, except Mr. Hanna put his in
terms of "jousting between knights."
But regardless of whether we frame the problem in terms of jousting
knights or chessplayers, it is clear that when, as in the 1956-62 period,
the Federal Reserve's monetary policies are too tight our fiscal policies
will be affected. I n an article written in November 1963 which he
submitted for the record, and which we have earlier cited, Professor
Samuelson noted that fiscal policies—
have thereby to be so much the looser. The result even at full
employment will be a bias against capital formation and a
bias toward present consumption.
He continued:
The founders of the Federal Reserve really didn't know
what they were doing. But surely none of them thought they
were designing an engine that would be a bulwark against
growth (1125-1126).



2. Effect of monetary stringency on the Government's debt
Obviously, inasmuch as Government spending had to increase to
prevent widespread unemployment, the Government debt was increased by the Federal Reserve's policies of monetary stringency. I t
is impossible to measure precisely how much Government debt monetary mismanagement has caused. But for the Federal Government's
debt a rough approximation or estimate can be obtained by adding
the taxes that would have been collected and could have been applied
to the debt plus the spending, including interest payments, that need
not have occurred if only monetary policy had been more sensible and
matched changes in the money supply with changes in our economy's
To accomplish this task it is necessary to have some idea of the
difference between what G N P would have been at full employment
and stable prices and what it actually was. The Economic Report of
the President provides these facts. Based on our entire postwar experience the President's report concluded that for the 1956-62 period
the economy's output potential grew at an annual rate of 3.5 percent,
whereas actual growth was at the slower rate of 2.7 percent. I n 1962
prices the cumulative excess of potential G N P over actual G N P totals
about $190 billion for the same period. If we had realized our full
economic potential and also maintained tax collections (measured as
a percent of G N P ) at the 1955 rate, the Federal Government would
have collected nearly $35 billion more in taxes than it did during the
1956-62 period.
Also, if we had realized our full potential, Government expenditures, especially transfer payments to individuals, grants-in-aid to
States and local governments, and business and farm subsidies, would
have been appreciably reduced during the period. I t is difficult to
estimate by how much transfers, grants, and subsidies would have
been cut. To avoid arguments this sum will be ignored. Of course
this procedure will minimize our estimate of total debt savings.
Interest payments also would have been lower if a more appropriate
monetary policy had been followed during the period in question. If
the rate of growth in the money supply had been a modest and noninflationary 3 percent per year, instead of 1.1 percent, rates of interest
now, in 1964, might be what they are, or even higher, but during
most of the intervening years, possibly through 1962, probably
could have been maintained at roughly 1955 levels. I n 1955
the computed rate of interest on the Federal Government's debt was
2.3 percent. If this rate had been maintained, and if all additional
tax collections from realizing our full economic potential plus all interest savings were applied to the debt in the years they were achieved,
the cumulative savings in interest payments on the debt for the fiscal
years 1956-62 would have been nearly $17% billion. When this sum
is added to the $35 billion additional taxes that would have been collected in this period if we had experienced full employment, we find
that the debt could have been only $251 billion at the end of fiscal
1962, rather than $303.5 billion. Further savings in interest payments
and so additional debt reduction might have been achieved in fiscal
years 1963 and 1964.
This $52% billion plus debt reduction could have been achieved without inflation. I t could have been achieved if only the Federal Reserve
had managed the money supply so that it grew roughly at an annual
rate of 3 percent. This rate would not have brought an economic
Digitized forparadise
FRASER but it would have been large enough to accommodate the ex



pansion of our population and technical know-how and yet small
enough to prevent inflation. Moreover, it would have permitted Congress either to retire debt or undertake Government investment in
pressing social overhead programs.
3. Effects of monetary stringency and monetary recessions on our
economy's marginal workers
From 1956 to 1962 the Federal Keserve did not "furnish" the
economy with a money supply that was "elastic" enough to permit
"accommodating" our growing labor force and know-how, and, by
inference, "with a view of accommodating commerce and business."
Monetary stringency and monetary recessions have differential effects
on our Nation's people. Some are hurt far more than others. All of
us know that some people are more employable than others. People
who live in depressed areas are, by definition, not as employable as
those who live elsewhere. Monetary stringency and recessions compel
these people to stay where they are because there are very few jobs elsewhere. Teenagers and persons over 60 years old are not as employable
as workers in intermediate age groups. And, nonwhites are not as
readily employed as whites. From the standpoint of the entire economy, the young and the old and nonwhites are observed to be the last
to be hired and the first to be laid off. These, then, are the persons who
suffer the most from monetary stringency and monetary recessions.
The term "structural unemployment" is sometimes used to define
present-day unemployment. According to this definition the problem is "structural" and "technological" and has little, if anything, to
do with recent monetary developments. But though there doubtless
are some nonmonetary roots of unemployment the principal cause in
recent years, as in the past, has been monetary stringency and monetary recessions. I t is significant that we did not hear the term "structural unemployment" in 1952-53 when, as Prof. Dudley Johnson
(Washington), observed in a previously cited statement:
Aggregate monetary demand was sufficiently high * * *
so that unemployment was only 3.1 percent in 1952 and 2.9
percent in 1953, even in the face of rapid technological change
The fact that monetary developments have been the principal root
of the recent unemployment problems of the aged was brought
out by Professor Friedman (Chicago) in answering a question put to
him by Representative Widnall (New Jersey). Representative Widnall asked:
Now, do you think that a change in the money stock would
have helped those who do not have the skills in today's unemployed ? Do you think it would help those who are frozen
out of employment because of age today?
Professor Friedman replied:
If you had not had the sharp decline in the rate of growth
of money from 1959 to 1960 I believe that the 1958-60 expansion would have continued for a longer period.
I believe that that would have meant more jobs for people,
including the people who are low in skill and including the
people who are at advanced ages.
The circumstances under which a man of 60 can get a job
depend on the general buoyancy of the market. I n a boom,




at a time when there are many job opportunities, he will get a
job more easily than at the time of a recession.
So I think the answer I would make is, "Yes." A more
stable, steady monetary policy during that period would have
meant that fewer people would have been unemployed and
among them would have been some of the people you mentioned (1145).
The fact that a more stable and steady monetary policy also would
have meant less unemployment in depressed areas and for the young
and nonwhites as well as among the aged is observable in employment
trends in the most recent months. Since the recession of 1960-61,
monetary policy even though possibly because of a happy accident,
was first moderately expansive and then (since the fall of 1962) expansive enough to produce our currently robust and growing economy.
The employment benefits have included decreases between 1961 and
today in total unadjusted but comparable unemployment figures from
8.1 to 6.2 percent; among persons over 60 years old from 6.1 to 5.5 percent; among persons 14 to 19 years old from 16.1 to 14.4 percent; in
"Appalachia" from 9.2 to 7.9 percent; and among nonwhites from 15
to 11.2 percent. 3 These facts will be enough to convince reasonable
men that our marginal workers are not insulated from monetary developments but rather are significantly affected by what happens
to money. One must conclude, as Dean Walden (North Dakota University School of Law) did, t h a t :
* * * as long as the executive and the Congress have concurred in a national policy to obliterate the enclaves of poverty in our midst, to promote full employment, to increase our
annual rate of economic growth * * * divergency of policy
between the central bank and the Central Government should
not be permitted * * * (1534).
The Federal Reserve cannot be permitted to force the economy to
suffer again from monetary strangulation and recessions. Congress
must instruct the System to give us a money supply that is truly
elastic and grows as it has in the period as a whole since August 1962
at about the same pace as our know-how and other productive resources, a pace large enough to create maximum employment and yet
small enough to prevent inflation. Only if this is done can attempts
to eradicate poverty succeed. Education, manpower retraining, area
redevelopment, and other antipoverty programs are all obviously
worth while, but none of these efforts can possibly succeed if monetary
policy does not allow. On the first day of the hearings Chairman
Martin stated:
We want to regulate the money supply, to be sure. And,
as you say, Mr. Patman, the volume of money, we like to see
it increase, to use my simile of the stream, as the riverbed
can absorb and handle it (48).
F o r our part, we, too, wish only this much. But we are mindful of the
years gone by like 1929-33, 1937-38, 1948-49, 1953-54, and most recently the 7 long years from 1956 to 1962 when, because of Federal
Reserve policies, "the riverbed" was "parched."
Information made available by the BLS. Figures are for February 1961 and February
1964 and are not seasonally adjusted, except for "Appalachia." In the case of "Appalachian the data are for the yeaue 1960 and 1963.


