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81ST CONGRESS!
2d Session
/

OTMSTP

SENA I T

/DOCUMENT
{ No. 129

MONETARY, CREDIT, AND FISCAL POLICIES

REPORT
OP THE

SUBCOMMITTEE OK MONETARY, CREDIT, AND FISCAL POLICIES
OP THE

JOINT COMMITTEE ON THE ECONOMIC BEPOBT
CONGBESS OF THE UNITED STATES
PURSUANT TO

S. Con. Res. 26

P R E S E N T E D BY ME. O'MAHONEY
JANUARY 23 (legislative day, JANUARY 4), 1950.—Ordered to be
printed, w i t h illustrations

UNITED STATES
GQVSRNMENT PRINTING OFFICE
60995°

WASMNGTON : 1950

JOINT COMMITTEE ON THE ECONOMIC REPORT
(Created pursuant to sec. 5 (a) of Public Law 304, 79th Cong.)
U N I T E D STATES SENATE
J O S E P H 0 . O ' M A H O N E Y , Wyoming, Chairman
F R A N C I S J . M Y E R S , Pennsylvania
J O H N J . S P A R K M A N , Alabama
P A U L H . D O U G L A S , Illinois
R O B E R T A. T A F T , Ohio
R A L P H E . F L A N D E R S , Vermont
A R T H U R V. W A T K I N S , Utah

HOUSE OF R E P R E S E N T A T I V E S
E D W A R D J . H A R T , New Jersey, Vice Chairman
W R I G H T P A T M AN, Texas
W A L T E R B. H U B E R , Ohio
F R A N K B U C H A N A N , Pennsylvania
J E S S E P . W O L C O T T , Michigan
R O B E R T F . R I C H , Pennsylvania
C H R I S T I A N A. H E R T E R , Massachusetts

THEODORE J. KRERS, Staff Director
GROVER W. ENSLEY, Associate Staff Director
JOHN W. LEHUAN, Clerk

SUBCOMMITTEE ON MONETARY, CREDIT, AND FISCAL POLICIES
U N I T E D STATES SENATE

HOUSE OF R E P R E S E N T A T I V E S

P A U L H . D O U G L A S , Illinois, Chairman

W R I G H T P A T M A N , Texas.

E A L P H E . F L A N D E R S , Vermont

F R A N K B U C H A N A N , Pennsylvania

J E S S E P . WOLCOTT, Michigan
LESTER Y. CHANDLER, Economist
II

CONTENTS
Page

Letters of transmittal
Part A. Summary of recommendations
Part B. Text of the report
;
I. The role of monetary, credit, and fiscal policies in achieving the
purposes of the Employment Act
II. Federal fiscal policies
III. Monetary ana debt-management policies
IV. Reserve requirements of commercial banks
V. Federal chartering, supervision, and examination of commercial banks
VI., Monetary policy relative to silver
VII. The restoration of a gold-coin standard in the United States. _
VIII. Deposit insurance
IX. Other Federal credit agencies
.
X. A national monetary and credit council
XI. A comprehensive study of money and credit
XII. A continuing study of fiscal policy by the Joint Committee on
the Economic Report
XIII. Earnings of the Federal Reserve in excess of dividend requirements
.
*

iv
1
5
5
11
17
32
37
40
41
44
46
48
48
50
51

LETTERS

TRANSMITTAL

H o n . JOSEPH C . O ' M A H O N E T ,

Chairman, Joint Committee on the Economic Report,
United States Senate, Washington, D. C.
D E A R SENATOR O ' M A H O N E Y : Transmitted herewith is the report
of the Subcommittee on Monetary, Credit, and Fiscal Policies. This
subcommittee was appointed by you in the early summer of 1949,
pursuant to Senate Concurrent Resolution 26, for the purpose of "conducting a full and complete study and investigation into the problem
of the effectiveness and coordination of monetary, credit, and fiscal
policies in dealing with general economic policy." In making our
studies, we have conformed to this directive, centering our attention
on the coordination of these policies and on their effectiveness as
methods of attaining economic.objectives, especially those objectives
related to high and stable levels of employment and production.
Within this area we have made our study as thorough and complete
as time permitted.
The subcommittee has gathered information and points of view in
many ways. (1) Its members and staff have made a continuous study
of existing materials and of the materials especially gathered for them
by the staffs of various Government agencies. (2) It sent questionnaires to a large number of people qualified to add to our understanding of these subjects. A comprehensive questionnaire covering the
most important aspects of the problems* in this field was sent to nearly
500 bankers, economists, and others. Though by no means all of
these people replied, the answers received by us did provide a large
amount of valuable information and did indicate the range of views
on many of the questions. Special questionnaires were sent to the
Secretary of the Treasury, the Chairman of the Board of Governors
of the Federal Reserve System, the presidents of the twelve Federal
Reserve banks, the Comptroller of the Currency, the Chairman of the
Federal Deposit Insurance Corporation, the Chairman of the Board of
Directors of the Reconstruction Finance Corporation, the Administrator of the Housing and Home Finance Agency, the Governor of the
Farm Credit Administration, and the Director of the Bureau of the
Budget. The official replies, together with a digest of the answers to
the general questionnaire and a statement on Federal expenditure and
revenue policies which was drawn up and unanimously approved by
15 economists, were published in a 443-page joint-committee print
entitled ''Monetary, Credit, and Fiscal Policies.'' Without necessarily
agreeing with the points of view expressed in it, we believe that this
volume constitutes a valuable contribution to an understanding of the
issues in these fields. (3) During 9 days of open hearings, the subcommittee received testimony from Government officials, bankers,
economists, and representatives of various agricultural, labor, and
IV

LETTER OF TRANSMITTAL

business groups. (4) It met in executive session with the Council of
Economic Advisers and with officials from the Treasury, the Bureau
of the Budget, and the Federal Reserve. And (5) it met with a group
of economists for a round-table discussion of some of the most important issues encountered during the investigation.
In transmitting this report we wish to express our appreciation to
the numerous people, both in and outside the Government, who so
generously assisted the subcommittee. We are especially indebted to
Dr. Lester V. Chandler, of Amherst College, the economist for the subcommittee, for his excellent services. His knowledge, energy, and
judgment have been of immeasurable aid.
Sincerely,
PAUL H .

DOUGLAS,

Chairman, Subcommittee on Monetary, Credit, and Fiscal Policies.
JANUARY 1 3 , 1 9 5 0 .

To the Congress;
Transmitted herewith is a report of the Monetary, Credit, and
Fiscal Policies Subcommittee of the Joint Committee on the Economic
Report. This report is one of four studies which have been prepared
under Senate Concurrent Resolution 26 (81st Cong., 1st sess.), and
represents the views of the subcommittee conducting the investigation.
It is to be regarded solely as the presentation of a point of view by
the subcommittee and does not in any sense represent a point of
view or recommendations by the full committee. The subcommittee's
findings will be given consideration by the full committee when it
assembles to review the reports of the four studies authorized under
Senate Concurrent Resolution 26((81st Cong., 1st sess.).
JOSEPH C . O'MAHONEY,

Chairman, Joint Committee on the Economic Report.
JANUARY

23,1950.

MONETARY, CREDIT, AND FISCAL POLICIES
PART A. SUMMARY OF RECOMMENDATIONS
I . T H E R O L E OP M O N E T A R Y , C R E D I T , A N D F I S C A L P O L I C I E S I N A C H I E V ING T H E P U R P O S E S OF T H E E M P L O Y M E N T A C T

We recommend not only that appropriate, vigorous, and coordinated
monetary, credit, and fiscal policies be employed to promote the purposes of the Employment Act, but also that such policies constitute
the Government's primary and principal method of promoting those
purposes.
II.

FEDERAL FISCAL

POLICIES

1. We recommend that Federal fiscal policies be such as not only, to
avoid aggravating economic instability but also to make a positive
and important contribution to stabilization, at the same time promoting equity and incentives in taxation and economy in expenditures. A
policy based on the principle of an annually balanced budget regardless
of fluctuations in the national income does not meet these tests; for, if
actually followed, it would require drastic increases of tax rates or drastic reductions of Government expenditures during periods of deflation
and unemployment, thereby aggravating the decline, and marked reductions of tax rates or increases of expenditures during periods of
inflationary boom, thereby accentuating the inflation. A policy that
will contribute to stability must produce a surplus of revenues over expenditures in periods of high prosperity and comparatively full employment and a surplus of expenditures over revenues in periods of deflation and abnormally high unemployment. Such a policy must,
however, be based on a recognition that there are limits to the effectiveness of fiscal policy because economic forecasting is highly imperfect
at present and tax and expenditure policies under present procedures
are very inflexible.
2. We recommend that the Joint Committee on the Economic Report make an intensive study of the various possible methods of
increasing the flexibility of tax and expenditure policies in order to discover whether and to what extent it is feasible to make these instruments more effective for stabilization purposes.
III.

M O N E T A R Y AND D E B T - M A N A G E M E N T

POLICIES1

1. We recommend that an appropriate, flexible, and vigorous monetary policy, employed in coordination with fiscal and other policies,
should be one of the principal methods used to achieve the purposes
1
Mr. Patman believes that these proposals do not make the Federal Reserve System sufficiently responsible to the executive department of the Federal Government. In creating money and regulating the
supply and cost of money and credit, the Federal Reserve Is performing a governmental function; it even
ksue3 Federal Reserve notes which become obligations of the United States. Moreover, It Is now possible
'or the Federal Reserve to follow policies that would conflict with, and perhaps defeat, the Government's
economic program. He believes, therefore, that steps should be taken to increase the responsibility of the
Federal Reserve System to the executive department. Though he favors, aa proposed in this report, the
establishment of a Monetary and Credit Council to be headed by the Chairman of the Council of Eco*
£omic Advisers, he does not believe that It will make the Federal Reserve sufficiently responsible to the
Executive.

MONETARY, CREDIT,'.AND FISCAL'POLICIES

of the Employment Act. Timely flexibility toward easy credit at
some times and credit restriction at other times is an essential characteristic of a monetary policy that will promote economic stability
rather than instability. The vigorous use of a restrictive monetary
policy as an anti-inflation measure has been inhibited since the war
by considerations relating to holding down the yields and supporting
the prices of United States Government securities. As a long-run
matter, we favor interest rates as low as they can be without inducing
inflation, for low interest rates stimulate capital investment. But we
believe that the advantages of avoiding inflation are so great and
that a restrictive monetary policy can contribute so much to this end
that the freedom of the Federal Reserve to restrict credit and raise
interest rates for general stabilization purposes should be restored
even if the cost should prove to be a significant increase in service
charges on the Federal debt and a greater inconvenience to the
Treasury in its sale of securities for new financing and refunding
purposes.
2. We recommend as means of promoting monetary and. debtmanagement policies that will contribute most to the purposes of
the Employment Act:
(а) That every effort be made to build up the quality and prestige
of Federal Reserve officials; among these measures should be a reduction in the number of members of the Board of Governors from seven
to not more than five and an increase in their compensation.
(б) That Congress by joint resolution issue general instructions to
the Federal Reserve and the Treasury regarding the objectives of
monetary and debt-management policies ana the division of authority
over those policies. These instructions need not, and in our judgment
should not, be detailed: they should accomplish their purpose if they
provide, in effect, that, (i) in determining and administering policies
relative to money, credit, and management of the Federal debt, the
Treasury and the Federal Reserve shall be guided primarily by considerations relating to their effects on employment, production, purchasing power, and price levels, and such policies shall be consistent
with and shall promote the purposes of the Employment Act of 1946;
and (ii) it is the will of Congress that the primary power and responsibility for regulating the supply, availability, and cost of credit in
general shall be vested in the duly constituted authorities of the
Federal Reserve System, and that Treasury actions relative to money,
credit, and transactions in the Federal debt shall be made consistent
with the policies of the Federal Reserve.
(c) That the Secretary of the Treasury and the Chairman of the
Board of Governors of the Federal Reserve System be made members
of the National Monetary and Credit Council recommended elsewhere
in this report.
IV.

R E S E R V E R E Q U I R E M E N T S OP C O M M E R C I A L B A N K S

1. We recommend that all banks which accept demand deposits,
including both member and nonmember banks, be made subject to
1
Mr. Wolcott dissents from this recommendation. It Is bis opinion that the so-called dual banking
system should be preserved in order that possible checks and balances may be maintained to prevent unwise
concentration of credit and economic controls. He contends that any such centralization of banking authority might well be interpreted as a step toward the nationalization of all banking and credit. That,
instead, there should be full cooperation between the State banking authorities and the Federal Reserve
Board to remove any discriminations which might seem to give advantage or disadvantage to either the
Federal or State systems.

MONETARY; CREDIT, AND FISCAL POLICIES

the same set of reserve requirements and that all such banks be given
access to loans at the Federal Reserve banks.
2. Without endorsing any particular plan, we recommend that
serious consideration be given to the Federal Reserve proposal that
the present system of member-bank reserve requirements based partly
on the size of the city in which a bank is located be replaced by a new
system of requirements that would be geographically uniform but
that might require different percentages of reserves against different
types of deposits.
V . FEDERAL

CHARTERING, SUPERVISION^ AND
COMMERCIAL B A N K S

EXAMINATION

We recommend a thorough .and complete study of the broad
question of Federal chartering, supervision, and examination of commercial banks, including not only the organization and coordination
of the Federal agencies performing these functions but also the sub*
stance and applicability of the relevant Federal laws and regulations.
V I . MONETARY POLICY RELATIVE TO SILVER

We recommend that the United States Government cease buying
silver for monetary purposes.
V I I . T H E RESTORATION OF A GOLD-COIN STANDARD IN THE UNITED
STATES

We believe that to restore the free domestic convertibility of money
into gold coin or gold bullion at this time would militate against,
rather than promote, the purposes of the Employment Act, and we
recommend that no action in this direction be taken. We also recommend a thorough congressional review of existing legislation relating
to the power to change the price of gold with a view to repealing
any legislation that might be so construed as to permit a change in
the price of gold by other than congressional action.
V I I I . DEPOSIT INSURANCE

We recommend that Congress, while considering questions relating
to the base and rate for deposit-insurance premiums, also study thoroughly the advantages and disadvantages of increasing the coverage
of deposit insurance for the primaiy purpose of protecting the
economy against the adverse deflationary pressures that would
accompany cash withdrawals from the banking system during any
depression period that may occur, and that no changes in depositinsurance premiums be made until after the completion of the study.
I X . OTHER FEDERAL CREDIT AGENCIES

1. We recommend that Congress review the programs and policies
of the various Federal credit agencies to find out to what extent jf at
aU they can be made to contribute more to the purposes of the
Employment Act without an undue sacrifice of the substantive programs to which they are related.
60095*—SO 2

MONETARY, CREDIT,'.AND FISCAL'POLICIES

2. We recommend that the head official of each of the most important agencies in this group be included on the National Monetary and
Credit Council, which we recommend elsewhere in this report.
X.

A NATIONAL MONETARY AND CREDIT COUNCIL

A C O M P R E H E N S I V E S T U D Y OF M O N E Y A N D C R E D I T

A C O N T I N U I N G S T U D Y OP F I S C A L P O L I C Y BY T H E J O I N T
C O M M I T T E E ON T H E E C O N O M I C R E P O R T

We recommend that the joint committee, while carrying out its
Seneral duties "to make a continuing study of matters relating to the
Iconomic Report" and "to study means of coordinating programs in
order to further the policy of the [Employment] Act," make a special
intensive study of the various possible methods of increasing the
flexibility of Federal tax and expenditure policies in order to discover
how and to what extent it may be feasible to make these instruments
more effective for stabilization purposes.
XIII.

E A R N I N G S OP T H E F E D E R A L R E S E R V E I N E X C E S S OP D I V I D E N D
REQUIREMENTS

We recommend that Congress enact a franchise tax on the net
earnings of the Federal Reserve System to replace the voluntary contributions now being made to the Treasury by the Board of Governors.
In view of recommendation III, 2, any franchise tax must take into
account the necessity for an ample reserve for losses in open-market
operations as compared with the present situation in which earnings
are automatic.
8
Mr. Wolcott joins In recommending the creation of a National Monetary and Credit Council, but disagrees with the recommendation that it should be beaded by the Chairman of the Council of Economic
Advisers. In his opinion, this would concentrate too much power in the Executive over the volume and
cost of credit. He recommends, instead, that the Chairman of the Credit Council be a person of neutral
interests removed as much as possible from the direct influence of either the Executive or the Federal Reserve
Board. He also agrees that periodic reports should be made to Congress by the Council.

MONETARY, CREDIT,'.AND FISCAL'POLICIES
P A R T B. T E X T OF T H E

REPORT

I . T H E ROLE OF MONETARY, CREDIT, AND FISCAL POLICIES IN
ACHIEVING THE PURPOSES OF THE EMPLOYMENT ACT

We recommend noi only that appropriate, vigorous, and coordinated
monetary, creditr and fiscal policies be employed to promote ihe purposes
oj the Employment Act, but also that such policies constitute ihe GovernmenVs primary and principal method oj promoting those purposes.
In the Employment Act of 1946 Congress declared:
* * * it is the continuing policy and responsibility of the Federal Government to use all practicable means consistent with its needs and obligations and
other essential considerations of national policy, with the assistance and cooperation of industry, agriculture, labor, and State and local governments, to coordinate and utilize all its plans, functions, and resources for the purpose of creating
and maintaining, in a manner calculated to foster and promote free competitive
enterprise and the general welfare, conditions under which there will be afforded
useful employment opportunities, including self-employment, for those able,
willing, and seeking to work, and to promote maximum employment, production,
and purchasing power.