In the middle of the recession of 1960-61, the volume of money, narrowly defined and seasonally adjusted, was $140 billion. Fifteen
months later it was $145 billion. It had increased at an annual rate
of roughly 3 percent. This was enough to end the recession and initiate the upswing that now is in its 40th month. The expansion faltered in the latter part of 1962 because for the first 9 months of that
year there was no increase in the money supply. But in the 21 months
from September 1962 to now, in June 1964, the money supply has
grown at an annual rate of 4 percent. Together with the tax cut,
which was initially proposed in January 1963 because first the growth
of the money supply and then the business upsurge had faltered in
1962, this latest increase in the volume of money has underwritten
continuation and even acceleration of the current business expansion.
If the Nation could be assured that these recent monetary developments have been the result of deliberate policy, and moreover that
this policy will not be significantly modified in the future, there might
be a less compelling need to restructure the Federal Reserve and terminate its authority to act independently of the administration and Congress. But the assurance is not forthcoming. Indeed by reason of
influences discussed below, the objective reviewer can only expect present policy to devolve into overreaction to balance-of-payments difficulties or carefully selected ad hoc harbingers of future inflation. In
fact, the signs of renewed monetary stringency are again appearing
as this is written in June 1964; the growth of the money supply as now
defined and measured by the Federal Eeserve, has fallen steadily recently. Hopefully this trend will be reversed.* If not, then, as in the
past, the results of renewed monetary stringency will be economic
stagnation, increased Government spending to bolster consumption as
opposed to needed private and public investment programs, increased
Government debt, and excessive unemployment. The reason for
gloomy expectations that past errors will be repeated in the future—
though perhaps not in the immediate future—stems from the very
structure and independence of the Federal Eeserve System, in the
opinion of staff. I t was for this reason that Professor Shapiro (Harvard) told the subcommittee:
I do regret, however, the intrusion of consideration of the
"tenor of monetary policy" into these proceedings. I say this
because even if the present course of monetary policy were
letter perfect, it should not preclude the discussion and enactment of necessary structural changes which might improve
the effective discharge of monetary policy in this country in
the futwre (1099). [Emphasis supplied.]
•In this connection, see note on p. 53.




The failures of U.S. monetary policy, documented in part I I I of
this report, were in Prof. H a r r y Johnson's judgment "inherent in
the conception, constitution, and operating responsibilities and methods of an independent monetary authority" (970), and we must
add that they are particularly rooted in the operating methods and
prejudices of the Federal Open Market Committee.
1. Structure of the Federal Reserve and its intellectual
As was earlier observed, the Federal Open Market Committee,
which is the System's principal monetary control body, consists of the
7 Governors of the Federal Eeserve Board, the president of the
New York Eeserve Bank, and 4 of the other 11 Eeserve bank presidents. The Cleveland and Chicago presidents serve as voting members of the Committee every other year, and the other nine presidents
every third year. The seven presidents not currently serving as
voting members of the Committee participate in its deliberations as
invited discussants.
The argument for continuing this arrangement whereby all 12
Eeserve bank presidents participate in open market policy deliberations, and 5 join the 7 Governors in determining policy was initially
given by the Board of Governors in answering a questionnaire submitted by the Patman subcommittee in 1952. The Board's argument
was iterated by Chairman Martin in his testimony at the present
hearings. Eeferring to the present arrangement, the Board stated
in 1952 and Chairman Martin repeated in 1964 that—
I t provides a means whereby the viewpoints of the presidents of the Federal Eeserve banks located in various parts
of the country, with technical experience in banking and with
their broad contacts with current credit and business developments, both indirectly and through their boards of directors, may be brought to bear upon the complex credit
problems of the System (13-14).
But, without impugning the integrity of any person or groups, it is
legitimate to question whether banking experience and contacts with
credit developments lend themselves to the formulation of sound
monetary policies or, on the contrary, to an intellectual myopia which
prevents effective monetary control.
Everyone agrees that not every occupational experience is conducive to the formulation of sound monetary policies. H . E . 9631
proposes making the Secretary of the Treasury Chairman of the
Board of Governors. The testimony argued persuasively for rejecting this proposal on the ground that the Secretary of the Treasury
is unduly concerned with the cost of carrying the Government debt.
This problem is directly and immediately in any Treasury Secretary's
line of vision. If, therefore, the Secretary were also Chairman of
the Federal Eeserve Board, monetary policy would tend to be unduly
concerned with this problem and, in turn, this would bring monetary
and economic instability.
The argument has widespread applicability. Treasury Secretaries
are not the only persons who can't "see the forest for the trees." I n
the sense that people take on the colorations and limitations of their



occupational surroundings, intellectual myopia is very nearly a universal affliction. Perhaps that is the basic reason for maintaining
civilian control over the National Defense Establishment. Because
human beings tend to select facts and appraise problems in terms of
their particular specializations, it is more in point to determine what,
if any, are the views and concepts with which Federal Reserve officials feel most at home and the sources of such views and concepts.
The Federal Eeserve has many direct ties to the banking business,
and some indirect ones to bankers. No one denies this. Indeed, as
Chairman Martin's statement (above) indicates, some believe that
these ties promote monetary and economic stability and prosperity.
Later we will explore this question. First we must delineate the ties.
Governor Mitchell's testimony is pertinent here. H e stated:
I think there are lots of relationships between the Federal
Eeserve and bankers because they are both in essentially the
same business and so they speak a common language in a
great many respects, and the Federal Eeserve engages in
supervisory operations which bring them in close contact
with the bankers (1201).
The formal ties between the Federal Eeserve and the commercial
banking business were described briefly and clearly by the American
Bankers Association in a monograph prepared for the Commission on
Money and Credit. The association observed:
Member banks are entitled to certain privileges such as
the use of various Federal Eeserve facilities, the ability to
borrow from the Federal Eeserve banks under certain conditions, the right to participate in the election of two-thirds of
the directors of their Federal Eeserve banks, and a 6 percent
dividend on their investment in capital stock of the Federal
Eeserve banks. I n turn, members undertake to abide by
the laws and regulations governing the System. Nonmember
banks may also be permitted to use certain of the System's
The commercial banks thus have close relationships with
their local Federal Eeserve banks. They also have indirect
but nonetheless important relationships with two other agencies of the Federal Eeserve System, the Board of Governors,
and the Federal Advisory Council. 1
As indicated by both Governor Mitchell and the American Bankers
Association, our Nation's monetary authority is specifically tied to
the commercial banking business in two ways. First, commercial
banks elect two-thirds of the directors of their Eeserve banks. Chairman Patman, early in 1964, conducted a confidential inquiry as to the
banking affiliations of class B and class C directors of the Federal
Eeserve banks. Individual responses remain confidential, in sole
custody of the chairman and available only to members of the
committee. Only aggregative figures were made available to staff.
These indicate that out of 36 class B directors, 20 presently own stock
in banks, and 11 others have owned bank stock in the past. I n addition, 17 have been commercial bank directors before becoming Federal
"The Commercial Banking Industry," a monograph prepared for the Commission on
Money and Credit by the American Bankers Association, p. 381.



Keserve directors, and 12 have held other positions and officerships in
Of the class C directors, 18 had formerly been directors of banks
and 20 of the present class C directors owned bank stock in the past.
When it is considered that class A directors are directly chosen from
the banking community, the heavy incidence of banking connections
of the B and C directors all add up to a strong banking orientation
among those who direct the affairs of the Reserve banks and select
men who participate in open market deliberations.
The second way in which our monetary authority is tied to the
commercial banking business is that the Federal Reserve, in addition
to being the Nation's monetary authority, also is one of the several
Government agencies which supervises and regulates the commercial
banking business.
Inescapably, those who make our Nation's monetary policy get a
considerable proportion of their information and "feel" about the
economy's problems and trends from their contacts with the commercial banking business. This was recognized by Professor Bach
(Carnegie Tech), who, as a director of the Pittsburgh Federal Reserve
Branch bank, is especially qualified to speak on the matter, when he
* * * Federal Reserve officials have ready access to recent
developments in financial and business affairs and to the
views of financial and business leaders * * * I suggest,
however, that this may provide a somewhat unbalanced flow
of information * * * (1391).
The degree of imbalance was brought out in a short colloquy between Congressman Minish, of New Jersey, and President Shuford
(St. Louis). Mr. Minish asked about memberships purchased for
Reserve Bank personnel in the St. Louis Chamber of Commerce.
President Shuford stated: "We get a lot of information from the
chamber of commerce. We work closely with these people * * *."
Mr. Minish then asked: "Do you consider * * * the labor organization out there—do you think about talking with those people?"
President Shuford answered: "* * * Personally, I have not" (407).
Given the present structure of the Federal Reserve, there is no reason why he would. As the Commission on Money and Credit observed, one of the hazards inherent in a close agency-clientele
relationship such as that between the Federal Reserve and commercial
banks is that "* * * parties on both sides come to take too parochial
a view of the national interest." 2 And this view is not necessarily
the wisest one.
I n addition to obtaining a disproportionate amount of information
on the nature of the economy's trends from their contacts with the
banking business, the Federal Reserve inescapably also gets an exaggerated notion of the remedial effects of using monetary control
tools to treat the problems encountered by bank managers and, more
specifically, bank examiners. The Federal Reserve's bank supervisory
and regulatory responsibilities contribute to the development of
expertise in problems that are unique to the credit market and the

Commission on Money and Credit, "Report," p. 92.