It is clear that, in addition to describing purposes, this statement
also indicates some of the characteristics of the methods to be used
in achieving them. In the first place, it indicates that the Federal
Government is not to rely on one method alone but is "to use all
practicable means * * * to coordinate and utilize all its plans,
functions, and resources * * V In the second place, it is not
to rely solely on its own actions but is to seek the assistance and
cooperation of other governmental units, industry, agriculture, and
labor. And in the third place, it is to achieve these objectives "in a
manner calculated to foster and promote free competitive enterprise * * V
We believe that these stipulations as to both purposes and methods
indicate not only that appropriate, vigorous, and coordinated monetary, credit, and fiscal policies should be employed, but also that they
should constitute our primary and principal defense against instability.
This conclusion rests on several considerations: (1) It will be practically impossible to attain the purposes of the Employment Act without
a deliberate use of these policies; (2) these policies can exert a powerful
influence toward stability without necessarily expanding the scope of
Government activity, and (3) these measures are much more compatible with the maintenance of democracy and free competitive enterprise than would be the only alternative—a complex harness of direct
controls.
It must be recognized that the Federal Government has for a long
time been engaged in a very large number of activities in the fields
of money, credit, and fiscal operations and that in the very process
of carrying out these activities it must formulate policies of some sort.
Whettier the Government plans it or not, these policies exert a powerful influence on the functioning of the economy and may work toward
either stability or instability. Table I, though highly simplified, indicates the scope and combined importance of these activities.

MONETARY, CREDIT,'.AND FISCAL'POLICIES

In many ways, but especially through the monetary and debtmanagement policies of the Federal Reserve and the Treasury, the
Federal Government determines the total supply and cost of money
for both private and public spending. Ours is and has been for a long
time a partially managed monetary system, and the Government cannot escape responsibility for its behavior. The tremendous growth of
the Federal debt during World War II has increased rather than diminished the influence of the Federal Reserve and the Treasury on the
supply and cost of credit and money. Nor is this power of the Federal
Government over money and credit limited to its chartering, supervision, and examination of banks and the general monetary and credit
controls administered by the Federal Reserve and the Treasury. It
also includes the activities of a very large number of other credit institutions. In 1916 the Federal Government founded the Federal
land-bank system to provide an ample supply of low-cost credit to
meet the long-term needs of farmers. In 1923 it added the Federal
intermediate-credit banks to enhance the supply of short-term and
intermediate-term credit for agricultural purposes. Then, beginning
in 1932, it .established, or promoted the establishment of, numerous
other credit institutions of many types. As a result, institutions established or promoted by the Federal Government and still regulated and
financed in varying degrees by it provide complete facilities for longterm, intermediate-term, and short-term credit for farmers and their
cooperatives; insure billions of dollars' worth of urban real-estate mortgages and regulate the interest rates, maturities, and other terms of
these mortgages; provide a secondary market for these mortgages, lend
to and purchase assets from financial institutions; regulate the policies
of many financial institutions in the real-estate-mortgage field; lend
and grant subsidies to local public-housing authorities; lend to and
guarantee private loans to business borrowers, States and their subdivisions, purchasers and builders of ships, and foreign borrowers; and
insure billions of dollars in bank deposits and accounts at savings and
loan associations.
With an annual budget in excess of $40,000,000,000, Federal fiscal
policy cannot fail to have a marked influence on the behavior of the
economy. Both directly and indirectly, Federal spendings are one
of the principal determinants of national money income and of the
total volume of spendings for output, and taxation—which is essentially an extraction of mone^ from private incomes—influences
markedly both the ability and willingness of the private sectors of the
economy to save and to spend for consumption and investment
purposes. Federal deficits, which reflect the fact that Government
spendings are in excess of current extractions from private money
incomes, exert an antideflationary or infiationaiy effect. To the
extent that these Federal deficits are financed by borrowing from
banks, new credit is created for the purchase of Government securities.
There is thus a creation of additional monetary purchasing power
which is then used by the Government to buy goods and pay for
services. In a depression period, when production, prices, and
employment are declining and when there is a considerable amount of
unutilized capital and labor, a Government deficit financed by bankcreated credit will therefore help to offset the decline in the total
volume of private purchasing power. It will thereby make a de

MONETARY, CREDIT,'.AND FISCAL'POLICIES

pression less severe and can help to further a revival of production and
employment. Conversely, in a period of high employment, when
both the labor force and the capital structure are being utilized, a
governmental deficit financed by the creation of additional monetary
purchasing power does not increase real national income, which is the
output of goods and services. It merely adds more money and credit
with which to buy the existing supply of goods. The effect of deficits
at such times is to raise the price level, and to divert to governmental
uses resources which would otherwise be used for private purposes.
TABLE I.—Federal activities in the fields of money, credit and fiscal operations, and the
controlling Government agencies
Activity

I. Provision of a legislative framework for the
monetary, credit, and fiscal system:
1. Legislation defining the monetary unit;
determining the roles of gold, silver,
and paper money; determining the
powers of administrative and executive agencies in the field; regulating
the establishment and operations of
private monetary and credit institutions, levying taxes, and determining Government expenditures.
II. The issue of coin and paper money:
1. Issue of Federal Reserve notes
2. Issue of Treasury coin and paper
money.
III. Commercial bank chartering, supervision, and
examination:
1. Chartering of national banks
,
2. Bank supervision and examination

Federal Agency

Congress,

Federal Reserve.
Treasury.

Comptroller of the Currency.
Comptroller of the Currency, Federal Reserve,
and the Federal Deposit
Insurance Corporation.

IV. General monetary and credit management:
1. Regulation of the total supply and cost Treasury and the Federal
of money and credit.
Reserve.
2. Selective credit control
Federal Reserve.
V. Insurance of bank deposits
Federal Deposit Insurance
Corporation.
VI. Agriculture credit
.
General regulation by the
Farm Credit Administration.
1. Loans for rural electrification
Rural Electrification Administration.
2. Loans to farm cooperatives.
13 banks for cooperatives.
3. Promotion and regulation of produc- 12 production-credit cortion credit associations.
porations.
4. Loans to, and discounts of paper for, 12 Federal intermediatevarious institutions that extend
credit banks,
short- and intermediate-term loans
to farmers and their cooperatives.
6. Loans to and regulation of national 12 Federal land banks,
farm-loan associations.
6. Loans and guaranties of private loans Farmers Home Administo small farmers unable to secure
tration.
adequate credit elsewhere.
7. Nonrecourse loans and guaranty of Commodity Credit Corprivate loans on agricultural proporation.
ducts.

MONETARY, CREDIT,'.AND FISCAL'POLICIES

TABLE I.—Federal activities in the fields of money, credit and fiscal operations, and
the controlling Government agencies—Continued
Activity

VII. Housing credit

1. Guaranty of. mortgages on residential
real estate and home modernization.
2. Chartering of Federal savings and loan
associations and supervision of institutions of this type.
3. Loans to savings and loan associations
and to certain other institutions of
this type.
4. Provision of a secondary market for
certain insured mortgages.
5. Insurance of savings accounts at savings and loan associations.
6. Loans and subsidies to local publichousing agencies for low-rent housing and slum clearance.
VIII. Insurance of home, farm, and business loans to
veterans.

Federal Agency

Over-all supervision by
the Housing and Home
Finance Agency,
Federal Housing Administration.
Home Loan Bank Board.
11 F e d e r a l h o m e - l o a n
banks,
Federal National Mortgage Association.
Federal Savings and Loan
Insurance Corporation.
Public Housing Administration.
1

Veterans' Administration
(also other agencies in
the performance of their
functions).

IX. Other loans and insurance of loans:
1. Loans to financial institutions

Reconstruction
Finance
Corporation, the Federal Reserve, and certain other agencies listed
above.
2. Loans to States and their subdivisions. Reconstruction
Finance
Corporation and certain
other agencies listed
above.
3. Loans and guarantee of private loans.- Reconstruction
Finance
Corporation and the
Federal Reserve.
4. Guarantee of loans for the construc- Maritime Commission.
tion and reconstruction of shipping.
5. Loans to foreign borrowers
Export-Import Bank and
certain other agencies.
X. Fiscal policy:
1. Taxation, including determination of Congress.
types, bases, and rates of taxes.
2. Spending, including determination of Congress and the agencies
the timing, amounts, and purposes
granted discretion as to
of expenditures.
the timing, rate, and
purposes of their expenditures.
3. Debt management
-Treasury and the Federal
Reserve.

On the other hand, Federal surpluses represent subtractions from
private incomes which are greater than the total of Government
spending. Government surpluses therefore exert an anti-inflationary
or an outright deflationary effect. In periods of depression, they withdraw from privatp incomes sums of which a major part would probably
have been spent for consumption or capital purposes. If the surpluses are then used to retire a part of the public debt, the banks and
private holders would be reluctant to invest these sums in new capital,
since at such times investment, because of fear about the future, falls
off. The sums thus received by people for their Government bonds
will largely be hoarded. The net effect of Government surpluses in

MONETARY, CREDIT,'.AND FISCAL'POLICIES

periods of depression is, therefore, to worsen conditions and intensify
unemployment.
But in a period of prosperity and rising prices, when labor and capital
are comparatively fully employed, a governmental surplus has a
healthful effect in checking inflation. The collection of taxes in excess
of Government's spendings tends to reduce private spendable incomes,
thereby reducing the pressure of spendings, and at the same time it
provides the Treasury with a weapon which can be used to restrict
the creation of money and credit. By using the money representing
the surplus to build up its deposits at the Federal Reserve banks or to
pay off securities held by the Federal Reserve banks, the Treasury
can reduce the volume of bank reserves and contract the lending power
of the banking system. This is the most powerful anti-inflationary
way in which the Treasury can use its surplus. The use of a surplus
to retire securities held by the commercial banks exerts a smaller
anti-inflationary effect, and the anti-inflationary, effect of using a
surplus to retire debt held by nonbank investors is the least antiinflationary of all.
Thus the mere existence of governmental deficits or surpluses
inevitably affects the economy whether they are planned or not.
They may tend toward greater or less stability, according to their
timing, their magnitude, and other economic conditions. At their
worst, they could make it impossible to achieve economic stability
and growth. For example, a very# easy monetary policy, liberal
Government loans and loan guaranties, and a large deficit-spending
program during a boom period could enhance the process of inflation.
A tight monetary policy, a contraction of Government loans and loan
guaranties, and a policy of taxing in excess of Government spendings
during a recession could seriously aggravate and prolong deflation
and unemployment. Such policies should clearly be avoided. And,
since it is unlikely that these policies could ever be so precisely managed as to be "neutral" in their effects on the economy, they should
be employed in such a way as to make a positive contribution to
economic stability and growth.
Another reason for preferring reliance on monetary, credit, and
fiscal policies as the major method of general economic stabilization
is that they are more consistent with the maintenance of our democratic system and with the fostering and promotion of free competitive
enterprise. These instruments do not involve the Government in
detailed control of the particulars of the economy; they do not require
the Government to intervene in individual transactions between
buyer and seller, in dealings between employer and employee, and in
the determination of the prices and production of particular commodities. These millions of intricate decisions are left to the operation of the market mechanism while general monetary, credit, and
fiscal policies work toward stabilization by influencing the total supply
and cost of money and the total amount of money income at the disosal of the private sectors of the economy. There is every difference
etween the effects of general over-all monetary, credit, and fiscal
policies which indirectly influence the economy toward stabilization
and the effects of an elaborate system of direct controls. This point
was made very strongly in testimony before the subcommittee by
J. Cameron Thomson, president of the Northwest Bancorporation
and chairman of the monetary and fiscal policy subcommittee of the

MONETARY, CREDIT,'.AND FISCAL'POLICIES

research and policy committee of the Committee for Economic
Development.
I want to draw a sharp distinction between fiscal, monetary, and debt-management policies on the one hand and direct controls on the other hand. By direct
controls, I mean such measures as Government price controls, wage controls,
rationing, allocations, and controls over the direction of investment. Failure to
distinguish between these two kinds of measures is responsible for much confusion
in public discussion and could lead to serious error in public policy. Two kinds of
confusion are common. One is to reject the attempt to achieve greater stability
by fiscal, monetary 2 and debt-management policies by putting these policies in the
same class with direct controls over the details of private economic activity.
The other is to accept and justify all manner of direct controls by putting them in
the same class with indirect financial measures for stability.
Fiscal, monetary* and debt policies are appropriate means for attacking the
problem of instability in a free society. The problem of instability is essentially a
problem of broad forces affecting the over-all magnitudes of the economy. The
problem arises when millions of workers are simultaneously unemployed, or when
there is a general, although probably uneven, rise of most prices. The advantage
of fiscal, monetary, apd debt policies is that they allow the Government to influence the over-all forces—especially the level of aggregate demand—that determine
the stability of the economy without necessanly involving the Government in
detailed control of the particulars of the economy. These over-all measures will,
of course, affect different individuals and businesses differently. But the differences are determined by the market process, not by Government decisions. The
Government does not have to make decisions that are with rare exceptions better
left to the market—the price of shoes relative to the price of automobiles, whether
the ABC company or the XYZ company should prosper, what kind of a job John
Jones or Robert Smith should have.
Direct controls do involve Government decisions about the particular interrelationships of the parts of the economy. One virtue olaimed for them by their
advocates is that they are "selective." But adding together a very large number
of selective controls is surely a clumsy, expensive, inefficient, and politically dangerous way to get the over-all effect needed to aeal with the stability problem.
While the market process is not perfect, any general substitution of Government
decisions for it would result in serious loss of efficiency, progress, and stability.
But more than efficiency, progress, and stability are at stake. Freedom is
also at stake. Any widespread system of direct controls would necessarily
involve widespread power of Government to affect the economic fortunes of particular individuals, businesses, industries, and regions "selectively"; that is,
discriminatingly. This power would have to be exercised by the Executive
subject to only the most general statutory limitations. It would be the power to
reward or punish, to coerce, by administrative action. The existence of such a
power would ominously threaten the survival of our free society, for so long as the
free society might endure.
We hear the concepts of "freedom" and "statism" used so much and so loosely
that we become callous and impatient with them. But, on the specific problem
of this subcommittee. I am convinced that the importance of fiscal, monetary,
and debt policy will not be sufficiently appreciated until we learn to make the
distinction between power to coerce individuals and power to affect the general
behavior of the economy. A precise line cannot be drawn between appropriate
and inappropriate powers; yet, we must recognize that there is a direction in
which we should not move except in cases of clearest necessity and even then only
with utmost caution.

Chairman McCabe, of the Board of Governors of the Federal Reserve
System, made a similar point with respect to monetary management
by central banks.
* * * Central banking institutions have always been considered the
necessary and essential complement of a free-enterprise economy. Money does
not manage itself. Once commercial banking institutions holding demand
deposits become important, central banking institutions must be organized to
avert money panics and to mitigate booms and depressions. Although they have
necessarily been given wide discretionary powers, they should in no sense be
regarded as an invention of or an adjunct to a "managed economy" or an "administered state." Instead, they are part and parcel of a free-enterprise economy,

MONETARY, CREDIT,'.AND FISCAL'POLICIES

designed to maintain full and continuous use of its human and material resources.
In modern terms, this means that they are expected to help maintain a high
and stable level of employment in a free-enterprise economy. They endeavor
to do this by the prompt and flexible use of adequate discretionary authority over
the cost and availability of money and credit. As in the case of the courts, they
must be operated purely in the interests of the public but at the same time they
should be immune from political bias and control.
That is the traditional, the conservative, the classic position. It is the issue
that was dealt with by Carter Glass, among others, when the Federal Reserve
System was established. Misunderstanding about it underlies much of the criticism of our actions. I cannot emphasize too strongly the difficulties we are
placed under when many of the most vociferous supporters of free enterprise,
businessmen and bankers, and their organizations criticize the possession and use
by the Federal Reserve System of necessary authority over the cost and availability of credit as if the delegation of this authority to the System were characteristic of a "managed economy" or an "administered state." It is exactly the
opposite. 4

Those who would oppose using monetary, credit, and fiscal policies
for stabilization purposes, either by refusing to give the Government
adequate powers or by obstructing its use of these powers, must therefore either oppose the purposes of the Employment Act or find other
methods of equal effectiveness and of equal compatibility with our
democratic, free-enterprise system.
We do not know precisely how much effectiveness as a stabilizing
device we can expect from appropriate, vigorous, and coordinated
monetary, credit, and fiscal policies. Our past experience is of little
help in making such an estimate, for a timely, vigorous, and coordinated use of all these policies for stabilization purposes has never been
seriously attempted in this country. Fortunately, however, the validity of our recommendations does not need such a precise estimate;
it is enough to know that these methods can be very powerful and
that they are preferable to other methods for promotmg general economic stability. We do, however, wish to make two points with
respect to the effectiveness of these instruments: (1) They are not a
panacea for all economic ills, nor do they make it unnecessary for us
to employ wise economic policies of other types. There are many
kinds of economic problems—for example, those relating to the maintenance of competition—that they cannot solve, and they are even
likely to lose a large part of their effectiveness as stabilization measures if other policies are unfriendly. And (2), if not used in a coordinated and supplementary manner, the various components of monetary, credit, and fiscal policies are likely to prove insufficient to cope
with strong cumulative forces which at times create depressions and
at other times inflation. In fact, these policies may completely defeat
each other. They can be much more effective if they are employed
as integrated parts of an appropriate over-all monetary, credit, and
fiscal program. We cannot afford, therefore, to rely solely on a few
of these measures and to neglect the others.
II.

FEDERAL FISCAL

POLICIES

1. We recommend that Federal fiscal policies be such as not only to
avoid aggravating economic instability but also to make a positive and
important contribution to stabilization, at the same time promoting equity
and incentives in taxation and economy in expenditures. A polity
4

Sec also the testimony of W. Randolph Burgess and of Alfred n . Williams.