banking business. It is this very involvement in bank supervision
and regulation, which, together with the ties to men with "technical
experience in banking," gives rise to the myopic concept that the
problems of the credit market and the banking business are problems
a monetary authority must solve. This is not necessarily a sound
working hypothesis, as will be developed later.
2. An unwarranted inference
The evidence is overwhelming that the close agency-clientele ties
between the Federal Reserve and the banking business lend themselves to a parochial view of what the Nation's monetary problems
are, and also to a myopic concept of how these problems can best be
treated. Before proceeding to a more precise analysis of the occupational limitations that characterize the Federal Reserve's interpretation of the economic winds as well as the concepts that dominate its
day-to-day operations, it is useful to examine a charge that is sometimes heard in the context of this subject matter: namely, that bankers
profit from their close contacts with the Federal Reserve. This
allegation has historical as well as immediate significance. It was
vigorously put by Congressman Charles Lindbergh, Sr., in 1913, in
his minority report on the Federal Reserve bill. Mr. Lindbergh
charged that instead of "providing relief from existing economic
evils, the Glass bill proposes to incorporate, canonize, and sanctify a
private monopoly of money and credit of the Nation—to remove all
the people's money from the U.S. Treasury and place it in the vaults
of the banks to be used by them for private gain." 3
It is to be stressed that no one made such an allegation in the current hearings, nor has the committee or its staff found any shred of
evidence to support the notion. However, since it often looms up
in the background of monetary policy discussions, it is prudent to deal
with it at this time.
Analytically the charge can be broken into two separate accusations.
One is that the Federal Reserve's policymaking executives are corruptible. The second is that commercial bankers use their contacts
with Federal Reserve officials to shape monetary policy so that it
benefits banks regardless of its impact on other economic sectors.
Either accusation, if true, would be scandalous. But both must be
true for the charge that bankers profit from their ties to the Federal
Reserve to be valid. We examine first the suggestion, or innuendo,
that Federal Reserve officials are liable to corruption.
If there was any tendency for anyone to believe that the Federal
Reserve's executives, including both the Governors and the Reserve
bank presidents, are in any sense whatever corrupt, or partial to the
banking community in any penal sense, it should have been completely erased by the many forceful and straightforward statements
on the subject which were made by Reserve bank presidents and
Governors of the System, and the non-Government witnesses who
testified on the matter.
President Hayes (New York) stated:
I reject as imaginary, and as unfounded in my experience,
the theoretical argument that suggests that the member
banks are able to make felt in the Open Market Committee

Congressional Record, Sept. 11, 1913, p. 4743.



a narrow partisan interest that influences the six directors of
the Eeserve banks whom they elect and in turn the presidents
who are elected by the directors, and, thereby, the Committee itself. Such an argument is fallacious, not only because
the bankers, even if they wanted to, could not by such a
means exert leverage on the presidents for this purpose, but
also because it cynically assumes that the presidents, whose
appointments must be approved by the Board of Governors,
are men of such little scruple that they would violate their
oaths of office as members of the Committee, by subordinating the public good to the private interest. The presidents
and the staffs of the Eeserve banks are public servants in
the finest sense of the word (528).
President Irons (Dallas) put it this way:
* * * I am not going to cotton to the bankers in our district, and I just know that that is typical of the Federal Eeserve presidents. I do not do anything under pressure, suggestion, or connivance with the bankers in our district. I
consider I am in my job because the Board of Governors said
"Yes, we will accept you" (896).
Governor Eobertson's comment also was very persuasive. Answering a question by Congressman Weltner (Georgia), he told the subcommittee :
* * * But I must say that on the basis of my observation of
open market operations over the past 12 years, I do not believe that any Federal Eeserve bank president could have been
more objective if he had been an employee of the United
States rather than the Federal Eeserve. I t has been amazing
to me to see the extent to which they have remained objective.
And I think the traditions within the System are such as
to assure real effort on the part of every individual to remain
impartial and objective, and avoid any conflict of interest
Similar comments could be listed. But there is no need to do this.
Beyond any doubt the men who administer the Federal Eeserve System
are men of great integrity and fairness.
Attention now is called to the accusation that bankers try to use
their contacts with Federal Eeserve officials to shape monetary policy
to the benefit of banks. Professor Friedman (Chicago) was questioned about this by Chairman Patman (Texas). Their dialog is
instructive. Congressman Patman asked:
Now, the question is, Professor, Do you believe that because
of people who are subjected to the bankers' influence all the
time, people like the 12 Federal Eeserve bank presidents, and
all of these advisory groups who are always conferring with
our money managers, that the views of the bankers have a
special influence on our money policies and this is not good
because if it is handled right one way the bankers gain a lot
and if it is not handled that way they do not make as much



Mr. FRIEDMAN. Well, I think that this is a very difficult
and complicated question.
My impression, on reading the evidence and looking over
the history, is that the bankers who have been associated with
the Reserve System in all capacities have been, in the main,
public-spirited citizens who have been trying to promote the
interests of the public.
To this extent I would not agree that they have, in any
deliberate way, used their position of influence on the System
to promote their private interests.
On the other hand, there is no doubt that each of us is very
much affected by the environment in which we are and know
best those things which we are familiar with. And there is
no doubt that from the point of view of the bankers, what
they are individually familiar with is the credit and investment market.
To them it seemed perfectly natural and understandable
in trying to serve the public interest to place major emphasis
on interest rates and credit conditions, rather than on the aggregate quantity of money. From this point of view, I think
it has been an unfortunate thing that we have had a Reserve
bank which has been as closely linked to the banking community and to the lending and investment process as it has,
not at all because the individuals are trying to feather their
own nests, not for that reason, but because they naturally
interpreted the instrument they were dealing with in terms
of the environment they knew best and were most familiar
And this was wrong interpretation, as I see it, from the
point of view of the public interest.
The CHAIRMAN. Substantially I agree with you, Professor.
I do not impugn the motives of these people.
I think they are in an environment where they just naturally think that way and they think, honestly, to serve the
public interest you have to serve the bankers and by serving
the bankers you have to serve the public interest.
Mr. FRIEDMAN. Pardon me, but I do not believe that is the
case either, because I think I can name times in history where
bankers did things that they thought were against the
The CHAIRMAN. Oh, I will agree with you; there have been
Mr. FRIEDMAN. So I do not think it is because they thought
they were trying to serve the banks' interest.
The CHAIRMAN. I did not go that far. I said where they
honestly believed
Mr. FRIEDMAN. Oh, yes. (1163).
The dialog between Chairman Patman and Professor Friedman,
confirmed by numerous other witnesses and observations, would appear to dispose effectively and thoroughly of innuendoes that the contacts between the Federal Reserve and commercial bankers have been
exploited to promote the private interests of bankers. Any such
innuendo is totally unwarranted.



On the other hand, the colloquy also forcefully reminds us that,
though corruption definitely is not the cause of the Federal Eeserve's
policy errors, occupational myopia, or "tunnel-vision," as Eepresentative Hanna (California) put it, may be the root of our monetary instability. This is because monetary policy has been formulated and
put into effect by persons with banking experience and therefore expertise in the problems of the credit and investment market, and this
expertise has often led the Federal Eeserve to aim monetary policy at
the wrong targets.
3. The defects of monetary policy and the Federal Reserve's myopia
As indicated in the preceding analyses of testimony, occupations
tend inevitably to produce a limited and ofttimes parochial view of
what is in the national interest and how best to achieve these goals,
based essentially on an exaggerated application to the rest of the world
of the concepts and precepts that are uniquely suitable to the particular
professional subject area. Men in the banking business, like Treasury
Secretaries, union leaders, and clergymen, are not immune to this affliction. Since it has already been established that the ties between the
Federal Reserve and the banking business and bankers provide both
an unbalanced flow of information about the nature of the economic
winds and a nearsighted view of how to treat whatever windstorms are
thought to be blowing, it is important to find out how men with technical experience in the commercial banking business view the economy.
What, if any, are their misconceptions and prejudices ?
(a) The Federal Reserve's immediate targets.—Many persons believe that "technical experience in banking," as Chairman Martin implied, qualifies a man to manage the Nation's money. Obviously this
view prevailed when the Federal Reserve Act was passed in 1913 and
again when it was amended in 1933 and 1935. But not every Member
of Congress agreed. Representative Graham of Illinois, for example,
tried to persuade his colleagues that banking experience lends itself to
the formation of erroneous conceptions concerning the Nation's money
system. Mr. Graham told the House:
The ordinary banker devotes very little of his time to a
study of financial systems. H e devotes himself rather to the
immediate management of his bank, such as determining the
soundness of the paper he discounts, the character of the loans
and investments made for the bank, and all that. I n fact, he
is so close to this part of the field that it is quite difficult for
him to have a clear and disinterested view of the entire field.4
As indicated by Congressman Graham back in 1913, men trained in
the banking business will tend to conceive the problems faced by individual banks as a miniature of the economy's monetary problems. To
them, therefore, it will be important to control the variables that are
vital to an individual bank's functioning and, as a corollary, its solvency, liquidity, and profits. Some of the things that are vital to a
bank's functioning are the quantity and quality of its credit; who
wants to borrow; the daily quotations on "Federal funds"; the loan
rate to dealers in Government securities; the daily price of Treasury
bills; excess and free reserves, etc. These variables have served and
* 63d Cong., 1st sess., p. 4843, Mr. Graham of Illinois.