60995*—60

MONETARY, CREDIT,'.AND FISCAL'POLICIES

based on the principle of an annually balanced budget regardless of
fluctuations in the national income does not meet these tests, for if actually
followed it would require drastic increases of tax rates or drastic reductions
of Government expenditures during periods of deflation and unemployment, thereby aggravating the decline, and marked reductions of tax rates
or increases of expenditures during periods of inflationary boom, thereby
accentuating the inflation. A policy that will contribute to stability
must produce a surplus of revenues over expenditures in periods of high
prosperity and comparatively full employment and a surplus of expenditures over revenues in periods of deflation and abnormally high unemployment. Such a policy must, however, be based on a recognition that
there are limits to the effectiveness of fiscal policy because economic forecasting is highly imperfect at present and tax and expenditure policies
under present procedures are very inflexible.
We recommend that the Joint Committee on the Economic Report
make an intensive study of the various possible methods of increasing the
flexibility of tax and expenditure policies in order to discover whether
and to what extent it is feasible to make these instruments more effective
for stabilization purposes:
Fifty years ago, when the Federal budget amounted to only about
half a billion dollars a year, it was not a very important influence
on the behavior of the economy. But the situation is now completely changed since the annual Federal budget has grown to about
$43,500,000,000, which amounts to about 19 percent of national income
and 17.5 percent of gross national product. Federal expenditure and
revenue policies now constitute one of the most important determinants of production and employment, and depending on the nature
of these policies their influence may help to .create either stability or
instability.
The Government exerts its influence on total spendings, production,
employment, and prices through both sides of its budget.6 Its purchases of goods and services add directly to the demand for output and
create money income for persons and business firms, while its expenditures for interest, veterans' and social-security benefits, and various
other transfer payments also add to private incomes and spending
power. Taken by themselves, therefore, Government expenditures
tend to expand money incomes and the market for business output.
On the other side of the budget, tax collections extract from personal
and business incomes large amounts of money that might have been
spent for consumption purposes or for capital improvements. Taken
by itself, therefore, the collection of taxes tends to shrink the spendable
money incomes of persons and business firms, to reduce the private
demand for output, and to diminish employment. Thus, the Government exerts a net antideflationary or an inflationary effect on the
economy by spending in excess of its current revenues, and a net anti* In dealing with the effects of fiscal policies on general economic conditions, we shall refer to the "cash
budget" rather than to the "conventional budget. 7 ' The former more accuratcly measures the impact of
Federal financial operations on the economy, for it reflects all Federal receipts of money from the public,
including social-security contributions, and all Federal payments to the public, including social-security
benefits; it does not Include "receipts" or "expenditures" which are merely bookkeeping transfers within
the Government. The "conventional budget," though highly useful for evaluating and controlling the
various governmental programs, fails to measure accurately the impact of Fedend revenues and expenditures on the economy, for it does not include all payments between the Government and the public, and it
does include some items that merely represent transfers on the books of the Government itself. In neither
case, of course, do "receipts" include proceeds from borrowing nor "expenditures" the amounts used to
retire debt.

MONETARY, CREDIT,'.AND FISCAL'POLICIES

inflationary or a deflationary effect by collecting revenues in excess
of its current spendings. Whether such policies contribute to stability
or instability depends on their timing and magnitude. Deficit spending in a period of high employment tends to induce or aggravate
inflation; the same policy in a period of serious underemployment
tends to retard deflation and recession and cannot constitute an
inflationary threat so long as there exists a considerable amount of
unemployed labor and other productive resources. A surplus of tax
collections over spendings in periods of recession and depression tends
to aggravate the decline by accentuating the fall of demand for business output, but the same policy in a period of actual or imminent
inflation promotes stability.
We recommend that the Federal Government employ a revenueexpenditure policy that will not only avoid aggravating instability
but will actively contribute to the maintenance of general economic
stability. A policy of balancing the budget annually despite fluctuations in production and employment does not meet this test; such a
policy, if actually followed, would magnify economic fluctuations.
Only a fiscal policy that will yield a surplus of revenues over expenditures at high levels of national income and an excess of expenditures
over revenues when there is more than a moderate amount of unemployment can at once avoid contributing to instability and make a
positive contribution to stabilization.
We want to make it perfectly clear at the outset that our proposed
revenue-expenditure policy for the Federal Government is thoroughly
consistent with two other important objectives of fiscal policy—the
preservation of incentives and the promotion of equity in the tax
? r stem and the promotion of economy in Government expenditures.
he tax system should be under constant scrutiny to find ways of
increasing the equity in the distribution of the tax burden and to
preserve the incentives of industry toward constantly greater production. The adoption of a flexible fiscal policy will promote rather
than make more difficult the attainment of these objectives. The
achievement of economy in Government expenditures is essential.
We are strongly and unalterably opposed to waste in Government.
No project should be undertaken that cannot be justified on its merits,
and the Government, no less than private industiy, should get the
most for every dollar spent. We are not rich enough to afford waste
in our homes, in our industries, or in our Government. The quest for
economy must be continuing and unrelenting; it must not be limited
to any one phase of the business cycle. Economy cannot be turned
on and off at will. While recommending a flexible fiscal policy, we
also recommend a continuous promotion of efficiency in Government.
We have two principal reasons for rejecting the principle of an
annually balanced Federal budget in the face of serious fluctuations
in our national money income: (1) Adherence to this principle would
aggravate economic instability. With a given structure of tax rates,
the aggregate yield of the Federal revenue system is highly responsive
to changes in the level of national income. Yields of the two taxes
that provide the major part of Federal revenues—the personal-income
and corporate-income taxes—fluctuate more widelye percentagewise,
than national money income, and the yields of social-security taxes
and of excises on alcoholic beverages, tobacco, and many other prod

MONETARY, CREDIT,'.AND FISCAL'POLICIES

nets are also sensitive to changes in income levels^ Thus, with a
given structure of tax rates, increases or decreases in the national
mcome automatically produce increases or decreases in total Federal
revenues. To apply the principle of an annually balanced budget in
the face of these facts would necessitate perverse variations in Federal
tax rates, or expenditures, or both. When total Federal revenues rose
in response to an inflationary rise of national income, the Government
would have to cut tax rates, which would increase the spendable
incomes of people and business, or increase Government expenditures,
which would still further increase spendings for output and add still
more to private incomes, or do both. Such a policy could only
aggravate inflation. And when Federal revenues fell in response to a
deflationary decline of national income and employment the principle
of an annually balanced budget would require an increase of tax rates,
which would further shrink the already-declining private spending
power, or decrease Government expenditures, which would reduce still
further the demand for business output and further shrink private
incomes, or do both. These policies would inevitably accentuate the
decline of production, employment, and prices.
(2) In actual practice the principle of an annually balanced budget
in the face of fluctuations in the national income will not be accepted
by the American people, and by continuing to pay lip service to it we
would probably promote inflation in the long run. It is unrealistic to
expect that the Federal budget could actually be balanced in periods
of serious deflation and unemployment; the Nation would not approve
or even condone the marked increase of tax rates or decrease of expenditures that would be required for the purpose. But the annualbudget-balance principle would be seized upon in an inflationary boom
period as a justification for decreasing tax rates or increasing expenditures. A frank recognition of the fact that the budget neither should,
nor as a practical matter can, be balanced in a period of depression
would bolster our ability to resist inflationary reductions of tax rates
and undue increases of Government expenditures during boom periods.
Our recommendations for a flexible fiscal policy have been strongly
influenced by the following considerations: (1) The unreliability of
economic forecasting. If we could accurately predict future economic
conditions it might be possible to anticipate turning points in business
activity and to use revenue-expenditure policies promptly enough to
hold fluctuations within very narrow limits. The poor record of the
forecasters in the past warns us as to the danger of this course. Thus
in the fall of 1945 virtually all of the economic forecasters predicted
that there would be a tremendous postwar slump which would create
from 8 to 12 million unemployed by the spring of 1946. This did
not occur; and, instead, we had rising production and even more
rapidly rising prices with substantially full employment. For us to
have embarked on a tremendous program of public works at this time,
as the forecasters had urged, would not only have been unnecessary
but it would have intensified and heightened the inflation. In fact,
the accumulation of a surplus and the retiring of a portion of the
public debt beginning in the latter part of 1946 helped to dampen
down inflation and prevented matters from becoming still worse.
Again in the winter of 1949 the official economic forecasters stated
that the real problem was inflation, to prevent which they wanted
further restrictive controls. Since it then developed that we were

MONETARY, CREDIT,'.AND FISCAL'POLICIES

in a recession which continued for some time, the putting into effect
of these recommendations could only have deepened the recession.
We mention these errors not to single out those who committed them
for blame but rather to show how unsafe it is to base fiscal policy
upon predictions of what it is alleged will happen in the future.
Under our recommended policy, therefore, decisions as to changes
in revenue and expenditure programs are not made to defend oh
forecasts of future levels and changes in business activity but, instead,
on current economic conditions and developments in the recent past.
Deviations from this rule should occur only when there are clear and
convincing reasons to believe that present conditions are not indicative
of those to be expected in the future. (2) The long period required
to enact revenue laws and the inflexibility of expenditure programs*
To change our tax laws under present procedures is a long and timer
consuming process. Moreover, many expenditure programs are not
suitable for countercyclical variations, and some others cannot be
quickly started, stopped, speeded up, and slowed down. There are
some projects, however, such as the building of roads and houses,
which can be varied in volume without too great loss or delay. We
recommend that the Joint Committee on the Economic Report study
the problem of how the rate of expenditures can be made more flexible.
But until this greater flexibility is actually achieved it will be well to
recognize this limitation on the effectiveness of fiscal policy as a
stabilization device, and not to discard or weaken monetary policy,
which, despite its other shortcomings, does have the great merit of
flexibility.
The nature of our recommended fiscal policy has already been indicated in broad terms; it may be outlined as follows: (1) The tax
system should be equitable and should preserve and even create
incentives toward an ever-increasing level of production. But, when
the tax system is changed in the interests of equity or incentives, the
effects on total revenue-expenditure relationships and on general economic stability should also be considered. For example, if in the
interest of equity or incentives some taxes are eliminated or reduced
at a time when economic conditions are not such as to warrant a
reduction of total revenues relative to expenditures, the loss of revenues should then be offset by the increase in other taxes or by a
reduction of expenditures. Remedying an inequity for one group of
people should not be allowed to create inequities for many others by
encouraging inflation. (2) Efficiency in Government should be promoted
at au times; every expenditure should be justified on its merits,
ft
nd the Government should strive to get the most for every dollar
spent. (3) The revenue-expenditure system should be so designed
that in normal periods—periods when unemployment is at or near its
Practical minimum, when price levels are relatively stable, and when
there is no clear-cut and convincing reason to expect a change in any
Particular direction—then Federal revenues should not only equal
expenditures but should show a small surplus to permit a slow reduction of the national debt. Moreover, newly planned increases or
decreases in expenditures should be matched with equivalent changes
to planned revenue receipts. This^ rule has a double advantage. In
fhefirstplace, it leads to economy in Government, for every proposed
^crease in expenditures has to be compared with its cost in taxes,
^ad in the second place, it leads to stability, for at such times the

MONETARY, CREDIT,'.AND FISCAL'POLICIES

Government should not seek to inject either a net -expansionary or
net contractionary influence into the economy, .
The only exceptions to the general principle that planned changes
in expenditures should be matched by offsetting changes in planned
revenues are (a) a decrease in planned expenditures should not be
balanced by an offsetting reduction of planned revenues if there is
clear and convincing evidence that such a reduction would initiate or
enhance inflation, and (6) a planned increase of expenditures should
not be offset by a planned increase of revenues if there is clear and
convincing evidence that the near future will be characterized by
deflation and unemployment so that an injection of a net expansionary influence would be desirable. But, because of the natural human
tendency to favor tax reductions and to oppose tax increases, the
presumption should be strongly in favor of abiding by the general
principle. (4) The maintenance of unchanged tax rates and expenditure programs will produce, as a response to fluctuations in the
national income, an "automatic flexibility" of revenues and actual
expenditures, winch will exert a stabilizing; effect on the economy.
For example, with a decline in the national income, Federal revenues
will automatically fall while expenditures under certain Government
programs, such as unemployment benefits and assistance to farmers,
will automatically rise. The decline will be somewhat cushioned as
the Government automatically taxes less money away from the
public and pays out more to it. On the other hand, with an inflationary rise of national money income, Federal revenues will automatically rise while certain types of expenditures, such as those mentioned
above, will automatically fall; the rise would be dampened down as
the Government taxed larger amounts from private incomes and paid
less into them. We believe that this automatic flexibility is a valuable contribution to stability, and that the degree of automatic
flexibility in our fiscal system should, if possible, be increased. But
its limitations should also be recognized. In the first place, though
it can retard or perhaps even stop a decline of business activity or a
rise of prices and can provide time for recovery forces to come into
play, it cannot by itself reestablish full-employment conditions or
push prices back to a preinflation level. In the second place, though
automatic flexibility probably represents the maximum extent to
which fiscal policy should be employed to combat moderate economic
fluctuations, it is almost certain to be inadequate in the face of a
serious depression or inflation. (5) In the event of such a serious
depression or inflation, automatic flexibility should be supplemented
by countercyclical changes in tax rates, expenditure programs, or
both. The considerations which should underlie such measures, as
well as some of the problems involved, were pointed out in a unanimous report presented to the subcommittee by 15 economists:
In the event of severe recession, it is not only politically necessary but economically desirable to provide additional employment projects that can be started
and ended quickly. Temporary tax relief should be given in order to stimulate
private spending and employment. Other incentives for private investment, such
as guaranties, should be considered. There can be no social or economic justification for allowing mass unemployment to persist for extended periods at a time
when there is abundant need for roads, schools, hospitals, and other useful objects
of public expenditures. However, we recognize that there are difficult questions
of extent and timing connected with any such program. An overambitious
Government program may impede the course of recovery in the private sectors of
the economy by dislocating resources and delaying needed price adjustments. On

MONETARY, CREDIT,'.AND FISCAL'POLICIES

the other hand, a program that was overcautious could needlessly fail to advance
recovery by not stimulating the demand for the products of private industry.
Much skill and judgment are required to move from depression to stable prosperity. We must not rely on tne private economy, unaided by Government
action, to perform that task. The Government must not shirk the responsibility
placed upon it by the Employment Act, and fiscal policy is one of the most
promising instruments it possesses.
On any occasion when serious inflation is inprospect, emergency measures would
be needed to curtail expenditures and increase taxation. Wartime and postwar
experience provides convincing evidence that the political obstacles to a fiscal
policy adequate to combat inflation are so great that there is little practical danger
of going too far. The survival of a relatively free and stable price system depends
heavily on our willingness to fight inflation by fiscal methods."

As we have stated, one of the greatest limitations on the effectiveness
of fiscal policy as a stabilization device is to be found in its inflexibility—the long period typically required to formulate, enact, and
put into operation tax changes and the time required to start, stop,
slow down, and speed up expenditure programs. Many possible
methods for improving this situation have been suggested, but time
did not permit us to study them thoroughly enough to make recommendations concerning them. We do, however, recommend that the
joint committee make an intensive study of the various possible
methods of increasing the flexibility of fiscal policy in order to discover
how and to what extent it is feasible to increase the effectiveness of
this instrument for stabilization purposes.
III.

MONETARY

AND D E B T MANAGEMENT

POLICIES7

L We recommend that an appropriate,flexible,and vigorous monetary
policy, employed in coordination with fiscal and other policies, should
be one of the principal methods used to achieve the purposes of the Employment Act. Timely flexibility toward easy credit at some times and
credit restriction at other times is an essential characteristic of a monetary
policy that will promote economic stability rather than instability. The
vigorous use of a restrictive monetary policy as an anti-inflation measure
has been inhibited since the war by considerations relating to holding down
the yields and supporting the prices of United States Government securities.
As a long-run matter, we favor interest rates as low as they can be without
inducing inflation, for low interest rates stimulate capital investment.
But we believe that the advantages of avoiding inflation are so great and
that a restrictive monetary policy can contribute so much to this end
that the freedom of the Federal Reserve to restrict credit and raise interest
fates for general stabilization purposes should be restored even if the cost
should prove to be a significant increase in service charges on the Federal
debt and a greater inconvenience to the Treasury in its sale of securities
for new financing and refunding purposes.
• See Monetary, Credit, and Fiscal Policies, a print of the Joint Committee on the Economic Report,
8lst Cong., 1st sess., 1949, p. 438. This volume will hereafter be referred to as Monetary, Credit and Fiscal
Policies. It contains a large amount of materials on fiscal policies that were submitted to the subcommittee.
Some of the most informative of these are two statements that were drawn up and unanimously approved by
15 university economists (pp. 435-443), a digest of replies to a questionnaire sent to bankers, economists,
and others (pp. 395-424), a statement by the Secretary of the Treasury (p. 14), and a statement by the Director of the Bureau of the Budget (pp. 285-287). Among the witnesses who testified at some length on fiscal
Policy were J. Cameron Thomson and Beardslcy Ruml of the Committee for Economic Development,
w. Randolph Burgess of the National City Bank of New York, William J. Grede and Harley Lutz of the
National Association of Manufacturers, Allan B. Kline of the American Farm Bureau Federation, and
Russcir.Smith of the National Farmers Union.
" For the further views of Mr. Patman, sec footnote 1, p. 1.