continue to serve as the target or instrument variables of the Federal
Reserve. The System's officials explain the fact t h a t the manager of
the Open Market Committee's account engages daily in so-called defensive operations—from which longrun money supply changes
emerge—as necessary to insulate these variables from the effects of
strikes, snowstorms, and other essentially random disturbances. Unfortunately they are the wrong targets. I t would be far better to aim
at controlling the money supply rather than, as at present, having the
money supply emerge as a byproduct from controlling bank credit
and other banking variables.
I n the present hearings, almost all of the economists who testified
were disturbed by the Federal Reserve's choice of targets. Professor
Lerner (Michigan State) called attention to the fact that expertise in
the banking business simply does not qualify a man as an expert in
monetary policy when he observed t h a t :
The historical accident that the management of the national
money supply developed out of the banking business is responsible for monetary policy being distracted from its
proper objectives by the bankers' natural but irrelevant concern with such matters as the quality of bank credit (1398).
Professor Friedman put the matter even more strongly when, in an
article he submitted for the record, he stated that—
an independent central bank will almost inevitably give undue emphasis to the point of view of bankers * * * (and)
since the banking community is concerned primarily with the
credit market, central banks are led to put altogether too
much emphasis on the credit effects of their policies and too
little emphasis on the monetary effects * * * (1172-1173).
Money and credit are not the same thing. Nor are they two sides
of the same coin. Most important, the volume of money and the supply of credit do not behave in the same way. Sometimes the growth
of the money supply accelerates faster than that of credit; sometimes
the converse is true. For example, in 1963, as reported by the Federal
Reserve, "The money supply increased by 3.8 percent * * * a substantially faster rate than in 1962 * * *." I n the same year, "Commercial bank credit increased * * * a little less than in 1962 * * *." 5
I n view of these facts it is unfortunate that the Federal Reserve
should conceive of monetary expansion and bank credit expansion as
identical. Professor Meltzer (Carnegie Tech) called attention to the
fact that this mistaken idea prevails among Federal Reserve executives. H e observed that—
When asked by the Joint Economic Committee to distinguish
between monetary expansion and credit expansion, the Board
submitted the following written reply:
"No difference was meant by the two terms 'bank credit
expansion' * * * and 'monetary expansion' * * *
"* * * 'bank credit expansion' and 'monetary expansion'
are essentially two sides of the same coin" (930).
"50th Annual Report, "Board of Governors of the Federal Reserve System, p. 6.
(Emphasis supplied.)



But as Professor Friedman pointed out, they—
are not the same thing. Monetary policy ought to be concerned with the quantity of money and not with the credit
market. The confusion between "money" and "credit" has a
long history and has been a major source of difficulty in monetary management (1151).
The problems created by confusing credit and money and acting to
change credit—money supply being an economic, not a banking concept—were brought out by Professor Meltzer. H e pointed out that
the Federal Reserve has—
permitted larger rates of growth in the money supply during
periods of expansion than during periods of contraction.
This is the direct opposite of a policy designed to expand
economic activity during recession and to control inflation.
On the other hand—
When we look at this stock of "bank credit" for the same
periods, we note "credit expansion" has behaved in a countercyclical way. The rate of "credit expansion" has been greater
during periods when unemployment and recession were our
national concern. And the rate of "credit expansion" slowed
during periods of expanding economic activity (930).
His observation squares with the facts cited immediately above
from the Board's "50th Annual Report" on the increases in money and
bank credit in 1962.
Using the quantity of bank credit as a target variable is apt to
amplify cyclical changes. Since the sum of bank loans and investments, i.e., bank credit, expands most rapidly during recessions, the
Federal Reserve's executives will be misled by looking at this total
into believing their policy is easy in recessions and tight in inflations.
If they looked at the volume of money instead of the volume of bank
credit they would not make this mistake because money expands most
rapidly in inflations and expands little, if at all, during recessions.
Using the quality of bank credit as a guide to action also leads to
error. This is because credit quality is determined by monetary policy
and hence cannot be itself a determinant of this policy. On this, it is
astonishing, as Professor Strotz (Northwestern) pointed out, that the
Federal Reserve is so concerned with the quality of credit. This
* * * little confidence in the banking community. My
feeling is that the problem of judging credit quality is a
problem for the commercial bankers and others who run lending institutions. I n the past they have been in serious difficulty only when the Federal Reserve System has permitted
the quantity of money to fall drastically, thereby producing
a situation very unlike anything that would constitute a
proper environment for the determination of terms of credit
The Federal Reserve's use of other banking phenomena as its immediate target variables also was criticized. Professor Brownlee
(Minnesota) was one of those who brought out that—



* * * many different levels of total reserves, and hence of
the potential money supply, can exist with a given amount
of "free reserves"—the target variable used by the Committee.
An increase in free reserves can be compatible with an increase or a decrease in the potential money supply (1063).
Professor Shapiro (Harvard) wTas among the witnesses who were
disturbed by the Federal Reserve's concern with the Government bond
market. He told the subcommittee:
Preoccupation with the minute variations in the financial
markets tends to cause erratic behavior on the part of the
Fed, and subjects these markets to uncertainties which, in
my opinion, are not helpful either to the outcome of monetary policy or to the effective functioning of these markets.
I believe that the bond market is more viable than is suggested by the Fed's almost minute concern with it. Moreover,
the concern with the state of the bond market appears to me
to constrain the Fed in pursuing monetary policies which
might substantially affect bond prices.
I n this sense, I agree with the Commission on Money and
Credit report, when it states: "The monetary authorities
should make full use of the fact that monetary measures can
be varied continually in either direction and reversed quickly
at their discretion."
If, in fact, our economic system contains more rigidities
than was true in the past, I believe a more active response
to projections in the rate of change of economic activity may
be desirable. For, if the Fed delays its action in the face of
an increasing number of signs of recession, and then later
reacts with an overactive policy of increasing reserves, it
tends to get the worst of two worlds. That is to say, unemployment is larger than it need be, and the subsequent increase in economic activity tends to be associated with more
price rise than is necessary (1103).
Professor Bach (Carnegie Tech) stated the objection of economists
to the Federal Reserve's operating methods at some length. His
criticisms merit attention and are given below.
The Federal Reserve has not made it clear that it has a
clear, explicit framework, or rationale, for its monetary policy, specifying the mechanism or steps connecting particular
Federal Reserve policy changes with the desired end results. * * * Federal Reserve policy statements indicate
recognition of a multiplicity of possible channels of impact
for their policy actions (open market operations and rediscount and reserve requirement changes) on the economy. But
without firm knowledge of the links connecting Federal Reserve actions with their immediate targets (for example, free
reserves or interest rates) and in turn with later goals (for
example, the money stock or availability of credit) and with
ultimate objectives (employment, output, and prices), neither
Federal Reserve officials nor the public can be at all sure of
the appropriateness of particular policy measures.



Federal Reserve officials speak of influencing "free" reserves, total reserves, the supply of money, the supply of
credit, interest rates, the "tone" of the market for Government securities, and other intermediate variables. A t times,
at least, these steps appear to be inconsistent.
For example, the supply of money and the supply of credit
often change at quite different rates, so it is critical for the
Federal Reserve to be clear and to make clear which it is
trying to influence and why. The System's heavy focus on
"free reserves" as an apparent central intermediate goal of
policy actions is another example.
While the Fed can substantially control free reserves,
merely making free reserves larger or smaller may have little relation to whether money will be easier or tighter. F o r
example, in mid-1963, the Fed announced a policy of "less
active ease" and apparently reduced its target level of free
reserves. Yet at about the same time, higher interest rates
and the rising demand for funds apparently led banks to reduce even further their desired level of free reserves. Thus
the Fed's policy of "less active ease" appears to have been
associated with a more rapid increase in bank reserves, and
hence a more rapid increase in both bank credit and the
stock in money, than was true in the preceding period of
presumably "more active" ease (1389-1390).
Prof. H a r r y Johnson (Chicago) summarized why economists object to the Federal Eeserve's concentrating on banking phenomena.
H e told the subcommittee:
* * * the methods of monetary management, which involve the central bank concentrating its attention on money
market conditions and interest rates, and on member bank
reserve positions and lending, rather than on the performance
of the economy in general, are extremely conducive to the behavior pattern of overreaction and delayed correction of error
already mentioned (971).
The money supply behaves erratically because changes in the volume
of money emerge as a byproduct from the Federal Reserve's attempts to offset random daily disturbances in float, the price of Treasury bills, etc. And, as was amply demonstrated by the testimony
summarized in part I I I of this report, it is the behavior of the money
supply that matters. Of course, Federal Reserve officials remain unconvinced, as a recent article in Business Week recognized when, referring to the money supply school of theorists, it observed—
They can muster piles of evidence to show that business
downturns have been preceded by declines in the money supply, but the Fed thinks the evidence is inconclusive. 6 [Emphasis supplied.]
A change in targets is essential. But to date there is no evidence
that the Federal Reserve is sufficiently flexible to make the required
• Business Week, May 16, 1964, p. 76.