MONETARY, CREDIT,'.AND FISCAL'POLICIES

:
We recommend as means of promoting monetary and debt-management policies that will contribute most to the purposes oj the Employment
Act—
.
,
(a) That every effort be made to build up the quality and prestige oj
Federal Reserve officials; among these measures should be a reduction in
the number oj members oj the Board oj Governors jrom seven to not more
than five and an increase in their compensation.
(b) That Congress by joint resolution issue general instructions to
the Federal Reserve and the Treasury regarding the objectives oj monetary
and debt-management policies and the division oj authority over those
policies. These instructions need not, and in our judgment should not,
be detailed; they should accomplish their purpose ij they provide, in effect,
that, (i) in determining and administering policies relative to money,
credit, and management oj the Federal debt, the Treasury and the Federal
Reserve shall be guided primarily by considerations relating to their effects
on employmentj productionf purchasing power, and price levels, and such
policies shall be consistent with and shall promote the purposes oj the
Employment Act of 1946; and (ii) it is the will oj Congress that the
primary power and responsibility jor regulating the supply, availability,
and cost oj credit in general shall be vested in the duly constituted authorities oj the Federal Reserve System, and that Treasury actions relative
to money, credit, and transactions in the Federal debt shall be made
consistent with the policies oj the Federal Reserve.
(c) That the Secretary oj the Treasury and the Chairman oj the Board
oj Governors oj the Federal Reserve System be made members oj the
National Monetary and Credit Council recommended elsewhere in this
report.
As indicated earlier, we believe that an appropriate, flexible, and
vigorous monetary policy, employed in coordination with fiscal and
other policies, should be one of our principal instruments for achieving
and maintaining economic stability. For several reasons we reject
the idea, held by a few economists and others, that for stabilization
purposes little or no reliance should be placed on monetary policy and
that we should rely exclusively on other measures, such as fiscal
policies. (1) It is highly doubtful that fiscal policy would be powerful enough to maintain stability in the face of strong destabilizing
forces even if monetary policy were neutral, and a conflicting monetary policy could lessen still further the effectiveness of fiscal policy.
(2) Monetary policy is strong precisely where fiscal policy is weakest;
it is capable of being higlily flexible. It can be altered with changes in
economic conditions on a monthly, daily, or even hourly basis. (3)
It is a familiar instrument of control and thoroughly consistent with
the maintenance of our democratic government and our competitive
free-enterprise system. It is certainly much to be preferred over a
harness of direct controls. (4) Our monetary history gives little
indication as to how effectively we can expect appropriate and vigorous monetary policies to promote stability, for we have never really
tried them.
For example, the effectiveness of these policies during the late
1920's was seriously reduced by the Federal Reserve's lack of powers
for the selective control of security loans. After 1929, a vigorous
easy-money policy was not adopted until bank reserves had been
allowed to shrink for more than 2 years, thousands of banks had

MONETARY, CREDIT,'.AND FISCAL'POLICIES

failed, and general business confidence had dwindled; and after World
War II its use as a restrictive measure with which to combat inflation
was very seriously hampered by considerations relating to the management of the Federal debt. With our improved banking structure
and the benefit of our past experience, we should be able to look forward to more effective monetary management characterized by
timely, vigorous, and flexible actions.
The essential characteristic of a monetary policy that will promote
general economic stability is its timely flexibility. To combat deflation and promote recovery, the monetary authorities must liberally
provide the banking system with enhanced lending power, thereby
tending to lower interest rates and increase the avaflability of credit.
To retard and stop inflation they must restrict the lending power of
banks, thereby tending to raise interest rates and to limit the availability of credit for private and Government spending. And these
actions must be taken promptly if they are to be most effective. The
Federal Reserve has three principal weapons which it can use to control the over-all supply ana cost of money and credit: (1) Altering the
discount rate at which it will lend to member banks, (2) open-market
operations in Government securities, and (3) altering the reserve
ratios which the member banks must keep against their deposits.
The first method, that of altering discount rates, was the one
chiefly relied upon during the early period of the Federal Reserve.
It was said that by raising the discount rate in periods of inflation the
member banks would not present so much paper to the Federal
Reserve for rediscount and consequently would not build up their
reserves and lending power as much as they would otherwise. Moreover, the rise in the discount rate would lead the member banks to
increase the interest rates which they in turn charged private borrowers, and this higher rate would curtail the amount of credit taken
and would curb the inflation. Conversely, in a period of recession,
it was said that the Federal Reserve by lowering its discount rate would
stimulate banks to present paper to build up their reserves. This
would give them abundant supplies of potential credit which they
would loan out to business at relatively cheap rates. This it was said
would induce private industry to borrow and would stimulate trade
and. investment and, consequently, production and employment.
For many years, however, the importance of the discount rate has
been far less than was originally intended. In the first place, commercial paper has become much less important. These loans from
banks were originally designed to help manufacturers finance the costs
of purchasing and fabricating raw materials prior to their final sale
and to finance the successive steps of consumers' goods as they moved
through the hands of wholesalers and retailers on their way to final
urchase and consumption. As business units have grown larger,
owever, they have tended to finance themselves to a much greater
extent out of earnings or from the sale of longer-term securities and
have issued much less commercial paper. In the second place, and
more important in explaining the decline in the significance of the
discount rate, the vast increase in the public debt and the readiness
of the Open Market Committee of the Federal Reserve System to
purchase these securities in virtually unlimited quantities and to give
the banks additional reserves in return has meant that the banks

MONETARY, CREDIT,'.AND FISCAL'POLICIES

depend almost exclusively on sales of Governments rather than on
borrowings from the Federal Reserve as a means of replenishing their
reserve accounts. Outstanding Federal Reserve loans have recently
averaged only about 1 percent as large as Federal Reserve holdings of
Government securities. The significance of the discount rate has
declined correspondingly. The discount rate of the System is not,
therefore, a very effective instrument with which to stabilize the
economy.
There is more hope in the second weapon of the Reserve System,
namely, open-market operations. Under this operation the Federal
Reserve will sell Government securities, which it holds in abundant
quantities, when it wishes to check an inflationary movement. When
the banks buy these securities, they pay for them by giving their
checks to the Federal Reserve, which then draws down the reserve
accounts of the member banks. This reduces the lending capacity
of the banking system by about six times the amount of shrinkage
in the reserve. The same result follows if the Government securities
are sold to nonbank purchasers, such as insurance companies. The
checks given to the Federal Reserve by these purchasers are drawn
on banks, and the Federal Reserve collects by drawing down the
reserve accounts of those banks. By thus curtailing the supply of
available reserves, the Reserve System can curtail the growth of
credit or force an actual contraction.
Conversely, Federal Reserve purchases of Government securities
in the open market.add to the volume of bank reserves, increase the
total lending power of the banking system, and tend to make credit
both cheaper and more available. This is true whether the purchases are from banks or from nonbank sellers. In both cases the
Federal Reserve pays for the securities with checks drawn on itself,
and when these checks are presented for collection the Federal Reserve
adds their amounts to the reserve accounts of the banks.
Both the discount rate and the open-market operations of the
Federal Reserve operate primarily through their effect on the dollar
volume of reserves available to the banking system. Reductions in
discount rates and purchases of securities in the open market tend to
increase the availability of reserves to banks, while increases in discount rates and sales of securities in the open market tend to reduce
the availability of bank reserves. But changes in the required reserve
ratios of the member banks influence the supply and cost of credit
not through their effect on the dollar volume of bank reserves but
through their effect on the number of dollars of credit that the banking system can extend on the basis of each dollar of its reserves. For
example, when the reserves required against deposits average 10 percent, the banking system can create and have outstanding deposits
equal to 10 times the volume of its reserves, but when the reserves
required against deposits average 20 percent the banking system
can create and have outstanding deposits equal to only 5 times
the volume of its reserves. Thus, when the Board of Governors of
the Federal Reserve as a restrictive measure increases the percentage
of reserves that banks are required to hold against deposits, it tends
to decrease or at least to curtail a rise of their lending power and of
the total supply of money and credit. Conversely, by lowering the
percentage of reserves required against deposits, the Federal Reserve
tends to increase or at least to retard a decline in their lending power

MONETARY, CREDIT,'.AND FISCAL'POLICIES

of the banking system and in the total potential supply of money and
credit.
At various points it will be noted that a restrictive monetary policy
usually produces higher interest rates and a liberal policy lower
interest rates. It must be emphasized, however, that the effectiveness of general monetary and credit policy does not depend solely on
the movement of interest rates. Typically, the Federal Reserve does
not operate directly on interest rates but on the total lending power
of the banking system and thereby on the total supply of credit. Its
actions in reducing the volume of bank reserves or increasing the percentages of reserves required against deposits decreases the total
lending power of banks. To some extent the banks curtail their
lending by raising interest rates, but they are likely to rely to a greater
extent on various kinds of credit rationing. A relatively small rise
in interest rates may be accomplished by a marked reduction in the
availability of credit. On the other hand, when the Federal Reserve
increases the total lending power of the banks, the latter use lower
interest rates to some extent to increase the amount of credit that they
can sell, but they tend also to rely on a relaxation of credit-rationing
restrictions. A relatively small decline in interest rates may be accompanied by a considerable increase in the availability of credit.
As noted earlier, flexibility is an essential characteristic of a monetarv policy that will promote general economic stability. To combat
deflation, it must make money and credit more available at lower
cost; and, to curb inflation, it must restrict the availability and raise
the cost of money and credit. During World War II and the postwar
period, however, the Federal Reserve and the Treasury did not vigorously restrict credit in order to fight the current inflation. Instead,
monetary policy became virtually fused with Federal borrowing and
debt-management policies and was used to prevent or limit increases
in the yields and decreases in the prices of Federal securities. General
credit restriction could not be vigorously tried out because of the
strong desire to maintain low interest rates and yields on Government
securities and to prevent or at least to hold within very narrow limits
any decline in the prices of Governments. This raises, we believe,
the most important current question in the field of monetary policy:
"To what extent should the use of a restrictive monetary policy to
curb inflation be inhibited by the desire to hold down the yields and
to hold up the prices of Federal securities?" A short sketch of the
development of this policy will help bring out the issues involved.8
Between early 1937 and our entrance into World War II, the Federal Reserve on several occasions bought and sold Federal securities
not for the primary purpose of affecting the volume of bank reserves
and aggregate lending power but for the express purpose of influencing
the prices of Governments, and especially the longer-term issues, in
order "to maintain an orderly market" for them. In justifying these
actions the Federal Reserve did not mention the needs of the Treasury,
but stressed that its principal purposes were: (1) To "exert a steadying influence on the capital market, which is an essential part of the
country's economic machinery, and disorganization in which would
»A large amount of materials on the relationship between monetary and debt-management policies was
presented to the subcommittee. The committee print on Monetary, Credit, and Fiscal Policies contains
statements b y the Secretary of the Treasury (pp. 4-11), the Chairman of the Board of Governors of the
Federal Reserve System (pp. 24-44), the presidents of the 12 Federal Reserve banks (pp. 102-124),
and a number of bankers, economists, and others (pp. 299-308). Moreover, practically all of the witnesses
who appeared at the hearings presented testimony on this subject.

MONETARY,

CREDIT,'.AND

FISCAL'POLICIES

be a serious obstacle to the progress of economic recovery*' and (2) to
safeguard the large Government portfolios of member banks
against
"unnecessarily wide and violent fluctuations in price." 9 In short,
by the time we entered World War II, "the maintenance of an orderly
market for Government securities" had already become an important
objective of Federal Reserve policy. But not yet had the Federal
Reserve reached the point of "pegging" Government prices at stated
levels and standing ready to buy all securities offered to it at the
pegged prices. It was "maintaining an orderly market for Governments" m the sense of preventing "disorderly" changes in their prices
and yields, but it was not yet maintaining a rigid yield pattern.
The next phase was entered at the time of Pearl Harbor. The
Federal Reserve assured the Nation that it could and would see that
the Treasury was supplied with all the money that it needed for war
finance, and in March 1942 its Open Market Committee agreed with
the Treasury to maintain for the duration of the war approximately
the then-existing structure of yields on Governments. These promises were completely fulfilled. Two facts about the frozen-yield structure are very significant. The first, as shown infigureI, was the very
low level of the entire yield structure. Partly because of the depressed
demand for credit and partly because of the huge volume of excess
bank reserves all interest rates, but especially those on short-term
safe paper, had fallen greatly since 1929 and the early 1930's. The
second fact, which is also shown in figure I, but which stands out
more clearly in figure II, was the very low level of yields on short-<
term paper relative to yields on the longer maturities. The pattern
above which yields were not to be allowed to rise ranged from threeeighths of 1 percent on 90-day Treasury bills, through seven-eighths of 1
percent on 9-12-month certificates of indebtedness, through about 2
percent on 10-year bonds, and up to a maximum of 2% percent on the
longest-term marketable issues.
Though several measures were employed to prevent a rise of these
yields above the agreed-upon pattern) by far the most important one,
and the only one that needs to be mentioned here, was the agreement
of the Federal Reserve to buy all the Governments that others were
unwilling to hold at yields not in excess of those agreed upon with the
Treasury. In effect, therefore, the Treasury and the Federal Reserve
fixed the pattern of prices and yields at which the Federal Reserve
would be a passive buyer, and the Federal Reserve relinquished control over the volume of its Government holdings to the Treasury as
issuer and to others as buyers and sellers. And, of course, its purchases of these securities both added directly to the money supply and
supplied the commercial banks with additional reserves on the basis
of which they could create money. What happened to Federal Reserve holdings of Governments as a result of this passive policy is
shown in figure III. Total holdings rose from a little more than
$2,000,000,000 at the beginning of 1942 to about $24,000,000,000 at
the end of 1945, and virtually all of this increase represented the rise
in Federal Reserve holdings of bills, certificates, and other short-term
Governments on which the yields were very low. Private investors
were "playing the pattern of the rates" - with the safety and liquidity
of the longer issues greatly enhanced by the Federal Reserve price
• For a short history of the development of this policy, see Monetary, Credit, and Fiscal Policies, pp. 29-42

1930

1932

/934

193$

Source: Board of Governors o/ the Federal Reserve S/«tem.

J938

1940

1942

1944
t

1946

1948

M t U S (N U h C S N CPA CSC NT CMi*aCS tM t S W C l I k C U I X D .

FIGURE I I

YIELDS ON U.S. GOVERNMENT SECURITIES
rULLY TAXASIC t»UC9
WeCKLY <YERASE5 Of DAILY HQUHES

1942

1944

1946

S o u r c e r B o a r d of G o v e r n o r s of t h e F e d e r a l R e s e r v e S y s t e m .

1948

1950

MONETARY, CREDIT,'.AND FISCAL'POLICIES

support program private buyers tended to concentrate on the purchase of them and to leave to the Federal Reserve the purchase of the
short-term, lower-yield maturities. In fact, during 1945 and 1946 the
great private demand for the longer-maturities bid down markedly
their yields.
As the war ended, therefore, the Federal Reserve was following a
rigid policy of preventing the yields on Governments from rising above
the agreed-upon pattern, and it was accomplishing this by passively
purchasing—and monetizing—all of these securities that others were
unwilling to hold at yields not above those on the pattern. In effect
the Federal Reserve had relinquished control over the amoimt of the
Federal debt that it would monetize in order to prevent yield increases.
Having committed itself to this policy, it could not refuse to buy and
monetize Governments at the agreed-upon price, for to do so would
have been to let the price of the security fall and the yield rise. This
policy was continued without significant change until July 1947, nearly
2 years after VJ-day. (See fig. II.) But in mid-1947 some upward
flexibility began to be introduced; in a series of steps the yield on bills
was increased to about 1.16 percent by late 1948, the yield on certificates to 1.25 percent, and long-term yields by lesser amounts. In
1949, as inflationary pressures abated and the private demand for
credit declined, yields were allowed to fall somewhat.
Though the policy from July 1947 until late 1948 did indicate an
ability of the Federal Reserve and the Treasury to agree upon a reintroduction of some upward flexibility in yields and interest rates, it
does not by any means indicate that the concern for "maintaining an
orderly market in Governments" has been abandoned and that the use
of a restrictive monetary policy to combat future inflations will not be
seriously hindered by a concern for preventing or limiting decreases in
the prices and increases in the yields on Governments. In fact,
throughout this period the Federal Reserve made it clear that it was
continuing its policy of maintaining an orderly market for Governments, the rise of even short-term rates was never allowed to proceed
very far, and in no case was the price of a Government security allowed to decline below par. The following press release by the Federal
Reserve on June 28, 1949, indicates, according to Chairman McCabe,
that policy in the future will be flexible:
The Federal Open Market Committee, after consultation with the Treasury,
announced today that with a view to increasing the supply of funds available in
the market to meet the needs of commerce, business, and agriculture it will be the
policy of the committee to direct purchases, sales, and exchanges of Government
securities by the Federal Reserve banks with primary regard to the general
business and credit situation. The policy of maintaining orderly conditions in
the Government security market, and the confidence of investers in Government
bonds will be continued. Under present conditions the maintenance of a relatively fixed pattern of rates has the undesirable effect of absorbing reserves from
the market at a time when the availability of credit should be increased.

But in interpreting this statement, two facts are important: (1)
The June 1949 decision had the effect of lowering interest rates,
thereby facilitating Treasury finance. The Treasury might not have
assented so readily had the policy been toward higher interest rates.
And (2) the statement did not, and of course could not, indicate the
extent of flexibility that will be employed in the future. The range
of flexibility may prove to be so narrow as to limit very seriously
the effectiveness of a restrictive monetary policy.

FIGURE I I I

RESERVE BANK HOLDINGS OF U S. GOVERNMENT SECURITIES

S o u r c e : B o a r d of G o v e r n o r s of t h e F e d e r a l R e s e r v e S y s t e m .