(b) The Federal Reserve's prejudices.—Professor
Beagan (Syracuse) made an interesting observation about prejudices in general
when he told the subcommittee:
I do not doubt for a moment that Eeserve bank presidents
are dedicated to the public interest and so think of themselves, and that the members of the Board of Governors are
devoted to the public interest, and the President is devoted to
the public interest, and that the Secretary of the Treasury is
devoted to the public interest. And I will hopefully assume
that Dean Walden and I , myself, are. The trouble is each of
us sees the public interest a little bit differently (1587).
The Federal Eeserve's deepest prejudice is that inflation is our
No. One economic enemy. This was recognized by Professor Fishman
(West Virginia). I n an article submitted for the record, he stated:
The Federal Open Market Committee has consistently regarded avoidance of inflation as the primary objective of
monetary policy, and has not regarded reduction of unemployment as an objective of comparable importance (1951).
Federal Keserve officials did not deny this. F o r the Federal Eeserve, is, as Chairman Martin told the Senate committee during the
1957-58 recession? "always fighting inflation." 7
The trouble with this philosophy is that sometimes, like the time
this statement was made, the enemy is deflation and unemployment.
The Federal Eeserve's executives pay lipservice to the goal of maximum employment but nearly always they direct the power of monetary
policy against an inflation which, in some mystical way, they see
in the future. The result is the economy usually must squirm in
order to fit into a tight monetary coat.
The testimony also indicated that the Federal Eeserve has—if not
a deep prejudice, then at least an operating bias—which favors higher
interest rates. I n part, this bias is a natural corollary of the Federal
Eeserve's deep fear of inflation. Higher interest rates are the classical
prescription for inflation and are used to fight both real and imagined
inflations. This, as Prof. John Kenneth Gralbraith ( H a r v a r d ) , who
served President Kennedy as an economic adviser and Ambassador
to India has pointed out, puts those who urge higher interest rates in
an enviable position.
Producers of wheat, copper, cotton, and even steel are
assumed to prefer higher prices for the larger revenues they
return. Those who lend money, in contrast, are permitted to
urge higher interest rates not for the greater return but as a
selfless step designed to protect the Nation from the evils of
soft money, loose financial practice, and deficient economic
morality. An economist who sees the need for a higher weekly wage may well be suspected of yielding to unions; one who
urges an increase in the rediscount rate, is however, invariably
a statesman.
"Investigation of the Condition of the United States," hearings before the Senate
Finance Committee, August 1959, p. 1345.



But, Professor Galbraith continued:
This should not keep anyone from penetrating to the fact.
There is a lively, insistent, and durable preference by the
money-lending community for high rates of return; this
related to an intelligent view of pecuniary self-interest,8
It goes without saying that Federal Reserve officials would be horrified at the thought they moved to higher interest rates because this
added to the profits of those in the lending business. Still, this is
one of the effects of higher interest rates, and, in view of the fact that
inflations the Federal Reserve fought in the post-Accord period were
more imagined than real, it may have been their only important benefit.
Professor Lerner (Michigan State) suggested this when he told the
The other point that I wanted to make is that I do not believe the bankers in the Federal Reserve System deliberately
twist their advice so as to raise the rate of interest in order to
increase bank earnings. I think they regard it as an honor
to work for the "Fed" and they try to serve the public interest
the way they see it.
I think, however, that there is good reason for doing what
the chairman recommends, of having the Governors of the
"Monetary Authority" consist only of people appointed as
public servants, because even though the bankers do not consciously try to pervert things2 they nevertheless cannot get
away from their habits and prejudices as bankers which makes
them tend to prefer higher rates of interest to lower rates of
This is one of the reasons why we have been suffering from
somewhat higher rates of interest than we should have had up
to the last year or so (1431).
By now the bad effects of the prejudices which have dominated
Federal Reserve policy will be familiar. Briefly, in past years the
combined effect of the Federal Reserve's neurotic fear of inflation
and preference for higher interest rates was to cause economic stagnation and recurrent recessions. It, therefore, would seem urgent to
agree with Mr. Goldfinger (AFL-CIO) that:
The Nation's monetary management is much too pervasive
in its influence to be left in the hands of people whose training and experience are mainly in big business and banking
and who are further insulated from the major currents of
American life by the "independence" of the Federal Reserve.
The entire Federal Reserve System must be made into a public system, fully a part of the U.S. Government and broadly
representative of the population (1473).
In addition to the bad economic effects which have resulted from
the large part now played in the formulation and execution of monetary policy by those whose training and experience is in banking,
there is a compelling political reason for freeing the monetary authority from the occupational prejudices and myopic concepts of those
J. K. Galbraith, "The Balance of Payments: A Political and Administrative View,"
Review of Economics and Statistics (Maj 1964), p. 118.



who are expert in extending credit and making investments in individual business enterprises and households. Chairman Patman
(Texas) called attention to this when he observed:
* * * Q n e 0f these days Congress is going to wake up to
this thing and say that the bankers have no right to set monetary policy any more than the owners of railroads have the
right to be on the I C C and set freight rates and the passenger
rates, or the broadcasting industry to be on the F C C and
determine the rights and privileges and responsibilities of the
broadcasting industry (897).
I t would appear that Chairman Martin's argument for keeping the
present Open Market Committee intact, which, recall, is in order
that the "viewpoints" of those "with technical experience in banking
* * * may be brought to bear upon the complex credit problems
* * *" flies in the face of both the economics and the political morality
of the matter.
4- The Federal Reserved independence and its inability to change
its ways
The Federal Reserve has authority to act independently, even at
variance with the administration whenever it chooses, and it has in
the past so chosen.9 Moreover, the Federal Reserve's decisions, under
the law, are not, as this report has shown, subject to review and cannot be reversed by any authority or authorities including the President
and the Congress. I t is foolish to believe the Federal Reserve is in
any meaningful sense an arm of Congress. I t s executives do what
they want independent of the desires of Congress. The late Speaker
of the House of Representatives, the Honorable Sam Rayburn, recognized this when he said, in 1959:
I have been forced to the conclusion that the Federal Reserve authorities * * * consider themselves immune to any
direction or suggestion by the Congress, let alone a simple
expression of the sense of Congress. 10
But most important of all, the executives of the Federal Reserve
System cannot be penalized by the President or the Congress for their
policies and actions no matter how mistaken and costly to our people
and free enterprise economy their policies and actions are.
The seven Governors of the System serve 14-year terms and so are
effectively insulated from public pressures. The Reserve bank presidents are directly accountable to their banks' directors and indirectly
to the seven insulated Governors, and so they, too, need not fear public
In this connection, a dialog between Senator Long (Louisiana) and Chairman Martin
which occurred in the 1957 Senate Finance Committee hearings, "Investigation of the
Financial Condition of the United States," is enlightening. Excerpts from the colloquy
which appears on p. 1362 are as follows:
"Senator LONG. And you believe that the Federal Reserve * * * has the right to pursue
a policy that is completely contrary to the policy that the administration proceeds to
follow * * *?
"Chairman MARTIN. Under the law we feel it is our prerogative; yes, sir.








"Senator LONG. Yes. Has the administration of recent date * * * been urging you to
take a position or adopt a policy contrary to the one that you have been pursuing?
"Chairman MARTIN. * * * They have tried on a number of occasions to persuade us
that we should not take action which we did take. * * *"
M Cited in Labor, Aug. 1, 1959, p. 1.




The executives of the Federal Reserve are not accountable to any
public authority, not even the electorate. Thus, though 50 years have
elapsed since the Federal Reserve was conceived, it still has not, as
Professor Brunner (UCLA) observed:
* * * acquired a validated knowledge about the monetary
process (1053).
Other witnesses also were critical of the Federal Reserve's failure to
develop a valid understanding of what it is actually doing. I n a
passage which was more fully quoted earlier, Professor Meltzer (Carnegie Tech) put the matter this way:
After 50 years, the Federal Reserve has little verified
knowledge to form the basis of its policy actions (927).
The comments of Dr. Warburton ( F D I C ) and Professor Bach
(Carnegie Tech) on the Federal Reserve's "knowledge g a p " also are
noteworthy. Dr. Warburton told the subcommittee:
One of the most serious problems in the formation of the
Federal Reserve policy has been a lack of adequate research
regarding the relation of central bank operations to business
conditions * * *. The lack of research on the relation of
changes in the supply, velocity, and value of money to fluctuations in output, employment, and gross national product becomes most evident when inquiries are made regarding the
character of the information used by the Federal Open Market Committee in arriving at its decisions. I t is not known
what quantitative guides, if any, the Committee uses in deciding what rate of growth in money or bank reserves is
needed or how much fluctuation is desirable when they adopt
differing degrees of "restraint" or "ease." The policy record
of the Committee published each year in the annual report
of the Board of Governors does not provide such information (1323-1324).
Professor Bach said:
Surely, improving our understanding of the behavior of
money, and of the linkage between central bank action and
ultimate policy goals, should be a major responsibility of the
central bank. The Fed has an excellent research department
for keeping it informed on current economic developments
and for providing staff work on current issues. But unfortunately, nearly all of its expertise has been devoted to these
activities and in my judgment the recent rapid growth in
tested knowledge on the behavior of money in our economy
has come primarily from academic economists. I believe that
the Fed deserves criticism for its failure to push more actively
on the fundamental research that must be done to continue
to improve further our monetary policy. If the Fed is to
make better policy, the sine qua non is a better base of tested
knowledge on which to base that policy (1390).
The Federal Reserve's "knowledge g a p " and the corollary lack of
guidelines for monetary policy will not be corrected if the present
structure of the System remains intact. This is because the present



structure of the Federal Eeserve lacks an educational feedback. The
14-year terms of the seven Governors and the complete insulation of
the Reserve bank presidents from the public's criticism in cases of
error, make it unnecessary for ranking Federal Reserve officials to
further their knowledge. If the present structure is maintained,
monetary policy will continue to emerge from the misguided operating methods and prejudices which the Federal Reserve has taken
secondhand from the business of extending credit and making investments, under the false assumption that the problems of this business
are a miniature of the economy's problems. With the present structure, these misguided methods and biases will persist and the recessions and other costs that result from them will continue to be inflicted
on our economy.