MONETARY, CREDIT,'.AND FISCAL'POLICIES

Treasury and Federal Reserve officials have advanced a number of
reasons for the policy of holding down the yields and supporting the
prices of Governments in the face of inflation. (1) Such a policy
holds down service charges on the Federal debt. The Secretary of
the Treasury stated to the subcommittee:
The interest cost of the debt to taxpayers is another of the many considerations
which must be taken into account in debt-mangement policies. I t is estimated
that the interest charge on the public debt during the fiscal year 1&50 will be
$5,450,000,000. This Item represents over 13 percent of the Federal budget for
the year. The interest cost is likely to grow over a period of time—in the absence
of substantial debt reduction—because the rate of interest on savings bonds
increases as the bonds are held to maturity, and because an increasingly large
proportion of the debt represents the accumulation of trust funds invested at
rates set forth in the law which are higher than the present average interest rate
on the debt.
A general rise in interest rates would bring about a further rise in the budget
charge for interest payments. An increase of as little as one-half of 1 percent
in the average interest paid on the debt would add about $1,250,000,000 to this
charge. The Treasury was able to finance the last war at an average borrowing
cost of less than one-half the borrowing cost of World War I. If this had not
been done, the interest charge at the present time would be more than $10,000,000,000 a year instead of $5,000,000,000 a year. It is clearly evident that this
$5,000,000,000 annual saving in the taxpayer's money is a highly important factor
in the budget picture of the Federal Government. 10

(2) The maintenance of relatively stable prices on Governments
helps to maintain confidence in the public credit and facilitates Treasury sales of securities*for both new financing and refunding purposes:
This looms important to the Treasury, with about $50,000,000,000
of its marketable debt maturing within a year and with large volumes
of outstanding nonmarketable issues, especially savings bonds, payable on demand. (3) The maintenance of stable security prices
protects investors against capital depreciation and prevents any loss
of public confidence in financial institutions, including banks, that
might result from a serious decline of these prices. (4) Any marked
decline in the price of Governments would be communicated to other
parts of the credit market and might bring about unemployment and
deflation by interfering with the flotation of new private securities.
And (5) any feasible rise of the yields on Governments would be so
ineffective as an anti-inflationarv measure as not to be worth its cost.
Though Federal Reserve and Treasury officials, and especially the
latter, seem to have been greatly influenced by the objectives of
holding down the service charges on the Federal debt and of facilitating
Treasury security flotations it is well to remember that there were
also other considerations behind the postwar policy, such as those
relating to protecting individual and institutional investors against
capital depreciation, prevention of a financial panic, and avoidance of
restrictive policies that would be so vigorous as to reduce employment
and production.
The principal argument against a monetary policy of preventing or
narrowly limiting the increase of yields on Governments is that it
seriously limits, if it does not completely prevent, the use of restrictive
monetary policy as an instrument for combating inflation. It is no
hindrance to the use of a liberal monetary policy to fight deflation and
unemployment; the very same low-interest, easy-money policy that
will be conducive to business recovery also holds down service cnarges
on the Federal debt and facilitates security sales by the Treasury.
» Monetary, Credit, a n i Fiscal Policies, p. 9.

MONETARY, CREDIT,'.AND FISCAL'POLICIES

But in periods of inflation the objective of preventing or narrowly
limiting increases of . yields on Governments may conflict directly
with that of combating inflation: the former objective requires a
policy of continued easy credit and low interest rates while the latter
requires a lessened availability of credit accompanied by higher
interest rates.
That the Federal Reserve is powerless to restrict credit in general
while maintaining low yields on Governments is brought out by, two
facts: (1) All holders of Governments, both individual and institutional, retain complete freedom to buy or to sell at will any or all of
these securities, of which their holdings are tremendous. At their
own option they may sell these securities to acquire money to spend
for consumption, to finance capital purchases, or to lend to others.
Any tendency for interest rates on private obligations to rise relative
to those on Governments tends to induce investors to sell Governments
in order to make funds available to private users. And (2) in order
to prevent yields on Governments from rising above any given level
the Federal Reserve must stand ready to buy at those yields all the
Government securities that others do not wish to hold. In this way
all holders of Governments, not merely member banks, are given
access to new money from the Federal Reserve. They get this money
by selling Governments, and the cost of the money to them is the
yield that they sacrifice on the securities sold. Thus for the Federal
Reserve to maintain low yields on Governments by passively purchasing them in unlimited quantities is to assure that money for other
uses will continue to be cheaply available in large amounts.
Such a policy of maintainirg low yields on Governments negates or
seriously reduces the effectiveness of every Federal Reserve instrument for general credit restriction. (1) Open market operations are
likely to be useless; the Federal Reserve is not free to refuse to buy
or actually to sell Governments in order to restrict credit in general
but must purchase these securities in such amounts as are required to
prevent undesired rises in their yields. Even if the Federal Reserve
should sell Governments in an attempt to restrict credit it would be
compelled, under this policy, to buy them back again to prevent a
rise of yields. (2) Increases in Federal Reserve discount rates are
likely to be largely ineffective as positive restrictive measures, for
banks will not need to borrow so long as they can secure funds at will
by selling Governments to the Federal Reserve. Even the psychological effects of increases in discount rates are much reduced by the
fact that banks are largely out of debt to the Federal Reserve and
know that they can remain so. (3) The restrictive-effects of increases
in member-bank reserve requirements are greatly reduced by the fact
that the banks can easily repair their reserve positions and restore
and even expand their lending power through the sale, at their own
option, of Governments to the. Federal Reserve.
It appears to us impossible to prescribe by legislation highly specific
rules to guide the determination of monetary and debt management
policies, for it is impossible to foresee all situations that may arise in
the future. The wisest course* for Congress to follow in this case is
to lay down general objectives, to indicate the general order of importance to be attached to these various objectives, and to leave more
specific decisions and actions to the judgment of the monetary and
debt management officials. We believe that specific policies should

MONETARY, CREDIT,'.AND FISCAL'POLICIES

conform to the following broad principles: (1) They should prevent
"disorderly" movements in the prices and yields of Governments while
avoiding the maintenance of such inflexibly low yields as to reduce
seriously the effectiveness of monetary policy for anti-inflation purposes. A few people, but apparently only a very small minority, have
argued that the Federal Reserve ought never to enter the market to
influence the behavior of prices and yields on Governments. This
position is, we believe, untenable. It is a central function of the
Federal Reserve to influence the behavior of yields in general, and
the behavior of yields on more than $250,000,000,000 of securities, making up more than half of all public and private debt in this country;
can hardly be ignored. The Federal Reserve should prevent not only
panicky declines in the prices of these securities but also other disorderly, erratic, and overly rapid changes. A part of the technique
of central banking is to avoid excessively harsh restrictive measures.
Declines of the magnitude that occurred after World War I, when
long-term Governments fell to about 80, serve no useful purpose. On
the other hand, the Federal Reserve and the Treasury should not
allow their concern for holding down yields and supporting the prices
of Governments to prevent a vigorous use of restrictive monetary
policy to combat inflation: To continue to maintain an easy availability of credit at low interest rates in the face of inflation is not to be
neutral; it is to feed the fires of inflation. (2) The advantages of
avoiding inflation are so great that they should be pursued even if
the cost is a significant increase in the service charges on the Federal
debt and a greater inconvenience to the Treasury m its sale of securities for new financing and refunding purposes. In general, the
Government ought not to use its monetary policy to maintain easy
credit and to facilitate the management of its own debt if that monetary policy is not conducive to the maintenance of general economic
stability. Exceptions to these principles should occur only at times
of serious national emergency. In emphasizing the desirability of
using a restrictive monetary policy, which must entail some rise of
interest rates, to combat future inflations we are not arguing for a
secularly higher interest rate structure. There is good reason to
believe that secularly low interest rates will be in the national interest for they will stimulate private capital construction. We favor
interest rates as low as they can be without inducing inflationary
pressures. But flexibility of interest rates, without which a flexible
monetary policy is impossible, should be restored.
Also involved in this broad problem of the relationship between
monetary and debt management are questions relating to the division
of authority. Who should determine and administer these policies?
The traditional position in this country has been that power and
responsibility for monetary policy should be lodged in the independent" Federal Reserve System, which though accountable to Congress
should not be responsible to the executive branch. To assure the
maintenance of this independence the members of the Board of
Governors were given 14-year terms, the Secretary of the Treasury
and the Comptroller of the Currency were removed from the Board,
and a certain amount of decentralization of authority within the
Federal Reserve System was continued. On the other hand, power
and responsibility for debt management within very broad limitations
laid down by Congress is delegated to the Treasury Department. In

MONETARY, CREDIT,'.AND FISCAL'POLICIES

theory, therefore, the Federal Reserve exercises the powers of monetary
management while the Treasury exercises the powers of debt management But this is hardly a realistic description of the actual location
of these powers. The Federal Reserve has always exercised an influence on debt management policies through its general monetary policies
and in recent years, as noted above, monetary management has been
an integral part of debt management. Moreover, the Treasury has
monetary control powers; it can tend to ease or tighten the money
market by shifting its general balance from the Federal Reserve banks
to commercial banks and vice versa, its purchases and sales of securities for the account of its trust funds have general effects similar to
those of Federal Reserve open-market operations, and at times in the
past it has had discretionary powers relative to gold and silver. But
in recent years the Treasury has exercised its greatest influence on
monetary policy through its debt management policies, and especially
through its power to fix the various terms, including interest rates, on
ts new issues.
As a practical matter there will be at any time an approximate
equality between the yields fixed by the Treasury on its new offerings
and to market yields on comparable outstanding Treasury issues, the
latter reflecting the general monetary policy being followed by the
Federal Reserve. The Treasury will not be able to sell its new issues
at yields below the market yields on comparable issues already outstanding, and it is not likely to offer significantly higher yields on the
new issues. But who determines the levels at which the yields on the
outstanding and new issues will be equalized—the Federal Reserve or
the Treasury? Do Federal Reserve officials determine the general
level of interest rates, including yields on Governments, that they will
establish so that the Treasury in fixing rates on new issues must conform to the decisions of the Federal Reserve? Or do Federal Reserve
officials conform their general credit policies, including their support
levels for Governments, to the pattern desired by the Treasury? The
evidence presented to the subcommittee indicates that there is no
simple answer to these questions. Federal Reserve and Treasury
officials and staff members are in frequent consultation, and many
decisions are agreed upon by the two agencies without marked differences of opinion. On some occasions when there were originally
differences of opinion the Treasury has "gone along" with Federal
Reserve requests for higher interest rates. But the evidence indicates
that in a majority of the cases where the judgments of the two agencies
differed it was the judgment of the Treasury that prevailed; the Federal Reserve was not willing to assert its independence and force
market yields to rise above the yields that the Treasury wished to
set on its new issues, thereby embarrassing the Treasury. It appears
that in the absence of strong Treasury influence the Federal Reserve
would have initiated a tighter monetary policy somewhat earlier and
that this policy would have been carried further. Allan Sproul, who
as president of the Federal Reserve Bank of New York and vice
chairman of the Federal Open Market Committee participated in
negotiations with the Treasury, offered this testimony at our hearings:
It is important that better means be found, if possible, for reconciling potential
differences between the Treasury and the Federal Reserve System, so tnat action
in the credit sphere may be taken promptly, as needed, in reasonable harmony with
the action being taken by the Treasury in the sphere of debt management.

MONETARY, CREDIT,'.AND FISCAL'POLICIES

The record of cooperation in the postwar years has been better than, might
have been expected, and so has the record of our economy, whatever connection
there majr be between the two. But agreed action, in my opinion, has most often
been too little and too late, so far as the aims of an effective monetary program were
concerned.
For example, the System wanted to discontinue its preferential discount rate
on Government securities maturing within 1 year, before the end of 1945; Treasury
acquiescence, and the action, did not come until April 1946.
From the closing months of 1945 through all of 1946, the System was pressing
for discontinuance of its artificially low buying rate—three-eighths of 1 percent—
on Treasury bills; the action finally came, with Treasury agreement, in July 1947.
From that point on, as inflationary pressures increased, the System wished to
follow a program of credit restraint which would have necessitated small but,
perhaps, frequent increases in short-term interest rates which would have meant
similar increases in rates on Treasury bills and certificates, and some increase in
the yield of other short and intermediate Government securities.
The Treasury did a large part of the job, of course, by devoting its substantial
cash surpluses to the retirement of debt in such a manner as greatly to aid in
achieving the common objective; but the Treasury was generally several months
behind in accepting the implications of a tightening policy for the interest rates on
its short-term securities.

The general thesis of the following statement to the subcommittee
by Marriner Eccles, a member of the Board of Governors and formerly
its Chairman, appears to be justified.
The Treasury * * * is not responsible to Congress for monetary and
credit policy and has had for a long time general easy-money bias under almost
any and all circumstances. As long as the Federal Reserve policy must be based
upon this criterion, it could not pursue a restrictive money policy to combat
inflationary pressures.
Decisions regarding management of the public debt set the framework within
which monetary and credit action can be taken. As the size of the debt grew
through the period of deficit finance in the thirties and particularly over the war
period, Treasury needs came to overshadow and finally to dominate completely
Federal Reserve monetary and credit policy. When the Treasury announces the
issue of securities at a very low-rate pattern during a period of credit expansion,
as it did last Wednesday, the Federal Reserve is forced to defend these terms
unless the System is prepared to let the financing fail, which it could not very
well do. To maintain a very low-rate pattern .when there Is a strong demand for
credit, the System cannot avoid supplying Federal Reserve credit at the will of
the market.
Under these conditions it can hardly be said that the Federal Reserve System
retains any effective influence in its own right over the supply of money In the
country or over the availability and cost of credit, although these are the major
duties for which the System has statutory responsibility. Nor can it be said
that the discount rate and open-market operations of the System are determined
by Federal Reserve authorities, except in form. They are predetermined by
debt-management decisions made by the Treasury. This will be true as long as
the System is not in a position to pursue an independent policy but must support
in the market any program of financing adopted by the Treasury, even though
the program may be inconsistent with the monetary and credit policies the
System considers appropriate in the public interest.

There have been many proposals for altering the division of authority and responsibility for monetary and debt management in the interest of securing more appropriate policies. These range all the way
from proposals that all monetary and debt-management powers be
lodged in the Treasury or in a newly created department of money and
finance directly responsible to the Government to proposals that all
these powers should be lodged in the Federal Reserve. We do not
favor either of these extreme proposals. We oppose the concentration of all these powers in the Federal Reserve primarily because we
doubt the wisdom of placing one authority in the position of borrower
and of determiner of the monetary and credit conditions under which

MONETARY, CREDIT,'.AND FISCAL'POLICIES

its borrowing will be done, but also because it seems inappropriate to
entrust the technical details of managing the debt to an independent
agency. We oppose concentration of all these powers in the Treasury,
or in a new department responsible to the President, because we fear
that considerations relating to service charges on the Federal debt
and to the ease of refunding would be weighed too heavily and would
create a bias toward inflexibly low interest rates' and continuously
easy money. Moreover, we see only a limited value in proposals designed merely to bring Federal Reserve and Treasury officials into
frequent consultations; such consultations already occur.
We recommend that three general methods be employed to secure
more appropriate monetary and debt-management policies. In the
first place, every effort should be made to build up the quality and
prestige of Federal Reserve officials. Measures for this purpose
should include (a) decreasing the number of members of the Board of
Governors from seven to not more than five in order to make the
position attractive to more capable men and to lessen the temptation
to appoint men of lesser stature, and (6) raising the salary of the
Chairman of the Board of Governors to the same level as the salaries
of Cabinet members—namely, $22,500—and raising the salaries of other
Board members to $20,000 a year. Inability to extend such salary
increases to certain other officials engaged in bank^supervision and
examination should not be allowed to prevent Board members from
receiving salaries more commensurate with the importance of their
functions.
In the second place, we recommend that Congress by joint resolution issue general instructions to the Federal Reserve ana the Treasury
regarding the objectives of monetary and debt-management policies
and the division of authority over these policies. These instructions
need not, and in our judgment should not, be detailed; they should
accomplish their purpose if they provide, in effect, that, (a) in determining and administering policies relative to money, credit, and
management of the Federal debt, the Treasury and the Federal
Reserve shall be guided primarily by considerations relating to their
effects on employment, production, purchasing power, and price
levels, and such policies shall be consistent with and shall promote the
purposes of the Employment Act of 1946; and (6) it is the .will of Congress that the primary power and responsibility for regulating the
supply, availability, and cost of credit in general shall be vested in
the duly constituted authorities of the Federal Reserve System, and
that Treasuiy action relative to money, credit, and transactions in
the Federal debt shall be made consistent with the policies of the
Federal Reserve. We believe that the issues involved here are of
such great importance to the people of the United States that ConKess should at this time give these further instructions to the Federal
eserve and the Treasury to guide them in the performance of their
functions.
In the third place, we recommend that the Secretary of the Treasury and the Chairman of the Board of Governors of the Federal
Reserve System be made members of the National Monetary and
Credit Council which we recommend elsewhere in this report.
The "independence" of the Federal Reserve does, of course, create
possibility that the Federal Reserve System might follow policies
which were directly at variance with important policies of the execu

MONETARY, CREDIT,'.AND FISCAL'POLICIES

tive department and. which might tend to defeat an over-all economic
program that met the approval of a majority of the Amei lean people.
In practice, however, this is not a real danger, and seriously adverse
effects from any such development can be guarded against without
making the Feaeral Reserve System more directly responsible to the
executive department. Federal Reserve officials are kept fully informed as to the Government's policies; the executive department is
perfectly free to make its views and wishes known to the Federal
Reserve, and Congress can always use its investigatory and legislative
powers to bring about a change in Federal Reserve policies if these
should at any time prove to be seriously at variance with important
national policies.
The effectiveness of monetary and debt-management policies in
simultaneously maintaining relatively stable price levels and maximum
production and employment is greatly influenced by the appropriateness of other economic policies, and especially those relating to prices
and wages. For example, widespread monopolistic increases in
prices and a widespread insistence upon unduly large increases in
money wage rates could make it impossible for the monetary authority
both to maintain relatively stable price levels and maximum production and employment. If in the face of such price and wage policies
it refused to supply more money and credit to finance a rise of price
levels, it might produce unemployment. And if it supplied the
additional money and credit needed to maintain maximum employment and production it might be financing an upward spiral of prices.
The monetary authorities may face such a dilemma in the future
unless the attitudes of employers and employees are such that wage
and price bargains can be arrived at within the framework of a relatively stable general price level.
I V . RESERVE REQUIREMENTS OF COMMERCIAL B A N K S *V

1. We recommend that all banks which accept demand deposits, including both member and nonmember banks} be made subject to the same set
oj reserve requirements and that all such banks be given access to loans at
the Federal Reserve banks.
2. Without endorsing any particular plan, we recommend that serious
consideration be given to the Federal Reserve proposal that the present
system oj .member-bank reserve requirements based partly on the size oj
the city in which a bank is located be replaced by a new system oj requirements that would be geographically unijorm but that might require different
percentages oj reserves against different types oj deposits.
Reserve requirements of commercial banks are an essential part of
the monetary-management mechanism. The volume of deposits that
the banks can create and have outstanding at any time is limited by
the dollar volume of legal reserves that they can command and by the
height of their legal-reserve requirements. The monetary authorities
influence the general monetary and credit situation both by regulating
the dollar volume of bank reserves and the terms on w h i c h , these
reserves are made available and by regulating reserve requirements.
There are, however, two aspects of the present system of reserve
11

For the further views of Mr. Wolcott, see footnote 2, p. 2.