This brief set of analytical conclusions is based on our staff review
of the testimony heard by the subcommittee. It will, in fact, serve as
a summary of this testimony.
While there is always a subjective element in evaluating testimony
received from many persons, representing individual as well as
organizational points of view, it is our belief that we have reviewed
and considered all points of view given in testimony before this committee. Upon such review the staff reached the inescapable conclusion
that the Federal Reserve has erred in the past and that these errors
derived from defects still present in the structure of the System.
One glaring deficiency in the Federal Reserve Act is the lack of
adequate guidelines. Members of the subcommittee were troubled
about this defect. Congressman Vanik (Ohio) indicated his concern
when he stated:
We would not be so critical of these actions if we understood some rule or regulation that would guide the conduct of
the Open Market Committee, the Board members, and the
presidents when you are acting on these important decisions.
For example, if we knew that there was some established
rule, and the presidents of the banks, that if certain conditions would occur, the discount rate would rise or fall, we
could understand that and then we could argue with the
reasoning that supports the rule.
As it stands now, it is a completely arbitrary decision. Arbitrary because we do not have any guide points on which we
can fix this course of action. In other words, if you were to
have some rulemaking body which said that if certain conditions happen in precisely such-and-such a way then "our decision will be to do thus and so," then we could study the wisdom and analyze the thinking behind the rulemaking on
which you have established your actions. Then we would
have an opportunity to know whether or not your guideposts
or decisions were in the public interest.
I think this is the area that we complain about. The arbitrary decisions that can be made without any review, without
any conformity to rule or regulation (658-659).



Chairman Patman (Texas) put the matter this way:
That discretionary power is preferable to fixed laws for
the performance of some functions seems unquestionable, but
definite norms must be present to guide progress toward
clearly defined objectives.
Congress set up the Federal Reserve to regulate the country's money. I am suggesting that the guidelines for policy
and responsibility furnished the Fed by Congress in the
original 1913 act have for many years been inadequate for
the severe demands of a more modern society (1534).
I n this connection, the 1946 Employment Act declares—
it is the continuing policy and responsibility of the Federal
Government to use all practicable means * * * to coordinate
and utilize all of its plans, functions, and resources * * * to
promote maximum employment, production, and purchasing
Professor Fishman (West Virginia) pointed out that—
Other portions of the act indicate more specifically that it is
the President who has the responsibility of achieving the required coordination of "all plans, functions, and resources"
to achieve these ends.
And moreover, that during the debates—
on one or two occasions it was observed that monetary policy
would be used by the President to promote the purposes of
the legislation (1955).
But, even if there had been no awareness in 1946 concerning the
importance of monetary policy for the prosperity of the Nation, both
fact and theory now demonstrate that mismanaged money can and all
too often has prevented our achieving the goals of the Employment
The facts show that money matters, and especially that a mismanaged money supply can retard our economy's growth and cause unemployment and business failures. Thus as Senator Clark (Pennsylvania) and Congressman Keuss (Wisconsin) pointed out a few years
omission of monetary and credit policies, on the ground of
the independence of the Federal Reserve System, is a serious
misconstruction of the Employment Act. I t defeats its
very purpose, which was to enable the President to come
forward with a coherent overall economic program directed
to the Employment Act's targets. 11
Clearly the Employment Act contemplates that the President will
be responsible for the determination of monetary policy but not
necessarily for its day-to-day management.
Our analyses also have shown that the Federal Eeserve Act is defective because it has established a system which is inherently prone
to exaggerate the danger of inflation, and, as a corollary, to understate
H. Rept. 539, 86th Cong., 1st sess., Committee on Government Operations, to accompany H.R. 6263i, amending the Employment Act of 1946 to provide for its more eifective
administration, and to bring to bear an informed public opinion upon price and wage Increases which weaken economic stability, 1959.



the peril of unemployment, and also to select the wrong target variables
for exercising monetary control. The facts of recent economic history demonstrate that money must be watched and controlled. But
the testimony has shown clearly that the growth of the Nation's money
supply is not controlled. Kather it emerges in fits and starts as a
byproduct of operations to control such variables as the quality of
credit, free reserves, and the loan rate to dealers in Government securities. Congress did not make the Federal Eeserve responsible
for the behavior of these variables. But because of its contacts and
ties to credit institutions it has unfortunately assumed this
responsibility. The combined effect of the Federal Reserve's excessive
fear of inflation and bad choice of target variables is to cause the longterm money supply growth trend to be deflationary and short-term
movements to be destabilizing.
The testimony also has revealed that because of its independence
from public pressures the Federal Eeserve lacks an educational feedback. Such a feedback is required to assure that mistakes lead to
critical reevaluations of operating objectives and methods. Without
it past errors are almost sure to be repeated in future years.
Secretary Dillon told the subcommittee:
If there are persuasive reasons for particular proposals
* * * by all means, this committee should act (1233).
Clearly, the hearings have established that there are valid and
vital reasons for restructuring the Federal Eeserve System. And so
the question becomes one of formulation by the subcommittee of specific proposals to remedy the deficiencies and defects brought to light
by the hearings.12
The set of proposals released by all of the majority members of the subcommittee
precedes this report.



One of the bills before the subcommittee, H.R. 9631, provides, inter
alia, for an annual audit of the Federal Reserve System by the General Accounting Office. The General Accounting Office was created in
1921 as an instrument of the Congress, to assist congressional review
of the expenditure of public funds. The GAO's integrity and effectiveness are well known, and do not need further documentation here.
Such supersensitive agencies as the State Department and Defense Department are audited by the GAO, and many of its reports are top
secret for this reason. The Federal Reserve System, however, is not
audited by the GAO or any other public auditor.
The operating expenses of the System run to over $200 million a
year. Yet the System is not subject to any public audit. Federal
Reserve officials were quick to point out that while the System is not
audited by the GAO, it does conduct numerous internal audits and,
further, calls in a commercial auditing firm to examine the accounts
of the Federal Reserve Board of Governors. But testimony
given before the subcommittee established that the work done for the
Federal Reserve banks by public accountants is not really an independent audit, and moreover is only a review of internal audits. A
tripartite colloquy among Representatives Ashley (Ohio) and Bolton
(Ohio) and Chairman Martin established the fact that work done by
a commercial auditing firm which is paid for by the Federal Reserve
is not the same as a public audit performed by the GAO. The further
finding that the commercial public accounting firm only reviews internal audits of the banks was brought out in a dialog between Representative Multer (New York) and Chairman Martin. The relevant
testimony follows:*
Mr. BOLTON. * * * the audit of the System, as I understand it, is an audit conducted by auditors who are hired by
the Board * * *. Is that correct?
Mr. MARTIN. That is correct.
Mr. BOLTON. SO, in effect, it is a public audit, though it
is not made by the public auditor.
Mr. ASHLEY. Who pays for it?
Mr. BOLTON. I believe the System pays for it.
Mr. ASHLEY. Then it is really not as public as it might be;
is it?
Representatives Ashley aftd Multer are members of the full committee and participated
in the subcommittee's questioning of Chairman Martin.




Mr. BOLTON. The only point I was trying to make is that
it is an audit and a public audit, though not in the sense—
and I understand
Mr. ASHLEY. I don't mean to quarrel with the gentleman.
I think it is a private audit, the results of which are made
public. But I think that is a very different thing from a
public audit as performed by the GAO (45-46).
Mr. MULTER. I wish somebody would clarify whether or
not this is a complete audit or just a review of an audit.
Mr. MARTIN. Mr. Multer, as I have pointed out, we have
independent auditors that are continuously auditing in each
of the 12 banks that are subject only to the direction of the
board of directors, not to the officers of the bank.
Mr. MULTER. I am referring now to the independent audit
by Haskins & Sells, or Price Waterhouse, or whoever you are
using for the System. Is that a complete audit ?
Mr. MARTIN. N O . T h a t is only of the Board. But they go
in with our examiners. We have a field force. They are
very dedicated individuals, because they are on the road most
of the time, and it is hard to get people to
Mr. MULTER. I wasn't questioning that. I am trying to
find out what they do. And you leave the impression with
me Price Waterhouse or Haskins & Sells looks over the
shoulder of your auditors and examiners, rather than doing
the work themselves.
Mr. MARTIN. That is correct. You are right (46).
I n addition, testimony given before the subcommittee indicated that
despite the System's internal audits and reviews of same, its remarkable freedom from any external public audit has led to many questionable expenditures. A random sample by the committee staff of the
System's expenditure vouchers reveals such items as $4,697.61 for
an employees' dinner, including $125 for a comedian and $435 for an
orchestra; $462.59 for an employees' bowling banquet; a contribution
of over $5,000 to a local chapter of the American Institute of Banking; and $5,350.35 for a luncheon given by the New York Federal
Reserve Bank for the New York Bankers Association at the WaldorfAstoria. No expenditures of these kinds without congressional approval would be allowed in the case of other Government activities
subject to the Budget and Accounting Act.
These expenditures were not even mentioned by the Board's examiners. Nor did the examiners question tuition payments for courses
in Shakespeare, art, history, philosophy of religion, and metropolitan
politics, as examples, for System employees. Similarly, the System's
own examiners found nothing questionable in a substantial annual
contribution by the Federal Reserve Bank of Boston to the New
England Council for Economic Development, a regional organization formed to attract industries to New England. Nor did they
question the appropriateness of an agency entrusted with monetary
policy hiring a specialist in "labor retraining." Conceivably, such
expenditures are justified. As Chairman Patman jointed out:
We are not trying to do your auditing for you but to learn
the extent to which you have built up standard expenditures
that vary considerably from the rest of the Government.