33 MONETARY, CREDIT,'.AND FISCAL'POLICIES

requirements to which we wish to draw attention: (1) Banks that are
nonmcmbers of the Federal Reserve do not operate under federally
determined reserve requirements, and (2) the present reserve requirements against demand deposits at member banks are made to 12
depend
on the location of the bank rather than on the type of deposit.
The minimum legal-reserve requirements of banks that are members
of the Federal Reserve System, which include all national banks and
those State banks that elect to join and can meet the entrance requirements, are fixed by the Board of Governors within limits set by Congress. The reserve requirements of the nonmember banks arefixedby
the laws of the 48 States. Thus, as shown by table II, the Federal
Government determines the reserve requirements of about 49 percent
of the banks holding about 85 percent of all deposits, while the 48
States control the reserve requirements of about. 51 percent of the
banks holding about 15 percent of all deposits.
TABLE II.—Commercial banks in the United States; Percentage
banks, by Slates, June SO, 1949 13

State

Mississippi
Georgia
South Carolina.
North Carolina.
Iowa
Tennessee
North Dakota..
Louisiana
Kentucky
Arkansas
Wisconsin
Missouri
Minnesota
Nebraska
Kansas
South D a k o t a . .
Florida.
Alabama
Washington
Oregon
Delaware
Arizona
Maryland
Indiana
Michigan
Rhode Island...

Percent
total
deposits
Percent
Numnon- held by
ber of memnonbanks
ber
member
banks
203
394

150

226
665
295
150
161
385
230
551
416
610
170
190
226
122
69
39

163
4S6
446
19

84.7
83.5
78.0
76.1
75.5
72.2
72.0
71.4
70.9
70.9
70.2
69.9
69.6
65.6
64.8
63.5
61.6
59.7
56.6
56.5
56.4
54.5
52.8
51.6
48.2
47.4

62.0
28.9
32.5
45.4
48.1
22.9
57.4
23.0
37.6
32.1
34.0
21.6
26.9
26.4
36.0
33.8
23.0
18.1
7.9

8.2

33.7
16.5
26.2
27.3
13.7
20.0

Statu

Utah
California
Illinois.
Vermont.
Connecticut
Oklahoma
--—
Maine
West Virginia.
Idaho
Colorado
Texas
Ohio
Virginia
New Mexico
New Hampshire
Wyoming
Nevada
Montana
Pennsylvania..
Massachusetts
District of Columbia
New Jersey
New York
Total

nonmember

Percent
total
deposits
Percent
Numnon- held by
ber of memnonbanks
member
ber
banks
55
204
891
70
114
387
64
179
45
147
898
662
314
50
75
55
8
111
979
183
19
334
648

43:6
43.6
43.2
42.9
42.1
41.9
40.6
40.2
40.0
37.4
36.6
36.0
35.0
32.0
30.7
25.5
25.0
24.3
24.0
21.9
15.8
15.3
12.8

16.5
8.5
9.6
48.1
31.4
14.0
31.4
23.0
13.5
11.0
11.1
11.6
19.3
20.5
32.3
16.3
8.4
13.3
13.5
8.8
6.1
12.5
4.5

14,150

51.2

15.0

The percentages of reserves that may be required against deposits
in member banks under present laws are shown in table III. All of
these legal reserves must be in the form of deposits at the Federal
Reserve banks; no other assets may be counted for this purpose.
" For information and points of view relative to the reserve requirements of commercial banks, see the
testimony offered a t the open hearings by almost all the witnesses; also see Monetary, Credit, and Fiscal
Policies for statements b y the Chairman of the Board of Governors of the Federal Reserve System (pp.
54-56, 58-66), by the presidents of the twelve Federal Reserve banks (pp. 134-142.154-161). and b y bankers,
economists,
and others (PP. 313-321, 327-342).
u
This table was included in the testimony of Thomas B. McCabe, Chairman of tho Board of Governors.

MONETARY, CREDIT,'.AND FISCAL'POLICIES
TABLE III.-—Reserve requirements of member banks
Maximum
Minimum
percentage
percentage
requirement requirement
that may be that may be
set b y the
set b y the
Board of
Board of
Governors
Governors

Demand deposits—
At central Reserve city b a n t s
At Reserve city banks
At other banks (country banks)
Time deposits at all member banks

13
10
7
3

26
20
14
6

The reserve requirements of the nonmember banks, being determined by the widely varied laws of the 48 States, are very difficult to
summarize. In one State there is no legal requirement at all; at the
other extreme axe States with percentage requirements at least as high
as those of member banks. The types of assets that may be counted
as reserves also vary widely among the different States, but in general
the nonmember banks may count their cash in vault, their deposits
with correspondent banks, and in some cases even earning assets such
as Government securities. When all these factors are taken into
consideration, member-bank reserve requirements are on the average
significantly more onerous than those of nonmember banks. In addition to their legally required reserves, all of which must be in the form
of nonearning deposits at the Federal Reserve, business necessity
requires'member banks to hold other nonearning assets in the form
of cash in vault, balances with other banks, and cash items in process
of collection. But the nonmember banks are permitted to count all
of these toward their legal-reserve requirements. As a result, as is
shown in table IV, the actual requirements of nonmember banks are,
on the average, significantly lower than those of member banks.
TABLE IV.—Ratio of cash assets to deposits of all insured commercial banks, by
class of bank, June 80, 1949—Ratios to total deposits 14
Member banks
Central Reserve
city banks
Total
New
York
Cash in vault
Balances due from banks
Cash items in process of collection
Subtotal
Reserves with Federal Reserve b a n k s . . . . .
Total, cash assets

Reserve
city
banks

Country
banks

Insured
nonmember
banks

Chicago

1.3
4.4
5.1

0.5
.3
9.3

0.4
2.5
5.8

1.1
4.0
5.9

2.1
7.2
1.9

2.6
14.7
.6

10.8
15.2

10.1
20.0

8.7
19.3

11.1
15.5

11.2
11.8

17.9

26.0

30.1

23.0

26.5

23.0

17.9

Many have proposed that the existing discrepancies between the
reserve requirements of member banks and those of nonmember banks
should be ended, either by requiring all banks that hold demand
deposits, or at least all such insured banks, to become members of the
» This table was submitted at the hearing by the Chairman of the Board of Governors of the Federal
Reserve System.

MONETARY, CREDIT,'.AND FISCAL'POLICIES

Federal Reserve System or by requiring all of these banks, even the
nonmembers, to hold the same reserves as member banks. Several
arguments are used to support this proposal that all commercial banks,
or at least all insured commercial banks, should be governed by the
same set of reserve requirements: (1) The fact that more than half
of all the banks and about 15 percent of all deposits are outside the
Federal Reserve System and not subject to its reserve requirements
or to changes in these requirements directly decreases the effectiveness
of Federal Reserve policies. (2) The present arrangement is inequitable in that the nonmember banks bear less than their fair share of
the cost of monetary management. The holding of nonearning reserves is in a sense a necessary cost of monetary control, but at the
present time the member banks have to carry more than their fair
share. (3) The lower reserve requirements of nonmember banks in
addition to other less onerous provisions may lead to withdrawals of
banks from the Federal Reserve System; they create ill will and
discontent among member banks, and fear of these adverse reactions
may deter Federal Reserve officials from raising reserve requirements
when this should be done. Among the evidence presented to the
subcommittee by Chairman McCabe to show, that there is a real
basis for these contentions was the following letter from H. G. Leedy,
president of the Federal Reserve Bank of Kansas City:
It is sometimes said that the effectiveness of the Federal Reserve System is not
reduced significantly by the presence of nonmember banks, as member banks hold
85 percent of all bank deposits in this country, leaving only 15 percent not directly
subject to Federal Reserve influence. This statement greatly understates the
problem.
Recently, one of our officers visited with a banker in a small town who is operating a national bank, and therefore a member bank. His competitor across the
street is a State nonmember bank. The national banker indicated that there was
serious question in his mind as to whether he should carry or could afford to carry
the cost of being a member bank when he was trying to compete with an institution across the street that did not have to meet those particular costs. He not
only thought that it was not fair and equitable, but he indicated serious doubt as
t o whether it was good judgment on his part to operate his bank as a member bank
in that kind of competitive situation. This conversation is only one example of a
host of similar conversations that we have had.
Repeatedly, we hear our member bankers raising serious question as to whether
it is either equitable or good judgment for them to incur the additional dollar cost
that is involved in being a member bank, and we hear nonmember banks commonly
giving that increased cost as a reason for not joining the Federal Reserve System.
Recently, a member bank withdrew from the Federal Reserve System, and in a
letter to this bank made the following statement: "In this action we want to assure
you that there is absolutely no ill feeling, as our association and business dealings
have all been most pleasant, but it was thought that keeping such a large reserve
with the Federal Reserve worked quite a hardship on us, and precluded our investing State and county funds in bonds, as we are required to keep the reserve with
you on such deposits."
We also must recognize that part of the effectiveness of Federal Reserve credit
action stems from the indication it gives of the viewpoint of the monetary authorities with respect to credit developments. An increase in member-bank reserve
requirements, for example, not only immobilizes part of a member bank's reserves
but it also makes the member bank acutely conscious of the fact that the Federal
Reserve officials think that credit expansion should be restrained. This in itself,
I am convinced, tends to make member banks more selective in their extension of
credit to customers. On the other hand, nonmember banks not only do not have
that additional part of their reserve immobilized, but the Federal Reserve's expression of its attitude with respect to further credit expansion has little effect
upon the nonmember banks' lending policy. In our Federal Reserve district, with
1,009 nonmember banks as compared with 759 member banks, this means that the
lending policy of the vast majority of banks, and in some areas of the district nearly
all banks, are affected little, if at all, by Federal Reserve credit actions.

MONETARY, CREDIT,'.AND FISCAL'POLICIES

The proposal to bring all commercial banks, or at least all of these
banks that are insured, under the same set of reserve requirements is
opposed on several grounds: (1) It is not necessary for effective monetary control; the Federal Reserve already has control over the reserve
requirements of banks holding 85 percent of total deposits. (2) For
the Federal Government to impose such requirements on State banks
that do not elect to join the Federal Reserve would be a violation of
States' rights and a threat to the dual banking system. (3) In fact,
very few hanks have withdrawn from the Federal Reserve because of
its higher reserve requirements. (4) The imposition of such reserve
requirements on nonmember banks would injure the large city banks
by reducing interbank deposits. And (5) the present arrangement is
a check on the imposition of "excessively high" reserve requirements
on member banks, for Federal Reserve officials will be deterred from
such a course by their fear of losing members and their feeling that
such action would be inequitable to their members.
Without taking any position as to what the ultimate decision
should be, we do not at this time recommend that all commercial
banks, or even all insured commercial banks, should be required by
law to become members of the Federal Reserve System. This question is part of a much broader one that we recommend for thorough
study. We do, however, recommend that all banks that accept
demand deposits, including both member and nonmember banks, be
made subject to the same set of reserve requirements and that all such
banks be given access to loans at the Federal Reserve banks. We do
not believe that such a requirement would in any way threaten either
States' rights or the continuance of the dual banking system. The
States would retain their right to charter and supervise banks, and
the banks would be able to meet the reserve requirements and still
prosper, iust as State-chartered banks that elected to join the Federal
Reserve have done in the past. The extension of these requirements
would enhance the effectiveness of Federal Reserve policies and would
remove unwarranted limitations on the justified use of Federal Reserve
powers. The granting of access to Federal Reserve credit, which is
the ultimate source of liquidity in time of strain, to nonmember as
well as member banks would serve a very useful purpose not only in
periods of crisis but also during periods of recession. This would be
useful to the economy as a whole as well as to nonmember banks.
Another aspect of reserve requirements to which we wish to call
attention is the geographical basis of member bank, reserve requirements against demand deposits (see table III above)* The height of
the requirement depends not on the type of deposit but on the size
of the city in which the bank is located. This basis for graduating
reserve requirements was carried over from the pre-1914 laws governing national banks, and the original justification was that country
banks held few deposits for other banks, that many banks located in
larger cities held deposits of country banks, and that a big majority
of the banks in the largest cities held deposits of both country banks
and banks located in reserve cities. The present reserve provisions
are subject to criticism on two counts. In the first place, net movements of deposits between banks with different levels of reserve requirements can produce an unwanted tightening or loosening of credit.

MONETARY, CREDIT,'.AND FISCAL'POLICIES

And in the second place, banks of similar size and doing similar types
of business may be subject to quite different reserve requirements.
For example, a small bank located in New York or Chicago and holding
no deposits of other banks must hold reserves almost twice as large,
percentagewise, as a similar bank located in any city that has not been
designated as a central reserve or reserve city bank. And a country
bank which does hold deposits of other banks is required to hold only
about half as large reserves as are required of a similar bank located in
a central reserve city. For some time the Federal Reserve has been
studying proposals that would abolish the present system of reserve
requirements based on the geographic location of banks and substitute
a system of geographically uniform requirements based on the type of
depositors. For example, there might be one requirement against
interbank deposits, another against other demand deposits, and
another against time deposits. Without endorsing any particular
plan, we believe that the general idea behind the proposal has merit
and that it should be given serious consideration.
V . FEDERAL

CHARTERING, SUPERVISION, AND
COMMERCIAL B A N K S

EXAMINATION

We recommend a thorough and complete study of the broad question of
Federal chartering, supervision, and examination of commercial banks,
including not only the organization and coordination of the Federal
agencies performing these functions but also the substance and applicarbility of the relevant Federal laws and regulations.
Federal activities in the chartering, supervision, and examination
of commercial banks are divided among three Federal agencies with
overlapping jurisdiction—the Comptroller of the Currency, the
Federal Reserve, and the Federal Deposit Insurance Corporation.
Owing to voluntary agreements among these agencies and the 48 State
supervisoiy authorities there is less confusion and duplication of
effort than might be expected from such overlapping jurisdictions;
nevertheless, there is evidence that a thorough study is needed. The
present arrangement, though not without its merits, involves an
undetermined amount of waste because of duplication of facilities and
supervisory personnel; it does not promote the development of
uniform supervision and examination policies, and there is evidence
that on some occasions the different agencies have been guided by
different concepts as to the purpose of bank supervision and examination; it does not facilitate coordination of policies; and there is evidence
of interagency rivalry of types that do not contribute to the development of a better banking system.
The study should also cover the substance and applicability of the
relevant Federal laws and regulations. The substance of these laws
and regulations have long needed an over-all review, and the method
of determining their applicability should also be studied at length.
Under the present plan, only a relatively small number of Federal
banking laws and regulations apply to all classes
of banks regardless
of their classification. (See IV in table V.) 1

MONETARY, CREDIT,'.AND FISCAL'POLICIES

TABLE V. : —Some of the - principal provisions of Federal statutes regulating
principal classes of banks

the

I. Applicable only to national banks:
1. Restrictions on real-estate loans.
2. Regulations governing the exercise of trust powers.
3. Restrictions on acting as insurance agent.
4. Restrictions on acting as real-estate loan broker.
5. Requirement that one-tenth of earnings be transferred to surplus
until surplus equals common capital.
6. Prohibition against holding other real estate for more -ban 5 years.
7. Restrictions on absorption of another bank.
8. Limitations on indebtedness which bank may incur.
II. Applicable only to national banks and to State banks that are members of
tne Federal Reserve:
1. Limitations on total loans to one borrower. (State member bank
loans to one borrower are not subject to the limitations applicable
to national banks, but loans in excess of the limits applicable to
national banks are not discountable at the Federal Reserve.)
2. Regulations governing purchase of investment securities.
S. Prohibition against purchasing stocks.
4. Prohibition against engaging in underwriting of investment securities and stocks.
5. Restrictions on loans to executive officers. _
6. Restrictions on dealings with directors.
7. Restrictions on interlocking directorates or other interlocking
relations with other banks and with securities companies.
8. Prohibition against bank having less than 5 or more than 25
directors.
9. Provision authorizing supervisory authority to remove officers and
directors for continued violations of law or continued unsafe or
unsound practices.
10. Prohibition against- affiliation with securities company.
11. Restriction on holding companies affiliates.
12. Restrictions on bank stock representing stock of other corporations.
13. Limitations on loans to affiliates.
14. Requirements of reports of affiliates and publication thereof.
15. Requirements for examination of affiliates.
16. Limitations on investment in bank premises.
17. Minimum capital requirements.
18. Minimum capital requirements for branches.
19. Prohibitions against loaning on or purchasing own stock.
20. Restrictions on withdrawal of capital and payment of unearned
dividends.
21. Requirement that reserves specified in the Federal Reserve Act be
maintained.
22. Requirement for specific number of condition reports annually and
for publication thereof.
23. Requirements in connection with the par clearance collection system.
24. Prohibition against false certification of checks.
25. Limitations on acceptance powers.
26. Prohibition against acting as agent for nonbanking institutions in
making loans to brokers and dealers in securities.
27. Limitations on loans to one borrower on stocks or bonds.
28. Limitations on aggregate loans to all borrowers on stocks or bonds.
29. Limitations on deposits with nonmember banks.
III. Applicable to national banks, State member banks, and nonmember banks
insuring their deposits with the FDIC:
1. Requirement for approval of establishment of branches.
2. Restriction on consolidating or merging with noninsured bank,
assuming liability for such bank's deposits, or transferring assets
to such bank for assumption of deposits.
3. Restrictions on payment of interest on deposits.
4. Restriction on paying time deposits before maturity or waiving
notice before payment of savings deposits.

MONETARY, CREDIT,'.AND FISCAL'POLICIES

TABLE V.—Some of the principal provisions of Federal statues• regulating
principal classes of
banks—Continued

the

III Applicable to national banks, State member banks, and nonmember banks
insuring their deposits with the FDIC—Continued
5. Prohibition against payment of dividends while delinquent on deposit insurance assessment.
6. Prohibitions against loans or gratuities to bank examiners.
7. Provision authorizing supervisory authority to publish examination
report if bank does not follow recommendations based thereon.
8. Provision authorizing supervisory authority to- require that banks
provide protection and indemnity against burglary, defalcation,
and similar insurable losses.
IV Applicable to all banks:
1. Provisions regulating loans for the purpose of purchasing or carrying
securities registered on national securities exchanges.
2. Laws granting certain tax advantages in connection with, the operation of a common trust fund if operated in conformity with the
regulations of the Board of Governors.
Source: Based on a chart in Banking Studies, a publication of the Board of Governors of the Federal
Reserve System.

Most of them become applicable only if a bank voluntarily elects to
submit itself to them. For example, if a bank elects to operate under
a national rather than a State charter it subjects itself to all the items
under I, II; III, and IV in this table, for a national bank is required
to join the Federal Reserve and the Federal Deposit Insurance
Corporation. It can, however, escape the Federal rides under I by
taking out a State charter and by the same action retain its freedom
to determine whether to subject itself to II and III. Likewise, a
State-chartered bank can avoid the rules under II by electing not to
become a member of the Federal Reserve, and it can avoid the rules
under III by electing not to join the Federal Deposit Insurance
Corporation. This system under which a bank itself determines
which Federal laws and regulations will apply to it merits a review.
But even if this general system is found to be desirable, there remain
questions regarding the reasonableness of the present applicability of
specific Federal laws and regulations. For example, II of this table,
which indicates the principal Federal provisions to which a bank subjects itself by electing to join the Federal Reserve, contains many
requirements that are only remotely related to general monetary and
credit control but which are designed to promote bank safety and
liquidity, to assure a fair distribution of credit, and to maintain
competition and prevent monopoly in banking. It is not at all clear
why these provisions should be attached to membership in the Federal
Reserve rather than to membership in the Federal Deposit Insurance
Corporation which should have a special interest in promoting bank
safety and liquidity. The present arrangement seems to imply that
monopoly among banks that are not members of the Federal Reserve
is not objectionable, and it gives rise to many cases in which banks
have enough capital and are safe enough to have their deposits insured
by the Federal Deposit Insurance Corporation but still cannot meet
the stricter requirements for membership in the Federal Reserve.
There seems to be no justification for this, or for a number of other
similar results of the present provisions. We believe, therefore, that a
thorough study is needed.

MONETARY,
VI.

CREDIT,'.AND

FISCAL'POLICIES

M O N E T A R Y P O L I C Y R E L A T I V E TO S I L V E R

We recommend thai the United States Government cease buying silver
for monetary purposes.
Table VI shows that since 1933 the Government has purchased
for monetary purposes 2 , 7 3 6 , 8 0 0 , 0 0 0 ounces of silver at a total cost of
$1,509,400,000,
Though a major part of this silver was purchased
abroad and a small part represents nationalized silver that was being
held in this country at the time of the Silver Purchase Act of 1934,
nearly a fifth of it by volume and over a quarter of it by cost to the
Government represents newly mined domestic silver, and only newly
mined domestic silver has been purchased since 1942. At all times
the price paid by the Treasury for newly mined domestic silver has
been significantly above the price it paid for other silver. The average prices per ounce paid for the nationalized and foreign silver were
50 cents and 50.1 cents, respectively, while the prices paid for newly
mined domestic silver have been as follows:
Period: *
1 9 3 4 - A p r . 9, 1 9 3 5
Apr. 9 - 2 3 ; 1935
Apr. 2 3 , 1 9 3 5 - D e c . 3 1 , 1 9 3 7
D e c . 3 1 , 1 9 3 7 - J u l y 1, 1 9 3 9 .
J u l y 1, 1 9 3 9 - J u l y 2, 1 9 4 6
J u l y 2, 1 9 4 6

Price per
ounce
< cent
64. 6 4
71.11
77. 5 7
64. 6 4
- 71.11
90. 50

It is clear that the Government's silver purchase policy has represented a subsidy to silver producers and that the full amount of the
subsidy is not indicated by the difference between the Treasury purchase price for newly mined domestic silver and the price of silver in
the market, for in the absence of Treasury purchases the market price
itself would have been lower.
TABLE V I . — S i l v e r production

the United
Government

States

and

silver

purchases

the

[In millions]
Silver acquired by U. S. Government
SUver
producTotal
Newly mined
tion
Nationalized
Foreign
domestic
in the
silver
silver
silver
United
States
(ounces) Ounces Dollars Ounces Dollars Ounces
Dollars Ounces Dollars

Year

193 4
193 5
193 6
1937
1038
1939
1940
1941
1942
1943
1944
1945
1946
19471918

Total A

32.5
45.6
63.4
71.3
61.7
63.9
67.0
71.1
55.9
40.8
35.7
29.3
21.4
36.1
36.1

21.8
35.0
61.1
70.6
61.6
60.7
68.3
70.5
47.9
5.5

14.1
27.3
47.3
54.6
42.4
40.1
48.5
50.1
34.0
3.9

.9
4.9
30.3
36.8

.6
4.4
27.4
33.3

731.8

578.9

428.0

Source: Treasury bulletins.

110.6
2.0
.4

113.0

55.3
1.0
.2

172.5
494.4
271.9
241.5
355.4
282.8
139.8
72.6
14.3

304.9
534.3
333.4
312.2
417.1
343.3
208.0
143.1
62.1
5.5

155.9
346.5
197.8
163.3
199.1
160. e
99.4
77.2
40.0
3.9

.9
4.9
30.3
36.8

.6
4.4
27.4
33.3

56.5 2,045.2 1,025.1 2,736.8

1,609.4

86.5
318.2
150.3
108.7
156.9
120.fi
£0.9
27.1
6.0

MONETARY,

CREDIT,'.AND

FISCAL'POLICIES

Under present laws the Treasury is required to purchase at 90.5
cents an ounce all newly mined domestic silver that is offered to it,
and since this price is considerably above the market level of 70-73
cents, practically the entire domestic output is going to the Government. Only a veiy small part of this purchase suver is used to supply
the public's demand for subsidiary silver, coins and silver dollars;
most of it is used as a basis for issuing additional paper money in
the form of silver certificates. In the very process of buying the
silver and issuing new money in exchange for it the Treasury tends to
add to the volume of bank reserves and to expand credit, for in the
absence of a demand on the part of the public for more coin and
currency the new paper money will flow to the Federal Reserve
banks and be added to member bank reserves.
The present monetary policy relative to silver is objectionable on
several grounds. (1) It is unnecessary. The Federal Reserve already has the power to expand the money supply, including both
paper money and deposits, far beyond any needs that are now expected to arise. The issue of silver-based money tends to lessen the
issue of monej^ by the Federal Reserve, which reduces Federal Reserve
bank net earnings and also Federal Reserve payments of net earnings
to the Treasury. This indicates the error in the argument of those
who defend the silver purchase program by saying: "It doesn't cost
the Government anything; actually the Government makes a profit
equal to the seigniorage." The fact is, however, that if the silver
were not purchased the Government could issue other types of paper
money instead of paper money in the form of silver certificates and
thereby profit on the entire amount of the issue rather than on only
the seigniorage. The silver purchase program is a net expense to
the Government. (2) It is continuously expansionary and in practice
irreversible. The Treasury must buy all silver offered to it and issue
new money at all times, during inflation as well as under other conditions. Not only is the Treasury prevented from selling silver freely
in order to exert an anti-inflationary effect, it is not even permitted
to cease these expansionary purchases in the midst of inflation.
(3) Even as a subsidy program it is defective. It grants aid to producers without any test as to whether aid is needed, it finances the
aid during all phases of the business cycle in the most expansionary
way possible, and it locks up the subsidized production in the monetary system and makes it unavailable for industrial, artistic, and other
uses."
VII.

T H E R E S T O R A T I O N OF A G O L D - C O I N S T A N D A R D I N T H E U N I T E D
STATES

We believe that to restore the free domestic convertibility of money into
gold coin or gold buttion at this time would militate against, rather than
promote, the purposes of the Employment Act, and we recommend that
no action in this direction be taken. We also recommend a thorough
congressional review of existing legislation relating to the power to change
the price of gold with a view to repealing any legislation that might be
so construed as to permit a change in the price of gold by other than
congressional action.
14
The committee print. Monetary, Credit, and Fiscal Policies, contains statements on silver by the
Secretary of the Treasury (p. 12), the Chairman of the Board of Governors of the Federal Reserve (p. 52),
the presidents of the 12 Federal Reserve banks (pp. 131-132), and a number of economists, bankers, and
others (pp. 353-357).

MONETARY, CREDIT,'.AND FISCAL'POLICIES

Since 1934 the United States has been on an international gold
bullion standard; gold may be held or dealt in only in accordance with
rules prescribed by the Secretaiy of the Treasury, but in practice the
Treasury sells gold freely to meet all bona fide demands for domestic
industrial, commercial, and artistic purposes, and it provides gold for
export to the extent necessary to prevent the dollar from declining in
foreign-exchange markets. It does, however, place some limitations
on gold exports and it prohibits the use of gold domestically for monetary or hoarding purposes. Some have proposed the reestablishment
of an unlimited gold-coin standard; they would require the Government to provide unlimited redeemability of its money into gold and
to remove all limitations on holding and dealing in gold. This proposal is usually supported by the following principal arguments: (1)
Only a money that is freely redeemable in gold is an "honest" money.
(2) To restore free redeemability would restore to the people of the
countiy an effective method of preventing monetary and fiscal abuses
by the Government. In a statement presented to the subcommittee,
Prof. Walter E. Spahr put this argument in the following terms:
Redeemability gives every individual with dollars the opportunity, to the extent
of his purchasing power, to get the standard metal if he prefers that to the promises
to pay it. This enables him to exercise some control over the use by his Government and banks of the people's gold and over the amount of promises these agencies
may issue. If either or both issue promises to an extent that invites lack of confidence, every individual, to the extent he has dollars, can express his lack of confidence. His demand for redemption is his right, if the promise means anything.
It is his effort to protect his savings against men's uncertain promises. His demand for redemption is a red flag of doubt. If many red flags appear, the banks,
the Treasury, and Congress receive warnings and must call a halt or exercise greater
restraint in their use of the people's money. In this manner redeemability provides a people with control over the Government's use of their purse.
The gold standard with provision for redemption in effect provides a system of
golden wires to every individual with dollars, over which he can send messages of
approval or disapproval to the central signal board. When our Government took
the people's gold and thrust irredeemable promises to pay on them, it cut all these
wires to the central signal box. The people were cut off. The lights went out on
the central signal system and the people were left helpless. Thus absolute control
of the people's gold and public purse passed to their Government. The latter
had freed itself from receipt of signals of disapproval and from any effective chcck.
The spending orgy is the result. Vote buying goes on and can go on without let or
hindrance. The people are helpless; the Government is the boss; irresponsibility
is in the saddle and it cannot be checked. The understanding, concerned, and
responsible men in Congress are in the minority and are helpless. Government
spending and bureaucracy are out of control. Apparently this course cannot be
brought to a halt except by restoring to our people control over their purse. That
can be done only by the institution of redeemability of the promises to pay of the
Treasury and banks. 16

And (3) for the United States to return to an unlimited gold coin
standard would set a good example for the rest of the world and would
hasten the reestablishment of a world-wide gold standard and of a
system of free multilateral payments in international trade.
An "honest money" in the sense of a money that maintains a
relatively constant purchasing power is essential to the attainment of
the purposes of the Employment Act; maximum production, employment, and purchasing power cannot be continuously maintained over
a period of time if either serious deflation or serious inflation is allowed
to occur. But we do not believe that the restoration of unlimited
convertibility of our money into gold would be either an appropriate
or an effective method of promoting stability of price levels and of
16

Monetary, Credit, and Fiscal Policies, pp. 361-362.

MONETARY, CREDIT,'.AND FISCAL'POLICIES

the purchasing power of the dollar. It probably could not prevent
a serious inflation in this country if other pressures were inflationary.
This is primarily because of this Nation's extremely strong gold position, the almost chronic tendency for gold to flow to our shores, and
the normal unpopularity of gold coin as a medium of payments here.
The monetary gold stock of the United States.has reached the huge
total of about $24,500,000,000, the Federal Reserve banks could more
than double the outstanding volume of their deposits and notes without even suspending their reserve requirements, and the present monetary gold stock could support at least a threefold increase in the
money supply. With the present strength of our international economic position, inflation here could probably reach very serious proportions before we began to lose gold reserves to other countries.
Nor is it at all certain that an internal drain of gold would occur
before the inflation had reached serious proportions. Even before
1933 Americans were not in the habit of using gold coin to any extent
as a means of payments. (See table VII.) Any significant demand
for gold would be a speculative demand based upon fear or hppe that
dollars in general would become inconvertible into gold, and such
hopes or fears would probably not be generated before a high degree
of inflation had already occurred.
TABLE VII.—Gold coin and gold certificates in circulation outside the Treasury and
Federal Reserve banks
[In millions of dollars]

June 30

1914
1920
1925
1926
19271928
1929
1930
1931
1932
1933

...

Gold ooin

323
18S
111
105
98
90
81
70
76
166
»284

Gold certificates

1,026
259
1,005
1,057
1,007
1,019
935
995
997
716
1
649

Gold coin in
circulation as a
Total currency percent of total
plus demand
currency and
deposits
demand deposits
11,615
23,721
24,949
25,601
25,539
25,881
,26,179
25,075
23,483
20,241
19,172

2.8
.8
.4
.4
.4
.3
.3
.3
.3
.8
1.5

* E n d of February.

In short, the restoration of free convertibility of our money into
gold would be neither a reliable nor an effective guard against serious
inflation. For this purpose there can be no effective substitute for
responsible monetary, credit, and fiscal management. There is no
reason to believe that a requirement of redeemability into gold would
promote wise monetary and credit policies; in fact, past experience
indicates that it would at times endanger such policies, for gold drains
can be induced by deflation as well as by inflation. For example,
the internal gold drains and gold hoarding in 1932 and 1933 probably
contributed somewhat to deflationary pressures in this country. We
concur in the following statement by the Chairman of the Board of
Governors of the Federal Reserve System:
An overriding reason against making gold coin freely available is that no
government should make promises to its citizens and to the world which it would

MONETARY, CREDIT,'.AND FISCAL'POLICIES

not be able to keep if the demand should arise. Monetary systems for over a
century, in response to the growth in real income, have expanded more rapidly
than would be permitted by accretions of gold. In the United States today OUT
gold stock, although large, is only 15 percent of our currency in circulation and
bank deposits, and less than 7 percent of the economy's total holdings of liquid
assets. The retention of a gold base is desirable in order to maintain international convertibility, and a gold-standard system has therefore evolved in
which the various forms of money and near money in the country are ultimately
convertible to gold, where that is necessary to meet the country's international
obligations. Return to a gold-coin standard, however, would clearly expose the
economy to the risk of drastic and undesirable deflation a t times of high speculative demand for gold for hoarding, or else the Government would have t o withdraw its promise of gold convertibility. Conjecture as to the possibility of such
a withdrawal would stimulate a speculative demand for gold and might precipitate the event feared. The long-run effect would be to weaken rather than
to strengthen confidence in the dollar.17

The restoration by other countries of the free redeemability of their
moneys into gold coin for internal hoarding as well as for other purposes would delay and hinder, rather than promote, the abolition of
exchange restrictions and the restoration of a system of free multilateral international payments, for it would mean that a part of the
gold reserves of those countries would be drained off into private
hoards and would not be available to meet adverse balances in international payments.
V I I I . D E P O S I T INSURANCE

We recommend that Congress, while considering questions relating to
the base and rate for deposit insurance premiums, <uso study thoroughly
the advantages and disadvantages of increasing the coverage of deposit insurance for the primary purpose of protecting the economy against the
adverse deflationary pressures that would accompany cash withdrawals
from the banking system during any depression period that may occur,
and that no changes in deposit insurance premiums be made until after
the completion of the study.
The insurance of bank deposits by a Federal agency was first
initiated in 1933 at the end of a period in which thousands of banks
had failed, billions of dollars of depositors' money had been lost or
frozen, huge withdrawals of cash had seriously depleted bank reserves,
depositors were afraid to entrust their money to banks, and bankers
were afraid to make loans and reduce their liquidity. Deposit insurance therefore had a multiple purpose: (1) To restore confidence
so that depositors would not only refrain from resuming their runs
on the banks when they reopened but would actually start a return
flow of cash, and also so that bankers would again feel safe in making
loans; (2) to offer full protection to small depositors who could not
be expected to be able to judge the quality of a bank; and (3) to
provide better supervision and examination for the thousands of banks
that were not members of the Federal Reserve System and that displayed a very high failure rate. Thus the original and continuing
!)urpose of deposit insurance is not only to protect depositors against
osses on their accounts but also to improve the quality of banking and
to promote general economic stability by preventing runs on banks
with the attendant drain of bank reserves.
Though the present plan for deposit insurance has contributed to a
strengthening of the banking system it has potentially serious shortcomings as a means of preventing runs on the banking system in times
11

Monetary, Credit, and Fiscal Policies, p. 51.