Elsewhere, Chairman Patman expanded on this point:
So when you spend this money, you spend money that would
otherwise go into the Treasury—and help the taxpayers.
And that being true, I am disappointed in you in not agreeing,
and also the whole Federal Reserve System, in not agreeing
that public funds should be audited like they are in all other
agencies of all kinds—this and one or two small ones are the
exception. That is my disappointment.
I don't criticize you for entertaining foreign guests, that
is all right. But I do criticize you for not wanting to make
a report to the Federal Reserve Board and to the Congress
about it. And I happen to know that the last few years, not
only have you not made a report, but they have been hidden.
And we had an awful time finding them ourselves.
There are several reasons for the failure of the System's audits to
uncover expenditures considered improper under the rules governing
other Government departments. I n the first place, the standards set
by the Board and the directors of the banks are often vague, so that
there is considerable variation in their application among the 12
regional banks. This is well illustrated by the following colloquy
between Representatives Reuss and the president of the New York
Federal Reserve Bank, Mr. Hayes:
Mr. REUSS. I think we all recognize that, Mr. Hayes. But
my question was, Where are the standards governing expenditures by the Federal Reserve Bank in this entertainment
field—where are they set forth, what do they say ?
Mr. HAYES. I think they are set forth only by the rule of
reason, Mr. Reuss. I think—if you would let me
Mr. REUSS. Then there are no standards at all ?
Mr. HAYES. N O , there are.
Mr. REUSS. Tell we what they are.
Mr. HAYES. I n conducting these foreign operations, the
bank performs, I think, an immense service to the country in
the way of—just for illustration, the last year of swap arrangements, up to about $2 billion, we have helped the Treasury sell bonds
Mr. REUSS. My time is limited. I will have to ask you to
be responsive to the question which is, What are the standards?
Mr. HAYES. Well, I will summarize that in conducting
these relations, it is common courtesy to treat the representatives of these foreign central banks courteously and cordially
when they come over here, just as they treat us cordially when
we go over there.
And it seems to me the maintenance of a friendly relationship between our people and these representatives of foreign
central banks is of immense importance to the country, and
has been proven to be very useful to the country in the achievements we have made all along the line. I don't say they are
doing it just because we are taking them to dinner and to the
theater. But I think that is part of the whole relationship
between central banking organizations that is widely accepted, generally throughout the world.



Mr. REUSS. But your answer io my request to you to designate the standard is that there is no standard (626 627).
But the vague mass of directives is not the only reason for the System's apparent laxness. As Mr. Reuss pointed out:
Mr. REUSS. Mr. Swan, you say in your statement, and I am
quoting from page 3 : " I hope that no one disputes that the
Federal Reserve banks are closely supervised and audited,
and are required to observe criteria established by the board
of directors and by the Board of Governors."
Mr. SWAN. Yes.
Mr. REUSS. Well,

of course, this committee disputed that
quite decisively in the matter of the mysterious disappearance
of $7.5 million worth of U.S. securities from your bank last
year when we found in our report, dated May 29, 1963, that
though your Federal Reserve bank had a manual which provided, on page 53, "wastepaper should be scrutinized daily,"
in fact wastepaper was not scrutinized daily and, as a result,
according to your own version of what happened, the $7.5
million worth of securities were burned or destroyed * * * .
Well, then your statement that no one disputes that the
Federal Reserve banks always follow their criteria is a little
too broad, is it not ?
Mr. SWAN. Well, I would say "No."
Mr. REUSS. Well, I will have to stay with this point then
because the criterion listed on page 53 of your manual of
miscellaneous instructions, dated May 21, 1956, is that wastepaper should be scrutinized daily.
That w^as not followed, was it ?
Mr. SWAN. Well, I am not denying that there are not occasions when errors are made. Certainly that is true. That is
true in any organization.
Mr. REUSS. Thank you, Mr. Swan (717-718).
I t is noteworthy, moreover, that this $7y2 million bond disappearance was not reported to Congress and was discovered only accidentally by a staff investigator of this committee during the random check
of Federal Reserve expenditures mentioned above.
With the exception of Governors Balclerston and Daane and President Bryan, who did not comment, all the Governors and presidents
of the Federal Reserve System oppose a GAO audit. Essentially, the
Federal Reserve's executives argue that a GAO audit would reduce
the System's independence. Also, they argue that the present internal
audits are adequate and a GAO audit would therefore be mere
As shown by colloquies already cited, internal audits and reviews
by public accountants are not equivalent to comprehensive audits by
the GAO. Still another dialog which points up this conclusion, and
is worth noting here, took place between Representative Vanik, of
Ohio, and Mr. Smith, the Deputy Director of the GAO Accounting
and Auditing Policy Staff. The dialog follows:
Mr. S M I T H . I n an ordinary public accountant's audit of
the financial statements of a corporation, he is primarily concerned with expressing an opinion as to the fairness of those



statements and how they are presented. H e looks at those
statements to see whether they are in accord with certain
principles of accounting, whether the disclosures are adequate
so that the reader is not misled, and so forth.
Mr. V A N I K . Here, when we are dealing with a public
agency, we are going a step further.
Mr. S M I T H . Yes,
Mr. V A N I K . We


are not saying it is a correct audit or it represents a fair situation. I t also must represent that in all
respects whatever has been done complies with the law (919).
The point brought out by Congressman Vanik and Mr. Smith is
that, by definition, a comprehensive independent audit would not be
performed by a commercial accountant.
The question of the System's independence is, to the Federal Eeserve
officials, apparently the most worrisome aspect of a GAO audit. They
fear that such an audit would somehow allow pressure to be brought
to bear on the Federal Eeserve, that it would confer on the GAO power
to dictate Federal Eeserve policy and to cut off Federal Eeserve funds,
and that it would undermine the authority of the Board of Governors
and the bank directors. Testimony by Mr. Smith, however, demonstrated that these fears are based on a misconception of GAO's powers
and functions. I n the first place, it is important to distinguish between
the Federal Eeserve's monetary policy and its internal management
policies. The GAO would not be concerned with monetary policy.
This distinction was brought out in the following discussion between
Eepresentative Widnall, of New Jersey, and Mr. Smith:
Mr. WIDNALL. When you audit the affairs of the ExportImport Bank, do you make recommendations as to interest
rates or terms of loans ?
Mr. S M I T H . N O , sir.

do not in any way go into the policy
of the Export-Import Bank ?
Mr. S M I T H . I n one of our reports we did raise some questions about them borrowing from the outside at rates that
were higher than they would have to pay to borrow from the
Treasury. T h a t borrowing was specifically authorized in
law. We are only questioning the cost of doing it (917).
The GAO would, of course, discuss the Federal Eeserve's internal
management, but this would not permit it to control or influence
policymaking. I n response to a question by Eepresentative Minish,
of New Jersey, Mr. Smith made it perfectly clear that the GAO's
power is limited to enforcing existing law when he stated:
The General Accounting Office has no authority to direct
the operation of an agency as such. Our authority is based
in law, and it is generally geared to our authority to disapprove or disallow illegal expenditures.
I n the course of our audits, many of them, we have called
the attention of the Congress and agency managers to policy
matters which we think were inefficient or ineffective; that
were not in accordance with the purposes of the agency as
set forth in law (909).



Thus there seems to be little reason for Federal Eeserve fears that
the GAO would dictate System policy. Indeed, President Clay of the
Kansas City bank confirmed this in a discussion with Eepresentative
Harvey, of Michigan. The relevant colloquy follows:
Mr. HARVEY. Well, you know the GAO has 20/20 hindsight vision with regard to all of its examinations and this
bothers the departments of our Federal Government. I t
bothers the Defense Department particularly to have these
persons breathing over the shoulder and coming in and substituting their judgment and yet I have not been convinced
that it really impairs their judgment over the long run or
whether it affects their future actions and so forth and I
wonder do you feel it would affect the future actions of the
Board here to have somebody come in an say, "You did wrong
the last time," or "We would have done it some other way."
Mr. CLAY. I think we would go ahead just as we have in
the past * * * (811-812).
The GAO cannot cut off an agency's funds, though it will refuse
to approve expenditures which were illegal. I t can and does recommend more effective and efficient means of accomplishing objectives,
but its recommendations are not binding. The authority of the Board
of Governors and the directors of the Federal Reserve banks to control the expenditures of the System would not, therefore, be undermined by a GAO audit. As Mr. Vanik said:
* * * it is not that the GAO dictates policy. I t reports
on the effect of policy * * * I t puts it on the table (384).
Eepresentative Waltner (Georgia), in his discussion with Mr.
Kelly, president of the American Bankers Association, brought out
the point that all of the internal audits of the Federal Eeserve System
failed to reveal extremely important information. The exchange of
views follows:
Mr. KELLY. Well as we discussed earlier, I think the public is getting the information through the process which is
now established.
Mr. WELTNER. Getting information that the subject desires
for it to have. Now, you believe in a system of checks and
balances, most assuredly, that we have in this Government.
We have three branches of Government. Yet on this matter
there is no check and no balance, because the only information that the public gets is what the Federal Eeserve System
itself desires it to have. I just don't think that is a healthy
situation (1920-1921).