MONETARY, CREDIT,'.AND FISCAL'POLICIES

of depression. This grows out of the fact that nominally only the
first $5,000 of each deposit account is insured by the FDIC. In
actual practice, however, the , coverage varies with the procedure
followed by the FDIC in handling the affairs of a failed insured bank.
The law provides the FDIC with three alternative procedures in such
cases. (1) It may secure from the Comptroller of the Currency a
charter for a Deposit Insurance National Bank. Such a bank may
not operate.for more than 2 years, it may only pay out and receive
deposits and invest its funds in Governments, and it may not perform
other banking functions; in effect, it is only a paying agent for the
FDIC. When this method is used, and it has been on only one
occasion, only- the first $5,000 of each deposit account is covered by
insurance. (2) It may allow the bank to go into receivership. When
this method is used the FDIC verifies deposit accounts at the bank,
pays each depositor up to a maximum of $5,000, and shares on a pro
rata basis with the unpaid depositors in the amounts realized on the
bank's assets. This method has several disadvantages. The first is
that realizations on the assets of a failed bank may .be small. The
costs of receivership are sometimes large, the disposal of assets at
"forced sale" frequently leads to only small recoveries, and some
borrowers make little effort to meet their obligations when they know
that the bank will not exist as a future source of loans. In the second
place, the liquidation of a bank may leave the community without
any, or with only inadequate bankmg facilities. And in the third
place, the use of this method often means that deposit accounts in
excess of $5,000 are frozen for a considerable period and subject to an
eventual loss. A community may suffer seriously when the deposit
accounts of its business concerns are frozen and partially lost. This
receivership method, though employed during the early period of the
FDIC's operations, has not been used for several years. (3) For a
number of years the FDIC has relied exclusively on the merger
method. Under this power it may make a loan to the bank, or purchase assets from it, or guarantee another insured bank against loss
from the assumption of the liabilities and assets of the bank, provided
that two conditions are met: (a) Such action will facilitate a merger or
consolidation with another insured bank, and (6) in the judgment of
the board of directors of the FDIC the risk of loss to the Corporation
will be reduced or averted. When this method is employed another
insured bank assumes all the liabilities of the bank in difficulty and
is protected against loss by the FDIC. All depositors are fully protected against loss, no deposit account is frozen, and the community
is not deprived of banking power.
. In short, coverage under the present deposit insurance plan depends
on the method used by the FDIC to handle the affairs of an insured
bank in financial difficulties. The coverage is limited to $5,000 for
each account under the receivership method, but there is unlimited
coverage when the merger method is used. And no depositor can
predict which method will be employed if his bank fails. Moreover,
there is no assurance at all that the 100-percent coverage of bank
deposits which has actually been in effect during the*past few yeare
can be continued in a period of depression, for under depressed conditions it might be impossible to find other insured banks that were
willing to assume the liabilities of failed banks, even with FDIC
assistance. A system of deposit insurance with unlimited coverage

MONETARY, CREDIT,'.AND FISCAL'POLICIES

during prosperity and a limit of So,000 for each account in depression
periods cannot promote stability to the maximum. This suggests the
desirability of reviewing the methods of payment and the coverage
of insurance by the FDIC.
Experience during the early 1930's indicates that a $5,000 coverage
may not be adequate to prevent serious runs on the banks during
disturbed periods. The available evidence suggests that large deposit
balances were more responsible than small ones for the crippling cash
withdrawals during the period. An investigation covering 67 banks
which suspended between November 1930 and March 1933 showed:
1. From the time that serious deposit withdrawals began until the date on
which they suspended, the banks included in the survey experienced an average
reduction of almost 40 percent in their deposits.
2. In most of the banks demand deposits showed somewhat larger percentage
reductions than time deposits, and interbank deposits showed much sharper
reductions than either demand or time.
3. A decrease of 70 percent took place in the balances of demand deposit
accounts of $100,000 and over. The magnitude of the percentage decline in
balances tended to decrease in each successively smaller size class, and became
negligible in accounts of less than $200. Large demand deposits were a very
important factor in withdrawals of deposits both because of their proportionate
magnitude and because they were reduced much more sharply than smaller
deposits. In the sample group of banks as a whole, reductions in the balances of
accounts of $25,000 and over accounted for 43 percent of the total decrease in
demand deposits, although demand deposits of this size accounted for only 28
percent of the total demand deposits on the date from which decreases were measured. Accounts of this size were reduced 64 percent, as contrasted with a reduction of 40 percent in total demand deposits, and a reduction of 6 percent of the
balances of accounts of less than $500.
4. The most important factor in explaining differences in the variability of
demand deposit balances in time of stress is apparently the size of the balance.
The influence of other factors, such as type of deposit (demand or time), residence
of holder (local or nonlocal), or type of holder (business or personal), seems to be of
comparatively minor importance. 18

There appears to be no reason to believe that similar withdrawals of
large deposits in excess of the $5,000 formal limit may not occur in
future disturbed periods in the absence of clear assurances that they
will be covered by insurance. Although 96 percent of all deposit
accounts are fully covered within the $5,000 limit, about 54 percent
of the total volume of deposits would remain uncovered if the $5,000
maximum were actually adhered to.
We recommend that Congress, while considering questions relating
to the base and rate for insurance premiums, study throughly the
advantages and disadvantages of increasing the coverage of deposit
insurance for the primary purpose of preventing cash withdrawals
from the banking system during any future depression periods that
may occur, and that no change be made in deposit insurance premiums
until after the study is completed.
I X . OTHER FEDERAL CREDIT AGENCIES

1. We recommend that Congress review the programs and policies oj
ihe various Federal credit agencies to jind out to what extent if at all they
can be madett>contribute more to the purposes oj the Employment Act
without an undue sacrifice oj the substantive programs to which they are
related.
Quoted from the March 1939 Fedenfl Reserve Bulletin by the Chairman of the F D I O hi a statement to
the subcommittee. Monetary, Credit, and Fiscal Policies, pp. 208-209.

MONETARY, CREDIT,'.AND FISCAL'POLICIES

2. We recommend that the head official oj each of the most important
agencies in this group be included on the National Monetary and Credit
Council, which we recommend elsewhere in this report.
As indicated earlier, many federally sponsored credit agencies lend
and insure loans to private borrowers. (See Table I, pp. 7 and 8.)
These include numerous agricultural and housing credit agencies, the
Reconstruction Finance Corporation, the Veterans' Administration,
the Federal Reserve banks, the Export-Import Bank, the Economic
Cooperation Administration, and a few others. In the aggregate,
the loans and guaranties of these agencies are very large. According
to an estimate of the Bureau of the Budget, the following situation
prevailed on June 30, 1949:
Status of major Federal loan, loan guarantee, and loan insurance programs, June SO,
1949
[In millions of dollars)

Loans:

Outstanding
Commitments to lend
Total

Guaranties and insurance:
Outstanding.
Commitments

;

9, 053
2, 192
11,245
12,582
2, 680

Total

15,262

Grand t o t a l . .

26,507

Outstanding loans and loan guaranties amounted to $21,634,000,000
and commitments to lend or guarantee loans amounted to another
$4,872,000,000, for a grand total of $26,507,000,000. Those agencies
with a stated limit on their activities still had $8,808,000,000 of
uncommitted authority to lend or guarantee loans. Between June
30 and the end of October Congress enlarged this commitment
authority by $3,876,000,000, and the President may at his discretion
add still another $2,000,000,000.
In view of the magnitude of their operations, it is clear that these
agencies exert a strong influence on the behavior of the economy, and
that this influence can be toward either stability or instability. By
lending and guaranteeing loans on liberal terms during depressed
periods and by following more restrictive policies in periods of high
employment they, can be an influence toward general economic
stability and can assist flexible monetary and fiscal policies. But by
following quite liberal policies at all times they may actually contribute
to instability and at least partially defeat appropriate monetary and
fiscal policies.
We recommend that Congress review the programs and policies of
the various Federal credit agencies to find out to what extent if at
all they can be made to contribute more to the purpose of the Employment Act without an undue sacrifice of the substantive programs
to which they are related. We also recommend that the head official
of each of the most important agencies in this group be included oh
the National Monetary and Credit Council, which we recommend
elsewhere in this report.

MONETARY, CREDIT,'.AND
X.

FISCAL'POLICIES

A NATIONAL MONETARY AND CREDIT COUNCIL 1 ®

We recommend the creation of a National Monetary and Credit
Council which would include the Secretary of the Treasury, the Chairman of the Board of Governors of the Federal Reserve System, the Comptroller of the Currency, the Chairman of the Federal Deposit Insurance
Corporation, and the heads of the other principal Federal agencies that
lend and guarantee loans. This Council should be established by legislative action, should be required to make periodic reports to Congressf,
and should be headed by the Chairman of the Council of Economic
Advisers. Its purpose should be purely consultative and advisory and
it should not have directive power over its members.
The National Advisory Council on International Monetary and
Financial Problems has performed a useful function relative to foreign lending. We believe that a similar Council to deal with domestic
monetary, credit, and debt management problems would also serve
a useful purpose. It could keep each of the various agencies informed
as to the problems and policies of the others, it could provide a forum
for the discussion of common problems, it could solve some disagreements by negotiation and serve as a means of bringing others to the
attention of the President, and it could call the attention of Congress
to the types of legislation needed in order to secure more appropriate
and better coordinated policies.
There are two principal reasons for recommending that the Monetary and Credit Council should be headed by the Chairman of the
Council of Economic Advisers. The first is that the head of such a
Monetary and Credit Council should be free from any bias that might
go with being head of an agency which is charged with the primary
responsibility for administering a substantive program as are, for example, the Treasury, the Federal Reserve, and the housing finance
agencies. The second is that this function is in line with the primary
function of the Council of Economic Advisers as economic adviser to
the President. The over-all view possessed by the Chairman of the
Council of Economic Advisers, his knowledge of the Government's entire economic program, and his study of all the principal monetary and
credit policies should make him an effective head of tho Monetary and
.Credit Council, just as his work in the latter capacity should assist the
work of the Council of Economic Advisers and enable him to take
promptly to the President any problems that merited his attention.
X I . A COMPREHENSIVE STUDY OF M O N E Y AND CREDIT

1. We recommend that the Joint Committee on the Economic Report,
as well as the Banking and Currency Committees of the Senate and of the
House of Representatives, continue a thorough and complete study of the
monetary arid credit systems and policies of the United States, ana that
they be provided with funds adequate for the purpose.
I. We recommend that S. 1559, which would provide for the establishment of a National Monetary Commission, be not enacted.
This subcommittee believes that its study of monetaxy, credit, and
fiscal policies has been thorough and complete enough to justify the
recommendations made in this report. There are, however, a large
For the further views of Mr. Wolcott, see footnote 3, p. 4.

49 MONETARY, CREDIT,'.AND FISCAL'POLICIES

number of important subjects in these general fields which lack of time
and resources prevented us from studying thoroughly but which merit
further investigation. We therefore recommend that the Banking and
Currency Committees of the two Houses of Congress and the Joint
Committee on the Economic Report be given adequate funds for the
purpose and that they be requested to make a comprehensive study of
the monetary and credit systems and policies of the United States.
We believe it important that the study be made by a committee
composed exclusively of Members of Congress rather than, as proposed in S. 1559, by a mixed commission composed of Members
of Congress, members of the executive department, and members
drawn from private life. The study should draw upon the information, judgment, and points of view of people both within and
outside the Government. For this purpose the investigating committee should engage experts to make thorough studies and reports
on various phases of the problem, and it should invite presentations from all who can be helpful. But the committee that receives the
information, weighs it, forms judgments about it, and submits reports
concerning it to Congress should be composed exclusively of Members
of Congress, for only in this way can the study contribute a maximum
to congressional understanding of all these complex problems and to
the quality of the resulting legislation. Congress should not abandon
its function of legislation, and to legislate wisely it must fully understand the reasons for its legislation. It should not be put in a position
of accepting on faith the recommendations made by private citizens
without knowing thoroughly the facts and reasoning that led to those
recommendations. There is no substitute for thorough congressional
investigation and hearings.
An illustrative but by no means complete list of the topics that
should be studied by these committees would include:
1. The proper role of the Federal Government in chartering, supervising, and examining commercial banks, and the appropriateness and
organization, laws, and policies for these
inking facilities in the various geographic
areas of the country and the appropriate means of remedying any
inadequacies that are found to exist. As a result of suspensions,
mergers, and consolidations prior to 1934 and of continued mergers
and consolidations since that time, many towns and cities and even
some counties are now without banking facilities. This situtation
should be studied to see whether or not it has harmful results, and
what, if anything, can and should be done about it.
3. Federal and State laws, regulations, and policies relative to
branch, chain, and group banking.
4. The appropriate role of Federal agencies that lend and guarantee
loans to private borrowers, and the changes in their structures and
policies that might make them conform more closely to that role.
This should include an investigation of the specific respects in which
the private credit system fails to meet all the legitimate needs of
private borrowers, as well as a study of the feasibility of altering the
structure, powers, and policies of the private credit system in such a
way as to reduce, or perhaps even to eliminate, the need for some of
these Federal agencies.

MONETARY, CREDIT,'.AND FISCAL'POLICIES

5. The requirements for membership in the Federal Reserve System.
6. The location of authority within the Federal Reserve System
and the composition and methods of selection of the System's governing authorities.
7. The appropriate role of consumer credit regulation and other
selective credit controls in a stabilization program.
8. The need for more effective Government supervision over speculative trading on the commodity exchanges.
9. The appropriateness and adequacy of the monetary and credit
control powers in the hands of the Federal Reserve and the Treasury,
the division of these powers between the two agencies, and the coordination of their policies.
10. The conditions and limitations that should apply to purchases
and sales of United States Government securities by the banking
system, including the feasibility and desirability of "sterilizing" or
"freezing" a part of the public debt as a means of regulating its
monetization, together with any other suggestions which might be
made in connection with the relationship of the debt and the money
supply.
11. The appropriateness of the present reserve requirements applicable to Federal Reserve banks.
X I I . A CONTINUING STUDY OF FISCAL POLICY BY THE JOINT
COMMITTEE ON THE ECONOMIC REPORT

We recommend that the joint committee, while carrying out its general
duties "to make a continuing study oj matters relating to the economic
report" and "to study means of coordinating programs in order to further
the policy of the [Employment] Act" make a special intensive study of
the various possible methods of increasing the flexibility of Federal tax
and expenditure policies in order to discover how and to what extent it may
be feasible to make these instruments 'more effective for stabilization
purposes.
The serious limitations on the flexibility of both Federal revenue
and Federal expenditure policies under existing procedures and the
resulting limitations on the effectiveness of fiscal policy for stabilization purposes were noted earlier in this report. (See II above.)
There have been many proposals for improving this situation, and the
joint committee has already called some of them, notably the desirability of flexibility in the timing of public housing and in grants-in-aid
to State and local governments, to the attention of Congress. We
believe that the joint committee can perform a useful function by
making a special study of the various proposals for improving the
flexibility of both revenue and expenditure policies to see which of
them, if any, would be both useful and consistent with our democratic
processes.

MONETARY, CREDIT,'.AND

FISCAL'POLICIES

X I I I . E A R N I N G S OF THE FEDERAL RESERVE IN EXCESS OF D I V I D E N D
REQUIREMENTS

We recommend that Congress enact a franchise tax on the net earnings
oj the Federal Reserve System to replace the voluntary contributions now
being made to the Treasury by the Board oj Governors. In view oj
recommendation / / / , 2, any jranchise tax must take into account the
necessity jor an ample reserve jor losses in open market operations as
compared with the present situation in which earnings are automatic.
Signed:
PAUL H . DOUGLAS, Chairman.

RALPH E . FLANDERS.
WRIGHT PATMAN.
FRANK BUCHANAN.
JESSE P . WOLCOTT.
O

Full text of Monetary, Credit, and Fiscal Policies : Report of the Subcommittee on Monetary, Credit, and Fiscal Policies of the Joint Committee on the Economic Report, Congress of the United States, Pursuant to S. Con. Res. 26.

FRASER