A related proposal on which testimony was heard, H.E. 9685, would
require that the Federal Eeserve banks pay to the Treasury all of the
interest earned on their portfolio of Government securities. The bill
would also provide that funds to defray the expenses of the System
be appropriated by the Congress, thus bringing into line the practices
established with respect to other Government departments.



With the exception of a few special agencies and the Federal Eeserve
System, the departments and agencies of the United States operate on
congressional appropriations. Each year the amounts requested by
the executive departments are carefully reviewed, by the Bureau of
the Budget and the Appropriations Committees; this budget review
process is the chief means by which Congress assures an efficient and
effective use of public funds and by which Congress exercises a control on aggregate expenditures.
The agencies that have been exempted from budgetary review are
usually Government corporations supported by the sale or rental of
services and are apparently regarded as quasi-business organizations.
I n the case of the Federal Eeserve, however, almost all of its earnings
(over 99 percent) come from interest payments on the Government
securities in its open market portfolio. As indicated in earlier sections
of this report, the Federal Eeserve purchases U.S. securities and pays
for them by creating deposits in favor of a commercial bank and the deposits are added to that bank's reserve account. The portfolio at
present amounts to $34 billion with interest income of over $1 billion
a year.
Significantly, while the present open market portfolio has been
accumulated primarily as a function of money market and credit management, the earnings derived from it are obviously far in excess of
the requirements of the Federal Eeserve System at the present time.
However, this was not always the case. I n the early days of its history, the Federal Eeserve acquired securities for the purpose of obtaining sufficient earnings to support itself while maintaining its
independence of the appropriations process. Unlike the Comptroller
of the Currency and the Federal Deposit Insurance Corporation, the
Federal Eeserve does not support itself by levies on the institutions it
oversees; rather, it supports itself by its power to tax the public at
large—its ability to create deposits with which to purchase interestbearing obligations of the United States.
The System's expenses currently approximate $200 million per year.
Unexpended funds are returned to the Treasury, or set aside as surplus. The System's billion dollar annual income is so huge that it
could expand its operations and quadruple its expenditures without
requiring any congressional appropriation. Thus, the System is in
the unusual position of having neither the practical nor legal need to
go before any congressional committee for review of its expenditure
Under such circumstances it is not surprising that the Federal Eeserve System shows a definite tendency toward liberality in expenditures. The Federal Eeserve Bank of Boston, for example, contributes
to regional booster groups and has conducted studies on the feasibility
of such local activities as ski resorts, which are of course quite unrelated to monetary policy and bank supervision, the areas in which
the Federal Eeserve is mandated to operate.
Of the 15 highest salaries paid by the Federal Government, 13 are
enjoyed by Federal Eeserve officials. Only the President of the
United States and the Chief Justice of the Supreme Court rank with
the top officials of the Federal Eeserve System.
A theater party given by the Chicago bank for its employees cost
over $3,000. Presumably, such expenditures are approved by the



Board of Governors which has ultimate control over the operating
policies of the System. Upon approval, these expenditures may well
be technically legal under the present regulations, but certainly they
would remain open to question by any objective observer comparing
them with the more stringent budgetary standards applied to executive departments generally.
Twelve of the nineteen leading Federal Reserve officials testified in
opposition to placing the Federal Reserve System under the appropriations process. The other seven Federal Reserve officials did not comment. Essentially, the Federal Reserve position hinged on the contention that congressional review of its appropriations would weaken the
independence of the System and perhaps impair its efficiency.
President Bopp of the Philadelphia bank cited the U.S. Mint as—
unable to secure sufficient appropriations from Congress to
see that we have available an adequate supply of coins. I
then move from that to currency and ask myself, if this were
required also with respect to currency, then the problem
would be even more difficult (468).
In reply to Mr. Bopp's point, Representative Reuss raised the question as to whether or not logic did not suggest that all agencies of
Government, all the bureaus and departments, upon that reasoning,
should be serviced by Treasury back-door financing. In short, the
fear expressed by Federal Reserve officials that Congress would be
able to exert pressures on the Federal Reserve's monetary policies
by threatening to cut off money would seem to be just as valid if
applied to the military and international activities of the Nation.
The absence of any indication that these latter activities are handicapped by congressional review would seem to argue convincingly for
a similar review of Federal policies. The fact is, appropriations
committees concern themselves with the effective and efficient use of
funds, but their jurisdiction does not normally extend to substantive
matters such as military policy or, for that matter, monetary policy.
As Chairman Patman said of the proposal:
[Do] you think I would want a subcommittee, an appropriations subcommittee, to determine policy for the Federal
Reserve ? Of course not (384).
It is an axiom of public law and public administration that unwarranted variations in public policy and procedure, as between one
agency and the other, are capricious and undesirable. When a case
can be made out for differentiation, variations in procedure of course
are acceptable. But in the opinion of staff, no valid case has been
made for exempting the Federal Reserve from the budgetary process.
On the contrary, the absence of congressional review appears to have
engendered variation in policy from bank to bank with some more
stringent than others in the standards applied. In particular, some
banks showed a strong propensity to become involved in community
affairs that seem remote from their monetary and banking responsibilities, or to carry on research projects that are only remotely related
to their institutional responsibilities.
Chairman Patman's colloquy with Mr. Hayes on the audit question
is equally applicable to the issue of whether or not the Federal Reserve



System should be brought under congressional appropriations procedures :
Mr. HAYES. Well, just before we leave that audit subject,
it seems to me that if there were any evidence of corruption
or bad management, inefficiency, I think there would be a
prima facie case for making some change. But it seems to
me that the reputation of the Federal Reserve System for integrity and honesty in the way they handle their affairs is
unrivaled. Certainly no one is better that I know of.
The CHAIRMAN. Of course, you can say that when there has
been no audit by a Government auditor or an independent
auditor acting on his own. Who could not say the same
thing? They could just challenge anybody to show any
corruption. I don't say there is any corruption; I don't accuse you or Mr. Martin or anybody else of being dishonest
or not trustworthy—of course, I don't. I trust you. But at
the same time this is public business. It involves a billion
dollars a year. And there is no audit, none of any kind—50
years with no audit (623).

1. The tax and loan accou/nts
The testimony on H.R. 9686, which would require banks to pay interest on the Government's "tax and loan" balances and remunerate them
for services rendered to the Government revealed some conflict of
opinion. Secretary Dillon told the subcommittee that the Treasury
is seeking to determine the value of these balances. The gross value
depends primarily on the Treasury bill rate. The net value equals
gross value less the imputed costs of services banks render to the Treasury in assisting in selling savings bonds, etc. Probably today, when
the Treasury bill rate is about &y2 percent, banks gain about $150
million a year net from handling these accounts. Also, some who
testified indicated that some banks gain from these deposits while
others lose.
The argument against H.E. 9686, expressed in Secretary Dillon's
supplementary statement, is as follows:
If the Treasury did not have an effective procedure for
smoothing the impact of its own operations on the banking system and the money market, the Federal Reserve would itself
have to try to counteract the effects of Treasury operations.
This would mean essentially that the Federal Reserve would
have to buy large amounts of Treasury bills whenever net
Treasury receipts were taking reserves out of the banking system, and would have to sell equally large amounts when the
Treasury, by net expenditures, was putting funds back into
the banking system. These purchases or sales would be almost a daily necessity, and there would be a serious question
as to the capacity of the market to handle this volume of
activity without severe repercussions on prices and yields



The "market" has, of course, been coddled so long that Secretary
Dillon's statement may well be correct. But many expressed the opinion (though not necessarily in the context of this bill) that the Government securities market is much more durable than is assumed by
the Treasury Department officials. Professor Shapiro's statement
(1103) cited previously at page 75 is one example of this opinion.
2. Interest on demand deposits
Almost all of the economists who testified favored H.E. 9687, which
would eliminate the prohibition against commercial banks paying interest on demand deposits. They were against the ban for precisely
the same reason that they oppose all price ceilings; namely, a price
rigidity interferes with the working of the free market's allocative
The argument for continuing the ban is that, as put by Mr. Milner,
the distinguished chairman of the legislative committee of the I B A :
Commercial banks in the financial centers characteristically hold a higher percentage of demand deposits with appropriately shorter term investments. Hence, the financial
center banks would enjoy greater flexibility in competition
for deposits. Furthermore, it is likely that larger banks,
possessed of a wider market for investments of funds, including in some cases foreign markets, would outbid their
smaller community bank competitors for deposits. There
could be some raiding of customer accounts by correspondent
banks which would weaken correspondent banking relationships (1705).
But, if Mr. Milner is correct, it follows consumer sovereignty dictates shifting demand deposits to large banks, and, this being so, it is
a fair question to ask whether the Government should impose a price
ceiling to prevent this shift from occurring. Like many other questions raised at these hearings, definitive answers require further